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

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and the notes relating thereto included herein. When necessary, reclassifications have been made to prior period’s data for purposes of comparability with current period presentation without impacting earnings.

Overview

Unity Bancorp, Inc. (the “Parent Company”) is a bank holding company incorporated in New Jersey and 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. The Bank provides a full range of commercial and retail banking services through the Internet and its sixteen branch offices located in Hunterdon, Middlesex, Somerset, Union and Warren counties in New Jersey and Northampton County in Pennsylvania. These services include the acceptance of demand, savings and time deposits and the extension of consumer, real estate, Small Business Administration (“SBA”) and other commercial credits.

Results of Operations

Net Income available to common share holders for the year ended December 31, 2010 was $720 thousand compared to a loss of $2.6 million in 2009.  The increase was attributable to an increase in net interest income, an increase in noninterest income and continued expense management.  During 2010, we have seen signs of economic recovery albeit at a moderate pace.  However there continues to be stress on the financial industry in terms of asset quality and loan demand.  Credit quality continues to remain a primary focus as delinquencies are inflated throughout the industry.  Due to this, in 2010 the Company intentionally decreased the size of the balance sheet and loan portfolio tfocus on improving credit quality and capital management.

Despite these economic conditions and the impact that the recession has had on our borrowers, we are pleased to report improvements in our financial performance as noted below.

·   Continued growth in net interest income,

·   The net interest margin expanded 45 basis points to 3.67 percent,

·   Noninterest income, excluding the effect of OTTI charges and security gains, increased 27.9 percent due to record gains on mortgage loan sales,

·   Nonperforming assets declined $3 million to $24 million from $27 million at year-end 2009,

·   The mix of our deposits improved, and

·   The Company remained well capitalized.

Items which materially impacted earnings for the year included:

·   A $7.3 million provision for loan losses due to the increased level of charge offs  and the inherent credit risk within the loan portfolio, and

·   A $1.1 million increase in expenses on other real estate owned (“OREO”)

The Company’s performance ratios are listed below:

		2010			2009
Net income (loss) per common share - Basic (1)	$	0.10		$	(0.36	)
Net income (loss) per common share - Diluted (1)	$	0.10		$	(0.36	)
Return (loss) on average assets		0.26	%		(0.12	)%
Return (loss) on average equity (2)		1.43	%		(5.29	)%
Efficiency ratio		71.43	%		75.49	%

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).

Net Interest Income

The primary source of income for the Company is net interest income, the difference between the interest earned on earning assets such as investments and loans, and the interest paid on deposits and borrowings.  Factors that impact the Company’s net interest income include the interest rate environment, the volume and mix of interest-earning assets and interest-bearing liabilities, and the competitive nature of the Company’s marketplace.

In 2008 the Federal Open Market Committee lowered interest rates 400 basis points in an attempt to stimulate economic activity.  By year-end 2008, the Fed Funds target rate had fallen to 0.25 percent and the Prime rate to 3.25 percent.  Interest rates continue to remain stable at this low level.  Consequently, the Company realized lower yields on earning assets and lower funding costs.

During 2010, tax-equivalent interest income decreased $5.4 million or 10.9 percent to $44.1 million.  This decrease was driven by the lower average yield on earning assets and a decrease in the average volume of earning assets:

·   Of the $5.4 million decrease in interest income on a tax-equivalent basis, $2.5 million was attributed to reduced yields on interest-earning assets, and $2.9 million was due to the decrease in average interest-earning assets.

·   The average volume of interest-earning assets decreased $45.9 million to $821.0 million in 2010 compared to $866.9 million in 2009. This was due primarily to a $25.3 million decrease in average investment securities and a $28.3 million decrease in average loans, partially offset by an $8.2 million increase in federal funds sold and interest-bearing deposits.

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 ·   The yield on interest-earning assets decreased 33 basis points to 5.38 percent in 2010 due to the continued re-pricing in an overall lower interest rate environment.  Yields on most earning assets, particularly those with variable rates, fell due to these lower market rates.  There was a slight increase in the yield on residential mortgage loans.

 Total interest expense was $14.0 million in 2010, a decrease of $7.5 million or 35.0 percent compared to 2009.  This decrease was driven by the lower overall interest rate environment combined with the shift in deposit mix away from higher priced products and a decrease in the average volume of interest-bearing liabilities:

·   Of the $7.5 million decrease in interest expense in 2010, $4.3 million was attributed to a decrease in the rates paid on interest-bearing liabilities, and $3.3 million was due to the decrease in the volume of average interest-bearing liabilities.

·   Interest-bearing liabilities averaged $707.8 million in 2010, a decrease of $49.6 million, or 6.5 percent, compared to 2009.  The decrease in interest-bearing liabilities was a result of decreases in average time deposits and borrowed funds, partially offset by increases in all other deposit categories.

·   The average cost of interest-bearing liabilities decreased 87 basis points to 1.97 percent, primarily due to the repricing of deposits in a lower interest rate environment.  This was partially offset by an increase in the cost of borrowings due to the use of low cost overnight lines of credit and a low rate repurchase agreement in 2009 and not in 2010.  The cost of interest-bearing deposits decreased 105 basis.

·   The lower cost of funding was also attributed to a shift in the mix of deposits from higher cost time deposits to lower cost savings deposits and demand deposits.

Tax-equivalent net interest income amounted to $30.1 million in 2010, an increase of $2.1 million, or 7.7 percent, compared to 2009. Net interest margin increased 45 basis points to 3.67 percent for 2010, compared to 3.22 percent in 2009.  The net interest spread was 3.41 percent, a 54 basis point increase from 2.87 percent in 2009.

The table on pages 8 and 9 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 (which is the average yield on interest-earning assets less the average rate on interest-bearing liabilities), 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.

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Consolidated Average Balance Sheets

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

For the years ended December 31,

	2010									2009
	Average						Rate/			Average						Rate/
	Balance			Interest			Yield			Balance			Interest			Yield
ASSETS
Interest-earning assets:
Federal funds sold and interest-bearing deposits	$	35,349		$	87			0.25	%	$	27,163		$	117			0.43	%
Federal Home Loan Bank stock		4,646			235			5.06			5,061			277			5.47
Securities:
Available for sale		118,984			4,353			3.66			135,537			6,189			4.57
Held to maturity		23,496			1,149			4.89			32,292			1,593			4.93
Total securities (A)		142,480			5,502			3.86			167,829			7,782			4.64
Loans, net of unearned discount:
SBA		95,353			5,264			5.52			103,031			6,246			6.06
SBA 504		66,767			4,305			6.45			73,517			4,821			6.56
Commercial		285,771			18,130			6.34			301,340			19,881			6.60
Residential mortgage		132,414			7,684			5.80			126,474			7,252			5.73
Consumer		58,200			2,926			5.03			62,481			3,160			5.06
Total loans (A),(B)		638,505			38,309			6.00			666,843			41,360			6.20
Total interest-earning assets	$	820,980		$	44,133			5.38	%	$	866,896		$	49,536			5.71	%
Noninterest-earning assets:
Cash and due from banks		20,672									18,948
Allowance for loan losses		(14,667	)								(11,721	)
Other assets		41,817									33,913
Total noninterest-earning assets		47,822									41,140
Total Assets	$	868,802								$	908,036
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing liabilities:
Interest-bearing demand deposits	$	100,729		$	737			0.73	%	$	89,500		$	1,063			1.19	%
Savings deposits		289,156			2,829			0.98			214,274			3,574			1.67
Time deposits		216,488			6,173			2.85			341,233			12,523			3.67
Total interest-bearing deposits		606,373			9,739			1.61			645,007			17,160			2.66
Borrowed funds and subordinated debentures		101,449			4,296			4.18			112,403			4,422			3.88
Total interest-bearing liabilities	$	707,822		$	14,035			1.97	%	$	757,410		$	21,582			2.84	%
Noninterest-bearing liabilities:
Demand deposits		87,684									79,252
Other liabilities		4,174									4,313
Total noninterest-bearing liabilities		91,858									83,565
Shareholders’ equity		69,122									67,061
Total Liabilities and Shareholders’ Equity	$	868,802								$	908,036
Net interest spread				$	30,098			3.41	%				$	27,954			2.87	%
Tax-equivalent basis adjustment					(98	)								(126	)
Net interest income				$	30,000								$	27,828
Net interest margin								3.67	%								3.22	%

A)   Yields related to securities and loans 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 tax 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.

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2008									2007									2006
Average Balance			Interest			Rate/ Yield			Average Balance			Interest			Rate/ Yield			Average Balance			Interest			Rate/ Yield
$	26,686		$	471			1.76	%	$	22,290		$	1,068			4.79	%	$	21,606		$	1,042			4.82	%
	4,353			240			5.51			3,336			258			7.73			2,340			139			5.94
	74,243			3,761			5.07			65,853			3,253			4.94			64,134			2,964			4.62
	31,710			1,654			5.22			37,724			1,986			5.26			41,156			2,069			5.03
	105,953			5,415			5.11			103,577			5,239			5.06			105,290			5,033			4.78
	101,430			8,370			8.25			84,185			9,039			10.74			84,113			8,615			10.24
	74,617			5,572			7.47			66,393			5,345			8.05			54,462			4,514			8.29
	308,751			21,424			6.94			275,448			20,393			7.40			240,311			17,400			7.24
	100,110			5,971			5.96			68,443			3,995			5.84			59,933			3,305			5.51
	59,291			3,462			5.84			54,789			3,722			6.79			47,652			3,208			6.73
	644,199			44,799			6.95			549,258			42,494			7.74			486,471			37,042			7.61
$	781,191		$	50,925			6.52	%	$	678,461		$	49,059			7.23	%	$	615,707		$	43,256			7.02	%
	17,529									13,467									12,439
	(9,179	)								(8,184	)								(7,493	)
	31,667									29,304									29,302
	40,017									34,587									34,248
$	821,208								$	713,048								$	649,955
$	84,336		$	1,468			1.74	%	$	85,750		$	1,928			2.25	%	$	117,730		$	2,648			2.25	%
	168,784			3,644			2.16			204,214			8,064			3.95			183,815			6,948			3.78
	330,174			13,836			4.19			213,407			10,206			4.78			169,572			7,101			4.19
	583,294			18,948			3.25			503,371			20,198			4.01			471,117			16,697			3.54
	108,214			4,526			4.18			84,962			4,276			5.03			55,756			2,735			4.91
$	691,508		$	23,474			3.39	%	$	588,333		$	24,474			4.16	%	$	526,873		$	19,432			3.69	%
	78,282									75,581									77,747
	2,531									2,416									2,218
	80,813									77,997									79,965
	48,887									46,718									43,117
$	821,208								$	713,048								$	649,955
			$	27,451			3.13	%				$	24,585			3.07	%				$	23,824			3.33	%
				(160	)								(159	)								(79	)
			$	27,291								$	24,426								$	23,745
							3.51	%								3.62	%								3.87	%

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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 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.

	2010 versus 2009									2009 versus 2008
Year ended December 31,	Increase (Decrease) Due to change in									Increase (Decrease) Due to change in
(In thousands on a tax-equivalent basis)	Volume			Rate			Net			Volume		Rate			Net
Interest Income:
Federal funds sold and interest-bearing deposits	$	28		$	(58	)	$	(30	)	$	8	$	(362	)	$	(354	)
Federal Home Loan Bank stock		(22	)		(20	)		(42	)		39		(2	)		37
Investment securities		(1,129	)		(1,151	)		(2,280	)		2,862		(495	)		2,367
Net loans		(1,750	)		(1,301	)		(3,051	)		1,242		(4,681	)		(3,439	)
Total interest income	$	(2,873	)	$	(2,530	)	$	(5,403	)	$	4,151	$	(5,540	)	$	(1,389	)
Interest Expense:
Interest-bearing demand deposits	$	122		$	(448	)	$	(326	)	$	85	$	(490	)	$	(405	)
Savings deposits		1,014			(1,759	)		(745	)		861		(931	)		(70	)
Time deposits		(3,941	)		(2,409	)		(6,350	)		451		(1,764	)		(1,313	)
Total deposits	$	(2,805	)	$	(4,616	)	$	(7,421	)	$	1,397	$	(3,185	)	$	(1,788	)
Borrowed funds and subordinated debentures		(452	)		326			(126	)		192		(296	)		(104	)
Total interest expense	$	(3,257	)	$	(4,290	)	$	(7,547	)	$	1,589	$	(3,481	)	$	(1,892	)
Net interest income – fully tax-equivalent	$	384		$	1,760		$	2,144		$	2,562	$	(2,059	)	$	503
Decrease (increase) in tax-equivalent adjustment								28								34
Net interest income							$	2,172							$	537

Provision for Loan Losses

The provision for loan losses totaled $7.3 million for 2010, a decrease of $750 thousand compared to $8.0 million for 2009.  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 caption, “Financial Condition - Allowance for Loan Losses and Unfunded Loan Commitments.” The current provision is considered appropriate under management’s assessment of the adequacy of the allowance for loan losses.

Noninterest Income

Noninterest income was $5.1 million for 2010, a $2.9 million increase compared to $2.1 million for 2009.  The increase is primarily due to other-than-temporary impairment (“OTTI”) charges recorded during 2009, compared to no OTTI charges during 2010 and to higher gains on the sale of residential mortgage loans.  Excluding OTTI, noninterest income would have increased $318 thousand.  The following table shows the components of noninterest income for 2010 and 2009:

(In thousands)	2010		2009
Branch fee income	$	1,424	$	1,418
Service and loan fee income		979		1,214
Gain on sale of SBA loans held for sale, net		500		393
Gain on sale of mortgage loans		1,052		217
Bank owned life insurance		310		222
Other-than-temporary impairment charges on securities		-		(2,611	)
Net security gains		85		855
Other income		719		432
Total noninterest income	$	5,069	$	2,140

Changes in our noninterest income reflect:

·   Branch fee income was relatively flat for 2010 when compared to 2009.

·   Service and loan fee income decreased $235 thousand, primarily as a result of lower levels of prepayment fees.

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·   Net gains on SBA loan sales amounted to $500 thousand on $4.8 million in sales.

·   Gains on the sale of mortgage loans increased $835 thousand due to a higher volume of loans sold. Sales of mortgage loans totaled $54.3 million and $17.7 million for 2010 and 2009, respectively.

·   In December 2004, the Company purchased $5.0 million of bank owned life insurance (“BOLI”).  An additional $2.5 million was purchased in January 2010 to help offset the rising costs of employee benefits.  The increase in the cash surrender value of BOLI was $310 thousand for 2010, compared to $222 thousand in 2009.

·   No OTTI charges on securities were recorded in 2010. During 2009, the Company recognized $2.6 million of credit related other-than-temporary impairment losses on two held to maturity securities due to the deterioration in the underlying collateral. These two pooled trust preferred securities, which had a cost basis of $3.0 million, had been previously written down $306 thousand in December of 2008.  The remaining book value of the trust preferred securities is approximately $50 thousand as of December 31, 2010.  

·   The Company realized net security gains of $85 thousand on the sale of securities in 2010 compared to $855 thousand in 2009.  The gross gains during 2010 are primarily attributed to the Company selling approximately $11.0 million in book value of mortgage-backed securities, resulting in pretax gains of approximately $329 thousand, five called structured agency securities with resulting gains of $8 thousand, and one called held to maturity municipal security with a resulting gain of $4 thousand.  These gains were partially offset by losses of $166 thousand on the sale of approximately $3.5 million in book value of three mortgage-backed securities and losses of $90 thousand on the sale of five held to maturity tax-exempt municipal securities with a total book value of approximately $2.0 million.  Although designated as held to maturity, these municipal securities were sold due to deterioration in the issuer’s creditworthiness, as evidenced by downgrades in their credit ratings.  The gross gains of $855 thousand in 2009 are primarily attributed to the Company selling approximately $31.5 million in book value of mortgage-backed securities, resulting in pretax gains of approximately $827 thousand on the sales.  The Company also sold its remaining callable Freddie Mac perpetual preferred securities resulting in pretax gains of $28 thousand. There were no realized losses in 2009.

·   Other income totaled $719 thousand and $432 thousand in 2010 and 2009, respectively.  The increase is primarily due to a refund of New Jersey state sales tax for overpayment in previous years received during the second quarter of 2010.

Noninterest Expense

Total noninterest expense was $25.0 million for 2010, an increase of $1.0 million or 4.4 percent over 2009. The following table presents a breakdown of noninterest expense for the years ended December 31, 2010 and 2009:

(In thousands)	2010		2009
Compensation and benefits	$	11,875	$	11,243
Occupancy		2,522		2,552
Processing and communications		2,139		2,077
Furniture and equipment		1,755		1,829
Professional services		737		1,042
Loan collection costs		964		1,023
OREO expense		1,316		220
Deposit insurance		1,301		1,707
Advertising		624		530
Other expenses		1,757		1,724
Total noninterest expense	$	24,990	$	23,947

Changes in noninterest expense reflect:

·   Compensation and benefits expense, the largest component of noninterest expense, increased $632 thousand or 5.6 percent.  This increase is attributable to an increase in compensation, higher employee medical benefits costs, and increased residential mortgage commissions due to higher sales volumes, partially offset by lower incentive bonus payouts.  At December 31, 2010 and 2009 there were 172 and 165 full-time equivalent employees, respectively.

·   Occupancy expense declined $30 thousand or 1.2 percent due primarily to the renegotiation of the lease on the Company’s corporate headquarters and a decline in depreciation expenses on capital expenditures, partially offset by an increase in seasonal snow removal costs, property taxes, and janitorial expenses.

·   Processing and communications expenses increased $62 thousand or 3.0 percent.  This increase was primarily the result of increased data processing line costs and cell phone expenses.

·   Furniture and equipment expense decreased $74 thousand or 4.0 percent due to lower depreciation expense as capital expenditures declined, as well as lower maintenance costs on equipment.

·   Professional service fees decreased $305 thousand or 29.3 percent in 2010 due to lower audit, legal and loan review fees.

·   Loan collection costs decreased $59 thousand or 5.8 percent due to decreased collections costs on a lower level of past due loans.

·   OREO expenses increased $1.1 million due to increased maintenance and valuation related expenses on OREO properties.

·   Deposit insurance expense decreased $406 thousand in 2010 due primarily to the $408 thousand special assessment in the second quarter of 2009, while there was no comparable charge in 2010.

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·   Advertising expense increased $94 thousand or 17.7 percent in 2010, which reflects the Company’s sales initiatives and brand recognition efforts.

·   Other expenses increased $33 thousand or 1.9 percent compared to the prior year.  This increase was due primarily to uninsured losses.

Income Tax Expense

For 2010, the Company reported income tax expense of $589 thousand for a 20.8 percent effective tax rate compared to an income tax benefit of $898 thousand or a 45.4 percent effective tax rate in 2009.  The benefit in 2009 was due to a net loss.  The Company anticipates a higher effective tax rate in 2011.

Financial Condition

Total assets decreased $111.9 million or 12.0 percent, to $818.4 million at December 31, 2010, compared to $930.4 million at December 31, 2009. This decrease was due to a $41.1 million decrease in total loans, a $40.8 million decrease in total securities, and a $29.7 million decrease in cash and cash equivalents, while total deposits decreased $103.5 million and total borrowed funds and subordinated debentures declined $10.0 million.  Total shareholders’ equity increased $2.2 million from the prior year. Average total assets for 2010 were $868.8 million, a $39.2 million decrease from the prior year’s $908.0 million average balance. Further discussion of these fluctuations is discussed in the sections that follow.

Investment 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 U.S. Government sponsored entities, obligations of state and political subdivisions, mortgage-backed securities, trust preferred securities and equity securities.

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 U.S. Government sponsored entities, obligations of state and political subdivisions, mortgage-backed securities and trust preferred securities.

AFS securities totaled $107.1 million at December 31, 2010, a decrease of $33.6 million or 23.9 percent, compared to $140.8 million at December 31, 2009.  This net decrease was the result of the following:

·   $65.9 million in principal payments, maturities and called bonds,

·   $14.3 million in sales net of realized gains, which consisted primarily of mortgage-backed securities and collateralized mortgage obligations (“CMOs”), and

·   $836 thousand in net amortization of premiums, partially offset by

·   $46.7 million in purchases, which consisted of $24.4 million of mortgage-backed securities and CMOs, $13.0 million of U.S. Government sponsored entities, $8.3 million state and political subdivision bonds, and $1.0 million of Community Reinvestment Act (“CRA”) investments, and

·   $705 thousand appreciation in the fair value of the portfolio.  At December 31, 2010, the portfolio had a net unrealized gain of $697 thousand compared to a net unrealized loss of $8 thousand at the end of the prior year. These unrealized gains (losses) are reflected net of tax in shareholders’ equity as accumulated other comprehensive income (loss).

The average balance of securities available for sale amounted to $119.0 million in 2010 compared to $135.5 million in 2009. The average yield earned on the available for sale portfolio decreased 91 basis points, to 3.66 percent in 2010 from 4.57 percent in 2009. The weighted average repricing of securities available for sale, adjusted for prepayments, amounted to 2.5 years at December 31, 2010 and 2009.

At December 31, 2010, the Company’s available for sale portfolio included one bank trust preferred security with a book value of $977 thousand and a fair value of $565 thousand. The Company monitors the credit worthiness of the issuer of this security quarterly. At December 31, 2010, the Company had not taken any OTTI credit loss adjustments on this security. Management will continue to monitor the performance of the security and the underlying institution for impairment.

HTM securities were $21.1 million at December 31, 2010, a decrease of $7.1 million or 25.3 percent, from year-end 2009.  This net decrease was the result of:

·   $8.9 million in principal payments, maturities and called bonds,

·   $2.0 million in sales net of realized losses, which consisted primarily of state and political subdivision bonds which were downgraded, and

·   $45 thousand in net amortization of premiums, partially offset by

·   $3.8 million in purchases of mortgage-backed securities and obligations of state and political subdivisions.

As of December 31, 2010 and 2009, the fair value of held to maturity securities was $21.4 million and $28.4 million, respectively. The average balance of securities held to maturity amounted to $23.5 million in 2010 compared to $32.3 million in 2009. The average yield earned on held to maturity securities decreased 4 basis points, from 4.93 percent in 2009 to 4.89 percent in 2010. The weighted average repricing of held to maturity securities, adjusted for prepay-

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Annual Report Page Number 12

ments, amounted to 3.5 years and 2.7 years at December 31, 2010 and December 31, 2009, respectively.

During 2009, the Company recognized $2.6 million of credit related other-than-temporary impairment losses on two held to maturity securities due to the deterioration in the underlying collateral. These two securities were transferred from the AFS portfolio to the HTM portfolio during 2008 at fair value with the adjustment being posted to other comprehensive income in shareholders’ equity.  Consequently, the $2.6 million OTTI charge resulted in a $1.5 million net decrease to HTM securities and a $1.1 million increase to other comprehensive income in shareholders’ equity. These two pooled trust preferred securities, which had a cost basis of $3.0 million, had been previously written down by $306 thousand in December of 2008.  The remaining book value of the trust preferred securities was approximately $50 thousand at December 31, 2010.

Securities with a carrying value of $63.4 million and $71.4 million at December 31, 2010 and 2009, respectively, were pledged to secure Government deposits, secure other borrowings and for other purposes required or permitted by law.

Approximately 84 percent of the total investment portfolio had a fixed rate of interest at December 31, 2010.

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. Different segments of the loan portfolio are subject to differing levels of credit and interest rate risk.

Total loans decreased $41.1 million or 6.3 percent to $615.9 million at December 31, 2010, compared to $657.0 million at year-end 2009. The declines occurred in all loan types, are a direct result of the economic downturn, low consumer and business confidence levels, and reflect the impact of loan sales and reduced loan demand.  Creditworthy borrowers are cutting back on capital expenditures or postponing their purchases in hopes that the economy will improve.  In general, banks are lending less because consumers and businesses are demanding less credit.

The following table sets forth the classification of loans by major category, including unearned fees, deferred costs and excluding the allowance for loan losses for the past five years at December 31:

	2010					2009					2008					2007					2006
(In thousands)	Amount		% of Total			Amount		% of Total			Amount		% of Total			Amount		% of Total			Amount		% of Total
SBA held for sale	$	10,397		1.7	%	$	21,406		3.3	%	$	22,181		3.2	%	$	24,640		4.2	%	$	12,273		2.4	%
SBA held to maturity		75,741		12.3			77,844		11.8			83,127		12.1			68,875		11.7			66,802		13.2
SBA 504		64,276		10.4			70,683		10.8			76,802		11.2			72,145		12.2			58,067		11.4
Commercial		281,205		45.7			293,739		44.6			308,165		44.9			293,641		49.7			254,128		50.1
Residential mortgage		128,400		20.8			133,059		20.3			133,110		19.5			73,697		12.5			63,493		12.5
Consumer		55,917		9.1			60,285		9.2			62,561		9.1			57,134		9.7			52,927		10.4
Total loans	$	615,936		100.0	%	$	657,016		100.0	%	$	685,946		100.0	%	$	590,132		100.0	%	$	507,690		100.0	%

Average loans decreased $28.3 million or 4.2 percent from $666.8 million in 2009 to $638.5 million in 2010.  The decrease in average loans was due to a decline in all loan products except residential mortgage loans. The yield on the overall loan portfolio fell 20 basis points to 6.00 percent in 2010 compared to 6.20 percent in 2009. This decrease was the result of variable rate, prime-based loan products such as SBA loans and home equity lines of credit repricing lower as market rates remained low in 2010.  The prime rate has remained at 3.25 percent since December 2008.

SBA loans, on which the SBA provides guarantees of up to 90 percent of the principal balance, are considered a higher risk loan product for the Company than its other loan products.  The Company’s SBA loans were historically sold in the secondary market with the nonguaranteed portion held in the portfolio as a loan held for investment.  During the third and fourth quarters of 2008, as a result of the significantly reduced premiums on sale and the ongoing credit crisis, the Company closed all SBA production offices outside of its New Jersey, Pennsylvania and New York primary trade area.  Consequently, the volume of new SBA loans and gains on SBA loans declined in 2010 and 2009.  In addition, new authoritative accounting guidance under FASB ASC Topic 860, “Transfers and Servicing,” requires that the gains on sales of SBA 7(a) loans be deferred for a 90-day period after the sale.

SBA 7(a) loans held for sale, carried at the lower of cost or market, amounted to $10.4 million at December 31, 2010, a decrease of $11.0 million from $21.4 million at December 31, 2009.  SBA 7(a) loans held to maturity amounted to $75.7 million at December 31, 2010, a decrease of $2.1 million from $77.8 million at December 31, 2009. The yield on SBA loans, which are generally floating and adjust quarterly to the Prime rate, was 5.52 percent for 2010, compared to 6.06 percent for the prior year due to the continued low interest rate environment.

At December 31, 2010, SBA 504 loans totaled $64.3 million, a decrease of $6.4 million from $70.7 million at December 31, 2009. 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 loan to value ratio on SBA 504 program loans.  The yield on SBA 504 loans dropped 11 basis points to 6.45 percent for 2010 compared to 6.56 percent for 2009.

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Annual Report Page Number 13

Commercial loans are generally made in the Company’s market place for the purpose of providing working capital, financing the purchase of equipment, inventory or commercial real estate and for other business purposes. These loans amounted to $281.2 million at December 31, 2010, a decrease of $12.5 million from year-end 2009. This decrease can be attributed to principal pay-downs on these loans with minimal new loan volume.  The yield on commercial loans was 6.34 percent for 2010, compared to 6.60 percent for the prior year.

Residential mortgage loans consist of loans secured by 1 to 4 family residential properties. These loans amounted to $128.4 million at December 31, 2010, a decrease of $4.7 million from $133.1 million at year-end 2009. New loan volume during the year was offset by the sale of mortgage loans totaling $54.3 million.  The yield on residential mortgages was 5.80 percent for the year ended December 31, 2010, compared to 5.73 percent for 2009.

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 $55.9 million at December 31, 2010, a decrease of $4.4 million from December 31, 2009.  The yield on consumer loans was 5.03 percent for 2010, compared to 5.06 percent for the prior year.

As of December 31, 2010, approximately 12 percent of the Company’s total loan portfolio consisted of loans to various unrelated and unaffiliated borrowers in the Hotel/Motel industry.  Such loans are collateralized by the underlying real property financed and/or partially guaranteed by the SBA.  There are no other concentrations of loans to any borrowers or group of borrowers exceeding 10 percent of the total loan portfolio. There are 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. However, 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.

The following table shows the maturity distribution or repricing of the loan portfolio and the allocation of floating and fixed interest rates at December 31, 2010:

(In thousands)	Within 1 Year		1-5 Years		After 5 Years		Total
SBA	$	62,733	$	12,712	$	10,693	$	86,138
SBA 504		18,079		40,768		5,429		64,276
Commercial		119,728		137,285		24,192		281,205
Residential mortgage		30,152		55,084		43,164		128,400
Consumer		37,567		11,723		6,627		55,917
Total	$	268,259	$	257,572	$	90,105	$	615,936
Amount of loans with maturities or repricing dates greater than one year:
Fixed interest rates							$	173,867
Floating or adjustable interest rates								173,810
Total							$	347,677

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 have 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 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.

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Annual Report Page Number 14

The following table sets forth information concerning nonperforming loans and nonperforming assets at December 31 for the past five years:

(In thousands)	2010			2009			2008			2007				2006
Nonperforming by category:
SBA (1)	$	8,162		$	6,559		$	4,228		$	2,110		$	5,212
SBA 504		2,714			5,575			4,600			-			-
Commercial		5,452			7,397			5,247			1,630			3,172
Residential mortgage		5,085			5,578			1,808			1,192			322
Consumer		249			387			237			529			203
Total nonperforming loans	$	21,662		$	25,496		$	16,120		$	5,461		$	8,909
OREO		2,346			1,530			710			106			211
Total nonperforming assets	$	24,008		$	27,026		$	16,830		$	5,567		$	9,120
Past due 90 days or more and still accruing interest:
SBA	$	374		$	592		$	332		$	114		$	-
SBA 504		-			-			-			-			-
Commercial		-			469			146			41			-
Residential mortgage		-			1,196			2,058			-			78
Consumer		-			29			-			-			-
Total	$	374		$	2,286		$	2,536		$	155		$	78
Nonperforming loans to total loans		3.52	%		3.88	%		2.35	%		0.93	%		1.75	%
Nonperforming assets to total loans and OREO		3.88			4.10			2.45			0.94			1.80
Nonperforming assets to total assets		2.93			2.90			1.87			0.74			1.31
(1) SBA loans guaranteed	$	2,706		$	1,931		$	1,983		$	714		$	2,953

The current state of the economy largely impacts the Company’s level of delinquent and nonperforming loans.  The recession that began in 2008 continues to put a strain on the Company’s borrowers and their ability to pay their loan obligations.  Unemployment rates are at the highest level in 25 years and businesses are reluctant to hire.  Unemployment and flat wages have caused consumer spending and demand for goods to decline, impacting the profitability of small businesses.  Consequently, the Company’s nonperforming loans remain at an elevated level.

Nonperforming loans were $21.7 million at December 31, 2010, a $3.8 million decrease from $25.5 million at year-end 2009.  Nonperforming loans decreased in all loan categories, except for SBA loans. Included in nonperforming loans at December 31, 2010, are approximately $2.7 million of loans guaranteed by the SBA, compared to $1.9 million at December 31, 2009.  In addition, there were $374 thousand and $2.3 million in loans past due 90 days or more and still accruing interest at December 31, 2010 and December 31, 2009, respectively.

Other real estate owned (“OREO”) properties totaled $2.3 million at December 31, 2010, an increase of $816 thousand from $1.5 million at year-end 2009.  During the year, the Company took title to nineteen properties totaling $9.7 million and sold sixteen properties totaling $8.9 million.  A net loss of $807 thousand was realized on the sales during 2010.

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 $5.5 million at December 31, 2010, an increase of $3.9 million from $1.6 million at December 31, 2009.  The increase is due to the addition of $8.8 million during 2010 which consisted primarily of SBA and commercial loans, partially offset by the removal of $4.9 million during the period.

The Company has defined impaired loans to be all nonperforming loans and 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, such as a below market interest rate, extending the maturity of a loan, or a combination of both.  At December 31, 2010, there were fifteen loans totaling $14.1 million that were classified as TDRs by the Company and are deemed impaired, compared to four loans totaling $6.6 million at December 31, 2009.  TDRs are not included in the nonperforming or potential problem loan figures listed above, as they continue to perform under their modified terms.

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Annual Report Page Number 15

Allowance for Loan Losses and Unfunded Loan Commitments

Management reviews the level of the allowance for loan losses on a quarterly basis.  The methodology used to assess the adequacy of the allowance includes the calculation of specific and general reserves.  Specific reserves are made to impaired loans, which have been defined to include all nonaccrual loans and troubled debt restructurings.  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.

 Beginning in the third quarter of 2009, when calculating the five-year historical net charge-off rate, the Company weights the past three years more heavily due to the higher amount of charge-offs experienced during those years.  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. Once a loss is known to exist, the loss approval process is immediately expedited.

Beginning in 2009, the Company significantly increased its loan loss provisions in response to the inherent credit risk within its loan portfolio and changes to some of the environmental factors noted above.  The inherent credit risk was evidenced by the increase in net charge-offs during the year, as the downturn in the economy impacted borrowers’ abilities to pay and factors, such as a weakened housing market, eroded the value of underlying collateral.

The allowance for loan losses totaled $14.4 million and $13.8 million at December 31, 2010 and December 31, 2009, respectively, with a resulting allowance to total loan ratios of 2.33 percent and 2.11 percent, respectively.  Net charge-offs amounted to $6.7 million in 2010, compared to $4.5 million in 2009.  The increase in net charge-offs was primarily related to the SBA 504 and commercial loan portfolios, most of which are secured by real estate.  Net charge-offs to average loan ratios are shown in the table below for each major loan category.  In 2010, the highest net charge-off ratio can be seen in the Company’s higher risk SBA 504 portfolio.

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The following is a summary of the allowance for loan losses for the past five years:

(In thousands)	2010			2009			2008			2007			2006
Balance, beginning of year	$	13,842		$	10,326		$	8,383		$	7,624		$	6,892
Provision charged to expense		7,250			8,000			4,500			1,550			1,550
Charge-offs:
SBA		1,351			1,874			1,246			770			573
SBA 504		1,548			812			1,000			-			-
Commercial		3,627			1,845			408			155			298
Residential mortgage		500			216			25			-			-
Consumer		245			27			145			50			62
Total charge-offs		7,271			4,774			2,824			975			933
Recoveries:
SBA		243			123			177			147			20
SBA 504		-			27			-			-			-
Commercial		296			134			39			18			75
Residential mortgage		-			-			-			-			-
Consumer		4			6			51			19			20
Total recoveries		543			290			267			184			115
Total net charge-offs	$	6,728		$	4,484		$	2,557		$	791		$	818
Balance, end of year	$	14,364		$	13,842		$	10,326		$	8,383		$	7,624
Selected loan quality ratios:
Net charge-offs to average loans:
SBA		1.16	%		1.70	%		1.05	%		0.74	%		0.66	%
SBA 504		2.32			1.07			1.34			0.00			0.00
Commercial		1.17			0.57			0.12			0.05			0.09
Residential mortgage		0.38			0.17			0.02			0.00			0.00
Consumer		0.41			0.03			0.16			0.06			0.09
Total loans		1.05			0.67			0.40			0.14			0.17
Allowance to total loans		2.33			2.11			1.51			1.42			1.50
Allowance to nonperforming loans		66.31			54.29			64.06			153.49			85.58

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 31st of each year.  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.

	2010					2009					2008					2007					2006
(In thousands)	Amount		% of Total			Amount		% of Total			Amount		% of Total			Amount		% of Total			Amount		% of Total
Balance applicable to:
SBA	$	4,198		14.0	%	$	3,247		15.1	%	$	2,579		15.3	%	$	2,181		15.9	%	$	1,961		15.6	%
SBA 504		1,551		10.4			1,872		10.8			1,065		11.2			902		12.2			726		11.4
Commercial		6,011		45.7			6,013		44.6			4,415		44.9			4,186		49.7			3,728		50.1
Residential mortgage		1,679		20.8			1,615		20.3			1,464		19.5			564		12.5			221		12.5
Consumer		586		9.1			632		9.2			646		9.1			505		9.7			319		10.4
Unallocated		339		-			463		-			157		-			45		-			669		-
Total	$	14,364		100.0	%	$	13,842		100.0	%	$	10,326		100.0	%	$	8,383		100.0	%	$	7,624		100.0	%

In addition to the allowance for loan losses, the Company maintains an allowance for unfunded loan commitments at a level that management believes is adequate to absorb estimated probable losses.  Management determines this amount using estimates of future loan funding and losses related to those credit exposures. Adjustments to the allowance are made through other expense and applied to the allowance which is maintained in other liabilities.  At December 31, 2010, a $66 thousand commitment reserve was reported on the balance sheet as an “other liability” compared to a $76 thousand commitment reserve at December 31, 2009.

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Annual Report Page Number 17

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 are period-end deposit balances for each of the last three years:

At December 31,	2010					2009					2008
(In thousands)	Amount		%			Amount		%			Amount		%
Ending balance:
Noninterest-bearing demand deposits	$	91,272		13.9	%	$	80,100		10.6	%	$	74,090		10.5	%
Interest-bearing demand deposits		105,530		16.1			100,046		13.2			87,046		12.3
Savings deposits		277,394		42.5			286,334		37.7			134,875		19.1
Time deposits		180,592		27.5			291,759		38.5			411,106		58.1
Total deposits	$	654,788		100.0	%	$	758,239		100.0	%	$	707,117		100.0	%

Total deposits decreased $103.5 million to $654.8 million at December 31, 2010, from $758.2 million at December 31, 2009.  The decrease in deposits was the result of a $111.2 million decrease in time deposits and an $8.9 million decrease in savings deposits, partially offset by an $11.2 million increase in noninterest-bearing demand deposits and a $5.5 million increase in interest-bearing demand deposits.  The decline in time deposits was due to the planned run off of a maturing high rate promotion done at the end of 2008 to bolster liquidity.  The increase in noninterest-bearing and interest-bearing demand deposits was a result of new sales initiatives and efforts by branch personnel to bring in deposit relationships.

The mix of deposits shifted to a more favorable mix during 2010 as the concentration of time deposits fell from 38.5 percent of total deposits at December 31, 2009 to 27.5 percent of total deposits at December 31, 2010.  The average cost of interest-bearing deposits in 2010 was 1.61 percent compared to 2.66 percent for 2009.  The decrease in the cost of deposits is attributed to the lower interest rate environment and the favorable shift from higher cost time deposits to demand and savings deposits.

The following are average deposits for each of the last three years:

	2010					2009					2008
(In thousands)	Amount		%			Amount		%			Amount		%
Average balance:
Noninterest-bearing demand deposits	$	87,684		12.6	%	$	79,252		10.9	%	$	78,282		11.8	%
Interest-bearing demand deposits		100,729		14.5			89,500		12.4			84,336		12.7
Savings deposits		289,156		41.7			214,274		29.6			168,784		25.5
Time deposits		216,488		31.2			341,233		47.1			330,174		50.0
Total deposits	$	694,057		100.0	%	$	724,259		100.0	%	$	661,576		100.0	%

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.

As of December 31, 2010, borrowed funds totaled $90.5 million, a decrease of $10.0 million from the prior year-end. This decrease was due to the maturity of a $10.0 million fixed rate FHLB advance in December 2010.

As of December 31, 2010 and 2009, the Company was a party to the following transactions:

(In thousands)	2010		2009
FHLB borrowings:
Fixed rate advances	$	30,000	$	40,000
Repurchase agreements		30,000		30,000
Other repurchase agreements		15,000		15,000
Subordinated debentures		15,465		15,465

At December 31, 2010, the Company had $73.2 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.

For additional information, see Note 10 to the Consolidated Financial Statements.

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Annual Report Page Number 18

Market Risk

Based on the Company’s business, the two largest risks facing the Company are market risk and credit 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 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.  RMC reviews the maturities and repricing of loans, investments, deposits and borrowings, cash flow needs, current market conditions, and interest rate levels.

The Company uses various techniques to evaluate risk levels on both a short and long-term basis.  One of the monitoring tools is the “gap” ratio.  A gap ratio, as a percentage of assets, is calculated to determine the maturity and repricing mismatch between interest rate-sensitive assets and interest rate-sensitive liabilities.  A gap is considered positive when the amount of interest rate-sensitive assets repricing exceeds the amount of interest rate-sensitive liabilities repricing in a designated time period.  A positive gap should result in higher net interest income with rising interest rates, as the amount of the assets repricing exceed the amount of liabilities repricing.  Conversely, a gap is considered negative when the amount of interest rate-sensitive liabilities exceeds interest rate-sensitive assets, and lower rates should result in higher net interest income.

Repricing of mortgage-related securities are shown by contractual amortization and estimated prepayments based on the most recent 3-month constant prepayment rate.  Callable agency securities are shown based upon their option-adjusted spread modified duration date (“OAS”), rather than the next call date or maturity date.  The OAS date considers the coupon on the security, the time to the next call date, the maturity date, market volatility and current rate levels.  Fixed rate loans are allocated based on expected amortization.

The following table sets forth the gap ratio at December 31, 2010.  Assumptions regarding the repricing characteristics of certain assets and liabilities are critical in determining the projected level of rate sensitivity.  Certain savings and interest checking accounts are less sensitive to market interest rate changes than other interest-bearing sources of funds.  Core deposits such as interest-bearing demand, savings and money market deposits are allocated based on their expected repricing in relation to changes in market interest rates.

(In thousands)	Under six months			Six months through one year			More than one year through three years			More than three years through five years			More than five years through ten years			More than ten years and not repricing			Total
Assets
Cash & due from banks	$	-		$	-		$	-		$	-		$	-		$	17,637		$	17,637
Federal funds sold and interest-bearing deposits		26,289			-			-			-			-			-			26,289
Federal Home Loan Bank stock		-			-			-			-			-			4,206			4,206
Securities		28,485			16,999			37,526			14,031			18,189			13,012			128,242
Loans		205,362			62,897			171,664			85,908			47,708			42,397			615,936
Other assets		-			-			-			-			-			26,100			26,100
Total Assets	$	260,136		$	79,896		$	209,190		$	99,939		$	65,897		$	103,352		$	818,410
Liabilities and Shareholders’ Equity
Noninterest-bearing demand deposits	$	-		$	-		$	-		$	-		$	-		$	91,272		$	91,272
Savings and interest-bearing demand deposits		156,307			943			103,784			72,881			49,009			-			382,924
Time deposits		61,296			42,952			65,103			10,935			306			-			180,592
Borrowed funds and subordinated debentures		15,000			-			-			10,000			65,000			465			90,465
Other liabilities		-			-			-			-			-			3,072			3,072
Shareholders’ equity		-			-			-			-			-			70,085			70,085
Total Liabilities and Shareholders’ Equity	$	232,603		$	43,895		$	168,887		$	93,816		$	114,315		$	164,894		$	818,410
Interest Rate Swap	$	15,000		$	(10,000	)	$	(5,000	)	$	-		$	-		$	-		$	-
Gap	$	42,533		$	26,001		$	35,303		$	6,123		$	(48,418	)	$	(61,542	)	$	-
Cumulative Gap	$	42,533		$	68,534		$	103,837		$	109,960		$	61,542		$	-		$	-
Cumulative Gap to Total Assets%		5.2	%		8.4	%		12.7	%		13.4	%		7.5	%		-			-

At December 31, 2010, there was a six-month asset-sensitive gap of $42.5 million and a one-year asset-sensitive gap of $68.5 million, as compared to asset-sensitive gaps of $31.6 million and $38.2 million at December 31, 2009.  The six-month and one-year cumulative gap to total assets ratios were within the Board-approved guidelines of +/- 20 percent.

Other models are also used in conjunction with the static gap table, which is not able to capture the risk of changing spread relationships over time, the effects of projected growth in the balance sheet or dynamic decisions such as the modifica-

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tion of investment maturities as a rate environment unfolds. For these reasons, a simulation model is used, where numerous interest rate scenarios and balance sheets are combined to produce a range of potential income results. Net interest income is managed within guideline ranges for interest rates rising or falling by 200 basis points.  Results outside of guidelines require action by RMC to correct the imbalance. Simulations are typically created over a 12 to 24 month time horizon. At December 31, 2010, these simulations show that with a 200 basis point rate increase over a 12 month period, net interest income would decrease by approximately $140 thousand, or 0.5 percent. A 200 basis point rate decline over a 12 month period would decrease net interest income by approximately $592 thousand or 1.9 percent. These variances in net interest income are within the Board-approved guidelines of +/- 5 percent.

Finally, to measure the impact of longer-term asset and liability mismatches beyond two years, the Company utilizes Modified Duration of Equity and Economic Value of Portfolio Equity (“EVPE”) models.  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.  Like the simulation model, results falling outside prescribed ranges require action by RMC.  The Company’s variance in the economic value of equity with rate shocks of 200 basis points is a decline of 8.46 percent in a rising rate environment and a decline of 9.13 percent in a falling rate environment at December 31, 2010.  At December 31, 2009, the Company’s variance in the economic value of equity with rate shocks of 200 basis points is a decline of 11.99 percent in a rising rate environment and a decline of 11.86 percent in a falling rate environment. The variance in the EVPE at December 31, 2010 and 2009 is within Board-approved guidelines of +/- 35 percent.

Financial Derivatives

In order to manage interest rate risk, the Company may enter into financial derivative contracts such as interest rate swaps.  At December 31, 2010 and 2009 the Company was a party to interest rate swap agreements used to hedge variable rate debt as follows:

(In thousands, except percentages and years)	2010			2009
Notional amount	$	15,000		$	15,000
Weighted average pay rate		4.05	%		4.05	%
Weighted average receive rate    (three-month LIBOR)		0.34	%		0.90	%
Weighted average maturity in years		0.90			1.90
Unrealized loss relating to interest rate swaps	$	(499	)	$	(777	)

For additional information, see Note 12 to the Company’s Consolidated Financial Statements.

Operating, Investing and Financing

The Consolidated Statements of Cash Flows present the changes in cash from operating, investing and financing activities. At December 31, 2010, the balance of cash and cash equivalents was $43.9 million, a decrease of $29.7 million from December 31, 2009.

Net cash provided by operating activities totaled $17.0 million for the year ended December 31, 2010, compared to $4.5 million for the prior year. The primary sources of funds were adjustments to net income, such as the provision for loan losses, depreciation expenses, proceeds from SBA loans held for sale and mortgage loans held for sale, offset by originations of SBA and mortgage loans held for sale.

Net cash provided by investing activities amounted to $67.7 million in 2010, compared to of $4.5 million in 2009.  The cash provided by investing activities was primarily a result of sales, maturities and principal payments on securities and a net decrease in loans, partially offset by purchases of securities.

Net cash used in financing activities was $114.4 million in 2010, compared to net cash provided by financing activities of $30.2 million for 2009.  Net cash used in financing activities consisted of a decline in deposits, the repayment of borrowings and dividends paid on preferred stock, partially offset by proceeds from the exercise of stock options and related tax benefits.

Liquidity

The Company’s liquidity is a measure of its ability to fund loans, withdrawals or maturities of deposits and other cash outflows in a cost-effective manner.

Parent Company

Generally, the Parent Company’s cash is used for the payment of operating expenses and cash dividends on the preferred stock issued to the U.S. Treasury.  The principal sources of funds for the Parent Company are dividends paid by the Bank. The Parent Company only pays expenses that are specifically for the benefit of the Parent Company. Other than its investment in the Bank, Unity Statutory Trust II and Unity Statutory Trust III, the Parent Company does not actively engage in other transactions or business.  The majority of expenses paid by the Parent Company are related to Unity Statutory Trust II and Unity Statutory Trust III.

At December 31, 2010, the Parent Company had $4.1 million in cash and $98 thousand in marketable securities, valued at fair market value compared to $5.1 million in cash and $90 thousand in marketable securities at December 31, 2009.  The decrease in cash at the Parent Company was primarily due to the payment of cash dividends on preferred stock.

Consolidated Bank

The principal sources of funds at the Bank are deposits, scheduled amortization and prepayments of loan and investment 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 flows and loan prepayments are

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greatly influenced by general interest rates, economic conditions and competition.

Total FHLB borrowings amounted to $60.0 million and third party repurchase agreements totaled $15.0 million as of December 31, 2010.  At December 31, 2010, $73.2 million was available for additional borrowings from 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.  An additional source of liquidity is the securities available for sale portfolio and SBA loans held for sale portfolio, which amounted to $107.1 million and $10.4 million, respectively, at December 31, 2010.

As of December 31, 2010, deposits included $36.3 million of Government deposits, as compared to $29.2 million at year-end 2009. 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 $32.1 million of deposits from five municipalities.  The withdrawal of these deposits, in whole or in part, would not create a liquidity shortfall for the Company.

 The Company was committed to advance approximately $66.0 million to its borrowers as of December 31, 2010, compared to $76.2 million at December 31, 2009.  At December 31, 2010, $17.2 million of these commitments expire after one year, compared to $32.7 million a year earlier.  At December 31, 2010, the Company had $1.5 million in standby letters of credit compared to $6.4 million at December 31, 2009.  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.

Off-Balance Sheet Arrangements and Contractual Obligations

The following table shows the amounts and expected maturities of off-balance sheet arrangements as of December 31, 2010. Further discussion of these commitments is included in Note 11 to the Consolidated Financial Statements.

(In thousands)	One Year or Less		One to Three Years		Three to Five Years		Over Five Years		Total
Standby letters of credit	$	1,419	$	-	$	-	$	48	$	1,467

The following table shows the contractual obligations of the Company by expected payment period, as of December 31, 2010. Further discussion of these commitments is included in Notes 10 and 11 to the Consolidated Financial Statements.

(In thousands)	One Year or Less		One to Three Years		Three to Five Years		Over Five Years		Total
Borrowed funds and subordinated debentures	$	-	$	-	$	10,000	$	80,465	$	90,465
Operating lease obligations		1,035		2,082		291		-		3,408
Purchase obligations		1,070		353		-		-		1,423
Total	$	2,105	$	2,435	$	10,291	$	80,465	$	95,296

Borrowed funds and subordinated debentures include fixed term borrowings from the Federal Home Loan Bank, repurchase agreements and subordinated debentures. The borrowings have defined terms and under certain circumstances are callable at the option of the lender.

Operating leases represent obligations, net of any sublease agreements, entered into by the Company for the use of land, premises and equipment. The leases generally have escalation terms based upon certain defined indexes.

Purchase obligations represent legally binding and enforceable agreements to purchase goods and services from third parties and consist primarily of contractual obligations under data processing service agreements.

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 other qualifying hybrid instruments, and (2) tier 2 capital, which includes a portion of the allowance for loan losses, certain qualifying long-term debt and preferred stock which does not qualify as tier 1 capital.  Minimum capital levels are regulated by risk-based capital adequacy guidelines, which require a bank to maintain certain capital as a percent of assets and certain off-balance sheet items adjusted for predefined credit risk factors (risk-weighted assets).  A bank is required to maintain, at a minimum, tier 1 capital as a percentage of risk-weighted assets of 4 percent and combined tier 1 and tier 2 capital as a percentage of risk-weighted assets of 8 percent.

In addition, banks are required to meet a leverage capital requirement, which measures tier 1 capital against average assets. Banks which are highly rated and not experiencing significant growth are required to maintain a leverage ratio of 3 percent while all other banks are expected to maintain a leverage ratio 1 to 2 percentage points higher.

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 The following table summarizes the Company’s and the Bank’s risk-based and leveraged capital ratios at December 31, 2010 and 2009, as well as the minimum regulatory capital ratios required to be deemed “well-capitalized.”

Company	2010			2009			Adequately Capitalized Requirements			Well- Capitalized Requirements
Leverage ratio		9.97	%		8.83	%		4.00	%		N/A
Tier 1 risk-based capital ratio		13.04			11.75			4.00			N/A
Total risk-based capital ratio		14.30			13.01			8.00			N/A

Bank	2010			2009			Adequately Capitalized Requirements			Well- Capitalized Requirements
Leverage ratio		8.48	%		7.38	%		4.00	%		5.00	%
Tier 1 risk-based capital ratio		11.10			9.82			4.00			6.00	%
Total risk-based capital ratio		13.69			12.30			8.00			10.00	%

At December 31, 2010, shareholders’ equity was $70.1 million, an increase of $2.2 million from year-end 2009.  The increase in shareholders’ equity was due to net income of $2.2 million, $430 thousand from the issuance of common stock under employee benefit plans, $418 thousand in net unrealized gains on the available for sale securities portfolio, and $166 thousand in net unrealized gains on cash flow hedge derivatives, partially offset by $1.0 million in dividends accrued on preferred stock.  The issuance of common stock under employee benefit plans includes nonqualified stock options, restricted stock expense, employee option exercises and the tax benefit of options exercised.

On December 5, 2008, the Company completed a transaction with the U.S. Treasury under the Capital Purchase Program (“CPP”) through which the Treasury purchased $20.6 million in preferred stock from the Company.  As part of the CPP, the Company’s future ability to pay cash dividends is limited for so long as the Treasury holds the preferred stock. Consequently the Company may not increase its quarterly cash dividend above $0.05 per share, the quarterly rate in effect at the time the CPP program was announced, without the prior approval of the Treasury.  No dividends were paid in 2010 or 2009.  The Company is currently preserving capital and will resume paying dividends when earnings improve and credit quality improves.

The Company pays quarterly dividends to the U.S. Treasury on the preferred stock which it holds.  During 2010, the Company accrued $1.0 million in dividends payable and $486 thousand in the accretion of the discount on the preferred stock.  The accrued preferred stock dividends and discount accretion are presented in the Consolidated Statements of Operations and Consolidated Statements of Changes in Shareholders’ Equity.  Amounts accrued and unpaid are included on the Consolidated Balance Sheets as “Accrued expenses and other liabilities.”  Cash dividends paid to the U.S. Treasury totaled $1.0 million during 2010 and appear on the Consolidated Statements of Cash Flows.

Pursuant to the requirements of the Treasury’s CPP, the Company has suspended its stock repurchase program.  The Company’s share repurchase program, which was approved on October 21, 2002, authorized the repurchase of up to 10 percent of its outstanding common stock.  The amount and timing of purchases is dependent on a number of factors, including the price and availability of the Company’s shares, general market conditions and competing alternate uses of funds.  As of December 31, 2010 the Company had repurchased a total of 556 thousand shares of which 131 thousand shares have been retired, leaving 153 thousand shares remaining to be repurchased under the plan.

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 the Company’s Annual Report on Form 10-K; 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

“Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon the Company’s Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to the Company’s Audited Consolidated Financial Statements for the year ended December 31, 2010, contains a summary of the

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Company’s significant accounting policies. Management believes the Company’s policies with respect to the methodology for the determination of the allowance for loan losses, income taxes, servicing assets, cash flow hedges and other-than-temporary impairment on securities involve a higher degree of complexity and require management to make difficult and subjective judgments, which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. These critical policies are periodically reviewed with the Audit Committee and the Board of Directors.

Allowance for Loan Losses

The provision for loan losses is based upon management’s evaluation of the adequacy of the allowance for loan losses, including an assessment of known and inherent risks in the portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which the full ability to collect may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions.  Although management uses the best information available, the level of the allowance for loan losses remains an estimate, which is subject to significant judgment and short-term change.  Various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses.  Such agencies may require the Company to make additional provisions for loan losses based upon information available to them at the time of their examination.  Furthermore, the majority of the Company’s loans are secured by real estate.  Accordingly, the ability to collect a substantial portion of the carrying value of the Company’s loan portfolio is susceptible to changes in local real estate market conditions and may be adversely affected should real estate values continue to decline.  Future adjustments to the allowance for loan losses may be necessary due to economic, operating, regulatory and other conditions beyond the Company’s control.

For additional information on the allowance for loan losses, see Note 6 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.  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 16 to the Consolidated Financial Statements.

Servicing Assets

Servicing assets represent the allocated value of retained servicing rights on loans sold.  Servicing assets are expensed 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.

For additional information on servicing assets, see Note 5 to the Consolidated Financial Statements.

Derivative Instruments and Hedging Activities

The Company uses derivative instruments, such as interest rate swaps, to manage interest rate risk.  The Company recognizes all derivative instruments at fair value as either assets or liabilities in other assets or other liabilities.  The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship.  For derivatives not designated as an accounting hedge, the gain or loss is recognized in trading noninterest income.  As of December 31, 2010, all of the Company’s derivative instruments qualified as hedging instruments.

For those derivative instruments that are designated and qualify as hedging instruments, the Company must designate the hedging instrument, based on the exposure being hedged, as a fair value hedge, a cash flow hedge or a hedge of a net investment in a foreign operation.  The Company does not have any fair value hedges or hedges of foreign operations.

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The Company formally documents the relationship between the hedging instruments and the hedged item, as well as the risk management objective and strategy before undertaking a hedge.  To qualify for hedge accounting, the derivatives and hedged items must be designated as a hedge.  For hedging relationships in which effectiveness is measured, the Company formally assesses, both at inception and on an ongoing basis, if the derivatives are highly effective in offsetting changes in fair values or cash flows of the hedged item.  If it is determined that the derivative instrument is not highly effective as a hedge, hedge accounting is discontinued.

For derivatives that are designated as cash flow hedges, the effective portion of the gain or loss on derivatives is reported as a component of other comprehensive income or loss and subsequently reclassified in interest income in the same period during which the hedged transaction affects earnings.  As a result, the change in fair value of any ineffective portion of the hedging derivative is recognized immediately in earnings.

The Company will discontinue hedge accounting when it is determined that the derivative is no longer qualifying as an effective hedge; the derivative expires or is sold, terminated or exercised; or the derivative is de-designated as a fair value or cash flow hedge or it is no longer probable that the forecasted transaction will occur by the end of the originally specified time period.  If the Company determines that the derivative no longer qualifies as a cash flow or fair value hedge and therefore hedge accounting is discontinued, the derivative will continue to be recorded on the balance sheet at its fair value with changes in fair value included in current earnings.

For additional information on derivative instruments, see Note 12 to the Consolidated Financial Statements.

Other-Than-Temporary Impairment

The Company has a process in place to identify debt securities that could potentially have a credit impairment that is other-than-temporary.  This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues.  Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concern warrants such evaluation.  This evaluation considers relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other-than-temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events and (4) for fixed maturity securities, our intent to sell a security or whether it is more likely than not we will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity and for equity securities, our ability and intent to hold the security for a period of time that allows for the recovery in value.

Management assesses their intent to sell or whether it is more likely than not that they 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.

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.

For additional information on other-than-temporary impairment, see Note 4 to the Consolidated Financial Statements.

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Management’s Report on Internal Control

Over Financial Reporting

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f) under the Securities Exchange Act of 1934. Under the supervision and with the participation of the principal executive officer and the principal financial officer, management conducted an evaluation of the effectiveness of our control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation under the framework, management has concluded that our internal control over financial reporting was effective as of December 31, 2010.

Pursuant to the rules of the Securities and Exchange Commission, management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2010 has not been attested to by McGladrey & Pullen, LLP, the independent registered public accounting firm that audited the Company’s Consolidated Financial Statements for the year ended December 31, 2010, as stated in their report which is included herein.

/s/ James A. Hughes
James A. Hughes

President and Chief Executive Officer

/s/ Alan J. Bedner

Alan J. Bedner

Executive Vice President and Chief Financial Officer

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Annual Report Page Number 25

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders

Unity Bancorp, Inc.

We have audited the accompanying consolidated balance sheets of Unity Bancorp, Inc. and subsidiaries (“the Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Unity Bancorp, Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

/s/ McGladrey & Pullen, LLP

McGladrey & Pullen, LLP

Blue Bell, Pennsylvania

March 17, 2011

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Consolidated Balance Sheets

(In thousands)

December 31,		2010			2009
ASSETS
Cash and due from banks	$	17,637		$	23,517
Federal funds sold and interest-bearing deposits		26,289			50,118
Cash and cash equivalents		43,926			73,635
Securities:
Available for sale		107,131			140,770
Held to maturity (fair value of $21,351 and $28,406 in 2010 and 2009, respectively)		21,111			28,252
Total securities		128,242			169,022
Loans:
SBA held for sale		10,397			21,406
SBA held to maturity		75,741			77,844
SBA 504		64,276			70,683
Commercial		281,205			293,739
Residential mortgage		128,400			133,059
Consumer		55,917			60,285
Total loans		615,936			657,016
Less: Allowance for loan losses		14,364			13,842
Net loans		601,572			643,174
Premises and equipment, net		10,967			11,773
Bank owned life insurance		8,812			6,002
Deferred tax assets		7,550			7,308
Federal Home Loan Bank stock		4,206			4,677
Accrued interest receivable		3,791			4,225
Prepaid FDIC insurance		3,266			4,739
Other real estate owned (“OREO”)		2,346			1,530
Other assets		2,188			2,713
Goodwill and other intangibles		1,544			1,559
Total Assets	$	818,410		$	930,357
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits:
Noninterest-bearing demand deposits	$	91,272		$	80,100
Interest-bearing demand deposits		105,530			100,046
Savings deposits		277,394			286,334
Time deposits, under $100,000		119,478			183,377
Time deposits, $100,000 and over		61,114			108,382
Total deposits		654,788			758,239
Borrowed funds		75,000			85,000
Subordinated debentures		15,465			15,465
Accrued interest payable		556			710
Accrued expenses and other liabilities		2,516			3,078
Total Liabilities		748,325			862,492
Commitments and contingencies (Note 11)		-			-
Shareholders’ equity:
Cumulative perpetual preferred stock, Series B, $1 liquidation preference per share, 500 shares authorized, 21 shares issued and outstanding in 2010 and 2009		19,019			18,533
Common stock, no par value, 12,500 shares authorized, 7,636 shares issued and 7,211 outstanding in 2010; 7,569 shares issued and 7,144 outstanding in 2009		55,884			55,454
Accumulated deficit		(772	)		(1,492	)
Treasury stock at cost (425 shares in 2010 and 2009)		(4,169	)		(4,169	)
Accumulated other comprehensive income (loss)		123			(461	)
Total Shareholders’ Equity		70,085			67,865
Total Liabilities and Shareholders’ Equity	$	818,410		$	930,357

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

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Annual Report Page Number 27

Consolidated Statements of Operations

(In thousands, except per share amounts)

For the years ended December 31,		2010		2009
INTEREST INCOME
Federal funds sold and interest-bearing deposits	$	87	$	117
Federal Home Loan Bank stock		235		277
Securities:
Available for sale		4,287		6,136
Held to maturity		1,117		1,520
Total securities		5,404		7,656
Loans:
SBA		5,264		6,246
SBA 504		4,305		4,821
Commercial		18,130		19,881
Residential mortgage		7,684		7,252
Consumer		2,926		3,160
Total loans		38,309		41,360
Total interest income		44,035		49,410
INTEREST EXPENSE
Interest-bearing demand deposits		737		1,063
Savings deposits		2,829		3,574
Time deposits		6,173		12,523
Borrowed funds and subordinated debentures		4,296		4,422
Total interest expense		14,035		21,582
Net interest income		30,000		27,828
Provision for loan losses		7,250		8,000
Net interest income after provision for loan losses		22,750		19,828
NONINTEREST INCOME
Branch fee income		1,424		1,418
Service and loan fee income		979		1,214
Gain on sale of SBA loans held for sale, net		500		393
Gain on sale of mortgage loans		1,052		217
Bank owned life insurance		310		222
Other-than-temporary impairment charges		-		(2,611	)
Net security gains		85		855
Other income		719		432
Total noninterest income		5,069		2,140
NONINTEREST EXPENSE
Compensation and benefits		11,875		11,243
Occupancy		2,522		2,552
Processing and communications		2,139		2,077
Furniture and equipment		1,755		1,829
Professional services		737		1,042
Loan collection costs		964		1,023
OREO expenses		1,316		220
Deposit insurance		1,301		1,707
Advertising		624		530
Other expenses		1,757		1,724
Total noninterest expense		24,990		23,947
Income (loss) before provision (benefit) for income taxes		2,829		(1,979	)
Provision (benefit) for income taxes		589		(898	)
Net income (loss)		2,240		(1,081	)
Preferred stock dividends and discount accretion		1,520		1,496
Income available (loss attributable) to common shareholders	$	720	$	(2,577	)
Net income (loss) per common share - Basic	$	0.10	$	(0.36	)
Net income(loss) per common share - Diluted		0.10		(0.36	)
Weighted average common shares outstanding - Basic		7,173		7,121
Weighted average common shares outstanding - Diluted		7,447		7,121

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

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Consolidated Statements of Changes in Shareholders’ Equity

(In thousands)	Preferred		Common Stock				Retained			Treasury			Accumulated Other Comprehensive Income			Total Shareholders'
	Stock		Shares		Amount		Earnings			Stock			Loss			Equity
Balance, December 31, 2008	$	18,064		7,119	$	55,179	$	1,085		$	(4,169	)	$	(2,356	)	$	67,803
Comprehensive income:
Net loss								(1,081	)								(1,081	)
Net unrealized gains on securities														1,733			1,733
Net unrealized gains on cash flow hedge derivatives														162			162
Total comprehensive income																	814
Accretion of discount on preferred stock		469						(469	)								-
Dividends on preferred stock (5% annually)								(1,027	)								(1,027	)
Common stock issued and related tax effects				25		275											275
Balance, December 31, 2009	$	18,533		7,144	$	55,454	$	(1,492	)	$	(4,169	)	$	(461	)	$	67,865
Comprehensive income:
Net income								2,240									2,240
Net unrealized gains on securities														418			418
Net unrealized gains on cash flow hedge derivatives														166			166
Total comprehensive income																	2,824
Accretion of discount on preferred stock		486						(486	)								-
Dividends on preferred stock (5% annually)								(1,034	)								(1,034	)
Common stock issued and related tax effects				67		430											430
Balance, December 31, 2010	$	19,019		7,211	$	55,884	$	(772	)	$	(4,169	)	$	123		$	70,085

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

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Consolidated Statements of Cash Flows

(In thousands)

For the years ended December 31,

		2010			2009
OPERATING ACTIVITIES:
Net income (loss)	$	2,240		$	(1,081	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for loan losses		7,250			8,000
Net amortization of purchase premiums and discounts on securities		881			535
Depreciation and amortization		1,282			1,418
Deferred income tax benefit		(641	)		(2,084	)
Other-than-temporary impairment charges on securities		-			2,611
Net security gains		(85	)		(855	)
Stock compensation expense		317			310
Loss on sale of OREO		807			150
Gain on sale of SBA loans held for sale, net		(500	)		(393	)
Gain on sale of mortgage loans		(1,052	)		(217	)
Origination of mortgage loans held for sale		(54,299	)		(17,711	)
Origination of SBA loans held for sale		(1,573	)		(6,446	)
Proceeds from the sale of mortgage loans held for sale, net		55,351			17,928
Proceeds from the sale of SBA loans held for sale, net		5,286			5,626
Loss on the sale of premises and equipment		9			6
Net change in other assets and liabilities		1,702			(3,283	)
Net cash provided by operating activities		16,975			4,514
INVESTING ACTIVITIES:
Purchases of securities held to maturity		(3,765	)		(4,036	)
Purchases of securities available for sale		(46,711	)		(104,779	)
Purchases of Federal Home Loan Bank stock, at cost		-			(8,469	)
Maturities and principal payments on securities held to maturity		8,882			6,362
Maturities and principal payments on securities available for sale		65,877			50,318
Proceeds from sale of securities held to maturity		1,893			-
Proceeds from sale of securities available for sale		14,513			32,403
Proceeds from redemption of Federal Home Loan Bank stock		471			8,649
Proceeds from the sale of OREO		8,078			2,272
Net decrease in loans		21,353			22,290
Purchase of bank owned life insurance		(2,500	)		-
Proceeds from the sale of premises and equipment		35			20
Purchases of premises and equipment		(421	)		(496	)
Net cash provided by investing activities		67,705			4,534
FINANCING ACTIVITIES:
Net (decrease) increase in deposits		(103,451	)		51,122
Proceeds from new borrowings		-			22,000
Repayments of borrowings		(10,000	)		(42,000	)
Proceeds from issuance of common stock		94			9
Cash dividends paid on preferred stock		(1,032	)		(975	)
Net cash (used in) provided by financing activities		(114,389	)		30,156
(Decrease) increase in cash and cash equivalents		(29,709	)		39,204
Cash and cash equivalents at beginning of year		73,635			34,431
Cash and cash equivalents at end of year	$	43,926		$	73,635
SUPPLEMENTAL DISCLOSURES:
Cash
Interest paid	$	14,189		$	21,677
Income taxes paid		1,328			1,056
Noncash investing activities:
Transfer of AFS SBA loans to HTM SBA loans		7,796			1,988
Transfer of loans to OREO		9,700			3,242

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

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Notes to Consolidated Financial Statements

1. Summary of Significant Accounting Policies

Overview

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”).  All significant intercompany balances and transactions have been eliminated in consolidation.

Unity Bancorp, Inc. is a bank holding company incorporated in New Jersey and registered under the Bank Holding Company Act of 1956, as amended.  Its wholly-owned subsidiary, the Bank, is chartered by the New Jersey Department of Banking and Insurance.   The Bank provides a full range of commercial and retail banking services through 16 branch offices located in Hunterdon, Middlesex, Somerset, Union and Warren counties in New Jersey and Northampton County in Pennsylvania.  These services include the acceptance of demand, savings, and time deposits and the extension of consumer, real estate, Small Business Administration (“SBA”) and other commercial credits.

Unity Bank has eight wholly-owned subsidiaries, Unity Investment Services, Inc., Unity Financial Services, Inc., AJB Residential Realty Enterprises, Inc., AJB Commercial Realty, Inc., MKCD Commercial, Inc., JAH Commercial, Inc., UB Commercial LLC, and ASBC Holdings LLC.  Unity Investment Services, Inc. is used to hold and administer part of the Bank’s investment portfolio.  Unity Financial Services, Inc. sells third party investments such as insurance and annuities.  The other subsidiaries hold, administer and maintain the Bank’s other real estate owned (“OREO”) properties.

The Company has two statutory trust subsidiaries that are wholly-owned by Unity Bancorp, Inc.  See details in Note 10 to the Consolidated Financial Statements.

Use of Estimates in the Preparation of Financial Statements

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  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 determination of other-than-temporary impairment for securities and fair value disclosures.  Actual results could differ from those estimates.

Reclassifications

Certain reclassifications have been made to the prior year to conform to the current year presentation, with no impact on prior year earnings.

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold and interest-bearing deposits.

Securities

The Company classifies its securities into two categories, available for sale and held to maturity.

Securities that are classified as available for sale are stated at fair value.  Unrealized gains and losses on securities available for sale are excluded from results of operations and are reported as other comprehensive income, a separate component of shareholders’ equity, net of taxes.  Securities classified as available for sale include securities that may be sold in response to changes in interest rates, changes in prepayment risks or for asset/liability management purposes.  The cost of securities sold is determined on a specific identification basis.  Gains and losses on sales of securities are recognized in the statements of operations on the date of sale.

Securities are classified as held to maturity based on management’s intent and ability to hold them to maturity.  Such securities are stated at cost, adjusted for unamortized purchase premiums and discounts using the level yield method.

Transfers between the available for sale and held to maturity portfolios are accounted for at fair value.  Unrealized holding gains and losses are accounted for at the date of transfer.  For securities transferred to available for sale from held to maturity, unrealized gains or losses as of the date of the transfer are recognized in other comprehensive income (loss), a separate component of shareholders’ equity.  For securities transferred into the held to maturity portfolio from the available for sale portfolio, unrealized gains or losses as of the date of transfer continue to be reported in other comprehensive income (loss), a separate component of shareholders’ equity and are amortized over the remaining life of the security as an adjustment to its yield, consistent with amortization of the premium or accretion of the discount.

The Company has a process in place to identify debt securities for impairment that is other-than-temporary.  This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues.  Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concern warrants such evaluation.  This evaluation considers relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other-than-temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events and (4) for fixed maturity securities, our intent to sell a security or

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whether it is more likely than not we will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity and for equity securities, our ability and intent to hold the security for a period of time that allows for the recovery in value.

Management assesses their intent to sell or whether it is more likely than not that they 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 the 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 (loss).

 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.

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

Federal Home Loan Bank Stock

Federal law requires a member institution of the Federal Home Loan Bank (“FHLB”) system to hold stock of its district FHLB according to a predetermined formula.  The stock is carried at cost.  Management reviews the stock for impairment based on the ultimate recoverability of the cost basis in the stock.  The stock’s value is determined by the ultimate recoverability of the par value rather than by recognizing temporary declines. Management considers such criteria as the significance of the decline in net assets, if any, of the FHLB, the length of time this situation has persisted, commitments by the FHLB to make payments required by law or regulation, the impact of legislative and regulatory changes on the customer base of the FHLB and the liquidity position of the FHLB.

Loans Held To Maturity and Loans Held For Sale

Loans held to maturity are stated at the unpaid principal balance, net of unearned discounts and net of deferred loan origination fees and costs.  Loan origination fees, net of direct loan origination costs, are deferred and are recognized over the estimated life of the related loans as an adjustment to the loan yield utilizing the level yield method.

Interest is credited to operations primarily based upon the principal amount outstanding.  When management believes there is sufficient doubt as to the ultimate ability to collect interest on a loan, interest accruals are discontinued and all past due interest, previously recognized as income, is reversed and charged against current period earnings.  Payments received on nonaccrual loans are applied as principal.  Loans are 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 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.

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, are charged off.  All loan charge-offs are approved by the Board of Directors.

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.

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 troubled debt restructurings and nonaccrual loans.  Impairment is evaluated in total for smaller-balance loans of a similar nature (consumer and residential mortgage loans), and on an individual basis for other loans.  Troubled debt restructurings 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, such as a below market interest rate.  Impairment of a loan is measured based on the present value of expected future cash flows, net of estimated costs to sell, discounted at the loan’s effective interest rate.  Impairment can also be measured based on a loan’s observable market price or the fair value of collateral,

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net of estimated costs to sell, if the loan is collateral dependent.  If the measure 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 or credit to the provision for loan losses.

Loans held for sale are SBA loans and are reflected at the lower of aggregate cost or fair value.  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.

The Company originates loans to customers under an SBA program that generally provides for SBA guarantees of up to 90 percent of each loan.  In the past, the Company generally sold the guaranteed portion of its SBA loans to a third party and retained the servicing, holding the nonguaranteed portion in its portfolio.  However, during the third quarter of 2007, the Company announced a change in its strategy to retain more SBA loans in its portfolio due to lower premiums received on the sale of these loans.  During late 2008, the Company withdrew from SBA lending as a primary line of business, but continues to offer SBA loan products as an additional credit product to its customers.  If 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.

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.

For additional information on loans, see Note 5 to the Consolidated Financial Statements.

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.

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, 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, see Note 6 to the Consolidated Financial Statements.

Premises and Equipment

Land is carried at cost.  Buildings and equipment are stated at cost less accumulated depreciation.  Depreciation is computed using the straight-line method over the estimated useful lives of the assets, not to exceed 30 years.  For additional information on premises and equipment, see Note 7 to the Consolidated Financial Statements.

Other Real Estate Owned

Other real estate owned is recorded at the fair value, less estimated costs to sell, at the date of acquisition, with a charge to the allowance for loan losses for any excess of the loan carrying value over such amount. Subsequently, other real estate owned is carried at the lower of cost or fair value, as determined by current appraisals, less estimated selling costs.  Certain costs incurred in preparing properties for sale are capitalized to the extent that the appraisal amount exceeds the carry value, and expenses of holding foreclosed properties are charged to operations as incurred.

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.  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.  

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 The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.  Valuation reserves are established against certain deferred tax assets when it is more likely than not that the deferred tax assets will not be realized.  Increases or decreases in the valuation reserve are charged or credited to the income tax provision.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that ultimately would be sustained.  The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any.  The evaluation of a tax position taken is considered by itself and not offset or aggregated with other positions.  Tax positions that meet the more likely than not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority.  The portion of benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest and penalties associated with unrecognized tax benefits are recognized in income tax expense on the income statement.

For additional information on income taxes, see Note 16 to the Consolidated Financial Statements.

Net Income Per Share

Basic net income (loss) per common share is calculated as net income available (loss attributable) to common shareholders divided by the weighted average common shares outstanding during the reporting period.  Net income available (loss attributable) to common shareholders is calculated as net income (loss) less accrued dividends and discount accretion related to preferred stock.

Diluted net income (loss) per common share is computed similarly to that of basic net income (loss) 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.

For additional information on income per share, see Note 17 to the Consolidated Financial Statements.

Other Comprehensive Income (Loss)

Other comprehensive income (loss) consists of the change in unrealized gain (loss) on securities available for sale and derivatives designated as cash flow hedges that were reported as a component of shareholders’ equity, net of tax.  For additional information on other comprehensive income, see Note 22 to the Consolidated Financial Statements.

Derivative Instruments and Hedging Activities

The Company uses derivative instruments, such as interest rate swaps, to manage interest rate risk.  The Company recognizes all derivative instruments at fair value as either assets or liabilities in other assets or other liabilities.  The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship.  For derivatives not designated as an accounting hedge, the gain or loss is recognized in trading noninterest income.

For those derivative instruments that are designated and qualify as hedging instruments, the Company must designate the hedging instrument, based on the exposure being hedged, as a fair value hedge, a cash flow hedge or a hedge of a net investment in a foreign operation.  The Company does not have any fair value hedges or hedges of foreign operations.

The Company formally documents the relationship between the hedging instruments and the hedged item, as well as the risk management objective and strategy before undertaking a hedge.  For hedging relationships in which effectiveness is measured, the Company formally assesses, both at inception and on an ongoing basis, if the derivatives are highly effective in offsetting changes in fair values or cash flows of the hedged item.  If it is determined that the derivative instrument is not highly effective as a hedge, hedge accounting is discontinued.

For derivatives that are designated as cash flow hedges, the effective portion of the gain or loss on derivatives is reported as a component of other comprehensive income or loss.  The change in fair value of any ineffective portion of the hedging derivative is recognized immediately in earnings.

Hedge accounting discontinues when it is determined that the derivative no longer qualifies as an effective hedge; the derivative expires or is sold, terminated or exercised; or the derivative is no longer designated as a fair value or cash flow hedge or it is no longer probable that the forecasted transaction will occur by the end of the originally specified time period.  If the Company determines that the derivative no longer qualifies as a cash flow or fair value hedge and therefore hedge accounting is discontinued, the derivative will continue to be recorded on the balance sheet at its fair value with changes in fair value included in current earnings.

For additional information on derivative instruments, see Note 12 to the Consolidated Financial Statements.

Stock-Based Compensation

The Company accounts for its stock-based compensation awards in accordance with FASB ASC Topic 718, “Compensation – Stock Compensation”, which requires recognition of compensation expense related to stock-based compensation awards over the period during which an employee is required to provide service for the award.  Compensation expense is equal to the fair value of the award, net of estimated forfeitures, and is recognized over the vesting period of such awards.  For additional information on the Company’s stock-based compensation, see Note 19 to the Consolidated Financial Statements.

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Treasury Stock

Treasury stock is accounted for under the cost method and accordingly is presented as a reduction in shareholders’ equity.

Bank Owned Life Insurance

The Company purchased life insurance policies on certain members of management.  Bank owned life insurance (“BOLI”) is recorded at its cash surrender value or the amount that can be realized.

Advertising

The Company expenses the costs of advertising in the period incurred.

Dividend Restrictions

Banking regulations require maintaining certain capital levels that may limit the dividends paid by our bank to our holding company or by our holding company to our shareholders.  In addition, the Company’s participation in the U.S. Department of Treasury’s Capital Purchase Program places restrictions on increased dividend declarations.

Operating Segments

While management monitors the revenue streams of its various products and services, operating results and financial performance are evaluated on a company-wide basis.  The Company’s management uses consolidated results to make operating and strategic decisions.  Accordingly, there is only one reportable segment.

Servicing Assets

Servicing assets represent the estimated fair value of retained servicing rights at the time loans are sold.  Servicing assets are expensed 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.

Fair Value

The Company follows FASB ASC Topic 820, “Fair Value Measurement and Disclosures,” which provides a framework for measuring fair value under generally accepted accounting principles. ASC Topic 820 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement of certain financial assets on a contract-by-contract basis and requires the difference between the carrying value before election of the fair value option and the fair value of these instruments be recorded as an adjustment to beginning retained earnings in the period of adoption.  The Company has presently elected not to report any of its existing financial assets or liabilities at fair value and consequently does not have any fair value related adjustments.

For additional information on the fair value of the Company’s financial instruments, see Note 20 to the Consolidated Financial Statements.

Recent Accounting Pronouncements

FASB ASC Topic 310, “Receivables.” New authoritative accounting guidance (Accounting Standards Update No. 2010-20) under ASC Topic 310, “Receivables”, amends the current disclosures required by ASC Topic 310.  As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. The disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010.  This new disclosure guidance did not have an impact on the Company’s reported financial condition or results of operations.  See Note 6 for new disclosures required by this guidance.

FASB ASC Topic 820, “Fair Value Measurements and Disclosures.” New authoritative accounting guidance (Accounting Standards Update No. 2010-6) provides amendments to ASC Topic 820 that require new disclosures as follows: 1) A reporting entity should disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers, and 2) In the reconciliation for fair value measurements using significant unobservable inputs (Level 3), a reporting entity should present separately information about purchases, sales, issuances, and settlements (that is, on a gross basis rather than as one net number).   The new authoritative guidance also clarifies existing disclosures as follows: 1) A reporting entity should provide fair value measurement disclosures for each class of assets and liabilities.  A class is often a subset of assets or liabilities within a line item in the statement of financial position.  A reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities.  2) A reporting entity should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements that fall in either Level 2 or Level 3.  These new disclosures and clarifications of existing disclosures were effective for the Company’s financial statements beginning after December 15, 2009 (except for the disclosures about the purchases, sales, issuances, and settlements in the roll forward activity of Level 3 fair value measurements, which is effective for fiscal years beginning after December 15, 2010) and did not have an impact on the Company’s financial statements.

FASB ASC Topic 860, “Transfers and Servicing.” New authoritative accounting guidance under ASC Topic 860, “Transfers and Servicing,” amends prior accounting guidance to enhance reporting about transfers of financial assets, including securitizations, and where companies have continuing exposure to the risks related to transferred financial assets. The new authoritative accounting guidance eliminates the concept of a “qualifying special-purpose entity” and changes the requirements for derecognizing financial assets. The new authoritative accounting guidance also requires additional disclosures about all continuing involvements with transferred financial assets including information about gains and losses resulting from transfers during the period. The new authoritative accounting guidance under ASC Topic 860 was effective

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January 1, 2010 and did not have a significant impact on the Company’s financial statements; however the guidance defers the gains of SBA 7(a) loans for a 90-day period after the sale of the loan.  There were no SBA 7(a) loan sales during the fourth quarter of 2010 that needed to be deferred.

2.Goodwill

The Company accounts for goodwill and other intangible assets in accordance with FASB ASC Topic 350, “Intangibles – Goodwill and Other”, which includes requirements to test goodwill and indefinite-lived intangible assets on an annual basis for impairment, rather than amortize them.  Management conducted an annual test and determined that the Company’s recorded goodwill totaling $1.5 million, which resulted from the 2005 acquisition of its Phillipsburg, New Jersey branch, is not impaired as of December 31, 2010.

3.Restrictions on Cash

Federal law requires depository institutions to maintain a prescribed amount of cash or noninterest-bearing balances with the Federal Reserve Bank.  As of December 31, 2010 and 2009, the Company was required to maintain reserve balances of $80 thousand.  In addition, the Company’s contract with its current electronic funds transfer (“EFT”) provider requires a pre-determined balance be maintained in a settlement account controlled by the provider equal to the Company’s average daily net settlement position multiplied by four days.  The required balance was $179 thousand as of December 31, 2010 and 2009.  This balance can be adjusted periodically to reflect actual transaction volume and seasonal factors.

4.Securities

This table provides the major components of securities available for sale (“AFS”) and held to maturity (“HTM”) at amortized cost and estimated fair value at December 31, 2010 and 2009:

	2010									2009
(In thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
Available for sale:
US Government sponsored entities	$	6,415	$	47	$	-		$	6,462	$	16,198	$	20	$	(211	)	$	16,007
State and political subdivisions		11,246		23		(306	)		10,963		2,946		9		(13	)		2,942
Residential mortgage-backed securities		84,359		2,022		(640	)		85,741		115,397		1,849		(1,021	)		116,225
Commercial mortgage-backed securities		1,827		3		(4	)		1,826		4,651		-		(24	)		4,627
Trust preferred securities		977		-		(412	)		565		976		-		(586	)		390
Other securities		1,610		-		(36	)		1,574		610		-		(31	)		579
Total securities available for sale	$	106,434	$	2,095	$	(1,398	)	$	107,131	$	140,778	$	1,878	$	(1,886	)	$	140,770
Held to maturity:
US Government sponsored entities	$	-	$	-	$	-		$	-	$	2,000	$	76	$	-		$	2,076
State and political subdivisions		2,297		-		(66	)		2,231		3,156		4		(92	)		3,068
Residential mortgage-backed securities		14,722		444		(318	)		14,848		18,700		545		(527	)		18,718
Commercial mortgage-backed securities		4,042		217		-			4,259		4,346		185		-			4,531
Trust preferred securities		50		-		(37	)		13		50		-		(37	)		13
Total securities held to maturity	$	21,111	$	661	$	(421	)	$	21,351	$	28,252	$	810	$	(656	)	$	28,406

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This table provides the remaining contractual maturities and yields of securities within the investment portfolios.  The carrying value of securities at December 31, 2010 is primarily 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.  The total weighted average yield excludes equity securities.

	Within one year					After one year through five years					After five years through ten years					After ten years					Total carrying value
(In thousands)	Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield			Amount		Yield
Available for sale at fair value:
US Government sponsored entities	$	-		-	%	$	893		2.36	%	$	2,594		2.48	%	$	2,975		4.26	%	$	6,462		3.28	%
State and political subdivisions		-		-			170		6.50			3,263		3.12			7,530		3.81			10,963		3.64
Residential mortgage-backed securities		-		-			1,091		2.58			5,912		5.24			78,738		3.06			85,741		3.21
Commercial mortgage-backed securities		-		-			-		-			-		-			1,826		6.11			1,826		6.11
Trust preferred securities		-		-			-		-			-		-			565		1.07			565		1.07
Other securities		-		-			-		-			-		-			1,574		3.49			1,574		3.49
Total securities available for sale	$	-		-	%	$	2,154		2.80	%	$	11,769		4.05	%	$	93,208		3.22	%	$	107,131		3.30	%
Held to maturity at cost:
State and political subdivisions	$	-		-	%	$	-		-	%	$	-		-	%	$	2,297		5.15	%	$	2,297		5.15	%
Residential mortgage-backed securities		-		-			494		4.28			3,829		4.77			10,399		4.67			14,722		4.68
Commercial mortgage-backed securities		-		-			-		-			-		-			4,042		5.55			4,042		5.55
Trust preferred securities		-		-			-		-			-		-			50		-			50		-
Total securities held to maturity	$	-		-	%	$	494		4.28	%	$	3,829		4.77	%	$	16,788		4.93	%	$	21,111		4.89	%

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The fair value of securities with unrealized losses by length of time that the individual securities have been in a continuous unrealized loss position at December 31, 2010 and 2009 are as follows:

	2010
			Less than 12 months					12 months and greater					Total
(In thousands)	Total Number in a Loss Position		Estimated Fair Value		Unrealized Loss			Estimated Fair Value		Unrealized Loss			Estimated Fair Value		Unrealized Loss
Available for sale:
State and political subdivisions		31	$	9,051	$	(306	)	$	-	$	-		$	9,051	$	(306	)
Residential mortgage-backed securities		17		14,651		(422	)		3,547		(218	)		18,198		(640	)
Commercial mortgage-backed securities		1		-		-			1,516		(4	)		1,516		(4	)
Trust preferred securities		1		-		-			565		(412	)		565		(412	)
Other equities		4		-		-			1,074		(36	)		1,074		(36	)
Total temporarily impaired investments		54	$	23,702	$	(728	)	$	6,702	$	(670	)	$	30,404	$	(1,398	)
Held to maturity:
State and political subdivisions		4	$	2,231	$	(66	)	$	-	$	-		$	2,231	$	(66	)
Residential mortgage-backed securities		5		2,243		(75	)		2,651		(243	)		4,894		(318	)
Trust preferred securities		2		-		-			13		(37	)		13		(37	)
Total temporarily impaired investments		11	$	4,474	$	(141	)	$	2,664	$	(280	)	$	7,138	$	(421	)

	2009
			Less than 12 months					12 months and greater					Total
(In thousands)	Total Number in a Loss Position		Estimated Fair Value		Unrealized Loss			Estimated Fair Value		Unrealized Loss			Estimated Fair Value		Unrealized Loss
Available for sale:
U.S. Government sponsored entities		10	$	12,807	$	(210	)	$	96	$	(1	)	$	12,903	$	(211	)
State and political subdivisions		7		1,820		(13	)		-		-			1,820		(13	)
Residential mortgage-backed securities		24		17,372		(207	)		7,735		(814	)		25,107		(1,021	)
Commercial mortgage-backed securities		4		4,627		(24	)		-		-			4,627		(24	)
Trust preferred securities		1		-		-			390		(586	)		390		(586	)
Other equities		3		-		-			579		(31	)		579		(31	)
Total temporarily impaired investments		49	$	36,626	$	(454	)	$	8,800	$	(1,432	)	$	45,426	$	(1,886	)
Held to maturity:
State and political subdivisions		6	$	1,753	$	(32	)	$	999	$	(60	)	$	2,752	$	(92	)
Residential mortgage-backed securities		5		124		(10	)		3,844		(517	)		3,968		(527	)
Trust preferred securities		2		5		(6	)		26		(31	)		31		(37	)
Total temporarily impaired investments		13	$	1,882	$	(48	)	$	4,869	$	(608	)	$	6,751	$	(656	)

Unrealized Losses

 The unrealized losses in each of the categories presented in the tables above are discussed in the paragraphs that follow:

 U.S. Government sponsored entities and state and political subdivision securities: The unrealized losses on investments in this type of security were caused by the increase in interest rate spreads.  The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the par value of the investment.  Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired as of December 31, 2010.

Residential and commercial mortgage-backed securities:  The unrealized losses on investments in mortgage-backed securities were caused by interest rate increases.  The majority of contractual cash flows of these securities are guaranteed by Fannie Mae, Ginnie Mae and the Federal Home Loan Mortgage Corporation.  It is expected that the securities would not be settled at a price significantly less than the par value of the investment.  Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired as of December 31, 2010.

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 Trust preferred securities:  The unrealized losses on trust preferred securities were caused by an inactive trading market and changes in market credit spreads.  At December 31, 2010, this category consisted of one single-issuer trust preferred security.  The Company that issued the trust preferred security is considered a well capitalized institution per regulatory standards and significantly strengthened its capital position. In addition, the Company has ample liquidity, bolstered its allowance for loan losses, was profitable in 2010 and is projected to be profitable in 2011. The contractual terms do notallow the security to be settled at a price less than the par value. Because the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, which may be at maturity, the Company does not consider this security to be other-than-temporarily impaired as of December 31, 2010.

Other securities: Included in this category is stock of other financial institutions and Community Reinvestment Act (“CRA”) investments.  The unrealized losses on other securities are caused by decreases in the market prices of the shares.  The Company has evaluated the prospects of the issuer and has forecasted a recovery period; therefore these investments are not considered other-than-temporarily impaired as of December 31, 2010.

Realized Gains and Losses and Other-Than-Temporary Impairment

Gross realized gains (losses) on securities and other-than-temporary impairment charges for 2010 and 2009 are detailed in the table below:

(In thousands)	2010			2009
Available for sale:
Realized gains	$	337		$	855
Realized losses		(166	)		-
Other-than-temporary impairment charges		-			-
Total securities available for sale	$	171		$	855
Held to maturity:
Realized gains	$	4		$	-
Realized losses		(90	)		-
Other-than-temporary impairment charges		-			(2,611	)
Total securities held to maturity	$	(86	)	$	(2,611	)
Net gains (losses) on sales of securities and other-than-temporary impairment charges	$	85		$	(1,756	)

The net realized gains and losses are included in noninterest income in the Consolidated Statements of Operations as net securities gains (losses).  For 2010 and 2009, gross realized gains on sales of securities amounted to $341 thousand and $855 thousand, respectively, and gross realized losses were $256 thousand and $0, respectively.  The gross gains during 2010 are primarily attributed to the Company selling approximately $11.0 million in book value of mortgage-backed securities, resulting in pretax gains of approximately $329 thousand, five called structured agency securities with resulting gains of $8 thousand, and one called held to maturity municipal security with a resulting gain of $4 thousand.  These gains were partially offset by losses of $166 thousand on the sale of approximately $3.5 million in book value of three mortgage-backed securities and losses of $90 thousand on the sale of five tax-exempt municipal securities with a total book value of approximately $2.0 million.  Although designated as held to maturity, these municipal securities were sold due to deterioration in the issuer’s creditworthiness, as evidenced by downgrades in their credit ratings.  The gross gains of $855 thousand in 2009 are primarily attributed to the Company selling approximately $31.5 million in book value of mortgage-backed securities, resulting in pretax gains of approximately $827 thousand on the sales.  The Company also sold its remaining callable Freddie Mac perpetual preferred securities resulting in pretax gains of $28 thousand. There were no realized losses in 2009.

Also included in noninterest income for 2009 are other-than-temporary-impairment charges of $2.6 million.  During 2009, the Company recognized $2.6 million of credit related other-than-temporary impairment losses on two held to maturity securities due to the deterioration in the underlying collateral.  The remaining book value of the trust preferred securities is approximately $50 thousand.  In estimating the present value of the expected cash flows on the two trust preferred securities which were other-than-temporarily impaired as of December 31, 2009, the following assumptions were made:

·   Moderate conditional repayment rates (“CRR”) were used due to the lack of new trust preferred issuances and the poor conditions of the financial industry. A CRR of 2 percent was used for performing issuers and 0 percent for nonperformers.

·   Conditional deferral rates (“CDR”) have been established based on the financial condition of the underlying trust preferred issuers in the pools. These ranged from 0.75 percent to 2.35 percent for performing issuers. Nonperforming issues were stated at 100 percent CDR

·   Expected loss severities of 95 percent were assumed (i.e. recoveries occur on only 5 percent of defaulted securities) for all performing issuers and ranged from 57.22 percent to 80.33 percent for nonperforming issues.

·   Internal rates of return (“IRR”) are the pre-tax yield used to discount the future cash flow stream expected from the collateral cash flows. The IRR used was 17 percent.

Pledged Securities

Securities with a carrying value of $63.4 million and $71.4 million at December 31, 2010 and 2009, respectively, were pledged to secure Government deposits, secure other borrowings and for other purposes required or permitted by law.  Included in these figures was $2.9 million pledged against Government deposits at December 31, 2010 and 2009.

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5.Loans

The composition of the loan portfolio, net of unearned discount and deferred loan origination fees and costs, at December 31, 2010 and 2009 was as follows:

(In thousands)	2010		2009
SBA held for sale	$	10,397	$	21,406
SBA held to maturity		75,741		77,844
SBA 504		64,276		70,683
Commercial		281,205		293,739
Residential mortgage		128,400		133,059
Consumer		55,917		60,285
Total loans	$	615,936	$	657,016

SBA loans sold to others and serviced by the Company are not included in the accompanying consolidated balance sheets.  The total amount of such loans serviced, but owned by outside investors, amounted to approximately $126.0 million and $131.3 million at December 31, 2010 and 2009, respectively.  At December 31, 2010 and 2009, the carrying value, which approximates fair value, of servicing assets was $512 thousand and $897 thousand, respectively and is included in Other Assets.  The fair value of servicing assets was determined using a discount rate of 15 percent, constant prepayment speeds ranging from 15 to 18, and interest strip multiples ranging from 2.08 to 3.80, depending on each individual credit.  A summary of the changes in the related servicing assets for the past two years follows:

	Years ending December 31,
(In thousands)		2010			2009
Balance, beginning of year	$	897		$	1,503
SBA servicing assets capitalized		74			83
Amortization of expense		(459	)		(689	)
Provision for loss in fair value		-			-
Balance, end of year	$	512		$	897

In addition, the Company had a $574 thousand and $1.0 million discount related to the retained portion of the unsold SBA loans at December 31, 2010 and 2009, respectively.

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 loan-to-value 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 (“ARM”) loans.

The majority of the Company’s loans are secured by real estate.  The 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.  Specifically, 89 percent of SBA 7(a) loans are secured by commercial or residential real estate and 11 percent by other non-real estate collateral.  Commercial real estate secures 100 percent of all SBA 504 loans.  Approximately 97 percent of consumer loans are secured by owner-occupied residential real estate, with the other 3 percent secured by automobiles or other.  The detailed allocation of the Company’s commercial loan portfolio collateral as of December 31, 2010 is shown in the table below:

	Concentration
(In thousands)	Balance		Percent
Commercial real estate – owner occupied	$	138,942		49.4	%
Commercial real estate – investment property		114,146		40.6
Undeveloped land		17,458		6.2
Other non-real estate collateral		10,659		3.8
Total commercial loans	$	281,205		100.0	%

As of December 31, 2010, approximately 12 percent of the Company’s total loan portfolio consists of loans to various unrelated and unaffiliated borrowers in the Hotel/Motel industry.  Such loans are collateralized by the underlying real property financed and/or partially guaranteed by the SBA.

As of December 31, 2010, residential mortgages provided $47.4 million in borrowing capacity at the Federal Home Loan Bank compared to $47.3 million at December 31, 2009.

In the ordinary course of business, the Company may extend credit to officers, directors or their associates.  These loans are subject to the Company’s normal lending policy.  An analysis of such loans, all of which are current as to principal and interest payments, is as follows:

(In thousands)	2010
Loans to officers, directors or their associates at December 31, 2009	$	16,438
New loans		1,717
Repayments		(650	)
Loans to officers, directors or their associates at December 31, 2010	$	17,505

6.Allowance for Loan Losses & 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.  The same standard methodology is used, regardless of loan type.  Specific reserves are made to individual impaired loans, (see Note 1 for additional information on this term).  The general reserve is set based upon a representative average historical net charge-off rate adjusted for 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.

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Beginning in the third quarter of 2009, when calculating the five-year historical net charge-off rate, the Company weights the past three years more heavily due to the higher amount of charge-offs experienced during those years.  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 loans, commercial real estate loans, and commercial construction loans.  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.  This charge-off policy is followed for all loan types.

An analysis of the change in the allowance for loan losses for the years 2010 and 2009 is presented in the table below.  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.

2010
(In thousands)	SBA			SBA 504			Commercial			Residential			Consumer			Unallocated			Total
Allowance for credit losses:
Beginning balance	$	3,247		$	1,872		$	6,013		$	1,615		$	632		$	463		$	13,842
Charge-offs		(1,351	)		(1,548	)		(3,627	)		(500	)		(245	)		-			(7,271	)
Recoveries		243			-			296			-			4			-			543
Net charge-offs		(1,108	)		(1,548	)		(3,331	)		(500	)		(241	)		-			(6,728	)
Provision for loan losses charged to expense		2,059			1,227			3,329			564			195			(124	)		7,250
Ending balance	$	4,198		$	1,551		$	6,011		$	1,679		$	586		$	339		$	14,364
Ending balance:
Individually evaluated for impairment	$	1,761		$	87		$	609		$	-		$	-		$	-		$	2,457
Collectively evaluated for impairment		2,437			1,464			5,402			1,679			586			339			11,907
Totals	$	4,198		$	1,551		$	6,011		$	1,679		$	586		$	339		$	14,364
Loan ending balances:
Individually evaluated for impairment	$	6,888		$	10,622		$	10,194		$	-		$	-		$	-		$	27,704
Collectively evaluated for impairment		79,250			53,654			271,011			128,400			55,917			-			588,232
Total ending balance	$	86,138		$	64,276		$	281,205		$	128,400		$	55,917		$	-		$	615,936

2009
Allowance for credit losses:
Beginning balance	$	10,326
Charge-offs		(4,774	)
Recoveries		290
Net charge-offs		(4,484	)
Provision for loan losses charged to expense		8,000
Ending balance	$	13,842

In addition to the allowance for loan losses, 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 expense and applied to the allowance which is maintained in other liabilities.  At December 31, 2010, a $66 thousand commitment reserve was reported on the balance sheet as an “other liability” compared to a $76 thousand commitment reserve at December 31, 2009.

Credit Risk: 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

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adhering to credit administration policies and procedures.  Due diligence on loans begins when we initiate contact regarding a loan with a borrower.  Documentation, including a borrower’s credit history, materials establishing the value and liquidity of potential collateral, the purpose of the loan, the source of funds for repayment of the loan, and other factors, are analyzed before a loan is submitted for approval.  The loan portfolio is then subject to on-going internal reviews for credit quality, as well as independent credit reviews by an outside firm.

For SBA 7(a), SBA 504 and commercial loans, management uses internally assigned risk ratings as the best indicator of credit quality.  A loan’s internal risk rating is updated at least annually and more frequently if circumstances warrant a change in risk rating.  The Company uses a 1 through 10 loan grading system that follows regulatory accepted definitions.

·   Risk ratings of 1 through 6 are used for loans that are performing, as they meet, and are expected to continue to meet, all of the terms and conditions set forth in the original loan documentation, and are generally current on principal and interest payments.  These performing loans are termed “Pass”.

·   Criticized loans are assigned a risk rating of 7 and termed “Special Mention”, as the borrowers exhibit potential credit weaknesses or downward trends deserving management’s close attention.  If not checked or corrected, these trends will weaken the Bank’s collateral and position.  While potentially weak, these borrowers are currently marginally acceptable and no loss of interest or principal is anticipated.  As a result, special mention assets do not expose an institution to sufficient risk to warrant adverse classification.  Included in “Special Mention” could be turnaround situations, such as borrowers with deteriorating trends beyond one year, borrowers in start up or deteriorating industries, or borrowers with a poor market share in an average industry.  An element of asset quality, financial flexibility, or management is below average.  Management and ownership may have limited depth or experience.  Regulatory agencies have agreed on a consistent definition of “Special Mention” as an asset with potential weaknesses which, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date.  This definition is intended to ensure that the “Special Mention” category is not used to identify assets that have as their sole weakness credit data exceptions or collateral documentation exceptions that are not material to the repayment of the asset.

·   Classified loans are assigned a risk rating of an 8 or 9, depending upon the prospect for collection, and deemed “Substandard”.  A risk rating of 8 is used for borrowers with well-defined weaknesses that jeopardize the orderly liquidation of debt.  The loan is inadequately protected by the current sound worth and paying capacity of the obligor or by the collateral pledged, if any.  Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned.  There is a distinct possibility that a partial loss of interest and/or principal will occur if the deficiencies are not corrected.  Loss potential, while existing in the aggregate amount of substandard assets, does not have to exist in individual assets classified “Substandard”.  A risk rating of 9 is used for borrowers that have all the weaknesses inherent in a loan with a risk rating of 8, with the added characteristic that the weaknesses make collection of debt in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.  Serious problems exist to the point where partial loss of principal is likely.  The possibility of loss is extremely high, but because of certain important, reasonably specific pending factors that may work to strengthen the assets, the loans’ classification as estimated losses is deferred until a more exact status may be determined.   Pending factors include proposed merger, acquisition, or liquidation procedures; capital injection; perfecting liens on additional collateral; and refinancing plans.  Partial charge-offs are likely.

·   Once a borrower is deemed incapable of repayment of unsecured debt, the risk rating becomes a 10, the loan is termed a “Loss”, and charged-off immediately.  Loans to such borrowers are considered uncollectible and of such little value that continuance as active assets of the Bank is not warranted.  This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off these basically worthless assets even though partial recovery may be affected in the future.

For residential mortgage and consumer loans, management uses performing versus nonperforming as the best indicator of credit quality.  Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt.   These credit quality indicators are updated on an ongoing basis, as a loan is placed on nonaccrual status as soon as management believes there is sufficient doubt as to the ultimate ability to collect interest on a loan.

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The tables below detail the Company’s loans by class according to their credit quality indicators discussed in the paragraphs above as of December 31, 2010 and 2009:

	2010
	SBA, SBA 504 & Commercial Loans - Internal Risk Ratings
(In thousands)	Pass		Special Mention		Substandard		Total
SBA loans	$	48,500	$	25,668	$	11,970	$	86,138
SBA 504 loans		30,235		15,366		18,675		64,276
Commercial loans
Commercial other		17,402		4,764		2,102		24,268
Commercial real estate		169,093		67,305		10,493		246,891
Commercial real estate construction		6,197		2,715		1,134		10,046
Total commercial loans	$	192,692	$	74,784	$	13,729	$	281,205

	2010
	Residential Mortgage & Consumer Loans - Performing/Nonperforming
(In thousands)	Performing		Nonperforming		Total
Residential mortgage loans
Residential mortgages	$	114,716	$	2,453	$	117,169
Residential construction		2,711		-		2,711
Purchased residential mortgages		5,888		2,632		8,520
Total residential mortgage loans	$	123,315	$	5,085	$	128,400
Consumer loans
Home equity	$	54,024	$	249	$	54,273
Consumer other		1,644		-		1,644
Total consumer loans	$	55,668	$	249	$	55,917
Total loans					$	615,936

	2009
	SBA, SBA 504 & Commercial Loans - Internal Risk Ratings
(In thousands)	Pass		Special Mention		Substandard		Total
SBA loans	$	57,725	$	18,506	$	23,019	$	99,250
SBA 504 loans		35,984		18,770		15,929		70,683
Commercial loans
Commercial other		18,421		4,442		2,554		25,417
Commercial real estate		183,579		45,499		27,086		256,164
Commercial real estate construction		2,974		5,911		3,273		12,158
Total commercial loans	$	204,974	$	55,852	$	32,913	$	293,739

	2009
	Residential Mortgage & Consumer Loans - Performing/Nonperforming
(In thousands)	Performing		Nonperforming		Total
Residential mortgage loans
Residential mortgages	$	115,587	$	5,078	$	120,665
Residential construction		3,353		-		3,353
Purchased residential mortgages		8,541		500		9,041
Total residential mortgage loans	$	127,481		5,578	$	133,059
Consumer loans
Home equity	$	57,756	$	387	$	58,143
Consumer other		2,142		-		2,142
Total consumer loans	$	59,898	$	387	$	60,285
Total loans					$	657,016

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Nonperforming and past due loans: Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to the contractual terms is in doubt.  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 generally represent loans that are well collateralized and in a continuing process that is expected to result in repayment or restoration to current status.

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 have 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.  

The following tables set forth an aging analysis of past due and nonaccrual loans as of December 31, 2010 and December 31, 2009:

	2010
(In thousands)	30-59 Days Past Due		60-89 Days Past Due		90+ Days and Still Accruing		Nonaccrual		Total Past Due		Current		Total Loans
SBA loans	$	1,297	$	1,181	$	374	$	8,162	$	11,014	$	75,124	$	86,138
SBA 504 loans		-		1,339		-		2,714		4,053		60,223		64,276
Commercial loans
Commercial other		693		86		-		179		958		23,310		24,268
Commercial real estate		3,051		176		-		4,139		7,366		239,525		246,891
Commercial real estate contruction		-		-		-		1,134		1,134		8,912		10,046
Residential mortgage loans
Residential mortgages		2,123		144		-		2,453		4,720		112,449		117,169
Residential construction		-		-		-		-		-		2,711		2,711
Purchased residential mortgages		117		-		-		2,632		2,749		5,771		8,520
Cosumer loans
Home equity		175		325		-		249		749		53,524		54,273
Consumer other		5		-		-		-		5		1,639		1,644
Total loans	$	7,461	$	3,251	$	374	$	21,662	$	32,748	$	583,188	$	615,936

	2009
(In thousands)	30-59 Days Past Due		60-89 Days Past Due		90+ Days and Still Accruing		Nonaccrual		Total Past Due		Current		Total Loans
SBA loans	$	3,508	$	995	$	592	$	6,559	$	11,654	$	87,596	$	99,250
SBA 504 loans		2,963		1,614		-		5,575		10,152		60,531		70,683
Commercial loans
Commercial other		789		-		150		617		1,556		23,861		25,417
Commercial real estate		3,287		4,335		319		5,977		13,918		242,246		256,164
Commercial real estate construction		-		339		-		803		1,142		11,016		12,158
Residential mortgage loans
Residential mortgages		2,246		103		1,196		5,078		8,623		112,042		120,665
Residential construction		-		-		-		-		-		3,353		3,353
Purchased residential mortgages		469		1,671		-		500		2,640		6,401		9,041
Consumer loans
Home equity		400		-		-		387		787		57,356		58,143
Consumer other		9		-		29		-		38		2,104		2,142
Total loans	$	13,671	$	9,057	$	2,286	$	25,496	$	50,510	$	606,506	$	657,016

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Impaired Loans: The Company has defined impaired loans to be all nonperforming loans and troubled debt restructurings.  Impairment is evaluated in total for smaller-balance loans of a similar nature, (consumer and residential mortgage loans), and on an individual basis for other loans.  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, such as a below market interest rate, extending the maturity of a loan, or a combination of both.  At December 31, 2010, there were fifteen loans totaling $14.1 million that were classified as TDRs by the Company and are deemed impaired, compared to four loans totaling $6.6 million at December 31, 2009.  TDRs are not included in the nonperforming loan figures listed above, as they continue to perform under their modified terms.

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 The following tables provide detail on the Company’s impaired loans as of December 31, 2010 and 2009:

	2010
(In thousands)	Recorded Investment (Balance less specific reserves)			Outstanding Principal Balance		Related Allowance		Average Recorded Investment		Lost Interest on Impaired Loans		Interest Income Collected on Impaired Loans
With no related allowance:
SBA loans(1)		$	2,362	$	2,362	$	-
SBA 504 loans			8,145		8,145		-
Commercial loans
Commercial other			179		179		-
Commercial real estate			7,891		7,891		-
Total commercial loans			8,070		8,070		-
Total impaired loans with no related allowance		$	18,577	$	18,577	$	-
With an allowance:
SBA loans(1)		$	2,765	$	4,526	$	1,761
SBA 504 loans			2,390		2,477		87
Commercial loans
Commercial real estate			764		990		226
Commercial real estate construction			751		1,134		383
Total commercial loans			1,515		2,124		609
Total impaired loans with a related allowance		$	6,670	$	9,127	$	2,457
Total individually evaluated impaired loans:
SBA loans(1)		$	5,127	$	6,888	$	1,761	$	6,792	$	317	$	234
SBA 504 loans			10,535		10,622		87		6,454		133		69
Commercial loans
Commercial other			179		179		-		425		16		1
Commercial real estate			8,655		8,881		226		10,964		367		143
Commercial real estate construction			751		1,134		383		813		84		47
Total commercial loans			9,585		10,194		609		12,202		467		191
Total individually evaluated impaired loans		$	25,247	$	27,704	$	2,457	$	25,448	$	917	$	494
Homogeneous loans collectively evaluated for impairment:
Residential mortgage loans
Residential mortgages		$	2,453	$	2,453	$	-	$	4,632	$	147	$	-
Purchased mortgages			2,632		2,632		-		1,897		136		-
Total residential mortgage loans			5,085		5,085		-		6,529		283		-
Consumer loans
Home equity			249		249		-		341		2		9
Total other homogeneous loans evaluated for impairment			5,334		5,334		-		6,870		285		9
Total impaired loans		$	30,581	$	33,038	$	2,457	$	32,318	$	1,202	$	503
(1) Balances are reduced by amount guaranteed by the Small Business Administration

	2009
(In thousands)	Recorded Investment (Balance less specific reserves)			Outstanding Principal Balance			Related Allowance			Average Recorded Investment			Lost Interest on Impaired Loans			Interest Income Collected on Impaired Loans
Total impaired loans with no related allowance		$	7,896		$	7,896		$	-
Total impaired loans with a related allowance			21,712			24,176			2,464
Total impaired loans		$	29,608		$	32,072		$	2,464		$	26,775		$	1,967		$	388

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7.Premises and Equipment

The detail of premises and equipment as of December 31, 2010 and 2009 is as follows:

(In thousands)		2010			2009
Land and buildings	$	10,606		$	10,497
Furniture, fixtures and equipment		6,724			6,488
Leasehold improvements		2,463			2,431
Gross premises and equipment		19,793			19,416
Less:  Accumulated depreciation		(8,826	)		(7,643	)
Net premises and equipment	$	10,967		$	11,773

Amounts charged to noninterest expense for depreciation of premises and equipment amounted to $1.2 million in 2010 and $1.3 million in 2009.

The Company currently accounts for all of its leases as operating leases.  In addition, the Company has one lease with a related party.  The Company leases its Clinton, New Jersey headquarters from a partnership in which two Board members, Messrs. D. Dallas and R. Dallas are partners. Under the lease for the facility, the partnership received aggregate rental payments of $410 thousand in 2010 and $400 thousand in 2009.  This lease was renegotiated in 2009 and the Company believes that rental payments reflect market rents and that the lease reflects terms that are comparable to those which could have been obtained in a lease with an unaffiliated third party.  This lease has a five-year term, expiring at the end of 2013.  After year one, the annual base rent of $400 thousand per annum is increased each year by the increase in the Consumer Price Index (“CPI”) for the New York Metropolitan area (not to exceed 3 percent).

8.Other Assets

The detail of other assets as of December 31, 2010 and 2009 is as follows:

(In thousands)	2010		2009
SBA servicing assets	$	512	$	897
Net receivable due from SBA		463		354
Prepaid expenses		378		363
Taxes receivable		-		268
Other		835		831
Total other assets	$	2,188	$	2,713

9.Deposits

The following schedules detail the maturity distribution of time deposits:

(In thousands)	3 months or less		More than 3 months through 6 months		More than 6 months through 12 months		More than 12 months		Total
At December 31, 2010
$100,000 or more	$	19,248	$	6,227	$	12,903	$	22,736	$	61,114
Less than $100,000		23,235		12,586		30,049		53,608		119,478
At December 31, 2009
$100,000 or more	$	40,726	$	17,523	$	19,819	$	30,314	$	108,382
Less than $100,000		42,896		17,257		44,066		79,158		183,377

(In thousands)	2011		2012		2013		2014		2015		Thereafter
Balance Maturing	$	104,248	$	42,032	$	23,052	$	6,571	$	4,365	$	324

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10. Borrowed Funds and Subordinated Debentures

The following tables present the period-end and average balances of borrowed funds and subordinated debentures for the last two years with resultant rates, as well as expected maturities over the next five years:

	2010					2009
(In thousands)	Amount		Rate			Amount		Rate
FHLB borrowings and repurchase agreements :
At December 31,	$	60,000		3.94	%	$	70,000		4.08	%
Year-to-date average		69,671		4.08			80,048		3.63
Maximum outstanding		70,000					121,000
Repurchase agreements:
At December 31,	$	15,000		3.67	%	$	15,000		3.67	%
Year-to-date average		15,000		3.65			16,890		3.59
Maximum outstanding		15,000					25,000
Subordinated debentures:
At December 31,	$	15,465		5.49	%	$	15,465		5.35	%
Year-to-date average		15,465		5.50			15,465		5.47
Maximum outstanding		15,465					15,465

(In thousands)	2011		2012		2013		2014		2015		Thereafter
FHLB borrowings and repurchase agreements	$	-	$	-	$	-	$	-	$	10,000	$	50,000
Other repurchase agreements		-		-		-		-		-		15,000
Subordinated debentures		-		-		-		-		-		15,465
Total	$	-	$	-	$	-	$	-	$	10,000	$	80,465

FHLB Borrowings

FHLB borrowings at December 31, 2010 consisted of three $10.0 million advances and three $10.0 million repurchase agreements compared to four $10.0 million advances and three $10.0 million repurchase agreements at December 31, 2009.  The terms of these transactions are as follows:

·   The FHLB advance that was issued on April 27, 2005 has a fixed rate of 3.70 percent, matures on April 27, 2015 and is callable on April 27, 2008 and quarterly thereafter on the 27th of July, October, January and April.

·   The FHLB advance that was issued on December 19, 2000 had a fixed rate of interest at 4.92 percent, matured on December 20, 2010 and was callable quarterly on the 19th of March, June, September and December.

·   The FHLB advance that was issued on November 2, 2006 has a fixed rate of 4.03 percent, matures on November 2, 2016 and is callable on November 2, 2007 and quarterly thereafter on the 2nd of February, May, August and November.

·   The FHLB advance that was issued on August 10, 2007 has a fixed rate of 4.23 percent, matures on August 10, 2017 and is callable on August 10, 2009 and quarterly thereafter on the 10th of November, February, May and August.

·   The FHLB repo-advance that was issued on December 15, 2006 has a fixed rate of 4.13 percent, matures on December 15, 2016 and is callable on December 15, 2008 and quarterly thereafter on the 15th of March, June, September and December.

·   The FHLB repo-advance that was issued on April 5, 2007 has a fixed rate of 4.21 percent, matures on April 5, 2017 and is callable on April 5, 2009 and quarterly thereafter on the 5th of July, October, January and April.

·   The FHLB repo-advance that was issued on December 20, 2007 has a fixed rate of 3.34 percent, matures on December 20, 2017 and is callable on December 20, 2010 and quarterly thereafter on the 20th of March, June, September and December.

Due to the call provisions of these advances, the expected maturity could differ from the contractual maturity.

Repurchase Agreements

At December 31, 2010 and 2009, the Company was a party to the following Repurchase Agreement:

·   A $15.0 million repurchase agreement that was entered into in February 2008 has a term of 10 years expiring on February 28, 2018, and a rate of 3.67 percent.  The borrowing may be called by the issuer on the repurchase date of May 29, 2008 and quarterly thereafter.

Due to the call provisions of these advances, the expected maturity could differ from the contractual maturity.

Subordinated Debentures

At December 31, 2010 and 2009, the Company was a party in the following subordinated debenture transactions:

·   On July 24, 2006, Unity (NJ) Statutory Trust II, a statutory business trust and wholly-owned subsid-

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iary of Unity Bancorp, Inc., issued $10.0 million of floating rate capital trust pass through securities to investors due on July 24, 2036. The subordinated debentures are redeemable in whole or part, prior to maturity but after July 24, 2011. The floating interest rate on the subordinated debentures is the three-month LIBOR plus 159 basis points and reprices quarterly.  The floating interest rate at December 31, 2010 was 1.89 percent and 1.84 percent at December 31, 2009.

·   On December 19, 2006, Unity (NJ) Statutory Trust III, a statutory business trust and wholly-owned subsidiary of Unity Bancorp, Inc., issued $5.0 million of floating rate capital trust pass through securities to investors due on December 19, 2036. The subordinated debentures are redeemable in whole or part, prior to maturity but after December 19, 2011. The floating interest rate on the subordinated debentures is the three-month LIBOR plus 165 basis points and reprices quarterly.  The floating interest rate at December 31, 2010 was 1.95 percent and 1.91 percent at December 31, 2009.

·   In connection with the formation of the statutory business trusts, the trusts also issued $465 thousand of common equity securities to the Company, which together with the proceeds stated above were used to purchase the subordinated debentures, under the same terms and conditions.

The rates paid on subordinated debentures which are presented in the table on page 48 include the cost of the related interest rate swap agreements.  These agreements provide for the Company to receive variable rate payments based on the three-month LIBOR index in exchange for making payments at afixed rate.  For additional information, see Note 12 “Derivative Instruments and Hedging Activities”.

The Company has the ability to defer interest payments on the subordinated debentures for up to five years without being in default.

The capital securities in each of the above transactions have preference over the common securities with respect to liquidation and other distributions and qualify as Tier I capital. Under the terms of the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act, these securities will continue to qualify as Tier 1 capital as the Company has less than $10 billion in assets.  In accordance with FASB ASC Topic 810, “Consolidation,” the Company does not consolidate the accounts and related activity of Unity (NJ) Statutory Trust II and Unity (NJ) Statutory Trust III.  The additional capital from each of these transactions was used to bolster the Company’s capital ratios and for general corporate purposes, including among other things, capital contributions to Unity Bank.

Due to the redemption provisions of these securities, the expected maturity could differ from the contractual maturity.

11. Commitments and Contingencies

Facility Lease Obligations

The Company operates sixteen branches, nine branches under operating leases, including its headquarters, and seven branches are owned.  In addition, the Company has a lease on one other location, which is subleased to a third party, with the third party paying rent in an amount equal to the Company’s rental obligation under the lease agreement between the Company and the lessor.  The leases’ contractual expiration range is generally between the years 2011 and 2015.  The following schedule summarizes the contractual rent payments for the future years.

(In thousands)	Operating Lease Rental Payments		Rent from Sublet Locations		Net Rent Obligation
2011		1,112		77		1,035
2012		1,054		-		1,054
2013		1,028		-		1,028
2014		274		-		274
2015		17		-		17
Thereafter		-		-		-

Rent expense totaled $1.1 million for 2010 and 2009.  The Company currently accounts for all of its leases as operating leases.

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.

Commitments to Borrowers

Commitments to extend credit are legally binding loan commitments with set expiration dates.  They are intended to be disbursed, subject to certain conditions, upon the request of the borrower.  The Company was committed to advance approximately $66.0 million to its borrowers as of December 31, 2010, compared to $76.2 million at December 31, 2009.  At December 31, 2010, $17.2 million of these commitments expire after one year, compared to $32.7 million a year earlier.  At December 31, 2010, the Company had $1.5 million in standby letters of credit compared to $6.4 million at December 31, 2009.  The estimated fair value of these guarantees is not significant.  The Company believes it has the necessary liquidity to honor all commitments.

12. Derivative Instruments and Hedging Activities

Derivative Financial Instruments

The Company has stand alone derivative financial instruments in the form of interest rate swap agreements, which derive their value from underlying interest rates.  These transactions involve both credit and market risk.  The notional amounts are amounts on which calculations, payments, and the value of the derivatives are based.  Notional amounts do not represent direct credit exposures.  Direct credit exposure is limited to the net difference between the

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calculated amounts to be received and paid, if any.  Such difference, which represents the fair value of the derivative instruments, is reflected on the Company’s balance sheet as other assets or other liabilities.

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

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

Risk Management Policies – Hedging Instruments

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

Interest Rate Risk Management – Cash Flow Hedging Instruments

The Company has long-term variable rate debt as a source of funds for use in the Company’s lending and investment activities and for other general business purposes.  These debt obligations expose the Company to variability in interest payments due to changes in interest rates.  If interest rates increase, interest expense increases.  Conversely, if interest rates decrease, interest expense decreases.  Management believes it is prudent to limit the variability of a portion of its interest payments and, therefore, hedged a portion of its variable-rate interest payments.  To meet this objective, management entered into interest rate swap agreements whereby the Company receives variable interest rate payments and makes fixed interest rate payments during the contract period.At December 31, 2010 and 2009, the information pertaining to outstanding interest rate swap agreements used to hedge variable rate debt is as follows:

(In thousands, except percentages and years)		2010			2009
Notional amount	$	15,000		$	15,000
Weighted average pay rate		4.05	%		4.05	%
Weighted average receive rate (three-month LIBOR)		0.34	%		0.90	%
Weighted average maturity in years		0.90			1.90
Unrealized loss relating to interest rate swaps	$	(499	)	$	(777	)

These agreements provided for the Company to receive payments at a variable rate determined by a specific index (three-month LIBOR) in exchange for making payments at a fixed rate.

At December 31, 2010 and 2009, the net unrealized loss relating to interest rate swaps was recorded as a derivative liability.  Changes in the fair value of interest rate swaps designated as hedging instruments of the variability of cash flows associated with long-term debt are reported in other comprehensive income.  The net spread between the fixed rate of interest which is paid and the variable interest received is classified in interest expense as a yield adjustment in the same period in which the related interest on the long-term debt affects earnings.

13. Shareholders’ Equity

Shareholders’ equity increased $2.2 million to $70.1 million at December 31, 2010 due to net income of $2.2 million, $430 thousand from the issuance of common stock under employee benefit plans, $418 thousand in net unrealized gains on the available for sale securities portfolio, and $166 thousand in net unrealized gains on cash flow hedge derivatives, partially offset by $1.0 million in dividends accrued on preferred 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.

On October 3, 2008, Congress passed the Emergency Economic Stabilization Act of 2008 (“EESA”), which provided the U.S. Secretary of the Treasury with broad authority to implement certain actions to help restore stability and liquidity to the U.S. markets.  One of the programs resulting from the EESA was the Treasury’s Capital Purchase Program (“CPP”) which provided direct equity investment of perpetual preferred stock by the U.S. Treasury in qualified financial institutions.   This program was voluntary and requires an institution to comply with several restrictions and provisions, including limits on executive compensation, stock redemptions, and declaration of dividends.  The perpetual preferred stock has a dividend rate of 5 percent per year until the fifth anniversary of the Treasury investment and a dividend of 9 percent thereafter.  The Company received an investment in perpetual preferred stock of $20.6 million on December 5, 2008.  These proceeds were allocated between the preferred stock and warrants based on relative fair value in accordance with FASB ASC Topic 740, “Debt.”  The allocation of proceeds resulted in a discount on the preferred stock that is being accreted over five years.  The Company issued 764,778 common stock warrants to the U.S. Treasury and $2.6 million of the proceeds were allocated to the warrants.  The warrants are accounted for as equity securities and have a contractual life of ten years and an exercise price of $4.05.

As part of the CPP, the Company’s future ability to pay cash dividends is limited for so long as the Treasury holds the preferred stock.  As so limited, the Company may not increase its quarterly cash dividend above $0.05 per share, the quarterly rate in effect at the time the CPP program was

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announced, without the prior approval of the Treasury.  No dividends were paid in 2010 or 2009.  The Company is currently preserving capital and will resume paying dividends when earnings and credit quality improve.

      The Company has suspended its share repurchase program, as required by the CPP and consequently, there were no shares repurchased in 2010 or 2009.  On October 21, 2002, the Company authorized the repurchase of up to 10% of its outstanding common stock.  The amount and timing of purchases would be 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.  As of December 31, 2010, the Company had repurchased a total of 556 thousand shares, of which 131 thousand shares have been retired, leaving 153 thousand shares remaining to be repurchased under the plan when it is reinstated.

14. Other Income

The components of other income for the years ended December 31, 2010 and 2009 are as follows:

(In thousands)	2010		2009
ATM and check card fees	$	267	$	203
Wire transfer fees		81		76
Safe deposit box fees		53		52
Other		318		101
Total other income	$	719	$	432

15. Other Expenses

The components of other expenses for the years ended December 31, 2010 and 2009 are as follows:

(In thousands)	2010		2009
Travel, entertainment, training and recruiting	$	603	$	618
Director fees		346		339
Insurance		325		312
Stationery and supplies		221		209
Other		262		246
Total other expenses	$	1,757	$	1,724

16. Income Taxes

The components of the provision (benefit) for income taxes are as follows:

(In thousands)		2010			2009
Federal – current provision	$	1,212		$	973
Federal – deferred benefit		(530	)		(1,099	)
Total Federal provision (benefit)		682			(126	)
State – current provision		18			213
State – deferred benefit		(111	)		(985	)
Total State benefit		(93	)		(772	)
Total provision (benefit) for income taxes	$	589		$	(898	)

A reconciliation between the reported income tax provision (benefit) and the amount computed by multiplying income before taxes by the statutory Federal income tax rate is as follows:

(In thousands)		2010			2009
Federal income tax provision (benefit) at statutory rate	$	962		$	(673	)
Increases (decreases) resulting from:
Tax-exempt interest		(105	)		(88	)
Bank owned life insurance		(68	)		(75	)
Meals and entertainment		15			15
True up to return		(180	)		-
State income taxes, net of federal income tax effect		86			-
Other, net		(121	)		(77	)
Provision (benefit) for income taxes	$	589		$	(898	)
Effective tax rate		20.8	%		46.0	%

Deferred income taxes are provided for temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities.  The components of the net deferred tax asset at December 31, 2010 and 2009 are as follows:

(In thousands)		2010			2009
Deferred tax assets:
Allowance for loan losses	$	5,737		$	5,438
Reserve for impaired securities		1,179			730
Lost interest on nonaccrual loans		855			1,102
State net operating loss		323			450
Stock-based compensation		290			242
Depreciation		240			65
Net unrealized cash flow hedge losses		199			311
Net unrealized security losses		-			13
Other		127			229
Gross deferred tax assets		8,950			8,580
Valuation allowance		(323	)		(450	)
Net deferred tax assets		8,627			8,130
Deferred tax liabilities:
Deferred loan costs		433			469
Net unrealized security gains		274			-
Goodwill		205			165
Bond accretion		165			188
Total deferred tax liabilities		1,077			822
Net deferred tax asset	$	7,550		$	7,308

The Company computes deferred income taxes under the asset and liability method.  Deferred income taxes are recognized for tax consequences of “temporary differences” by applying enacted statutory tax rates to differences between the financial reporting and the tax basis of existing assets and liabilities.  A deferred tax liability is recognized for all temporary differences that will result in future taxable income.  A deferred tax asset is recognized for all temporary differences that will result in future tax deductions subject to

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reduction of the asset by a valuation allowance.

During 2009, the Company established a $450 thousand valuation allowance for deferred tax assets related to its state net operating loss carry-forward deferred tax asset, the balance of which was $323 thousand at December 31, 2010 due to subsequent utilization of the net operating loss carry-forwards.  The Company’s state net operating loss carry-forwards totaled approximately $5.4 million at December 31, 2010 and $7.6 million at December 31, 2009 and expire between 2014 and 2029.

Included as a component of deferred tax assets is an income tax expense (benefit) related to unrealized losses on securities available for sale and cash flow hedges.  The after tax component of the unrealized gain on securities available for sale of $423 thousand and $5 thousand in 2010 and 2009, respectively, is included in other comprehensive income in shareholders’ equity.  In addition, other comprehensive income included $(300) thousand and $(466) thousand related to cash flow hedges at December 31, 2010 and 2009, respectively.

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.  The Company did not recognize or accrue any interest or penalties related to income taxes during the years ended December 31, 2010 and 2009.  The Company does not have an accrual for uncertain tax positions as of December 31, 2010 or 2009, 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 2006 and thereafter are subject to future examination by tax authorities.

17. Net Income per Share

The following is a reconciliation of the calculation of basic and dilutive income per share.

(In thousands, except per share amounts)	2010			2009
Net income (loss)	$	2,240	$	(1,081	)
Less: Preferred stock dividends and discount accretion		1,520		1,496
Income available (loss attributable) to common shareholders	$	720	$	(2,577	)
Weighted average common shares outstanding (basic)		7,173		7,121
Plus:  Potential dilutive common stock		274		-
Weighted average common shares outstanding (diluted)		7,447		7,121
Net income (loss) per common share -
Basic	$	0.10	$	(0.36	)
Diluted		0.10		(0.36	)
Stock options and common stock excluded from the income per share computation as their effect would have been anti-dilutive		444		1,403

The 2010 potential dilutive common stock figure shown in the prior table includes the dilutive impact of 764,778 common stock warrants issued to the U.S. Department of Treasury under the Capital Purchase Program in 2008.  During 2009, these common stock warrants were anti-dilutive and reported as such in the prior table.

18. 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, which meets the regulator’s highest performance and operation standards, maintain a minimum leverage ratio of 3 percent.  For those banks 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.

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The Company’s capital amounts and ratios for the last two years are presented in the following table.

	Actual					For Capital Adequacy Purposes					To Be Well-Capitalized Under Prompt Corrective Action Provisions
(In thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2010
Leverage ratio	$	83,550		9.97	%	≥ $ 33,531			4.00	%	≥ $ 41,914			N/A
Tier I risk-based capital ratio		83,550		13.04			25,628		4.00			38,442		N/A
Total risk-based capital ratio		91,638		14.30			51,257		8.00			64,071		N/A
As of December 31, 2009
Leverage ratio	$	81,824		8.83	%	≥ $ 37,058			4.00	%	≥ $ 46,323			N/A
Tier I risk-based capital ratio		81,824		11.75			27,852		4.00			41,778		N/A
Total risk-based capital ratio		90,592		13.01			55,704		8.00			69,630		N/A

The Bank’s capital amounts and ratios for the last two years are presented in the following table.

	Actual					For Capital Adequacy Purposes					To Be Well-Capitalized Under Prompt Corrective Action Provisions
(In thousands)	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2010
Leverage ratio	$	71,053		8.48	%	≥ $ 33,497			4.00	%	≥ $ 41,871			5.00	%
Tier I risk-based capital ratio		71,053		11.10			25,595		4.00			38,393		6.00
Total risk-based capital ratio		87,631		13.69			51,191		8.00			63,988		10.00
As of December 31, 2009
Leverage ratio	$	68,299		7.38	%	≥ $ 37,020			4.00	%	≥ $ 46,275			5.00	%
Tier I risk-based capital ratio		68,299		9.82			27,815		4.00			41,722		6.00
Total risk-based capital ratio		85,555		12.30			55,630		8.00			69,537		10.00

19. Employee Benefit Plans

The Bank has a 401(k) savings plan covering substantially all employees.  Under the Plan, an employee can contribute up to 80 percent of their salary on a tax deferred basis.  The Bank may also make discretionary contributions to the Plan.  The Bank contributed $211 thousand and $192 thousand to the Plan in 2010 and 2009, respectively.

The Company has a deferred fee plan for Directors and executive management.  Directors of the Company have the option to elect to defer up to 100% of their respective retainer and Board of Director fees, and each member of executive management has the option to elect to defer 100% of their year-end cash bonuses.  Director and executive deferred fees totaled $15 thousand in 2010 and $14 thousand in 2009, and the interest paid on deferred balances totaled $14 thousand in 2010 and $13 thousand in 2009.

Certain members of management are also enrolled in a split-dollar life insurance plan with a post retirement death benefit of $250 thousand.  Total expenses related to this plan were $40 thousand in 2010.  There were no expenses in 2009.

The Company has incentive and nonqualified option plans, which allow for the grant of options to officers, employees and members of the Board of Directors.  In addition, restricted stock is issued under the stock bonus program to reward employees and directors and to retain them by distributing stock over a period of time.

The Bank does not currently provide any other post retirement or post employment benefits to its employees other than the plans mentioned above.

Stock Option Plans

Grants under the Company’s incentive and nonqualified option plans generally vest over 3 years and must be exercised within 10 years of the date of grant.  The exercise price of each option is the market price on the date of grant.  As of December 31, 2010, 1,520,529 shares have been reserved for issuance upon the exercise of options, 775,468 option grants are outstanding, and 717,204 option grants have been exercised, forfeited or expired, leaving 27,857 shares available for grant.

The Company granted no options in 2010 as compared to 59,250 options in 2009.  The fair value of the options

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 granted in 2009 was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

	2010			2009
Number of options granted		-			59,250
Weighted average exercise price	$	-		$	3.98
Weighted average fair value of options	$	-		$	1.86
Expected life (years)		-			4.26
Expected volatility		-	%		57.37	%
Risk-free interest rate		-	%		1.73	%
Dividend yield		-	%		-	%

The expected life of the options was estimated based on historical employee behavior and represents the period of time that options granted are expected to be outstanding.  Expected volatility of the Company’s stock price was based on the historical volatility over the period commensurate with the expected life of the options.  The risk-free interest rate is the U.S. Treasury rate commensurate with the expected life of the options on the date of grant.  The expected dividend yield is the projected annual yield based on the grant date stock price.

FASB ASC Topic 718, “Compensation - Stock Compensation,” requires an entity to recognize the fair value of equity awards as compensation expense over the period during which an employee is required to provide service in exchange for such an award (vesting period).  Compensation expense related to stock options totaled $202 thousand and $156 thousand in 2010 and 2009, respectively.  The related income tax benefit was approximately $80 thousand and $58 thousand in 2010 and 2009, respectively.  As of December 31, 2010, unrecognized compensation costs related to nonvested share-based compensation arrangements granted under the Company’s stock option plans totaled approximately $115 thousand.  That cost is expected to be recognized over a weighted average period of 1.5 years.

Transactions under the Company’s stock option plans for the last two years are summarized in the following table:

	Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)	Aggregate Intrinsic Value
Outstanding at December 31, 2008	871,422		$	5.94	5.0	$	252,815
Options granted	59,250			3.98
Options exercised	(3,261	)		2.70
Options forfeited	(1,267	)		5.38
Options expired	(39,858	)		7.91
Outstanding at December 31, 2009	886,286		$	5.73	4.6	$	293,911
Options granted	-			-
Options exercised	(80,626	)		2.79
Options forfeited	(5,524	)		4.44
Options expired	(24,668	)		10.37
Outstanding at December 31, 2010	775,468		$	5.90	3.9	$	1,049,184
Exercisable at December 31, 2010	690,338		$	6.06	3.4	$	903,094

The following table summarizes information about stock options outstanding at December 31, 2010:

		Options Outstanding						Options Exercisable
Range of Exercise Prices		Shares Outstanding		Weighted Average Remaining Contractual Life (in years)		Weighted Average Exercise Price		Shares Exercisable		Weighted Average Exercise Price
$	0.00 - 4.00		332,821		3.6	$	3.45		271,326	$	3.34
	4.01 - 8.00		248,163		4.2		5.73		224,528		5.67
	8.01 - 12.00		129,022		3.2		9.20		129,022		9.20
	12.01 - 16.00		65,462		5.9		12.55		65,462		12.55
Total			775,468		3.9	$	5.90		690,338	$	6.06

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The following table presents information about options exercised:

	2010		2009
Number of options exercised		80,626		3,261
Total intrinsic value of options exercised	$	136,723	$	4,659
Cash received from options exercised		93,721		8,814
Tax deduction realized from options exercised		54,607		1,861

Upon exercise, the Company issues shares from its authorized but unissued, common stock to satisfy the options.

Restricted Stock Awards

Restricted stock awards granted to date vest over a period of 4 years and are recognized as compensation to the recipient over the vesting period.  The awards are recorded at fair market value and amortized into salary expense on a straight line basis over the vesting period.  As of December 31, 2010, 121,551 shares of restricted stock were reserved for issuance, of which 12,335 shares are available for grant.

Restricted stock awards granted during the past two years include:

Grant Year	Shares		Average Grant Date Fair Value
2010		13,200	$	5.30
2009		21,400	$	3.98

Compensation expense related to the restricted stock awards totaled $115 thousand in 2010 and $154 thousand in 2009.  As of December 31, 2010, there was approximately $165 thousand of unrecognized compensation cost related to nonvested restricted stock awards granted under the Company’s stock incentive plans.  That cost is expected to be recognized over a weighted average period of 2.9 years.

The following table summarizes nonvested restricted stock activity for the twelve months ended December 31, 2010:

	Shares			Average Grant Date Fair Value
Nonvested restricted stock at December 31, 2009		54,282		$	7.25
Granted		13,200			5.30
Vested		(21,688	)		9.03
Forfeited		(2,427	)		6.18
Nonvested restricted stock at December 31, 2010		43,367		$	5.83

20. Fair Value

Fair Value Measurement

The Company follows FASB ASC Topic 820, “Fair Value Measurement and Disclosures,” which requires additional disclosures about the Company’s assets and liabilities that are measured at fair value.  Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  In determining fair value, the Company uses various methods including market, income and cost approaches.  Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and or the risks inherent in the inputs to the valuation technique.  These inputs can be readily observable, market corroborated, or generally unobservable inputs.  The Company utilizes techniques that maximize the use of observable inputs and minimize the use of unobservable inputs.  Based on the observability of the inputs used in valuation techniques, the Company is required to provide the following information according to the fair value hierarchy.  The fair value hierarchy ranks the quality and reliability of the information used to determine fair values.  Financial assets and liabilities carried at fair value will be classified and disclosed as follows:

Level 1 Inputs

·   Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

·   Generally, this includes debt and equity securities and derivative contracts that are traded in an active exchange market (i.e. New York Stock Exchange), as well as certain U.S. Treasury, U.S. Government and sponsored entity mortgage-backed securities that are highly liquid and are actively traded in over-the-counter markets.

Level 2 Inputs

·   Quoted prices for similar assets or liabilities in active markets.

·   Quoted prices for identical or similar assets or liabilities in inactive markets.

·   Inputs other than quoted prices that are observable, either directly or indirectly, for the term of the asset or liability (i.e., interest rates, yield curves, credit risks, prepayment speeds or volatilities) or “market corroborated inputs.”

·   Generally, this includes U.S. Government and sponsored entity mortgage-backed securities, corporate debt securities and derivative contracts.

Level 3 Inputs

·   Prices or valuation techniques that require inputs that are both unobservable (i.e. supported by little or no market activity) and that are significant to the fair value of the assets or liabilities.

·   These assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

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Fair Value on a Recurring Basis

The following is a description of the valuation methodologies used for instruments measured at fair value:

Securities Available for Sale

The fair value of available for sale (“AFS”) securities is the market value based on quoted market prices for identical securities, when available, or market prices provided by recognized broker dealers (Level 1).  If listed prices or quotes are not available, fair value is based upon quoted market prices for similar or identical assets or other observable inputs (Level 2) or externally developed models that use unobservable inputs due to limited or no market activity of the instrument (Level 3).

As of December 31, 2010, the fair value of the Company’s AFS securities portfolio was $107.1 million.  Approximately 80 percent of the portfolio was made up of residential mortgage-backed securities, which had a fair value of $85.7 million at December 31, 2010.  Approximately $75.4 million of the residential mortgage-backed securities are guaranteed by the Government National Mortgage Association (“GNMA”), the Federal National Mortgage Association (“FNMA”) or the Federal Home Loan Mortgage Corporation (“FHLMC”).  The underlying loans for these securities are residential mortgages that are geographically dispersed throughout the United States.  All AFS securities were classified as Level 2 assets at December 31, 2010.  The valuation of AFS securities using Level 2 inputs was primarily determined using the market approach, which uses quoted prices for similar assets or liabilities in active markets and all other relevant information.  It includes model pricing, defined as valuing securities based upon their relationship with other benchmark securities.

Interest Rate Swap Agreements

Based on the complex nature of interest rate swap agreements, the markets these instruments trade in are not as efficient and are less liquid than that of Level 1 markets.  These markets do, however, have comparable, observable inputs in which an alternative pricing source values these assets or liabilities in order to arrive at a fair value.  The fair values of our interest swaps are measured based on the difference between the yield on the existing swaps and the yield on current swaps in the market (i.e. The Yield Book); consequently, they are classified as Level 2 instruments.

There were no changes in the inputs or methodologies used to determine fair value during the year ended

December 31, 2010 as compared to the year ended December 31, 2009.

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The tables below present the balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 2010 and December 31, 2009.

	As of December 31, 2010
(In thousands)	Level 1		Level 2		Level 3		Total
Financial Assets:
Securities available for sale:
U.S. government sponsored entities	$	-	$	6,462	$	-	$	6,462
State and political subdivisions		-		10,963		-		10,963
Residential mortgage-backed securities		-		85,741		-		85,741
Commercial mortgage-backed securities		-		1,826		-		1,826
Trust preferred securities		-		565		-		565
Other equities		-		1,574		-		1,574
Total securities available for sale		-		107,131		-		107,131
Financial Liabilities:
Interest rate swap agreements		-		499		-		499

	As of December 31, 2009
(In thousands)	Level 1		Level 2		Level 3		Total
Financial Assets:
Securities available for sale:
U.S. government sponsored entities	$	500	$	15,507	$	-	$	16,007
State and political subdivisions		-		2,942		-		2,942
Residential mortgage-backed securities		8,756		107,469		-		116,225
Commercial mortgage-backed securities		-		4,627		-		4,627
Trust preferred securities		-		390		-		390
Other equities		-		579		-		579
Total securities available for sale		9,256		131,514		-		140,770
Financial Liabilities:
Interest rate swap agreements		-		777		-		777

The changes in Level 1 assets and liabilities measured at fair value on a recurring basis as of December 31, 2010 are summarized as follows:

	As of December 31, 2010
(In thousands)	Securities Available for Sale
Beginning balance January 1, 2010	$	9,256
Total net gains (losses) included in:
Net income		-
Other comprehensive income		-
Purchases, sales, issuances and settlements, net		(500	)
Transfers in and/or out of Level 1 (a)		(8,756	)
Ending balance December 31, 2010	$	-

(a) Transferred from Level 1 to Level 2 because of lack of observable market data due to decreased market activity for these securities.  The transferred available for sale securities consisted entirely of residential mortgage-backed securities.

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The changes in Level 2 assets and liabilities measured at fair value on a recurring basis as of December 31, 2010 are summarized as follows:

	As of December 31, 2010
(In thousands)	Securities Available for Sale		Interest Rate Swap Agreements
Beginning balance January 1, 2010	$	131,514	$	777
Total net gains (losses) included in:
Net income		171		-
Other comprehensive income		705		(278	)
Purchases, sales, issuances and settlements, net		34,015		-
Transfers in and/or out of Level 2		8,756		-
Ending balance December 31, 2010	$	107,131	$	499

There were no gains or losses (realized or unrealized) included in earnings for assets and liabilities held at December 31, 2010 or December 31, 2009.

Fair Value on a Nonrecurring Basis

Certain assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).  The following is a description of the valuation methodologies used for instruments measured at fair value on a nonrecurring basis:

Other Real Estate Owned (“OREO”)

The fair value was determined using appraisals, which may be discounted based on management’s review and changes in market conditions (Level 3 Inputs).

Impaired Collateral-Dependent Loans

The fair value of impaired collateral-dependent loans is derived in accordance with FASB ASC Topic 310, “Receivables.”  Fair value is determined based on the loan’s observable market price or the fair value of the collateral.  The valuation allowance for impaired loans is included in the allowance for loan losses in the consolidated balance sheets.  During the twelve months ended December 31, 2010, the valuation allowance for impaired loans decreased $7 thousand to $2.5 million at December 31, 2010.  During the twelve months ended December 31, 2009, the valuation allowance for impaired loans increased $1.5 million from $957 thousand at December 31, 2008 to $2.5 million at December 31, 2009.

The following tables present the assets and liabilities carried on the balance sheet by caption and by level within the hierarchy (as described above) as of December 31, 2010 and December 31, 2009:

	As of December 31, 2010
(In thousands)	Level 1			Level 2		Level 3			Total		Total fair value gain (loss) during year ended December 31, 2010
Financial Assets:
Other real estate owned (“OREO”)		$	-	-			$	2,346	$	2,346		$	(807	)
Impaired collateral-dependent loans			-		-			6,054		6,054			(7	)

	As of December 31, 2009
(In thousands)	Level 1			Level 2		Level 3		Total		Total fair value loss during year ended December 31, 2009
Financial Assets:
Other real estate owned (“OREO”)		$	-	$	-	$	1,530	$	1,530		$	150
Impaired collateral-dependent loans			-	-			21,712		21,712			1,507

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Fair Value of Financial Instruments

FASB ASC Topic 825, “Financial Instruments,” requires the disclosure of the estimated fair value of certain financial instruments, including those financial instruments which the Company does not record at fair value. These estimated fair values as of December 31, 2010 and December 31, 2009 have been determined using available market information and appropriate valuation methodologies.  Considerable judgment is required to interpret market data to develop estimates of fair value.  The estimates presented are not necessarily indicative of amounts the Company could realize in a current market exchange.  The use of alternative market assumptions and estimation methodologies could have had a material effect on these estimates of fair value.  The methodology for estimating the fair value of financial assets and liabilities that are measured on a recurring or nonrecurring basis are discussed above.  The following methods and assumptions were used to estimate the fair value of other financial instruments for which it is practicable to estimate that value:

Cash and Cash Equivalents

For these short-term instruments, the carrying value is a reasonable estimate of fair value.

Loans

The fair value of loans is estimated by discounting the future cash flows using current market rates that reflect the interest rate risk inherent in the loan, except for previously discussed impaired loans.

Federal Home Loan Bank Stock

Federal Home Loan Bank stock is carried at cost.  Carrying value approximates fair value based on the redemption provisions of the issues.

Deposit Liabilities

The fair value of demand deposits and savings accounts is the amount payable on demand at the reporting date.  The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using current market rates.

Borrowed Funds & Subordinated Debentures

The fair value of borrowings is estimated by discounting the projected future cash flows using current market rates.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

Standby Letters of Credit

At December 31, 2010, the Bank had standby letters of credit outstanding of $1.5 million, as compared to $6.4 million at December 31, 2009.  The fair value of these commitments is nominal.

The table below presents the estimated fair values of the Company’s financial instruments as of December 31, 2010 and 2009:

	2010				2009
(In thousands)	Carrying  Amount		Estimated  Fair Value		Carrying  Amount		Estimated Fair Value
Financial assets:
Cash and cash equivalents	$	43,926	$	43,926	$	73,635	$	73,635
Securities available for sale		107,131		107,131		140,770		140,770
Securities held to maturity		21,111		21,351		28,252		28,406
Loans, net of allowance for possible loan losses		601,572		599,567		643,174		640,246
Federal Home Loan Bank stock		4,206		4,206		4,677		4,677
SBA servicing assets		512		512		897		897
Accrued interest receivable		3,791		3,791		4,225		4,225
Financial liabilities:
Deposits		654,788		634,713		758,239		739,909
Borrowed funds and subordinated debentures		90,465		103,704		100,465		113,227
Accrued interest payable		556		556		710		710
Interest rate swap agreements		499		499		777		777

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21.Condensed Financial Statements of Unity Bancorp, Inc.

(Parent Company Only)

Balance Sheets	December 31,
(In thousands)	2010		2009
Assets:
Cash	$	4,056	$	5,077
Securities available for sale		98		90
Capital note due from Bank		8,500		8,500
Investment in subsidiaries		72,888		69,806
Other assets		669		783
Total Assets	$	86,211	$	84,256
Liabilities & Shareholders’ Equity:
Other liabilities	$	661	$	926
Other borrowings		15,465		15,465
Shareholders’ equity		70,085		67,865
Total Liabilities & Shareholders’ Equity	$	86,211	$	84,256

Statements of Operations	Years ended December 31,
(In thousands)		2010			2009
Interest income	$	746		$	745
Interest expense		862			858
Net interest expense		(116	)		(113	)
Net security gains		-			2
Other expenses		21			19
Loss before income tax benefit and equity in undistributed net income (loss) of subsidiary		(137	)		(130	)
Income tax benefit		(45	)		(43	)
Loss before equity in undistributed net (loss) of subsidiary		(92	)		(87	)
Equity in undistributed net income (loss) of subsidiary		2,332			(994	)
Net income (loss)		2,240			(1,081	)
Preferred stock dividends and discount accretion		1,520			1,496
Income available (loss attributable) to common shareholders	$	720		$	(2,577	)

Statements of Cash Flows	Years ended December 31,
(In thousands)		2010			2009
Operating Activities:
Net income (loss)	$	2,240		$	(1,081	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Equity in undistributed net (income) loss of subsidiary		(2,332	)		994
Gains on sales of securities available for sale		-			(2	)
Net change in other assets and liabilities		9			21
Net cash used in operating activities		(83	)		(68	)
Investing Activities:
Sales and maturities of securities available for sale		-			17
Net cash provided by investing activities		-			17
Financing Activities:
Proceeds from issuance of common stock		94			9
Cash dividends on preferred stock		(1,032	)		(975	)
Net cash used in financing activities		(938	)		(966	)
Net decrease in cash and cash equivalents		(1,021	)		(1,017	)
Cash, beginning of year		5,077			6,094
Cash, end of year	$	4,056		$	5,077
Supplemental disclosures:  Interest paid	$	860		$	860

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22.Other Comprehensive Income (Loss)

(In thousands)	Pre-tax			Tax			After-tax
Net unrealized security gains (losses):
Balance at December 31, 2008							$	(1,728	)
Unrealized holding gain on securities arising during the period	$	1,821		$	266			1,555
Less: Reclassification adjustment for gains included in net income		855			286			569
Less: Reclassification adjustment for OTTI charges included in net income		(1,123	)		(376	)		(747	)
Net unrealized gain on securities arising during the period		2,089			356			1,733
Balance at December 31, 2009								5
Unrealized holding gain on securities arising during the period		790			315			475
Less: Reclassification adjustment for gains included in net income		85			28			57
Net unrealized gain on securities arising during the period		705			287			418
Balance at December 31, 2010							$	423
Net unrealized losses on cash flow hedges:
Balance at December 31, 2008							$	(628	)
Unrealized holding gain on cash flow hedges arising during the period	$	236		$	74			162
Balance at December 31, 2009								(466	)
Unrealized holding gain on cash flow hedges arising during the period		278			112			166
Balance at December 31, 2010								(300	)
Total Accumulated Other Comprehensive Income at December 31, 2010							$	123

Two securities with a market value of $1.9 million were transferred from the available for sale category to held to maturity during the third quarter of 2008, consistent with the Company’s intent and ability to hold these securities until maturity.  Unrealized losses at the date of transfer amounted to $1.1 million and were included in accumulated other comprehensive income as of December 31, 2008.  During 2009, other-than-temporary impairment charges were taken on these same two securities; therefore reversing the unrealized losses recorded in 2008 from other comprehensive income, as they were now realized losses.

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Quarterly Financial Information (Unaudited)

 The following quarterly financial information for the years ended December 31, 2010 and 2009 is unaudited.However, in the opinion of management, all adjustments, which include normal recurring adjustments necessary to present fairly the results of operations for the periods, are reflected.

(In thousands, except per share data)
2010	March 31		June 30		September 30		December 31
Total interest income	$	11,513	$	10,944	$	10,726	$	10,852
Total interest expense		4,049		3,681		3,314		2,991
Net interest income		7,464		7,263		7,412		7,861
Provision for loan losses		1,500		1,500		1,500		2,750
Net interest income after provision for loan losses		5,964		5,763		5,912		5,111
Total noninterest income		910		1,170		1,460		1,529
Total noninterest expense		5,941		6,040		6,404		6,605
Income before provision (benefit) for income taxes		933		893		968		35
Provision (benefit) for income taxes		185		212		242		(50	)
Net income		748		681		726		85
Preferred stock dividends and discount accretion		373		379		385		383
Income available (loss attributable) to common shareholders	$	375	$	302	$	341	$	(298	)
Net income (loss) per common share - Basic	$	0.05	$	0.04	$	0.05	$	(0.04	)
Net income (loss) per common share - Diluted	$	0.05	$	0.04	$	0.05	$	(0.04	)

(In thousands, except per share data)
2009	March 31		June 30			September 30				December 31
Total interest income	$	12,590	$	12,531			$	12,185		$	12,104
Total interest expense		5,816		5,673				5,327			4,766
Net interest income		6,774		6,858				6,858			7,338
Provision for loan losses		1,500		1,500				3,000			2,000
Net interest income after provision for loan losses		5,274		5,358				3,858			5,338
Total noninterest income (loss)		1,348		(907	)			1,162			537
Total noninterest expense		5,555		6,203				6,110			6,079
Income (loss) before provision (benefit) for income taxes		1,067		(1,752	)			(1,090	)		(204	)
Provision (benefit) for income taxes		336		(552	)			(343	)		(339	)
Net income (loss)		731		(1,200	)			(747	)		135
Preferred stock dividends and discount accretion		379		372				372			373
Income available (loss attributable) to common shareholders	$	352	$	(1,572	)		$	(1,119	)	$	(238	)
Net income (loss) per common share - Basic	$	0.05	$	(0.22	)		$	(0.16	)	$	(0.03	)
Net income (loss) per common share - Diluted	$	0.05	$	(0.22	)		$	(0.16	)	$	(0.03	)

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Selected Consolidated Financial Data

(In thousands)

At or for the years ended December 31,
	2010				2009			2008			2007			2006
Selected Results of Operations
Interest income	$	44,035		$	49,410		$	50,765		$	48,900		$	43,177
Interest expense		14,035			21,582			23,474			24,474			19,432
Net interest income		30,000			27,828			27,291			24,426			23,745
Provision for loan losses		7,250			8,000			4,500			1,550			1,550
Noninterest income		5,069			2,140			2,694			5,940			7,638
Noninterest expense		24,990			23,947			22,939			22,113			21,045
Provision (benefit) for income taxes		589			(898	)		616			1,978			2,943
Net income (loss)		2,240			(1,081	)		1,930			4,725			5,845
Preferred stock dividends and discount accretion		1,520			1,496			110			-			-
Income available (loss attributable) to common shareholders		720			(2,577	)		1,820			4,725			5,845
Per Share Data
Net income (loss) per common share - Basic	$	0.10		$	(0.36	)	$	0.26		$	0.65		$	0.81
Net income (loss) per common share - Diluted		0.10			(0.36	)		0.25			0.63			0.77
Book value per common share		7.08			6.91			6.99			6.70			6.34
Market value per common share		6.05			4.02			3.90			8.10			13.34
Cash dividends declared on common shares		-			-			0.10			0.19			0.18
Selected Balance Sheet Data
Assets	$	818,410		$	930,357		$	898,310		$	752,196		$	694,106
Loans		615,936			657,016			685,946			590,132			507,690
Allowance for loan losses		14,364			13,842			10,326			8,383			7,624
Securities		128,242			169,022			149,509			98,591			105,457
Deposits		654,788			758,239			707,117			601,268			566,465
Borrowed funds and subordinated debentures		90,465			100,465			120,465			100,465			79,744
Shareholders’ equity		70,085			67,865			67,803			47,260			46,228
Common shares outstanding		7,211			7,144			7,119			7,063			7,296
Performance Ratios
Return (loss) on average assets		0.26	%		(0.12	) %		0.23	%		0.66	%		0.90	%
Return (loss) on average equity		1.43			(5.29	)		3.72			10.11			13.56
Efficiency ratio		71.43			75.49			71.90			71.48			67.21
Net interest spread		3.41			2.87			3.13			3.07			3.33
Net interest margin		3.67			3.22			3.51			3.62			3.87
Asset Quality Ratios
Allowance for loan losses to loans		2.33	%		2.11	%		1.51	%		1.42	%		1.50	%
Allowance for loan losses to nonperforming loans		66.31			54.29			64.06			153.49			85.58
Nonperforming loans to total loans		3.52			3.88			2.35			0.93			1.75
Nonperforming assets to total loans and OREO		3.88			4.10			2.45			0.94			1.80
Nonperforming assets to total assets		2.93			2.90			1.87			0.74			1.31
Net charge-offs to average loans		1.05			0.67			0.40			0.14			0.17
Capital Ratios – Company
Leverage ratio		9.97	%		8.83	%		9.54	%		8.25	%		9.08	%
Tier I risk-based capital ratio		13.04			11.75			12.02			9.81			10.80
Total risk-based capital ratio		14.30			13.01			13.27			11.06			13.60
Capital Ratios – Bank
Leverage ratio		8.48	%		7.38	%		7.88	%		7.06	%		7.20	%
Tier I risk-based capital ratio		11.10			9.82			9.93			8.39			8.55
Total risk-based capital ratio		13.69			12.30			12.41			11.00			12.38

All share amounts have been adjusted for the 5% stock distributions paid on June 27, 2008, June 29, 2007, and June 30, 2006.

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