SECURITY FEDERAL CORP - Quarter Report: 2016 September (Form 10-Q)

OUTSTANDING SHARES AT:

Common Stock, par value $0.01 per share

November 14, 2016

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10 – Q

(Mark one)

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2016

( ) 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 NORTHWEST, 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 September 30, 2016 and December 31, 2015	3
	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2016 and 2015	4
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2016 and 2015	5
	Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2016 and 2015	6
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2016 and 2015	7
	Notes to Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	46
Item 4.	Controls and Procedures	47

PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	47
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults Upon Senior Securities	47
Item 4.	Mine Safety Disclosures	47
Item 5.	Other Information	47
Item 6.	Exhibits	48
	Signatures	50

SCHEDULES OMITTED

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Part 1. Financial Information

Item 1. Financial Statements

Consolidated Balance Sheets



	September 30, 2016			December 31, 2015
	(Unaudited)			(Audited)
ASSETS:
Cash and Cash Equivalents	$	11,352,028		$	8,381,951
Certificates of Deposit with Other Banks	3,445,005			3,445,005
Investment and Mortgage-Backed Securities:
Available For Sale	380,970,307			375,513,870
Held To Maturity (Fair Value of $28,090,167 and $29,681,280 at September 30, 2016 and December 31, 2015, Respectively)	27,483,390			29,873,098
Total Investments and Mortgage-Backed Securities	408,453,697			405,386,968
Loans Receivable, Net:
Held For Sale	4,143,431			2,462,559
Held For Investment (Net of Allowance of $8,111,111 and $8,275,133 at September 30, 2016 and December 31, 2015, Respectively)	347,675,139			328,110,170
Total Loans Receivable, Net	351,818,570			330,572,729
Accrued Interest Receivable:
Loans	848,627			886,968
Mortgage-Backed Securities	629,809			614,925
Investment Securities	1,432,494			1,523,200
Total Accrued Interest Receivable	2,910,930			3,025,093
Premises and Equipment, Net	20,663,421			20,116,918
Federal Home Loan Bank ("FHLB") Stock, at Cost	2,674,700			2,214,800
Other Real Estate Owned ("OREO")	2,327,345			4,361,411
Bank Owned Life Insurance ("BOLI")	16,969,045			16,573,045
Goodwill	1,199,754			1,199,754
Other Assets	2,110,251			4,449,956
Total Assets	$	823,924,746		$	799,727,630
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Liabilities:
Deposit Accounts	$	650,298,252		$	652,096,545
Advances From FHLB	46,000,000			34,640,000
Other Borrowings	12,597,519			6,411,977
Advance Payments By Borrowers For Taxes and Insurance	635,964			256,730
Junior Subordinated Debentures	5,155,000			5,155,000
Senior Convertible Debentures	6,084,000			6,084,000
Other Liabilities	5,680,730			4,115,956
Total Liabilities	726,451,465			708,760,208
Shareholders' Equity:
Serial Preferred Stock, $.01 Par Value; Authorized 200,000 Shares; Issued and Outstanding Shares, 22,000	22,000,000			22,000,000
Common Stock, $.01 Par Value; Authorized 5,000,000 Shares; Issued and Outstanding Shares, 3,146,407 and 2,945,474, Respectively	31,464			31,464
Additional Paid-In Capital	12,034,808			12,028,832
Treasury Stock, at Cost (200,933 Shares)	(4,330,712		)	(4,330,712		)
Unvested Restricted Stock	(25,358		)	(25,358		)
Accumulated Other Comprehensive Income	6,736,410			4,262,361
Retained Earnings	61,026,669			57,000,835
Total Shareholders' Equity	97,473,281			90,967,422
Total Liabilities And Shareholders' Equity	$	823,924,746		$	799,727,630

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)



	Three Months Ended September 30,					Nine Months Ended September 30,
	2016		2015			2016			2015
Interest Income:
Loans	$	4,912,317	$	4,521,458		$	14,378,826		$	13,680,762
Mortgage-Backed Securities	1,192,792		1,259,822			3,672,252			4,037,511
Investment Securities	1,042,765		1,124,683			3,245,857			3,198,542
Other	4,944		1,897			14,057			6,034
Total Interest Income	7,152,818		6,907,860			21,310,992			20,922,849
Interest Expense:
NOW and Money Market Accounts	102,321		103,819			309,757			326,099
Statement Savings Accounts	8,984		7,805			25,468			22,535
Certificate Accounts	407,283		444,385			1,239,282			1,393,648
FHLB Advances and Other Borrowed Money	132,889		296,497			561,316			1,057,485
Senior Convertible Debentures	121,680		121,680			365,040			365,040
Junior Subordinated Debentures	31,445		26,279			91,002			77,070
Total Interest Expense	804,602		1,000,465			2,591,865			3,241,877
Net Interest Income	6,348,216		5,907,395			18,719,127			17,680,972
Provision For Loan Losses	—		(200,000		)	—			(100,000		)
Net Interest Income After Provision For Loan Losses	6,348,216		6,107,395			18,719,127			17,780,972
Non-Interest Income:
Gain on Sale of Investment Securities	360,425		7,651			772,143			1,676,404
Gain on Sale of Loans	256,918		191,194			657,473			526,295
Service Fees on Deposit Accounts	266,960		258,522			772,341			790,689
Commissions From Insurance Agency	149,529		139,980			441,519			373,639
Trust Income	197,000		152,200			521,000			449,800
BOLI Income	132,000		117,000			396,000			291,000
Check Card Fee Income	247,331		239,739			742,583			719,159
Grant Income	—		97,640			265,496			97,640
Other	170,519		164,488			504,200			482,380
Total Non-Interest Income	1,780,682		1,368,414			5,072,755			5,407,006
Non-Interest Expense:
Compensation and Employee Benefits	3,167,112		3,002,259			9,675,430			8,976,214
Occupancy	502,352		481,713			1,469,602			1,427,424
Advertising	100,251		95,226			343,034			290,951
Depreciation and Maintenance of Equipment	510,645		401,102			1,486,060			1,263,932
Federal Deposit Insurance Corporation ("FDIC") Insurance Premiums	62,163		140,172			322,653			455,985
Net Cost (Benefit) of Operation of OREO	25,991		(19,713		)	(647,990		)	267,784
Prepayment Penalties on FHLB Advances	260,594		—			789,306			787,851
Other	1,065,209		1,029,201			3,485,289			3,249,451
Total Non-Interest Expense	5,694,317		5,129,960			16,923,384			16,719,592
Income Before Income Taxes	2,434,581		2,345,849			6,868,498			6,468,386
Provision For Income Taxes	654,850		601,446			1,805,750			1,696,268
Net Income	1,779,731		1,744,403			5,062,748			4,772,118
Preferred Stock Dividends	110,000		110,000			330,000			330,000
Net Income Available to Common Shareholders	$	1,669,731	$	1,634,403		$	4,732,748		$	4,442,118
Net Income Per Common Share (Basic)	$	0.57	$	0.56		$	1.61		$	1.51
Net Income Per Common Share (Diluted)	$	0.54	$	0.53		$	1.53		$	1.44
Cash Dividend Per Share on Common Stock	$	0.08	$	0.08		$	0.24		$	0.24
Weighted Average Shares Outstanding (Basic)	2,944,001		2,944,001			2,944,001			2,944,001
Weighted Average Shares Outstanding (Diluted)	3,248,526		3,248,361			3,248,474			3,248,284

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)



	Three Months Ended September 30,
	2016			2015
Net Income	$	1,779,731		$	1,744,403
Other Comprehensive Income (Loss)
Unrealized Gains (Losses) on Securities:
Unrealized Holding Gains (Losses) on Securities Available For Sale, Net of Taxes of $(774,093) and $979,277 at September 30, 2016 and 2015, Respectively	(1,263,332		)	1,598,158
Reclassification Adjustment for Gains Included in Net Income, Net of Taxes of $136,962 and $2,907 at September 30, 2016 and 2015, Respectively	(223,463		)	(4,744		)
Amortization of Unrealized Gains on Available For Sale Securities Transferred to Held To Maturity, Net of Taxes of $(20,270) and $(22,996) at September 30, 2016 and 2015, Respectively	(33,128		)	(37,584		)
Other Comprehensive Income (Loss)	(1,519,923		)	1,555,830
Comprehensive Income	$	259,808		$	3,300,233



	Nine Months Ended September 30,
	2016			2015
Net Income	$	5,062,748		$	4,772,118
Other Comprehensive Income (Loss)
Unrealized Gains on Securities:
Unrealized Holding Gains on Securities Available For Sale, Net of Taxes of $1,861,700 and $220,764 at September 30, 2016 and 2015, Respectively	3,044,091			357,366
Reclassification Adjustment for Gains Included in Net Income, Net of Taxes of $293,415 and $637,033 at September 30, 2016 and 2015, Respectively	(478,728		)	(1,039,371		)
Amortization of Unrealized Gains on Available For Sale Securities Transferred to Held To Maturity, Net of Taxes of $(55,872) and $(29,337) at September 30, 2016 and 2015, Respectively	(91,314		)	(47,948		)
Other Comprehensive Income (Loss)	2,474,049			(729,953		)
Comprehensive Income	$	7,536,797		$	4,042,165

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity (Unaudited)

For the Nine Months Ended September 30, 2016 and 2015



	Preferred Stock		Common Stock		Unvested Restricted Stock			Additional Paid – In Capital		Treasury Stock			Accumulated Other Comprehensive Income		Retained Earnings			Total
Balance at December 31, 2015	$	22,000,000	$	31,464	$	(25,358	)	$	12,028,832	$	(4,330,712	)	$	4,262,361	$	57,000,835		$	90,967,422
Net Income	—		—		—			—		—			—		5,062,748			5,062,748
Other Comprehensive Income, Net of Tax	—		—		—			—		—			2,474,049		—			2,474,049
Stock Option Compensation Expense	—		—		—			5,976		—			—		—			5,976
Cash Dividends on Preferred Stock	—		—		—			—		—			—		(330,000		)	(330,000		)
Cash Dividends on Common Stock	—		—		—			—		—			—		(706,914		)	(706,914		)
Balance at September 30, 2016	$	22,000,000	$	31,464	$	(25,358	)	$	12,034,808	$	(4,330,712	)	$	6,736,410	$	61,026,669		$	97,473,281



	Preferred Stock		Common Stock		Unvested Restricted Stock			Additional Paid – In Capital		Treasury Stock			Accumulated Other Comprehensive Income			Retained Earnings			Total
Balance at December 31, 2014	$	22,000,000	$	31,449	$	—		$	11,990,813	$	(4,330,712	)	$	5,476,375		$	52,267,460		$	87,435,385
Net Income	—		—		—			—		—			—			4,772,118			4,772,118
Other Comprehensive Loss, Net of Tax	—		—		—			—		—			(729,953		)	—			(729,953		)
Common Stock Issuance	—		15		(25,358		)	25,343		—			—			—			—
Stock Option Compensation Expense	—		—		—			9,507		—			—			—			9,507
Cash Dividends on Preferred Stock	—		—		—			—		—			—			(330,000		)	(330,000		)
Cash Dividends on Common Stock	—		—		—			—		—			—			(706,914		)	(706,914		)
Balance at September 30, 2015	$	22,000,000	$	31,464	$	(25,358	)	$	12,025,663	$	(4,330,712	)	$	4,746,422		$	56,002,664		$	90,450,143

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)



	Nine Months Ended September 30,
	2016			2015
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	5,062,748		$	4,772,118
Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities:
Depreciation Expense	1,053,224			914,784
Stock Option Compensation Expense	5,976			9,507
Discount Accretion and Premium Amortization	4,038,220			3,496,657
Provisions for Losses on Loans	—			(100,000		)
Income From BOLI	(396,000		)	(291,000		)
Gain on Sales of Loans	(657,473		)	(526,295		)
Gain on Sales of Mortgage-Backed Securities	(55,958		)	(510,702		)
Gain on Sales of Investment Securities	(716,185		)	(1,165,702		)
Gain on Sale of OREO	(841,728		)	(218,293		)
Write Down on OREO	40,000			174,400
Gain on Disposal of Premises and Equipment	—			(5,647		)
Amortization of Deferred Costs on Loans	88,054			47,756
Proceeds From Sale of Loans Held For Sale	23,896,772			19,049,761
Origination of Loans Held For Sale	(24,920,171		)	(18,177,098		)
Decrease (Increase) in Accrued Interest Receivable:
Loans	38,341			98,607
Mortgage-Backed Securities	(14,884		)	55,154
Investment Securities	90,706			(122,738		)
Increase in Advance Payments By Borrowers	379,234			329,797
Other, Net	2,244,880			946,839
Net Cash Provided By Operating Activities	9,335,756			8,777,905

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Mortgage-Backed Securities Available For Sale	(37,793,135		)	(30,816,752		)
Principal Repayments on Mortgage-Backed Securities Available For Sale	23,942,058			21,983,963
Proceeds From Sale of Mortgage-Backed Securities Available For Sale	3,082,591			27,329,862
Purchase of Mortgage-Backed Securities Held To Maturity	(1,507,125		)	—
Principal Repayments on Mortgage-Backed Securities Held To Maturity	3,496,657			1,780,222
Purchase of Investment Securities Available For Sale	(30,233,311		)	(66,339,293		)
Principal Repayments on Investment Securities Available For Sale	13,174,779			—
Maturities of Investment Securities Available For Sale	5,227,465			22,152,393
Proceeds From Sale of Investment Securities Available For Sale	18,410,863			30,890,194
Purchase of FHLB Stock	(5,014,800		)	(2,765,900		)
Redemption of FHLB Stock	4,554,900			3,686,300
Purchase of Bank Owned Life Insurance	—			(5,000,000		)
(Increase) Decrease in Loans Receivable	(19,976,753		)	15,800,516
Proceeds From Sale of OREO	3,159,524			2,369,726
Purchase and Improvement of Premises and Equipment	(1,599,727		)	(2,232,816		)
Proceeds From Disposal of Premises and Equipment	—			8,516
Net Cash Provided (Used) By Investing Activities	(21,076,014		)	18,846,931

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES



Consolidated Statements of Cash Flows (Unaudited) (Continued)

	Nine Months Ended September 30,
	2016			2015
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease in Deposit Accounts	$	(1,798,293	)	$	(7,988,147	)
Proceeds from FHLB Advances	251,755,000			199,184,000
Repayment of FHLB Advances	(240,395,000		)	(218,804,000		)
Increase (Decrease) in Other Borrowings, Net	6,185,542			(797,988		)
Dividends to Preferred Stock Shareholders	(330,000		)	(330,000		)
Dividends to Common Stock Shareholders	(706,914		)	(706,914		)
Net Cash Provided (Used) By Financing Activities	14,710,335			(29,443,049		)
Net Increase (Decrease) in Cash and Cash Equivalents	2,970,077			(1,818,213		)
Cash and Cash Equivalents at Beginning of Period	8,381,951			10,192,702
Cash and Cash Equivalents at End of Period	$	11,352,028		$	8,374,489
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Paid During the Period For:
Interest	$	2,565,836		$	3,288,927
Income Taxes	$	572,242		$	1,393,388
Supplemental Schedule of Non Cash Transactions:
Transfers From Loans Receivable to OREO	$	323,730		$	4,025,121
Transfers from Mortgage-Backed Securities Available For Sale to Held To Maturity	$	—		$	32,811,452

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 ("U.S. GAAP"); therefore, they do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows. Such statements are unaudited but, in the opinion of management, reflect all adjustments, which are of a normal recurring nature and necessary for a fair presentation of results for the selected interim periods. Users of financial information produced for interim periods are encouraged to refer to the footnotes contained in the audited consolidated financial statements appearing in Security Federal Corporation’s (the “Company”) 2015 Annual Report to Shareholders which was filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2015 (“2015 10-K”) when reviewing interim financial statements.

2. Principles of Consolidation

The accompanying unaudited 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, and home insurance. SFINS has a wholly owned subsidiary, Collier Jennings Financial Corporation, which has as subsidiaries Security Federal Auto Insurance, The Auto Insurance Store Inc., and Security Federal Premium Pay Plans Inc. 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, 2015 included in our 2015 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 regulatory agencies, including the Board of Governors of the Federal Reserve System ("Federal Reserve"), the FDIC and the South Carolina Board of Financial Institutions, that may require adjustments to be made to the allowance 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 EPS 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:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Earnings Available To Common Shareholders:
Net Income		$1,779,731		$1,744,403		$5,062,748		$4,772,118
Preferred Stock Dividends	110,000		110,000		330,000		330,000
Net Income Available To Common Shareholders		$1,669,731		$1,634,403		$4,732,748		$4,442,118

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

4. Earnings Per Common Share, Continued

The following tables include a summary of the Company's basic and diluted EPS for the periods indicated.



	Three Months Ended September 30,
	2016					2015
	Income		Shares	Per Share Amounts		Income		Shares	Per Share Amounts
Basic EPS	$	1,669,731	2,944,001	$	0.57	$	1,634,403	2,944,001	$	0.56
Effect of Dilutive Securities:
Senior Convertible Debentures	75,442		304,200	(0.03)		75,442		304,200	(0.03)
Unvested Restricted Stock	—		325	—		—		160	—
Diluted EPS	$	1,745,173	3,248,526	$	0.54	$	1,709,845	3,248,361	$	0.53



	Nine Months Ended September 30,
	2016					2015
	Income		Shares	Per Share Amounts		Income		Shares	Per Share Amounts
Basic EPS	$	4,732,748	2,944,001	$	1.61	$	4,442,118	2,944,001	$	1.51
Effect of Dilutive Securities:
Senior Convertible Debentures	226,325		304,200	(0.07)		226,325		304,200	(0.07)
Unvested Restricted Stock	—		273	(0.01)		—		83	—
Diluted EPS	$	4,959,073	3,248,474	$	1.53	$	4,668,443	3,248,284	$	1.44

5. Stock-Based Compensation

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



	Three Months Ended September 30,
	2016			2015
	Shares		Weighted Average Exercise Price	Shares	Weighted Average Exercise Price
	Shares		Weighted Average Exercise Price	Shares	Weighted Average Exercise Price
Balance, Beginning of Period	25,000		$23.50	29,500	$23.55
Options Granted	—		—	—	—
Options Exercised	—		—	—	—
Options Forfeited	(3,500	)	23.03	—	—
Balance, End of Period	21,500		$23.57	29,500	$23.55

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

5. Stock-Based Compensation, Continued



	Nine Months Ended September 30,
	2016			2015
	Shares		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
	Shares		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
Balance, Beginning of Period	29,500		$23.55	47,500		$22.41
Options Granted	—		—	—		—
Options Exercised	—		—	—		—
Options Forfeited	(8,000	)	23.47	(18,000	)	20.55
Balance, End of Period	21,500		$23.57	29,500		$23.55

Options Exercisable	17,800			21,100

Options Available For Grant	50,000			50,000

At September 30, 2016, the Company had the following options outstanding:



Grant Date	Outstanding Options	Option Price	Expiration Date
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	12,000	$23.49	01/01/18

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

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

None of the options outstanding at September 30, 2016 or 2015 had an exercise price below the average market price during the three or nine month periods ended September 30, 2016 or 2015. Therefore, these options were not deemed to be dilutive to EPS in those periods.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

6. 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 at the dates indicated were as follows:



	September 30, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Federal National Mortgage Association ("FNMA") Bonds	$	998,131	$	19,550	$	—	$	1,017,681
Small Business Administration (“SBA”) Bonds	100,978,165		1,343,672		123,707		102,198,130
Tax Exempt Municipal Bonds	77,997,989		5,073,181		114,675		82,956,495
Taxable Municipal Bonds	1,014,619		26,041		—		1,040,660
Mortgage-Backed Securities	189,223,545		4,512,200		309,738		193,426,007
Equity Securities	250,438		80,896		—		331,334
Total Available For Sale	$	370,462,887	$	11,055,540	$	548,120	$	380,970,307

	December 31, 2015
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLB Securities	$	2,000,000	$	—	$	67,912	$	1,932,088
Federal Farm Credit Bank ("FFCB") Securities	2,000,000		—		12,064		1,987,936
FNMA Bonds	997,564		6,767		—		1,004,331
SBA Bonds	110,195,113		1,415,464		193,795		111,416,782
Tax Exempt Municipal Bonds	73,499,636		2,770,115		204,132		76,065,619
Mortgage-Backed Securities	180,197,347		3,281,116		681,251		182,797,212
Equity Securities	250,438		59,464		—		309,902
Total Available For Sale	$	369,140,098	$	7,532,926	$	1,159,154	$	375,513,870

The FHLB, FFCB, FNMA and the Federal Home Loan Mortgage Corporation (“FHLMC”) are government sponsored enterprises ("GSEs") and the securities and bonds issued by 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 Government National Mortgage Association ("GNMA") mortgage-backed securities, which are also backed by the full faith and credit of the United States government. At September 30, 2016 the Bank held an amortized cost and fair value of $112.4 million and $115.0 million, respectively, in GNMA mortgage-backed securities included in mortgage-backed securities listed above compared to an amortized cost and fair value of $116.8 million and $118.5 million, respectively, at December 31, 2015.

Also included in mortgage-backed securities in the tables above and below are private label collateralized mortgage obligation ("CMO") securities. These securities are issued by non-governmental real estate mortgage investment conduits, which are not backed by the full faith and credit of the United States government. At September 30, 2016 the Bank held an amortized cost and fair value of $18.6 million and $18.3 million, respectively, in private label CMO mortgage-backed securities, which are included in mortgage-backed securities in the table above, compared to an amortized cost and fair value of $3.8 million at December 31, 2015.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

The amortized cost and fair value of investment and mortgage-backed securities available for sale at September 30, 2016 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. Since mortgage-backed securities are not due at a single maturity date, they are disclosed separately, rather than allocated over the maturity groupings set forth in the table below.



Investment Securities	Amortized Cost		Fair Value
Less Than One Year	$	60,932	$	61,202
One – Five Years	17,522,944		17,846,103
Over Five – Ten Years	44,282,485		45,359,270
More Than Ten Years	119,372,981		124,277,725
Mortgage-Backed Securities	189,223,545		193,426,007
	$	370,462,887	$	380,970,307

At September 30, 2016 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 $71.6 million and $74.1 million, respectively, compared to an amortized cost and fair value of $81.0 million and $83.2 million, respectively, at December 31, 2015.

The Bank received $6.9 million and $4.0 million in gross proceeds from sales of available for sale securities during the three months ended September 30, 2016 and 2015, respectively. As a result, the Bank recognized gross gains of $360,000 and $8,000, respectively, for the three months ended September 30, 2016 and 2015, with no gross losses recognized for the same periods.

During the nine months ended September 30, 2016 and 2015, the Bank received $21.5 million and $58.2 million, respectively, in gross proceeds from sales of available for sale securities. As a result, the Bank recognized gross gains of $772,000 and $1.7 million, respectively, and gross losses of $0 and $47,000, respectively, for the nine months ended September 30, 2016 and 2015.

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



	September 30, 2016
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
SBA Bonds	$	16,016,982	$	79,654	$	6,595,575	$	44,053	$	22,612,557	$	123,707
Tax Exempt Municipal Bonds	8,068,360		114,675		—		—		8,068,360		114,675
Mortgage-Backed Securities	25,294,568		236,812		6,766,526		72,926		32,061,094		309,738
	$	49,379,910	$	431,141	$	13,362,101	$	116,979	$	62,742,011	$	548,120



	December 31, 2015
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Securities	$	—	$	—	$	1,932,088	$	67,912	$	1,932,088	$	67,912
FFCB Securities	1,987,936		12,064		—		—		1,987,936		12,064
SBA Bonds	25,090,453		119,533		7,982,777		74,262		33,073,230		193,795
Tax Exempt Municipal Bonds	13,668,473		175,020		709,800		29,112		14,378,273		204,132
Mortgage-Backed Securities	63,273,417		648,862		1,706,086		32,389		64,979,503		681,251
	$	104,020,279	$	955,479	$	12,330,751	$	203,675	$	116,351,030	$	1,159,154

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

Securities classified as available for sale are recorded at fair market value. At September 30, 2016 and December 31, 2015, 21.3% and 17.6% of the unrealized losses, representing 13 and nine 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 the Company 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. There was no OTTI recognized during the nine months ended September 30, 2016.

7. Investment and Mortgage-Backed Securities, Held to Maturity

The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of held to maturity securities at the dates indicated below were as follows:



	September 30, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Mortgage-Backed Securities (1)	$	27,483,390	$	606,777	$	—	$	28,090,167
Total Held To Maturity	$	27,483,390	$	606,777	$	—	$	28,090,167

^{(1) COMPRISED OF GSEs OR GNMA MORTGAGE-BACKED SECURITIES}



	December 31, 2015
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Mortgage-Backed Securities (1)	$	29,873,098	$	22,600	$	214,418	$	29,681,280
Total Held To Maturity	$	29,873,098	$	22,600	$	214,418	$	29,681,280

^{(1) COMPRISED OF GSEs OR GNMA MORTGAGE-BACKED SECURITIES}

Other than the mortgage-backed securities included above, there were no other investment securities classified as held to maturity at September 30, 2016 and December 31, 2015.

At September 30, 2016, the Bank held an amortized cost and fair value of $17.5 million and $17.8 million, respectively in GNMA mortgage-backed securities, which are included in the table above, compared to an amortized cost and fair value of $20.5 million and $20.4 million, respectively, at December 31, 2015. The Company has not invested in any private label mortgage-backed securities classified as held to maturity.

At September 30, 2016, the amortized cost and fair value of mortgage-backed securities held to maturity that were pledged as collateral for certain deposit accounts, FHLB advances and other borrowings were $25.0 million and $25.5 million, respectively, compared to an amortized cost and fair value of $26.0 million and $25.8 million, respectively, at December 31, 2015.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

There were no gross unrealized losses at September 30, 2016. The following table shows gross unrealized losses, fair value, and length of time that individual held to maturity securities were in a continuous unrealized loss position at December 31, 2015.



	December 31, 2015
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-Backed Securities (1)	$	25,484,972	$	214,418	$	—	$	—	$	25,484,972	$	214,418
	$	25,484,972	$	214,418	$	—	$	—	$	25,484,972	$	214,418

^{(1) COMPRISED OF GSEs OR GNMA MORTGAGE-BACKED SECURITIES}

The Company’s held to maturity portfolio is recorded at amortized cost. The Company has the ability and intent to hold these securities to maturity.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net

Loans receivable, net, consisted of the following as of the dates indicated below:



	September 30, 2016		December 31, 2015
Residential Real Estate Loans	$	81,030,012	$	76,373,071
Consumer Loans	50,686,906		50,380,289
Commercial Business Loans	16,242,394		12,514,133
Commercial Real Estate Loans	211,930,466		200,083,125
Total Loans Held For Investment	359,889,778		339,350,618
Loans Held For Sale	4,143,431		2,462,559
Total Loans Receivable, Gross	364,033,209		341,813,177
Less:
Allowance For Loan Losses	8,111,111		8,275,133
Loans In Process	4,003,973		2,902,849
Deferred Loan Fees	99,555		62,466
	12,214,639		11,240,448
Total Loans Receivable, Net	$	351,818,570	$	330,572,729

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 to have the least amount of risk in terms of determining the allowance for loan losses. Loans that are graded as substandard are considered to have the most risk. 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 caution and special mention categories fall in between the pass and substandard grades and consist of loans that do not currently expose the Company to sufficient risk to warrant adverse classification but possess weaknesses.

The following tables list the loan grades used by the Company as credit quality indicators and the balance for each loan category at the dates presented, excluding loans held for sale.



	Credit Quality Measures
September 30, 2016	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	73,440,126	$	687,636	$	424,306	$	6,477,944	$	81,030,012
Consumer	47,022,390		2,506,844		7,331		1,150,341		50,686,906
Commercial Business	14,780,095		953,963		54,669		453,667		16,242,394
Commercial Real Estate	116,912,982		72,253,892		15,691,107		7,072,485		211,930,466
Total	$	252,155,593	$	76,402,335	$	16,177,413	$	15,154,437	$	359,889,778



	Credit Quality Measures
December 31, 2015	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	67,605,311	$	1,264,415	$	607,336	$	6,896,009	$	76,373,071
Consumer	46,344,056		2,510,519		81,617		1,444,097		50,380,289
Commercial Business	10,519,123		1,465,136		102,046		427,828		12,514,133
Commercial Real Estate	129,242,390		43,863,659		17,304,431		9,672,645		200,083,125
Total	$	253,710,880	$	49,103,729	$	18,095,430	$	18,440,579	$	339,350,618

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net, Continued

The following tables present an age analysis of past due balances by category at September 30, 2016 and December 31, 2015:



September 30, 2016	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	$	—	$	1,133,054	$	2,869,815	$	4,002,869	$	77,027,143	$	81,030,012
Consumer	855,472		46,622		283,770		1,185,864		49,501,042		50,686,906
Commercial Business	131,323		43,082		145,401		319,806		15,922,588		16,242,394
Commercial Real Estate	4,645,754		183,888		2,933,751		7,763,393		204,167,073		211,930,466
Total	$	5,632,549	$	1,406,646	$	6,232,737	$	13,271,932	$	346,617,846	$	359,889,778



December 31, 2015	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	$	—	$	1,144,381	$	3,306,675	$	4,451,056	$	71,922,015	$	76,373,071
Consumer	710,881		282,314		575,866		1,569,061		48,811,228		50,380,289
Commercial Business	101,201		—		178,076		279,277		12,234,856		12,514,133
Commercial Real Estate	3,309,287		929,819		2,973,135		7,212,241		192,870,884		200,083,125
Total	$	4,121,369	$	2,356,514	$	7,033,752	$	13,511,635	$	325,838,983	$	339,350,618

At September 30, 2016 and December 31, 2015, the Company did not have any loans that were 90 days or more past due and still accruing interest. Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the existing collateral. In the event an acceptable arrangement cannot be reached, we may have to acquire these properties through foreclosure or other means and subsequently sell, develop, or liquidate them.

The following table shows non-accrual loans by category at September 30, 2016 compared to December 31, 2015:



	September 30, 2016				December 31, 2015				$			%
	Amount		Percent ⁽¹⁾		Amount		Percent ⁽¹⁾		Increase (Decrease)			Increase (Decrease)
Non-accrual Loans:
Residential Real Estate	$	2,869,815	0.81	%	$	3,306,675	0.98	%	$	(436,860	)	(13.2	)%
Consumer	283,770		0.08		575,866		0.17		(292,096		)	(50.7	)
Commercial Business	145,401		0.04		178,076		0.05		(32,675		)	(18.3	)
Commercial Real Estate	2,933,751		0.82		2,973,135		0.80		(39,384		)	(1.3	)
Total Non-accrual Loans	$	6,232,737	1.75	%	$	7,033,752	2.09	%	$	(801,015	)	(11.4	)%

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net, Continued

The following tables show the activity in the allowance for loan losses by category for the three and nine months ended September 30, 2016 and 2015:



	Three Months Ended September 30, 2016
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,462,636		$	1,115,976		$	865,867		$	4,950,735		$	8,395,214
Provision for Loan Losses	31,415			(155,298		)	713,276			(589,393		)	—
Charge-Offs	(137,935		)	(35,312		)	(150,000		)	—			(323,247		)
Recoveries	1,228			23,569			11,731			2,616			39,144
Ending Balance	$	1,357,344		$	948,935		$	1,440,874		$	4,363,958		$	8,111,111



	Nine Months Ended September 30, 2016
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,323,183		$	1,063,153		$	773,948		$	5,114,849		$	8,275,133
Provision for Loan Losses	160,823			(1,501		)	805,195			(964,517		)	—
Charge-Offs	(137,935		)	(189,193		)	(150,000		)	(202,618		)	(679,746		)
Recoveries	11,273			76,476			11,731			416,244			515,724
Ending Balance	$	1,357,344		$	948,935		$	1,440,874		$	4,363,958		$	8,111,111



	Three Months Ended September 30, 2015
	Residential Real Estate			Consumer			Commercial Business		Commercial Real Estate			Total
Beginning Balance	$	1,310,078		$	1,007,984		$	747,067	$	4,730,453		$	7,795,582
Provision for Loan Losses	142,917			199,719			4,565		(547,201		)	(200,000		)
Charge-Offs	(59,996		)	(77,720		)	—		(303,682		)	(441,398		)
Recoveries	782			26,783			564		752,710			780,839
Ending Balance	$	1,393,781		$	1,156,766		$	752,196	$	4,632,280		$	7,935,023



	Nine Months Ended September 30, 2015
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,392,065		$	886,716		$	159,353		$	5,919,362		$	8,357,496
Provision for Loan Losses	106,079			656,424			595,906			(1,458,409		)	(100,000		)
Charge-Offs	(105,912		)	(471,345		)	(10,947		)	(750,154		)	(1,338,358		)
Recoveries	1,549			84,971			7,884			921,481			1,015,885
Ending Balance	$	1,393,781		$	1,156,766		$	752,196		$	4,632,280		$	7,935,023

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net, Continued

The following tables present information related to impaired loans evaluated individually and collectively for impairment in the allowance for loan losses at the dates indicated:



	Allowance For Loan Losses
September 30, 2016	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	—	$	1,357,344	$	1,357,344
Consumer	1,752		947,183		948,935
Commercial Business	—		1,440,874		1,440,874
Commercial Real Estate	145,953		4,218,005		4,363,958
Total	$	147,705	$	7,963,406	$	8,111,111



	Allowance For Loan Losses
December 31, 2015	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	—	$	1,323,183	$	1,323,183
Consumer	32,300		1,030,853		1,063,153
Commercial Business	—		773,948		773,948
Commercial Real Estate	49,300		5,065,549		5,114,849
Total	$	81,600	$	8,193,533	$	8,275,133

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



	Loans Receivable
September 30, 2016	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	2,621,211	$	78,408,801	$	81,030,012
Consumer	188,571		50,498,335		50,686,906
Commercial Business	145,401		16,096,993		16,242,394
Commercial Real Estate	6,796,582		205,133,884		211,930,466
Total	$	9,751,765	$	350,138,013	$	359,889,778



	Loans Receivable
December 31, 2015	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	2,922,105	$	73,450,966	$	76,373,071
Consumer	372,382		50,007,907		50,380,289
Commercial Business	162,201		12,351,932		12,514,133
Commercial Real Estate	9,190,640		190,892,485		200,083,125
Total	$	12,647,328	$	326,703,290	$	339,350,618

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. 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 the 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 $10.6 million for the three months ended September 30, 2016 compared to $14.1 million for the three months ended September 30, 2015.

The following tables present information related to impaired loans by loan category at September 30, 2016 and December 31, 2015 and for the three and nine months ended September 30, 2016 and 2015.



	September 30, 2016						December 31, 2015
Impaired Loans	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
With No Related Allowance Recorded:
Residential Real Estate	$	2,621,212	$	2,792,712	$	—	$	2,922,105	$	3,033,735	$	—
Consumer	127,360		135,660		—		120,889		129,188		—
Commercial Business	145,401		995,401		—		162,201		362,201		—
Commercial Real Estate	6,157,972		8,118,513		—		8,620,301		10,969,642		—
With An Allowance Recorded:
Residential Real Estate	—		—		—		—		—		—
Consumer	61,210		61,210		1,752		251,493		256,923		32,300
Commercial Business	—		—		—		—		—		—
Commercial Real Estate	638,610		651,624		145,953		570,339		577,139		49,300
Total
Residential Real Estate	2,621,212		2,792,712		—		2,922,105		3,033,735		—
Consumer	188,570		196,870		1,752		372,382		386,111		32,300
Commercial Business	145,401		995,401		—		162,201		362,201		—
Commercial Real Estate	6,796,582		8,770,137		145,953		9,190,640		11,546,781		49,300
Total	$	9,751,765	$	12,755,120	$	147,705	$	12,647,328	$	15,328,828	$	81,600

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net, Continued



	Three Months Ended September 30,
	2016				2015
Impaired Loans	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With No Related Allowance Recorded:
Residential Real Estate	$	3,319,559	$	—	$	3,084,808	$	—
Consumer	128,751		—		97,894		—
Commercial Business	296,401		—		170,601		—
Commercial Real Estate	6,180,761		67,380		10,168,004		71,766
With An Allowance Recorded:
Residential Real Estate	—		—		—		—
Consumer	61,581		772		100,743		1,201
Commercial Business	—		—		—		—
Commercial Real Estate	641,743		28,534		452,393		2,303
Total
Residential Real Estate	3,319,559		—		3,084,808		—
Consumer	190,332		772		198,637		1,201
Commercial Business	296,401		—		170,601		—
Commercial Real Estate	6,822,504		95,914		10,620,397		74,069
Total	$	10,628,796	$	96,686	$	14,074,443	$	75,270



	Nine Months Ended September 30,
	2016				2015
Impaired Loans	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With No Related Allowance Recorded:
Residential Real Estate	$	3,469,066	$	8,282	$	3,132,323	$	8,477
Consumer	294,714		—		100,937		247
Commercial Business	301,881		—		198,430		—
Commercial Real Estate	8,589,845		192,017		10,510,256		246,219
With An Allowance Recorded:
Residential Real Estate	—		—		—		—
Consumer	62,322		3,470		101,435		3,615
Commercial Business	—		—		—		—
Commercial Real Estate	652,867		28,534		456,982		15,919
Total
Residential Real Estate	3,469,066		8,282		3,132,323		8,477
Consumer	357,036		3,470		202,372		3,862
Commercial Business	301,881		—		198,430		—
Commercial Real Estate	9,242,712		220,551		10,967,238		262,138
Total	$	13,370,695	$	232,303	$	14,500,363	$	274,477

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net, Continued

In the course of resolving delinquent loans, the Bank may choose to restructure the contractual terms of certain loans. A troubled debt restructuring ("TDR") is a restructuring in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a borrower that it would not otherwise consider (Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 310-40). The concessions granted on TDRs generally include terms to reduce the interest rate, extend the term of the debt obligation, or modify the payment structure on the debt obligation. The Bank grants such concessions to reassess the borrower’s financial status and develop a plan for repayment. TDRs included in impaired loans at September 30, 2016 and December 31, 2015 were $5.2 million and $6.7 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 loan is reasonably assured of repayment and performance is expected in accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the concession date if reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. Nonaccrual TDRs are returned to accruing status when there is economic substance to the restructuring, there is documented credit evaluation of the borrower's financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated sustained repayment performance in accordance with the modified terms for a reasonable period of time (generally a minimum of six months).

The Bank did not modify any loans that were considered to be TDRs during the nine months ended September 30, 2016. The following table is a summary of loans restructured as TDRs during the nine months ended September 30, 2015.



	Nine Months Ended September 30, 2015
Troubled Debt Restructurings	Number of Contracts	Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Consumer	1	$	36,460	$	36,460
Commercial Real Estate	5	872,703		872,703
Total	6	$	909,163	$	909,163

During the nine months ended September 30, 2015, the Bank modified six loans that were considered to be TDRs, three of which were modified during the three months ended September 30, 2015. The Bank lowered the interest rate on two of the loans to allow the borrowers to begin making monthly principal and interest payments and changed the monthly payment to interest only for an agreed upon period for the other four loans.

At September 30, 2016, six loans totaling $765,000 that had previously been restructured as TDRs were in default, none of which had been restructured within the last 12 months. Three of the loans, with a balance of $637,000, defaulted during the nine month period ended September 30, 2016. In comparison, at September 30, 2015, three loans totaling $684,000 that had previously been restructured as TDRs were in default, and two of the loans, with a balance of $555,000 defaulted during the nine month period. 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 as 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 probable. 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 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 modified loan terms before that loan can be placed back on accrual status. In addition to this payment history, the borrower must demonstrate an ability to continue making payments on the loan prior to restoration of accrual status.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

9. Regulatory Matters

As a state-chartered, federally insured commercial bank, the Bank is subject to the capital requirements established by the FDIC. Under the FDIC’s capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of Tier 1 capital (as defined in the regulations) to total average assets (as defined), and minimum ratios of Tier 1 total capital (as defined) and common equity Tier 1 (“CET1”) capital to risk-weighted assets (as defined).

In addition to the minimum CET1, Tier 1 and total capital ratios, the Bank is required to maintain a capital conservation buffer consisting of additional CET1 capital above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of eligible retained income that could be utilized for such actions. This new capital conservation buffer requirement began to be phased in starting in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019.

The Company is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. For a bank holding company with less than $1.0 billion in assets, the capital guidelines apply on a bank only basis and the Federal Reserve expects the holding company's subsidiary banks to be well-capitalized under the prompt corrective action regulations. If Security Federal Corporation was subject to regulatory guidelines for bank holding companies with $1.0 billion or more in assets, at September 30, 2016, it would have exceeded all regulatory capital requirements.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

9. Regulatory Matters, Continued

As of September 30, 2016, the Bank and the Company exceeded all regulatory capital requirements and the Bank was considered “well capitalized” under regulatory capital guidelines of the FDIC. The following tables provide the Company’s and the Bank’s regulatory capital requirements and actual results at the dates indicated below:



	Actual				For Capital Adequacy				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in Thousands)
September 30, 2016
SECURITY FEDERAL CORP.
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	90,047	21.2	%	$	25,475	6.0	%	N/A		N/A
Total Risk-Based Capital (To Risk Weighted Assets)	99,874		23.5	%	33,967		8.0	%	N/A		N/A
Common Equity Tier 1 Capital (To Risk Weighted Assets)	67,536		15.9	%	19,106		4.5	%	N/A		N/A
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	90,047		11.1	%	32,338		4.0	%	N/A		N/A

SECURITY FEDERAL BANK
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	88,588	20.9	%	$	25,457	6.0	%	$	33,943	8.0	%
Total Risk-Based Capital (To Risk Weighted Assets)	93,926		22.1	%	33,943		8.0	%	42,428		10.0	%
Common Equity Tier 1 Capital (To Risk Weighted Assets)	88,588		20.9	%	19,093		4.5	%	27,578		6.5	%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	88,588		11.0	%	32,329		4.0	%	40,411		5.0	%

December 31, 2015
SECURITY FEDERAL CORP.
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	84,672	21.7	%	$	23,429	6.0	%	N/A		N/A
Total Risk-Based Capital (To Risk Weighted Assets)	95,429		24.4	%	31,239		8.0	%	N/A		N/A
Common Equity Tier 1 Capital (To Risk Weighted Assets)	63,504		16.3	%	17,572		4.5	%	N/A		N/A
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	84,672		10.6	%	31,811		4.0	%	N/A		N/A

SECURITY FEDERAL BANK
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	87,728	22.5	%	$	23,440	6.0	%	$	31,254	8.0	%
Total Risk-Based Capital (To Risk Weighted Assets)	92,653		23.7	%	31,254		8.0	%	39,067		10.0	%
Common Equity Tier 1 Capital (To Risk Weighted Assets)	87,728		22.5	%	17,580		4.5	%	25,394		6.5	%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	87,728		11.0	%	31,801		4.0	%	39,751		5.0	%

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

10. Carrying Amounts and Fair Value of Financial Instruments

The Company has adopted accounting guidance which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value under generally accepted accounting principles. This guidance applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.

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



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

The following is a description of the valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. At September 30, 2016, the Company’s investment portfolio was comprised of government and agency bonds, mortgage-backed securities issued by government agencies or GSEs, private label CMO mortgage-backed securities, municipal securities, and two equity investments. Fair value measurement is based upon prices obtained from third party pricing services that 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 a result, 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 the FHLMC 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 a commitment to, and receives funding from, the investor within 30 days. Commitments to sell these loans to the investor are considered derivative contracts and are sold to investors on a “best efforts" basis. The Company is not obligated to deliver a loan or pay a penalty if a loan is not delivered to the investor. As a result of the short-term nature of these derivative contracts, the fair value of the mortgage loans held for sale in most cases is the same as the value of the loan amount at its origination. These loans are classified as Level 2.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

Impaired Loans

The Company does not record loans held for investment at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established as necessary. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as impaired, management measures the impairment by determining the fair value of the collateral for the loan.

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.

Impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2016, our impaired loans were generally 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. At September 30, 2016 and December 31, 2015, the recorded investment in impaired loans was $9.8 million and $12.6 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 at September 30, 2016 were as follows:



Assets:	Quoted Market Price In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
FNMA Bonds	$	—	$	1,017,681	$	—
SBA Bonds	—		102,198,130		—
Tax Exempt Municipal Bonds	—		82,956,495		—
Taxable Municipal Bonds			1,040,660
Mortgage-Backed Securities	—		193,426,007		—
Equity Securities	—		331,334		—
Total	$	—	$	380,970,307	$	—

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

Assets measured at fair value on a recurring basis at December 31, 2015 were as follows:



Assets:	Quoted Market Price In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
FHLB Securities	$	—	$	1,932,088	$	—
FFCB Securities	—		1,987,936		—
FNMA Bonds	—		1,004,331		—
SBA Bonds	—		111,416,782		—
Tax Exempt Municipal Bonds	—		76,065,619		—
Mortgage-Backed Securities	—		182,797,212		—
Equity Securities	—		309,902		—
Total	$	—	$	375,513,870	$	—

There were no liabilities measured at fair value on a recurring basis at September 30, 2016 or December 31, 2015.

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 at September 30, 2016 and December 31, 2015, aggregated by the level in the fair value hierarchy within which those measurements fall.



Assets:	Level 1		Level 2		Level 3		Balance at September 30, 2016
Mortgage Loans Held For Sale	$	—	$	4,143,431	$	—	$	4,143,431
Collateral Dependent Impaired Loans ⁽¹⁾	—		—		9,604,060		9,604,060
Foreclosed Assets	—		—		2,327,345		2,327,345
Total	$	—	$	4,143,431	$	11,931,405	$	16,074,836

^{(1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF $}^147,705



Assets:	Level 1		Level 2		Level 3		Balance at December 31, 2015
Mortgage Loans Held For Sale	$	—	$	2,462,559	$	—	$	2,462,559
Collateral Dependent Impaired Loans ⁽¹⁾	—		—		12,565,728		12,565,728
Foreclosed Assets	—		—		4,361,411		4,361,411
Total	$	—	$	2,462,559	$	16,927,139	$	19,389,698

^{(1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF}^$81,600

There were no liabilities measured at fair value on a nonrecurring basis at September 30, 2016 or December 31, 2015.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

10. 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 at September 30, 2016, the significant unobservable inputs used in the fair value measurements were as follows:



			Valuation	Significant
	Fair Value		Technique	Unobservable Inputs	Range
Collateral Dependent Impaired Loans	$	9,604,060	Appraised Value	Discount Rates/ Discounts to Appraised Values	0% - 16%

Foreclosed Assets	2,327,345		Appraised Value/Comparable Sales	Discount Rates/ Discounts to Appraised Values	16% - 100%

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

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

Certificates of Deposit with Other Banks—Fair value is based on market prices for similar assets.

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

Loans Receivable, Net—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

10. 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 at September 30, 2016 and December 31, 2015 presented in accordance with the applicable accounting guidance.



	September 30, 2016
	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash and Cash Equivalents	$	11,352	$	11,352	$	11,352	$	—	$	—
Certificates of Deposits with Other Banks	3,445		3,445		—		3,445		—
Investment and Mortgage-Backed Securities	408,454		409,060		—		409,060		—
Loans Receivable, Net	351,819		353,269		—		—		353,269
FHLB Stock	2,675		2,675		2,675		—		—

Financial Liabilities:
Deposits:
Checking, Savings, and Money Market Accounts	$	429,109	$	429,109	$	429,109	$	—	$	—
Certificate Accounts	221,189		220,988		—		220,988		—
Advances from FHLB	46,000		46,069		—		46,069		—
Other Borrowed Money	12,598		12,598		12,598		—		—
Senior Convertible Debentures	6,084		6,084		—		6,084		—
Junior Subordinated Debentures	5,155		5,155		—		5,155		—



	December 31, 2015
	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash and Cash Equivalents	$	8,382	$	8,382	$	8,382	$	—	$	—
Certificates of Deposits with Other Banks	3,445		3,445		—		3,445		—
Investment and Mortgage-Backed Securities	405,387		405,196		—		405,196		—
Loans Receivable, Net	330,573		327,460		—		—		327,460
FHLB Stock	2,215		2,215		2,215		—		—

Financial Liabilities:
Deposits:
Checking, Savings, and Money Market Accounts	$	415,975	$	415,975	$	415,975	$	—	$	—
Certificate Accounts	236,122		235,476		—		235,476		—
Advances from FHLB	34,640		35,676		—		35,676		—
Other Borrowed Money	6,412		6,412		6,412		—		—
Senior Convertible Debentures	6,084		6,084		—		6,084		—
Junior Subordinated Debentures	5,155		5,155		—		5,155		—

At September 30, 2016, the Bank had $70.0 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 amount 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

10. 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.

11. Accounting and Reporting Changes

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

In January 2014, the FASB amended the Investments-Equity Method and Joint Ventures topic of the ASC 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 were effective for the Company for interim and annual reporting periods beginning after December 15, 2014 and were applied retrospectively for all periods presented. The amendments did not have a material effect on the Company's consolidated financial statements.

In May 2014 and August 2015, the FASB issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a modified retrospective approach. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In June 2014, the FASB issued guidance which makes limited amendments to the guidance on accounting for certain repurchase agreements. The new guidance (1) requires entities to account for repurchase-to-maturity transactions as secured borrowings (rather than as sales with forward repurchase agreements), (2) eliminates accounting guidance on linked repurchase financing transactions, and (3) expands disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers (specifically, repos, securities lending transactions, and repurchase-to-maturity transactions) accounted for as secured borrowings. The amendments were effective for the Company on January 1, 2015. These amendments did not have a material effect on the Company's consolidated financial statements.

In June 2014, the FASB issued guidance which clarifies that performance targets associated with stock compensation should be treated as a performance condition and should not be reflected in the grant date fair value of the stock award. The amendments were effective for the Company on January 1, 2016. These amendments did not have a material effect on the Company's consolidated financial statements.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

11. Accounting and Reporting Changes, Continued

In February 2015, the FASB issued guidance which amends the consolidation requirements and significantly changes the consolidation analysis required under U.S. GAAP. Although the amendments are expected to result in the deconsolidation of many entities, the Company will need to reevaluate all its previous consolidation conclusions. The amendments were effective for the Company on January 1, 2016. These amendments did not have a material effect on the Company's consolidated financial statements.

In January 2016, the FASB amended the Financial Instruments topic of the ASC to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company will apply the guidance by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values will be applied prospectively to equity investments that exist as of the date of adoption of the amendments. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In February 2016, the FASB amended the Leases topic of the ASC to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. The amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently evaluating the effect that implementation of the new standard will have on its financial position, results of operations, and cash flows.

In March 2016, the FASB amended the Revenue from Contracts with Customers topic of the ASC to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In March 2016, the FASB issued guidance to simplify several aspects of the accounting for share-based payment award transactions including the income tax consequences, the classification of awards as either equity or liabilities, and the classification on the statement of cash flows. Additionally, the guidance simplifies two areas specific to entities other than public business entities allowing them apply a practical expedient to estimate the expected term for all awards with performance or service conditions that have certain characteristics and also allowing them to make a one-time election to switch from measuring all liability-classified awards at fair value to measuring them at intrinsic value. The amendments will be effective for the Company for annual periods beginning after December 15, 2016 and interim periods within those annual periods. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In April 2016, the FASB amended the Revenue from Contracts with Customers topic of the ASC to clarify guidance related to identifying performance obligations and accounting for licenses of intellectual property. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In May 2016, the FASB amended the Revenue from Contracts with Customers topic of the ASC to clarify guidance related to collectability, noncash consideration, presentation of sales tax, and transition. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. The Company is currently evaluating the effect that implementation of the new standard will have on its consolidated financial position, results of operations, and cash flows.

In August 2016, the FASB amended the Statement of Cash Flows topic of the ASC to clarify how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

12. 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 determined that the following subsequent event required disclosure.

On September 29, 2010, the Company issued 22,000 shares of Series B Fixed Rate Cumulative Perpetual Preferred Stock to the United States Department of the Treasury (“Treasury”) in connection with its participation in the Community Development Capital Initiative.

On October 31, 2016, the Company repurchased all 22,000 shares of its Series B Fixed Rate Cumulative Perpetual Preferred Stock from Treasury for a repurchase amount of $21.3 million plus accrued but unpaid interest of $93,000 for a total payment amount of $21.4 million. In connection with this repurchase, the Company obtained a $14 million term loan with another financial institution. The loan accrues and pays interest quarterly at a floating rate of the Wall Street Journal Prime index minus 30 basis points. The note matures on October 1, 2019.

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

Certain matters discussed in this Quarterly Report on Form 10-Q may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words "believes," "expects," "anticipates," "estimates," "forecasts," "intends," "plans," "targets," "potentially," "probably," "projects," "outlook" or similar expressions or future or conditional verbs such as "may," "will," "should," "would" and "could." Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risk and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors, including, but not limited to:

•

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 affected 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 allowance for loan losses;


•	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 Board of Governors of the Federal Reserve System ("Federal Reserve") and our bank subsidiary by the Federal Deposit Insurance Corporation ("FDIC") and the South Carolina State 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, or impose additional requirements or restrictions on us, any of which could adversely affect our liquidity and earnings;


•	legislative or regulatory changes that adversely affect our business, including the effect of the Dodd-Frank Wall Street Reform and Consumer Protection Act; changes in regulatory policies and principles, or the interpretation of regulatory capital requirements or other rules, including as a result of Basel III;


•	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 the 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 manage loan delinquency rates;


•	increased competitive pressures among financial services companies;


•	changes in consumer spending, borrowing and savings habits;

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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


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


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


•	adverse changes in the securities markets;


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


•	changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the FASB, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; 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 2015 Form 10-K under Item 1A, “Risk Factors.” Such developments could have an adverse impact on our consolidated financial position and results of operations.

Any of the forward-looking statements that we make in this quarterly report on Form 10-Q and in other public reports and 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 2016 and beyond to differ materially from those expressed in any forward-looking statements by or on behalf of us, and could negatively affect the Company’s financial condition, liquidity and operating and stock price performance.

Financial Condition at September 30, 2016 and December 31, 2015

Assets

Total assets increased $24.2 million or 3.0% to $823.9 million at September 30, 2016 from $799.7 million at December 31, 2015. The primary reason for the increase in total assets was an increase of $21.2 million or 6.4% in loans receivable. The increases and decreases in total assets were primarily concentrated in the following asset categories:



					Increase (Decrease)
	September 30, 2016		December 31, 2015		Amount			Percent
Cash and Cash Equivalents	$	11,352,028	$	8,381,951	$	2,970,077		35.4%
Investment and Mortgage-Backed Securities – Available For Sale	380,970,307		375,513,870		5,456,437			1.5
Investment and Mortgage-Backed Securities – Held To Maturity	27,483,390		29,873,098		(2,389,708		)	(8.0)
Loans Receivable, Net	351,818,570		330,572,729		21,245,841			6.4
OREO	2,327,345		4,361,411		(2,034,066		)	(46.6)
Premises and Equipment, Net	20,663,421		20,116,918		546,503			2.7
FHLB Stock	2,674,700		2,214,800		459,900			20.8
BOLI	16,969,045		16,573,045		396,000			2.4
Other Assets	2,110,251		4,449,956		(2,339,705		)	(52.6)

Cash and cash equivalents increased $3.0 million or 35.4% to $11.4 million at September 30, 2016 from $8.4 million at December 31, 2015. Investment and mortgage-backed securities available for sale increased $5.5 million or 1.5% to $381.0 million at September 30, 2016 from $375.5 million at December 31, 2015. Investment and mortgage-backed securities held to maturity decreased $2.4 million or 8.0% to $27.5 million at September 30, 2016 from $29.9 million at December 31, 2015. The Bank purchased 45 investment and mortgage-backed securities classified as available for sale for $68.0 million and one mortgage-backed security classified as held to maturity for $1.5 million during the nine months ended of September 30, 2016.

Loans receivable, net, increased $21.2 million or 6.4% to $351.8 million at September 30, 2016 from $330.6 million at December 31, 2015 as a result of increased loan originations in all loan categories. Residential real estate loans increased $4.7 million or 6.1%

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

to $81.0 million at September 30, 2016 from $76.4 million at December 31, 2015. Commercial real estate loans increased $11.8 million or 5.9% to $211.9 million at September 30, 2016 from $200.1 million at December 31, 2015. Commercial business loans increased $3.7 million or 29.8% to $16.2 million at September 30, 2016 from $12.5 million at December 31, 2015. Consumer loans increased $307,000 or 0.6% to $50.7 million at September 30, 2016 compared to $50.4 million at December 31, 2015. Loans held for sale increased $1.7 million or 68.3% to $4.1 million at September 30, 2016 from $2.5 million at December 31, 2015.

OREO decreased $2.0 million or 46.6% to $2.3 million at September 30, 2016 from $4.4 million at December 31, 2015. The decrease was due to the sale of 14 OREO properties during the nine months ended September 30, 2016 with a total book value of $2.3 million offset slightly by the addition of four OREO properties with a total book value of $324,000. At September 30, 2016, OREO consisted of the following real estate properties: six single-family residences and 23 lots within residential subdivisions located throughout our market areas in South Carolina and Georgia; four parcels of commercial land in South Carolina; one commercial building in South Carolina; and eight lots within a residential subdivision and the adjacent 22.96 acres of land in Aiken, South Carolina.

Premises and equipment, net increased $547,000 or 2.7% to $20.7 million at September 30, 2016 from $20.1 million at December 31, 2015. The increase was primarily due to additions to construction in progress related to the construction of the Bank's new branch in Evans, Georgia, which is scheduled to open in early 2017.

The cash value of BOLI increased $396,000 or 2.4% to $17.0 million at September 30, 2016 compared to $16.6 million at December 31, 2015. BOLI, which earns tax-free yields, is utilized to partially offset the cost of the Bank’s employee benefits programs and to provide key person insurance on certain officers of the Company.

FHLB stock increased $460,000 or 20.8% to $2.7 million at September 30, 2016 compared to $2.2 million at December 31, 2015 as a result of an increase in advances from the FHLB. 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 0.09% of total assets, plus a transaction component, which is 4.25% of outstanding advances (borrowings) from the FHLB of Atlanta. As the Bank's total advances have increased, so has its required investment in FHLB stock.

Other assets decreased $2.3 million or 52.6% to $2.1 million at September 30, 2016 from $4.4 million at December 31, 2015. The decrease was primarily the result of a $2.0 million decrease in net deferred taxes, which was 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 at the dates indicated below:



	September 30, 2016			December 31, 2015			Balance Increase (Decrease)
	Balance		Weighted Rate	Balance		Weighted Rate	Amount			Percent
Demand Accounts:
Checking	$	160,298,382	0.02%	$	155,765,968	0.03%	$	4,532,414		2.9%
Money Market	233,352,617		0.17	229,016,993		0.16	4,335,624			1.9
Statement Savings Accounts	35,458,314		0.10	31,191,828		0.10	4,266,486			13.7
Total	$	429,109,313	0.11%	$	415,974,789	0.11%	$	13,134,524		3.2%

Certificate Accounts
0.00 – 0.99%	$	157,954,136		$	175,755,511		$	(17,801,375	)	(10.1)%
1.00 – 1.99%	62,535,859			51,479,431			11,056,428			21.5
2.00 – 2.99%	698,944			8,886,814			(8,187,870		)	(92.1)
Total	221,188,939		0.75%	236,121,756		0.69%	(14,932,817		)	(6.3)%
Total Deposits	$	650,298,252	0.32%	$	652,096,545	0.32%	$	(1,798,293	)	(0.3)%

Included in the certificate accounts above were $38.3 million and $42.5 million in brokered deposits at September 30, 2016 and December 31, 2015, respectively, with a weighted average interest rate of 1.09% and 0.94%, respectively.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

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



	September 30, 2016			December 31, 2015			Increase (Decrease)
Year Due:	Balance		Rate	Balance		Rate	Balance			Percent
2016	$	17,500,000	1.48%	$	16,740,000	1.51%	$	760,000		4.54%
2017	7,500,000		0.75	12,900,000		4.38	(5,400,000		)	(41.86)
2018	10,000,000		1.05	5,000,000		3.39	5,000,000			100.00
2019	8,000,000		1.16	—		—	8,000,000			100.00
Thereafter	3,000,000		1.38	—		—	3,000,000			—
Total Advances	$	46,000,000	1.21%	$	34,640,000	3.87%	$	11,360,000		32.79%

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 $69.6 million and $67.5 million at September 30, 2016, respectively, and $77.8 million and $74.7 million at December 31, 2015, respectively. Advances are subject to prepayment penalties. During the nine months ended September 30, 2016, the Bank prepaid three FHLB advances totaling $17.9 million and incurred $789,000 in prepayment penalties in order to reduce interest expense in future periods and improve net interest spread.

There were no callable FHLB advances at September 30, 2016. Callable advances are callable at the option of the FHLB. If an advance is called, the Bank has the option to pay off the advance without penalty, re-borrow funds on different terms, or convert the advance to a three-month floating rate advance tied to LIBOR.

Other Borrowings – The Bank had $12.6 million in other borrowings (non-FHLB advances) at September 30, 2016, an increase of $6.2 million or 96.5% from $6.4 million at December 31, 2015. These borrowings consist of short-term repurchase agreements with certain commercial demand deposit customers for sweep accounts. The repurchase agreements typically mature within one to three days and the interest rate paid on these borrowings floats monthly with money market type rates. At both September 30, 2016 and December 31, 2015, the interest rate paid on the repurchase agreements was 0.15%. The Bank had pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $18.6 million and $19.0 million, respectively, at September 30, 2016 and $14.3 million and $14.6 million, respectively, at December 31, 2015.

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. The Capital Securities accrue and pay distributions at a floating rate of three month LIBOR plus 170 basis points annually which was equal to 2.55% at September 30, 2016. The distribution rate payable on the Capital Securities is cumulative and payable quarterly in arrears. 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 $6.5 million or 7.2% to $97.5 million at September 30, 2016 from $91.0 million at December 31, 2015. Accumulated other comprehensive income, net of tax, comprised primarily of unrealized gains on securities available for sale, net of tax, increased $2.5 million or 58.0% to $6.7 million at September 30, 2016 from $4.3 million at December 31, 2015. The Company’s net income available for common shareholders was $4.7 million for the nine months ended September 30, 2016, after payment of $330,000 in preferred stock dividends. The Board of Directors of the Company declared common stock dividends totaling $707,000 during the nine months ended September 30, 2016. Book value per common share was $25.62 at September 30, 2016 compared to $23.41 at December 31, 2015.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Results of Operations for the Three Month Periods Ended September 30, 2016 and 2015

Net Income Available to Common Shareholders - Net income available to common shareholders increased $35,000 or 2.2% to $1.7 million or $0.54 per diluted common share for the three months ended September 30, 2016 compared to $1.6 million or $0.53 per diluted common share for the three months ended September 30, 2015. The increase in earnings was primarily the result of increases in net interest income and non-interest income offset by an increase in non-interest expense.

Net Interest Income - The net interest margin on a tax equivalent basis increased 19 basis points to 3.46% for the three months ended September 30, 2016 from 3.27% for the comparable period in 2015 as the average yield earned on interest-earning assets increased to 3.89% and the average cost of interest-bearing liabilities declined to 0.49%. Net interest income increased $441,000 or 7.5% to $6.3 million during the three months ended September 30, 2016, compared to $5.9 million for the same period in 2015. During the three months ended September 30, 2016, average interest earning assets increased $10.2 million or 1.4% to $755.4 million from $745.2 million for the same period in 2015. Average interest-bearing liabilities increased $5.2 million or 0.8% to $652.5 million for the three months ended September 30, 2016 from $647.2 million for the comparable period in 2015.

Interest Income - Total tax equivalent interest income increased $247,000 or 3.5% to $7.3 million during the three months ended September 30, 2016 compared to $7.1 million during the same period in 2015. This increase was the result of an eight basis point increase in the yield on interest-earning assets. Total interest income on loans increased $391,000 or 8.6% to $4.9 million during the three months ended September 30, 2016 from $4.5 million during the comparable period in 2015. The increase was the result of a $28.7 million or 9.0% increase in the average loan portfolio balance to $347.7 million for the three months ended September 30, 2016 offset by a decrease of two basis points in the yield. Interest income from mortgage-backed securities decreased $67,000 or 5.3% to $1.2 million from $1.3 million during the same period in 2015 as a result of a 15 basis point decrease in the portfolio yield offset by a $2.5 million increase in the average balance of mortgage-backed securities. Tax equivalent interest income from investment securities decreased $80,000 or 6.1% to $1.2 million during the three months ended September 30, 2016 from $1.3 million during the same period in 2015 due to a $19.7 million or 9.7% decrease in the average balance of the investment securities portfolio offset by a 10 basis point increase in the yield.

The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the three months ended September 30, 2016 and 2015:



	Three Months Ended September 30,								Increase (Decrease) In Interest Income
	2016				2015
	Average Balance		Yield⁽¹⁾		Average Balance		Yield⁽¹⁾
Loans Receivable, Net	$	347,680,574	5.65	%	$	318,992,863	5.67	%	$	390,859
Mortgage-Backed Securities	219,616,424		2.17		217,157,267		2.32		(67,030		)
Investment Securities⁽²⁾	184,332,296		2.66		204,071,269		2.56		(79,660)
Overnight Time and Certificates of Deposit	3,725,864		0.53		4,945,029		0.15		3,047
Total Interest-Earning Assets	$	755,355,158	3.89	%	$	745,166,428	3.81	%	$	247,216

⁽¹⁾ Annualized

⁽²⁾ Tax equivalent basis recognizes the income tax savings when comparing taxable and tax-exempt assets and was calculated using an effective tax rate of 34%. The tax equivalent adjustment relates to the tax exempt municipal bonds and was $183,850 and $181,592 for the quarters ended September 30, 2016 and 2015, respectively.

Interest Expense - Total interest expense decreased $196,000 or 19.6% to $805,000 during the quarter ended September 30, 2016 compared to $1.0 million for the same period in 2015. The decrease in total interest expense was attributable to decreases in interest rates paid offset by a $5.2 million or 0.8% increase in the average balance of interest-bearing liabilities to $652.5 million for the three months ended September 30, 2016. Interest expense on deposits decreased $37,000 or 6.7% to $519,000 during the quarter ended September 30, 2016 compared to $556,000 for the same period in 2015. The decrease was attributable to a two basis point decrease in the cost of deposit accounts combined with a $10.2 million or 1.7% decrease in average interest-bearing deposits to $586.0 million for the quarter ended September 30, 2016 compared to $596.2 million for the quarter ended September 30, 2015.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Interest expense on FHLB advances and other borrowings decreased $164,000 or 55.2% to $133,000 during the quarter ended September 30, 2016 from $296,000 for the same period in 2015. The decrease was attributable to a 202 basis point decrease in the yield offset by a $15.4 million or 38.8% increase in the average balance of FHLB advances and other borrowed money to $55.3 million during the quarter ended September 30, 2016 from $39.8 million for the same period in 2015. During the quarter ended September 30, 2016 the Bank prepaid one FHLB advance with a balance of $5.0 million at a 3.4% rate in order to reduce interest expense in future periods and improve its net interest spread.

The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the three months ended September 30, 2016 and 2015.



	Three Months Ended September 30,								Increase (Decrease) In Interest Expense
	2016				2015
	Average Balance		Yield⁽¹⁾		Average Balance		Yield⁽¹⁾
Now and Money Market Accounts	$	328,232,542	0.12	%	$	322,814,725	0.13	%	$	(1,498	)
Statement Savings Accounts	35,673,260		0.10		31,006,921		0.10		1,179
Certificate Accounts	222,077,392		0.73		242,356,598		0.73		(37,102		)
FHLB Advances and Other Borrowed Money	55,272,079		0.96		39,827,699		2.98		(163,608		)
Junior Subordinated Debentures	5,155,000		2.44		5,155,000		2.04		5,166
Senior Convertible Debentures	6,084,000		8.00		6,084,000		8.00		—
Total Interest-Bearing Liabilities	$	652,494,273	0.49	%	$	647,244,943	0.62	%	$	(195,863	)

⁽¹⁾ Annualized

Provision for Loan Losses - The amount of the provision is determined by management’s on-going monthly analysis of the loan portfolio and the adequacy of the allowance for loan losses. The Company has policies and procedures in place for evaluating and 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 loan portfolio based on historical trends and the risk inherent in each loan category. Currently, management applies a four year historical loss ratio to each loan category to estimate the inherent loss in these pooled loans.

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 underlying the loan.

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

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

The Company had net charge-offs of $284,000 for the quarter ended September 30, 2016 compared to net recoveries of $339,000 for the same three month period in 2015. There was no provision for loan losses recorded during the quarter ended September 30, 2016 compared to a negative provision of $200,000 for the quarter ended September 30, 2015. The negative provision was the result of an increase in recoveries and a decrease in non-performing assets.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

The following table includes selected activity associated with the allowance for loan losses for the three months ended September 30, 2016 and 2015:



	Three Months Ended September 30,
	2016		2015
Beginning Balance	$	8,395,214	$	7,795,582
Provision for Loan Losses	—		(200,000)
Charge-offs	(323,247)		(441,398)
Recoveries	39,144		780,839
Net (Charge-offs) Recoveries	(284,103)		339,441
Ending Balance	$	8,111,111	$	7,935,023

Allowance For Loan Losses as a Percentage of Gross Loans Receivable, Held For Investment at the End of the Period	2.3%		2.4%
Allowance For Loan Losses as a Percentage of Impaired Loans at the End of the Period	83.2%		57.2%
Impaired Loans	$	9,751,765	$	13,883,988
Gross Loans Receivable, Held For Investment ⁽¹⁾	$	355,786,250	$	326,171,126
Total Loans Receivable, Net	$	351,818,570	$	319,754,734

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

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 increased $412,000 or 30.1% to $1.8 million for the three months ended September 30, 2016, compared to $1.4 million for the three months ended September 30, 2015. The following table provides a detailed analysis of the changes in the components of non-interest income for the three months ended September 30, 2016 and 2015:



	Three Months Ended September 30,				Increase (Decrease)
	2016		2015		Amounts			Percent
Gain on Sale of Investment Securities	$	360,425	$	7,651	$	352,774		4,610.8	%
Gain on Sale of Loans	256,918		191,194		65,724			34.4
Service Fees on Deposit Accounts	266,960		258,522		8,438			3.3
Commissions From Insurance Agency	149,529		139,980		9,549			6.8
Bank Owned Life Insurance Income	132,000		117,000		15,000			12.8
Trust Income	197,000		152,200		44,800			29.4
Check Card Fee Income	247,331		239,739		7,592			3.2
Grant Income	—		97,640		(97,640		)	(100.0)
Other	170,519		164,488		6,031			3.7
Total Non-Interest Income	$	1,780,682	$	1,368,414	$	412,268		30.1	%

Gain on sale of investment securities increased $353,000 or 4,610.8% to $360,000 during the quarter ended September 30, 2016, compared to $8,000 for the same period last year due to an increase in the number of investment securities sold. The Bank sold eight investment securities during the quarter ended September 30, 2016 compared to two during the same period in 2015.

Income from the cash value of BOLI increased $15,000 or 12.8% to $132,000 during the quarter ended September 30, 2016 from $117,000 for the same period in 2015. The Company did not receive any life insurance proceeds during the third quarter of 2016 or 2015. All BOLI income recognized during both quarters was related to accrued interest credited to the cash surrender value underlying the BOLI policies.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Non-Interest Expense –For the quarter ended September 30, 2016, non-interest expense increased $564,000 or 11.0% to $5.7 million compared to $5.1 million for the same period in 2015. The following table provides a detailed analysis of the changes in the components of non-interest expense for the three months ended September 30, 2016 and 2015:



	Three Months Ended September 30,					Increase (Decrease)
	2016		2015			Amounts			Percent
Compensation and Employee Benefits	$	3,167,112	$	3,002,259		$	164,853		5.5%
Occupancy	502,352		481,713			20,639			4.3
Advertising	100,251		95,226			5,025			5.3
Depreciation and Maintenance of Equipment	510,645		401,102			109,543			27.3
FDIC Insurance Premiums	62,163		140,172			(78,009		)	(55.7)
Net Cost of Operation of OREO	25,991		(19,713		)	45,704			(231.8)
Prepayment Penalties on FHLB Advances	260,594		—			260,594			100.0
Other	1,065,209		1,029,201			36,008			3.5
Total Non-Interest Expense	$	5,694,317	$	5,129,960		$	564,357		11.0%

Compensation and employee benefits expenses increased $165,000 or 5.5% to $3.2 million for the three months ended September 30, 2016 compared to $3.0 million for the same period last year due to general cost of living increases.

Depreciation and maintenance of equipment increased $110,000 or 27.3% to $511,000 during the quarter ended September 30, 2016 from $401,000 during the quarter ended September 30, 2015. The increase was primarily related to the most recent branch opened in Ballentine in December 2015 which added $2.6 million in depreciable fixed assets to the balance sheet.

The Company incurred a prepayment penalty of $261,000 for prepaying one FHLB advance during the three months ended September 30, 2016 compared to no prepayment penalties during the same period in 2015. The Company elected to prepay this higher rate advance in order to reduce interest expense in future periods and improve net interest spread.

Provision For Income Taxes – The provision for income taxes increased $53,000 or 8.9% to $655,000 for the quarter ended September 30, 2016 from $601,000 for the same period one year ago. Income before income taxes was $2.4 million for the quarter ended September 30, 2016 compared to $2.3 million for the same quarter in 2015. The Company’s combined federal and state effective income tax rate for the current quarter was 26.9% compared to 25.6% for the same quarter one year ago.

Results of Operations for the Nine Month Periods Ended September 30, 2016 and 2015

Net Income Available to Common Shareholders - Net income available to common shareholders increased $291,000 or 6.5% to $4.7 million for the nine months ended September 30, 2016 compared to $4.4 million for the nine months ended September 30, 2015. The increase in earnings was primarily the result of an increase in net interest income offset by a decrease in non-interest income and an increase in non-interest expense.

Net Interest Income - The net interest margin on a tax equivalent basis increased 23 basis points to 3.42% for the nine months ended September 30, 2016 from 3.19% for the comparable period in 2015. Net interest income increased $1.0 million or 5.9% to $18.7 million for the nine months ended September 30, 2016 compared to $17.7 million during the same period in 2015. During the nine months ended September 30, 2016, average interest earning assets decreased $16.2 million or 2.1% to $750.7 million from $758.0 million for the nine months ended September 30, 2015, while average interest-bearing liabilities decreased $12.3 million or 1.9% to $650.0 million for the nine months ended September 30, 2016 from $662.2 million for the same period in 2015.

Interest Income - Total tax equivalent interest income increased $461,000 or 2.2% to $21.9 million during the nine months ended September 30, 2016 from $21.4 million for the same period in 2015. This increase was primarily the result of a 12 basis point increase in the yield on interest-earning assets. Total interest income on loans increased $698,000 or 5.1% to $14.4 million during the nine months ended September 30, 2016 from $13.7 million for the same period in 2015. The increase was a result of a $12.5 million or 3.8% increase in the average loan portfolio to $339.6 million from $327.1 million for the same period in 2015 combined with a seven basis point increase in the yield. Interest income from mortgage-backed securities decreased $365,000 or 9.0% to $3.7 million for the nine months ended September 30, 2016 from $4.0 million for the same period in 2015 as a result of an 11

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

basis point decrease in the portfolio yield combined with a $10.6 million or 4.6% decrease in the average balance of mortgage-backed securities. Tax equivalent interest income from investment securities increased $120,000 or 3.3% to $3.8 million for the nine months ended September 30, 2016 from $3.7 million for the same period in 2015 due to a 20 basis point increase in the yield offset by a $8.5 million or 4.3% decrease in the average balance of the investment securities portfolio.

The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the nine months ended September 30, 2016 and 2015:



	Nine Months Ended September 30,								Increase (Decrease) In Interest Income
	2016				2015
	Average Balance		Yield⁽¹⁾		Average Balance		Yield⁽¹⁾
Loans Receivable, Net	$	339,586,855	5.65	%	$	327,091,312	5.58	%	$	698,064
Mortgage-Backed Securities	219,104,199		2.23		229,664,849		2.34		(365,259		)
Investment Securities⁽²⁾	187,917,792		2.69		196,423,029		2.49		120,442
Overnight Time and Certificates of Deposit	4,062,429		0.46		4,776,354		0.17		8,023
Total Interest-Earning Assets	$	750,671,275	3.88	%	$	757,955,544	3.76	%	$	461,270

⁽¹⁾ Annualized

⁽²⁾ Tax equivalent basis recognizes the income tax savings when comparing taxable and tax-exempt assets and was calculated using an effective tax rate of 34%. The tax equivalent adjustment relates to the tax exempt municipal bonds and was $540,948 and $467,821 for the nine months ended September 30, 2016 and 2015, respectively.

Interest Expense - Interest expense decreased $650,000 or 20.1% to $2.6 million during the nine months ended September 30, 2016 compared to $3.2 million for the same period in 2015. The decrease in total interest expense is attributable to decreases in interest rates paid and a $12.3 million or 1.9% decrease in the average balance of interest-bearing liabilities. Interest expense on deposits decreased $168,000 or 9.6% to $1.6 million during the nine months ended September 30, 2016 compared to $1.7 million for the same period last year. The decrease was attributable to a three basis point decrease in the cost of deposit accounts combined with an $11.3 million or 1.9% decrease in average interest-bearing deposits to $592.5 million for the nine months ended September 30, 2016 compared to $603.8 million for the nine months ended September 30, 2015. The decrease was concentrated in the certificate accounts, which decreased $19.3 million or 7.7% to $230.6 million during the nine months ended September 30, 2016 from $249.9 million for the same period in 2015. The Bank is focusing on increasing its core deposits, or deposits other than time deposits, and has been competing less aggressively for time deposits.

Interest expense on FHLB advances and other borrowings decreased $496,000 or 46.9% to $561,000 during the nine months ended September 30, 2016 from $1.1 million during the same period in 2015. The average balance of FHLB advances and other borrowed money decreased $956,000 or 2.0% to $46.2 million during the nine months ended September 30, 2016 from $47.2 million for the same period last year. During the nine months ended September 30, 2015 the Bank prepaid $17.9 million in FHLB advances with a weighted average rate of 4.1% in order to reduce interest expense in future periods and improve net interest spread.

The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the nine months ended September 30, 2016 and 2015:



	Nine Months Ended September 30,								Increase (Decrease) In Interest Expense
	2016				2015
	Average Balance		Yield⁽¹⁾		Average Balance		Yield⁽¹⁾
Now and Money Market Accounts	$	327,971,402	0.13%		$	323,744,195	0.13	%	$	(16,342	)
Statement Savings Accounts	33,969,461		0.10		30,176,938		0.10		2,933
Certificates Accounts	230,563,133		0.72		249,878,789		0.74		(154,366		)
FHLB Advances and Other Borrowed Money	46,227,108		1.62		47,182,869		2.99		(496,169		)
Junior Subordinated Debentures	5,155,000		2.35		5,155,000		1.99		13,932
Senior Convertible Debentures	6,084,000		8.00		6,084,000		8.00		—
Total Interest-Bearing Liabilities	$	649,970,104	0.53	%	$	662,221,791	0.65	%	$	(650,012	)

⁽¹⁾ Annualized

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Provision for Loan Losses - There was no provision for loan losses for the nine months ended September 30, 2016 compared to a negative provision of $100,000 for the same period in the prior year. The Company had net charge-offs of $164,000 for the nine months ended September 30, 2016 compared to net charge-offs of $322,000 during the comparable period in 2015. The following table details selected activity associated with the allowance for loan losses for the nine months ended September 30, 2016 and 2015:



	Nine Months Ended September 30,
	2016		2015
Beginning Balance	$	8,275,133	$8,357,496
Provision for Loan Losses	—		(100,000)
Charge-offs	(679,746)		(1,338,358)
Recoveries	515,724		1,015,885
Net Charge-offs	(164,022)		(322,473)
Ending Balance	$	8,111,111	$	7,935,023

Non-Interest Income - Non-interest income decreased $334,000 or 6.2% to $5.1 million for the nine months ended September 30, 2016, compared to $5.4 million for the nine months ended September 30, 2015. The following table provides a detailed analysis of the changes in the components of non-interest income:



	Nine Months Ended September 30,				Increase (Decrease)
	2016		2015		Amounts			Percent
Gain on Sale of Investment Securities	$	772,143	$	1,676,404	$	(904,261	)	(53.9	)%
Gain on Sale of Loans	657,473		526,295		131,178			24.9
Service Fees on Deposit Accounts	772,341		790,689		(18,348		)	(2.3)
BOLI Income	396,000		291,000		105,000			36.1
Commissions From Insurance Agency	441,519		373,639		67,880			18.2
Trust Income	521,000		449,800		71,200			15.8
Check Card Fee Income	742,583		719,159		23,424			3.3
Grant Income	265,496		97,640		167,856			171.9
Other	504,200		482,380		21,820			4.5
Total Non-Interest Income	$	5,072,755	$	5,407,006	$	(334,251	)	(6.2	)%

Gain on sale of investment securities was $772,000 during the nine months ended September 30, 2016, a decrease of $904,000 or 53.9% compared to a gain of $1.7 million during the same period last year. The decrease resulted from a decrease in the sale of investment securities. The Bank sold 19 investment securities and received gross proceeds of $21.5 million during the nine months ended September 30, 2016 compared to 43 investment securities sold with gross proceeds of $58.2 million during the comparable period of 2015.

Grant income increased $168,000 or 171.9% to $265,000 during the nine months ended September 30, 2016 compared to $98,000 during the same period in 2015. The grant received in 2016 was awarded by the Bank Enterprise Award Program in recognition of the Bank’s investments in distressed communities and its continued commitment to community development. The amount of the award increases as the Bank’s investment in these distressed communities increases.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Non-Interest Expense – For the nine months ended September 30, 2016, non-interest expense decreased $204,000 or 1.2% to $16.9 million compared to $16.7 million for the same period in 2015. The following table provides a detailed analysis of the changes in the components of non-interest expense:



	Nine Months Ended September 30,					Increase (Decrease)
	2016			2015		Amounts			Percent
Compensation and Employee Benefits	$	9,675,430		$	8,976,214	$	699,216		7.8	%
Occupancy	1,469,602			1,427,424		42,178			3.0
Advertising	343,034			290,951		52,083			17.9
Depreciation and Maintenance of Equipment	1,486,060			1,263,932		222,128			17.6
FDIC Insurance Premiums	322,653			455,985		(133,332		)	(29.2)
Net Cost of Operation of OREO	(647,990		)	267,784		(915,774		)	(342.0)
Prepayment Penalties on FHLB Advances	789,306			787,851		1,455			0.2
Other	3,485,289			3,249,451		235,838			7.3
Total Non-Interest Expense	$	16,923,384		$	16,719,592	$	203,792		1.2	%

Compensation and employee benefits expenses were $9.7 million for the nine months ended September 30, 2016, an increase of $699,000 or 7.8% from $9.0 million during the same period last year. The increase was due to general increases in the economy combined with increases related to the addition of several new employees during the nine months ended September 30, 2016.

Depreciation and maintenance of equipment increased $222,000 or 17.6% to $1.5 million during the nine months ended September 30, 2016 from $1.3 million during the nine months ended September 30, 2015. The increase was primarily related to the most recent branch opened in Ballentine in December 2015 which added $2.6 million in depreciable fixed assets to the balance sheet.

The Company had a net gain from the operation of OREO properties of $648,000 during the nine months ended September 30, 2016 compared to a net cost of $268,000 during the nine months ended September 30, 2015. The majority of the net gain for the nine months ended September 30, 2016 was related to the sale of one OREO property in February 2016, which resulted in a $739,000 gain that was recorded as an offset to the cost of operating OREO properties during the nine months ended September 30, 2016.

Other expenses increased $236,000 or 7.3% to $3.5 million for the nine months ended September 30, 2016 compared to $3.2 million for the same period in the prior year. Other expenses include legal, professional, and consulting fees; supplies; telephone and other miscellaneous expenses.

Provision For Income Taxes – The provision for income taxes increased $109,000 or 6.5% to $1.8 million for the nine months ended September 30, 2016 from $1.7 million for the same period in 2015. Income before taxes was $6.9 million and $6.5 million for the nine months ended September 30, 2016 and 2015, respectively. The Company’s combined federal and state effective income tax rate was 26.3% for the nine months ended September 30, 2016 compared to 26.2% for the same period in 2015.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

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

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

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

During the nine months ended September 30, 2016 loan disbursements exceeded loan repayments resulting in a $21.2 million or 6.4% increase in total net loans receivable. During the nine months ended September 30, 2016, deposits decreased $1.8 million or 0.3% and FHLB advances increased $11.4 million or 32.8%. The Bank had $214.1 million in additional borrowing capacity at the FHLB at the end of the period. At September 30, 2016, the Bank had $131.8 million of certificates of deposit maturing within one year. Based on previous experience, the Bank anticipates a significant portion of these certificates will be renewed on maturity.

At September 30, 2016, the Bank exceeded all regulatory capital requirements with Common Equity Tier 1 Capital (CET1), Tier 1 leverage-based capital, Tier 1 risk-based capital, and total risk-based capital ratios of 20.9%, 11.0%, 20.9%, and 22.1%, respectively. To be categorized as “well capitalized” under the prompt corrective action provisions the Bank must maintain minimum CET1, total risk based capital, Tier 1 risk based capital and Tier 1 leverage capital ratios of 6.5%, 10.0%, 8.0% and 5.0%, respectively.

The Company also exceeded all regulatory capital requirements with CET1, Tier 1 leverage-based capital, Tier 1 risk- based capital and total risk-based capital ratios of 15.9%, 11.1%, 21.2%, and 23.5%, respectively, at September 30, 2016.

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

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at September 30, 2016.



(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	$	610	$	2,089	$	23,505	$	26,204	$	43,422	$	69,626
Standby Letters of Credit	—		191		211		402		—		402
Total	$	610	$	2,280	$	23,716	$	26,606	$	43,422	$	70,028

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. Net portfolio value is defined as the net present value of assets, liabilities, and off-balance sheet contracts.

For the three and nine months ended September 30, 2016, the Bank's interest rate spread, defined as the average yield on interest bearing assets less the average rate paid on interest bearing liabilities was 3.39% and 3.35%, respectively.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a - 15(e) of the Securities Exchange Act of 1934 (“Act”)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members of the Company’s senior management as of the end of the period covered by this quarterly report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that at September 30, 2016 the Company’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms. There have been no significant changes in our internal controls over financial reporting during the quarter ended September 30, 2016 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, 2015.

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Item 6 Exhibits



3.1		Articles of Incorporation, as amended (1)
3.2		Articles of Amendment, including Certificate of Designation relating to the Company's Fixed Rate Cumulative Perpetual Preferred Stock Series 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 Certificate for the Series B Preferred Shares (2)
4.3		Form of Indenture with respect to the Company's 8.0% Convertible Senior Debentures Due 2029 (5)
4.4		Specimen Convertible Senior Debenture Due 2029 (5)
4.5		Letter Agreement (including Securities Exchange Agreement B Standard Terms, attached as Exhibit A) dated September 29, 2010 between the Company and the United States Department of the Treasury (2)
4.6		Letter Agreement (including Securities Purchase Agreement B Standard Terms, attached as Exhibit A) dated September 29, 2010 between the Company and the United States Department of the Treasury (2)
10.1		1993 Salary Continuation Agreements (6)
10.2		Amendment One to 1993 Salary Continuation Agreements (7)
10.3		Form of 2006 Salary Continuation Agreement (8)
10.4		Form of Security Federal Split Dollar Agreement (8)
10.5		1999 Stock Option Plan (9)
10.6		2002 Stock Option Plan (10)
10.7		2006 Stock Option Plan (11)
10.8		2008 Equity Incentive Plan (12)
10.9		Form of incentive stock option agreement and non-qualified stock option agreement pursuant to the 2006 Stock Option Plan (11)
10.10		2004 Employee Stock Purchase Plan (13)
10.11		Incentive Compensation Plan (6)
10.12		Form of Compensation Modification Agreement (14)
14		Code of Ethics (15)
25		Subsidiaries of Registrant
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
101		The following materials from Security Federal Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2016, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income; (d) Consolidated Statements of Changes in Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements

_____________


(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 January 16, 2015.


(4)	Filed on August 12, 1987, as an exhibit to the Company’s Registration Statement on Form 8-A and incorporated herein by reference.


(5)	Filed on July 13, 2009 as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-160553) and incorporated herein by reference.


(6)	Filed on June 28, 1993, as an exhibit to the Company’s Annual Report on Form 10-KSB and incorporated herein by reference.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES


(7)	Filed as an exhibit to the Company’s Quarterly Report on Form 10-QSB for the quarter ended September 30, 1993 and incorporated herein by reference.


(8)	Filed on May 24, 2006 as an exhibit to the Company’s Current Report on Form 8-K dated May 18, 2006 and incorporated herein by reference.


(9)	Filed on March 2, 2000, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference


(10)	Filed on January 3, 2003, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference.


(11)	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.


(12)	Filed on November 12, 2008, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference.


(13)	Filed on June 18, 2004, as an exhibit to the Company’s Proxy Statement and incorporated herein by reference.


(14)	Incorporated by reference to the Company's Current Report on Form 8-K filed on December 23, 2008.


(15)	Filed on June 29, 2006, as an exhibit to the Company’s Annual Report on Form 10-K and incorporated herein by reference.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

Signatures

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

SECURITY FEDERAL CORPORATION



Date:	November 14, 2016	By:	/s/J. Chris Verenes
				J. Chris Verenes
				Chief Executive Officer
				Duly Authorized Representative



Date:	November 14, 2016	By:	/s/Jessica T. Cummins
				Jessica T. Cummins
				Chief Financial Officer
				Duly Authorized Representative

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

EXHIBIT INDEX


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


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


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

101

The following materials from Security Federal Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2016, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income; (d) Consolidated Statements of Changes in Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements