UNTY - Unity Bancorp: Attractively Valued With A Flattish Earnings Outlook

• Strength in New Jersey’s markets will likely keep the loan growth in a double-digit range.
• The excess cash position presents an opportunity to improve the asset mix and expand the margin.
• Provisioning will likely normalize this year, which will restrict earnings growth.
• The December 2022 target price suggests a high upside from the current market price. Further, UNTY is offering a modest dividend yield.

Earnings of Unity Bancorp, Inc. ( UNTY ) will likely remain flattish this year. Strength in regional markets will likely drive loan growth this year, which will, in turn, boost earnings. On the other hand, the normalization of provisioning for expected loan losses will counter the benefit of loan growth. Overall, I'm expecting Unity Bancorp to report earnings of $3.44 per share for 2022, up by just 0.2% year-over-year. The year-end target price suggests a high upside from the current market price. Therefore, I'm adopting a buy rating on Unity Bancorp.

New Jersey's Markets to Play Pivotal Role in Loan Growth

Unity Bancorp's loan portfolio grew by a strong 3.2% in the first quarter of 2022, or 13% annualized. Loan growth will likely slow down in the remainder of the year because of high interest rates that should dampen demand, especially for residential mortgage loans.

Nevertheless, loan growth will likely remain in the double-digit range this year because of strength in the regional market. Unity Bancorp mostly caters to retail, corporate, and small businesses. Therefore, the purchasing managers’ index (“PMI”) is a good gauge of the credit demand of Unity Bancorp's customers. As shown below, the index has declined but remains well in the expansionary territory (above 50).

Residential mortgage loans are another big loan category for Unity Bancorp. The company operates in New Jersey; therefore, the state's unemployment rate and house price index are good indicators of credit demand for home purchases. Both metrics indicate satisfactory credit demand for the near future.

The unemployment rate for New Jersey is almost back to the pre-pandemic level, as shown below. This strength in the job market means more people will be able to afford their first homes.

Moreover, the prices of houses in New Jersey have increased sharply over the last couple of years, but the rate of growth is still below the national average.

Considering these factors, I'm expecting the loan portfolio to increase by 11.1% by the end of 2022 from the end of 2021. Meanwhile, I'm expecting deposit growth to match loan growth in the last three quarters of 2022. The following table shows my balance sheet estimates.

Actual earnings may differ materially from estimates because of the risks and uncertainties related to inflation, and consequently the timing and magnitude of interest rate hikes. Further, the threat of a recession can increase the provisioning for expected loan losses beyond my expectation.

Adopting a Buy rating

Unity Bancorp usually increases its dividend in the first quarter of every year. Therefore, there is little chance of a dividend hike in the remainder of this year. Assuming Unity maintains its dividend at $0.11 per share for the last two quarters of the year, the company will offer a different yield of 1.6% for 2022. This dividend estimate suggests a payout ratio of just 12.5% for 2022, which is close to the last five-year average of 14.4%.

I’m using the historical price-to-tangible book (“P/TB”) and price-to-earnings (“P/E”) multiples to value Unity Bancorp. The stock has traded at an average P/TB ratio of 1.40x in the past, as shown below.

The stock has traded at an average P/E ratio of around 9.9x in the past, as shown below.

Equally weighting the target prices from the two valuation methods gives a combined target price of $32.6 , which implies a 19.8% upside from the current market price. Adding the forward dividend yield gives a total expected return of 21.4%. Hence, I’m adopting a buy rating on Unity Bancorp.

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