The following discussion and analysis of financial condition and results of operations should be read in conjunction with the 2011 consolidated audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011. When necessary, reclassifications have been made to prior period data throughout the following discussion and analysis for purposes of comparability. This Quarterly Report on Form 10-Q contains certain "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, which may be identified by the use of such words as "believe", "expect", "anticipate", "should", "planned", "estimated" and "potential". Examples of forward looking statements include, but are not limited to, estimates with respect to the financial condition, results of operations and business of Unity Bancorp, Inc. that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, in addition to those items contained in the Company's Annual Report on Form 10-K under Item IA-Risk Factors, as updated by our subsequent Quarterly Reports on Form 10-Q, the following: changes in general, economic, and market conditions, legislative and regulatory conditions, or the development of an interest rate environment that adversely affects Unity Bancorp, Inc.'s interest-rate spread or other income anticipated from operations and investments.

Overview

Unity Bancorp, Inc. (the "Parent Company") is incorporated in New Jersey and is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended. Its wholly-owned subsidiary, Unity Bank (the "Bank" or, when consolidated with the Parent Company, the "Company") was granted a charter by the New Jersey Department of Banking and Insurance and commenced operations on September 13, 1991. The Bank provides a full range of commercial and retail banking services through 15 branch offices located in Hunterdon, Somerset, Middlesex, Union and Warren counties in New Jersey, and Northampton County in Pennsylvania. These services include the acceptance of demand, savings, and time deposits and the extension of consumer, real estate, Small Business Administration and other commercial credits. Unity Investment Services, Inc., a wholly-owned subsidiary of the Bank, is used to hold part of the Bank's investment portfolio.

Unity (NJ) Statutory Trust II is a statutory business trust and wholly owned subsidiary of Unity Bancorp, Inc. On July 24, 2006, the Trust issued $10.0 million of trust preferred securities to investors. Unity (NJ) Statutory Trust III is a statutory business trust and wholly owned subsidiary of Unity Bancorp, Inc. On December 19, 2006, the Trust issued $5.0 million of trust preferred securities to investors. These floating rate securities are treated as subordinated debentures on the Company's financial statements. However, they qualify as Tier I Capital for regulatory capital compliance purposes, subject to certain limitations. The Company does not consolidate the accounts and related activity of any of its business trust subsidiaries.

Earnings Summary

Net income available to common shareholders totaled $509 thousand, or $0.07 per diluted share for the quarter ended March 31, 2012, compared to a net loss attributable to common shareholders of $164 thousand, or $0.02 per diluted share for the same period a year ago. The continued improvement in our operating results is the result of our strategic initiatives, including a reduction in the portfolio of loans outside our footprint, expansion of our in-market business relationships and further reduction of our cost of funds. Net interest income has been impacted by the sustained low interest rate environment, which the Federal Open Market Committee ("FOMC") forecasts will continue into 2014. This rate environment has resulted in a tighter net interest margin as our earning assets continue to re-price at lower rates. Partially offsetting these declines are lower funding costs. However, as the Bank has been steadily reducing rates on its deposit products, the reduction in yield on earning assets is anticipated to exceed the benefits of further declines in the cost of funds.

The Company's accomplishments during the first quarter of 2012 include the following:

· Noninterest income increased 36.7 percent over the same period in the prior year, due to increased gains on mortgage and SBA loan sales,
· Core deposits, which exclude time deposits, increased $8.6 million during the quarter, improving our deposit mix,
· Shareholders' equity increased $444 thousand from year-end 2011, primarily due to the increase in net income,

· Nonperforming assets decreased $2.0 million during the quarter, and
· The Company remains well-capitalized.

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

                                          For the three months ended March 31,
                                                    2012                   2011
Net income (loss) per common share -
Basic (1)                              $            0.07         $        (0.02 )
Net income (loss) per common share -
Diluted (1)                            $            0.07         $        (0.02 )
Return on average assets                            0.45 %                 0.11 %
Return (loss) on average common
equity (2)                                          3.81 %                (1.31 )%
Efficiency ratio                                   71.80 %                71.56 %

(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.

Our net interest income has been adversely impacted by the sustained low interest rate environment, which the Federal Open Market Committee ("FOMC") forecasts will continue into 2014. This rate environment has resulted in a tighter net interest margin as our earning assets continue to re-price at lower rates. Partially offsetting these declines are lower funding costs, however the reduction in yield on earning assets is anticipated to exceed the benefits of further declines in the cost of funds.

During the three months ended March 31, 2012, tax-equivalent interest income decreased $1.2 million or 11.4 percent to $9.1 million when compared to the same period in the prior year. This decrease was driven by the lower average yield on earning assets and a shift in the mix of earning assets as average loans decreased and Federal funds sold and interest-bearing deposits increased:

· Of the $1.2 million decrease in interest income on a tax-equivalent basis, $777 thousand was attributed to reduced yields on average interest-earning assets and $392 thousand was attributable to the decrease in volume of average interest-earning assets.
· The average volume of interest-earning assets decreased $697 thousand to $777.4 million for the first quarter of 2012 compared to $778.1 million for the same period in 2011. This was due primarily to a $27.9 million decrease in average loans, a $4.1 million decrease in average investment securities, and a $118 thousand decrease in Federal Home Loan Bank stock, partially offset by a $31.4 million increase in Federal funds sold and interest-bearing deposits.
· The yield on interest-earning assets decreased 63 basis points to 4.71 percent for the three months ended March 31, 2012 when compared to the same period in 2011, due to continued re-pricing in a lower overall interest rate environment. Yields on most earning assets, particularly those with variable rates, fell due to these lower market rates.

Total interest expense was $2.3 million for the three months ended March 31, 2012, a decrease of $517 thousand or 18.7 percent compared to the same period in 2011. 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 $517 thousand decrease in interest expense, $409 thousand was attributed to a decrease in the rates paid on interest-bearing liabilities and $108 thousand was due to the decrease in the volume of average interest-bearing liabilities.
· Interest-bearing liabilities averaged $639.7 million for the first quarter of 2012, a decrease of $18.7 million or 2.8 percent, compared to the first quarter of 2011. The decrease in interest-bearing liabilities was a result of a decrease in average time deposits and average savings deposits, partially offset by an increase in interest-bearing demand deposits.
· The average cost of interest-bearing liabilities decreased 29 basis points to 1.41 percent, primarily due to the repricing of deposits in a lower interest rate environment. The cost of interest-bearing deposits decreased 27 basis points to 1.03 percent for the first quarter of 2012 and the cost of borrowed funds and subordinated debentures decreased 50 basis points to 3.70 percent.
· 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 interest-bearing demand deposits.

During the quarter ended March 31, 2012, tax-equivalent net interest income amounted to $6.9 million, a decrease of $652 thousand or 8.7 percent when compared to the same period in 2011. Net interest margin decreased 36 basis points to 3.56 percent for the quarter ended March 31, 2012, compared to 3.92 percent for the same period in 2011. The net interest spread was 3.30 percent for the first quarter of 2012, a 34 basis point decrease from 3.64 for the same period in 2011.

The following table reflects the components of net interest income, setting forth for the periods presented herein: (1) average assets, liabilities and shareholders' equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) net interest spread (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.

Consolidated Average Balance Sheets

(Dollar amounts in thousands - interest amounts and interest rates/yields on a
fully tax-equivalent basis)
For the three months
ended March 31,                           2012                                         2011
                          Average                          Rate/       Average                          Rate/
                          Balance        Interest          Yield       Balance        Interest          Yield
ASSETS

Interest-earning
assets:
Federal funds sold
and interest-bearing
deposits                $  64,660      $       32           0.20 %   $  33,252      $       11           0.13 %
Federal Home Loan
Bank stock                  4,088              51           5.02         4,206              66           6.36
Securities:
Available for sale        102,101             782           3.06       105,027             912           3.47
Held to maturity           18,374             180           3.92        19,516             292           5.98
Total securities (A)      120,475             962           3.19       124,543           1,204           3.87
Loans, net of
unearned discount:
SBA                        71,760             924           5.15        85,861           1,236           5.76
SBA 504                    51,710             759           5.90        61,998             955           6.25
Commercial                284,237           4,183           5.92       282,605           4,306           6.18
Residential mortgage      132,824           1,655           4.98       130,745           1,831           5.60
Consumer                   47,608             560           4.73        54,849             686           5.07
Total loans (B)           588,139           8,081           5.52       616,058           9,014           5.91
Total
interest-earning
assets                  $ 777,362      $    9,126           4.71 %   $ 778,059      $   10,295           5.34 %
Noninterest-earning
assets:
Cash and due from
banks                      15,949                                       17,764
Allowance for loan
losses                    (16,788 )                                    (15,054 )
Other assets               40,287                                       39,767
Total
noninterest-earning
assets                     39,448                                       42,477
Total Assets            $ 816,810                                    $ 820,536

LIABILITIES AND
SHAREHOLDERS' EQUITY
Interest-bearing
liabilities:
Interest-bearing
demand deposits         $ 108,988      $      136           0.50 %   $ 103,550      $      139           0.54 %
Savings deposits          283,261             354           0.50       289,805             581           0.81
Time deposits             156,999             913           2.34       174,620           1,097           2.55
Total
interest-bearing
deposits                  549,248           1,403           1.03       567,975           1,817           1.30
Borrowed funds and
subordinated
debentures                 90,465             847           3.70        90,465             950           4.20
Total
interest-bearing
liabilities             $ 639,713      $    2,250           1.41 %   $ 658,440      $    2,767           1.70 %
Noninterest-bearing
liabilities:
Demand deposits           100,496                                       88,797
Other liabilities           3,249                                        3,530
Total
noninterest-bearing
liabilities               103,745                                       92,327
Shareholders' equity       73,352                                       69,769
Total Liabilities and
Shareholders' Equity    $ 816,810                                    $ 820,536
Net interest spread                    $    6,876           3.30 %                  $    7,528           3.64 %
Tax-equivalent basis
adjustment                                    (68 )                                        (53 )
Net interest income                    $    6,808                                   $    7,475
Net interest margin                                         3.56 %                                       3.92 %

(A) Yields related to securities exempt from federal and state income taxes are stated on a fully tax-equivalent basis. They are reduced by the nondeductible portion of interest expense, assuming a federal tax rate of 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.

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.

                           Three months ended March 31, 2012 versus March 31, 2011
                                     Increase (Decrease) Due to Change in
(In thousands on a
tax-equivalent basis)             Volume                    Rate                  Net
Interest Income:
Federal funds sold and
interest-bearing
deposits                 $            13         $             8         $         21
Federal Home Loan Bank
stock                                 (2 )                   (13 )                (15 )
Investment securities                (40 )                  (202 )               (242 )
Net loans                           (363 )                  (570 )               (933 )
Total interest income    $          (392 )       $          (777 )       $     (1,169 )
Interest Expense:
Interest-bearing
demand deposits          $             7         $           (10 )       $         (3 )
Savings deposits                     (13 )                  (214 )               (227 )
Time deposits                       (102 )                   (82 )               (184 )
Total deposits                      (108 )                  (306 )               (414 )
Borrowed funds and
subordinated
debentures                             -                    (103 )               (103 )
Total interest expense              (108 )                  (409 )               (517 )
Net interest income -
fully tax-equivalent     $          (284 )       $          (368 )       $       (652 )
Increase in
tax-equivalent
adjustment                                                                        (15 )
Net interest income                                                      $       (667 )

Provision for Loan Losses

The provision for loan losses totaled $1.2 million for the three months ended March 31, 2012, compared to $2.5 million for the three months ended March 31, 2011. Each period's loan loss provision is the result of management's analysis of the loan portfolio and reflects changes in the size and composition of the portfolio, the level of net charge-offs, delinquencies, current economic conditions and other internal and external factors impacting the risk within the loan portfolio. Additional information may be found under the captions "Financial Condition-Asset Quality" and "Financial Condition - Allowance for Loan Losses and Unfunded Loan Commitments." The current provision is considered appropriate under management's assessment of the adequacy of the allowance for loan losses.

Noninterest Income

Our noninterest income consists primarily of branch and loan fee income, gains on the sale of SBA and mortgage loans and BOLI income. For the three months ended March 31, 2012, noninterest income amounted to $1.7 million, an increase of $460 thousand from the prior year period. The increase during the three month-period was primarily due to increased gains on the sale of mortgage loans and securities.

The following table shows the components of noninterest income for the three three months ended March 31, 2012 and 2011:

                                               For the three months ended March
                                                              31,
(In thousands)                                        2012                  2011
Branch fee income                              $       386         $         344
Service and loan fee income                            302                   243
Gain on sale of SBA loans held for sale, net           157                   111
Gain on sale of mortgage loans, net                    411                   169
BOLI income                                             73                    73
Net security gains                                     224                   125
Other income                                           162                   190
Total noninterest income                       $     1,715         $       1,255

Changes in our noninterest income for the three months ended March 31, 2012 versus the three months ended March 31, 2011 reflect:

· Branch fee income, which consists of deposit service charges and overdraft fees, increased 12.2 percent as increased overdraft activity offset reduced deposit account service charges.
· Service and loan fee income increased $59 thousand due to higher servicing fee income, partially offset by reduced payoff charges and other processing fees.
· Gains on SBA loan sales amounted to $157 thousand on $1.9 million in sales and $111 thousand on $1.2 million in sales for the three months ended March 31, 2012 and 2011, respectively.
· Gains on the sale of mortgage loans amounted to $411 thousand, an increase of $242 thousand. This increase is directly related to the volume of mortgage loans originated and sold. Sales of mortgage loans totaled $21.2 million and $9.7 million for the three months ended March 31, 2012 and 2011, respectively.
· The increase in the cash surrender value of BOLI remained flat at $73 thousand.

· Net realized gains on the sale of securities amounted to $224 thousand and $125 thousand, respectively. For additional information, see Note 7 - Securities.
· Other income decreased $28 thousand when compared to the same period in the prior year.

Noninterest Expense
Total noninterest expense was $6.0 million for the first quarter of 2012, a
decrease of $199 thousand or 3.2 percent from the same period a year go.  This
decrease was due primarily to FDIC deposit insurance savings and reduced
occupancy expenses.

The following table presents a breakdown of noninterest expense for the three
months ended March 31, 2012 and 2011:

                                    For the three months ended March 31,
(In thousands)                              2012                         2011
Compensation and benefits       $          3,182         $              3,057
Occupancy                                    609                          720
Processing and communications                534                          507
Furniture and equipment                      362                          384
Professional services                        190                          202
Loan collection costs                        180                          224
OREO expenses                                124                          222
Deposit insurance                            171                          319
Advertising                                  146                          118
Other expenses                               461                          405
Total noninterest expense       $          5,959         $              6,158

Changes in noninterest expense for the three months ended March 31, 2012 versus the three months ended March 31, 2011 reflect:

· Compensation and benefits expense, the largest component of noninterest expense, increased $125 thousand, due to higher payroll expenses, mortgage origination commissions and equity compensation related costs.
· Occupancy expense decreased $111 thousand, as the mild winter resulted in lower snow removal costs and prior year branch closures resulted in lower rental and leasehold depreciation expenses.
· Processing and communications expenses increased $27 thousand. The increase was primarily due to increased ATM charges for card ordering.
· Furniture and equipment expense decreased $22 thousand. This decrease was primarily due to lower depreciation expenses as a result of lower capital expenditures, partially offset by losses on the disposal of furniture and equipment.
· Professional service fees decreased $12 thousand. This decrease was primarily due to lower expenses accrued for supervisory exams and legal fees.
· Loan collection costs decreased $44 thousand, due to lower loan legal, forced placed insurance and other collection related expenses.
· OREO expenses decreased $98 thousand, due to lower maintenance, utility and legal related expenses, partially offset by losses on the sale of OREO properties.
· Deposit insurance expense decreased $148 thousand. Effective April 1, 2011, the FDIC modified its assessment calculation method from a deposits-based method to an assets-based method. This resulted in a significantly lower assessment for the Company.
· Advertising expense increased $28 thousand. This increase is primarily due to heightened promotions related to the Company's opening of the new Washington branch and other increased marketing efforts.
· Other expenses increased $56 thousand, primarily due to an increased reserve for outstanding loan commitments, and higher NJ sales tax and insurance premiums.

For the quarter ended March 31, 2012, the Company reported income tax expense of $459 thousand for an effective tax rate of 33.7 percent, compared to an income tax benefit of $148 thousand in the prior year's quarter.

Total assets decreased $648 thousand or 0.1 percent, to $810.2 million at March 31, 2012, compared to $810.8 million at December 31, 2011. This decrease was partially due to a decrease of $10.8 million in cash and cash equivalents, and a decrease of $9.8 million in total loans, partially offset by a $20.5 million increase in securities. Total deposits decreased $870 thousand and there were no changes to borrowed funds and subordinated debentures. Total shareholders' equity increased $444 thousand over year-end 2011. These fluctuations are discussed in further detail in the paragraphs 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 obligations of U.S. Government sponsored entities, obligations of state and political subdivisions, mortgage-backed securities, trust preferred securities, corporate securities, asset-backed 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 obligations of state and political subdivisions and mortgage-backed securities.

AFS securities totaled $110.2 million at March 31, 2012, an increase of $21.4 million or 24.1 percent, compared to $88.8 million at December 31, 2011. This net increase was the result of the following:

. . .