Form 10-Q

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

for the quarterly period ended September 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 November 7, 2011 there were 3,215,764 common shares issued and outstanding.

 

 

 


PART I – FINANCIAL INFORMATION

 

Item 1.  

Consolidated Financial Statements

  
 

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

     3   
 

Consolidated Statements of Income, Nine Months Ended September 30, 2011 and 2010 (Unaudited)

     4   
 

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

     5   
 

Consolidated Statements of Cash Flows, Nine Months Ended September 30, 2011 and 2010 (Unaudited)

     6   
 

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

     7   
 

Notes to Consolidated Financial Statements

     8-23   
Item 2.  

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

     24-31   
Item 3.  

Quantitative and Qualitative Disclosures about Market Risk

     32   
Item 4.  

Controls and Procedures

     33   

PART II – OTHER INFORMATION

  
Item 1.  

Legal Proceedings

     34   
Item 1A.  

Risk Factors

     34   
Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

     34   
Item 3.  

Defaults Upon Senior Securities

     34   
Item 4.  

(Removed and Reserved)

     34   
Item 5.  

Other Information

     34   
Item 6.  

Exhibits

     34   

SIGNATURES

     35   

CERTIFICATIONS

     36-38   


Consolidated Balance Sheets

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

 

 

     September
2011
    December
2010
 

Assets

    

Cash and due from banks

   $ 2,570,375      $ 2,398,433   

Interest-bearing deposits with banks

     33,791,894        22,792,088   

Federal funds sold

     709,646        702,121   

Investment securities available for sale

     2,512,078        2,012,132   

Restricted equity securities

     852,629        941,379   

Loans, net of allowance for loan losses of $4,628,232 at September 30, 2011 and $6,683,922 at December 31, 2010

     176,116,287        171,794,247   

Property and equipment, net

     4,632,998        4,726,483   

Foreclosed assets

     182,480        450,532   

Accrued income

     1,043,727        955,516   

Goodwill

     120,000        120,000   

Bank owned life insurance

     3,363,465        3,284,990   

Other assets

     3,111,630        3,474,563   
  

 

 

   

 

 

 

Total assets

   $ 229,007,209      $ 213,652,484   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Liabilities

    

Deposits:

    

Noninterest-bearing

   $ 36,568,922      $ 27,954,669   

Interest-bearing

     151,730,369        146,005,404   
  

 

 

   

 

 

 

Total deposits

     188,299,291        173,960,073   

Long-term debt

     8,100,000        9,450,000   

Dividends payable

     46,233        35,515   

Accrued interest payable

     249,132        227,887   

Other liabilities

     1,931,024        1,334,854   
  

 

 

   

 

 

 

Total liabilities

     198,625,680        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; 3,215,764 and 3,206,495 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively

     9,500,158        9,464,178   

Retained earnings

     17,067,974        15,380,083   

Accumulated other comprehensive loss

     (55,410     (68,913
  

 

 

   

 

 

 

Total stockholders’ equity

     30,381,529        28,644,155   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 229,007,209      $ 213,652,484   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

3


Consolidated Statements of Income

Nine months ended September 30, 2011 and 2010 (Unaudited)

 

 

     2011     2010  

Interest income

    

Loans and fees on loans

   $ 8,138,762      $ 8,277,716   

Federal funds sold

     1,210        594   

Investment securities, taxable

     40,275        37,655   

Deposits with banks

     11,645        20,053   
  

 

 

   

 

 

 

Total interest income

     8,191,892        8,336,018   
  

 

 

   

 

 

 

Interest expense

    

Deposits

     1,368,776        1,557,497   

Short-term debt

     —          17,720   

Long-term debt

     264,361        298,394   
  

 

 

   

 

 

 

Total interest expense

     1,633,137        1,873,611   
  

 

 

   

 

 

 

Net interest income

     6,558,755        6,462,407   

Provision for loan losses

     67,190        1,840,578   
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     6,491,565        4,621,829   
  

 

 

   

 

 

 

Noninterest income

    

Service charges on deposit accounts

     767,978        800,693   

Gain on sale of government guaranteed loans

     —          244,924   

Fees and yield spread premiums on loans delivered to correspondents

     78,865        91,511   

Other service charges and fees

     372,673        335,456   

Other operating income

     548,662        529,071   
  

 

 

   

 

 

 

Total noninterest income

     1,768,178        2,001,655   
  

 

 

   

 

 

 

Noninterest expense

    

Salaries and employee benefits

     2,624,411        2,563,874   

Occupancy expense

     294,493        313,507   

Equipment expense

     179,090        192,050   

Data processing

     271,504        306,287   

Foreclosed assets, net

     140,190        23,644   

Postage, printing and supplies

     146,904        159,239   

Professional fees

     267,558        217,045   

FDIC insurance premiums

     176,286        184,271   

Litigation settlement

     130,000        —     

Other expense

     1,075,861        950,463   
  

 

 

   

 

 

 

Total noninterest expense

     5,306,297        4,910,380   
  

 

 

   

 

 

 

Net income before income taxes

     2,953,446        1,713,104   

Income tax expense

     1,128,365        626,756   
  

 

 

   

 

 

 

Net income

     1,825,081        1,086,348   

Preferred stock dividends and accretion of discount

     (137,190     (194,107
  

 

 

   

 

 

 

Net income available to common stockholders

   $ 1,687,891      $ 892,241   
  

 

 

   

 

 

 

Basic earnings per common share

   $ 0.53      $ 0.28   
  

 

 

   

 

 

 

Diluted earnings per common share

   $ 0.48      $ 0.27   
  

 

 

   

 

 

 

Basic weighted average common shares outstanding

     3,212,087        3,206,341   
  

 

 

   

 

 

 

Diluted weighted average common shares outstanding

     3,788,389        3,603,784   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

4


Consolidated Statements of Income

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

 

 

     2011     2010  

Interest income

    

Loans and fees on loans

   $ 2,762,166      $ 2,738,272   

Federal funds sold

     415        190   

Investment securities, taxable

     13,917        11,992   

Deposits with banks

     3,641        8,342   
  

 

 

   

 

 

 

Total interest income

     2,780,139        2,758,796   
  

 

 

   

 

 

 

Interest expense

    

Deposits

     435,353        515,211   

Short-term debt

     —          —     

Long-term debt

     81,461        94,931   
  

 

 

   

 

 

 

Total interest expense

     516,814        610,142   
  

 

 

   

 

 

 

Net interest income

     2,263,325        2,148,654   

Provision for loan losses

     188,118        636,736   
  

 

 

   

 

 

 

Net interest income after provision for loan losses

     2,075,207        1,511,918   
  

 

 

   

 

 

 

Noninterest income

    

Service charges on deposit accounts

     259,093        268,216   

Gain on sale of government guaranteed loans

     —          —     

Fees and yield spread premiums on loans delivered to correspondents

     25,247        41,774   

Other service charges and fees

     125,646        112,407   

Other operating income

     188,683        159,609   
  

 

 

   

 

 

 

Total noninterest income

     598,669        582,006   
  

 

 

   

 

 

 

Noninterest expense

    

Salaries and employee benefits

     862,414        840,474   

Occupancy expense

     97,313        116,277   

Equipment expense

     58,593        55,667   

Data processing

     85,916        109,513   

Foreclosed assets, net

     (142     7,962   

Postage, printing and supplies

     44,150        48,996   

Professional fees

     77,098        64,467   

FDIC insurance premiums

     36,709        65,990   

Litigation settlement

     130,000        —     

Other expense

     381,421        307,179   
  

 

 

   

 

 

 

Total noninterest expense

     1,773,472        1,616,525   
  

 

 

   

 

 

 

Net income before income taxes

     900,404        477,399   

Income tax expense

     338,691        171,600   
  

 

 

   

 

 

 

Net income

     561,713        305,799   

Preferred stock dividends and accretion of discount

     (46,233     (65,294
  

 

 

   

 

 

 

Net income available to common stockholders

   $ 515,480      $ 240,505   
  

 

 

   

 

 

 

Basic earnings per common share

   $ 0.16      $ 0.08   
  

 

 

   

 

 

 

Diluted earnings per common share

   $ 0.15      $ 0.08   
  

 

 

   

 

 

 

Basic weighted average common shares outstanding

     3,215,213        3,206,495   
  

 

 

   

 

 

 

Diluted weighted average common shares outstanding

     3,791,515        3,601,643   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

5


Consolidated Statements of Cash Flows

Nine months ended September 30, 2011 and 2010 (Unaudited)

 

 

     2011     2010  

Cash flows from operating activities

    

Net income

   $ 1,825,081      $ 1,086,348   

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

    

Depreciation and amortization

     183,205        194,072   

Gain on sale of property and equipment

     (760     (400

Loss on the sale of foreclosed assets

     50,254        10,695   

Stock-based compensation, net of tax benefit

     17,155        21,774   

Provision for loan losses

     67,190        1,840,578   

Deferred income taxes

     (6,853     13,738   

Accretion of discount on securities, net of amortization of premiums

     1,526        1,958   

Increase in cash surrender value of life insurance

     (78,475     (83,364

Changes in assets and liabilities:

    

Accrued income

     (88,211     54,612   

Other assets

     361,314        (1,216,011

Accrued interest payable

     21,245        (4,385

Other liabilities

     596,170        730,336   
  

 

 

   

 

 

 

Net cash provided by operating activities

     2,948,841        2,649,951   
  

 

 

   

 

 

 

Cash flows from investing activities

    

Net increase in interest-bearing deposits with banks

     (10,999,806     (9,525,379

Net increase in federal funds sold

     (7,525     (41,123

Purchases of investment securities

     (2,002,500     (2,000,000

Sales and maturities of investment securities

     1,523,003        2,007,127   

Redemption of restricted equity securities

     88,800        71,385   

Purchase of restricted equity securities

     (50     —     

Net (increase) decrease in loans

     (4,634,755     5,082,011   

Proceeds from the sale of foreclosed assets

     463,323        68,340   

Purchases of property and equipment

     (89,720     (108,105

Proceeds from the sale of property and equipment

     760        400   
  

 

 

   

 

 

 

Net cash (used in) investing activities

     (15,658,470     (4,445,344
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net increase in deposits

     14,339,218        5,798,745   

Net decrease in short-term debt

     —          (3,750,000

Net (decrease) increase in long-term debt

     (1,350,000     250,000   

Dividends paid

     (126,472     (170,976

Common stock options exercised

     18,825        34,450   
  

 

 

   

 

 

 

Net cash provided by financing activities

     12,881,571        2,162,219   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     171,942        366,826   

Cash and due from banks, beginning

     2,398,433        1,923,621   
  

 

 

   

 

 

 

Cash and due from banks, ending

   $ 2,570,375      $ 2,290,447   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information

    

Interest paid

   $ 1,611,892      $ 1,877,996   
  

 

 

   

 

 

 

Taxes paid

   $ 626,319      $ 1,246,897   
  

 

 

   

 

 

 

Loans transferred to foreclosed properties

   $ 245,525      $ 322,034   
  

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

6


Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income

Nine months ended September 30, 2011 and 2010 (Unaudited)

 

 

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

     —           —           —           1,086,348        —          1,086,348   

Net change in unrealized gain (loss) on investment securities available for sale, net of income tax of $1,308

     —           —           —           —          (2,085     (2,085
               

 

 

 

Total comprehensive income

                  1,084,263   

Common stock options exercised

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

Stock-based compensation, net of tax benefit

     —           —           21,774         —          —          21,774   

Dividends declared on convertible Series A preferred stock ($.47 per share)

     —           —           —           (89,226     —          (89,226

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

     25,944         —           —           (104,881     —          (81,145
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance, September 30, 2010

   $ 4,652,774         3,206,495       $ 9,462,653       $ 15,360,330      $ (78,081   $ 29,395,468   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

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

     —           —           —           1,825,081        —          1,825,081   

Net change in unrealized gain (loss) on investment securities available for sale, net of income tax of $8,471

     —           —           —           —          13,503        13,503   
               

 

 

 

Total comprehensive income

                  1,838,584   

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

     —           9,269         18,825         —          —          18,825   

Stock-based compensation, net of tax benefit

     —           —           17,155         —          —          17,155   

Dividends declared on Series A convertible preferred stock ($.47 per share)

     —           —           —           (89,225     —          (89,225

Dividends declared on Series D convertible preferred stock ($.26 per share)

     —           —           —           (47,965     —          (47,965
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance, September 30, 2011

   $ 3,868,807         3,215,764       $ 9,500,158       $ 17,067,974      $ (55,410   $ 30,381,529   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

See Notes to Consolidated Financial Statements

 

7


SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and therefore, do not include all disclosures required by generally accepted accounting principles for a complete presentation of financial statements. In the opinion of management, the consolidated financial statements contain all adjustments necessary to present fairly the financial condition of Surrey Bancorp, (the “Company), as of September 30, 2011, the results of operations for the nine and three months ended September 30, 2011 and 2010, and its changes in stockholders’ equity and comprehensive income and cash flows for the nine months ended September 30, 2011 and 2010. The results of operations for the nine and three months ended September 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


SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1. BASIS OF PRESENTATION, CONTINUED

 

Presentation of Cash Flows

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

Investment Securities

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

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


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 its 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 the 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


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 have been presented in Note 7.

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.

In September 2011, the Intangibles topic was again amended to permit an entity to consider qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. These amendments will be effective for the Company on January 1, 2012.

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


SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2. SECURITIES

Debt and equity securities have been classified in the balance sheets according to management’s intent. The amortized costs of securities available for sale and their approximate fair values at September 30, 2011 and December 31, 2010 follow:

 

     Amortized      Unrealized      Unrealized      Fair  
     Cost      Gains      Losses      Value  

September 30, 2011

           

Government-sponsored enterprises

   $ 2,001,016       $ 8,679       $ —         $ 2,009,695   

Mortgage-backed securities

     51,232         1,526         —           52,758   

Corporate bonds

     550,000         —           100,375         449,625   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,602,248       $ 10,205       $ 100,375       $ 2,512,078   
  

 

 

    

 

 

    

 

 

    

 

 

 

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 September 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 September 30, 2011, were as follows:

 

     Amortized      Fair  
     Cost      Value  

Due in one year or less

   $ —         $ —     

Due after one year through five years

     2,001,016         2,009,695   

Due after five years through ten years

     586,895         487,542   

Due after ten years

     14,337         14,841   
  

 

 

    

 

 

 
   $ 2,602,248       $ 2,512,078   
  

 

 

    

 

 

 

The following table shows investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at September 30, 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 September 30, 2011 and December 31, 2010.

 

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

September 30, 2011

                 

Corporate bonds

   $ —         $ —         $ 449,625       $ 100,375       $ 449,625       $ 100,375   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ —         $ —         $ 449,625       $ 100,375       $ 449,625       $ 100,375   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

December 31, 2010

                 

Corporate bonds

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

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

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

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

12


SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 2. SECURITIES, CONTINUED

Management considers the nature of the investment, the underlying causes of the decline in the market value and the severity and duration of the decline in market value in determining if impairment is other than temporary. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Based upon this evaluation, there are two securities in the portfolio 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 nine and three month periods ended September 30, 2011 and 2010.

NOTE 3. EARNINGS PER SHARE

Basic earnings per share for the nine and three months ended September 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 September 30, 2011, the Company had commitments to extend credit, including unused lines of credit of approximately $36,414,000. Letters of credit totaling $1,349,531 were outstanding.

NOTE 5. LOANS

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

 

     2011     2010  

Commercial

   $ 71,722,630      $ 66,377,076   

Real estate:

    

Construction and land development

     5,253,339        5,986,045   

Residential, 1-4 families

     41,806,459        46,356,711   

Residential, 5 or more families

     2,259,445        1,853,346   

Farmland

     2,903,144        2,854,481   

Nonfarm, nonresidential

     49,721,494        48,170,698   

Agricultural

     43,263        73,852   

Consumer, net of discounts of $21,169 in 2011 and $14,770 in 2010

     7,013,836        6,759,770   
  

 

 

   

 

 

 
     180,723,610        178,431,979   

Deferred loan origination costs, net of fees

     20,909        46,190   
  

 

 

   

 

 

 
     180,744,519        178,478,169   

Allowance for loan losses

     (4,628,232     (6,683,922
  

 

 

   

 

 

 
   $ 176,116,287      $ 171,794,247   
  

 

 

   

 

 

 

 

13


SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 5. LOANS, CONTINUED

Residential, 1-4 family loans pledged as collateral against FHLB advances approximated $20,483,000 and $25,141,000 at September 30, 2011 and December 31, 2010.

NOTE 6. ALLOWANCE FOR LOAN LOSSES

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

 

     Construction
&
Development
    1-4 Family
Residential
    Nonfarm,
Nonresidential
    Commercial
& 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     (1,113,243     (203,418     (1,007,729     (45,010     —          (2,396,868

Recoveries

     996        56,241        108,114        83,804        24,833        —          273,988   

Provision

     3,621        185,093        (233,826     77,669        29,233        5,400        67,190   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 95,946      $ 824,159      $ 870,162      $ 2,565,147      $ 214,718      $ 58,100      $ 4,628,232   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ 146      $ 156,159      $ 277,262      $ 1,447,747      $ —        $ —        $ 1,881,314   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 95,800      $ 668,000      $ 592,900      $ 1,117,400      $ 214,718      $ 58,100      $ 2,746,918   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: loans acquired with deteriorated credit quality

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans Receivable:

              

Ending balance

   $ 5,253,339      $ 41,806,459      $ 49,721,494      $ 71,722,630      $ 7,013,836      $ 5,205,852      $ 180,723,610   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ 93,385      $ 949,971      $ 4,054,573      $ 6,338,214      $ 5,475      $ —        $ 11,441,618   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 5,159,954      $ 40,856,488      $ 45,666,921      $ 65,384,416      $ 7,008,361      $ 5,205,852      $ 169,281,992   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

     —          (26,748     (109,948     (545,752     (92,774     —          (775,222

Recoveries

     —          950        20,501        368        25,789        —          47,608   

Provision

     (25,800     161,128        100,831        1,573,613        35,606        (4,800     1,840,578   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 80,597      $ 764,293      $ 707,428      $ 3,931,496      $ 249,755      $ 49,300      $ 5,782,869   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ 12,097      $ 198,093      $ 120,928      $ 3,049,496      $ —        $ —        $ 3,380,614   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 68,500      $ 566,200      $ 586,500      $ 882,000      $ 249,755      $ 49,300      $ 2,402,255   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: loans acquired with deteriorated credit quality

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans Receivable:

              

Ending balance

   $ 5,790,613      $ 47,054,360      $ 47,351,314      $ 67,199,483      $ 6,977,325      $ 4,538,213      $ 178,911,308   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: individually evaluated for impairment

   $ 56,363      $ 703,762      $ 712,351      $ 6,104,973      $ 3,301      $ —        $ 7,580,750   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: collectively evaluated for impairment

   $ 5,734,250      $ 46,350,598      $ 46,638,963      $ 61,094,510      $ 6,974,024      $ 4,538,213      $ 171,330,558   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance: loans acquired with deteriorated credit quality

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

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

14


SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 6. ALLOWANCE FOR LOAN LOSSES, CONTINUED

The following table presents impaired loans individually evaluated by class of loan as of September 30, 2011 and December 31, 2010:

 

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

September 30, 2011

              

With no related allowance recorded:

              

Construction and development

   $ 77,213       $ 77,213       $ —         $ 78,049       $ —     

1-4 family residential

     387,371         445,185         —           396,325         3,713   

Nonfarm, nonresidential

     2,426,530         2,589,261         —           2,434,737         68,967   

Commercial and industrial

     2,081,475         2,255,962         —           2,184,723         77,625   

Consumer

     5,475         5,475         —           5,475         —     

Other loans

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     4,978,064         5,373,096         —           5,099,309         150,305   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

With an allowance recorded:

              

Construction and development

   $ 16,172       $ 16,172       $ 146       $ 16,453       $ —     

1-4 family residential

     562,600         589,965         156,159         557,367         10,624   

Nonfarm, nonresidential

     1,628,043         1,628,043         277,262         1,638,660         8,004   

Commercial and industrial

     4,256,739         4,256,739         1,447,747         4,672,517         106,814   

Consumer

     —           —           —           —           —     

Other loans

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     6,463,554         6,490,919         1,881,314         6,884,997         125,442   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Combined:

              

Construction and development

   $ 93,385       $ 93,385       $ 146       $ 94,502       $ —     

1-4 family residential

     949,971         1,035,150         156,159         953,692         14,337   

Nonfarm, nonresidential

     4,054,573         4,217,304         277,262         4,073,397         76,971   

Commercial and industrial

     6,338,214         6,512,701         1,447,747         6,857,240         184,439   

Consumer

     5,475         5,475         —           5,475         —     

Other loans

     —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 11,441,618       $ 11,864,015       $ 1,881,314       $ 11,984,306       $ 275,747   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

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


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  

September 30, 2011

                 

Construction and development

   $ 36,488       $ —         $ 36,488       $ 5,216,851       $ 5,253,339       $ —     

1-4 family residential

     490,283         710,586         1,200,869         40,605,590         41,806,459         263,960   

Nonfarm, nonresidential

     940,468         686,495         1,626,963         48,094,531         49,721,494         686,495   

Commercial and industrial

     1,330,747         3,298,976         4,629,723         67,092,907         71,722,630         1,611,684   

Consumer

     148,817         5,475         154,292         6,859,544         7,013,836         —     

Other loans

     —           —           —           5,205,852         5,205,852         —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,946,803       $ 4,701,532       $ 7,648,335       $ 173,075,275       $ 180,723,610       $ 2,562,139   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Non-accruals included above

   $ 126,751       $ 2,139,393       $ 2,266,144       $ 2,262,092       $ 4,528,236      
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

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


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  

September 30, 2011

Construction and development

   $ 5,253,339      $ 5,159,954      $ 93,385      $ —        $ —     

1-4 family residential

     41,806,459        40,786,605        1,019,854        —          —     

Nonfarm, nonresidential

     49,721,494        47,459,188        1,889,139        373,167     

Commercial and industrial

     71,722,630        67,403,744        4,318,886        —          —     

Consumer

     7,013,836        7,011,216        94        2,526        —     

Other loans

     5,205,852        5,205,852        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
   $ 180,723,610      $ 173,026,559      $ 7,321,358      $ 375,693      $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     100.0     95.7     4.1     0.2     0.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Guaranteed portion of loans

   $ 37,399,239      $ 34,523,956      $ 2,875,283      $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
                 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      $ —        $ —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

NOTE 7. TROUBLED DEBT RESTRUCTURINGS

As a result of adopting the amendments in ASU 2011-02, the Bank reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they are considered troubled debt restructurings (TDRs) under the amended guidance. The Bank identified no TDRs for which the allowance for loan losses had previously been measured under a general allowance methodology.

     For the nine months ended
September 30, 2011
     For the three months ended
September 30, 2011
 
     Number
of Contracts
     Pre-Modification
Outstanding
Recorded
Investment
     Post-Modification
Outstanding
Recorded
Investment
     Number
of Contracts
     Pre-Modification
Outstanding
Recorded
Investment
     Post-Modification
Outstanding
Recorded
Investment
 

Troubled Debt Restructurings

                 

Construction and development

     1       $ 16,172       $ 16,172         1       $ 16,172       $ 16,172   

1-4 Family residential

     4         257,298         224,214         1         84,093         84,093   

Nonfarm, nonresidential

     7         2,201,519         2,038,788         5         1,045,255         1,045,255   

Commercial and industrial

     11         1,660,797         1,486,309         5         1,197,642         1,197,642   

During the nine months ended September 30, 2011, the Bank modified 23 loans that were considered to be troubled debt restructurings. We extended the terms for 16 of these loans and the interest rate was lowered for four of these loans. Three other loans were demanded due to default.

 

17


SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 7. TROUBLED DEBT RESTRUCTURINGS, CONTINUED

 

     For the nine months  ended
September 30, 2011
     For the three months ended
September 30, 2011
 
     Number
of Contracts
     Recorded Investment      Number
of Contracts
     Recorded Investment  

Troubled Debt Restructurings

That Subsequently Defaulted

During the Period:

           

Construction and development

     —         $ —           —         $ —     

1-4 Family residential

     3         193,301         1         84,093   

Nonfarm, nonresidential

     1         337,084         1         337,084   

Commercial and industrial

     4         1,176,757         3         1,094,181   

During the nine months ended September 30, 2011, eight loans that had previously been restructured, were in default, two of which went into default in the quarter.

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

 

18


SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 8. FAIR VALUE

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

Fair Value Hierarchy

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

 

Level 1    Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2    Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3    Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

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

Investment Securities Available for Sale

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

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with the Receivables Topic of the FASB ASC. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 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.

 

19


SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 8. FAIR VALUE, CONTINUED

Servicing Assets

A valuation of loan servicing rights is performed on an individual basis due to the small number of loans serviced. Loans are evaluated on a discounted earnings basis to determine the present value of future earnings. The present value of the future earnings is the estimated market value for the loan, calculated using consensus assumptions that a 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)                            
September 30, 2011    Total      Level 1      Level 2      Level 3  

Government-sponsored enterprises

   $ 2,010       $ —         $ 2,010       $ —     

Mortgage-backed securities

     53         —           53         —     

Corporate bonds

     449         —           449         —     

Servicing assets

     93         —           —           93   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets at fair value

   $ 2,605       $ —         $ 2,512       $ 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

   $ —         $ —         $ —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

20


SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 8. FAIR VALUE, CONTINUED

 

For the nine months ended September 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

     —          97,053   

Amortization included in other income

     (2,196     (1,478
  

 

 

   

 

 

 

Balance, September 30

   $ 92,682      $ 95,575   
  

 

 

   

 

 

 

Changes in Level 3 assets and liabilities measured at fair value on a recurring basis for the three month period ended September 30, 2011 and September 30, 2010, was $769 and $720, respectively, which was amortized to other income.

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

Loans-commercial and industrial

   $ 2,862       $ —         $ 2,862       $ —     

Loans-nonfarm, non-residential

     1,724         —           1,724         —     

Loans-other

     467         —           467         —     

Foreclosed assets

     182         —           182         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets at fair value

   $ 5,235       $ —         $ 5,235       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

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 September 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.

 

21


SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 8. 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):

 

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

Financial Assets

           

Cash and due from banks

   $ 2,570       $ 2,570       $ 2,398       $ 2,398   

Federal funds sold and interest-bearing deposits with banks

     34,502         34,502         23,494         23,494   

Securities, available for sale

     2,512         2,512         2,012         2,012   

Restricted equity securities

     853         853         941         941   

Loans, net of allowance for loan losses

     176,116         169,231         171,794         163,470   

Bank owned life insurance

     3,363         3,363         3,285         3,285   

Financial Liabilities

           

Deposits

     188,299         179,312         173,960         156,565   

Long-term debt

     8,100         8,670         9,450         9,848   

Commitments and contingencies

     —           —           —           —     

 

22


SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 9. 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 nine months ended September 30, 2011 and 2010.

 

     Convertible                                 Convertible  
     Preferred Stock Series A      Preferred Stock Series B      Preferred Stock Series C     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

     —           —           —           25,944         —           (2,208     —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Balance, September 30, 2010

     189,356       $ 2,620,325         2,000       $ 1,929,227         100       $ 101,014        —         $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Balance, January 1, 2011

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

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

Balance, September 30, 2011

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

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

 

NOTE 10. LITIGATION SETTLEMENT

During the third quarter of 2011, a lawsuit was settled in mediation that resulted in the Bank paying damages to a customer arising from the ordinary operations of the Bank. The Bank has no other liability under the agreement.

 

23


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 nine and three months ending September 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 September 30, 2011, was $515,480 or $0.15 per diluted share outstanding, compared to a $240,505 or $0.08 per diluted share outstanding, for the same period in 2010. Earnings for the three months ended September 30, 2011, are approximately 114.3% higher than for the same period in 2010. The increase results from a reduction in the provision for loan losses. The provision decreased from $636,736 in the third quarter of 2010 to $188,118 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 September 30, 2011, the guaranteed portion of loans equaled 20.8% of total loans compared to 18.1% at December 31, 2010. Net interest income increased slightly from $2,148,654 in the third quarter of 2010 to $2,263,325 in 2011. A reduction in the cost of deposits from the third quarter of 2010 to 2011 contributed to the margin improvement. Asset yields decreased from 5.28% to 5.09% from 2010 to 2011 due to the change in earning asset mix from higher yielding loans to lower yielding deposits in other banks. The cost of funds continued to decrease from 1.31% in the third quarter of 2010 to 1.05% in the third quarter of 2011. Noninterest income increased 2.8% in 2011 primarily due to an increase in revenues from the Company’s insurance and investment subsidiary. Noninterest expenses increased 9.7% from $1,616,525 in the third quarter of 2010, to $1,773,472 in 2011. Most of the increase is associated with a litigation settlement during the third quarter. The settlement, agreed to in mediation, states, among other things, that the Bank has no further liability under the agreement.

Net income available for common stockholders for the nine months ended September 30, 2011, was $1,687,891 or $0.48 per diluted share outstanding compared to $892,241 or $0.27 per diluted share outstanding for the same period in 2010. This represents a 89.2% increase in earnings for the first nine 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 $1,840,578 in the first nine months of 2010 to $67,190 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 lower provision.

 

24


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

 

Additionally loan guarantee enhancements increased as a percentage of total loans which further improved the credit quality of the loan portfolio. Net interest income increased slightly from $6,462,407 in the first nine months of 2010 to $6,558,755 in 2011. This increase is due to a reduction in deposit cost and deposit mix for the period ended September 30, 2011 versus the same period in 2010. Overall asset yields have decreased, but a corresponding reduction in the cost of deposits, primarily time deposits, and a larger mix of non interest bearing deposits maintained the margin percentage at near 2010 levels. Increases in overall interest earning assets over 2010 resulted in a larger net interest margin. Noninterest income decreased 11.7% 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 nine months of 2010. Noninterest expenses increased 8.1% from $4,910,380 in the nine months ended September 30, 2010, to $5,306,297 for the same period in 2011. Most of the increase is associated with write downs and expenses associated with foreclosed assets, the cost of litigation settlement and fees paid on government guaranteed loans. Foreclosed asset expense increased from $23,644 in first nine months of 2010 to $140,190 in 2011. Fees paid for guaranteed loans increased from $84,916 in the nine months ended September 30, 2010 to $124,246 in 2011.

On September 30, 2011, Surrey Bancorp’s assets totaled $229,007,209 compared to $213,652,484 on December 31, 2010. Net loans were $176,116,287 compared to $171,794,247 on December 31, 2010. This increase was attributable to an increase in gross loans of approximately $2,266,000 coupled with a net decrease in the loan loss reserve of approximately $2,056,000. Commercial loans increased 8.1% during the nine month period ended September 30, 2011; however real estate loans decreased over 3.1% leading to an overall increase in gross loans of 1.3%. Interest-bearing deposits with banks increased from $22,792,088 at December 31, 2010 to $33,791,894 at September 30, 2011, due to approximately a $14,339,000 increase in deposits over the first nine months of 2011.

Total deposits on September 30, 2011, were $188,299,291 compared to $173,960,073 at the end of 2010. This increase is attributable to increases in all primary deposit categories: demand deposits, savings deposits, including money market accounts and certificates of deposit. Demand deposits increased 13.4% from 2010 totals, while savings deposits increased 17.3%. Certificates of deposit increased 2.9% from December 31, 2010 totals.

Common stockholders’ equity increased by $1,737,374, or 7.01%, during the nine months ended September 30, 2011. The increase is comprised of net income of $1,825,081, adjustments to Accumulated Other Comprehensive Income of $13,503, proceeds from exercised stock options of $18,825, and other stock based compensation of $17,155. Decreases included the payment and accrual of preferred dividends of $137,190. The net increase resulted in a common stock book value of $8.24 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 September 30, 2011, as detailed in Note 9 to the financial statements. Combined preferred and common stockholders’ equity increased $1,737,374, or 6.07%, for the nine months ended September 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.

 

25


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

 

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

Investments in available for sale securities of $2,512,078 consisted of U.S. Governmental Agency obligations with maturities ranging from 10 to 29 months, corporate bonds with maturities of 6.75 years to 7.0 years, that reprice quarterly, and GNMA adjustable rate mortgage securities, which adjust annually.

Loans

Net loans outstanding on September 30, 2011, were $176,116,287 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 71.7% of the Bank’s loans as of September 30, 2011, are fixed rate loans with 28.3% floating with the Bank’s prime rate or other appropriate internal or external indices.

Deposits

Deposits on September 30, 2011, were $188,299,291, compared to $173,960,073 on December 31, 2010. The September total comes from a base of approximately 12,173 accounts compared to 12,295 accounts at December 31, 2010. Interest-bearing accounts represented 80.6% of September 30, 2011 period end deposits versus 83.9% at December 31, 2010.

Federal Funds Purchased

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

 

26


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
 

September 30, 2011:

    

Total Capital

    

(to Risk-Weighted Assets)

    

Surrey Bancorp (Consolidated)

     18.31     8.0

Surrey Bank & Trust

     18.15     8.0

Tier I Capital

    

(to Risk-Weighted Assets)

    

Surrey Bancorp (Consolidated)

     17.04     4.0

Surrey Bank & Trust

     16.89     4.0

Tier I Capital

    

(to Average Assets)

    

Surrey Bancorp (Consolidated)

     12.66     4.0

Surrey Bank & Trust

     12.54     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

 

27


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 is provided to the Board of Directors.

Nonperforming assets are detailed below.

 

     September 30,     December 31,  
     2011     2010  

Nonaccrual loans

   $ 4,528,236      $ 6,362,127   

Loans past due 90 days and still accruing

     2,562,139        —     

Foreclosed assets

     182,480        450,532   
  

 

 

   

 

 

 

Total

   $ 7,278,855      $ 6,812,659   
  

 

 

   

 

 

 

Total assets

   $ 229,007,209      $ 213,652,484   
  

 

 

   

 

 

 

Ratio of nonperforming assets to total assets

     3.18     3.19
  

 

 

   

 

 

 

At September 30, 2011, the Bank had loans totaling $4,528,236 in nonaccrual status. Loans past due 90 days and still accruing are primarily government guaranteed loans which will pay interest up to 120 days in arrears. The amount of loans over 90 days but less than 120 days past due equals $2,064,214. The guaranteed loans past due 90 days and still accruing equals $1,328,332 at September 30, 2011 of which the guaranteed portion is $780,077. Foreclosed assets at September 30, 2011 primarily include 1-4 family dwellings and nonfarm, nonresidential property. Loans that were considered impaired but were still accruing interest at September 30, 2011, including troubled debt restructurings, totaled $6,913,382. 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 $1,881,314 at quarter end, or 16.4% of the balances outstanding.

Nonaccrual and impaired loans still accruing are summarized below:

 

     September 30,      December 31,  
     2011      2010  

Construction and development

   $ 93,385       $ 136,703   

1-4 family residential

     949,971         2,172,065   

Nonfarm, nonresidential

     4,054,573         4,268,396   

Commercial and industrial

     6,338,214         8,050,109   

Consumer

     5,475         10,439   
  

 

 

    

 

 

 

Total impaired and nonaccrual

   $ 11,441,618       $ 14,637,712   
  

 

 

    

 

 

 

 

28


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:

 

     September 30, 2011     December 31, 2010  

Construction and development

   $ 5,253,339         2.91   $ 5,986,045         3.35

1-4 family residential

     41,806,459         23.13     46,356,711         25.98

Multi-family

     2,259,445         1.25     1,853,346         1.04

Farmland

     2,903,144         1.61     2,854,481         1.60

Nonfarm, non-residential

     49,721,494         27.51     48,170,698         27.00
  

 

 

    

 

 

   

 

 

    

 

 

 

Total real estate

     101,943,881         56.41     105,221,281         58.97

Agricultural

     43,263         0.02     73,852         0.04

Commercial and industrial

     71,722,630         39.69     66,377,076         37.20

Consumer

     7,013,836         3.88     6,759,770         3.79
  

 

 

    

 

 

   

 

 

    

 

 

 

Total loans

   $ 180,723,610         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 $47,206,000 in loans that carry government guarantees. The guaranteed portion of these loans amounts to $37,399,000 at September 30, 2011. Loan guarantees by loan class are below:

 

     September 30,      Guaranteed Portion  
     2011      Amount      Percentage  

Construction and development

   $ 5,253,339       $ —           —  

1-4 family residential

     41,806,459         947,418         2.27

Multi-family

     2,259,445         27,148         1.20

Farmland

     2,903,144         543,302         18.71

Nonfarm, non-residential

     49,721,494         13,736,925         27.63

Total real estate

     101,943,881         15,254,793         14.96
  

 

 

    

 

 

    

 

 

 

Agricultural

     43,263         —           —  

Commercial and industrial

     71,722,630         22,144,446         30.88

Consumer

     7,013,836         —           —  
  

 

 

    

 

 

    

 

 

 

Total loans

   $ 180,723,610       $ 37,399,239         20.69
  

 

 

    

 

 

    

 

 

 

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 $2,340,023 at September 30, 2011. Non-owner occupied nonfarm, non-residential properties included in nonfarm, non-residential loans above amounted to $9,279,818 at September 30, 2011.

 

29


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

 

The consolidated provision for loan losses was $67,190 in the first nine months of 2011 compared to a provision of $1,840,578 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 nine 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 September 30, 2011. Charge offs totaling $2,374,651 were taken by the Bank in the nine month period ended September 30, 2011. Additional charge offs of $22,217 were taken by Freedom Finance, LLC, resulting in total consolidated charge offs of $2,396,868 for the period. Reserves for nonaccrual and impaired loans at September 30, 2011 amounted to $1,881,314, compared to $4,069,260 at December 31, 2010.

The reserve for loan losses on September 30, 2011, was $4,628,232 or 2.56% of period end loans. This percentage is derived from total loans. Approximately $47,206,000 of the total loans outstanding at September 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 3.18% 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 nine months ended September 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 nine 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 September 30, 2011 and December 31, 2010.

 

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

Construction and development

   $ 36,488      $ —        $ 67,993      $ 39,267   

1-4 family residential

     490,283        710,586        766,017        272,405   

Nonfarm, non-residential

     940,468        686,495        229,393        220,321   

Commercial and industrial

     1,330,747        3,298,976        567,740        1,351,710   

Consumer

     148,817        5,475        143,832        —     

Other loans

     —          —          3,472        —     
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 2,946,803      $ 4,701,532      $ 1,778,447      $ 1,883,703   
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-accrual loans included above

   $ 126,751      $ 2,139,393      $ 369,103      $ 1,883,703   
  

 

 

   

 

 

   

 

 

   

 

 

 

Guaranteed portion

   $ 1,443,114      $ 2,315,316      $ 226,094      $ 994,931   
  

 

 

   

 

 

   

 

 

   

 

 

 

Ratio to total loans

     1.63     2.60     1.00     1.06
  

 

 

   

 

 

   

 

 

   

 

 

 

Ratio to total loans, net of guarantees

     1.05     1.66     1.06     0.61
  

 

 

   

 

 

   

 

 

   

 

 

 

Past due loans are reviewed weekly and collection efforts assessed to determine potential problems arising in the loan portfolio. Proactive monitoring of past due accounts allows management to anticipate trends within the portfolio and make appropriate adjustments to collection efforts and to the allowance for loan losses. Collectively, past dues increased from December 31, 2010 to September 30, 2011. The largest increases were in commercial and industrial loans and nonfarm, non-residential loans. These increases are primarily attributable to four customers, two of which accounted for approximately $1,098,000 of the commercial 30-89 day past dues at September 30, 2011 and $760,000 of the nonfarm non-residential loans 30-89 days past due. Those same customers were not past due at December 31, 2010. Approximately, $2,971,000 of the commercial 90 day past dues and $309,000 of the nonfarm, non-residential 90 day past due loans at September 30, 2011 are attributable to two other customers. At December 31, 2010, $1,282,000 of the commercial 90 day past dues was attributable to the same customers. Overall past dues increased approximately 47% from the end of 2010 to September 30, 2011. This increase in past dues is somewhat mitigated by the government guaranteed portions of the loans. At September 30, 2011, the guaranteed portion of total past due loans equals 49% compared to 33% at December 31, 2010.

 

30


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

 

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.

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 September 30, 2011, the liquidity position of the Company was good, in management’s opinion, with short-term liquid assets of $37,071,915. 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 September 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 $14,761,000 of which $8,100,000 of advances had been taken down at September 30, 2011.

 

31


ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable as a “Smaller Reporting Company”.

 

32


ITEM 4. CONTROLS AND PROCEDURES

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

 

33


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

 

34


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: November 14, 2011

 

/s/ Edward C. Ashby, III

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

Date: November 14, 2011

 

/s/ Mark H. Towe

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

 

35