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

FORM 10-Q

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

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

COMMISSION FILE NO. 000-50313

SURREY BANCORP
(Exact name of registrant as specified in its charter)

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

145 North Renfro Street, Mount Airy, NC  27030
 (Address of principal executive offices)

(336) 783-3900
(Registrant's telephone number)
 

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

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

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

Large accelerated filer
☐
Accelerated filer
☐
       
Non-accelerated filer
☐
Smaller reporting company
☒

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

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

On May 14, 2015 there were 3,549,665 common shares issued and outstanding.
 
PART I – FINANCIAL INFORMATION

Item 1.
Consolidated Financial Statements
  
     
 
3
     
 
4
     
 
5
     
 
6
     
 
7
     
 
8-22
     
Item 2.
23-29
     
Item 3.
30
     
Item 4.
31
     
PART II – OTHER INFORMATION
  
     
Item 1.
32
     
Item 1A.
32
     
Item 2.
32
     
Item 3.
32
     
Item 4.
32
     
Item 5.
32
     
Item 6.
32
     
33
     
CERTIFICATIONS
34-36
 
Consolidated Balance Sheets
March 31, 2015 (Unaudited) and December 31, 2014 (Audited)
 
   
March
2015
    
December
2014
  
         
Assets
        
Cash and due from banks
  
$
5,401,971
    
$
6,236,749
  
Interest-bearing deposits with banks
    
42,625,181
      
37,315,779
  
Federal funds sold
    
1,215,007
      
1,212,776
  
Investment securities available for sale
    
4,373,630
      
4,363,805
  
Restricted equity securities
    
629,209
      
618,109
  
Loans, net of allowance for loan losses of $3,419,908 at March 31, 2015 and $3,554,664 at December 31, 2014
    
189,141,256
      
189,549,072
  
Property and equipment, net
    
4,545,762
      
4,368,589
  
Foreclosed assets
    
175,526
      
280,821
  
Accrued income
    
1,001,168
      
997,681
  
Goodwill
    
120,000
      
120,000
  
Bank owned life insurance
    
5,013,006
      
5,623,087
  
Other assets
    
2,003,253
      
2,514,855
  
Total assets
  
$
256,244,969
    
$
253,201,323
  
                 
Liabilities and Stockholders’ Equity
                
Liabilities
                
Deposits:
                
Noninterest-bearing
  
$
53,981,233
    
$
52,969,691
  
Interest-bearing
    
155,925,316
      
153,696,890
  
Total deposits
    
209,906,549
      
206,666,581
  
                 
Long-term debt
    
6,250,000
      
6,250,000
  
Dividends payable
    
45,227
      
827,159
  
Accrued interest payable
    
133,070
      
110,261
  
Other liabilities
    
2,451,126
      
2,576,668
  
Total liabilities
    
218,785,972
      
216,430,669
  
                 
Commitments and contingencies (Note 4)
                
                 
Stockholders’ equity
                
Preferred stock, 1,000,000 shares authorized, 189,356 shares of Series A issued and outstanding with no par value 4.5% convertible non-cumulative, perpetual, with a liquidation value of $14 per share;
    
2,620,325
      
2,620,325
  
181,154 shares of Series D issued and outstanding with no par value 5.0% convertible non-cumulative, perpetual; with a liquidation value of $7.08 per share;
    
1,248,482
      
1,248,482
  
Common stock, 10,000,000 shares authorized at no par value; 3,549,665 shares issued and outstanding at March 31, 2015 and December 31, 2014
    
12,101,480
      
12,101,480
  
Retained earnings
    
21,491,516
      
20,808,309
  
Accumulated other comprehensive loss
    
(2,806
)
    
(7,942
)
Total stockholders’ equity
    
37,458,997
      
36,770,654
  
Total liabilities and stockholders’ equity
  
$
256,244,969
    
$
253,201,323
  
 
See Notes to Consolidated Financial Statements
 
3
Consolidated Statements of Income
Three months ended March 31, 2015 and 2014 (Unaudited)
 
   
2015
    
2014
  
Interest income
        
Loans and fees on loans
  
$
2,679,309
    
$
2,592,470
  
Federal funds sold
    
691
      
684
  
Investment securities available for sale, taxable
    
16,807
      
16,262
  
Investment securities available for sale, dividends
    
2,234
      
3,617
  
Deposits with banks
    
20,837
      
19,610
  
Total interest income
    
2,719,878
      
2,632,643
  
                 
Interest expense
                
Deposits
    
236,397
      
274,949
  
Fed funds purchased
    
-
      
17
  
Long-term debt
    
60,705
      
71,874
  
Total interest expense
    
297,102
      
346,840
  
Net interest income
    
2,422,776
      
2,285,803
  
                 
Recapture of loan losses
    
(113,794
)
    
(62,362
)
Net interest income after recapture of loan losses
    
2,536,570
      
2,348,165
  
                 
Noninterest income
                
Service charges on deposit accounts
    
191,344
      
199,084
  
Fees on loans delivered to correspondents
    
5,646
      
530
  
Other service charges and fees
    
171,193
      
146,016
  
Gain on the sale of investment securities
    
4,376
      
2,898
  
Income from bank owned life insurance
    
36,824
      
40,010
  
Insurance commissions
    
83,777
      
93,336
  
Brokerage commissions
    
79,041
      
47,132
  
Other operating income
    
53,033
      
52,922
  
Total noninterest income
    
625,234
      
581,928
  
                 
Noninterest expense
                
Salaries and employee benefits
    
1,032,331
      
1,009,500
  
Occupancy expense
    
109,348
      
107,884
  
Equipment expense
    
62,896
      
58,871
  
Data processing
    
123,006
      
105,311
  
Foreclosed assets, net
    
38,844
      
(894
)
Postage, printing and supplies
    
41,324
      
45,626
  
Professional fees
    
141,999
      
115,323
  
FDIC insurance premiums
    
24,458
      
29,626
  
Other expense
    
458,462
      
396,140
  
Total noninterest expense
    
2,032,668
      
1,867,387
  
Net income before income taxes
    
1,129,136
      
1,062,706
  
                 
Income tax expense
    
400,702
      
386,306
  
Net income
    
728,434
      
676,400
  
                 
Preferred stock dividends
    
(45,227
)
    
(45,227
)
Net income available to common stockholders
  
$
683,207
    
$
631,173
  
                 
Basic earnings per common share
  
$
0.19
    
$
0.18
  
Diluted earnings per common share
  
$
0.17
    
$
0.16
  
Basic weighted average common shares outstanding
    
3,549,665
      
3,542,984
  
Diluted weighted average common shares outstanding
    
4,187,410
      
4,176,919
  
 
See Notes to Consolidated Financial Statements
 
4
Consolidated Statements of Comprehensive Income
Three months ended March 31, 2015 and 2014 (Unaudited)
 
   
2015
    
2014
  
         
Net income
  
$
728,434
    
$
676,400
  
                 
Other comprehensive income:
                
Investment securities available for sale:
                
Unrealized holding gains
    
12,825
      
4,565
  
Tax effect
    
(4,801
)
    
(1,583
)
Reclassification of gains recognized in net income
    
(4,376
)
    
(2,898
)
Tax effect
    
1,488
      
985
  
     
5,136
      
1,069
  
Comprehensive income
  
$
733,570
    
$
677,469
  
 
See Notes to Consolidated Financial Statements
 
5
Consolidated Statements of Cash Flows
Three months ended March 31, 2015 and 2014 (Unaudited)
 
   
2015
    
2014
  
Cash flows from operating activities
        
Net income
  
$
728,434
    
$
676,400
  
Adjustments to reconcile net income to net cash provided by operations:
                
Depreciation and amortization
    
67,627
      
66,677
  
Gain on sale of property and equipment
    
(50
)
    
(75
)
Gain on the sale of securities
    
(4,376
)
    
(2,898
)
Loss on the sale of foreclosed assets
    
8,507
      
-
  
Recapture of loan losses
    
(113,794
)
    
(62,362
)
Deferred income tax expense (benefit)
    
(2,071
)
    
(1,036
)
Accretion of discount on securities, net of amortization of premiums
    
(103
)
    
7
  
Increase in cash surrender value of life insurance
    
(36,824
)
    
(40,010
)
Life insurance proceeds
    
1,001,320
      
-
  
Changes in assets and liabilities:
                
Accrued income
    
(3,487
)
    
10,813
  
Other assets
    
91,210
      
(31,738
)
Accrued interest payable
    
22,809
      
29,029
  
Other liabilities
    
(60,807
)
    
193,123
  
Net cash provided by operating activities
    
1,698,395
      
837,930
  
                 
Cash flows from investing activities
                
Net increase in interest-bearing deposits with banks
    
(5,309,402
)
    
(11,768,946
)
Net (increase) decrease in federal funds sold
    
(2,231
)
    
98,686
  
Purchases of investment securities
    
(1,009,610
)
    
(1,011,509
)
Maturities of investment securities
    
1,001,578
      
1,001,223
  
Redemption of restricted equity securities
    
-
      
59,000
  
Purchase of restricted equity securities
    
(11,100
)
    
(60
)
Net decrease in loans
    
481,474
      
798,931
  
Proceeds from the sale of investment securities
    
11,135
      
9,259
  
Proceeds from the sale of foreclosed assets
    
136,924
      
-
  
Purchases of property and equipment
    
(244,800
)
    
(57,536
)
Proceeds from the sale of property and equipment
    
50
      
75
  
Net cash used in investing activities
    
(4,945,982
)
    
(10,870,877
)
                 
Cash flows from financing activities
                
Net increase in deposits
    
3,239,968
      
9,314,599
  
Dividends paid
    
(827,159
)
    
(790,259
)
Net cash provided by financing activities
    
2,412,809
      
8,524,340
  
Net decrease in cash and cash equivalents
    
(834,778
)
    
(1,508,607
)
Cash and due from banks, beginning
    
6,236,749
      
7,424,593
  
Cash and due from banks, ending
  
$
5,401,971
    
$
5,915,986
  
                 
Supplemental disclosures of cash flow information
                
Interest paid
  
$
274,293
    
$
317,840
  
Taxes paid
  
$
-
    
$
63,722
  
Supplemental disclosures of non-cash transactions
                
Loans transferred to foreclosed properties
  
$
40,136
    
$
144,521
  
Cash dividends declared but not paid
  
$
45,227
    
$
45,227
  
 
See Notes to Consolidated Financial Statements
 
6
Consolidated Statements of Changes in Stockholders’ Equity
Three months ended March 31, 2015 and 2014 (Unaudited)

   
Preferred
Stock
    
Common Stock
    
Retained
    
Accumulated
Other
Comprehensive 
      
   
Amount
    
Shares
    
Amount
    
Earnings
    
Income (Loss)
    
Total
  
                         
Balance, January 1, 2014
  
$
3,868,807
    
$
3,542,984
      
12,061,153
    
$
18,329,089
    
$
(41,423
)
  
$
34,217,626
  
                                                 
Net income
    
-
      
-
      
-
      
676,400
      
-
      
676,400
  
Other comprehensive income
    
-
      
-
      
-
      
-
      
1,069
      
1,069
  
                                                 
Dividends declared and accrued on convertible
                                                
Series A preferred stock ($.16 per share)
    
-
      
-
      
- 
      
(29,415
)
    
-
      
(29,415
)
Dividends declared and accrued on convertible
            
 
                                  
Series D preferred stock ($.09 per share)
     -      
-
       -      
(15,812
)
    
-
      
(15,812
)
Balance, March 31, 2014
  
$
3,868,807
    
$
3,542,984
      
12,061,153
    
$
18,960,262
    
$
(40,354
)
  
$
34,849,868
  
                                                 
Balance, January 1, 2015
  
$
3,868,807
    
$
3,549,665
      
12,101,480
    
$
20,808,309
    
$
(7,942
)
  
$
36,770,654
  
                                                 
Net income
    
-
      
-
      
-
      
728,434
      
-
      
728,434
  
Other comprehensive income
    
-
      
-
      
-
      
-
      
5,136
      
5,136
  
Dividends declared and accrued on convertible
            
 
                                  
Series A preferred stock ($.16 per share)
    
-
      
-
      
-
      
(29,415
)
    
-
      
(29,415
)
Dividends declared and accrued on convertible
                                                
Series D preferred stock ($.09 per share)
    
-
      
-
      
-
      
(15,812
)
    
-
      
(15,812
)
Balance, March 31, 2015
  
$
3,868,807
    
$
3,549,665
      
12,101,480
    
$
21,491,516
    
$
(2,806
)
  
$
37,458,997
  
See Notes to Consolidated Financial Statements
 
7
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
 
NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and therefore, do not include all disclosures required by generally accepted accounting principles for a complete presentation of financial statements. In the opinion of management, the consolidated financial statements contain all adjustments necessary to present fairly the financial condition of Surrey Bancorp, (the “Company), as of March 31, 2015, the results of its operations and comprehensive income for the three months ended March 31, 2015 and 2014, and its changes in stockholders’ equity and cash flows for the three months ended March 31, 2015 and 2014.  These adjustments are of a normal and recurring nature. The results of operations for the three months ended March 31, 2015, are not necessarily indicative of the results expected for the full year. These consolidated financial statements should be read in conjunction with the Company’s audited financial statements and related disclosures for the year ended December 31, 2014, included in the Company’s Form 10-K. The balance sheet at December 31, 2014, has been taken from the audited financial statements at that date.

Organization

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

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

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

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

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

Critical Accounting Policies

The notes to the audited consolidated financial statements for the year ended December 31, 2014 contain a summary of the significant accounting policies.  The Company believes our policies with respect to the methodology for the determination of the allowance for loan losses, and asset impairment judgments, including the recoverability of intangible assets involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters.  Changes in these judgments, assumptions or estimates could cause reported results to differ materially.  These critical policies and their application are periodically reviewed with the Audit Committee and our Board of Directors.  See our Annual Report on Form 10-K for full details on critical accounting policies.

Principles of Consolidation

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


NOTE 1.
BASIS OF PRESENTATION, CONTINUED

Presentation of Cash Flows

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

Investment Securities

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

Investment securities classified as held to maturity are those debt securities that the Bank has the ability and intent to hold to maturity. Accordingly, these securities are carried at cost adjusted for amortization of premiums and accretion of discount, computed by the interest-method over their contractual lives. At March 31, 2015 and December 31, 2014, the Bank had no investments classified as held to maturity.

Loans Held for Sale

The Bank originates and holds Small Business Administration (SBA) and United States Department of Agriculture (USDA) guaranteed loans in its portfolio in the normal course of business. Occasionally, the Bank sells the guaranteed portions of these loans into the secondary market. The loans are generally variable rate loans, which eliminates the market risk to the Bank and are therefore carried at cost. Fixed rate loans are carried at the lower of cost or market. The Bank recognizes gains on the sale of the guaranteed portion upon the consummation of the transaction. The Bank plans to continue to originate guaranteed loans for sales, however no such loans were funded and held for sale at March 31, 2015 and December 31, 2014.

Loans Receivable

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

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

Interest is accrued and credited to income based on the principal amount outstanding.  The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due.  When the interest accrual is discontinued, all unpaid accrued interest is reversed.  Interest income is subsequently recognized only to the extent cash payments are received.  Payments received on nonaccrual loans are first applied to principal and any residual amounts are then applied to interest.  When facts and circumstances indicate the borrower has regained the ability to meet the required payments, the loan is returned to accrual status.  Past due loans are determined on the basis of contractual terms.
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1. BASIS OF PRESENTATION, CONTINUED

Allowance for Loan Losses

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

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

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

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

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

Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements:

In January 2014, the FASB amended Receivables topic of the Accounting Standards Codification. The amendments are intended to resolve diversity in practice with respect to when a creditor should reclassify a collateralized consumer mortgage loan to other real estate owned (OREO). In addition, the amendments require a creditor reclassify a collateralized consumer mortgage loan to OREO upon obtaining legal title to the real estate collateral, or the borrower voluntarily conveying all interest in the real estate property to the lender to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement. The amendments will be effective for the Company for annual periods, and interim periods within those annual period beginning after December 15, 2014, with early implementation of the guidance permitted. In implementing this guidance, assets that are reclassified from real estate to loans are measured at the carrying value of the real estate at the date of adoption. Assets reclassified from loans to real estate are measured at the lower of the net amount of the loan receivable or the fair value of the real estate less costs to sell at the date of adoption. The Company will apply the amendments prospectively. The Company does not expect these amendments to have a material effect on its financial statements.
 
10
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.
 
11
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2. SECURITIES

Debt and equity securities have been classified in the balance sheets according to management’s intent.  The amortized costs of securities available for sale and their approximate fair values at March 31, 2015 and December 31, 2014 follow:

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

At March 31, 2015 and December 31, 2014, substantially all government-sponsored enterprises securities were pledged as collateral on public deposits and for other purposes as required or permitted by law.  The mortgage-backed securities were pledged to the Federal Home Loan Bank.

Maturities of mortgage-backed bonds are stated based on contractual maturities.  Actual maturities of these bonds may vary as the underlying mortgages are prepaid.  The investment in equities and mutual funds by nature have no maturity date and are classified as due in one year or less. The scheduled maturities of securities (all available for sale) at March 31, 2015, were as follows:

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

The following table shows investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at March 31, 2015 and December 31, 2014. These unrealized losses on investment securities are a result of volatility in interest rates which relate to government-sponsored enterprises and corporate bonds issued by other banks and market volatility as it relates to equity and mutual fund investments at March 31, 2015 and December 31, 2014.

   
Less Than 12 Months
    
12 Months or More
    
Total
  
   
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
  
                         
March 31, 2015
                        
Government-sponsored enterprises
  
$
2,492,110
    
$
5,499
    
$
499,975
    
$
25
    
$
2,992,085
    
$
5,524
  
Corporate bonds
    
-
      
-
      
270,000
      
30,000
      
270,000
      
30,000
  
Equities and mutual funds
    
144,979
      
9,753
      
53,261
      
479
      
198,240
      
10,232
  
   
$
2,637,089
    
$
15,252
    
$
823,236
    
$
30,504
    
$
3,460,325
    
$
45,756
  
                                                 
December 31, 2014
                                                
Government-sponsored enterprises
  
$
1,995,360
    
$
4,640
    
$
-
    
$
-
    
$
1,995,360
    
$
4,640
  
Corporate bonds
    
-
      
-
      
255,000
      
45,000
      
255,000
      
45,000
  
Equities and mutual funds
    
69,129
      
5,592
      
107,999
      
3,975
      
177,128
      
9,567
  
   
$
2,064,489
    
$
10,232
    
$
362,999
    
$
48,975
    
$
2,427,488
    
$
59,207
  
 
12
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2. SECURITIES, CONTINUED

Management considers the nature of the investment, the underlying causes of the decline in the market value and the severity and duration of the decline in market value in determining if impairment is other than temporary. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Based upon this evaluation, there are two securities in the portfolio at March 31, 2015, with unrealized losses for a period greater than 12 months. One of these securities also had unrealized losses for a period greater than 12 months at December 31, 2014. We have analyzed each individual security for Other Than Temporary Impairment (“OTTI”) purposes by reviewing delinquencies, loan-to-value ratios, and credit quality and concluded that all unrealized losses presented in the tables above are not related to an issuer’s financial condition but are due to changes in the level of interest rates and no declines are deemed to be other than temporary in nature.

The Company had realized gains of $4,376 from the sales of equity and mutual fund investment securities for the three month period ended March 31, 2015, and realized gains of $2,898 from the sales of equity and mutual fund investment securities for the three month periods ended March 31, 2014. Total proceeds from the sales amounted to $11,135 and $9,259 in 2015 and 2014, respectively.

NOTE 3. EARNINGS PER COMMON SHARE

Basic earnings per common share for the three months ended March 31, 2015 and 2014 were calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period.

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

NOTE 4. COMMITMENTS AND LETTERS OF CREDIT

At March 31, 2015, the Company had commitments to extend credit, including unused lines of credit of approximately $43,318,000 and letters of credit outstanding of $2,414,247.

NOTE 5. LOANS

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

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

NOTE 5.
LOANS, CONTINUED

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

NOTE 6.
ALLOWANCE FOR LOAN LOSSES

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

   
Construction 
&
Development
    
1-4 Family
Residential
    
Nonfarm,
Nonresidential
    
Commercial
&
Industrial
    
Consumer
    
Other
    
Total
  
                             
March 31, 2015
                            
                             
Allowance for credit losses:
                            
Beginning balance
  
$
160,100
    
$
798,199
    
$
1,067,315
    
$
1,301,900
    
$
158,750
    
$
68,400
    
$
3,554,664
  
Charge-offs
    
-
      
(47,169
)
    
-
      
(897
)
    
(35,562
)
    
-
      
(83,628
)
Recoveries
    
-
      
889
      
205
      
49,023
      
12,549
      
-
      
62,666
  
Provision
  
 
(68,000
)
    
28,773
      
35,371
      
(137,135
)
    
22,997
      
4,200
      
(113,794
)
Ending balance
   $
92,100
    
$
780,692
    
$
1,102,891
    
$
1,212,891
    
$
158,734
    
$
72,600
    
$
3,419,908
  
                                                         
Ending balance: individually evaluated for impairment
  
$
-
    
$
64,992
    
$
113,491
    
$
143,291
    
$
-
    
$
-
    
$
321,774
  
Ending balance: collectively evaluated for impairment
  
$
92,100
    
$
715,700
    
$
989,400
    
$
1,069,600
    
$
158,734
    
$
72,600
    
$
3,098,134
  
                                                         
Loans Receivable:
                                                        
Ending balance
  
$
5,788,579
    
$
42,097,111
    
$
81,314,177
    
$
52,969,456
    
$
4,743,081
    
$
5,523,054
    
$
192,435,458
  
                                                         
Ending balance: individually evaluated for impairment
  
$
12,953
    
$
706,295
    
$
2,904,189
    
$
1,052,132
    
$
-
    
$
242,361
    
$
4,917,930
  
Ending balance: collectively evaluated for impairment
  
$
5,775,626
    
$
41,390,816
    
$
78,409,988
    
$
51,917,324
    
$
4,743,081
    
$
5,280,693
    
$
187,517,528
  
                                                         
March 31, 2014
                                                        
                                                         
Allowance for credit losses:
                                                        
Beginning balance
  
$
73,000
    
$
617,629
      
753,050
    
$
1,708,962
    
$
181,309
    
$
41,400
    
$
3,375,350
  
Charge-offs
    
-
      
(77,957
)
    
(1,778
)
    
(3,283
)
    
(14,460
)
    
-
      
(97,478
)
Recoveries
    
-
      
219
      
133
      
144,173
      
4,019
      
-
      
148,544
  
Provision
    
20,600
      
184,445
      
2,268
      
(279,273
)
    
9,298
      
300
      
(62,362
)
Ending balance
  
$
93,600
    
$
724,336
    
$
753,673
    
$
1,570,579
    
$
180,166
    
$
41,700
    
$
3,364,054
  
                                                         
Ending balance: individually evaluated for impairment
  
$
-
    
$
54,436
    
$
132,173
    
$
258,579
    
$
-
    
$
-
    
$
445,188
  
Ending balance: collectively evaluated for impairment
  
$
93,600
    
$
669,900
    
$
621,500
    
$
1,312,000
    
$
180,166
    
$
41,700
    
$
2,918,866
  
                                                         
Loans Receivable:
                                                        
Ending balance
  
$
7,367,581
    
$
39,564,157
    
$
59,798,495
    
$
66,457,837
    
$
5,436,073
    
$
3,491,934
    
$
182,116,077
  
                                                         
Ending balance: individually evaluated for impairment
  
$
315,826
    
$
556,204
    
$
2,817,421
    
$
2,514,876
    
$
-
    
$
-
    
$
6,204,327
  
Ending balance: collectively evaluated for impairment
  
$
7,051,755
    
$
39,007,953
    
$
56,981,074
    
$
63,942,961
    
$
5,436,073
    
$
3,491,934
    
$
175,911,750
  


SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 6.
ALLOWANCE FOR LOAN LOSSES, CONTINUED

The following table presents impaired loans individually evaluated by class of loan as of March 31, 2015 and December 31, 2014 and the recognized interest income per the related period:

   
Recorded
Investment
    
Unpaid
Principal
Balance
    
Related
Allowance
    
Average
Recorded
Investment
    
Interest
Income
Recognized
  
                     
March 31, 2015
                    
With no related allowance recorded:
                    
Construction and development
  
$
12,953
    
$
12,953
    
$
-
    
$
13,261
    
$
265
  
1-4 family residential
    
474,593
      
474,593
      
-
      
482,174
      
5,467
  
Nonfarm, nonresidential
    
2,130,362
      
2,130,362
      
-
      
2,149,197
      
22,701
  
Commercial and industrial
    
743,378
      
879,937
      
-
      
764,445
      
2,071
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
242,361
      
242,361
      
-
      
243,371
      
3,885
  
     
3,603,647
      
3,740,206
      
-
      
3,652,448
      
34,389
  
                                         
With an allowance recorded:
                                        
Construction and development
    
-
      
-
      
-
      
-
      
-
  
1-4 family residential
    
231,702
      
271,053
      
64,992
      
265,176
      
-
  
Nonfarm, nonresidential
    
773,827
      
773,827
      
113,491
      
776,175
      
-
  
Commercial and industrial
    
308,754
      
308,754
      
143,291
      
552,054
      
-
  
Consumer
    
-
      
-
      
-
       -      
-
  
Other loans
    
-
      
-
      
-
      
-
      
-
  
     
1,314,283
      
1,353,634
      
321,774
      
1,593,405
      
-
  
                                         
Combined:
                                        
Construction and development
    
12,953
      
12,953
      
-
      
13,261
      
265
  
1-4 family residential
    
706,295
      
745,646
      
64,992
      
747,350
      
5,467
  
Nonfarm, nonresidential
    
2,904,189
      
2,904,189
      
113,491
      
2,925,372
      
22,701
  
Commercial and industrial
    
1,052,132
      
1,188,691
      
143,291
      
1,316,499
      
2,071
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
242,361
      
242,361
      
-
      
243,371
      
3,885
  
   
$
4,917,930
    
$
5,093,840
    
$
321,774
    
$
5,245,853
    
$
34,389
  
                                         
December 31, 2014
                                        
With no related allowance recorded:
                                        
Construction and development
  
$
13,536
    
$
13,536
    
$
-
    
$
13,788
    
$
2,710
  
1-4 family residential
    
174,314
      
174,314
      
-
      
174,882
      
7,269
  
Nonfarm, nonresidential
    
1,806,013
      
1,806,013
      
-
      
1,826,306
      
94,953
  
Commercial and industrial
    
844,682
      
844,682
      
-
      
986,462
      
9,452
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
228,111
      
228,111
      
-
      
228,884
      
15,244
  
     
3,066,656
      
3,066,656
      
-
      
3,230,322
      
129,628
  
                                         
With an allowance recorded:
                                        
Construction and development
    
-
      
-
      
-
      
-
      
-
  
1-4 family residential
    
399,764
      
399,764
      
97,799
      
402,691
      
8,141
  
Nonfarm, nonresidential
    
852,925
      
852,925
      
117,215
      
852,872
      
358
  
Commercial and industrial
    
554,787
      
554,787
      
162,900
      
552,865
      
72
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
-
      
-
      
-
      
-
      
-
  
     
1,807,476
      
1,807,476
      
377,914
      
1,808,428
      
8,571
  
                                         
Combined:
                                        
Construction and development
    
13,536
      
13,536
      
-
      
13,788
      
2,710
  
1-4 family residential
    
574,078
      
574,078
      
97,799
      
577,573
      
15,410
  
Nonfarm, nonresidential
    
2,658,938
      
2,658,938
      
117,215
      
2,679,178
      
95,311
  
Commercial and industrial
    
1,399,469
      
1,399,469
      
162,900
      
1,539,327
      
9,524
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
228,111
      
228,111
      
-
      
228,884
      
15,244
  
   
$
4,874,132
    
$
4,874,132
    
$
377,914
    
$
5,038,750
    
$
138,199
  
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 6.
ALLOWANCE FOR LOAN LOSSES, CONTINUED

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

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

Credit Quality Indicators:

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

NOTE 6.
ALLOWANCE FOR LOAN LOSSES, CONTINUED

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

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

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

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

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

   
Total
    
Pass Credits
    
Special
Mention
    
Substandard
    
Doubtful
  
                     
March 31, 2015
                    
                     
Construction and development
  
$
5,788,579
    
$
5,788,579
    
$
-
    
$
-
    
$
-
  
1-4 family residential
    
42,097,111
      
41,282,941
      
762,112
      
52,058
      
-
  
Nonfarm, nonresidential
    
81,314,177
      
79,716,603
      
1,597,574
      
-
      
-
  
Commercial and industrial
    
52,969,456
      
52,005,812
      
963,644
      
-
      
-
  
Consumer
    
4,743,081
      
4,733,603
      
9,478
      
-
      
-
  
Other loans
    
5,523,054
      
5,507,916
      
15,138
      
-
      
-
  
   
$
192,435,458
    
$
189,035,454
    
$
3,347,946
    
$
52,058
    
$
-
  
                                         
Percentage of total loans
    
100.0
%
    
98.2
%
    
1.8
%
    
-
%
    
-
%
                                         
Guaranteed portion of loans
                                        
                                         
Construction and development
  
$
15,455
    
$
15,455
    
$
-
    
$
-
    
$
-
  
1-4 family residential
    
576,171
      
341,677
      
234,494
      
-
      
-
  
Nonfarm, nonresidential
    
35,034,171
      
34,208,947
      
825,224
      
-
      
-
  
Commercial and industrial
    
13,443,941
      
12,730,033
      
713,908
      
-
      
-
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
765,446
      
765,446
      
-
      
-
      
-
  
   
$
49,835,184
    
$
48,061,558
    
$
1,773,626
    
$
-
    
$
-
  

   
Total
    
Pass Credits
    
Special
Mention
    
Substandard
    
Doubtful
  
                     
December 31, 2014
                    
                     
Construction and development
  
$
10,061,249
    
$
10,061,249
    
$
-
    
$
-
    
$
-
  
1-4 family residential
    
41,824,806
      
41,009,963
      
641,862
      
172,981
      
-
  
Nonfarm, nonresidential
    
74,275,793
      
72,657,724
      
1,618,069
      
-
      
-
  
Commercial and industrial
    
56,602,425
      
55,274,007
      
1,328,418
      
-
      
-
  
Consumer
    
4,997,023
      
4,996,479
      
544
      
-
      
-
  
Other loans
    
5,271,062
      
5,254,896
      
16,166
      
-
      
-
  
   
$
193,032,358
    
$
189,254,318
    
$
3,605,059
    
$
172,981
    
$
-
  
                                         
     
100.0
%
    
98.0
%
    
1.9
%
    
0.1
%
    
-
%
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6.
ALLOWANCE FOR LOAN LOSSES, CONTINUED

   
Total
    
Pass Credits
    
Special
Mention
    
Substandard
    
Doubtful
  
                     
Guaranteed portion of loans
                    
                     
Construction and development
  
$
15,604
    
$
15,604
    
$
-
    
$
-
    
$
-
  
1-4 family residential
    
584,842
      
306,212
      
278,630
      
-
      
-
  
Nonfarm, nonresidential
    
29,914,244
      
29,082,499
      
831,745
      
-
      
-
  
Commercial and industrial
    
13,858,258
      
12,877,497
      
980,761
      
-
      
-
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
768,869
      
760,786
      
8,083
      
-
      
-
  
   
$
45,141,817
    
$
43,042,598
    
$
2,099,219
    
$
-
    
$
-
  

NOTE 7.
TROUBLED DEBT RESTRUCTURINGS

For the three months ended March 31, 2015 and 2014, the following table presents loans modified during the period that were considered to be troubled debt restructurings.

   
For the three months ended
March 31, 2015
     For the three months ended
March 31, 2014
  
   
Number
of
Contracts
    
Pre-
Modification
Outstanding
Recorded
Investment
    
Post-
Modification
Outstanding
Recorded
Investment
    
Number
of
Contracts
    
Pre-
Modification
Outstanding
Recorded
Investment
    
Post-
Modification
Outstanding
Recorded
Investment
  
Troubled Debt Restructurings
                        
Construction and development
    
-
    
$
-
    
$
-
      
-
    
$
-
    
$
-
  
1-4 Family residential
    
-
      
-
      
-
      
3
      
159,927
      
163,627
  
Nonfarm, nonresidential
    
-
      
-
      
-
      
-
      
-
      
-
  
Commercial and industrial
    
-
      
-
      
-
      
-
      
-
      
-
  

During the three months ended March 31, 2015 and 2014, no loans that had previously been restructured were in default.

In the determination of the allowance for loan losses, management considers troubled debt restructurings and subsequent defaults in these restructurings by adjusting the loan grades of such loans, which figure into the environmental factors associated with the allowance. Defaults resulting in charge-offs affect the historical loss experience ratios which are a component of the allowance calculation. Additionally, specific reserves may be established on restructured loans evaluated individually.
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8.
FAIR VALUE

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available for sale, trading securities and derivatives, if present, are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair Value Hierarchy

Under the Fair Value Measurements and Disclosures Topic of the FASB ASC, the Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1 Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2 Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with the Receivables Topic of the FASB ASC. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At March 31, 2015, substantially all of the total impaired loans were evaluated based on the fair value of the collateral and discounted cash flows. In accordance with the Fair Value and Measurement Topic of the FASB ASC, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8.
FAIR VALUE, CONTINUED

Servicing Assets

A valuation of loan servicing rights is performed on an individual basis due to the small number of loans serviced. Loans are evaluated on a discounted earnings basis to determine the present value of future earnings. The present value of the future earnings is the estimated market value for the loan, calculated using consensus assumptions that a first party purchaser would utilize in evaluating a potential acquisition of the servicing. As such, the Company classifies loan servicing rights as Level 3.

Foreclosed Assets

Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.
 
Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis.

(in thousands)
                
March 31, 2015
  
Total
    
Level 1
    
Level 2
    
Level 3
  
Government-sponsored enterprises
  
$
3,492
    
$
-
    
$
3,492
    
$
-
  
Mortgage-backed securities
    
25
      
-
      
25
      
-
  
Corporate bonds
    
270
      
-
      
-
      
270
  
Equities and mutual funds
    
587
      
587
      
-
      
-
  
Total assets at fair value
  
$
4,374
    
$
587
    
$
3,517
    
$
270
  

(in thousands)
                
December 31, 2014
  
Total
    
Level 1
    
Level 2
    
Level 3
  
Government-sponsored enterprises
  
$
3,497
    
$
-
    
$
3,497
    
$
-
  
Mortgage-backed securities
    
26
      
-
      
26
      
-
  
Corporate bonds
    
255
      
-
      
-
      
255
  
Equities and mutual funds
    
586
      
586
      
-
      
-
  
Total assets at fair value
  
$
4,364
    
$
586
    
$
3,523
    
$
255
  

For the three months ended March 31, 2015 and 2014, the changes in Level 3 assets and liabilities measured at fair value on a recurring basis were as follows:

   
Level 3
  
   
2015
    
2014
  
(in thousands)
  
Fair Value
    
Fair Value
  
Corporate Bonds – Available for Sale
Balance, January 1
  
$
255
    
$
451
  
Total unrealized gain (loss) included in income
    
-
      
-
  
Total unrealized gain (loss) included in other comprehensive income
    
15
      
-
  
Bonds called
    
-
      
-
  
Balance, March 31
  
$
270
    
$
451
  
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8.
FAIR VALUE, CONTINUED

The change in the fair value of corporate bond assets for the three month period ended March 31, 2015 was $15,000. There was no change in the fair value for the three months period ended March 31, 2104.

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

The Company may be required, from time to time, to measure certain assets or liabilities at fair value on a nonrecurring basis in accordance with U.S. generally accepted accounting principles. These include assets and liabilities that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets and liabilities measured at fair value on a nonrecurring basis are included in the table below.

(in thousands)
                
March 31, 2015
  
Total
    
Level 1
    
Level 2
    
Level 3
  
                 
Impaired loans:
                
Commercial and industrial
  
$
165
    
$
-
    
$
-
    
$
165
  
Nonfarm, non-residential
    
660
      
-
      
-
      
660
  
1-4 family residential
    
167
      
-
      
-
      
167
  
Foreclosed assets
    
176
      
-
      
-
      
176
  
Servicing assets
    
348
      
-
      
-
      
348
  
Total assets at fair value
  
$
1,516
    
$
-
    
$
-
    
$
1,516
  

 
(in thousands)
                
December 31, 2014
  
Total
    
Level 1
    
Level 2
    
Level 3
  
                 
Impaired loans:
                
Commercial and industrial
  
$
392
    
$
-
    
$
-
    
$
392
  
Nonfarm, non-residential
    
736
      
-
      
-
      
736
  
1-4 family residential
    
302
      
-
      
-
      
302
  
Foreclosed assets
    
281
      
-
      
-
      
281
  
Servicing assets
    
350
      
-
      
-
      
350
  
Total assets at fair value
  
$
2,061
    
$
-
    
$
-
    
$
2,061
  

Financial Instruments

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:

Cash and due from banks:  The carrying amounts reported in the balance sheet for cash and due from banks approximate their fair values.

Interest-bearing deposits with banks:  Fair values for time deposits are estimated using a discounted cash flow analysis that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits.

Federal funds sold:  Due to the short-term nature of these assets, the carrying value approximates fair value.

Securities:  Fair values for securities, excluding restricted equity securities, are based on quoted market prices, where available.  If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.  The carrying values of restricted equity securities approximate fair values.
 
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8.
FAIR VALUE, CONTINUED

Loans receivable:  For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts.  The fair values for other loans are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics.  The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows.

Bank owned life insurance:  The carrying amount reported in the balance sheet approximates the fair value as it represents the cash surrender value of the life insurance.

Deposit liabilities:  The fair values disclosed for demand and savings deposits are, by definition, equal to the amount payable on demand at the reporting date.  The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits.

Federal funds purchased, securities sold under agreements to repurchase and short-term debt:  The carrying amounts of federal funds purchased, securities sold under agreements to repurchase and short-term debt approximate their fair values.

Long-term debt:  The fair value of long-term debt is estimated using a discounted cash flow calculation that applies interest rates currently available on similar instruments.

Other liabilities:  For fixed-rate loan commitments, fair value considers the difference between current levels of interest rates and the committed rates.  The carrying amounts of other liabilities approximate fair value.

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of March 31, 2015 and December 31, 2014.  This table excludes financial instruments for which the carrying amount approximates fair value.

           
Fair Value Measurements
  
           
Quoted
Prices in
Active
Markets for
Identical
Assets or
Liabilities
    
 
 
 
Significant
Other
Observable
Inputs
    
 
 
 
 
Significant
Unobservable
Inputs
  
(dollars in thousands)
  
Carrying
Amount
    
Fair Value
    
(Level 1)
    
(Level 2)
    
(Level 3)
  
March 31, 2015
                    
Financial Instruments – Assets
Loans, net
  
$
189,141
    
$
196,053
    
$
-
    
$
-
    
$
196,053
  
                                         
Financial Instruments-Liabilities
                                        
Deposits
    
209,907
      
205,987
      
-
      
65,516
      
140,471
  
Long-Term Debt
    
6,250
      
6,427
      
-
      
-
      
6,427
  
                                         
December 31, 2014
                                        
Financial Instruments – Assets
                                        
Loans, net
  
$
189,549
    
$
195,254
      
-
      
-
    
$
195,254
  
                                         
Financial Instruments-Liabilities
                                        
Deposits
    
206,667
      
202,750
      
-
      
61,925
      
140,825
  
Long-Term Debt
    
6,250
      
6,486
      
-
      
-
      
6,486
  
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

This discussion, analysis and related financial information are presented to explain the significant factors which affected Surrey Bancorp's financial condition and results of operations for the three months ended March 31, 2015 and 2014. This discussion should be read in conjunction with the financial statements and related notes contained within this report.

Surrey Bancorp (“Company”) is a North Carolina corporation, located in Mount Airy, North Carolina. The Company was incorporated on February 6, 2003, and began business on May 1, 2003.

Surrey Bank & Trust ("Bank") is a North Carolina state chartered bank, located in Mount Airy, North Carolina. The Bank was chartered on July 15, 1996, and began operations on July 22, 1996. The Bank has two operating subsidiaries: Surrey Investment Services, Inc. and Freedom Finance, LLC.

Effective March 5, 1998, the Bank became a member of the Federal Home Loan Bank.

Highlights

Certain information contained in this discussion may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import.  Such forward-looking statements involve known and unknown risks including, but not limited to, changes in general economic and business conditions, interest rate fluctuations, competition within and from outside the banking industry, new products and services in the banking industry, risk inherent in making loans such as repayment risks and fluctuating collateral values, problems with technology utilized by the Company, changing trends in customer profiles and changes in laws and regulations applicable to the Company.  Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

Net income available for common stockholders for the three months ended March 31, 2015, was $683,207 or $0.17 per diluted share outstanding, compared to a $631,173 or $0.16 per diluted share outstanding, for the same period in 2014. Earnings for the three months ended March 31, 2015, are approximately 8.2% higher than for the same period in 2014. The increase in earnings results from an increase in net interest income and an increase in the recapture of loan loss reserves.  Net interest income increased from $2,285,803 in the first quarter of 2014 to $2,422,776 in 2015. Most of this increase is due to loan growth. Average loans outstanding increased 4.7% from the first quarter of 2014 to 2015, or approximately $8,587,000. The net interest margin increased from 4.12% to 4.17% from 2014 to 2015 due to lower deposit costs. Asset yields dropped from 4.74% in 2014 to 4.68% in 2015 but the reduction was offset by a reduction in the cost of funds. The cost of funds decreased from 0.68% in the first quarter of 2014 to 0.57% in the first quarter of 2015. The recapture of loan loss reserves increased from a recapture of $62,362 in the first quarter of 2014 to a recapture of $113,794 in 2015. The recapture of reserve is partially due to a reduction in gross loans since the beginning of the year and an increase in the percentage of loans carrying government guarantees. Gross loans decreased $596,900 from December 31, 2014 to March 31, 2015. However, the percentage of loans carrying government guarantees increased from $45,141,818, or 23.4% of gross loans at the end of 2014 to $49,835,184, or 25.9% of gross loans at March 31, 2015. The decreased credit exposure resulted in lower reserves.

Noninterest income increased from $581,928 in the first quarter of 2014 to $625,234 in 2015. The increase primarily results from an increase in brokerage commissions from the Bank’s brokerage and investment subsidiary, Surrey Investment Services, Inc., and increased fees from debit card transactions. Brokerage commissions increased from $47,132 in the first quarter of 2014 to $79,041 in 2015. Debit card income, included in other service charges and fees, increased by approximately $21,000, or 21.1% from 2014 to 2015. Noninterest expenses increased 8.9% from $1,867,387 in the first quarter of 2014, to $2,032,668 in 2015. This increase was due to expenses associated with foreclosed assets. Increases in foreclosed assets expense, professional fees and other expense all increased as a result of cost required to take possession and dispose of foreclosed properties.
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED

On March 31, 2015, Surrey Bancorp's assets totaled $256,244,969 compared to $253,201,323 on December 31, 2014. Net loans were $189,141,256 compared to $189,549,072 on December 31, 2014. This net decrease was the result of a $542,572 decrease in loans and net deferred fees and a $134,756 net decrease in the loan loss reserve. Construction and commercial loans account for the decrease, with nonfarm, nonresidential loans representing most of the growth. There was a 42.5% decrease in construction loans while other real estate loans collectively grew 2.5%. Commercial loans decreased by 6.4%. Overall gross loans decreased 0.3%

Total deposits on March 31, 2015, were $209,906,549 compared to $206,666,581 at the end of 2014. This increase is attributable to an increase in interest-bearing demand deposits accounts, which increased from $30,302,622 at December 31, 2014 to $33,925,416 at March 31, 2015. Overall, noninterest-bearing and interest-bearing demand deposits increased 5.6% from 2014 totals, while savings deposits, including money market accounts, increased 2.5%. Certificates of deposit decreased 3.0% from December 31, 2014 totals.

Common stockholders’ equity increased by $688,343, or 1.87%, during the three months ended March 31, 2015. The increase is comprised of net income of $728,434 and adjustments to other comprehensive income of $5,136. Decreases included the declaration and accrual of preferred dividends of $45,227. The net increase resulted in a common stock book value of $9.46 per share, up from $9.27 on December 31, 2014.

The book value per common share is calculated by taking total stockholders’ equity, subtracting all preferred equity, and then dividing by the total number of common shares outstanding at the end of the reporting period.

Preferred stockholders’ equity remained the same during the period ended March 31, 2015.

Financial Condition, Liquidity and Capital Resources

Investments

The Bank maintains a portfolio of securities as part of its asset/liability and liquidity management programs which emphasize effective yields and maturities to match its needs. The composition of the investment portfolio is examined periodically and appropriate realignments are initiated to meet liquidity and interest rate sensitivity needs for the Bank. The Company also invests funds in a brokerage account made up of selected equities and mutual funds. The investments were made to increase income in the holding company and improve yields.

Available for sale securities are reported at fair value and consist of bonds, notes, debentures and equity securities and mutual funds not classified as trading securities or as held to maturity securities.

Unrealized holding gains and losses, net of tax, on available for sale securities are reported as a net amount in a separate component of stockholders' equity. Realized gains and losses on the sale of available for sale securities are determined using the specific-identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity or to call dates.

Declines in the fair value of individual held to maturity and available for sale securities below cost that are other than temporary are reflected as write-downs of the individual securities to fair value.  Related write-downs are included in earnings as realized losses.

Investments in available for sale securities of $4,373,630 consisted of Government-sponsored enterprise obligations with maturities ranging from 5 to 34 months, corporate bonds with maturities of 3.50 years, that reprice quarterly, GNMA adjustable rate mortgage securities, which adjust annually, and equity securities and mutual funds.

Loans

Net loans outstanding on March 31, 2015, were $189,141,256 compared to $189,549,072 on December 31, 2014. The Bank maintains a loan portfolio dominated by real estate and commercial loans diversified among various industries. Approximately 63.6% of the Bank's loans as of March 31, 2015, are fixed rate loans with 36.4% floating with the Bank's prime rate or other appropriate internal or external indices.
 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED

Deposits

Deposits on March 31, 2015, were $209,906,549, compared to $206,666,581 on December 31, 2014. The March total consists of a base of approximately 12,778 accounts compared to 12,690 accounts at December 31, 2014. Interest-bearing accounts represent 74.3% of March 31, 2015 period end deposits versus 74.4% at December 31, 2014.

Stockholders' Equity

Surrey Bancorp and Surrey Bank & Trust are subject to various regulatory capital requirements administered by federal banking agencies. The Company and the Bank maintain strong capital positions which exceed all capital adequacy re­quirements of federal regulatory authorities. Common Equity Tier I Capital “CET1” is a new regulatory ratio resulting from BASEL III. CET1 primarily consist of the Company’s and the Bank’s common shares, common share surplus, retained earnings and accumulated other comprehensive income. The Company’s and the Bank’s capital ratios are presented in the following table.

   
Ratio
    
Minimum
Required
For Capital
Adequacy
Purposes
  
March 31, 2015:
        
Total Capital
        
(to Risk-Weighted Assets)
        
Surrey Bancorp (Consolidated)
    
21.93
%
    
8.0
%
Surrey Bank & Trust
    
21.58
%
    
8.0
%
Common Equity Tier I Capital
                
(to Risk-Weighted Assets)
                
Surrey Bancorp (Consolidated)
    
18.47
%
    
5.0
%
Surrey Bank & Trust
    
20.33
%
    
5.0
%
Tier I Capital
                
(to Risk-Weighted Assets)
                
Surrey Bancorp (Consolidated)
    
20.68
%
    
4.0
%
Surrey Bank & Trust
    
20.33
%
    
4.0
%
Tier I Capital
                
(to Average Assets)
                
Surrey Bancorp (Consolidated)
    
14.37
%
    
4.0
%
Surrey Bank & Trust
    
14.11
%
    
4.0
%
                 
December 31, 2014:
                
Total Capital
                
(to Risk-Weighted Assets)
                
Surrey Bancorp (Consolidated)
    
21.55
%
    
8.0
%
Surrey Bank & Trust
    
21.11
%
    
8.0
%
Common Equity Tier I Capital
                
(to Risk-Weighted Assets)
                
Surrey Bancorp (Consolidated)
    
n/
a
    
n/
a
Surrey Bank & Trust
    
n/
a
    
n/
a
Tier I Capital
                
(to Risk-Weighted Assets)
                
Surrey Bancorp (Consolidated)
    
20.29
%
    
4.0
%
Surrey Bank & Trust
    
19.85
%
    
4.0
%
Tier I Capital
                
(to Average Assets)
                
Surrey Bancorp (Consolidated)
    
13.93
%
    
4.0
%
Surrey Bank & Trust
    
13.65
%
    
4.0
%
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED

Asset Quality

The Company actively monitors delinquencies, nonperforming assets and potential problem loans. Unsecured loans past due more than 90 days are placed into nonaccrual status. Secured loans reach nonaccrual status when they surpass 120 days past due. When facts and circumstances indicate the borrower has regained the ability to meet the required payments, the loan is returned to accrual status.
 
Management reviews all criticized loans on a periodic basis for possible charge offs. Any unsecured loans that are 90 plus days past due must be charged off in full.  If secured, a reserve equal to the potential loss will be established. Any charge off must be reported to the Board of Directors within 30 days. On a monthly basis, a management report of recovery actions is provided to the Board of Directors.
 
Nonperforming assets are detailed below.

   
March 31,
2015
    
December 31,
2014
  
         
Nonaccrual loans
  
$
2,639,553
    
$
2,988,949
  
Loans past due 90 days and still accruing
    
27,059
      
53,185
  
Foreclosed assets
    
175,526
      
280,821
  
Total
  
$
2,842,138
    
$
3,322,955
  
Total assets
  
$
256,244,969
    
$
253,201,323
  
                 
Ratio of nonperforming assets to total assets
    
1.11
%
    
1.31
%

At March 31, 2015, the Bank had loans totaling $2,639,553 in nonaccrual status. Nonaccrual loans totaling $555,630 were current at the end of March. The guaranteed portion of nonaccrual loans at March 31, 2015 is $1,338,866. Foreclosed assets at March 31, 2015 primarily consist of nonfarm, nonresidential properties. Loans that were considered impaired but were still accruing interest at March 31, 2015, including troubled debt restructurings, totaled $2,695,275. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due under the contractual terms of the loan agreement. Specific reserves on nonaccrual and impaired loans totaled $321,774 at March 31, 2015, or 6.0% of the balances outstanding.

Nonaccrual and impaired loans still accruing are summarized below:

   
March 31,
2015
    
December 31,
2014
  
         
Construction and development
  
$
12,953
    
$
13,536
  
1-4 family residential
    
1,104,813
      
601,587
  
Nonfarm, nonresidential
    
2,904,188
      
2,658,937
  
Commercial and industrial
    
1,052,132
      
1,399,470
  
Consumer
    
18,381
      
8,854
  
Other loans
    
242,361
      
228,111
  
Total impaired and nonaccrual
  
$
5,334,828
    
$
4,910,495
  
Guaranteed portion
  
$
2,207,232
    
$
2,090,348
  

At March 31, 2015, consumer loans totaling $415,778 are included above that were not individually evaluated for impairment in the determination of the allowance for loan loss reserve (See Note 6). These loans are primarily home equity loans collateralized by 1-4 family properties which are considered consumer loans. These loans are on nonaccrual status at March 31, 2015 and therefore considered impaired.
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED

The loan portfolio is dominated by real estate and commercial loans. The general composition of the loan portfolio is as follows:

   
March 31, 2015
    
December 31, 2014
  
Construction and development
  
$
5,788,579
      
3.01
%
  
$
10,061,249
      
5.21
%
1-4 family residential
    
42,097,111
      
21.88
%
    
41,824,806
      
21.67
%
Multi-family
    
1,229,561
      
0.64
%
    
1,109,586
      
0.57
%
Farmland
    
3,660,210
      
1.90
%
    
3,486,002
      
1.81
%
Nonfarm, nonresidential
    
81,314,177
      
42.26
%
    
74,275,793
      
38.48
%
Total real estate
    
134,089,638
      
69.69
%
    
130,757,436
      
67.74
%
                                 
Agricultural
    
633,283
      
0.33
%
    
675,474
      
0.35
%
Commercial and industrial
    
52,969,456
      
27.52
%
    
56,602,425
      
29.32
%
Consumer
    
4,743,081
      
2.46
%
    
4,997,023
      
2.59
%
Total loans
  
$
192,435,458
      
100.00
%
  
$
193,032,358
      
100.00
%

The concentrations represented above do not, based on managements’ assessment, expose the Bank to any unusual concentration risk. Based on the Bank’s asset size, the concentrations that are above area peer group analysis are nonfarm nonresidential and commercial and industrial loans. Management recognizes the inherent risk associated with commercial real estate and commercial lending, including a borrower's actual results of operations not corresponding to those projected by the borrower when the loan was funded; economic factors such as the number of housing starts and increases in interest rates, etc.; depression of collateral values; and completion of projects within the original cost and time estimates. The Bank mitigates some of that risk by actively seeking government guarantees on these loans. Collectively, the Bank has approximately $62,895,089 in loans that carry government guarantees. The guaranteed portion of these loans amounts to $49,835,184 at March 31, 2015. Loan guarantees by loan class are below:
 
    March 31,    
Guaranteed Portion
  
   
2015
    
Amount
    
Percentage
  
Construction and development
  
$
5,788,579
    
$
15,455
      
0.27
%
1-4 family residential
    
42,097,111
      
576,171
      
1.37
%
Multi-family
    
1,229,561
      
7,569
      
0.62
%
Farmland
    
3,660,210
      
757,877
      
20.71
%
Nonfarm, nonresidential
    
81,314,177
      
35,034,171
      
43.08
%
Total real estate
    
134,089,638
      
36,391,243
      
27.14
%
                         
Agricultural
    
633,283
      
-
      
-
%
Commercial and industrial
    
52,969,456
      
13,443,941
      
25.38
%
Consumer
    
4,743,081
      
-
      
-
%
Total loans
  
$
192,435,458
    
$
49,835,184
      
25.90
%

Loans in higher risk categories, such as non-owner occupied nonfarm, non-residential property and commercial real estate construction represent a small segment of our loan portfolio. Commercial construction loans included in construction and development loans amounted to $1,956,921, or 1.02% of total loans at March 31, 2015. Non-owner occupied nonfarm, non-residential properties included in nonfarm, non-residential loans above amounted to $14,115,423, or 7.34% of total loans at March 31, 2015.

The consolidated recapture of loan losses was $113,794 for the first three months of 2015 compared to a recapture of $62,362 for the same period in 2014. Gross loans decreased $596,900 from December 31, 2014 to March 31, 2015. However, the percentage of loans carrying government guarantees increased from $45,141,818, or 23.4% of gross loans at the end of 2014 to $49,835,184, or 25.9% of gross loans at March 31, 2015. The decreased credit exposure resulted in lower reserves.

The reserve for loan losses on March 31, 2015, was $3,419,908 or 1.77% of period end loans. This percentage is derived from total loans. Approximately $62,895,000 of total loans outstanding at March 31, 2015, are government guaranteed loans which carry guarantees ranging from 49% to 100% of the outstanding loan balance. When the guaranteed portion of the loans, for which the Bank has no credit exposure, is removed from the equation the loan loss reserve is approximately 2.39% of outstanding loans.  At December 31, 2014 the loan loss reserve percentage was 1.83% of total loans and 2.40% of loans net of government guarantees.
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED

The level of reserve is established based upon management's evaluation of historical loss data and the effects of certain environmental factors on the loan portfolio. The historical loss portion of the reserve is computed using the average loss data from the past applied to its corresponding category of loans. However, historical losses only reflect a small portion of the Bank’s loan loss reserve. The environmental factors represent risk from external economic influences on the credit quality of the loan portfolio. These factors include the movement of interest rates, unemployment rates, past due and charge off trends, loan grading migrations, movement in collateral values and the Bank’s exposure to certain loan concentrations. Positive or negative movements in any of these factors have an effect on the credit quality of the loan portfolio. As a result, management continues to actively monitor the Bank's asset quality affected by these environmental factors.  The following table is a summary of loans past due at March 31, 2015 and December 31, 2014.

   
March 31, 2015
    
December 31, 2014
  
   
30-89 Days
    
90 Days Plus
    
30-89 Days
    
90 Days Plus
  
                 
Construction and development
  
$
14,539
    
$
-
    
$
94,736
    
$
-
  
1-4 family residential
    
1,264,395
      
59,841
      
637,000
      
172,981
  
Nonfarm, non-residential
    
298,478
      
663,902
      
243,206
      
663,902
  
Commercial and industrial
    
110,934
      
878,035
      
84,221
      
1,271,937
  
Consumer
    
208,300
      
28,181
      
218,680
      
55,428
  
Other loans
    
-
      
-
      
-
      
-
  
   
$
1,896,646
    
$
1,629,959
    
$
1,277,843
    
$
2,164,248
  
Non-accrual loans included above
  
$
481,023
    
$
1,602,900
    
$
370,697
    
$
2,109,942
  
Guaranteed portion
  
$
132,804
    
$
1,163,058
    
$
100,869
    
$
1,935,839
  
                                 
Ratio to total loans
    
0.99
%
    
0.85
%
    
0.66
%
    
1.12
%
Ratio to total loans, net of guarantees
    
1.24
%
    
0.33
%
    
0.80
%
    
0.15
%

Past due loans are reviewed weekly and collection efforts assessed to determine potential problems arising in the loan portfolio. Proactive monitoring of past due accounts allows management to anticipate trends within the portfolio and make appropriate adjustments to collection efforts and to the allowance for loan losses. Collectively, past dues increased slightly from December 31, 2014 to March 31, 2015. The increase is in the 30-89 day time frame, as the 90 day plus time frame decreased. The largest increase is in 1-4 family residential loans which increased $627,395. Three loans make up $585,469 of the increase in 1-4 family residential delinquencies.

Net of loan guarantees, total past dues have increased from $1,405,383 at December 31, 2014, to $2,230,743 at March 31, 2015, or 58.7%. Total past due loans at March 31, 2015 consist of forty-eight loans with an average balance of $73,470, compared to fifty-seven loans at December 31, 2014, with an average balance of $58,614. Loans over $250,000 delinquent at March 31, 2015 and December 31, 2014 amounted to $1,261,779 and $1,223,882, respectively. The March 2014 and December 2014 totals consist of three loans, respectively, two of which are the same. The guaranteed portion of these loans at March 31, 2015 and December 31, 2014, is $752,731 and $1,072,042, respectively.

Management believes that its loan portfolio is sufficiently diversified such that a downturn in a particular market or industry will not have a significant impact on the loan portfolio or the Bank's financial condition. Management believes that its provision and reserve offer an adequate allowance for loan losses and provide an appropriate reserve for the loan portfolio. The Bank lends primarily in Surry County, North Carolina and Patrick Country, Virginia and surrounding counties.
 
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED

Interest Rate Sensitivity and Liquidity

One of the principal duties of the Bank's Asset/Liability Committee is management of interest rate risk. The Bank utilizes quarterly asset/liability reports prepared by a regional correspondent bank to project the impact on net interest income that might occur with hypothetical interest rate changes. The committee monitors and manages asset and liability strategies and pricing.

Another function of the Asset/Liability Committee is maintaining adequate liquidity and planning for future liquidity needs. Having adequate liquidity means the ability to meet current funding needs, including deposit withdrawals and commitments, in an orderly manner without sacrificing earnings. The Bank funds its investing activities, including making loans and purchasing investments, by attracting deposits and utilizing short-term borrowings when necessary.

At March 31, 2015, the liquidity position of the Company was excellent, in management’s opinion, with short-term liquid assets of $53,615,789 compared to $49,129,109 at December 31, 2014. To provide supplemental liquidity, the Bank has seven unsecured lines of credit with correspondent banks totaling $35,500,000. At March 31, 2015, there were no advances against these lines. Additionally, the Bank has a secured borrowing arrangement with the Federal Home Loan Bank (FHLB). The maximum credit available under this agreement approximates $12,776,000 of which $6,250,000 had been advanced at March 31, 2015.
 

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 
Not Applicable as a “Smaller Reporting Company”.
 
ITEM 4.
CONTROLS AND PROCEDURES

 
As of the end of the period covered by the report, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15e. Based on the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective. There have not been any changes in the Company’s internal control over financial reporting that occurred during the Company’s last quarter that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.
 
PART II - OTHER INFORMATION

Item 1. Legal Proceedings

None

Item 1A. Risk Factors

Not Applicable as a “Smaller Reporting Company”

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

Not Applicable

Item 4. Mine Safety Disclosures

Not Applicable

Item 5.
Other Information

None

Item 6. Exhibits

Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act
Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes Oxley Act
Certification of PEO/PFO Pursuant to Section 906 of the Sarbanes Oxley Act
101
Interactive Data File

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized officers.

 
Surrey Bancorp
   
Date: May, 14, 2015
/s/ Edward C. Ashby, III
     
 
Edward C. Ashby, III
 
President and Chief Executive Officer
 
(Principal Executive Officer)
   
Date: May 14, 2015
/s/ Mark H. Towe
     
 
Mark H. Towe
 
Sr. Vice President and Chief Financial Officer
 
(Principal Financial Officer)
 
 
33