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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the quarterly period ended June 30, 2014

o TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from ____________ to ___________

COMMISSION FILE NO. 000-50313

SURREY BANCORP

(Exact name of registrant as specified in its charter)

North Carolina
 
59-3772016
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)

145 North Renfro Street, Mount Airy, NC  27030

 (Address of principal executive offices)

(336) 783-3900

 (Registrant's telephone number)
 
Check whether the registrant: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 
Yes   x  No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes  x  No  o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 
Large accelerated filer
o
Accelerated filer
o
 
 
 
 
 
 
Non-accelerated filer
o
Smaller reporting company
x

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o   No  x

State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practical date:

On August 12, 2014 there were 3,542,984 common shares issued and outstanding.
 


PART I – FINANCIAL INFORMATION

Item 1.
Consolidated Financial Statements
 
 
 
 
 
3
 
 
 
 
4
 
 
 
 
5
 
 
 
 
6
 
 
 
 
7
 
 
 
 
8
 
 
 
 
9-23
 
 
 
Item 2.
24-31
 
 
 
Item 3.
32
 
 
 
Item 4.
33
 
 
 
PART II – OTHER INFORMATION
 
 
 
 
Item 1.
34
 
 
 
Item 1A.
34
 
 
 
Item 2.
34
 
 
 
Item 3.
34
 
 
 
Item 4.
34
 
 
 
Item 5.
34
 
 
 
Item 6.
34
 
 
 
35
 
 
 
CERTIFICATIONS
35-37

Consolidated Balance Sheets
June 30, 2014 (Unaudited) and December 31, 2013 (Audited)
 
 
 
June
   
December
 
 
 
2014
   
2013
 
 
 
   
 
Assets
 
   
 
Cash and due from banks
 
$
6,971,199
   
$
7,424,593
 
Interest-bearing deposits with banks
   
41,871,263
     
34,351,505
 
Federal funds sold
   
1,212,154
     
1,311,641
 
Investment securities available for sale
   
4,370,738
     
4,549,702
 
Restricted equity securities
   
617,929
     
676,799
 
Loans, net of allowance for loan losses of $3,523,292 at June 30, 2014 and $3,375,350 at December 31, 2013
   
180,910,373
     
179,908,825
 
Property and equipment, net
   
4,403,132
     
4,440,215
 
Foreclosed assets
   
134,111
     
-
 
Accrued income
   
1,015,072
     
966,042
 
Goodwill
   
120,000
     
120,000
 
Bank owned life insurance
   
5,541,820
     
5,462,336
 
Other assets
   
2,888,539
     
1,707,319
 
Total assets
 
$
250,056,330
   
$
240,918,977
 
 
               
Liabilities and Stockholders’ Equity
               
Liabilities
               
Deposits:
               
Noninterest-bearing
 
$
49,731,847
   
$
42,713,122
 
Interest-bearing
   
153,625,052
     
153,087,839
 
Total deposits
   
203,356,899
     
195,800,961
 
 
               
Long-term debt
   
7,750,000
     
7,750,000
 
Dividends payable
   
45,730
     
790,259
 
Accrued interest payable
   
181,815
     
123,558
 
Other liabilities
   
3,104,570
     
2,236,573
 
Total liabilities
   
214,439,014
     
206,701,351
 
 
               
Commitments and contingencies (Note 4)
               
 
               
Stockholders’ equity
               
Preferred stock, 1,000,000 shares authorized, 189,356 shares of Series A, issued and outstanding with no par value, 4.5% convertible non-cumulative, perpetual, with a liquidation value of $14 per share;
   
2,620,325
     
2,620,325
 
181,154 shares of Series D, issued and outstanding with no par value 5.0% convertible non-cumulative, perpetual; with a liquidation value of $7.08 per share;
   
1,248,482
     
1,248,482
 
Common stock, 10,000,000 shares authorized at no par value; 3,542,984 shares issued and outstanding at June 30, 2014 and December 31, 2013
   
12,061,153
     
12,061,153
 
Retained earnings
   
19,682,311
     
18,329,089
 
Accumulated other comprehensive income (loss)
   
5,045
     
(41,423
)
Total stockholders’ equity
   
35,617,316
     
34,217,626
 
Total liabilities and stockholders’ equity
 
$
250,056,330
   
$
240,918,977
 

See Notes to Consolidated Financial Statements
Consolidated Statements of Income
Three months ended June 30, 2014 and 2013 (Unaudited)
 
 
 
2014
   
2013
 
Interest income
       
Loans and fees on loans
 
$
5,224,048
   
$
5,220,767
 
Federal funds sold
   
1,354
     
905
 
Investment securities, taxable
   
32,407
     
26,800
 
Investment securities, dividends
   
7,131
     
6,021
 
Deposits with banks
   
47,244
     
38,703
 
Total interest income
   
5,312,184
     
5,293,196
 
 
               
Interest expense
               
Deposits
   
546,508
     
599,132
 
Fed funds purchased
   
19
     
80
 
Short-term debt
   
-
     
38,543
 
Long-term debt
   
144,547
     
144,518
 
Total interest expense
   
691,074
     
782,273
 
Net interest income
   
4,621,110
     
4,510,923
 
 
               
Provision for (recapture of) loan losses
   
(6,575
)
   
135,796
 
Net interest income after provision for loan losses
   
4,627,685
     
4,375,127
 
 
               
Noninterest income
               
Service charges on deposit accounts
   
401,545
     
437,060
 
Gain on the sale of government guaranteed loans
   
127,362
     
229,130
 
Realized gain (loss) on the sale of investment securities
   
(2,543
)
   
5,297
 
Fees on loans delivered to correspondents
   
6,117
     
35,320
 
Other service charges and fees
   
322,050
     
271,944
 
Income from Bank Owned Life Insurance
   
79,484
     
80,766
 
Other operating income
   
379,799
     
395,502
 
Total noninterest income
   
1,313,814
     
1,455,019
 
 
               
Noninterest expense
               
Salaries and employee benefits
   
1,949,012
     
1,871,496
 
Occupancy expense
   
224,255
     
218,758
 
Equipment expense
   
133,117
     
120,635
 
Data processing
   
211,077
     
212,293
 
Foreclosed assets, net
   
7,304
     
24,305
 
Postage, printing and supplies
   
96,948
     
98,933
 
Professional fees
   
207,861
     
212,571
 
FDIC insurance premiums
   
59,183
     
46,868
 
Other expense
   
776,375
     
714,724
 
Total noninterest expense
   
3,665,132
     
3,520,583
 
Net income before income taxes
   
2,276,367
     
2,309,563
 
 
               
Income tax expense
   
832,188
     
856,944
 
Net income
   
1,444,179
     
1,452,619
 
 
               
Preferred stock dividends
   
(90,957
)
   
(90,957
)
Net income available to common stockholders
 
$
1,353,222
   
$
1,361,662
 
 
               
Basic earnings per common share
 
$
0.38
   
$
0.38
 
Diluted earnings per common share
 
$
0.35
   
$
0.35
 
Basic weighted average common shares outstanding
   
3,542,984
     
3,542,984
 
Diluted weighted average common shares outstanding
   
4,176,919
     
4,176,919
 

See Notes to Consolidated Financial Statements
Consolidated Statements of Income
Three months ended June 30, 2014 and 2013 (Unaudited)

 
 
2014
   
2013
 
 
 
   
 
Interest income
       
Loans and fees on loans
 
$
2,631,578
   
$
2,612,056
 
Federal funds sold
   
670
     
560
 
Investment securities, taxable
   
16,145
     
13,160
 
Investment securities, dividends
   
3,514
     
3,403
 
Deposits with banks
   
27,634
     
19,012
 
Total interest income
   
2,679,541
     
2,648,191
 
 
               
Interest expense
               
Deposits
   
271,559
     
290,444
 
Fed funds purchased
   
2
     
80
 
Short-term debt
   
-
     
33,824
 
Long-term debt
   
72,673
     
72,705
 
Total interest expense
   
344,234
     
397,053
 
Net interest income
   
2,335,307
     
2,251,138
 
 
               
Provision for (recapture of) loan losses
   
55,787
     
93,402
 
Net interest income after provision for loan losses
   
2,279,520
     
2,157,736
 
 
               
Noninterest income
               
Service charges on deposit accounts
   
202,461
     
205,735
 
Gain on the sale of government guaranteed loans
   
127,362
     
229,130
 
Realized gain (loss) on the sale of securities
   
(5,441
)
   
3,339
 
Fees on loans delivered to correspondents
   
5,587
     
14,025
 
Other service charges and fees
   
176,034
     
143,620
 
Income from Bank Owned Life Insurance
   
39,474
     
40,311
 
Other operating income
   
186,409
     
160,483
 
Total noninterest income
   
731,886
     
796,643
 
 
               
Noninterest expense
               
Salaries and employee benefits
   
939,512
     
910,375
 
Occupancy expense
   
116,371
     
119,015
 
Equipment expense
   
74,246
     
57,937
 
Data processing
   
105,766
     
110,622
 
Foreclosed assets, net
   
8,198
     
(18,030
)
Postage, printing and supplies
   
51,322
     
61,199
 
Professional fees
   
92,538
     
86,981
 
FDIC insurance premiums
   
29,557
     
13,693
 
Other expense
   
380,235
     
336,965
 
Total noninterest expense
   
1,797,745
     
1,678,757
 
Net income before income taxes
   
1,213,661
     
1,275,622
 
 
               
Income tax expense
   
445,882
     
474,779
 
Net income
   
767,779
     
800,843
 
 
               
Preferred stock dividends
   
(45,730
)
   
(45,730
)
Net income available to common stockholders
 
$
722,049
   
$
755,113
 
 
Basic earnings per common share
 
$
0.20
   
$
0.21
 
Diluted earnings per common share
 
$
0.18
   
$
0.19
 
Basic weighted average common shares outstanding
   
3,542,984
     
3,542,984
 
Diluted weighted average common shares outstanding
   
4,176,919
     
4,174,919
 
 
See Notes to Consolidated Financial Statements
Consolidated Statements of Comprehensive Income
Three and Six months ended June 30, 2014 and 2013 (Unaudited)

 
 
Three Months
   
Six Months
 
 
 
Ended June 30,
   
Ended June 30,
 
 
 
2014
   
2013
   
2014
   
2013
 
 
 
 
Net income
 
$
767,779
   
$
800,843
   
$
1,444,179
   
$
1,452,619
 
 
                               
Other comprehensive income (loss):
                               
Investment securities available for sale:
                               
Unrealized holding gains (losses)
   
65,746
     
(24,205
)
   
70,311
     
5,339
 
Tax effect
   
(23,939
)
   
8,925
     
(25,522
)
   
(1,442
)
Reclassification of (gains) losses recognized in net income
   
5,441
     
(3,339
)
   
2,543
     
(5,297
)
Tax effect
   
(1,849
)
   
1,135
     
(864
)
   
1,801
 
 
   
45,399
     
(17,484
)
   
46,468
     
401
 
Comprehensive income
 
$
813,178
   
$
783,359
   
$
1,490,647
   
$
1,453,020
 

See Notes to Consolidated Financial Statements

Consolidated Statements of Cash Flows
Six months ended June 30, 2014 and 2013 (Unaudited)

 
 
2014
   
2013
 
Cash flows from operating activities
 
   
 
Net income
 
$
1,444,179
   
$
1,452,619
 
Adjustments to reconcile net income to net cash provided by operations:
               
Depreciation and amortization
   
133,858
     
123,958
 
Gain on sale of property and equipment
   
(406
)
   
(100
)
Gain on the sale of government guaranteed loans
   
(127,362
)
   
(229,130
)
Gain (loss) on the sale of securities
   
2,543
     
(5,297
)
Gain on the sale of foreclosed assets
   
(3,465
)
   
(33,520
)
Provision for (recapture of) loan losses
   
(6,575
)
   
135,796
 
Deferred income tax expense (benefit)
   
(1,026
)
   
2,853
 
Accretion of discount on securities, net of amortization of premiums
   
14
     
19
 
Increase in cash surrender value of life insurance
   
(79,484
)
   
(80,766
)
Changes in assets and liabilities:
               
Accrued income
   
(49,030
)
   
(20,305
)
Other assets
   
(1,063,577
)
   
(982,267
)
Accrued interest payable
   
58,257
     
49,578
 
Other liabilities
   
724,995
     
1,154,737
 
Net cash provided by operating activities
   
1,032,921
     
1,568,175
 
 
               
Cash flows from investing activities
               
Net (increase) decrease in interest-bearing deposits with banks
   
(7,519,758
)
   
3,281,821
 
Net (increase) decrease in federal funds sold
   
99,487
     
(500,404
)
Purchases of investment securities
   
(1,127,843
)
   
(1,550,863
)
Maturities of investment securities
   
1,253,612
     
1,003,508
 
Redemption of restricted equity securities
   
59,000
     
61,800
 
Purchase of restricted equity securities
   
(130
)
   
(185
)
Net increase in loans
   
(1,024,672
)
   
(7,038,966
)
Proceeds from the sale of investment securities
   
123,491
     
47,268
 
Proceeds from the sale of foreclosed assets
   
26,415
     
475,983
 
Purchases of property and equipment
   
(98,944
)
   
(55,677
)
Proceeds from the sale of property and equipment
   
2,575
     
100
 
Net cash used in investing activities
   
(8,206,767
)
   
(4,275,615
)
 
               
Cash flows from financing activities
               
Net increase in deposits
   
7,555,938
     
2,324,811
 
Dividends paid
   
(835,486
)
   
(91,333
)
Net cash provided by financing activities
   
6,720,452
     
2,233,478
 
Net decrease in cash and cash equivalents
   
(453,394
)
   
(473,962
)
Cash and due from banks, beginning
   
7,424,593
     
5,973,042
 
Cash and due from banks, ending
 
$
6,971,199
   
$
5,499,080
 
 
               
Supplemental disclosures of cash flow information
               
Interest paid
 
$
632,817
   
$
732,695
 
Taxes paid
 
$
983,722
   
$
872,255
 
 
               
Supplemental disclosures of non-cash transactions
               
Loans transferred to foreclosed properties
 
$
157,061
   
$
30,300
 
Proceeds from the sale of guaranteed loan previously recorded as short term debt
 
$
-
   
$
3,743,820
 

See Notes to Consolidated Financial Statements
Consolidated Statements of Changes in Stockholders’ Equity
Six months ended June 30, 2014 and 2013 (Unaudited)

                 
Accumulated
     
 
Preferred
               
Other
     
 
 
Stock
   
Common Stock
   
Retained
   
Comprehensive
   
 
 
 
Amount
   
Shares
   
Amount
   
Earnings
   
Income (Loss)
   
Total
 
 
 
   
   
   
   
   
 
Balance, January 1, 2013
 
$
3,868,807
     
3,542,984
   
$
12,061,153
   
$
16,367,187
   
$
(59,846
)
 
$
32,237,301
 
 
                                               
Net income
   
-
     
-
     
-
     
1,452,619
     
-
     
1,452,619
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
401
     
401
 
 
                                               
Dividends declared and accrued on convertible Series A preferred stock ($.32 per share)
   
-
     
-
     
-
     
(59,157
)
   
-
     
(59,157
)
Dividends declared and accrued on convertible Series D preferred stock ($.18 per share)
   
-
     
-
     
-
     
(31,800
)
   
-
     
(31,800
)
Balance, June 30, 2013
 
$
3,868,807
     
3,542,984
   
$
12,061,153
   
$
17,728,849
   
$
(59,445
)
 
$
35,599,364
 
 
                                               
Balance, January 1, 2014
 
$
3,868,807
     
3,542,984
   
$
12,061,153
   
$
18,329,089
   
$
(41,423
)
 
$
34,217,626
 
 
                                               
Net income
   
-
     
-
     
-
     
1,444,179
     
-
     
1,444,179
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
46,468
     
46,468
 
 
                                               
Dividends declared and accrued on convertible Series A preferred stock ($.32 per share)
   
-
     
-
     
-
     
(59,157
)
   
 
   
(59,157
)
Dividends declared and accrued on convertible Series D preferred stock ($.18 per share)
   
-
     
-
     
-
     
(31,800
)
      
 
   
(31,800
)
Balance, June 30, 2014
 
$
3,868,807
     
3,542,984
   
$
12,061,153
   
$
19,682,311
   
$
5,045
   
$
35,617,316
 

See Notes to Consolidated Financial Statements
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and therefore, do not include all disclosures required by generally accepted accounting principles for a complete presentation of financial statements. In the opinion of management, the consolidated financial statements contain all adjustments necessary to present fairly the financial condition of Surrey Bancorp, (the “Company), as of June 30, 2014, the results of its operations and comprehensive income for the six and three months ended June 30, 2014 and 2013, and its changes in stockholders’ equity and cash flows for the six months ended June 30, 2014 and 2013.  These adjustments are of a normal and recurring nature. The results of operations for the six months ended June 30, 2014, are not necessarily indicative of the results expected for the full year. These consolidated financial statements should be read in conjunction with the Company’s audited financial statements and related disclosures for the year ended December 31, 2013, included in the Company’s Form 10-K. The balance sheet at December 31, 2013, has been taken from the audited financial statements at that date.

Organization

Surrey Bancorp began operation on May 1, 2003 and was created for the purpose of acquiring all the outstanding shares of common stock of Surrey Bank & Trust (“the Bank”). Stockholders of the bank received six shares of Surrey Bancorp common stock for every five shares of Surrey Bank & Trust common stock owned. The Company is subject to regulation by the Federal Reserve.

Surrey Bank & Trust was organized and incorporated under the laws of the State of North Carolina on July 15, 1996 and commenced operations on July 22, 1996. The Bank currently serves Surry County, North Carolina and Patrick County, Virginia and surrounding areas through five banking offices. As a state chartered bank, which is not a member of the Federal Reserve, the Bank is subject to regulation by the State of North Carolina Banking Commission and the Federal Deposit Insurance Corporation.

Surrey Investment Services, Inc., (“Subsidiary”) was organized and incorporated under the laws of the State of North Carolina on February 10, 1998. The subsidiary provides insurance services through SB&T Insurance and investment advice and brokerage services through LPL Financial.

On July 31, 2000, Surrey Bank & Trust formed Freedom Finance, LLC, a subsidiary operation specializing in the purchase of sales finance contracts from local automobile dealers.

The accounting and reporting policies of the Company, the Bank, and its subsidiaries follow generally accepted accounting principles and general practices within the financial services industry. Following is a summary of the more significant policies.

Critical Accounting Policies

The notes to the audited consolidated financial statements for the year ended December 31, 2013 contain a summary of the significant accounting policies.  The Company believes our policies with respect to the methodology for the determination of the allowance for loan losses, and asset impairment judgments, including the recoverability of intangible assets 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 cause reported results to differ materially.  These critical policies and their application are periodically reviewed with the Audit Committee and our Board of Directors.  See our Annual Report on Form 10-K for full details on critical accounting policies.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, the Bank and the subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION, CONTINUED

Presentation of Cash Flows

For purposes of reporting cash flows, cash and cash equivalents includes cash and amounts due from depository institutions (including cash items in process of collection). Overnight interest bearing deposits and federal funds sold are shown separately.  Federal funds purchased are shown with securities sold under agreements to repurchase.

Investment Securities

Investments classified as available for sale are intended to be held for indefinite periods of time and include those securities that management may employ as part of asset/liability strategy or that may be sold in response to changes in interest rates, prepayments, regulatory capital requirements or similar factors. These securities are carried at fair value and are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments or significant other observable inputs.

Investment securities classified as held to maturity are those debt securities that the Bank has the ability and intent to hold to maturity. Accordingly, these securities are carried at cost adjusted for amortization of premiums and accretion of discount, computed by the interest-method over their contractual lives. At June 30, 2014 and December 31, 2013, the Bank had no investments classified as held to maturity.

Loans Held for Sale

The Bank originates and holds Small Business Administration (SBA) and United States Department of Agriculture (USDA) guaranteed loans in its portfolio in the normal course of business. Occasionally, the Bank sells the guaranteed portions of these loans into the secondary market. The loans are generally variable rate loans, which eliminates the market risk to the Bank and are therefore carried at cost. The Bank recognizes gains on the sale of the guaranteed portion upon the consummation of the transaction. The Bank plans to continue to originate guaranteed loans for sales, however no such loans were funded at June 30, 2014 and December 31, 2013.

Loans Receivable

Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal amount adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or cost on originated loans and unamortized premiums or discounts on purchased loans.

Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan using the interest method.  Discounts and premiums on any purchased residential real estate loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments.  Discounts and premiums on any purchased consumer loans are recognized over the expected lives of the loans using methods that approximate the interest method.

Interest is accrued and credited to income based on the principal amount outstanding.  The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due.  When the interest accrual is discontinued, all unpaid accrued interest is reversed.  Interest income is subsequently recognized only to the extent cash payments are received.  Payments received on nonaccrual loans are first applied to principal and any residual amounts are then applied to interest.  When facts and circumstances indicate the borrower has regained the ability to meet the required payments, the loan is returned to accrual status.  Past due loans are determined on the basis of contractual terms.
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION, CONTINUED

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components.  The specific component relates to loans that are classified as impaired.  For loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.  The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors.  An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.

Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements:

In January 2014, the FASB amended Receivables topic of the Accounting Standards Codification. The amendments are intended to resolve diversity in practice with respect to when a creditor should reclassify a collateralized consumer mortgage loan to other real estate owned (OREO). In addition, the amendments require a creditor reclassify a collateralized consumer mortgage loan to OREO upon obtaining legal title to the real estate collateral, or the borrower voluntarily conveying all interest in the real estate property to the lender to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement. The amendments will be effective for the Company for annual periods, and interim periods within those annual period beginning after December 15, 2014, with early implementation of the guidance permitted. In implementing this guidance, assets that are reclassified from real estate to loans are measured at the carrying value of the real estate at the date of adoption. Assets reclassified from loans to real estate are measured at the lower of the net amount of the loan receivable or the fair value of the real estate less costs to sell at the date of adoption. The Company will apply the amendments prospectively. The Company does not expect these amendments to have a material effect on its financial statements.
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION, CONTINUED

Recent Accounting Pronouncements, continued

In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for reporting periods beginning after December 15, 2016. The Company will apply the guidance using a full retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued.  Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.  Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.  Management has reviewed events occurring through the date the financial statements were issued and no subsequent events have occurred requiring accrual or disclosure.
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2. SECURITIES

Debt and equity securities have been classified in the balance sheets according to management’s intent.  The amortized costs of securities available for sale and their approximate fair values at June 30, 2014 and December 31, 2013 follow:

 
 
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
 
 
Cost
   
Gains
   
Losses
   
Value
 
 
 
   
   
   
 
June 30, 2014
 
   
   
   
 
Government-sponsored enterprises
 
$
3,500,000
   
$
3,500
   
$
545
   
$
3,502,955
 
Mortgage-backed securities
   
28,473
     
780
     
-
     
29,253
 
Corporate bonds
   
300,000
     
-
     
54,000
     
246,000
 
Equities and mutual funds
   
537,135
     
56,110
     
715
     
592,530
 
 
 
$
4,365,608
   
$
60,390
   
$
55,260
   
$
4,370,738
 
 
                               
December 31, 2013
                               
Government-sponsored enterprises
 
$
3,500,000
   
$
795
   
$
2,030
   
$
3,498,765
 
Mortgage-backed securities
   
32,099
     
1,022
     
-
     
33,121
 
Corporate bonds
   
550,000
     
-
     
99,000
     
451,000
 
Equities and mutual funds
   
535,326
     
43,260
     
11,770
     
566,816
 
 
 
$
4,617,425
   
$
45,077
   
$
112,800
   
$
4,549,702
 

At June 30, 2014 and December 31, 2013, substantially all government-sponsored enterprises securities were pledged as collateral on public deposits and for other purposes as required or permitted by law.  The mortgage-backed securities were pledged to the Federal Home Loan Bank.

Maturities of mortgage-backed bonds are stated based on contractual maturities.  Actual maturities of these bonds may vary as the underlying mortgages are prepaid.  The investment in equities and mutual funds by nature have no maturity date and are classified as due in one year or less. The scheduled maturities of securities (all available for sale) at June 30, 2014, were as follows:

 
 
Amortized
   
Fair
 
 
 
Cost
   
Value
 
Due in one year or less
 
$
1,037,135
   
$
1,092,960
 
Due after one year through five years
   
3,308,142
     
3,256,754
 
Due after five years through ten years
   
10,209
     
10,580
 
Due after ten years
   
10,122
     
10,444
 
 
 
$
4,365,608
   
$
4,370,738
 

The following table shows investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at June 30, 2014 and December 31, 2013. These unrealized losses on investment securities are a result of volatility in interest rates which relate to government-sponsored enterprises and corporate bonds issued by other banks and market volatility as it relates to equity and mutual fund investments at June 30, 2014 and December 31, 2013.

 
 
Less Than 12 Months
   
12 Months or More
   
Total
 
 
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
 
 
   
   
   
   
   
 
June 30, 2014
 
   
   
   
   
   
 
Government-sponsored enterprises
 
$
499,555
   
$
445
   
$
999,900
   
$
100
   
$
1,499,455
   
$
545
 
Corporate bonds
   
-
     
-
     
246,000
     
54,000
     
246,000
     
54,000
 
Equities and mutual funds
   
6,639
     
383
     
106,932
     
332
     
113,571
     
715
 
 
 
$
506,194
   
$
828
   
$
1,352,832
   
$
54,432
   
$
1,859,026
   
$
55,260
 
 
                                               
December 31, 2013
                                               
Government-sponsored enterprises
 
$
1,497,970
   
$
2,030
   
$
-
   
$
-
   
$
1,497,970
   
$
2,030
 
Corporate bonds
   
-
     
-
     
451,000
     
99,000
     
451,000
     
99,000
 
Equities and mutual funds
   
245,218
     
11,770
     
-
     
-
     
245,218
     
11,770
 
 
 
$
1,743,188
   
$
13,800
   
$
451,000
   
$
99,000
   
$
2,194,188
   
$
112,800
 

SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2. SECURITIES, CONTINUED

Management considers the nature of the investment, the underlying causes of the decline in the market value and the severity and duration of the decline in market value in determining if impairment is other than temporary. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Based upon this evaluation, there are two securities in the portfolio at June 30, 2014, with unrealized losses for a period greater than 12 months. One of these securities also had unrealized losses for a period greater than 12 months at December 31, 2013. We have analyzed each individual security for Other Than Temporary Impairment (“OTTI”) purposes by reviewing delinquencies, loan-to-value ratios, and credit quality and concluded that all unrealized losses presented in the tables above are not related to an issuer’s financial condition but are due to changes in the level of interest rates and no declines are deemed to be other than temporary in nature.

The Company had realized losses of $2,543 from the sales of equity and mutual fund investment securities for the six month period ended June 30, 2014, and realized gains of $5,297 from the sales of equity and mutual fund investment securities for the six month periods ended June 30, 2013. Total proceeds from the sales amounted to $123,491 and $47,268 in 2014 and 2013, respectively.

NOTE 3. EARNINGS PER COMMON SHARE

Basic earnings per common share for the six and three months ended June 30, 2014 and 2013 were calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period.

The computation of diluted earnings per common share is similar to the computation of basic earnings per common share except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. The numerator is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares. The potential dilutive shares are represented by common stock options and by the Series A and D convertible preferred stock. Each share of the Series A preferred is convertible into 2.2955 shares of common stock. Each share of Series D preferred is convertible into 1.10 shares of common stock.

NOTE 4. COMMITMENTS AND LETTERS OF CREDIT

At June 30, 2014, the Company had commitments to extend credit, including unused lines of credit of approximately $43,277,000 and letters of credit outstanding of $2,266,620.

NOTE 5. LOANS

The major components of loans in the balance sheets at June 30, 2014 and December 31, 2013 are below.
 
 
 
2014
   
2013
 
 
 
   
 
Commercial, net of discounts of $52,579 in 2014
 
$
65,638,983
   
$
66,612,984
 
Real estate:
               
Construction and land development
   
8,554,036
     
6,353,787
 
Residential, 1-4 families
   
40,112,807
     
40,203,978
 
Residential, 5 or more families
   
1,335,218
     
1,515,239
 
Farmland
   
2,304,060
     
2,219,688
 
Nonfarm, nonresidential
   
60,709,768
     
60,316,018
 
Agricultural
   
422,791
     
107,974
 
Consumer, net of discounts of $12,235 in 2014 and $10,931 in 2013
   
5,072,907
     
5,685,407
 
   
184,150,570
     
183,015,075
 
Deferred loan origination costs, net of (fees)
   
283,095
     
269,100
 
   
184,433,665
     
183,284,175
 
Allowance for loan losses
   
(3,523,292
)
   
(3,375,350
)
 
 
$
180,910,373
   
$
179,908,825
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5.
LOANS, CONTINUED

Residential, 1-4 family loans pledged as collateral against FHLB advances approximated $17,748,000 and $17,376,000 at June 30, 2014 and December 31, 2013, respectively.

NOTE 6.
ALLOWANCE FOR LOAN LOSSES

The activity of the allowance for loan losses by loan components during the six months ended June 30, 2014 and 2013 was as follows:

 
 
Construction
   
   
   
Commercial
   
   
   
 
 
 
&
   
1-4 Family
   
Nonfarm,
   
&
   
   
   
 
 
 
Development
   
Residential
   
Nonresidential
   
Industrial
   
Consumer
   
Other
   
Total
 
 
     
   
           
   
   
 
June 30, 2014
         
   
           
   
   
 
 
         
   
           
   
   
 
Allowance for credit losses:
         
   
           
   
   
 
Beginning balance
 
$
73,000
   
$
617,629
   
$
753,050
   
$
1,708,962
   
$
181,309
   
$
41,400
   
$
3,375,350
 
Charge-offs
   
-
     
(76,891
)
   
(1,778
)
   
(3,506
)
   
(21,420
)
   
-
     
(103,595
)
Recoveries
   
-
     
1,463
     
78,604
     
147,917
     
30,128
     
-
     
258,112
 
Provision
   
37,500
     
179,624
     
(5,389
)
   
(174,521
)
   
(48,189
)
   
4,400
     
(6,575
)
Ending balance
 
$
110,500
   
$
721,825
   
$
824,487
   
$
1,678,852
   
$
141,828
   
$
45,800
   
$
3,523,292
 
 
                                                       
Ending balance: individually evaluated for impairment
 
$
-
   
$
47,025
   
$
122,587
   
$
253,152
   
$
-
   
$
-
   
$
422,764
 
Ending balance: collectively evaluated for impairment
 
$
110,500
   
$
674,800
   
$
701,900
   
$
1,425,700
   
$
141,828
   
$
45,800
   
$
3,100,528
 
Ending balance: loans acquired with deteriorated credit quality
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
 
                                                       
Loans Receivable:
                                                       
Ending balance
 
$
8,554,036
   
$
40,112,807
   
$
60,709,768
   
$
65,638,983
   
$
5,072,907
   
$
4,062,069
   
$
184,150,570
 
 
                                                       
Ending balance: individually evaluated for impairment
 
$
244,821
   
$
415,487
   
$
2,814,048
   
$
1,542,364
   
$
-
   
$
-
   
$
5,016,720
 
Ending balance: collectively evaluated for impairment
 
$
8,309,215
   
$
39,697,320
   
$
57,895,720
   
$
64,096,619
   
$
5,072,907
   
$
4,062,069
   
$
179,133,850
 
Ending balance: loans acquired with deteriorated credit quality
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
 
                                                       
June 30, 2013
                                                       
 
                                                       
Allowance for credit losses:
                                                       
Beginning balance
 
$
86,300
   
$
668,700
   
$
801,999
   
$
1,604,510
   
$
198,789
   
$
42,800
   
$
3,403,098
 
Charge-offs
   
-
     
(8,122
)
   
(79,609
)
   
(6,150
)
   
(54,118
)
   
-
     
(147,999
)
Recoveries
   
517
     
401
     
949
     
19,892
     
18,719
     
-
     
40,478
 
Provision
   
3,983
     
26,321
     
153,631
     
(69,156
)
   
17,017
     
4,000
     
135,796
 
Ending balance
 
$
90,800
   
$
687,300
   
$
876,970
   
$
1,549,096
   
$
180,407
   
$
46,800
   
$
3,431,373
 
 
                                                       
Ending balance: individually evaluated for impairment
 
$
-
   
$
-
   
$
254,670
   
$
217,296
   
$
-
   
$
-
   
$
471,966
 
Ending balance: collectively evaluated for impairment
 
$
90,800
   
$
687,300
   
$
622,300
   
$
1,331,800
   
$
180,407
   
$
46,800
   
$
2,959,407
 
Ending balance: loans acquired with deteriorated credit quality
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
 
                                                       
Loans Receivable:
                                                       
Ending balance
 
$
5,524,198
   
$
38,621,785
   
$
62,740,245
   
$
66,397,808
   
$
6,086,325
   
$
4,237,240
   
$
183,607,601
 
 
                                                       
Ending balance: individually evaluated for impairment
 
$
86,589
   
$
269,392
   
$
3,345,220
   
$
2,464,599
   
$
-
   
$
-
   
$
6,165,800
 
Ending balance: collectively evaluated for impairment
 
$
5,437,609
   
$
38,352,393
   
$
59,395,025
   
$
63,933,209
   
$
6,086,325
   
$
4,237,240
   
$
177,441,801
 
Ending balance: loans acquired with deteriorated credit quality
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 

SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6.
ALLOWANCE FOR LOAN LOSSES, CONTINUED

The following table presents impaired loans individually evaluated by class of loan as of June 30, 2014 and December 31, 2013 and the recognized interest income per the related period:

 
 
   
Unpaid
   
   
Average
   
Interest
 
 
 
Recorded
   
Principal
   
Related
   
Recorded
   
Income
 
 
 
Investment
   
Balance
   
Allowance
   
Investment
   
Recognized
 
 
 
   
   
   
   
 
June 30, 2014
 
   
   
   
   
 
With no related allowance recorded:
 
   
   
   
   
 
Construction and development
 
$
244,821
   
$
244,821
   
$
-
   
$
245,761
   
$
8,163
 
1-4 family residential
   
187,597
     
187,597
     
-
     
187,691
     
5,550
 
Nonfarm, nonresidential
   
1,957,023
     
1,957,023
     
-
     
1,885,354
     
33,991
 
Commercial and industrial
   
154,577
     
154,577
     
-
     
161,686
     
4,937
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
-
     
-
     
-
     
-
     
-
 
   
2,544,018
     
2,544,018
     
-
     
2,480,492
     
52,641
 
 
                                       
With an allowance recorded:
                                       
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
1-4 family residential
   
227,890
     
227,890
     
47,025
     
230,031
     
1,913
 
Nonfarm, nonresidential
   
857,025
     
857,025
     
122,587
     
872,012
     
416
 
Commercial and industrial
   
1,387,787
     
1,387,787
     
253,152
     
1,406,334
     
6,208
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
-
     
-
     
-
     
-
     
-
 
   
2,472,702
     
2,472,702
     
422,764
     
2,508,377
     
8,537
 
 
                                       
Combined:
                                       
Construction and development
 
$
244,821
   
$
244,821
   
$
-
   
$
245,761
   
$
8,163
 
1-4 family residential
   
415,487
     
415,487
     
47,025
     
417,722
     
7,463
 
Nonfarm, nonresidential
   
2,814,048
     
2,814,048
     
122,587
     
2,757,366
     
34,407
 
Commercial and industrial
   
1,542,364
     
1,542,364
     
253,152
     
1,568,020
     
11,145
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
-
     
-
     
-
     
-
     
-
 
 
 
$
5,016,720
   
$
5,016,720
   
$
422,764
   
$
4,988,869
   
$
61,178
 
 
                                       
December 31, 2013
                                       
With no related allowance recorded:
                                       
Construction and development
 
$
318,111
   
$
318,111
   
$
-
   
$
320,260
   
$
21,825
 
1-4 family residential
   
263,562
     
263,562
     
-
     
261,364
     
21,295
 
Nonfarm, nonresidential
   
2,095,645
     
2,165,883
     
-
     
2,144,605
     
120,322
 
Commercial and industrial
   
1,359,371
     
1,561,253
     
-
     
1,393,077
     
71,409
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
-
     
-
     
-
     
-
     
-
 
   
4,036,689
     
4,308,809
     
-
     
4,119,306
     
234,851
 
 
                                       
With an allowance recorded:
                                       
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
1-4 family residential
   
74,205
     
74,205
     
10,829
     
77,144
     
4,300
 
Nonfarm, nonresidential
   
816,776
     
816,776
     
131,950
     
930,060
     
24,653
 
Commercial and industrial
   
1,140,160
     
1,140,160
     
206,162
     
1,163,698
     
47,393
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
-
     
-
     
-
     
-
     
-
 
   
2,031,141
     
2,031,141
     
348,941
     
2,170,902
     
76,346
 
 
                                       
Combined:
                                       
Construction and development
 
$
318,111
   
$
318,111
   
$
-
   
$
320,260
   
$
21,825
 
1-4 family residential
   
337,767
     
337,767
     
10,829
     
338,508
     
25,595
 
Nonfarm, nonresidential
   
2,912,421
     
2,982,659
     
131,950
     
3,074,665
     
144,975
 
Commercial and industrial
   
2,499,531
     
2,701,413
     
206,162
     
2,556,775
     
118,802
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
-
     
-
     
-
     
-
     
-
 
 
 
$
6,067,830
   
$
6,339,950
   
$
348,941
   
$
6,290,208
   
$
311,197
 

SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6. ALLOWANCE FOR LOAN LOSSES, CONTINUED

The following presents by class, an aging analysis of the recorded investment in loans.

 
 
   
   
   
   
   
   
Recorded
 
 
 
   
   
   
   
   
   
Investment
 
     
   
   
   
   
Total
   
> 90 Days
 
 
30-59 Days
   
60-89 Days
   
90 Days Plus
   
Total
       
Financing
   
and
 
 
Past Due
   
Past Due
   
Past Due
   
Past Due
   
Current
   
Receivables
   
Accruing
 
June 30, 2014
 
   
   
   
   
   
   
 
 
 
   
   
   
   
   
   
 
Construction and development
 
$
27,775
   
$
-
   
$
-
   
$
27,775
   
$
8,526,261
   
$
8,554,036
   
$
-
 
1-4 family residential
   
1,159,716
     
123,115
     
224,781
     
1,507,612
     
38,605,195
     
40,112,807
     
56,078
 
Nonfarm, nonresidential
   
226,788
     
492,302
     
137,512
     
856,602
     
59,853,166
     
60,709,768
     
-
 
Commercial and industrial
   
224,807
     
160,634
     
277,201
     
662,642
     
64,976,341
     
65,638,983
     
-
 
Consumer
   
151,161
     
25,682
     
29,744
     
206,587
     
4,866,320
     
5,072,907
     
28,623
 
Other loans
   
-
     
-
     
-
     
-
     
4,062,069
     
4,062,069
     
-
 
Total
 
$
1,790,247
   
$
801,733
   
$
669,238
   
$
3,261,218
   
$
180,889,352
   
$
184,150,570
   
$
84,701
 
Percentage of total loans
   
0.97
%
   
0.44
%
   
0.36
%
   
1.77
%
   
98.23
%
   
100.00
%
       
 
                                                       
Non-accruals included above
                                                       
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
         
1-4 family residential
   
-
     
-
     
168,702
     
168,702