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

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
for the quarterly period ended March 31, 2014

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

COMMISSION FILE NO. 000-50313

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

North Carolina
 
59-3772016
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)
 
145 North Renfro Street, Mount Airy, NC  27030
(Address of principal executive offices)

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes   x     No   o
 
Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

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

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes   o  No
 
State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practical date:

On May 9, 2014 there were 3,542,984 common shares issued and outstanding.

PART I – FINANCIAL INFORMATION
 
 
 
 
Item 1.
Consolidated Financial Statements
 
 
 
 
 
3
 
 
 
 
4
 
 
 
 
5
 
 
 
 
6
 
 
 
 
7
 
 
 
 
8
 
 
 
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, 2014 (Unaudited) and December 31, 2013 (Audited)

 
  
March
2014
    
December
2013
  
 
  
   
 
Assets
  
   
 
Cash and due from banks
  
$
5,915,986
    
$
7,424,593
  
Interest-bearing deposits with banks
    
46,120,451
      
34,351,505
  
Federal funds sold
    
1,212,955
      
1,311,641
  
Investment securities available for sale
    
4,555,287
      
4,549,702
  
Restricted equity securities
    
617,859
      
676,799
  
Loans, net of allowance for loan losses of $3,364,054 at March 31, 2014 and $3,375,350 at December 31, 2013
    
179,027,735
      
179,908,825
  
Property and equipment, net
    
4,431,074
      
4,440,215
  
Foreclosed assets
    
144,521
      
-
  
Accrued income
    
955,229
      
966,042
  
Goodwill
    
120,000
      
120,000
  
Bank owned life insurance
    
5,502,346
      
5,462,336
  
Other assets
    
1,786,401
      
1,707,319
  
Total assets
  
$
250,389,844
    
$
240,918,977
  
 
                
Liabilities and Stockholders’ Equity
                
Liabilities
                
Deposits:
                
Noninterest-bearing
  
$
44,364,868
    
$
42,713,122
  
Interest-bearing
    
160,750,692
      
153,087,839
  
Total deposits
    
205,115,560
      
195,800,961
  
 
                
Long-term debt
    
7,750,000
      
7,750,000
  
Dividends payable
    
45,227
      
790,259
  
Accrued interest payable
    
152,587
      
123,558
  
Other liabilities
    
2,476,602
      
2,236,573
  
Total liabilities
    
215,539,976
      
206,701,351
  
 
                
Commitments and contingencies (Note 4)
                
 
                
Stockholders’ equity
                
Preferred stock, 1,000,000 shares authorized, 189,356 shares of Series A, issued and outstanding with no par value, 4.5% convertible non-cumulative, perpetual, with a liquidation value of $14 per share;
    
2,620,325
      
2,620,325
  
181,154 shares of Series D, issued and outstanding with no par value 5.0% convertible non-cumulative, perpetual; with a liquidation value of $7.08 per share;
    
1,248,482
      
1,248,482
  
Common stock, 10,000,000 shares authorized at no par value; 3,542,984 shares issued and outstanding at March 31, 2014 and December 31, 2013
    
12,061,153
      
12,061,153
  
Retained earnings
    
18,960,262
      
18,329,089
  
Accumulated other comprehensive loss
    
(40,354
)
    
(41,423
)
Total stockholders’ equity
    
34,849,868
      
34,217,626
  
Total liabilities and stockholders’ equity
  
$
250,389,844
    
$
240,918,977
  

See Notes to Consolidated Financial Statements
Consolidated Statements of Income
Three months ended March 31, 2014 and 2013 (Unaudited)

 
2014
    
2013
  
       
Interest income
        
Loans and fees on loans
  
$
2,592,470
    
$
2,608,711
  
Federal funds sold
    
684
      
345
  
Investment securities, taxable
    
16,262
      
13,640
  
Investment securities, dividends
    
3,617
      
2,618
  
Deposits with banks
    
19,610
      
19,691
  
Total interest income
    
2,632,643
      
2,645,005
  
 
                
Interest expense
                
Deposits
    
274,949
      
308,688
  
Fed funds purchased
    
17
      
-
  
Short-term debt
    
-
      
4,719
  
Long-term debt
    
71,874
      
71,813
  
Total interest expense
    
346,840
      
385,220
  
Net interest income
    
2,285,803
      
2,259,785
  
 
                
Provision for loan losses
    
(62,362
)
    
42,394
  
Net interest income after provision for loan losses
    
2,348,165
      
2,217,391
  
 
                
Noninterest income
                
Service charges on deposit accounts
    
199,084
      
231,325
  
Realized gain on the sale of investment securities
    
2,898
      
1,958
  
Fees on loans delivered to correspondents
    
530
      
21,295
  
Other service charges and fees
    
146,016
      
128,324
  
Income from Bank Owned Life Insurance
    
40,010
      
40,455
  
Other operating income
    
193,390
      
235,019
  
Total noninterest income
    
581,928
      
658,376
  
 
                
Noninterest expense
                
Salaries and employee benefits
    
1,009,500
      
961,121
  
Occupancy expense
    
107,884
      
99,743
  
Equipment expense
    
58,871
      
62,698
  
Data processing
    
105,311
      
101,671
  
Foreclosed assets, net
    
(894
)
    
42,335
  
Postage, printing and supplies
    
45,626
      
37,734
  
Professional fees
    
115,323
      
125,590
  
FDIC insurance premiums
    
29,626
      
33,175
  
Other expense
    
396,140
      
377,759
  
Total noninterest expense
    
1,867,387
      
1,841,826
  
Net income before income taxes
    
1,062,706
      
1,033,941
  
 
                
Income tax expense
    
386,306
      
382,165
  
Net income
    
676,400
      
651,776
  
 
                
Preferred stock dividends
    
(45,227
)
    
(45,227
)
Net income available to common stockholders
  
$
631,173
    
$
606,549
  
 
                
Basic earnings per common share
  
$
0.18
    
$
0.17
  
Diluted earnings per common share
  
$
0.16
    
$
0.16
  
Basic weighted average common shares outstanding
    
3,542,984
      
3,542,984
  
Diluted weighted average common shares outstanding
    
4,176,919
      
4,176,919
  

See Notes to Consolidated Financial Statements
Consolidated Statements of Comprehensive Income
Three months ended March 31, 2014 and 2013 (Unaudited)

 
  
2014
    
2013
  
 
  
   
 
Net income
  
$
676,400
    
$
651,776
  
 
                
Other comprehensive income:
                
Investment securities available for sale:
                
Unrealized holding gains
    
4,565
      
29,459
  
Tax effect
    
(1,583
)
    
(10,282
)
Reclassification of gains recognized in net income
    
(2,898
)
    
(1,958
)
Tax effect
    
985
      
666
  
 
    
1,069
      
17,885
  
Comprehensive income
  
$
677,469
    
$
669,661
  

See Notes to Consolidated Financial Statements

Consolidated Statements of Cash Flows
Three months ended March 31, 2014 and 2013 (Unaudited)

 
  
2014
    
2013
  
 
  
   
 
Cash flows from operating activities
  
   
 
Net income
  
$
676,400
    
$
651,776
  
Adjustments to reconcile net income to net cash provided by operations:
                
Depreciation and amortization
    
66,677
      
65,197
  
Gain on sale of property and equipment
    
(75
)
    
(100
)
Gain on the sale of investments
    
(2,898
)
    
(1,958
)
Loss on the sale of foreclosed assets
    
-
      
273
  
Provision for loan losses
    
(62,362
)
    
42,394
  
Deferred income taxes
    
(1,036
)
    
2,579
  
Accretion of discount on securities, net of amortization of premiums
    
7
      
9
  
Increase in cash surrender value of life insurance
    
(40,010
)
    
(40,455
)
Changes in assets and liabilities:
                
Accrued income
    
10,813
      
1,605
  
Other assets
    
(31,738
)
    
22,945
  
Accrued interest payable
    
29,029
      
26,406
  
Other liabilities
    
193,123
      
472,436
  
Net cash provided by operating activities
    
837,930
      
1,243,107
  
 
                
Cash flows from investing activities
                
Net increase in interest-bearing deposits with banks
    
(11,768,946
)
    
(6,506,267
)
Net (increase) decrease in federal funds sold
    
98,686
      
(154
)
Purchases of investment securities
    
(1,011,509
)
    
(1,529,339
)
Maturities of investment securities
    
1,001,223
      
501,689
  
Redemption of restricted equity securities
    
59,000
      
61,800
  
Purchase of restricted equity securities
    
(60
)
    
(125
)
Net (increase) decrease in loans
    
798,931
      
(4,457,012
)
Proceeds from the sale of investment securities
    
9,259
      
27,937
  
Proceeds from the sale of foreclosed assets
    
-
      
30,859
  
Purchases of property and equipment
    
(57,536
)
    
(24,430
)
Proceeds from the sale of property and equipment
    
75
      
100
  
Net cash used in investing activities
    
(10,870,877
)
    
(11,894,942
)
 
                
Cash flows from financing activities
                
Net increase in deposits
    
9,314,599
      
6,352,368
  
Proceeds from short-term debt
    
-
      
3,743,820
  
Dividends paid
    
(790,259
)
    
(46,106
)
Net cash provided by financing activities
    
8,524,340
      
10,050,082
  
Net decrease in cash and cash equivalents
    
(1,508,607
)
    
(601,753
)
Cash and due from banks, beginning
    
7,424,593
      
5,973,042
  
Cash and due from banks, ending
  
$
5,915,986
    
$
5,371,289
  
 
                
Supplemental disclosures of cash flow information
                
Interest paid
  
$
317,840
    
$
358,814
  
Taxes paid
  
$
63,722
    
$
48,255
  
Supplemental disclosures of non-cash transactions
                
Loans transferred to foreclosed properties
  
$
144,521
    
$
27,580
  

See Notes to Consolidated Financial Statements
Consolidated Statements of Changes in Stockholders’ Equity
Three months ended March 31, 2014 and 2013 (Unaudited)

 
  
   
   
   
   
Accumulated
    
 
 
  
Preferred
    
   
   
   
Other
    
 
 
  
Stock
    
Common Stock
    
Retained
    
Comprehensive
    
 
 
  
Amount
    
Shares
    
Amount
    
Earnings
    
Loss
    
Total
  
 
  
   
   
   
   
   
 
Balance, January 1, 2013
  
$
3,868,807
      
3,542,984
    
$
12,061,153
    
$
16,367,187
    
$
(59,846
)
  
$
32,237,301
  
 
                                                
Net income
    
-
      
-
      
-
      
651,776
      
-
      
651,776
  
Other comprehensive income
    
-
      
-
      
-
      
-
      
17,885
      
17,885
  
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, 2013
  
$
3,868,807
      
3,542,984
    
$
12,061,153
    
$
16,973,736
    
$
(41,961
)
  
$
32,861,735
  
 
                                                
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
  

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

NOTE 1.
BASIS OF PRESENTATION

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

Organization

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

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

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

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

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

Critical Accounting Policies

The notes to the audited consolidated financial statements for the year ended December 31, 2013 contain a summary of the significant accounting policies.  The Company believes our policies with respect to the methodology for the determination of the allowance for loan losses, and asset impairment judgments, including the recoverability of intangible assets involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters.  Changes in these judgments, assumptions or estimates could cause reported results to differ materially.  These critical policies and their application are periodically reviewed with the Audit Committee and our Board of Directors.  See our Annual Report on Form 10-K for full details on critical accounting policies.

Principles of Consolidation

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

NOTE 1.
BASIS OF PRESENTATION, CONTINUED

Presentation of Cash Flows

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

Investment Securities

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

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

Loans Held for Sale

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

Loans Receivable

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

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

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

NOTE 1.
BASIS OF PRESENTATION, CONTINUED

Allowance for Loan Losses

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

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

The allowance consists of specific, general and unallocated components.  The specific component relates to loans that are classified as impaired.  For loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.  The general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors.  An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
 
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

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

Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements:

In January 2014, the FASB amended the Receivables—Troubled Debt Restructurings by Creditors subtopic of the Codification to address the reclassification of consumer mortgage loans collateralized by residential real estate upon foreclosure.  The amendments clarify the criteria for concluding that an in substance repossession or foreclosure has occurred, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan.  The amendments also outline interim and annual disclosure requirements.  The amendments will be effective for the Company for interim and annual reporting periods beginning after December 15, 2014. Companies are allowed to use either a modified retrospective transition method or a prospective transition method when adopting this update.  Early adoption is permitted.  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.
SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.
BASIS OF PRESENTATION, CONTINUED

Subsequent Events

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

NOTE 2.
SECURITIES

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

 
  
Amortized
Cost
    
Unrealized
Gains
    
Unrealized
Losses
    
Fair
Value
  
 
  
   
   
   
 
March 31, 2014
  
   
   
   
 
Government-sponsored enterprises
  
$
3,500,000
    
$
1,955
    
$
2,290
    
$
3,499,665
  
Mortgage-backed securities
    
30,870
      
1,057
      
-
      
31,927
  
Corporate bonds
    
550,000
      
-
      
99,000
      
451,000
  
Equities and mutual funds
    
540,474
      
41,676
      
9,455
      
572,695
  
 
  
$
4,621,344
    
$ 
44,688
    
$
110,745
    
$
4,555,287
  
 
                                
December 31, 2013
                                
Government-sponsored enterprises
  
$
3,500,000
    
$
795
    
$
2,030
    
$
3,498,765
  
Mortgage-backed securities
    
32,099
      
1,022
      
-
      
33,121
  
Corporate bonds
    
550,000
      
-
      
99,000
      
451,000
  
Equities and mutual funds
    
535,326
      
43,260
      
11,770
      
566,816
  
 
  
$
4,617,425
    
$
45,077
    
$
112,800
    
$
4,549,702
  

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

Maturities of mortgage-backed bonds are stated based on contractual maturities.  Actual maturities of these bonds may vary as the underlying mortgages are prepaid.  The investment in equities and mutual funds by nature have no maturity date and are classified as due in one year or less. The scheduled maturities of securities (all available for sale) at March 31, 2014, were as follows:

 
  
Amortized
    
Fair
  
 
  
Cost
    
Value
  
Due in one year or less
  
$
1,040,474
    
$
1,073,065
  
Due after one year through five years
    
3,559,875
      
3,460,427
  
Due after five years through ten years
    
10,676
      
11,099
  
Due after ten years
    
10,319
      
10,696
  
 
  
$
4,621,344
    
$
4,555,287
  

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, 2014 and December 31, 2013. These unrealized losses on investment securities are a result of volatility in interest rates which relate to government-sponsored enterprises and corporate bonds issued by other banks and market volatility as it relates to equity and mutual fund investments at March 31, 2014 and December 31, 2013.

 
  
Less Than 12 Months
    
12 Months or More
    
Total
  
 
  
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
  
 
  
   
   
   
   
   
 
March 31, 2014
  
   
   
   
   
   
 
Government-sponsored enterprises
  
$
997,760
    
$
2,240
    
$
999,950
    
$
50
    
$
1,997,710
    
$
2,290
  
Corporate bonds
    
-
      
-
      
451,000
      
99,000
      
451,000
      
99,000
  
Equities and mutual funds
    
256,892
      
9,455
      
-
      
-
      
256,892
      
9,455
  
 
  
$
1,254,652
    
$
11,695
    
$
1,450,950
    
$
99,050
    
$
2,705,602
    
$
110,745
  
 
                                                
December 31, 2013
                                                
Government-sponsored enterprises
  
$
1,497,970
      
2,030
    
$
-
    
$
-
    
$
1,497,970
    
$
2,030
  
Corporate bonds
    
-
      
-
      
451,000
      
99,000
      
451,000
      
99,000
  
Equities and mutual funds
    
245,218
      
11,770
      
-
      
-
      
245,218
      
11,770
  
 
  
$
1,743,188
    
$
13,800
    
$
451,000
    
$
99,000
    
$
2,194,188
    
$
112,800
  

SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2.
SECURITIES, CONTINUED

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

The Company had realized gains of $2,898 and $1,958 from the sales of equity and mutual fund investment securities for the three month periods ended March 31, 2014 and 2013, respectively. Total proceeds from the sales amounted to $9,259 and $27,937 in 2014 and 2013, respectively.
 
NOTE 3.
EARNINGS PER COMMON SHARE

Basic earnings per common share for the three months ended March 31, 2014 and 2013 were calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period.

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

NOTE 4.
COMMITMENTS AND LETTERS OF CREDIT

At March 31, 2014, the Company had commitments to extend credit, including unused lines of credit of approximately $39,889,000 and letters of credit outstanding of $1,204,834.

NOTE 5.
LOANS

The major components of loans in the balance sheets at March 31, 2014 and December 31, 2013 are below.
 
  
2014
    
2013
  
Commercial
  
$
66,457,837
    
$
66,612,984
  
Real estate:
                
Construction and land development
    
7,367,581
      
6,353,787
  
Residential, 1-4 families
    
39,564,157
      
40,203,978
  
Residential, 5 or more families
    
1,397,463
      
1,515,239
  
Farmland
    
1,823,049
      
2,219,688
  
Nonfarm, nonresidential, net of discounts of $135,377 in 2014 and $136,040 in 2013
    
59,798,495
      
60,316,018
  
Agricultural
    
271,422
      
107,974
  
Consumer, net of discounts of $12,551 in 2014 and $10,931 in 2013
    
5,436,073
      
5,685,407
  
     
182,116,077
      
183,015,075
  
Deferred loan origination costs, net of (fees)
    
275,712
      
269,100
  
     
182,391,789
      
183,284,175
  
Allowance for loan losses
    
(3,364,054
)
    
(3,375,350
)
   
$
179,027,735
    
$
179,908,825
  

SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5.
LOANS, CONTINUED

Residential, 1-4 family loans pledged as collateral against FHLB advances approximated $17,523,000 and $17,376,000 at March 31, 2014 and December 31, 2013, respectively.

NOTE 6.
ALLOWANCE FOR LOAN LOSSES

The activity of the allowance for loan losses by loan components during the three months ended March 31, 2014 and 2013 was as follows:
 
 
  
Construction
&
Development
    
 
1-4 Family
Residential
    
 
Nonfarm,
Nonresidential
    
Commercial
&
Industrial
    
 
 
Consumer
    
 
 
Other
    
 
 
Total
  
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
  
Ending balance: loans acquired with deteriorated credit quality
  
$
-
    
$
-
    
$
-
    
$
-
    
$
-
    
$
-
    
$
-
  
 
                                                        
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
  
Ending balance: loans acquired with deteriorated credit quality
  
$
-
    
$
-
    
$
-
    
$
-
    
$
-
    
$
-
    
$
-
  
 
                                                        
March 31, 2013
                                                        
 
                                                        
Allowance for credit losses:
                                                        
Beginning balance
  
$
86,300
    
$
668,700
    
$
801,999
    
$
1,604,510
    
$
198,789
    
$
42,800
    
$
3,403,098
  
Charge-offs
    
-
      
-
      
(79,609
)
    
-
      
(46,185
)
    
-
      
(125,794
)
Recoveries
    
318
      
401
      
136
      
6,299
      
15,182
      
-
      
22,336
  
Provision
    
(9,618
)
    
(19,301
)
    
99,370
      
(50,111
)
    
21,554
      
500
      
42,394
  
Ending balance
  
$
77,000
    
$
649,800
    
$
821,896
    
$
1,560,698
    
$
189,340
    
$
43,300
    
$
3,342,034
  
 
                                                        
Ending balance: individually evaluated for impairment
  
$
-
    
$
-
    
$
213,096
    
$
207,398
    
$
-
    
$
-
    
$
420,494
  
Ending balance: collectively evaluated for impairment
  
$
77,000
    
$
649,800
    
$
608,800
    
$
1,353,300
    
$
189,340
    
$
43,300
    
$
2,921,540
  
Ending balance: loans acquired with deteriorated credit quality
  
$
-
    
$
-
    
$
-
    
$
-
    
$
-
    
$
-
    
$
-
  
 
                                                        
Loans Receivable:
                                                        
Ending balance
  
$
4,261,466
    
$
35,608,828
    
$
64,420,526
    
$
65,731,927
    
$
6,713,173
    
$
4,163,685
    
$
180,899,605
  
 
                                                        
Ending balance: individually evaluated for impairment
  
$
87,283
    
$
553,793
    
$
3,157,290
    
$
2,430,635
    
$
-
    
$
206,241
    
$
6,435,242
  
Ending balance: collectively evaluated for impairment
  
$
4,174,183
    
$
35,055,035
    
$
61,263,236
    
$
63,301,292
    
$
6,713,173
    
$
3,957,444
    
$
174,464,363
  
Ending balance: loans acquired with deteriorated credit quality
  
$
-
    
$
-
    
$
-
    
$
-
    
$
-
    
$
-
    
$
-
  

SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


NOTE 6.
ALLOWANCE FOR LOAN LOSSES, CONTINUED

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

 
  
 
Recorded
 Investment
    
Unpaid
Principal
Balance
    
 
Related
Allowance
    
Average
Recorded
Investment
    
Interest
Income
Recognized
  
 
  
   
   
   
   
 
March 31, 2014
  
   
   
   
   
 
With no related allowance recorded:
  
   
   
   
   
 
Construction and development
  
$
348,141
    
$
348,141
    
$
-
    
$
349,296
    
$
4,496
  
1-4 family residential
    
323,750
      
323,750
      
-
      
326,574
      
2,355
  
Nonfarm, nonresidential
    
1,931,231
      
2,001,469
      
-
      
1,955,298
      
10,565
  
Commercial and industrial
    
997,620
      
1,025,014
      
-
      
981,726
      
14,227
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
-
      
-
      
-
      
-
      
-
  
 
    
3,600,742
      
3,698,374
      
-
      
3,612,894
      
31,643
  
 
                                        
With an allowance recorded:
                                        
Construction and development
  
$
-
    
$
-
    
$
-
    
$
-
    
$
-
  
1-4 family residential
    
232,453
      
232,453
      
54,436
      
235,709
      
1,479
  
Nonfarm, nonresidential
    
885,085
      
885,085
      
132,173
      
886,996
      
416
  
Commercial and industrial
    
1,486,047
      
1,486,047
      
258,579
      
1,487,665
      
6,211
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
-
      
-
      
-
      
-
      
-
  
 
    
2,603,585
      
2,603,585
      
445,188
      
2,610,370
      
8,106
  
 
                                        
Combined:
                                        
Construction and development
  
$
348,141
    
$
348,141
    
$
-
    
$
349,296
    
$
4,496
  
1-4 family residential
    
556,203
      
556,203
      
54,436
      
562,283
      
3,834
  
Nonfarm, nonresidential
    
2,816,316
      
2,886,554
      
132,173
      
2,842,294
      
10,981
  
Commercial and industrial
    
2,483,667
      
2,511,061
      
258,579
      
2,469,391
      
20,438
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
-
      
-
      
-
      
-
      
-
  
 
  
$
6,204,327
    
$
6,301,959
    
$
445,188
    
$
6,223,264
    
$
39,749
  
 
                                        
 
                                        
December 31, 2013
                                        
With no related allowance recorded:
                                        
Construction and development
  
$
318,111
    
$
318,111
    
$
-
    
$
320,260
    
$
21,825
  
1-4 family residential
    
263,562
      
263,562
      
-
      
261,364
      
21,295
  
Nonfarm, nonresidential
    
2,095,645
      
2,165,883
      
-
      
2,144,605
      
120,322
  
Commercial and industrial
    
1,359,371
      
1,561,253
      
-
      
1,393,077
      
71,409
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
-
      
-
      
-
      
-
      
-
  
 
    
4,036,689
      
4,308,809
      
-
      
4,119,306
      
234,851
  
 
                                        
With an allowance recorded:
                                        
Construction and development
  
$
-
    
$
-
    
$
-
    
$
-
    
$
-
  
1-4 family residential
    
74,205
      
74,205
      
10,829
      
77,144
      
4,300
  
Nonfarm, nonresidential
    
816,776
      
816,776
      
131,950
      
930,060
      
24,653
  
Commercial and industrial
    
1,140,160
      
1,140,160
      
206,162
      
1,163,698
      
47,393
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
-
      
-
      
-
      
-
      
-
  
 
    
2,031,141
      
2,031,141
      
348,941
      
2,170,902
      
76,346
  
 
                                        
Combined:
                                        
Construction and development
  
$
318,111
    
$
318,111
    
$
-
    
$
320,260
    
$
21,825
  
1-4 family residential
    
337,767
      
337,767
      
10,829
      
338,508
      
25,595
  
Nonfarm, nonresidential
    
2,912,421
      
2,982,659
      
131,950
      
3,074,665
      
144,975
  
Commercial and industrial
    
2,499,531
      
2,701,413
      
206,162
      
2,556,775
      
118,802
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
-
      
-
      
-
      
-
      
-
  
 
  
$
6,067,830
    
$
6,339,950
    
$
348,941
    
$
6,290,208
    
$
311,197
  

SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6.
ALLOWANCE FOR LOAN LOSSES, CONTINUED

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

 
  
 
 
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, 2014
  
   
   
   
   
   
   
 
 
  
   
   
   
   
   
   
 
Construction and development
  
$
11,979
    
$
31,260
    
$
-
    
$
43,239
    
$
7,324,342
    
$
7,367,581
    
$
-
  
1-4 family residential
    
616,331
      
146,599
      
108,967
      
871,897
      
38,692,260
      
39,564,157
      
21,022
  
Nonfarm, nonresidential
    
591,708
      
79,307
      
761,865
      
1,432,880
      
58,365,615
      
59,798,495
      
-
  
Commercial and industrial
    
32,031
      
381,328
      
568,155
      
981,514
      
65,476,323
      
66,457,837
      
-
  
Consumer
    
104,267
      
35,169
      
27,558
      
166,994
      
5,269,079
      
5,436,073
      
26,178
  
Other loans
    
-
      
-
      
-
      
-
      
3,491,934
      
3,491,934
      
-
  
Total
  
$
1,356,316
    
$
673,663
    
$
1,466,545
    
$
3,496,524
    
$
178,619,553
    
$
182,116,077
    
$
47,200
  
Percentage of total loans
    
0.74
%
    
0.37
%
    
0.81
%
    
1.92
%
    
98.08
%
    
100.00
%
        
 
                                                        
Non-accruals included above
                                                        
Construction and development
  
$
-
    
$
-
    
$
-
    
$
-
    
$
69,410
    
$
69,410
          
1-4 family residential
    
-
      
-
      
87,945
      
87,945
      
356,631
      
444,576
          
Nonfarm, nonresidential
    
-
      
-
      
761,865
      
761,865
      
1,213,376
      
1,975,241
          
Commercial and industrial
    
-
      
381,328
      
568,155
      
949,483
      
566,884
      
1,516,367
          
Consumer
    
-
      
-
      
1,381
      
1,381
      
-
      
1,381
          
Other loans
    
-
      
-
      
-
      
-
      
-
      
-
          
 
  
$
-
    
$
381,328
    
$
1,419,346
    
$
1,800,674
    
$
2,206,301
    
$
4,005,975
          
 
                                                        
December 31, 2013
                                                        
 
                                                        
Construction and development
  
$
-
    
$
-
    
$
-
    
$
-
    
$
6,353,787
    
$
6,353,787
    
$
-
  
1-4 family residential
    
544,559
      
165,244
      
173,786
      
883,589
      
39,320,389
      
40,203,978
      
-
  
Nonfarm, nonresidential
    
193,411
      
336,036
      
791,148
      
1,320,595
      
58,995,423
      
60,316,018
      
-
  
Commercial and industrial
    
84,145
      
2,528
      
929,552
      
1,016,225
      
65,596,759
      
66,612,984
      
15,837
  
Consumer
    
103,463
      
68,767
      
20,742
      
192,972
      
5,492,435
      
5,685,407
      
19,602
  
Other loans
    
-
      
-
      
-
      
-
      
3,842,901
      
3,842,901
      
-
  
Total
  
$
925,578
    
$
572,575
    
$
1,915,228
    
$
3,413,381
    
$
179,601,694
    
$
183,015,075
    
$
35,439
  
Percentage of total loans
    
0.51
%
    
0.31
%
    
1.05
%
    
1.87
%
    
98.13
%
    
100.00
%
        
 
                                                        
Non-accruals included above
                                                        
Construction and development
  
$
-
    
$
-
    
$
-
    
$
-
    
$
70,058
    
$
70,058
          
1-4 family residential
    
29,269
      
-
      
173,786
      
203,055
      
190,032
      
393,087
          
Nonfarm, nonresidential
    
85,646
      
-
      
791,148
      
876,794
      
1,222,090
      
2,098,884
          
Commercial and industrial
    
-
      
-
      
913,715
      
913,715
      
321,592
      
1,235,307
          
Consumer
    
259
      
547
      
1,141
      
1,947
      
1,044
      
2,991
          
Other loans
    
-
      
-
      
-
      
-
      
-
      
-
          
 
  
$
115,174
    
$
89,322
    
$
1,879,790
    
$
1,995,511
    
$
1,804,816
    
$
3,800,327
          
 
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.

 
March 31, 2014
 
Total
  
 
Pass Credits
  
Special
Mention
  
 
Substandard
  
 
Doubtful
  
 
 
 
 
 
 
Construction and development
  
$
7,367,581
    
$
7,298,171
    
$
69,410
    
$
-
    
$
-
  
1-4 family residential
    
39,564,157
      
39,031,696
      
532,461
      
-
      
-
  
Nonfarm, nonresidential
    
59,798,495
      
57,415,160
      
2,281,516
      
101,819
      
-
  
Commercial and industrial
    
66,457,837
      
64,094,477
      
2,363,360
      
-
      
-
  
Consumer
    
5,436,073
      
5,434,374
      
1,699
      
-
      
-
  
Other loans
    
3,491,934
      
3,491,934
      
-
      
-
      
-
  
 
  
$
182,116,077
    
$
176,765,812
    
$
5,248,446
    
$
101,819
    
$
-
  
 
                                        
 
    
100.0
%
    
97.1
%
    
2.8
%
    
0.1
%
    
-
%
 
                                        
Guaranteed portion of loans
                                        
 
                                        
Construction and development
  
$
70,441
    
$
70,441
      
-
            
$
-
  
1-4 family residential
    
641,337
      
599,149
      
42,188
      
-
      
-
  
Nonfarm, nonresidential
    
26,613,258
      
25,655,167
      
958,091
      
-
      
-
  
Commercial and industrial
    
19,841,881
      
18,700,142
      
1,141,739
      
-
      
-
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
542,548
      
542,548
      
-
      
-
      
-
  
 
  
$
47,709,465
    
$
45,567,447
    
$
2,142,018
    
$
-
    
$
-
  
 
                                        
 
Total
Pass Credits
Special
Mention
Substandard
Doubtful
 
                                        
December 31, 2013
                                        
 
                                        
Construction and development
  
$
6,353,787
    
$
6,283,729
    
$
70,058
    
$
-
    
$
-
  
1-4 family residential
    
40,203,978
      
39,586,647
      
617,331
      
-
      
-
  
Nonfarm, nonresidential
    
60,316,018
      
58,188,799
      
2,022,868
      
104,351
      
-
  
Commercial and industrial
    
66,612,984
      
64,556,331
      
2,056,653
      
-
      
-
  
Consumer
    
5,685,407
      
5,684,245
      
1,162
      
-
      
-
  
Other loans
    
3,842,901
      
3,842,901
      
-
      
-
      
-
  
 
  
$
183,015,075
    
$
178,142,652
    
$
4,768,072
    
$
104,351
    
$
-
  
 
                                        
 
    
100.0
%
    
97.3
%
    
2.6
%
    
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
  
$
73,000
    
$
73,000
    
$
-
    
$
-
    
$
-
  
1-4 family residential
    
673,854
      
629,939
      
43,915
      
-
      
-
  
Nonfarm, nonresidential
    
26,835,404
      
26,063,658
      
771,746
      
-
      
-
  
Commercial and industrial
    
19,589,284
      
18,737,759
      
851,525
      
-
      
-
  
Consumer
    
-
      
-
      
-
      
-
      
-
  
Other loans
    
544,195
      
544,195
      
-
      
-
      
-
  
 
  
$
47,715,737
    
$
46,048,551
    
$
1,667,186
    
$
-
    
$
-
  

NOTE 7.
TROUBLED DEBT RESTRUCTURINGS

For the three months ended March 31, 2014 and 2013, the following table presents loans modified during the period that were considered to be troubled debt restructurings.

 
  
For the three months ended
March 31, 2014
     For the Three months ended
March 31, 2013
  
 
  
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 quarter ended March 31, 2014, the Bank modified three loans that were considered to be troubled debt restructurings. The interest rates were lowered and the terms extended on the three loans.

During the three months ended March 31, 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, 2014, 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, 2014
  
Total
    
Level 1
    
Level 2
    
Level 3
  
Government-sponsored enterprises
  
$
3,499
    
$
-
    
$
3,499
    
$
-
  
Mortgage-backed securities
    
32
      
-
      
32
      
-
  
Corporate bonds
    
451
      
-
      
-
      
451
  
Equities and mutual funds
    
573
      
573
      
-
      
-
  
Total assets at fair value
  
$
4,555
    
$
573
    
$
3,531
    
$
451
  
 
                                
Total liabilities at fair value
  
$
-
    
$
-
    
$
-
    
$
-
  
 
                                
(in thousands)
                                
December 31, 2013
  
Total
    
Level 1
    
Level 2
    
Level 3
  
Government-sponsored enterprises
  
$
3,499
    
$
-
    
$
3,499
    
$
-
  
Mortgage-backed securities
    
33
      
-
      
33
      
-
  
Corporate bonds
    
451
      
-
      
-
      
451
  
Equities and mutual funds
    
567
      
567
      
-
      
-
  
Total assets at fair value
  
$
4,550
    
$
567
    
$
3,532
    
$
451
  
 
                                
Total liabilities at fair value
  
$
-
    
$
-
    
$
-
    
$
-
  

For the three months ended March 31, 2014 and 2013, the changes in Level 3 assets and liabilities measured at fair value on a recurring basis were as follows:

 
  
Level 3
  
 
  
2014
    
2013
  
(in thousands)
  
Fair Value
    
Fair Value
  
Corporate Bonds – Available for Sale
  
   
 
Balance, January 1
  
$
451
    
$
443
  
Total unrealized gain (loss) included in income
    
-
      
-
  
Total unrealized gain (loss) included in other comprehensive income
    
-
      
8
  
Balance, March 31
  
$
451
    
$
451
  

SURREY BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8.
FAIR VALUE, CONTINUED

There were no changes in Level 3 corporate bond assets measured at fair value on a recurring basis for the three month period ended March 31, 2014. The change in corporate bond assets for the three month period ended March 31, 2013 was $8,250.

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, 2014
  
Total
    
Level 1
    
Level 2
    
Level 3
  
Loans-commercial and industrial
  
$
1,227
    
$
-
    
$
-
    
$
1,227
  
Loans-nonfarm, non-residential
    
753
      
-
      
-
      
753
  
Loans-1-4 family residential
    
178
      
-
      
-
      
178
  
Foreclosed assets
    
145
      
-
      
-
      
145
  
Servicing assets
    
260
      
-
      
-
      
260
  
Total assets at fair value
  
$
2,563
    
$
-
    
$
-
    
$
2,563
  
Total liabilities at fair value
  
$
-
    
$
-
    
$
-
    
$
-
  
 
                                
(in thousands)
                                
December 31, 2013
  
Total
    
Level 1
    
Level 2
    
Level 3
  
Loans-commercial and industrial
  
$
934
    
$
-
    
$
-
    
$
934
  
Loans-nonfarm, non-residential
    
685
      
-
      
-
      
685
  
Loans-1-4 family residential
    
63
      
-
      
-
      
63
  
Foreclosed assets
    
-
      
-
      
-
      
-
  
Servicing assets
    
261
      
-
      
-
      
261
  
Total assets at fair value
  
$
1,943
    
$
-
    
$
-
    
$
1,943
  
Total liabilities at fair value
  
$
-
    
$
-
    
$
-
    
$
-
  
 
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, 2014 and December 31, 2013.  This table excludes financial instruments for which the carrying amount approximates fair value.

 
  
   
   
Fair Value Measurements
  
 
  
   
   
   
   
 
 
  
   
   
Quoted
    
   
 
 
  
   
   
Prices in
    
   
 
 
  
   
   
Active Markets
    
Significant
      
 
  
   
   
ForIdentical
    
Other
    
Significant
  
Inputs
  
   
   
   
   
 
(dollars in thousands)
  
Amount
    
Fair Value
    
(Level 1)
    
(Level 2)
    
(Level 3)
  
 
  
   
   
   
   
 
March 31, 2014
  
   
   
   
   
 
Financial Instruments - Assets
  
   
   
   
   
 
Loans
  
$
179,028
    
$
179,032
    
$
-
    
$
-
    
$
179,032
  
 
                                        
Financial Instruments – Liabilities
                                        
Deposits
    
205,116
      
186,080
      
-
      
186,080
      
-
  
Long-Term Debt
    
7,750
      
8,062
      
-
      
8,062
      
-
  
 
                                        
December 31, 2013
                                        
Financial Instruments - Assets
                                        
Loans
  
$
179,909
    
$
179,531
    
$
-
    
$
-
    
$
179,531
  
 
                                        
Financial Instruments – Liabilities
                                        
Deposits
    
195,801
      
171,649
      
-
      
171,649
      
-
  
Long-Term Debt
    
7,750
      
8,100
      
-
      
8,100
          

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, 2014 and 2013. 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, 2014, was $631,173 or $0.16 per diluted share outstanding, compared to a $606,549 or $0.16 per diluted share outstanding, for the same period in 2013. Earnings for the three months ended March 31, 2014, are approximately 4.1% higher than for the same period in 2013. The increase results from a reduction in the provision for loan losses.  The provision for loan losses decreased from $42,394 in the first quarter of 2013 to a recapture of $62,362 in 2014. This decrease is partially due to a reduction in gross loans in the first quarter of 2014, while gross loans increased in the first quarter of 2013. Gross loans decreased $898,998 from December 31, 2013 to March 31, 2014. During the same period in 2013 gross loans increased $4,212,276. In addition the Bank experienced net charge off recoveries in the first quarter of 2014 compared to 2013. Net recoveries amounted to $51,067 in 2014 compared to net charge offs of $103,457 in the first quarter of 2013, a $154,524 difference. At March 31, 2014, the percentage of loans receiving pass credit risk grades was 97.1%, compared to 97.8% at December 31, 2013 and 98.3% at March 31, 2013. Although credit quality slightly decreased over the period credit quality continues to be enhanced by loans carrying government guarantees. At March 31, 2014, the guaranteed portion of loans equaled 26.2% of total loans compared to 26.1% at December 31, 2013. Net interest income increased from $2,217,391 in the first quarter of 2013 to $2,348,165 in 2014. This increased due to loan growth and is also associated with the Bank’s net charge off recoveries in 2014. The payoff of previously charged off or nonaccrual loans recaptured the lost interest on those loans. Asset yields decreased from 4.93% to 4.74% from 2013 to 2014 partially due to the change in average earning asset mix from higher yielding loans to lower yielding deposits in other banks. Loan yields also decreased from 5.93% in the first quarter of 2013 to 5.75% in the first quarter of 2014. Loan yields fell due to the prolonged low rate environment and competition. A reduction in the cost of deposits from the first quarter of 2013 to 2014 was unable to offset the tightening asset yields. The cost of funds decreased from 0.78% in the first quarter of 2013 to 0.68% in the first quarter of 2014. Noninterest income decreased from $658,376 in the first quarter of 2013 to $581,928 in 2014. The decrease results from a reduction in service charges on deposit accounts and a reduction in contingency bonus revenue from the Bank’s insurance subsidiary. Noninterest expenses increased slightly from $1,841,826 in the first quarter of 2013, to $1,867,387 in 2014. Salaries and employee benefits accounted for most of the change increasing from $961,121 in 2013 to $1,009,500 in 2014. This increase was primarily due to normal salary adjustments. This increase was partially offset by a reduction in expenses associated with foreclosed assets which decreased from $42,335 in 2013 to a gain of $894 in 2014.
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED

On March 31, 2014, Surrey Bancorp's assets totaled $250,389,844 compared to $240,918,977 on December 31, 2013. Net loans were $179,027,735 compared to $179,908,825 on December 31, 2013. This net decrease was the result of an $892,386 decrease in gross loans and an $11,296 net decrease in the loan loss reserve. Real estate loans account for most of the reduction decreasing 0.8% during the three month period ended March 31, 2014. There was a 16.0% increase in construction loans but decreases in 1-4 family loans, nonfarm nonresidential real estate loans and other real estate loans decreased over 28.5% resulting in an overall decrease in gross loans of 0.5%.

Total deposits on March 31, 2014, were $205,115,560 compared to $195,800,961 at the end of 2013. This increase is attributable to a sizable increase in interest-bearing demand deposits accounts, which increased from $30,917,403 at December 31, 2013 to $36,232,331 at March 31, 2014. This was a temporary spike due to trust account activity at the end of the quarter. Overall, noninterest-bearing and interest-bearing demand deposits increased 9.5% from 2013 totals, while savings deposits, including money market accounts, decreased 0.9%. Certificates of deposit increased 3.2% from December 31, 2013 totals.

Common stockholders’ equity increased by $632,242, or 1.85%, during the three months ended March 31, 2014. The increase is comprised of net income of $676,400 and adjustments to other comprehensive income of $1,069. Decreases included the payment and accrual of preferred dividends of $45,227. The net increase resulted in a common stock book value of $8.74 per share, up from $8.57 on December 31, 2013.

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, 2014.

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 $4,555,287 consisted of Government-sponsored enterprise obligations with maturities ranging from 11 to 35 months, corporate bonds with maturities of 4.25 years to 4.50 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, 2014, were $179,027,735 compared to $179,908,825 on December 31, 2013. The Bank maintains a loan portfolio dominated by real estate and commercial loans diversified among various industries. Approximately 60.4% of the Bank's loans as of March 31, 2014, are fixed rate loans with 39.6% 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, 2014, were $205,115,560, compared to $195,800,961 on December 31, 2013. The March total consists of a base of approximately 12,743 accounts compared to 12,742 accounts at December 31, 2013. Interest-bearing accounts represent 78.4% of March 31, 2014 period end deposits versus 78.2% at December 31, 2013.

Federal Funds Purchased

The Company had no federal funds purchased at March 31, 2014 or December 31, 2013. Federal funds purchased were not utilized due to the adequate liquidity resulting from the increase in deposits.

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. The Company’s and the Bank’s capital ratios are presented in the following table.

 
  
   
Minimum
  
 
  
   
Required
  
 
  
   
For Capital
  
 
  
   
Adequacy
  
 
  
Ratio
    
Purposes
  
 
  
   
 
March 31, 2014:
  
   
 
Total Capital (to Risk-Weighted Assets)
  
   
 
Surrey Bancorp (Consolidated)
    
22.34
%
    
8.0
%
Surrey Bank & Trust
    
21.93
%
    
8.0
%
Tier I Capital (to Risk-Weighted Assets)
                
Surrey Bancorp (Consolidated)
    
21.08
%
    
4.0
%
Surrey Bank & Trust
    
20.67
%
    
4.0
%
Tier I Capital (to Average Assets)
                
Surrey Bancorp (Consolidated)
    
13.85
%
    
4.0
%
Surrey Bank & Trust
    
13.60
%
    
4.0
%
 
                
December 31, 2013:
                
Total Capital (to Risk-Weighted Assets)
                
Surrey Bancorp (Consolidated)
    
21.90
%
    
8.0
%
Surrey Bank & Trust
    
21.46
%
    
8.0
%
Tier I Capital (to Risk-Weighted Assets)
                
Surrey Bancorp (Consolidated)
    
20.64
%
    
4.0
%
Surrey Bank & Trust
    
20.20
%
    
4.0
%
Tier I Capital (to Average Assets)
                
Surrey Bancorp (Consolidated)
    
13.58
%
    
4.0
%
Surrey Bank & Trust
    
13.31
%
    
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,
    
December 31,
  
 
  
2014
    
2013
  
 
  
   
 
Nonaccrual loans
  
$
4,006,975
    
$
3,800,327
  
Loans past due 90 days and still accruing
    
47,200
      
35,439
  
Foreclosed assets
    
144,521
      
-
  
Total
  
$
4,198,696
    
$
3,835,766
  
Total assets
  
$
250,389,844
    
$
240,918,977
  
 
                
Ratio of nonperforming assets to total assets
    
1.68
%
    
1.59
%

At March 31, 2014, the Bank had loans totaling $4,006,975 in nonaccrual status. Approximately $2,206,302 of the nonaccrual loans were current at the end of March. All of the loans past due 90 days and still accruing are less than 120 days past due. All the loans are secured loans. The guaranteed portion of nonaccrual loans at March 31, 2014 is $1,862,569. Foreclosed assets at March 31, 2014 primarily consist of 1-4 family dwellings. Loans that were considered impaired but were still accruing interest at March 31, 2014, including troubled debt restructurings, totaled $2,227,301. 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 $445,188 at March 31, 2014, or 7.1% of the balances outstanding.

Nonaccrual and impaired loans still accruing are summarized below:

 
  
March 31,
    
December 31,
  
 
  
2014
    
2013
  
 
  
   
 
Construction and development
  
$
315,826
    
$
318,111
  
1-4 family residential
    
584,772
      
386,564
  
Nonfarm, nonresidential
    
2,817,421
      
2,912,421
  
Commercial and industrial
    
2,514,876
      
2,499,531
  
Consumer
    
1,381
      
2,991
  
Total impaired and nonaccrual
  
$
6,234,276
    
$
6,119,618
  
Guaranteed portion
  
$
2,464,124
    
$
2,235,481
  

At March 31, 2014, consumer loans totaling $29,949 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, 2014 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, 2014
    
December 31, 2013
  
Construction and development
  
$
7,367,581
      
4.05
%
  
$
6,353,787
      
3.47
%
1-4 family residential
    
39,564,157
      
21.72
%
    
40,203,978
      
21.97
%
Multi-family
    
1,397,463
      
0.77
%
    
1,515,239
      
0.83
%
Farmland
    
1,823,049
      
1.00
%
    
2,219,688
      
1.21
%
Nonfarm, nonresidential
    
59,798,495
      
32.84
%
    
60,316,018
      
32.96
%
Total real estate
    
109,950,745
      
60.38
%
    
110,608,710
      
60.44
%
 
                                
Agricultural
    
271,422
      
0.15
%
    
107,974
      
0.06
%
Commercial and industrial
    
66,457,837
      
36.49
%
    
66,612,984
      
36.40
%
Consumer
    
5,436,073
      
2.98
%
    
5,685,407
      
3.10
%
Total loans
  
$
182,116,077
      
100.00
%
  
$
183,015,075
      
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 $60,707,863 in loans that carry government guarantees. The guaranteed portion of these loans amounts to $47,709,465 at March 31, 2014. Loan guarantees by loan class are below:

 
  
March 31,
    
Guaranteed Portion
  
 
  
2014
    
Amount
    
Percentage
  
Construction and development
  
$
7,367,581
    
$
70,441
      
0.96
%
1-4 family residential
    
39,564,157
      
641,337
      
1.62
%
Multi-family
    
1,397,463
      
9,143
      
0.65
%
Farmland
    
1,823,049
      
448,405
      
24.60
%
Nonfarm, nonresidential
    
59,798,495
      
26,613,258
      
44.50
%
Total real estate
    
109,950,745
      
27,782,584
      
25.27
%
 
                        
Agricultural
    
271,422
      
85,000
      
31.32
%
Commercial and industrial
    
66,457,837
      
19,841,881
      
29.86
%
Consumer
    
5,436,073
      
-
      
-
%
Total loans
  
$
182,116,077
    
$
47,709,465
      
26.20
%

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 $4,311,737 at March 31, 2014. Non-owner occupied nonfarm, non-residential properties included in nonfarm, non-residential loans above amounted to $9,045,363 at March 31, 2014.

The consolidated provision for loan losses was a recapture of $62,362 for the first three months of 2014 compared to a provision of $42,394 for the same period in 2013. Significant charge off recoveries and a decrease in loans in 2014, in comparison to 2013, resulted in the provision decrease.

The reserve for loan losses on March 31, 2014, was $3,364,054 or 1.84% of period end loans. This percentage is derived from total loans. Approximately $60,708,000 of total loans outstanding at March 31, 2014, 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 2.50% of outstanding loans.  At December 31, 2013 the loan loss reserve percentage was 1.84% of total loans and 2.49% 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. That portion did decrease during the first Three months of 2013 due to changes in the loan portfolio. 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, 2014 and December 31, 2013.

 
  
March 31, 2014
    
December 31, 2013
  
 
  
30-89 Days
    
90 Days Plus
    
30-89 Days
    
90 Days Plus
  
 
  
   
   
   
 
Construction and development
  
$
43,239
    
$
-
    
$
-
    
$
-
  
1-4 family residential
    
762,930
      
108,967
      
709,803
      
173,786
  
Nonfarm, non-residential
    
671,015
      
761,865
      
529,447
      
791,148
  
Commercial and industrial
    
413,359
      
568,155
      
86,673
      
929,552
  
Consumer
    
139,436
      
27,558
      
172,230
      
20,742
  
Other loans
    
-
      
-
      
-
      
-
  
 
  
$
2,029,979
    
$
1,466,545
    
$
1,498,153
    
$
1,915,228
  
Non-accrual loans included above
  
$
381,328
    
$
1,419,346
    
$
249,344
    
$
1,879,790
  
Guaranteed portion
  
$
592,170
    
$
915,651
    
$
288,601
    
$
1,193,581
  
 
                                
Ratio to total loans
    
1.11
%
    
0.81
%
    
0.82
%
    
1.05
%
Ratio to total loans, net of guarantees
    
1.07
%
    
0.41
%
    
0.89
%
    
0.53
%

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, 2013 to March 31, 2014. The increase is in the 30-89 day time frame.

Net of loan guarantees, total past dues have increased from $1,931,199 at December 31, 2013, to $1,988,704 at March 31, 2014, or 3.0%. Total past due loans at March 31, 2014 consist of sixty-nine loans with an average balance of $50,674, compared to seventy-seven loans at December 31, 2013, with an average balance of $44,330. Loans over $250,000 delinquent at March 31, 2014 and December 31, 2013 amounted to $1,525,010 and $1,549,868, respectively. The March 2014 and December 2013 totals consist of four loans, three of which are the same. The guaranteed portion of these loans at March 31, 2014 and December 31, 2013, is $1,161,124 and $1,218,890, 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, 2014, the liquidity position of the Company was excellent, in management’s opinion, with short-term liquid assets of $57,804,679 compared to $47,637,441 at December 31, 2013. Deposit growth and decreases in gross loan account for the increase in liquidity. To provide supplemental liquidity, the Bank has seven unsecured lines of credit with correspondent banks totaling $35,500,000. At March 31, 2014, 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 $10,251,000 of which $7,750,000 of advances had been taken down at March 31, 2014.
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 12, 2014
/s/ Edward C. Ashby, III
 
 
 
Edward C. Ashby, III
 
President and Chief Executive Officer
 
(Principal Executive Officer)
 
 
Date: May 12, 2014
/s/ Mark H. Towe
 
 
 
Mark H. Towe
 
Sr. Vice President and Chief Financial Officer
 
(Principal Financial Officer)
 
 
33