SECURITY FEDERAL CORP - Quarter Report: 2010 December (Form 10-Q)

q123110sfdl.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, 2010

( ) 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		February 11, 2011		2,944,001

INDEX


PART I.	FINANCIAL INFORMATION (UNAUDITED)	PAGE NO.

Item 1.	Financial Statements (Unaudited):

	Consolidated Balance Sheets at December 31, 2010 and March 31, 2010	1

	Consolidated Statements of Income for the Three and Nine Months Ended December 31, 2010 and 2009	2

	Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income for the Nine Months Ended December 31, 2010 and 2009	4

	Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2010 and 2009	5

	Notes to Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	42

Item 4.	Controls and Procedures	42


PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	43

Item 1A.	Risk Factors	43

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	44

Item 3.	Defaults Upon Senior Securities	44

Item 4.	(Removed and Reserved)	44

Item 5.	Other Information	44

Item 6.	Exhibits	44

	Signatures	46

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, 2010		March 31, 2010
Assets:		(Unaudited)		(Audited)
Cash And Cash Equivalents	$	8,604,915	$	8,804,645
Certificates Of Deposits With Other Banks		100,000		-
Investment And Mortgage-Backed Securities:
Available For Sale: (Amortized cost of $313,436,672 at December 31, 2010 and $284,831,441 at March 31, 2010)		320,033,387		292,261,039
Held To Maturity: (Fair value of $15,406,440 at December 31, 2010 and $19,854,106 at March 31, 2010)		14,351,155		18,785,380
Total Investment And Mortgage-Backed Securities		334,384,542		311,046,419
Loans Receivable, Net:
Held For Sale		13,500,063		3,161,463
Held For Investment: (Net of allowance of $12,408,796 at December 31, 2010 and $12,307,394 at March 31, 2010)		506,022,938		565,237,372
Total Loans Receivable, Net		519,523,001		568,398,835
Accrued Interest Receivable:
Loans		1,802,435		1,787,471
Mortgage-Backed Securities		870,095		964,380
Investments		924,484		703,339
Premises And Equipment, Net		20,172,623		20,720,484
Federal Home Loan Bank Stock, At Cost		11,267,485		12,624,400
Bank Owned Life Insurance		10,306,305		10,001,305
Repossessed Assets Acquired In Settlement Of Loans		14,977,764		10,773,050
Intangible Assets, Net		182,000		249,500
Goodwill		1,199,754		1,199,754
Other Assets		8,135,631		8,728,076
Total Assets	$	932,451,034	$	956,001,658

Liabilities And Shareholders’ Equity
Liabilities:
Deposit Accounts	$	689,294,592	$	694,252,437
Advances From Federal Home Loan Bank (“FHLB”)		137,890,420		164,003,882
Other Borrowed Money		11,225,060		12,060,470
Advance Payments By Borrowers For Taxes And Insurance		220,913		327,332
Mandatorily Redeemable Financial Instrument		1,658,312		1,663,312
Senior Convertible Debentures		6,084,000		6,084,000
Junior Subordinated Debentures		5,155,000		5,155,000
Other Liabilities		4,511,338		4,594,606
Total Liabilities		856,039,635		888,141,039

Shareholders' Equity:
Serial Preferred Stock, $.01 Par Value; Authorized Shares – 200,000; Issued And Outstanding Shares, 22,000 and 18,000 At December 31, 2010 And March 31, 2010, Respectively		22,000,000		17,692,609
Common Stock, $.01 Par Value; Authorized Shares – 5,000,000; Issued And Outstanding Shares -3,144,934 And 2,944,001, Respectively, At December 31, 2010; And 2,662,028 And 2,461,095, Respectively, At March 31, 2010		30,884		26,055
Warrant Issued In Conjunction With Serial Preferred Stock		400,000		400,000
Additional Paid-In Capital		10,201,218		5,352,144
Treasury Stock, (At Cost, 200,933 Shares, At December 31, 2010 And March 31,2010)		(4,330,712)		(4,330,712)
Accumulated Other Comprehensive Income		4,091,533		4,608,080
Retained Earnings, Substantially Restricted		44,018,476		44,112,443
Total Shareholders' Equity		76,411,399		67,860,619
Total Liabilities And Shareholders' Equity	$	932,451,034	$	956,001,658

See accompanying notes to consolidated financial statements.

Security Federal Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)

		Three Months Ended December 31,
		2010		2009
Interest Income:
Loans	$	8,011,236	$	8,899,817
Mortgage-Backed Securities		1,966,515		2,789,088
Investment Securities		579,571		555,733
Other		1,956		46
Total Interest Income		10,559,278		12,244,684

Interest Expense:
NOW And Money Market Accounts		459,440		637,225
Statement Savings Accounts		13,134		19,202
Certificate Accounts		1,846,667		2,342,602
Advances And Other Borrowed Money		1,382,049		1,634,734
Convertible Senior Debentures		121,680		40,560
Junior Subordinated Debentures		58,451		58,431
Total Interest Expense		3,881,421		4,732,754

Net Interest Income		6,677,857		7,511,930
Provision For Loan Losses		1,900,000		2,475,000
Net Interest Income After Provision For Loan Losses		4,777,857		5,036,930
Non-Interest Income:
Gain On Sale Of Investments		492,975		300,976
Gain On Sale Of Loans		334,713		215,080
Loss On Sale Of Repossessed Assets Acquired In Settlement Of Loans		(35,580)		(3,742)
Service Fees On Deposit Accounts		289,810		347,164
Income From Cash Value Of Life Insurance		105,000		90,000
Commissions From Insurance Agency		92,619		94,544
Other Agency Income		91,742		108,302
Trust Income		109,500		105,000
Mandatorily Redeemable Financial Instrument Valuation		90,000		(65,000)
Other		173,603		236,120
Total Non-Interest Income		1,744,382		1,428,444

General And Administrative Expenses:
Salaries And Employee Benefits		3,016,325		3,007,360
Occupancy		439,374		497,423
Advertising		97,491		102,946
Depreciation And Maintenance Of Equipment		453,291		433,734
FDIC Insurance Premiums		366,000		366,000
Amortization of Intangibles		22,500		22,500
Other		1,443,441		1,078,312
Total General And Administrative Expenses		5,838,422		5,508,275

Income Before Income Taxes		683,817		957,099
Provision For Income Taxes		229,446		395,008
Net Income		454,371		562,091
Preferred Stock Dividends		110,001		225,000
Accretion Of Preferred Stock To Redemption Value		-		17,579
Net Income Available To Common Shareholders	$	344,370	$	319,512

Basic Net Income Per Common Share	$	0.12	$	0.13
Diluted Net Income Per Common Share	$	0.12	$	0.13
Cash Dividend Per Share On Common Stock	$	0.08	$	0.08
Basic Weighted Average Shares Outstanding		2,869,205		2,461,095
Diluted Weighted Average Shares Outstanding		2,931,633		2,543,389

See accompanying notes to consolidated financial statements.

Security Federal Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)

		Nine Months Ended December 31,
		2010		2009
Interest Income:
Loans	$	24,649,276	$	26,096,241
Mortgage-Backed Securities		6,359,160		8,166,348
Investment Securities		1,928,999		1,818,640
Other		3,433		376
Total Interest Income		32,940,868		36,081,605

Interest Expense:
NOW And Money Market Accounts		1,638,090		1,960,383
Statement Savings Accounts		46,191		58,654
Certificate Accounts		5,963,591		8,424,088
Advances And Other Borrowed Money		4,440,815		4,970,069
Convertible Senior Debentures		365,040		40,560
Junior Subordinated Debentures		176,121		182,474
Total Interest Expense		12,629,848		15,636,228

Net Interest Income		20,311,020		20,445,377
Provision For Loan Losses		5,950,000		5,475,000
Net Interest Income After Provision For Loan Losses		14,361,020		14,970,377
Non-Interest Income:
Gain On Sale Of Investments		1,188,381		675,101
Gain On Sale Of Loans		1,180,870		811,545
Loss On Sale Of Repossessed Assets Acquired In Settlement Of Loans		(228,447)		(64,846)
Service Fees On Deposit Accounts		879,627		935,846
Income From Cash Value Of Life Insurance		305,000		270,000
Commissions From Insurance Agency		301,585		341,874
Other Agency Income		277,480		349,813
Trust Income		328,500		315,000
Mandatorily Redeemable Financial Instrument Valuation		5,000		(109,000)
Other		752,970		645,340
Total Non-Interest Income		4,990,966		4,170,673

General And Administrative Expenses:
Salaries And Employee Benefits		9,023,500		8,828,625
Occupancy		1,443,340		1,490,587
Advertising		298,839		318,875
Depreciation And Maintenance Of Equipment		1,377,859		1,316,130
FDIC Insurance Premiums		994,048		1,473,000
Amortization of Intangibles		67,500		67,500
Other		3,845,001		3,080,447
Total General And Administrative Expenses		17,050,087		16,575,164

Income Before Income Taxes		2,301,899		2,565,886
Provision For Income Taxes		849,590		1,049,548
Net Income		1,452,309		1,516,338
Preferred Stock Dividends		556,452		675,000
Accretion Of Preferred Stock To Redemption Value		18,816		53,935
Net Income Available To Common Shareholders	$	877,041	$	787,403

Basic Net Income Per Common Share	$	0.34	$	0.32
Diluted Net Income Per Common Share	$	0.33	$	0.31
Cash Dividend Per Share On Common Stock	$	0.24	$	0.24
Basic Weighted Average Shares Outstanding		2,599,081		2,460,777
Diluted Weighted Average Shares Outstanding		2,678,530		2,521,964

See accompanying notes to consolidated financial statements.

Security Federal Corporation and Subsidiaries

Consolidated Statements of Changes in 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, 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

		Preferred Stock		Warrants		Common Stock		Additional Paid – In Capital		Treasury Stock			Accumulated Other Comprehensive Income		Retained Earnings		Total
Balance At March 31, 2010	$	17,692,609	$	400,000	$	26,055	$	5,352,144	$		(4,330,712)	$	4,608,080	$	44,112,443	$	67,860,619
Net Income		-		-		-		-			-		-		1,452,309		1,452,309
Other Comprehensive Income, Net Of Tax:
Unrealized Holding Gains On Securities Available For Sale, Net Of Taxes		-		-		-		-			-		220,249		-		220,249
Reclassification Adjustment For Gains Included In Net Income, Net Of Taxes		-		-		-		-			-		(736,796)		-		(736,796)
Comprehensive Income		-		-		-		-			-		-		-		935,762
Common Stock Issuance		-		-		4,829		4,824,231			-		-		-		4,829,060
Preferred Stock Issuance		22,000,000		-		-		-			-		-		-		22,000,000
Preferred Stock Redemption		(17,711,425)		-		-		-			-		-		(288,575)		(18,000,000)
Accretion Of Preferred Stock To Redemption Value		18,816		-		-		-			-		-		(18,816)		-
Stock Compensation Expense		-		-		-		24,843			-		-		-		24,843
Cash Dividends On Preferred		-		-		-		-			-		-		(616,222)		(616,222)
Cash Dividends On Common		-		-		-		-			-		-		(622,663)		(622,663)
Balance At December 31, 2010	$	22,000,000	$	400,000	$	30,884	$	10,201,218	$		(4,330,712)	$	4,091,533	$	44,018,476	$	76,411,399

See accompanying notes to consolidated financial statements.

Security Federal Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

		Nine Months Ended December 31,
		2010		2009
Cash Flows From Operating Activities:
Net Income	$	1,452,309	$	1,516,338
Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities:
Depreciation Expense		1,173,023		1,164,294
Amortization Of Intangible Assets		67,500		67,500
Stock Option Compensation Expense		24,843		24,843
Discount Accretion And Premium Amortization		2,547,909		1,326,548
Provisions For Losses On Loans And Real Estate		5,950,000		5,475,000
Write Down Of Goodwill		-		222,000
Write Down Of Repossessed Assets Acquired In Settlement Of Loans		621,496		-
Mandatorily Redeemable Financial Instrument Valuation Expense (Income)		(5,000)		109,000
Gain On Sale Of Mortgage-Backed Securities Available For Sale		(1,038,435)		(273,330)
Gain On Sale Of Investment Securities Available For Sale		(149,946)		(401,771)
Gain On Sale Of Loans		(1,180,870)		(811,545)
Loss On Sale Of Repossessed Assets Acquired In Settlement Of Loans		228,447		64,846
Gain On Disposition Of Premises And Equipment		-		(25)
Amortization Of Deferred Fees On Loans		(18,405)		(96,392)
Income From Bank Owned Life Insurance		(305,000)		(270,000)
Proceeds From Sale Of Loans Held For Sale		63,318,003		54,823,727
Origination Of Loans For Sale		(72,475,733)		(53,458,227)
(Increase) Decrease In Accrued Interest Receivable:
Loans		(14,964)		17,890
Mortgage-Backed Securities		94,285		136,103
Investments		(221,145)		(464,738)
Decrease In Advance Payments By Borrowers		(106,419)		(227,589)
Other, Net		825,513		(6,358,358)
Net Cash Provided By Operating Activities		787,411		2,586,114

Cash Flows From Investing Activities:
Principal Repayments On Mortgage-Backed Securities Held To Maturity		3,018,518		5,981,325
Principal Repayments On Mortgage-Backed Securities Available For Sale		44,906,395		49,180,520
Purchase Of Investment Securities Available For Sale		(72,633,466)		(49,800,374)
Purchase Of Mortgage-Backed Securities Available For Sale		(72,675,609)		(58,437,257)
Maturities Of Investment Securities Available For Sale		26,631,467		13,490,722
Maturities Of Investment Securities Held To Maturity		1,388,855		4,258,066
Proceeds From Sale Of Mortgage-Backed Securities Available For Sale		38,291,203		17,599,784
Proceeds From Sale Of Investment Securities Available For Sale		5,442,103		12,576,398
Redemption Of FHLB Stock		1,356,915		38,300
Decrease In Loans To Customers		42,031,986		13,388,374
Proceeds From Sale Of Repossessed Assets		6,196,196		501,544
Purchase And Improvement Of Premises And Equipment		(625,162)		(487,281)
Proceeds From Sale Of Premises And Equipment		-		971
Net Cash Provided By Investing Activities		23,329,401		8,291,092

(Continued)

Security Federal Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

		Nine Months Ended December 31,
		2010		2009
Cash Flows From Financing Activities:
Increase (Decrease) In Deposit Accounts		(4,957,845)		11,050,407
Proceeds From FHLB Advances		113,120,000		257,705,000
Repayment Of FHLB Advances		(139,233,462)		(305,371,886)
Proceeds From TAF Advances		-		117,000,000
Repayment Of TAF Advances		-		(87,000,000)
Proceeds From Convertible Senior Debentures Offering		-		6,084,000
Net Repayment Of Other Borrowings		(835,410)		(5,661,820)
Proceeds From Issuance Of Preferred Stock		22,000,000		-
Proceeds From Issuance Of Common Stock		4,829,060
Redemption Of Preferred Stock		(18,000,000)
Dividends To Preferred Shareholders		(622,663)		(675,000)
Dividends To Common Shareholders		(616,222)		(590,661)
Proceeds From Employee Stock Purchases		-		19,800
Net Cash Used By Financing Activities		(24,316,542)		(7,440,160)

Net Increase (Decrease) In Cash And Cash Equivalents		(199,730)		3,437,046
Cash And Cash Equivalents At Beginning Of Period		8,804,645		6,562,394
Cash And Cash Equivalents At End Of Period	$	8,604,915	$	9,999,440

Supplemental Disclosure Of Cash Flows Information:
Cash Paid During The Period For Interest	$	12,925,718	$	15,704,896
Cash Paid During The Period For Income Taxes	$	19,432	$	2,513,082
Additions To Repossessed Acquired Through Foreclosure	$	11,250,853	$	2,163,972

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 2010 Annual Report to Stockholders, which was filed as an exhibit to the Annual Report on Form 10-K for the year ended March 31, 2010 (“2010 10-K”), when reviewing interim financial statements. The results of operations for the nine-month period ended December 31, 2010 are not necessarily indicative of the results that may be expected for the entire fiscal year. This Quarterly Report on Form 10-Q contains certain forward-looking statements with respect to the financial condition, results of operations, and business of the Company. These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those anticipated by such forward-looking statements include, but are not limited to, the general business environment, interest rates, the South Carolina real estate market, the demand for loans, competitive conditions between banks and non-bank financial services providers, regulatory changes, and other factors and risks detailed in the Company’s reports filed with the Securities and Exchange Commission, including the 2010 10-K for the fiscal year ended March 31, 2010. Management cautions readers of this Form 10-Q not to place undue reliance on the forward-looking statements contained herein.

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. 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 was inactive for several years. During the quarter ended December 31, 2010, it was reactivated and utilitzed to hold and operate a repossessed hotel located in Hardeeville, South Carolina.

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. 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 our financial statements. Our significant accounting policies are described in the footnotes to the audited consolidated financial statements at March 31, 2010 included in our 2010 Annual Report to Stockholders, which was filed as an exhibit to our 2010 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. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe 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 our carrying values of assets and liabilities and our results of operations.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

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. Such factors considered by management include the fair value of the underlying collateral, stated guarantees by the borrower (if applicable), the borrower’s ability to repay from other economic resources, growth and composition of the loan portfolio, the relationship of the allowance for loan losses to the outstanding loans, loss experience, delinquency trends, and general economic conditions. Management evaluates the carrying value of the loans periodically and the allowance is adjusted accordingly.

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. The allowance for loan losses is 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.

The Company uses assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax liabilities and assets for events recognized differently in its financial statements and income tax returns, and income tax expense. Determining these amounts requires analysis of certain transactions and interpretation of tax laws and regulations. The Company exercises considerable judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments and estimates are reevaluated on a continual basis as regulatory and business factors change. No assurance can be given that either the tax returns submitted by us or the income tax reported on the Consolidated Financial Statements will not be adjusted by either adverse rulings by the United States Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service.

4.	Earnings Per Common Share

Accounting guidance specifies the computation, presentation and disclosure requirements for earnings per share (“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. Basic EPS is computed by dividing net income 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 common shares had been issued. The dilutive effect of options outstanding under the Company’s stock option plan 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 conjunction with the acquisition of the Collier-Jennings Companies.

Net income available to common shareholders represents consolidated net income adjusted for preferred dividends declared, accretions 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 table provides a reconciliation of net income to net income available to common shareholders for the periods presented:

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

4. Earnings Per Common Share, Continued

For the Quarter Ended:		December 31,
		2010		2009
Earnings Available to Common Shareholders:
Net Income	$	454,371	$	562,091
Preferred Stock Dividends		110,001		225,000
Deemed Dividends On Preferred Stock From Net Accretion of Preferred Stock		-		17,579
Net Income Available To Common Shareholders	$	344,370	$	319,512

For the Nine Months Ended:		December 31,
		2010		2009
Earnings Available to Common Shareholders:
Net Income	$	1,452,309	$	1,516,338
Preferred Stock Dividends		556,452		675,000
Deemed Dividends On Preferred Stock From Net Accretion of Preferred Stock		18,816		53,935
Net Income Available To Common Shareholders	$	877,041	$	787,403

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

	For the Quarter Ended
	December 31, 2010
	Income (Numerator) Amount	Shares (Denominator)		Per Share

Basic EPS	$ 344,370	2,869,205	$	0.12
Effect of Diluted Securities:
Mandatorily Redeemable Shares	-	62,428		-
Senior Convertible Debentures	-	-		-
Stock Options & Warrants	-	-		-

Diluted EPS	$ 344,370	2,931,633	$	0.12

	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

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, 2010
	Income (Numerator) Amount	Shares (Denominator)		Per Share

Basic EPS	$ 877,041	2,599,081	$	0.34
Effect of Diluted Securities:
Mandatorily Redeemable Shares	-	79,449		(0.01)
Senior Convertible Debentures	-	-		-
Stock Options & Warrants	-	-		-

Diluted EPS	$ 877,041	2,678,530	$	0.33

	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

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, 2010 and 2009:

	Three Months Ended December 31, 2010		Nine Months Ended December 31, 2010
	Shares	Weighted Average Exercise Price	Shares	Weighted Average Exercise Price
Balance, Beginning of Period/Year	90,900	$22.57	90,900	$22.57
Options granted	-	-	-	-
Options exercised	-	-	-	-
Options forfeited	9,500	23.09	9,500	23.09
Balance, December 31, 2010	81,400	$22.51	81,400	$22.51

Options Exercisable	49,900		49,900

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

	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

There were no stock option awards granted by the Company during the three and nine month periods ended December 31, 2010 and 2009.

At December 31, 2010, 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	5,000	$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	5,000	$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

6.	Stock Warrants

In conjunction with its participation in the U.S. Treasury’s Capital Purchase Program, the Company sold a warrant to the U.S. Treasury to purchase 137,966 shares of the Company’s common stock at $19.57 per share. The warrant has a 10-year term and was immediately exercisable upon issuance. At December 31, 2010, the warrant was anti-dilutive. There were no changes in the Company’s stock warrants during the three and nine month periods ended December 31, 2010 and 2009.

7. Stock Issuance and Exchange

The Company was approved to participate in United States Department of the Treasury’s (the “Treasury”) Community Development Capital Initiative (“CDCI”). The CDCI was established by the Treasury to invest lower cost capital in Community Development Financial Institutions (“CDFI”), supporting their efforts to provide credit to small businesses and other qualified customers during this challenging economic period.

In connection with its participation in the CDCI, the Company (i) exchanged all $18.0 million aggregate liquidation preference amount of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), previously sold to the Treasury pursuant to the TARP Capital Purchase Program, for $18.0 million aggregate liquidation amount of the Company’s newly designated Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Stock”), (ii) sold 400,000 shares of its common stock at $10.00 per share in a private offering to board members of the Company as a result of a required match, for aggregate gross proceeds of $4.0 million; and (iii) received an additional $4.0 million investment from the Treasury through the sale of an additional $4.0 million aggregate liquidation preference amount of Series B Preferred Stock to the Treasury. The additional $4.0 million investment from the Treasury was contingent upon the completion of the $4.0 million match through a private offering of common stock.

Participation in the CDCI provided the Company with $8.0 million in additional capital and lowered the cost of capital received from the Treasury. The annual dividend rate on the Series A Preferred Stock was 5% and was to have increased to 9% on February 15, 2014. The annual dividend rate on the Series B Preferred Stock will be 2% for the first eight years from the date of issuance and 9% thereafter if still then outstanding. The Company and Security Federal Bank must maintain eligibility as a community development financial institution (“CDFI”) under Treasury regulations, otherwise, the annual dividend rate on the Series B Preferred Stock will increase to 5% if it is not corrected within 180 days and will further increase to 9% if not corrected after 270 days.

In addition, on December 22, 2010, the Company sold 82,906 shares of its common stock, $0.01 par value per share, through a private placement. The purchase price was $10.00 per share and the net proceeds received from the sale of these shares was $829,060. This was the final phase in the Company’s current plan to raise additional capital.

8. Carrying Amounts and Fair Value of Financial Instruments

Effective April 1, 2008, the Company adopted accounting guidance which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value under generally accepted accounting principles. This guidance 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.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

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

Accounting guidance 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, the guidance 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.

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, 2010, the Company’s investment portfolio was comprised of government and agency bonds, mortgage-backed securities issued by government agencies or government sponsored enterprises, 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.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

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

Impaired Loans

The Company does not record loans held for investment 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 as necessary. 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.

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 current 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, 2010, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. 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.

As of December 31, 2010 and March 31, 2010, the recorded investment in impaired loans was $37.9 million and $35.3 million, respectively. The average recorded investment in impaired loans was $37.9 million for the nine months ended December 31, 2010 and $33.6 million for the year ended March 31, 2010.

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 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.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

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

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. This instrument is classified as Level 2.

Assets and liabilities measured at fair value on a recurring basis are as follows as of December 31, 2010:

Assets:	Quoted Market Price In Active Markets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
FHLB Securities	$ -	$ 15,813,251	$ -
Federal Farm Credit Securities	-	1,081,460	-
Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”) Bonds	-	10,671,500	-
Small Business Administration (“SBA”) Bonds	-	67,572,776	-
Taxable Municipal Securities	-	4,500,333	-
Mortgage-Backed Securities	-	220,317,567	-
Equity Securities	-	76,500	-
Mortgage Loans Held For Sale	-	13,500,063	-
Total	$ -	$ 333,533,450	$ -
Liabilities:
Mandatorily Redeemable Financial Instrument	$ -	$ 1,658,312	$ -
Total	$ -	$ 1,658,312	$ -

Assets and liabilities measured at fair value on a recurring basis are as follows as of March 31, 2010:

Assets:	Quoted Market Price In Active Markets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
FHLB Securities	$ -	$ 9,369,901	$ -
Federal Farm Credit Securities	-	4,208,672	-
FNMA and FHLMC Bonds	-	5,963,270	-
SBA Bonds	-	37,186,061	-
Taxable Municipal Bond	-	3,225,926	-
Mortgage-Backed Securities	-	232,235,059	-
Equity Securities	-	72,150	-
Mortgage Loans Held For Sale	-	3,161,463	-
Total	$ -	$ 295,422,502	$ -
Liabilities:
Mandatorily Redeemable Financial Instrument	$ -	$ 1,663,312	$ -
Total	$ -	$ 1,663,312	$ -

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

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

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, 2010, aggregated by the level in the fair value hierarchy within which those measurements fall. Other intangible assets are measured on a non-recurring basis at least annually. Specifically, the valuation of goodwill is performed each year at September 30.

Assets:	Level 1	Level 2	Level 3	Balance At December 31, 2010
Intangible Assets	$ -	$ -	$ 182,000	$ 182,000
Impaired Loans (1)	-	32,305,805	4,836,772	37,142,577
Foreclosed Assets	-	14,977,764	-	14,977,764
Total	$ -	$ 47,283,569	$ 5,018,772	$ 52,302,341

(1) Impaired loans are reported net of specific reserves of $725,417.

The table below presents assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2010, aggregated by the level in the fair value hierarchy within which those measurements fall.

Assets:	Level 1	Level 2	Level 3	Balance At March 31, 2010
Goodwill	$ -	$ -	$ 249,500	$ 249,500
Impaired Loans (1)	-	19,735,647	13,548,107	33,283,754
Foreclosed Assets	-	8,738,965	2,034,085	10,773,050
Total	$ -	$ 28,474,612	$ 15,831,692	$ 44,306,304

(1) Impaired loans are reported net of specific reserves of $2.0 million.

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

Certificates of deposits with other banks—Fair value is based on market prices for similar assets.

Investment securities held to maturity—Securities held to maturity are valued at quoted market prices or dealer quotes.

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.

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.

Federal Home Loan Bank Advances—Fair value is estimated based on discounted cash flows using current market rates for borrowings with similar terms.

Other Borrowed Money—The carrying value of these short term borrowings 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

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 of junior subordinated debentures approximates fair value.

The following table is a summary of the carrying value and estimated fair value of the Company’s financial instruments as of December 31, 2010 and March 31, 2010 presented in accordance with the applicable accounting guidance.


		December 31, 2010				March 31, 2010
		Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
		(In Thousands)
Financial Assets:
Cash And Cash Equivalents	$	8,605	$	8,605	$	8,805	$	8,805
Certificates of Deposits With Other Banks		100		100		-		-
Investment And Mortgage-Backed Securities		334,385		335,440		311,046		312,115
Loans Receivable, Net		519,523		511,951		568,399		578,851
FHLB Stock		11,267		11,267		12,624		12,624

Financial Liabilities:
Deposits:
Checking, Savings, And Money Market Accounts	$	319,712	$	319,712	$	301,983	$	301,983
Certificate Accounts		369,583		373,986		392,270		398,206
Advances From FHLB		137,890		147,562		164,004		172,983
Other Borrowed Money		11,225		11,225		12,060		12,060
Senior Convertible Debentures		6,084		6,084		6,084		6,084
Junior Subordinated Debentures		5,155		5,155		5,155		5,155

At December 31, 2010, the Bank had $40.6 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 January 2010, fair value guidance was amended to require disclosures for significant amounts transferred in and out of Levels 1 and 2 and the reasons for such transfers and to require that gross amounts of purchases, sales, issuances and settlements be provided in the Level 3 reconciliation. Disaggregation of classes of assets and liabilities is also required. The new disclosures are effective for the Company for the current year and have been reflected in the Fair Value footnote.

In July 2010, the Receivables topic of the ASC was amended to require expanded disclosures related to a company’s allowance for credit losses and the credit quality of its financing receivables. The amendments will require the allowance disclosures to be provided on a disaggregated basis. The Company is required to begin to comply with the disclosures in its financial statements for the interim period ended December 31, 2010.

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which significantly changes the regulation of financial institutions and the financial services industry. The Dodd-Frank Act includes several provisions that will affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the future. Among other things, these provisions abolish the Office of Thrift Supervision and transfer its functions to the other federal banking agencies, relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of federal deposit insurance coverage, and impose new capital requirements on bank and thrift holding companies. The Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will be given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks. Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting originator compensation, minimum repayment standards, and pre-payments. Management is actively reviewing the provisions of the Dodd-Frank Act and assessing its probable impact on our business, financial condition, and results of operations.

In August 2010, two updates were issued to amend various SEC rules and schedules pursuant to Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules and Codification of Financial Reporting Policies and based on the issuance of SEC Staff Accounting Bulletin 112. The amendments related primarily to business combinations and removed references to “minority interest” and added references to “controlling” and “noncontrolling interests(s)”. The updates were effective upon issuance but had no impact on the Company’s financial statements.

In December 2010, the Intangibles topic of the ASC was amended to modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. Any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings upon adoption. Impairments occurring subsequent to adoption should be included in earnings. The amendment is effective for the Company beginning January 1, 2011. Early adoption is not permitted. The Company does not expect the amendment to have any impact on the financial statements.

Also in December 2010, the Business Combinations topic of the ASC was amended to specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendment also requires that the supplemental pro forma disclosures include a description of the nature and amount of any material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. This amendment is effective for the Company for business combinations for which the acquisition date is on or after January 1, 2011, although early adoption is permitted. The Company does not expect the amendment to have any impact on the 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.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

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, 2010		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLB Securities	$	16,008,334	$	163,741	$	358,824	$	15,813,251
Federal Farm Credit Securities		1,007,350		74,110		-		1,081,460
Federal National Mortgage Association (“FNMA”) And Federal Home Loan Mortgage Corporation (“FHLMC”) Bonds		11,000,581		-		329,081		10,671,500
Small Business Administration (“SBA”) Bonds		66,880,242		928,174		235,640		67,572,776
Taxable Municipal Bonds		4,558,189		-		57,856		4,500,333
Mortgage-Backed Securities		213,879,038		7,007,676		569,147		220,317,567
Equity Securities		102,938		-		26,438		76,500
Total	$	313,436,672	$	8,173,701	$	1,576,986	$	320,033,387


March 31, 2010		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
FHLB Securities	$	9,209,585	$	204,066	$	43,750	$	9,369,901
Federal Farm Credit Securities		4,173,462		40,079		4,869		4,208,672
FNMA Bonds and FHLMC Bonds		5,993,806		-		30,536		5,963,270
SBA Bonds		36,955,783		313,976		83,698		37,186,061
Taxable Municipal Bond		3,192,950		32,976		-		3,225,926
Mortgage-Backed Securities		225,202,917		7,396,067		363,925		232,235,059
Equity Securities		102,938		-		30,788		72,150
	$	284,831,441	$	7,987,164	$	557,566	$	292,261,039

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.

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, 2010 and March 31, 2010, the Company held an amortized cost and fair value of $136.1 million and $139.5 million and $129.1 million and $132.4 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 $43.7 million and $30.2 million, respectively, in proceeds from sales of available for sale securities during the nine months ended December 31, 2010 and 2009 and recognized approximately $1.2 million in gross gains in the nine months ended December 31, 2010 and $675,000 in gross gains in the nine months ended December 31, 2009.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

10. Securities, Continued

The amortized cost and fair value of investment and mortgage-backed securities available for sale at December 31, 2010 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	$	-	$	-
One – Five Years		8,242,117		8,356,325
Over Five – Ten Years		43,320,510		43,439,858
After Ten Years		47,995,007		47,919,637
Mortgage-Backed Securities		213,879,038		220,317,567
	$	313,436,672	$	320,033,387

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, 2010.

		Less than 12 Months				12 Months or More				Total
		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Securities	$	11,490,657	$	358,824	$	-	$	-	$	11,490,657	$	358,824
Mortgage-Backed Securities		41,613,962		569,147		-		-		41,613,962		569,147
SBA Bonds		19,238,660		235,640		-		-		19,238,660		235,640
FNMA and FHLMC Bonds		10,671,500		329,081		-		-		10,671,500		329,081
Taxable Municipal Bonds		955,880		57,856						955,880		57,856
Equity Securities		-		-		76,500		26,438		76,500		26,438
	$	83,970,659	$	1,550,548	$	76,500	$	26,438	$	84,047,159	$	1,576,986

		Less than 12 Months				12 Months or More				Total
		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Securities	$	2,956,250	$	43,750	$	-	$	-	$	2,956,250	$	43,750
Federal Farm Credit Securities		1,037,500		4,869		-		-		1,037,500		4,869
Mortgage-Backed Securities		36,866,308		363,925		-		-		36,866,308		363,925
FNMA and FHLMC Bonds		4,963,270		30,536		-		-		4,963,270		30,536
SBA Bonds		10,464,706		83,698		-		-		10,464,706		83,698
Equity Securities		-		-		72,150		30,788		72,150		30,788
	$	56,288,034	$	526,778	$	72,150	$	30,788	$	56,360,184	$	557,566

Securities classified as available for sale are recorded at fair market value. Approximately 1.7% of the unrealized losses, or one individual security, consisted of securities in a continuous loss position for 12 months or more at December 31, 2010. At March 31, 2010, approximately 5.5% 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.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

10. Securities, Continued

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 a portion may be recognized in other comprehensive income. The fair value of investments on which OTTI is recognized then becomes the new cost basis of the investment.

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, 2010		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLB Securities	$	3,000,000	$	289,430	$	-	$	3,289,430
SBA Bonds		4,095,554		285,529		-		4,381,083
Mortgage-Backed Securities		7,100,601		480,326		-		7,580,927
Equity Securities		155,000		-		-		155,000
Total	$	14,351,155	$	1,055,285	$	-	$	15,406,440

March 31, 2010		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLB Securities	$	4,000,000	$	284,070	$	-	$	4,284,070
SBA Bonds		4,481,515		262,584		-		4,744,099
Mortgage-Backed Securities		10,148,865		522,072		-		10,670,937
Equity Securities		155,000		-		-		155,000
Total	$	18,785,380	$	1,068,726	$	-	$	19,854,106

At December 31, 2010, the Company held an amortized cost and fair value of $4.1 million and $4.4 million, respectively in GNMA mortgage-backed securities included in mortgage-backed securities listed above. At March 31, 2010, the Company held an amortized cost and fair value of $5.6 million and $5.9 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, 2010, 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	$	-	$	-
One – Five Years		4,053,464		4,395,583
Over Five – Ten Years		-		-
More Than Ten Years		3,197,090		3,429,930
Mortgage-Backed Securities		7,100,601		7,580,927
	$	14,351,155	$	15,406,440

The Company did not have any held to maturity securities that were in an unrealized loss position at December 31, 2010 or March 31, 2010. 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, 2010.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

11. Loans Receivable, Net

Loans receivable, net, at December 31, 2010 and March 31, 2010 consisted of the following:

		December 31, 2010		March 31, 2010
Residential Real Estate	$	109,751,903	$	118,256,972
Consumer		65,548,802		68,526,203
Commercial Business		15,683,163		17,813,383
Commercial Real Estate		333,134,851		378,719,217
Loans Held For Sale		13,500,063		3,161,463
		537,618,782		586,477,238

Less:
Allowance For Possible Loan Loss		12,408,796		12,307,394
Loans In Process		5,668,470		5,619,822
Deferred Loan Fees		18,515		151,187
		18,095,781		18,078,403
	$	519,523,001	$	568,398,835

The Company uses a risk based approach based on the following credit quality measures when analyzing the loan portfolio: pass, watch, special mention, and substandard. These indicators are used to rate the credit quality of loans for the purposes of determining the Company’s allowance for loan losses. Pass loans are loans that are performing and are deemed adequately protected by the net worth of the borrower or the underlying collateral value. These loans are considered the least risky in terms of determining the allowance for loan losses. Substandard loans are considered the most risky category. These loans typically have an identified weakness or weaknesses and are inadequately protected by the net worth of the borrower or collateral value. All loans 60 days or more past due are automatically classified in this category. The other two categories fall in between these two grades. The following table lists the loan grades used by the Company as credit quality indicators and the balance in each category at December 31, 2010, excluding loans held for sale.

Credit Quality Measures	Pass		Watch		Special Mention		Substandard		Total Loans
Residential Real Estate	$	102,135,728	$	-	$	192,154	$	7,424,021	$	109,751,903
Consumer		61,833,610		68,918		10,059		3,636,215		65,548,802
Commercial Business		15,421,665		16,062		-		245,436		15,683,163
Commercial Real Estate		248,714,350		11,612,535		29,792,088		43,015,878		333,134,851
Total	$	428,105,353	$	11,697,515	$	29,994,301	$	54,321,550	$	524,118,719

The following table presents an age analysis of past due balances by category at December 31, 2010.

	30-59 Days Past Due		60-89 Days Past Due		90 Day or More Past Due		Total Past Due		Current		Total Loans Receivable
Residential Real Estate	$	478,300	$	2,405,807	$	4,068,660	$	6,952,767	$	102,799,136	$	109,751,903
Consumer		1,055,281		1,776,274		2,430,912		5,262,467		60,286,335		65,548,802
Commercial Business		506,487		95,702		224,153		826,342		14,856,821		15,683,163
Commercial Real Estate		23,138,447		3,304,482		16,325,666		42,768,595		290,366,255		333,134,851
Total	$	25,178,515	$	7,582,265	$	23,049,391	$	55,810,171	$	468,308,548	$	524,118,719

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

11. Loans Receivable, Net, Continued

At December 31, 2010, the Company did not have any loans that were 90 days or more past due and still accruing interest. Our strategy is 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. The following table shows non-accrual loans by category at December 31, 2010 compared to March 31, 2010.

	At December 31, 2010					At March 31, 2010					$			%
	Amount		Percent (1)			Amount		Percent (1)			Increase (Decrease)			Increase (Decrease)
Non-accrual loans:
Residential real estate	$	4,068,660		0.8	%	$	4,344,060		0.8	%	$	(275,400	)		6.3	%
Commercial business		224,153		0.0			699,182		0.1			(475,029	)		(67.9	)
Commercial real estate		16,325,666		3.2			25,479,420		4.4			(9,153,754	)		(35.9	)
Consumer		2,430,912		0.4			703,288		0.1			1,727,624			245.6
Total non-accural loans	$	23,049,391		4.4	%	$	31,225,950		5.4	%	$	(8,176,559	)		(26.2	)%

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

The following table details selected activity associated with the allowance for loan losses for the nine months ended December 31, 2010.

		December 31, 2010		December 31, 2009
Beginning Balance	$	12,307,394	$	10,181,599
Provision		5,950,000		5,475,000
Charge-offs		(5,916,333)		(1,718,860)
Recoveries		67,735		27,040
Ending Balance	$	12,408,796	$	13,964,779

The following table presents information related to impaired loans evaluated individually for impairment and collectively evaluated for impairment in the allowance for loan losses.

Ending Balances		Allowance For Loan Losses
December 31, 2010		Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	-	$	1,763,016	$	1,763,016
Consumer		138,100		1,111,611		1,249,711
Commercial Business		192,048		701,120		893,168
Commercial Real Estate		395,269		8,107,632		8,502,901
Total	$	725,417	$	11,683,379	$	12,408,796

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 and records the loan at fair value. 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.

Security Federal Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited), Continued

11. Loans Receivable, Net, Continued

The average balance of impaired loans was $38.1 million for the nine months ended December 31, 2010 compared to $33.2 million for the same period in the prior year. The following table is a summary of information related to impaired loans as of December 31, 2010.

IMPAIRED LOANS		Recorded Investment		Unpaid Principal Balance		Related Allowance

With no related allowance recorded:
Residential Real Estate	$	1,435,638	$	1,435,638	$	-
Consumer Loans		726,192		726,192		-
Commercial Business		435,408		435,408		-
Commercial Real Estate		31,252,983		31,252,983		-

With an allowance recorded:
Residential Real Estate		-		-		-
Consumer Loans		499,108		499,108		138,100
Commercial Business		198,959		198,959		192,048
Commercial Real Estate		3,319,706		3,319,706		395,269

Total
Residential Real Estate		1,435,638		1,435,638		-
Consumer Loans		1,225,300		1,225,300		138,100
Commercial Business		634,367		634,367		192,048
Commercial Real Estate		34,572,689		34,572,689		395,269

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

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

·	future legislative changes and our ability to comply with the requirement of the U.S. Treasury Community Development Capital Initiative (“CDCI”); 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 2010 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 2011 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, 2010 and March 31, 2010

General – Total assets decreased $23.6 million or 2.5% to $932.5 million at December 31, 2010 from $956.0 million at March 31, 2010. The primary reason for the decrease in total assets was a $48.9 million or 8.6% decrease in net loans receivable to $519.5 million combined with a $4.4 million or 23.6% decrease in investment and mortgage-backed securities-held to maturity. These decreases were offset partially by an increase in investment and mortgage-backed securities available for sale and repossessed assets.

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

					Increase (Decrease)
	December 31, 2010		March 31, 2010		Amount			Percent
Cash And Cash Equivalents	$	8,604,915	$	8,804,645	$	(199,730	)		(2.3	)%
Investment And Mortgage- Backed Securities – Available For Sale		320,033,387		292,261,039		27,772,348			9.5
Investment And Mortgage- Backed Securities – Held To Maturity		14,351,155		18,785,380		(4,434,225	)		(23.6	)
Loan Receivable, Net		519,523,001		568,398,835		(48,875,834	)		(8.6	)
FHLB Stock		11,267,485		12,624,400		(1,356,915	)		(10.8	)
Repossessed Assets Acquired In Settlement of Loans		14,977,764		10,773,050		4,204,714			39.0

Cash and cash equivalents decreased $200,000 to $8.6 million at December 31, 2010 from $8.8 million at March 31, 2010.

Investments and mortgage-backed securities available for sale increased $27.8 million or 9.5% to $320.0 million at December 31, 2010 from $292.3 million at March 31, 2010. The increase in investments and mortgage-backed securities available for sale is attributable to additional purchases of mortgage-backed securities and investments. 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 $4.4 million to $14.4 million at December 31, 2010 compared to $18.8 million at March 31, 2010. This is a result of maturities and paydowns on investments.

Loans receivable, net decreased $48.9 million or 8.6% to $519.5 million at December 31, 2010 from $568.4 million at March 31, 2010. Residential real estate loans decreased $8.5 million to $109.8 million at December 31, 2010 from $118.3 million at March 31, 2010. Consumer loans decreased $3.0 million to $65.5 million at December 31, 2010 from $68.5 million at March 31, 2010. Commercial business loans decreased $2.1 million to $15.7 million at December 31, 2010 from $17.8 million at March 31, 2010 while commercial real estate loans decreased $45.6 million to $333.1 million at December 31, 2010 from $378.7 million at March 31, 2010. The decreases in loans are primarily a result of increased rates, tightened underwriting standards and a general decrease in loan demand. Loans held for sale increased $10.3 million or 327.0% to $13.5 million at December 31, 2010 from $3.2 million at March 31, 2010. The increase is primarily attributable to an increase in refinancing activity as a result of increased offering rates.

Security Federal Corporation and Subsidiaries

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

FHLB stock decreased $1.4 million or 10.8% to $11.3 million at December 31, 2010 from $12.6 million at March 31, 2010. The amount of FHLB stock the Bank is required to invest in as a member of the FHLB of Atlanta is determined based on a percent of total assets and advances outstanding. Therefore, as the Bank’s total assets or advances decrease, so does the required investment in FHLB stock.

Repossessed assets acquired in settlement of loans increased $4.2 million or 39.0% to $15.0 million at December 31, 2010 from $10.8 million at March 31, 2010. The Company sold 25 real estate properties and repossessed 28 additional properties during the period for a net increase during the nine month period ended December 31, 2010. At December 31, 2010, the balance of repossessed assets consisted of the following 32 real estate properties: 15 single-family residences located throughout the Company’s market area in South Carolina and Georgia; nine lots within six subdivisions in Aiken County and Lexington County, South Carolina and approximately 17 acres of land in Aiken, South Carolina; one mobile home and small acreage in Aiken County, South Carolina; one commercial building in Lexington County, South Carolina and one commercial building in Augusta, Georgia; a 55 lot subdivision development and adjacent 17 acres of land in Columbia, South Carolina; and 34.8 acres of land in Bluffton, South Carolina originally acquired as a participation loan from another financial institution, a commercial building in Charleston, South Carolina that was a loan originally acquired through a loan broker, and a hotel in Hardeeville, South Carolina. In addition to the properties listed above, the balance also included $21,000 in various other repossessed assets that were not real estate.

Liabilities

Deposit Accounts

												Balance
		December 31, 2010					March 31, 2010					Increase (Decrease)
		Balance		Weighted Rate			Balance		Weighted Rate			Amount			Percent
Demand Accounts:
Checking		$	111,521,249		0.14	%	$	109,086,367		0.20	%	$	2,434,882			2.2	%
Money Market			188,941,553		0.91			173,904,664		1.28			15,036,889			8.6
Statement Savings Accounts			19,248,788		0.25			18,991,543		0.39			257,245			1.4
Total			319,711,590		0.60			301,982,574		0.83			17,729,016			5.9

Certificate Accounts
	0.00 – 1.99%		213,377,160					118,796,507					94,580,653			79.6
	2.00 – 2.99%		143,582,110					255,352,355					(111,770,245	)		(43.8	)
	3.00 – 3.99%		3,423,489					4,571,860					(1,148,371	)		(25.1	)
	4.00 – 4.99%		5,509,875					8,818,487					(3,308,612	)		(37.5	)
	5.00 – 5.99%		3,690,368					4,730,654					(1,040,286	)		(22.0	)
Total			369,583,002		1.85			392,269,863		2.15			(22,686,861	)		(5.8	)
Total Deposits		$	689,294,592		1.27	%	$	694,252,437		1.58	%	$	(4,957,845	)		(0.7	)%

Included in the certificates above were $39.7 million and $34.4 million in brokered deposits at December 31, 2010 and March 31, 2010, respectively with a weighted average interest rate of 2.18% and 2.07%, 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, 2010					March 31, 2010					Increase (Decrease)
Fiscal Year Due:	Balance		Rate			Balance		Rate			Balance			Percent
2011	$	-		-		$	31,100,000		2.54	%	$	(31,100,000	)		(100.0	)%
2012		24,700,000		2.26	%		34,700,000		3.66	%		(10,000,000	)		(28.8	)
2013		10,000,000		4.76	%		10,000,000		4.76	%		-			-
2014		30,000,000		3.45	%		20,000,000		3.84	%		10,000,000			(50.0	)
2015		20,290,420		3.01	%		15,303,882		3.44	%		4,986,538			32.6
Thereafter		52,900,000		4.27	%		52,900,000		4.27	%		-			-
Total Advances	$	137,890,420		3.58	%	$	164,003,882		3.71	%	$	(26,113,462	)		(15.9	)%

Advances from the FHLB decreased $26.1 million to $137.9 million at December 31, 2010 from $164.0 million at March 31, 2010. 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 totaling $85.5 million at December 31, 2010 and investment securities with approximate amortized cost and fair value of $91.9 million and $97.1 million, respectively, at December 31, 2010 and $130.8 million and $136.0 million, respectively at March 31, 2010. 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, 2010
Borrow Date	Maturity Date	Amount	Int. Rate	Type	Call Dates

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
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
03/09/07	03/09/12	4,700,000	4.286%	Multi-Call	06/09/10 and quarterly thereafter
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
12/17/10	06/17/14	5,000,000	1.685%	1 Time Call	03/17/11

Other Borrowings – The Bank had $11.2 million and $12.1 million in other borrowings at December 31, 2010 and March 31, 2010, respectively. These borrowings consist of short-term repurchase agreements with certain commercial demand deposit customers for sweep accounts. 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, 2010 and March 31, 2010, the interest rate paid on the repurchase agreements was 0.40% and 0.80%, respectively. The Bank had pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $25.3 million and $26.6 million, respectively, at December 31, 2010 and $20.6 million and $21.3 million, respectively, at March 31, 2010.

Security Federal Corporation and Subsidiaries

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

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 released the shares to the shareholder of the Collier-Jennings Companies over a three-year period. The stock is mandatorily redeemable by 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, 2010, the shareholder had not elected to redeem any of the shares.

The mandatorily redeemable financial instrument is carried at fair value. At December 31, 2010 and March 31, 2010, the fair value was $1.7 million based on the Company’s book value per common share. The Company recognized income of $90,000 during the quarter ended December 31, 2010 to properly reflect the fair value of the instrument.

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 4.44% at December 31, 2010. 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 2.00% at December 31, 2010. 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 $8.6 million or 12.6% to $76.4 million at December 31, 2010 from $67.9 million at March 31, 2010. Accumulated other comprehensive income, net of tax decreased $517,000 to $4.1 million at December 31, 2010. The Company’s net income available for common shareholders was $877,000 for the nine month period ended December 31, 2010, after preferred stock dividends and accretion of preferred stock of $575,000. The Board of Directors of the Company declared common stock dividends, which were $0.08 per share, totaling $623,000. Book value per common share was $18.35 at December 31, 2010 and $20.22 at March 31, 2010.

On September 29, 2010, the Company entered into a Letter Agreement with the U.S. Department of the Treasury in connection with participation in the CDCI established by the Treasury pursuant to the TARP. That same day, pursuant to the Exchange Agreement, all 18,000 shares of our Fixed Rate Cumulative Perpetual Preferred Stock, Series A, liquidation preference amount $1,000 per share previously sold to the Treasury on December 19, 2008 pursuant to the TARP Capital Purchase Program, were exchanged for 18,000 shares of our newly designated Fixed Rate Cumulative Perpetual Preferred Stock, Series B, liquidation preference amount $1,000 per share.

Security Federal Corporation and Subsidiaries

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

In connection with our participation in the CDCI, on September 29, 2010, we also entered into a Letter Agreement with the Treasury, pursuant to which Security Federal Corporation sold an additional 4,000 shares of Series B Preferred Stock to the Treasury that same day at a price of $4.0 million. As a result of our participation in the CDCI and the transactions under the Exchange Agreement and the Purchase Agreement, the Treasury now holds 22,000 shares of the Security Federal Corporation Series B Preferred Stock, with an aggregate liquidation preference amount of $22.0 million

The additional capital received by us from the Treasury pursuant to the Purchase Agreement was contingent upon the Company’s completion of a separate stock offering of the same amount, as required by our primary regulator, the Office of Thrift Supervision. In satisfaction of this requirement, on September 29, 2010, the Company sold 400,000 shares of its common stock, in a private offering at a price of $10.00 per share, for gross proceeds of $4.0 million. In addition, on December 22, 2010 the Company sold 82,906 shares of its common stock in a private placement for $10.00 a share. Together with the gross proceeds of the sale of Series B Preferred Stock to the Treasury pursuant to the Purchase Agreement, the Company raised $8.8 million of capital in the aggregate.

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

	At December 31, 2010						At March 31, 2010						$			%
	Amount			Percent (1)			Amount			Percent (1)			Increase (Decrease)			Increase (Decrease)
Loans 90 days or more past due or non- accrual loans:
Residential real estate	$	4,068,660			0.8	%	$	4,344,060			0.8	%	$	(275,400	)		(6.3	)%
Commercial business		224,153			0.0			699,182			0.1			(475,029	)		(67.9	)
Commercial real estate		16,325,666			3.2			25,479,420			4.4			(9,153,754	)		(35.9	)
Consumer		2,430,912			0.4			703,288			0.1			1,727,624			245.6
Total non-performing loans		23,049,391			4.4			31,225,950			5.4			(8,176,559	)		(26.2	)

Other non-performing assets:
Repossessed assets		21,370			0.0			43,106			0.0			(21,736	)		(50.4	)
Real estate owned		14,956,394			2.9			10,729,944			1.9			4,226,450			39.4
Total other non-performing assets		14,977,764			2.9			10,773,050			1.9			4,204,714			39.0
Total non-performing assets	$	38,027,155			7.3	%	$	41,999,000			7.3	%	$	(3,971,845	)		(9.5	)%

Total non-performing assets as a percentage of total assets		4.1	%					4.4	%

(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 decreased $4.0 million to $38.0 million at December 31, 2010 from $42.0 million at March 31, 2010. The decrease was primarily concentrated in non-performing commercial real estate loans which decreased $9.2 million to $16.3 million at December 31, 2010 from $25.5 million at March 31, 2010. The balance in non-performing commercial real estate loans consisted of 51 loans to 31 borrowers with an average loan balance of $320,000.

A large portion of the non-performing commercial real estate category, or $7.7 million consisted of six loans to three separate borrowers. Of this amount, $4.5 million was for four land acquisition and development type loans to two different borrowers (“A&D loans”) in the Midlands area of South Carolina, $1.2 million was secured by an apartment complex in Lexington, South Carolina, and another $ 2.0 million loan was secured by a building in Columbia, South Carolina.

Non-performing residential real estate loans decreased slightly to $4.1 million at December 31, 2010 from $4.3 million at March 31, 2010. The balance consisted of 19 loans to 18 borrowers with an average balance of $214,000. The balance in non-performing commercial business loans decreased $475,000 to $224,000 at December 31, 2010. The balance consisted of 7 loans to 7 borrowers with an average loan balance of $32,000. Total non-performing consumer loans increased $1.7 million to $2.4 million at December 31, 2010 compared to $703,000 at March 31, 2010 and consisted of 30 loans to 26 borrowers with an average balance of $81,000.

Security Federal Corporation and Subsidiaries

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

Repossessed assets acquired in settlement of loans increased $4.2 million to $15.0 million at December 31, 2010 from $10.8 million at March 31, 2010. The Company foreclosed on 28 real estate properties during the period ended December 31, 2010 and sold 25 properties. During the quarter ended September 30, 2010, the Bank foreclosed on a building located in Charleston, South Carolina, which accounts for $4.0 million of the increase in repossessed assets at December 31, 2010.

The Bank reviews its loan portfolio and allowance for loan losses on a monthly basis. Future additions to the Bank's allowance for loan losses are dependent on, among other things, the performance of the Bank's loan portfolio, the economy, changes in real estate values, and interest rates. There can be no assurance that additions to the allowance will not be required in future periods. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. 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. 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 allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations. Management continually monitors its loan portfolio for the impact of local economic changes. The ratio of allowance for loan losses to total loans was 2.39% at December 31, 2010 and 2.13% at March 31, 2010. The Bank continues to practice conservative lending and past due loans are monitored closely.

The cumulative interest not accrued during the nine months ended December 31, 2010 relating to all non-performing loans totaled $952,000. At December 31, 2010, the Company did not have any loans that were 90 days or more past due and still accruing interest. Our strategy is 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.

The balance of loans in troubled debt restructurings increased during the nine months ended December 31, 2010. The Bank had 34 loans that were troubled debt restructurings totaling $12.2 million at December 31, 2010 compared to five loans totaling $336,000 at March 31, 2010. All troubled debt restructurings are considered impaired and reviewed for potential impairment losses. At December 31, 2010, the Bank held $37.9 million in impaired loans including troubled debt restructurings compared to $35.3 million at March 31, 2010. The Bank had specific reserves totaling $725,000 related to $4.0 million in impaired loans at December 31, 2010 compared to $2.0 million in specific reserves related to $10.9 million in impaired loans at March 31, 2010

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, 2010 AND 2009

Net Income - Net income available to common shareholders increased $25,000 or 7.8% to $344,000 for the three months ended December 31, 2010 compared to $320,000 for the three months ended December 31, 2009. The increase in net income is primarily the result of an increase in other income and a decrease in preferred stock dividends. These factors were offset slightly by a decrease in net interest income.

Net Interest Income - Net interest income decreased $834,000 or 11.1% to $6.7 million during the three months ended December 31, 2010, compared to $7.5 million for the same period in 2009, as a result of a decrease in interest income offset in part by a decrease in interest expense. The Company’s net interest margin decreased 16 basis points to 3.09% for the quarter ended December 31, 2010 from 3.25% for the same quarter in 2009. Average interest-earning assets decreased $59.4 million to $865.6 million at December 31, 2010 while average interest-bearing liabilities increased $387,000 to $863.6 million at December 31, 2010. The interest rate spread decreased 14 basis points to 2.97% during the three months ended December 31, 2010 compared to 3.11% for the same period in 2009.

Interest Income - Total interest income decreased $1.7 million or 13.8% to $10.6 million during the three months ended December 31, 2010 from $12.2 million for the same period in 2009. Total interest income on loans decreased $889,000 or 10.0% to $8.0 million during the three months ended December 31, 2010 compared to $8.9 million for the same period one year prior. The decrease was a result of a decrease in the average loan portfolio balance of $67.1 million offset slightly by the yield in the loan portfolio increasing eight basis points. Interest income from mortgage-backed securities decreased $823,000 or 29.5% to $2.0 million for the quarter ended December 31, 2010 from $2.8 million for the same quarter in 2009. This decrease was the result of a decrease in the average balance of $24.1 million combined with a decrease in the portfolio yield of 99 basis points. Interest income from investment securities increased $24,000 or 4.3% as a result of an increase in the average balance of the investment securities portfolio of $25.6 million offset by a decrease in the portfolio yield of 55 basis points.

The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the three months ended December 31, 2010 and 2009:

	Three Months Ended December 31,
	2010			2009
		Average Balance	Yield		Average Balance	Yield		Increase (Decrease) In Interest And Dividend Income From 2009
Loans Receivable, Net	$	528,369,487	6.06%	$	595,444,922	5.98%	$	(888,581)
Mortgage-Backed Securities		222,572,127	3.53		246,652,675	4.52		(822,573)
Investment Securities		107,929,680	2.15		82,351,288	2.70		23,838
Overnight Time Deposits		6,730,533	0.12		507,937	0.04		1,910
Total Interest-Earning Assets	$	865,601,827	4.88%	$	924,956,822	5.30%	$	(1,685,406)

Interest Expense - Total interest expense decreased $851,000 or 18.0% to $3.9 million during the three months ended December 31, 2010 compared to $4.7 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 $680,000 or 22.7% to $2.3 million during the period. The decrease was attributable to a 49 basis point decrease in the cost of deposits offset by an increase in average interest-bearing deposits of $25.7 million compared to the average balance in the three months ended December 31, 2009. 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 $253,000 or 15.5% as the cost of debt outstanding increased 87 basis points during the quarter ended December 31, 2010 compared to the same quarter in 2009. Average total borrowings outstanding decreased $80.4 million during the same period. Interest expense on senior convertible debentures was $122,000 for the quarter ended December 31, 2010 compared to $41,000 for the same quarter in 2009. These debentures were issued during the quarter ended December 31, 2009. Interest expense on junior subordinated debentures was $58,000 for the three months ended December 31, 2010 and 2009. 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, 2010 and 2009:

Security Federal Corporation and Subsidiaries

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

	Three Months Ended December 31,
	2010			2009
		Average Balance	Yield		Average Balance	Yield		Increase (Decrease) In Interest Expense From 2009
Now And Money Market Accounts	$	254,551,918	0.72%	$	229,575,608	1.11%	$	(177,785)
Statement Savings Accounts		19,265,588	0.27		17,302,147	0.44		(6,068)
Certificates Accounts		378,853,218	1.95		380,085,063	2.47		(495,935)
Advances And Other Borrowed Money		148,734,175	3.72		229,088,616	2.85		(252,685)
Convertible Senior Debentures		6,084,000	8.00		2,050,043	7.91		81,120
Junior Subordinated Debentures		5,155,000	4.54		5,155,000	4.53		20
Total Interest-Bearing Liabilities	$	812,643,899	1.91%	$	863,256,477	2.19%	$	(851,333)

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 shortened the loss period to 24 months 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 $1.9 million and $2.5 million during the three months ended December 31, 2010 and 2009, respectively. The following table details selected activity associated with the allowance for loan losses for the three months ended December 31, 2010 and 2009:

		December 31, 2010		December 31, 2009
Beginning Balance	$	11,528,220	$	12,723,921
Provision		1,900,000		2,475,000
Charge-offs		(1,041,439)		(1,238,686)
Recoveries		22,015		4,544
Ending Balance	$	12,408,796	$	13,964,779

Allowance For Loan Losses As A Percentage Of Gross Loans Receivable, Held For Investment At The End Of The Period		2.39%		2.33%
Allowance For Loan Losses As A Percentage Of Impaired Loans At The End Of The Period		32.77%		41.78%
Impaired Loans	$	37,867,994	$	33,426,994
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		4.44%		6.56%
Gross Loans Receivable, Held For Investment	$	518,431,733	$	598,411,891
Total Loans Receivable, Net	$	519,523,001	$	589,604,964

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 $725,000 at December 31, 2010 related to $4.0 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 $32.2 million in impaired loans.

Non-accrual loans and loans 90 days or more past due decreased $8.2 million to $23.0 million at December 31, 2010 compared to $31.2 million at March 31, 2010. At December 31, 2010, 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 $316,000 or 22.1% to $1.7 million for the three months ended December 31, 2010 from $1.4 million for the same period one year ago primarily as a result of an increase in gain on sale of investments and mortgage 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)
		2010		2009		Amounts	Percent
Gain On Sale Of Investments	$	492,975	$	300,976	$	191,999	63.8%
Gain On Sale Of Loans		334,713		215,080		119,633	55.6
Loss On Sale Of Repossessed Asssets Acquired In Settlement Of Loans		(35,580)		(3,742)		(31,838)	(850.8)
Service Fees On Deposit Accounts		289,810		347,164		(57,354)	(16.5)
Income From Cash Value Of Life Insurance		105,000		90,000		15,000	16.7
Commissions From Insurance Agency		92,619		94,544		(1,925)	(2.0)
Other Agency Income		91,742		108,302		(16,560)	(15.3)
Trust Income		109,500		105,000		4,500	4.3
Mandatorily Redeemable Financial Instrument Valuation		90,000		(65,000)		155,000	238.5
Other		173,603		236,120		(62,517)	(26.4)
Total Non-Interest Income	$	1,744,382	$	1,428,444	$	315,938	22.1%

Security Federal Corporation and Subsidiaries

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

Gain on sale of investments was $493,000 during the quarter ended December 31, 2010 compared to $301,000 in the same period one year earlier. 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 adjustable rates scheduled to reprice down in the near future.

Gain on sale of loans increased $120,000 to $335,000 during the three months ended December 31, 2010 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 decreased $57,000 to $290,000 for the quarter ended December 31, 2010 compared to the same quarter in 2009. Income from cash value of life insurance was $105,000 for the three months ended December 31, 2010 compared to $90,000 for the same period in 2009.

Commissions from insurance decreased $2,000 to $93,000 during the three months ended December 31, 2010 compared to the same period one year ago. Other agency income decreased $17,000 or 15.3% to $92,000 for the three months ended December 31, 2010 compared to $108,000 for the same period in the prior year. Trust income increased $5,000 or 4.3% to $109,500 during the three months ended December 31, 2010 compared to $105,000 during the same period in 2009.

Mandatorily redeemable financial instrument valuation was a gain of $90,000 for the three months ended December 31, 2010 compared to a loss of $65,000 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 valuation income to properly reflect the fair value of the instrument at December 31, 2010 based on the book value.

Other miscellaneous income including credit life insurance commissions, safe deposit rental income, annuity and stock brokerage commissions, trust fees, and other miscellaneous fees, decreased $63,000 to $174,000 during the three months ended December 31, 2010 compared to the same period one year ago.

General and Administrative Expenses – General and administrative expenses increased $330,000 or 6.0% to $5.8 million for the three months ended December 31, 2010 from $5.5 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)
		2010		2009		Amounts	Percent
Salaries And Employee Benefits	$	3,016,325	$	3,007,360	$	8,965	0.3%
Occupancy		439,374		497,423		(58,049)	(11.7)
Advertising		97,491		102,946		(5,455)	(5.3)
Depreciation And Maintenance Of Equipment		453,291		433,734		19,557	4.5
FDIC Insurance Premiums		366,000		366,000		-	-
Amortization of Intangibles		22,500		22,500		-	-
Other		1,443,441		1,078,312		365,129	33.9
Total General And Administrative Expenses	$	5,838,422	$	5,508,275	$	330,147	6.0%

Salary and employee benefits remained relatively unchanged at $3.0 million for the three months ended December 31, 2010, increasing only $9,000 or 0.3% when compared to the same period one year ago. Occupancy decreased 11.7% to $439,000 for the three months ended December 31, 2010 from $497,000 for the same period one year ago. Advertising expense decreased $5,000 to $97,000 for the three months ended December 31, 2010 from $103,000 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 $20,000 or 4.5% to $453,000 for the three months ended December 31, 2010 from $434,000 for the same period one year ago. Other expenses increased $365,000 to $1.4 million for the three month period ended December 31, 2010, an increase of 33.9% when compared to the same period in the prior year. Other expenses include legal fees, consultant fees, real estate owned expenses and expenses associated with loan collection and workout efforts. The primary reason for the increase in other expenses was an increase in real estate owned expenses and loan collection and workout efforts.

Provision For Income Taxes – Provision for income taxes decreased $166,000 or 41.9% to $229,000 for the three months ended December 31, 2010 from $395,000 for the same period one year ago. Income before income taxes was $684,000 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, 2010 compared to $957,000 for the three months ended December 31, 2009. The Company’s combined federal and state effective income tax rate for the current quarter was 33.6% compared to 41.3% 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, 2010 AND 2009

Net Income - For the nine months ended December 31, 2010, net income available to common shareholders increased $90,000 or 11.44% to $877,000 or $0.34 per common share (basic) compared to $787,000 or $0.32 per common share (basic) for the nine months ended December 31, 2009. The increase in earnings for the period is primarily a result of an increase in other income and a decrease in preferred stock dividends. These factors were offset slightly by a decrease in net interest income.

Net Interest Income. The net interest margin increased 15 basis points to 3.10% for the nine months ended December 31, 2010 compared to 2.95% for the comparable period in the previous year. Despite the increase in margin, net interest income decreased $134,000 or 0.66% to $20.31 million for the nine months ended December 31, 2010, compared to $20.45 million for the nine months ended December 31, 2009.

The decrease is a result of a decrease in interest income offset by a slight decrease in interest expense. Average interest-earning assets decreased $50.3 million to $874.1 million while average interest-bearing liabilities decreased $37.7 million to $825.8 million. The interest rate spread was 2.98% and 2.79% during the nine months ended December 31, 2010 and 2009, respectively.

Interest Income - Total interest income decreased $3.1 million or 8.7% to $32.9 million during the nine months ended December 31, 2010 from $36.1 million for the same period in 2009. Total interest income on loans decreased $1.4 million or 5.5% to $24.6 million during the nine months ended December 31, 2010 as a result of the average loan portfolio balance decreasing $58.3 million, offset by the portfolio yield increasing 26 basis points, as a result of stricter underwriting standards. Interest income from mortgage-backed securities decreased $1.8 million or 22.1% to $6.4 million as a result of a decrease in the average balance of the portfolio of $17.3 million combined with a 72 basis point decrease in the yield in the mortgage-backed portfolio. Interest income from investment securities increased $110,000 or 6.1% to $1.9 million as a result of an increase in the average balance offset by a 62 basis point decrease in the yield. The average balance of the investment securities portfolio increased $22.5 million to $96.3 million for the nine months ended December 31, 2010 from $73.8 million for the comparable period in 2009. Interest income on overnight time deposits increased $3,000 as a result of an increase 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, 2010 and 2009:

	Nine Months Ended December 31,
	2010					2009
	Average Balance		Yield			Average Balance		Yield			Increase (Decrease) In Interest And Dividend Income From 2009
Loans Receivable, Net	$	545,657,873		6.02	%	$	603,913,556		5.76	%	$	(1,446,965	)
Mortgage-Backed Securities		228,704,199		3.71			245,980,360		4.43			(1,807,188	)
Investments		96,285,864		2.67			73,796,185		3.29			110,359
Overnight Time Deposits		3,427,522		0.13			755,359		0.07			3,057
Total Interest-Earning Assets	$	874,075,458		5.02	%	$	924,445,460		5.20	%	$	(3,140,737	)

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 $3.0 million or 19.2% to $12.6 million during the nine months ended December 31, 2010 compared to $15.6 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, and a decrease in the amount of interest-bearing deposits and borrowings. Interest expense on deposits decreased $2.8 million or 26.8% during the period as average interest bearing deposits grew $31.9 million to $656.0 million compared to the average balance of $624.0 million for the nine months ended December 31, 2009, and the cost of deposits decreased 68 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 $529,000 or 10.6% to $4.4 million compared to $5.0 million for the same period in 2009 as the cost of debt outstanding increased 89 basis points during the nine months ended December 31, 2010 while average borrowings outstanding decreased $25.0 million.

Interest expense on senior convertible debentures was $365,000 for the nine months ended December 31, 2010 compared to $41,000 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 $176,000 for the nine months ended December 31, 2010 compared to $182,000 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, 2010 and 2009:

	Nine Months Ended December 31,
	2010					2009
	Average Balance		Yield			Average Balance		Yield			Increase (Decrease) In Interest Expense From 2009
Now And Money Market Accounts	$	247,884,852		0.88	%	$	223,134,518		1.17	%	$	(322,293	)
Statement Savings Accounts		19,220,447		0.32			17,329,303		0.45			(12,463	)
Certificates Accounts		388,807,686		2.05			383,526,603		2.93			(2,460,497	)
FHLB Advances, TAF Advances And Other Borrowed Money		158,690,300		3.73			233,703,084		2.84			(529,254	)
Senior Convertible Debentures		6,084,000		8.00			685,833		7.89			324,480
Junior Subordinated Debentures		5,155,000		4.56			5,155,000		4.72			(6,353	)
Total Interest-Bearing Liabilities	$	825,842,285		2.04	%	$	863,534,341		2.41	%	$	(3,006,380	)

Provision for Loan Losses – The provision for loan losses was $6.0 million for the nine months ended December 31, 2010 compared to $5.5 million for the same period in the prior year. The following table details selected activity associated with the allowance for loan losses for the nine months ended December 31, 2010 and 2009:

		December 31, 2010		December 31, 2009
Beginning Balance	$	12,307,394	$	10,181,599
Provision		5,950,000		5,475,000
Charge-offs		(5,916,333)		(1,718,860)
Recoveries		67,735		27,040
Ending Balance	$	12,408,796	$	13,964,779

Annualized net charge-offs as a percent of gross loans were 1.50% for the nine months ended December 31, 2010 compared to 1.04% for the year ended March 31, 2010 and 0.37% for the nine months ended December 31, 2009. The average balance of impaired loans was $38.1 million for the nine months ended December 31, 2010 compared to $33.2 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 $820,000 or 19.7% to $5.0 million for the nine months ended December 31, 2010 from $4.2 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)
		2010		2009		Amounts	Percent
Gain On Sale Of Investments	$	1,188,381	$	675,101	$	513,280	76.0%
Gain On Sale Of Loans		1,180,870		811,545		369,325	45.5
Loss On Sale Of Repossessed Asssets Acquired In Settlement Of Loans		(228,447)		(64,846)		(163,601)	(252.3)
Service Fees On Deposit Accounts		879,627		935,846		(56,219)	(6.0)
Income From Cash Value Of Life Insurance		305,000		270,000		35,000	13.0
Commissions From Insurance Agency		301,585		341,874		(40,289)	(11.8)
Other Agency Income		277,480		349,813		(72,333)	(20.7)
Trust Income		328,500		315,000		13,500	4.3
Mandatorily Redeemable Financial Instrument Valuation		5,000		(109,000)		114,000	104.6
Other		752,970		645,340		107,630	16.7
Total Non-Interest Income	$	4,990,966	$	4,170,673	$	820,293	19.7%

Gain on sale of investments was $1.2 million for the nine months ended December 31, 2010 compared to $675,000 in the comparable period in the prior year as a result of the sale of 47 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 50 securities in the same period in the prior year.

Gain on sale of loans increased $369,000 to $1.2 million during the nine months ended December 31, 2010 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 decreased $56,000 to $880,000 for the nine months ended December 31, 2010, compared to the same period in 2009. Commissions from insurance agency decreased $40,000 during the nine months ended December 31, 2010 compared to the same period one year ago. Other agency income decreased $72,000 or 20.7% to $277,000 for the nine months ended December 31, 2010 compared to $350,000 for the same period in 2009. Trust income increased to $329,000 during the nine months ended December 31, 2010 compared to $315,000 for the nine months ended December 21, 2009.

The Company recorded $5,000 in mandatorily redeemable financial instrument valuation income for the nine months ended December 31, 2010 compared to expense of $109,000 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 valuation income to properly reflect the fair value of the instrument at December 31, 2010 based on the book value.

Other miscellaneous income including credit life insurance commissions, safe deposit rental income, annuity and stock brokerage commissions, trust fees, and other miscellaneous fees, increased $108,000 to $753,000 during the nine months ended December 31, 2010 compared to the same period one year ago.

Security Federal Corporation and Subsidiaries

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

General and Administrative Expenses – General and administrative expenses increased $475,000 or 2.9% to $17.1 million for the nine months ended December 31, 2010 from $16.6 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)
		2010		2009		Amounts	Percent
Salaries And Employee Benefits	$	9,023,500	$	8,828,625	$	194,875	2.2%
Occupancy		1,443,340		1,490,587		(47,247)	3.2
Advertising		298,839		318,875		(20,036)	(6.3)
Depreciation And Maintenance Of Equipment		1,377,859		1,316,130		61,729	4.7
FDIC Insurance Premiums		994,048		1,473,000		(478,952)	(32.5)
Amortization of Intangibles		67,500		67,500		-	-
Other		3,845,001		3,080,447		764,554	24.8
Total General And Administrative Expenses	$	17,050,087	$	16,575,164	$	474,923	2.9%

Salary and employee benefits increased $195,000 to $9.0 million for the nine months ended December 31, 2010 from $8.8 million for 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.

Occupancy expense decreased slightly to $1.4 million for the nine month period ended December 31, 2010 compared to the same period one year ago. Depreciation and maintenance expense increased $62,000 or 4.7% to $1.4 million for the nine months ended December 31, 2010 from $1.3 million for the same period one year ago. Advertising expense decreased $20,000 to $299,000 for the nine months ended December 31, 2010 from $319,000 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 decreased $479,000 or 32.5% to $994,000 for the nine month period ended December 31, 2010 compared to the same period a year ago. The Company recorded $425,000 in additional FDIC insurance premiums during the nine month period ended December 31, 2009 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.

Other expenses increased $765,000 to $3.8 million for the nine month period ended December 31, 2010, an increase of 24.8% when compared to the same period in the prior year. Other expenses include legal fees, consultant fees, real estate owned expenses and expenses associated with loan collection and workout efforts.

Provision For Income Taxes – Provision for income taxes decreased $200,000 or 19.1% to $850,000 for the nine months ended December 31, 2010 compared to $1.0 million for the same period in 2009. Income before income taxes was $2.3 million for the nine months ended December 31, 2010 compared to $2.6 million for the nine months ended December 31, 2009. The Company’s combined federal and state effective income tax rate for the nine month ended December 31, 2010 was 36.9% compared to 40.9% for the same period one year earlier.

Security Federal Corporation and Subsidiaries

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

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, 2010, loan repayments exceeded loan disbursements resulting in a $48.9 million or 8.6% decrease in total net loans receivable. During the nine months ended December 31, 2010, deposits decreased $5.0 million, and FHLB advances decreased $26.1 million. The Bank had $146.2 million in additional borrowing capacity at the FHLB at the end of the period. At December 31, 2010, the Bank had $270.8 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.

As of December 31, 2010 and March 31, 2010, 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, 2010:

(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	$800	$1,060	$7,209	$9,069	$30,004	$39,073

Standby letters of credit	62	113	1,174	1,348	216	1,564

Total	$862	$1,173	$8,383	$10,417	$30,220	$40,637

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. 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 4. 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, 2010 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. There have been no significant changes in our internal controls over financial reporting during the fiscal quarter ended December 31, 2010 that have materially affected or are reasonably likely to affect our internal controls over financial reporting

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.

Security Federal Corporation and Subsidiaries

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.

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, 2010 except that the following risk factors are added to those previously contained in the Form 10-K:

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 nine months ended December 31, 2010, we recorded a provision for loan losses of $6.0 million compared to $5.5 million for the nine months ended December 31, 2009. We also recorded net loan charge-offs of $5.8 million for the nine months ended December 31, 2010 compared to $1.7 million for the nine months ended December 31, 2009. 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, 2010, our total non-performing assets were $38.0 million compared to $42.8 million at December 31, 2009. Further, our portfolio is concentrated in acquisition and development 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.

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 significant estimates of current credit risks and future trends, all of which may undergo material changes. 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.

Security Federal Corporation and Subsidiaries

Item 2 Unregistered sales of Equity Securities and Use Of Proceeds

None

Item 3 Defaults Upon Senior Securities

None

Item 4 [Removed and Reserved]

Item 5 Other Information

None

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.

Security Federal Corporation and Subsidiaries

(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 be signed on its behalf by the undersigned thereunto duly authorized.

			SECURITY FEDERAL CORPORATION



Date:	February 11, 2011	By:	/s/ Timothy W. Simmons
				Timothy W. Simmons
				President
				Duly Authorized Representative

Date:	February 11, 2011	By:	/s/ Roy G. Lindburg
				Roy G. Lindburg
				CFO
				Duly Authorized Representative