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 March 31, 2010

¨	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 ¨ 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 May 7, 2010 there were 3,206,495 common shares issued and outstanding.


PART I – FINANCIAL INFORMATION

Item 1.	Consolidated Financial Statements

	Consolidated Balance Sheets March 31, 2010 (Unaudited) and December 31, 2009	3

	Consolidated Statements of Income, Three Months Ended March 31, 2010 and 2009 (Unaudited)	4

	Consolidated Statements of Cash Flows, Three Months Ended March 31, 2010 and 2009 (Unaudited)	5

	Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income Three Months Ended March 31, 2010 and 2009 (Unaudited)	6

	Notes to Consolidated Financial Statements	7-16

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17-23

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	24

Item 4.	Controls and Procedures	25

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	26

Item 1A.	Risk Factors	26

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	26

Item 3.	Defaults Upon Senior Securities	26

Item 4.	(Removed and Reserved)	26

Item 5.	Other Information	26

Item 6.	Exhibits	26

SIGNATURES		27

CERTIFICATIONS		28-30

Consolidated Balance Sheets

March 31, 2010 (Unaudited) and December 31, 2009 (Audited)


	March 2010			December 2009
Assets
Cash and due from banks	$	1,755,684		$	1,923,621
Interest-bearing deposits with banks		24,656,449			19,067,374
Federal funds sold		512,947			412,947
Investment securities available for sale		2,000,962			2,011,925
Restricted equity securities		1,047,479			1,047,514
Loans, net of allowance for loan losses of $5,437,608 at March 31, 2010 and $4,669,905 at December 31, 2009		176,870,907			180,442,154
Property and equipment, net		4,842,782			4,881,770
Foreclosed assets		220,912			53,336
Accrued income		1,039,862			1,032,989
Goodwill		120,000			120,000
Bank owned life insurance		3,200,278			3,173,307
Other assets		2,866,852			2,782,845

Total assets	$	219,135,114		$	216,949,782


Liabilities and Stockholders’ Equity
*Liabilities*
Deposits:
Noninterest-bearing	$	27,501,373		$	24,709,970
Interest-bearing		148,519,498			149,264,588

Total deposits		176,020,871			173,974,558

Short-term debt		2,631,300			3,750,000
Long-term debt		10,200,000			9,200,000
Dividends payable		42,737			44,603
Accrued interest payable		313,284			291,111
Other liabilities		1,289,665			1,264,158

Total liabilities		190,497,857			188,524,430


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
2,000 shares of Series B, issued and outstanding with no par value, fixed rate (5%) cumulative perpetual, with a liquidation value of $1,000 per share, net of accreted discount;		1,911,608			1,903,283
100 shares of Series C, issued and outstanding with no par value, fixed rate (9%) cumulative perpetual, with a liquidation value of $1,000 per share, net of amortized premium		102,504			103,222
Common stock, 10,000,000 shares authorized at no par value; 3,206,495 and 3,198,105 shares issued and outstanding at March 31, 2010 and December 31, 2009, respectively		9,448,137			9,406,429
Retained earnings		14,634,805			14,468,089
Accumulated other comprehensive loss		(80,122	)		(75,996	)

Total stockholders’ equity		28,637,257			28,425,352

Total liabilities and stockholders’ equity	$	219,135,114		$	216,949,782

See Notes to Consolidated Financial Statements

Consolidated Statements of Income

Three months ended March 31, 2010 and 2009 (Unaudited)


	2010			2009
*Interest income*
Loans and fees on loans	$	2,765,188		$	2,621,312
Federal funds sold		156			141
Investment securities, taxable		13,628			20,073
Deposits with banks		4,153			6,388

Total interest income		2,783,125			2,647,914


*Interest expense*
Deposits		526,275			808,092
Federal funds purchased and securities sold under agreements to repurchase		—			387
Short-term debt		3,761			7,694
Long-term debt		99,076			108,068

Total interest expense		629,112			924,241

Net interest income		2,154,013			1,723,673

*Provision for loan losses*		949,357			754,716

Net interest income after provision for loan losses		1,204,656			968,957


*Noninterest income*
Service charges on deposit accounts		262,175			286,717
Gain on sale of government guaranteed loans		212,059			—
Fees and yield spread premiums on loans delivered to correspondents		26,683			29,717
Other service charges and fees		99,135			89,747
Other operating income		204,708			168,586
Life insurance proceeds		—			1,000,000

Total noninterest income		804,760			1,574,767


*Noninterest expense*
Salaries and employee benefits		871,010			859,992
Occupancy expense		109,309			115,673
Equipment expense		64,036			64,753
Data processing		96,559			89,076
Foreclosed assets, net		4,192			17,929
FDIC insurance premiums		51,882			26,291
Other expense		459,752			455,567

Total noninterest expense		1,656,740			1,629,281

Net income before income taxes		352,676			914,443

Income tax expense (benefit)		122,900			(71,225	)

Net income		229,776			985,668

*Preferred stock dividends and accretion of discount*		(63,060	)		(61,633	)

Net income available to common stockholders	$	166,716		$	924,035


*Basic earnings per common share*	$	0.05		$	0.29

*Diluted earnings per common share*	$	0.05		$	0.27

*Basic weighted average common shares outstanding*		3,206,029			3,179,773

*Diluted weighted average common shares outstanding*		3,604,712			3,574,921

See Notes to Consolidated Financial Statements

Consolidated Statements of Cash Flows

Three months ended March 31, 2010 and 2009 (Unaudited)


	2010			2009
*Cash flows from operating activities*
Net income	$	229,776		$	985,668
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		63,441			68,047
Loss on the sale of foreclosed assets		(237	)		17,929
Stock-based compensation, net of tax benefit		7,258			7,508
Provision for loan losses		949,357			754,716
Deferred income taxes		(12,628	)		(15,025	)
Accretion of discount on securities, net of amortization of premiums		1,927			2,710
Increase in cash surrender value of life insurance		(26,971	)		(26,615	)
Changes in assets and liabilities:
Accrued income		(6,873	)		183,558
Other assets		(68,791	)		34,217
Accrued interest payable		22,173			(82,801	)
Other liabilities		25,507			(36,895	)

Net cash provided by operating activities		1,183,939			1,893,017


*Cash flows from investing activities*
Net (increase) decrease in interest-bearing deposits with banks		(5,589,075	)		4,116,471
Net (increase) decrease in federal funds sold		(100,000	)		(100,000	)
Purchases of investment securities		(1,500,000	)		(999,780	)
Sales and maturities of investment securities		1,502,322			502,575
Redemption of restricted equity securities		35			168,900
Purchases of restricted equity securities		—			(112,550	)
Net (increase) decrease in loans		2,439,864			(2,156,992	)
Proceeds from the sale of foreclosed assets		14,687			84,812
Purchases of property and equipment		(24,453	)		(36,060	)

Net cash (used in) provided by investing activities		(3,256,620	)		1,467,376


*Cash flows from financing activities*
Net increase in deposits		2,046,313			1,732,576
Net (decrease) in federal funds purchased and securities sold under agreements to repurchase		—			(1,856,032	)
Net (decrease) increase in short-term debt		(1,118,700	)		1,010,000
Net increase (decrease) in long-term debt		1,000,000			(750,000	)
Dividends paid		(57,319	)		(40,866	)
Common stock options exercised		34,450			82,322
Proceeds from the issuance of preferred stock, net		—			1,975,015
Tax benefit related to exercise of non-incentive stock options		—			19,903

Net cash provided by financing activities		1,904,744			2,172,898

Net increase (decrease) in cash and cash equivalents		(167,937	)		5,533,291

*Cash and cash equivalents, beginning*		1,923,621			1,293,770

*Cash and cash equivalents, ending*	$	1,755,684		$	6,827,061


*Supplemental disclosures of cash flow information*
Interest paid	$	606,939		$	1,007,042

Taxes paid	$	69,577		$	—

Loans transferred to foreclosed properties	$	182,026		$	79,345

See Notes to Consolidated Financial Statements

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income

Three months ended March 31, 2010 and 2009 (Unaudited)


															Retained Earnings			Unrealized Appreciation (Depreciation) on Securities			Total
	Convertible
	Preferred Stock Series A			Preferred Stock Series B				Preferred Stock Series C				Common Stock
	Shares	Amount		Shares	Amount			Shares	Amount			Shares	Amount

*Balance, January 1, 2009*	189,356	$	2,620,325	—	$	—		—	$	—		3,167,568	$	9,270,253	$	12,493,763		$	(1,338	)	$	24,383,003

Comprehensive income
Net income	—		—	—		—		—		—		—		—		985,668			—			985,668
Net change in unrealized gain on investment securities available for sale, net of income tax of $6,704	—		—	—		—		—		—		—		—		—			(9,742	)		(9,742	)

*Total comprehensive income*																						975,926

Common stock options exercised	—		—	—		—		—		—		29,013		82,322		—			—			82,322
Tax benefit related to exercise of non-qualified stock options	—		—	—		—		—		—		—		19,903		—			—			19,903
Stock-based compensation, net of tax benefit	—		—	—		—		—		—		—		7,508		—			—			7,508
Issue Series B preferred stock to the U.S. Treasury, net of issuance costs	—		—	2,000		1,975,015		—		—		—		—		—			—			1,975,015
Issue Series C preferred stock to the U.S. Treasury	—		—	—		(106,000	)	100		106,000		—		—		—			—			—
Dividends declared on convertible Series A preferred stock ($.47 per share)	—		—	—		—		—		—		—		—		(29,415	)		—			(29,415	)
Dividends declared and accrued on Series B and Series C preferred stock, net of discount accretion and (premium) amortization	—		—	—		7,938		—		(548	)	—		—		(32,217	)		—			(24,827	)

*Balance, March 31, 2009*	189,356	$	2,620,325	2,000	$	1,876,953		100	$	105,452		3,196,581	$	9,379,986	$	13,417,799		$	(11,080	)	$	27,389,435


*Balance, January 1, 2010*	189,356	$	2,620,325	2,000	$	1,903,283		100	$	103,222		3,198,105	$	9,406,429	$	14,468,089		$	(75,996	)	$	28,425,352

Comprehensive income
Net income	—		—	—		—		—		—		—		—		229,776			—			229,776
Net change in unrealized gain on investment securities available for sale, net of income tax of $2,588	—		—	—		—		—		—		—		—		—			(4,126	)		(4,126	)

*Total comprehensive income*																						225,650

Common stock options exercised	—		—	—		—		—		—		8,390		34,450		—			—			34,450
Stock-based compensation, net of tax benefit	—		—	—		—		—		—		—		7,258		—			—			7,258
Dividends declared on convertible Series A preferred stock ($.16 per share)	—		—	—		—		—		—		—		—		(29,415	)		—			(29,415	)
Dividends declared and accrued on Series B and Series C preferred stock, net of discount accretion and (premium) amortization	—		—	—		8,325		—		(718	)	—		—		(33,645	)		—			(26,038	)

*Balance, March 31, 2010*	189,356	$	2,620,325	2,000	$	1,911,608		100	$	102,504		3,206,495	$	9,448,137	$	14,634,805		$	(80,122	)	$	28,637,257

See Notes to Consolidated Financial Statements

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 March 31, 2010, the results of operations for the three months ended March 31, 2010 and 2009, and its changes in stockholders’ equity and comprehensive income and cash flows for the three months ended March 31, 2010 and 2009. All adjustments are of a normal and recurring nature. The results of operations for the three months ended March 31, 2010, 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, 2009, included in the Company’s Form 10-K. The balance sheet at December 31, 2009, has been taken from the audited financial statements at that date.

Organization

Surrey Bancorp (the “Company”) 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 U-VEST.

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, 2009 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

Business Segments

The Company reports its activities in two business segments. In determining the appropriateness of segment definition, the Company considers the materiality of potential business segments and components of the business about which financial information is available and regularly evaluated relative to resource allocation and performance assessment.

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 March 31, 2010 and December 31, 2009, 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 March 31, 2010 and December 31, 2009.

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.

The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. The allowance is increased by provisions charged to operating expense and reduced by net charge-offs. The Bank makes continuous credit reviews of the loan portfolio and considers economic conditions, historical loan loss experience, review of specific problem loans and other factors in determining the adequacy of the allowance balance.

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. BASIS OF PRESENTATION, CONTINUED

Loans Receivable, continued

Activity in the allowance for loan losses for the three months ended March 31, 2010 and 2009 follows:


	March 31,
	2010			2009
Balance at beginning of year	$	4,669,905		$	3,365,370
Add provision charged to expense		949,357			754,716
Less net charge-offs		(181,654	)		(114,879	)

	$	5,437,608		$	4,005,207

Interest on all loans is accrued daily on the outstanding balance. Accrual of interest is discontinued on a loan when management believes, after considering collection efforts and other factors, the borrower’s financial condition is such that collection of interest is doubtful.

Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements:

In January 2010, fair value guidance was amended to require disclosures for significant amounts transferred in and out of Levels 1 and 2 and the reasons for such transfers and to require that gross amounts of purchases, sales, issuances and settlements be provided in the Level 3 reconciliation. The new disclosures are effective for the Company for the current quarter and have been reflected in the Fair Value footnote.

Guidance related to subsequent events was amended in February 2010 to remove the requirement for an SEC filer to disclose the date through which subsequent events were evaluated. The amendments were effective upon issuance and had no significant impact on the Company’s 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

The Company has evaluated events and transactions subsequent to the date of these financial statements for potential recognition or disclosure. On April 28, 2010, the shareholders of the Company approved increasing the number of common shares authorized from 5,000,000 to 10,000,000, which has been reflected on the balance sheet.

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 carrying amounts of securities available for sale and their approximate fair values at March 31, 2010 and December 31, 2009 follow:


	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value

March 31, 2010
Government-sponsored enterprises	$	1,500,000	$	—	$	3,190	$	1,496,810
Mortgage-backed securities		81,348		2,054		—		83,402
Corporate bonds		550,000		—		129,250		420,750

	$	2,131,348	$	2,054	$	132,440	$	2,000,962


December 31, 2009
Government-sponsored enterprises	$	1,501,913	$	3,687	$	145	$	1,505,455
Mortgage-backed securities		83,684		2,036		—		85,720
Corporate bonds		550,000		—		129,250		420,750

	$	2,135,597	$	5,723	$	129,395	$	2,011,925

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 March 31, 2010, were as follows:


	Amortized Cost		Fair Value
Due in one year or less	$	—	$	—
Due after one year through five years		1,500,000		1,496,810
Due after five years through ten years		601,014		472,877
Due after ten years		30,334		31,275

	$	2,131,348	$	2,000,962

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 March 31, 2010 and December 31, 2009. These unrealized losses on investment securities are a result of volatility in interest rates and primarily relate to government-sponsored enterprises and corporate bonds issued by other banks at March 31, 2010 and December 31, 2009.


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

March 31, 2010
Government-sponsored enterprises	$	1,496,810	$	3,190	$	—	$	—	$	1,496,810	$	3,190
Corporate bonds		—		—		420,750		129,250		420,750		129,250

	$	1,496,810	$	3,190	$	420,750	$	129,250	$	1,917,560	$	132,440


December 31, 2009
Government-sponsored enterprises	$	499,855	$	145	$	—	$	—	$	499,855	$	145
Corporate bonds		—		—		420,750		129,250		420,750		129,250

	$	499,855	$	145	$	420,750	$	129,250	$	920,605	$	129,395

Management considers the nature of the investment, the underlying causes of the decline in market value, the severity and duration of the decline in market value and other evidence, on a security by security basis, in determining if the decline in market value is other than temporary. Management believes all unrealized losses presented in the table above to be temporary in nature.

The Company had no gross realized gains or losses for the three month periods ended March 31, 2010 and 2009.

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3. EARNINGS PER SHARE

Basic earnings per share for the three months ended March 31, 2010 and 2009 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 convertible preferred stock each share of which is convertible into 2.0868 shares of common stock.

NOTE 4. COMMITMENTS AND LETTERS OF CREDIT

At March 31, 2010, the Company had commitments to extend credit, including unused lines of credit of approximately $34,834,000. Letters of credit totaling $1,662,512 were outstanding.

NOTE 5. 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.

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5. FAIR VALUE, CONTINUED

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 March 31, 2010, 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.

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.

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5. FAIR VALUE, CONTINUED

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

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


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

Government-sponsored enterprises	$	1,497	$	—	$	1,497	$	—
Mortgage-backed securities		83		—		83		—
Corporate bonds		421		—		421		—

Total assets at fair value	$	2,001	$	—	$	2,001	$	—


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


*(in thousands)*	Total		Level 1		Level 2		Level 3
December 31, 2009

Government-sponsored enterprises	$	1,505	$	—	$	1,505	$	—
Mortgage-backed securities		86		—		86		—
Corporate bonds		421		—		421		—

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


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

The Company had no Level 3 assets or liabilities measured at fair value on a recurring basis at March 31, 2010 or December 31, 2009.

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

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


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

Loans-commercial and industrial	$	3,266	$	—	$	3,266	$	—
Loans-nonfarm, non-residential		285		—		285		—
Loans-other		218		—		218		—
Foreclosed assets		221		—		221		—

Total assets at fair value	$	3,990	$	—	$	3,990	$	—


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


*(in thousands)*	Total		Level 1		Level 2		Level 3
December 31, 2009

Loans-commercial and industrial	$	2,790	$	—	$	2,790	$	—
Loans-nonfarm, non-residential		652		—		652		—
Loans-other		393		—		393		—
Foreclosed assets		53		—		53		—

Total assets at fair value	$	3,888	$	—	$	3,888	$	—


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

The Company had no Level 3 assets or liabilities measured at fair value on a non-recurring basis at March 31, 2010 or December 31, 2009.

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5. FAIR VALUE, CONTINUED

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.

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. The carrying amount of accrued interest receivable approximates its fair value.

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. The carrying amount of accrued interest payable approximates fair value.

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 approximates fair value.

NOTE 5. FAIR VALUE, CONTINUED

Financial Instruments, continued

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


	March 31, 2010				December 31, 2009
	Carrying Amount		Fair Value		Carrying Amount		Fair Value

*Financial Assets*
Cash and due from banks	$	1,756	$	1,756	$	1,924	$	1,924
Federal funds sold and interest-bearing deposits with banks		25,169		25,169		19,480		19,480
Securities, available for sale		2,001		2,001		2,012		2,012
Restricted equity securities		1,047		1,047		1,048		1,048
Loans, net of allowance for loan losses		176,871		172,178		180,442		180,354
Bank owned life insurance		3,200		3,200		3,173		3,173

*Financial Liabilities*
Deposits		176,021		166,364		173,975		163,638
Long-term and short-term debt		12,831		12,831		12,950		12,953
Commitments and contingencies		—		—		—		—

NOTE 6. SEGMENT REPORTING

The Company has two reportable segments, the Bank and Freedom Finance, LLC. The Bank provides mortgage, consumer and commercial loans. Freedom Finance, LLC specializes in the purchase of sales finance contracts from local automobile dealers. Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the three months ended March 31, 2010 and 2009 is as follows:


	Bank		Freedom Finance, LLC			Intersegment Elimination			Consolidated Totals
*March 31, 2010*
Net interest income	$	2,099,942	$	54,071		$	—		$	2,154,013
Other income		804,656		104			—			804,760
Depreciation and amortization		63,210		231			—			63,441
Provision for loan losses		950,876		(1,519	)		—			949,357
Net income		228,249		1,527			—			229,776
Assets		219,495,688		1,268,828			(1,629,402	)		219,135,114

*March 31, 2009*
Net interest income	$	1,635,973	$	88,861		$	—		$	1,724,834
Other income		573,389		1,000,217			—			1,573,606
Depreciation and amortization		67,650		397			—			68,047
Provision for loan losses		699,401		55,315			—			754,716
Net income		14,698		970,970			—			985,668
Assets		206,403,427		2,468,150			(1,656,926	)		207,214,651

The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately because each segment appeals to different markets and, accordingly, requires different technology and marketing strategies.

SURREY BANCORP

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6. SEGMENT REPORTING, CONTINUED

The Company derives a majority of its revenue from interest income and relies primarily on net interest income to assess the performance of the segments and make decisions about resources to be allocated to the segment. Therefore, the segments are reported using net interest income for the period ended March 31, 2010. The Company does allocate income taxes to the segments. Other income represents noninterest income which is also allocated to the segments. The Company includes the holding company and an insurance and investment agency in its Bank segment above. The Company does not have any single external customer from which is derives 10 percent or more of its revenues and operations in any one geographical area.

NOTE 7. SHORT-TERM DEBT

Short-term debt at March 31, 2010 and December 31, 2009 is as follows:


	March 31, 2010		December 31, 2009
Federal Home Loan Bank advances	$	1,500,000	$	3,750,000
Payable under secured borrowing		1,131,300		—

	$	2,631,300	$	3,750,000

The amounts payable under secured borrowing represents proceeds from a transaction involving a loan guaranteed by the SBA. The transaction meets all the criteria to receive sales treatment under ASC 860 except for the lapse of the 90-day warranty period for prepayments. Upon the expiration of the warranty period in June 2010, the transaction will be recorded as an asset sale with the securing loan and secured borrowing being removed from the balance sheet and the gain recorded in the income statement. The loan securing the borrowing amounts to $1,257,000 and carries an annual interest rate of 6.50%. The secured borrowing carries annual interest rate of 5.50%.

NOTE 8. STOCKHOLDERS’ EQUITY

On January 9, 2009, the Company issued and sold to the US Department of the Treasury 2,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B, with a liquidation preference of $1,000 per share and a warrant to purchase 100.001 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series C, with a liquidation preference of $1,000 per share, at an initial exercise price of $0.01 per share. The Warrant was immediately exercised. The Series B Preferred Stock pays cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter. The Series C Warrant Preferred Stock pays a cumulative dividend of 9%, per annum. Net proceeds from the issuance, after legal fees, amounted to $1,975,015. Net accretion of discounts over amortization of premiums on the Series B and C Preferred Stock amounted to $7,607 for the three months ended March 31, 2010, bringing the total Series B and C Preferred Stock investment to $2,014,112. Dividends accrued on the Series B and C Preferred Stock at March 31, 2010 totaled $13,322, which is included in dividends payable with accrued dividends on the Series A Preferred Stock.

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 months ending March 31, 2010 and 2009. 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 March 31, 2010, was $166,716 or $0.05 per diluted share outstanding, compared to a $924,035 or $0.27 per diluted share outstanding, for the same period in 2009. Earnings for the three months ended March 31, 2010, are approximately 81.2% lower than for the same period in 2009. The decrease results from a 48.9% decrease in noninterest income from $1,574,767 in the first quarter of 2009 to $804,760 in 2010. The 2009 noninterest income included tax-exempt life insurance proceeds of $1,000,000 recorded in Freedom Finance, LLC, the Bank’s sales finance subsidiary. When the tax-exempt life insurance proceeds are excluded from the 2009 first quarter results, net income available for common stockholders increased from a loss of $75,965 in 2009 to a net income of $166,716 in 2010. This earnings increase results from an increase in net interest income. Net interest income increased 24.8% from $1,723,673 in the first quarter of 2009 to $2,154,013 in 2010. The lower cost of funds from the first quarter of 2009, compared to the first quarter of 2010 was largely responsible for the margin increase. The cost of funds decreased from 2.09% in the first quarter of 2009 to 1.37% in the first quarter of 2010. Asset yields increased slightly from 5.41% to 5.54% from 2009 to 2010. The provision for loan losses increased from $754,716 in the first quarter of 2009 to $949,357 in the first quarter of 2010. The increase in the loan loss provision results from continued weakness in the economy that necessitated an increase in reserves associated with impaired loans. Noninterest income, excluding the life insurance proceeds of 2009, increased 40% in 2010 primarily due to a gain of $212,059 on the sale of a government guaranteed loan. No such sales were made in 2009. Noninterest expenses increased 1.7% from $1,629,281 in the first quarter of 2009, to $1,656,740 in 2010. Most of the increase is associated with increased FDIC insurance premiums, which increased from $26,291 in 2009 to $51,882 in 2010.

On March 31, 2010, Surrey Bancorp’s assets totaled $219,135,114 compared to $216,949,782 on December 31, 2009. Net loans were $176,870,907 compared to $180,442,154 on December 31, 2009. This decrease was attributable to the sale of the guaranteed portion of a government guaranteed loan amounting to approximately $3,400,000 and a net increase in the loan loss reserve of approximately $770,000. Otherwise, loan growth remained relatively flat with commercial loans seeing the only significant increase. Commercial loans increased 2.2% during the quarter ended March 31, 2010.

ITEM 2.

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

Total deposits on March 31, 2010, were $176,020,871 compared to $173,974,558 at the end of 2009. This increase is primarily attributable to increases in demand deposits and savings deposits, which include money market accounts. Demand deposits increased 9.42% from 2009 totals, while savings deposits increased 1.52%. Certificates of deposit deceased 2.51% from December 31, 2009 totals.

Common stockholders’ equity increased by $204,298 or 0.86% during the three months ended March 31, 2010. The increase is comprised of net income of $229,776, proceeds from exercised stock options of $34,450, and other stock based compensation of $7,258. Decreases included the payment and accrual of preferred dividends and adjustments to Accumulated Other Comprehensive Income of $63,060 and $4,126, respectively. The net increase resulted in a common stock book value of $7.49 per share, up from $7.44 on December 31, 2009.

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 increased $7,607 during the period ended March 31, 2010, as detailed in Note 8 to the financial statements. Combined preferred and common stockholders’ equity increased $211,905, or 0.8% for the three months ended March 31, 2010.

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.

Investments in available for sale securities of $2,000,962 consisted of U.S. Governmental Agency obligations with maturities ranging from 27 to 29 months, corporate bonds with maturities of 8.25 years to 8.50 years, that reprice quarterly, and GNMA adjustable rate mortgage securities, which adjust annually.

Loans

Net loans outstanding on March 31, 2010, were $176,870,907 compared to $180,442,154 on December 31, 2009. The Bank maintains a loan portfolio dominated by real estate and commercial loans diversified among various industries. Approximately 72.1% of the Bank’s loans as of March 31, 2010, are fixed rate loans with 27.9% floating with the Bank’s prime rate or other appropriate internal or external indices.

Deposits

Deposits on March 31, 2010, were $176,020,871, compared to $173,974,558 on December 31, 2009. The March total comes from a base of approximately 12,331 accounts compared to 12,176 accounts at December 31, 2009. Interest-bearing accounts represented 84.4% of March 31, 2010 period end deposits versus 85.8% at December 31, 2009.

ITEM 2.

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

Federal Funds Purchased

The Company had no federal funds purchased at March 31, 2010 or December 31, 2009. Federal funds purchased were not utilized due to the adequate liquidity resulting from the increase in deposits and the reduction of loans outstanding.

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

*March 31, 2010:*
Total Capital
(to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)	17.30	%	8.0	%
Surrey Bank & Trust	16.43	%	8.0	%
Tier I Capital
(to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)	16.02	%	4.0	%
Surrey Bank & Trust	15.16	%	4.0	%
Tier I Capital
(to Average Assets)
Surrey Bancorp (Consolidated)	12.57	%	4.0	%
Surrey Bank & Trust	11.88	%	4.0	%

*December 31, 2009:*
Total Capital
(to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)	17.00	%	8.0	%
Surrey Bank & Trust	16.12	%	8.0	%
Tier I Capital
(to Risk-Weighted Assets)
Surrey Bancorp (Consolidated)	15.73	%	4.0	%
Surrey Bank & Trust	14.86	%	4.0	%
Tier I Capital
(to Average Assets)
Surrey Bancorp (Consolidated)	12.50	%	4.0	%
Surrey Bank & Trust	11.80	%	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 will be provided to the Board of Directors of recovery actions.

The chart below shows the amount of non-performing assets.

Non-Performing Assets to Total Assets:


	March 31, 2010			December 31, 2009

Nonaccrual loans	$	3,598,773		$	983,043
Loans past due 90 days and still accruing		7,707			2,825
Troubled debt restructurings		339,455			384,584
Foreclosed assets		220,912			53,336

Total	$	4,166,847		$	1,423,788

Total assets	$	219,135,114		$	216,949,782


Ratio		1.90	%		0.66	%

At March 31, 2010, the Bank had loans totaling $3,598,773 in nonaccrual status. Foreclosed assets at March 31, 2010 primarily include commercial real estate and undeveloped land. Loans that were considered impaired but were still accruing interest at March 31, 2010 including troubled debt restructurings, totaled $4,189,562. 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 to the contractual terms of the loan agreement. Specific reserves on nonaccrual and impaired loans totaled $2,977,713 at quarter end, or 38.2% of the balances outstanding.

Nonaccrual and impaired loans still accruing are summarized below:


	March 31, 2010		December 31, 2009

Construction and development	$	85,581	$	144,255
1-4 family residential		431,158		612,516
Nonfarm, nonresidential		379,952		781,797
Commercial and industrial		6,863,152		5,192,563
Consumer		25,819		50,924
Other loans		2,673		1,060

Total impaired and nonaccural	$	7,788,335	$	6,783,115

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:


	March 31, 2010				December 31, 2009

Construction and development	$	7,871,429	4.32	%	$	8,044,967	4.35	%
1-4 family residential		46,355,242	25.43	%		46,355,854	25.05	%
Multi-family		1,979,241	1.09	%		2,005,142	1.08	%
Farmland		2,504,041	1.37	%		2,458,748	1.33	%
Nonfarm, non-residential		47,375,159	25.99	%		51,527,856	27.84	%

Total real estate		106,085,112	58.20	%		110,392,567	59.65	%

Commercial and industrial		68,885,846	37.81	%		67,428,438	36.44	%
Consumer		6,955,156	3.82	%		7,085,464	3.83	%
Other loans		325,318	0.17	%		155,653	0.08	%

Total loans	$	182,251,432	100.00	%	$	185,062,122	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 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 $42,305,000 in loans that carry government guarantees. The guaranteed portion of these loans amounts to $33,252,000 at March 31, 2010. Loan guarantees by loan class are below:


	March 31, 2010		Guaranteed Portion
	March 31, 2010		Amount		Percentage
Construction and development	$	7,871,429	$	—	0.00	%
1-4 family residential		46,355,242		1,181,921	2.55	%
Multi-family		1,979,241		41,252	2.08	%
Farmland		2,504,041		153,067	6.11	%
Nonfarm, non-residential		47,375,159		14,472,974	30.55	%

Total real estate		106,085,112		15,849,214	14.94	%

Commercial and industrial		68,885,846		17,402,930	25.26	%
Consumer		6,955,156		—	0.00	%
Other loans		325,318		—	0.00	%

Total loans	$	182,251,432	$	33,252,144	18.25	%

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 $2,781,218 at March 31, 2010. Non-owner occupied nonfarm, non-residential properties included in nonfarm, non-residential loans above amounted to $11,766,743 at March 31, 2010.

ITEM 2.

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

The consolidated provision for loan losses charged to operations was $949,357 in the first three months of 2010 compared to $754,716 for the same period in 2009. The provision attributable to the Bank increased from $699,401 in 2009 to $950,876 in 2010. This increase is primarily attributable to increases in reserves on impaired loans. The increased reserves on impaired loans primarily resulted from the deterioration of the debtors’ collateral bases on specific loans during the first three months of 2010. These collateral bases include inventory and accounts receivable, among other operating assets. Reserves for nonaccrual and impaired loans at March 31, 2010 amounted to $2,977,712, compared to $2,132,474 at December 31, 2009. The provision attributable to Freedom Finance, LLC decreased from $55,315 in 2009 to a recapture of $1,519 for the three months ended March 31, 2010. The decrease in the Freedom Finance, LLC provision was due to a decreasing loan base. Loan balances in the finance subsidiary decreased from $1,063,311 at December 31, 2009 to $946,950 at the end of March 2010. The notes to the consolidated financial statements contained within this report provide details of the activity in the allowance for loan losses.

The reserve for loan losses on March 31, 2010, was $5,437,608 or 2.98% of period end loans. This percentage is derived from total loans. Approximately $42,305,000 of the total loans outstanding at March 31, 2010, are government guaranteed loans for which the Bank’s exposure ranges from 10% to 49% of the outstanding balance. When the guaranteed portions of the loans are removed from the equation, the loan loss reserve is approximately 3.64% of outstanding loans.

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 three years 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 March 31, 2010 and December 31, 2009.


	March 31, 2010						December 31, 2009
	30-89 Days			90 Days Plus			30-89 Days			90 Days Plus

Construction and development	$	—		$	—		$	257,318		$	—
1-4 family residential		934,377			—			580,428			—
Nonfarm, non-residential		925,741			—			353,239			—
Commercial and industrial		3,038,884			5,903			429,361			—
Consumer		131,088			1,804			106,873			2,825
Other loans		—			—			7,243			—

	$	5,030,090		$	7,707		$	1,734,462		$	2,825


Percentage total loans		2.76	%		0.00	%		0.94	%		0.00	%

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, 2009 to March 31, 2010. The largest increase was in commercial and industrial loans. The increase is primarily attributable to two customers. Overall past dues increased approximately 190 percent from the end of 2009 to March 31, 2010.

Management believes that its loan portfolio is diversified so 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 March 31, 2010, the liquidity position of the Company was good, in management’s opinion with short-term liquid assets of $26,925,080. Deposit increases and proceeds from the sale of government guaranteed loans primarily accounted for the net increase in liquidity from December 31, 2009 totals. To provide supplemental liquidity, the Bank has six unsecured lines of credit with correspondent banks totaling $19,000,000. At March 31, 2010, 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 $16,312,000 of which $11,700,000 of advances had been taken down at March 31, 2010.

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

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: May 13, 2010				/s/ Edward C. Ashby, III
				Edward C. Ashby, III
				President and Chief Executive Officer
				(Principal Executive Officer)

Date: May 13, 2010				/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