Edgar Filing: SURREY BANCORP

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Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

for the quarterly period ended June 30, 2011

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

For the transition period from to

COMMISSION FILE NO. 000-50313

SURREY BANCORP

(Exact name of registrant as specified in its charter)

North Carolina

59-3772016

(State or other jurisdiction of

incorporation or organization)

(IRS Employer

Identification No.)

145 North Renfro Street, Mount Airy, NC 27030

(Address of principal executive offices)

(336) 783-3900

(Registrant’s telephone number)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

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

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

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

On August 5, 2011 there were 3,215,764 common shares issued and outstanding.

PART I – FINANCIAL INFORMATION


Item 1.	Consolidated Financial Statements

	Consolidated Balance Sheets June 30, 2011 (Unaudited) and December 31, 2010	3

	Consolidated Statements of Income, Six Months Ended June 30, 2011 and 2010 (Unaudited)	4

	Consolidated Statements of Income, Three Months Ended June 30, 2011 and 2010 (Unaudited)	5

	Consolidated Statements of Cash Flows, Six Months Ended June 30, 2011 and 2010 (Unaudited)	6

	Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income Six Months Ended June 30, 2011 and 2010 (Unaudited)	7

	Notes to Consolidated Financial Statements	8-22

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23-30

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	31

Item 4.	Controls and Procedures	32

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	33

Item 1A.	Risk Factors	33

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	33

Item 3.	Defaults Upon Senior Securities	33

Item 4.	(Removed and Reserved)	33

Item 5.	Other Information	33

Item 6.	Exhibits	33

SIGNATURES		34

CERTIFICATIONS		35-37

Consolidated Balance Sheets

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


	June 2011			December 2010

Assets
Cash and due from banks	$	2,641,584		$	2,398,433
Interest-bearing deposits with banks		37,255,803			22,792,088
Federal funds sold		705,453			702,121
Investment securities available for sale		2,516,590			2,012,132
Restricted equity securities		892,304			941,379
Loans, net of allowance for loan losses of $4,468,475 at June 30, 2011 and $6,683,922 at December 31, 2010		172,005,516			171,794,247
Property and equipment, net		4,694,516			4,726,483
Foreclosed assets		186,730			450,532
Accrued income		925,856			955,516
Goodwill		120,000			120,000
Bank owned life insurance		3,337,525			3,284,990
Other assets		3,062,606			3,474,563

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


Liabilities and Stockholders’ Equity
*Liabilities*
Deposits:
Noninterest-bearing	$	33,666,556		$	27,954,669
Interest-bearing		153,884,442			146,005,404

Total deposits		187,550,998			173,960,073

Long-term debt		9,100,000			9,450,000
Dividends payable		45,729			35,515
Accrued interest payable		247,017			227,887
Other liabilities		1,556,053			1,334,854

Total liabilities		198,499,797			185,008,329


Commitments and contingencies		—			—

*Stockholders’ equity*
Preferred stock, 1,000,000 shares authorized, 189,356 shares of Series A, issued and outstanding with no par value, 4.5% convertible non-cumulative, perpetual, with a liquidation value of $14 per share;		2,620,325			2,620,325
181,154 shares of Series D, issued and outstanding with no par value 5.0% convertible non-cumulative, perpetual; with a liquidation value of $7.08 per share;		1,248,482			1,248,482
Common stock, 10,000,000 shares authorized at no par value; 3,213,230 and 3,206,495 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively		9,487,704			9,464,178
Retained earnings		16,552,494			15,380,083
Accumulated other comprehensive loss		(64,319	)		(68,913	)

Total stockholders’ equity		29,844,686			28,644,155

Total liabilities and stockholders’ equity	$	228,344,483		$	213,652,484

See Notes to Consolidated Financial Statements

Consolidated Statements of Income

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


	2011			2010

*Interest income*
Loans and fees on loans	$	5,376,596		$	5,539,444
Federal funds sold		795			404
Investment securities, taxable		26,358			25,663
Deposits with banks		8,004			11,711

Total interest income		5,411,753			5,577,222


*Interest expense*
Deposits		933,423			1,042,286
Short-term debt		—			17,720
Long-term debt		182,900			203,463

Total interest expense		1,116,323			1,263,469

Net interest income		4,295,430			4,313,753

*Provision for loan losses*		(120,928	)		1,203,842

Net interest income after provision for loan losses		4,416,358			3,109,911


*Noninterest income*
Service charges on deposit accounts		508,885			532,477
Gain on sale of government guaranteed loans		—			244,924
Fees and yield spread premiums on loans delivered to correspondents		53,618			49,737
Other service charges and fees		247,027			223,049
Other operating income		359,979			369,462

Total noninterest income		1,169,509			1,419,649


*Noninterest expense*
Salaries and employee benefits		1,761,997			1,723,400
Occupancy expense		197,180			197,230
Equipment expense		120,497			136,383
Data processing		185,588			196,774
Foreclosed assets, net		140,332			15,682
Postage, printing and supplies		102,754			118,508
Professional fees		190,460			152,578
FDIC insurance premiums		139,577			118,281
Other expense		694,440			635,019

Total noninterest expense		3,532,825			3,293,855

Net income before income taxes		2,053,042			1,235,705

Income tax expense		789,674			455,156

Net income		1,263,368			780,549

*Preferred stock dividends and accretion of discount*		(90,957	)		(128,813	)

Net income available to common stockholders	$	1,172,411		$	651,736


*Basic earnings per common share*	$	0.37		$	0.20

*Diluted earnings per common share*	$	0.33		$	0.20

*Basic weighted average common shares outstanding*		3,210,498			3,206,263

*Diluted weighted average common shares outstanding*		3,786,800			3,604,913

See Notes to Consolidated Financial Statements

Consolidated Statements of Income

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


	2011			2010

*Interest income*
Loans and fees on loans	$	2,652,444		$	2,774,256
Federal funds sold		458			248
Investment securities, taxable		13,944			12,035
Deposits with banks		2,673			7,558

Total interest income		2,669,519			2,794,097


*Interest expense*
Deposits		459,353			516,011
Short-term debt		—			13,959
Long-term debt		91,364			104,387

Total interest expense		550,717			634,357

Net interest income		2,118,802			2,159,740

*Provision for loan losses*		(279,825	)		254,485

Net interest income after provision for loan losses		2,398,627			1,905,255


*Noninterest income*
Service charges on deposit accounts		260,994			270,302
Gain on sale of government guaranteed loans		—			32,865
Fees and yield spread premiums on loans delivered to correspondents		26,442			23,054
Other service charges and fees		128,068			123,914
Other operating income		160,527			164,754

Total noninterest income		576,031			614,889


*Noninterest expense*
Salaries and employee benefits		883,412			852,390
Occupancy expense		101,720			87,921
Equipment expense		61,634			72,347
Data processing		98,757			100,215
Foreclosed assets, net		120,908			11,490
Postage, printing and supplies		60,251			68,497
Professional fees		67,253			68,683
FDIC insurance premiums		56,287			66,399
Other expense		352,231			309,173

Total noninterest expense		1,802,453			1,637,115

Net income before income taxes		1,172,205			883,029

Income tax expense		461,028			332,256

Net income		711,177			550,773

*Preferred stock dividends and accretion of discount*		(45,729	)		(65,753	)

Net income available to common stockholders	$	665,448		$	485,020


*Basic earnings per common share*	$	0.21		$	0.15

*Diluted earnings per common share*	$	0.19		$	0.14

*Basic weighted average common shares outstanding*		3,212,247			3,206,495

*Diluted weighted average common shares outstanding*		3,788,549			3,605,146

See Notes to Consolidated Financial Statements

Consolidated Statements of Cash Flows

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


	2011			2010

*Cash flows from operating activities*
Net income	$	1,263,368		$	780,549
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		120,055			127,763
Gain on sale of property and equipment		(670	)		(300	)
Loss on the sale of foreclosed assets		50,254			9,411
Stock-based compensation, net of tax benefit		11,213			14,516
Provision for loan losses		(120,928	)		1,203,842
Deferred income taxes		(1,156	)		12,724
Accretion of discount on securities, net of amortization of premiums		870			1,944
Increase in cash surrender value of life insurance		(52,535	)		(55,308	)
Changes in assets and liabilities:
Accrued income		29,660			(12,829	)
Other assets		410,231			(868,538	)
Accrued interest payable		19,130			(3,996	)
Other liabilities		221,198			494,029

Net cash provided by operating activities		1,950,690			1,703,807


*Cash flows from investing activities*
Net increase in interest-bearing deposits with banks		(14,463,715	)		(6,105,763	)
Net increase in federal funds sold		(3,332	)		(88,085	)
Purchases of investment securities		(1,502,500	)		(1,500,000	)
Sales and maturities of investment securities		1,004,648			1,505,051
Redemption of restricted equity securities		49,100			10
Purchase of restricted equity securities		(25	)		—
Net (increase) decrease in loans		(315,466	)		4,219,857
Proceeds from the sale of foreclosed assets		438,673			54,890
Purchases of property and equipment		(88,088	)		(32,727	)
Proceeds from the sale of property and equipment		670			300

Net cash (used in) investing activities		(14,880,035	)		(1,946,467	)


*Cash flows from financing activities*
Net increase in deposits		13,590,925			3,598,122
Net decrease in short-term debt		—			(3,750,000	)
Net (decrease) increase in long-term debt		(350,000	)		750,000
Dividends paid		(80,742	)		(113,984	)
Common stock options exercised		12,313			34,450

Net cash provided by financing activities		13,172,496			518,588

Net increase (decrease) in cash and cash equivalents		243,151			275,928

*Cash and due from banks, beginning*		2,398,433			1,923,621

*Cash and due from banks, ending*	$	2,641,584		$	2,199,549


*Supplemental disclosures of cash flow information*
Interest paid	$	1,097,193		$	1,267,465

Taxes paid	$	424,019		$	819,457

Loans transferred to foreclosed properties	$	225,125		$	305,490

See Notes to Consolidated Financial Statements

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income

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


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

*Balance, January 1, 2010*	$	4,626,830		3,198,105	$	9,406,429	$	14,468,089		$	(75,996	)	$	28,425,352

*Comprehensive income*
Net income		—		—		—		780,549			—			780,549
Net change in unrealized gain (loss) on investment securities available for sale, net of income tax of $9,764		—		—		—		—			15,564			15,564

*Total comprehensive income*														796,113

Common stock options exercised		—		8,390		34,450		—			—			34,450
Stock-based compensation, net of tax benefit		—		—		14,516		—			—			14,516
Dividends declared on convertible
Series A preferred stock ($.31 per share)		—		—		—		(59,157	)		—			(59,157	)
Dividends declared and accrued on Series B and
Series C preferred stock, net of discount accretion and (premium) amortization		15,762		—		—		(69,656	)		—			(53,894	)

*Balance, June 30, 2010*	$	4,642,592		3,206,495	$	9,455,395	$	15,119,825		$	(60,432	)	$	29,157,380


*Balance, January 1, 2011*	$	3,868,807		3,206,495	$	9,464,178	$	15,380,083		$	(68,913	)	$	28,644,155

*Comprehensive income*
Net income		—		—		—		1,263,368			—			1,263,368
Net change in unrealized gain (loss) on investment securities available for sale, net of income tax of $2,882		—		—		—		—			4,594			4,594

*Total comprehensive income*														1,267,962

Common stock options exercised, net of shares surrendered in cashless exchange		—		6,735		12,313		—			—			12,313
Stock-based compensation, net of tax benefit		—		—		11,213		—			—			11,213

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

*Balance, June 30, 2011*	$	3,868,807		3,213,230	$	9,487,704	$	16,552,494		$	(64,319	)	$	29,844,686

See Notes to Consolidated Financial Statements

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1.

BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and therefore, do not include all disclosures required by generally accepted accounting principles for a complete presentation of financial statements. In the opinion of management, the consolidated financial statements contain all adjustments necessary to present fairly the financial condition of Surrey Bancorp, (the “Company), as of June 30, 2011, the results of operations for the six and three months ended June 30, 2011 and 2010, and its changes in stockholders’ equity and comprehensive income and cash flows for the six months ended June 30, 2011 and 2010. The results of operations for the three and six months ended June 30, 2011, are not necessarily indicative of the results expected for the full year. These consolidated financial statements should be read in conjunction with the Company’s audited financial statements and related disclosures for the year ended December 31, 2010, included in the Company’s Form 10-K. The balance sheet at December 31, 2010, has been taken from the audited financial statements at that date.

Organization

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

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

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

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

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

Critical Accounting Policies

The notes to the audited consolidated financial statements for the year ended December 31, 2010 contain a summary of the significant accounting policies. The Company believes our policies with respect to the methodology for the determination of the allowance for loan losses, and asset impairment judgments, including the recoverability of intangible assets involve a higher degree of complexity and require management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. These critical policies and their application are periodically reviewed with the Audit Committee and our Board of Directors. See our Annual Report for full details on critical accounting policies.

Principles of Consolidation

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

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.

BASIS OF PRESENTATION, CONTINUED

Presentation of Cash Flows

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

Investment Securities

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

Investment securities classified as held to maturity are those debt securities that the Bank has the ability and intent to hold to maturity. Accordingly, these securities are carried at cost adjusted for amortization of premiums and accretion of discount, computed by the interest-method over their contractual lives. At June 30, 2011 and December 31, 2010, the Bank had no investments classified as held to maturity.

Loans Held for Sale

The Bank originates and holds Small Business Administration (SBA) and United States Department of Agriculture (USDA) guaranteed loans in its portfolio in the normal course of business. Occasionally, the Bank sells the guaranteed portions of these loans into the secondary market. The loans are generally variable rate loans, which eliminates the market risk to the Bank and are therefore carried at cost. The Bank recognizes gains on the sale of the guaranteed portion upon the consummation of the transaction. The Bank plans to continue to originate guaranteed loans for sales, however no such loans were funded at June 30, 2011 and December 31, 2010.

Loans Receivable

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

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

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

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.

BASIS OF PRESENTATION, CONTINUED

Allowance for Loan Losses

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

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

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

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

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

Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements:

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

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

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.

BASIS OF PRESENTATION, CONTINUED

Recent Accounting Pronouncements, continued

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

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

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

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

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

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

Subsequent Events

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

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2. SECURITIES

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


	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value

June 30, 2011
Government-sponsored enterprises	$	2,001,656	$	10,184	$	—	$	2,011,840
Mortgage-backed securities		69,603		2,022		—		71,625
Corporate bonds		550,000		—		116,875		433,125

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


December 31, 2010
Government-sponsored enterprises	$	1,500,000	$	1,770	$	—	$	1,501,770
Mortgage-backed securities		74,278		1,584		—		75,862
Corporate bonds		550,000		—		115,500		434,500

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

At June 30, 2011 and December 31, 2010, substantially all government-sponsored enterprises securities were pledged as collateral on public deposits and for other purposes as required or permitted by law. The mortgage-backed securities were pledged to the Federal Home Loan Bank.

Maturities of mortgage-backed bonds are stated based on contractual maturities. Actual maturities of these bonds may vary as the underlying mortgages are prepaid. The scheduled maturities of securities (all available for sale) at June 30, 2011, were as follows:


	Amortized Cost		Fair Value

Due in one year or less	$	—	$	—
Due after one year through five years		2,001,656		2,011,840
Due after five years through ten years		605,061		489,693
Due after ten years		14,542		15,057

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

The following table shows investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, at June 30, 2011 and December 31, 2010. These unrealized losses on investment securities are a result of volatility in interest rates and primarily relate to corporate bonds issued by other banks at June 30, 2011 and December 31, 2010.


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

June 30, 2011
Corporate bonds	$	—	$	—	$	433,125	$	116,875	$	433,125	$	116,875

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


December 31, 2010
Corporate bonds	$	—	$	—	$	434,500	$	115,500	$	434,500	$	115,500

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

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2. SECURITIES, CONTINUED

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

The Company had no gross realized gains or losses from the sales of investment securities for the six and three month periods ended June 30, 2011 and 2010.

NOTE 3.

EARNINGS PER SHARE

Basic earnings per share for the six and three months ended June 30, 2011 and 2010 were calculated by dividing net income available to common stockholders by the weighted average number of shares outstanding during the period.

The computation of diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. The numerator is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares. The potential dilutive shares are represented by common stock options and by the Series A and D convertible preferred stock. Each share of the Series A preferred is convertible into 2.0868 shares of common stock. Each share of Series D preferred is convertible into one share of common stock.

NOTE 4.

COMMITMENTS AND LETTERS OF CREDIT

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

NOTE 5.

LOANS

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


	2011			2010

Commercial	$	67,791,434		$	66,377,076
Real estate:
Construction and land development		5,544,068			5,986,045
Residential, 1-4 families		42,991,762			46,356,711
Residential, 5 or more families		2,257,358			1,853,346
Farmland		2,735,521			2,854,481
Nonfarm, nonresidential		48,365,786			48,170,698
Agricultural		50,088			73,852
Consumer, net of discounts of $16,063 in 2011 and $14,770 in 2010		6,697,606			6,759,770

		176,433,623			178,431,979

Deferred loan origination costs, net of fees		40,368			46,190

		176,473,991			178,478,169
Allowance for loan losses		(4,468,475	)		(6,683,922	)

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

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5. LOANS, CONTINUED

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

NOTE 6. ALLOWANCE FOR LOAN LOSSES

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


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

2011

*Allowance for credit losses:*
Beginning balance	$	118,797		$	1,696,068		$	1,199,292		$	3,411,403		$	205,662		$	52,700		$	6,683,922
Charge-offs		(27,468	)		(1,105,516	)		(203,418	)		(959,152	)		(27,387	)		—			(2,322,941	)
Recoveries		996			54,285			83,772			71,500			17,869			—			228,422
Provision		6,720			77,596			(204,924	)		(537	)		(3,383	)		3,600			(120,928	)

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


Ending balance: individually evaluated for impairment	$	645		$	42,233		$	301,922		$	1,468,614		$	—		$	—		$	1,813,414

Ending balance: collectively evaluated for impairment	$	98,400		$	680,200		$	572,800		$	1,054,600		$	192,761		$	56,300		$	2,655,061

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


*Loans Receivable:*
Ending balance	$	5,544,068		$	42,991,762		$	48,365,786		$	67,791,434		$	6,697,606		$	5,042,967		$	176,433,623


Ending balance: individually evaluated for impairment	$	95,121		$	1,052,398		$	4,094,870		$	6,998,129		$	16,896		$	—		$	12,257,414

Ending balance: collectively evaluated for impairment	$	5,448,947		$	41,939,364		$	44,270,916		$	60,793,305		$	6,680,710		$	5,042,967		$	164,176,209

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


2010

*Allowance for credit losses:*
Beginning balance	$	106,397		$	628,963		$	696,044		$	2,903,267		$	281,134		$	54,100		$	4,669,905
Charge-offs		—			(26,728	)		(109,948	)		(82,830	)		(48,427	)		—			(267,933	)
Recoveries		—			—			20,501			—			16,672			—			37,173
Provision		(23,497	)		17,173			54,634			1,153,274			5,358			(3,100	)		1,203,842

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


Ending balance: individually evaluated for impairment	$	—		$	54,908		$	87,331		$	3,068,511		$	—		$	—		$	3,210,750

Ending balance: collectively evaluated for impairment	$	82,900		$	564,500		$	573,900		$	905,200		$	254,737		$	51,000		$	2,432,237

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


*Loans Receivable:*
Ending balance	$	6,897,511		$	46,751,717		$	46,438,718		$	68,522,853		$	7,038,277		$	4,636,669		$	180,285,745


Ending balance: individually evaluated for impairment	$	18,144		$	652,749		$	499,457		$	6,543,616		$	17,224		$	5,813		$	7,737,003

Ending balance: collectively evaluated for impairment	$	6,879,367		$	46,098,968		$	45,939,261		$	61,979,237		$	7,021,053		$	4,630,856		$	172,548,742

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

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6. ALLOWANCE FOR LOAN LOSSES, CONTINUED

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


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

June 30, 2011
With no related allowance recorded:
Construction and development	$	78,500	$	78,500	$	—	$	79,635	$	—
1-4 family residential		865,148		922,961		—		933,245		15,566
Nonfarm, nonresidential		2,437,161		2,599,892		—		2,619,716		49,880
Commercial and industrial		2,645,793		2,645,794		—		2,722,209		70,210
Consumer		16,896		16,896		—		18,437		301
Other loans		—		—		—		—		—

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


With an allowance recorded:
Construction and development	$	16,622	$	16,622	$	645	$	17,194	$	—
1-4 family residential		187,249		215,624		42,233		198,000		372
Nonfarm, nonresidential		1,657,709		1,657,709		301,992		1,691,991		8,004
Commercial and industrial		4,352,336		4,478,247		1,468,614		4,723,398		76,791
Consumer		—		—		—		—		—
Other loans		—		—		—		—		—

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


Combined:
Construction and development	$	95,122	$	95,122	$	645	$	96,829	$	—
1-4 family residential		1,052,397		1,138,585		42,233		1,131,245		15,938
Nonfarm, nonresidential		4,094,870		4,257,601		301,922		4,311,707		57,884
Commercial and industrial		6,998,129		7,124,041		1,468,614		7,445,607		147,001
Consumer		16,896		16,896		—		18,437		301
Other loans		—		—		—		—		—

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


December 31, 2010
With no related allowance recorded:
Construction and development	$	97,436	$	97,436	$	—	$	173,163	$	5,758
1-4 family residential		931,920		931,920		—		938,365		55,516
Nonfarm, nonresidential		2,098,860		2,098,860		—		2,136,591		110,297
Commercial and industrial		2,246,985		2,246,985		—		2,289,276		123,804
Consumer		10,439		10,439		—		10,439		—
Other loans		—		—		—		—		—

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


With an allowance recorded:
Construction and development	$	39,267	$	39,267	$	12,097	$	38,893	$	1,357
1-4 family residential		1,240,144		1,240,144		1,118,468		1,243,083		39,709
Nonfarm, nonresidential		2,169,536		2,169,536		604,692		2,216,160		126,030
Commercial and industrial		5,803,125		5,803,125		2,334,003		6,076,005		276,677
Consumer		—		—		—		—		—
Other loans		—		—		—		—		—

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


Combined:
Construction and development	$	136,703	$	136,703	$	12,097	$	212,056	$	7,115
1-4 family residential		2,172,064		2,172,064		1,118,468		2,181,448		95,225
Nonfarm, nonresidential		4,268,396		4,268,396		604,692		4,352,751		236,327
Commercial and industrial		8,050,110		8,050,110		2,334,003		8,365,281		400,481
Consumer		10,439		10,439		—		10,439		—
Other loans		—		—		—		—		—

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

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6. ALLOWANCE FOR LOAN LOSSES, CONTINUED

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


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

June 30, 2011

Construction and development	$	180,544	$	—	$	180,544	$	5,363,524	$	5,544,068	$	—
1-4 family residential		943,179		264,167		1,207,346		41,784,416		42,991,762		23,549
Nonfarm, nonresidential		552,023		—		552,023		47,813,763		48,365,786		—
Commercial and industrial		893,742		1,727,612		2,621,354		65,170,080		67,791,434		43,268
Consumer		53,130		8,463		61,593		6,636,013		6,697,606		2,742
Other loans		—		—		—		5,042,967		5,042,967		—

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

Non-accruals included above	$	494,212	$	1,930,683	$	2,424,895	$	2,453,363	$	4,878,258


December 31, 2010

Construction and development	$	67,993	$	39,267	$	107,260	$	5,878,785	$	5,986,045	$	—
1-4 family residential		766,017		272,405		1,038,422		45,318,289		46,356,711		—
Nonfarm, nonresidential		229,393		220,321		449,714		47,720,984		48,170,698		—
Commercial and industrial		567,740		1,351,710		1,919,450		64,457,626		66,377,076		—
Consumer		143,832		—		143,832		6,615,938		6,759,770		—
Other loans		3,472		—		3,472		4,778,207		4,781,679		—

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

Non-accruals included above	$	369,103	$	1,883,703	$	2,252,806	$	4,109,322	$	6,362,128

Credit Quality Indicators:

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

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

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

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

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

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6. ALLOWANCE FOR LOAN LOSSES, CONTINUED

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


							Special
	Total			Pass Credits			Mention			Substandard			Doubtful

June 30, 2011

Construction and development	$	5,544,068		$	5,448,947		$	95,121		$	—		$	—
1-4 family residential		42,991,762			41,870,311			1,121,451			—			—
Nonfarm, nonresidential		48,365,786			47,987,952			377,834			—			—
Commercial and industrial		67,791,434			62,937,773			4,853,661			—			—
Consumer		6,697,606			6,683,255			11,638			2,713			—
Other loans		5,042,967			5,042,967			—			—			—

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


		100.0	%		96.3	%		3.7	%		0.0	%		0.0	%


Guaranteed portion of loans	$	35,638,702		$	32,665,430		$	2,973,272		$	—		$	—


							Special
	Total			Pass Credits			Mention			Substandard			Doubtful

December 31, 2010

Construction and development	$	5,986,045		$	5,779,959		$	206,086		$	—		$	—
1-4 family residential		46,356,711			43,990,930			1,333,354			65,143			967,284
Nonfarm, nonresidential		48,170,698			45,750,435			2,420,263			—			—
Commercial and industrial		66,377,076			59,501,127			6,094,833			—			781,116
Consumer		6,759,770			6,743,029			13,864			2,877			—
Other loans		4,781,679			4,781,679			—			—			—

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


		100.0	%		93.3	%		5.7	%		0.0	%		1.0	%


Guaranteed portion of loans	$	32,259,668		$	29,142,378		$	3,117,290		$	—		$	—

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 7. FAIR VALUE

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

Fair Value Hierarchy

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


Level 1		Valuation is based upon quoted prices for identical instruments traded in active markets.

Level 2		Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3		Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

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

Investment Securities Available for Sale

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

Loans

The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with the Receivables Topic of FASB ASC. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 2011 substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with the Fair Value and Measurement Topic of the FASB ASC, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 7. FAIR VALUE, CONTINUED

Servicing Assets

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

Foreclosed Assets

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

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

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


*(in thousands)*
June 30, 2011	Total		Level 1		Level 2		Level 3
Government-sponsored enterprises	$	2,012	$	—	$	2,012	$	—
Mortgage-backed securities		72		—		72		—
Corporate bonds		433		—		433		—
Servicing assets		93		—		—		93

Total assets at fair value	$	2,610	$	—	$	2,517	$	93


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


*(in thousands)*
December 31, 2010	Total		Level 1		Level 2		Level 3
Government-sponsored enterprises	$	1,502	$	—	$	1,502	$	—
Mortgage-backed securities		76		—		76		—
Corporate bonds		434		—		434		—
Servicing assets		95		—		—		95


Total assets at fair value	$	2,107	$	—	$	2,012	$	95


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

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 7. FAIR VALUE, CONTINUED

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


	Level 3
	2011			2010
	Fair Value			Fair Value

*Balance, January 1*	$	94,878		$	—
Capitalized		—			64,115
Amortization included in other income		(1,427	)		(101	)

*Balance, June 30*	$	93,451		$	64,014

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

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

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


*(in thousands)*
June 30, 2011	Total		Level 1		Level 2		Level 3
Loans-commercial and industrial	$	2,884	$	—	$	2,884	$	—
Loans-nonfarm, non-residential		1,734		—		1,734		—
Loans-other		207		—		207		—
Foreclosed assets		187		—		187		—

Total assets at fair value	$	5,012	$	—	$	5,012	$	—

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


*(in thousands)*
December 31, 2010	Total		Level 1		Level 2		Level 3
Loans-commercial and industrial	$	3,469	$	—	$	3,469	$	—
Loans-nonfarm, non-residential		1,565		—		1,565		—
Loans- 1- 4 family residential		90		—		90		—
Loans-other		56		—		56		—
Foreclosed assets		451		—		451		—

Total assets at fair value	$	5,631	$	—	$	5,631	$	—

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

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

Financial Instruments

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

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

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

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 7. FAIR VALUE, CONTINUED

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

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

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

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

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

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

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

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

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


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

*Financial Assets*
Cash and due from banks	$	2,642	$	2,642	$	2,398	$	2,398
Federal funds sold and interest-bearing deposits with banks		37,961		37,961		23,494		23,494
Securities, available for sale		2,517		2,517		2,012		2,012
Restricted equity securities		892		892		941		941
Loans, net of allowance for loan losses		172,006		161,750		171,794		163,470
Bank owned life insurance		3,338		3,338		3,285		3,285

*Financial Liabilities*
Deposits		187,551		172,949		173,960		156,565
Long-term debt		9,100		9,456		9,450		9,848
Commitments and contingencies		—		—		—		—

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8.

STOCKHOLDERS’ EQUITY

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

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

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


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

*Balance, January 1, 2010*		189,356	$	2,620,325		2,000	$	1,903,283		100	$	103,222			—	$	—

Dividends declared and accrued on Series B and Series C preferred stock, net of discount accretion and (premium) amortization		—		—		—		17,231		—		(1,469	)		—		—

*Balance, June 30, 2010*		189,356	$	2,620,325		2,000	$	1,920,514		100	$	101,753			—	$	—


*Balance, January 1, 2011*		189,356	$	2,620,325		—	$	—		—	$	—			181,154	$	1,248,482


*Balance, June 30, 2011*		189,356	$	2,620,325		—	$	—		—	$	—			181,154	$	1,248,482

ITEM 2.

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

Introduction

This discussion, analysis and related financial information are presented to explain the significant factors which affected Surrey Bancorp’s financial condition and results of operations for the six and three months ending June 30, 2011 and 2010. This discussion should be read in conjunction with the financial statements and related notes contained within this report.

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

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

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

Highlights

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

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

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

ITEM 2.

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

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

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

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

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

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

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

Financial Condition, Liquidity and Capital Resources

Investments

The Bank maintains a portfolio of securities as part of its asset/liability and liquidity management programs which emphasize effective yields and maturities to match its needs. The composition of the investment portfolio is examined periodically and appropriate realignments are initiated to meet liquidity and interest rate sensitivity needs for the Bank.

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

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

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

ITEM 2.

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

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

Loans

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

Deposits

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

Federal Funds Purchased

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

ITEM 2.

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

Stockholders’ Equity

Surrey Bancorp and Surrey Bank & Trust are subject to various regulatory capital requirements administered by federal banking agencies. The Company and the Bank maintain strong capital positions which exceed all capital adequacy requirements of federal regulatory authorities. The Company’s and the Bank’s capital ratios are presented in the following table.


	Ratio			Minimum Required For Capital Adequacy Purposes

*June 30, 2011:*
Total Capital
(to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		18.19	%		8.0	%
Surrey Bank & Trust		18.01	%		8.0	%
Tier I Capital
(to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		16.93	%		4.0	%
Surrey Bank & Trust		16.74	%		4.0	%
Tier I Capital
(to Average Assets)
Surrey Bancorp (Consolidated)		12.50	%		4.0	%
Surrey Bank & Trust		12.36	%		4.0	%

*December 31, 2010:*
Total Capital
(to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		17.24	%		8.0	%
Surrey Bank & Trust		16.99	%		8.0	%
Tier I Capital
(to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)		15.97	%		4.0	%
Surrey Bank & Trust		15.72	%		4.0	%
Tier I Capital
(to Average Assets)
Surrey Bancorp (Consolidated)		11.88	%		4.0	%
Surrey Bank & Trust		11.69	%		4.0	%

ITEM 2.

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

Asset Quality

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

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

Nonperforming assets are detailed below.


	June 30, 2011			December 31, 2010

Nonaccrual loans	$	4,878,258		$	6,362,127
Loans past due 90 days and still accruing		69,559			—
Foreclosed assets		186,730			450,532

Total	$	5,134,547		$	6,812,659

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


Ratio of nonperforming assets to total assets		2.24	%		3.19	%

At June 30, 2011, the Bank had loans totaling $4,878,258 in nonaccrual status. Foreclosed assets at June 30, 2011 primarily include 1-4 family dwellings and nonfarm, nonresidential property. Loans that were considered impaired but were still accruing interest at June 30, 2011, including troubled debt restructurings, totaled $7,379,156. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due under the contractual terms of the loan agreement. Specific reserves on nonaccrual and impaired loans totaled $1,813,414 at quarter end, or 14.8% of the balances outstanding.

Nonaccrual and impaired loans still accruing are summarized below:


	June 30, 2011		December 31, 2010

Construction and development	$	95,122	$	136,703
1-4 family residential		1,052,397		2,172,065
Nonfarm, nonresidential		4,094,870		4,268,396
Commercial and industrial		6,998,129		8,050,109
Consumer		16,896		10,439

Total impaired and nonaccrual	$	12,257,414	$	14,637,712

ITEM 2.

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

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


	June 30, 2011				December 31, 2010

Construction and development	$	5,544,068	3.14	%	$	5,986,045	3.35	%
1-4 family residential		42,991,761	24.37	%		46,356,711	25.98	%
Multi-family		2,257,358	1.28	%		1,853,346	1.04	%
Farmland		2,735,521	1.55	%		2,854,481	1.60	%
Nonfarm, non-residential		48,365,786	27.41	%		48,170,698	27.00	%

Total real estate		101,894,494	57.75	%		105,221,281	58.97	%

Agricultural		50,088	0.03	%		73,852	0.04	%
Commercial and industrial		67,791,434	38.42	%		66,377,076	37.20	%
Consumer		6,697,607	3.80	%		6,759,770	3.79	%

Total loans	$	176,433,623	100.00	%	$	178,431,979	100.00	%

The concentrations represented above do not, based on managements’ assessment, expose the Bank to any unusual concentration risk. Based on the Bank’s asset size, the only concentration that is above area peer group analysis is commercial and industrial loans. Management recognizes the inherent risk associated with commercial lending, including whether or not a borrower’s actual results of operations will correspond to those projected by the borrower when the loan was funded; economic factors such as the number of housing starts and increases in interest rates, etc.; depression of collateral values; and completion of projects within the original cost and time estimates. The Bank mitigates some of that risk by actively seeking government guarantees on these loans. Collectively, the Bank has approximately $45,071,000 in loans that carry government guarantees. The guaranteed portion of these loans amounts to $35,639,000 at June 30, 2011. Loan guarantees by loan class are below:


	June 30, 2011		Guaranteed Portion
	June 30, 2011		Amount		Percentage

Construction and development	$	5,544,068	$	—		—	%
1-4 family residential		42,991,761		1,009,782		2.35	%
Multi-family		2,257,358		29,499		1.31	%
Farmland		2,735,521		529,754		19.37	%
Nonfarm, non-residential		48,365,786		13,875,919		28.69	%

Total real estate		101,894,494		15,444,954		15.16	%

Agricultural		50,088		—		—	%
Commercial and industrial		67,791,434		20,193,748		29.79	%
Consumer		6,697,607		—		—	%

Total loans	$	176,433,623	$	35,638,702		20.20	%

Loans in higher risk categories, such as non-owner occupied nonfarm, non-residential property and commercial real estate construction represent a small segment of our loan portfolio. Commercial construction loans included in construction and development loans amounted to $2,223,521 at June 30, 2011. Non-owner occupied nonfarm, non-residential properties included in nonfarm, non-residential loans above amounted to $8,560,739 at June 30, 2011.

ITEM 2.

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

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

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

The level of reserve is established based upon management’s evaluation of historical loss data and the effects of certain environmental factors on the loan portfolio. The historical loss portion of the reserve is computed using the average loss data from the past two years applied to its corresponding category of loans. However, historical losses only reflect a small portion of the Bank’s loan loss reserve, although that portion did increase during the first six months of 2011 due to the effect of charged off loans. The environmental factors represent risk from external economic influences on the credit quality of the loan portfolio. These factors include the movement of interest rates, unemployment rates, past due and charge off trends, loan grading migrations, movement in collateral values and the Bank’s exposure to certain loan concentrations. Positive or negative movements in any of these factors have an effect on the credit quality of the loan portfolio. As a result, management continues to actively monitor the Bank’s asset quality affected by these environmental factors. The following table is a summary of loans past due at June 30, 2011 and December 31, 2010.


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

Construction and development	$	180,544		$	—		$	67,993		$	39,267
1-4 family residential		943,179			264,167			766,017			272,405
Nonfarm, non-residential		552,023			—			229,393			220,321
Commercial and industrial		893,742			1,727,612			567,740			1,351,710
Consumer		53,130			8,463			143,832			—
Other loans		—			—			3,472			—

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


Ratio to total loans		1.49	%		1.13	%		1.00	%		1.06	%

Past due loans are reviewed weekly and collection efforts assessed to determine potential problems arising in the loan portfolio. Proactive monitoring of past due accounts allows management to anticipate trends within the portfolio and make appropriate adjustments to collection efforts and to the allowance for loan losses. Collectively, past dues increased from December 31, 2010 to June 30, 2011. The largest increase was in commercial and industrial loans. The increase is primarily attributable to one customer which accounted for approximately $435,000 of the 30-89 day past dues at June 30, 2011, compared to $61,000 at December 31, 2010. Approximately, $1,654,000 of the commercial 90 day past dues at June 30, 2011 is attributable to one customer. At December 31, 2010, $1,282,000 of the commercial 90 day past dues was attributable to the same customer. Overall past dues increased approximately 29% from the end of 2010 to June 30, 2011. Past dues are down from the March 31, 2011, increase of 34% over 2010 year end totals.

Management believes that its loan portfolio is sufficiently diversified such that a downturn in a particular market or industry will not have a significant impact on the loan portfolio or the Bank’s financial condition. Management believes that its provision and reserve offer an adequate allowance for loan losses and provide an appropriate reserve for the loan portfolio. The Bank lends primarily in Surry County, North Carolina and Patrick Country, Virginia and surrounding counties.

ITEM 2.

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

Interest Rate Sensitivity and Liquidity

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

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

At June 30, 2011, the liquidity position of the Company was good, in management’s opinion, with short-term liquid assets of $40,602,840. Deposit increases accounted for the net increase in liquidity from December 31, 2010 totals. To provide supplemental liquidity, the Bank has six unsecured lines of credit with correspondent banks totaling $25,500,000. At June 30, 2011, there were no advances against these lines. Additionally, the Bank has a secured borrowing arrangement with the Federal Home Loan Bank (FHLB). The maximum credit available under this agreement approximates $17,694,000 of which $9,100,000 of advances had been taken down at June 30, 2011.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable as a “Smaller Reporting Company”.

ITEM 4.

CONTROLS & PROCEDURES

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

PART II - OTHER INFORMATION

Item 1.

Legal Proceedings

None

Item 1A.

Risk Factors

Not Applicable as a “Smaller Reporting Company”

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3.

Defaults Upon Senior Securities

Not Applicable

Item 4.

(Removed and Reserved)

Item 5.

Other Information

None

Item 6.

Exhibits


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

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

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

101		Interactive Data File

SIGNATURES

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


		Surrey Bancorp

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

Date: August 12, 2011		/s/ Mark H. Towe
		Mark H. Towe
		Sr. Vice President and Chief Financial Officer
		(Principal Financial Officer)

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company