Edgar Filing: SURREY BANCORP

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Form 10-Q

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 June 30, 2013

¨	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 ¨

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 ¨

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):

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

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

On August 5, 2013 there were 3,542,984 common shares issued and outstanding.

PART I – FINANCIAL INFORMATION


Item 1.	Consolidated Financial Statements

	Consolidated Balance Sheets June 30, 2013 (Unaudited) and December 31, 2012	3

	Consolidated Statements of Income, Six Months Ended June 30, 2013 and 2012 (Unaudited)	4

	Consolidated Statements of Income, Three Months Ended June 30, 2013 and 2012 (Unaudited)	5

	Consolidated Statements of Comprehensive Income, Six Months Ended June 30, 2013 and 2012 (Unaudited)	6

	Consolidated Statements of Cash Flows, Six Months Ended June 30, 2013 and 2012 (Unaudited)	7

	Consolidated Statements of Changes in Stockholders’ Equity Six Months Ended June 30, 2013 and 2012 (Unaudited)	8

	Notes to Consolidated Financial Statements	9-23

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24-31

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	32

Item 4.	Controls and Procedures	33

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	34

Item 1A.	Risk Factors	34

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34

Item 3.	Defaults Upon Senior Securities	34

Item 4.	Mine Safety Disclosures	34

Item 5.	Other Information	34

Item 6.	Exhibits	34

SIGNATURES		35

CERTIFICATIONS		36-38

Consolidated Balance Sheets

June 30, 2013 (Unaudited) and December 31, 2012 (Audited)


	June 2013			December 2012

Assets
Cash and due from banks	$	5,499,080		$	5,973,042
Interest-bearing deposits with banks		29,084,497			32,366,318
Federal funds sold		1,210,992			710,588
Investment securities available for sale		4,008,175			3,502,852
Restricted equity securities		676,709			738,324
Loans, net of allowance for loan losses of $3,431,373 at June 30, 2013 and $3,403,098 at December 31, 2012		180,450,435			173,577,565
Property and equipment, net		4,475,457			4,543,738
Foreclosed assets		79,261			491,424
Accrued income		999,403			979,098
Goodwill		120,000			120,000
Bank owned life insurance		5,379,120			5,298,354
Other assets		2,590,986			1,611,129

Total assets	$	234,574,115		$	229,912,432


Liabilities and Stockholders’ Equity
*Liabilities*
Deposits:
Noninterest-bearing	$	44,029,296		$	36,979,419
Interest-bearing		146,118,552			150,843,618

Total deposits		190,147,848			187,823,037

Long-term debt		7,750,000			7,750,000
Dividends payable		45,730			46,106
Accrued interest payable		185,379			135,801
Other liabilities		2,845,794			1,920,187

Total liabilities		200,974,751			197,675,131


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 June 30, 2013 and December 31, 2012		12,061,153			12,061,153
Retained earnings		17,728,849			16,367,187
Accumulated other comprehensive loss		(59,445	)		(59,846	)

Total stockholders’ equity		33,599,364			32,237,301

Total liabilities and stockholders’ equity	$	234,574,115		$	229,912,432

See Notes to Consolidated Financial Statements

Consolidated Statements of Income

Six months ended June 30, 2013 and 2012 (Unaudited)


	2013			2012

*Interest income*
Loans and fees on loans	$	5,220,767		$	5,435,450
Federal funds sold		905			779
Investment securities, taxable		26,800			26,418
Investment securities, dividends		6,021			—
Deposits with banks		38,703			23,806

Total interest income		5,293,196			5,486,453


*Interest expense*
Deposits		599,132			719,681
Fed funds purchased		80			150
Short-term debt		38,543			—
Long-term debt		144,518			151,854

Total interest expense		782,273			871,685

Net interest income		4,510,923			4,614,768

*Provision for loan losses*		135,796			738,988

Net interest income after provision for loan losses		4,375,127			3,875,780


*Noninterest income*
Service charges on deposit accounts		437,060			461,730
Gain on sale of government guaranteed loans		229,130			—
Realized gains on the sale of securities		5,297			—
Fees on loans delivered to correspondents		35,320			70,234
Other service charges and fees		271,944			276,704
Other operating income		476,268			423,420

Total noninterest income		1,455,019			1,232,088


*Noninterest expense*
Salaries and employee benefits		1,871,496			1,788,521
Occupancy expense		218,758			225,213
Equipment expense		120,635			117,612
Data processing		212,293			182,419
Foreclosed assets, net		24,305			32,294
Postage, printing and supplies		98,933			97,233
Professional fees		212,571			206,673
FDIC insurance premiums		46,868			84,505
Other expense		714,724			742,382

Total noninterest expense		3,520,583			3,476,852

Net income before income taxes		2,309,563			1,631,016

Income tax expense		856,944			599,378

Net income		1,452,619			1,031,638

*Preferred stock dividends*		(90,957	)		(91,210	)

Net income available to common stockholders	$	1,361,662		$	940,428


*Basic earnings per common share*	$	0.38		$	0.27

*Diluted earnings per common share*	$	0.35		$	0.25

*Basic weighted average common shares outstanding*		3,542,984			3,538,822

*Diluted weighted average common shares outstanding*		4,176,919			4,172,757

See Notes to Consolidated Financial Statements

Consolidated Statements of Income

Three months ended June 30, 2013 and 2012 (Unaudited)


	2013			2012

*Interest income*
Loans and fees on loans	$	2,612,056		$	2,690,474
Federal funds sold		560			387
Investment securities, taxable		13,160			12,215
Investment securities, dividends		3,403			—
Deposits with banks		19,012			13,359

Total interest income		2,648,191			2,716,435


*Interest expense*
Deposits		290,444			346,669
Fed funds purchased		80			150
Short-term debt		33,824			—
Long-term debt		72,705			75,448

Total interest expense		397,053			422,267

Net interest income		2,251,138			2,294,168

*Provision for loan losses*		93,402			671,770

Net interest income after provision for loan losses		2,157,736			1,622,398


*Noninterest income*
Service charges on deposit accounts		205,735			225,788
Gain on the sale of government guaranteed loans		229,130			—
Realized gains on the sale of securities		3,339			—
Fees on loans delivered to correspondents		14,025			29,413
Other service charges and fees		143,620			144,798
Other operating income		200,794			172,252

Total noninterest income		796,643			572,251


*Noninterest expense*
Salaries and employee benefits		910,375			861,138
Occupancy expense		119,015			107,051
Equipment expense		57,937			54,399
Data processing		110,622			90,004
Foreclosed assets, net		(18,030	)		(936	)
Postage, printing and supplies		61,199			56,041
Professional fees		86,981			74,628
FDIC insurance premiums		13,693			35,650
Other expense		336,965			345,233

Total noninterest expense		1,678,757			1,623,208

Net income before income taxes		1,275,622			571,441

Income tax expense		474,779			203,860

Net income		800,843			367,581

*Preferred stock dividends*		(45,730	)		(45,605	)

Net income available to common stockholders	$	755,113		$	321,976


*Basic earnings per common share*	$	0.21		$	0.09

*Diluted earnings per common share*	$	0.19		$	0.09

*Basic weighted average common shares outstanding*		3,542,984			3,540,920

*Diluted weighted average common shares outstanding*		4,176,919			4,174,855

See Notes to Consolidated Financial Statements

Consolidated Statements of Comprehensive Income

Six months ended June 30, 2013 and 2012 (Unaudited)


	2013			2012

Net income	$	1,452,619		$	1,031,638


Other comprehensive income (loss):
Investment securities available for sale:
Unrealized losses arising during the period		(42	)		(7,360	)
Tax benefit related to unrealized losses		443			2,838

Total other comprehensive income (loss)		401			(4,522	)

Total comprehensive income	$	1,453,020		$	1,027,116

See Notes to Consolidated Financial Statements

Consolidated Statements of Cash Flows

Six months ended June 30, 2013 and 2012 (Unaudited)


	2013			2012
*Cash flows from operating activities*
Net income	$	1,452,619		$	1,031,638
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		123,958			115,562
Gain on sale of property and equipment		(100	)		(650	)
Gain on the sale of government guaranteed loans		(229,130	)		—
Gain on the sale of foreclosed assets		(33,520	)		(63,705	)
Stock-based compensation, net of tax benefit		—			11,504
Provision for loan losses		135,796			738,988
Deferred income taxes		2,853			3,895
Accretion of discount on securities, net of amortization of premiums		19			395
Increase in cash surrender value of life insurance		(80,766	)		(74,163	)
Changes in assets and liabilities:
Accrued income		(20,305	)		3,741
Other assets		(982,267	)		(74,462	)
Accrued interest payable		49,578			6,197
Other liabilities		1,154,737			632,341

Net cash provided by operating activities		1,573,472			2,331,281


*Cash flows from investing activities*
Net decrease in interest-bearing deposits with banks		3,281,821			12,245,078
Net (increase) decrease in federal funds sold		(500,404	)		633
Purchases of investment securities		(1,508,892	)		(2,000,000	)
Sales and maturities of investment securities		1,003,508			1,502,960
Purchase of Bank Owned Life Insurance		—			(1,750,000	)
Redemption of restricted equity securities		61,800			45,000
Purchase of restricted equity securities		(185	)		(2,150	)
Net increase in loans		(7,038,966	)		(617,530	)
Proceeds from the sale of foreclosed assets		475,983			520,316
Purchases of property and equipment		(55,677	)		(124,389	)
Proceeds from the sale of property and equipment		100			650

Net cash provided by (used in) investing activities		(4,280,912	)		9,820,568


*Cash flows from financing activities*
Net increase in deposits		2,324,811			(5,297,996	)
Repayments of long-term debt		—			(350,000	)
Dividends paid		(91,333	)		(622,346	)
Common stock options exercised		—			30,111

Net cash provided by (used in) financing activities		2,233,478			(6,240,231	)

Net increase (decrease) in cash and cash equivalents		(473,962	)		5,911,618
*Cash and due from banks, beginning*		5,973,042			2,269,116

*Cash and due from banks, ending*	$	5,499,080		$	8,180,734


*Supplemental disclosures of cash flow information*
Interest paid	$	732,695		$	865,488

Taxes paid	$	872,255		$	255,000


*Supplemental disclosures of non-cash transactions*
Loans transferred to foreclosed properties	$	30,300		$	147,639

Proceeds from the sale of guaranteed loan previously recorded as short term debt	$	3,743,820		$	—

See Notes to Consolidated Financial Statements

Consolidated Statements of Changes in Stockholders’ Equity

Six months ended June 30, 2013 and 2012 (Unaudited)


	Preferred Stock		Common Stock				Retained			Accumulated Other Comprehensive
	Amount		Shares		Amount		Earnings			Loss			Total

*Balance, January 1, 2012*	$	3,868,807		3,536,724	$	12,009,588	$	14,405,467		$	(57,300	)	$	30,226,562

Net income		—		—		—		1,031,638			—			1,031,638
Other comprehensive loss		—		—		—		—			(4,522	)		(4,522	)

Common stock options exercised		—		6,260		30,111		—			—			30,111
Stock-based compensation, net of tax benefit		—		—		11,504		—			—			11,504
Dividends declared and accrued on convertible Series A preferred stock ($.31 per share)		—		—		—		(59,322	)		—			(59,322	)
Dividends declared and accrued on convertible Series D preferred stock ($.18 per share)		—		—		—		(31,888	)		—			(31,888	)

*Balance, June 30, 2012*	$	3,868,807		3,542,984	$	12,051,203	$	15,345,895		$	(61,822	)	$	31,204,083


*Balance, January 1, 2013*	$	3,868,807		3,542,984	$	12,061,153	$	16,367,187		$	(59,846	)	$	32,237,301

Net income		—		—		—		1,452,619			—			1,452,619
Other comprehensive income		—		—		—		—			401			401

Dividends declared and accrued on convertible Series A preferred stock ($.32 per share)		—		—		—		(59,157	)		—			(59,157	)
Dividends declared and accrued on convertible Series D preferred stock ($.18 per share)		—		—		—		(31,800	)		—			(31,800	)

*Balance, June 30, 2013*	$	3,868,807		3,542,984	$	12,061,153	$	17,728,849		$	(59,445	)	$	33,599,364

See Notes to Consolidated Financial Statements

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1.

BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and therefore, do not include all disclosures required by generally accepted accounting principles for a complete presentation of financial statements. In the opinion of management, the consolidated financial statements contain all adjustments necessary to present fairly the financial condition of Surrey Bancorp, (the “Company), as of June 30, 2013, the results of operations for the six and three months ended June 30, 2013 and 2012, and its changes in stockholders’ equity, comprehensive income and cash flows for the six months ended June 30, 2013 and 2012. These adjustments are of a normal and recurring nature. The results of operations for the six months ended June 30, 2013, 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, 2012, included in the Company’s Form 10-K. The balance sheet at December 31, 2012, 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. 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 (the “Bank”) 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, 2012 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 for full details on critical accounting policies.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, the Bank and the subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.

BASIS OF PRESENTATION, CONTINUED

Presentation of Cash Flows

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

Investment Securities

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

Investment securities classified as held to maturity are those debt securities that the Bank has the ability and intent to hold to maturity. Accordingly, these securities are carried at cost adjusted for amortization of premiums and accretion of discount, computed by the interest-method over their contractual lives. At June 30, 2013 and December 31, 2012, 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 June 30, 2013 and December 31, 2012.

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 July 2012, the Intangibles topic was amended to permit an entity to consider qualitative factors to determine whether it is more likely than not that indefinite-lived intangible assets are impaired. If it is determined to be more likely than not that indefinite-lived intangible assets are impaired, then the entity is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount. The amendments were effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The amendments did not have a material effect on the Company’s financial statements.

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.

BASIS OF PRESENTATION, CONTINUED

Recent Accounting Pronouncements, continued

The Comprehensive Income topic of the ASC was amended in June 2011. The amendment eliminated the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity and required consecutive presentation of the statement of net income and other comprehensive income. The amendments were applicable to the Company January 1, 2012 and have been applied retrospectively. In December 2011, the topic was further amended to defer the effective date of presenting reclassification adjustments from other comprehensive income to net income on the face of the financial statements while the FASB redeliberated the presentation requirements for the reclassification adjustments. In February 2013, the FASB further amended the Comprehensive Income topic clarifying the conclusions from such redeliberations. Specifically, the amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments do require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, in certain circumstances an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income. The amendments were effective for the Company on a prospective basis beginning January 1, 2013. These amendments did not have a material effect on the Company’s financial statements.

On April 22, 2013, the FASB issued guidance addressing application of the liquidation basis of accounting. The guidance is intended to clarify when an entity should apply the liquidation basis of accounting. In addition, the guidance provides principles for the recognition and measurement of assets and liabilities and requirements for financial statements prepared using the liquidation basis of accounting. The amendments will be effective for entities that determine liquidation is imminent during annual reporting periods beginning after December 15, 2013, and interim reporting periods therein and those requirements should be applied prospectively from the day that liquidation becomes imminent. Early adoption is permitted. The Company does not expect these amendments to have any effect on its financial statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

Subsequent Events

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

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2.

SECURITIES

Debt and equity securities have been classified in the balance sheets according to management’s intent. The amortized costs of securities available for sale and their approximate fair values at June 30, 2013 and December 31, 2012 follow:


	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value

June 30, 2013
Government-sponsored enterprises	$	3,000,000	$	1,790	$	11,800	$	2,989,990
Mortgage-backed securities		38,132		1,270		—		39,402
Corporate bonds		550,000		—		101,750		448,250
Equities and mutual funds		517,728		22,008		9,203		530,533

	$	4,105,860	$	25,068	$	122,753	$	4,008,175


December 31, 2012
Government-sponsored enterprises	$	2,500,000	$	4,875	$	—	$	2,504,875
Mortgage-backed securities		41,659		1,316		—		42,975
Corporate bonds		550,000		—		107,250		442,750
Equities and mutual funds		508,836		3,416		—		512,252

	$	3,600,495	$	9,607	$	107,250	$	3,502,852

At June 30, 2013 and December 31, 2012, 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 scheduled maturities of securities (all available for sale) at June 30, 2013, were as follows:


	Amortized Cost		Fair Value
Due in one year or less	$	517,728	$	530,533
Due after one year through five years		3,250,000		3,193,740
Due after five years through ten years		326,468		271,761
Due after ten years		11,664		12,141

	$	4,105,860	$	4,008,175

The following table shows investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at June 30, 2013 and December 31, 2012. These unrealized losses on investment securities are a result of volatility in interest rates which relate to government-sponsored enterprises and corporate bonds issued by other banks and market volatility as it relates to equity and mutual fund investments at June 30, 2013 and December 31, 2012.


	Less Than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses

June 30, 2013
Government-sponsored enterprises	$	1,988,200	$	11,800	$	—	$	—	$	1,988,200	$	11,800
Corporate bonds		—		—		448,250		101,750		448,250		101,750
Equities and mutual funds		238,526		9,203		—		—		238,526		9,203

	$	2,226,726	$	21,003	$	448,250	$	101,750	$	2,674,976	$	122,753


December 31, 2012
Corporate bonds	$	—	$	—	$	442,750	$	107,250	$	442,750	$	107,250

	$	—	$	—	$	442,750	$	107,250	$	442,750	$	107,250

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 June 30, 2013, 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, 2012. 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 $5,297 from the sales of equity and mutual fund investment securities for the six month periods ended June 30, 2013. There were no such gains in 2012.

NOTE 3.

EARNINGS PER SHARE

Basic earnings per share for the six and three months ended June 30, 2013 and 2012 were calculated by dividing net income available to common stockholders by the weighted average number of shares outstanding during the period.

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

NOTE 4.

COMMITMENTS AND LETTERS OF CREDIT

At June 30, 2013, the Company had commitments to extend credit, including unused lines of credit of approximately $35,076,000 and letters of credit outstanding of $1,673,838.

NOTE 5.

LOANS

The major components of loans in the balance sheets at June 30, 2013 and December 31, 2012 are below.


	2013			2012

Commercial	$	66,397,808		$	75,914,072
Real estate:
Construction and land development		5,524,198			4,873,512
Residential, 1-4 families		38,621,785			36,091,051
Residential, 5 or more families		1,603,611			1,676,449
Farmland		2,483,567			2,284,155
Nonfarm, nonresidential, net of discounts of $137,407 in 2013 and $22,001 in 2012		62,740,245			48,993,867
Agricultural		147,811			147,860
Consumer, net of discounts of $13,633 in 2013 and $17,764 in 2012		6,086,325			6,703,363
Other		2,251			3,000


		183,607,601			176,687,329

Deferred loan origination costs, net of (fees)		274,207			293,334

		183,881,808			176,980,663
Allowance for loan losses		(3,431,373	)		(3,403,098	)

	$	180,450,435		$	173,577,565

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5.

LOANS, CONTINUED

Residential, 1-4 family loans pledged as collateral against FHLB advances approximated $17,500,000 and $17,765,000 at June 30, 2013 and December 31, 2012, respectively.

NOTE 6.

ALLOWANCE FOR LOAN LOSSES

The activity of the allowance for loan losses by loan components during the six months ended June 30, 2013 and 2012 was as follows:


	Construction & Development			1-4 Family Residential			Nonfarm, Nonresidential			Commercial & Industrial			Consumer			Other			Total

June 30, 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		—			(8,122	)		(79,609	)		(6,150	)		(54,118	)		—			(147,999	)
Recoveries		517			401			949			19,892			18,719			—			40,478
Provision		3,983			26,321			153,631			(69,156	)		17,017			4,000			135,796

Ending balance	$	90,800		$	687,300		$	876,970		$	1,549,096		$	180,407		$	46,800		$	3,431,373


Ending balance: individually evaluated for impairment	$	—		$	—		$	254,670		$	217,296		$	—		$	—		$	471,966

Ending balance: collectively evaluated for impairment	$	90,800		$	687,300		$	622,300		$	1,331,800		$	180,407		$	46,800		$	2,959,407

Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—		$	—


*Loans Receivable:*
Ending balance	$	5,524,198		$	38,621,785		$	62,740,245		$	66,397,808		$	6,086,325		$	4,237,240		$	183,607,601


Ending balance: individually evaluated for impairment	$	86,589		$	269,392		$	3,345,220		$	2,464,599		$	—		$	—		$	6,165,800

Ending balance: collectively evaluated for impairment	$	5,437,609		$	38,352,393		$	59,395,025		$	63,933,209		$	6,086,325		$	4,237,240		$	177,441,801

Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—		$	—


June 30, 2012

*Allowance for credit losses:*
Beginning balance	$	103,200		$	836,860		$	865,854		$	1,808,260		$	210,807		$	55,600		$	3,880,581
Charge-offs		(7,286	)		(268,006	)		(21,831	)		(579,503	)		(128,611	)		—			(1,005,237	)
Recoveries		100			532			83,506			89,538			14,196			—			187,872
Provision		9,386			161,912			(87,540	)		541,671			119,559			(6,000	)		738,988

Ending balance	$	105,400		$	731,298		$	839,989		$	1,859,966		$	215,951		$	49,600		$	3,802,204


Ending balance: individually evaluated for impairment	$	—		$	23,598		$	318,189		$	383,366		$	—		$	—		$	725,153

Ending balance: collectively evaluated for impairment	$	105,400		$	707,700		$	521,800		$	1,476,000		$	215,951		$	49,600		$	3,077,051

Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—		$	—


*Loans Receivable:*
Ending balance	$	5,876,390		$	36,568,561		$	45,463,526		$	79,246,988		$	7,351,882		$	4,450,720		$	178,958,534


Ending balance: individually evaluated for impairment	$	90,391		$	336,705		$	3,302,888		$	3,199,855		$	—		$	—		$	6,929,839

Ending balance: collectively evaluated for impairment	$	5,786,466		$	36,231,856		$	42,160,638		$	76,047,133		$	7,351,882		$	4,450,720		$	172,028,695

Ending balance: loans acquired with deteriorated credit quality	$	—		$	—		$	—		$	—		$	—		$	—		$	—

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6.

ALLOWANCE FOR LOAN LOSSES, CONTINUED

The following table presents impaired loans individually evaluated by class of loan as of June 30, 2013 and December 31, 2012 and the recognized interest income per the related period:


	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized

June 30, 2013
With no related allowance recorded:
Construction and development	$	86,589	$	86,589	$	—	$	87,038	$	3,735
1-4 family residential		269,392		269,392		—		272,985		—
Nonfarm, nonresidential		1,667,084		1,667,084		—		1,715,533		28,557
Commercial and industrial		1,292,535		1,292,535		—		1,226,791		14,463
Consumer		—		—		—		—		—
Other loans		—		—		—		—		—

		3,315,600		3,315,600		—		3,302,347		46,755


With an allowance recorded:
Construction and development	$	—	$	—	$	—	$	—	$	—
1-4 family residential		—		—		—		—		—
Nonfarm, nonresidential		1,678,136		1,779,577		254,670		1,692,293		7,351
Commercial and industrial		1,172,064		1,172,064		217,296		1,187,910		13,622
Consumer		—		—		—		—		—
Other loans		—		—		—		—		—

		2,850,200		2,951,641		471,966		2,880,203		20,973


Combined:
Construction and development	$	86,589	$	86,589	$	—	$	87,038	$	3,735
1-4 family residential		269,392		269,392		—		272,985		—
Nonfarm, nonresidential		3,345,220		3,446,661		254,670		3,407,826		35,908
Commercial and industrial		2,464,599		2,464,599		217,296		2,414,701		28,085
Consumer		—		—		—		—		—
Other loans		—		—		—		—		—

	$	6,165,800	$	6,267,241	$	471,966	$	6,182,550	$	67,728


December 31, 2012
With no related allowance recorded:
Construction and development	$	86,567	$	86,567	$	—	$	87,668	$	4,898
1-4 family residential		284,884		284,884		—		287,802		19,798
Nonfarm, nonresidential		1,381,111		1,381,111		—		1,396,123		81,741
Commercial and industrial		1,372,796		1,547,284		—		1,312,662		67,194
Consumer		—		—		—		—		—
Other loans		195,989		195,989		—		199,895		18,025

		3,321,347		3,495,835		—		3,284,150		191,656


With an allowance recorded:
Construction and development	$	—	$	—	$	—	$	—	$	—
1-4 family residential		—		—		—		—		—
Nonfarm, nonresidential		1,804,769		1,826,600		319,699		1,813,156		70,705
Commercial and industrial		1,000,379		1,000,379		195,410		1,006,640		39,320
Consumer		—		—		—		—		—
Other loans		—		—		—		—		—

		2,805,148		2,826,979		515,109		2,819,796		110,025


Combined:
Construction and development	$	86,567	$	86,567	$	—	$	87,668	$	4,898
1-4 family residential		284,884		284,884		—		287,802		19,798
Nonfarm, nonresidential		3,185,880		3,207,711		319,699		3,209,279		152,446
Commercial and industrial		2,373,175		2,547,663		195,410		2,319,302		106,514
Consumer		—		—		—		—		—
Other loans		195,989		195,989		—		199,895		18,025

	$	6,126,495	$	6,322,814	$	515,109	$	6,103,946	$	301,681

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
June 30, 2013

Construction and development	$	32,810		$	—		$	—		$	32,810		$	5,491,388		$	5,524,198		$	—
1-4 family residential		383,899			24,158			51,203			459,260			38,162,525			38,621,785			19,427
Nonfarm, nonresidential		214,957			451,298			633,990			1,300,245			61,440,000			62,740,245			212,995
Commercial and industrial		758,204			1,171			827,659			1,587,034			64,810,774			66,397,808			412,588
Consumer		72,514			44,129			—			116,643			5,969,682			6,086,325			—
Other loans		—			—			—			—			4,237,240			4,237,240			—

Total	$	1,462,384		$	520,756		$	1,512,852		$	3,495,992		$	180,111,609		$	183,607,601		$	645,010

Percentage of total loans		0.80	%		0.28	%		0.82	%		1.90	%		98.10	%		100.00	%


Non-accruals included above
Construction and development	$	—		$	—		$	—		$	—		$	71,973		$	71,973
1-4 family residential		99,438			—			31,775			131,213			187,008			318,221
Nonfarm, nonresidential		—			—			420,994			420,994			1,702,701			2,123,695
Commercial and industrial		80,796			1,171			415,071			497,038			540,552			1,037,590
Consumer		1,181			—			—			1,181			1,936			3,117
Other loans		—			—			—			—			—			—

	$	181,415		$	1,171		$	867,840		$	1,050,426		$	2,504,170		$	3,554,596


December 31, 2012

Construction and development	$	73,572		$	—		$	—		$	73,572		$	4,799,940		$	4,873,512		$	—
1-4 family residential		380,731			—			324,357			705,088			35,385,963			36,091,051			292,583
Nonfarm, nonresidential		711,408			197,479			386,160			1,295,047			47,698,820			48,993,867			—
Commercial and industrial		256,672			53,391			429,226			739,289			75,174,783			75,914,072			377,494
Consumer		172,379			28,922			13,643			214,944			6,488,419			6,703,363			13,643
Other loans		—			—			—			—			4,111,464			4,111,464			—

Total	$	1,594,762		$	279,792		$	1,153,386		$	3,027,940		$	173,659,389		$	176,687,329		$	683,720

Percentage of total loans		0.90	%		0.16	%		0.65	%		1.71	%		98.29	%		100.00	%


Non-accruals included above
Construction and development	$	73,572		$	—		$	—		$	73,572		$	12,995		$	86,567
1-4 family residential		84,838			—			31,775			116,613			359,129			475,742
Nonfarm, nonresidential		—			89,322			386,160			475,482			1,690,633			2,166,115
Commercial and industrial		—			—			51,731			51,731			760,662			812,393
Consumer		1,612			—			—			1,612			2,306			3,918
Other loans		—			—			—			—			195,990			195,990

	$	160,022		$	89,322		$	469,666		$	719,010		$	3,021,715		$	3,740,725

Credit Quality Indicators:

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

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6.

ALLOWANCE FOR LOAN LOSSES, CONTINUED

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

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

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

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

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


	Total			Pass Credits			Special Mention			Substandard			Doubtful

June 30, 2013

Construction and development	$	5,524,198		$	5,452,226		$	71,972		$	—		$	—
1-4 family residential		38,621,785			38,224,692			378,248			18,845			—
Nonfarm, nonresidential		62,740,245			61,248,788			1,181,274			310,183			—
Commercial and industrial		66,397,808			65,285,199			936,051			176,558			—
Consumer		6,086,325			6,083,165			3,160			—			—
Other loans		4,237,240			4,237,240			—			—			—

	$	183,607,601		$	180,531,310		$	2,570,705		$	505,586		$	—


		100.0	%		98.3	%		1.4	%		0.3	%		—	%


Guaranteed portion of loans

Construction and development	$	16,268			16,268		$	—		$	—		$	—
1-4 family residential		743,156			696,936			46,220			—			—
Nonfarm, nonresidential		27,502,038			27,253,825			155,718			92,495			—
Commercial and industrial		17,293,583			16,526,969			634,488			132,126			—
Consumer		—			—			—			—			—
Other loans		502,104			502,104			—			—			—

	$	46,057,149		$	44,996,102		$	836,426		$	224,621		$	—


	Total			Pass Credits			Special Mention			Substandard			Doubtful

December 31, 2012

Construction and development	$	4,873,512		$	4,786,945		$	86,567		$	—		$	—
1-4 family residential		36,091,051			35,755,061			335,990			—			—
Nonfarm, nonresidential		48,993,867			47,500,758			1,230,275			262,834			—
Commercial and industrial		75,914,072			74,878,901			1,035,171			—			—
Consumer		6,703,363			6,696,475			6,888			—			—
Other loans		4,111,464			3,915,474			195,990			—			—

	$	176,687,329		$	173,533,614		$	2,890,881		$	262,834		$	—


		100.0	%		98.2	%		1.6	%		0.2	%		—	%

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	$	—	$	—	$	—	$	—	$	—
1-4 family residential		752,677		752,677		—		—		—
Nonfarm, nonresidential		19,855,775		19,654,773		201,002		—		—
Commercial and industrial		22,001,515		21,354,422		647,093		—		—
Consumer		—		—		—		—		—
Other loans		508,363		508,363		—		—		—

	$	43,118,330	$	42,270,235	$	848,095	$	—	$	—

NOTE 7.

TROUBLED DEBT RESTRUCTURINGS

For the quarters and six months ended June 30, 2013 and 2012, the following table presents loans modified during the period that were considered to be troubled debt restructurings.


	For the three months ended June 30, 2013						For the six months ended June 30, 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		1		54,376		54,376		1		54,376		54,376
Nonfarm, nonresidential		1		145,219		145,219		1		145,219		145,219
Commercial and industrial		—		—		—		—		—		—


	For the three months ended June 30, 2012						For the six months ended June 30, 2012
	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	$	237,883	$	237,883
1-4 Family residential		—		—		—		1		113,743		116,438
Nonfarm, nonresidential		—		—		—		1		96,028		96,028
Commercial and industrial		1		76,358		76,358		2		343,060		343,060

During the six months ended June 30, 2013, 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 June 30, 2013, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. 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)*
	Total		Level 1		Level 2		Level 3
June 30, 2013
Government-sponsored enterprises	$	2,990	$	—	$	2,990	$	—
Mortgage-backed securities		39		—		39		—
Corporate bonds		448		—		—		448
Equities and mutual funds		531		531		—		—
Servicing assets		264		—		—		264

Total assets at fair value	$	4,272	$	531	$	3,029	$	712


Total liabilities at fair value	$	—	$	—	$	—	$	—


*(in thousands)*
	Total		Level 1		Level 2		Level 3
December 31, 2012
Government-sponsored enterprises	$	2,505	$	—	$	2,505	$	—
Mortgage-backed securities		43		—		43		—
Corporate bonds		443		—		—		443
Equities and mutual funds		512		512		—		—
Servicing assets		63		—		—		63

Total assets at fair value	$	3,566	$	512	$	2,548	$	506


Total liabilities at fair value	$	—	$	—	$	—	$	—

For the six months ended June 30, 2013 and 2012, the changes in Level 3 assets and liabilities measured at fair value on a recurring basis were as follows:


	Level 3
	2013		2012
*(in thousands)*	Fair Value		Fair Value
Corporate Bonds – Available for Sale
*Balance, January 1*	$	443	$	451
Total unrealized gain (loss) included in income		—		—
Total unrealized gain (loss) included in other comprehensive income		5		(3	)

*Balance, June 30*	$	448	$	448

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8.

FAIR VALUE, CONTINUED


	Level 3
	2013		2012
*(in thousands)*	Fair Value		Fair Value
Servicing Assets
*Balance, January 1*	$	63	$	93
Capitalized		201		—
Amortization included in other income		—		(3	)

*Balance, June 30*	$	264	$	90

*Total Level 3 Assets June 30*	$	712	$	538

Changes in Level 3 corporate bond assets measured at fair value on a recurring basis for the three month period ended June 30, 2013 was ($2,750) which was included in other comprehensive income. There was no change in corporate bond assets for the three month period ended June 30, 2012. Changes in servicing assets measured at fair value on a recurring basis for the three month period ended June 30, 2013 was $200,769.

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)*
	Total		Level 1		Level 2		Level 3
June 30, 2013
Loans-commercial and industrial	$	955	$	—	$	—	$	955
Loans-nonfarm, non-residential		1,771		—		—		1,771
Foreclosed assets		79		—		—		79

Total assets at fair value	$	2,805	$	—	$	—	$	2,805

Total liabilities at fair value	$	—	$	—	$	—	$	—


*(in thousands)*
	Total		Level 1		Level 2		Level 3
December 31, 2012
Loans-commercial and industrial	$	805	$	—	$	—	$	805
Loans-nonfarm, non-residential		1,485		—		—		1,485
Foreclosed assets		491		—		—		491

Total assets at fair value	$	2,781	$	—	$	—	$	2,781

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 June 30, 2013 and December 31, 2012. This table excludes financial instruments for which the carrying amount approximates fair value.


					Fair Value Measurements
*(dollars in thousands)*	Carrying Amount		Fair Value		Quoted Prices in Active Markets for Identical Assets or Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

June 30, 2013
Financial Instruments – Assets
Loans	$	180,450	$	181,593	$	—	$	—	$	181,593

Financial Instruments – Liabilities
Deposits		190,148		174,044		—		174,044		—
Long-Term Debt		7,750		8,155		—		8,155		—

December 31, 2012
Financial Instruments – Assets
Loans	$	173,578	$	173,813	$	—	$	—	$	173,813

Financial Instruments – Liabilities
Deposits		187,823		180,777		—		180,777		—
Long-Term Debt		7,750		8,291		—		8,291		—

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 and six months ended June 30, 2013 and 2012. 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 June 30, 2013, was $755,113 or $0.19 per diluted share outstanding, compared to a $321,976 or $0.09 per diluted share outstanding, for the same period in 2012. Earnings for the three months ended June 30, 2013, are approximately 117.9% higher than for the same period in 2012. The increase results from a reduction in the provision for loan losses and an increase in noninterest income. The provision for loan losses decreased from $671,770 in the second quarter of 2012 to a provision of $93,402 in 2013. This decrease is due to a reduction in net loan charge offs from $771,374 in the second quarter of 2012 to $4,064 in the second quarter of 2013. At June 30, 2013, the percentage of loans receiving pass credit risk grades was 98.3%, compared to 98.2% at December 31, 2012 and 97.9% at June 30, 2012. Credit quality was further enhanced by an increase in loans carrying government guarantees. At June 30, 2013, the guaranteed portion of loans equaled 25.1% of total loans compared to 24.4% December 31, 2012 and 22.5% at June 30, 2012. Noninterest income increased due to a gain on the sale of a government guaranteed loan. The gain of $229,130 increased noninterest income from $572,251 in the second quarter 2012 to $796,643 in 2013. Net interest income decreased from $2,294,168 in the second quarter of 2012 to $2,251,138 in 2013. Asset yields decreased from 5.27% to 4.83% from 2012 to 2013 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 6.01% in the second quarter of 2012 to 5.71% in the second quarter of 2013. Loan yields fell due to the prolonged low rate environment and competition. A reduction in the cost of deposits from the second quarter of 2012 to 2013 was unable to offset the tightening asset yields. The cost of funds decreased from 0.89% in the second quarter of 2012 to 0.80% in the second quarter of 2013. Noninterest expenses increased slightly from $1,623,208 in the second quarter of 2012, to $1,678,757 in 2013. Salaries and employee benefits accounted for most of the change increasing from $861,138 in 2012 to $910,375 in 2013. This increase was primarily due to normal salary adjustments.

ITEM 2.

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

On June 30, 2013, Surrey Bancorp’s assets totaled $234,574,115 compared to $229,912,432 on December 31, 2012. Net loans were $180,450,435 compared to $173,577,565 on December 31, 2012. This net increase was the result of a $6,901,145 increase in gross loans and a $28,275 net increase in the loan loss reserve. Commercial loans decreased 12.5% during the six month period ended June 30, 2013; however nonfarm nonresidential real estate loans increased over 28.1% resulting in an overall increase in gross loans to 3.9%.

Net income available for common stockholders for the six months ended June 30, 2013, was $1,361,662 or $0.35 per diluted share outstanding compared to $940,428 or $0.25 per diluted share outstanding for the same period in 2012. This represents a 44.8% increase in earnings for the first six months of 2013 compared to the same period in 2012. The increase results from a reduction in the provision for loan losses and an increase in noninterest income. The provision for loan losses decreased from $738,988 in the first six months of 2012 to $135,796 for the same period in 2013. This decrease is due to a reduction in net loan charge offs from $817,365 during the first six month period of 2012 to $107,521 in 2013. Noninterest income increased due to a gain on the sale of a government guaranteed loan. The gain of $229,130 increased noninterest income from $1,232,088 during the six months ended June 30, 2012 to $1,455,019 during the same period in 2013. Net interest income decreased from $4,614,768 in the first six months of 2012 to $4,510,923 in 2013. This decrease is due to a decrease in average loans as a percentage of total earning assets for the six month period ended June 30, 2013 versus the same period in 2012. Overall assets yields have also decreased as a result of lower yields on loans. Loan yields also decreased from 6.11% in the first six months of 2012 to 5.80% in 2013. Noninterest expenses increased 1.3% from $3,476,852 in the six months ended June 30, 2012, to $3,520,583 for the same period in 2013. Most of the increase is associated with salaries and employee benefits which increased from $1,788,521 in first six months of 2012 to $1,871,496 in 2013.

Total deposits on June 30, 2013, were $190,147,848 compared to $187,823,037 at the end of 2012. This increase is attributable to a sizable increase in noninterest-bearing demand deposits accounts, which increased from $36,979,419 at December 31, 2012 to $44,029,296 at June 30, 2013. The bank’s large commercial business accounts are primarily responsible for the increase in noninterest-bearing accounts. Overall, noninterest-bearing and interest-bearing demand deposits increased 7.0% from 2012 totals, while savings deposits, including money market accounts, increased 0.5%. Certificates of deposit decreased 2.9% from December 31, 2012 totals.

Common stockholders’ equity increased by $1,362,063, or 4.80%, during the six months ended June 30, 2013. The increase is comprised of net income of $1,452,619 and adjustments to Accumulated Other Comprehensive Income of $401. Decreases included the payment and accrual of preferred dividends of $90,957. The net increase resulted in a common stock book value of $8.39 per share, up from $8.01 on December 31, 2012.

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 June 30, 2013.

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.

ITEM 2.

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

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 $4,008,175 consisted of U.S. Governmental Agency obligations with maturities ranging from 8 to 31 months, corporate bonds with maturities of 5.00 years to 5.25 years, that reprice quarterly, GNMA adjustable rate mortgage securities, which adjust annually, equity securities and mutual funds.

Loans

Net loans outstanding on June 30, 2013, were $180,450,435 compared to $173,577,565 on December 31, 2012. The Bank maintains a loan portfolio dominated by real estate and commercial loans diversified among various industries. Approximately 61.9% of the Bank’s loans as of June 30, 2013, are fixed rate loans with 38.1% floating with the Bank’s prime rate or other appropriate internal or external indices.

Deposits

Deposits on June 30, 2013, were $190,147,848, compared to $187,823,037 on December 31, 2012. The June total consists of a base of approximately 12,395 accounts compared to 12,352 accounts at December 31, 2012. Interest-bearing accounts represent 76.8% of June 30, 2013 period end deposits versus 80.3% at December 31, 2012.

Federal Funds Purchased

The Company had no federal funds purchased at June 30, 2013 or December 31, 2012. Federal funds purchased were not utilized due to the adequate liquidity resulting from the increase in deposits.

ITEM 2.

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

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.


	Ratio			Minimum Required For Capital Adequacy Purposes

*June 30, 2013:*
Total Capital
(to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		20.97	%		8.0	%
Surrey Bank & Trust		20.60	%		8.0	%
Tier I Capital
(to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		19.70	%		4.0	%
Surrey Bank & Trust		19.34	%		4.0	%
Tier I Capital
(to Average Assets)
Surrey Bancorp (Consolidated)		13.78	%		4.0	%
Surrey Bank & Trust		13.45	%		4.0	%

*December 31, 2012:*
Total Capital
(to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		20.77	%		8.0	%
Surrey Bank & Trust		20.49	%		8.0	%
Tier I Capital
(to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		19.51	%		4.0	%
Surrey Bank & Trust		19.23	%		4.0	%
Tier I Capital
(to Average Assets)
Surrey Bancorp (Consolidated)		13.49	%		4.0	%
Surrey Bank & Trust		13.28	%		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.


	June 30, 2013			December 31, 2012

Nonaccrual loans	$	3,544,596		$	3,740,725
Loans past due 90 days and still accruing		645,010			683,720
Foreclosed assets		79,261			491,424

Total	$	4,268,867		$	4,915,869

Total assets	$	234,574,115		$	229,912,432


Ratio of nonperforming assets to total assets		1.82	%		2.14	%

At June 30, 2013, the Bank had loans totaling $3,544,596 in nonaccrual status. Approximately $2,504,169 of the nonaccrual loans were current at the end of June. 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 these loans is $479,065. The guaranteed portion of nonaccrual loans at June 30, 2013 is $1,398,097. Foreclosed assets at June 30, 2013 primarily include 1-4 family dwellings. Loans that were considered impaired but were still accruing interest at June 30, 2013, including troubled debt restructurings, totaled $2,673,150. 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 $471,966 at June 30, 2013, or 7.6% of the balances outstanding.

Nonaccrual and impaired loans still accruing are summarized below:


	June 30, 2013		December 31, 2012

Construction and development	$	86,589	$	86,567
1-4 family residential		318,258		475,742
Multi-family		—		—
Nonfarm, nonresidential		3,345,220		3,185,880
Commercial and industrial		2,464,599		2,373,175
Consumer		3,080		3,918
Other loans		—		195,990

Total impaired and nonaccrual	$	6,217,746	$	6,321,272

Guaranteed portion	$	2,527,643	$	2,381,400

At June 30, 2013, consumer loans totaling $50,620 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 June 30, 2013 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:


	June 30, 2013				December 31, 2012
Construction and development	$	5,524,198	3.01	%	$	4,873,512	2.76	%
1-4 family residential		38,621,785	21.03	%		36,091,051	20.43	%
Multi-family		1,603,611	0.87	%		1,676,449	0.95	%
Farmland		2,483,567	1.35	%		2,284,155	1.29	%
Nonfarm, nonresidential		62,740,245	34.18	%		48,993,867	27.73	%

Total real estate		110,973,406	60.44	%		93,919,034	53.16	%

Agricultural		147,811	0.08	%		147,860	0.08	%
Commercial and industrial		66,397,808	36.17	%		75,914,072	42.97	%
Consumer		6,086,325	3.31	%		6,703,363	3.79	%
Other		2,251	—	%		3,000	—	%

Total loans	$	183,607,601	100.00	%	$	176,687,329	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 $59,601,519 in loans that carry government guarantees. The guaranteed portion of these loans amounts to $46,057,149 at June 30, 2013. Loan guarantees by loan class are below:


	June 30,		Guaranteed Portion
	2013		Amount		Percentage
Construction and development	$	5,524,198	$	16,268		0.29	%
1-4 family residential		38,621,785		743,156		1.92	%
Multi-family		1,603,611		13,827		0.86	%
Farmland		2,483,567		403,276		16.24	%
Nonfarm, nonresidential		62,740,245		27,502,039		43.83	%

Total real estate		110,973,406		28,678,566		25.84	%

Agricultural		147,811		85,000		—	%
Commercial and industrial		66,397,808		17,293,583		26.05	%
Consumer		6,086,325		—		—	%
Other		2,251		—		—	%

Total loans	$	183,607,601	$	46,057,149		25.08	%

Loans in higher risk categories, such as non-owner occupied nonfarm, non-residential property and commercial real estate construction represent a small segment of our loan portfolio. Commercial construction loans included in construction and development loans amounted to $1,913,395 at June 30, 2013. Non-owner occupied nonfarm, non-residential properties included in nonfarm, non-residential loans above amounted to $8,400,985 at June 30, 2013.

The consolidated provision for loan losses was $135,796 for the first six months of 2013 compared to $738,988 for the same period in 2012. Significant charge off of nonperforming loans in 2012, in comparison to 2013, resulted in the provision decrease.

The reserve for loan losses on June 30, 2013, was $3,431,373 or 1.86% of period end loans. This percentage is derived from total loans. Approximately $59,260,000 of total loans outstanding at June 30, 2013, 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 2.49% of outstanding loans. At December 31, 2012 the loan loss reserve percentage was 1.92% of total loans and 2.54% 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 six 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 June 30, 2013 and December 31, 2012.


	June 30, 2013						December 31, 2012
	30-89 Days			90 Days Plus			30-89 Days			90 Days Plus

Construction and development	$	32,810		$	—		$	73,572		$	—
1-4 family residential		408,057			51,203			380,731			324,357
Nonfarm, non-residential		666,255			633,990			908,887			386,160
Commercial and industrial		759,375			827,659			310,063			429,226
Consumer		116,643			—			201,301			13,643
Other loans		—			—			—			—

	$	1,983,140		$	1,512,852		$	1,874,554		$	1,153,386

Non-accrual loans included above	$	182,586		$	867,841		$	249,344		$	469,666

Guaranteed portion	$	255,612		$	479,066		$	467,962		$	339,744


Ratio to total loans		1.08	%		0.82	%		1.06	%		0.65	%

Ratio to total loans, net of guarantees		1.25	%		0.75	%		1.05	%		0.61	%

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, 2012 to June 30, 2013. The majority of the increase is in the over 90 day time frame.

Net of loan guarantees, total past dues have increased from $2,220,234 at December 31, 2012, to $2,791,314 at June 30, 2013, or 25.7%. Total past due loans at June 30, 2013 consist of forty-six loans with an average balance of $76,000, compared to seventy-six loans at December 31, 2012, with an average balance of $39,841. Loans over $250,000 delinquent at June 30, 2013 and December 31, 2012 amounted to $1,252,611 and $1,219,565, respectively. The June 2013 total consisted of three loans. One, amounting to $606,176 was only thirty days past due. The December 2012 total included four loans.

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 June 30, 2013, the liquidity position of the Company was excellent, in management’s opinion, with short-term liquid assets of $39,802,744 compared to $42,552,800 at December 31, 2012. Gross loan growth in excess of deposit increases account for the decrease in liquidity. To provide supplemental liquidity, the Bank has six unsecured lines of credit with correspondent banks totaling $27,500,000. At June 30, 2013, 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 $9,901,000 of which $7,750,000 of advances had been taken down at June 30, 2013.

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


31.1		Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes Oxley Act

31.2		Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes Oxley Act

32.1		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: August 9, 2013		/s/ Edward C. Ashby, III

		Edward C. Ashby, III
		President and Chief Executive Officer
		(Principal Executive Officer)

Date: August 9, 2013		/s/ Mark H. Towe

		Mark H. Towe
		Sr. Vice President and Chief Financial Officer
		(Principal Financial Officer)

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company