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

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the quarterly period ended March 31, 2015

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   ☒     No   ☐

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   ☒                             No   ☐

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
Accelerated filer
       
Non-accelerated filer
Smaller reporting company

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

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

On May 14, 2015 there were 3,549,665 common shares issued and outstanding.
 


PART I – FINANCIAL INFORMATION

Item 1.
Consolidated Financial Statements
 
     
 
3
     
 
4
     
 
5
     
 
6
     
 
7
     
 
8-22
     
Item 2.
23-29
     
Item 3.
30
     
Item 4.
31
     
PART II – OTHER INFORMATION
 
     
Item 1.
32
     
Item 1A.
32
     
Item 2.
32
     
Item 3.
32
     
Item 4.
32
     
Item 5.
32
     
Item 6.
32
     
33
     
CERTIFICATIONS
34-36
 
Consolidated Balance Sheets
March 31, 2015 (Unaudited) and December 31, 2014 (Audited)

 
   
March
2015
   
December
2014
 
         
Assets
       
Cash and due from banks
 
$
5,401,971
   
$
6,236,749
 
Interest-bearing deposits with banks
   
42,625,181
     
37,315,779
 
Federal funds sold
   
1,215,007
     
1,212,776
 
Investment securities available for sale
   
4,373,630
     
4,363,805
 
Restricted equity securities
   
629,209
     
618,109
 
Loans, net of allowance for loan losses of $3,419,908 at March 31, 2015 and $3,554,664 at December 31, 2014
   
189,141,256
     
189,549,072
 
Property and equipment, net
   
4,545,762
     
4,368,589
 
Foreclosed assets
   
175,526
     
280,821
 
Accrued income
   
1,001,168
     
997,681
 
Goodwill
   
120,000
     
120,000
 
Bank owned life insurance
   
5,013,006
     
5,623,087
 
Other assets
   
2,003,253
     
2,514,855
 
Total assets
 
$
256,244,969
   
$
253,201,323
 
                 
Liabilities and Stockholders’ Equity
               
Liabilities
               
Deposits:
               
Noninterest-bearing
 
$
53,981,233
   
$
52,969,691
 
Interest-bearing
   
155,925,316
     
153,696,890
 
Total deposits
   
209,906,549
     
206,666,581
 
                 
Long-term debt
   
6,250,000
     
6,250,000
 
Dividends payable
   
45,227
     
827,159
 
Accrued interest payable
   
133,070
     
110,261
 
Other liabilities
   
2,451,126
     
2,576,668
 
Total liabilities
   
218,785,972
     
216,430,669
 
                 
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; 3,549,665 shares issued and outstanding at March 31, 2015 and December 31, 2014
   
12,101,480
     
12,101,480
 
Retained earnings
   
21,491,516
     
20,808,309
 
Accumulated other comprehensive loss
   
(2,806
)
   
(7,942
)
Total stockholders’ equity
   
37,458,997
     
36,770,654
 
Total liabilities and stockholders’ equity
 
$
256,244,969
   
$
253,201,323
 
 
See Notes to Consolidated Financial Statements
 
Consolidated Statements of Income
Three months ended March 31, 2015 and 2014 (Unaudited)
 
   
2015
   
2014
 
Interest income
       
Loans and fees on loans
 
$
2,679,309
   
$
2,592,470
 
Federal funds sold
   
691
     
684
 
Investment securities available for sale, taxable
   
16,807
     
16,262
 
Investment securities available for sale, dividends
   
2,234
     
3,617
 
Deposits with banks
   
20,837
     
19,610
 
Total interest income
   
2,719,878
     
2,632,643
 
                 
Interest expense
               
Deposits
   
236,397
     
274,949
 
Fed funds purchased
   
-
     
17
 
Long-term debt
   
60,705
     
71,874
 
Total interest expense
   
297,102
     
346,840
 
Net interest income
   
2,422,776
     
2,285,803
 
                 
Recapture of loan losses
   
(113,794
)
   
(62,362
)
Net interest income after recapture of loan losses
   
2,536,570
     
2,348,165
 
                 
Noninterest income
               
Service charges on deposit accounts
   
191,344
     
199,084
 
Fees on loans delivered to correspondents
   
5,646
     
530
 
Other service charges and fees
   
171,193
     
146,016
 
Gain on the sale of investment securities
   
4,376
     
2,898
 
Income from bank owned life insurance
   
36,824
     
40,010
 
Insurance commissions
   
83,777
     
93,336
 
Brokerage commissions
   
79,041
     
47,132
 
Other operating income
   
53,033
     
52,922
 
Total noninterest income
   
625,234
     
581,928
 
                 
Noninterest expense
               
Salaries and employee benefits
   
1,032,331
     
1,009,500
 
Occupancy expense
   
109,348
     
107,884
 
Equipment expense
   
62,896
     
58,871
 
Data processing
   
123,006
     
105,311
 
Foreclosed assets, net
   
38,844
     
(894
)
Postage, printing and supplies
   
41,324
     
45,626
 
Professional fees
   
141,999
     
115,323
 
FDIC insurance premiums
   
24,458
     
29,626
 
Other expense
   
458,462
     
396,140
 
Total noninterest expense
   
2,032,668
     
1,867,387
 
Net income before income taxes
   
1,129,136
     
1,062,706
 
                 
Income tax expense
   
400,702
     
386,306
 
Net income
   
728,434
     
676,400
 
                 
Preferred stock dividends
   
(45,227
)
   
(45,227
)
Net income available to common stockholders
 
$
683,207
   
$
631,173
 
                 
Basic earnings per common share
 
$
0.19
   
$
0.18
 
Diluted earnings per common share
 
$
0.17
   
$
0.16
 
Basic weighted average common shares outstanding
   
3,549,665
     
3,542,984
 
Diluted weighted average common shares outstanding
   
4,187,410
     
4,176,919
 
 
See Notes to Consolidated Financial Statements
 
Consolidated Statements of Comprehensive Income
Three months ended March 31, 2015 and 2014 (Unaudited)
 
   
2015
   
2014
 
         
Net income
 
$
728,434
   
$
676,400
 
                 
Other comprehensive income:
               
Investment securities available for sale:
               
Unrealized holding gains
   
12,825
     
4,565
 
Tax effect
   
(4,801
)
   
(1,583
)
Reclassification of gains recognized in net income
   
(4,376
)
   
(2,898
)
Tax effect
   
1,488
     
985
 
     
5,136
     
1,069
 
Comprehensive income
 
$
733,570
   
$
677,469
 
 
See Notes to Consolidated Financial Statements
 
Consolidated Statements of Cash Flows
Three months ended March 31, 2015 and 2014 (Unaudited)

 
   
2015
   
2014
 
Cash flows from operating activities
       
Net income
 
$
728,434
   
$
676,400
 
Adjustments to reconcile net income to net cash provided by operations:
               
Depreciation and amortization
   
67,627
     
66,677
 
Gain on sale of property and equipment
   
(50
)
   
(75
)
Gain on the sale of securities
   
(4,376
)
   
(2,898
)
Loss on the sale of foreclosed assets
   
8,507
     
-
 
Recapture of loan losses
   
(113,794
)
   
(62,362
)
Deferred income tax expense (benefit)
   
(2,071
)
   
(1,036
)
Accretion of discount on securities, net of amortization of premiums
   
(103
)
   
7
 
Increase in cash surrender value of life insurance
   
(36,824
)
   
(40,010
)
Life insurance proceeds
   
1,001,320
     
-
 
Changes in assets and liabilities:
               
Accrued income
   
(3,487
)
   
10,813
 
Other assets
   
91,210
     
(31,738
)
Accrued interest payable
   
22,809
     
29,029
 
Other liabilities
   
(60,807
)
   
193,123
 
Net cash provided by operating activities
   
1,698,395
     
837,930
 
                 
Cash flows from investing activities
               
Net increase in interest-bearing deposits with banks
   
(5,309,402
)
   
(11,768,946
)
Net (increase) decrease in federal funds sold
   
(2,231
)
   
98,686
 
Purchases of investment securities
   
(1,009,610
)
   
(1,011,509
)
Maturities of investment securities
   
1,001,578
     
1,001,223
 
Redemption of restricted equity securities
   
-
     
59,000
 
Purchase of restricted equity securities
   
(11,100
)
   
(60
)
Net decrease in loans
   
481,474
     
798,931
 
Proceeds from the sale of investment securities
   
11,135
     
9,259
 
Proceeds from the sale of foreclosed assets
   
136,924
     
-
 
Purchases of property and equipment
   
(244,800
)
   
(57,536
)
Proceeds from the sale of property and equipment
   
50
     
75
 
Net cash used in investing activities
   
(4,945,982
)
   
(10,870,877
)
                 
Cash flows from financing activities
               
Net increase in deposits
   
3,239,968
     
9,314,599
 
Dividends paid
   
(827,159
)
   
(790,259
)
Net cash provided by financing activities
   
2,412,809
     
8,524,340
 
Net decrease in cash and cash equivalents
   
(834,778
)
   
(1,508,607
)
Cash and due from banks, beginning
   
6,236,749
     
7,424,593
 
Cash and due from banks, ending
 
$
5,401,971
   
$
5,915,986
 
                 
Supplemental disclosures of cash flow information
               
Interest paid
 
$
274,293
   
$
317,840
 
Taxes paid
 
$
-
   
$
63,722
 
Supplemental disclosures of non-cash transactions
               
Loans transferred to foreclosed properties
 
$
40,136
   
$
144,521
 
Cash dividends declared but not paid
 
$
45,227
   
$
45,227
 
 
See Notes to Consolidated Financial Statements
 
Consolidated Statements of Changes in Stockholders’ Equity
Three months ended March 31, 2015 and 2014 (Unaudited)

   
Preferred
Stock
   
Common Stock
   
Retained
   
Accumulated
Other
Comprehensive 
     
   
Amount
   
Shares
   
Amount
   
Earnings
   
Income (Loss)
   
Total
 
                         
Balance, January 1, 2014
 
$
3,868,807
   
$
3,542,984
     
12,061,153
   
$
18,329,089
   
$
(41,423
)
 
$
34,217,626
 
                                                 
Net income
   
-
     
-
     
-
     
676,400
     
-
     
676,400
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
1,069
     
1,069
 
                                                 
Dividends declared and accrued on convertible
                                               
Series A preferred stock ($.16 per share)
   
-
     
-
     
     
(29,415
)
   
-
     
(29,415
)
Dividends declared and accrued on convertible
           
 
                                 
Series D preferred stock ($.09 per share)
    -      
-
      -      
(15,812
)
   
-
     
(15,812
)
Balance, March 31, 2014
 
$
3,868,807
   
$
3,542,984
     
12,061,153
   
$
18,960,262
   
$
(40,354
)
 
$
34,849,868
 
                                                 
Balance, January 1, 2015
 
$
3,868,807
   
$
3,549,665
     
12,101,480
   
$
20,808,309
   
$
(7,942
)
 
$
36,770,654
 
                                                 
Net income
   
-
     
-
     
-
     
728,434
     
-
     
728,434
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
5,136
     
5,136
 
Dividends declared and accrued on convertible
           
 
                                 
Series A preferred stock ($.16 per share)
   
-
     
-
     
-
     
(29,415
)
   
-
     
(29,415
)
Dividends declared and accrued on convertible
                                               
Series D preferred stock ($.09 per share)
   
-
     
-
     
-
     
(15,812
)
   
-
     
(15,812
)
Balance, March 31, 2015
 
$
3,868,807
   
$
3,549,665
     
12,101,480
   
$
21,491,516
   
$
(2,806
)
 
$
37,458,997
 
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 March 31, 2015, the results of its operations and comprehensive income for the three months ended March 31, 2015 and 2014, and its changes in stockholders’ equity and cash flows for the three months ended March 31, 2015 and 2014.  These adjustments are of a normal and recurring nature. The results of operations for the three months ended March 31, 2015, 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, 2014, included in the Company’s Form 10-K. The balance sheet at December 31, 2014, 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, 2014 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 March 31, 2015 and December 31, 2014, 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. Fixed rate loans are carried at the lower of cost or market. 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 and held for sale at March 31, 2015 and December 31, 2014.

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, 2017. 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.

In January 2015, the FASB issued guidance to eliminate from U.S. GAAP the concept of an extraordinary item, which is an event or transaction that is both (1) unusual in nature and (2) infrequently occurring. Under the new guidance, an entity will no longer (1) segregate an extraordinary item from the results of ordinary operations; (2) separately present an extraordinary item on its income statement, net of tax, after income from continuing operations; or (3) disclose income taxes and earnings-per-share data applicable to an extraordinary item. The amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company will apply the guidance prospectively. The Company does not expect these amendments to have a material effect on its financial statements.

In February 2015, the FASB issued guidance which amends the consolidation requirements and significantly changes the consolidation analysis required under U.S. GAAP. Although the amendments are expected to result in the deconsolidation of many entities, the Company will need to reevaluate all its previous consolidation conclusions. The amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted (including during an interim period), provided that the guidance is applied as of the beginning of the annual period containing the adoption date. 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 March 31, 2015 and December 31, 2014 follow:

   
Amortized
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
                 
March 31, 2015
               
Government-sponsored enterprises
 
$
3,497,609
   
$
395
   
$
5,524
   
$
3,492,480
 
Mortgage-backed securities
   
24,008
     
704
     
-
     
24,712
 
Corporate bonds
   
300,000
     
-
     
30,000
     
270,000
 
Equities and mutual funds
   
557,986
     
38,684
     
10,232
     
586,438
 
   
$
4,379,603
   
$
39,783
   
$
45,756
   
$
4,373,630
 
                                 
December 31, 2014
                               
Government-sponsored enterprises
 
$
3,500,000
   
$
1,170
   
$
4,640
   
$
3,496,530
 
Mortgage-backed securities
   
25,592
     
715
     
-
     
26,307
 
Corporate bonds
   
300,000
     
-
     
45,000
     
255,000
 
Equities and mutual funds
   
552,635
     
42,900
     
9,567
     
585,968
 
   
$
4,378,227
   
$
44,785
   
$
59,207
   
$
4,363,805
 

At March 31, 2015 and December 31, 2014, 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 March 31, 2015, were as follows:

   
Amortized
Cost
   
Fair
Value
 
Due in one year or less
 
$
1,057,986
   
$
1,086,833
 
Due after one year through five years
   
3,306,866
     
3,271,574
 
Due after five years through ten years
   
5,546
     
5,685
 
Due after ten years
   
9,205
     
9,538
 
   
$
4,379,603
   
$
4,373,630
 

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 March 31, 2015 and December 31, 2014. 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 March 31, 2015 and December 31, 2014.

   
Less Than 12 Months
   
12 Months or More
   
Total
 
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
 
                         
March 31, 2015
                       
Government-sponsored enterprises
 
$
2,492,110
   
$
5,499
   
$
499,975
   
$
25
   
$
2,992,085
   
$
5,524
 
Corporate bonds
   
-
     
-
     
270,000
     
30,000
     
270,000
     
30,000
 
Equities and mutual funds
   
144,979
     
9,753
     
53,261
     
479
     
198,240
     
10,232
 
   
$
2,637,089
   
$
15,252
   
$
823,236
   
$
30,504
   
$
3,460,325
   
$
45,756
 
                                                 
December 31, 2014
                                               
Government-sponsored enterprises
 
$
1,995,360
   
$
4,640
   
$
-
   
$
-
   
$
1,995,360
   
$
4,640
 
Corporate bonds
   
-
     
-
     
255,000
     
45,000
     
255,000
     
45,000
 
Equities and mutual funds
   
69,129
     
5,592
     
107,999
     
3,975
     
177,128
     
9,567
 
   
$
2,064,489
   
$
10,232
   
$
362,999
   
$
48,975
   
$
2,427,488
   
$
59,207
 
 
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 March 31, 2015, 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, 2014. 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 gains of $4,376 from the sales of equity and mutual fund investment securities for the three month period ended March 31, 2015, and realized gains of $2,898 from the sales of equity and mutual fund investment securities for the three month periods ended March 31, 2014. Total proceeds from the sales amounted to $11,135 and $9,259 in 2015 and 2014, respectively.

NOTE 3. EARNINGS PER COMMON SHARE

Basic earnings per common share for the three months ended March 31, 2015 and 2014 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 March 31, 2015, the Company had commitments to extend credit, including unused lines of credit of approximately $43,318,000 and letters of credit outstanding of $2,414,247.

NOTE 5. LOANS

The major components of loans in the balance sheets at March 31, 2015 and December 31, 2014 are below.

   
2015
   
2014
 
         
Commercial
 
$
52,969,456
   
$
56,602,425
 
Real estate:
               
Construction and land development
   
5,788,579
     
10,061,249
 
Residential, 1-4 families
   
42,097,111
     
41,824,806
 
Residential, 5 or more families
   
1,229,561
     
1,109,586
 
Farmland
   
3,660,210
     
3,486,002
 
Nonfarm, nonresidential
   
81,314,177
     
74,275,793
 
Agricultural
   
633,283
     
675,474
 
Consumer, net of discounts of $13,915 in 2015 and $11,950 in 2014
   
4,743,081
     
4,997,023
 
     
192,435,458
     
193,032,358
 
Deferred loan origination costs, net of (fees)
   
125,706
     
71,378
 
     
192,561,164
     
193,103,736
 
Allowance for loan losses
   
(3,419,908
)
   
(3,554,664
)
   
$
189,141,256
   
$
189,549,072
 
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5.
LOANS, CONTINUED

Residential, 1-4 family loans pledged as collateral against FHLB advances approximated $18,141,000 and $18,124,000 at March 31, 2015 and December 31, 2014, respectively.

NOTE 6.
ALLOWANCE FOR LOAN LOSSES

The activity of the allowance for loan losses by loan components during the three months ended March 31, 2015 and 2014 was as follows:

   
Construction 
&
Development
   
1-4 Family
Residential
   
Nonfarm,
Nonresidential
   
Commercial
&
Industrial
   
Consumer
   
Other
   
Total
 
                             
March 31, 2015
                           
                             
Allowance for credit losses:
                           
Beginning balance
 
$
160,100
   
$
798,199
   
$
1,067,315
   
$
1,301,900
   
$
158,750
   
$
68,400
   
$
3,554,664
 
Charge-offs
   
-
     
(47,169
)
   
-
     
(897
)
   
(35,562
)
   
-
     
(83,628
)
Recoveries
   
-
     
889
     
205
     
49,023
     
12,549
     
-
     
62,666
 
Provision
 
 
(68,000
)
   
28,773
     
35,371
     
(137,135
)
   
22,997
     
4,200
     
(113,794
)
Ending balance
  $
92,100
   
$
780,692
   
$
1,102,891
   
$
1,212,891
   
$
158,734
   
$
72,600
   
$
3,419,908
 
                                                         
Ending balance: individually evaluated for impairment
 
$
-
   
$
64,992
   
$
113,491
   
$
143,291
   
$
-
   
$
-
   
$
321,774
 
Ending balance: collectively evaluated for impairment
 
$
92,100
   
$
715,700
   
$
989,400
   
$
1,069,600
   
$
158,734
   
$
72,600
   
$
3,098,134
 
                                                         
Loans Receivable:
                                                       
Ending balance
 
$
5,788,579
   
$
42,097,111
   
$
81,314,177
   
$
52,969,456
   
$
4,743,081
   
$
5,523,054
   
$
192,435,458
 
                                                         
Ending balance: individually evaluated for impairment
 
$
12,953
   
$
706,295
   
$
2,904,189
   
$
1,052,132
   
$
-
   
$
242,361
   
$
4,917,930
 
Ending balance: collectively evaluated for impairment
 
$
5,775,626
   
$
41,390,816
   
$
78,409,988
   
$
51,917,324
   
$
4,743,081
   
$
5,280,693
   
$
187,517,528
 
                                                         
March 31, 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
   
-
     
(77,957
)
   
(1,778
)
   
(3,283
)
   
(14,460
)
   
-
     
(97,478
)
Recoveries
   
-
     
219
     
133
     
144,173
     
4,019
     
-
     
148,544
 
Provision
   
20,600
     
184,445
     
2,268
     
(279,273
)
   
9,298
     
300
     
(62,362
)
Ending balance
 
$
93,600
   
$
724,336
   
$
753,673
   
$
1,570,579
   
$
180,166
   
$
41,700
   
$
3,364,054
 
                                                         
Ending balance: individually evaluated for impairment
 
$
-
   
$
54,436
   
$
132,173
   
$
258,579
   
$
-
   
$
-
   
$
445,188
 
Ending balance: collectively evaluated for impairment
 
$
93,600
   
$
669,900
   
$
621,500
   
$
1,312,000
   
$
180,166
   
$
41,700
   
$
2,918,866
 
                                                         
Loans Receivable:
                                                       
Ending balance
 
$
7,367,581
   
$
39,564,157
   
$
59,798,495
   
$
66,457,837
   
$
5,436,073
   
$
3,491,934
   
$
182,116,077
 
                                                         
Ending balance: individually evaluated for impairment
 
$
315,826
   
$
556,204
   
$
2,817,421
   
$
2,514,876
   
$
-
   
$
-
   
$
6,204,327
 
Ending balance: collectively evaluated for impairment
 
$
7,051,755
   
$
39,007,953
   
$
56,981,074
   
$
63,942,961
   
$
5,436,073
   
$
3,491,934
   
$
175,911,750
 


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 March 31, 2015 and December 31, 2014 and the recognized interest income per the related period:

   
Recorded
Investment
   
Unpaid
Principal
Balance
   
Related
Allowance
   
Average
Recorded
Investment
   
Interest
Income
Recognized
 
                     
March 31, 2015
                   
With no related allowance recorded:
                   
Construction and development
 
$
12,953
   
$
12,953
   
$
-
   
$
13,261
   
$
265
 
1-4 family residential
   
474,593
     
474,593
     
-
     
482,174
     
5,467
 
Nonfarm, nonresidential
   
2,130,362
     
2,130,362
     
-
     
2,149,197
     
22,701
 
Commercial and industrial
   
743,378
     
879,937
     
-
     
764,445
     
2,071
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
242,361
     
242,361
     
-
     
243,371
     
3,885
 
     
3,603,647
     
3,740,206
     
-
     
3,652,448
     
34,389
 
                                         
With an allowance recorded:
                                       
Construction and development
   
-
     
-
     
-
     
-
     
-
 
1-4 family residential
   
231,702
     
271,053
     
64,992
     
265,176
     
-
 
Nonfarm, nonresidential
   
773,827
     
773,827
     
113,491
     
776,175
     
-
 
Commercial and industrial
   
308,754
     
308,754
     
143,291
     
552,054
     
-
 
Consumer
   
-
     
-
     
-
      -      
-
 
Other loans
   
-
     
-
     
-
     
-
     
-
 
     
1,314,283
     
1,353,634
     
321,774
     
1,593,405
     
-
 
                                         
Combined:
                                       
Construction and development
   
12,953
     
12,953
     
-
     
13,261
     
265
 
1-4 family residential
   
706,295
     
745,646
     
64,992
     
747,350
     
5,467
 
Nonfarm, nonresidential
   
2,904,189
     
2,904,189
     
113,491
     
2,925,372
     
22,701
 
Commercial and industrial
   
1,052,132
     
1,188,691
     
143,291
     
1,316,499
     
2,071
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
242,361
     
242,361
     
-
     
243,371
     
3,885
 
   
$
4,917,930
   
$
5,093,840
   
$
321,774
   
$
5,245,853
   
$
34,389
 
                                         
December 31, 2014
                                       
With no related allowance recorded:
                                       
Construction and development
 
$
13,536
   
$
13,536
   
$
-
   
$
13,788
   
$
2,710
 
1-4 family residential
   
174,314
     
174,314
     
-
     
174,882
     
7,269
 
Nonfarm, nonresidential
   
1,806,013
     
1,806,013
     
-
     
1,826,306
     
94,953
 
Commercial and industrial
   
844,682
     
844,682
     
-
     
986,462
     
9,452
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
228,111
     
228,111
     
-
     
228,884
     
15,244
 
     
3,066,656
     
3,066,656
     
-
     
3,230,322
     
129,628
 
                                         
With an allowance recorded:
                                       
Construction and development
   
-
     
-
     
-
     
-
     
-
 
1-4 family residential
   
399,764
     
399,764
     
97,799
     
402,691
     
8,141
 
Nonfarm, nonresidential
   
852,925
     
852,925
     
117,215
     
852,872
     
358
 
Commercial and industrial
   
554,787
     
554,787
     
162,900
     
552,865
     
72
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
-
     
-
     
-
     
-
     
-
 
     
1,807,476
     
1,807,476
     
377,914
     
1,808,428
     
8,571
 
                                         
Combined:
                                       
Construction and development
   
13,536
     
13,536
     
-
     
13,788
     
2,710
 
1-4 family residential
   
574,078
     
574,078
     
97,799
     
577,573
     
15,410
 
Nonfarm, nonresidential
   
2,658,938
     
2,658,938
     
117,215
     
2,679,178
     
95,311
 
Commercial and industrial
   
1,399,469
     
1,399,469
     
162,900
     
1,539,327
     
9,524
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
228,111
     
228,111
     
-
     
228,884
     
15,244
 
   
$
4,874,132
   
$
4,874,132
   
$
377,914
   
$
5,038,750
   
$
138,199
 
 
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.

   
30-59 Days
Past Due
   
60-89 Days
Past Due
   
90 Days Plus
Past Due
   
Total
Past Due
   
Current
   
Total
Financing
Receivables
   
Recorded
Investment
> 90 Days
and
Accruing
 
March 31, 2015
                           
                             
Construction and development
 
$
14,539
   
$
-
   
$
-
   
$
14,539
   
$
5,774,040
   
$
5,788,579
   
$
-
 
1-4 family residential
   
697,334
     
567,061
     
59,840
     
1,324,235
     
40,772,876
     
42,097,111
     
-
 
Nonfarm, nonresidential
   
55,113
     
243,365
     
663,902
     
962,380
     
80,351,797
     
81,314,177
     
-
 
Commercial and industrial
   
110,934
     
-
     
878,035
     
988,969
     
51,980,487
     
52,969,456
     
-
 
Consumer
   
149,748
     
58,551
     
28,182
     
236,481
     
4,506,600
     
4,743,081
     
27,059
 
Other loans
   
-
     
-
     
-
     
-
     
5,523,054
     
5,523,054
      -  
Total
 
$
1,027,668
   
$
868,977
   
$
1,629,959
   
$
3,526,604
   
$
188,908,854
   
$
192,435,458
   
$
27,059
 
Percentage of total loans
   
0.53
%
   
0.45
%
   
0.85
%
   
1.83
%
   
98.17
%
   
100.00
%
       
                                                         
Non-accruals included above
                                                       
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
 
 
 
1-4 family residential
   
159,100
     
214,322
     
59,841
     
433,263
     
95,071
     
528,334
         
Nonfarm, nonresidential
   
55,113
     
52,488
     
663,902
     
771,503
     
405,249
     
1,176,752
         
Commercial and industrial
   
-
     
-
     
878,035
     
878,035
     
55,310
     
933,345
         
Consumer
   
-
     
-
     
1,122
     
1,122
     
-
     
1,122
         
Other loans
   
-
     
-
     
-
     
-
     
-
     
-
         
   
$
214,213
   
$
266,810
   
$
1,602,900
   
$
2,083,923
   
$
555,630
   
$
2,639,553
         
                                                         
December 31, 2014
                                                       
                                                         
Construction and development
 
$
94,736
   
$
-
   
$
-
   
$
94,736
   
$
9,966,513
   
$
10,061,249
   
$
-
 
1-4 family residential
   
362,406
     
274,595
     
172,981
     
809,982
     
41,014,824
     
41,824,806
     
-
 
Nonfarm, nonresidential
   
137,733
     
105,473
     
663,902
     
907,108
     
73,368,685
     
74,275,793
     
-
 
Commercial and industrial
   
63,744
     
20,476
     
1,271,937
     
1,356,157
     
55,246,268
     
56,602,425
     
-
 
Consumer
   
169,895
     
48,785
     
54,306
     
272,986
     
4,724,037
     
4,997,023
     
53,184
 
Other loans
   
-
     
-
     
-
     
-
     
5,271,062
     
5,271,062
     
-
 
Total
 
$
828,514
   
$
449,329
   
$
2,163,126
   
$
3,440,969
   
$
189,591,389
   
$
193,032,358
   
$
53,184
 
Percentage of total loans
   
0.43
%
   
0.23
%
   
1.12
%
   
1.78
%
   
98.22
%
   
100.00
%
       
                                                         
Non-accruals included above
                                                       
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
         
1-4 family residential
   
162,027
     
56,664
     
172,981
     
391,672
     
112,752
     
504,424
         
Nonfarm, nonresidential
   
133,147
     
-
     
663,902
     
797,049
     
395,558
     
1,192,607
         
Commercial and industrial
   
18,859
     
-
     
1,271,937
     
1,290,796
     
-
     
1,290,796
         
Consumer
   
-
     
-
     
1,122
     
1,122
     
-
     
1,122
         
Other loans
   
-
     
-
     
-
     
-
     
-
     
-
         
   
$
314,033
   
$
56,664
   
$
2,109,942
   
$
2,480,639
   
$
508,310
   
$
2,988,949
         

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. Loans classified as substandard or special mention are reviewed quarterly by the Company for further impairment or improvement to determine if appropriately classified. All other loans greater than $500,000, commercial lines greater than $250,000 and personal lines of credit greater than $100,000, and unsecured loans greater than $100,000 are specifically reviewed at least annually to determine the appropriate loan grading. In addition, during the renewal process of any loan, as well as when a loan becomes past due, the Company will evaluate the loan grade.
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6.
ALLOWANCE FOR LOAN LOSSES, CONTINUED

Loans excluded from the scope of the annual review process above are generally classified as pass credits until: (a) they become past due; (b) management becomes aware of deterioration in the credit worthiness of the borrower; or (c) the customer contacts the Company for a modification. In these circumstances, the loan is specifically evaluated for potential classification as to special mention, substandard or even charged off. The Company uses the following definitions for risk ratings:

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and payment capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans by credit quality indicator are provided in the following table.

   
Total
   
Pass Credits
   
Special
Mention
   
Substandard
   
Doubtful
 
                     
March 31, 2015
                   
                     
Construction and development
 
$
5,788,579
   
$
5,788,579
   
$
-
   
$
-
   
$
-
 
1-4 family residential
   
42,097,111
     
41,282,941
     
762,112