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

OUTSTANDING SHARES AT:

Common Stock, par value $0.01 per share

May 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 MARCH 31, 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 (Unaudited):	3
	Consolidated Balance Sheets at March 31, 2014 and December 31, 2013	3
	Consolidated Statements of Income for the Three Months Ended March 31, 2014 and 2013	4
	Consolidated Statements of Comprehensive Income (Loss) for the Three Months Ended March 31, 2014 and 2013	5
	Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2014 and 2013	6
	Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2014 and 2013	7
	Notes to Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	41
Item 4.	Controls and Procedures	42

PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	42
Item 1A.	Risk Factors	42
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 3.	Defaults Upon Senior Securities	42
Item 4.	Mine Safety Disclosures	42
Item 5.	Other Information	42
Item 6.	Exhibits	42
	Signatures	45

SCHEDULES OMITTED

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Part 1. Financial Information

Item 1. Financial Statements

Consolidated Balance Sheets



	March 31, 2014			December 31, 2013
ASSETS:	Unaudited			Audited
Cash And Cash Equivalents	$	8,145,145		$	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 $432,951,620 And $430,241,854 At March 31, 2014 And December 31, 2013, Respectively)	436,445,047			431,003,452
Loans Receivable, Net:
Held For Sale	2,909,734			1,234,158
Held For Investment: (Net Of Allowance Of $9,845,755 and $10,241,970 At March 31, 2014 And December 31, 2013, Respectively)	352,071,562			357,682,507
Total Loans Receivable, Net	354,981,296			358,916,665
Accrued Interest Receivable:
Loans	981,297			1,031,747
Mortgage-Backed Securities	733,103			732,100
Investment Securities	1,271,151			1,393,156
Total Accrued Interest Receivable	2,985,551			3,157,003
Premises And Equipment, Net	17,084,972			17,243,390
Federal Home Loan Bank ("FHLB") Stock, At Cost	4,152,000			5,016,600
Repossessed Assets Acquired In Settlement Of Loans	4,520,886			3,947,226
Bank Owned Life Insurance	11,195,717			11,474,305
Intangible Assets, Net	—			11,970
Goodwill	1,199,754			1,199,754
Other Assets	5,974,483			7,547,528
Total Assets	$	848,779,851		$	849,248,059
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Liabilities:
Deposit Accounts	$	667,083,545		$	658,696,772
Advances From FHLB	75,285,723			87,740,058
Other Borrowings	9,266,388			8,002,739
Junior Subordinated Debentures	5,155,000			5,155,000
Advance Payments By Borrowers For Taxes And Insurance	346,063			255,364
Senior Convertible Debentures	6,084,000			6,084,000
Other Liabilities	4,913,966			5,324,046
Total Liabilities	768,134,685			771,257,979
Shareholders' Equity:
Serial Preferred Stock, $.01 Par Value; Authorized 200,000 Shares; Issued And Outstanding, 22,000 Shares At March 31, 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 March 31, 2014 And At December 31, 2013, Respectively	31,449			31,449
Additional Paid-In Capital	11,981,306			11,978,137
Treasury Stock, At Cost (200,933 Shares At March 31, 2014 And December 31, 2013, Respectively)	(4,330,712		)	(4,330,712		)
Accumulated Other Comprehensive Income	2,167,323			472,406
Retained Earnings	48,795,800			47,838,800
Total Shareholders' Equity	80,645,166			77,990,080
Total Liabilities And Shareholders' Equity	$	848,779,851		$	849,248,059

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)



	Three Months Ended March 31,
	2014		2013
Interest Income:
Loans	$	4,863,488	$	5,584,886
Mortgage-Backed Securities	1,389,118		1,361,176
Investment Securities	937,301		755,871
Other	3,568		2,336
Total Interest Income	7,193,475		7,704,269
Interest Expense:
NOW And Money Market Accounts	180,759		232,088
Statement Savings Accounts	6,127		11,064
Certificate Accounts	508,795		739,875
FHLB Advances And Other Borrowed Money	707,715		983,105
Senior Convertible Debentures	121,680		121,680
Junior Subordinated Debentures	25,015		25,810
Total Interest Expense	1,550,091		2,113,622
Net Interest Income	5,643,384		5,590,647
Provision For Loan Losses	100,000		1,145,381
Net Interest Income After Provision For Loan Losses	5,543,384		4,445,266
Non-Interest Income:
Gain On Sale Of Investment Securities	84,356		384,051
Gain On Sale Of Loans	128,242		184,788
Service Fees On Deposit Accounts	276,485		263,831
Commissions From Insurance Agency	91,634		140,313
Trust Income	105,000		135,000
Bank Owned Life Insurance Income	205,827		105,000
Check Card Fee Income	210,695		195,193
Community Development Financial Institution ("CDFI") Financial Award Income	281,960		416,071
Other	152,200		120,735
Total Non-Interest Income	1,536,399		1,944,982
Non-Interest Expense:
Compensation And Employee Benefits	2,847,002		2,821,375
Occupancy	500,916		475,314
Advertising	100,396		107,643
Depreciation And Maintenance Of Equipment	417,506		439,172
Federal Deposit Insurance Corporation ("FDIC") Insurance Premiums	185,457		167,722
Amortization Of Intangibles	11,970		12,501
Net Cost Of Operation Of Other Real Estate Owned	269,096		396,369
Prepayment Penalties on FHLB Advances	—		153,253
Other	994,336		939,535
Total General And Administrative Expenses	5,326,679		5,512,884
Income Before Income Taxes	1,753,104		877,364
Provision For Income Taxes	450,584		205,995
Net Income	1,302,520		671,369
Preferred Stock Dividends	110,000		110,000
Net Income Available To Common Shareholders	$	1,192,520	$	561,369
Net Income Per Common Share (Basic)	$	0.41	$	0.19
Net Income Per Common Share (Diluted)	$	0.39	$	0.19
Cash Dividend Per Share On Common Stock	$	0.08	$	0.08
Weighted Average Shares Outstanding (Basic)	2,944,001		2,944,001
Weighted Average Shares Outstanding (Diluted)	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 March 31,
	2014			2013
Net Income	$	1,302,520		$	671,369
Other Comprehensive Income (Loss)
Unrealized Gains (Losses) On Securities:
Unrealized Holding Gains (Losses) On Securities Available For Sale, Net Of Taxes Of $1,068,967 And $558,694 At March 31, 2014 And 2013, Respectively	1,747,218			(911,573		)
Reclassification Adjustment For Gains Included In Net Income, Net Of Taxes Of $32,055 And $145,939 At March 31, 2014 And 2013, Respectively	(52,301		)	(238,112		)
Other Comprehensive Income (Loss)	1,694,917			(1,149,685		)
Comprehensive Income (Loss)	$	2,997,437		$	(478,316	)

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity (Unaudited)

For the Three Months Ended March 31, 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	—		—		—		—			—			—			671,369			671,369
Other Comprehensive Loss, Net Of Tax	—		—		—		—			—			(1,149,685		)	—			(1,149,685		)
Stock Option Compensation Expense	—		—		—		(12,089		)	—			—			—			(12,089		)
Cash Dividends On Preferred	—		—		—		—			—			—			(110,000		)	(110,000		)
Cash Dividends On Common	—		—		—		—			—			—			(235,520		)	(235,520		)
Balance at March 31, 2013	$	22,000,000	$	400,000	$	31,449	$	11,618,628		$	(4,330,712	)	$	6,281,625		$	45,755,569		$	81,756,559



	Preferred Stock		Warrants		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	—		—		—		—		—			—		1,302,520			1,302,520
Other Comprehensive Income, Net Of Tax	—		—		—		—		—			1,694,917		—			1,694,917
Stock Option Compensation Expense	—		—		—		3,169		—			—		—			3,169
Cash Dividends On Preferred	—		—		—		—		—			—		(110,000		)	(110,000		)
Cash Dividends On Common	—		—		—		—		—			—		(235,520		)	(235,520		)
Balance at March 31, 2014	$	22,000,000	$	—	$	31,449	$	11,981,306	$	(4,330,712	)	$	2,167,323	$	48,795,800		$	80,645,166

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)



	Three Months Ended March 31,
	2014			2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	1,302,520		$	671,369
Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities:
Depreciation Expense	298,464			342,063
Amortization Of Intangible Assets	11,970			12,501
Stock Option Compensation Expense	3,169			(12,089		)
Discount Accretion And Premium Amortization	1,564,137			1,889,488
Provisions For Losses On Loans	100,000			1,145,381
Income From Bank Owned Life Insurance	(205,827		)	(105,000		)
Gain On Sales Of Loans	(128,242		)	(184,788		)
Gain On Sales Of Mortgage-Backed Securities	(254,538		)	(384,051		)
Loss On Sales Of Investment Securities	170,182			—
(Gain) Loss On Sale Of Real Estate Owned	(41,845		)	501
Write Down On Real Estate Owned	205,000			264,378
Amortization Of Deferred Fees On Loans	6,583			(3,369		)
Proceeds From Sale Of Loans Held For Sale	3,808,798			9,596,054
Origination Of Loans Held For Sale	(5,356,132		)	(6,902,708		)
(Increase) Decrease In Accrued Interest Receivable:
Loans	50,450			71,882
Mortgage-Backed Securities	(1,003		)	84,055
Investment Securities	122,005			(41,215		)
Increase In Advance Payments By Borrowers	90,699			173,441
Other, Net	131,449			127,215
Net Cash Provided By Operating Activities	1,877,839			6,745,108

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase Of Mortgage-Backed Securities Available For Sale	(25,481,066		)	(23,258,838		)
Principal Repayments On Mortgage-Backed Securities Available For Sale	7,413,707			15,733,179
Principal Repayments On Mortgage-Backed Securities Held To Maturity	—			367,737
Purchase Of Investment Securities Available For Sale	(5,971,321		)	(21,368,984		)
Maturities Of Investment Securities Available For Sale	5,914,950			4,322,231
Purchase of Investment Securities Held To Maturity	—			(1,000,000		)
Maturities Of Investment Securities Held To Maturity	—			2,288,499
Proceeds From Sale of Investment Securities Available For Sale	5,132,069			—
Proceeds From Sale of Mortgage-Backed Securities Available For Sale	8,802,113			20,946,735
Purchase Of FHLB Stock	(2,021,200		)	(445,500		)
Redemption Of FHLB Stock	2,885,800			1,400,906
Proceeds From Bank Owned Life Insurance	484,415			—
Decrease In Loans Receivable	4,611,602			8,759,426
Proceeds From Sale Of Repossessed Assets	155,945			2,276,298
Purchase And Improvement Of Premises And Equipment	(140,046		)	(106,829		)
Net Cash Provided By Investing Activities	1,786,968			9,914,860

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES



	Three months Ended March 31,
	2014			2013
	Continued
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (Decrease) In Deposit Accounts	$	8,386,773		$	(1,812,188	)
Proceeds From FHLB Advances	46,630,000			13,900,000
Repayment Of FHLB Advances	(59,084,335		)	(26,004,249		)
Increase in Other Borrowings, Net	1,263,649			88,925
Dividends To Preferred Stock Shareholders	(110,000		)	(110,000		)
Dividends To Common Stock Shareholders	(235,520		)	(235,520		)
Net Cash Used By Financing Activities	(3,149,433		)	(14,173,032		)
Net Increase In Cash And Cash Equivalents	515,374			2,486,936
Cash And Cash Equivalents At Beginning Of Period	7,629,771			7,903,950
Cash And Cash Equivalents At End Of Period	$	8,145,145		$	10,390,886
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Paid During The Period For:
Interest	$	1,497,977		$	2,096,095
Income Taxes	$	24,100		$	10,419
Supplemental Schedule Of Non Cash Transactions:
Transfers From Loans Receivable To Other Real Estate Owned	$	892,760		$	2,278,659

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 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 month period ended March 31, 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 March 31,
	2014		2013
Earnings Available To Common Shareholders:
Net Income		$1,302,520		$671,369
Preferred Stock Dividends	110,000		110,000
Net Income Available To Common Shareholders		$1,192,520		$561,369

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 period indicated:



	For the Three Months Ended March 31, 2014
	Income		Shares	Per Share Amounts
Basic EPS		$1,192,520	2,944,001		$0.41
Effect of Dilutive Securities:
Senior Convertible Debentures	75,422		304,200	(0.02)
Diluted EPS		$1,267,942	3,248,201		$0.39

There were no dilutive securities or options for the three months ended March 31, 2013, therefore no reconciliation is provided for this period.

5. Stock-Based Compensation

Certain officers and directors of the Company participate in an incentive and non-qualified stock option plan. Options are granted at exercise prices not less than the fair value of the Company’s common stock on the date of the grant. The following is a summary of the activity under the Company’s stock option plans for the periods presented:



	Three Months Ended March 31,
	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	(11,000	)	22.44	—	—
Balance, End Of Period	50,500		$22.49	68,400	$22.63

Options Exercisable	34,100			46,600

Options Available For Grant	50,000			50,000

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

5. Stock-Based Compensation, Continued

At March 31, 2014, the Company had the following options outstanding:




Grant Date	Outstanding Options	Option Price	Expiration Date

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

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	14,000	$23.49	01/01/18

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

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

None of the options outstanding at March 31, 2014 or 2013 had an exercise price below the average market price during the three month periods ended March 31, 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:



	March 31, 2014
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
FHLB Securities	$	13,403,194	$	23,825	$	656,960	$	12,770,059
Federal Farm Credit Bank ("FFCB") Securities	5,750,000		—		275,010		5,474,990
Fannie Mae ("FNMA") And Freddie Mac ("FHLMC") Bonds	1,994,888		—		4,718		1,990,170
Small Business Administration (“SBA”) Bonds	95,294,537		1,795,194		270,243		96,819,488
Tax Exempt Municipal Bonds	61,653,704		935,280		1,502,605		61,086,379
Mortgage-Backed Securities	254,597,359		5,939,411		2,491,309		258,045,461
Equity Securities	257,938		562		—		258,500
	$	432,951,620	$	8,694,272	$	5,200,845	$	436,445,047

	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 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 GNMA mortgage-backed securities, which are also backed by the full faith and credit of the United States government. At March 31, 2014 the Bank held an amortized cost and fair value of $174.2 million and $177.7 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 March 31, 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	$	—	$	—
One – Five Years	10,555,457		10,775,763
Over Five – Ten Years	74,843,233		75,378,283
More Than Ten Years	92,955,571		92,245,540
Mortgage-Backed Securities	254,597,359		258,045,461
	$	432,951,620	$	436,445,047

At March 31, 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 $120.0 million and $122.6 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 $13.9 million and $20.9 million, respectively, in gross proceeds from sales of available for sale securities during the three months ended March 31, 2014 and 2013. As a result, the Bank recognized gross gains of $309,000 and $384,000, respectively, and gross losses of $224,000 and $0, respectively for the three months ended March 31, 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.



	March 31, 2014
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Securities	$	9,457,540	$	470,120	$	1,813,160	$	186,840	$	11,270,700	$	656,960
FFCB Securities	4,522,390		227,610		952,600		47,400		5,474,990		275,010
FNMA And FHLMC Bonds	1,990,170		4,718		—		—		1,990,170		4,718
SBA Bonds	11,881,591		247,459		3,310,277		22,784		15,191,868		270,243
Tax Exempt Municipal Bond	28,504,159		1,130,510		6,303,922		372,095		34,808,081		1,502,605
Mortgage-Backed Securities	83,561,832		2,014,684		11,230,026		476,625		94,791,858		2,491,309
	$	139,917,682	$	4,095,101	$	23,609,985	$	1,105,744	$	163,527,667	$	5,200,845

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 March 31, 2014 and December 31, 2013, 21.3% and 11.4% of the unrealized losses, representing seventeen and eleven individual securities, respectively, 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 in an effort 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 it has tainted its held to maturity classification and judgment will be required in the future in determining when circumstances have changed such that management can assert with a great degree of credibility that it has the intent and ability to hold debt securities to maturity. Based on this guidance, the Company does not expect to classify any securities as held to maturity within the near future.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9. Loans Receivable, Net

Loans receivable, net, consisted of the following as of the dates shown:




	March 31, 2014		December 31, 2013
Residential Real Estate Loans	$	79,352,237	$	83,004,482
Consumer Loans	51,681,511		52,205,901
Commercial Business	8,982,884		7,775,098
Commercial Real Estate	223,946,101		228,399,555
Total Loans Held For Investment	363,962,733		371,385,036
Loans Held For Sale	2,909,734		1,234,158
Total Loans Receivable, Gross	366,872,467		372,619,194
Less:
Allowance For Loan Losses	9,845,755		10,241,970
Loans In Process	2,030,733		3,465,072
Deferred Loan Fees (Costs)	14,683		(4,513		)
	11,891,171		13,702,529
Total Loans Receivable, Net	$	354,981,296	$	358,916,665

Changes in the allowance for loan losses for the three months ended March 31, 2014 and 2013 are summarized as follows:



	Three Months Ended March 31,
	2014			2013
Balance At Beginning Of Period	$	10,241,970		$	11,318,371
Provision For Loan Losses	100,000			1,145,381
Charge Offs	(777,575		)	(1,385,460		)
Recoveries	281,360			26,934
Total Allowance For Loan Losses	$	9,845,755		$	11,105,226

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
March 31, 2014	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	71,352,992	$	1,370,589	$	400,455	$	6,228,201	$	79,352,237
Consumer	49,889,585		1,083,313		141,451		567,162		51,681,511
Commercial Business	7,847,583		410,369		59,526		665,406		8,982,884
Commercial Real Estate	132,015,857		38,442,618		34,424,437		19,063,189		223,946,101
Total	$	261,106,017	$	41,306,889	$	35,025,869	$	26,523,958	$	363,962,733



	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 March 31, 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	$	1,417,622	$	148,800	$	4,505,186	$	6,071,608	$	73,280,629	$	79,352,237
Consumer	1,152,159		30,135		464,889		1,647,183		50,034,328		51,681,511
Commercial Business	362,929		16,235		758,886		1,138,050		7,844,834		8,982,884
Commercial Real Estate	7,322,047		1,939,721		5,085,637		14,347,405		209,598,696		223,946,101
Total	$	10,254,757	$	2,134,891	$	10,814,598	$	23,204,246	$	340,758,487	$	363,962,733

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 March 31, 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 March 31, 2014 compared to December 31, 2013:



	At March 31, 2014				At December 31, 2013				$			%
	Amount		Percent ⁽¹⁾		Amount		Percent ⁽¹⁾		Increase (Decrease)			Increase (Decrease)
Non-accrual Loans:
Residential Real Estate	$	4,505,186	1.24	%	$	4,607,613	1.25	%	$	(102,427	)	(2.2	)%
Commercial Business	758,886		0.21		33,055		0.01		725,831			2,195.8
Commercial Real Estate	5,085,637		1.41		4,972,667		1.35		112,970			2.3
Consumer	464,889		0.13		399,062		0.11		65,827			16.5
Total Non- accrual Loans	$	10,814,598	2.99	%	$	10,012,397	2.72	%	$	802,201		8.0	%

^{(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 March 31, 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	43,506			127,341			(74,961		)	4,114			100,000
Charge-Offs	(82,472		)	(194,449		)	—			(500,654		)	(777,575		)
Recoveries	479			23,199			17,684			239,998			281,360
Ending Balance	$	1,668,156		$	803,868		$	369,381		$	7,004,350		$	9,845,755



	For the Three Months Ended March 31, 2013
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,521,559		$	1,001,271		$	618,919		$	8,176,622		$	11,318,371
Provision	99,571			(81,813		)	(77,066		)	1,204,689			1,145,381
Charge-Offs	(29,246		)	(19,576		)	(4,436		)	(1,332,202		)	(1,385,460		)
Recoveries	—			8,511			5,486			12,937			26,934
Ending Balance	$	1,591,884		$	908,393		$	542,903		$	8,062,046		$	11,105,226

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 the allowance for loan losses:



	Allowance For Loan Losses
March 31, 2014	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	156,067	$	1,512,089	$	1,668,156
Consumer	2,600		801,268		803,868
Commercial Business	17,900		351,481		369,381
Commercial Real Estate	711,700		6,292,650		7,004,350
Total	$	888,267	$	8,957,488	$	9,845,755



	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

The following tables present information related to impaired loans evaluated individually for impairment and collectively evaluated for impairment in loans receivable for the periods indicated:



	Loans Receivable
March 31, 2014	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	5,422,317	$	73,929,920	$	79,352,237
Consumer	326,563		51,354,948		51,681,511
Commercial Business	498,039		8,484,845		8,982,884
Commercial Real Estate	23,581,275		200,364,826		223,946,101
Total	$	29,828,194	$	334,134,539	$	363,962,733



	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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9. Loans Receivable, Net, Continued

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 $30.2 million for three months ended March 31, 2014 compared to $38.5 million for the three months ended March 31, 2013.

The following tables are a summary of information related to impaired loans as of March 31, 2014 and December 31, 2013 and for the three months ended March 31, 2014 and 2013.



			At				For The Three Months Ended March 31,
	March 31, 2014						2014				2013
Impaired Loans	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Invesment		Interest Income Recognized		Average Recorded Invesment		Interest Income Recognized
With No Related Allowance Recorded:
Residential Real Estate	$	4,438,004	$	5,220,333	$	—	$	4,494,249	$	12,942	$	4,289,656	$	10,686
Consumer Loans	258,423		258,423		—		259,796		88		318,396		1,445
Commercial Business	465,401		465,401		—		465,402		—		34,316		—
Commercial Real Estate	18,850,811		23,633,930		—		19,096,530		157,070		30,937,044		336,089
With An Allowance Recorded:
Residential Real Estate	984,313		984,313		156,067		989,513		—		—		—
Consumer Loans	68,140		68,140		2,600		68,474		1,247		—		—
Commercial Business	32,638		32,638		17,900		32,638		—		—		—
Commercial Real Estate	4,730,464		4,817,264		711,700		4,751,376		47,794		2,970,219		20,743
Total
Residential Real Estate	5,422,317		6,204,646		156,067		5,483,762		12,942		4,289,656		10,686
Consumer Loans	326,563		326,563		2,600		328,270		1,335		318,396		1,445
Commercial Business	498,039		498,039		17,900		498,040		—		34,316		—
Commercial Real Estate	23,581,275		28,451,194		711,700		23,847,906		204,864		33,907,263		356,832
Total	$	29,828,194	$	35,480,442	$	888,267	$	30,157,978	$	219,141	$	38,549,631	$	368,963

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9. Loans Receivable, Net, Continued



	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

In the course of resolving delinquent loans, the Bank may choose to restructure the contractual terms of certain loans. A troubled debt restructuring ("TDR") is a restructuring in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a borrower that it would not otherwise consider (Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 310-40). The concessions granted on TDRs generally include terms to reduce the interest rate, extend the term of the debt obligation, or modify the payment structure on the debt obligation. The Bank grants such concessions to reassess the borrower’s financial status and develop a plan for repayment. TDRs included in impaired loans at March 31, 2014 and December 31, 2013 were $11.7 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).

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9. Loans Receivable, Net, Continued

The following table is a summary of loans restructured as TDRs during the periods indicated:



	For the three months Ended March 31, 2014					For the three months Ended March 31, 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	—	—		—		3	1,321,024		1,321,024
Total	—	$	—	$	—	3	$	1,321,024	$	1,321,024

During the three months ended March 31, 2014, two loans totaling $293,000 that had been previously restructured within the last twelve months defaulted. 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 March 31, 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)
March 31, 2014
SECURITY FEDERAL CORP.
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	71,818	18.4	%	$	15,628	4.0	%	N/A		N/A
Total Risk-Based Capital (To Risk Weighted Assets)	85,337		21.8	%	31,255		8.0	%	N/A		N/A
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	71,818		8.5	%	33,822		4.0	%	N/A		N/A

SECURITY FEDERAL BANK
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	82,352	21.1	%	$	15,617	4.0	%	$	23,426	6.0	%
Total Risk-Based Capital (To Risk Weighted Assets)	87,294		22.4	%	31,234		8.0	%	39,043		10.0	%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	82,352		9.8	%	33,612		4.0	%	42,015		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 March 31, 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. As such, these securities are classified as Level 2.

Mortgage Loans Held for Sale

The Company originates fixed rate residential loans on a servicing released basis in the secondary market. Loans closed but not yet settled with Freddie Mac or other investors, are carried in the Company’s loans held for sale portfolio. These loans are fixed rate residential loans that have been originated in the Company’s name and have closed. Virtually all of these loans have commitments to be purchased by investors and the majority of these loans were locked in by price with the investors on the same day or shortly thereafter that the loan was locked in with the Company’s customers. Therefore, these loans present very little market risk for the Company.

The Company usually delivers to, and receives funding from, the investor within 30 days. Commitments to sell these loans to the investor are considered derivative contracts and are sold to investors on a “best efforts" basis. The Company is not obligated to deliver a loan or pay a penalty if a loan is not delivered to the investor. As a result of the short-term nature of these derivative

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 March 31, 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 March 31, 2014 and December 31, 2013, the recorded investment in impaired loans was $29.8 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 March 31, 2014:



Assets:	Quoted Market Price In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
FHLB Securities	$	—	$	12,770,059	$	—
FFCB Securities	—		5,474,990		—
FNMA And FHLMC Bonds	—		1,990,170		—
SBA Bonds	—		96,819,488		—
Tax Exempt Municipal Bonds	—		61,086,379		—
Mortgage-Backed Securities	—		258,045,461		—
Equity Securities	—		258,500		—
Total	$	—	$	436,445,047	$	—

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 March 31, 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 March 31, 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 March 31, 2014 and December 31, 2013.



Assets:	Level 1		Level 2		Level 3		Balance At March 31, 2014
Mortgage Loans Held For Sale	$	—	$	2,909,734	$	—	$	2,909,734
Collateral Dependent Impaired Loans ⁽¹⁾	—		—		28,939,927		28,939,927
Foreclosed Assets	—		—		4,520,886		4,520,886
Total	$	—	$	2,909,734	$	33,460,813	$	36,370,547

^{(1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF $888,267}



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 March 31, 2014, the significant unobservable inputs used in the fair value measurements were as follows:



	Fair Value			Significant
	March 31		Valuation	Unobservable
	2014		Technique	Inputs	Range
Collateral Dependent Impaired Loans	$	28,939,927	Appraised Value	Discount Rates/ Discounts to Appraised Values	0% - 87%
Foreclosed Assets	4,520,886		Appraised Value/Comparable Sales	Discount Rates/ Discounts to Appraised Values	9% - 98%

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

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

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

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

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

FHLB Stock—The fair value approximates the carrying value.

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

FHLB Advances—Fair value is estimated based on discounted cash flows using current market rates for 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 March 31, 2014 and December 31, 2013 presented in accordance with the applicable accounting guidance.



	March 31, 2014
	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash And Cash Equivalents	$	8,145	$	8,145	$	8,145	$	—	$	—
Certificates Of Deposits With Other Banks	2,095		2,095		—		2,095		—
Investment And Mortgage-Backed Securities	436,445		436,445		—		436,445		—
Loans Receivable, Net	354,981		352,721		—		—		352,721
FHLB Stock	4,152		4,152		4,152		—		—

Financial Liabilities:
Deposits:
Checking, Savings, And Money Market Accounts	$	402,902	$	402,902	$	402,902	$	—	$	—
Certificate Accounts	264,182		264,906		—		264,906		—
Advances From FHLB	75,286		79,606		—		79,606		—
Other Borrowed Money	9,266		9,266		9,266		—		—
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 March 31, 2014, the Bank had $45.0 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 April 2013, the FASB issued guidance addressing application of the liquidation basis of accounting. The guidance is intended to clarify when an entity should apply the liquidation basis of accounting. In addition, the guidance provides principles for the recognition and measurement of assets and liabilities and requirements for financial statement prepared using the liquidation basis of accounting. The amendments went into effect for entities that determine liquidation is imminent during annual reporting periods beginning after December 15, 2013, and interim periods therein and those requirements should be applied prospectively from the day that liquidation becomes imminent. Early adoption is permitted. The amendments did not have a material effect of the Company's financial statements.

In July 2013, the FASB issued guidance to eliminate the diversity in practice regarding presentation of unrecognized tax benefits in the statement of financial position. Under the clarified guidance, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, will be presented in the financial statements as a reduction to a deferred tax asset unless certain criteria are met. The requirements should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The amendments became effective for the Company for reporting periods beginning after December 15, 2013 and did not have a material effect on the Company’s financial statements.

In January 2014, the FASB amended the Investments-Equity Method and Joint Ventures topic of the Codification to address accounting for investments in qualified affordable housing projects. If certain conditions are met, the amendments permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects by amortizing the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizing the net investment performance in the income statement as a component of income tax expense (benefit). If those conditions are not met, the investment should be accounted for as an equity method investment or a cost method investment in accordance with existing accounting guidance. The amendments will be effective for the Company for interim and annual reporting periods beginning after December 15, 2014 and should be applied retrospectively for all periods presented. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

In January 2014, the FASB amended the Receivables-Troubled Debt Restructurings by Creditors subtopic of the Codification to address the reclassification of consumer mortgage loans collateralized by residential real estate upon foreclosure. The amendments clarify the criteria for concluding that an in substance repossession or foreclosure has occurred, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan. The amendments also outline interim and annual disclosure requirements. The amendments will be effective for the Company for interim and annual reporting periods beginning after December 2014. Companies are allowed to use either a modified retrospective transition method or a prospective transition method when adopting this update. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

12. Accounting and Reporting Changes, Continued

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 changes in regulatory policies and principles, or the interpretation of regulatory capital, including changes as a result of Basel III, or other rules, and any changes in rules applicable to institutions participating in the U.S. Department of Treasury 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 impact of new legislation, including the Jumpstart Out Business Startups Act and Dodd-Frank Wall Street Reform and Consumer Protection Act and the implementing regulations;


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


•	our ability to pay dividends on our common and preferred stock;


•	adverse changes in the securities markets;

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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


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


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


•	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 March 31, 2014 and December 31, 2013

General – Total assets decreased $468,000 or 0.1% to $848.8 million at March 31, 2014 from $849.2 million at December 31, 2013. The primary reason for the decrease in total assets was a decrease in net loans receivable and other assets offset partially by an increase in investment and mortgage- backed securities available for sale.

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



						Increase (Decrease)
		March 31, 2014		December 31, 2013		Amount		Percent
Cash And Cash Equivalents	$	8,145,145	$	7,629,771	$	515,374		6.8%
Investment And Mortgage- Backed Securities – Available For Sale		436,445,047		431,003,452		5,441,595		1.3
Loans Receivable, Net		354,981,296		358,916,665		(3,935,369	)	(1.1)
Repossessed Assets Acquired In Settlement Of Loans		4,520,886		3,947,226		573,660		14.5
FHLB Stock		4,152,000		5,016,600		(864,600	)	(17.2)
Intangible Assets, Net		—		11,970		(11,970	)	(100.0)
Other Assets		5,974,483		7,547,528		(1,573,045	)	(20.8)

Cash and cash equivalents increased $515,000 or 6.8% to $8.1 million at March 31, 2014 from $7.6 million at December 31, 2013. Investment and mortgage-backed securities available for sale increased $5.4 million or 1.3% to $436.4 million at March 31, 2014 from $431.0 million at December 31, 2013.

Loans receivable, net, decreased $3.9 million or 1.1% to $355.0 million at March 31, 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 $3.7 million or 4.4% to $79.4 million at March 31, 2014 from $83.0 million at December 31, 2013. Consumer loans decreased $524,000 or 1.0% to $51.7 million at March 31, 2014 compared to $52.2 million at December 31, 2013. Commercial real estate loans decreased $4.5 million or 1.9% to $223.9 million at March 31, 2014 from $228.4 million at December 31, 2013.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Commercial business loans increased $1.2 million or 15.5% to $9.0 million at March 31, 2014 from $7.8 million at December 31, 2013. Loans held for sale increased $1.7 million or 135.8% to $2.9 million at March 31, 2014 from $1.2 million at December 31, 2013.

Repossessed assets acquired in settlement of loans increased $574,000 or 14.5% to $4.5 million at March 31, 2014 from $3.9 million at December 31, 2013. At March 31, 2014, the balance of repossessed assets consisted of the following real estate properties: 13 single-family residences and 18 lots within residential subdivisions located throughout our market areas in South Carolina and Georgia; six parcels of land in South Carolina; one commercial building in South Carolina; eight lots within a subdivision and adjacent 22.96 acres of land in Aiken, South Carolina; and 34.8 acres of land in Bluffton, South Carolina which was originally acquired as a participation loan from another financial institution.

FHLB stock decreased $865,000 or 17.2% to $4.2 million at March 31, 2014 compared to $5.0 million at December 31, 2013 as a result of stock redemption. The Bank, as a member of the FHLB of Atlanta, is required to acquire and hold shares of capital stock in the FHLB of Atlanta in an amount equal to a membership component, which is 0.15% of total assets plus a transaction component which equals 4.5% of outstanding advances (borrowings) from the FHLB of Atlanta. As total assets and total advances have decreased, so has the Bank’s required investment in FHLB stock.

Other assets decreased $1.6 million or 20.8% to $6.0 million at March 31, 2014 compared to $7.5 million at December 31, 2013 as 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
		March 31, 2014			December 31, 2013			Increase (Decrease)
		Balance	Weighted Rate		Balance	Weighted Rate		Amount		Percent
Demand Accounts:
Checking	$	142,173,828	0.03%	$	136,695,876	0.04%	$	5,477,952		4.01%
Money Market		234,618,613	0.28		240,631,708	0.28		(6,013,095	)	(2.50)
Statement Savings Accounts		26,109,193	0.10		24,485,648	0.10		1,623,545		6.63
Total		402,901,634	0.18		401,813,232	0.19		1,088,402		0.27

Certificate Accounts
0.00 – 1.99%		237,820,872			226,750,180			11,070,692		4.88
2.00 – 2.99%		25,188,876			28,848,252			(3,659,376)		(12.68)
3.00 – 3.99%		1,172,163			1,285,108			(112,945)		(8.79)
4.00 – 4.99%		—			—			—		—
5.00 – 5.99%		—			—			—		—
Total		264,181,911	0.78		256,883,540	0.83		7,298,371		2.84
Total Deposits	$	667,083,545	0.42%	$	658,696,772	0.44%	$	8,386,773		1.27%

Included in the certificate accounts above were $29.5 million and $25.6 million in brokered deposits at March 31, 2014 and December 31, 2013, respectively, with a weighted average interest rate of 1.05% 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:

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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



								Balance
		March 31, 2014			December 31, 2013			Decrease
Fiscal Year Due:		Balance	Rate		Balance	Rate		Balance	Percent
2014	$	22,385,783	1.72%	$	34,840,058	1.64%	$	(12,454,275)	(35.75)%
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	$	75,285,783	3.60%	$	87,740,058	3.23%	$	(12,454,275)	(14.19)%

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 $104.0 million and $97.3 million at March 31, 2014 and $111.6 million and $102.7 million at December 31, 2013, respectively. Advances are subject to prepayment penalties.

The following table shows at March 31, 2014 FHLB advances that are callable as of the dates indicated. These advances are also included in the above table. All callable advances are callable at the option of the FHLB. If an advance is called, the Bank has the option to payoff the advance without penalty, reborrow funds on different terms, or convert the advance to a three-month floating rate advance tied to LIBOR.



As of March 31, 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 $9.2 million and $8.0 million in other borrowings (non-FHLB advances) at March 31, 2014 and December 31, 2013, respectively. These borrowings consist of short-term repurchase agreements with certain commercial demand deposit customers for sweep accounts. The repurchase agreements typically mature within one to three days and the interest rate paid on these borrowings floats monthly with money market type rates. At both March 31, 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 $12.9 million and $13.4 million, respectively, at March 31, 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 (the 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 documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the Trust.

The Capital Securities accrue and pay distributions annually at a rate per annum equal to 1.93% at March 31, 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 rate is a floating rate of three month LIBOR plus 170 basis points as the fixed rate portion was converted to the floating rate. The distribution rate payable on the Capital Securities is cumulative and payable quarterly in arrears.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

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

The Capital Securities mature or are mandatorily redeemable upon maturity on December 15, 2036, or upon earlier optional redemption as provided in the indenture. The Company has the right to redeem the Capital Securities in whole or in part.

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

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

Equity – Shareholders’ equity increased $2.7 million or 3.4% to $80.6 million at March 31, 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 $1.7 million or 358.8% to $2.2 million at March 31, 2014. The Company’s net income available for common shareholders was $1.2 million for the three months ended March 31, 2014, after payment of $110,000 in preferred stock dividends. The Board of Directors of the Company declared common stock dividends totaling $235,000 during the three months ended March 31, 2014. Book value per common share was $19.92 at March 31, 2014 and $19.02 at December 31, 2013.

Results of Operations for the Three Month Periods Ended March 31, 2014 and 2013

Net Income Available to Common Shareholders - Net income available to common shareholders increased $631,000 or 112.4% to $1.2 million or $0.41 per diluted common share for the three months ended March 31, 2014 compared to $561,000 or $0.19 per diluted common share for the three months ended March 31, 2013. The increase in net income was primarily the result of a $1.0 million decrease in the provision for loan losses offset slightly by a decrease of $409,000 in non-interest income.

Net Interest Income - The net interest margin on a tax equivalent basis increased 11 basis points to 2.90% for the three months ended March 31, 2014 from 2.79% for the comparable period in 2013 as the decline in the average cost of interest-bearing liabilities outpaced the decline in the average yield earned on interest-earning assets. Net interest income increased $53,000 or 0.9% to $5.6 million during the three months ended March 31, 2014, compared to the same period in 2013. During the three months ended March 31, 2014, average interest earning assets decreased $21.6 million or 2.6% to $794.7 million while average interest-bearing liabilities decreased $34.5 million or 4.6% to $710.5 million.

Interest Income - Total tax equivalent interest income decreased $484,000 or 6.2% to $7.3 million during the three months ended March 31, 2014 from $7.8 million for 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 $721,000 or 12.9% to $4.9 million during the three months ended March 31, 2014 from $5.6 million during the comparable period in 2013 as a result of the average loan portfolio balance decreasing $35.9 million or 9.1% to $357.4 million combined with the yield on the loan portfolio decreasing 24 basis point to 5.44%. Interest income from mortgage-backed securities increased $28,000 or 2.1% to $1.4 million as a result of a two basis point increase in the portfolio yield combined with a $3.2 million increase in the average balance. Tax equivalent interest income from investment securities increased $208,000 or 24.3% to $1.1 million as a result of an increase of 27 basis points in the yield combined with an increase of $16.4 million 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 three months ended March 31, 2014 and 2013:

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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



	Three Months Ended March 31,
	2014				2013
		Average Balance	Yield⁽¹⁾			Average Balance	Yield⁽¹⁾			Increase (Decrease) In Interest And Dividend Income From 2013
Loans Receivable, Net	$	357,392,216	5.44	%	$	393,269,063	5.68	%	$	(721,398)
Mortgage-Backed Securities		249,268,862	2.23			246,038,565	2.21			27,942
Investment Securities⁽²⁾		184,949,653	2.30			168,598,396	2.03			207,849
Overnight Time And Certificates of Deposit		3,104,619	0.46			8,407,959	0.11			1,232
Total Interest-Earning Assets	$	794,715,350	3.68	%	$	816,313,983	3.82	%	$	(484,375)

⁽¹⁾ Annualized

⁽²⁾ Tax equivalent basis is calculated using an effective tax rate of 34% and amounted to $127,532 and $101,113 for the

quarters ended March 31, 2014 and 2013, respectively.

Interest Expense - Total interest expense decreased $564,000 or 26.7% to $1.6 million during the three months ended March 31, 2014 compared to $2.1 million for the same period last year. The decrease in total interest expense was attributable to decreases in interest rates paid and a $34.5 million decrease in the average balance of interest-bearing liabilities. Interest expense on deposits decreased $287,000 or 29.2% to $696,000 during the three months ended March 31, 2014 compared to $983,000 for the same period last year. The decrease was attributable to a 18 basis point decrease in the cost of deposit accounts combined with a $10.2 million decrease in average interest-bearing deposits to $611.2 million for the three month period ended March 31, 2014 when compared to $621.3 million for the three month period ended March 31, 2013. The decrease was concentrated in the certificate accounts, which decreased $21.7 million or 7.7% to $260.9 million during the three months ended March 31, 2014 compared to $282.7 million for the same period in 2013. The Bank has been competing less aggressively for time deposits in its local area and focusing instead on core deposits, or non time deposits.

Interest expense on FHLB advances and other borrowings decreased $275,000 or 28.0% to $708,000 during the three months ended March 31, 2014 from $983,000 for the same period in 2013. The average balance of FHLB advances and other borrowed money decreased $24.4 million or 21.7% to $88.1 million during the three months ended March 31, 2014 from $112.5 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 three months ended March 31, 2014 and 2013.



	Three Months Ended March 31,
	2014			2013
		Average Balance	Yield⁽¹⁾		Average Balance	Yield⁽¹⁾		Decrease In Interest Expense From 2013
Now And Money Market Accounts	$	325,345,853	0.22%	$	315,696,505	0.29%	$	(51,329	)
Statement Savings Accounts		24,889,448	0.10		22,967,552	0.19		(4,937	)
Certificates Accounts		260,927,661	0.78		282,670,827	1.05		(231,080	)
FHLB Advances And Other Borrowed Money		88,136,130	3.21		112,490,450	3.50		(275,390	)
Junior Subordinated Debentures		5,155,000	1.94		5,155,000	2.00		(795	)
Senior Convertible Debentures		6,084,000	8.00		6,084,000	8.00		—
Total Interest-Bearing Liabilities	$	710,538,092	0.87%	$	745,064,334	1.13%	$	(563,531	)

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

Management’s monthly review of the adequacy of the allowance includes three main components. The first component is an analysis of loss potential in various 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. Management began applying 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.

Annualized net charge-offs were $2.0 million or 0.55% of gross loans during the three months ended March 31, 2014 compared to $5.4 million or 1.39% of gross loans for the same three month period in 2013. The provision for loan losses was $100,000 for the quarter ended March 31, 2014 compared to $1.1 million for the same quarter in the prior year. The following table details selected activity associated with the allowance for loan losses for the three months ended March 31, 2014 and 2013:



		Three Months Ended March 31,
		2014			2013
Beginning Balance	$	10,241,970		$	11,318,371
Provision		100,000			1,145,381
Charge-offs		(777,575)			(1,385,460)
Recoveries		281,360			26,934
Ending Balance	$	9,845,755		$	11,105,226

Allowance For Loan Losses As A Percentage Of Gross Loans Receivable, Held For Investment At The End Of The Period		2.7	%		2.8	%
Allowance For Loan Losses As A Percentage Of Impaired Loans At The End Of The Period		33.0	%		29.2	%
Impaired Loans	$	29,828,194		$	37,993,710
Gross Loans Receivable, Held For Investment And Held For Sale	$	366,872,467		$	396,312,975
Total Loans Receivable, Net	$	354,981,296		$	383,017,165

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 $409,000 or 21.0% to $1.5 million for the three months ended March 31, 2014, compared to $1.9 million for the three months ended March 31, 2013. The following table provides a detailed analysis of the changes in the components of non-interest income:



	Three Months Ended March 31,				Increase (Decrease)
		2014		2013		Amounts		Percent
Gain On Sale Of Investments	$	84,356	$	384,051	$	(299,695)		(78.0)%
Gain On Sale Of Loans		128,242		184,788		(56,546	)	(30.6)
Service Fees On Deposit Accounts		276,485		263,831		12,654		4.8
Commissions From Insurance Agency		91,634		140,313		(48,679	)	(34.7)
Income From Cash Value Of Life Insurance		205,827		105,000		100,827		96.0
Trust Income		105,000		135,000		(30,000	)	(22.2)
Check Card Fee Income		210,695		195,193		15,502		7.9
CDFI Financial Award Income		281,960		416,071		(134,111	)	(32.2)
Other		152,200		120,735		31,465		26.1
Total Non-Interest Income	$	1,536,399	$	1,944,982	$	(408,583)		(21.0)%

Gain on sale of investments was $84,000 during the quarter ended March 31, 2014, a decrease of $300,000 or 78.0% compared to $384,000 for the same period last year. The net gain resulted from the sale of nine investments during the quarter ended March 31, 2014 compared to five investments during the same period in 2013. Market interest rates increased sharply in June 2013 as a result of a discussions by the Federal Reserve of reducing its monthly purchases of bonds and mortgage-backed securities sooner than expected. Long term interest rates were especially affected by this. As a result, the market values in our investment and mortgage-backed securities portfolio were negatively impacted.

Gain on sale of loans decreased $57,000 or 30.6% to $128,000 during the three months ended March 31, 2014 compared to $185,000 for the same period last year, directly related to a decrease in refinancing activity.

Income from cash value of life insurance increased $101,000 or 96.0% to $206,000 during the quarter ended March 31, 2014 from $105,000 for the same period in 2013. The Company recognized $131,000 in life insurance proceeds in 2014.

CDFI financial award income decreased $134,000 or 32.2% during the three months ended March 31, 2014, compared to the same period in 2013.

General And Administrative Expenses –For the quarter ended March 31, 2014, non-interest expense decreased $186,000 or 3.4% to $5.3 million compared to $5.5 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 March 31,				Increase (Decrease)
		2014		2013		Amounts		Percent
Compensation And Employee Benefits	$	2,847,002	$	2,821,375	$	25,627		0.9%
Occupancy		500,916		475,314		25,602		5.4
Advertising		100,396		107,643		(7,247	)	(6.7)
Depreciation And Maintenance Of Equipment		417,506		439,172		(21,666	)	(4.9)
FDIC Insurance Premiums		185,457		167,722		17,735		10.6
Amortization of Intangibles		11,970		12,501		(531	)	(4.2)
Net Cost Of Operation Of Other Real Estate Owned		269,096		396,369		(127,273	)	(32.1)
Prepayment Penalties on FHLB Advances		—		153,253		(153,253	)	(100.0)
Other		994,336		939,535		54,801		5.8
Total General And Administrative Expenses	$	5,326,679	$	5,512,884	$	(186,205	)	(3.4)%

Compensation and employee benefits expenses increased $26,000, or 0.9% to $2.8 million for the three months ended March 31, 2014 compared to the same period last year. Occupancy also increased $26,000 or 5.4% to $501,000 for the three months ended March 31, 2014 compared to $475,000 for the three months ended March 31, 2013. Depreciation and maintenance of equipment decreased $21,000 or 4.9% during the same period.

Net cost of operation of other real estate owned decreased $127,000 or 32.1% to $269,000 during the quarter ended March 31, 2014 from $396,000 during the quarter ended March 31, 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. Other real estate owned was $4.5 million at March 31, 2014 compared to $6.5 million at March 31, 2013.

The Company incurred a prepayment penalty of $153,000 for paying down FHLB advances during the three months ended March 31, 2013. The Company elected to prepay these higher rate advances to lower cost of funds. The Company did not prepay any advances during the three months ended March 31, 2014.

Other expenses increased $55,000, or 5.8% to $994,000 for the three month period ended March 31, 2014 compared to $940,000 for the same period in the prior year. Other expenses include legal, professional, and consulting expenses, stationary and office supplies and other miscellaneous expenses.

Provision For Income Taxes – The provision for income taxes increased $245,000 or 118.7% to $451,000 for the three months ended March 31, 2014 from $206,000 for the same period one year ago. Income before income taxes was $1.8 million and $877,000 for the three months ended March 31, 2014 and 2013, respectively. The Company’s combined federal and state effective income tax rate for the current quarter was 25.7% compared to 23.5% for the same quarter one year ago.

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 three months ended March 31, 2014 loan repayments exceeded loan disbursements resulting in a $3.9 million or 1.1% decrease in total net loans receivable. During the three months ended March 31, 2014, deposits increased $8.4 million and FHLB advances decreased $12.5 million. The Bank had $179.4 million in additional borrowing capacity at the FHLB at the end of the period. At March 31, 2014, the Bank had $159.9 million of certificates of deposit maturing within one year. Based on previous experience, the Bank anticipates a significant portion of these certificates will be renewed on maturity.

At March 31, 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 22.4%, 21.1% and 9.8%, 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 March 31, 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	$	1,092	$	1,393	$	11,469	$	13,954	$	29,232	$	43,186
Standby Letters Of Credit	—		800		1,033		1,833		11		1,844
Total	$	1,092	$	2,193	$	12,502	$	15,787	$	29,243	$	45,030

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 months ended March 31, 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 2.81%.

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 March 31, 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 March 31, 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 March 31, 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:	May 14, 2014	By:	/s/J. Chris Verenes
				J. Chris Verenes
				President & Chief Executive Officer
				Duly Authorized Representative



Date:	May 14, 2014	By:	/s/Roy G. Lindburg
				Roy G. Lindburg
				Chief Financial Officer
				Duly Authorized Representative

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

EXHIBIT INDEX


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


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


32	Certifications of the Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act

101

The following materials from Security Federal Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 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