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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 September 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 November 12, 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.
32
     
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
September 30, 2015 (Unaudited) and December 31, 2014 (Audited)

   
September
2015
   
December
2014
 
         
Assets
       
Cash and due from banks
 
$
5,040,193
   
$
6,236,749
 
Interest-bearing deposits with banks
   
54,449,791
     
37,315,779
 
Federal funds sold
   
1,217,554
     
1,212,776
 
Investment securities available for sale
   
5,343,021
     
4,363,805
 
Restricted equity securities
   
524,939
     
618,109
 
Loans, net of allowance for loan losses of $3,567,517 at September 30, 2015 and $3,554,664 at December 31, 2014
   
195,175,423
     
189,549,072
 
Property and equipment, net
   
5,061,728
     
4,368,589
 
Foreclosed assets
   
421,491
     
280,821
 
Accrued income
   
1,124,759
     
997,681
 
Goodwill
   
120,000
     
120,000
 
Bank owned life insurance
   
5,087,372
     
5,623,087
 
Other assets
   
3,349,697
     
2,514,855
 
Total assets
 
$
276,915,968
   
$
253,201,323
 
                 
Liabilities and Stockholders’ Equity
               
Liabilities
               
Deposits:
               
Noninterest-bearing
 
$
60,441,761
   
$
52,969,691
 
Interest-bearing
   
169,507,737
     
153,696,890
 
Total deposits
   
229,949,498
     
206,666,581
 
                 
Long-term debt
   
4,250,000
     
6,250,000
 
Dividends payable
   
46,233
     
827,159
 
Accrued interest payable
   
147,932
     
110,261
 
Other liabilities
   
3,641,905
     
2,576,668
 
Total liabilities
   
238,035,568
     
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
   
22,938,076
     
20,808,309
 
Accumulated other comprehensive loss
   
(27,963
)
   
(7,942
)
Total stockholders’ equity
   
38,880,400
     
36,770,654
 
Total liabilities and stockholders’ equity
 
$
276,915,968
   
$
253,201,323
 

See Notes to Consolidated Financial Statements
 
Consolidated Statements of Income
Nine months ended September 30, 2015 and 2014 (Unaudited)

   
2015
   
2014
 
Interest income
       
Loans and fees on loans
 
$
8,096,051
   
$
7,908,742
 
Federal funds sold
   
2,046
     
2,036
 
Investment securities available for sale, taxable
   
54,184
     
45,837
 
Investment securities available for sale, dividends
   
11,782
     
10,656
 
Deposits with banks
   
74,108
     
69,381
 
Total interest income
   
8,238,171
     
8,036,652
 
                 
Interest expense
               
Deposits
   
702,058
     
816,409
 
Fed funds purchased
   
3
     
19
 
Long-term debt
   
162,591
     
218,019
 
Total interest expense
   
864,652
     
1,034,447
 
Net interest income
   
7,373,519
     
7,002,205
 
                 
Provision for loan losses
   
85,717
     
132,952
 
Net interest income after provision for loan losses
   
7,287,802
     
6,869,253
 
                 
Noninterest income
               
Service charges on deposit accounts
   
592,842
     
598,988
 
Gain on the sale of government guaranteed loans
   
-
     
127,362
 
Fees on loans delivered to correspondents
   
71,583
     
18,464
 
Other service charges and fees
   
543,378
     
499,856
 
Gain (loss) on the sale of investment securities
   
5,244
     
(1,670
)
Income from bank owned life insurance
   
111,190
     
119,720
 
Insurance commissions
   
374,972
     
388,778
 
Brokerage commissions
   
135,374
     
139,911
 
Other operating income
   
83,030
     
51,176
 
Total noninterest income
   
1,917,613
     
1,942,585
 
                 
Noninterest expense
               
Salaries and employee benefits
   
2,914,354
     
2,869,549
 
Occupancy expense
   
338,881
     
339,324
 
Equipment expense
   
206,926
     
204,098
 
Data processing
   
336,903
     
341,079
 
Foreclosed assets, net
   
119,015
     
12,770
 
Postage, printing and supplies
   
148,879
     
143,987
 
Professional fees
   
371,484
     
323,384
 
FDIC insurance premiums
   
87,228
     
89,503
 
Other expense
   
1,146,040
     
1,094,460
 
Total noninterest expense
   
5,669,710
     
5,418,154
 
Net income before income taxes
   
3,535,705
     
3,393,684
 
                 
Income tax expense
   
1,268,748
     
1,234,817
 
Net income
   
2,266,957
     
2,158,867
 
                 
Preferred stock dividends
   
(137,190
)
   
(137,190
)
Net income available to common stockholders
 
$
2,129,767
   
$
2,021,677
 
                 
Basic earnings per common share
 
$
0.60
   
$
0.57
 
Diluted earnings per common share
 
$
0.54
   
$
0.52
 
Basic weighted average common shares outstanding
   
3,549,665
     
3,542,984
 
Diluted weighted average common shares outstanding
   
4,186,647
     
4,178,933
 
 
See Notes to Consolidated Financial Statements
 
Consolidated Statements of Income
Three months ended September 30, 2015 and 2014 (Unaudited)

 
   
2015
   
2014
 
Interest income
       
Loans and fees on loans
 
$
2,739,903
    $
2,684,694
 
Federal funds sold
   
683
     
682
 
Investment securities available for sale, taxable
   
20,099
     
13,430
 
Investment securities available for sale, dividends
   
5,663
     
3,525
 
Deposits with banks
   
26,111
     
22,137
 
Total interest income
   
2,792,459
     
2,724,468
 
                 
Interest expense
               
Deposits
   
234,890
     
269,901
 
Long-term debt
   
44,127
     
73,472
 
Total interest expense
   
279,017
     
343,373
 
Net interest income
   
2,513,442
     
2,381,095
 
                 
Provision for loan losses
   
129,213
     
139,527
 
Net interest income after provision for loan losses
   
2,384,229
     
2,241,568
 
                 
Noninterest income
               
Service charges on deposit accounts
   
193,177
     
197,443
 
Fees on loans delivered to correspondents
   
43,775
     
12,347
 
Other service charges and fees
   
183,890
     
177,806
 
Gain on the sale of investment securities
   
868
     
873
 
Income from bank owned life insurance
   
37,621
     
40,236
 
Insurance commissions
   
159,657
     
134,552
 
Brokerage commissions
   
32,914
     
50,260
 
Other operating income
   
15,462
     
15,254
 
Total noninterest income
   
667,364
     
628,771
 
                 
Noninterest expense
               
Salaries and employee benefits
   
922,424
     
920,537
 
Occupancy expense
   
110,303
     
115,069
 
Equipment expense
   
79,670
     
70,981
 
Data processing
   
105,695
     
130,002
 
Foreclosed assets, net
   
33,404
     
5,466
 
Postage, printing and supplies
   
42,238
     
47,039
 
Professional fees
   
123,479
     
115,523
 
FDIC insurance premiums
   
30,689
     
30,320
 
Other expense
   
351,758
     
318,085
 
Total noninterest expense
   
1,799,660
     
1,753,022
 
Net income before income taxes
   
1,251,933
     
1,117,317
 
                 
Income tax expense
   
453,346
     
402,629
 
Net income
   
798,587
     
714,688
 
                 
Preferred stock dividends
   
(46,233
)
   
(46,233
)
Net income available to common stockholders
 
$
752,354
   
$
668,455
 
                 
Basic earnings per common share
 
$
0.21
   
$
0.19
 
Diluted earnings per common share
 
$
0.19
   
$
0.17
 
Basic weighted average common shares outstanding
   
3,549,665
     
3,542,984
 
Diluted weighted average common shares outstanding
   
4,185,109
     
4,180,983
 

See Notes to Consolidated Financial Statements
 
Consolidated Statements of Comprehensive Income
Three and Nine months ended September 30, 2015 and 2014 (Unaudited)

   
Three Months
Ended September 30,
   
Nine Months
Ended September 30,
 
   
2015
   
2014
   
2015
   
2014
 
                 
Net income
 
$
798,587
   
$
714,688
   
$
2,266,957
   
$
2,158,867
 
                                 
Other comprehensive income (loss):
                               
Investment securities available for sale:
                               
Unrealized holding gains (losses)
   
(32,904
)
   
(4,561
)
   
(22,693
)
   
65,750
 
Tax effect
   
10,597
     
1,492
     
6,133
     
(24,030
)
Reclassification of (gains) losses recognized in net income
   
(868
)
   
(873
)
   
(5,244
)
   
1,670
 
Tax effect
   
295
     
296
     
1,783
     
(568
)
     
(22,880
)
   
(3,646
)
   
(20,021
)
   
42,822
 
Comprehensive income
 
$
775,707
   
$
711,042
   
$
2,246,936
   
$
2,201,689
 

See Notes to Consolidated Financial Statements
 
Consolidated Statements of Cash Flows
Nine months ended September 30, 2015 and 2014 (Unaudited)

   
2015
   
2014
 
Cash flows from operating activities
       
Net income
 
$
2,266,957
   
$
2,158,867
 
Adjustments to reconcile net income to net cash provided by operations:
               
Depreciation and amortization
   
202,084
     
203,536
 
Gain on sale of property and equipment
   
(50
)
   
(3,406
)
Gain on the sale of government guaranteed loans
   
-
     
(127,362
)
(Gain) loss on the sale of securities
   
(5,244
)
   
1,670
 
(Gain) loss on the sale of foreclosed assets
   
21,248
     
(3,466
)
Provision for of loan losses
   
85,717
     
132,952
 
Deferred income taxes
   
1,868
     
(3,828
)
(Accretion) of discount on securities, net of amortization of premiums
   
(505
)
   
21
 
Increase in cash surrender value of life insurance
   
(111,190
)
   
(119,719
)
Life insurance proceeds
   
1,001,320
     
-
 
Changes in assets and liabilities:
               
Accrued income
   
(127,078
)
   
(79,743
)
Other assets
   
(1,247,944
)
   
(1,595,392
)
Accrued interest payable
   
37,671
     
76,734
 
Other liabilities
   
1,129,972
     
1,418,609
 
Net cash provided by operating activities
   
3,254,826
     
2,059,473
 
                 
Cash flows from investing activities
               
Net increase in interest-bearing deposits with banks
   
(17,134,012
)
   
(2,234,562
)
Net (increase) decrease in federal funds sold
   
(4,778
)
   
99,166
 
Purchases of investment securities
   
(3,024,364
)
   
(1,137,854
)
Maturities of investment securities
   
2,004,016
     
1,255,282
 
Redemption of restricted equity securities
   
104,400
     
59,000
 
Purchase of restricted equity securities
   
(11,230
)
   
(170
)
Net increase in loans
   
(6,185,511
)
   
(9,088,199
)
Proceeds from the sale of investment securities
   
18,944
     
131,403
 
Proceeds from the sale of foreclosed assets
   
311,525
     
39,591
 
Purchases of property and equipment
   
(895,223
)
   
(192,537
)
Proceeds from the sale of property and equipment
   
50
     
5,575
 
Net cash used in investing activities
   
(24,816,183
)
   
(11,063,305
)
                 
Cash flows from financing activities
               
Net increase in deposits
   
23,282,917
     
8,919,589
 
Maturities of long-term debt
   
(2,000,000
)
   
-
 
Dividends paid
   
(918,116
)
   
(881,216
)
Net cash provided by financing activities
   
20,364,801
     
8,038,373
 
Net decrease in cash and cash equivalents
   
(1,196,556
)
   
(965,459
)
Cash and due from banks, beginning
   
6,236,749
     
7,424,593
 
Cash and due from banks, ending
 
$
5,040,193
   
$
6,459,134
 
                 
Supplemental disclosures of cash flow information
               
Interest paid
 
$
826,981
   
$
957,713
 
Taxes paid
 
$
1,292,479
   
$
1,486,722
 
Supplemental disclosures of non-cash transactions
               
Loans transferred to foreclosed properties
 
$
473,443
   
$
177,461
 
Cash dividends declared but not paid
 
$
46,233
   
$
46,233
 

See Notes to Consolidated Financial Statements
 
Consolidated Statements of Changes in Stockholders’ Equity
Nine months ended September 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
   
-
     
-
     
-
     
2,158,867
     
-
     
2,158,867
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
42,822
     
42,822
 
                                                 
Dividends declared and accrued on convertible Series A preferred stock ($.47 per share)
   
-
     
-
     
-
     
(89,225
)
   
-
     
(89,225
)
Dividends declared and accrued on convertible Series D preferred stock ($.26 per share)
   
-
     
-
     
-
     
(47,965
)
   
-
     
(47,965
)
Balance, September 30, 2014
 
$
3,868,807
     
3,542,984
   
$
12,061,153
   
$
20,350,766
   
$
1,399
   
$
36,282,125
 
                                                 
Balance, January 1, 2015
 
$
3,868,807
     
3,549,665
   
$
12,101,480
   
$
20,808,309
   
$
(7,942
)
 
$
36,770,654
 
                                                 
Net income
   
-
     
-
     
-
     
2,266,957
     
-
     
2,266,957
 
Other comprehensive income
   
-
     
-
     
-
     
-
     
(20,021
)
   
(20,021
)
                                                 
Dividends declared and accrued on convertible Series A preferred stock ($.47 per share)
   
-
     
-
     
-
     
(89,225
)
   
-
     
(89,225
)
Dividends declared and accrued on convertible Series D preferred stock ($.26 per share)
   
-
     
-
     
-
     
(47,965
)
   
-
     
(47,965
)
Balance, September 30, 2015
 
$
3,868,807
     
3,549,665
   
$
12,101,480
   
$
22,938,076
   
$
(27,963
)
 
$
38,880,400
 

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 September 30, 2015, the results of its operations and comprehensive income for the nine and three months ended September 30, 2015 and 2014, and its changes in stockholders’ equity and cash flows for the nine months ended September 30, 2015 and 2014.  These adjustments are of a normal and recurring nature. The results of operations for the nine months ended September 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 September 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 September 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 became effective for the Company on January 1, 2015. 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 modified retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements. In August 2015, the FASB deferred the effective date of ASU 2014-09, Revenue from Contracts with Customers. As a result of the deferral, the guidance in ASU 2014-09 will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a modified 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

In June 2015, the FASB issued amendments to clarify the Accounting Standards Codification (ASC), correct unintended application of guidance, and make minor improvements to the ASC that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to most entities. The amendments were effective upon issuance (June 12, 2015) for amendments that do not have transition guidance. Amendments that are subject to transition guidance will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. The Company does not expect these amendments to have a material effect on its financial statements.
 
In August 2015, the FASB issued amendments to the Interest topic of the Accounting Standards Codification to clarify the SEC staff’s position on presenting and measuring debt issuance costs incurred in connection with line-of-credit arrangements. The amendments were effective upon issuance. 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 September 30, 2015 and December 31, 2014 follow:

   
Amortized
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value
 
                 
September 30, 2015
               
Government-sponsored enterprises
 
$
4,498,020
   
$
6,335
   
$
720
   
$
4,503,635
 
Mortgage-backed securities
   
21,561
     
601
     
-
     
22,162
 
Corporate bonds
   
300,000
     
-
     
6,000
     
294,000
 
Equities and mutual funds
   
565,799
     
16,824
     
59,399
     
523,224
 
   
$
5,385,380
   
$
23,760
   
$
66,119
   
$
5,343,021
 
                                 
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 September 30, 2015 and December 31, 2014, approximately $3,931,000 of the 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 September 30, 2015, were as follows:
 
   
Amortized
Cost
   
Fair
Value
 
Due in one year or less
 
$
565,799
   
$
523,224
 
Due after one year through five years
   
4,805,983
     
4,805,782
 
Due after five years through ten years
   
4,950
     
5,078
 
Due after ten years
   
8,648
     
8,937
 
   
$
5,385,380
   
$
5,343,021
 

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 September 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 September 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
 
                         
September 30, 2015
                       
Government-sponsored enterprises
 
$
999,280
   
$
720
   
$
-
   
$
-
   
$
999,280
   
$
720
 
Corporate bonds
   
-
     
-
     
294,000
     
6,000
     
294,000
     
6,000
 
Equities and mutual funds
   
252,350
     
48,458
     
141,657
     
10,941
     
394,007
     
59,399
 
   
$
1,251,630
   
$
49,178
   
$
435,657
   
$
16,941
   
$
1,687,287
   
$
66,119
 
                                                 
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 seven securities in the portfolio at September 30, 2015, with unrealized losses for a period greater than 12 months. Two 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 market fluctuations. No declines are deemed to be other than temporary in nature.

The Company had realized gains of $5,244 from the sales of equity and mutual fund investment securities for the nine month period ended September 30, 2015, and realized losses of $1,670 from the sales of equity and mutual fund investment securities for the nine month periods ended September 30, 2014. Total proceeds from the sales amounted to $18,944 and $131,403 in 2015 and 2014, respectively.
 
NOTE 3.
EARNINGS PER COMMON SHARE

Basic earnings per common share for the nine and three months ended September 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 September 30, 2015, the Company had commitments to extend credit, including unused lines of credit of approximately $49,729,000 and letters of credit outstanding of $2,370,151.

NOTE 5.
LOANS

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

   
2015
   
2014
 
         
Commercial
 
$
52,651,131
   
$
56,602,425
 
Real estate:
               
Construction and land development
   
6,484,974
     
10,061,249
 
Residential, 1-4 families
   
41,938,912
     
41,824,806
 
Residential, 5 or more families
   
1,178,251
     
1,109,586
 
Farmland
   
3,360,755
     
3,486,002
 
Nonfarm, nonresidential
   
83,725,388
     
74,275,793
 
Agricultural
   
4,846,125
     
675,474
 
Consumer, net of discounts of $12,872 in 2015 and $11,950 in 2014
   
4,373,523
     
4,997,023
 
     
198,559,059
     
193,032,358
 
Deferred loan origination costs, net of (fees)
   
183,881
     
71,378
 
     
198,742,940
     
193,103,736
 
Allowance for loan losses
   
(3,567,517
)
   
(3,554,664
)
   
$
195,175,423
   
$
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 $12,351,000 and $18,124,000 at September 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 nine months ended September 30, 2015 and 2014 was as follows:

   
Construction
&
Development
   
1-4 Family
Residential
   
Nonfarm,
Nonresidential
   
Commercial
&
Industrial
   
Consumer
   
Other
   
Total
 
                             
September 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
   
-
     
(153,023
)
   
(8,481
)
   
(198,523
)
   
(95,503
)
   
-
     
(455,530
)
Recoveries
   
-
     
1,645
     
761
     
351,320
     
28,940
     
-
     
382,666
 
Provision
   
(57,200
)
   
119,448
     
(65,395
)
   
(50,097
)
   
75,161
     
63,800
     
85,717
 
Ending balance
 
$
102,900
   
$
766,269
   
$
994,200
   
$
1,404,600
   
$
167,348
   
$
132,200
   
$
3,567,517
 
                                                         
Ending balance: individually evaluated for impairment
 
$
-
   
$
4,869
   
$
-
   
$
-
   
$
-
   
$
-
   
$
4,869
 
Ending balance: collectively evaluated for impairment
 
$
102,900
   
$
761,400
   
$
994,200
   
$
1,404,600
   
$
167,348
   
$
132,200
   
$
3,562,648
 
                                                         
Loans Receivable:
                                                       
Ending balance
 
$
6,484,974
   
$
41,938,912
   
$
83,725,388
   
$
52,651,131
   
$
4,373,523
   
$
9,385,131
   
$
198,559,059
 
                                                         
Ending balance: individually evaluated for impairment
 
$
11,729
   
$
1,107,891
   
$
2,582,894
   
$
644,828
   
$
-
   
$
11,585
   
$
4,358,927
 
Ending balance: collectively evaluated for impairment
 
$
6,473,245
   
$
40,831,021
   
$
81,142,494
   
$
52,006,303
   
$
4,373,523
   
$
9,373,546
   
$
194,200,132
 
                                                         
September 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
)
   
(41,118
)
   
-
     
(123,293
)
Recoveries
   
-
     
1,463
     
80,314
     
153,121
     
33,319
     
-
     
268,217
 
Provision
   
79,100
     
157,076
     
(10,304
)
   
(81,778
)
   
(22,042
)
   
10,900
     
132,952
 
Ending balance
 
$
152,100
   
$
699,277
   
$
821,282
   
$
1,776,799
   
$
151,468
   
$
52,300
   
$
3,653,226
 
                                                         
Ending balance: individually evaluated for impairment
 
$
-
   
$
86,377
   
$
120,382
   
$
257,699
   
$
-
   
$
-
   
$
464,458
 
Ending balance: collectively evaluated for impairment
 
$
152,100
   
$
612,900
   
$
700,900
   
$
1,519,100
   
$
151,468
   
$
52,300
   
$
3,188,768
 
                                                         
Loans Receivable:
                                                       
Ending balance
 
$
10,988,313
   
$
40,577,088
   
$
61,894,643
   
$
69,456,737
   
$
5,009,585
   
$
4,486,996
   
$
192,413,362
 
                                                         
Ending balance: individually evaluated for impairment
 
$
243,827
   
$
632,885
   
$
2,779,367
   
$
1,547,309
   
$
-
   
$
-
   
$
5,203,388
 
Ending balance: collectively evaluated for impairment
 
$
10,744,486
   
$
39,944,203
   
$
59,115,276
   
$
67,909,428
   
$
5,009,585
   
$
4,486,996
   
$
187,209,974
 
 
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 September 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
 
September 30, 2015
                   
With no related allowance recorded:
                   
Construction and development
 
$
11,729
   
$
11,729
   
$
-
   
$
12,684
   
$
774
 
1-4 family residential
   
1,088,402
     
1,088,402
     
-
     
1,097,425
     
29,983
 
Nonfarm, nonresidential
   
2,582,894
     
2,582,894
     
-
     
2,739,901
     
82,669
 
Commercial and industrial
   
644,828
     
644,828
     
-
     
796,205
     
8,123
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
11,585
     
11,585
     
-
     
13,546
     
503
 
     
4,339,438
     
4,339,438
     
-
     
4,659,761
     
122,052
 
                                         
With an allowance recorded:
   
-
     
-
     
-
     
-
     
-
 
Construction and development
   
19,489
     
19,489
     
4,869
     
20,272
     
-
 
1-4 family residential
   
-
     
-
     
-
     
-
     
-
 
Nonfarm, nonresidential
   
-
     
-
     
-
     
-
     
-
 
Commercial and industrial
   
-
     
-
     
-
     
-
     
-
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
19,489
     
19,489
     
4,869
     
20,272
     
-
 
                                         
                                         
Combined:
                                       
Construction and development
   
11,729
     
11,729
     
-
     
12,684
     
774
 
1-4 family residential
   
1,107,891
     
1,107,891
     
4,869
     
1,117,697
     
29,983
 
Nonfarm, nonresidential
   
2,582,894
     
2,582,894
     
-
     
2,739,901
     
82,669
 
Commercial and industrial
   
644,828
     
644,828
     
-
     
796,205
     
8,123
 
Consumer
   
-
     
-
     
-
     
-
     
-
 
Other loans
   
11,585
     
11,585
     
-
     
13,546
     
503
 
   
$
4,358,927
   
$
4,358,927
   
$
4,869
   
$
4,680,033
   
$
122,052
 
                                         
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
 
September 30, 2015
                           
                             
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
6,484,974
   
$
6,484,974
     
-
 
1-4 family residential
   
426,321
     
345,031
     
413,710
     
1,185,062
     
40,753,850
     
41,938,912
     
66,793
 
Nonfarm, nonresidential
   
533,724
     
71,648
     
317,421
     
922,793
     
82,802,595
     
83,725,388
     
-
 
Commercial and industrial
   
90,150
     
680,430
     
185,300
     
955,880
     
51,695,251
     
52,651,131
     
-
 
Consumer
   
127,833
     
17,368
     
44,467
     
189,668
     
4,183,855
     
4,373,523
     
43,345
 
Other loans
   
-
     
-
     
-
     
-
     
9,385,131
     
9,385,131
     
-
 
Total
 
$
1,178,028
   
$
1,114,477
   
$
960,898
   
$
3,253,403
   
$
195,305,656
   
$
198,559,059
   
$
110,138
 
Percentage of total loans
   
0.59
%
   
0.56
%
   
0.48
%
   
1.64
%
   
98.36
%
   
100.00
%
       
                                                         
Non-accruals included above
                                                       
Construction and development
 
$
-
   
$
-
   
$
-
   
$
-
   
$
-
   
$
-
         
1-4 family residential
   
-
     
-
     
346,917
     
346,917
     
252,324
     
599,241
         
Nonfarm, nonresidential
   
116,473
     
-
     
317,421
     
433,894
     
94,516
     
528,410
         
Commercial and industrial
   
-
     
-
     
185,300
     
185,300
     
-
     
185,300
         
Consumer
   
-
     
-
     
1,122
     
1,122
     
948
     
2,070
         
Other loans
   
-
     
-
     
-
     
-
     
-
     
-
         
   
$
116,473
   
$
-
   
$
850,760
   
$
967,233
   
$
347,788
     
1,315,021
         
                                                         
December 31, 2014
                                                       
                                                         
Construction and development
 
$
94,736
   
$
-
   
$
-
   
$
94,736
   
$
9,966,513
   
$
10,061,249
   
$