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EX-31.2 - EXHIBIT 31.2 - SURREY BANCORPex31_2.htm

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 June 30, 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 August 13, 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
     
 
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
36-38
 
Consolidated Balance Sheets
June 30, 2015 (Unaudited) and December 31, 2014 (Audited)
 
   
June
2015
   
December
2014
 
         
Assets
       
Cash and due from banks
 
$
6,110,887
   
$
6,236,749
 
Interest-bearing deposits with banks
   
36,882,799
     
37,315,779
 
Federal funds sold
   
1,215,322
     
1,212,776
 
Investment securities available for sale
   
4,372,473
     
4,363,805
 
Restricted equity securities
   
524,889
     
618,109
 
Loans, net of allowance for loan losses of $3,686,569 at June 30, 2015 and $3,554,664 at December 31, 2014
   
189,881,404
     
189,549,072
 
Property and equipment, net
   
4,723,827
     
4,368,589
 
Foreclosed assets
   
193,801
     
280,821
 
Accrued income
   
1,063,955
     
997,681
 
Goodwill
   
120,000
     
120,000
 
Bank owned life insurance
   
5,049,751
     
5,623,087
 
Other assets
   
2,940,463
     
2,514,855
 
Total assets
 
$
253,079,571
   
$
253,201,323
 
                 
Liabilities and Stockholders’ Equity
               
Liabilities
               
Deposits:
               
Noninterest-bearing
 
$
54,431,532
   
$
52,969,691
 
Interest-bearing
   
153,001,537
     
153,696,890
 
Total deposits
   
207,433,069
     
206,666,581
 
                 
Long-term debt
   
4,250,000
     
6,250,000
 
Dividends payable
   
45,730
     
827,159
 
Accrued interest payable
   
140,516
     
110,261
 
Other liabilities
   
3,059,330
     
2,576,668
 
Total liabilities
   
214,928,645
     
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
   
12,101,480
     
12,101,480
 
Retained earnings
   
22,185,722
     
20,808,309
 
Accumulated other comprehensive loss
   
(5,083
)
   
(7,942
)
Total stockholders’ equity
   
38,150,926
     
36,770,654
 
Total liabilities and stockholders’ equity
 
$
253,079,571
   
$
253,201,323
 
 
See Notes to Consolidated Financial Statements
 
Consolidated Statements of Income
Six months ended June 30, 2015 and 2014 (Unaudited)

 
   
2015
   
2014
 
Interest income
       
Loans and fees on loans
 
$
5,356,148
   
$
5,224,048
 
Federal funds sold
   
1,363
     
1,354
 
Investment securities available for sale, taxable
   
34,085
     
32,407
 
Investment securities available for sale, dividends
   
6,119
     
7,131
 
Deposits with banks
   
47,997
     
47,244
 
Total interest income
   
5,445,712
     
5,312,184
 
                 
Interest expense
               
Deposits
   
467,168
     
546,508
 
Fed funds purchased
   
3
     
19
 
Long-term debt
   
118,464
     
144,547
 
Total interest expense
   
585,635
     
691,074
 
Net interest income
   
4,860,077
     
4,621,110
 
                 
Recapture of loan losses
   
(43,496
)
   
(6,575
)
Net interest income after recapture of loan losses
   
4,903,573
     
4,627,685
 
                 
Noninterest income
               
Service charges on deposit accounts
   
399,665
     
401,545
 
Gain on the sale of government guaranteed loans
   
-
     
127,362
 
Fees on loans delivered to correspondents
   
27,808
     
6,117
 
Other service charges and fees
   
359,488
     
322,050
 
Gain (loss) on the sale of investment securities
   
4,376
     
(2,543
)
Income from bank owned life insurance
   
73,569
     
79,484
 
Insurance commissions
   
215,315
     
254,226
 
Brokerage commissions
   
102,460
     
89,651
 
Other operating income
   
67,568
     
35,922
 
Total noninterest income
   
1,250,249
     
1,313,814
 
                 
Noninterest expense
               
Salaries and employee benefits
   
1,991,930
     
1,949,012
 
Occupancy expense
   
228,578
     
224,255
 
Equipment expense
   
127,256
     
133,117
 
Data processing
   
231,208
     
211,077
 
Foreclosed assets, net
   
85,611
     
7,304
 
Postage, printing and supplies
   
106,641
     
96,948
 
Professional fees
   
248,005
     
207,861
 
FDIC insurance premiums
   
56,539
     
59,183
 
Other expense
   
794,282
     
776,375
 
Total noninterest expense
   
3,870,050
     
3,665,132
 
Net income before income taxes
   
2,283,772
     
2,276,367
 
                 
Income tax expense
   
815,402
     
832,188
 
Net income
   
1,468,370
     
1,444,179
 
                 
Preferred stock dividends
   
(90,957
)
   
(90,957
)
Net income available to common stockholders
 
$
1,377,413
   
$
1,353,222
 
                 
Basic earnings per common share
 
$
0.39
   
$
0.38
 
Diluted earnings per common share
 
$
0.35
   
$
0.35
 
Basic weighted average common shares outstanding
   
3,549,665
     
3,542,984
 
Diluted weighted average common shares outstanding
   
4,187,334
     
4,176,919
 
 
See Notes to Consolidated Financial Statements
 
Consolidated Statements of Income
Three months ended June 30, 2015 and 2014 (Unaudited)

   
2015
   
2014
 
Interest income
       
Loans and fees on loans
 
$
2,676,839
   
$
2,631,578
 
Federal funds sold
   
672
     
670
 
Investment securities available for sale, taxable
   
17,278
     
16,145
 
Investment securities available for sale, dividends
   
3,885
     
3,514
 
Deposits with banks
   
27,160
     
27,634
 
Total interest income
   
2,725,834
     
2,679,541
 
                 
Interest expense
               
Deposits
   
230,771
     
271,559
 
Fed funds purchased
   
3
     
2
 
Long-term debt
   
57,759
     
72,673
 
Total interest expense
   
288,533
     
344,234
 
Net interest income
   
2,437,301
     
2,335,307
 
                 
Provision for loan losses
   
70,298
     
55,787
 
Net interest income after provision for loan losses
   
2,367,003
     
2,279,520
 
                 
Noninterest income
               
Service charges on deposit accounts
   
208,321
     
202,461
 
Gain on the sale of government guaranteed loans
   
-
     
127,362
 
Fees on loans delivered to correspondents
   
22,162
     
5,587
 
Other service charges and fees
   
188,295
     
176,034
 
Loss on the sale of investment securities
   
-
     
(5,441
)
Income from bank owned life insurance
   
36,745
     
39,474
 
Insurance commissions
   
131,538
     
124,168
 
Brokerage commissions
   
23,419
     
42,519
 
Other operating income
   
14,535
     
19,722
 
Total noninterest income
   
625,015
     
731,886
 
                 
Noninterest expense
               
Salaries and employee benefits
   
959,599
     
939,512
 
Occupancy expense
   
119,230
     
116,371
 
Equipment expense
   
64,360
     
74,246
 
Data processing
   
108,202
     
105,766
 
Foreclosed assets, net
   
46,767
     
8,198
 
Postage, printing and supplies
   
65,317
     
51,322
 
Professional fees
   
106,006
     
92,538
 
FDIC insurance premiums
   
32,081
     
29,557
 
Other expense
   
335,820
     
380,235
 
Total noninterest expense
   
1,837,382
     
1,797,745
 
Net income before income taxes
   
1,154,636
     
1,213,661
 
                 
Income tax expense
   
414,700
     
445,882
 
Net income
   
739,936
     
767,779
 
                 
Preferred stock dividends
   
(45,730
)
   
(45,730
)
Net income available to common stockholders
 
$
694,206
   
$
722,049
 
                 
Basic earnings per common share
 
$
0.20
   
$
0.20
 
Diluted earnings per common share
 
$
0.18
   
$
0.18
 
Basic weighted average common shares outstanding
   
3,549,665
     
3,542,984
 
Diluted weighted average common shares outstanding
   
4,187,257
     
4,176,919
 
 
See Notes to Consolidated Financial Statements
 
Consolidated Statements of Comprehensive Income
Three and Six months ended June 30, 2015 and 2014 (Unaudited)

 
   
Three Months
Ended June 30,
   
Six Months
Ended June 30,
 
   
2015
   
2014
   
2015
   
2014
 
                 
Net income
 
$
739,936
   
$
767,779
   
$
1,468,370
   
$
1,444,179
 
                                 
Other comprehensive income (loss):
                               
Investment securities available for sale:
                               
Unrealized holding gains (losses)
   
(2,615
)
   
65,746
     
10,211
     
70,311
 
Tax effect
   
338
     
(23,939
)
   
(4,464
)
   
(25,522
)
Reclassification of (gains) losses recognized in net income
   
-
     
5,441
     
(4,376
)
   
2,543
 
Tax effect
   
-
     
(1,849
)
   
1,488
     
(864
)
     
(2,277
)
   
45,399
     
2,859
     
46,468
 
Comprehensive income
 
$
737,659
   
$
813,178
   
$
1,471,229
   
$
1,490,647
 
 
See Notes to Consolidated Financial Statements
 
Consolidated Statements of Cash Flows
Six months ended June 30, 2015 and 2014 (Unaudited)

 
   
2015
   
2014
 
Cash flows from operating activities
       
Net income
 
$
1,468,370
   
$
1,444,179
 
Adjustments to reconcile net income to net cash provided by operations:
               
Depreciation and amortization
   
134,855
     
133,858
 
Gain on sale of property and equipment
   
(50
)
   
(406
)
Gain on the sale of government guaranteed loans
   
-
     
(127,362
)
(Gain) loss on the sale of securities
   
(4,376
)
   
2,543
 
(Gain) loss on the sale of foreclosed assets
   
9,620
     
(3,465
)
Recapture of loan losses
   
(43,496
)
   
(6,575
)
Deferred income tax benefit
   
(630
)
   
(1,026
)
(Accretion) of discount on securities, net of amortization of premiums
   
(304
)
   
14
 
Increase in cash surrender value of life insurance
   
(73,569
)
   
(79,484
)
Life insurance proceeds
   
1,001,320
     
-
 
Changes in assets and liabilities:
               
Accrued income
   
(66,274
)
   
(49,030
)
Other assets
   
(847,103
)
   
(1,063,577
)
Accrued interest payable
   
30,255
     
58,257
 
Other liabilities
   
547,397
     
724,995
 
Net cash provided by operating activities
   
2,156,015
     
1,032,921
 
                 
Cash flows from investing activities
               
Net (increase) decrease in interest-bearing deposits with banks
   
432,980
     
(7,519,758
)
Net (increase) decrease in federal funds sold
   
(2,546
)
   
99,487
 
Purchases of investment securities
   
(1,012,202
)
   
(1,127,843
)
Maturities of investment securities
   
1,002,913
     
1,253,612
 
Redemption of restricted equity securities
   
104,400
     
59,000
 
Purchase of restricted equity securities
   
(11,180
)
   
(130
)
Net increase in loans
   
(419,410
)
   
(1,024,672
)
Proceeds from the sale of investment securities
   
11,135
     
123,491
 
Proceeds from the sale of foreclosed assets
   
207,974
     
26,415
 
Purchases of property and equipment
   
(490,093
)
   
(98,944
)
Proceeds from the sale of property and equipment
   
50
     
2,575
 
Net cash used in investing activities
   
(175,979
)
   
(8,206,767
)
                 
Cash flows from financing activities
               
Net increase in deposits
   
766,488
     
7,555,938
 
Maturities of long-term debt
   
(2,000,000
)
   
-
 
Dividends paid
   
(872,386
)
   
(835,486
)
Net cash provided (used) by financing activities
   
(2,105,898
)
   
6,720,452
 
Net decrease in cash and cash equivalents
   
(125,862
)
   
(453,394
)
Cash and due from banks, beginning
   
6,236,749
     
7,424,593
 
Cash and due from banks, ending
 
$
6,110,887
   
$
6,971,199
 
                 
Supplemental disclosures of cash flow information
               
Interest paid
 
$
555,635
   
$
632,817
 
Taxes paid
 
$
828,479
   
$
983,722
 
Supplemental disclosures of non-cash transactions
               
Loans transferred to foreclosed properties
 
$
130,574
   
$
157,061
 
Cash dividends declared but not paid
 
$
45,730
   
$
45,730
 
 
See Notes to Consolidated Financial Statements
 
Consolidated Statements of Changes in Stockholders’ Equity
Six months ended June 30, 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
   
-
     
-
     
-
     
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
 
                                                 
Balance, January 1, 2015
 
$
3,868,807
     
3,549,665
   
$
12,101,480
   
$
20,808,309
   
$
(7,942
)
 
$
36,770,654
 
                                                 
                                                 
Net income
   
-
     
-
     
-
     
1,468,370
     
-
     
1,468,370
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
2,859
     
2,859
 
 
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, 2015
 
$
3,868,807
     
3,549,665
   
$
12,101,480
   
$
22,185,722
   
$
(5,083
)
 
$
38,150,926
 
 
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, 2015, the results of its operations and comprehensive income for the six and three months ended June 30, 2015 and 2014, and its changes in stockholders’ equity and cash flows for the six months ended June 30, 2015 and 2014.  These adjustments are of a normal and recurring nature. The results of operations for the six months ended June 30, 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 June 30, 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 June 30, 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 June 30, 2015 and December 31, 2014 follow:

   
Amortized
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
                 
June 30, 2015
               
Government-sponsored enterprises
 
$
3,497,814
   
$
776
   
$
4,165
   
$
3,494,425
 
Mortgage-backed securities
   
22,668
     
673
     
-
     
23,341
 
Corporate bonds
   
300,000
     
-
     
15,000
     
285,000
 
Equities and mutual funds
   
560,578
     
28,417
     
19,288
     
569,707
 
   
$
4,381,060
   
$
29,866
   
$
38,453
   
$
4,372,473
 
                                 
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 June 30, 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 June 30, 2015, were as follows:
 
   
Amortized
Cost
   
Fair
Value
 
Due in one year or less
 
$
1,060,578
   
$
1,069,707
 
Due after one year through five years
   
3,311,607
     
3,293,552
 
Due after five years through ten years
   
-
     
-
 
Due after ten years
   
8,875
     
9,214
 
   
$
4,381,060
   
$
4,372,473
 

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, 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 June 30, 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
 
                         
June 30, 2015
                       
Government-sponsored enterprises
 
$
1,500,000
   
$
4,115
   
$
499,950
   
$
50
   
$
1,999,950
   
$
4,165
 
Corporate bonds
   
-
     
-
     
285,000
     
15,000
     
285,000
     
15,000
 
Equities and mutual funds
   
175,096
     
17,646
     
114,993
     
1,642
     
290,089
     
19,288
 
   
$
1,675,096
   
$
21,761
   
$
899,943
   
$
16,692
   
$
2,575,039
   
$
38,453
 
                                                 
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 four securities in the portfolio at June 30, 2015, with unrealized losses for a period greater than 12 months. Three 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 six month period ended June 30, 2015, and realized losses of $2,543 from the sales of equity and mutual fund investment securities for the six month periods ended June 30, 2014. Total proceeds from the sales amounted to $11,135 and $123,491 in 2015 and 2014, respectively.

NOTE 3. EARNINGS PER COMMON SHARE

Basic earnings per common share for the six and three months ended June 30, 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 June 30, 2015, the Company had commitments to extend credit, including unused lines of credit of approximately $46,014,000 and letters of credit outstanding of $2,350,151.

NOTE 5. LOANS

The major components of loans in the balance sheets at June 30, 2015 and December 31, 2014 are below.

   
2015
   
2014
 
         
Commercial
 
$
54,582,484
   
$
56,602,425
 
Real estate:
               
Construction and land development
   
5,003,033
     
10,061,249
 
Residential, 1-4 families
   
42,429,891
     
41,824,806
 
Residential, 5 or more families
   
1,203,369
     
1,109,586
 
Farmland
   
3,781,568
     
3,486,002
 
Nonfarm, nonresidential
   
81,471,018
     
74,275,793
 
Agricultural
   
571,378
     
675,474
 
Consumer, net of discounts of $12,625 in 2015 and $11,950 in 2014
   
4,453,977
     
4,997,023
 
     
193,496,718
     
193,032,358
 
Deferred loan origination costs, net of (fees)
   
71,255
     
71,378
 
     
193,567,973
     
193,103,736
 
Allowance for loan losses
   
(3,686,569
)
   
(3,554,664
)
   
$
189,881,404
   
$
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 $12,084,000 and $18,124,000 at June 30, 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 six months ended June 30, 2015 and 2014 was as follows:

   
Construction
&
Development
   
1-4 Family
Residential
   
Nonfarm,
Nonresidential
   
Commercial
&
Industrial
   
Consumer
   
Other
   
Total
 
                             
June 30, 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
   
-
     
(119,738
)
   
-
     
(14,308
)
   
(63,747
)
   
-
     
(197,793
)
Recoveries
   
-
     
1,470
     
556
     
355,079
     
16,089
     
-
     
373,194
 
Provision
   
(79,500
)
   
99,807
     
(20,437
)
   
(109,264
)
   
61,398
     
4,500
     
(43,496
)
Ending balance
 
$
80,600
   
$
779,738
   
$
1,047,434
   
$
1,533,407
   
$
172,490
   
$
72,900
   
$
3,686,569
 
                                                         
Ending balance: individually evaluated for impairment
 
$
-
   
$
5,538
   
$
82,334
   
$
130,207
   
$
-
   
$
-
   
$
218,079
 
Ending balance: collectively evaluated for impairment
 
$
80,600
   
$
774,200
   
$
965,100
   
$
1,403,200
   
$
172,490
   
$
72,900
   
$
3,468,490
 
                                                         
Loans Receivable:
                                                       
Ending balance
 
$
5,003,033
   
$
42,429,891
   
$
81,471,018
   
$
54,582,484
   
$
4,453,977
   
$
5,556,315
   
$
193,496,718
 
                                                         
Ending balance: individually evaluated for impairment
 
$
12,364
   
$
902,831
   
$
2,638,166
   
$
1,001,378
   
$
-
   
$
238,369
   
$
4,793,108
 
Ending balance: collectively evaluated for impairment
 
$
4,990,669
   
$
41,527,060
   
$
78,832,852
   
$
53,581,106
   
$
4,453,977
   
$
5,317,946
   
$
188,703,610
 
                                                         
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
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
 
 
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, 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
 
                     
June 30, 2015
                   
With no related allowance recorded:
                   
Construction and development
 
$
12,364
   
$
12,364
   
$
-
   
$
13,261
   
$
526
 
1-4 family residential
   
882,673
     
940,638
     
-
     
967,164
     
7,947
 
Nonfarm, nonresidential
   
2,205,425
     
2,205,425
     
-
     
2,210,993
     
50,894
 
Commercial and industrial
   
715,138
     
768,811
     
-
     
740,948
     
4,765
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
238,369
     
238,369
     
-
     
243,371
     
8,331
 
     
4,053,969
     
4,165,607
     
-
     
4,175,737
     
72,463
 
                                         
With an allowance recorded:
                                       
Construction and development
   
-
     
-
     
-
     
-
     
-
 
1-4 family residential
   
20,158
     
20,158
     
5,538
     
21,016
     
-
 
Nonfarm, nonresidential
   
432,741
     
432,741
     
82,334
     
776,175
     
-
 
Commercial and industrial
   
286,240
     
286,240
     
130,207
     
518,266
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
-
     
-
     
-
     
-
     
-
 
     
739,139
     
739,139
     
218,079
     
1,315,457
     
-
 
                                         
Combined:
                                       
Construction and development
   
12,364
     
12,364
     
-
     
13,261
     
526
 
1-4 family residential
   
902,831
     
960,796
     
5,538
     
988,180
     
7,947
 
Nonfarm, nonresidential
   
2,638,166
     
2,638,166
     
82,334
     
2,987,168
     
50,894
 
Commercial and industrial
   
1,001,378
     
1,055,051
     
130,207
     
1,259,214
     
4,765
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
238,369
     
238,369
     
-
     
243,371
     
8,331
 
   
$
4,793,108
   
$
4,904,746
   
$
218,079
   
$
5,491,194
   
$
72,463
 
                                         
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
Loans
   
Recorded
Investment
> 90 Days
and
Accruing
 
June 30, 2015
                           
                             
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
5,003,033
   
$
5,003,033
     
-
 
1-4 family residential
   
613,778
     
182,740
     
455,672
     
1,252,190
     
41,177,701
     
42,429,891
     
7,887
 
Nonfarm, nonresidential
   
236,857
     
76,862
     
56,543
     
370,262
     
81,100,756
     
81,471,018
     
-
 
Commercial and industrial
   
194,786
     
-
     
464,692
     
659,478
     
53,923,006
     
54,582,484
     
-
 
Consumer
   
203,433
     
46,495
     
23,983
     
273,911
     
4,180,066
     
4,453,977
     
22,862
 
Other loans
   
-
     
-
     
54,812
     
54,812
     
5,501,503
     
5,556,315
     
54,812
 
Total
 
$
1,248,854
   
$
306,097
   
$
1,055,702
   
$
2,610,653
   
$
190,886,065
   
$
193,496,718
   
$
85,561
 
Percentage of total loans
   
0.65
%
   
0.16
%
   
0.55
%
   
1.35
%
   
98.65
%
   
100.00
%
       
                                                         
Non-accruals included above
                                                       
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
         
1-4 family residential
   
-
     
-
     
447,785
     
447,785
     
257,251
     
705,036
         
Nonfarm, nonresidential
   
99,313
     
-
     
56,542
     
155,855