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SECURITY FEDERAL CORP - Quarter Report: 2013 March (Form 10-Q)


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 MARCH 31, 2013
( ) 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
(Exact name of registrant as specified in its charter)
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
X
 
NO
 

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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
 
 
NO
X
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
 
May 13, 2013
 
2,944,001





SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations


 
 
 
 
PART I.
FINANCIAL INFORMATION (UNAUDITED)
 
PAGE NO.
Item 1.
Financial Statements (Unaudited):
 
 
 
Consolidated Balance Sheets at March 31, 2013 and December 31, 2012
 
3
 
Consolidated Statements of Income for the Three Months Ended March 31, 2013 and 2012
 
4
 
Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended March 31, 2013 and 2012
 
5
 
Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2013 and 2012
 
6
 
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2013 and 2012
 
7
 
Notes to Consolidated Financial Statements
 
9
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
32
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
 
41
Item 4.
Controls and Procedures
 
41
 
 
 
 
PART II.
OTHER INFORMATION
 
 
Item 1.
Legal Proceedings
 
42
Item 1A.
Risk Factors
 
42
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
42
Item 3.
Defaults Upon Senior Securities
 
42
Item 4.
Mine Safety Disclosures
 
42
Item 5.
Other Information
 
42
Item 6.
Exhibits
 
42
 
Signatures
 
45
 
 
 
 

SCHEDULES OMITTED

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





SECURITY FEDERAL CORPORATION AND SUBSIDIARIES


Part 1. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets (Unaudited)
 
March 31, 2013
 
December 31, 2012
ASSETS:
 
 
 
Cash And Cash Equivalents
$
10,390,886

 
$
7,903,950

Certificates Of Deposit With Other Banks
1,729,015

 
1,728,567

Investment And Mortgage-Backed Securities:
 
 
 
Available For Sale:  (Amortized Cost Of $345,275,616 And $342,936,153 At March 31, 2013 And December 31, 2012, Respectively)
355,401,361

 
354,916,216

Held To Maturity:  (Fair Value Of $77,376,402 And $79,671,886 At March 31, 2013 And December 31, 2012, Respectively)
74,196,803

 
76,072,262

Total Investments And Mortgage-Backed Securities
429,598,164

 
430,988,478

Loans Receivable, Net:
 
 
 
Held For Sale
2,262,202

 
4,770,760

Held For Investment:  (Net Of Allowance Of $11,105,226 and $11,318,371 At March 31, 2013 And December 31, 2012, Respectively)
380,754,963

 
392,935,060

Total Loans Receivable, Net
383,017,165

 
397,705,820

Accrued Interest Receivable:
 
 
 
Loans
1,170,190

 
1,242,072

Mortgage-Backed Securities
817,368

 
901,423

Investment Securities
1,172,477

 
1,131,262

Total Accrued Interest Receivable
3,160,035

 
3,274,757

Premises And Equipment, Net
17,682,663

 
17,917,897

Federal Home Loan Bank ("FHLB") Stock, At Cost
5,223,294

 
6,178,700

Repossessed Assets Acquired In Settlement Of Loans
6,491,907

 
6,754,425

Bank Owned Life Insurance
11,240,305

 
11,151,305

Intangible Assets, Net
49,473

 
61,974

Goodwill
1,199,754

 
1,199,754

Other Assets
5,937,889

 
5,488,960

Total Assets
$
875,720,550

 
$
890,354,587

LIABILITIES AND SHAREHOLDERS’ EQUITY:
 
 
 
Liabilities:
 
 
 
Deposit Accounts
$
674,526,465

 
$
676,338,653

Advances From FHLB
93,152,933

 
105,257,182

Other Borrowings
9,406,169

 
9,317,244

Junior Subordinated Debentures
5,155,000

 
5,155,000

Advance Payments By Borrowers For Taxes And Insurance
362,865

 
189,424

Senior Convertible Debentures
6,084,000

 
6,084,000

Other Liabilities
5,276,559

 
5,420,600

Total Liabilities
793,963,991

 
807,762,103

Shareholders' Equity:
 
 
 
Serial Preferred Stock, $.01 Par Value; Authorized 200,000 Shares; Issued And Outstanding, 22,000 Shares At March 31, 2013 And December 31, 2012, Respectively
22,000,000

 
22,000,000

Common Stock, $.01 Par Value; Authorized 5,000,000 Shares; Issued 3,144,934 Shares At March 31, 2013 And At December 31, 2012
31,449

 
31,449

Warrant Issued In Conjunction With Serial Preferred Stock
400,000

 
400,000

Additional Paid-In Capital
11,618,628

 
11,630,717

Treasury Stock, At Cost (200,933 Shares At March 31, 2013 And December 31, 2012, Respectively)
(4,330,712
)
 
(4,330,712
)
Accumulated Other Comprehensive Income
6,281,625

 
7,431,310

Retained Earnings
45,755,569

 
45,429,720

Total Shareholders' Equity
81,756,559

 
82,592,484

Total Liabilities And Shareholders' Equity
$
875,720,550

 
$
890,354,587


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
Consolidated Statements of Income (Unaudited)
 
 
Three Months Ended March 31,
 
 
2013
 
2012
Interest Income:
 
 
 
 
Loans
 
$
5,584,886

 
$
6,591,610

Mortgage-Backed Securities
 
1,361,176

 
1,772,204

Investment Securities
 
755,871

 
586,977

Other
 
2,336

 
784

Total Interest Income
 
7,704,269

 
8,951,575

Interest Expense:
 
 
 
 
NOW And Money Market Accounts
 
232,088

 
357,973

Statement Savings Accounts
 
11,064

 
10,510

Certificate Accounts
 
739,875

 
1,123,178

FHLB Advances And Other Borrowed Money
 
983,105

 
1,171,487

Senior Convertible Debentures
 
121,680

 
121,680

Junior Subordinated Debentures
 
25,810

 
29,093

Total Interest Expense
 
2,113,622

 
2,813,921

Net Interest Income
 
5,590,647

 
6,137,654

Provision For Loan Losses
 
1,145,381

 
1,950,000

Net Interest Income After Provision For Loan Losses
 
4,445,266

 
4,187,654

Non-Interest Income:
 
 
 
 
Gain On Sale Of Investment Securities
 
384,051

 
534,960

Gain On Sale Of Loans
 
184,788

 
143,158

Service Fees On Deposit Accounts
 
263,831

 
277,264

Commissions From Insurance Agency
 
140,313

 
118,170

Trust Income
 
135,000

 
126,000

Bank Owned Life Insurance Income
 
105,000

 
105,000

Check Card Fee Income
 
195,193

 
198,323

Grant Income
 
416,000

 

Other
 
120,806

 
111,612

Total Non-Interest Income
 
1,944,982

 
1,614,487

General And Administrative Expenses:
 
 
 
 
Compensation And Employee Benefits
 
2,821,375

 
2,740,079

Occupancy
 
475,314

 
443,530

Advertising
 
107,643

 
77,307

Depreciation And Maintenance Of Equipment
 
439,172

 
428,726

Federal Deposit Insurance Corporation ("FDIC") Insurance Premiums
 
167,722

 
138,821

Amortization Of Intangibles
 
12,501

 
12,501

Net Cost Of Operation Of Other Real Estate Owned
 
396,369

 
411,704

Other
 
1,092,788

 
872,201

Total General And Administrative Expenses
 
5,512,884

 
5,124,869

Income Before Income Taxes
 
877,364

 
677,272

Provision For Income Taxes
 
205,995

 
247,325

Net Income
 
671,369

 
429,947

Preferred Stock Dividends
 
110,000

 
110,000

Net Income Available To Common Shareholders
 
$
561,369

 
$
319,947

Net Income Per Common Share (Basic)
 
$
0.19

 
$
0.11

Net Income Per Common Share (Diluted)
 
$
0.19

 
$
0.11

Cash Dividend Per Share On Common Stock
 
$
0.08

 
$
0.08

Weighted Average Shares Outstanding (Basic)
 
2,944,001

 
2,944,001

Weighted Average Shares Outstanding (Diluted)
 
2,944,001

 
2,944,001

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

3


SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

 
 
Three Months Ended March 31,
 
 
2013
 
2012
Net Income
 
$
671,369

 
$
429,947

Other Comprehensive Income (Loss)
 
 
 
 
Unrealized Gains (Losses) On Securities:
 
 
 
 
Unrealized Holding Gains (Losses) On Securities Available For Sale, Net Of Taxes Of $558,694 And $71,891 At March 31, 2013 And 2012, Respectively
 
(911,573
)
 
448,971

Reclassification Adjustment For Gains Included In Net Income, Net Of Taxes Of $145,939 And $203,285 At March 31, 2013 And 2012, Respectively
 
(238,112
)
 
(331,675
)
Other Comprehensive Income (Loss)
 
$
(1,149,685
)
 
$
117,296

Comprehensive Income (Loss)
 
$
(478,316
)
 
$
547,243


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.


4


SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity (Unaudited)
For the Three Months Ended March 31, 2013 and 2012

 
 
 
Preferred
 Stock
 
 
 
 
Warrants
 
 
 
Common
Stock
 
 
Additional
Paid – In
 Capital
 
 
 
Treasury
Stock
 
Accumulated
Other
 Comprehensive Income
 
 
 
Retained
Earnings
 
 
 
 
Total
Balance at December 31, 2011
$
22,000,000

 
$
400,000

 
$
31,449

 
$
11,617,964

 
$
(4,330,712
)
 
$
6,416,277

 
$
44,426,903

 
$
80,561,881

Net Income

 

 

 

 

 

 
429,947

 
429,947

Other Comprehensive Income, Net Of Tax

 

 

 

 

 
117,296

 

 
117,296

Stock Compensation Expense

 

 

 
8,281

 

 

 

 
8,281

Cash Dividends On  Preferred

 

 

 

 

 

 
(110,000
)
 
(110,000
)
Cash Dividends On Common

 

 

 

 

 

 
(235,519
)
 
(235,519
)
Balance at March 31, 2012
$
22,000,000

 
$
400,000

 
$
31,449

 
$
11,626,245

 
$
(4,330,712
)
 
$
6,533,573

 
$
44,511,331

 
$
80,771,886



 
 
 
Preferred
Stock
 
 
 
 
Warrants
 
 
 
Common
Stock
 
 
Additional
Paid – In
 Capital
 
 
 
Treasury
Stock
 
Accumulated Other Comprehensive Income
 
 
 
Retained
Earnings
 
 
 
 
Total
Balance at December 31, 2012
$
22,000,000

 
$
400,000

 
$
31,449

 
$
11,630,717

 
$
(4,330,712
)
 
$
7,431,310

 
$
45,429,720

 
$
82,592,484

Net Income

 

 

 

 

 

 
671,369

 
671,369

Other Comprehensive Income, Net Of Tax

 

 

 

 

 
(1,149,685
)
 

 
(1,149,685
)
Stock Compensation Expense

 

 

 
(12,089
)
 

 

 

 
(12,089
)
Cash Dividends On  Preferred

 

 

 

 

 

 
(110,000
)
 
(110,000
)
Cash Dividends On Common

 

 

 

 

 

 
(235,520
)
 
(235,520
)
Balance at March 31, 2013
$
22,000,000

 
$
400,000

 
$
31,449

 
$
11,618,628

 
$
(4,330,712
)
 
$
6,281,625

 
$
45,755,569

 
$
81,756,559


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

5


SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)
 
Three Months Ended March 31,
 
2013
 
2012
CASH FLOWS FROM OPERATING ACTIVITIES:
 

 
 

Net Income
$
671,369

 
$
429,947

Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities:
 

 
 

Depreciation Expense
342,063

 
372,692

Amortization Of Intangible Assets
12,501

 
12,501

Stock Option Compensation Expense
(12,089
)
 
8,281

Discount Accretion And Premium Amortization
1,889,488

 
1,720,153

Provisions For Losses On Loans
1,145,381

 
1,950,000

Income From Bank Owned Life Insurance
(105,000
)
 
(105,000
)
Gain On Sales Of Loans
(184,788
)
 
(143,158
)
Gain On Sales Of Mortgage-Backed Securities
(384,051
)
 
(209,362
)
Gain On Sales Of Investment Securities

 
(325,598
)
Loss On Sale Of Real Estate Owned
501

 
19,286

Write Down On Real Estate Owned
264,378

 
200,000

Amortization Of Deferred Fees On Loans
(3,369
)
 
(2,845
)
Proceeds From Sale Of Loans Held For Sale
9,596,054

 
10,842,803

Origination Of Loans Held For Sale
(6,902,708
)
 
(7,740,325
)
(Increase) Decrease In Accrued Interest Receivable:
 
 
 
Loans
71,882

 
125,079

Mortgage-Backed Securities
84,055

 
(22,344
)
Investment Securities
(41,215
)
 
245,526

Increase In Advance Payments By Borrowers
173,441

 
135,454

Other, Net
127,215

 
(1,030,572
)
Net Cash Provided By Operating Activities
6,745,108

 
6,482,518

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
  Purchase Of Mortgage-Backed Securities Available For Sale
(23,258,838
)
 
(25,255,315
)
  Principal Repayments On Mortgage-Backed Securities Available For Sale
15,733,179

 
12,648,907

  Purchase Of Mortgage-Backed Securities Held To Maturity

 
(4,334,682
)
  Principal Repayments On Mortgage-Backed Securities Held To Maturity
367,737

 
347,958

Purchase Of Investment Securities Available For Sale
(21,368,984
)
 
(25,944,399
)
Maturities Of Investment Securities Available For Sale
4,322,231

 
10,099,410

Purchase of Investment Securities Held To Maturity
(1,000,000
)
 
(8,540,310
)
Maturities Of Investment Securities Held To Maturity
2,288,499

 
3,240,074

  Proceeds From Sale of Investment Securities Available For Sale

 
6,151,868

  Proceeds From Sale of Mortgage-Backed Securities Available For Sale
20,946,735

 
7,352,190

Purchase Of FHLB Stock
(445,500
)
 

Redemption Of FHLB Stock
1,400,906

 

Decrease In Loans Receivable
8,759,426

 
11,176,834

Capital Improvements To Repossessed Assets

 
(36,877
)

6


SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

 
Three Months Ended March 31,
 
2013
 
2012
Proceeds From Sale Of Repossessed Assets
2,276,298

 
523,243

Purchase And Improvement Of Premises And Equipment
(106,829
)
 
(4,629
)
Net Cash Provided (Used) By Investing Activities
9,914,860

 
(12,575,728
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Increase (Decrease) In Deposit Accounts
(1,812,188
)
 
6,470,068

Proceeds From FHLB Advances
13,900,000

 
25,800,001

Repayment Of FHLB Advances
(26,004,249
)
 
(24,304,166
)
Repayments Of Other Borrowings, Net
88,925

 
6,654

Dividends To Preferred Stock Shareholders
(110,000
)
 
(110,000
)
Dividends To Common Stock Shareholders
(235,520
)
 
(235,519
)
Net Cash Provided (Used) By Financing Activities
(14,173,032
)
 
7,627,038

Net Increase In Cash And Cash Equivalents
2,486,936

 
1,533,828

Cash And Cash Equivalents At Beginning Of Period
7,903,950

 
7,797,544

Cash And Cash Equivalents At End Of Period
$
10,390,886

 
$
9,331,372

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
 
 
Cash Paid During The Period For:
 

 
 

Interest
$
2,096,095

 
$
2,737,060

Income Taxes
$
10,419

 
$
1,247,160

Supplemental Schedule Of Non Cash Transactions:
 

 
 

Transfers From Loans Receivable To Other Real Estate Owned
$
2,278,659

 
$
1,205,375

  Unrealized Gains (Losses) On Securities Available For Sale, Net Of
  Taxes
$
(911,573
)
 
$
448,971


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.


7



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements





1. Basis of Presentation

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.  Users of financial information produced for interim periods are encouraged to refer to the footnotes contained in the audited financial statements appearing in Security Federal Corporation’s (the “Company”) 2012 Annual Report to Shareholders which was filed as an exhibit to our Annual Report on Form 10-KT for the transitional nine months ended December 31, 2012 (“2012 10-KT”) when reviewing interim financial statements.  The Company changed its fiscal year from March 31 to December 31 effective January 17, 2013. The results of operations for the three month period ended March 31, 2013 are not necessarily indicative of the results that may be expected for the entire fiscal year.

2. Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Security Federal Bank (the “Bank”) and the Bank’s wholly owned subsidiaries, Security Federal Insurance, Inc. (“SFINS”) and Security Financial Services Corporation (“SFSC”). SFINS was formed during fiscal 2002 and began operating during the December 2001 quarter and 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 Security Federal Insurance Technologies, Inc. and Security Federal Premium Pay Plans Inc. (the “Collier Jennings Companies”). Security Federal Premium Pay Plans Inc. has one wholly owned premium finance subsidiary and also has an ownership interest in four other premium finance subsidiaries.

SFSC was formed in 1975 and was inactive for several years. During the quarter ended December 31, 2010, it was reactivated and utilized to hold and operate a repossessed hotel located in Hardeeville, South Carolina. Subsequently, in fiscal 2012 the hotel was sold and the subsidiary once again returned to inactive status.

The Company 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.  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.

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 December 31, 2012 included in our 2012 Annual Report to Shareholders.  Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities, and, as such, have a greater possibility of producing results that could be materially different than originally reported.  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.

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 impact of an unexpected and sudden large loss could deplete the allowance and potentially require increased provisions to replenish the allowance, which would negatively affect earnings. 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.

8



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



3. Critical Accounting Policies, Continued

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 our bank regulators, including the Board of Governors of the Federal Reserve System ("Federal Reserve"), the FDIC and the South Carolina Board of Financial Institutions, and may be subject to adjustments based upon the information that is available at the time of their examination. For additional information see the risk factor entitled: “Our provision for loan losses and net loan charge offs have remained at elevated levels 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-,” in Item 1A. Risk Factors of our 2012 Form 10-KT. 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.

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:
 
For the Three Months Ended March 31,
 
2013
 
2012
Earnings Available To Common Shareholders:
 
 
 
Net Income

$671,369

 

$429,947

Preferred Stock Dividends
110,000

 
110,000

Net Income Available To Common Shareholders

$561,369

 

$319,947


There were no dilutive securities or options at March 31, 2013 or 2012.    


9



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



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 stock option plans for the periods presented:

 
Three Months Ended March 31, 2013
 
Shares
 
Weighted Average Exercise Price
 
 
Balance, Beginning of Period
68,400

 
$22.63
Options Granted

 
Options Exercised

 
Options Forfeited

 
Balance, End Of Period
68,400

 
$22.63
 
 
 
 
Options Exercisable
46,600

 
 
 
 
 
 
Options Available For Grant
50,000

 
 

 
Three Months Ended March 31, 2012
 
Shares
 
Weighted Average Exercise Price
 
 
Balance, Beginning of Period
74,900

 
$22.61
Options Granted

 
Options Exercised

 
Options Forfeited
(2,000
)
 
22.02
Balance, End Of Period
72,900

 
$22.62
 
 
 
 
Options Exercisable
43,600

 
 
 
 
 
 
Options Available For Grant
50,000

 
 



10



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



5. Stock-Based Compensation, Continued

At March 31, 2013, 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
 
7,000
 
$21.43
 
03/08/14
 
 
 
 
 
 
 
06/07/04
 
2,000
 
$24.00
 
06/07/14
 
 
 
 
 
 
 
01/01/05
 
18,000
 
$20.55
 
12/31/14
 
 
 
 
 
 
 
01/01/06
 
4,000
 
$23.91
 
01/01/16
 
 
 
 
 
 
 
08/24/06
 
3,500
 
$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
 
14,000
 
$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

None of the options outstanding at March 31, 2013 or 2012 had an exercise price below the average market price during the three month periods ended March 31, 2013 or 2012. Therefore these options were not deemed to be dilutive to earnings per share in those periods.

6. Stock Warrants

In conjunction with its participation in the U.S. Department of the Treasury’s (“U.S. Treasury”) 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 March 31, 2013 and 2012, the warrant was not deemed to be dilutive. There were no changes in the Company’s stock warrant during the three month periods ended March 31, 2013 and 2012.


11



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



7. 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:
 
March 31, 2013
 
Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair value
FHLB Securities
$
8,983,672

 
$
48,214

 
$
18,189

 
$
9,013,697

Small Business Administration
   (“SBA”) Bonds
93,589,413

 
2,514,953

 
204,158

 
95,900,208

Tax Exempt Municipal Bonds
49,806,615

 
1,408,452

 
268,729

 
50,946,338

Mortgage-Backed Securities
192,792,978

 
6,799,757

 
145,367

 
199,447,368

Equity Securities
102,938

 

 
9,188

 
93,750

 
$
345,275,616

 
$
10,771,376

 
$
645,631

 
$
355,401,361

 
December 31, 2012
 
Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair value
FHLB Securities
$
6,115,036

 
$
53,954

 
$
4,320

 
$
6,164,670

SBA Bonds
94,152,203

 
2,466,354

 
156,287

 
96,462,270

Tax Exempt Municipal Bonds
35,772,115

 
1,770,567

 
60,534

 
37,482,148

Mortgage-Backed Securities
206,793,861

 
8,030,008

 
91,966

 
214,731,903

Equity Securities
102,938

 

 
27,713

 
75,225

 
$
342,936,153

 
$
12,320,883

 
$
340,820

 
$
354,916,216

FHLB securities, 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 and below 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 March 31, 2013 and December 31, 2012, the Bank held an amortized cost and fair value of $118.7 million and $123.5 million, respectively, and $135.3 million and $141.2 million, respectively, in GNMA mortgage-backed securities included in mortgage-backed securities listed above. All mortgage-backed securities above are either GSEs or GNMA mortgage-backed securities. The Company has not invested in any private label mortgage-backed securities.

The amortized cost and fair value of investment and mortgage-backed securities available for sale at March 31, 2013 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
15,540,739

 
15,932,338

Over Five – Ten Years
61,815,281

 
63,170,489

More Than Ten Years
75,126,618

 
76,851,166

Mortgage-Backed Securities
192,792,978

 
199,447,368

 
$
345,275,616

 
$
355,401,361



12



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



7. Investment and Mortgage-Backed Securities, Available For Sale, Continued

At March 31, 2013 and December 31, 2012, the amortized cost and fair value of investment and mortgage-backed securities available for sale pledged as collateral for certain deposit accounts, FHLB advances and other borrowings were $103.7 million and $108.7 million, respectively, and $108.9 million $114.4 million, respectively.

The Bank received $20.9 million and $13.5 million, respectively, in proceeds from sales of available for sale securities during the three months ended March 31, 2013 and 2012. As a result, the Bank recognized $384,000 and $535,000, respectively, in gross gains and no gross losses for the three months ended March 31, 2013 and 2012.

The following tables show 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 ate the dates indicated.
 
March 31, 2013
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
FHLB Securities
$
5,979,820

 
$
18,189

 
$

 
$

 
$
5,979,820

 
$
18,189

SBA Bonds
6,440,340

 
170,489

 
1,716,490

 
33,669

 
8,156,830

 
204,158

Tax Exempt Municipal Bond
16,952,240

 
268,729

 

 

 
16,952,240

 
268,729

Mortgage-Backed Securities
19,458,520

 
145,367

 

 

 
19,458,520

 
145,367

Equity Securities

 

 
93,750

 
9,188

 
93,750

 
9,188

 
$
48,830,920

 
$
602,774

 
$
1,810,240

 
$
42,857

 
$
50,641,160

 
$
645,631


 
December 31, 2012
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
FHLB Securities
$
995,680

 
$
4,320

 
$

 
$

 
$
995,680

 
$
4,320

SBA Bonds
4,583,177

 
119,825

 
1,833,076

 
36,462

 
6,416,253

 
156,287

Tax Exempt Municipal Bond
4,538,734

 
60,534

 

 

 
4,538,734

 
60,534

Mortgage-Backed Securities
16,259,037

 
91,966

 

 

 
16,259,037

 
91,966

Equity Securities

 

 
75,225

 
27,713

 
75,225

 
27,713

 
$
26,376,628

 
$
276,645

 
$
1,908,301

 
$
64,175

 
$
28,284,929

 
$
340,820


Securities classified as available-for-sale are recorded at fair market value.  At March 31, 2013 and December 31, 2012, 6.6% and 18.8% of the unrealized losses, respectively, or two individual securities, 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.

13



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



7. Investment and Mortgage-Backed Securities, Available For Sale, 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 we may recognize a portion in other comprehensive income. The fair value of investments on which OTTI is recognized then becomes the new cost basis of the investment.

8. 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:
 
March 31, 2013
 
 
 
Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
 
 
Fair Value
FHLB Securities
$
8,996,919

 
$
81,331

 
$
32,920

 
$
9,045,330

Federal Farm Credit Bank ("FFCB") Securities
5,775,661

 

 
8,963

 
5,766,698

Fannie Mae ("FNMA") And Freddie Mac ("FHLMC") Bonds
3,017,594

 
20,326

 
3,770

 
3,034,150

SBA Bonds
5,566,499

 
292,341

 
3,161

 
5,855,679

Mortgage-Backed Securities
50,685,130

 
2,963,974

 
129,559

 
53,519,545

Equity Securities
155,000

 

 

 
155,000

 
$
74,196,803

 
$
3,357,972

 
$
178,373

 
$
77,376,402


 
December 31, 2012
 
 
 
Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
 
 
Fair Value
FHLB Securities
$
7,996,378

 
$
123,702

 
$
21,160

 
$
8,098,920

FFCB Securities
6,796,255

 
2,070

 
23,727

 
6,774,598

FNMA and FHLMC Bonds
4,019,931

 
29,029

 
4,560

 
4,044,400

SBA Bonds
5,865,767

 
315,841

 
6,139

 
6,175,469

Mortgage-Backed Securities
51,238,931

 
3,280,100

 
95,532

 
54,423,499

Equity Securities
155,000

 

 

 
155,000

 
$
76,072,262

 
$
3,750,742

 
$
151,118

 
$
79,671,886


Included in the tables above and below in mortgage-backed securities are GNMA mortgage-backed securities, which are backed by the full faith and credit of the United States government.  At March 31, 2013 and December 31, 2012, the Bank held an amortized cost and fair value of $46.9 million and $49.7 million, respectively, and $47.2 million and $50.4 million, respectively, in GNMA mortgage-backed securities included in mortgage-backed securities listed above. All mortgage-backed securities above are either GSEs or GNMA mortgage-backed securities. The Company has not invested in any private label mortgage-backed securities.


14



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



8. Investment and Mortgage-Backed Securities, Held to Maturity, Continued

The amortized cost and fair value of investment and mortgage-backed securities held to maturity at March 31, 2013, 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
$
3,000,000

 
$
3,044,300

One – Five Years
158,720

 
165,813

Over Five – Ten Years
11,048,656

 
11,054,549

More Than Ten Years
9,304,297

 
9,592,195

Mortgage-Backed Securities
50,685,130

 
53,519,545

 
$
74,196,803

 
$
77,376,402


At March 31, 2013 and December 31, 2012, the amortized cost and fair value of investment and mortgage-backed securities held to maturity pledged as collateral for certain deposit accounts, FHLB advances and other borrowings were $13.8 million and $14.4 million, respectively, and $12.2 million and $12.8 million, respectively.

The following tables show 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 for the periods indicated.
 
March 31, 2013
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
FHLB Securities
$
1,967,080

 
$
32,920

 
$

 
$

 
$
1,967,080

 
$
32,920

FFCB Securities
5,766,697

 
8,963

 

 

 
5,766,697

 
8,963

FNMA And FHLMC Bonds
1,019,380

 
3,770

 

 

 
1,019,380

 
3,770

SBA Bonds
1,252,240

 
3,161

 

 

 
1,252,240

 
3,161

Mortgage-Backed Securities
7,526,437

 
129,559

 

 

 
7,526,437

 
129,559

 
$
17,531,834

 
$
178,373

 
$

 
$

 
$
17,531,834

 
$
178,373

 
December 31, 2012
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
FHLB Securities
$
1,978,840

 
$
21,160

 
$

 
$

 
$
1,978,840

 
$
21,160

FFCB Securities
5,772,528

 
23,727

 

 

 
5,772,528

 
23,727

FNMA And FHLMC Bonds
1,021,910

 
4,560

 

 

 
1,021,910

 
4,560

SBA Bonds
3,249,478

 
6,139

 

 

 
3,249,478

 
6,139

Mortgage-Backed Securities
7,659,461

 
95,532

 

 

 
7,659,461

 
95,532

 
$
19,682,217

 
$
151,118

 
$

 
$

 
$
19,682,217

 
$
151,118


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 three months ended March 31, 2013 and 2012.

15



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



9.    Loans Receivable, Net

Loans receivable, net, consisted of the following as of the dates shown:
 
March 31, 2013
 
December 31, 2012
Residential Real Estate Loans
$
90,039,701

 
$
90,677,625

Consumer Loans
54,944,279

 
56,595,093

Commercial Business
7,113,335

 
8,063,901

Commercial Real Estate
241,953,458

 
250,924,094

Total Loans Held For Investment
394,050,773

 
406,260,713

Loans Held For Sale
2,262,202

 
4,770,760

Total Loans Receivable, Gross
396,312,975

 
411,031,473

Less:
 
 
 
Allowance For Loan Losses
11,105,226

 
11,318,371

Loans In Process
2,188,137

 
2,002,595

Deferred Loan Fees
2,447

 
4,687

 
13,295,810

 
13,325,653

Total Loans Receivable, Net
$
383,017,165

 
$
397,705,820


Changes in the allowance for loan losses for the three months ended March 31, 2013 and 2012 are summarized as follows:
 
Three Months Ended March 31,
 
2013
 
2012
Balance At Beginning Of Period
$
11,318,371

 
$
14,261,374

Provision For Loan Losses
1,145,381

 
1,950,000

Charge Offs
(1,385,460
)
 
(1,617,510
)
Recoveries
26,934

 
21,334

Total Allowance For Loan Losses
$
11,105,226

 
$
14,615,198


The Company uses a risk based approach based on the following credit quality measures when analyzing the loan portfolio: pass, caution, 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 tables list the loan grades used by the Company as credit quality indicators and the balance in each category at the dates presented, excluding loans held for sale.
 
Credit Quality Measures
March 31, 2013
 
Pass
 
 
Caution
 
Special
Mention
 
 
Substandard
 
 
Total Loans
Residential Real Estate
$
82,024,814

 
$
489,538

 
$
291,660

 
$
7,233,689

 
$
90,039,701

Consumer
53,532,784

 
151,495

 
180,951

 
1,079,049

 
54,944,279

Commercial Business
5,714,074

 
244,999

 
583,401

 
570,861

 
7,113,335

Commercial Real Estate
156,432,330

 
37,623,987

 
13,684,717

 
34,212,424

 
241,953,458

Total
$
297,704,002

 
$
38,510,019

 
$
14,740,729

 
$
43,096,023

 
$
394,050,773


16



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



9.    Loans Receivable, Net, Continued

 
Credit Quality Measures
December 31, 2012
 
Pass
 
 
Caution
 
Special
Mention
 
 
Substandard
 
 
Total Loans
Residential Real Estate
$
82,565,630

 
$
222,046

 
$
293,079

 
$
7,596,870

 
$
90,677,625

Consumer
54,899,665

 
152,368

 
184,731

 
1,358,329

 
56,595,093

Commercial Business
7,256,607

 
151,521

 
514,253

 
141,520

 
8,063,901

Commercial Real Estate
162,570,021

 
32,049,447

 
17,417,778

 
38,886,848

 
250,924,094

Total
$
307,291,923

 
$
32,575,382

 
$
18,409,841

 
$
47,983,567

 
$
406,260,713


The following table presents an age analysis of past due balances by category at March 31, 2013.
 
 
30-59 Days
Past Due
 
 
60-89 Days
Past Due
 
90 Days or
More Past
Due
 
 
Total Past
Due
 
 
 
Current
 
 
Total Loans
Receivable
Residential
   Real Estate
$
1,519,094

 
$
134,425

 
$
3,442,273

 
$
5,095,792

 
$
84,943,909

 
$
90,039,701

Consumer
803,800

 
66,855

 
563,615

 
1,434,270

 
53,510,009

 
54,944,279

Commercial
   Business
23,801

 

 
32,559

 
56,360

 
7,056,975

 
7,113,335

Commercial
   Real Estate
5,113,535

 
3,393,772

 
10,717,862

 
19,225,169

 
222,728,289

 
241,953,458

Total
$
7,460,230

 
$
3,595,052

 
$
14,756,309

 
$
25,811,591

 
$
368,239,182

 
$
394,050,773


The following table presents an age analysis of past due balances by category at December 31, 2012.
 
 
30-59 Days
Past Due
 
 
60-89 Days
Past Due
 
90 Days or
More Past
Due
 
 
Total Past
Due
 
 
 
Current
 
 
Total Loans
Receivable
Residential
   Real Estate
$

 
$
1,794,644

 
$
3,757,801

 
$
5,552,445

 
$
85,125,180

 
$
90,677,625

Consumer
1,862,611

 
211,756

 
646,136

 
2,720,503

 
53,874,590

 
56,595,093

Commercial
   Business
445,113

 
36,079

 
86,991

 
568,183

 
7,495,718

 
8,063,901

Commercial
   Real Estate
2,432,423

 
4,852,227

 
13,913,190

 
21,197,840

 
229,726,254

 
250,924,094

Total
$
4,740,147

 
$
6,894,706

 
$
18,404,118

 
$
30,038,971

 
$
376,221,742

 
$
406,260,713


At March 31, 2013 and December 31, 2012, 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 March 31, 2013 compared to December 31, 2012.

17



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



9.    Loans Receivable, Net, Continued

 
At March 31, 2013
 
At December 31, 2012
 
$
 
%
 
Amount
 
Percent (1)
 
Amount
 
Percent (1)
 
Increase (Decrease)
 
Increase (Decrease)
Non-accrual Loans:
 
 
 
 
 
 
 
 
 
 
 
Residential Real Estate
$
3,442,273

 
0.9
%
 
$
3,757,801

 
0.9
%
 
$
(315,528
)
 
(8.4
)%
Commercial Business
32,559

 

 
86,991

 

 
(54,432
)
 
(62.6
)
Commercial Real Estate
10,717,862

 
2.7

 
13,913,190

 
3.4

 
(3,195,328
)
 
(23.0
)
Consumer
563,615

 
0.1

 
646,136

 
0.2

 
(82,521
)
 
(12.8
)
Total Non- accrual Loans
$
14,756,309

 
3.7
%
 
$
18,404,118

 
4.5
%
 
$
(3,647,809
)
 
(19.8
)%

(1) PERCENT OF GROSS LOANS RECEIVABLE, NET OF DEFERRED FEES AND LOANS IN PROCESS AND LOANS HELD FOR SALE. 
The following tables show the activity in the allowance for loan losses by category for the periods indicated.
 
 
For the Three Months Ended March 31, 2013
 
 
Residential
Real Estate
 
 
Consumer
 
Commercial
Business
 
Commercial
Real Estate
 
 
Total
Beginning Balance
 
$
1,521,559

 
$
1,001,271

 
$
618,919

 
$
8,176,622

 
$
11,318,371

Provision
 
99,571

 
(81,813
)
 
(77,066
)
 
1,204,689

 
1,145,381

Charge-Offs
 
(29,246
)
 
(19,576
)
 
(4,436
)
 
(1,332,202
)
 
(1,385,460
)
Recoveries
 

 
8,511

 
5,486

 
12,937

 
26,934

Ending Balance
 
$
1,591,884

 
$
908,393

 
$
542,903

 
$
8,062,046

 
$
11,105,226

 
 
For the Three Months Ended March 2012
 
 
Residential
Real Estate
 
 
Consumer
 
Commercial
Business
 
Commercial
Real Estate
 
 
Total
Beginning Balance
 
$
2,416,356

 
$
996,780

 
$
720,405

 
$
10,127,833

 
$
14,261,374

Provision
 
(222,048
)
 
1,542,300

 
(76,075
)
 
705,823

 
1,950,000

Charge-Offs
 
(265,683
)
 
(1,061,778
)
 

 
(290,049
)
 
(1,617,510
)
Recoveries
 

 
20,809

 
525

 

 
21,334

Ending Balance
 
$
1,928,625

 
$
1,498,111

 
$
644,855

 
$
10,543,607

 
$
14,615,198


The following tables present information related to impaired loans evaluated individually for impairment and collectively evaluated for impairment in the allowance for loan losses.
 
 
Allowance For Loan Losses
March 31, 2013
 
Individually Evaluated For
Impairment
 
Collectively Evaluated For
Impairment
 
 
Total
Residential Real Estate
 
$

 
$
1,591,884

 
$
1,591,884

Consumer
 

 
908,393

 
908,393

Commercial Business
 

 
542,903

 
542,903

Commercial Real Estate
 
563,075

 
7,498,971

 
8,062,046

Total
 
$
563,075

 
$
10,542,151

 
$
11,105,226


18



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



9.    Loans Receivable, Net, Continued
 
 
Allowance For Loan Losses
December 31, 2012
 
Individually Evaluated For
Impairment
 
Collectively Evaluated For
Impairment
 
 
Total
Residential Real Estate
 
$

 
$
1,521,559

 
$
1,521,559

Consumer
 

 
1,001,271

 
1,001,271

Commercial Business
 

 
618,919

 
618,919

Commercial Real Estate
 
440,000

 
7,736,622

 
8,176,622

Total
 
$
440,000

 
$
10,878,371

 
$
11,318,371


The following tables present information related to impaired loans evaluated individually for impairment and collectively evaluated for impairment in loans receivable for the periods indicated.
 
 
Loans Receivable
March 31, 2013
 
Individually Evaluated For
Impairment
 
Collectively Evaluated For
Impairment
 
 
Total
Residential Real Estate
 
$
4,265,092

 
$
85,774,609

 
$
90,039,701

Consumer
 
316,900

 
54,627,379

 
54,944,279

Commercial Business
 
32,559

 
7,080,776

 
7,113,335

Commercial Real Estate
 
33,379,159

 
208,574,299

 
241,953,458

Total
 
$
37,993,710

 
$
356,057,063

 
$
394,050,773

 
 
Loans Receivable
December 31, 2012
 
Individually Evaluated For
Impairment
 
Collectively Evaluated For
Impairment
 
 
Total
Residential Real Estate
 
$
4,500,902

 
$
86,176,723

 
$
90,677,625

Consumer
 
322,588

 
56,272,505

 
56,595,093

Commercial Business
 
7,853

 
8,056,048

 
8,063,901

Commercial Real Estate
 
35,115,195

 
215,808,899

 
250,924,094

Total
 
$
39,946,538

 
$
366,314,175

 
$
406,260,713


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. The average balance of impaired loans was $38.5 million for three months ended March 31, 2013 compared to $36.4 million for the three months ended March 31, 2012.



19



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



9.    Loans Receivable, Net, Continued

The following tables are a summary of information related to impaired loans as of and for the three months ended March 31, 2013 and 2012 and the nine months ended December 31, 2012.
 
 
 
 
At
 
 
 
For The Three Months Ended March 31,
 
 
March 31, 2013
 
2013
 
2012
Impaired Loans
 
Recorded
Investment
 
Unpaid
Principal
Balance
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With No Related Allowance
   Recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential Real Estate
 
$
4,265,092

 
$
4,376,063

 
$

 
$
4,289,656

 
$
10,686

 
$
1,933,259

 
$
59,319

Consumer Loans
 
316,900

 
380,900

 

 
318,396

 
1,445

 
2,470,969

 
7,083

Commercial Business
 
32,559

 
32,559

 

 
34,316

 

 
111,165

 

Commercial Real Estate
 
30,408,364

 
34,466,445

 

 
30,937,044

 
336,089

 
24,756,622

 
716,441

With An Allowance Recorded:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential Real Estate
 

 

 

 

 

 
1,301,687

 
6,137

Consumer Loans
 

 

 

 

 

 
9,784

 

Commercial Business
 

 

 

 

 

 
148,610

 
956

Commercial Real Estate
 
2,970,795

 
3,211,695

 
563,075

 
2,970,219

 
20,743

 
5,675,189

 
185,521

Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential Real Estate
 
4,265,092

 
4,376,063

 

 
4,289,656

 
10,686

 
3,234,946

 
65,456

Consumer Loans
 
316,900

 
380,900

 

 
318,396

 
1,445

 
2,480,753

 
7,083

Commercial Business
 
32,559

 
32,559

 

 
34,316

 

 
259,775

 
956

Commercial Real Estate
 
33,379,159

 
37,678,140

 
563,075

 
33,907,263

 
356,832

 
30,431,811

 
901,962

Total
 
$
37,993,710

 
$
42,467,662

 
$
563,075

 
$
38,549,631

 
$
368,963

 
$
36,407,285

 
$
975,457



20



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



9.    Loans Receivable, Net, Continued
 
 
December 31, 2012
Impaired Loans
 
Recorded
Investment
 
Unpaid
Principal
Balance
 
 
Related
Allowance
 
Average
Recorded
Investment
 
Interest
Income
Recognized
With No Related Allowance
   Recorded:
 
 
 
 
 
 
 
 
 
 
Residential Real Estate
 
$
4,500,902

 
$
4,611,873

 
$

 
$
4,531,543

 
$
130,896

Consumer Loans
 
322,588

 
386,588

 

 
342,916

 
28,419

Commercial Business
 
7,853

 
7,853

 

 
12,236

 

Commercial Real Estate
 
31,808,577

 
35,373,833

 

 
32,963,079

 
1,036,344

With An Allowance Recorded:
 
 
 
 
 
 
 
 
 
 
Residential Real Estate
 

 

 

 

 

Consumer Loans
 

 

 

 

 

Commercial Business
 

 

 

 

 

Commercial Real Estate
 
3,306,618

 
4,766,031

 
440,000

 
3,705,660

 

Total
 
 
 
 
 
 
 
 
 
 
Residential Real Estate
 
4,500,902

 
4,611,873

 

 
4,531,543

 
130,896

Consumer Loans
 
322,588

 
386,588

 

 
342,916

 
28,419

Commercial Business
 
7,853

 
7,853

 

 
12,236

 

Commercial Real Estate
 
35,115,195

 
40,139,864

 
440,000

 
36,668,739

 
1,036,344

Total
 
$
39,946,538

 
$
45,146,178

 
$
440,000

 
$
41,555,434

 
$
1,195,659



21



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



9.    Loans Receivable, Net, Continued

In the course of resolving delinquent loans, the Bank may choose to restructure the contractual terms of certain loans. A troubled debt restructuring ("TDR") is a restructuring in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a borrower that it would not otherwise consider (Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 310-40).  The concessions granted on TDRs generally include terms to reduce the interest rate, extend the term of the debt obligation, or modify the payment structure on the debt obligation. The Bank grants such concessions to reassess the borrower’s financial status and develop a plan for repayment.  TDRs included in impaired loans at March 31, 2013 and December 31, 2012 amounted to $13.9 million and $15.9 million, respectively.

Loans on nonaccrual status at the date of modification are initially classified as nonaccrual TDRs. Loans on accruing status at the date of concession are initially classified as accruing TDRs if the note is reasonably assured of repayment and performance is expected in accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the concession date if reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. Nonaccrual TDRs are returned to accruing status when there is economic substance to the restructuring, there is documented credit evaluation of the borrower's financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated sustained repayment performance in accordance with the modified terms for a reasonable period of time (generally a minimum of six months).

The following table is a summary of loans restructured as TDRs during the periods indicated:
 
 
For the Three Months Ended March 31, 2013
 
For the Three Months Ended
March 31, 2012
 
 
 
 
Troubled Debt
Restructurings
 
 
 
Number of
Contracts
 
Pre-
Modification
Outstanding
Recorded
Investment
 
Post-
Modification
Outstanding
Recorded
Investment
 
 
 
Number of
Contracts
 
Pre-
Modification
Outstanding
Recorded
Investment
 
Post-
Modification
Outstanding
Recorded
Investment
Residential Real Estate
 

 
$

 
$

 

 
$

 
$

Consumer Loans
 

 

 

 
1

 
15,358

 
15,358

Commercial Business
 

 

 

 

 

 

Commercial Real Estate
 
3

 
1,321,024

 
1,321,024

 
9

 
7,871,114

 
7,871,114

Total
 
3

 
$
1,321,024

 
$
1,321,024

 
10

 
$
7,886,472

 
$
7,886,472


During the three months ended March 31, 2013, the Bank modified three loans that were considered to be TDRs. The Bank lowered the interest rate on all three of these loans, extended the term on one loan and changed the payment terms on one loan. During the three months ended March 31, 2012, the Bank modified 10 loans that were considered to be TDRs. The modification for these loans consisted of lowering the interest rate. At March 31, 2013, all of the TDRs were current therefore no loans previously restructured within the last twelve months were in default. The Bank considers any loan 30 days or more past due to be in default. During the quarter ended March 31, 2012, six loans that had been previously restructured were in default. However, there were no loans restructured during the previous twelve months that subsequently defaulted during the quarter ended March 31, 2012.

Our policy with respect to accrual of interest on loans restructured in a TDR follows relevant supervisory guidance.  That is, if a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is likely.  If a borrower was materially delinquent on payments prior to the restructuring but shows capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual going forward.  Lastly, if the borrower does not perform under the restructured terms, the loan is placed on nonaccrual status.

We will continue to closely monitor these loans and will cease accruing interest on them if management believes that the borrowers may not continue performing based on the restructured note terms.  If, after previously being classified as a TDR, a loan is restructured a second time, then that loan is automatically placed on nonaccrual status.  Our policy with respect to nonperforming loans requires the borrower to make a minimum of six consecutive payments in accordance with the loan terms before that loan can be placed back on accrual status.  Further, the borrower must show capacity to continue performing into the future prior to restoration of accrual status.

22



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



10. Regulatory Matters

The Federal Reserve and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders' equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. The Bank is required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio.

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.  As of March 31, 2013 and December 31, 2012, the Bank was categorized as “well capitalized” under the regulatory framework for prompt corrective action.  The Company and the Bank’s regulatory capital amounts and ratios are as follows as of the dates indicated:
 
 
 
Actual
 
 
 
For Capital Adequacy
 
To Be Well Capitalized
Under Prompt Corrective
Action Provisions
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
(Dollars in Thousands)
March 31, 2013
 
 
 
 
 
 
 
 
 
 
 
SECURITY FEDERAL CORP.
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Risk-Based Core Capital
(To Risk Weighted Assets)
$
69,091

 
16.9
%
 
$
16,334

 
4.0
%
 
N/A
 
N/A
Total Risk-Based Capital
(To Risk Weighted Assets)
84,397

 
20.7
%
 
32,668

 
8.0
%
 
N/A
 
N/A
Tier 1 Leverage (Core) Capital
(To Adjusted Tangible Assets)
69,091

 
7.9
%
 
34,819

 
4.0
%
 
N/A
 
N/A
 
 
 
 
 
 
 
 
 
 
 
 
SECURITY FEDERAL BANK
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Risk-Based Core Capital
(To Risk Weighted Assets)
$
81,597

 
20.0
%
 
$
16,324

 
4.0
%
 
$
24,485

 
6.0
%
Total Risk-Based Capital
(To Risk Weighted Assets)
86,761

 
21.3
%
 
32,647

 
8.0
%
 
40,809

 
10.0
%
Tier 1 Leverage (Core) Capital
(To Adjusted Tangible Assets)
81,597

 
9.4
%
 
34,808

 
4.0
%
 
43,510

 
5.0
%
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
SECURITY FEDERAL CORP.
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Risk-Based Core Capital
(To Risk Weighted Assets)
$
68,639

 
16.5
%
 
$
16,619

 
4.0
%
 
 
N/A

 
 
N/A

Total Risk-Based Capital
(To Risk Weighted Assets)
84,148

 
20.3
%
 
33,237

 
8.0
%
 
 
N/A

 
 
N/A

Tier 1 Leverage (Core) Capital
(To Adjusted Tangible Assets)
68,639

 
7.7
%
 
35,552

 
4.0
%
 
 
N/A

 
 
N/A

 
 
 
 
 
 
 
 
 
 
 
 
SECURITY FEDERAL BANK
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Risk-Based Core Capital
(To Risk Weighted Assets)
$
80,822

 
19.5
%
 
$
16,606

 
4.0
%
 
$
24,909

 
6.0
%
Total Risk-Based Capital
(To Risk Weighted Assets)
86,012

 
20.7
%
 
33,212

 
8.0
%
 
41,515

 
10.0
%
Tier 1 Leverage (Core) Capital
(To Adjusted Tangible Assets)
80,822

 
9.1
%
 
35,541

 
4.0
%
 
44,426

 
5.0
%

23



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



11. Carrying Amounts and Fair Value of Financial Instruments

The Company has 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.

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.
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 March 31, 2013, the Company’s investment portfolio was comprised of government and agency bonds, mortgage-backed securities issued by government agencies or GSEs, municipal securities, and two equity investments. 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.

24



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



11. 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 sell, 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 March 31, 2013, 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. The Company records impaired loans as nonrecurring Level 3.

As of March 31, 2013 and December 31, 2012, the recorded investment in impaired loans was $38.0 million and $39.9 million, respectively.

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 3. 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.

Assets measured at fair value on a recurring basis are as follows as of March 31, 2013:
 
 
Assets:
Quoted Market Price
In Active Markets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
FHLB Securities
$

 
$
9,013,697

 
$

SBA Bonds

 
95,900,208

 

Tax Exempt Municipal Bonds

 
50,946,338

 

Mortgage-Backed Securities

 
199,447,368

 

Equity Securities

 
93,750

 

Total
$

 
$
355,401,361

 
$



25



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



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

Assets measured at fair value on a recurring basis are as follows as of December 31, 2012:
 
 
Assets:
 
Quoted Market Price
In Active Markets
(Level 1)
 
Significant Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
FHLB Securities
 
$

 
$
6,164,670

 
$

SBA Bonds
 

 
96,462,270

 

Tax Exempt Municipal Bonds
 

 
37,482,148

 

Mortgage-Backed Securities
 

 
214,731,903

 

Equity Securities
 

 
75,225

 

Total
 
$

 
$
354,916,216

 
$


There were no liabilities measured at fair value on a recurring basis as of March 31, 2013 or December 31, 2012.

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 March 31, 2013 and December 31, 2012, 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, 2013
Mortgage Loans Held For Sale
 
$

 
$
2,262,202

 
$

 
$
2,262,202

Collateral Dependent Impaired Loans (1)
 

 

 
37,430,635

 
37,430,635

Foreclosed Assets
 

 

 
6,491,907

 
6,491,907

Total
 
$

 
$
2,262,202

 
$
43,922,542

 
$
46,184,744


(1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF $563,075  
Assets:
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
Balance At
December 31, 2012
Mortgage Loans Held For Sale
 
$

 
$
4,770,760

 
$

 
$
4,770,760

Collateral Dependent Impaired Loans (1)
 

 

 
39,506,538

 
39,506,538

Foreclosed Assets
 

 

 
6,754,425

 
6,754,425

Total
 
$

 
$
4,770,760

 
$
46,260,963

 
$
51,031,723


(1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF $440,000  

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of March 31, 2013, the significant unobservable inputs used in the fair value measurements were as follows:
 
Fair Value
 
 
 
Significant
 
 
 
March 31,
 
Valuation
 
Unobservable
 
 
 
2013
  
Technique
 
Inputs
 
Range
Collateral Dependent Impaired Loans
$
37,430,635

 
Appraised Value
  
Discount Rates/ Discounts to Appraised Values
  
 
0% - 70%
Foreclosed Assets
6,491,907

 
Appraised Value/Comparable Sales
 
Discount Rates/ Discounts to Appraised Values
 
 
0% - 66%


26



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



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

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


27



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



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

The following tables are a summary of the carrying value and estimated fair value of the Company’s financial instruments as of March 31, 2013 and December 31, 2012 presented in accordance with the applicable accounting guidance.
 
March 31, 2013
 
Carrying
 
Fair Value
(In Thousands)
Amount
 
Total
 
Level 1
 
Level 2
 
Level 3
Financial Assets:
 
 
 
 
 
 
 
 
 
Cash And Cash Equivalents
$
10,391

 
$
10,391

 
$
10,391

 
$

 
$

Certificates of Deposits With Other Banks
1,729

 
1,729

 

 
1,729

 

Investment And Mortgage-Backed Securities
429,598

 
432,778

 

 
432,778

 

Loans Receivable, Net
383,017

 
387,152

 

 

 
387,152

FHLB Stock
5,223

 
5,223

 
5,223

 

 

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
 
 
  Checking, Savings, And Money Market
    Accounts
$
394,039

 
$
394,039

 
$
394,039

 
$

 
$

  Certificate Accounts
280,487

 
282,974

 

 
282,974

 

Advances From FHLB
93,153

 
100,915

 

 
100,915

 

Other Borrowed Money
9,406

 
9,406

 
9,406

 

 

Senior Convertible Debentures
5,155

 
5,155

 

 
5,155

 

Junior Subordinated Debentures
6,084

 
6,084

 

 
6,084

 


 
December 31, 2012
 
Carrying
 
Fair Value
(In Thousands)
Amount
 
Total
 
Level 1
 
Level 2
 
Level 3
Financial Assets:
 
 
 
 
 
 
 
 
 
Cash And Cash Equivalents
$
7,904

 
$
7,904

 
$
7,904

 
$

 
$

Certificates of Deposits With Other Banks
1,729

 
1,729

 

 
1,729

 

Investment And Mortgage-Backed Securities
430,988

 
434,588

 

 
434,588

 

Loans Receivable, Net
397,706

 
397,360

 

 

 
397,360

FHLB Stock
6,179

 
6,179

 
6,179

 

 

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
 
 
  Checking, Savings, And Money Market
    Accounts
$
383,534

 
$
383,534

 
$
383,534

 
$

 
$

  Certificate Accounts
292,804

 
295,734

 

 
295,734

 

Advances From FHLB
105,257

 
113,471

 

 
113,471

 

Other Borrowed Money
9,317

 
9,317

 
9,317

 

 

Senior Convertible Debentures
5,155

 
5,155

 

 
5,155

 

Junior Subordinated Debentures
6,084

 
6,084

 

 
6,084

 



28



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



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

At March 31, 2013, the Bank had $32.3 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.

12. Accounting and Reporting Changes

The following is a summary of recent authoritative pronouncements that could affect accounting, reporting, and disclosure of financial information by the Company:

On February 5, 2013, the FASB issued ASU No. 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The amendments in the Accounting Standards Update ("ASU" or "Update") do not change the current requirements for reporting net income or other comprehensive income in financial statements. All of the information that this Update requires already is required to be disclosed elsewhere in the financial statements under U.S. Generally Accepted Accounting Principles ("U.S. GAAP"). The new amendments will require an organization to:

Present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income-but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period.

Cross-reference to other disclosures currently required under U.S. GAAP for other reclassification items (that are not required under U.S. GAAP) to be reclassified directly to net income in their entirety in the same reporting period.

The amendments are effective prospectively for reporting periods beginning after December 15, 2012. Early adoption is permitted.

On July 27, 2012, the FASB issued an ASU No. 2012-02, Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment. Previous guidance required an entity to test indefinite-lived intangible assets for impairment, on at least an annual basis, by comparing the fair value of the asset with its carrying amount. If the carrying amount of the intangible asset exceeds its fair value, an entity should recognize an impairment loss in the amount of that excess. The amendments allow both public and nonpublic entities an option to first assess qualitative factors to determine whether it is necessary to perform the impairment test in a manner that is similar to the goodwill impairment testing guidance in Update 2011-08. Under the provisions of ASU No. 2012-02, an entity no longer would be required to calculate the fair value of the indefinite-lived intangible assets unless it determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount.

The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted, including for annual and interim impairment tests performed as of a date before July 27, 2012,

29



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



12. Accounting and Reporting Changes, Continued

if a public entity's financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance.

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

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 all events occurring through the date the financial statements were available to be issued and no subsequent events occurred requiring accrual or disclosure.
 

30



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations

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 the Company by the Federal Reserve, and our bank subsidiary by the FDIC and the South Carolina Board of Financial Institutions 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;
our ability to implement our business strategies
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 have acquired or 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 impact of new legislation, including the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Jumpstart Our Business Startups Act and the Basel III regulatory capital requirements and the implementing regulations;
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 FASB, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods;

31



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations

Future legislative changes and our ability to continue to comply with the requirements of the U.S. Department of Treasury’s Community Development Capital Initiative; and
other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in this document.

Some of these and other factors are discussed in the Company's 2012 Form 10-KT under Item 1A, “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 inaccurate as a result of our beliefs and assumptions we make in connection with the factors set forth above or because of other unidentified and unpredictable factors. 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 2013 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.

Financial Condition At March 31, 2013 and December 31, 2012

General – Total assets decreased $14.6 million or 1.6% to $875.7 million at March 31, 2013 from $890.4 million at December 31, 2012. The primary reason for the decrease in total assets was a decrease in net loans receivable and investment and mortgage backed securities.

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

 
 
 
 
 
 
 
 
Increase (Decrease)
 
 
March 31,
2013

 
 
December 31, 2012
 
 

Amount
 

Percent
Cash And Cash Equivalents
$
10,390,886

 
$
7,903,950

 
$
2,486,936

 
31.5%
Investment And Mortgage-
   Backed Securities –
   Available For Sale
 
355,401,361

 
 
354,916,216

 
 
485,145

 
0.1
Investment And Mortgage-
   Backed Securities – Held
   To Maturity
 
74,196,803

 
 
76,072,262

 
 
(1,875,459
)
 
(2.5)
Loans Receivable, Net
 
383,017,165

 
 
397,705,820

 
 
(14,688,655
)
 
(3.7)
Repossessed Assets
   Acquired In
   Settlement Of Loans
 
6,491,907

 
 
6,754,425

 
 
(262,518
)
 
(3.9)
FHLB Stock
 
5,223,294

 
 
6,178,700

 
 
(955,406
)
 
(15.5)

Cash and cash equivalents increased $2.5 million or 31.5% to $10.4 million at March 31, 2013 from $7.9 million at December 31, 2012.

Investment and mortgage-backed securities available for sale increased $485,000 or 0.1% to $355.4 million at March 31, 2013 from $354.9 million at December 31, 2012. This increase was the result of investment purchases offset slightly by principal repayments and calls on securities coupled with the sale of five securities during the three months ended March 31, 2013. Investment and mortgage-backed securities held to maturity decreased $1.9 million or 2.5% to $74.2 million at March 31, 2013 as a result of investment calls as well as principal repayments on mortgage-backed securities. There were no purchases of held to maturity securities during the three months ended March 31, 2013.

Loans receivable, net, decreased $14.7 million or 3.7% to $383.0 million at March 31, 2013 from $397.7 million at December 31, 2012. This decrease was a result of the Company’s efforts to tighten underwriting standards combined with overall lower loan demand from creditworthy borrowers. Residential real estate loans decreased $638,000 or 0.7% to $90.0 million at March 31, 2013 from $90.7 million at December 31, 2012. Consumer loans decreased $1.7 million or 2.9% to $54.9 million at March 31,

32



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations

2013 compared to $56.6 million at December 31, 2012. Commercial real estate loans and commercial business loans decreased $9.0 million and $951,000, respectively, to $242.0 million and $7.1 million, respectively, at March 31, 2013 from $250.9 million or 3.6% and $8.1 million or 11.8%, respectively, at December 31, 2012. Loans held for sale decreased $2.5 million or 52.6% to $2.3 million at March 31, 2013 from $4.8 million at December 31, 2012.

Repossessed assets acquired in settlement of loans decreased $263,000 or 3.9% to $6.5 million at March 31, 2013 from $6.8 million at December 31, 2012. At March 31, 2013, the balance of repossessed assets consisted of the following real estate properties: nine single-family residences and 15 lots within residential subdivisions located throughout our market area in South Carolina and Georgia; four parcels of land in South Carolina; one commercial building in South Carolina and one commercial building in Augusta, Georgia; a 21 lot subdivision development and adjacent 12 acres of land in Columbia, South Carolina; eight lots within a subdivision and adjacent 22.96 acres of land in Aiken, South Carolina; an 8 acre subdivision in Elgin, South Carolina; and 34.8 acres of land in Bluffton, South Carolina which was originally acquired as a participation loan from another financial institution.

FHLB stock decreased $955,000 or 15.5% to $5.2 million at March 31, 2013 compared to $6.2 million at December 31, 2012. The Bank, as a member of the FHLB of Atlanta, is required to acquire and hold shares of capital stock in the FHLB of Atlanta in an amount equal to a membership component, which is 0.15% of total assets plus a transaction component which equals 4.5% of outstanding advances (borrowings) from the FHLB of Atlanta. As total assets and total advances have decreased, so has the Bank’s required investment in FHLB stock.

Liabilities
Deposit Accounts – The balances, weighted average rates and increases and decreases in deposit accounts were as follows :
 
 
 
 
 
 
Balance
 
 
March 31, 2013
 
December 31, 2012
 
Increase (Decrease)
 
 

Balance
 
Weighted Rate
 

Balance
 
Weighted Rate
 

Amount
 

Percent
Demand Accounts:
 
 
 
 
 
 
 
 
 
 
 
 
Checking
$
131,701,992

 
0.06%
$
126,740,707

 
0.06%
$
4,961,285

 
3.91%
Money Market
 
238,216,286

 
0.38
 
234,382,412

 
0.38
 
3,833,874

 
1.64%
Statement Savings
   Accounts
 
24,120,858

 
0.20
 
22,411,240

 
0.20
 
1,709,618

 
7.63%
Total
 
394,039,136

 
0.26
 
383,534,359

 
0.26
 
10,504,777

 
2.74%
 
 
 
 
 
 
 
 
 
 
 
 
 
Certificate Accounts
 
 
 
 
 
 
 
 
 
 
 
 
0.00 – 1.99%
 
244,551,066

 
 
 
255,422,955

 
 
 
(10,871,889)

 
(4.26)%
2.00 – 2.99%
 
32,122,202

 
 
 
32,975,486

 
 
 
(853,284)

 
(2.59)%
3.00 – 3.99%
 
2,032,301

 
 
 
2,380,728

 
 
 
(348,427)

 
(14.64)%
4.00 – 4.99%
 
1,274,056

 
 
 
1,523,474

 
 
 
(249,418)

 
(16.37)%
5.00 – 5.99%
 
507,704

 
 
 
501,651

 
 
 
6,053

 
1.21%
Total
 
280,487,329

 
1.02
 
292,804,294

 
1.11
 
(12,316,965)

 
(4.21)%
Total Deposits
$
674,526,465

 
0.58%
$
676,338,653

 
0.63%
$
(1,812,188)

 
(0.27)%

Included in the certificates above were $20.1 million and $22.6 million in brokered deposits at March 31, 2013 and December 31, 2012, respectively, with a weighted average interest rate of 1.31% and 1.47%, respectively.


33



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations

Advances From FHLB – FHLB advances are summarized by contractual year of maturity and weighted average interest rate in the table below:
 
 
 
 
 
 
Balance
 
 
March 31, 2013
 
December 31, 2012
 
Decrease
Fiscal Year Due:
 
Balance
Rate
 
Balance
Rate
 
Balance
 
Percent
2013
$
10,000,000
3.53%
$
22,100,000
2.92%
$
(12,100,000)

 
(54.75)%
2014
 
30,252,933
3.33
 
30,257,182
3.33%
 
(4,249)

 
(0.01)
2015
 
15,000,000
4.01
 
15,000,000
4.01%
 

 
2016
 
20,000,000
4.60
 
20,000,000
4.60%
 

 
2017
 
12,900,000
4.38
 
12,900,000
4.38%
 

 
Thereafter
 
5,000,000
3.39
 
5,000,000
3.39%
 

 
Total Advances
$
93,152,933
3.89%
$
105,257,182
3.72%
$
(12,104,249)

 
(11.50)%

These advances are secured by a blanket collateral agreement with the FHLB by pledging the Bank’s portfolio of residential first mortgage loans and investment securities with an amortized cost and fair value of $124.3 million and $119.0 million at March 31, 2013 and $135.7 million and $129.4 million at December 31, 2012, respectively. 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, reborrow funds on different terms, or convert the advance to a three-month floating rate advance tied to LIBOR.
As of March 31, 2013
Borrow Date
 
Maturity Date
 
Amount
 
Int. Rate
 
Type
 
Call Dates
11/23/05
 
11/23/15
$
5,000,000
 
3.933
%
 
Multi-Call
 
5/23/08 and quarterly thereafter
07/11/06
 
07/11/16
 
5,000,000
 
4.800

 
Multi-Call
 
7/11/08 and quarterly thereafter
11/29/06
 
11/29/16
 
5,000,000
 
4.025

 
Multi-Call
 
5/29/08 and quarterly thereafter
05/24/07
 
05/24/17
 
7,900,000
 
4.375

 
Multi-Call
 
5/27/08 and quarterly thereafter
07/25/07
 
07/25/17
 
5,000,000
 
4.396

 
Multi-Call
 
7/25/08 and quarterly thereafter


Other Borrowings – The Bank had $9.4 million and $9.3 million in other borrowings (non-FHLB advances) at March 31, 2013 and December 31, 2012, 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 March 31, 2013 and December 31, 2012, the interest rate paid on the repurchase agreements was 0.20%. The Bank had pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $14.3 million and $15.2 million, respectively, at March 31, 2013 and $15.4 million and $16.3 million, respectively, at December 31, 2012.

Junior Subordinated Debentures – On September 21, 2006, the Trust (Security Federal Statutory Trust), issued and sold fixed and floating rate capital securities of the Trust (the “Capital Securities”). The Trust used the net proceeds from the sale of the Capital Securities to purchase a like amount of junior subordinated debentures (the “Debentures”) of the Company which are reported on the Consolidated Balance Sheets as junior subordinated debentures, generating proceeds of $5.0 million. The Company used the proceeds for general corporate purposes, primarily to provide capital to the Bank. The debentures qualify as Tier 1 capital under Federal Reserve guidelines. The Debentures are the sole assets of the Trust. The Company’s obligations under the Debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the Trust.

The Capital Securities accrue and pay distributions annually at a rate per annum equal to 1.98% at March 31, 2013. Prior to September 2011, one-half of the Capital Securities issued in the transaction had a fixed rate of 6.88% and the remaining half had a floating rate of three-month LIBOR plus 170 basis points. After September 2011, the rate is a floating rate of three month LIBOR plus 170 basis points as the fixed rate portion was converted to the floating rate. The distribution rate payable on the Capital Securities is cumulative and payable quarterly in arrears.

34



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations


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.

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 and commenced on 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 are 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.

Equity – Shareholders’ equity decreased $836,000 or 1.0% to $81.8 million at March 31, 2013 from $82.6 million at December 31, 2012. Accumulated other comprehensive income, net of tax decreased $1.1 million or 15.5% to $6.3 million at March 31, 2013. The Company’s net income available for common shareholders was $561,000 for the three months ended March 31, 2013, after payment of $110,000 in preferred stock dividends.

The Board of Directors of the Company declared common stock dividends totaling $236,000 during the three months ended March 31, 2013. Book value per common share was $20.16 at March 31, 2013 and $20.45 at December 31, 2012.

Results of Operations for the Three Month Periods Ended March 31, 2013 and 2012

Net Income Available to Common Shareholders - Net income available to common shareholders increased $241,000 or 75.5% to $561,000 for the three months ended March 31, 2013 compared to $320,000 for the three months ended March 31, 2012. The increase in net income was primarily the result of an $805,000 decrease in the provision for loan losses offset by a $547,000 decrease in net interest income.

Net Interest Income - The net interest margin decreased 13 basis points to 2.79% for the three months ended March 31, 2013 from 2.92% for the comparable period in 2012. The significant decrease in the volume of interest earning assets, particularly loans, resulted in a decrease in net interest income. Net interest income decreased $547,000 or 8.9% to $5.6 million during the three months ended March 31, 2013, compared to $6.1 million for the same period in 2012. During the three months ended March 31, 2013, average interest earning assets decreased $30.8 million or 3.6% to $816.3 million while average interest-bearing liabilities decreased $46.2 million or 5.8% to $745.1 million.
Interest Income - Total interest income decreased $1.2 million or 13.9% to $7.7 million during the three months ended March 31, 2013 from $9.0 million for the same period in 2012. This decrease is primarily the result of the decrease in interest-earning assets. Total interest income on loans decreased $1.0 million or 15.3% to $5.6 million during the three months ended March 31, 2013 as a result of the average loan portfolio balance decreasing $45.2 million or 10.3% to $393.3 million and the yield on the loan portfolio decreasing 33 basis points to 5.68%. Interest income from mortgage-backed securities decreased $411,000 or 23.2% to $1.4 million as a result of a 47 basis point decrease in the portfolio yield combined with a $18.6 million decrease in the average balance. Tax equivalent interest income from investment securities increased $214,000 or 33.4% to $857,000 as a result of an increase of 16 basis points in the yield combined with an increase of $31.4 million in the average balance of the investment securities portfolio.

35



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations


The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the three months ended March 31, 2013 and 2012:
 
Three Months Ended March 31,
 
 
2013
 
2012
 
 
 
 
 
 



Average Balance
 




Yield(1)
 
 



Average Balance
 




Yield(1)
 
 
Increase (Decrease) In Interest And Dividend Income From 2012
 
Loans Receivable, Net
$
393,269,063
 
5.68
%
 
$
438,454,079

 
6.01
%
 
$
(1,006,724)

 
Mortgage-Backed Securities
 
246,038,565
 
2.21

 
 
264,643,210

 
2.68

 
 
(411,028)

 
Investment Securities(2)
 
168,598,396
 
2.03

 
 
137,231,976

 
1.87

 
 
214,421

 
Overnight Time And
   Certificates of Deposit
 
8,407,959
 
0.11

 
 
6,782,618

 
0.05

 
 
1,552

 
Total Interest-Earning Assets
$
816,313,983
 
3.82
%
 
$
847,111,883

 
4.25
%
 
$
(1,201,779)

 
(1) Annualized
(2) Tax equivalent basis is calculated using an effective tax rate of 34% and amounted to $101,113 and $55,586 for the quarters
ended March 31, 2013 and 2012, respectively.

Interest Expense - Total interest expense decreased $700,000 or 24.9% to $2.1 million during the three months ended March 31, 2013 compared to $2.8 million for the same period last year. The decrease in total interest expense is attributable to decreases in interest rates paid and a $46.2 million decrease in the average balance of interest-bearing liabilities. Interest expense on deposits decreased $509,000 or 34.1% to $983,000 during the three months ended March 31, 2013 compared to $1.5 million for the same period last year. The decrease was attributable to a 29 basis point decrease in the cost of deposit accounts combined with a decrease in average interest-bearing deposits of $30.0 million when compared to the three month period ended March 31, 2012. The decreases were primarily concentrated in the certificate accounts, which decreased $4.3 million during the three months ended March 31, 2013 compared to the same period in 2012. Interest expense on advances and other borrowings decreased $188,000 or 16.1% to $983,000 during the three months ended March 31, 2013. The average balance of FHLB advances and other borrowed money decreased $16.2 million or 12.6% to $112.5 million during the three months ended March 31, 2013 from $128.7 million for the same period last year, directly reflecting the decrease in interest earning assets.

The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the three months ended March 31, 2013 and 2012:
 
Three Months Ended March 31,
 
2013
 
2012
 
 
 
 



Average Balance
 




Yield(1)
 
 



Average Balance
 




Yield(1)
 
Increase (Decrease) In Interest Expense From 2012
Now And Money Market
   Accounts

$
315,696,505

 
0.29
%
 

$
303,792,026

 
0.47
%

$
(125,885
)
Statement Savings Accounts
 
22,967,552

 
0.19
 
 
21,078,296

 
0.20

 
554

Certificates Accounts
 
282,670,827

 
1.05
 
 
326,453,338

 
1.38

 
(383,303
)
FHLB Advances And
   Other Borrowed Money
 
112,490,450

 
3.50
 
 
128,721,056

 
3.64

 
(188,382
)
Junior Subordinated Debentures
 
5,155,000

 
2.00
 
 
5,155,000

 
2.26

 
(3,283
)
Senior Convertible Debentures
 
6,084,000

 
8.00
 
 
6,084,000

 
8.00

 

Total Interest-Bearing Liabilities
$
745,064,334

 
1.13
%
 
$
791,283,716

 
1.42
%
$
(700,299
)
(1) Annualized

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

36



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations

monitoring the overall credit quality of the loan portfolio and for timely identification of potential problem loans including internal and external loan reviews. The adequacy of the allowance for loan losses is reviewed monthly by the Asset Classification Committee and quarterly by the Board of Directors.

Management’s monthly review of the adequacy of the allowance includes three main components. The first component is an analysis of loss potential in various homogenous segments of the portfolio based on historical trends and the risk inherent in each category. Previously, management applied a five year historical loss ratio to each loan category to estimate the inherent loss in these pooled loans. However, as a result of the decline in economic conditions and the unprecedented increases in delinquencies and charge offs experienced by the industry in recent periods, the Company no longer considers five year historical losses relevant indicators of future losses. Management began applying 12 to 24 month historical loss ratios to each loan category in recent quarters to more accurately project losses in the near future.

The second component of management’s monthly analysis is the specific review and evaluation of significant problem credits identified through the Company’s internal monitoring system. These loans are evaluated for impairment and recorded in accordance with accounting guidance. For each loan deemed impaired, 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.

The provision for loan losses was $1.1 million for the quarter ended March 31, 2013 compared to $2.0 million for the same quarter in the prior year. The following table details selected activity associated with the allowance for loan losses for the three months ended March 31, 2013 and 2012:

 
 
Three Months Ended March 31,
 
 
2013
 
2012
Beginning Balance
$
11,318,371

$
14,261,374

Provision
 
1,145,381

 
1,950,000

Charge-offs
 
(1,385,460)

 
(1,617,510)

Recoveries
 
26,934

 
21,334

Ending Balance
$
11,105,226

$
14,615,198

 
 
 
 
 
Allowance For Loan Losses As A Percentage Of Gross Loans Receivable, Held For Investment At The End Of The Period
 
2.8
%
 
3.3
%
Allowance For Loan Losses As A Percentage Of Impaired Loans At
  The End Of The Period
 
29.2
%
 
35.8
%
Impaired Loans
$
37,993,710

$
40,797,186

Gross Loans Receivable, Held For Investment And Held For Sale
$
396,312,975

$
445,035,160

Total Loans Receivable, Net
$
383,017,165

$
428,510,606


The cumulative interest not accrued during the three months ended March 31, 2013 relating to all non-performing loans totaled$210,000. 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.


37



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations

Non-Interest Income - Non-interest income increased $330,495 or 20.5% to $1.9 million for the three months ended March 31, 2013, compared to $1.6 million for the three months ended March 31, 2012. The following table provides a detailed analysis of the changes in the components of non-interest income:

 
Three Months Ended March 31,
 
Increase (Decrease)
 
 
2013
 
 
2012
 
 
Amounts
 
 
Percent
Gain On Sale Of Investments
$
384,051

 
$
534,960

 
$
(150,909)

 
 
(28.2)%
Gain On Sale Of Loans
 
184,788

 
 
143,158

 
 
41,630

 
 
29.1
Service Fees On Deposit Accounts
 
263,831

 
 
277,264

 
 
(13,433
)
 
 
(4.8)
Income From Cash Value Of
   Life Insurance
 
140,313

 
 
118,170

 
 
22,143

 
 
18.7
Commissions From Insurance Agency
 
135,000

 
 
126,000

 
 
9,000

 
 
7.1
Trust Income
 
105,000

 
 
105,000

 
 

 
 
Check Card Fee Income
 
195,193

 
 
198,323

 
 
(3,130
)
 
 
(1.6)
Grant Income
 
416,000

 
 

 
 
416,000

 
 
100.0
Other
 
120,806

 
 
111,612

 
 
9,194

 
 
8.2
Total Non-Interest Income
$
1,944,982

 
$
1,614,487

 
$
330,495

 
 
20.5%

Gain on sale of investments was $384,000 during the quarter ended March 31, 2013 a decrease of $151,000 or 28.2% compared to $535,000 during the same period last year. The gain resulted from the sale of five investments during the period. 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 re-price down in the near future. The Company sold 13 securities during the same quarter of last year.

Gain on sale of loans increased $42,000 or 29.1% to $185,000 during the three months ended March 31, 2012 compared to $143,000 for the same period last year. Grant income increased $416,000 or 100.0% during the three months ended March 31, 2013 primarily due to an award the Bank received in recognition of its commitment to community development. The Company did not recognize any grant income during the three months ended March 31, 2012. Other income increased $9,000 or 8.2% to 121,000 during the three months ended March 31, 2013 compared to 112,000 during the same period in 2012.

General And Administrative Expenses –For the quarter ended March 31, 2013, non-interest expense increased $388,000 or 7.6% to $5.5 million compared to $5.1 million for the same period in 2012. The increase in non-interest expense is primarily a result of an increase in other expenses of $221,000 during the three months ended March 31, 2013. The increase was primarily the result of a prepayment penalty of $153,000 the Company incurred for paying down FHLB advances during the three months ended March 31, 2013. The following table provides a detailed analysis of the changes in the components of general and administrative expenses:
 
Three Months Ended March 31,
 
Increase (Decrease)
 
 
2013
 
 
2012
 
 
Amounts
 
 
Percent
Salaries And Employee Benefits
$
2,821,375

 
$
2,740,079

 
$
81,296

 
 
2.97%
Occupancy
 
475,314

 
 
443,530

 
 
31,784

 
 
7.2
Advertising
 
107,643

 
 
77,307

 
 
30,336

 
 
39.2
Depreciation And Maintenance
   Of Equipment
 
439,172

 
 
428,726

 
 
10,446

 
 
2.4
FDIC Insurance Premiums
 
167,722

 
 
138,821

 
 
28,901

 
 
20.8
Amortization of Intangibles
 
12,501

 
 
12,501

 
 

 
 
Net Cost Of Operation Of Other Real
   Estate Owned
 
396,369

 
 
411,704

 
 
(15,335
)
 
 
(3.7)
Other
 
1,092,788

 
 
872,201

 
 
220,587

 
 
25.3
Total General And Administrative
   Expenses

$
5,512,884

 

$
5,124,869

 

$
388,015

 
 
7.6%

Salary and employee benefits costs remained relatively constant at $2.8 million for the three months ended March 31, 2013, increasing $81,000 or 3.0% from $2.7 million during the same period last year.

38



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations


Occupancy expense increased $32,000 or 7.2 to $475,000 for the three months ended March 31, 2013 from $444,000 for the same period one year ago while depreciation and maintenance of equipment costs increased $10,000 or 2.4% to $439,000 for the three months ended March 31, 2013 from $429,000 for the same period in 2012. Advertising expense increased $30,000 or 39.2% to $108,000 for the three months ended March 31, 2013 from $77,000 for the same period one year ago.

FDIC insurance premiums increased $29,000 or 20.8% to $168,000 for the three months ended March 31, 2013 compared to $139,000 for the same period a year ago. Net cost of operation of other real estate owned decreased $15,000 or 3.7% to $396,000 during the quarter ended March 31, 2013 from $412,000 during the quarter ended March 31, 2012. Net cost of operation of other real estate includes any gain or loss on the sale of other real estate owned and all other expenses related to these properties incurred during the period.

Other expenses increased $221,000 to $1.1 million for the three month period ended March 31, 2013, an increase of 25.3% compared to the same period in the prior year. The increase was primarily the result of a prepayment penalty of $153,000 the Company incurred for paying down FHLB advances during the three months ended March 31, 2013. As part of the Company's strategy, management elected to replace some higher rate advances with lower rate callable certificates of deposit. Other expenses also include legal, professional, and consulting expenses, stationary and office supplies and other miscellaneous expenses.

Provision For Income Taxes – The provision for income taxes decreased $41,000 or 16.7% to $206,000 for the three months ended March 31, 2013 from $247,000 for the same period one year ago. Income before income taxes was $877,000 and $677,000 for the three months ended March 31, 2013 and 2012, respectively. The Company’s combined federal and state effective income tax rate for the current quarter was 23.5% compared to 36.5% for the same quarter one year ago. The decrease in the effective income tax rate is the result of a decrease in the state income tax rate. On December 28, 2011, Security Federal Bank completed a charter conversion from a federally chartered stock savings bank to a South Carolina chartered commercial bank. As a result of this transaction, the Company is subject to a lower state income tax rate and therefore expects to experience lower income tax expense in future periods.

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. 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 three months ended March 31, 2013 loan repayments exceeded loan disbursements resulting in a $14.7 million or 3.7% decrease in total net loans receivable. During the three months ended March 31, 2013, deposits decreased $1.8 million and FHLB advances decreased $12.1 million. The Bank had $173.9 million in additional borrowing capacity at the FHLB at the end of the period. At March 31, 2013, the Bank had $173.5 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 on maturity.

At March 31, 2013, the Bank was categorized as “well capitalized” under the regulatory framework for prompt corrective action with total risk based, Tier 1 risk based and Tier 1 leverage ratios of 21.3%, 20.0% and 9.4%, respectively. To be categorized as “well capitalized” the Bank must maintain minimum total risk based, Tier 1 risk based and Tier 1 leverage ratios of 10%, 6% and 5%, respectively. There are no current conditions or events that management believes would change the Company’s or the Bank’s category.

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

39



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations

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. Collateral is not required to support commitments.

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at March 31, 2013.




(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
$
347

 
$
376

 
$
3,011

 
$
3,734

 
$
26,400

 
$
30,134

Standby Letters Of Credit

 
840

 
1,309

 
2,149

 

 
2,149

Total
$
347

 
$
1,216

 
$
4,320

 
$
5,883

 
$
26,400

 
$
32,283


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.

For the three months ended March 31, 2013, the Bank's interest rate spread, defined as the average yield on interest bearing assets less the average rate paid on interest bearing liabilities was 2.69%.

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 March 31, 2013 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 March 31, 2013 that have materially affected or are reasonably likely to affect our internal controls over financial reporting


40


SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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.
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-KT for the year ended December 31, 2012.

Item 2    Unregistered Sales of Equity Securities and Use Of Proceeds

None

Item 3    Defaults Upon Senior Securities
None

Item 4    Mine Safety Disclosures

Not applicable

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 B (2)
3.3    Amended and Restated Bylaws (3)
4.1    Form of Stock Certificate of the Company and other instruments defining the rights of security holders,
including indentures (4)
4.2    Form of Stock Certificate for the Series B Preferred Shares (2)
4.3    Warrant to purchase shares of the Company’s common stock dated December 19, 2008 (5)
4.4    Form of Indenture with respect to the Company’s 8.0% Convertible Senior Debentures Due
2029 (6)
4.5    Specimen Convertible Senior Debenture Due 2029 (6)
4.6
Letter Agreement dated September 29, 2010 between Security Federal Corporation and the United States Department of the Treasury, including the Exchange Agreement – Standard Terms, with respect to the

41


SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

exchange of the Series A Fixed Rate Cumulative Perpetual Preferred Stock for the Series B Fixed Rate Cumulative Perpetual Preferred Stock (2)
4.7
Letter Agreement dated September 29, 2010 between Security Federal Corporation and the United States Department of the Treasury, including the Securities Purchase Agreement – Standard Terms, with respect to the purchase of the Series B Fixed Rate Cumulative Perpetual Preferred Stock (2)
10.1    1993 Salary Continuation Agreements (7)
10.2    Amendment One to 1993 Salary Continuation Agreements (8)
10.3    Form of 2006 Salary Continuation Agreement (9)
10.4    1999 Stock Option Plan (10)
10.5    2002 Stock Option Plan (11)
10.6    2006 Stock Option Plan (12)
10.7    2008 Equity Incentive Plan (13)
10.8    Form of incentive stock option agreement and non-qualified stock option agreement pursuant to the 2006 Stock Option Plan (12)
10.9    2004 Employee Stock Purchase Plan (14)
10.10    Incentive Compensation Plan (7)
10.11    Form of Security Federal Bank Salary Continuation Agreement (9)
10.12    Form of Security Federal Split Dollar Agreement (9)
10.13    Form of Compensation Modification Agreement (5)
14    Code of Ethics (15)
25    Form T-1; Statement Eligibility of Trustee (6)
31.1    Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2    Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32    Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
101
The following materials from Security Federal Corporation’s Quarterly Report on Form 10-Q for the quarter     ended March 31, 2013, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated
Balance     Sheets;     (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income (Loss); (d) Consolidated Statements of Changes in Shareholders’Equity and Comprehensive Income; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements (16)
_____________
(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 Company’s Current Report on Form 8-K filed on September 30, 2010.
    
(3)    Incorporated by reference to the Company’s Current Report on Form 8-K filed on December 19, 2011.
(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)
Incorporated by reference to the Company’s Current Report on Form 8-K filed on December 23, 2008.
(6)    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.
(7)    Filed on June 28, 1993, as an exhibit to the Company’s Annual Report on Form 10-KSB and incorporated herein by reference.
(8)    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.
(9)    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.
(10)    Filed on March 2, 2000, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference
(11)    Filed on January 3, 2003, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference.
(12)    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.
(13)    Filed on November 12, 2008, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference.

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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

(14)
Filed on June 18, 2004, as an exhibit to the Company’s Proxy Statement and incorporated herein by reference.
(15)    Filed on June 29, 2006, as an exhibit to the Company’s Annual Report on Form 10-K and incorporated herein by reference.
(16)    Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a                 registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section
        18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those             sections.





43



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes To Consolidated Financial Statements



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:
May 14, 2013
 
By:
/s/J. Chris Verenes
 
J. Chris Verenes
 
President & Chief Executive Officer
 
Duly Authorized Representative

Date:
May 14, 2013
 
By:
/s/Roy G. Lindburg
 
Roy G. Lindburg
 
Chief Financial Officer
 
Duly Authorized Representative









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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

EXHIBIT INDEX

31.1
Certifications of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2
Certifications of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32
Certifications of the Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
101
The following materials from Security Federal Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2013, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income; (d) Consolidated Statements of Changes in Shareholders’Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements




45