SECURITY FEDERAL CORP - Quarter Report: 2009 December (Form 10-Q)

q21210.htm

UNITED STATES
 
 SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC  20549

FORM 10-Q

(Mark one)

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

FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2009

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

FOR THE TRANSITION PERIOD:

FROM:

TO:

COMMISSION FILE NUMBER: 0-16120

SECURITY FEDERAL CORPORATION

	South Carolina	57-0858504
	(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

238 RICHLAND AVENUE, WEST, AIKEN, SOUTH CAROLINA 29801

(Address of Principal Executive Office And Zip code)

(803) 641-3000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 (Not yet applicable to Registrant)

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a “smaller reporting company.” See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filed [ ]		Accelerated filer [ ]
Non-accelerated filer [ ]		Smaller reporting company[X]

Indicate by check mark whether the registrant is a shell corporation (defined in Rule 12b-2 of the Exchange Act).

YES

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

	CLASS:		OUTSTANDING SHARES AT:		SHARES:
	Common Stock, par value $0.01 per share		January 31, 2010		2,461,095

INDEX


PART I.	FINANCIAL INFORMATION (UNAUDITED)	PAGE NO.

Item 1.	Financial Statements (Unaudited):

	Consolidated Balance Sheets at December 31, 2009 and March 31, 2009	1

	Consolidated Statements of Income for the Three and Nine Months Ended December 31, 2009 and 2008	2

	Consolidated Statements of Shareholders’ Equity and Comprehensive Income at December 31, 2009 and 2008	4

	Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2009 and 2008	5

	Notes to Consolidated Financial Statements	7

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

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	39

Item 4T.	Controls and Procedures	39

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	39

Item 1A.	Risk Factors	40

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43

Item 3.	Defaults Upon Senior Securities	43

Item 4.	Submission of Matters to Vote of Security Holders	43

Item 5.	Other Information	43

Item 6.	Exhibits	44

	Signatures	45

SCHEDULES OMITTED

All schedules other than those indicated above are omitted because of the absence of the conditions under which they are required or because the information is included in the consolidated financial statements and related notes.

Part I. Financial Information

Item 1. Financial Statements

Security Federal Corporation and Subsidiaries

Consolidated Balance Sheets

		December 31, 2009		March 31, 2009
Assets:		(Unaudited)		(Audited)
Cash And Cash Equivalents	$	9,999,440	$	6,562,394
Investment And Mortgage-Backed Securities:
Available For Sale: (Amortized cost of $291,527,310 at December 31, 2009 and $276,687,428 at March 31, 2009)		298,559,096		282,832,735
Held To Maturity: (Fair value of $22,074,370 at December 31, 2009 and $32,492,407 at March 31, 2009)		20,925,353		31,265,866
Total Investment And Mortgage-Backed Securities		319,484,449		314,098,601
Loans Receivable, Net:
Held For Sale		5,157,852		5,711,807
Held For Investment: (Net of allowance of $13,964,779 at December 31, 2009 and $10,181,599 at March 31, 2009)		584,447,112		605,378,066
Total Loans Receivable, Net		589,604,964		611,089,873
Accrued Interest Receivable:
Loans		1,994,077		2,011,967
Mortgage-Backed Securities		1,002,808		1,138,911
Investments		828,445		363,707
Premises And Equipment, Net		20,997,475		21,675,434
Federal Home Loan Bank Stock, At Cost		12,624,400		12,662,700
Bank Owned Life Insurance		9,911,305		9,641,305
Repossessed Assets Acquired In Settlement Of Loans		3,582,754		1,985,172
Intangible Assets, Net		272,000		352,500
Goodwill		1,199,754		1,421,754
Other Assets		7,993,708		1,657,189
Total Assets	$	979,495,579	$	984,661,507

Liabilities And Shareholders’ Equity
Liabilities:
Deposit Accounts	$	672,763,982	$	661,713,575
Advances From Federal Home Loan Bank (“FHLB”)		171,331,548		218,998,434
Term Auction Facility Advances (“TAF”)		40,000,000		10,000,000
Other Borrowed Money		10,394,146		16,055,966
Advance Payments By Borrowers For Taxes And Insurance		193,872		421,461
Mandatorily Redeemable Financial Instrument		1,709,312		1,600,312
Senior Convertible Debentures		6,084,000		-
Junior Subordinated Debentures		5,155,000		5,155,000
Other Liabilities		3,925,204		3,624,461
Total Liabilities		911,557,064		917,569,209

Shareholders' Equity:
Serial Preferred Stock, $.01 Par Value; Authorized Shares – 200,000; Issued And Outstanding Shares,18,000 At December 31, 2009 And March 31, 2009		17,674,000		17,620,065
Common Stock, $.01 Par Value; Authorized Shares – 5,000,000; Issued And Outstanding Shares -2,662,028 And 2,461,095 Respectively, At December 31, 2009; And 2,660,528 And 2,459,595, Respectively, At March 31, 2009		26,055		26,040
Warrants Issued In Conjunction With Serial Preferred Stock		400,000		400,000
Additional Paid-In Capital		5,343,863		5,299,235
Treasury Stock, (At Cost, 200,933 Shares, At December 31, 2009 And At March 31, 2009)		(4,330,712)		(4,330,712)
Accumulated Other Comprehensive Income		4,360,831		3,809,934
Retained Earnings, Substantially Restricted		44,464,478		44,267,736
Total Shareholders' Equity		67,938,515		67,092,298
Total Liabilities And Shareholders' Equity	$	979,495,579	$	984,661,507

See accompanying notes to consolidated financial statements.

Security Federal Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)

		Three Months Ended December 31,
		2009		2008
Interest Income:
Loans	$	8,899,817	$	8,999,835
Mortgage-Backed Securities		2,789,088		2,558,840
Investment Securities		555,733		694,633
Other		46		729
Total Interest Income		12,244,684		12,254,037

Interest Expense:
NOW And Money Market Accounts		637,225		1,115,271
Statement Savings Accounts		19,202		27,033
Certificate Accounts		2,342,602		3,520,046
Advances And Other Borrowed Money		1,634,734		2,025,915
Convertible Senior Debentures		40,560		-
Junior Subordinated Debentures		58,431		74,140
Total Interest Expense		4,732,754		6,762,405

Net Interest Income		7,511,930		5,491,632
Provision For Loan Losses		2,475,000		525,000
Net Interest Income After Provision For Loan Losses		5,036,930		4,966,632
Non-Interest Income:
Gain On Sale Of Investments		300,976		-
Gain On Sale Of Loans		215,080		107,726
Service Fees On Deposit Accounts		347,164		293,327
Income From Cash Value Of Life Insurance		90,000		90,000
Commissions From Insurance Agency		94,544		141,771
Other Agency Income		108,302		85,633
Trust Income		105,000		105,000
Other		236,120		196,893
Total Non-Interest Income		1,497,186		1,020,350

General And Administrative Expenses:
Salaries And Employee Benefits		3,007,360		2,949,973
Occupancy		497,423		500,193
Advertising		102,946		155,088
Depreciation And Maintenance Of Equipment		433,734		380,470
FDIC Insurance Premiums		366,000		201,882
Amortization of Intangibles		22,500		22,500
Mandatorily Redeemable Financial Instrument Valuation Expense		65,000		45,000
Loss On Sale Of Repossessed Assets Acquired In Settlement Of Loans		3,742		11,600
Other		1,078,312		977,797
Total General And Administrative Expenses		5,577,017		5,244,503

Income Before Income Taxes		957,099		742,479
Provision For Income Taxes		395,008		252,855
Net Income		562,091		489,624
Preferred Stock Dividends		225,000		27,500
Accretion Of Preferred Stock To Redemption Value		17,579		-
Net Income Available To Common Shareholders	$	319,512	$	462,124

Basic Net Income Per Common Share	$	0.13	$	0.19
Diluted Net Income Per Common Share	$	0.13	$	0.18
Cash Dividend Per Share On Common Stock	$	0.08	$	0.08
Basic Weighted Average Shares Outstanding		2,461,095		2,490,630
Diluted Weighted Average Shares Outstanding		2,543,389		2,511,910

See accompanying notes to consolidated financial statements.

Security Federal Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)

		Nine Months Ended December 31,
		2009		2008
Interest Income:
Loans	$	26,096,241	$	26,483,081
Mortgage-Backed Securities		8,166,348		7,575,321
Investment Securities		1,818,640		2,361,362
Other		376		9,806
Total Interest Income		36,081,605		36,429,570

Interest Expense:
NOW And Money Market Accounts		1,960,383		3,006,058
Statement Savings Accounts		58,654		90,595
Certificate Accounts		8,424,088		10,752,681
Advances And Other Borrowed Money		4,970,069		6,278,073
Convertible Senior Debentures		40,560		-
Junior Subordinated Debentures		182,474		223,112
Total Interest Expense		15,636,228		20,350,519

Net Interest Income		20,445,377		16,079,051
Provision For Loan Losses		5,475,000		1,025,000
Net Interest Income After Provision For Loan Losses		14,970,377		15,054,051
Non-Interest Income:
Gain On Sale Of Investments		675,101		126,440
Gain On Sale Of Loans		811,545		335,444
Service Fees On Deposit Accounts		935,846		850,720
Income From Cash Value Of Life Insurance		270,000		268,492
Commissions From Insurance Agency		341,874		474,901
Other Agency Income		349,813		208,651
Trust Income		315,000		315,000
Other		645,340		622,512
Total Non-Interest Income		4,344,519		3,202,160

General And Administrative Expenses:
Salaries And Employee Benefits		8,828,625		8,565,480
Occupancy		1,490,587		1,490,879
Advertising		318,875		402,765
Depreciation And Maintenance Of Equipment		1,316,130		1,222,304
FDIC Insurance Premiums		1,473,000		549,227
Amortization of Intangibles		67,500		67,500
Mandatorily Redeemable Financial Instrument Valuation Expense		109,000		105,000
Loss On Sale Of Repossessed Assets Acquired In Settlement Of Loans		64,846		18,890
Other		3,080,447		2,719,836
Total General And Administrative Expenses		16,749,010		15,141,881

Income Before Income Taxes		2,565,886		3,114,330
Provision For Income Taxes		1,049,548		1,037,963
Net Income		1,516,338		2,076,367
Preferred Stock Dividends		675,000		27,500
Accretion Of Preferred Stock To Redemption Value		53,935		-
Net Income Available To Common Shareholders	$	787,403	$	2,048,867

Basic Net Income Per Common Share	$	0.32	$	0.81
Diluted Net Income Per Common Share	$	0.31	$	0.81
Cash Dividend Per Share On Common Stock	$	0.24	$	0.24
Basic Weighted Average Shares Outstanding		2,460,777		2,515,579
Diluted Weighted Average Shares Outstanding		2,521,964		2,529,702

See accompanying notes to consolidated financial statements.

Security Federal Corporation and Subsidiaries

Consolidated Statements of Shareholders’ Equity and Comprehensive Income (Unaudited)

		Preferred Stock		Warrants		Common Stock		Additional Paid – In Capital		Treasury Stock		Accumulated Other Comprehensive Income		Retained Earnings		Total
Balance At March 31, 2008	$	-	$	-	$	25,925	$	5,072,086	$	(2,769,446)	$	2,395,537	$	42,772,311	$	47,496,413
Net Income		-		-		-		-		-		-		2,076,367		2,076,367
Other Comprehensive Income, Net Of Tax:
Unrealized Holding Losses On Securities Available For Sale, Net Of Taxes		-		-		-		-		-		(283,156)		-		(283,156)
Reclassification Adjustment For Gains Included In Net Income, Net Of Taxes		-		-		-		-		-		(78,393)		-		(78,393)
Comprehensive Income		-		-		-		-		-		-		-		1,714,818
Purchase Of Treasury Stock At Cost, 84,098 shares		-		-		-		-		(1,561,266)		-		-		(1,561,266)
Issuance Of Preferred Stock And Related Warrants		17,600,000		400,000		-		-		-		-		-		18,000,000
Employee Stock Purchase Plan Purchases		-		-		40		75,110		-		-		-		75,150
Exercise Of Stock Options		-		-		60		99,960		-		-		-		100,020
Stock Compensation Expense		-		-		-		24,410		-		-		-		24,410
Cash Dividends- Common		-		-		-		-		-		-		(601,115)		(601,115)
Balance At December 31, 2008	$	17,600,000	$	400,000	$	26,025	$	5,271,566	$	(4,330,712)	$	2,033,988	$	44,247,563	$	65,248,430

		Preferred Stock		Warrants		Common Stock		Additional Paid – In Capital		Treasury Stock			Accumulated Other Comprehensive Income		Retained Earnings		Total
Balance At March 31, 2009	$	17,620,065	$	400,000	$	26,040	$	5,299,235	$		(4,330,712)	$	3,809,934	$	44,267,736	$	67,092,298
Net Income		-		-		-		-			-		-		1,516,338		1,516,338
Other Comprehensive Income, Net Of Tax:
Unrealized Holding Gains On Securities Available For Sale, Net Of Taxes		-		-		-		-			-		969,460		-		969,460
Reclassification Adjustment For Gains Included In Net Income, Net Of Taxes		-		-		-		-			-		(418,563)		-		(418,563)
Comprehensive Income		-		-		-		-			-		-		-		2,067,235
Accretion Of Preferred Stock To Redemption Value		53,935		-		-		-			-		-		(53,935)		-
Employee Stock Purchase Plan Purchases		-		-		15		19,785			-		-		-		19,800
Stock Compensation Expense		-		-		-		24,843			-		-		-		24,843
Cash Dividends On Preferred		-		-		-		-			-		-		(675,000)		(675,000)
Cash Dividends On Common		-		-		-		-			-		-		(590,661)		(590,661)
Balance At December 31, 2009	$	17,674,000	$	400,000	$	26,055	$	5,343,863	$		(4,330,712)	$	4,360,831	$	44,464,478	$	67,938,515

See accompanying notes to consolidated financial statements.

Security Federal Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

		Nine Months Ended December 31,
		2009		2008
Cash Flows From Operating Activities:
Net Income	$	1,516,338	$	2,076,367
Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities:
Depreciation Expense		1,164,294		1,116,801
Amortization Of Intangible Assets		67,500		67,500
Stock Option Compensation Expense		24,843		24,410
Discount Accretion And Premium Amortization		1,326,548		273,331
Provisions For Losses On Loans And Real Estate		5,475,000		1,025,000
Write Down Of Goodwill		222,000		-
Mandatorily Redeemable Financial Instrument Valuation Expense		109,000		105,000
Gain On Sale Of Mortgage-Backed Securities Available For Sale		(273,330)		-
Gain On Sale Of Investment Securities Available For Sale		(401,771)		(126,440)
Gain On Sale Of Loans		(811,545)		(335,444)
Loss On Sale Of Repossessed Assets Acquired In Settlement Of Loans		64,846		18,890
(Gain) Loss On Disposition Of Premises And Equipment		(25)		61
Amortization Of Deferred Fees On Loans		(96,392)		(81,819)
Proceeds From Sale Of Loans Held For Sale		54,823,727		26,912,369
Origination Of Loans For Sale		(53,458,227)		(27,191,255)
(Increase) Decrease In Accrued Interest Receivable:
Loans		17,890		49,774
Mortgage-Backed Securities		136,103		(119,822)
Investments		(464,738)		179,462
Decrease In Advance Payments By Borrowers		(227,589)		(302,943)
Other, Net		(6,628,358)		(253,198)
Net Cash Provided By Operating Activities		2,586,114		3,438,044

Cash Flows From Investing Activities:
Principal Repayments On Mortgage-Backed Securities Held To Maturity		5,981,325		126,754
Principal Repayments On Mortgage-Backed Securities Available For Sale		49,180,520		32,064,937
Purchase Of Investment Securities Available For Sale		(49,800,374)		(8,184,620)
Purchase Of Mortgage-Backed Securities Available For Sale		(58,437,257)		(48,075,466)
Purchase Of Mortgage-Backed Securities Held To Maturity		-		(26,588,294)
Purchase Of Investment Securities Held To Maturity		-		(1,000,000)
Maturities Of Investment Securities Available For Sale		13,490,722		16,677,263
Maturities Of Investment Securities Held To Maturity		4,258,066		12,000,000
Proceeds From Sale Of Mortgage-Backed Securities Available For Sale		17,599,784		2,993,520
Proceeds From Sale Of Investment Securities Available For Sale		12,576,398		7,135,335
Purchase Of FHLB Stock		-		(8,284,200)
Redemption Of FHLB Stock		38,300		6,237,200
Decrease (Increase) In Loans To Customers		13,388,374		(79,966,426)
Proceeds From Sale Of Repossessed Assets		501,544		367,000
Purchase And Improvement Of Premises And Equipment		(487,281)		(1,461,534)
Proceeds From Sale Of Premises And Equipment		971		1,650
Purchase Of Bank Owned Life Insurance		-		(1,240,492)
Net Cash Provided (Used) By Investing Activities		8,291,092		(97,197,373)

(Continued)

Security Federal Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

		Nine Months Ended December 31,
		2009		2008
Cash Flows From Financing Activities:
Increase In Deposit Accounts		11,050,407		29,792,773
Proceeds From FHLB Advances		257,705,000		247,900,000
Repayment Of FHLB Advances		(305,371,886)		(202,411,651)
Proceeds From TAF Advances		117,000,000		-
Repayment Of TAF Advances		(87,000,000)		-
Proceeds From Convertible Senior Debentures Offering		6,084,000		-
Net Proceeds (Repayment) Of Other Borrowings		(5,661,820)		1,632,387
Proceeds From Issuance Of Preferred Stock		-		18,000,000
Dividends To Preferred Shareholders		(675,000)		-
Dividends To Common Shareholders		(590,661)		(601,115)
Purchase Of Treasury Stock		-		(1,561,266)
Proceeds From Employee Stock Purchases		19,800		75,150
Proceeds From Exercise of Stock Options		-		100,020
Net Cash Provided (Used) By Financing Activities		(7,440,160)		92,926,298

Net Increase (Decrease) In Cash And Cash Equivalents		3,437,046		(833,031)
Cash And Cash Equivalents At Beginning Of Period		6,562,394		10,539,054
Cash And Cash Equivalents At End Of Period	$	9,999,440	$	9,706,023

Supplemental Disclosure Of Cash Flows Information:
Cash Paid During The Period For Interest	$	15,704,896	$	20,635,914
Cash Paid During The Period For Income Taxes	$	2,513,082	$	1,549,900
Additions To Repossessed Acquired Through Foreclosure	$	2,163,972	$	247,450
Increase (Decrease) In Unrealized Gain On Securities Available For Sale, Net Of Taxes	$	969,460	$	(283,156)

See accompanying notes to consolidated financial statements.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

1.	Basis of Presentation

The consolidated financial statements presented in this quarterly report include the accounts of Security Federal Corporation, a South Carolina corporation (the “Company”), and its wholly-owned subsidiary, Security Federal Bank (the “Bank”), which is headquartered in Aiken, South Carolina. The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and accounting principles generally accepted in the United States of America; therefore, they do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows. Such statements are unaudited but, in the opinion of management, reflect all adjustments, which are of a normal recurring nature and necessary for a fair presentation of results for the selected interim periods. Certain information and note disclosures normally included in the Company’s annual consolidated financial statements have been condensed or omitted. Therefore, these consolidated financial statements and notes thereto should be read in conjunction with the audited financial statements and notes included in the Company’s 2009 Annual Report to Stockholders, which was filed as an exhibit to the Annual Report on Form 10-K for the year ended March 31, 2009 (“2009 10-K”), when reviewing interim financial statements. The results of operations for the nine-month period ended December 31, 2009 are not necessarily indicative of the results that may be expected for the entire fiscal year.

2.	Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Security Federal Bank, and the Bank’s wholly owned subsidiaries, Security Federal Insurance, Inc. (“SFINS”) and Security Financial Services Corporation (“SFSC”). All significant intercompany accounts and transactions have been eliminated.

The Bank is primarily engaged in the business of accepting savings and demand deposits and originating mortgage loans and other loans to individuals and small businesses for various personal and commercial purposes. SFINS was formed during fiscal 2002 and began operating during the December 2001 quarter. SFINS is an insurance agency offering auto, business, health, and home insurance. SFINS has a wholly owned subsidiary, Collier Jennings Financial Corporation which has as subsidiaries Collier Jennings Inc., The Auto Insurance Store Inc., and Security Federal Premium Pay Plans Inc (the “Collier-Jennings Companies”). SFSC is currently an inactive subsidiary.

Prior to April 1, 2009, the Bank had two additional subsidiaries: Security Federal Investments, Inc. (“SFINV”) and Security Federal Trust Inc. (“SFT”). SFINV provided primarily investment brokerage services. SFT offered trust, financial planning and financial management services. On April 1, 2009, the assets and operations of SFINV and SFT were dissolved into the Bank. The services of these two entities are now offered through the trust and investment divisions of the Bank.

Security Federal Corporation has a wholly owned subsidiary, Security Federal Statutory Trust (the “Trust”), which issued and sold fixed and floating rate capital securities of the Trust. However, under current accounting guidance, the Trust is not consolidated in the Company’s financial statements.

3. Critical Accounting Policies

The Company has adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States in the preparation of the financial statements. The Company’s significant accounting policies are described in the footnotes to the audited consolidated financial statements at March 31, 2009 included in its 2009 Annual Report to Stockholders, which was filed as an exhibit to the 2009 10-K. Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities. The Company considers these accounting policies to be critical accounting policies. The judgments and assumptions the Company uses are based on historical experience and other factors, which the Company believes to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on the carrying values of assets and liabilities and the results of operations.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

3.	Critical Accounting Policies, Continued

The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of the consolidated financial statements. The Company provides for loan losses using the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to the allowance for loan losses. Additions to the allowance for loan losses are provided by charges to operations based on various factors, which, in management’s judgment, deserve current recognition in estimating possible losses.

While management uses the best information available to make evaluations, future adjustments may be necessary if economic conditions differ substantially from the assumptions used in making these evaluations. Allowance for loan losses are subject to periodic evaluations by various authorities and may be subject to adjustments based upon the information that is available at the time of their examination.

The Company values impaired loans at the loan’s fair value if it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement at the present value of expected cash flows, the market price of the loan, if available, or the value of the underlying collateral. Expected cash flows are required to be discounted at the loan’s effective interest rate. When the ultimate collectibility of an impaired loan’s principal is in doubt, wholly or partially, all cash receipts are applied to principal. When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to interest and then to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amounts previously charged off.

4.	Earnings Per Common Share

The Company calculates earnings per common share (“EPS”) in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 260, “Earnings Per Share” (“ASC 260”). ASC 260 specifies the computation, presentation and disclosure requirements for EPS for entities with publicly held common stock or potential common stock such as options, warrants, convertible securities or contingent stock agreements if those securities trade in a public market.

This standard specifies computation and presentation requirements for both basic EPS and, for entities with complex capital structures, diluted EPS. Basic EPS is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding. Diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. The dilutive effect of options and warrants outstanding is reflected in diluted earnings per share by application of the treasury stock method. The reverse treasury stock method is used to determine the dilutive effect of the mandatorily redeemable shares outstanding, which were issued by the Company in connection with the acquisition of the Collier-Jennings Companies.

Net income available to common shareholders represents consolidated net income adjusted for preferred dividends declared, accretion of discounts and amortization of premiums on preferred stock issuances and cumulative dividends related to the current dividend period that have not been declared as of period end. The following tables provide a reconciliation of net income to net income available to common shareholders for the periods presented:

For the Quarter Ended:		December 31,
		2009		2008
Earnings Available to Common Shareholders:
Net Income	$	562,091	$	489,624
Preferred Stock Dividends		225,000		27,500
Deemed Dividends On Preferred Stock From Net Accretion of Preferred Stock		17,579		-
Net Income Available To Common Shareholders	$	319,512	$	462,124

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

4. Earnings Per Common Share, Continued

For the Nine Months Ended:		December 31,
		2009		2008
Earnings Available to Common Shareholders:
Net Income	$	1,516,338	$	2,076,367
Preferred Stock Dividends		675,000		27,500
Deemed Dividends On Preferred Stock From Net Accretion of Preferred Stock		53,935		-
Net Income Available To Common Shareholders	$	787,403	$	2,048,867

The following table provides a reconciliation of the numerators and denominators of the basic and diluted EPS computations:

	For the Quarter Ended
	December 31, 2009
	Income (Numerator) Amount	Shares (Denominator)		Per Share

Basic EPS	$ 319,512	2,461,095	$	0.13
Effect of Diluted Securities:
Mandatorily Redeemable Shares	-	82,294		-
Senior Convertible Debentures	-	-		-
Stock Options & Warrants	-	-		-
Diluted EPS	$ 319,512	2,543,389	$	0.13

	For the Quarter Ended
	December 31, 2008
	Income (Numerator) Amount	Shares (Denominator)		Per Share

Basic EPS	$ 462,124	2,490,630	$	0.19
Effect of Diluted Securities:
Mandatorily Redeemable Shares	-	21,280		(0.01)
Stock Options	-	-		-
Diluted EPS	$ 462,124	2,511,910	$	0.18

	For the Nine Months Ended
	December 31, 2009
	Income (Numerator) Amount	Shares (Denominator)		Per Share

Basic EPS	$ 787,403	2,460,777	$	0.32
Effect of Diluted Securities:
Mandatorily Redeemable Shares	-	61,187		(0.01)
Senior Convertible Debentures	-	-		-
Stock Options & Warrants	-	-		-
Diluted EPS	$ 787,403	2,521,964	$	0.31

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

4. Earnings Per Common Share, Continued

	For the Nine Months Ended
	December 31, 2008
	Income (Numerator) Amount	Shares (Denominator)		Per Share

Basic EPS	$ 2,048,867	2,515,579	$	0.81
Effect of Diluted Securities:
Mandatorily Redeemable Shares	-	14,123		-
Stock Options	-	-		-
Diluted EPS	$ 2,048,867	2,529,702	$	0.81

5.	Stock-Based Compensation

Certain officers and directors of the Company participate in an incentive and non-qualified stock option plan. Options are granted at exercise prices not less than the fair value of the Company’s common stock on the date of the grant. The following is a summary of the activity under the Company’s incentive stock option plan for the three months and nine months ended December 31, 2009 and 2008:

	Three Months Ended December 31, 2009		Nine Months Ended December 31, 2009
	Shares	Weighted Average Exercise Price	Shares	Weighted Average Exercise Price
Balance, Beginning of Period/Year	90,900	$22.57	100,500	$22.01
Options granted	-	-	-	-
Options exercised	-	-	-	-
Options forfeited	-	-	(9,600)	16.67
Balance, December 31, 2009	90,900	$22.57	90,900	$22.57

Options Exercisable	50,400		50,400

Options Available For Grant	50,000		50,000

	Three Months Ended December 31, 2008		Nine Months Ended December 31, 2008
	Shares	Weighted Average Exercise Price	Shares	Weighted Average Exercise Price
Balance, Beginning of Period/Year	100,500	$22.01	111,100	$21.55
Options granted	-	-	4,500	22.91
Options exercised	-	-	6,000	16.67
Options forfeited	-	-	9,100	20.32
Balance, December 31, 2008	100,500	$22.01	100,500	$22.01

Options Exercisable	60,000		60,000
Options Available For Grant	50,000		50,000

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

5. Stock-Based Compensation, Continued

The following table summarizes the stock option awards granted by the Company, the fair market value of each award granted as estimated on the date of grant using the Black-Scholes option-pricing model, and the weighted average assumptions used for such grants for the periods indicated:

	For Awards Granted During The Three Month Period Ended December 31,		For Awards Granted During The Nine Month Period Ended December 31,
	2009	2008	2009	2008
Awards granted	-	-	-	4,500
Dividend Yield	-	-	-	1.76-1.79%
Expected Volatility	-	-	-	17.62 -18.10%
Risk-free interest rate	-	-	-	3.69-3.88%
Expected life	-	-	-	9.00

At December 31, 2009, the Company had the following options outstanding:

Grant Date	Outstanding Options	Option Price	Expiration Date

09/01/03	2,400	$24.00	08/31/13

12/01/03	3,000	$23.65	11/30/13

01/01/04	5,500	$24.22	12/31/13

03/08/04	13,000	$21.43	03/08/14

06/07/04	2,000	$24.00	06/07/14

01/01/05	20,500	$20.55	12/31/14

01/01/06	4,000	$23.91	01/01/16

08/24/06	14,000	$23.03	08/24/16

05/24/07	2,000	$24.34	05/24/17

07/09/07	1,000	$24.61	07/09/17

10/01/07	2,000	$24.28	10/01/17

01/01/08	17,000	$23.49	01/01/18

05/19/08	2,500	$22.91	05/19/18

07/01/08	2,000	$22.91	07/01/18

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

5.	Stock Warrants

In conjunction with its participation in the U.S. Treasury’s Capital Purchase Program, the Company sold warrants to the U.S. Treasury to purchase 137,966 shares of the Company’s common stock at $19.57 per share. For more information, see Note 7 Preferred Stock Issuance. These warrants are considered additional paid in capital and have a 10-year term, and were immediately exercisable upon issuance. The shares issuable upon exercise of the warrants are common stock equivalents and therefore increase the number of shares in the computation of diluted earnings per share in periods where the effect is dilutive.

At December 31, 2009, these warrants were anti-dilutive. The following tables show a summary of the status of the Company’s stock warrants and changes during the periods presented.

For the Quarter Ended:	December 31, 2009			December 31, 2008
	Shares		Weighted-Average Exercise Price	Shares		Weighted-Average Exercise Price
Balance, Beginning of the Period	137,966	$	19.57	-	$	-
Granted	-		-	137,966		19.57
Exercised	-		-	-		-
Forfeited	-		-	-		-
Balance, End of Period	137,966	$	19.57	137,966	$	19.57

For the Nine Months Ended:	December 31, 2009			December 31, 2008
	Shares		Weighted-Average Exercise Price	Shares		Weighted-Average Exercise Price
Balance, Beginning of the Period	137,966	$	19.57	-	$	-
Granted	-		-	137,966		19.57
Exercised	-		-	-		-
Forfeited	-		-	-		-
Balance, End of Period	137,966	$	19.57	137,966	$	19.57

7. Preferred Stock Issuance

On December 19, 2008, as part of the Troubled Asset Relief Capital Purchase Program (“CPP”) of the United States Department of the Treasury (“Treasury”), the Company sold to Treasury 18,000 shares of Cumulative Perpetual Preferred Stock, Series A and a warrant to purchase 137,966 shares of the Company’s common stock, par value $0.01 per share, for an aggregate purchase price of $18.0 million in cash. In accordance with Generally Accepted Accounting Principles (“GAAP”), the value of the preferred stock was discounted upon issuance by the amount allocated to the warrants to reflect that the warrants were granted in exchange for the below market rate on the preferred stock. The allocation of the proceeds between the preferred stock and warrants was determined based on the relative individual fair value of the warrants compared to the relative individual fair value of the preferred stock.

The fair value of the warrants was determined using a Black-Scholes model. Key assumptions were: stock price volatility of 21.70%, a dividend yield of 3.35%, and an expected life of eight years. The fair value of the preferred shares was determined based on a discounted cash flow model using an estimated life of five years and a discount rate of 12%. Based on the resulting fair values, the preferred stock represented 97.8% of the total fair value and the warrants represented 2.2% of the total fair value. As a result, $17.6 million was allocated to preferred stock and $400,000 was allocated to the warrants.

The resulting discount on the preferred shares is being accreted through retained earnings over the five year estimated life using the effective interest method, with a corresponding increase to the carrying value of the preferred stock. For the nine months ended December 31, 2009, accretion of the preferred stock discount totaled $54,000 and was treated as a deemed, non-cash dividend to preferred stockholders in the computation of earnings per share.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

7. Preferred Stock Issuance, Continued

The preferred stock requires cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter. The Company, subject to the prior regulatory approval, may redeem the Series A preferred stock at any time at its option, in whole or in part, at a redemption price of 100% of the liquidation preference amount plus any accrued and unpaid dividends. The warrant has a 10-year term and is currently exercisable with an exercise price equal to $19.57 per share of common stock. This price was based on the trailing 20-day average common stock price as of the date of Treasury approval. The Treasury has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the warrant that it holds.

In conjunction with participation in the CPP, the Company is subject to certain limitations. The agreement subjects the Company to certain executive compensation limitations included in the Emergency Economic Stabilization Act of 2008 and restricts the Company from increasing dividends from the last quarterly cash dividend per share ($0.08) declared on its common stock prior to December 19, 2008. These restrictions will terminate on the earlier of December 19, 2011 or the date on which the preferred stock is redeemed in whole or transferred fully by the Treasury to a third party.

8. Carrying Amounts and Fair Value of Financial Instruments

Effective April 1, 2008, the Company adopted ASC 820: “Fair Value Measurements and Disclosures” (“ASC 820”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value under generally accepted accounting principles. Topic 820 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.

ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

Level 1	Valuation is based upon quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as U.S. Treasuries and money market funds.
Level 2	Valuation is based upon quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments, mortgage-backed securities, municipal bonds, corporate debt securities and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes certain derivative contracts and impaired loans.
Level 3	Valuation is generated from model-based techniques that use at least one significant assumption based on unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

8. Carrying Amounts and Fair Value of Financial Instruments, Continued

The following is a description of the 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. At December 31, 2009, the Company’s investment portfolio was comprised of government and agency bonds, mortgage-backed securities issued by government agencies or government sponsored enterprises, five municipals and one equity investment. The portfolio did not contain any private label mortgage-backed securities. Fair value measurement is based upon prices obtained from third party pricing services who use independent pricing models which rely on a variety of factors including reported trades, broker/dealer quotes, benchmark yields, economic and industry events and other relevant market information. As such, these securities are classified as Level 2.

Mortgage Loans Held for Sale

The Company originates fixed rate residential loans on a servicing released basis in the secondary market. Loans closed but not yet settled with Freddie Mac or other investors, are carried in the Company’s loans held for sale portfolio. These loans are fixed rate residential loans that have been originated in the Company’s name and have closed. Virtually all of these loans have commitments to be purchased by investors and the majority of these loans were locked in by price with the investors on the same day or shortly thereafter that the loan was locked in with the Company’s customers. Therefore, these loans present very little market risk for the Company. The Company usually delivers to, and receives funding from, the investor within 30 days. Commitments to sell these loans to the investor are considered derivative contracts and are sold to investors on a “best efforts" basis. The Company is not obligated to deliver a loan or pay a penalty if a loan is not delivered to the investor. As a result of the short-term nature of these derivative contracts, the fair value of the mortgage loans held for sale in most cases is the same as the value of the loan amount at its origination. These loans are classified as Level 2.

Impaired 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 ASC 310-10, “Accounting by Creditors for Impairment of a Loan” (“ASC 310-10”).

In accordance with this standard, the fair value is estimated using one of the following methods: fair value of the collateral less estimated costs to sale, discounted cash flows, or market value of the loan based on similar debt. The fair value of the collateral less estimated costs to sell is the most frequently used method. Typically, the Company reviews the most recent appraisal and if it is over 24 months old will request a new third party appraisal. Depending on the particular circumstances surrounding the loan, including the location of the collateral, the date of the most recent appraisal and the value of the collateral relative to the recorded investment in the loan, management may order an independent appraisal immediately or, in some instances, may elect to perform an internal analysis. Specifically as an example, in situations where the collateral on a nonperforming commercial real estate loan is out of the Company’s primary market area, management would typically order an independent appraisal immediately, at the earlier of the date the loan becomes nonperforming or immediately following the determination that the loan is impaired. However, as a second example, on a nonperforming commercial real estate loan where management is familiar with the property and surrounding areas and where the original appraisal value far exceeds the recorded investment in the loan, management may perform an internal analysis whereby the previous appraisal value would be reviewed and adjusted for recent conditions including recent sales of similar properties in the area and any other relevant economic trends. These valuations are reviewed at a minimum on a quarterly basis.

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 December 31, 2009, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. In accordance with ASC 820, 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.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

8. Carrying Amounts and Fair Value of Financial Instruments, Continued

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.

Goodwill and Other Intangible Assets

Goodwill and identified intangible assets are subject to impairment testing. The Company’s approach to testing for impairment is to compare the business unit’s carrying value to the implied fair value based on a multiple of revenue approach. Impairment testing is performed annually as of September 30th or when events or circumstances occur indicating that goodwill of the reporting unit might be impaired. In the event the fair value is determined to be less than the carrying value, the asset is recorded at fair value as determined by the valuation model. As such, goodwill and other intangible assets subjected to nonrecurring fair value adjustments are classified as Level 3.

Mandatorily Redeemable Financial Instrument

The fair value is determined, in accordance with the underlying agreement at the instrument’s redemption value, as the number of shares issuable pursuant to the agreement at a price per share determined as the greater of a) $26 per share or b) 1.5 times the book value per share of the Company. See the section entitled “Mandatorily Redeemable Financial Instrument” of Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations for a description of this instrument. This instrument is classified as Level 2.

The table below presents assets and liabilities measured at fair value on a recurring basis as of December 31, 2009, aggregated by the level in the fair value hierarchy within which those measurements fall.

Assets:	Level 1	Level 2	Level 3	Balance At December 31, 2009
Investment Securities Available For Sale	-	$ 298,559,096	-	$ 298,559,096
Mortgage Loans Held For Sale	-	5,157,852	-	5,157,852
Total	-	$ 303,716,948	-	$ 303,716,948
Liabilities:
Mandatorily Redeemable Financial Instrument	-	$ 1,709,312	-	$ 1,709,312
Total	-	$ 1,709,312	-	$ 1,709,312

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. The table below presents assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2009, aggregated by the level in the fair value hierarchy within which those measurements fall.

Assets:	Level 1	Level 2	Level 3	Balance At December 31, 2009
Goodwill	-	$ -	$ 1,199,754	$ 1,199,754
Intangible Assets	-	-	272,000	272,000
Impaired Loans	-	26,084,436	7,342,558	33,426,994
Foreclosed Assets	-	3,582,754	-	3,582,754
Total	-	$ 29,667,190	$ 8,814,312	$ 38,481,502

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

8. Carrying Amounts and Fair Value of Financial Instruments, Continued

For assets and liabilities that are not presented on the balance sheet at fair value, the following methods are used to determine fair value:

Cash and cash equivalents

The carrying amount of these financial instruments approximates fair value. All mature within 90 days and do not present unanticipated credit concerns.

Loans

The fair value of loans are estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. As discount rates are based on current loan rates as well as management estimates, the fair values presented may not be indicative of the value negotiated in an actual sale.

Federal Home Loan Bank (“FHLB”) Stock

The fair value approximates the carrying value.

Deposits

The fair value of demand deposits, savings accounts, and money market accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposits is estimated by discounting the future cash flows using rates currently offered for deposits of similar remaining maturities.

FHLB Advances

Fair value is estimated based on discounted cash flows using current market rates for borrowings with similar terms.

TAF Borrowings and Other Borrowed Money

The carrying value of these short term borrowings approximates fair value.

Senior Convertible Debentures

The fair value is estimated by discounting the future cash flows using the current rates at which similar debenture offerings with similar terms and maturities would be issued by similar institutions. As discount rates are based on current debenture rates as well as management estimates, the fair values presented may not be indicative of the value negotiated in an actual sale.

Junior Subordinated Debentures

The carrying value approximates fair value.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

8. Carrying Amounts and Fair Value of Financial Instruments, Continued

The following table is a summary of the carrying value and estimated fair value of the Company’s financial instruments as of the periods presented as defined by Statement of Financial Accountings Standards (“SFAS”) Disclosures about Fair Value of Financial Instruments (ASC 825-10-50):

		December 31, 2009				March 31, 2009
		Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
		(In Thousands)
Financial Assets:
Cash And Cash Equivalents	$	9,999	$	9,999	$	6,562	$	6,562
Investment And Mortgage-Back Securities		319,484		320,633		314,099		315,325
Loans Receivable, Net		589,605		587,510		611,090		623,362
FHLB Stock		12,624		12,624		12,663		12,663

Financial Liabilities:
Deposits:
Checking, Savings, And Money Market Accounts	$	293,086	$	293,086	$	272,363	$	272,363
Certificate Accounts		379,678		387,498		389,351		395,647
Advances From FHLB		171,332		179,804		218,998		225,852
Term Auction Facility Borrowings		40,000		40,000		10,000		10,000
Other Borrowed Money		10,394		10,394		16,056		16,056
Senior Convertible Debentures		6,084		6,084		-		-
Junior Subordinated Debentures		5,155		5,155		5,155		5,155
Mandatorily Redeemable Financial Instrument		1,709		1,709		1,600		1,600

At December 31, 2009, the Bank had $62.6 million of off-balance sheet financial commitments. These commitments are to originate loans and unused consumer lines of credit and credit card lines. Because these obligations are based on current market rates, if funded, the original principal is considered to be a reasonable estimate of fair value.

Fair value estimates are made on a specific date, based on relevant market data and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the Bank’s entire holdings of a particular financial instrument. Because no active market exists for a significant portion of the Bank’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, current interest rates and prepayment trends, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in any of these assumptions used in calculating fair value would also significantly affect the estimates. Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Bank has significant assets and liabilities that are not considered financial assets or liabilities including deposit franchise values, loan servicing portfolios, deferred tax liabilities, and premises and equipment.

In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates. The Company has used management’s best estimate of fair value on the above assumptions. Thus, the fair values presented may not be the amounts, which could be realized, in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses that would be incurred in an actual sale or settlement are not taken into consideration in the fair value presented.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

9. Accounting and Reporting Changes

The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and/or disclosure of financial information by the Company.

In June 2009, the FASB issued guidance which restructured GAAP and simplified access to all authoritative literature by providing a single source of authoritative nongovernmental GAAP. The guidance is presented in a topically organized structure referred to as the FASB Accounting Standards Codification (“ASC”). The new structure is effective for interim or annual periods ending after September 15, 2009. All existing accounting standards have been superseded and all other accounting literature not included is considered non-authoritative.

The FASB issued new accounting guidance on accounting for transfers of financial assets in June 2009. The guidance limits the circumstances in which a financial asset should be derecognized when the transferor has not transferred the entire financial asset by taking into consideration the transferor’s continuing involvement. The standard requires that a transferor recognize and initially measure at fair value all assets obtained (including a transferor’s beneficial interest) and liabilities incurred as a result of a transfer of financial assets accounted for as a sale. The concept of a qualifying special-purpose entity is no longer applicable. The standard is effective for the first annual reporting period that begins after November 15, 2009, for interim periods within the first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. The Company does not expect the guidance to have any impact on the Company’s financial statements. The ASC was amended in December, 2009, to include this guidance.

Guidance was issued in June 2009 requiring a company to analyze whether its interest in a variable interest entity (“VIE”) gives it a controlling financial interest that should be included in consolidated financial statements. A company must assess whether it has an implicit financial responsibility to ensure that the VIE operates as designed when determining whether it has the power to direct the activities of the VIE that significantly impact its economic performance, making it the primary beneficiary. Ongoing reassessments of whether a company is the primary beneficiary are also required by the standard. This guidance amends the criteria to qualify as a primary beneficiary as well as how to determine the existence of a VIE. The standard also eliminates certain exceptions that were previously available. This guidance is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. Comparative disclosures will be required for periods after the effective date. The Company does not expect the guidance to have any impact on the Company’s financial position. An update was issued in December, 2009, to include this guidance in the ASC.

An update was issued in October 2009 to provide guidance requiring companies to allocate revenue in multi-element arrangements. Under this guidance, products or services (deliverables) must be accounted for separately rather than as a combined unit utilizing a selling price hierarchy to determine the selling price of a deliverable. The selling price is based on vendor-specific evidence, third-party evidence or estimated selling price. The amendments in the update are effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 with early adoption permitted. The Company does not expect the update to have an impact on its financial statements.

In October 2009, updated guidance was issued to provide for accounting and reporting for own-share lending arrangements issued in contemplation of a convertible debt issuance. At the date of issuance, a share-lending arrangement entered into on an entity’s own shares should be measured at fair value in accordance with prior guidance and recognized as an issuance cost, with an offset to additional paid-in capital. Loaned shares are excluded from basic and diluted earnings per share unless default of the share-lending arrangement occurs. The amendment also requires several disclosures including a description and the terms of the arrangement and the reason for entering into the arrangement. The effective dates of the amendment are dependent upon the date the share-lending arrangement was entered into and include retrospective application for arrangements outstanding as of the beginning of fiscal years beginning on or after December 15, 2009. The Company does not expect the update to have an impact on its financial statements.

In January 2010, guidance was issued to alleviate diversity in the accounting for distributions to shareholders that allow the shareholder to elect to receive their entire distribution in cash or shares but with a limit on the aggregate amount of cash to be paid. The amendment states that the stock portion of a distribution to shareholders that allows them to elect to receive cash or shares with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance. The amendment is effective for interim and annual periods ending on or after December 15, 2009 and had no impact on the Company’s financial statements.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

9. Accounting and Reporting Changes, Continued

Also in January, 2010, an amendment was issued to clarify the scope of subsidiaries for consolidation purposes. The amendment provides that the decrease in ownership guidance should apply to (1) a subsidiary or group of assets that is a business or nonprofit activity, (2) a subsidiary that is a business or nonprofit activity that is transferred to an equity method investee or joint venture, and (3) an exchange of a group of assets that constitutes a business or nonprofit activity for a non-controlling interest in an entity. The guidance does not apply to a decrease in ownership in transactions related to sales of in substance real estate or conveyances of oil and gas mineral rights. The update is effective for the interim or annual reporting periods ending on or after December 15, 2009 and had no 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.

10. Securities

Investment And Mortgage-Backed Securities, Available For Sale

The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of investment and mortgage-backed securities available for sale are as follows:

December 31, 2009		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLB Securities	$	18,717,173	$	200,285	$	118,862	$	18,798,596
Federal Farm Credit Securities		8,522,690		27,186		40,766		8,509,110
Federal National Mortgage Association (“FNMA”) And Federal Home Loan Mortgage Corporation (“FHLMC”) Bonds		4,997,912		-		80,242		4,917,670
Small Business Administration (“SBA”) Bonds		22,685,921		136,787		189,779		22,632,929
Taxable Municipal Bonds		5,248,597		13,655		27,787		5,234,465
Mortgage-Backed Securities		231,252,079		7,573,965		420,618		238,405,426
Equity Securities		102,938		-		42,038		60,900
Total	$	291,527,310	$	7,951,878	$	920,092	$	298,559,096


March 31, 2009		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
FHLB Securities	$	15,401,116	$	428,886	$	18,450	$	15,811,552
Federal Farm Credit Securities		14,521,626		121,699		8,855		14,634,470
FNMA Bonds		2,000,000		7,810		-		2,007,810
SBA Bonds		3,319,651		65,119		18,201		3,366,569
Taxable Municipal Bond		1,019,781		26,818		-		1,046,599
Mortgage-Backed Securities		240,322,316		5,718,587		112,668		245,928,235
Equity Securities		102,938		-		65,438		37,500
	$	276,687,428	$	6,368,919	$	223,612	$	282,832,735

FHLB securities, Federal Farm Credit securities, FNMA bonds, and FNMA and FHLMC mortgage-backed securities are issued by government-sponsored enterprises (“GSEs”). GSEs are not backed by the full faith and credit of the United States government. SBA bonds are backed by the full faith and credit of the United States government.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

10. Securities, Continued

Included in the tables above in mortgage-backed securities are GNMA mortgage-backed securities, which are also backed by the full faith and credit of the United States government. At December 31, 2009 and March 31, 2009, the Company held an amortized cost and fair value of $131.1 million and $134.5 million and $107.3 million and $110.2 million, respectively in GNMA mortgage-backed securities included in mortgage-backed securities listed above. All mortgage-backed securities in the Company’s portfolio are either GSEs or GNMA mortgage-backed securities. The balance does not include any private label mortgage-backed securities.

The Bank received approximately $30.2 million and $10.1 million, respectively, in proceeds from sales of available for sale securities during the nine months ended December 31, 2009 and 2008 and recognized approximately $675,000 in gross gains in 2009 and $146,000 in gross gains and $20,000 in gross losses in 2008.

The amortized cost and fair value of investment and mortgage-backed securities available for sale at December 31, 2009 are shown below by contractual maturity. Expected maturities will differ from contractual maturities because borrowers have the right to prepay obligations with or without call or prepayment penalties.

		Amortized Cost		Fair Value

Less Than One Year	$	783,465	$	806,316
One – Five Years		2,658,507		2,709,620
Over Five – Ten Years		25,900,263		25,826,531
After Ten Years		30,932,996		30,811,203
Mortgage-Backed Securities		231,252,079		238,405,426
	$	291,527,310	$	298,559,096

The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual available for sale securities have been in a continuous unrealized loss position, at December 31, 2009.

		Less than 12 Months				12 Months or More				Total
		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Securities	$	8,987,530	$	118,862	$	-	$	-	$	8,987,530	$	118,862
Federal Farm Credit Securities		4,043,450		40,766						4,043,450		40,766
Mortgage-Backed Securities		30,257,873		420,618		-		-		30,257,873		420,618
SBA Bonds		11,465,705		189,779		-		-		11,465,705		189,779
FNMA Bonds		3,917,670		80,242		-		-		3,917,670		80,242
Taxable Municipal Bonds		3,168,581		27,787						3,168,581		27,787
Equity Securities		-		-		60,900		42,038		60,900		42,038
	$	61,840,809	$	878,054	$	60,900	$	42,038	$	61,901,709	$	920,092

Securities classified as available for sale are recorded at fair market value. Approximately 4.6% of the unrealized losses, or one individual security, consisted of securities in a continuous loss position for 12 months or more. The Company has the ability and intent to hold these securities until such time as the value recovers or the securities mature. The Company believes, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and is not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary. The Company reviews its investment securities portfolio at least quarterly and more frequently when economic conditions warrant, assessing whether there is any indication of other-than-temporary impairment (“OTTI”). Factors considered in the review include estimated future cash flows, length of time and extent to which market value has been less than cost, the financial condition and near term prospects of the issuer, and our intent and ability to retain the security to allow for an anticipated recovery in market value.

If the review determines that there is OTTI, then an impairment loss is recognized in earnings equal to the entire difference between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made, or may recognize a portion in other comprehensive income. The fair value of investments on which OTTI is recognized then becomes the new cost basis of the investment.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

10. Securities, Continued

Investment and Mortgage-Backed Securities, Held to Maturity

The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of investment and mortgage-backed securities held to maturity are as follows:

December 31, 2009	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLB Securities	$	4,000,000	$	324,070	$	-	$	4,324,070
SBA Bonds		5,100,665		273,243		-		5,373,908
Mortgage-Backed Securities		11,669,688		551,704		-		12,221,392
Equity Securities		155,000		-		-		155,000
Total	$	20,925,353	$	1,149,017	$	-	$	22,074,370

March 31, 2009	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLB Securities	$	7,000,000	$	371,260	$	8,750	$	7,362,510
Federal Farm Credit Securities		1,000,000		19,060		-		1,019,060
SBA Bonds		5,355,028		336,242		-		5,691,270
Mortgage-Backed Securities		17,755,838		508,729		-		18,264,567
Equity Securities		155,000		-		-		155,000
Total	$	31,265,866	$	1,235,291	$	8,750	$	32,492,407

At December 31, 2009, the Company held an amortized cost and fair value of $6.5 million and $6.8 million, respectively in GNMA mortgage-backed securities included in mortgage-backed securities listed above. At March 31, 2009, the Company held an amortized cost and fair value of $10.8 million and $11.1 million, respectively in GNMA mortgage-backed securities included in mortgage-backed securities listed above. All mortgage-backed securities in the Company’s portfolio above are either GSEs or GNMA mortgage-backed securities. The balance does not include any private label mortgage-backed securities.

The amortized cost and fair value of investment and mortgage-backed securities held to maturity at December 31, 2009, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities resulting from call features on certain investments.

	Amortized Cost		Fair Value

Less Than One Year	$	1,000,000	$	1,028,440
One – Five Years		4,369,468		4,732,226
Over Five – Ten Years		-		-
More Than Ten Years		3,886,197		4,092,312
Mortgage-Backed Securities		11,669,688		12,221,392
	$	20,925,353	$	22,074,370

The Company did not have any held to maturity securities that were in an unrealized loss position at December 31, 2009. The Company’s held to maturity portfolio is recorded at amortized cost. The Company has the ability and intends to hold these securities to maturity. There were no sales of securities held to maturity during the quarter or nine month period ended December 31, 2009.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

11. Loans Receivable, Net

Loans receivable, net, at December 31, 2009 and March 31, 2009 consisted of the following:

		December 31, 2009		March 31, 2009
Residential Real Estate	$	118,609,716	$	126,980,894
Consumer		70,056,961		69,025,082
Commercial Business		19,152,250		21,032,000
Commercial Real Estate		394,482,721		404,403,186
Loans Held For Sale		5,157,852		5,711,807
		607,459,500		627,152,969

Less:
Allowance For Possible Loan Loss		13,964,779		10,181,599
Loans In Process		3,712,588		5,602,248
Deferred Loan Fees		177,169		279,249
		17,854,536		16,063,096
	$	589,604,964	$	611,089,873

12. Senior Convertible Debentures

Effective December 1, 2009, the Company issued $6.1 million in convertible senior debentures. The debentures will mature on December 1, 2029 and accrue interest at the rate of 8.0% per annum until maturity or earlier redemption or repayment. Interest on the debentures is payable on June 1 and December 1 of each year, commencing June 1, 2010. The debentures are convertible into the Company’s common stock at a conversion price of $20 per share at the option of the holder at any time prior to maturity.

The debentures are redeemable, in whole or in part, at the option of the Company at any time on or after December 1, 2019, at a price equal to 100% of the principal amount of the debentures to be purchased plus any accrued and unpaid interest to, but excluding, the date of redemption. The debentures will be unsecured general obligations of the Company ranking equal in right of payment to all of our present and future unsecured indebtedness that is not expressly subordinated.

13. Subsequent Events

Management has evaluated events and transactions through February 12, 2010 for potential recognition or disclosure in the consolidated financial statements and has determined there are no subsequent events that require disclosure.

Security Federal Corporation and Subsidiaries

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

Forward-Looking Statements and “Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995

This report contains forward-looking statements, which can be identified by the use of words such as “believes,” “intends,” “expects,” “anticipates,” “estimates” or similar expressions. Forward-looking statements include, but are not limited to:

·	statements of our goals, intentions and expectations;

·	statements regarding our business plans, prospects, growth and operating strategies;

·	statements regarding the quality of our loan and investment portfolios; and

·	estimates of our risks and future costs and benefits.

These forward-looking statements are subject to significant risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:

·	the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be impacted by deterioration in the housing and commercial real estate markets;

·	changes in general economic conditions, either nationally or in our market areas;

·	changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources;

·	fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas;

·	secondary market conditions for loans and our ability to sell loans in the secondary market;

results of examinations of us by the Office of Thrift Supervision or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;

·	legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules;

·	our ability to attract and retain deposits;

·	further increases in premiums for deposit insurance;

·	our ability to control operating costs and expenses;

·	the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;

·	difficulties in reducing risks associated with the loans on our balance sheet;

·	staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

·	computer systems on which we depend could fail or experience a security breach;

·	our ability to retain key members of our senior management team;

·	costs and effects of litigation, including settlements and judgments;

·	our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;

·	increased competitive pressures among financial services companies;

·	changes in consumer spending, borrowing and savings habits;

·	the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;

·	our ability to pay dividends on our common stock;

·	adverse changes in the securities markets;

·	inability of key third-party providers to perform their obligations to us;

·	changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; and

·	other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in this prospectus and the incorporated documents.

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

Some of these and other factors are discussed in the 2009 10-K under the caption “Risk Factors” Such developments could have an adverse impact on our financial position and our results of operations.

Any of the forward-looking statements that we make in this quarterly report and in other public statements we make may turn out to be wrong because of inaccurate assumptions we might make, because of the factors illustrated above or because of other factors that we cannot foresee. Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements and you should not rely on such statements. The Company undertakes no obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. These risks could cause our actual results for fiscal year 2010 and beyond to differ materially from those expressed in any forward-looking statements by or on behalf of us, and could negatively affect the Company’s financial condition, liquidity and operating and stock price performance.

Comparison Of Financial Condition At December 31, 2009 and March 31, 2009

General – Total assets decreased $5.2 million or 0.5% to $979.5 million at December 31, 2009 from $984.7 million at March 31, 2009. The primary reason for the decrease in total assets was a $21.5 million or 3.5% decrease in net loans receivable to $589.6 million combined with a $10.3 million or 33.1% decrease in investment and mortgage-backed securities-held to maturity. These decreases were offset partially by an increase in cash, investment and mortgage-backed securities available for sale and other assets.

Assets – The increases and decreases in total assets were primarily concentrated in the following asset categories:

					Increase (Decrease)
	December 31, 2009		March 31, 2009		Amount			Percent
Cash And Cash Equivalents	$	9,999,440	$	6,562,394	$	3,437,046			52.4	%
Investment And Mortgage- Backed Securities – Available For Sale		298,559,096		282,832,735		15,726,361			5.6
Investment And Mortgage- Backed Securities – Held To Maturity		20,925,353		31,265,866		(10,340,513	)		(33.1	)
Loan Receivable, Net		589,604,964		611,089,873		(21,484,909	)		(3.5	)
Premises And Equipment, Net		20,997,475		21,675,434		(677,959	)		(3.1	)
Bank Owned Life Insurance		9,911,305		9,641,305		270,000			2.8
Repossessed Assets Acquired in Settlement of Loans		3,582,754		1,985,172		1,597,582			80.5
Other Assets		7,993,708		1,657,189		6,336,519			382.4

Cash and cash equivalents increased $3.4 million to $10.0 million at December 31, 2009 from $6.6 million at March 31, 2009.

Investments and mortgage-backed securities available for sale increased $15.7 million or 5.6% to $298.6 million at December 31, 2009 from $282.8 million at March 31, 2009. The increase in investments and mortgage-backed securities available for sale is attributable to additional purchases of mortgage-backed securities and investments and increases in the market values of these securities. This is offset partially by paydowns on mortgage-backed securities and sales, calls and maturities on mortgage-backed securities and investments. Investments and mortgage-backed securities held to maturity decreased $10.3 million to $20.9 million at December 31, 2009 compared to $31.3 million at March 31, 2009. This is a result of maturities and paydowns on investments.

Loans receivable, net decreased $21.5 million or 3.5% to $589.6 million at December 31, 2009 from $611.1 million at March 31, 2009. The decrease is a result of the slowing down of the national and local economy combined with more restrcitive underwriting standards. Residential real estate loans decreased $8.4 million to $118.6 million at December 31, 2009 from $127.0 million at March 31, 2009 primarily as a result of a slowdown in the local real estate market combined with generally lower market interest rates. In a low interest rate environment, borrowers tend to refinance their mortgages into lower fixed rate loans. We typically sell these types of loans to minimize interest rate risk. Consumer loans increased $1.0 million to $70.1 million at December 31, 2009 from $69.0 million at March 31, 2009.

Security Federal Corporation and Subsidiaries

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

Commercial business loans decreased $1.9 to $19.2 million at December 31, 2009 from $21.0 million at March 31, 2009 while commercial real estate loans decreased $9.9 million to $394.5 million at December 31, 2009 from $404.4 million at March 31, 2009. Loans held for sale decreased $554,000 or 9.7% to $5.2 million at December 31, 2009 from $5.7 million at March 31, 2009.

Premises and equipment, net decreased $678,000 or 3.1% to $21.0 million at December 31, 2009 from $21.7 million at March 31, 2009. The majority of the decrease related to depreciation consistent with the normal course of business. The Company did not undergo any significant asset purchases during the period. Bank Owned Life Insurance increased $270,000 or 2.8% to $9.9 million at December 31, 2009 from $9.6 million at March 31, 2009.

Repossessed assets acquired in settlement of loans increased $1.6 million or 80.5% to $3.6 million at December 31, 2009 from $2.0 million at March 31, 2009. The Company sold five real estate properties and repossessed 13 additional properties during the quarter ended December 31, 2009. At December 31, 2009, the balance of repossessed assets consisted of the following 21 real estate properties: two lots within one subdivision of Aiken, South Carolina, one lot within a subdivision of Lexington, South Carolina and one lot within a subdivision of Martinez, Georgia; approximately 17 acres of land and one commercial building in Aiken, South Carolina; a commercial building and four single-family residences in Augusta, Georgia; one single-family residence under construction in North Augusta, South Carolina; three manufactured homes in South Carolina; and six single-family residences in South Carolina.

Other assets increased $6.3 million or 382.4% to $8.0 million at December 31, 2009 from $1.7 million at March 31, 2009. The majority of this increase was attributable to $4.3 million in prepaid FDIC insurance premiums at December 31, 2009. In accordance with the guidelines mandated by the FDIC that are applicable to all FDIC insured depository institutions, the Company recorded $4.7 million in FDIC prepaid insurance premiums. The prepaid insurance premiums paid are intended to cover the Bank’s insurance premiums through June 30, 2013.

Liabilities

Deposit Accounts

											Balance
	December 31, 2009					March 31, 2009					Increase (Decrease)
	Balance		Weighted Rate			Balance		Weighted Rate			Amount			Percent
Demand Accounts:
Checking	$	106,916,219		0.20	%	$	104,662,377		0.21	%	$	2,253,842			2.2	%
Money Market		168,608,501		1.42			150,513,010		1.88			18,095,491			12.0
Statement Savings Accounts		17,561,666		0.44			17,187,295		0.54			374,371			2.2
Total		293,086,386		0.92			272,362,682		1.15			20,723,704			7.6

Certificate Accounts
0.00 – 0.99%		13,312,828					-					13,312,828			100.0
1.00 – 1.99%		96,270,279					21,143,194					75,127,085			355.3
2.00 – 2.99%		229,336,950					112,373,285					116,963,665			104.1
3.00 – 3.99%		7,280,652					76,088,180					(68,807,528	)		(90.4	)
4.00 – 4.99%		28,561,434					173,467,216					(144,905,782	)		(83.5	)
5.00 – 5.99%		4,915,453					6,279,018					(1,363,565	)		(21.7	)
Total		379,677,596		2.32			389,350,893		3.51			( 9,673,297	)		(2.5	)
Total Deposits	$	672,763,982		1.71	%	$	661,713,575		2.54	%	$	11,050,407			1.7	%

Included in the certificates above were $30.0 million and $25.4 million in brokered deposits at December 31, 2009 and March 31, 2009, respectively with a weighted average interest rate of 2.03% and 2.04%, respectively.

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

Advances From FHLB – FHLB advances are summarized by year of maturity and weighted average interest rate in the table below:

											Balance
	December 31, 2009					March 31, 2009					Increase (Decrease)
Fiscal Year Due:	Balance		Rate			Balance		Rate			Balance			Percent
2010		$ -		-	%	$	91,080,000		0.94	%	$	(91,080,000	)		(100.0	%)
2011		38,425,000		2.14			15,000,000		4.87			23,425,000			156.17
2012		34,700,000		3.66			24,700,000		4.56			10,000,000			40.5
2013		10,000,000		4.76			10,000,000		4.76			-			-
2014		20,000,000		3.84			20,000,000		3.84			-			-
Thereafter		68,206,548		4.08			58,218,434		4.30			9,988,114			17.2
Total Advances		$ 171,331,548		3.57	%	$	218,998,434		2.95	%	$	(47,666,886	)		(21.8	)%

Advances from the FHLB decreased $47.7 million to $171.3 million at December 31, 2009 from $219.0 million at March 31, 2009. The Company replaced maturing FHLB advances with lower cost TAF borrowings, which increased $30.0 million to $40.0 million during the same nine month period. In addition, the decrease in loans during the period allowed the Company to repay some of these advances.

Advances from the FHLB are secured by a blanket collateral agreement with the FHLB by pledging the Bank’s portfolio of residential first mortgage loans and investment securities with approximate amortized cost and fair value of $140.4 million and $145.8 million, respectively, at December 31, 2009. Advances are subject to prepayment penalties.

The following table shows callable FHLB advances as of the dates indicated. These advances are also included in the above table. All callable advances are callable at the option of the FHLB. If an advance is called, the Bank has the option to payoff the advance without penalty, re-borrow funds on different terms, or convert the advance to a three-month floating rate advance tied to LIBOR.

As of December 31, 2009
Borrow Date	Maturity Date	Amount		Int. Rate	Type	Call Dates

06/24/05	06/24/15	5,000,000	3	3.710%	1 Time Call	06/24/10
11/23/05	11/23/15	5,000,000		3.933%	Multi-Call	05/25/08 and quarterly thereafter
01/12/06	01/12/16	5,000,000		4.450%	1 Time Call	01/12/11
03/01/06	03/03/14	5,000,000		4.720%	1 Time Call	03/03/10
06/02/06	06/02/16	5,000,000		5.160%	1 Time Call	06/02/11
07/11/06	07/11/16	5,000,000		4.800%	Multi-Call	07/11/08 and quarterly thereafter
11/29/06	11/29/16	5,000,000		4.025%	Multi-Call	05/29/08 and quarterly thereafter
01/19/07	07/21/14	5,000,000		4.885%	1 Time Call	07/21/11
05/24/07	05/24/17	7,900,000		4.375%	Multi-Call	05/27/08 and quarterly thereafter
07/25/07	07/25/17	5,000,000		4.396%	Multi-Call	07/25/08 and quarterly thereafter
11/16/07	11/16/11	5,000,000		3.745%	Multi-Call	11/17/08 and quarterly thereafter
08/28/08	08/28/13	5,000,000		3.113%	Multi-Call	08/30/10 and quarterly thereafter
08/28/08	08/28/18	5,000,000		3.385%	1 Time Call	08/29/11

Other Borrowings – The Bank had $10.4 million and $16.1 million in other borrowings at December 31, 2009 and March 31, 2009, respectively. These borrowings consist of short-term repurchase agreements with certain commercial demand deposit customers for sweep accounts and the current balance on a revolving line of credit with another financial institution. At December 31, 2009 and March 31, 2009, short-term repurchase agreements were $10.4 million and $11.3 million, respectively. The repurchase agreements typically mature within one to three days and the interest rate paid on these borrowings floats monthly with money market type rates. At December 31, 2009 and March 31, 2009, the interest rate paid on the repurchase agreements was 0.85% and 1.24%, respectively. The Bank had pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $20.6 million and $21.7 million, respectively, at December 31, 2009 and $25.5 million and $26.0 million, respectively, at March 31, 2009.

At March 31, 2009, the balance on the revolving line of credit was $4.8 million. At December 31, 2009, the balance was zero. The unsecured line of credit had an interest rate equal to one month LIBOR plus 2.0% and matured on December 1, 2009.

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

Term Auction Facility Borrowings – During the year ended March 31, 2009, the Company began participating in the Federal Reserve’s TAF (Term Auction Facility) program, an auction program designed to provide liquidity for qualifying depository institutions. Under the program, institutions place a bid for an advance from their local Federal Reserve Bank at an interest rate that is determined as the result of the auction. Borrowings under the program typically have a maturity of 84-days or less. At December 31, 2009, the Company had $40.0 million outstanding in advances obtained through the TAF program, an increase of $30.0 million from $10.0 million at March 31, 2009. The interest rate on these advances was 0.25% at December 31, 2009 and March 31, 2009. The balance at December 31, 2009 matures within three months. The Company had pledged as collateral for these borrowings investment and mortgage-backed securities with amortized costs and fair values of $64.3 million and $65.2 million, respectively, at December 31, 2009 and $17.8 million and $17.9 million, respectively, at March 31, 2009.

Mandatorily Redeemable Financial Instrument – On June 30, 2006, the Company recorded a $1.4 million mandatorily redeemable financial instrument as a result of the acquisition of the Collier-Jennings Companies. The shareholder of the Collier-Jennings Companies received cash and was issued stock in the Company to settle the acquisition. The Company will release the shares to the shareholder of the Collier-Jennings Companies over a three-year period. The stock is mandatorily redeemable at the option of the shareholder of the Collier-Jennings Companies in cumulative increments of 20% per year for a five-year period at the greater of $26 per share or one and one-half times the book value of the Company’s stock. At December 31, 2009, the shareholder had not elected to have any of the shares redeemed.

Senior Convertible Debentures Offering – Effective December 1, 2009, the Company issued $6.1 million in 8.0% convertible senior debentures to be due December 1, 2029. The debentures are convertible into the Company’s common stock at a conversion price of $20 per share at the option of the holder at any time prior to maturity. The debentures are redeemable at the option of the Company, in whole or in part, at any time on or after December 1, 2019 at the redemption price equal to 100% of the principal amount of the debentures to be redeemed, plus accrued and unpaid interest, if any.

Junior Subordinated Debentures – On September 21, 2006, Security Federal Statutory Trust (the “Trust”), a wholly-owned subsidiary of the Company, issued and sold fixed and floating rate capital securities of the Trust (the “Capital Securities”), which are reported on the consolidated balance sheet as junior subordinated debentures, generating proceeds of $5.0 million. The Trust loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank. The debentures qualify as Tier 1 capital under Federal Reserve Board guidelines.

The Capital Securities accrue and pay distributions quarterly at a rate per annum equal to a blended rate of 4.42% at December 31, 2009. One-half of the Capital Securities issued in the transaction has a fixed rate of 6.88% and the remaining half has a floating rate of three-month LIBOR plus 170 basis points, which was 1.95% at December 31, 2009. The distribution rate payable on the Capital Securities is cumulative and payable quarterly in arrears.

The Company has the right, subject to events of default, to defer payments of interest on the Capital Securities for a period not to exceed 20 consecutive quarterly periods, provided that no extension period may extend beyond the maturity date of December 15, 2036. The Company has no current intention to exercise its right to defer payments of interest on the Capital Securities.

The Capital Securities mature or are mandatorily redeemable upon maturity on December 15, 2036, and or upon earlier optional redemption as provided in the indenture. The Company has the right to redeem the Capital Securities in whole or in part, on or after September 15, 2011. The Company may also redeem the capital securities prior to such dates upon occurrence of specified conditions and the payment of a redemption premium.

Equity – Shareholders’ equity increased $846,000 or 1.3% to $67.9 million at December 31, 2009 from $67.1 million at March 31, 2009. Accumulated other comprehensive income, net of tax increased $551,000 to $4.4 million at December 31, 2009. The Company’s net income available for common shareholders was $787,000 for the nine month period ended December 31, 2009, after preferred stock dividends of $675,000 and accretion of preferred stock of $54,000. The Board of Directors of the Company declared the 74th, 75th, and 76th consecutive quarterly common stock dividends, which were $0.08 per share, in May 2009, August 2009, and October 2009, which totaled $591,000. Book value per common share was $20.26 at December 31, 2009 and $19.95 at March 31, 2009.

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

Non-performing Assets- The following table sets forth detailed information concerning our non-performing assets for the periods indicated:

	At December 31, 2009		At March 31, 2009		$ Increase	% Increase
	Amount	Percent (1)	Amount	Percent (1)	(Decrease)	(Decrease)
Loans 90 days or more past due or non-accrual loans:
Residential real estate	$ 3,213,009	0.6%	$ 1,112,023	0.2%	$ 2,100,986	188.9%
Commercial business	745,811	0.1	2,808,080	0.5	(2,062,269)	(73.4)
Commercial real estate	34,079,054	5.7	8,044,372	1.3	26,034,682	323.6
Consumer	1,199,579	0.2	955,683	0.1	243,896	25.5
Total non-performing loans	39,237,453	6.6	12,920,158	2.1	26,317,295	203.7

Other non-performing assets
Repossessed assets	57,526	0.0	61,126	0.0	(3,600)	(5.9)
Real estate owned	3,525,228	0.6	1,924,046	0.3	1,601,182	83.2
Total other non-performing assets	3,582,754	0.6	1,985,172	0.3	1,597,582	80.5
Total non-performing assets	$ 42,820,207	7.2%	$ 14,905,330	2.4%	$ 27,914,877	187.3%

Total non-performing assets as a percentage of total assets	4.4%		1.5%

(1) Percent of gross loans receivable, net of deferred fees and loans in process and loans held for sale

The Company’s non-performing assets increased $27.9 million to $42.8 million at December 31, 2009 from $14.9 million at March 31, 2009. The increase was primarily concentrated in non-performing commercial real estate loans which increased $26.0 million to $34.1 million at December 31, 2009 from $8.0 million at March 31, 2009. The balance in non-performing commercial real estate loans consisted of 56 loans to 33 borrowers with an average loan balance of $608,000.

The majority of the increase in the commercial real estate category was concentrated in acquisition and development loans (“A&D loans”) and land loans. The Company placed approximately $11.6 million in A&D loans and land loans on non accrual status during the period consisting of four A&D loans for the development of residential subdivisions in the Midlands area of South Carolina and three land loans throughout South Carolina.

The next largest increase was concentrated in commercial mortgage loans, which totaled $10.5 million and represented 31.3% of the total commercial real estate non-performing loans at December 31, 2009. The Company placed approximately $9.0 million in commercial mortgage loans on non accrual status during the period consisting of 11 loans to 10 borrowers.

The Company also experienced an increase in non-performing one- to four- family real estate loans which increased $2.1 million to $3.2 million at December 31, 2009 from $1.1 million at March 31, 2009. At December 31, 2009, this balance was comprised of 13 loans with an average balance of $247,000. The increase in non-performing one- to four- family real estate loans is a result of the general deteriorating conditions in the local economy including rising unemployment rates and declining housing prices.

The cumulative interest not accrued during the nine months ended December 31, 2009 relating to all non-performing loans totaled $810,000. We intend to work with our borrowers to reach acceptable payment plans while protecting our interests in the existing collateral. In the event an acceptable arrangement cannot be reached, we may have to acquire these properties through foreclosure or other means and subsequently sell, develop, or liquidate them.

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2009 AND 2008

Net Income - Net income available to common shareholders decreased $143,000 or 30.9% to $320,000 for the three months ended December 31, 2009 compared to $462,000 for the three months ended December 31, 2008. The decrease in net income is primarily the result of the Company’s decision to increase the allowance for loan losses as a result of current economic conditions and increases in its nonperforming loans coupled with an increase in general and administrative expenses attributable primarily to increased FDIC insurance premiums paid. These factors were offset slightly by an increase in the Company’s net interest margin and an increase in non-interest income.

Net Interest Income - Net interest income increased $2.0 million or 36.8% to $7.5 million during the three months ended December 31, 2009, compared to $5.5 million for the same period in 2008, as a result of a decrease in interest expense offset in part by a decrease in interest income. The Company’s net interest margin increased 73 basis points to 3.25% for the quarter ended December 31, 2009 from 2.52% for the same quarter in 2008. Average interest-earning assets increased $54.6 million to $925.0 million at December 31, 2009 while average interest-bearing liabilities increased $36.9 million to $863.3 million at December 31, 2009. The interest rate spread increased 75 basis points to 3.11% during the three months ended December 31, 2009 compared to 2.36% for the same period in 2008.

Interest Income - Total interest income decreased $9,000 or 0.1% to $12.2 million during the three months ended December 31, 2009 from $12.3 million for the same period in 2008. Total interest income on loans decreased $100,000 or 1.1% to $8.9 million during the three months ended December 31, 2009 compared to $9.0 million for the same period one year prior. The decrease was a result of the yield in the loan portfolio decreasing 12 basis points offset partially by an increase in the average loan portfolio balance of $5.3 million. Interest income from mortgage-backed securities increased $230,000 or 9.0% to $2.8 million for the quarter ended December 31, 2009 from $2.6 million for the same quarter in 2008. This increase was the result of an increase in the average balance of $34.2 million offset partially by a decrease in the portfolio yield of 30 basis points. Interest income from investment securities decreased $139,000 or 20.0% as a result of a 161 basis point decrease in the yield offset by an increase in the average balance of the investment securities portfolio of $18.0 million.

The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the three months ended December 31, 2009 and 2008:

	Three Months Ended December 31,
	2009					2008
	Average Balance		Yield			Average Balance		Yield			Increase (Decrease) In Interest And Dividend Income From 2008
Loans Receivable, Net	$	595,444,922		5.98	%	$	590,171,933		6.10	%	$	(100,018	)
Mortgage-Backed Securities		246,652,675		4.52			212,464,776		4.82			230,248
Investment Securities		82,351,288		2.70			64,393,513		4.31			(138,900	)
Overnight Time Deposits		507,937		0.04			3,352,759		0.09			(683	)
Total Interest-Earning Assets	$	924,956,822		5.30	%	$	870,382,981		5.63	%	$	(9,353	)

Interest Expense - Total interest expense decreased $2.0 million or 30.0% to $4.7 million during the three months ended December 31, 2009 compared to $6.8 million for the same period one-year earlier. The decrease in total interest expense is attributable to decreases in interest rates paid offset slightly by an increase in the average balances of interest-bearing liabilities. Interest expense on deposits decreased $1.7 million or 35.7% to $3.0 million during the period. The decrease was attributable to a 132 basis point decrease in the cost of deposits offset by an increase in average interest-bearing deposits of $49.5 million compared to the average balance in the three months ended December 31, 2008. The decrease in the cost of deposits primarily resulted from maturing certificate accounts repricing at lower interest rates. Interest expense on advances and other borrowings decreased $391,000 or 19.3% as the cost of debt outstanding decreased 47 basis points during the 2009 quarter ended December 31, 2009 compared to the same quarter in 2008. Average total borrowings outstanding decreased $14.6 million during the same period. The Company replaced maturing FHLB advances with lower cost TAF advances. Interest expense on senior convertible debentures was $41,000 for the quarter ended December 31, 2009 compared to zero for the same quarter in 2008. The Company issued $6.1 million in senior convertible debentures during the quarter ended December 31, 2009. Interest expense on junior subordinated debentures was $58,000 for the three months

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

ended December 31, 2009 compared to $74,000 for the same period one year ago. The average balance of junior subordinated debentures remained the same during both periods.

The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the three months ended December 31, 2009 and 2008:

	Three Months Ended December 31,
	2009					2008
	Average Balance		Yield			Average Balance		Yield			Increase (Decrease) In Interest Expense From 2008
Now And Money Market Accounts	$	229,575,608		1.11	%	$	202,314,408		2.21	%	$	(478,046	)
Statement Savings Accounts		17,302,147		0.44			15,660,153		0.69			(7,831	)
Certificates Accounts		380,085,063		2.47			359,534,279		3.92			(1,177,444	)
Advances And Other Borrowed Money		229,088,616		2.85			243,724,712		3.32			(391,181	)
Convertible Senior Debentures		2,050,043		7.91			-		-			40,560
Junior Subordinated Debentures		5,155,000		4.53			5,155,000		5.75			(15,709	)
Total Interest-Bearing Liabilities	$	863,256,477		2.19	%	$	826,388,552		3.27		$	(2,029,651	)

Provision for Loan Losses - The amount of the provision is determined by management’s on-going monthly analysis of the loan portfolio and the adequacy of the allowance for loan losses. The Company has policies and procedures in place for evaluating and monitoring the overall credit quality of the loan portfolio and for timely identification of potential problem loans including internal and external loan reviews. The adequacy of the allowance for loan losses is reviewed monthly by the Asset Classification Committee and quarterly by the Board of Directors.

Management’s monthly review of the adequacy of the allowance includes three main components. The first component is an analysis of loss potential in various homogenous segments of the portfolio based on historical trends and the risk inherent in each category. Previously, management applied a five year historical loss ratio to each loan category to estimate the inherent loss in these pooled loans. However as a result of the decline in economic conditions and the unprecedented increases in delinquencies and charge offs experienced by the industry in recent periods, the Company no longer considers five year historical losses relevant indicators of future losses. Management began applying 12 month historical loss ratios to each loan category in recent quarters to more accurately project losses in the near future.

The second component of management’s monthly analysis is the specific review and evaluation of significant problem credits identified through the Company’s internal monitoring system. These loans are evaluated for impairment and recorded in accordance with ASC 310-10. For each loan deemed impaired as permitted under ASC 310-10, management calculates a specific reserve for the amount in which the recorded investment in the loan exceeds the fair value. This estimate is based on a thorough analysis of the most probable source of repayment, which is typically liquidation of the collateral.

The third component is an analysis of changes in qualitative factors that may affect the portfolio, including but not limited to: relevant economic trends that could impact borrowers’ ability to repay, industry trends, changes in the volume and composition of the portfolio, credit concentrations, or lending policies and the experience and ability of the staff and Board of Directors. Management also reviews and incorporates certain ratios such as percentage of classified loans, average historical loan losses by loan category, delinquency percentages, and the assignment of percentage targets of reserves in each loan category when evaluating the allowance.

Once the analysis is completed, the three components are combined and compared to the allowance amount. Based on this, charges are made to the provision as needed.

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

The Bank’s provision for loan losses was $2.5 million and $525,000 during the three months ended December 31, 2009 and 2008, respectively. The increase reflects the Company’s concern for deteriorating economic conditions in the local economy coupled with an increase in non-performing assets within its loan portfolio during the quarter. The following table details selected activity associated with the allowance for loan losses for the three months ended December 31, 2009 and 2008:

		December 31, 2009		December 31, 2008
Beginning Balance	$	12,723,921	$	8,263,335
Provision		2,475,000		525,000
Charge-offs		(1,238,686)		(132,819)
Recoveries		4,544		18,011
Ending Balance	$	13,964,779	$	8,673,527

Allowance For Loan Losses As A Percentage Of Gross Loans Receivable, Held For Investment At The End Of The Period		2.33%		1.43%
Allowance For Loan Losses As A Percentage Of Impaired Loans At The End Of The Period		41.78%		73.20%
Impaired Loans	$	33,426,994	$	11,849,874
Non-accrual Loans And 90 Days Or More Past Due Loans As A Percentage Of Loans Receivable, Held For Investment At The End Of The Period		6.56%		1.83%
Gross Loans Receivable, Held For Investment	$	598,411,891	$	585,826,823
Total Loans Receivable, Net	$	589,604,964	$	597,321,830

Non-performing assets, which consisted of 103 non-accrual loans and 22 repossessed properties, increased $27.9 million to $42.8 million at December 31, 2009 from $14.9 million at March 31, 2009. Despite this increase, the Bank maintained relatively low and stable trends related to net charge-offs. Annualized net charge-offs as a percent of gross loans were 0.82% for the three months ended December 31, 2009 compared to 0.12% for the year ended March 31, 2009 and 0.08% for the three months ended December 31, 2008. Management of the Bank continues to be concerned about current market conditions and closely monitors the loan portfolio on an ongoing basis to proactively identify any potential issues. The Company established specific reserves totaling $4.5 million at December 31, 2009 related to $13.3 million of the impaired loans. These reserves will be subsequently charged off when the properties are taken into other repossessed assets or as circumstances warrant. The Company had no specific reserves for the remaining $20.0 million in impaired loans.

Non-accrual loans and loans 90 days or more past due increased $26.3 million to $39.2 million at December 31, 2009 compared to $12.9 million at March 31, 2009. At December 31, 2009, the Company did not have any loans that were 90 days or more past due and still accruing interest.

Non-Interest Income - Non-interest income increased $477,000 or 46.7% to $1.5 million for the three months ended December 31, 2009 from $1.0 million for the same period one year ago primarily as a result of an increase in gain on sale of investments and loans. The following table provides a detailed analysis of the changes in the components of non-interest income:

	Three Months Ended December 31,				Increase (Decrease)
		2009		2008		Amounts	Percent
Gain On Sale Of Investments	$	300,976	$	-	$	300,976	100%
Gain On Sale Of Loans		215,080		107,726		107,354	99.7
Service Fees On Deposit Accounts		347,164		293,327		53,837	18.4
Income From Cash Value Of Life Insurance		90,000		90,000		-	-
Commissions From Insurance Agency		94,544		141,771		(47,227)	(33.3)
Other Agency Income		108,302		85,633		22,669	26.5
Trust Income		105,000		105,000		-	-
Other		236,120		196,893		39,227	19.9)
Total Non-Interest Income	$	1,497,186	$	1,020,350	$	476,836	46.7%

Gain on sale of investments was $301,000 during the quarter ended December 31, 2009 compared to zero in the same period one year earlier. The gain resulted from the sale of 28 investment securities during the three month period. Based on an analysis of the portfolio,

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

the Company was able to maximize return by selling securities with short average lives as a result of call features or securities with adjustable rates scheduled to reprice down in the near future.

Gain on sale of loans increased $107,000 to $215,000 during the three months ended December 31, 2009 compared to the same period one year ago as a result of an increase in the volume of fixed rate residential mortgage loans originated and sold. The increase in volume is primarily attributable to an increase in refinancing activity as a result of the current low interest rate environment. Service fees on deposit accounts increased $54,000 to $347,000 for the quarter ended December 31, 2009 compared to the same quarter in 2008. Income from cash value of life insurance was $90,000 for the three months ended December 31, 2009 and 2008, respectively.

Commissions from insurance decreased $47,000 to $95,000 during the three months ended December 31, 2009 compared to the same period one year ago. The Company sold the South Augusta office of its insurance subsidiary, Security Federal Insurance, during the first quarter of the fiscal year, which resulted in the loss of premium income associated with this location. Other agency income increased $23,000 or 26.5% to $108,000 for the three months ended December 31, 2009 compared to $86,000 for the same period in the prior year. The increase in other agency income is a result of the continued growth and expansion of the Company’s insurance subsidiary and specifically the premium finance business.

Trust income was $105,000 during the three months ended December 31, 2009 and 2008, respectively. Other miscellaneous income including credit life insurance commissions, safe deposit rental income, annuity and stock brokerage commissions, trust fees, and other miscellaneous fees, increased $39,000 to $236,000 during the three months ended December 31, 2009 compared to the same period one year ago.

General and Administrative Expenses – General and administrative expenses increased $333,000 or 6.3% to $5.6 million for the three months ended December 31, 2009 from $5.2 million for the same period one year ago. The following table provides a detailed analysis of the changes in the components of general and administrative expenses:

	Three Months Ended December 31,				Increase (Decrease)
		2009		2008		Amounts	Percent
Salaries And Employee Benefits	$	3,007,360	$	2,949,973	$	57,387	1.9%
Occupancy		497,423		500,193		(2,770)	(0.6)
Advertising		102,946		155,088		(52,142)	(33.6)
Depreciation And Maintenance Of Equipment		433,734		380,470		53,264	14.0
FDIC Insurance Premiums		366,000		201,882		164,118	81.3
Amortization of Intangibles		22,500		22,500		-	-
Mandatorily Redeemable Financial Instrument Valuation Expense		65,000		45,000		20,000	44.4
Loss On Sale Of Repossessed Assets Acquired In Settlement Of Loans		3,742		11,600		(7,858)	(67.7)
Other		1,078,312		977,797		100,515	10.3
Total General And Administrative Expenses	$	5,577,017	$	5,244,503	$	332,514	6.3%

Salary and employee benefits increased $57,000 or 1.9% to $3.0 million for the three months ended December 31, 2009 from $2.9 million for the same period one year ago. This increase was primarily the result of standard annual cost of living increases offset by a decrease in the number of employees employed by the Company. At December 31, 2009, the Company had 224 full time equivalent employees compared to 232 full time equivalents at December 31, 2008.

Occupancy decreased 0.6% to $497,000 for the three months ended December 31, 2009 from $500,000 for the same period one year ago. Advertising expense decreased $52,000 to $103,000 for the three months ended December 31, 2009 from $155,000 for the same period one year ago. These decreases were a result of the Company’s efforts to control expenses during the quarter.

Depreciation and maintenance expense increased $53,000 or 14.0% to $434,000 for the three months ended December 31, 2009 from $380,000 for the same period one year ago. FDIC insurance premiums increased $164,000 or 81.3% to $366,000 for the three month period ended December 31, 2009 compared to $202,000 for the same period a year ago.

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

Mandatorily redeemable financial instrument valuation expense was $65,000 for the three months ended December 31, 2009 compared to $45,000 for the same period one year earlier. Based on its terms, the mandatorily redeemable financial instrument is redeemable at the greater of $26 per share or one and a half times the book value of the Company. The Company recorded a valuation expense to properly reflect the fair value of the instrument at December 31, 2009 based on the book value.

Other general and administrative expenses increased $101,000 or 10.3% to $1.1 million for the three months ended December 31, 2009 compared to $978,000 for the same period one year ago.

Provision For Income Taxes – Provision for income taxes increased $142,000 or 56.2% to $395,000 for the three months ended December 31, 2009 from $253,000 for the same period one year ago. Income before income taxes was $957,000 for the three months ended December 31, 2009 compared to $742,000 for the three months ended December 31, 2008. The Company’s combined federal and state effective income tax rate for the current quarter was 41.3% compared to 34.1% for the same quarter one year ago. Expense associated with the valuation of the mandatorily redeemable financial instrument is not tax deductible.

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

COMPARISON OF THE RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED DECEMBER 31, 2009 AND 2008

Net Income - Net income available to common shareholders decreased $1.3 million or 61.6% to $787,000 for the nine months ended December 31, 2009 compared to $2.0 million for the nine months ended December 31, 2008. The decrease in net income was primarily the result of the Company’s decision to increase the allowance for loan losses in conjunction with an increase in general and administrative expenses attributable primarily to increased FDIC insurance premiums. These factors were offset slightly by an increase in the Company’s net interest margin and an increase in non-interest income.

Net Interest Income - Despite the negative impact of rising credit costs, the Company’s core performance improved during the nine months ended December 31, 2009. The net interest margin increased 39 basis points to 2.95% for the nine months ended December 31, 2009 compared to 2.56% for the comparable period in the previous year.

Net interest income increased $4.4 million or 27.2% to $20.4 million during the nine months ended December 31, 2009, compared to $16.1 million during the same period in 2008. The increase is a result of a decrease in interest expense offset by a slight decrease in interest income. Average interest-earning assets increased $87.8 million to $924.4 million while average interest-bearing liabilities increased $69.4 million to $863.5 million. The interest rate spread was 2.79% and 2.39% during the nine months ended December 31, 2009 and 2008, respectively.

Interest Income - Total interest income decreased $348,000 or 1.0% to $36.1 million during the nine months ended December 31, 2009 from $36.4 million for the same period in 2008. Total interest income on loans decreased $387,000 or 1.5% to $26.1 million during the nine months ended December 31, 2009 as a result of the yield in the loan portfolio decreasing 57 basis points in connection with lower market interest rates generally, offset by the average loan portfolio balance increasing $45.9 million. Interest income from mortgage-backed securities increased $591,000 or 7.8% to $8.2 million as a result of an increase in the average balance of the portfolio of $36.7 million offset by a 40 basis point decrease in the yield in the mortgage-backed portfolio. Interest income from investment securities decreased $543,000 or 23.0% to $1.8 million as a result of a 138 basis point decrease in the yield. The average balance of the investment securities portfolio increased $6.4 million to $73.8 million for the nine months ended December 31, 2009 from $67.4 million for the comparable period in 2008. Interest income on overnight time deposits decreased $9,000 as a result of a decrease in the yield and average balance of overnight time deposits.

The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the nine months ended December 31, 2009 and 2008:

	Nine Months Ended December 31,
	2009					2008
	Average Balance		Yield			Average Balance		Yield			Increase (Decrease) In Interest And Dividend Income From 2008
Loans Receivable, Net	$	603,913,556		5.76	%	$	558,021,225		6.33	%	$	(386,840	)
Mortgage-Backed Securities		245,980,360		4.43			209,265,802		4.83			591,027
Investments		73,796,185		3.29			67,408,412		4.67			(542,722	)
Overnight Time Deposits		755,359		0.07			1,931,124		0.68			(9,430	)
Total Interest-Earning Assets	$	924,445,460		5.20	%	$	836,626,563		5.81	%	$	(347,965	)

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

Interest Expense - Total interest expense decreased $4.7 million or 23.2% to $15.6 million during the nine months ended December 31, 2009 compared to $20.4 million for the same period one year earlier. The decrease in total interest expense is attributable to the decreases in interest rates paid, reflecting a lower market interest rate environment, despite an increase in the amount of interest-bearing deposits, and borrowings. Interest expense on deposits decreased $3.4 million or 24.6% during the period as average interest bearing deposits grew $65.6 million to $624.0 million compared to the average balance of $558.4 million for the nine months ended December 31, 2008, and the cost of deposits decreased 108 basis points. The decrease in the cost of deposits was primarily a result of maturing certificates that repriced at lower rates during the period. Interest expense on advances and other borrowings decreased $1.3 million or 20.8% to $5.0 million as the cost of debt outstanding decreased 79 basis points during the nine months ended December 31, 2009 compared to $6.3 million for the same period in 2008 while average borrowings outstanding increased approximately $3.1 million.

Interest expense on senior convertible debentures was $41,000 for the nine months ended December 31, 2009 compared to zero for the same period in the prior year. The Company issued $6.1 million in 8% senior convertible debentures on December 1, 2009. Interest expense on junior subordinated debentures was $182,000 for the nine months ended December 31, 2009 compared to $223,000 for the same period one year ago.

The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the nine months ended December 31, 2009 and 2008:

	Nine Months Ended December 31,
	2009					2008
	Average Balance		Yield			Average Balance		Yield			Increase (Decrease) In Interest Expense From 2008
Now And Money Market Accounts	$	223,134,518		1.17	%	$	202,900,887		1.98	%	$	(1,045,675	)
Statement Savings Accounts		17,329,303		0.45			16,106,786		0.75			(31,941	)
Certificates Accounts		383,526,603		2.93			339,425,711		4.22			(2,328,593	)
FHLB Advances, TAF Advances And Other Borrowed Money		233,703,084		2.84			230,557,226		3.63			(1,308,004	)
Senior Convertible Debentures		685,833		7.89			-		-			40,560
Junior Subordinated Debentures		5,155,000		4.72			5,155,000		5.77			(40,638	)
Total Interest-Bearing Liabilities	$	863,534,341		2.41	%	$	794,145,610		3.42	%	$	(4,714,291	)

Provision for Loan Losses – The provision for loan losses was $5.5 million for the nine months ended December 31, 2009 compared to $1.0 million for the same period in the prior year. This increase reflects the Company’s concern for deteriorating economic conditions in the local economy coupled with an increase in non-performing assets within its loan portfolio. The following table details selected activity associated with the allowance for loan losses for the nine months ended December 31, 2009 and 2008:

		December 31, 2009		December 31, 2008
Beginning Balance	$	10,181,599	$	8,066,762
Provision		5,475,000		1,025,000
Charge-offs		(1,718,860)		(444,409)
Recoveries		27,040		26,174
Ending Balance	$	13,964,779	$	8,673,527

Annualized net charge-offs as a percent of gross loans were 0.37% for the nine months ended December 31, 2009 compared to 0.12% for the year ended March 31, 2009 and 0.09% for the nine months ended December 31, 2008. Management of the Bank continues to be concerned about current market conditions and closely monitors the loan portfolio on an ongoing basis to proactively identify any potential issues. The average balance of impaired loans was $33.2 million for the nine months ended December 31, 2009 compared to $7.4 million for the same period in the prior year.

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

Non-Interest Income - Non-interest income increased $1.1 million or 35.7% to $4.3 million for the nine months ended December 31, 2009 from $3.2 million for the same period one year ago. The following table provides a detailed analysis of the changes in the components of non-interest income:

	Nine Months Ended December 31,				Increase (Decrease)
		2009		2008		Amounts	Percent
Gain On Sale Of Investments	$	675,101	$	126,440	$	548,661	433.9%
Gain On Sale Of Loans		811,545		335,444		476,101	141.9
Service Fees On Deposit Accounts		935,846		850,720		85,126	10.0
Income From Cash Value Of Life Insurance		270,000		268,492		1,508	0.6
Commissions From Insurance Agency		341,874		474,901		(133,027)	(28.0)
Other Agency Income		349,813		208,651		141,162	67.7
Trust Income		315,000		315,000		-	-
Other		645,340		622,512		22,828	3.7
Total Non-Interest Income	$	4,344,519	$	3,202,160	$	1,142,359	35.7%

Gain on sale of investments was $675,000 for the nine months ended December 31, 2009 compared to $126,000 in the comparable period in the prior year as a result of the sale of 50 investment securities. Based on an analysis of the portfolio, the Company was able to maximize return by selling securities with short average lives as a result of call features or securities with an adjustable rate scheduled to reprice down in the near future. The Company sold 11 securities in the same period in the prior year.

Gain on sale of loans increased $476,000 to $812,000 during the nine months ended December 31, 2009 compared to the same period one year ago. This increase is attributable to the increase in the origination and sale of fixed rate residential mortgage loans that is the result of the continued low interest rate environment. Service fees on deposit accounts increased $85,000 to $936,000 for the nine months ended December 31, 2009, compared to the same period in 2008. Commissions from insurance agency decreased $133,000 during the nine months ended December 31, 2009 compared to the same period one year ago. Other agency income increased $141,000 or 67.7% to $350,000 for the nine months ended December 31, 2009 compared to $209,000 for the same period in 2008. Trust income remained constant at $315,000 during the nine months ended December 31, 2009 and 2008, respectively.

Other miscellaneous income including credit life insurance commissions, safe deposit rental income, annuity and stock brokerage commissions, trust fees, and other miscellaneous fees, increased $23,000 to $645,000 during the nine months ended December 31, 2009 compared to the same period one year ago.

General and Administrative Expenses – General and administrative expenses increased $1.6 million or 10.6% to $16.7 million for the nine months ended December 31, 2009 from $15.1 million for the same period one year ago. The following table provides a detailed analysis of the changes in the components of general and administrative expenses:

	Nine Months Ended December 31,				Increase (Decrease)
		2009		2008		Amounts	Percent
Salaries And Employee Benefits	$	8,828,625	$	8,565,480	$	263,145	3.1%
Occupancy		1,490,587		1,490,879		(292)	0.0
Advertising		318,875		402,765		(83,890)	(20.8)
Depreciation And Maintenance Of Equipment		1,316,130		1,222,304		93,826	7.7
FDIC Insurance Premiums		1,473,000		549,227		923,773	168.2
Amortization of Intangibles		67,500		67,500		-	-
Mandatorily Redeemable Financial Instrument Valuation Expense		109,000		105,000		4,000	3.8
Loss On Sale Of Repossessed Assets Acquired In Settlement Of Loans		64,846		18,890		45,956	243.3
Other		3,080,447		2,719,836		360,611	13.3
Total General And Administrative Expenses	$	16,749,010	$	15,141,881	$	1,607,129	10.6%

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

Salary and employee benefits increased $263,000 to $8.8 million for the nine months ended December 31, 2009 from $8.6 million for the same period one year ago. Occupancy decreased slightly to $1.5 million for the nine month period ended December 31, 2009 compared to the same period one year ago. These changes were primarily the result of standard annual cost of living increases offset by a decrease in the number of employees employed by the Company.

Depreciation and maintenance expense increased $94,000 or 7.7% to $1.3 million for the nine months ended December 31, 2009 from $1.2 million for the same period one year ago. Advertising expense decreased $84,000 to $319,000 for the nine months ended December 31, 2009 from $403,000 for the same period one year ago. The decrease can be attributed to the Company’s effort to reduce expenses during the period.

FDIC insurance premiums increased $924,000 or 168.2% to $1.5 million for the nine month period ended December 31, 2009 compared to the same period a year ago. The Company recorded $425,000 in additional FDIC insurance premiums as a result of a one-time special assessment mandated by the FDIC to help replenish the government’s deposit insurance fund. This amount was in addition to the regular quarterly assessment amount. The special assessment applied to all federally insured depository institutions and is calculated based on 5% of an assessment base determined relative to asset size.

Mandatorily redeemable financial instrument valuation expense was $109,000 for the nine months ended December 31, 2009 compared to $105,000 for the same period one year earlier. Based on its terms, the mandatorily redeemable financial instrument is redeemable at the greater of $26 per share or one and a half times the book value of the Company. The Company recorded a valuation expense to properly reflect the fair value of the instrument at December 31, 2009 based on the book value.

Provision For Income Taxes – Provision for income taxes remained relatively stable at $1.0 million for the nine months ended December 31, 2009 and 2008, increasing $12,000 or 1.1%. Income before income taxes was $2.6 million for the nine months ended December 31, 2009 compared to $3.1 million for the nine months ended December 31, 2008. The Company’s combined federal and state effective income tax rate for the nine month ended December 31, 2009 was 40.9% compared to 33.3% for the same period one year earlier.

Liquidity Commitments, Capital Resources, and Impact of Inflation and Changing Prices

Liquidity – The Company actively analyzes and manages the Bank’s liquidity with the objective of maintaining an adequate level of liquidity and to ensure the availability of sufficient cash flows to support loan growth, fund deposit withdrawals, fund operations, and satisfy other financial commitments. See the “Consolidated Statements of Cash Flows” contained in Item 1 – Financial Statements, herein.

The primary sources of funds are customer deposits, loan repayments, loan sales, maturing investment securities, and advances from the FHLB and from the Federal Reserve’s TAF program. The sources of funds, together with retained earnings and equity, are used to make loans, acquire investment securities and other assets, and fund continuing operations. While maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage repayments are greatly influenced by the level of interest rates, economic conditions, and competition. Management believes that the Company’s current liquidity position and its forecasted operating results are sufficient to fund all of its existing commitments.

During the nine months ended December 31, 2009, loan repayments exceeded loan disbursements resulting in a $21.5 million or 3.5% decrease in total net loans receivable. During the nine months ended December 31, 2009, deposits increased $11.1 million, TAF advances increased $30.0 million, and FHLB advances decreased $47.7 million. The Bank had $118.1 million in additional borrowing capacity at the FHLB at the end of the period. At December 31, 2009, the Bank had $312.4 million of certificates of deposit maturing within one year. Based on previous experience, the Bank anticipates a significant portion of these certificates will be renewed.

The Bank is subject to various regulatory capital requirements that are administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that could have a material adverse effect on the Company. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classifications are also subject to qualitative judgments by regulators with regard to components, risk weightings, and other factors.

Security Federal Corporation and Subsidiaries

Item 2- Management’s Discussion and Analysis of Financial Condition and Results of Operations, Continued

As of December 31, 2009 and March 31, 2009, the Bank was categorized as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank had to maintain total risk-based capital, Tier 1 risk-based capital, and Tier 1 leverage ratios at 10%, 6%, and 5%, respectively. There are no conditions or events that management believes have changed the Bank’s classification.

Off-Balance Sheet Commitments – The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally include commitments to originate mortgage, commercial and consumer loans, and involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company’s maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount of those instruments. Since some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments.

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at December 31, 2009:

(Dollars in thousands)	Within One Month	After One Through Three Months	After Three Through Twelve Months	Within One Year	Greater Than One Year	Total

Unused lines of credit	$1,802	$3,746	$22,829	$28,377	$33,503	$61,880

Standby letters of credit		262	385	647	107	754

Total	$1,802	$4,008	$23,214	$29,024	$33,610	$62,634

Security Federal Corporation and Subsidiaries

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises principally from interest rate risk inherent in its lending, investment, deposit and borrowing activities. Management actively monitors and manages its interest rate risk exposure. Although the Company manages other risks such as credit quality and liquidity risk in the normal course of business, management considers interest rate risk to be its most significant market risk that could potentially have the largest material effect on the Company’s financial condition and results of operations. Other types of market risks such as foreign currency exchange rate risk and commodity price do not arise in the normal course of the Company’s business activities.

The Company’s profitability is affected by fluctuations in the market interest rate. Management’s goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase or decrease in interest rates may adversely impact the Company’s earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same rate, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using a test that measures the impact on net interest income and net portfolio value of an immediate change in interest rates in 100 basis point increments and by measuring the Bank’s interest sensitivity gap (“Gap”). Net portfolio value is defined as the net present value of assets, liabilities, and off-balance sheet contracts. Gap is the amount of interest sensitive assets repricing or maturing over the next twelve months compared to the amount of interest sensitive liabilities maturing or repricing in the same time period. Recent net portfolio value reports furnished by the OTS indicate that the Bank’s interest rate risk sensitivity has improved slightly over the past year. The Bank has rated favorably compared to thrift peers concerning interest rate sensitivity. However, these reports are based on estimates and may vary from actual circumstances.

Item 4T. Controls and Procedures

a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a - 15(e) of the Securities Exchange Act of 1934 (“Act”)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members of the Company’s senior management as of the end of the period covered by this quarterly report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that at December 31, 2009 the Company’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms.

The Company does not expect that its disclosure controls and procedures will prevent all error and or fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

(b) Changes in Internal Controls: In the quarter ended December 31, 2009, the Company did not make any significant changes in, nor take any corrective actions regarding, its internal controls or other factors that could significantly affect these controls.

Part II: Other Information

Item 1 Legal Proceedings

The Company is not engaged in any legal proceedings of a material nature at the present time. From time to time, the Company is a party to legal proceedings in the ordinary course of business wherein it enforces its security interest in mortgage loans it has made.

Security Federal Corporation and Subsidiaries

Item 1A Risk Factors

There have been no material changes in the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended March 31, 2009 except that the following risk factors are added to those previously contained in the Form 10-K:

Our loan portfolio includes commercial real estate loans with a higher risk of loss.

At December 31, 2009 commercial real estate loans were $394.5 million or 64.9% of our total loan portfolio. These loans typically involve higher principal amounts than other types of loans. Repayment is dependent upon income being generated from the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions. Commercial real estate loans may expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate. Included within this category are acquisition and development (“A&D”) loans. At December 31, 2009 A&D loans were $23.2 million or 3.8% of our total loan portfolio. This type of lending contains the inherent difficulty in estimating both a property’s value at completion of the project and the estimated cost (including interest) of the project. If the estimate of construction cost proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value upon completion proves to be inaccurate, we may be confronted at, or prior to, the maturity of the loan with a project the value of which is insufficient to assure full repayment. In addition, speculative construction loans to a builder are often associated with homes that are not pre-sold, and thus pose a greater potential risk to us than construction loans to individuals on their personal residences. Loans on land under development or held for future construction also poses additional risk because of the lack of income being produced by the property and the potential illiquid nature of the collateral. These risks can be significantly impacted by supply and demand conditions. As a result, this type of lending often involves the disbursement of substantial funds with repayment dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property, rather than the ability of the borrower or guarantor to independently repay principal and interest. While our origination of these types of loans have decreased significantly in the last two years, we continue to have significant levels of construction loan balances. Most of our construction loans are for the construction of single family residences. Reflecting the current slowdown in the residential market, the secondary market for land and construction loans is not readily liquid, so we have less opportunity to mitigate our credit risk by selling part or all of our interest in these loans. If we foreclose on a construction loan, our holding period for the collateral typically may be longer than we have historically experienced because there are fewer potential purchasers of the collateral. The decline in the number of potential purchasers has contributed to the decline in the value of these loans. Accordingly, charge-offs on construction and land loans may be larger than those incurred by other segments of our loan portfolio.

Our provision for loan losses and net loan charge offs have increased significantly and we may be required to make further increases in our provisions for loan losses and to charge off additional loans in the future, which could adversely affect our results of operations.

For the quarter and nine months ended December 31, 2009, we recorded a provision for loan losses of $2.5 million and $5.5 million, respectively, compared to $525,000 and $1.0 million for the comparable periods of 2008, respectively. We also recorded net loan charge-offs of $1.2 million and $1.7 million for the quarter and nine months ended December 31, 2009, respectively, compared to $115,000 and $418,000 for the comparable periods in 2008, respectively. We are experiencing elevated levels of loan delinquencies and credit losses. Slower sales, excess inventory and declining prices have been the primary causes of the increase in delinquencies and foreclosures for A&D loans and commercial real estate loans. At December 31, 2009, our total non-performing assets had increased to $42.8 million compared to $14.9 million at March 31, 2009. Further, our portfolio is concentrated in A&D loans, commercial business and commercial real estate loans, all of which generally have a higher risk of loss than residential mortgage loans. If current weak conditions in the housing and real estate markets continue, we expect that we will continue to experience higher than normal delinquencies and credit losses. Moreover, if the recession is prolonged, we expect that it could severely impact economic conditions in our market areas and that we could experience significantly higher delinquencies and credit losses. As a result, we may be required to make further increases in our provision for loan losses and to charge off additional loans in the future, which could materially adversely affect our financial condition and results of operations.

Security Federal Corporation and Subsidiaries

Item 1A Risk Factors, Continued

Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.

Lending money is a substantial part of our business and each loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:

·	cash flow of the borrower and/or the project being financed;

·	the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;

·	the duration of the loan;

·	the character and creditworthiness of a particular borrower; and

·	changes in economic and industry conditions.

We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by our management through periodic reviews and consideration of several factors, including, but not limited to:

·	our general reserve, based on our historical default and loss experience and certain macroeconomic factors based on management’s expectations of future events; and

·	our specific reserve, based on our evaluation of non-performing loans and their underlying collateral

The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and loss and delinquency experience, and evaluate economic conditions and make significant estimates of current credit risks and future trends, all of which may undergo material changes. If our estimates are incorrect, the allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in the need for additions to our allowance through an increase in the provision for loan losses. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. Our allowance for loan losses was 2.44% of total loans outstanding and 35.6% of non-performing loans at December 31, 2009. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the provision for loan losses will result in a decrease in net income and may have a material adverse effect on our financial condition, results of operations and capital.

Our federal thrift charter may be eliminated under the Obama Administration’s Financial Regulatory Reform Plan.

The Obama administration has proposed the creation of a new federal government agency, the National Bank Supervisor (“NBS”) that would charter and supervise all federally chartered depository institutions, and all federal branches and agencies of foreign banks. It is proposed that the NBS take over the responsibilities of the Office of the Comptroller of the Currency, which currently charters and supervises nationally chartered banks, and responsibility for the institutions currently supervised by the Office of Thrift Supervision, which supervises federally chartered thrift and thrift holding companies, such as Security Federal Corporation and Security Federal Bank. In addition, under the administration’s proposal, the thrift charter, under which Security Federal Bank is organized, would be eliminated. If the administration’s proposal is finalized, Security Federal Bank may be subject to a new charter mandated by the NBS. It is uncertain as to how this new charter, or the supervision by the NBS, will affect our operations going forward.

Security Federal Corporation and Subsidiaries

Item 1A Risk Factors, Continued

Increases in deposit insurance premiums and special FDIC assessments will hurt our earnings.

Beginning in late 2008, the economic environment caused higher levels of bank failures, which dramatically increased FDIC resolution costs and led to a significant reduction in the Deposit Insurance Fund. As a result, the FDIC has significantly increased the initial base assessment rates paid by financial institutions for deposit insurance. The base assessment rate was increased by seven basis points (seven cents for every $100 of deposits) for the first quarter of 2009. Effective April 1, 2009, initial base assessment rates were changed to range from 12 basis points to 45 basis points across all risk categories with possible adjustments to these rates based on certain debt-related components. These increases in the base assessment rate have increased our deposit insurance costs and negatively impacted our earnings. In addition, in May 2009, the FDIC imposed a special assessment on all insured institutions as a result of recent bank and savings association failures. The emergency assessment amounts to five basis points on each institution’s assets minus Tier 1 capital as of June 30, 2009, subject to a maximum equal to 10 basis points times the institution’s assessment base.

Additionally, as a potential alternative to special assessments, in September 2009, the FDIC required financial institutions to prepay its estimated quarterly risk-based assessment for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. As a result of this requirement, the Company prepaid $4.3 million in FDIC assessments. This proposal did not immediately impact our earnings as the payment will be expensed over time.

We operate in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations, including changes that may restrict our ability to foreclose on single-family home loans and offer overdraft protection.

We are subject to extensive examination, supervision and comprehensive regulation by the OTS and the FDIC. Banking regulations are primarily intended to protect depositors' funds, federal deposit insurance funds, and the banking system as a whole, and not holders of our common stock. These regulations affect our lending practices, capital structure, investment practices, dividend policy, and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations, and policies for possible changes. Changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer, restrict mergers and acquisitions, investments, access to capital, the location of banking offices, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputational damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.

New legislation proposed by Congress may give bankruptcy courts the power to reduce the increasing number of home foreclosures by giving bankruptcy judges the authority to restructure mortgages and reduce a borrower’s payments. Property owners would be allowed to keep their property while working out their debts. Other similar bills placing additional temporary moratoriums on foreclosure sales or otherwise modifying foreclosure procedures to the benefit of borrowers and the detriment of lenders may be enacted by either Congress or the State of Missouri in the future. These laws may further restrict our collection efforts on one-to-four single-family loans. Additional legislation proposed or under consideration in Congress would give current debit and credit card holders the chance to opt out of an overdraft protection program and limit overdraft fees which could result in additional operational costs and a reduction in our non-interest income.

Security Federal Corporation and Subsidiaries

Item 1A Risk Factors, Continued

Liquidity risk could impair the Company’s ability to fund operations and jeopardize its financial condition, growth and prospects.

Liquidity is essential to the Company’s business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on the Company’s liquidity. The Company relies on customer deposits and advances from the FHLB of Atlanta (“FHLB”), and other borrowings to fund its operations. Although the Company has historically been able to replace maturing deposits and advances if desired, it may not be able to replace such funds in the future if, among other things, the Company’s financial condition, the financial condition of the FHLB or market conditions change. The Company’s access to funding sources in amounts adequate to finance its activities or the terms of which are acceptable could be impaired by factors that affect the Company specifically or the financial services industry or economy in general - such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets. Factors that could detrimentally impact the Company’s access to liquidity sources include a decrease in the level of the Company’s business activity as a result of a downturn in the South Carolina or Georgia markets where its loans are concentrated or adverse regulatory action against it.

The Company’s financial flexibility will be severely constrained if it was unable to maintain its access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Although the Company considers its sources of funds adequate for its liquidity needs, the Company may seek additional debt in the future to achieve its long-term business objectives. Additional borrowings, if sought, may not be available to the Company or, if available, may not be available on reasonable terms. If additional financing sources are unavailable, or are not available on reasonable terms, the Company’s financial condition, results of operations, growth and future prospects could be materially adversely affected. Finally, if the Company is required to rely more heavily on more expensive funding sources to support future growth, its revenues may not increase proportionately to cover its costs.

Item 2 Unregistered sales of Equity Securities and Use Of Proceeds

None

Item 3 Defaults Upon Senior Securities

None

Item 4 Submission Of Matters To A Vote Of Security Holders

None

Item 5 Other Information

None

Security Federal Corporation and Subsidiaries

Item 6 Exhibits

	3.1	Articles Of Incorporation, as amended (1)
	3.2	Articles of Amendment, Including Certificate of Designation relating to the Company’s Fixed Rate Cumulative Perpetual Preferred Stock Series A(2)
	3.3	Bylaws (3)
	4.1	Instruments defining the rights of security holders, including indentures (4)
	4.2	Warrant to purchase shares of the Company’s common stock dated December 19, 2008(2)
	4.3	Letter Agreement (including Securities Purchase Agreement Standard Terms) dated December 19, 2008 between the Company and the United States Department of the Treasury (2)
	4.4	Form of Indenture with respect to the Company’s 8.0% Convertible Senior Debentures Due 2029 (5)
	4.5	Specimen Convertible Senior Debenture Due 2029 (5)
	10.1	1993 Salary Continuation Agreements (6)
	10.2	Amendment One to 1993 Salary Continuation Agreement (7)
	10.3	Form of 2006 Salary Continuation Agreement(8)
	10.4	1999 Stock Option Plan (3)
	10.5	1987 Stock Option Plan (6)
	10.6	2002 Stock Option Plan (9)
	10.7	2006 Stock Option Plan (10
	10.8	2004 Employee Stock Purchase Plan (12)
	10.9	Incentive Compensation Plan (6)
	10.10	Form of Security Federal Bank Salary Continuation Agreement (13)
	10.11	Form of Security Federal Split Dollar Agreement (13)
	10.12	2008 Equity Incentive Plan (11)
	10.12	Form of Compensation Modification Agreement (2)
	14	Code of Ethics (14)
	25.0	Form T-1: Statement of Eligibility of Trustee (5)
	31.1	Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
	31.2	Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act.
	32	Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act

(1)	Filed on June 26, 1998, as an exhibit to the Company’s Proxy Statement and incorporated herein by reference.
(2)	Incorporated by reference to the Registrant’s Current Report on Form 8-K on December 23, 2008.
(3)	Filed on March 2, 2000, as an exhibit to the Company’s Registration Statement on Form S-8 and incorporated herein by reference.
(4)	Filed on August 12, 1987, as an exhibit to the Company’s Registration Statement on Form 8-A and incorporated herein by reference.
(5)	Filed on July 13, 2009 as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-160553) and incorporated herein by reference.
(6)	Filed on June 28, 1993, as an exhibit to the Company’s Annual Report on Form 10-KSB and incorporated herein by reference.
(7)	Filed as an exhibit to the Company’s Quarterly Report on Form 10-QSB for the quarter ended September 30, 1993 and incorporated herein by reference.
(8)	Filed on May 24, 2006 as an exhibit to the Company’s Current Report on Form 8-K dated May 18, 2006 and incorporated herein by reference.
(9)	Filed on June 19, 2002, as an exhibit to the Company’s Proxy Statement and incorporated herein by reference.
(10)	Filed on August 22, 2006, as an exhibit to the Company’s Registration Statement on Form S-8 (Registration Statement No. 333-136813) and incorporated herein by reference.
(11)	Filed on June 20, 2008, as an exhibit to the Company’s Proxy Statement and incorporated herein by reference.
(12)	Filed on June 18, 2004, as an exhibit to the Company’s Proxy Statement and incorporated herein by reference.
(13)	Filed on May 24, 2006 as an exhibit to the Current Report on Form 8-K and incorporated herein by reference.
(14)	Filed on June 27, 2008 as an exhibit to the Company’s Annual Report on Form 10-K and incorporated herein by reference.

Security Federal Corporation and Subsidiaries

Signatures

Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to the signed on its behalf by the undersigned thereunto duly authorized.

			SECURITY FEDERAL CORPORATION


Date:	February 12, 2010	By:	/s/Timothy W. Simmons
				Timothy W. Simmons
				President
				Duly Authorized Representative

Date:	February 12, 2010	By:	/s/Roy G. Lindburg
				Roy G. Lindburg
				CFO
				Duly Authorized Representative