Form 10-Q
Table of Contents

 

 

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, 2011

 

¨ 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):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨    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  ¨    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, 2011 there were 3,215,764 common shares issued and outstanding.

 

 

 


Table of Contents

PART I – FINANCIAL INFORMATION

 

Item 1.

  

Consolidated Financial Statements

  
  

Consolidated Balance Sheets June 30, 2011 (Unaudited)
and December 31, 2010

     3   
  

Consolidated Statements of Income, Six Months Ended
June 30, 2011 and 2010 (Unaudited)

     4   
  

Consolidated Statements of Income, Three Months Ended
June 30, 2011 and 2010 (Unaudited)

     5   
  

Consolidated Statements of Cash Flows, Six Months Ended
June 30, 2011 and 2010 (Unaudited)

     6   
  

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income
Six Months Ended June 30, 2011 and 2010 (Unaudited)

     7   
  

Notes to Consolidated Financial Statements

     8-22   

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     23-30   

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

     31   

Item 4.

  

Controls and Procedures

     32   
PART II – OTHER INFORMATION   

Item 1.

  

Legal Proceedings

     33   

Item 1A.

  

Risk Factors

     33   

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

     33   

Item 3.

  

Defaults Upon Senior Securities

     33   

Item 4.

  

(Removed and Reserved)

     33   

Item 5.

  

Other Information

     33   

Item 6.

  

Exhibits

     33   
SIGNATURES      34   
CERTIFICATIONS      35-37   


Table of Contents

 

Consolidated Balance Sheets

June 30, 2011 (Unaudited) and December 31, 2010 (Audited)

 

 

     June
2011
    December
2010
 

Assets

    

Cash and due from banks

   $ 2,641,584      $ 2,398,433   

Interest-bearing deposits with banks

     37,255,803        22,792,088   

Federal funds sold

     705,453        702,121   

Investment securities available for sale

     2,516,590        2,012,132   

Restricted equity securities

     892,304        941,379   

Loans, net of allowance for loan losses of $4,468,475 at June 30, 2011 and $6,683,922 at December 31, 2010

     172,005,516        171,794,247   

Property and equipment, net

     4,694,516        4,726,483   

Foreclosed assets

     186,730        450,532   

Accrued income

     925,856        955,516   

Goodwill

     120,000        120,000   

Bank owned life insurance

     3,337,525        3,284,990   

Other assets

     3,062,606        3,474,563   
  

 

 

   

 

 

 

Total assets

   $ 228,344,483      $ 213,652,484   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    
Liabilities     

Deposits:

    

Noninterest-bearing

   $ 33,666,556      $ 27,954,669   

Interest-bearing

     153,884,442        146,005,404   
  

 

 

   

 

 

 

Total deposits

     187,550,998        173,960,073   

Long-term debt

     9,100,000        9,450,000   

Dividends payable

     45,729        35,515   

Accrued interest payable

     247,017        227,887   

Other liabilities

     1,556,053        1,334,854   
  

 

 

   

 

 

 

Total liabilities

     198,499,797        185,008,329   
  

 

 

   

 

 

 

Commitments and contingencies

     —          —     
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; 3,213,230 and 3,206,495 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively

     9,487,704        9,464,178   

Retained earnings

     16,552,494        15,380,083   

Accumulated other comprehensive loss

     (64,319     (68,913
  

 

 

   

 

 

 

Total stockholders’ equity

     29,844,686        28,644,155   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 228,344,483      $ 213,652,484   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

3


Table of Contents

 

Consolidated Statements of Income

Six months ended June 30, 2011 and 2010 (Unaudited)

 

 

     2011     2010  

Interest income

    

Loans and fees on loans

   $ 5,376,596      $ 5,539,444   

Federal funds sold

     795        404   

Investment securities, taxable

     26,358        25,663   

Deposits with banks

     8,004        11,711   
  

 

 

   

 

 

 

Total interest income

     5,411,753        5,577,222   
  

 

 

   

 

 

 

Interest expense

    

Deposits

     933,423        1,042,286   

Short-term debt

     —          17,720   

Long-term debt

     182,900        203,463   
  

 

 

   

 

 

 

Total interest expense

     1,116,323        1,263,469   
  

 

 

   

 

 

 

Net interest income

     4,295,430        4,313,753   

Provision for loan losses

     (120,928     1,203,842   
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     4,416,358        3,109,911   
  

 

 

   

 

 

 

Noninterest income

    

Service charges on deposit accounts

     508,885        532,477   

Gain on sale of government guaranteed loans

     —          244,924   

Fees and yield spread premiums on loans delivered to correspondents

     53,618        49,737   

Other service charges and fees

     247,027        223,049   

Other operating income

     359,979        369,462   
  

 

 

   

 

 

 

Total noninterest income

     1,169,509        1,419,649   
  

 

 

   

 

 

 

Noninterest expense

    

Salaries and employee benefits

     1,761,997        1,723,400   

Occupancy expense

     197,180        197,230   

Equipment expense

     120,497        136,383   

Data processing

     185,588        196,774   

Foreclosed assets, net

     140,332        15,682   

Postage, printing and supplies

     102,754        118,508   

Professional fees

     190,460        152,578   

FDIC insurance premiums

     139,577        118,281   

Other expense

     694,440        635,019   
  

 

 

   

 

 

 

Total noninterest expense

     3,532,825        3,293,855   
  

 

 

   

 

 

 

Net income before income taxes

     2,053,042        1,235,705   

Income tax expense

     789,674        455,156   
  

 

 

   

 

 

 

Net income

     1,263,368        780,549   

Preferred stock dividends and accretion of discount

     (90,957     (128,813
  

 

 

   

 

 

 

Net income available to common stockholders

   $ 1,172,411      $ 651,736   
  

 

 

   

 

 

 

Basic earnings per common share

   $ 0.37      $ 0.20   
  

 

 

   

 

 

 

Diluted earnings per common share

   $ 0.33      $ 0.20   
  

 

 

   

 

 

 

Basic weighted average common shares outstanding

     3,210,498        3,206,263   
  

 

 

   

 

 

 

Diluted weighted average common shares outstanding

     3,786,800        3,604,913   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

4


Table of Contents

 

Consolidated Statements of Income

Three months ended June 30, 2011 and 2010 (Unaudited)

 

 

     2011     2010  

Interest income

    

Loans and fees on loans

   $ 2,652,444      $ 2,774,256   

Federal funds sold

     458        248   

Investment securities, taxable

     13,944        12,035   

Deposits with banks

     2,673        7,558   
  

 

 

   

 

 

 

Total interest income

     2,669,519        2,794,097   
  

 

 

   

 

 

 

Interest expense

    

Deposits

     459,353        516,011   

Short-term debt

     —          13,959   

Long-term debt

     91,364        104,387   
  

 

 

   

 

 

 

Total interest expense

     550,717        634,357   
  

 

 

   

 

 

 

Net interest income

     2,118,802        2,159,740   

Provision for loan losses

     (279,825     254,485   
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     2,398,627        1,905,255   
  

 

 

   

 

 

 

Noninterest income

    

Service charges on deposit accounts

     260,994        270,302   

Gain on sale of government guaranteed loans

     —          32,865   

Fees and yield spread premiums on loans delivered to correspondents

     26,442        23,054   

Other service charges and fees

     128,068        123,914   

Other operating income

     160,527        164,754   
  

 

 

   

 

 

 

Total noninterest income

     576,031        614,889   
  

 

 

   

 

 

 

Noninterest expense

    

Salaries and employee benefits

     883,412        852,390   

Occupancy expense

     101,720        87,921   

Equipment expense

     61,634        72,347   

Data processing

     98,757        100,215   

Foreclosed assets, net

     120,908        11,490   

Postage, printing and supplies

     60,251        68,497   

Professional fees

     67,253        68,683   

FDIC insurance premiums

     56,287        66,399   

Other expense

     352,231        309,173   
  

 

 

   

 

 

 

Total noninterest expense

     1,802,453        1,637,115   
  

 

 

   

 

 

 

Net income before income taxes

     1,172,205        883,029   

Income tax expense

     461,028        332,256   
  

 

 

   

 

 

 

Net income

     711,177        550,773   

Preferred stock dividends and accretion of discount

     (45,729     (65,753
  

 

 

   

 

 

 

Net income available to common stockholders

   $ 665,448      $ 485,020   
  

 

 

   

 

 

 

Basic earnings per common share

   $ 0.21      $ 0.15   
  

 

 

   

 

 

 

Diluted earnings per common share

   $ 0.19      $ 0.14   
  

 

 

   

 

 

 

Basic weighted average common shares outstanding

     3,212,247        3,206,495   
  

 

 

   

 

 

 

Diluted weighted average common shares outstanding

     3,788,549        3,605,146   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

5


Table of Contents

 

Consolidated Statements of Cash Flows

Six months ended June 30, 2011 and 2010 (Unaudited)

 

 

     2011     2010  

Cash flows from operating activities

    

Net income

   $ 1,263,368      $ 780,549   

Adjustments to reconcile net income to net cash provided by operations:

    

Depreciation and amortization

     120,055        127,763   

Gain on sale of property and equipment

     (670     (300

Loss on the sale of foreclosed assets

     50,254        9,411   

Stock-based compensation, net of tax benefit

     11,213        14,516   

Provision for loan losses

     (120,928     1,203,842   

Deferred income taxes

     (1,156     12,724   

Accretion of discount on securities, net of amortization of premiums

     870        1,944   

Increase in cash surrender value of life insurance

     (52,535     (55,308

Changes in assets and liabilities:

    

Accrued income

     29,660        (12,829

Other assets

     410,231        (868,538

Accrued interest payable

     19,130        (3,996

Other liabilities

     221,198        494,029   
  

 

 

   

 

 

 

Net cash provided by operating activities

     1,950,690        1,703,807   
  

 

 

   

 

 

 

Cash flows from investing activities

    

Net increase in interest-bearing deposits with banks

     (14,463,715     (6,105,763

Net increase in federal funds sold

     (3,332     (88,085

Purchases of investment securities

     (1,502,500     (1,500,000

Sales and maturities of investment securities

     1,004,648        1,505,051   

Redemption of restricted equity securities

     49,100        10   

Purchase of restricted equity securities

     (25     —     

Net (increase) decrease in loans

     (315,466     4,219,857   

Proceeds from the sale of foreclosed assets

     438,673        54,890   

Purchases of property and equipment

     (88,088     (32,727

Proceeds from the sale of property and equipment

     670        300   
  

 

 

   

 

 

 

Net cash (used in) investing activities

     (14,880,035     (1,946,467
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net increase in deposits

     13,590,925        3,598,122   

Net decrease in short-term debt

     —          (3,750,000

Net (decrease) increase in long-term debt

     (350,000     750,000   

Dividends paid

     (80,742     (113,984

Common stock options exercised

     12,313        34,450   
  

 

 

   

 

 

 

Net cash provided by financing activities

     13,172,496        518,588   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     243,151        275,928   

Cash and due from banks, beginning

     2,398,433        1,923,621   
  

 

 

   

 

 

 

Cash and due from banks, ending

   $ 2,641,584      $ 2,199,549   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information

    

Interest paid

   $ 1,097,193      $ 1,267,465   
  

 

 

   

 

 

 

Taxes paid

   $ 424,019      $ 819,457   
  

 

 

   

 

 

 

Loans transferred to foreclosed properties

   $ 225,125      $ 305,490   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

6


Table of Contents

 

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income

Six months ended June 30, 2011 and 2010 (Unaudited)

 

 

     Preferred
Stock
     Common Stock      Retained     Unrealized
Appreciation
(Depreciation) on
       
     Amount      Shares      Amount      Earnings     Securities     Total  

Balance, January 1, 2010

   $ 4,626,830         3,198,105       $ 9,406,429       $ 14,468,089      $ (75,996   $ 28,425,352   

Comprehensive income

               

Net income

     —           —           —           780,549        —          780,549   

Net change in unrealized gain (loss) on investment securities available for sale, net of income tax of $9,764

     —           —           —           —          15,564        15,564   
               

 

 

 

Total comprehensive income

                  796,113   

Common stock options exercised

     —           8,390         34,450         —          —          34,450   

Stock-based compensation, net of tax benefit

     —           —           14,516         —          —          14,516   

Dividends declared on convertible

               

Series A preferred stock ($.31 per share)

     —           —           —           (59,157     —          (59,157

Dividends declared and accrued on Series B and

               

Series C preferred stock, net of discount accretion and (premium) amortization

     15,762         —           —           (69,656     —          (53,894
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance, June 30, 2010

   $ 4,642,592         3,206,495       $ 9,455,395       $ 15,119,825      $ (60,432   $ 29,157,380   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance, January 1, 2011

   $ 3,868,807         3,206,495       $ 9,464,178       $ 15,380,083      $ (68,913   $ 28,644,155   

Comprehensive income

               

Net income

     —           —           —           1,263,368        —          1,263,368   

Net change in unrealized gain (loss) on investment securities available for sale, net of income tax of $2,882

     —           —           —           —          4,594        4,594   
               

 

 

 

Total comprehensive income

                  1,267,962   

Common stock options exercised, net of shares surrendered in cashless exchange

     —           6,735         12,313         —          —          12,313   

Stock-based compensation, net of tax benefit

     —           —           11,213         —          —          11,213   

Dividends declared on Series A convertible preferred stock ($.31 per share)

     —           —           —           (59,157     —          (59,157

Dividends declared on Series D convertible preferred stock ($.18 per share)

     —           —           —           (31,800     —          (31,800
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance, June 30, 2011

   $ 3,868,807         3,213,230       $ 9,487,704       $ 16,552,494      $ (64,319   $ 29,844,686   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

7


Table of Contents

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, 2011, the results of operations for the six and three months ended June 30, 2011 and 2010, and its changes in stockholders’ equity and comprehensive income and cash flows for the six months ended June 30, 2011 and 2010. The results of operations for the three and six months ended June 30, 2011, 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, 2010, included in the Company’s Form 10-K. The balance sheet at December 31, 2010, 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, 2010 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.

 

8


Table of Contents

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, 2011 and December 31, 2010, 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, 2011 and December 31, 2010.

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.

 

9


Table of Contents

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 2010, the Receivables topic of the Accounting Standards Codification (“ASC”) was amended by Accounting Standards Update (“ASU”) 2010-20 to require expanded disclosures related to a company’s allowance for credit losses and the credit quality of its financing receivables. The amendments require the allowance disclosures to be provided on a disaggregated basis. The Company is required to include these disclosures in their interim and annual financial statements. See Note 6.

Disclosures about Troubled Debt Restructurings (“TDRs”) required by ASU 2010-20 were deferred by the Financial Accounting Standards Board (“FASB”) in ASU 2011-01 issued in January 2011. In April 2011 FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a TDR. The determination is based on whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties as both events must be present.

 

10


Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1. BASIS OF PRESENTATION, CONTINUED

 

Recent Accounting Pronouncements, continued

Disclosures related to TDRs under ASU 2010-20 will be effective for reporting periods beginning after June 15, 2011.

In December 2010, the Intangibles topic of the ASC was amended to modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. Any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings upon adoption. Impairments occurring subsequent to adoption should be included in earnings. The amendment was effective for the Company beginning January 1, 2011 and had no effect on the financial statements.

In April 2011, the criteria used to determine effective control of transferred assets in the Transfers and Servicing topic of the ASC was amended by ASU 2011-03. The requirement for the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms and the collateral maintenance implementation guidance related to that criterion were removed from the assessment of effective control. The other criteria to assess effective control were not changed. The amendments are effective for the Company beginning January 1, 2012 but are not expected to have a material effect on the financial statements.

ASU 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements. The amendments will be effective for the Company beginning January 1, 2012 but are not expected to have a material effect on the financial statements.

The Comprehensive Income topic of the ASC was amended in June 2011. The amendment eliminates the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity. The amendment requires consecutive presentation of the statement of net income and other comprehensive income and requires an entity to present reclassification adjustments from other comprehensive income to net income on the face of the financial statements. The amendments will be applicable to the Company on January 1, 2012 and will be applied retrospectively.

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

Subsequent Events

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

 

11


Table of Contents

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, 2011 and December 31, 2010 follow:

 

     Amortized
Cost
     Unrealized
Gains
     Unrealized
Losses
     Fair
Value
 

June 30, 2011

           

Government-sponsored enterprises

   $ 2,001,656       $ 10,184       $ —         $ 2,011,840   

Mortgage-backed securities

     69,603         2,022         —           71,625   

Corporate bonds

     550,000         —           116,875         433,125   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,621,259       $ 12,206       $ 116,875       $ 2,516,590   
  

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2010

           

Government-sponsored enterprises

   $ 1,500,000       $ 1,770       $ —         $ 1,501,770   

Mortgage-backed securities

     74,278         1,584         —           75,862   

Corporate bonds

     550,000         —           115,500         434,500   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,124,278       $ 3,354       $ 115,500       $ 2,012,132   
  

 

 

    

 

 

    

 

 

    

 

 

 

At June 30, 2011 and December 31, 2010, 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, 2011, were as follows:

 

     Amortized
Cost
     Fair
Value
 

Due in one year or less

   $ —         $ —     

Due after one year through five years

     2,001,656         2,011,840   

Due after five years through ten years

     605,061         489,693   

Due after ten years

     14,542         15,057   
  

 

 

    

 

 

 
   $ 2,621,259       $ 2,516,590   
  

 

 

    

 

 

 

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, 2011 and December 31, 2010. These unrealized losses on investment securities are a result of volatility in interest rates and primarily relate to corporate bonds issued by other banks at June 30, 2011 and December 31, 2010.

 

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

June 30, 2011

                 

Corporate bonds

   $ —         $ —         $ 433,125       $ 116,875       $ 433,125       $ 116,875   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ —         $ 433,125       $ 116,875       $ 433,125       $ 116,875   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2010

                 

Corporate bonds

   $ —         $ —         $ 434,500       $ 115,500       $ 434,500       $ 115,500   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ —         $ 434,500       $ 115,500       $ 434,500       $ 115,500   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

12


Table of Contents

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 with unrealized losses for a period greater than 12 months. 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 no gross realized gains or losses from the sales of investment securities for the six and three month periods ended June 30, 2011 and 2010.

 

NOTE 3. EARNINGS PER SHARE

Basic earnings per share for the six and three months ended June 30, 2011 and 2010 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 2.0868 shares of common stock. Each share of Series D preferred is convertible into one share of common stock.

 

NOTE 4. COMMITMENTS AND LETTERS OF CREDIT

At June 30, 2011, the Company had commitments to extend credit, including unused lines of credit of approximately $37,364,000. Letters of credit totaling $1,341,974 were outstanding.

 

NOTE 5. LOANS

The major components of loans in the balance sheets at June 30, 2011 and December 31, 2010 are below.

 

     2011     2010  

Commercial

   $ 67,791,434      $ 66,377,076   

Real estate:

    

Construction and land development

     5,544,068        5,986,045   

Residential, 1-4 families

     42,991,762        46,356,711   

Residential, 5 or more families

     2,257,358        1,853,346   

Farmland

     2,735,521        2,854,481   

Nonfarm, nonresidential

     48,365,786        48,170,698   

Agricultural

     50,088        73,852   

Consumer, net of discounts of $16,063 in 2011 and $14,770 in 2010

     6,697,606        6,759,770   
  

 

 

   

 

 

 
     176,433,623        178,431,979   

Deferred loan origination costs, net of fees

     40,368        46,190   
  

 

 

   

 

 

 
     176,473,991        178,478,169   

Allowance for loan losses

     (4,468,475     (6,683,922
  

 

 

   

 

 

 
   $ 172,005,516      $ 171,794,247   
  

 

 

   

 

 

 

 

13


Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 5. LOANS, CONTINUED

 

Residential, 1-4 family loans pledged as collateral against FHLB advances approximated $24,288,000 and $25,141,000 at June 30, 2011 and December 31, 2010.

NOTE 6.  ALLOWANCE FOR LOAN LOSSES

The allocation of the allowance for loan losses by loan components at June 30, 2011 and 2010 was as follows:

 

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

2011

              

Allowance for credit losses:

              

Beginning balance

   $ 118,797      $ 1,696,068      $ 1,199,292      $ 3,411,403      $ 205,662      $ 52,700      $ 6,683,922   

Charge-offs

     (27,468     (1,105,516     (203,418     (959,152     (27,387     —          (2,322,941

Recoveries

     996        54,285        83,772        71,500        17,869        —          228,422   

Provision

     6,720        77,596        (204,924     (537     (3,383     3,600        (120,928
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 99,045      $ 722,433      $ 874,722      $ 2,523,214      $ 192,761      $ 56,300      $ 4,468,475   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ 645      $ 42,233      $ 301,922      $ 1,468,614      $ —        $ —        $ 1,813,414   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 98,400      $ 680,200      $ 572,800      $ 1,054,600      $ 192,761      $ 56,300      $ 2,655,061   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: loans acquired with deteriorated credit quality

   $ —        $ —        $ —        $ —        $ —        $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans Receivable:

              

Ending balance

   $ 5,544,068      $ 42,991,762      $ 48,365,786      $ 67,791,434      $ 6,697,606      $ 5,042,967      $ 176,433,623   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ 95,121      $ 1,052,398      $ 4,094,870      $ 6,998,129      $ 16,896      $ —        $ 12,257,414   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 5,448,947      $ 41,939,364      $ 44,270,916      $ 60,793,305      $ 6,680,710      $ 5,042,967      $ 164,176,209   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: loans acquired with deteriorated credit quality

   $ —        $ —        $ —        $ —        $ —        $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

2010

              

Allowance for credit losses:

              

Beginning balance

   $ 106,397      $ 628,963      $ 696,044      $ 2,903,267      $ 281,134      $ 54,100      $ 4,669,905   

Charge-offs

     —          (26,728     (109,948     (82,830     (48,427     —          (267,933

Recoveries

     —          —          20,501        —          16,672        —          37,173   

Provision

     (23,497     17,173        54,634        1,153,274        5,358        (3,100     1,203,842   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 82,900      $ 619,408      $ 661,231      $ 3,973,711      $ 254,737      $ 51,000      $ 5,642,987   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ —        $ 54,908      $ 87,331      $ 3,068,511      $ —        $ —        $ 3,210,750   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 82,900      $ 564,500      $ 573,900      $ 905,200      $ 254,737      $ 51,000      $ 2,432,237   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: loans acquired with deteriorated credit quality

   $ —        $ —        $ —        $ —        $ —        $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans Receivable:

              

Ending balance

   $ 6,897,511      $ 46,751,717      $ 46,438,718      $ 68,522,853      $ 7,038,277      $ 4,636,669      $ 180,285,745   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ 18,144      $ 652,749      $ 499,457      $ 6,543,616      $ 17,224      $ 5,813      $ 7,737,003   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 6,879,367      $ 46,098,968      $ 45,939,261      $ 61,979,237      $ 7,021,053      $ 4,630,856      $ 172,548,742   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: loans acquired with deteriorated credit quality

   $ —        $ —        $ —        $ —        $ —        $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

14


Table of Contents

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, 2011 and December 31, 2010:

 

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

June 30, 2011

              

With no related allowance recorded:

              

Construction and development

   $ 78,500       $ 78,500       $ —         $ 79,635       $ —     

1-4 family residential

     865,148         922,961         —           933,245         15,566   

Nonfarm, nonresidential

     2,437,161         2,599,892         —           2,619,716         49,880   

Commercial and industrial

     2,645,793         2,645,794         —           2,722,209         70,210   

Consumer

     16,896         16,896         —           18,437         301   

Other loans

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     6,043,498         6,264,043         —           6,373,242         135,957   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

              

Construction and development

   $ 16,622       $ 16,622       $ 645       $ 17,194       $ —     

1-4 family residential

     187,249         215,624         42,233         198,000         372   

Nonfarm, nonresidential

     1,657,709         1,657,709         301,992         1,691,991         8,004   

Commercial and industrial

     4,352,336         4,478,247         1,468,614         4,723,398         76,791   

Consumer

     —           —           —           —           —     

Other loans

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     6,213,916         6,368,202         1,813,414         6,630,583         85,167   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Combined:

              

Construction and development

   $ 95,122       $ 95,122       $ 645       $ 96,829       $ —     

1-4 family residential

     1,052,397         1,138,585         42,233         1,131,245         15,938   

Nonfarm, nonresidential

     4,094,870         4,257,601         301,922         4,311,707         57,884   

Commercial and industrial

     6,998,129         7,124,041         1,468,614         7,445,607         147,001   

Consumer

     16,896         16,896         —           18,437         301   

Other loans

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 12,257,414       $ 12,632,245       $ 1,813,414       $ 13,003,825       $ 221,124   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2010

              

With no related allowance recorded:

              

Construction and development

   $ 97,436       $ 97,436       $ —         $ 173,163       $ 5,758   

1-4 family residential

     931,920         931,920         —           938,365         55,516   

Nonfarm, nonresidential

     2,098,860         2,098,860         —           2,136,591         110,297   

Commercial and industrial

     2,246,985         2,246,985         —           2,289,276         123,804   

Consumer

     10,439         10,439         —           10,439         —     

Other loans

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     5,385,640         5,385,640         —           5,547,834         295,375   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

              

Construction and development

   $ 39,267       $ 39,267       $ 12,097       $ 38,893       $ 1,357   

1-4 family residential

     1,240,144         1,240,144         1,118,468         1,243,083         39,709   

Nonfarm, nonresidential

     2,169,536         2,169,536         604,692         2,216,160         126,030   

Commercial and industrial

     5,803,125         5,803,125         2,334,003         6,076,005         276,677   

Consumer

     —           —           —           —           —     

Other loans

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     9,252,072         9,252,072         4,069,260         9,574,141         443,773   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Combined:

              

Construction and development

   $ 136,703       $ 136,703       $ 12,097       $ 212,056       $ 7,115   

1-4 family residential

     2,172,064         2,172,064         1,118,468         2,181,448         95,225   

Nonfarm, nonresidential

     4,268,396         4,268,396         604,692         4,352,751         236,327   

Commercial and industrial

     8,050,110         8,050,110         2,334,003         8,365,281         400,481   

Consumer

     10,439         10,439         —           10,439         —     

Other loans

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 14,637,712       $ 14,637,712       $ 4,069,260       $ 15,121,975       $ 739,148   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

15


Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6. ALLOWANCE FOR LOAN LOSSES, CONTINUED

 

Nonperforming loans and impaired loans are defined differently. As such, some loans may be included in both categories, whereas other loans may only be included in one category. The following presents by class, an aging analysis of the recorded investment in loans.

 

                                        Recorded  
                                        Investment  
                                        > 90 Days  
     30-89 Days      90 Days Plus      Total                    and  
     Past Due      Past Due      Past Due      Current      Total      Accruing  

June 30, 2011

                 

Construction and development

   $ 180,544       $ —         $ 180,544       $ 5,363,524       $ 5,544,068       $ —     

1-4 family residential

     943,179         264,167         1,207,346         41,784,416         42,991,762         23,549   

Nonfarm, nonresidential

     552,023         —           552,023         47,813,763         48,365,786         —     

Commercial and industrial

     893,742         1,727,612         2,621,354         65,170,080         67,791,434         43,268   

Consumer

     53,130         8,463         61,593         6,636,013         6,697,606         2,742   

Other loans

     —           —           —           5,042,967         5,042,967         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,622,618       $ 2,000,242       $ 4,622,860       $ 171,810,763       $ 176,433,623       $ 69,559   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Non-accruals included above

   $ 494,212       $ 1,930,683       $ 2,424,895       $ 2,453,363       $ 4,878,258      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

December 31, 2010

                 

Construction and development

   $ 67,993       $ 39,267       $ 107,260       $ 5,878,785       $ 5,986,045       $ —     

1-4 family residential

     766,017         272,405         1,038,422         45,318,289         46,356,711         —     

Nonfarm, nonresidential

     229,393         220,321         449,714         47,720,984         48,170,698         —     

Commercial and industrial

     567,740         1,351,710         1,919,450         64,457,626         66,377,076         —     

Consumer

     143,832         —           143,832         6,615,938         6,759,770         —     

Other loans

     3,472         —           3,472         4,778,207         4,781,679         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 1,778,447       $ 1,883,703       $ 3,662,150       $ 174,769,829       $ 178,431,979       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Non-accruals included above

   $ 369,103       $ 1,883,703       $ 2,252,806       $ 4,109,322       $ 6,362,128      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

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.

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.

 

16


Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6. ALLOWANCE FOR LOAN LOSSES, CONTINUED

 

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

 

                 Special              
     Total     Pass Credits     Mention     Substandard     Doubtful  

June 30, 2011

          

Construction and development

   $ 5,544,068      $ 5,448,947      $ 95,121      $ —        $ —     

1-4 family residential

     42,991,762        41,870,311        1,121,451        —          —     

Nonfarm, nonresidential

     48,365,786        47,987,952        377,834        —          —     

Commercial and industrial

     67,791,434        62,937,773        4,853,661        —          —     

Consumer

     6,697,606        6,683,255        11,638        2,713        —     

Other loans

     5,042,967        5,042,967        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 176,433,623      $ 169,971,205      $ 6,459,705      $ 2,713      $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     100.0     96.3     3.7     0.0     0.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Guaranteed portion of loans

   $ 35,638,702      $ 32,665,430      $ 2,973,272      $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
                 Special              
     Total     Pass Credits     Mention     Substandard     Doubtful  

December 31, 2010

          

Construction and development

   $ 5,986,045      $ 5,779,959      $ 206,086      $ —        $ —     

1-4 family residential

     46,356,711        43,990,930        1,333,354        65,143        967,284   

Nonfarm, nonresidential

     48,170,698        45,750,435        2,420,263        —          —     

Commercial and industrial

     66,377,076        59,501,127        6,094,833        —          781,116   

Consumer

     6,759,770        6,743,029        13,864        2,877        —     

Other loans

     4,781,679        4,781,679        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 178,431,979      $ 166,547,159      $ 10,068,400      $ 68,020      $ 1,748,400   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     100.0     93.3     5.7     0.0     1.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Guaranteed portion of loans

   $ 32,259,668      $ 29,142,378      $ 3,117,290      $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

17


Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 7. 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 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 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, 2011 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.

 

18


Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 7. 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 third 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)                            
June 30, 2011    Total      Level 1      Level 2      Level 3  

Government-sponsored enterprises

   $ 2,012       $ —         $ 2,012       $ —     

Mortgage-backed securities

     72         —           72         —     

Corporate bonds

     433         —           433         —     

Servicing assets

     93         —           —           93   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets at fair value

   $ 2,610       $ —         $ 2,517       $ 93   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities at fair value

   $ —         $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 
(in thousands)                            
December 31, 2010    Total      Level 1      Level 2      Level 3  

Government-sponsored enterprises

   $ 1,502       $ —         $ 1,502       $ —     

Mortgage-backed securities

     76         —           76         —     

Corporate bonds

     434         —           434         —     

Servicing assets

     95         —           —           95   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets at fair value

   $ 2,107       $ —         $ 2,012       $ 95   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities at fair value

   $ —         $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

19


Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 7. FAIR VALUE, CONTINUED

 

For the six months ended June 30, 2011 and 2010, the changes in Level 3 assets and liabilities measured at fair value on a recurring basis were as follows:

 

     Level 3  
     2011     2010  
     Fair Value     Fair Value  

Balance, January 1

   $ 94,878      $ —     

Capitalized

     —          64,115   

Amortization included in other income

     (1,427     (101
  

 

 

   

 

 

 

Balance, June 30

   $ 93,451      $ 64,014   
  

 

 

   

 

 

 

Changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the three month period ended June 30, 2011 was $732, which was amortized to other income. Gains on the sale of government guaranteed loans are presented as a separate component of noninterest income on the consolidated statements of income for the six and three months ended June 30, 2011 and 2010.

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)                            
June 30, 2011    Total      Level 1      Level 2      Level 3  

Loans-commercial and industrial

   $ 2,884       $ —         $ 2,884       $ —     

Loans-nonfarm, non-residential

     1,734         —           1,734         —     

Loans-other

     207         —           207         —     

Foreclosed assets

     187         —           187         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets at fair value

   $ 5,012       $ —         $ 5,012       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities at fair value

   $ —         $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 
(in thousands)                            
December 31, 2010    Total      Level 1      Level 2      Level 3  

Loans-commercial and industrial

   $ 3,469       $ —         $ 3,469       $ —     

Loans-nonfarm, non-residential

     1,565         —           1,565         —     

Loans- 1- 4 family residential

     90         —           90         —     

Loans-other

     56         —           56         —     

Foreclosed assets

     451         —           451         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets at fair value

   $ 5,631       $ —         $ 5,631       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities at fair value

   $ —         $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company had no Level 3 assets or liabilities measured at fair value on a non-recurring basis at June 30, 2011 or December 31, 2010.

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.

 

20


Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 7. FAIR VALUE, CONTINUED

 

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.

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 estimated fair values of the Company’s financial instruments are as follows (dollars in thousands):

 

     June 30, 2011      December 31, 2010  
     Carrying
Amount
     Fair
Value
     Carrying
Amount
     Fair
Value
 

Financial Assets

           

Cash and due from banks

   $ 2,642       $ 2,642       $ 2,398       $ 2,398   

Federal funds sold and interest-bearing deposits with banks

     37,961         37,961         23,494         23,494   

Securities, available for sale

     2,517         2,517         2,012         2,012   

Restricted equity securities

     892         892         941         941   

Loans, net of allowance for loan losses

     172,006         161,750         171,794         163,470   

Bank owned life insurance

     3,338         3,338         3,285         3,285   

Financial Liabilities

           

Deposits

     187,551         172,949         173,960         156,565   

Long-term debt

     9,100         9,456         9,450         9,848   

Commitments and contingencies

     —           —           —           —     

 

21


Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 8. STOCKHOLDERS’ EQUITY

On December 1, 2010, the Company issued 181,154 shares of Series D 5.0% Convertible Non-Cumulative Perpetual Preferred Stock for $7.08 per share, netting proceeds of $1,248,482 after issue costs. The shares have a liquidation value of $7.08 per share and are convertible into one share of common stock at the election of the holder, but are not redeemable at the option of the holder. Provided that the market value of the Company’s common stock is $8.85 on or after January 1, 2014, the Company may redeem all or a portion of the outstanding shares of Series D Preferred Stock at a redemption price of $7.08 per share. The shares were issued in a private placement and are held by approximately 15 stockholders of record. The shares are non-voting and convertible into one share of common stock.

On December 29, 2010, the Company repurchased all of its remaining outstanding Fixed Rate Cumulative Perpetual Preferred Stock, Series B and Fixed Rate Cumulative Perpetual Preferred Stock, Series C, which was issued by the Company to the United States Treasury Department, for an aggregate purchase price of $2.1 million, including approximately $13 thousand of accrued and unpaid dividends and approximately $40 thousand in discount accretions. The Company funded the repurchase of the Preferred Stock primarily with cash on hand and the net proceeds received on December 1, 2010 upon the completion of its private placement of its Series D Preferred Stock as described above.

The following table details preferred stock transactions for the six months ended June 30, 2011 and 2010.

 

     Convertible
Preferred Stock Series A
     Preferred Stock
Series B
     Preferred Stock
Series C
    Convertible
Preferred Stock Series D
 
     Shares      Amount      Shares      Amount      Shares      Amount     Shares      Amount  

Balance, January 1, 2010

     189,356       $ 2,620,325         2,000       $ 1,903,283         100       $ 103,222        —         $ —     

Dividends declared and accrued on Series B and Series C preferred stock, net of discount accretion and (premium) amortization

     —           —           —           17,231         —           (1,469     —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Balance, June 30, 2010

     189,356       $ 2,620,325         2,000       $ 1,920,514         100       $ 101,753        —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Balance, January 1, 2011

     189,356       $ 2,620,325         —         $ —           —         $ —          181,154       $ 1,248,482   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Balance, June 30, 2011

     189,356       $ 2,620,325         —         $ —           —         $ —          181,154       $ 1,248,482   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

 

22


Table of Contents
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 six and three months ending June 30, 2011 and 2010. 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 June 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, 2011, was $665,448 or $0.19 per diluted share outstanding, compared to a $485,020 or $0.14 per diluted share outstanding, for the same period in 2010. Earnings for the three months ended June 30, 2011, are approximately 37.2% higher than for the same period in 2010. The increase results from a reduction in the provision for loan losses. The provision decreased from $254,485 in the second quarter of 2010 to a recapture of $279,825 in 2011. Over the past two years reserves were increased due to weakness in the economy that necessitated an increase in reserves associated with impaired loans. During the first half of 2011 the level of impaired loans stabilized. Certain loans that were reserved in previous quarters were charged off resulting in an improvement of the credit quality of the loan portfolio, as noted in Note 6 to the financial statements. The reserve was further impacted by an increase in loans carrying government guarantees. At June 30, 2011, the guaranteed portion of loans equaled 20.2% of total loans compared to 18.1% at December 31, 2010. Net interest income decreased slightly from $2,159,740 in the second quarter of 2010 to $2,118,802 in 2011. A reduction in average loan balances from the second quarter of 2010 to 2011 contributed to this decrease. Asset yields decreased from 5.32% to 4.97% from 2010 to 2011 due to the change in earning asset mix. The cost of funds continued to decrease from 1.35% in the second quarter of 2010 to 1.14% in the second quarter of 2011. Noninterest income decreased 6.3% in 2011 primarily due to a reduction in gains on the sale of a government guaranteed loan. No such sales were made in 2011 after recording income of $32,865 in the second quarter of 2010. Noninterest expenses increased 10.1% from $1,637,115 in the second quarter of 2010, to $1,802,453 in 2011. Most of the increase is associated with write downs of foreclosed assets and expenses incurred to maintain those assets. Foreclosed asset expense increased from $11,490 in the second quarter of 2010 to $120,908 in 2011.

Net income available for common stockholders for the six months ended June 30, 2011, was $1,172,411 or $0.33 per diluted share outstanding compared to $651,736 or $0.20 per diluted share outstanding for the same period in 2010. This represents an 80.9% increase in earnings for the first six months of 2011 compared to the same period in 2010. This increase is attributable to a reduction in the provision for loan losses. The provision decreased from $1,203,842 in the first six months of 2010 to a recapture of $120,928 during the same period in 2011. The charge off of nonperforming loans and the stabilization of the level of impaired loans during the period resulted in the recapture

 

23


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

 

of reserve. Additionally loan guarantee enhancements increased as a percentage of total loans which further improved the credit quality of the loan portfolio. Net interest income decreased slightly from $4,313,753 in the first six months of 2010 to $4,295,430 in 2011. This decrease is due to a reduction in the percentage of average loans compared to total earning assets for the six month period ended June 30, 2011 versus the same period in 2010. Overall assets yields have decreased as a result. A corresponding reduction in the cost of funds maintained the margin at near 2010 levels. Noninterest income decreased 17.6% in 2011 primarily due to a reduction in gains on the sale of a government guaranteed loan. No such sales were made in 2011 after recording income of $244,924 in the first six months of 2010. Noninterest expenses increased 7.3% from $3,293,855 in the six months ended June 30, 2010, to $3,532,825 for the same period in 2011. Most of the increase is associated with write downs and expenses associated with foreclosed assets. Foreclosed asset expense increased from $15,682 in first six months of 2010 to $140,332 in 2011. Other contributors to the increase were professional fees and FDIC premiums.

On June 30, 2011, Surrey Bancorp’s assets totaled $228,344,483 compared to $213,652,484 on December 31, 2010. Net loans were $172,005,516 compared to $171,794,247 on December 31, 2010. This increase was attributable to a reduction in total loans of approximately $2,004,000 coupled with a net decrease in the loan loss reserve of approximately $2,215,000. Commercial loans increased 2.0% during the six month period ended June 30, 2011, however real estate loans decreased over 3.2% leading to the net decrease. Interest-bearing deposits with banks increased from $22,792,088 at December 31, 2010 to $37,255,803 at June 30, 2011, due to approximately a $13,600,000 increase in deposits the first six months of 2011.

Total deposits on June 30, 2011, were $187,550,998 compared to $173,960,073 at the end of 2010. This increase is primarily attributable to increases in all primary deposit categories: demand deposits, savings deposits, including money market accounts and certificates of deposit. Demand deposits increased 8.82% from 2010 totals, while savings deposits increased 16.90%. Certificates of deposit increased 4.70% from December 31, 2010 totals.

Common stockholders’ equity increased by $1,200,531, or 4.85%, during the six months ended June 30, 2011. The increase is comprised of net income of $1,263,368, adjustments to Accumulated Other Comprehensive Income of $4,594, proceeds from exercised stock options of $12,313, and other stock based compensation of $11,213. Decreases included the payment and accrual of preferred dividends of $90,957. The net increase resulted in a common stock book value of $8.08 per share, up from $7.73 on December 31, 2010.

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, 2011, as detailed in Note 8 to the financial statements. Combined preferred and common stockholders’ equity increased $1,200,531, or 4.19%, for the six months ended June 30, 2011.

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.

Available for sale securities are reported at fair value and consist of bonds, notes, debentures, and certain equity securities 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.

 

24


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

 

Investments in available for sale securities of $2,516,590 consisted of U.S. Governmental Agency obligations with maturities ranging from 13 to 32 months, corporate bonds with maturities of 7.0 years to 7.25 years, that reprice quarterly, and GNMA adjustable rate mortgage securities, which adjust annually.

Loans

Net loans outstanding on June 30, 2011, were $172,005,516 compared to $171,794,247 on December 31, 2010. The Bank maintains a loan portfolio dominated by real estate and commercial loans diversified among various industries. Approximately 72.5% of the Bank’s loans as of June 30, 2011, are fixed rate loans with 27.5% floating with the Bank’s prime rate or other appropriate internal or external indices.

Deposits

Deposits on June 30, 2011, were $187,550,998, compared to $173,960,073 on December 31, 2010. The June total comes from a base of approximately 12,388 accounts compared to 12,295 accounts at December 31, 2010. Interest-bearing accounts represented 82.0% of June 30, 2011 period end deposits versus 83.9% at December 31, 2010.

Federal Funds Purchased

The Company had no federal funds purchased at June 30, 2011 or December 31, 2010. Federal funds purchased were not utilized due to the adequate liquidity resulting from the increase in deposits.

 

25


Table of Contents
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, 2011:

    

Total Capital

    

(to Risk-Weighted Assets)

    

Surrey Bancorp (Consolidated)

     18.19     8.0

Surrey Bank & Trust

     18.01     8.0

Tier I Capital

    

(to Risk-Weighted Assets)

    

Surrey Bancorp (Consolidated)

     16.93     4.0

Surrey Bank & Trust

     16.74     4.0

Tier I Capital

    

(to Average Assets)

    

Surrey Bancorp (Consolidated)

     12.50     4.0

Surrey Bank & Trust

     12.36     4.0

December 31, 2010:

    

Total Capital

    

(to Risk-Weighted Assets)

    

Surrey Bancorp (Consolidated)

     17.24     8.0

Surrey Bank & Trust

     16.99     8.0

Tier I Capital

    

(to Risk-Weighted Assets)

    

Surrey Bancorp (Consolidated)

     15.97     4.0

Surrey Bank & Trust

     15.72     4.0

Tier I Capital

    

(to Average Assets)

    

Surrey Bancorp (Consolidated)

     11.88     4.0

Surrey Bank & Trust

     11.69     4.0

 

26


Table of Contents
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 that are 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 will be provided to the Board of Directors.

Nonperforming assets are detailed below.

 

     June 30,
2011
    December 31,
2010
 

Nonaccrual loans

   $ 4,878,258      $ 6,362,127   

Loans past due 90 days and still accruing

     69,559        —     

Foreclosed assets

     186,730        450,532   
  

 

 

   

 

 

 

Total

   $ 5,134,547      $ 6,812,659   
  

 

 

   

 

 

 

Total assets

   $ 228,344,483      $ 213,652,484   
  

 

 

   

 

 

 

Ratio of nonperforming assets to total assets

     2.24     3.19
  

 

 

   

 

 

 

At June 30, 2011, the Bank had loans totaling $4,878,258 in nonaccrual status. Foreclosed assets at June 30, 2011 primarily include 1-4 family dwellings and nonfarm, nonresidential property. Loans that were considered impaired but were still accruing interest at June 30, 2011, including troubled debt restructurings, totaled $7,379,156. 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 $1,813,414 at quarter end, or 14.8% of the balances outstanding.

Nonaccrual and impaired loans still accruing are summarized below:

 

     June 30,
2011
     December 31,
2010
 

Construction and development

   $ 95,122       $ 136,703   

1-4 family residential

     1,052,397         2,172,065   

Nonfarm, nonresidential

     4,094,870         4,268,396   

Commercial and industrial

     6,998,129         8,050,109   

Consumer

     16,896         10,439   
  

 

 

    

 

 

 

Total impaired and nonaccrual

   $ 12,257,414       $ 14,637,712   
  

 

 

    

 

 

 

 

27


Table of Contents
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, 2011     December 31, 2010  

Construction and development

   $ 5,544,068         3.14   $ 5,986,045         3.35

1-4 family residential

     42,991,761         24.37     46,356,711         25.98

Multi-family

     2,257,358         1.28     1,853,346         1.04

Farmland

     2,735,521         1.55     2,854,481         1.60

Nonfarm, non-residential

     48,365,786         27.41     48,170,698         27.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate

     101,894,494         57.75     105,221,281         58.97

Agricultural

     50,088         0.03     73,852         0.04

Commercial and industrial

     67,791,434         38.42     66,377,076         37.20

Consumer

     6,697,607         3.80     6,759,770         3.79
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans

   $ 176,433,623         100.00   $ 178,431,979         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 only concentration that is above area peer group analysis is commercial and industrial loans. Management recognizes the inherent risk associated with commercial lending, including whether or not a borrower’s actual results of operations will correspond 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 $45,071,000 in loans that carry government guarantees. The guaranteed portion of these loans amounts to $35,639,000 at June 30, 2011. Loan guarantees by loan class are below:

 

     June  30,
2011
     Guaranteed Portion  
        Amount      Percentage  

Construction and development

   $ 5,544,068       $ —           —  

1-4 family residential

     42,991,761         1,009,782         2.35

Multi-family

     2,257,358         29,499         1.31

Farmland

     2,735,521         529,754         19.37

Nonfarm, non-residential

     48,365,786         13,875,919         28.69
  

 

 

    

 

 

    

 

 

 

Total real estate

     101,894,494         15,444,954         15.16

Agricultural

     50,088         —           —  

Commercial and industrial

     67,791,434         20,193,748         29.79

Consumer

     6,697,607         —           —  
  

 

 

    

 

 

    

 

 

 

Total loans

   $ 176,433,623       $ 35,638,702         20.20
  

 

 

    

 

 

    

 

 

 

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 $2,223,521 at June 30, 2011. Non-owner occupied nonfarm, non-residential properties included in nonfarm, non-residential loans above amounted to $8,560,739 at June 30, 2011.

 

28


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

 

The consolidated provision for loan losses recaptured through operations was $120,928 in the first six months of 2011 compared to a provision of $1,203,842 for the same period in 2010. The decrease in the loan loss provision is primarily attributable to a stabilization of impaired loans in the first six months of 2011. Additionally, certain loans that were reserved in previous quarters were charged off resulting in an improvement in the overall credit quality of the loan portfolio (see Note 6). These factors combined to negate the need for higher reserves during the period ended June 30, 2011. Charge offs totaling $2,322,941 were taken by the Bank in the six month period ended June 30, 2011. Reserves for nonaccrual and impaired loans at June 30, 2011 amounted to $1,813,414, compared to $4,069,260 at December 31, 2010.

The reserve for loan losses on June 30, 2011, was $4,468,475 or 2.53% of period end loans. This percentage is derived from total loans. Approximately $45,071,000 of the total loans outstanding at June 30, 2011, are government guaranteed loans for which the Bank’s exposure ranges from zero% to 49% of the outstanding balance. When the guaranteed portions of the loans are removed from the equation, the loan loss reserve is approximately 3.13% of outstanding loans, compared to 4.57% as of December 31, 2010. This decrease is directly related to the charge off of troubled loans during the six months ended June 30, 2011.

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 two years applied to its corresponding category of loans. However, historical losses only reflect a small portion of the Bank’s loan loss reserve, although that portion did increase during the first six months of 2011 due to the effect of charged off loans. 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, 2011 and December 31, 2010.

 

     June 30, 2011     December 31, 2010  
     30-89 Days     90 Days Plus     30-89 Days     90 Days Plus  

Construction and development

   $ 180,544      $ —        $ 67,993      $ 39,267   

1-4 family residential

     943,179        264,167        766,017        272,405   

Nonfarm, non-residential

     552,023        —          229,393        220,321   

Commercial and industrial

     893,742        1,727,612        567,740        1,351,710   

Consumer

     53,130        8,463        143,832        —     

Other loans

     —          —          3,472        —     
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 2,622,618      $ 2,000,242      $ 1,778,447      $ 1,883,703   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ratio to total loans

     1.49     1.13     1.00     1.06
  

 

 

   

 

 

   

 

 

   

 

 

 

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 from December 31, 2010 to June 30, 2011. The largest increase was in commercial and industrial loans. The increase is primarily attributable to one customer which accounted for approximately $435,000 of the 30-89 day past dues at June 30, 2011, compared to $61,000 at December 31, 2010. Approximately, $1,654,000 of the commercial 90 day past dues at June 30, 2011 is attributable to one customer. At December 31, 2010, $1,282,000 of the commercial 90 day past dues was attributable to the same customer. Overall past dues increased approximately 29% from the end of 2010 to June 30, 2011. Past dues are down from the March 31, 2011, increase of 34% over 2010 year end totals.

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.

 

29


Table of Contents
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, 2011, the liquidity position of the Company was good, in management’s opinion, with short-term liquid assets of $40,602,840. Deposit increases accounted for the net increase in liquidity from December 31, 2010 totals. To provide supplemental liquidity, the Bank has six unsecured lines of credit with correspondent banks totaling $25,500,000. At June 30, 2011, 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 $17,694,000 of which $9,100,000 of advances had been taken down at June 30, 2011.

 

30


Table of Contents
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable as a “Smaller Reporting Company”.

 

31


Table of Contents
ITEM 4. CONTROLS & 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.

 

32


Table of Contents

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. (Removed and Reserved)

 

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

 

33


Table of Contents

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 12, 2011  

/s/ Edward C. Ashby, III

  Edward C. Ashby, III
  President and Chief Executive Officer
  (Principal Executive Officer)
Date: August 12, 2011  

/s/ Mark H. Towe

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

 

34