Edgar Filing: SURREY BANCORP

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

for the quarterly period ended June 30, 2015

☐	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

For the transition period from ____________ to ___________

COMMISSION FILE NO. 000-50313

SURREY BANCORP

(Exact name of registrant as specified in its charter)

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

145 North Renfro Street, Mount Airy, NC 27030

(Address of principal executive offices)

(336) 783-3900

(Registrant's telephone number)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ☒ No ☐

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

Large accelerated filer	☐	Accelerated filer	☐

Non-accelerated filer	☐	Smaller reporting company	☒

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

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

On August 13, 2015 there were 3,549,665 common shares issued and outstanding.

PART I – FINANCIAL INFORMATION

Item 1.	Consolidated Financial Statements

	Consolidated Balance Sheets June 30, 2015 (Unaudited) and December 31, 2014	3

	Consolidated Statements of Income, Six Months Ended June 30, 2015 and 2014 (Unaudited)	4

	Consolidated Statements of Income, Three Months Ended June 30, 2015 and 2014 (Unaudited)	5

	Consolidated Statements of Comprehensive Income, Three and Six Months Ended June 30, 2015 and 2014 (Unaudited)	6

	Consolidated Statements of Cash Flows, Six Months Ended June 30, 2015 and 2014 (Unaudited)	7

	Consolidated Statements of Changes in Stockholders’ Equity Six Months Ended June 30, 2015 and 2014 (Unaudited)	8

	Notes to Consolidated Financial Statements	9-23

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

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	32

Item 4.	Controls and Procedures	33

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	34

Item 1A.	Risk Factors	34

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

Item 3.	Defaults Upon Senior Securities	34

Item 4.	Mine Safety Disclosures	34

Item 5.	Other Information	34

Item 6.	Exhibits	34

SIGNATURES		35

CERTIFICATIONS		36-38

Table of Contents

Consolidated Balance Sheets

June 30, 2015 (Unaudited) and December 31, 2014 (Audited)

	June 2015			December 2014

Assets
Cash and due from banks	$	6,110,887		$	6,236,749
Interest-bearing deposits with banks		36,882,799			37,315,779
Federal funds sold		1,215,322			1,212,776
Investment securities available for sale		4,372,473			4,363,805
Restricted equity securities		524,889			618,109
Loans, net of allowance for loan losses of $3,686,569 at June 30, 2015 and $3,554,664 at December 31, 2014		189,881,404			189,549,072
Property and equipment, net		4,723,827			4,368,589
Foreclosed assets		193,801			280,821
Accrued income		1,063,955			997,681
Goodwill		120,000			120,000
Bank owned life insurance		5,049,751			5,623,087
Other assets		2,940,463			2,514,855
Total assets	$	253,079,571		$	253,201,323

Liabilities and Stockholders’ Equity
Liabilities
Deposits:
Noninterest-bearing	$	54,431,532		$	52,969,691
Interest-bearing		153,001,537			153,696,890
Total deposits		207,433,069			206,666,581

Long-term debt		4,250,000			6,250,000
Dividends payable		45,730			827,159
Accrued interest payable		140,516			110,261
Other liabilities		3,059,330			2,576,668
Total liabilities		214,928,645			216,430,669

Commitments and contingencies (Note 4)

Stockholders’ equity
Preferred stock, 1,000,000 shares authorized, 189,356 shares of Series A issued and outstanding with no par value 4.5% convertible non-cumulative, perpetual, with a liquidation value of $14 per share;		2,620,325			2,620,325
181,154 shares of Series D issued and outstanding with no par value 5.0% convertible non-cumulative, perpetual; with a liquidation value of $7.08 per share;		1,248,482			1,248,482
Common stock, 10,000,000 shares authorized at no par value; 3,549,665 shares issued and outstanding		12,101,480			12,101,480
Retained earnings		22,185,722			20,808,309
Accumulated other comprehensive loss		(5,083	)		(7,942	)
Total stockholders’ equity		38,150,926			36,770,654
Total liabilities and stockholders’ equity	$	253,079,571		$	253,201,323

See Notes to Consolidated Financial Statements

Table of Contents

Consolidated Statements of Income

Six months ended June 30, 2015 and 2014 (Unaudited)

	2015			2014
Interest income
Loans and fees on loans	$	5,356,148		$	5,224,048
Federal funds sold		1,363			1,354
Investment securities available for sale, taxable		34,085			32,407
Investment securities available for sale, dividends		6,119			7,131
Deposits with banks		47,997			47,244
Total interest income		5,445,712			5,312,184

Interest expense
Deposits		467,168			546,508
Fed funds purchased		3			19
Long-term debt		118,464			144,547
Total interest expense		585,635			691,074
Net interest income		4,860,077			4,621,110

Recapture of loan losses		(43,496	)		(6,575	)
Net interest income after recapture of loan losses		4,903,573			4,627,685

Noninterest income
Service charges on deposit accounts		399,665			401,545
Gain on the sale of government guaranteed loans		-			127,362
Fees on loans delivered to correspondents		27,808			6,117
Other service charges and fees		359,488			322,050
Gain (loss) on the sale of investment securities		4,376			(2,543	)
Income from bank owned life insurance		73,569			79,484
Insurance commissions		215,315			254,226
Brokerage commissions		102,460			89,651
Other operating income		67,568			35,922
Total noninterest income		1,250,249			1,313,814

Noninterest expense
Salaries and employee benefits		1,991,930			1,949,012
Occupancy expense		228,578			224,255
Equipment expense		127,256			133,117
Data processing		231,208			211,077
Foreclosed assets, net		85,611			7,304
Postage, printing and supplies		106,641			96,948
Professional fees		248,005			207,861
FDIC insurance premiums		56,539			59,183
Other expense		794,282			776,375
Total noninterest expense		3,870,050			3,665,132
Net income before income taxes		2,283,772			2,276,367

Income tax expense		815,402			832,188
Net income		1,468,370			1,444,179

Preferred stock dividends		(90,957	)		(90,957	)
Net income available to common stockholders	$	1,377,413		$	1,353,222

Basic earnings per common share	$	0.39		$	0.38
Diluted earnings per common share	$	0.35		$	0.35
Basic weighted average common shares outstanding		3,549,665			3,542,984
Diluted weighted average common shares outstanding		4,187,334			4,176,919

See Notes to Consolidated Financial Statements

Table of Contents

Consolidated Statements of Income

Three months ended June 30, 2015 and 2014 (Unaudited)

	2015			2014
Interest income
Loans and fees on loans	$	2,676,839		$	2,631,578
Federal funds sold		672			670
Investment securities available for sale, taxable		17,278			16,145
Investment securities available for sale, dividends		3,885			3,514
Deposits with banks		27,160			27,634
Total interest income		2,725,834			2,679,541

Interest expense
Deposits		230,771			271,559
Fed funds purchased		3			2
Long-term debt		57,759			72,673
Total interest expense		288,533			344,234
Net interest income		2,437,301			2,335,307

Provision for loan losses		70,298			55,787
Net interest income after provision for loan losses		2,367,003			2,279,520

Noninterest income
Service charges on deposit accounts		208,321			202,461
Gain on the sale of government guaranteed loans		-			127,362
Fees on loans delivered to correspondents		22,162			5,587
Other service charges and fees		188,295			176,034
Loss on the sale of investment securities		-			(5,441	)
Income from bank owned life insurance		36,745			39,474
Insurance commissions		131,538			124,168
Brokerage commissions		23,419			42,519
Other operating income		14,535			19,722
Total noninterest income		625,015			731,886

Noninterest expense
Salaries and employee benefits		959,599			939,512
Occupancy expense		119,230			116,371
Equipment expense		64,360			74,246
Data processing		108,202			105,766
Foreclosed assets, net		46,767			8,198
Postage, printing and supplies		65,317			51,322
Professional fees		106,006			92,538
FDIC insurance premiums		32,081			29,557
Other expense		335,820			380,235
Total noninterest expense		1,837,382			1,797,745
Net income before income taxes		1,154,636			1,213,661

Income tax expense		414,700			445,882
Net income		739,936			767,779

Preferred stock dividends		(45,730	)		(45,730	)
Net income available to common stockholders	$	694,206		$	722,049

Basic earnings per common share	$	0.20		$	0.20
Diluted earnings per common share	$	0.18		$	0.18
Basic weighted average common shares outstanding		3,549,665			3,542,984
Diluted weighted average common shares outstanding		4,187,257			4,176,919

See Notes to Consolidated Financial Statements

Table of Contents

Consolidated Statements of Comprehensive Income

Three and Six months ended June 30, 2015 and 2014 (Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2015			2014			2015			2014

Net income	$	739,936		$	767,779		$	1,468,370		$	1,444,179

Other comprehensive income (loss):
Investment securities available for sale:
Unrealized holding gains (losses)		(2,615	)		65,746			10,211			70,311
Tax effect		338			(23,939	)		(4,464	)		(25,522	)
Reclassification of (gains) losses recognized in net income		-			5,441			(4,376	)		2,543
Tax effect		-			(1,849	)		1,488			(864	)
		(2,277	)		45,399			2,859			46,468
Comprehensive income	$	737,659		$	813,178		$	1,471,229		$	1,490,647

See Notes to Consolidated Financial Statements

Table of Contents

Consolidated Statements of Cash Flows

Six months ended June 30, 2015 and 2014 (Unaudited)

	2015			2014
Cash flows from operating activities
Net income	$	1,468,370		$	1,444,179
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		134,855			133,858
Gain on sale of property and equipment		(50	)		(406	)
Gain on the sale of government guaranteed loans		-			(127,362	)
(Gain) loss on the sale of securities		(4,376	)		2,543
(Gain) loss on the sale of foreclosed assets		9,620			(3,465	)
Recapture of loan losses		(43,496	)		(6,575	)
Deferred income tax benefit		(630	)		(1,026	)
(Accretion) of discount on securities, net of amortization of premiums		(304	)		14
Increase in cash surrender value of life insurance		(73,569	)		(79,484	)
Life insurance proceeds		1,001,320			-
Changes in assets and liabilities:
Accrued income		(66,274	)		(49,030	)
Other assets		(847,103	)		(1,063,577	)
Accrued interest payable		30,255			58,257
Other liabilities		547,397			724,995
Net cash provided by operating activities		2,156,015			1,032,921

Cash flows from investing activities
Net (increase) decrease in interest-bearing deposits with banks		432,980			(7,519,758	)
Net (increase) decrease in federal funds sold		(2,546	)		99,487
Purchases of investment securities		(1,012,202	)		(1,127,843	)
Maturities of investment securities		1,002,913			1,253,612
Redemption of restricted equity securities		104,400			59,000
Purchase of restricted equity securities		(11,180	)		(130	)
Net increase in loans		(419,410	)		(1,024,672	)
Proceeds from the sale of investment securities		11,135			123,491
Proceeds from the sale of foreclosed assets		207,974			26,415
Purchases of property and equipment		(490,093	)		(98,944	)
Proceeds from the sale of property and equipment		50			2,575
Net cash used in investing activities		(175,979	)		(8,206,767	)

Cash flows from financing activities
Net increase in deposits		766,488			7,555,938
Maturities of long-term debt		(2,000,000	)		-
Dividends paid		(872,386	)		(835,486	)
Net cash provided (used) by financing activities		(2,105,898	)		6,720,452
Net decrease in cash and cash equivalents		(125,862	)		(453,394	)
Cash and due from banks, beginning		6,236,749			7,424,593
Cash and due from banks, ending	$	6,110,887		$	6,971,199

Supplemental disclosures of cash flow information
Interest paid	$	555,635		$	632,817
Taxes paid	$	828,479		$	983,722
Supplemental disclosures of non-cash transactions
Loans transferred to foreclosed properties	$	130,574		$	157,061
Cash dividends declared but not paid	$	45,730		$	45,730

See Notes to Consolidated Financial Statements

Table of Contents

Consolidated Statements of Changes in Stockholders’ Equity

Six months ended June 30, 2015 and 2014 (Unaudited)

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

Balance, January 1, 2014	$	3,868,807		3,542,984	$	12,061,153	$	18,329,089		$	(41,423	)	$	34,217,626


Net income		-		-		-		1,444,179			-			1,444,179
Other comprehensive income		-		-		-		-			46,468			46,468

Dividends declared and accrued on convertible
Series A preferred stock ($.32 per share)		-		-		-		(59,157	)		-			(59,157	)
Dividends declared and accrued on convertible
Series D preferred stock ($.18 per share)		-		-		-		(31,800	)		-			(31,800	)
Balance, June 30, 2014	$	3,868,807		3,542,984	$	12,061,153	$	19,682,311		$	5,045		$	35,617,316

Balance, January 1, 2015	$	3,868,807		3,549,665	$	12,101,480	$	20,808,309		$	(7,942	)	$	36,770,654


Net income		-		-		-		1,468,370			-			1,468,370
Other comprehensive income		-		-		-		-			2,859			2,859

Dividends declared and accrued on convertible
Series A preferred stock ($.32 per share)		-		-		-		(59,157	)		-			(59,157	)
Dividends declared and accrued on convertible
Series D preferred stock ($.18 per share)		-		-		-		(31,800	)		-			(31,800	)
Balance, June 30, 2015	$	3,868,807		3,549,665	$	12,101,480	$	22,185,722		$	(5,083	)	$	38,150,926

See Notes to Consolidated Financial Statements

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SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1.

BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and therefore, do not include all disclosures required by generally accepted accounting principles for a complete presentation of financial statements. In the opinion of management, the consolidated financial statements contain all adjustments necessary to present fairly the financial condition of Surrey Bancorp, (the “Company), as of June 30, 2015, the results of its operations and comprehensive income for the six and three months ended June 30, 2015 and 2014, and its changes in stockholders’ equity and cash flows for the six months ended June 30, 2015 and 2014. These adjustments are of a normal and recurring nature. The results of operations for the six months ended June 30, 2015, are not necessarily indicative of the results expected for the full year. These consolidated financial statements should be read in conjunction with the Company’s audited financial statements and related disclosures for the year ended December 31, 2014, included in the Company’s Form 10-K. The balance sheet at December 31, 2014, has been taken from the audited financial statements at that date.

Organization

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

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

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

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

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

Critical Accounting Policies

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

Principles of Consolidation

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

Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.

BASIS OF PRESENTATION, CONTINUED

Presentation of Cash Flows

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

Investment Securities

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

Investment securities classified as held to maturity are those debt securities that the Bank has the ability and intent to hold to maturity. Accordingly, these securities are carried at cost adjusted for amortization of premiums and accretion of discount, computed by the interest-method over their contractual lives. At June 30, 2015 and December 31, 2014, the Bank had no investments classified as held to maturity.

Loans Held for Sale

The Bank originates and holds Small Business Administration (SBA) and United States Department of Agriculture (USDA) guaranteed loans in its portfolio in the normal course of business. Occasionally, the Bank sells the guaranteed portions of these loans into the secondary market. The loans are generally variable rate loans, which eliminates the market risk to the Bank and are therefore carried at cost. Fixed rate loans are carried at the lower of cost or market. The Bank recognizes gains on the sale of the guaranteed portion upon the consummation of the transaction. The Bank plans to continue to originate guaranteed loans for sales, however no such loans were funded and held for sale at June 30, 2015 and December 31, 2014.

Loans Receivable

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

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

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

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SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.

BASIS OF PRESENTATION, CONTINUED

Allowance for Loan Losses

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

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

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

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

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

Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements:

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

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SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.

BASIS OF PRESENTATION, CONTINUED

Recent Accounting Pronouncements, continued

In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a full retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.

In January 2015, the FASB issued guidance to eliminate from U.S. GAAP the concept of an extraordinary item, which is an event or transaction that is both (1) unusual in nature and (2) infrequently occurring. Under the new guidance, an entity will no longer (1) segregate an extraordinary item from the results of ordinary operations; (2) separately present an extraordinary item on its income statement, net of tax, after income from continuing operations; or (3) disclose income taxes and earnings-per-share data applicable to an extraordinary item. The amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. The Company will apply the guidance prospectively. The Company does not expect these amendments to have a material effect on its financial statements.

In February 2015, the FASB issued guidance which amends the consolidation requirements and significantly changes the consolidation analysis required under U.S. GAAP. Although the amendments are expected to result in the deconsolidation of many entities, the Company will need to reevaluate all its previous consolidation conclusions. The amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted (including during an interim period), provided that the guidance is applied as of the beginning of the annual period containing the adoption date. The Company does not expect these amendments to have a material effect on its financial statements

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

Subsequent Events

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

Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2.

SECURITIES

Debt and equity securities have been classified in the balance sheets according to management’s intent. The amortized costs of securities available for sale and their approximate fair values at June 30, 2015 and December 31, 2014 follow:

	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value

June 30, 2015
Government-sponsored enterprises	$	3,497,814	$	776	$	4,165	$	3,494,425
Mortgage-backed securities		22,668		673		-		23,341
Corporate bonds		300,000		-		15,000		285,000
Equities and mutual funds		560,578		28,417		19,288		569,707
	$	4,381,060	$	29,866	$	38,453	$	4,372,473

December 31, 2014
Government-sponsored enterprises	$	3,500,000	$	1,170	$	4,640	$	3,496,530
Mortgage-backed securities		25,592		715		-		26,307
Corporate bonds		300,000		-		45,000		255,000
Equities and mutual funds		552,635		42,900		9,567		585,968
	$	4,378,227	$	44,785	$	59,207	$	4,363,805

At June 30, 2015 and December 31, 2014, substantially all government-sponsored enterprises securities were pledged as collateral on public deposits and for other purposes as required or permitted by law. The mortgage-backed securities were pledged to the Federal Home Loan Bank.

Maturities of mortgage-backed bonds are stated based on contractual maturities. Actual maturities of these bonds may vary as the underlying mortgages are prepaid. The investment in equities and mutual funds by nature have no maturity date and are classified as due in one year or less. The scheduled maturities of securities (all available for sale) at June 30, 2015, were as follows:

	Amortized Cost		Fair Value
Due in one year or less	$	1,060,578	$	1,069,707
Due after one year through five years		3,311,607		3,293,552
Due after five years through ten years		-		-
Due after ten years		8,875		9,214
	$	4,381,060	$	4,372,473

The following table shows investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at June 30, 2015 and December 31, 2014. These unrealized losses on investment securities are a result of volatility in interest rates which relate to government-sponsored enterprises and corporate bonds issued by other banks and market volatility as it relates to equity and mutual fund investments at June 30, 2015 and December 31, 2014.

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

June 30, 2015
Government-sponsored enterprises	$	1,500,000	$	4,115	$	499,950	$	50	$	1,999,950	$	4,165
Corporate bonds		-		-		285,000		15,000		285,000		15,000
Equities and mutual funds		175,096		17,646		114,993		1,642		290,089		19,288
	$	1,675,096	$	21,761	$	899,943	$	16,692	$	2,575,039	$	38,453

December 31, 2014
Government-sponsored enterprises	$	1,995,360	$	4,640	$	-	$	-	$	1,995,360	$	4,640
Corporate bonds		-		-		255,000		45,000		255,000		45,000
Equities and mutual funds		69,129		5,592		107,999		3,975		177,128		9,567
	$	2,064,489	$	10,232	$	362,999	$	48,975	$	2,427,488	$	59,207

Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2.

SECURITIES, CONTINUED

Management considers the nature of the investment, the underlying causes of the decline in the market value and the severity and duration of the decline in market value in determining if impairment is other than temporary. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Based upon this evaluation, there are four securities in the portfolio at June 30, 2015, with unrealized losses for a period greater than 12 months. Three of these securities also had unrealized losses for a period greater than 12 months at December 31, 2014. We have analyzed each individual security for Other Than Temporary Impairment (“OTTI”) purposes by reviewing delinquencies, loan-to-value ratios, and credit quality and concluded that all unrealized losses presented in the tables above are not related to an issuer’s financial condition but are due to changes in the level of interest rates and no declines are deemed to be other than temporary in nature.

The Company had realized gains of $4,376 from the sales of equity and mutual fund investment securities for the six month period ended June 30, 2015, and realized losses of $2,543 from the sales of equity and mutual fund investment securities for the six month periods ended June 30, 2014. Total proceeds from the sales amounted to $11,135 and $123,491 in 2015 and 2014, respectively.

NOTE 3.

EARNINGS PER COMMON SHARE

Basic earnings per common share for the six and three months ended June 30, 2015 and 2014 were calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period.

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

NOTE 4.

COMMITMENTS AND LETTERS OF CREDIT

At June 30, 2015, the Company had commitments to extend credit, including unused lines of credit of approximately $46,014,000 and letters of credit outstanding of $2,350,151.

NOTE 5.

LOANS

The major components of loans in the balance sheets at June 30, 2015 and December 31, 2014 are below.

	2015			2014

Commercial	$	54,582,484		$	56,602,425
Real estate:
Construction and land development		5,003,033			10,061,249
Residential, 1-4 families		42,429,891			41,824,806
Residential, 5 or more families		1,203,369			1,109,586
Farmland		3,781,568			3,486,002
Nonfarm, nonresidential		81,471,018			74,275,793
Agricultural		571,378			675,474
Consumer, net of discounts of $12,625 in 2015 and $11,950 in 2014		4,453,977			4,997,023
		193,496,718			193,032,358
Deferred loan origination costs, net of (fees)		71,255			71,378
		193,567,973			193,103,736
Allowance for loan losses		(3,686,569	)		(3,554,664	)
	$	189,881,404		$	189,549,072

Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5.

LOANS, CONTINUED

Residential, 1-4 family loans pledged as collateral against FHLB advances approximated $12,084,000 and $18,124,000 at June 30, 2015 and December 31, 2014, respectively.

NOTE 6.

ALLOWANCE FOR LOAN LOSSES

The activity of the allowance for loan losses by loan components during the six months ended June 30, 2015 and 2014 was as follows:

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

June 30, 2015

Allowance for credit losses:
Beginning balance	$	160,100		$	798,199		$	1,067,315		$	1,301,900		$	158,750		$	68,400	$	3,554,664
Charge-offs		-			(119,738	)		-			(14,308	)		(63,747	)		-		(197,793	)
Recoveries		-			1,470			556			355,079			16,089			-		373,194
Provision		(79,500	)		99,807			(20,437	)		(109,264	)		61,398			4,500		(43,496	)
Ending balance	$	80,600		$	779,738		$	1,047,434		$	1,533,407		$	172,490		$	72,900	$	3,686,569

Ending balance: individually evaluated for impairment	$	-		$	5,538		$	82,334		$	130,207		$	-		$	-	$	218,079
Ending balance: collectively evaluated for impairment	$	80,600		$	774,200		$	965,100		$	1,403,200		$	172,490		$	72,900	$	3,468,490

Loans Receivable:
Ending balance	$	5,003,033		$	42,429,891		$	81,471,018		$	54,582,484		$	4,453,977		$	5,556,315	$	193,496,718

Ending balance: individually evaluated for impairment	$	12,364		$	902,831		$	2,638,166		$	1,001,378		$	-		$	238,369	$	4,793,108
Ending balance: collectively evaluated for impairment	$	4,990,669		$	41,527,060		$	78,832,852		$	53,581,106		$	4,453,977		$	5,317,946	$	188,703,610

June 30, 2014

Allowance for credit losses:
Beginning balance	$	73,000		$	617,629		$	753,050		$	1,708,962		$	181,309		$	41,400	$	3,375,350
Charge-offs		-			(76,891	)		(1,778	)		(3,506	)		(21,420	)		-		(103,595	)
Recoveries		-			1,463			78,604			147,917			30,128			-		258,112
Provision		37,500			179,624			(5,389	)		(174,521	)		(48,189	)		4,400		(6,575	)
Ending balance	$	110,500		$	721,825		$	824,487		$	1,678,852		$	141,828		$	45,800	$	3,523,292

Ending balance: individually evaluated for impairment	$	-		$	47,025		$	122,587		$	253,152		$	-		$	-	$	422,764
Ending balance: collectively evaluated for impairment	$	110,500		$	674,800		$	701,900		$	1,425,700		$	141,828		$	45,800	$	3,100,528
Ending balance: loans acquired with deteriorated credit quality	$	-		$	-		$	-		$	-		$	-		$	-	$	-

Loans Receivable:
Ending balance	$	8,554,036		$	40,112,807		$	60,709,768		$	65,638,983		$	5,072,907		$	4,062,069	$	184,150,570

Ending balance: individually evaluated for impairment	$	244,821		$	415,487		$	2,814,048		$	1,542,364		$	-		$	-	$	5,016,720
Ending balance: collectively evaluated for impairment	$	8,309,215		$	39,697,320		$	57,895,720		$	64,096,619		$	5,072,907		$	4,062,069	$	179,133,850
Ending balance: loans acquired with deteriorated credit quality	$	-		$	-		$	-		$	-		$	-		$	-	$	-

Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6.

ALLOWANCE FOR LOAN LOSSES, CONTINUED

The following table presents impaired loans individually evaluated by class of loan as of June 30, 2015 and December 31, 2014 and the recognized interest income per the related period:

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

June 30, 2015
With no related allowance recorded:
Construction and development	$	12,364	$	12,364	$	-	$	13,261	$	526
1-4 family residential		882,673		940,638		-		967,164		7,947
Nonfarm, nonresidential		2,205,425		2,205,425		-		2,210,993		50,894
Commercial and industrial		715,138		768,811		-		740,948		4,765
Consumer		-		-		-		-		-
Other loans		238,369		238,369		-		243,371		8,331
		4,053,969		4,165,607		-		4,175,737		72,463

With an allowance recorded:
Construction and development		-		-		-		-		-
1-4 family residential		20,158		20,158		5,538		21,016		-
Nonfarm, nonresidential		432,741		432,741		82,334		776,175		-
Commercial and industrial		286,240		286,240		130,207		518,266		-
Consumer		-		-		-		-		-
Other loans		-		-		-		-		-
		739,139		739,139		218,079		1,315,457		-

Combined:
Construction and development		12,364		12,364		-		13,261		526
1-4 family residential		902,831		960,796		5,538		988,180		7,947
Nonfarm, nonresidential		2,638,166		2,638,166		82,334		2,987,168		50,894
Commercial and industrial		1,001,378		1,055,051		130,207		1,259,214		4,765
Consumer		-		-		-		-		-
Other loans		238,369		238,369		-		243,371		8,331
	$	4,793,108	$	4,904,746	$	218,079	$	5,491,194	$	72,463

December 31, 2014
With no related allowance recorded:
Construction and development	$	13,536	$	13,536	$	-	$	13,788	$	2,710
1-4 family residential		174,314		174,314		-		174,882		7,269
Nonfarm, nonresidential		1,806,013		1,806,013		-		1,826,306		94,953
Commercial and industrial		844,682		844,682		-		986,462		9,452
Consumer		-		-		-		-		-
Other loans		228,111		228,111		-		228,884		15,244
		3,066,656		3,066,656		-		3,230,322		129,628

With an allowance recorded:
Construction and development		-		-		-		-		-
1-4 family residential		399,764		399,764		97,799		402,691		8,141
Nonfarm, nonresidential		852,925		852,925		117,215		852,872		358
Commercial and industrial		554,787		554,787		162,900		552,865		72
Consumer		-		-		-		-		-
Other loans		-		-		-		-		-
		1,807,476		1,807,476		377,914		1,808,428		8,571

Combined:
Construction and development		13,536		13,536		-		13,788		2,710
1-4 family residential		574,078		574,078		97,799		577,573		15,410
Nonfarm, nonresidential		2,658,938		2,658,938		117,215		2,679,178		95,311
Commercial and industrial		1,399,469		1,399,469		162,900		1,539,327		9,524
Consumer		-		-		-		-		-
Other loans		228,111		228,111		-		228,884		15,244
	$	4,874,132	$	4,874,132	$	377,914	$	5,038,750	$	138,199

Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6.

ALLOWANCE FOR LOAN LOSSES, CONTINUED

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

	30-59 Days Past Due			60-89 Days Past Due			90 Days Plus Past Due			Total Past Due			Current			Total Loans			Recorded Investment > 90 Days and Accruing
June 30, 2015

Construction and development	$	-		$	-		$	-		$	-		$	5,003,033		$	5,003,033			-
1-4 family residential		613,778			182,740			455,672			1,252,190			41,177,701			42,429,891			7,887
Nonfarm, nonresidential		236,857			76,862			56,543			370,262			81,100,756			81,471,018			-
Commercial and industrial		194,786			-			464,692			659,478			53,923,006			54,582,484			-
Consumer		203,433			46,495			23,983			273,911			4,180,066			4,453,977			22,862
Other loans		-			-			54,812			54,812			5,501,503			5,556,315			54,812
Total	$	1,248,854		$	306,097		$	1,055,702		$	2,610,653		$	190,886,065		$	193,496,718		$	85,561
Percentage of total loans		0.65	%		0.16	%		0.55	%		1.35	%		98.65	%		100.00	%

Non-accruals included above
Construction and development	$	-		$	-		$	-		$	-		$	-		$	-
1-4 family residential		-			-			447,785			447,785			257,251			705,036
Nonfarm, nonresidential		99,313			-			56,542			155,855			389,601			545,456
Commercial and industrial		51,655			-			464,692			516,347			-			516,347
Consumer		-			-			1,122			1,122			-			1,122
Other loans		-			-			-			-			-			-
	$	150,968		$	-		$	970,141		$	1,121,109		$	646,852			1,767,961

December 31, 2014

Construction and development	$	94,736		$	-		$	-		$	94,736		$	9,966,513		$	10,061,249		$	-
1-4 family residential		362,406			274,595			172,981			809,982			41,014,824			41,824,806			-
Nonfarm, nonresidential		137,733			105,473			663,902			907,108			73,368,685			74,275,793			-
Commercial and industrial		63,744			20,476			1,271,937			1,356,157			55,246,268			56,602,425			-
Consumer		169,895			48,785			54,306			272,986			4,724,037			4,997,023			53,184
Other loans		-			-			-			-			5,271,062			5,271,062			-
Total	$	828,514		$	449,329		$	2,163,126		$	3,440,969		$	189,591,389		$	193,032,358		$	53,184
Percentage of total loans		0.43	%		0.23	%		1.12	%		1.78	%		98.22	%		100.00	%

Non-accruals included above
Construction and development	$	-		$	-		$	-		$	-		$	-		$	-
1-4 family residential		162,027			56,664			172,981			391,672			112,752			504,424
Nonfarm, nonresidential		133,147			-			663,902			797,049			395,558			1,192,607
Commercial and industrial		18,859			-			1,271,937			1,290,796			-			1,290,796
Consumer		-			-			1,122			1,122			-			1,122
Other loans		-			-			-			-			-			-
	$	314,033		$	56,664		$	2,109,942		$	2,480,639		$	508,310		$	2,988,949

Credit Quality Indicators:

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

Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6.

ALLOWANCE FOR LOAN LOSSES, CONTINUED

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

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

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

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

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

	Total			Pass Credits			Special Mention			Substandard			Doubtful

June 30, 2015

Construction and development	$	5,003,033		$	5,003,033		$	-		$	-		$	-
1-4 family residential		42,429,891			41,452,350			977,541			-			-
Nonfarm, nonresidential		81,471,018			80,453,145			1,017,873			-			-
Commercial and industrial		54,582,484			53,659,088			923,396			-			-
Consumer		4,453,977			4,445,525			8,452			-			-
Other loans		5,556,315			5,543,657			12,658			-			-
	$	193,496,718		$	190,556,798		$	2,939,920		$	-		$	-

Percentage of total loans		100.0	%		98.5	%		1.5	%		-	%		-	%

Guaranteed portion of loans

Construction and development	$	15,051		$	15,051		$	-		$	-		$	-
1-4 family residential		561,738			341,769			219,969			-			-
Nonfarm, nonresidential		36,196,650			35,632,674			563,976			-			-
Commercial and industrial		12,821,542			12,453,196			368,346			-			-
Consumer		-			-			-			-			-
Other loans		753,014			746,685			6,329			-			-
	$	50,347,995		$	49,189,375		$	1,158,620		$	-		$	-

	Total			Pass Credits			Special Mention			Substandard			Doubtful

December 31, 2014

Construction and development	$	10,061,249		$	10,061,249		$	-		$	-		$	-
1-4 family residential		41,824,806			41,009,963			641,862			172,981			-
Nonfarm, nonresidential		74,275,793			72,657,724			1,618,069			-			-
Commercial and industrial		56,602,425			55,274,007			1,328,418			-			-
Consumer		4,997,023			4,996,479			544			-			-
Other loans		5,271,062			5,254,896			16,166			-			-
	$	193,032,358		$	189,254,318		$	3,605,059		$	172,981		$	-

		100.0	%		98.0	%		1.9	%		0.1	%		-	%

Table of Contents

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6.

ALLOWANCE FOR LOAN LOSSES, CONTINUED

	Total		Pass Credits		Special Mention		Substandard		Doubtful

Guaranteed portion of loans

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

NOTE 7.

TROUBLED DEBT RESTRUCTURINGS

There have been no troubled debt restructurings for the six and three months ended June 30, 2015. For the six and three months ended June 30, 2014, the following table presents loans modified during the period that were considered to be troubled debt restructurings.

	For the three months ended June 30, 2014						For the six months ended June 30, 2014
	Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		Number of Contracts		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Construction and development		-	$	-	$	-		-	$	-	$	-
1-4 Family residential		-		-		-		3		159,927		163,627
Nonfarm, nonresidential		-		-		-		-		-		-
Commercial and industrial		-		-		-		-		-		-

During the six and three months ended June 30, 2015 and 2014, no loans that had previously been restructured were in default.

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

NOTE 8.

NORTH CAROLINA TAX RATE CHANGE

On July 23, 2013, North Carolina Governor Pat McCrory signed a major tax reform bill into law that lowered the North Carolina corporate income tax rate among other things. Specifically, the corporate income tax rate was reduced from 6.9% to 6% in 2014 and to 5% in 2015. The rate will be further reduced to 4% during the 2016 tax year and to 3% for post-2016 tax years provided that specified revenue growth targets are reached. Based on projected state income tax revenues, North Carolina’s revenues will exceed the target for FYE June 30, 2015 and the income tax rates will be reduced.

As of June 30, the Company estimates the rate reduction trigger will result in a $24,146 reduction in deferred income taxes. The Company plans to record the impact of this legislation as a reduction in deferred income taxes as of September 30, 2015 as we believe the enactment of the additional rate reductions outlined in the North Carolina tax law will be triggered when revenue collection totals are finalized.

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SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9.

FAIR VALUE

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

Fair Value Hierarchy

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

Level 1

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

Level 2

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

Level 3

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

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

Investment Securities Available for Sale

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

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with the Receivables Topic of the FASB ASC. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 2015, substantially all of the total impaired loans were evaluated based on the fair value of the collateral and discounted cash flows. In accordance with the Fair Value and Measurement Topic of the FASB ASC, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

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SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9.

FAIR VALUE, CONTINUED

Servicing Assets

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

Foreclosed Assets

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

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

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

(in thousands) June 30, 2015	Total		Level 1		Level 2		Level 3
Government-sponsored enterprises	$	3,494	$	-	$	3,494	$	-
Mortgage-backed securities		23		-		23		-
Corporate bonds		285		-		-		285
Equities and mutual funds		570		570		-		-
Total assets at fair value	$	4,372	$	570	$	3,517	$	285

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

For the six months ended June 30, 2015 and 2014, the changes in Level 3 assets and liabilities measured at fair value on a recurring basis were as follows:

	Level 3
	2014		2015
(in thousands)	Fair Value		Fair Value
Corporate Bonds – Available for Sale
Balance, January 1	$	255	$	451
Total unrealized gain (loss) included in income		-		-
Total unrealized gain (loss) included in other comprehensive income		30		45
Bonds called		-		(250	)
Balance, June 30	$	285	$	246

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SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9.

FAIR VALUE, CONTINUED

The change in the fair value of corporate bond assets for the six and three month periods ended June 30, 2015 was $30,000 and $15,000, respectively. There were no changes in Level 3 corporate bond assets measured at fair value on a recurring basis for the three month period ended June 30, 2014, except for the call of a $250,000 corporate bond with a recorded fair valued of $205,000.

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

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

(in thousands) June 30, 2015	Total		Level 1		Level 2		Level 3

Impaired loans:
Commercial and industrial	$	156	$	-	$	-	$	156
Nonfarm, non-residential		350		-		-		350
1-4 family residential		15		-		-		15
Foreclosed assets		194		-		-		194
Servicing assets		347		-		-		347
Total assets at fair value	$	1,062	$	-	$	-	$	1,062

(in thousands) December 31, 2014	Total		Level 1		Level 2		Level 3

Impaired loans:
Commercial and industrial	$	392	$	-	$	-	$	392
Nonfarm, non-residential		736		-		-		736
1-4 family residential		302		-		-		302
Foreclosed assets		281		-		-		281
Servicing assets		350		-		-		350
Total assets at fair value	$	2,061	$	-	$	-	$	2,061

Financial Instruments

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

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

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

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

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

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SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9.

FAIR VALUE, CONTINUED

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

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

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

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

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

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

The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments as of June 30, 2015 and December 31, 2014. This table excludes financial instruments for which the carrying amount approximates fair value.

					Fair Value Measurements
					Quoted Prices in Active Markets for Identical Assets or Liabilities		Significant Other Observable Inputs		Significant Unobservable Inputs
(dollars in thousands)	Carrying Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
June 30, 2015
Financial Instruments – Assets
Loans, net	$	189,881	$	196,835	$	-	$	-	$	196,835

Financial Instruments-Liabilities
Deposits		207,433		203,184		-		65,455		137,729
Long-Term Debt		4,250		4,408		-		-		4,408

December 31, 2014
Financial Instruments – Assets
Loans, net	$	189,549	$	195,254		-		-	$	195,254

Financial Instruments-Liabilities
Deposits		206,667		202,750		-		61,925		140,825
Long-Term Debt		6,250		6,486		-		-		6,486

Table of Contents

ITEM 2.

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

Introduction

This discussion, analysis and related financial information are presented to explain the significant factors which affected Surrey Bancorp's financial condition and results of operations for the three and six months ended June 30, 2015 and 2014. This discussion should be read in conjunction with the financial statements and related notes contained within this report.

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

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

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

Highlights

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

Net income available for common stockholders for the three months ended June 30, 2015, was $694,206 or $0.18 per diluted share outstanding, compared to a $722,049 or $0.18 per diluted share outstanding, for the same period in 2014. Earnings for the three months ended June 30, 2015, are approximately 3.9% lower than for the same period in 2014. The decrease in earnings results from a decrease in gains on the sale of government guaranteed loans. A gain of $127,362 was recognized in the quarter ended June 30, 2014. No such gains occurred in the second quarter of 2015. Net interest income increased from $2,335,307 in the second quarter of 2014 to $2,437,301 in 2015. Most of this increase is due to loan growth. Average loans outstanding increased 4.3% from the second quarter of 2014 to the second quarter of 2015, or approximately $7,851,000. The net interest margin increased slightly from 4.09% to 4.10% from 2014 to 2015 due to lower deposit costs. Asset yields dropped from 4.69% in 2014 to 4.59% in 2015 but the reduction was offset by a reduction in the cost of funds. The cost of funds decreased from 0.66% in the second quarter of 2014 to 0.54% in the second quarter of 2015. The provision for loan loss reserves increased from $55,787 in the second quarter of 2014 to a provision of $70,298 in 2015. The increase in the provision is partially due to an increase in the look back period used in computing the historical loss component of the allowance for loan losses. The look back period was generally increased by eighteen months. Noninterest expenses increased from $1,797,745 in the second quarter of 2014 to $1,837,382 in 2015, a 2.2% increase. Salary and employee benefits and professional fees accounted for the increase.

Table of Contents

ITEM 2.

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

Net income available for common stockholders for the six months ended June 30, 2015, was $1,377,413 or $0.35 per diluted share outstanding, compared to a $1,353,222 or $0.35 per diluted share outstanding, for the same period in 2014. Earnings for the six months ended June 30, 2015, are approximately 1.8% higher than for the same period in 2014. The increase in earnings results from an increase in net interest income and an increase in the recapture of loan loss reserves. Net interest income increased from $4,621,110 in the first six months of 2014 to $4,860,077 in 2015. Most of this increase is due to loan growth. Average loans outstanding increased 4.5% from the first six months of 2014 to the same period in 2015, or approximately $8,217,000. The net interest margin increased from 4.08% to 4.14% from 2014 to 2015 due to lower deposit costs. Asset yields dropped from 4.69% in 2014 to 4.64% in 2015 but the reduction was offset by a reduction in the cost of funds. The cost of funds decreased from 0.67% in the first six months of 2014 to 0.55% in 2015. The recapture of loan loss reserves increased from a recapture of $6,575 in 2014 to a recapture of $43,496 in 2015. The recapture of reserve is due to small loan growth since the 2014 year end, increased loans carrying government guarantees and net recoveries of charged off loans in the first six months of 2015. Gross loans increased approximately $464,000 from December 31, 2014 to June 30, 2015. However, the percentage of loans carrying government guarantees increased from $45,141,818, or 23.4% of gross loans at the end of 2014 to $50,347,995, or 26.0% of gross loans at June 30, 2015. The decreased credit exposure resulted in lower reserves. Net charge off recoveries amounted to $175,400 in the first six months of 2015 compared to net recoveries of $154,517 in the same period of 2014. Noninterest income decreased from $1,313,814 in the first six months of 2014 to $1,250,249 in 2015. The decrease primarily results a reduction in gains from the sale of government guaranteed loans. The Company had no gains for the first six months of 2015, down from the $127,362 reported in 2014. Noninterest expenses increased 5.6% from $3,665,132 in 2014, to $3,870,050 in 2015. This increase was due increases in salaries and benefits and to expenses associated with foreclosed assets. Salaries and benefits increased 2.2% from 1,949,012 in 2014 to 1,991,930 in 2015. Increases in foreclosed assets expense, professional fees and other expense all rose as a result of cost required to take possession and dispose of foreclosed properties.

On June 30, 2015, Surrey Bancorp's assets totaled $253,079,571 compared to $253,201,323 on December 31, 2014. Net loans were $189,881,404 compared to $189,549,072 on December 31, 2014. This net increase was the result of a $464,237 increase in loans and net deferred fees and a $131,905 net increase in the loan loss reserve. Nonfarm, nonresidential loans represent most of the growth in the loan portfolio. There was a 50.3% decrease in construction loans while other real estate loans collectively grew 6.8%. Commercial loans decreased by 3.6%. Overall gross loans increased 0.2%

Total deposits on June 30, 2015, were $207,433,069 compared to $206,666,581 at the end of 2014. This increase is attributable to an increase in demand deposit accounts, interest-bearing demand deposits accounts and savings accounts which increased collectively from $126,665,409 at December 31, 2014 to $132,857,447 at June 30, 2015. Overall, noninterest-bearing and interest-bearing demand deposits increased 4.7% from 2014 totals, while savings deposits, including money market accounts, increased 5.2%. Certificates of deposit decreased 6.8% from December 31, 2014 totals, or $5,425,550.

Common stockholders’ equity increased by $1,380,272, or 3.75%, during the six months ended June 30, 2015. The increase is comprised of net income of $1,468,370 and adjustments to other comprehensive income of $2,859. Decreases included the declaration and accrual of preferred dividends of $90,957. The net increase resulted in a common stock book value of $9.66 per share, up from $9.27 on December 31, 2014.

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

Preferred stockholders’ equity remained the same during the period ended June 30, 2015.

Table of Contents

ITEM 2.

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

Financial Condition, Liquidity and Capital Resources

Investments

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

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

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

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

Investments in available for sale securities of $4,372,473 consisted of Government-sponsored enterprise obligations with maturities ranging from 2 to 31 months, corporate bonds with maturities of 3.25 years, that reprice quarterly, GNMA adjustable rate mortgage securities, which adjust annually, and equity securities and mutual funds.

Loans

Net loans outstanding on June 30, 2015, were $189,881,404 compared to $189,549,072 on December 31, 2014. The Bank maintains a loan portfolio dominated by real estate and commercial loans diversified among various industries. Approximately 62.8% of the Bank's loans as of June 30, 2015, are fixed rate loans with 37.2% floating with the Bank's prime rate or other appropriate internal or external indices.

Table of Contents

ITEM 2.

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

Deposits

Deposits on June 30, 2015, were $207,433,069, compared to $206,666,581 on December 31, 2014. The June total consists of a base of approximately 12,820 accounts compared to 12,690 accounts at December 31, 2014. Interest-bearing accounts represent 73.8% of June 30, 2015 period end deposits versus 74.4% at December 31, 2014.

Stockholders' Equity

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

	Ratio			Minimum Required For Capital Adequacy Purposes
June 30, 2015:

Total Capital (to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		22.12	%		8.0	%
Surrey Bank & Trust		21.80	%		8.0	%
Common Equity Tier I Capital (to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		18.64	%		5.0	%
Surrey Bank & Trust		20.53	%		5.0	%
Tier I Capital (to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		20.85	%		4.0	%
Surrey Bank & Trust		20.53	%		4.0	%
Tier I Capital (to Average Assets)
Surrey Bancorp (Consolidated)		14.38	%		4.0	%
Surrey Bank & Trust		14.14	%		4.0	%

December 31, 2014:
Total Capital
(to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		21.55	%		8.0	%
Surrey Bank & Trust		21.11	%		8.0	%
Common Equity Tier I Capital (to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		n/	a		n/	a
Surrey Bank & Trust		n/	a		n/	a
Tier I Capital (to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		20.29	%		4.0	%
Surrey Bank & Trust		19.85	%		4.0	%
Tier I Capital (to Average Assets)
Surrey Bancorp (Consolidated)		13.93	%		4.0	%
Surrey Bank & Trust		13.65	%		4.0	%

Table of Contents

ITEM 2.

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

Asset Quality

The Company actively monitors delinquencies, nonperforming assets and potential problem loans. Unsecured loans past due more than 90 days are placed into nonaccrual status. Secured loans reach nonaccrual status when they surpass 120 days past due. When facts and circumstances indicate the borrower has regained the ability to meet the required payments, the loan is returned to accrual status.

Management reviews all criticized loans on a periodic basis for possible charge offs. Any unsecured loans that are 90 plus days past due must be charged off in full. If secured, a reserve equal to the potential loss will be established. Any charge off must be reported to the Board of Directors within 30 days. On a monthly basis, a management report of recovery actions is provided to the Board of Directors.

Nonperforming assets are detailed below.

	June 30, 2015			December 31, 2014
Nonaccrual loans	$	1,767,961		$	2,988,949
Loans past due 90 days and still accruing		85,561			53,184
Foreclosed assets		193,801			280,821
Total	$	2,047,323		$	3,322,954
Total assets	$	253,079,571		$	253,201,323

Ratio of nonperforming assets to total assets		0.81	%		1.31	%

At June 30, 2015, the Bank had loans totaling $1,767,961 in nonaccrual status. Nonaccrual loans totaling $646,852 were current at the end of June. The guaranteed portion of nonaccrual loans at June 30, 2015 is $653,239. Foreclosed assets at June 30, 2015 primarily consist of nonfarm, nonresidential properties. Loans that were considered impaired but were still accruing interest at June 30, 2015, including troubled debt restructurings, totaled $3,215,994. 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 $218,079 at June 30, 2015, or 4.4% of the balances outstanding.

Nonaccrual and impaired loans still accruing are summarized below:

	June 30, 2015		December 31, 2014
Construction and development	$	12,364	$	13,536
1-4 family residential		1,092,557		601,587
Nonfarm, nonresidential		2,638,166		2,658,937
Commercial and industrial		1,001,377		1,399,470
Consumer		1,122		8,854
Other loans		238,369		228,111
Total impaired and nonaccrual	$	4,983,955	$	4,910,495
Guaranteed portion	$	1,563,473	$	2,090,348

At June 30, 2015, consumer loans totaling $190,847 are included above that were not individually evaluated for impairment in the determination of the allowance for loan loss reserve (See Note 6). These loans are primarily home equity loans collateralized by 1-4 family properties which are considered consumer loans. These loans are on nonaccrual status at June 30, 2015 and therefore considered impaired.

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ITEM 2.

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

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

	June 30, 2015				December 31, 2014
Construction and development	$	5,003,033	2.59	%	$	10,061,249	5.21	%
1-4 family residential		42,429,891	21.93	%		41,824,806	21.67	%
Multi-family		1,203,369	0.62	%		1,109,586	0.57	%
Farmland		3,781,568	1.95	%		3,486,002	1.81	%
Nonfarm, nonresidential		81,471,018	42.10	%		74,275,793	38.48	%
Total real estate		133,888,879	69.19	%		130,757,436	67.74	%

Agricultural		571,378	0.30	%		675,474	0.35	%
Commercial and industrial		54,582,484	28.21	%		56,602,425	29.32	%
Consumer		4,453,977	2.30	%		4,997,023	2.59	%
Total loans	$	193,496,718	100.00	%	$	193,032,358	100.00	%

The concentrations represented above do not, based on managements’ assessment, expose the Bank to any unusual concentration risk. Based on the Bank’s asset size, the concentrations that are above area peer group analysis are nonfarm nonresidential and commercial and industrial loans. Management recognizes the inherent risk associated with commercial real estate and commercial lending, including a borrower's actual results of operations not corresponding to those projected by the borrower when the loan was funded; economic factors such as the number of housing starts and increases in interest rates, etc.; depression of collateral values; and completion of projects within the original cost and time estimates. The Bank mitigates some of that risk by actively seeking government guarantees on these loans. Collectively, the Bank has approximately $63,345,087 in loans that carry government guarantees. The guaranteed portion of these loans amounts to $50,347,995 at June 30, 2015. Loan guarantees by loan class are below:

	June 30,		Guaranteed Portion
	2015		Amount		Percentage
Construction and development	$	5,003,033	$	15,051		0.30	%
1-4 family residential		42,429,891		561,738		1.32	%
Multi-family		1,203,369		6,329		0.53	%
Farmland		3,781,568		746,685		19.75	%
Nonfarm, nonresidential		81,471,018		36,196,650		44.43	%
Total real estate		133,888,879		37,526,453		28.03	%

Agricultural		571,378		-		-	%
Commercial and industrial		54,582,484		12,821,542		23.49	%
Consumer		4,453,977		-		-	%
Total loans	$	193,496,718	$	50,347,995		26.02	%

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 $2,125,200, or 1.10% of total loans at June 30, 2015. Non-owner occupied nonfarm, non-residential properties included in nonfarm, non-residential loans above amounted to $14,513,133, or 7.50% of total loans at June 30, 2015.

The consolidated recapture of loan losses was $43,496 for the first six months of 2015 compared to a recapture of $6,575 for the same period in 2014. Gross loans increased $464,360 from December 31, 2014 to June 30, 2015. However, the percentage of loans carrying government guarantees increased from $45,141,818, or 23.4% of gross loans at the end of 2014 to $50,347,995, or 26.02% of gross loans at June 30, 2015. The decreased credit exposure resulted in lower reserves.

The reserve for loan losses on June 30, 2015, was $3,686,569 or 1.86% of period end loans. This percentage is derived from total loans. Approximately $63,345,000 of total loans outstanding at June 30, 2015, are government guaranteed loans which carry guarantees ranging from 49% to 100% of the outstanding loan balance. When the guaranteed portion of the loans, for which the Bank has no credit exposure, is removed from the equation the loan loss reserve is approximately 2.51% of outstanding loans. At December 31, 2014 the loan loss reserve percentage was 1.83% of total loans and 2.40% of loans net of government guarantees.

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ITEM 2.

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

The level of reserve is established based upon management's evaluation of historical loss data and the effects of certain environmental factors on the loan portfolio. The historical loss portion of the reserve is computed using the average loss data from the past applied to its corresponding category of loans. However, historical losses only reflect a small portion of the Bank’s loan loss reserve. The environmental factors represent risk from external economic influences on the credit quality of the loan portfolio. These factors include the movement of interest rates, unemployment rates, past due and charge off trends, loan grading migrations, movement in collateral values and the Bank’s exposure to certain loan concentrations. Positive or negative movements in any of these factors have an effect on the credit quality of the loan portfolio. As a result, management continues to actively monitor the Bank's asset quality affected by these environmental factors. The following table is a summary of loans past due at June 30, 2015 and December 31, 2014.

	June 30, 2015						December 31, 2014
	30-89 Days			90 Days Plus			30-89 Days			90 Days Plus

Construction and development	$	-		$	-		$	94,736		$	-
1-4 family residential		796,518			455,672			637,000			172,981
Nonfarm, non-residential		313,719			56,543			243,206			663,902
Commercial and industrial		194,786			464,692			84,221			1,271,937
Consumer		249,928			23,983			218,680			54,306
Other loans		-			54,812			-			-
	$	1,554,951		$	1,055,702		$	1,277,843		$	2,163,126
Non-accrual loans included above	$	150,968		$	970,141		$	370,697		$	2,109,942
Guaranteed portion	$	232,292		$	352,709		$	100,869		$	1,935,839

Ratio to total loans		0.81	%		0.55	%		0.66	%		1.12	%
Ratio to total loans, net of guarantees		0.93	%		0.49	%		0.80	%		0.15	%

Past due loans are reviewed weekly and collection efforts assessed to determine potential problems arising in the loan portfolio. Proactive monitoring of past due accounts allows management to anticipate trends within the portfolio and make appropriate adjustments to collection efforts and to the allowance for loan losses. Collectively, past dues decreased from December 31, 2014 to June 30, 2015. The decrease is in the 90 day plus time frame, as the 30-89 day plus time frame increased. The largest decrease was in commercial and industrial loans 90 days past due. The largest increase is in 1-4 family residential loans which increased collectively $442,209. This increase is made up of two loans, one of which has been partially charged off.

Net of loan guarantees, total past dues have increased from $1,405,383 at December 31, 2014, to $2,025,652 at June 30, 2015, or 44.2%. Total past due loans at June 30, 2015 consist of seventy-five loans with an average balance of $34,808, compared to fifty-seven loans at December 31, 2014, with an average balance of $58,614. Loans over $250,000 delinquent at June 30, 2015 and December 31, 2014 amounted to $680,313 and $1,223,882, respectively. The June 2015 and December 2014 totals consist of two and three loans, respectively, one of which is the same. The guaranteed portion of these loans at December 31, 2014, is $1,072,042. The June 30, 2015 total has no guarantees.

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.

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ITEM 2.

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

Interest Rate Sensitivity and Liquidity

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

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

At June 30, 2015, the liquidity position of the Company was excellent, in management’s opinion, with short-term liquid assets of $48,581,481 compared to $49,129,109 at December 31, 2014. To provide supplemental liquidity, the Bank has seven unsecured lines of credit with correspondent banks totaling $35,500,000. At June 30, 2015, there were no advances against these lines. Additionally, the Bank has a secured borrowing arrangement with the Federal Home Loan Bank (FHLB). The maximum credit available under this agreement approximates $8,488,000 of which $4,250,000 had been advanced at June 30, 2015.

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ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable as a “Smaller Reporting Company”.

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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.

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PART II - OTHER INFORMATION

Item 1.

Legal Proceedings

None

Item 1A.

Risk Factors

Not Applicable as a “Smaller Reporting Company”

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3.

Defaults Upon Senior Securities

Not Applicable

Item 4.

Mine Safety Disclosures

Not Applicable

Item 5.

Other Information

None

Item 6.

Exhibits

31.1

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

31.2

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

32.1

Certification of PEO/PFO Pursuant to Section 906 of the Sarbanes Oxley Act

101

Interactive Data File

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SIGNATURES

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

	Surrey Bancorp

Date: August, 13, 2015	/s/ Edward C. Ashby, III
	Edward C. Ashby, III
	President and Chief Executive Officer
	(Principal Executive Officer)

Date: August 13, 2015	/s/ Mark H. Towe
	Mark H. Towe
	Sr. Vice President and Chief Financial Officer
	(Principal Financial Officer)