SECURITY FEDERAL CORP - Quarter Report: 2014 September (Form 10-Q)

OUTSTANDING SHARES AT:

Common Stock, par value $0.01 per share

November 12, 2014

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 SEPTEMBER 30, 2014

( ) 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.




PART I.	FINANCIAL INFORMATION (UNAUDITED)	PAGE NO.
Item 1.	Financial Statements:	3
	Consolidated Balance Sheets at September 30, 2014 (Unaudited) and December 31, 2013	3
	Consolidated Statements of Income (Unaudited) for the Three and Nine Months Ended September 30, 2014 and 2013	4
	Consolidated Statements of Comprehensive Income (Loss) (Unaudited) for the Three and Nine Months Ended September 30, 2014 and 2013	5
	Consolidated Statements of Changes in Shareholders’ Equity (Unaudited) for the Nine Months Ended September 30, 2014 and 2013	6
	Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2014 and 2013	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	46
Item 4.	Controls and Procedures	47

PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	47
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults Upon Senior Securities	47
Item 4.	Mine Safety Disclosures	47
Item 5.	Other Information	47
Item 6.	Exhibits	47
	Signatures	50

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



	September 30, 2014			December 31, 2013
ASSETS:
Cash And Cash Equivalents	$	8,210,921		$	7,629,771
Certificates Of Deposit With Other Banks	2,095,000			2,100,395
Investment And Mortgage-Backed Securities:
Available For Sale (Amortized Cost Of $421,262,865 And $430,241,854 At September 30, 2014 And December 31, 2013, Respectively)	428,819,911			431,003,452
Loans Receivable, Net:
Held For Sale	2,057,504			1,234,158
Held For Investment (Net Of Allowance Of $8,646,974 And $10,241,970 At September 30, 2014 And December 31, 2013, Respectively)	342,057,363			357,682,507
Total Loans Receivable, Net	344,114,867			358,916,665
Accrued Interest Receivable:
Loans	985,215			1,031,747
Mortgage-Backed Securities	720,806			732,100
Investment Securities	1,425,548			1,393,156
Total Accrued Interest Receivable	3,131,569			3,157,003
Premises And Equipment, Net	18,377,829			17,243,390
Federal Home Loan Bank ("FHLB") Stock, At Cost	3,851,600			5,016,600
Repossessed Assets Acquired In Settlement Of Loans	3,859,424			3,947,226
Bank Owned Life Insurance	11,075,045			11,474,305
Intangible Assets, Net	—			11,970
Goodwill	1,199,754			1,199,754
Other Assets	4,139,647			7,547,528
Total Assets	$	828,875,567		$	849,248,059
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Liabilities:
Deposit Accounts	$	646,463,924		$	658,696,772
Advances From FHLB	68,320,000			87,740,058
Other Borrowings	10,781,356			8,002,739
Junior Subordinated Debentures	5,155,000			5,155,000
Advance Payments By Borrowers For Taxes And Insurance	578,614			255,364
Senior Convertible Debentures	6,084,000			6,084,000
Other Liabilities	5,822,307			5,324,046
Total Liabilities	743,205,201			771,257,979
Shareholders' Equity:
Serial Preferred Stock, $.01 Par Value; Authorized 200,000 Shares; Issued And Outstanding, 22,000 Shares At September 30, 2014 And December 31, 2013, Respectively	22,000,000			22,000,000
Common Stock, $.01 Par Value; Authorized 5,000,000 Shares; Issued 3,144,934 Shares At September 30, 2014 And December 31, 2013, Respectively	31,449			31,449
Additional Paid-In Capital	11,987,644			11,978,137
Treasury Stock, At Cost (200,933 Shares At September 30, 2014 And December 31, 2013, Respectively)	(4,330,712		)	(4,330,712		)
Accumulated Other Comprehensive Income	4,689,769			472,406
Retained Earnings	51,292,216			47,838,800
Total Shareholders' Equity	85,670,366			77,990,080
Total Liabilities And Shareholders' Equity	$	828,875,567		$	849,248,059

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)



	Three Months Ended September 30,					Nine Months Ended September 30,
	2014			2013		2014		2013
Interest Income:
Loans	$	4,852,458		$	5,375,962	$	14,636,508	$	16,485,033
Mortgage-Backed Securities	1,538,902			1,360,586		4,568,036		3,943,033
Investment Securities	995,233			966,936		3,006,439		2,655,352
Other	2,345			2,219		8,370		6,262
Total Interest Income	7,388,938			7,705,703		22,219,353		23,089,680
Interest Expense:
NOW And Money Market Accounts	125,749			186,183		435,482		630,239
Statement Savings Accounts	6,821			6,932		19,537		27,720
Certificate Accounts	488,300			601,056		1,497,402		2,015,069
FHLB Advances And Other Borrowed Money	617,271			854,292		2,049,563		2,753,183
Senior Convertible Debentures	121,680			121,680		365,040		365,040
Junior Subordinated Debentures	25,441			25,952		75,643		77,549
Total Interest Expense	1,385,262			1,796,095		4,442,667		5,868,800
Net Interest Income	6,003,676			5,909,608		17,776,686		17,220,880
Provision For Loan Losses	—			600,000		200,000		2,645,381
Net Interest Income After Provision For Loan Losses	6,003,676			5,309,608		17,576,686		14,575,499
Non-Interest Income:
Gain On Sale Of Investment Securities	142,816			419,360		187,687		1,173,140
Gain On Sale Of Loans	119,041			227,332		465,571		622,960
Service Fees On Deposit Accounts	300,920			303,350		861,476		845,444
Commissions From Insurance Agency	116,894			103,330		317,757		348,292
Trust Income	158,000			135,000		404,000		405,000
Bank Owned Life Insurance Income	75,000			78,000		479,364		261,000
Check Card Fee Income	229,542			222,252		674,098		640,374
Community Development Financial Institution ("CDFI") Financial Award Income	183,789			97,000		483,499		733,071
Other	160,304			152,467		481,191		396,695
Total Non-Interest Income	1,486,306			1,738,091		4,354,643		5,425,976
Non-Interest Expense:
Compensation And Employee Benefits	2,781,418			2,677,608		8,464,967		8,267,433
Occupancy	515,881			484,857		1,491,633		1,447,835
Advertising	115,268			79,130		358,527		256,861
Depreciation And Maintenance Of Equipment	408,685			412,020		1,219,461		1,220,952
Federal Deposit Insurance Corporation ("FDIC") Insurance Premiums	177,537			191,535		541,779		555,733
Amortization Of Intangibles	—			12,501		11,970		37,503
Net (Profit) Cost Of Operation Of Other Real Estate Owned	(71,623		)	506,174		451,947		1,243,935
Prepayment Penalties On FHLB Advances	—			191,181		—		429,523
Other	1,095,710			1,109,892		3,125,894		3,109,619
Total General And Administrative Expenses	5,022,876			5,664,898		15,666,178		16,569,394
Income Before Income Taxes	2,467,106			1,382,801		6,265,151		3,432,081
Provision For Income Taxes	756,466			360,970		1,775,175		860,319
Net Income	1,710,640			1,021,831		4,489,976		2,571,762
Preferred Stock Dividends	110,000			110,000		330,000		330,000
Net Income Available To Common Shareholders	$	1,600,640		$	911,831	$	4,159,976	$	2,241,762
Net Income Per Common Share (Basic)	$	0.54		$	0.31	$	1.41	$	0.76
Net Income Per Common Share (Diluted)	$	0.52		$	0.31	$	1.35	$	0.76
Cash Dividend Per Share On Common Stock	$	0.08		$	0.08	$	0.24	$	0.24
Weighted Average Shares Outstanding (Basic)	2,944,001			2,944,001		2,944,001		2,944,001
Weighted Average Shares Outstanding (Diluted)	3,248,201			2,944,001		3,248,201		2,944,001

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)



	Three Months Ended September 30,
	2014			2013
Net Income	$	1,710,640		$	1,021,831
Other Comprehensive Loss
Unrealized Gains On Securities:
Unrealized Holding Losses On Securities Available For Sale, Net Of Taxes Of $67,172 And $752,070 At September 30, 2014 And 2013, Respectively	(111,155		)	(1,230,443		)
Reclassification Adjustment For Gains Included In Net Income, Net Of Taxes Of $54,270 And $159,357 At September 30, 2014 And 2013, Respectively	(88,546		)	(260,003		)
Other Comprehensive Loss	(199,701		)	(1,490,446		)
Comprehensive Income (Loss)	$	1,510,939		$	(468,615	)



	Nine Months Ended September 30,
	2014			2013
Net Income	$	4,489,976		$	2,571,762
Other Comprehensive Income (Loss)
Unrealized Gains (Losses) On Securities:
Unrealized Holding Gains (Losses) On Securities Available For Sale, Net Of Taxes Of $2,649,406 And $4,113,767 At September 30, 2014 And 2013, Respectively	4,333,729			(6,720,796		)
Reclassification Adjustment For Gains Included In Net Income, Net Of Taxes Of $71,321 And $445,793 At September 30, 2014 And 2013, Respectively	(116,366		)	(727,347		)
Held To Maturity Transfer To Available For Sale, Net Of Taxes of $0 and $530,733 at September 30, 2014 and 2013, Respectively	—			865,933
Other Comprehensive Income (Loss)	4,217,363			(6,582,210		)
Comprehensive Income (Loss)	$	8,707,339		$	(4,010,448	)

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity (Unaudited)

For the Nine Months Ended September 30, 2014 and 2013



	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	—		—			—		—			—			—			2,571,762			2,571,762
Other Comprehensive Loss, Net Of Tax	—		—			—		—			—			(6,582,210		)	—			(6,582,210		)
Stock Option Compensation Expense	—		—			—		(5,749		)	—			—			—			(5,749		)
Redemption Of Warrant Issued In Conjunction With Serial Preferred Stock	—		(400,000		)	—		350,000			—			—			—			(50,000		)
Cash Dividends On Preferred	—		—			—		—			—			—			(330,000		)	(330,000		)
Cash Dividends On Common	—		—			—		—			—			—			(706,549		)	(706,549		)
Balance at September 30, 2013	$	22,000,000	$	—		$	31,449	$	11,974,968		$	(4,330,712	)	$	849,100		$	46,964,933		$	77,489,738



	Preferred Stock		Common Stock		Additional Paid – In Capital		Treasury Stock			Accumulated Other Comprehensive Income		Retained Earnings			Total
Balance at December 31, 2013	$	22,000,000	$	31,449	$	11,978,137	$	(4,330,712	)	$	472,406	$	47,838,800		$	77,990,080
Net Income	—		—		—		—			—		4,489,976			4,489,976
Other Comprehensive Income, Net Of Tax	—		—		—		—			4,217,363		—			4,217,363
Stock Option Compensation Expense	—		—		9,507		—			—		—			9,507
Cash Dividends On Preferred	—		—		—		—			—		(330,000		)	(330,000		)
Cash Dividends On Common	—		—		—		—			—		(706,560		)	(706,560		)
Balance at September 30, 2014	$	22,000,000	$	31,449	$	11,987,644	$	(4,330,712	)	$	4,689,769	$	51,292,216		$	85,670,366

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)



	Nine Months Ended September 30,
	2014			2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	4,489,976		$	2,571,762
Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities:
Depreciation Expense	891,142			947,448
Amortization Of Intangible Assets	11,970			37,503
Stock Option Compensation (Benefit) Expense	9,507			(5,749		)
Discount Accretion And Premium Amortization	3,922,542			5,485,576
Provisions For Losses On Loans	200,000			2,645,381
Income Accrued On Bank Owned Life Insurance	(225,000		)	(261,000		)
Gain On Sales Of Loans	(465,571		)	(622,960		)
Gain On Sales Of Mortgage-Backed Securities	(451,751		)	(791,003		)
(Gain) Loss On Sales Of Investment Securities	264,064			(382,137		)
Gain On Sale Of Real Estate Owned	(193,403		)	(80,001		)
Write Down On Real Estate Owned	405,000			1,124,378
Amortization Of Net Deferred Costs (Fees) On Loans	12,775			(3,255		)
Gain On Disposition Of Premises And Equipment	—			431
Proceeds From Sale Of Loans Held For Sale	16,877,096			27,252,344
Origination Of Loans Held For Sale	(17,234,871		)	(23,244,549		)
(Increase) Decrease In Accrued Interest Receivable:
Loans	46,532			17,586
Mortgage-Backed Securities	11,294			157,418
Investment Securities	(32,392		)	(168,844		)
Increase In Advance Payments By Borrowers	323,250			414,946
Other, Net	1,333,451			2,576,122
Net Cash Provided By Operating Activities	10,195,611			17,671,397

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase Of Mortgage-Backed Securities Available For Sale	(50,417,565		)	(64,782,671		)
Principal Repayments On Mortgage-Backed Securities Available For Sale	24,085,687			45,539,786
Principal Repayments On Mortgage-Backed Securities Held To Maturity	—			942,806
Purchase Of Investment Securities Available For Sale	(40,181,576		)	(60,296,593		)
Maturities Of Investment Securities Available For Sale	17,167,888			16,419,156
Purchase of Investment Securities Held To Maturity	—			(1,000,000		)
Maturities Of Investment Securities Held To Maturity	—			3,501,978
Proceeds From Sale of Investment Securities Available For Sale	29,526,067			16,947,896
Proceeds From Sale of Mortgage-Backed Securities Available For Sale	25,063,634			31,945,850
Proceeds From Redemption of Certificates Of Deposits With Other Banks	—			250,000
Purchase Of FHLB Stock	(4,434,480		)	(2,696,106		)
Redemption Of FHLB Stock	5,599,480			4,200,106
Proceeds From Bank Owned Life Insurance	624,260			—
Decrease In Loans Receivable	13,826,634			23,717,082
Proceeds From Sale Of Repossessed Assets	1,461,940			5,256,365
Purchase And Improvement Of Premises And Equipment	(2,025,581		)	(513,144		)
Proceeds From Sale of Premises and Equipment	—			1,750
Net Cash Provided By Investing Activities	20,296,388			19,434,261

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES



Consolidated Statements of Cash Flows (Unaudited) (Continued)	Nine Months Ended September 30,
	2014			2013

CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease In Deposit Accounts	$	(12,232,848	)	$	(6,985,633	)
Proceeds From FHLB Advances	171,890,000			77,900,000
Repayment Of FHLB Advances	(191,310,058		)	(105,012,811		)
Increase In Other Borrowings, Net	2,778,617			555,375
Repayment Of Warrant Issued In Conjunction With Preferred Stock	—			(50,000		)
Dividends To Preferred Stock Shareholders	(330,000		)	(330,000		)
Dividends To Common Stock Shareholders	(706,560		)	(706,549		)
Net Cash Used By Financing Activities	(29,910,849		)	(34,629,618		)
Net Increase In Cash And Cash Equivalents	581,150			2,476,040
Cash And Cash Equivalents At Beginning Of Period	7,629,771			7,903,950
Cash And Cash Equivalents At End Of Period	$	8,210,921		$	10,379,990
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Paid During The Period For:
Interest	$	4,407,602		$	5,921,035
Income Taxes	$	180,350		$	358,419
Supplemental Schedule Of Non Cash Transactions:
Transfers From Loans Receivable To Other Real Estate Owned	$	1,038,960		$	3,038,682
Transfers From Investment Securities Held To Maturity To Available For Sale	$	—		$	49,907,323
Transfers From Mortgage-Backed Securities Held To Maturity To Available For Sale	$	—		$	22,100,000

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

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 consolidated financial statements appearing in Security Federal Corporation’s (the “Company”) 2013 Annual Report to Shareholders which was filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2013 (“2013 10-K”) 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 and nine months ended September 30, 2014 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 is currently inactive.

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, 2013 included in our 2013 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.

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. 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 September 30,				For the Nine Months Ended September 30,
	2014		2013		2014		2013
Earnings Available To Common Shareholders:
Net Income		$1,710,640		$1,021,831		$4,489,976		$2,571,762
Preferred Stock Dividends	110,000		110,000		330,000		330,000
Net Income Available To Common Shareholders		$1,600,640		$911,831		$4,159,976		$2,241,762

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

4. Earnings Per Common Share, Continued

The following table shows the effect of dilutive options and warrants on the Company's earnings per share for the periods indicated:



	For the Three Months Ended September 30, 2014					For the Nine Months Ended September 30, 2014
	Income		Shares	Per Share Amounts		Income		Shares	Per Share Amounts
Basic EPS		$1,600,640	2,944,001		$0.54		$4,159,976	2,944,001		$1.41
Effect of Dilutive Securities:
Senior Convertible Debentures	75,442		304,200	(0.02)		226,325		304,200	(0.06)
Diluted EPS		$1,676,082	3,248,201		$0.52		$4,386,301	3,248,201		$1.35

There were no dilutive securities or options for the three and nine months ended September 30, 2013, therefore no reconciliation is provided for these periods.

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 September 30,
	2014		2013
	Shares	Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
	Shares	Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
Balance, Beginning of Period	47,500	$22.41	68,400		$22.63
Options Granted	—	—	—		—
Options Exercised	—	—	—		—
Options Forfeited	—	—	(3,400	)	24.06
Balance, End Of Period	47,500	$22.41	65,000		$22.55



	Nine Months Ended September 30,
	2014			2013
	Shares		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
	Shares		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
Balance, Beginning of Period	61,500		$22.49	68,400		$22.63
Options Granted	—		—	—		—
Options Exercised	—		—	—		—
Options Forfeited	(14,000	)	22.74	(3,400	)	24.06
Balance, End Of Period	47,500		$22.41	65,000		$22.55

Options Exercisable	33,900			45,400

Options Available For Grant	50,000			50,000

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

5. Stock-Based Compensation, Continued

At September 30, 2014, the Company had the following options outstanding:




Grant Date	Outstanding Options	Option Price	Expiration Date

01/01/05	18,000	$20.55	12/31/14

01/01/06	3,500	$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	13,000	$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 September 30, 2014 or 2013 had an exercise price below the average market price during the three or nine month periods ended September 30, 2014 or 2013. 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 had a 10-year term and was immediately exercisable upon issuance.

On July 31, 2013, the Company repurchased its outstanding warrant at a fair market value of $50,000 from the U.S. Treasury. As a result of the transaction the warrant was canceled which reduced warrants outstanding by $400,000 and increased additional paid in capital by $350,000.

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:



	September 30, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
FHLB Securities	$	11,360,428	$	67,439	$	270,512	$	11,157,355
Federal Farm Credit Bank ("FFCB") Securities	5,750,000		—		177,026		5,572,974
Fannie Mae ("FNMA") Bonds	996,641		—		1,143		995,498
Small Business Administration (“SBA”) Bonds	93,610,391		1,730,343		411,445		94,929,289
Tax Exempt Municipal Bonds	63,623,690		2,234,988		46,117		65,812,561
Mortgage-Backed Securities	245,663,777		5,949,642		1,554,523		250,058,896
Equity Securities	257,938		35,400		—		293,338
	$	421,262,865	$	10,017,812	$	2,460,766	$	428,819,911

	December 31, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
FHLB Securities	$	13,538,723	$	25,695	$	893,968	$	12,670,450
FFCB Securities	5,750,000		—		383,820		5,366,180
FNMA And Freddie Mac ("FHLMC") Bonds	1,993,473		—		18,543		1,974,930
SBA Bonds	99,228,708		1,914,720		319,443		100,823,985
Tax Exempt Municipal Bonds	63,590,959		410,151		2,685,988		61,315,122
Mortgage-Backed Securities	245,882,053		5,843,365		3,128,883		248,596,535
Equity Securities	257,938		—		1,688		256,250
	$	430,241,854	$	8,193,931	$	7,432,333	$	431,003,452

FHLB securities, FFCB 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 Ginnie Mae ("GNMA") mortgage-backed securities, which are also backed by the full faith and credit of the United States government. At September 30, 2014 the Bank held an amortized cost and fair value of $162.2 million and $166.2 million, respectively, in GNMA mortgage-backed securities included in mortgage-backed securities listed above compared to an amortized cost and fair value of $170.4 million and $173.5 million, respectively, at December 31, 2013. 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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

The amortized cost and fair value of investment and mortgage-backed securities available for sale at September 30, 2014 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.



Investment Securities	Amortized Cost		Fair Value
Less Than One Year	$	658,223	$	668,859
One – Five Years	12,750,683		12,967,641
Over Five – Ten Years	65,430,624		66,324,657
More Than Ten Years	96,759,558		98,799,858
Mortgage-Backed Securities	245,663,777		250,058,896
	$	421,262,865	$	428,819,911

At September 30, 2014 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 $125.7 million and $129.1 million, respectively, compared to an amortized cost and fair value of $118.3 million and $121.1 million, respectively, at December 31, 2013.

The Bank received $27.3 million and $17.1 million in gross proceeds from sales of available for sale securities during the three months ended September 30, 2014 and 2013, respectively. As a result, the Bank recognized gross gains of $319,000 and $520,000, respectively, and gross losses of $176,000 and $101,000, respectively, for the three months ended September 30, 2014 and 2013.

The Bank received $54.6 million and $48.9 million in gross proceeds from sales of available for sale securities during the nine months ended September 30, 2014 and 2013, respectively. As a result, the Bank recognized gross gains of $795,000 and $1.3 million, respectively, and gross losses of $607,000 and $101,000, respectively, for the nine months ended September 30, 2014 and 2013.

The following tables show gross unrealized losses and fair value, aggregated by investment category, and length of time that the individual available for sale securities have been in a continuous unrealized loss position at the dates indicated.



	September 30, 2014
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Securities	$	1,990,966	$	9,034	$	3,738,525	$	261,478	$	5,729,491	$	270,512
FFCB Securities	5,572,974		177,026		—		—		5,572,974		177,026
FNMA Bonds	995,498		1,143		—		—		995,498		1,143
SBA Bonds	21,286,280		321,062		3,711,116		90,383		24,997,396		411,445
Tax Exempt Municipal Bond	1,335,360		3,378		7,827,171		42,739		9,162,531		46,117
Mortgage-Backed Securities	20,395,081		1,049,063		48,229,099		505,460		68,624,180		1,554,523
	$	51,576,159	$	1,560,706	$	63,505,911	$	900,060	$	115,082,070	$	2,460,766

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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



	December 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	$	10,288,110	$	651,608	$	1,757,640	$	242,360	$	12,045,750	$	893,968
FFCB Securities	4,435,070		314,930		931,110		68,890		5,366,180		383,820
FNMA Bonds	1,974,930		18,543		—		—		1,974,930		18,543
SBA Bonds	12,183,961		288,678		3,541,453		30,765		15,725,414		319,443
Tax Exempt Municipal Bond	39,848,206		2,556,014		2,008,272		129,974		41,856,478		2,685,988
Mortgage-Backed Securities	88,516,030		2,756,216		6,436,369		372,667		94,952,399		3,128,883
Equity Securities	—		—		101,250		1,688		101,250		1,688
	$	157,246,307	$	6,585,989	$	14,776,094	$	846,344	$	172,022,401	$	7,432,333

Securities classified as available for sale are recorded at fair market value. At September 30, 2014, 11.3% of the unrealized losses, or 22 individual securities consisted of securities in a continuous loss position for 12 months or more. At December 31, 2013, 11.4% of the unrealized losses, or 11 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.

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

On June 30, 2013, the Company transferred all of its investment and mortgage-backed securities classified as held to maturity to available for sale. Based on changes in the current rate environment, management elected this change to more effectively manage the investment portfolio, including subsequently selling some securities that were formerly classified as held to maturity. The amortized cost of the securities that were transferred totaled $72.0 million and the net unrealized gain related to these securities totaled $1.4 million on the date of the transfer. As a result of the transfer and subsequent sales, the Company believes its held to maturity classification process has been compromised and careful evaluation and analysis will be required going forward in determining when circumstances are suitable for management to assert with a great degree of credibility that it has the intent and ability to hold debt securities to maturity.

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:




	September 30, 2014		December 31, 2013
Residential Real Estate Loans	$	79,702,132	$	83,004,482
Consumer Loans	50,290,048		52,205,901
Commercial Business	10,154,181		7,775,098
Commercial Real Estate	213,004,588		228,399,555
Total Loans Held For Investment	353,150,949		371,385,036
Loans Held For Sale	2,057,504		1,234,158
Total Loans Receivable, Gross	355,208,453		372,619,194
Less:
Allowance For Loan Losses	8,646,974		10,241,970
Loans In Process	2,412,953		3,465,072
Deferred Loan Fees (Costs)	33,659		(4,513		)
	11,093,586		13,702,529
Total Loans Receivable, Net	$	344,114,867	$	358,916,665

Changes in the allowance for loan losses for the three and nine months ended September 30, 2014 and 2013 are summarized as follows:



	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
Balance At Beginning Of Period	$	9,112,157		$	11,007,279		$	10,241,970		$	11,318,371
Provision For Loan Losses	—			600,000			200,000			2,645,381
Charge Offs	(590,942		)	(1,002,990		)	(2,384,994		)	(3,470,300		)
Recoveries	125,759			45,042			589,998			155,879
Total Allowance For Loan Losses	$	8,646,974		$	10,649,331		$	8,646,974		$	10,649,331

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 90 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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9. Loans Receivable, Net, Continued



	Credit Quality Measures
September 30, 2014	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	71,912,700	$	966,600	$	645,340	$	6,177,492	$	79,702,132
Consumer	48,075,273		1,054,675		133,982		1,026,118		50,290,048
Commercial Business	9,209,345		362,845		110,068		471,923		10,154,181
Commercial Real Estate	123,194,407		38,901,566		35,187,083		15,721,532		213,004,588
Total	$	252,391,725	$	41,285,686	$	36,076,473	$	23,397,065	$	353,150,949



	Credit Quality Measures
December 31, 2013	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	74,505,587	$	890,902	$	403,138	$	7,204,855	$	83,004,482
Consumer	50,370,640		843,799		143,649		847,813		52,205,901
Commercial Business	6,807,620		368,019		524,928		74,531		7,775,098
Commercial Real Estate	135,793,150		43,252,464		25,581,235		23,772,706		228,399,555
Total	$	267,476,997	$	45,355,184	$	26,652,950	$	31,899,905	$	371,385,036

The following table presents an age analysis of past due balances by category at September 30, 2014:



	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	$	—	$	983,996	$	3,121,609	$	4,105,605	$	75,596,527	$	79,702,132
Consumer	735,649		85,847		543,421		1,364,917		48,925,131		50,290,048
Commercial Business	242,346		21,290		452,119		715,755		9,438,426		10,154,181
Commercial Real Estate	4,809,091		452,022		9,636,646		14,897,759		198,106,829		213,004,588
Total	$	5,787,086	$	1,543,155	$	13,753,795	$	21,084,036	$	332,066,913	$	353,150,949

The following table presents an age analysis of past due balances by category at December 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	$	—	$	1,363,132	$	4,607,613	$	5,970,745	$	77,033,737	$	83,004,482
Consumer	1,494,429		234,878		399,062		2,128,369		50,077,532		52,205,901
Commercial Business	115,186		—		33,055		148,241		7,626,857		7,775,098
Commercial Real Estate	5,103,522		2,046,666		4,972,667		12,122,855		216,276,700		228,399,555
Total	$	6,713,137	$	3,644,676	$	10,012,397	$	20,370,210	$	351,014,826	$	371,385,036

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9. Loans Receivable, Net, Continued

At September 30, 2014 and December 31, 2013, 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 September 30, 2014 compared to December 31, 2013:



	At September 30, 2014				At December 31, 2013				$			%
	Amount		Percent ⁽¹⁾		Amount		Percent ⁽¹⁾		Increase (Decrease)			Increase (Decrease)
Non-accrual Loans:
Residential Real Estate	$	3,121,609	0.89	%	$	4,607,613	1.25	%	$	(1,486,004	)	(32.25	)%
Commercial Business	452,119		0.13		33,055		0.01		419,064			1,267.78
Commercial Real Estate	9,636,646		2.75		4,972,667		1.35		4,663,979			93.79
Consumer	543,421		0.15		399,062		0.11		144,359			36.17
Total Non- accrual Loans	$	13,753,795	3.92	%	$	10,012,397	2.72	%	$	3,741,398		37.37	%

^{(1) PERCENT OF TOTAL LOANS HELD FOR INVESTMENT, NET OF DEFERRED FEES AND LOANS IN PROCESS.}

The following tables show the activity in the allowance for loan losses by category for the periods indicated:



	For the Three Months Ended September 30, 2014
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,507,281		$	833,746		$	496,578		$	6,274,552		$	9,112,157
Provision	26,596			73,403			36,529			(136,528		)	—
Charge-Offs	(71,701		)	(75,262		)	(3,703		)	(440,276		)	(590,942		)
Recoveries	121			8,440			1,950			115,248			125,759
Ending Balance	$	1,462,297		$	840,327		$	531,354		$	5,812,996		$	8,646,974



	For the Nine Months Ended September 30, 2014
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,706,643		$	847,777		$	426,658		$	7,260,892		$	10,241,970
Provision	(60,716		)	230,236			104,527			(74,047		)	200,000
Charge-Offs	(319,364		)	(283,302		)	(20,835		)	(1,761,493		)	(2,384,994		)
Recoveries	135,734			45,616			21,004			387,644			589,998
Ending Balance	$	1,462,297		$	840,327		$	531,354		$	5,812,996		$	8,646,974

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9. Loans Receivable, Net, Continued



	For the Three Months Ended September 30, 2013
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,665,871		$	888,913		$	488,554		$	7,963,941		$	11,007,279
Provision	175,482			(26,974		)	(66,101		)	517,593			600,000
Charge-Offs	(212,876		)	(27,916		)	—			(762,198		)	(1,002,990		)
Recoveries	—			18,953			10,219			15,870			45,042
Ending Balance	$	1,628,477		$	852,976		$	432,672		$	7,735,206		$	10,649,331



	For the Nine Months Ended September 30, 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	431,317			(42,636		)	(201,148		)	2,457,848			2,645,381
Charge-Offs	(324,399		)	(143,991		)	(4,436		)	(2,997,474		)	(3,470,300		)
Recoveries	—			38,332			19,337			98,210			155,879
Ending Balance	$	1,628,477		$	852,976		$	432,672		$	7,735,206		$	10,649,331

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
September 30, 2014	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	—	$	1,462,297	$	1,462,297
Consumer	2,600		837,727		840,327
Commercial Business	200,000		331,354		531,354
Commercial Real Estate	104,500		5,708,496		5,812,996
Total	$	307,100	$	8,339,874	$	8,646,974



	Allowance For Loan Losses
December 31, 2013	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	158,791	$	1,547,852	$	1,706,643
Consumer	103,109		744,668		847,777
Commercial Business	—		426,658		426,658
Commercial Real Estate	840,658		6,420,234		7,260,892
Total	$	1,102,558	$	9,139,412	$	10,241,970

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9. Loans Receivable, Net, Continued

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
September 30, 2014	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	2,567,695	$	77,134,437	$	79,702,132
Consumer	222,046		50,068,002		50,290,048
Commercial Business	452,119		9,702,062		10,154,181
Commercial Real Estate	17,586,319		195,418,269		213,004,588
Total	$	20,828,179	$	332,322,770	$	353,150,949



	Loans Receivable
December 31, 2013	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	4,838,236	$	78,166,246	$	83,004,482
Consumer	275,491		51,930,410		52,205,901
Commercial Business	19,775		7,755,323		7,775,098
Commercial Real Estate	26,221,312		202,178,243		228,399,555
Total	$	31,354,814	$	340,030,222	$	371,385,036

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 $21.2 million for three months ended September 30, 2014 compared to $34.6 million for the three months ended September 30, 2013.

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 September 30, 2014 and December 31, 2013 and for the three and nine months ended September 30, 2014 and 2013.



			At				For the Three Months Ended September 30,
	September 30, 2014						2014				2013
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	$	2,567,695	$	2,665,884	$	—	$	2,618,971	$	—	$	3,834,984	$	9,662
Consumer Loans	155,176		162,677		—		161,882		—		397,003		1,783
Commercial Business	16,089		16,089		—		16,089		—		21,438		226
Commercial Real Estate	16,432,495		20,824,664		—		16,726,235		98,542		28,838,663		271,472
With An Allowance Recorded:
Residential Real Estate	—		—		—		—		—		405,872		—
Consumer Loans	66,870		66,870		2,600		67,239		2,082		—		—
Commercial Business	436,030		436,030		200,000		458,059		—		—		—
Commercial Real Estate	1,153,824		1,160,624		104,500		1,159,433		22,781		1,151,053		8,326
Total
Residential Real Estate	2,567,695		2,665,884		—		2,618,971		—		4,240,856		9,662
Consumer Loans	222,046		229,547		2,600		229,121		2,082		397,003		1,783
Commercial Business	452,119		452,119		200,000		474,148		—		21,438		226
Commercial Real Estate	17,586,319		21,985,288		104,500		17,885,668		121,323		29,989,716		279,798
Total	$	20,828,179	$	25,332,838	$	307,100	$	21,207,908	$	123,405	$	34,649,013	$	291,469

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9. Loans Receivable, Net, Continued



	For the Nine Months Ended September 30,
	2014				2013
Impaired Loans	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With No Related Allowance Recorded:
Residential Real Estate	$	2,676,070	$	—	$	3,911,750	$	20,289
Consumer Loans	171,364		—		394,775		7,494
Commercial Business	16,089		—		23,745		335
Commercial Real Estate	18,142,478		266,000		30,090,250		1,031,806
With An Allowance Recorded:
Residential Real Estate	—		—		405,872		—
Consumer Loans	67,872		4,168		—		—
Commercial Business	461,206		—		—		—
Commercial Real Estate	1,173,816		51,156		1,278,434		23,274
Total
Residential Real Estate	2,676,070		—		4,317,622		20,289
Consumer Loans	239,236		4,168		394,775		7,494
Commercial Business	477,295		—		23,745		335
Commercial Real Estate	19,316,294		317,156		31,368,684		1,055,080
Total	$	22,708,895	$	321,324	$	36,104,826	$	1,083,198



	December 31, 2013
Impaired Loans	Recorded Investment		Unpaid Principal Balance		Related Allowance
With No Related Allowance Recorded:
Residential Real Estate	$	3,936,316	$	4,588,645	$	—
Consumer Loans	106,197		106,198		—
Commercial Business	19,775		19,775		—
Commercial Real Estate	21,810,347		26,775,853		—
With An Allowance Recorded:
Residential Real Estate	901,920		901,920		158,791
Consumer Loans	169,294		169,294		103,109
Commercial Business	—		—		—
Commercial Real Estate	4,410,965		4,954,058		840,658
Total
Residential Real Estate	4,838,236		5,490,565		158,791
Consumer Loans	275,491		275,492		103,109
Commercial Business	19,775		19,775		—
Commercial Real Estate	26,221,312		31,729,911		840,658
Total	$	31,354,814	$	37,515,743	$	1,102,558

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 September 30, 2014 and December 31, 2013 were $9.9 million and $12.4 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).

There were no loan modifications during the three months ended September 30, 2014 or 2013 that were TDRs. The following table is a summary of loans restructured as TDRs during the periods indicated:



	For the Nine Months Ended September 30, 2014					For the Nine Months Ended September 30, 2013
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	—	—		—		—	—		—
Commercial Business	—	—		—		—	—		—
Commercial Real Estate	1	79,072		79,072		4	1,651,023		1,651,023
Total	1	$	79,072	$	79,072	4	$	1,651,023	$	1,651,023

During the nine months ended September 30, 2014, the Bank modified one loan that was considered to be a TDR by lowering the interest rate. This modification enabled the customer to begin making monthly principal and interest payments.

During the nine months ended September 30, 2014, five loans totaling $2.2 million that had previously been restructured were in default, all of which went into default during the nine month period. There were no loans restructured within the last twelve months that went into default during the three and nine months ended September 30, 2014. One loan for $142,000 that had been previously restructured within the last twelve months defaulted during the three and nine months ended September 30, 2013. The Bank considers any loan 30 days or more past due to be in default.

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.

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 September 30, 2014 and December 31, 2013, 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)
September 30, 2014
SECURITY FEDERAL CORP.
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	75,436	19.8	%	$	15,211	4.0	%	N/A		N/A
Total Risk-Based Capital (To Risk Weighted Assets)	87,978		23.1	%	30,422		8.0	%	N/A		N/A
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	75,436		9.2	%	32,977		4.0	%	N/A		N/A

SECURITY FEDERAL BANK
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	84,807	22.3	%	$	15,200	4.0	%	$	22,800	6.0	%
Total Risk-Based Capital (To Risk Weighted Assets)	89,605		23.6	%	30,400		8.0	%	37,999		10.0	%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	84,807		10.3	%	32,967		4.0	%	41,209		5.0	%

December 31, 2013
SECURITY FEDERAL CORP.
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	70,598	17.8	%	$	15,894	4.0	%	N/A		N/A
Total Risk-Based Capital (To Risk Weighted Assets)	84,529		21.3	%	31,788		8.0	%	N/A		N/A
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	70,598		8.3	%	34,079		4.0	%	N/A		N/A

SECURITY FEDERAL BANK
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	81,624	20.6	%	$	15,883	4.0	%	$	23,825	6.0	%
Total Risk-Based Capital (To Risk Weighted Assets)	86,652		21.8	%	31,767		8.0	%	39,709		10.0	%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	81,624		9.6	%	34,069		4.0	%	42,586		5.0	%

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 September 30, 2014, 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. 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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

contracts, the fair value of the mortgage loans held for sale in most cases is the same as the value of the loan amount at its origination. These loans are classified as Level 2.

Impaired Loans

The Company does not record loans 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 September 30, 2014, most 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 September 30, 2014 and December 31, 2013, the recorded investment in impaired loans was $20.8 million and $31.4 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 September 30, 2014:



Assets:	Quoted Market Price In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
FHLB Securities	$	—	$	11,157,355	$	—
FFCB Securities	—		5,572,974		—
FNMA Bonds	—		995,498		—
SBA Bonds	—		94,929,289		—
Tax Exempt Municipal Bonds	—		65,812,561		—
Mortgage-Backed Securities	—		250,058,896		—
Equity Securities	—		293,338		—
Total	$	—	$	428,819,911	$	—

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, 2013:



Assets:	Quoted Market Price In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
FHLB Securities	$	—	$	12,670,450	$	—
FFCB Securities	—		5,366,180		—
FNMA Bonds	—		1,974,930		—
SBA Bonds	—		100,823,985		—
Tax Exempt Municipal Bonds	—		61,315,122		—
Mortgage-Backed Securities	—		248,596,535		—
Equity Securities	—		256,250		—
Total	$	—	$	431,003,452	$	—

There were no liabilities measured at fair value on a recurring basis as of September 30, 2014 or December 31, 2013.

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 measured at fair value on a nonrecurring basis as of September 30, 2014 and December 31, 2013, aggregated by the level in the fair value hierarchy within which those measurements fall. There were no liabilities measured at fair value on a nonrecurring basis as of September 30, 2014 and December 31, 2013.



Assets:	Level 1		Level 2		Level 3		Balance At September 30, 2014
Mortgage Loans Held For Sale	$	—	$	2,057,504	$	—	$	2,057,504
Collateral Dependent Impaired Loans ⁽¹⁾	—		—		20,521,079		20,521,079
Foreclosed Assets	—		—		3,859,424		3,859,424
Total	$	—	$	2,057,504	$	24,380,503	$	26,438,007

^{(1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF $307,000}



Assets:	Level 1		Level 2		Level 3		Balance At December 31, 2013
Mortgage Loans Held For Sale	$	—	$	1,234,158	$	—	$	1,234,158
Collateral Dependent Impaired Loans ⁽¹⁾	—		—		30,252,256		30,252,256
Foreclosed Assets	—		—		3,947,226		3,947,226
Total	$	—	$	1,234,158	$	34,199,482	$	35,433,640

^{(1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF}^$1,103,000

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of September 30, 2014, the significant unobservable inputs used in the fair value measurements were as follows:



	Fair Value			Significant
	September 30,		Valuation	Unobservable
	2014		Technique	Inputs	Range
Collateral Dependent Impaired Loans	$	20,521,079	Appraised Value	Discount Rates/ Discounts to Appraised Values	6% - 70%
Foreclosed Assets	3,859,424		Appraised Value/Comparable Sales	Discount Rates/ Discounts to Appraised Values	9% - 76%

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 deposit 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 advances 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.

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 September 30, 2014 and December 31, 2013 presented in accordance with the applicable accounting guidance.



	September 30, 2014
	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash And Cash Equivalents	$	8,211	$	8,211	$	8,211	$	—	$	—
Certificates Of Deposits With Other Banks	2,095		2,095		—		2,095		—
Investment And Mortgage-Backed Securities	428,820		428,820		—		428,820		—
Loans Receivable, Net	344,115		343,657		—		—		343,657
FHLB Stock	3,852		3,852		3,852		—		—

Financial Liabilities:
Deposits:
Checking, Savings, And Money Market Accounts	$	399,349	$	399,349	$	399,349	$	—	$	—
Certificate Accounts	247,115		247,124		—		247,124		—
Advances From FHLB	68,320		69,757		—		69,757		—
Other Borrowed Money	10,781		10,781		10,781		—		—
Senior Convertible Debentures	6,084		6,084		—		6,084		—
Junior Subordinated Debentures	5,155		5,155		—		5,155		—



	December 31, 2013
	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash And Cash Equivalents	$	7,630	$	7,630	$	7,630	$	—	$	—
Certificates Of Deposits With Other Banks	2,100		2,100		—		2,100		—
Investment And Mortgage-Backed Securities	431,003		431,003		—		431,003		—
Loans Receivable, Net	358,917		356,623		—		—		356,623
FHLB Stock	5,017		5,017		5,017		—		—

Financial Liabilities:
Deposits:
Checking, Savings, And Money Market Accounts	$	401,813	$	401,813	$	401,813	$	—	$	—
Certificate Accounts	256,884		257,883		—		257,883		—
Advances From FHLB	87,740		92,608		—		92,608		—
Other Borrowed Money	8,003		8,003		8,003		—		—
Senior Convertible Debentures	6,084		6,084		—		6,084		—
Junior Subordinated Debentures	5,155		5,155		—		5,155		—

At September 30, 2014, the Bank had $49.3 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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

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:

In January 2014, the Financial Accounting Statndards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-04, “Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” . The amendments in this ASU are intended to resolve diversity in practice with respect to when a creditor should reclassify a collateralized consumer mortgage loan to other real estate owned (OREO). In addition, the amendments require a creditor to reclassify a collateralized consumer mortgage loan to OREO upon obtaining legal title to the real estate collateral, or the borrower voluntarily conveying all interest in the real estate property to the lender to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement. The amendments will be effective for the Company for annual periods, and interim periods within those annual periods beginning after December 15, 2014, with early implementation of the guidance permitted. In implementing this guidance, assets that are reclassified from real estate to loans are measured at the carrying value of the real estate at the date of adoption. Assets reclassified from loans to real estate are measured at the lower of the net amount of the loan receivable or the fair value of the real estate less costs to sell at the date of adoption. The Company will apply the amendments prospectively. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers,” which creates Topic 606 and supercedes Topic 605, “Revenue Recognition.” The core principle of the new guidance in this ASU is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for reporting periods beginning after December 15, 2016. The Company will apply the guidance using a modified retrospective approach. The Company does not expect the adoption of this ASU to have a material effect on its consolidated financial statements.

In June 2014, the FASB issued ASU No. 2014-11, “Repurchase-To-Maturity Transactions Repurchase Financings and Disclosures,” which makes limited amendments to the guidance on accounting for certain repurchase agreements. The new guidance (1) requires entities to account for repurchase-to-maturity transactions as secured borrowings (rather than as sales with forward repurchase agreements), (2) eliminates accounting guidance on linked repurchase financing transactions, and (3) expands disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers (specifically, repos, securities lending transactions, and repurchase-to-maturity transactions) accounted for as secured borrowings. The amendments will be effective for the Company for the first interim or annual period beginning after December 15, 2014. The Company will apply the guidance by making a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. The Company does not expect the adoption of this ASU to have a material effect on its consolidated financial statements.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

In August 2014, the FASB issued ASU 2014-14," Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure." Current U.S. generally accepted accounting principles (“GAAP”) provides classification and measurement guidance for situations in which a creditor obtains a debtor’s assets in satisfaction of a receivable, including receipt of assets through foreclosure, but does not provide specific guidance on how to classify and measure foreclosed loans that are government guaranteed. Current GAAP also does not provide guidance on how to determine the unit of account; that is, whether a single asset should be recognized or whether two separate assets should be recognized (real estate and a guarantee receivable). In practice, most creditors derecognize the loan and recognize a single asset. Some creditors recognize a nonfinancial asset (other real estate owned), while others recognize a financial asset (typically, a guarantee receivable). Regardless of the classification of the asset (or assets), measurement of the asset (or total measurement of the assets) in practice generally represents the amount recoverable under the guarantee. The amendments in this ASU should reduce variations in practice by providing guidance on how to classify and measure certain government-guaranteed mortgage loans upon foreclosure. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The Company’s adoption of this ASU is not expected to have a material effect on its consolidated financial statements.

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern. ASU 2014-15 defines management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. In connection with preparing financial statements, management will need to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the organization’s ability to continue as a going concern within one year after the date that the financial statements are issued. The ASU is effective for annual and interim periods beginning after December 15, 2016, and should be applied prospectively. The Company does not expect the adoption of this ASU will have a material effect on its consolidated financial statements.

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 consolidated financial statements were available to be issued and no other subsequent events occurred requiring accrual or disclosure.

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 which may lead to increased losses and non-performing assets in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our loan loss reserves;


•	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 the effect of the Dodd-Frank Wall Street Reform and Consumer Protection Act, and changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules, including as a result of Basel III, and any changes in rules applicable to institutions participating in the U.S. Department of Treasury’s Community Development Capital Initiative or other rules;


•	our ability to attract and retain deposits;


•	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 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 and preferred stock;


•	adverse changes in the securities markets;


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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition and Results of Operations


•	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;


•	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 2013 Form 10-K 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 2014 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 September 30, 2014 and December 31, 2013

General – Total assets decreased $20.4 million or 2.4% to $828.9 million at September 30, 2014 from $849.2 million at December 31, 2013. The primary reason for the decrease in total assets was a decrease of $14.8 million and $3.4 million in net loans receivable and other assets, respectively, offset partially by an increase of $1.1 million in premises and equipment, net.

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



						Increase (Decrease)
		September 30, 2014		December 31, 2013		Amount		Percent
Cash And Cash Equivalents	$	8,210,921	$	7,629,771	$	581,150		7.6%
Investment And Mortgage- Backed Securities – Available For Sale		428,819,911		431,003,452		(2,183,541	)	(0.5)
Loans Receivable, Net		344,114,867		358,916,665		(14,801,798	)	(4.1)
Premises And Equipment, Net		18,377,829		17,243,390		1,134,439		6.6
FHLB Stock		3,851,600		5,016,600		(1,165,000	)	(23.2)
Bank Owned Life Insurance		11,075,045		11,474,305		(399,260	)	(3.5)
Intangible Assets, Net		—		11,970		(11,970	)	(100.0)
Other Assets		4,139,647		7,547,528		(3,407,881	)	(45.2)

Cash and cash equivalents increased $581,000 or 7.6% to $8.2 million at September 30, 2014 from $7.6 million at December 31, 2013. Investment and mortgage-backed securities available for sale decreased $2.2 million or 0.5% to $428.8 million at September 30, 2014 from $431.0 million at December 31, 2013.

Loans receivable, net, decreased $14.8 million or 4.1% to $344.1 million at September 30, 2014 from $358.9 million at December 31, 2013. This decrease was a result of increased loan paydowns combined with lower loan demand from creditworthy borrowers. Residential real estate loans decreased $3.3 million or 4.0% to $79.7 million at September 30, 2014 from $83.0 million at December 31, 2013. Consumer loans decreased $1.9 million or 3.7% to $50.3 million at September 30, 2014 compared to $52.2 million at December 31, 2013. Commercial real estate loans decreased $15.4 million or 6.7% to $213.0 million at September 30, 2014 from $228.4 million at December 31, 2013.

Commercial business loans increased $2.4 million or 30.6% to $10.2 million at September 30, 2014 from $7.8 million at December 31, 2013. Loans held for sale increased $823,000 or 66.7% to $2.1 million at September 30, 2014 from $1.2 million at December 31, 2013.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition and Results of Operations

Premises and equipment, net increased $1.1 million or 6.6% to $18.4 million at September 30, 2014 from $17.2 million at December 31, 2013. The increase is attributable to land purchased for $1.3 million during the nine months ended September 30, 2014 for a prospective future branch site in Columbia County, Georgia.

Bank owned life insurance decreased $399,000 or 3.5% to $11.1 million at September 30, 2014 compared to $11.5 million at December 31, 2013. The decrease reflects the redemption of $624,000 in life insurance during the nine months ended September 30, 2014, which was offset slightly by $225,000 in income from bank owned life insurance.

Other assets decreased $3.4 million or 45.2% to $4.1 million at September 30, 2014 compared to $7.5 million at December 31, 2013. The decrease is a result of deferred taxes related to increased unrealized gains in the investment portfolio.

Liabilities

Deposit Accounts – The balances, weighted average rates and increases and decreases in deposit accounts were as follows:



								Balance
		September 30, 2014			December 31, 2013			Increase (Decrease)
		Balance	Weighted Rate		Balance	Weighted Rate		Amount		Percent
Demand Accounts:
Checking	$	141,623,047	0.03%	$	136,695,876	0.04%	$	4,927,171		3.60%
Money Market		229,895,626	0.19		240,631,708	0.28		(10,736,082	)	(4.46)
Statement Savings Accounts		27,830,465	0.10		24,485,648	0.10		3,344,817		13.66
Total		399,349,138	0.13		401,813,232	0.19		(2,464,094	)	(0.61)

Certificate Accounts
0.00 – 1.99%		223,355,236			226,750,180			(3,394,944)		(1.50)
2.00 – 2.99%		23,585,952			28,848,252			(5,262,300)		(18.24)
3.00 – 3.99%		173,598			1,285,108			(1,111,510)		(86.49)
Total		247,114,786	0.77		256,883,540	0.83		(9,768,754)		(3.80)
Total Deposits	$	646,463,924	0.37%	$	658,696,772	0.44%	$	(12,232,848)		(1.86)%

Included in the certificate accounts above were $30.6 million and $25.6 million in brokered deposits at September 30, 2014 and December 31, 2013, respectively, with a weighted average interest rate of 1.01% and 1.23%, respectively.

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



								Balance
		September 30, 2014			December 31, 2013			Decrease
Fiscal Year Due:		Balance	Rate		Balance	Rate		Balance	Percent
2014	$	15,420,000	1.93%	$	34,840,058	1.64%	$	(19,420,058)	(55.74)%
2015		15,000,000	4.01		15,000,000	4.01		—	—
2016		20,000,000	4.61		20,000,000	4.61		—	—
2017		12,900,000	4.38		12,900,000	4.38		—	—
2018		5,000,000	3.39		5,000,000	3.39		—	—
Thereafter		—	—		—	—		—	—
Total Advances	$	68,320,000	3.74%	$	87,740,058	3.23%	$	(19,420,058)	(22.13)%

Advances are secured by a blanket collateral agreement with the FHLB pledging the Bank’s portfolio of residential first mortgage loans and investment securities with an amortized cost and fair value of $99.1 million and $100.6 million at September 30, 2014,

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition and Results of Operations

respectively, and $111.6 million and $102.7 million at December 31, 2013, respectively. Advances are subject to prepayment penalties.

The following table shows FHLB advances at September 30, 2014 that are callable at the option of the FHLB as of the dates indicated. These advances are also included in the above table. If an advance is called, the Bank has the option to pay off the advance without penalty, reborrow the funds on different terms, or convert the advance to a three-month floating rate advance tied to the London Interbank Offered Rate (“LIBOR”).



As of September 30, 2014
Borrow Date	Maturity Date		Amount	Int. Rate		Type	Call Dates
11/23/05	11/23/15	$	5,000,000	3.993	%	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 $10.8 million in other borrowings (non-FHLB advances) at September 30, 2014 an increase of $2.8 million or 34.7% from $8.0 million at December 31, 2013. 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 both September 30, 2014 and December 31, 2013, the interest rate paid on the repurchase agreements was 0.15%. The Bank had pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $18.5 million and $19.2 million, respectively, at September 30, 2014 and $14.8 million and $15.4 million, respectively, at December 31, 2013.

Junior Subordinated Debentures – On September 21, 2006, 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 Capital Securities 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 instruments, 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 1.93% at September 30, 2014. 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 fixed rate was converted to the floating rate, with all of the Capital Securities having a floating rate of three month LIBOR plus 170 basis points. The distribution rate payable on the Capital Securities is cumulative and payable quarterly in arrears.

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

The Capital Securities mature or are mandatorily redeemable upon maturity on December 15, 2036, 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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition and Results of Operations

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 the Company's present and future unsecured indebtedness that is not expressly subordinated.

Equity – Shareholders’ equity increased $7.7 million or 9.8% to $85.7 million at September 30, 2014 from $78.0 million at December 31, 2013. Accumulated other comprehensive income, net of tax, comprised primarily of unrealized gains on securities available for sale, net of tax, increased $4.2 million or 892.7% to $4.7 million at September 30, 2014 from $472,000 at December 31, 2013. The Company’s net income available for common shareholders was $4.2 million for the nine months ended September 30, 2014, after payment of $330,000 in preferred stock dividends. The Board of Directors of the Company declared common stock dividends totaling $707,000 during the nine months ended September 30, 2014. Book value per common share was $21.63 at September 30, 2014 and $19.02 at December 31, 2013.

Results of Operations for the Three Month Periods Ended September 30, 2014 and 2013

Net Income Available to Common Shareholders - Net income available to common shareholders increased $689,000 or 75.5% to $1.6 million or $0.52 per diluted common share for the three months ended September 30, 2014 compared to $912,000 or $0.31 per diluted common share for the three months ended September 30, 2013. The increase in net income available to common shareholders was primarily a result of an increase in net interest income combined with decreases in the provision for loan losses. These factors were offset in part by a decrease in non-interest income in both periods.

Net Interest Income - The net interest margin on a tax equivalent basis increased 11 basis points to 3.15% for the three months ended September 30, 2014 from 3.04% for the comparable period in 2013 as the decline in the average cost of interest-bearing liabilities outpaced the decline in the average balance of interest-earning assets. Net interest income increased $94,000 or 1.6% to $6.0 million during the three months ended September 30, 2014, compared to $5.9 million for the same period in 2013. During the three months ended September 30, 2014, average interest earning assets decreased $26.1 million or 3.2% to $778.2 million from $804.4 million for the same period in 2013. Average interest-bearing liabilities decreased $38.5 million or 5.3% to $685.0 million for the three months ended September 30, 2014 from $723.5 million for the comparable period in 2013.

Interest Income - Total tax equivalent interest income decreased $389,000 or 4.9% to $7.5 million during the three months ended September 30, 2014 compared to the same period in 2013. This decrease was primarily the result of the decrease in interest-earning assets, particularly loans. Total interest income on loans decreased $524,000 or 9.7% to $4.9 million during the three months ended September 30, 2014 from $5.4 million during the comparable period in 2013 as a result of the average loan portfolio balance decreasing $22.6 million or 6.1% to $347.0 million combined with the yield on the loan portfolio decreasing 23 basis points to 5.59% from 5.82%. Interest income from mortgage-backed securities increased $178,000 or 13.1% to $1.5 million as a result of a 27 basis point increase in the portfolio yield combined with a $2.2 million increase in the average balance. Tax equivalent interest income from investment securities decreased $44,000 or 3.7% to $1.1 million as a result of a decrease of 5 basis points in the yield combined with a decrease of $3.1 million in the average balance of the investment securities portfolio.

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 September 30, 2014 and 2013:



	Three Months Ended September 30,
	2014				2013
		Average Balance	Yield⁽¹⁾			Average Balance	Yield⁽¹⁾			Increase (Decrease) In Interest And Dividend Income From 2013
Loans Receivable, Net	$	347,042,171	5.59	%	$	369,685,192	5.82	%	$	(523,504)
Mortgage-Backed Securities		248,093,103	2.48			245,876,609	2.21			178,316
Investment Securities⁽²⁾		180,227,672	2.49			183,338,969	2.54			(43,582)
Overnight Time And Certificates of Deposit		2,878,994	0.33			5,487,687	0.16			126
Total Interest-Earning Assets	$	778,241,940	3.86	%	$	804,388,457	3.93	%	$	(388,644)

⁽¹⁾ Annualized

⁽²⁾ Tax equivalent basis is calculated using an effective tax rate of 34% and amounted to $124,799 and $196,678 for the

quarters ended September 30, 2014 and 2013, respectively.

Interest Expense - Total interest expense decreased $411,000 or 22.9% to $1.4 million during the three months ended September 30, 2014 compared to $1.8 million for the same period in 2013. The decrease in total interest expense was attributable to decreases in interest rates paid and a $38.5 million decrease in the average balance of interest-bearing liabilities. Interest expense on deposits decreased $173,000 or 21.8% to $621,000 during the three months ended September 30, 2014 compared to $794,000 for the same period in 2013. The decrease was attributable to a 10 basis point decrease in the cost of deposit accounts combined with a $20.9 million decrease in average interest-bearing deposits to $595.9 million for the three months ended September 30, 2014 compared to $616.8 million for the three months ended September 30, 2013. The decrease was concentrated primarily in certificate accounts, which decreased $15.0 million or 5.6% to $251.3 million during the three months ended September 30, 2014 compared to $266.4 million for the same period in 2013. The Bank has been competing less aggressively for time deposits in its local market area and focusing instead on core deposits, or non time deposits.

Interest expense on FHLB advances and other borrowings decreased $237,000 or 27.7% to $617,000 during the three months ended September 30, 2014 from $854,000 for the same period in 2013. The average balance of FHLB advances and other borrowed money decreased $17.7 million or 18.4% to $77.8 million during the three months ended September 30, 2014 from $95.4 million for the same period in 2013. The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the three months ended September 30, 2014 and 2013.



	Three Months Ended September 30,
	2014			2013
		Average Balance	Yield⁽¹⁾		Average Balance	Yield⁽¹⁾		Decrease In Interest Expense From 2013
Now And Money Market Accounts	$	317,476,865	0.16%	$	325,852,310	0.23%	$	(60,434	)
Statement Savings Accounts		27,095,232	0.10		24,556,885	0.11		(111	)
Certificates Accounts		251,348,542	0.78		266,366,465	0.90		(112,756	)
FHLB Advances And Other Borrowed Money		77,792,528	3.17		95,442,908	3.58		(237,021	)
Junior Subordinated Debentures		5,155,000	1.97		5,155,000	2.01		(511	)
Senior Convertible Debentures		6,084,000	8.00		6,084,000	8.00		—
Total Interest-Bearing Liabilities	$	684,952,167	0.81%	$	723,457,568	0.99%	$	(410,833	)

⁽¹⁾ Annualized

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition and Results of Operations

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 established policies and procedures for evaluating and monitoring the overall credit quality of the loan portfolio and for the 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 homogeneous 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, the Company no longer considers five year historical losses relevant indicators of future losses. As a result management applies 12 to 24 month historical loss ratios to each loan category 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.

Net charge-offs were $465,000 or 0.13% of gross loans during the three months ended September 30, 2014 compared to $958,000 or 0.26% of gross loans for the same three month period in 2013. There was no provision for loan losses for the quarter ended September 30, 2014 compared to $600,000 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 September 30, 2014 and 2013:



		Three Months Ended September 30,
		2014			2013
Beginning Balance	$	9,112,157		$	11,007,279
Provision		—			600,000
Charge-offs		(590,942)			(1,002,990)
Recoveries		125,759			45,042
Ending Balance	$	8,646,974		$	10,649,331

Allowance For Loan Losses As A Percentage Of Gross Loans Receivable, Held For Investment At The End Of The Period		2.4	%		2.8	%
Allowance For Loan Losses As A Percentage Of Impaired Loans At The End Of The Period		41.5	%		31.6	%
Impaired Loans	$	20,828,179		$	34,527,535
Gross Loans Receivable, Held For Investment And Held For Sale	$	355,208,453		$	378,121,468
Total Loans Receivable, Net	$	344,114,867		$	364,923,095

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition and Results of Operations

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 need to acquire these properties through foreclosure or other means and subsequently sell, develop or liquidate them.

Non-Interest Income - Non-interest income decreased $252,000 or 14.5% to $1.5 million for the three months ended September 30, 2014, compared to $1.7 million for the three months ended September 30, 2013. The following table provides a detailed analysis of the changes in the components of non-interest income:



	Three Months Ended September 30,				Increase (Decrease)
		2014		2013		Amounts		Percent
Gain On Sale Of Investments	$	142,816	$	419,360	$	(276,544)		(65.9)%
Gain On Sale Of Loans		119,041		227,332		(108,291	)	(47.6)
Service Fees On Deposit Accounts		300,920		303,350		(2,430	)	(0.8)
Commissions From Insurance Agency		116,894		103,330		13,564		13.1
Income From Cash Value Of Life Insurance		75,000		78,000		(3,000	)	(3.8)
Trust Income		158,000		135,000		23,000		17.0
Check Card Fee Income		229,542		222,252		7,290		3.3
CDFI Financial Award Income		183,789		97,000		86,789		89.5
Other		160,304		152,467		7,837		5.1
Total Non-Interest Income	$	1,486,306	$	1,738,091	$	(251,785)		(14.5)%

The gain on sale of investments was $143,000 during the quarter ended September 30, 2014, a decrease of $277,000 or 65.9% compared to $419,000 for the same period last year. The gain resulted from the sale of 20 investments during the quarter ended September 30, 2014 compared to 10 investments during the same period in 2013. Management elected to sell a portion of the Bank's investments that were anticipated to perform poorly when interest rates increase. These investments were replaced with alternative investments that perform better in a rising interest rate environment. Gain on sale of loans decreased $108,000 or 47.6% to $119,000 for the three months ended September 30, 2014 from $227,000 three months ended September 30, 2013 as the number of mortgage refinances are at a record low.

CDFI financial award income increased $87,000 or 89.5% to $184,000 during the three months ended September 30, 2014, compared to $97,000 for the same period in 2013. In 2012, the Bank received a Community Development Financial Assistance ("CDFA") award in recognition of its commitment to community development. The Bank used the CDFA award to fund a new Small Business Microloan program which provides small, short-term loans to small businesses. These microloans help boost the local economy by enabling small businesses to obtain credit not otherwise available to them. The Bank received a total award of $1.5 million to be recognized on a pro-rata basis as the microloans are funded. At September 30, 2014, the Bank had $243,000 in microloans left to be funded.

General And Administrative Expenses –For the quarter ended September 30, 2014, non-interest expense decreased $642,000 or 11.3% to $5.0 million compared to $5.7 million for the same period in 2013. The decrease in non-interest expense was primarily a result of a decrease in the prepayment penalties on FHLB advances and net cost of operation of other real estate owned. The following table provides a detailed analysis of the changes in the components of general and administrative expenses:

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition and Results of Operations



	Three Months Ended September 30,					Increase (Decrease)
		2014			2013		Amounts		Percent
Compensation And Employee Benefits	$	2,781,418		$	2,677,608	$	103,810		3.9%
Occupancy		515,881			484,857		31,024		6.4
Advertising		115,268			79,130		36,138		45.7
Depreciation And Maintenance Of Equipment		408,685			412,020		(3,335	)	(0.8)
FDIC Insurance Premiums		177,537			191,535		(13,998	)	(7.3)
Amortization Of Intangibles		—			12,501		(12,501	)	(100.0)
Net (Profit) Cost Of Operation Of Other Real Estate Owned		(71,623	)		506,174		(577,797	)	(114.1)
Prepayment Penalties On FHLB Advances		—			191,181		(191,181	)	(100.0)
Other		1,095,710			1,109,892		(14,182	)	(1.3)
Total General And Administrative Expenses	$	5,022,876		$	5,664,898	$	(642,022	)	(11.3)%

Compensation and employee benefits expenses increased $104,000, or 3.9% to $2.8 million for the three months ended September 30, 2014 compared to $2.7 million for the same period last year. The Company recognized $75,000 in accrued bonuses during the three months ended September 30, 2014 related to a new incentive compensation plan offered to employees during the year. Occupancy expense increased $31,000 or 6.4% to $516,000 for the three months ended September 30, 2014 compared to $485,000 for the three months ended September 30, 2013. Advertising expense increased $36,000 or 45.7% during the same period.

Net profit of operation of other real estate owned decreased $578,000 or 114.1% to $72,000 during the quarter ended September 30, 2014 from net cost of $506,000 during the quarter ended September 30, 2013. This amount includes all expenses associated with other real estate owned including write-down in value and gain or loss on sales incurred during the period. For the three months ended September 30, 2014, the Bank had no write-downs on other real estate owned compared to write-downs on other real estate owned of $550,000 during the three months ended September 30, 2013.

The Company did not prepay any FHLB advances during the three months ended September 30, 2014 compared to the prepayment penalty of $191,000 incurred for paying down FHLB advances during the three months ended September 30, 2013. During 2013, the Company elected to prepay these higher rate advances to lower cost of funds.

Provision For Income Taxes – The provision for income taxes increased $395,000 or 109.6% to $756,000 for the three months ended September 30, 2014 from $361,000 for the same period one year ago. Income before income taxes was $2.5 million and $1.4 million for the three months ended September 30, 2014 and 2013, respectively. The Company’s combined federal and state effective income tax rate for the current quarter was 30.6% compared to 26.1% for the same quarter one year ago.

Results of Operations for the Nine Month Periods Ended September 30, 2014 and 2013

Net Income Available to Common Shareholders - Net income available to common shareholders increased $1.9 million or 85.6% to $4.2 million for the nine months ended September 30, 2014 compared to $2.2 million for the nine months ended September 30, 2013. The increase in net income was primarily the result of an increase of $556,000 in net interest income combined with a decrease of $2.4 million in the provision for loan losses. These factors were offset partially by a decrease of $1.1 million in non-interest income.

Net Interest Income - The net interest margin increased 17 basis points to 3.07% for the nine months ended September 30, 2014 from 2.90% for the comparable period in 2013. As a result, net interest income increased $556,000 or 3.2% to $17.8 million during the nine months ended September 30, 2014, compared to $17.2 million for the same period in 2013. During the nine months ended September 30, 2014, average interest earning assets decreased $22.9 million or 2.8% to $789.1 million while average interest-bearing liabilities decreased $35.7 million or 4.8% to $700.1 million from $735.8 million for the nine months ended September 30, 2013.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition and Results of Operations

Interest Income - Total interest income decreased $870,000 or 3.8% to $22.2 million during the nine months ended September 30, 2014 from $23.1 million for the same period in 2013. This decrease is the result of the decrease in interest-earning assets and a slight decrease in yield. Total interest income on loans decreased $1.8 million or 11.2% to $14.6 million during the nine months ended September 30, 2014 from $16.5 million for the same period in 2013 as a result of the average loan portfolio balance decreasing $28.4 million or 7.4% to $353.0 million from $381.4 million for the same period in 2013 and the yield on the loan portfolio decreasing 23 basis points to 5.53%. Interest income from mortgage-backed securities increased $625,000 or 15.9% to $4.6 million as a result of a 29 basis point increase in the portfolio yield combined with a $4.1 million or 1.6% increase in the average balance. Tax equivalent interest income from investment securities increased $292,000 or 9.4% to $3.4 million as a result of an increase of 66 basis points in the yield combined with an increase of $4.2 million or 2.3% in the average balance of the investment securities portfolio.

The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the nine months ended September 30, 2014 and 2013:



	Nine Months Ended September 30,
	2014				2013
		Average Balance	Yield⁽¹⁾			Average Balance	Yield⁽¹⁾			Increase (Decrease) In Interest And Dividend Income From 2013
Loans Receivable, Net	$	352,966,633	5.53	%	$	381,399,510	5.76	%	$	(1,848,525)
Mortgage-Backed Securities		251,245,215	2.42			247,102,910	2.13			625,003
Investment Securities⁽²⁾		182,051,212	2.47			177,810,780	2.31			291,905
Overnight Time And Certificates Of Deposit		2,882,492	0.39			5,741,907	0.15			2,108
Total Interest-Earning Assets	$	789,145,552	3.82	%	$	812,055,107	3.86	%	$	(929,509)

⁽¹⁾ Annualized

⁽²⁾ Tax equivalent basis is calculated using an effective tax rate of 34% and was $372,247 and $431,429 for the nine

months ended September 30, 2014 and 2013, respectively.

Interest Expense - Total interest expense decreased $1.4 million or 24.3% to $4.4 million during the nine months ended September 30, 2014 compared to $5.9 million for the same period last year. The decrease in total interest expense is attributable to decreases in interest rates paid and a $35.7 million decrease in the average balance of interest-bearing liabilities. Interest expense on deposits decreased $721,000 or 26.9% to $2.0 million during the nine months ended September 30, 2014 compared to $2.7 million for the same period last year. The decrease was attributable to a 16 basis point decrease in the cost of deposit accounts combined with a $15.3 million decrease in average interest-bearing deposits to $604.7 million for the nine month period ended September 30, 2014 when compared to $620.0 million for the nine month period ended September 30, 2013. The decrease was concentrated in the certificate accounts, which decreased $17.6 million or 6.4% to $257.0 million during the nine months ended September 30, 2014 compared to the same period in 2013. Interest expense on FHLB advances and other borrowings decreased $704,000 or 25.6% to $2.0 million during the nine months ended September 30, 2014. The average balance of FHLB advances and other borrowed money decreased $20.4 million or 19.4% to $84.2 million during the nine months ended September 30, 2014 from $104.6 million for the same period last year.

The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the nine months ended September 30, 2014 and 2013:

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition and Results of Operations



	Nine Months Ended September 30,
	2014				2013
		Average Balance	Yield⁽¹⁾			Average Balance	Yield⁽¹⁾			Decrease In Interest Expense From 2013
Now And Money Market Accounts	$	321,526,411	0.18%		$	321,456,199	0.26%		$	(194,757	)
Statement Savings Accounts		26,162,629	0.10			23,966,047	0.15			(8,183	)
Certificates Accounts		257,008,845	0.78			274,567,650	0.98			(517,667	)
FHLB Advances And Other Borrowed Money		84,183,061	3.25			104,555,567	3.58			(703,620	)
Junior Subordinated Debentures		5,155,000	1.96			5,155,000	2.01			(1,906	)
Senior Convertible Debentures		6,084,000	8.00			6,084,000	8.00			—
Total Interest-Bearing Liabilities	$	700,119,946	0.85	%	$	735,784,463	1.06	%	$	(1,426,133	)

⁽¹⁾ Annualized

Provision for Loan Losses - The provision for loan losses was $200,000 for the nine months ended September 30, 2014 compared to $2.6 million for the same period in the prior year. The decrease in the provision for loan losses is attributable to a decline in net charge offs. Net charge offs for the nine months ended September 30, 2014 declined $1.5 million or 45.8% to $1.8 million from $3.3 million during the comparable period in 2013.

The following table details selected activity associated with the allowance for loan losses for the nine months ended September 30, 2014 and 2013:



		Nine Months Ended September 30,
		2014		2013
Beginning Balance	$	10,241,970	$	11,318,371
Provision		200,000		2,645,381
Charge-offs		(2,384,994)		(3,470,300)
Recoveries		589,998		155,879
Ending Balance	$	8,646,974	$	10,649,331

Non-Interest Income - Non-interest income decreased $1.1 million or 19.7% to $4.4 million for the nine months ended September 30, 2014, compared to $5.4 million for the nine months ended September 30, 2013. The following table provides a detailed analysis of the changes in the components of non-interest income:

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition and Results of Operations



	Nine Months Ended September 30,				Increase (Decrease)
		2014		2013		Amounts		Percent
Gain On Sale Of Investments	$	187,687	$	1,173,140	$	(985,453)		(84.0)%
Gain On Sale Of Loans		465,571		622,960		(157,389	)	(25.3)
Service Fees On Deposit Accounts		861,476		845,444		16,032		1.9
Income From Cash Value Of Life Insurance		479,364		261,000		218,364		83.7
Commissions From Insurance Agency		317,757		348,292		(30,535	)	(8.8)
Trust Income		404,000		405,000		(1,000	)	(0.2)
Check Card Fee Income		674,098		640,374		33,724		5.3
CDFI Financial Award Income		483,499		733,071		(249,572	)	(34.0)
Other		481,191		396,695		84,496		21.3
Total Non-Interest Income	$	4,354,643	$	5,425,976	$	(1,071,333)		(19.7)%

Gain on sale of investments was $188,000 during the nine months ended September 30, 2014 a decrease of $985,000 or 84.0% compared to $1.2 million during the same period last year. The gain resulted from the sale of 41 investments during the period compared to 22 in the comparable period of 2013. Management elected to sell a portion of the Bank's investments that were anticipated to perform poorly when interest rates increase. These investments were replaced with investments that perform better in a rising interest rate environment.

Gain on sale of loans decreased $157,000 or 25.3% to $466,000 for the nine months ended September 30, 2014 compared to $623,000 for the same period last year. Mortgage refinances have been significantly reduced as a result of the prolonged period of historically low interest rates.

Income from the cash value of life insurance increased $218,000 or 83.7% to $479,000 for the nine months ended September 30, 2014 compared to $261,000 for the same period in 2013. The Bank recognized $254,000 in death benefits in 2014 in addition to $225,000 in income related to changes in the cash surrender value of the bank owned life insurance policies.

CDFI financial award income decreased $250,000 or 34.0% to $483,000 during the nine months ended September 30, 2014 compared to $733,000 for the same period in 2013. The Bank received a CDFA award in 2013 in recognition of its commitment to community development. The CDFA award totaled $1.5 million, of which $243,000 in income remains to be recognized as the microloans are funded.

General And Administrative Expenses – For the nine months ended September 30, 2014, non-interest expense decreased $903,000 or 5.5% to $15.7 million compared to $16.6 million for the same period in 2013. The decrease in non-interest expense is primarily a result of a decrease in the net cost of operation of other real estate owned and prepayment penalties on FHLB advances during the nine months ended September 30, 2014 offset partially by an increase in compensation and employee benefits and advertising expenses. The following table provides a detailed analysis of the changes in the components of general and administrative expenses:

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition and Results of Operations



	Nine Months Ended September 30,				Increase (Decrease)
		2014		2013		Amounts		Percent
Compensation And Employee Benefits	$	8,464,967	$	8,267,433	$	197,534		2.4%
Occupancy		1,491,633		1,447,835		43,798		3.0
Advertising Expense		358,527		256,861		101,666		39.6
Depreciation And Maintenance Of Equipment		1,219,461		1,220,952		(1,491	)	(0.1)
FDIC Insurance Premiums		541,779		555,733		(13,954	)	(2.5)
Amortization Of Intangibles		11,970		37,503		(25,533	)	(68.1)
Net Cost Of Operation Of Other Real Estate Owned		451,947		1,243,935		(791,988	)	(63.7)
Prepayment Penalties On FHLB Advances		—		429,523		(429,523	)	(100.0)
Other		3,125,894		3,109,619		16,275		0.5
Total General And Administrative Expenses	$	15,666,178	$	16,569,394	$	(903,216	)	(5.5)%

Net cost of operation of other real estate owned decreased $792,000 or 63.7% to $452,000 for the nine months ended September 30, 2014 from $1.2 million during the nine months ended September 30, 2013. For the nine months ended September 30, 2013, the Bank had $1.1 million in write downs on other real estate owned compared to $405,000 for the nine months ended September 30, 2014.

The Company did not prepay any FHLB advances during the nine months ended September 30, 2014, compared to a prepayment penalty of $430,000 for paying down FHLB advances during the nine months ended September 30, 2013. As part of the Company's strategy during 2013, management elected to replace some higher rate advances with lower rate callable certificates of deposit.

Compensation and employee benefits expenses were at $8.5 million for the nine months ended September 30, 2014, increasing $198,000 or 2.4% from $8.3 million during the same period last year. The Company recognized $175,000 in accrued bonuses during the nine months ended September 30, 2014 related to a new incentive compensation plan offered to employees during the year compared to none in 2013. Advertising expense increased $102,000 or 39.6% to $359,000 for the nine months ended September 30, 2014 compared to $257,000 for the nine months ended September 30, 2013.

Provision For Income Taxes – The provision for income taxes increased $915,000 or 106.3% to $1.8 million for the nine months ended September 30, 2014 from $860,000 for the same period one year ago. Income before income taxes was $6.3 million and $3.4 million for the nine months ended September 30, 2014 and 2013, respectively. The Company’s combined federal and state effective income tax rate for the nine months ended September 30, 2014 was 28.3% compared to 25.0% for the same period in 2013.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management's Discussion and Analysis of Financial Condition and Results of Operations

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 nine months ended September 30, 2014 loan repayments exceeded loan disbursements resulting in a $14.8 million or 4.1% decrease in total net loans receivable. During the nine months ended September 30, 2014, deposits decreased $12.2 million and FHLB advances decreased $19.4 million. The Bank had $184.9 million in additional borrowing capacity at the FHLB at the end of the period. At September 30, 2014, the Bank had $138.5 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 September 30, 2014, 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 23.6%, 22.3% and 10.3%, 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 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 September 30, 2014.



(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	$	2,100	$	1,322	$	15,854	$	19,276	$	29,162	$	48,438
Standby Letters Of Credit	134		110		550		794		33		827
Total	$	2,234	$	1,432	$	16,404	$	20,070	$	29,195	$	49,265

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

The Company’s profitability is affected by fluctuations in the market interest rate. Management’s goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase or decrease in interest rates may adversely impact the Company’s earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same rate, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using a test that measures the impact on net interest income and net portfolio value of an immediate change in interest rates in 100 basis point increments and by measuring the Bank’s interest sensitivity gap (“Gap”). Net portfolio value is defined as the net present value of assets, liabilities, and off-balance sheet contracts. Gap is the amount of interest sensitive assets repricing or maturing over the next twelve months compared to the amount of interest sensitive liabilities maturing or repricing in the same time period.

For the three and nine months ended September 30, 2014, 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 3.05% and 2.97% respectively.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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 September 30, 2014 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 quarter ended September 30, 2014 that have materially affected or are reasonably likely to affect our internal controls over financial reporting.

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

Part II: Other Information

Item 1 Legal Proceedings

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

Item 1A Risk Factors

There have been no material changes in the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES


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 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 September 30, 2014, 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; (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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES


(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.


(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.

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:	November 12, 2014	By:	J. Chris Verenes
				J. Chris Verenes
				Chief Executive Officer
				Duly Authorized Representative



Date:	November 12, 2014	By:	Jessica T. Cummins
				Jessica T. Cummins
				Chief Financial Officer
				Duly Authorized Representative

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

EXHIBIT INDEX


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


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


32	Certifications 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 September 30, 2014, 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; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements