SECURITY FEDERAL CORP - Quarter Report: 2019 September (Form 10-Q)

OUTSTANDING SHARES AT:

Common Stock, par value $0.01 per share

November 14, 2019

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, 2019

( ) 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: 000-16120

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 every Interactive Data File required to be submitted 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 such files.) Yes [ X ] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.



	Large accelerated filed [ ]		Smaller reporting company [ X ]
	Non-accelerated filer [ X ]		Emerging growth company [ ]
	Accelerated filer [ ]

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.



YES				NO

Indicate by check mark whether the registrant is a shell corporation (defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

Securities registered pursuant to Section 12(b) of the Act: None

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, 2019 and December 31, 2018	3
	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2019 and 2018	4
	Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2019 and 2018	5
	Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2019 and 2018	6
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2019 and 2018	7
	Notes to Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	32
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	46
Item 4.	Controls and Procedures	46

PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	47
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults Upon Senior Securities	47
Item 4.	Mine Safety Disclosures	47
Item 5.	Other Information	47
Item 6.	Exhibits	47
	Signatures	49

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, 2019			December 31, 2018
	(Unaudited)			(Audited)
ASSETS:
Cash and Cash Equivalents	$	13,793,394		$	12,705,910
Certificates of Deposit with Other Banks	950,005			1,200,010
Investment and Mortgage-Backed Securities:
Available For Sale ("AFS")	438,243,435			386,255,837
Held To Maturity ("HTM") (Fair Value of $21,953,200 and $23,249,400 at September 30, 2019 and December 31, 2018, Respectively)	21,416,599			23,638,013
Total Investments and Mortgage-Backed Securities	459,660,034			409,893,850
Loans Receivable, Net:
Held For Sale	3,682,876			1,781,985
Held For Investment (Net of Allowance of $8,758,639 and $9,171,717 at September 30, 2019 and December 31, 2018, Respectively)	449,958,619			428,271,532
Total Loans Receivable, Net	453,641,495			430,053,517
Accrued Interest Receivable:
Loans	1,149,852			1,257,683
Mortgage-Backed Securities	601,984			591,849
Investment Securities	1,728,088			1,877,844
Total Accrued Interest Receivable	3,479,924			3,727,376
Operating Lease Right-of-Use Assets	2,811,157			—
Premises and Equipment, Net	26,377,920			24,174,707
Federal Home Loan Bank ("FHLB") Stock, at Cost	2,852,900			2,204,000
Other Real Estate Owned ("OREO")	703,540			722,442
Bank Owned Life Insurance ("BOLI")	21,366,647			21,237,893
Goodwill	1,199,754			1,199,754
Other Assets	4,424,714			5,494,800
Total Assets	$	991,261,484		$	912,614,259
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Liabilities:
Deposit Accounts	$	814,620,366		$	767,496,707
Advance Payments By Borrowers for Taxes and Insurance	599,108			258,505
Advances From FHLB	47,800,000			34,030,000
Other Borrowings	14,988,524			10,698,429
Note Payable	—			2,362,500
Junior Subordinated Debentures	5,155,000			5,155,000
Senior Convertible Debentures	6,044,000			6,064,000
Operating Lease Liabilities	2,829,652			—
Other Liabilities	6,922,828			6,030,685
Total Liabilities	$	898,959,478		$	832,095,826
Shareholders' Equity:
Common Stock, $.01 Par Value; Authorized 5,000,000 Shares; Issued and Outstanding Shares, 3,157,310 and 2,956,377, Respectively, at September 30, 2019 and 3,154,829 and 2,953,896, Respectively, at December 31, 2018	$	31,573		$	31,548
Additional Paid-In Capital ("APIC")	12,294,432			12,235,341
Treasury Stock, at Cost (200,933 Shares)	(4,330,712		)	(4,330,712		)
Accumulated Other Comprehensive Income (Loss) ("AOCI")	6,331,710			(27,909		)
Retained Earnings	77,975,003			72,610,165
Total Shareholders' Equity	$	92,302,006		$	80,518,433
Total Liabilities and Shareholders' Equity	$	991,261,484		$	912,614,259

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,
	2019		2018			2019			2018
Interest Income:
Loans	$	6,369,586	$	5,890,317		$	18,419,922		$	16,965,442
Mortgage-Backed Securities	1,807,876		1,351,134			4,978,614			3,943,521
Investment Securities	1,459,810		1,239,798			4,307,922			3,357,698
Other	4,069		25,228			94,106			42,384
Total Interest Income	9,641,341		8,506,477			27,800,564			24,309,045
Interest Expense:
NOW and Money Market Accounts	541,494		325,427			1,597,932			774,637
Savings Accounts	18,753		14,120			53,947			38,420
Certificate Accounts	1,204,990		706,590			3,181,783			1,856,348
FHLB Advances and Other Borrowed Money	351,825		157,148			675,985			513,018
Note Payable	—		51,856			35,515			190,790
Senior Convertible Debentures	120,880		121,280			362,640			363,840
Junior Subordinated Debentures	53,522		53,218			166,703			147,234
Total Interest Expense	2,291,464		1,429,639			6,074,505			3,884,287
Net Interest Income	7,349,877		7,076,838			21,726,059			20,424,758
Provision For Loan Losses	75,000		150,000			175,000			150,000
Net Interest Income After Provision For Loan Losses	7,274,877		6,926,838			21,551,059			20,274,758
Non-Interest Income:
Gain on Sale of Investment Securities	96,057		—			1,056,959			436,304
Gain on Sale of Loans	580,220		345,396			1,126,551			999,045
Service Fees on Deposit Accounts	279,360		262,821			785,987			770,493
Commissions From Insurance Agency	201,253		196,817			528,246			525,153
Trust Income	270,000		249,000			787,200			725,000
BOLI Income	273,609		135,000			543,609			405,000
Check Card Fee Income	365,659		320,708			1,063,314			966,365
Grant Income	55,364		318,102			332,393			318,102
Other	286,935		241,837			872,591			712,785
Total Non-Interest Income	2,408,457		2,069,681			7,096,850			5,858,247
Non-Interest Expense:
Compensation and Employee Benefits	4,270,515		4,032,245			12,587,421			11,683,664
Occupancy	599,512		586,527			1,728,732			1,677,970
Advertising	190,070		181,663			539,234			455,753
Depreciation and Maintenance of Equipment	644,800		575,750			1,894,997			1,673,470
Federal Deposit Insurance Corporation ("FDIC") Insurance Premiums	41,540		72,837			184,022			206,218
Net Cost (Recovery) of OREO Operation	189,467		(203,104		)	(62,680		)	(362,864		)
Other	1,053,219		1,171,664			4,103,020			3,842,576
Total Non-Interest Expense	6,989,123		6,417,582			20,974,746			19,176,787
Income Before Income Taxes	2,694,211		2,578,937			7,673,163			6,956,218
Provision For Income Taxes	474,744		471,245			1,480,792			1,298,455
Net Income	2,219,467		2,107,692			6,192,371			5,657,763
Net Income Per Common Share (Basic)	$	0.75	$	0.71		$	2.10		$	1.92
Net Income Per Common Share (Diluted)	$	0.71	$	0.68		$	1.98		$	1.82
Cash Dividend Per Share on Common Stock	$	0.10	$	0.09		$	0.28		$	0.27
Weighted Average Shares Outstanding (Basic)	2,956,156		2,953,424			2,955,446			2,953,340
Weighted Average Shares Outstanding (Diluted)	3,258,356		3,256,624			3,257,646			3,256,540

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)



	Three Months Ended September 30,
	2019			2018
Net Income	$	2,219,467		$	2,107,692
Other Comprehensive Income (Loss)
Unrealized Gains (Losses) on Securities:
Unrealized Holding Gains (Losses) on Securities AFS, Net of Taxes of $421,086 and $(618,602) at September 30, 2019 and 2018, Respectively	1,304,435			(1,888,549		)
Reclassification Adjustment for Gains Included in Net Income, Net of Taxes of $24,014 at September 30, 2019	(72,043		)	—
Amortization of Unrealized Gains on AFS Securities Transferred to HTM, Net of Taxes of $(1,095) and $(6,000) at September 30, 2019 and 2018, Respectively	(3,287		)	(17,998		)
Other Comprehensive Income (Loss), Net of Tax	1,229,105			(1,906,547		)
Comprehensive Income	$	3,448,572		$	201,145



	Nine Months Ended September 30,
	2019			2018
Net Income	$	6,192,371		$	5,657,763
Other Comprehensive Income (Loss)
Unrealized Gains (Losses) on Securities:
Unrealized Holding Gains (Losses) on Securities AFS Net of Taxes of $2,341,270 and $(1,804,885) at September 30, 2019 and 2018, Respectively	7,171,440			(5,515,962		)
Reclassification Adjustment for Gains Included in Net Income, Net of Taxes of $264,240 and $109,076 at September 30, 2019 and 2018, Respectively	(792,719		)	(327,228		)
Amortization of Unrealized Gains on AFS Securities Transferred to HTM, Net of Taxes of $(6,368) and $(23,718) at September 30, 2019 and 2018, Respectively	(19,102		)	(64,238		)
Other Comprehensive Income (Loss)	6,359,619			(5,907,428		)
Comprehensive Income (Loss)	$	12,551,990		$	(249,665	)

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, 2019 and 2018



	Common Stock		APIC		Treasury Stock			AOCI			Retained Earnings			Total
Balance at December 31, 2017	$	31,539	$	12,212,844	$	(4,330,712	)	$	2,932,122		$	67,077,661		$	77,923,454
Net Income	—		—		—			—			1,730,117			1,730,117
Other Comprehensive Loss, Net of Tax	—		—		—			(3,095,804		)	—			(3,095,804		)
Reclassification of stranded tax effects from AOCI to Retained Earnings	—		—		—			611,091			(611,091		)	—
Stock Options Exercised	4		8,015		—			—			—			8,019
Cash Dividends on Common Stock											(265,889		)	(265,889		)
Balance at March 31, 2018	$	31,543	$	12,220,859	$	(4,330,712	)	$	447,409		$	67,930,798		$	76,299,897
Net Income	—		—		—			—			1,819,954			1,819,954
Other Comprehensive Loss, Net of Tax	—		—		—			(905,077		)	—			(905,077		)
Stock Options Exercised	1		2,290		—			—			—			2,291
Cash Dividends on Common Stock	—		—		—			—			(265,898		)	(265,898		)
Balance at June 30, 2018	$	31,544	$	12,223,149	$	(4,330,712	)	$	(457,668	)	$	69,484,854		$	76,951,167
Net Income	—		—		—			—			2,107,692			2,107,692
Other Comprehensive Loss, Net of Tax	—		—		—			(1,906,547		)	—			(1,906,547		)
Cash Dividends on Common Stock	—		—		—			—			(265,899		)	(265,899		)
Balance at September 30, 2018	$	31,544	$	12,223,149	$	(4,330,712	)	$	(2,364,215	)	$	71,326,647		$	76,886,413



	Common Stock		APIC		Treasury Stock			AOCI			Retained Earnings			Total
Balance at December 31, 2018	$	31,548	$	12,235,341	$	(4,330,712	)	$	(27,909	)	$	72,610,165		$	80,518,433
Net Income	—		—		—			—			2,088,873			2,088,873
Other Comprehensive Income, Net of Tax	—		—		—			2,817,917			—			2,817,917
Employee Stock Purchases	5		12,004		—			—			—			12,009
Redemption of Convertible Debentures	10		19,990		—			—			—			20,000
Cash Dividends on Common Stock	—		—		—			—			(265,982		)	(265,982		)
Balance at March 31, 2019	$	31,563	$	12,267,335	$	(4,330,712	)	$	2,790,008		$	74,433,056		$	85,191,250
Net Income	—		—		—			—			1,884,031			1,884,031
Other Comprehensive Loss, Net of Tax	—		—		—			2,312,597			—			2,312,597
Employee Stock Purchases	6		14,780		—			—			—			14,786
Cash Dividends on Common Stock	—		—		—			—			(266,034		)	(266,034		)
Balance at June 30, 2019	$	31,569	$	12,282,115	$	(4,330,712	)	$	5,102,605		$	76,051,053		$	89,136,630
Net Income	—		—		—			—			2,219,467			2,219,467
Other Comprehensive Loss, Net of Tax	—		—		—			1,229,105			—			1,229,105
Employee Stock Purchases	4		12,317		—			—			—			12,321
Cash Dividends on Common Stock	—		—		—			—			(295,517		)	(295,517		)
Balance at September 30, 2019	$	31,573	$	12,294,432	$	(4,330,712	)	$	6,331,710		$	77,975,003		$	92,302,006

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)



	Nine Months Ended September 30,
	2019			2018
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	6,192,371		$	5,657,763
Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities:
Depreciation Expense	1,167,945			1,062,542
Discount Accretion and Premium Amortization	3,925,218			4,271,865
Provision for Loan Losses	175,000			150,000
Earnings on BOLI	(405,000		)	(405,000		)
Income Recognized From BOLI Death Benefit	(138,609		)	—
Gain on Sales of Loans	(1,126,551		)	(999,045		)
Gain on Sales of Mortgage-Backed Securities ("MBS")	(98,515		)	(181,034		)
Gain on Sales of Investment Securities	(958,443		)	(255,270		)
Gain on Sales of OREO	(181,552		)	(547,685		)
Write Down on OREO	22,000			56,000
Amortization of Operating Lease Right-of-Use Assets	279,355			—
Amortization of Deferred Loan Costs	138,045			73,163
Proceeds From Sale of Loans Held For Sale	39,321,961			38,316,435
Origination of Loans Held For Sale	(40,096,301		)	(35,002,538		)
Decrease (Increase) in Accrued Interest Receivable:
Loans	107,831			(129,675		)
MBS	(10,135		)	11,356
Investment Securities	149,756			(50,354		)
Increase in Advance Payments By Borrowers	340,603			363,864
Decrease in Other, Net	(394,763		)	(134,725		)
Net Cash Provided By Operating Activities	$	8,410,216		$	12,257,662
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of MBS AFS	$	(97,828,479	)	$	(41,314,618	)
Proceeds from Sales and Maturities of MBS AFS	60,486,276			45,040,636
Proceeds from Payments and Maturities of MBS Held To Maturity ("HTM")	2,057,157			2,536,945
Purchase of Investment Securities AFS	(70,741,583		)	(38,965,898		)
Proceeds from Sales and Maturities of Investment Securities AFS	61,847,936			35,120,779
Proceeds from Payments and Maturities of Investment Securities HTM	—			2,000,000
Proceeds from Redemption of Certificates of Deposits with Other Banks	250,005			—
Purchase of FHLB Stock	(7,365,500		)	(4,194,300		)
Redemption of FHLB Stock	6,716,600			4,640,500
Purchase of BOLI	—			(1,900,000		)
Proceeds From BOLI Death Benefit	414,855			—
Increase in Loans Receivable	(22,802,932		)	(36,340,156		)
Proceeds From Sale of OREO	981,254			1,064,664
Purchase and Improvement of Premises and Equipment	(3,371,158		)	(2,325,360		)
Net Cash Used By Investing Activities	$	(69,355,569	)	$	(34,636,808	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in Deposit Accounts	$	47,123,659		$	48,891,690
Proceeds from FHLB Advances	228,708,000			160,083,000
Repayment of FHLB Advances	(214,938,000		)	(172,763,000		)
Increase in Other Borrowings, Net	4,290,095			1,345,109
Repayment of Note Payable	(2,362,500		)	(4,600,000		)
Proceeds from Employee Stock Options Exercised	—			10,310
Proceeds from Employee Stock Purchases	39,116			—
Dividends to Common Stock Shareholders	(827,533		)	(797,686		)
Net Cash Provided By Financing Activities	$	62,032,837		$	32,169,423
Net Increase in Cash and Cash Equivalents	1,087,484			9,790,277
Cash and Cash Equivalents at Beginning of Period	12,705,910			10,319,624
Cash and Cash Equivalents at End of Period	$	13,793,394		$	20,109,901

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES




Consolidated Statements of Cash Flows (Unaudited) (Continued)

	Nine Months Ended September 30,
	2019		2018
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Paid for Interest	$	5,654,177	$	3,719,123
Cash Paid for Income Taxes	$	1,199,541	$	992,273
Non-Cash Transactions:
Initial Recognition of Operating Lease Right-of-Use Assets	$	3,090,512	$	—
Initial Recognition of Operating Lease Liabilities	$	3,090,512	$	—
Transfers From Loans Receivable to OREO	$	802,800	$	315,550
Other Comprehensive Income (Loss)	$	6,359,619	$	(5,907,428	)

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 ("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”) 2018 Annual Report to Shareholders which was filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Form 10-K”) when reviewing interim financial statements. The unaudited consolidated results of operations for the three and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

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”), Security Federal Investments, Inc. ("SFINV"), and Security Financial Services Corporation (“SFSC”). SFINS is an insurance agency offering auto, business, health and home insurance. SFINS has a wholly owned subsidiary, Collier Jennings Financial Corporation, which has as subsidiaries 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. SFINV was formed to hold investment securities and allow for better management of the securities portfolio. SFSC is currently inactive. All significant intercompany transactions and balances have been eliminated in consolidation.

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, 2018 included in our 2018 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 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. There were no stock options outstanding at either September 30, 2019 or September 30, 2018. Diluted EPS also assumes the convertible debentures were converted into 302,200 and 303,200 shares of common stock at the beginning of both the three and nine month periods ended September 30, 2019 and 2018, respectively. The related interest expense recorded during the period is added back to the EPS numerator while the underlying shares are added to the denominator. The following tables include a summary of the Company's basic and diluted EPS for the periods indicated.



	Three Months Ended September 30,
	2019						2018
	Income		Shares	Per Share			Income		Shares	Per Share
Basic EPS	$	2,219,467	2,956,156	$	0.75		$	2,107,692	2,953,424	$	0.71
Senior Convertible Debentures	90,660		302,200	(0.04		)	90,960		303,200	(0.03)
Diluted EPS	$	2,310,127	3,258,356	$	0.71		$	2,198,652	3,256,624	$	0.68



	Nine Months Ended September 30,
	2019					2018
	Income		Shares	Per Share		Income		Shares	Per Share
Basic EPS	$	6,192,371	2,955,446	$	2.10	$	5,657,763	2,953,340	$	1.92
Senior Convertible Debentures	271,980		302,200	(0.12)		272,880		303,200	(0.10)
Diluted EPS	$	6,464,351	3,257,646	$	1.98	$	5,930,643	3,256,540	$	1.82

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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. At September 30, 2019, the Company had no remaining options outstanding and there was no activity during the nine months ended September 30, 2019.

The following is a summary of the activity under the Company’s stock option plans for the three and nine months ended September 30, 2018.



	Three Months Ended September 30,				Nine Months Ended September 30,
	2018				2018
	Shares		Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
Balance, Beginning of Period	1,650		$	22.91	4,500	$	22.91
Options Exercised	—		—		(450)	22.91
Options Forfeited	(1,650	)	22.91		(4,050)	22.91
Balance, End of Period	—		$	—	—	$	—

Options Available For Grant	50,000				50,000

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, 2019
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Student Loan Pools	$	41,569,303	$	4,007	$	329,972	$	41,243,338
Small Business Administration (“SBA”) Bonds	120,910,755		717,658		651,988		120,976,425
Tax Exempt Municipal Bonds	43,187,057		4,329,929		—		47,516,986
Taxable Municipal Bonds	2,013,786		40,892		37,623		2,017,055
Mortgage-Backed Securities	221,931,218		4,836,297		494,126		226,273,389
State Tax Credit	61,242		—		—		61,242
Equity Securities	155,000		—		—		155,000
Total Available For Sale	$	429,828,361	$	9,928,783	$	1,513,709	$	438,243,435

	December 31, 2018
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Student Loan Pools	$	12,934,037	$	20,713	$	69,249	$	12,885,501
SBA Bonds	125,777,016		560,352		890,837		125,446,531
Tax Exempt Municipal Bonds	60,141,164		1,518,974		329,769		61,330,369
Taxable Municipal Bonds	1,998,258		3,546		23,919		1,977,885
Mortgage-Backed Securities	185,291,038		1,073,432		1,903,919		184,460,551
Equity Securities	155,000		—		—		155,000
Total Available For Sale	$	386,296,513	$	3,177,017	$	3,217,693	$	386,255,837

Student Loan Pools are typically 97% guaranteed by the United States government while SBA bonds are 100% 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, 2019, AFS GNMA mortgage-backed securities had an amortized cost and fair value of $84.2 million and $85.1 million, respectively, compared to an amortized cost and fair value of $80.4 million and $80.2 million, respectively, at December 31, 2018.

Also included in mortgage-backed securities in the tables above and below are private label collateralized mortgage obligation ("CMO") securities, which are issued by non-governmental real estate mortgage investment conduits and are not backed by the full faith and credit of the United States government. At September 30, 2019 the Bank held AFS private label CMO mortgage-backed securities with an amortized cost and fair value of $25.1 million and $25.4 million, respectively, compared to an amortized cost and fair value of $29.7 million and $29.5 million, respectively, at December 31, 2018.

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, 2019 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.



	September 30, 2019
Investment Securities:	Amortized Cost		Fair Value
One Year or Less	$	99,189	$	98,978
After One – Five Years	7,796,197		7,840,171
After Five – Ten Years	59,181,477		59,258,866
More Than Ten Years	140,820,280		144,772,031
Mortgage-Backed Securities	221,931,218		226,273,389
Total Available For Sale	$	429,828,361	$	438,243,435

At September 30, 2019 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 $145.1 million and $147.5 million, respectively, compared to an amortized cost and fair value of $111.8 million and $111.7 million, respectively, at December 31, 2018.

The Company received $70.8 million and $28.6 million in gross proceeds from sales of available for sale securities during the nine months ended September 30, 2019 and 2018, respectively. As a result, the Company recognized gross gains of $1.3 million and $503,000 during the nine months ended September 30, 2019 and 2018, respectively, with $288,000 and $67,000 gross losses recognized for the same periods, respectively.

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 were in a continuous unrealized loss position at the dates indicated.



	September 30, 2019
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Student Loan Pools	$	31,327,315	$	283,132	$	3,030,566	$	46,840	$	34,357,881	$	329,972
SBA Bonds	20,192,185		101,704		49,743,150		550,284		69,935,335		651,988
Taxable Municipal Bonds	981,630		37,623		—		—		981,630		37,623
Mortgage-Backed Securities	44,595,549		256,776		20,595,466		237,350		65,191,015		494,126
	$	97,096,679	$	679,235	$	73,369,182	$	834,474	$	170,465,861	$	1,513,709



	December 31, 2018
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Student Loan Pools	$	8,384,145	$	69,249	$	—	$	—	$	8,384,145	$	69,249
SBA Bonds	59,496,936		479,955		25,054,861		410,882		84,551,797		890,837
Tax Exempt Municipal Bonds	4,585,849		91,281		9,626,613		238,488		14,212,462		329,769
Taxable Municipal Bond	—		—		980,520		23,919		980,520		23,919
Mortgage-Backed Securities	38,168,598		249,050		81,947,249		1,654,869		120,115,847		1,903,919
	$	110,635,528	$	889,535	$	117,609,243	$	2,328,158	$	228,244,771	$	3,217,693

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, 2019 and December 31, 2018, 55.1% and 72.4% of the unrealized losses, representing 71 and 92 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, 2019.

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, 2019
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Federal Home Loan Mortgage Corporation ("FHLMC") Bond	$	998,880	$	1,548	$	—	$	1,000,428
Mortgage-Backed Securities ⁽¹⁾	20,417,719		536,275		1,222		20,952,772
Total Held To Maturity	$	21,416,599	$	537,823	$	1,222	$	21,953,200

	December 31, 2018
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLMC Bond	$	998,541	$	—	$	20,564	$	977,977
Mortgage-Backed Securities ⁽¹⁾	22,639,472		78,281		446,330		22,271,423
Total Held To Maturity	$	23,638,013	$	78,281	$	466,894	$	23,249,400

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

The FHLB, FHLMC and the Federal National Mortgage Association ("FNMA") 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. At September 30, 2019, the Bank held an amortized cost and fair value of $12.0 million and $12.4 million, respectively, in GNMA mortgage-backed securities classified as held to maturity, which are included in the table above, compared to an amortized cost and fair value of $13.3 million and $13.1 million, respectively, at December 31, 2018. The Company has not invested in any private label mortgage-backed securities classified as held to maturity.

At September 30, 2019, 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 $19.6 million and $20.1 million, respectively, compared to an amortized cost and fair value of $19.8 million and $19.4 million, respectively, at December 31, 2018.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

The amortized cost and fair value of investment and mortgage-backed securities held to maturity at September 30, 2019 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.



	September 30, 2019
Investment Securities HTM:	Amortized Cost		Fair Value
One – Five Years	$	998,880	$	1,000,428
Mortgage-Backed Securities	20,417,719		20,952,772
Total Held to Maturity	$	21,416,599	$	21,953,200

The following tables show gross unrealized losses, fair value, and length of time that individual held to maturity securities have been in a continuous unrealized loss position at the dates indicated below.



	September 30, 2019
	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⁾	$	—	$	—	$	828,312	$	1,222	$	828,312	$	1,222
	$	—	$	—	$	828,312	$	1,222	$	828,312	$	1,222

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



	December 31, 2018
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLMC Bond	$	—	$	—	$	977,977	$	20,564	$	977,977	$	20,564
Mortgage-Backed Securities ⁽¹⁾	—		—		16,855,973		446,330		16,855,973		446,330
	$	—	$	—	$	17,833,950	$	466,894	$	17,833,950	$	466,894

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

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, 2019		December 31, 2018
Residential Real Estate	$	85,770,830	$	83,965,416
Consumer	55,265,561		56,907,555
Commercial Business	26,925,440		28,086,686
Commercial Real Estate	299,354,651		275,960,438
Total Loans Held For Investment	467,316,482		444,920,095
Loans Held For Sale	3,682,876		1,781,985
Total Loans Receivable, Gross	$	470,999,358	$	446,702,080
Less:
Allowance For Loan Losses	8,758,638		9,171,717
Loans in Process	8,169,557		7,225,271
Deferred Loan Fees	429,668		251,575
	17,357,863		16,648,563
Total Loans Receivable, Net	$	453,641,495	$	430,053,517

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 tables below summarize the balance within each risk category by loan type, excluding loans held for sale, at September 30, 2019 and December 31, 2018.



September 30, 2019	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	76,539,946	$	4,267,222	$	744,155	$	4,219,507	$	85,770,830
Consumer	43,907,321		8,968,651		513,664		1,875,925		55,265,561
Commercial Business	21,827,500		4,425,501		345,998		326,441		26,925,440
Commercial Real Estate	228,561,878		53,711,353		13,198,173		3,883,247		299,354,651
Total	$	370,836,645	$	71,372,727	$	14,801,990	$	10,305,120	$	467,316,482



December 31, 2018	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	75,558,544	$	3,369,776	$	958,354	$	4,078,742	$	83,965,416
Consumer	46,948,251		6,899,912		567,682		2,491,710		56,907,555
Commercial Business	22,670,318		4,708,036		339,533		368,799		28,086,686
Commercial Real Estate	204,197,354		45,653,796		18,492,785		7,616,503		275,960,438
Total	$	349,374,467	$	60,631,520	$	20,358,354	$	14,555,754	$	444,920,095

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, including loans on non-accrual status, by category at September 30, 2019 and December 31, 2018:



	September 30, 2019
	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	$	—	$	803,055	$	393,183	$	1,196,238	$	84,574,592	$	85,770,830
Consumer	408,637		186,571		70,458		665,666		54,599,895		55,265,561
Commercial Business	104,213		51,709		1,797		157,719		26,767,721		26,925,440
Commercial Real Estate	1,006,503		—		1,716,611		2,723,114		296,631,537		299,354,651
Total	$	1,519,353	$	1,041,335	$	2,182,049	$	4,742,737	$	462,573,745	$	467,316,482



	December 31, 2018
	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	$	—	$	332,000	$	497,713	$	829,713	$	83,135,703	$	83,965,416
Consumer	555,798		247,894		1,120,462		1,924,154		54,983,401		56,907,555
Commercial Business	205,613		106,163		18,648		330,424		27,756,262		28,086,686
Commercial Real Estate	1,556,863		424,103		1,634,770		3,615,736		272,344,702		275,960,438
Total	$	2,318,274	$	1,110,160	$	3,271,593	$	6,700,027	$	438,220,068	$	444,920,095

At September 30, 2019 and December 31, 2018, the Company did not have any loans that were 90 days or more past due and still accruing interest. The Company's strategy is to work with its borrowers to reach acceptable payment plans while protecting its interests in the existing collateral. In the event an acceptable arrangement cannot be reached, the Company 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, 2019 compared to December 31, 2018:



	September 30, 2019				December 31, 2018				Increase (Decrease)
	Amount		Percent ⁽¹⁾		Amount		Percent ⁽¹⁾		$			%
Non-accrual Loans:
Residential Real Estate	$	1,375,320	0.3	%	$	2,084,870	0.5	%	$	(709,550	)	(34.0)%
Consumer	326,972		0.1		1,274,673		0.3		(947,701		)	(74.3)
Commercial Business	124,791		—		124,458		—		333			0.3
Commercial Real Estate	2,254,125		0.5		3,564,494		0.8		(1,310,369		)	(36.8)
Total Non-accrual Loans	$	4,081,208	0.9	%	$	7,048,495	1.6	%	$	(2,967,287	)	(42.1)%

^{(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, 2019 and 2018:



	Three Months Ended September 30, 2019
	Residential Real Estate		Consumer			Commercial Business			Commercial Real Estate		Total
Beginning Balance	$	1,125,812	$	1,092,327		$	896,843		$	5,638,557	$	8,753,539
Provision for Loan Losses	15,059		8,207			(136,254		)	187,988		75,000
Charge-Offs	—		(102,273		)	—			—		(102,273		)
Recoveries	600		25,289			549			5,934		32,372
Ending Balance	$	1,141,471	$	1,023,550		$	761,138		$	5,832,479	$	8,758,638



	Nine Months Ended September 30, 2019
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,191,443		$	1,203,593		$	923,600		$	5,853,081		$	9,171,717
Provision for Loan Losses	(20,899		)	82,715			(176,443		)	289,627			175,000
Charge-Offs	(34,599		)	(367,753		)	(1,132		)	(428,164		)	(831,648		)
Recoveries	5,526			104,995			15,113			117,935			243,569
Ending Balance	$	1,141,471		$	1,023,550		$	761,138		$	5,832,479		$	8,758,638



	Three Months Ended September 30, 2018
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,309,069		$	1,213,774		$	1,077,433		$	5,010,900		$	8,611,176
Provision for Loan Losses	128,753			(21,106		)	(144,996		)	187,349			150,000
Charge-Offs	(27,489		)	(27,181		)	—			(117,822		)	(172,492		)
Recoveries	—			8,519			—			4,875			13,394
Ending Balance	$	1,410,333		$	1,174,006		$	932,437		$	5,085,302		$	8,602,078



	Nine Months Ended September 30, 2018
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,233,843		$	1,144,815		$	1,011,227		$	4,831,733		$	8,221,618
Provision for Loan Losses	217,702			51,275			(46,272		)	(72,705		)	150,000
Charge-Offs	(41,419		)	(118,207		)	(32,518		)	(127,712		)	(319,856		)
Recoveries	207			96,123			—			453,986			550,316
Ending Balance	$	1,410,333		$	1,174,006		$	932,437		$	5,085,302		$	8,602,078

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, 2019	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	—	$	1,141,471	$	1,141,471
Consumer	—		1,023,550		1,023,550
Commercial Business	—		761,138		761,138
Commercial Real Estate	565,000		5,267,479		5,832,479
Total	$	565,000	$	8,193,638	$	8,758,638



	Allowance For Loan Losses
December 31, 2018	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	—	$	1,191,443	$	1,191,443
Consumer	73,662		1,129,931		1,203,593
Commercial Business	—		923,600		923,600
Commercial Real Estate	665,000		5,188,081		5,853,081
Total	$	738,662	$	8,433,055	$	9,171,717

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, 2019	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	1,125,232	$	84,645,598	$	85,770,830
Consumer	132,538		55,133,023		55,265,561
Commercial Business	64,406		26,861,034		26,925,440
Commercial Real Estate	3,000,884		296,353,767		299,354,651
Total	$	4,323,060	$	462,993,422	$	467,316,482



	Loans Receivable
December 31, 2018	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	1,700,861	$	82,264,555	$	83,965,416
Consumer	1,060,043		55,847,512		56,907,555
Commercial Business	77,206		28,009,480		28,086,686
Commercial Real Estate	6,526,015		269,434,423		275,960,438
Total	$	9,364,125	$	435,555,970	$	444,920,095

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 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. The average balance of impaired loans was $4.7 million for the three months ended September 30, 2019 compared to $12.9 million for the three months ended September 30, 2018.

The following tables present information related to impaired loans by loan category at September 30, 2019 and December 31, 2018 and for the three and nine months ended September 30, 2019 and 2018.



	September 30, 2019						December 31, 2018
Impaired Loans	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
With No Related Allowance Recorded:
Residential Real Estate	$	1,125,232	$	1,125,232	$	—	$	1,700,861	$	1,700,861	$	—
Consumer	132,538		140,838		—		986,380		994,680		—
Commercial Business	64,406		959,406		—		77,206		972,206		—
Commercial Real Estate	2,003,894		2,296,850		—		5,084,458		6,116,761		—
With an Allowance Recorded:
Consumer	—		—		—		73,662		73,662		73,662
Commercial Real Estate	996,990		1,396,990		565,000		1,441,558		1,441,558		665,000
Total
Residential Real Estate	1,125,232		1,125,232		—		1,700,861		1,700,861		—
Consumer	132,538		140,838		—		1,060,042		1,068,342		73,662
Commercial Business	64,406		959,406		—		77,206		972,206		—
Commercial Real Estate	3,000,884		3,693,840		565,000		6,526,016		7,558,319		665,000
Total	$	4,323,060	$	5,919,316	$	565,000	$	9,364,125	$	11,299,728	$	738,662

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net, Continued



	Three Months Ended September 30,
	2019				2018
Impaired Loans	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With No Related Allowance Recorded:
Residential Real Estate	$	1,133,768	$	—	$	1,967,761	$	—
Consumer	204,782		—		957,392		—
Commercial Business	70,406		—		78,206		—
Commercial Real Estate	2,320,973		14,377		9,926,344		42,699
With an Allowance Recorded:
Commercial Real Estate	996,990		—		—		—
Total
Residential Real Estate	1,133,768		—		1,967,761		—
Consumer	204,782		—		957,392		—
Commercial Business	70,406		—		78,206		—
Commercial Real Estate	3,317,963		14,377		9,926,344		42,699
Total	$	4,726,919	$	14,377	$	12,929,703	$	42,699



	Nine Months Ended September 30,
	2019				2018
Impaired Loans	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With No Related Allowance Recorded:
Residential Real Estate	$	1,336,122	$	—	$	2,407,872	$	10,585
Consumer	1,052,347		—		1,043,893		—
Commercial Business	73,526		—		87,284		—
Commercial Real Estate	2,830,359		42,709		10,495,262		162,763
With an Allowance Recorded:
Commercial Real Estate	1,125,904		—		—		—
Total
Residential Real Estate	1,336,122		—		2,407,872		10,585
Consumer	1,052,347		—		1,043,893		—
Commercial Business	73,526		—		87,284		—
Commercial Real Estate	3,956,263		42,709		10,495,262		162,763
Total	$	6,418,258	$	42,709	$	14,034,311	$	173,348

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net, Continued

In the course of resolving delinquent loans, the Company may choose to restructure the contractual terms of certain loans. A troubled debt restructuring ("TDR") is a restructuring in which the Company, 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") 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 Company grants such concessions to reassess the borrower’s financial status and develop a plan for repayment.

At the date of modification, TDRs are initially classified as nonaccrual TDRs. TDR loans 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).

TDRs included in impaired loans were $848,000 and $1.4 million at September 30, 2019 and December 31, 2018, respectively, and the Company had no commitments at those dates to lend additional funds on these loans. There were no new TDRs during the nine months ended September 30, 2019 and 2018. At September 30, 2019, there were no TDR loans in default. In comparison, at September 30, 2018, one TDR loan with a balance of $570,000 was in default. There were no TDRs, for which there was a payment default within the first 12 months of the modification during the nine months ended September 30, 2019 and 2018. The Bank considers any loan 30 days or more past due to be in default.

The Company's 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.

The Company closely monitors 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. The Company's 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. Further, the borrower must demonstrate the capacity to continue making payments on the loan prior to restoration of accrual status.

9. Regulatory Matters

The Bank, as a state-chartered, federally insured savings 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 weighting and other factors.

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 $3.0 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 $3.0 billion or more in assets, it would have exceeded all regulatory capital requirements with Common Equity Tier 1 ("CET1") capital, Tier 1 leverage-based capital, Tier 1 risk-based capital and total risk-based capital ratios of 14.6%, 9.1%, 15.5% and 16.7%, respectively, at September 30, 2019.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

9. Regulatory Matters, Continued

Based on its capital levels at September 30, 2019, the Bank exceeded all regulatory capital requirements as of that date. Consistent with the Bank's goals to operate a sound and profitable organization, it is the Bank's policy to maintain a "well-capitalized" status under the regulatory capital categories of the FDIC. Based on capital levels at September 30, 2019, the Bank was considered to be "well-capitalized" under applicable regulatory requirements. Management monitors the capital levels to provide for current and future business opportunities and to maintain the Bank's "well-capitalized" status.

The tables below provide the Bank’s regulatory capital requirements and actual results at the dates indicated.



	Actual			For Capital Adequacy			To Be "Well-Capitalized"
(Dollars in Thousands)	Amount		Ratio	Amount		Ratio	Amount		Ratio
	September 30, 2019
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	91,013	15.7%	$	34,791	6.0%	$	46,389	8.0%
Total Risk-Based Capital (To Risk Weighted Assets)	98,273		16.9%	46,389		8.0%	57,986		10.0%
Common Equity Tier 1 Capital (To Risk Weighted Assets)	91,013		15.7%	26,094		4.5%	37,691		6.5%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	91,013		9.3%	39,274		4.0%	49,092		5.0%
	December 31, 2018
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	89,188	16.2%	$	33,005	6.0%	$	44,007	8.0%
Total Risk-Based Capital (To Risk Weighted Assets)	96,092		17.5%	44,007		8.0%	55,009		10.0%
Common Equity Tier 1 Capital (To Risk Weighted Assets)	89,188		16.2%	24,754		4.5%	35,756		6.5%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	89,188		9.8%	36,486		4.0%	45,608		5.0%

In addition to the minimum capital requirements, the Bank must maintain a capital conservation buffer, which consists of additional CET1 capital greater than 2.5% of risk weighted assets above the required minimum levels in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses. At September 30, 2019 the Bank’s conservation buffer was 8.9%.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

10. Carrying Amounts and Fair Value of Financial Instruments

GAAP requires the Company to disclose fair value of financial instruments measured at amortized cost on the balance sheet and to measure that fair value using an exit price notion, the price that would be received for an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date under current market conditions.

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 -	Quoted Market Price in Active Markets 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 -	Significant Other Observable Inputs 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 -	Significant Unobservable Inputs 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, 2019, the Company’s investment portfolio was comprised of student loan pools, government and agency bonds, mortgage-backed securities issued by government agencies or GSEs, private label CMO mortgage-backed securities, municipal securities, one state tax credit, and one equity investment. 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.

Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2019, 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, 2019 and December 31, 2018, the recorded investment in impaired loans was $4.3 million and $9.4 million, respectively.

Foreclosed Assets

Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. Foreclosed assets are recorded as nonrecurring Level 3.

Assets measured at fair value on a recurring basis were as follows at September 30, 2019 and December 31, 2018:



	September 30, 2019						December 31, 2018
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
Student Loan Pools	$	—	$	41,243,338	$	—	$	—	$	12,885,501	$	—
SBA Bonds	—		120,976,425		—		—		125,446,531		—
Tax Exempt Municipal Bonds	—		47,516,986		—		—		61,330,369		—
Taxable Municipal Bonds	—		2,017,055		—		—		1,977,885		—
Mortgage-Backed Securities	—		226,273,389		—		—		184,460,551		—
State Tax Credit	—		61,242		—		—		—		—
Equity Securities	—		155,000		—		—		155,000		—
Total	$	—	$	438,243,435	$	—	$	—	$	386,255,837	$	—

There were no liabilities measured at fair value on a recurring basis at either September 30, 2019 or December 31, 2018.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. The tables below present assets measured at fair value on a nonrecurring basis at September 30, 2019 and December 31, 2018, aggregated by the level in the fair value hierarchy within which those measurements fall.



	September 30, 2019
Assets:	Level 1		Level 2		Level 3		Total
Mortgage Loans Held For Sale	$	—	$	3,682,876	$	—	$	3,682,876
Collateral Dependent Impaired Loans ⁽¹⁾	—		—		3,749,734		3,749,734
Foreclosed Assets	—		—		703,540		703,540
Total	$	—	$	3,682,876	$	4,453,274	$	8,136,150



	December 31, 2018
Assets:	Level 1		Level 2		Level 3		Total
Mortgage Loans Held For Sale	$	—	$	1,781,985	$	—	$	1,781,985
Collateral Dependent Impaired Loans ⁽¹⁾	—		—		8,613,570		8,613,570
Foreclosed Assets	—		—		722,442		722,442
Total	$	—	$	1,781,985	$	9,336,012	$	11,117,997

^{(1) COLLATERAL IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF $565,000 AND $739,000 AT SEPTEMBER 30, 2019 AND DECEMBER 31, 2018, RESPECTIVELY.}

There were no liabilities measured at fair value on a nonrecurring basis at either September 30, 2019 or December 31, 2018.

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis at September 30, 2019, the significant unobservable inputs used in the fair value measurements were as follows:



			Valuation	Significant
Level 3 Assets	Fair Value		Technique	Unobservable Inputs	Range
Collateral Dependent Impaired Loans	$	3,749,734	Appraised Value	Discount Rates/ Discounts to Appraised Values	4% - 97%
Foreclosed Assets	$	703,540	Appraised Value/Comparable Sales	Discount Rates/ Discounts to Appraised Values	16% - 68%

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

FHLB Advances—Fair value is estimated using discounted cash flows with current market rates for borrowings with similar terms.

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

Note Payable—The carrying value of the note payable 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.

The following tables provide a summary of the carrying value and estimated fair value of the Company’s financial instruments at September 30, 2019 and December 31, 2018 presented in accordance with the applicable accounting guidance.



September 30, 2019	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash and Cash Equivalents	$	13,793	$	13,793	$	13,793	$	—	$	—
Certificates of Deposits with Other Banks	950		950		—		950		—
Investment and Mortgage-Backed Securities	459,660		460,197		—		460,197		—
Loans Receivable, Net	453,641		450,165		—		—		450,165
FHLB Stock	2,853		2,853		2,853		—		—
Financial Liabilities:
Deposits:
Checking, Savings & Money Market Accounts	$	534,622	$	534,622	$	534,622	$	—	$	—
Certificate Accounts	279,999		279,987		—		279,987		—
Advances from FHLB	47,800		47,920		—		47,920		—
Other Borrowed Money	14,989		14,989		14,989		—		—
Senior Convertible Debentures	6,044		6,044		—		6,044		—
Junior Subordinated Debentures	5,155		5,155		—		5,155		—



December 31, 2018	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash and Cash Equivalents	$	12,706	$	12,706	$	12,706	$	—	$	—
Certificates of Deposits with Other Banks	1,200		1,200		—		1,200		—
Investment and Mortgage-Backed Securities	409,894		409,505		—		409,505		—
Loans Receivable, Net	430,054		421,379		—		—		421,379
FHLB Stock	2,204		2,204		2,204		—		—
Financial Liabilities:
Deposits:
Checking, Savings & Money Market Accounts	$	529,043	$	529,043	$	529,043	$	—	$	—
Certificate Accounts	238,454		236,103		—		236,103		—
Advances from FHLB	34,030		33,771		—		33,771		—
Other Borrowed Money	10,698		10,698		10,698		—		—
Note Payable	2,363		2,363		—		2,363		—
Senior Convertible Debentures	6,064		6,064		—		6,064		—
Junior Subordinated Debentures	5,155		5,155		—		5,155		—

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

At September 30, 2019, the Bank had $99.9 million in 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.

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 February 2016, the FASB amended the Leases topic of the ASC to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. In July 2018, the FASB further amended the Leases Topic of the ASC to make narrow amendments to clarify how to apply certain aspects of the new leases standard. The amendments also give entities another additional and optional method for transition to the new guidance and to provide lessors with a practical expedient. The amendments were effective for reporting periods beginning after December 15, 2018. The Company adopted the new standard and recorded a right-of use asset and lease liability of $3.1 million effective January 1, 2019. Additional disclosures required by the ASC have been included in "Note 13 - Leases."

In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The guidance significantly changes the impairment model for most financial assets that are measured at amortized cost and certain other instruments from an incurred loss model to an expected loss model. The amendments will be effective for the Company for reporting periods beginning after December 15, 2022, assuming the adoption of guidance implementing the FASB board decision in October 2019 extending the adoption date for certain registrants, including the Company, with early adoption permitted. The Company is in the process of identifying required changes to the loan loss estimation models and processes and evaluating the impact of this new guidance. Once adopted, the Company expects the allowance for loan losses to increase, however, until its evaluation is complete the magnitude of the increase will be unknown.

In March 2017, the FASB issued guidance on Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The guidance shortens the amortization period for certain callable debt securities held at a premium. The amendments were effective for the Company for reporting periods beginning after December 15, 2018. The adoption of 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 June 2018, the FASB amended the Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. The amendments expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. Previously, these awards were recorded at the fair value of consideration received or the fair value of the equity instruments issued and was measured as the earlier of the commitment date or date performance was completed. The guidance requires the awards to be measured at the grant-date fair value of the equity instrument. The new standard became effective for reporting periods beginning after December 15, 2018. The adoption of these amendments did not have a material effect on the Company's consolidated financial statements.

In August 2018, the FASB amended the Fair Value Measurement Topic of the ASC to remove, modify, and add certain fair value disclosure requirements based on the concepts in the FASB Concepts Statement, Conceptual Framework for Financial Reporting-Chapter 8: Notes to Financial Statements. The amendments will be effective for reporting periods beginning after December 15, 2019. Early adoption is permitted. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this guidance and delay adoption of the additional disclosures until their effective date. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In March 2019, the FASB issued guidance to address concerns by lessors that are not manufacturers or dealers when assessing the fair value of underlying assets under the leases standard discussed above and to clarify that lessees and lessors are exempt from a certain interim disclosure requirement associated with adopting the new standard. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In April 2019, the FASB issued guidance to provide entities that have certain financial instruments measured at amortized cost that have credit losses, to irrevocably elect the fair value option in Subtopic 825-10, upon adoption of the June 2016 guidance related to accounting for credit losses and modifying the impairment model for certain debt securities. The fair value option applies to available-for-sale debt securities. This guidance should be applied at adoption on a modified-retrospective basis as a cumulative-effect adjustment to the opening balance of retained earnings in the statement of financial condition. 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.

12. Non-Interest Income

The Company recognizes revenue as it is earned and noted no impact to its revenue recognition policies as a result of the adoption of ASU 2014-09. The following is a discussion of key revenues within the scope of this guidance.

Revenue Recognition

In accordance with Topic 606, revenues are recognized when control of promised goods or services is transferred to customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of Topic 606, the Company performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the Company satisfies a performance obligation.

The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of Topic 606, the Company assesses the goods or services that are promised within each contract and identifies those that contain performance obligations, and assesses whether each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

12. Non-Interest Income, Continued

Deposit Fees

The Bank earns fees from its deposit customers for account maintenance, transaction-based and overdraft services. Account maintenance fees consist primarily of account fees and analyzed account fees charged on deposit accounts on a monthly basis. The performance obligation is satisfied and the fees are recognized on a monthly basis as the service period is completed. Transaction-based fees on deposits accounts are charged to deposit customers for specific services provided to the customer, such as non-sufficient funds fees, overdraft fees, and wire fees. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer.

Check Card Fee Income

Check card fee income represents fees earned when a debit card issued by the Bank is used. The Bank earns interchange fees from debit cardholder transactions through the Mastercard payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the card. Certain expenses directly associated with the debit card are recorded on a net basis with the fee income.

Trust Income

Trust income includes monthly advisory fees that are based on assets under management and certain transaction fees that are assessed and earned monthly, concurrently with the investment management services provided to the customer. The Bank does not charge performance based fees for its trust services and does not currently have any institutional clients, hedge funds or mutual funds. Although trust income is included within the scope of ASC 606, based on the fees charged by the Bank, there were no changes in the accounting for trust income at this time.

Gains/Losses on OREO Sales

Gains/losses on the sale of OREO are included in non-interest expense and are generally recognized when the performance obligation is complete. This is typically at delivery of control over the property to the buyer at the time of each real estate closing.

The following table presents the Company's non-interest income for the three and nine months ended September 30, 2019 and 2018. All of the Company’s revenue from contracts with customers within the scope of ASC 606 is recognized in non-interest income, with the exception of gains on the sale of OREO, which are included in non-interest expense when applicable.



	Three Months Ended September 30,				Nine Months Ended September 30,
	2019		2018		2019		2018
Non-interest income:
Service fees on deposit accounts	$	279,360	$	262,821	$	785,987	$	770,493
Check card fee income	365,659		320,708		1,063,314		966,365
Trust income	270,000		249,000		787,200		725,000
Insurance commissions ⁽¹⁾	201,253		196,817		528,246		525,153
Gain on sale of investment securities, net ⁽¹⁾	96,057		—		1,056,959		436,304
Gain on sale of loans, net⁽¹⁾	580,220		345,396		1,126,551		999,045
BOLI income ⁽¹⁾	273,609		135,000		543,609		405,000
Grant income ⁽¹⁾	55,364		318,102		332,393		318,102
Other non-interest income ⁽¹⁾	286,935		241,837		872,591		712,785
Total non-interest income	$	2,408,457	$	2,069,681	$	7,096,850	$	5,858,247
⁽¹⁾ Not within the scope of ASC 606

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

13. Leases

Effective January 1, 2019 the Company adopted ASC 842 “Leases.” Currently, the Company has operating leases on six of its branches that are accounted for under this standard. As a result of this standard, the Company recognized a right-of-use asset of $3.1 million effective January 1, 2019. During the nine months ended September 30, 2019, the Company made cash payments in the amount of $332,000 for operating leases. The lease expense recognized during this period amounted to $343,000 and the lease liability was reduced by $280,000. The following table is a maturity analysis of the operating lease liabilities. The weighted average lease term is eight years and the weighted average discount rate used is 3.2%.



Year	Cash Payments		Lease Expense		Liability Reduction
2019	$	443,858	$	458,364	$	458,364
2020	434,395		448,568		448,568
2021	425,078		438,771		438,771
2022	436,496		438,771		438,771
2023	448,299		438,771		438,771
Thereafter	1,317,256		1,282,137		1,282,137
Total	$	3,505,382	$	3,505,382	$	3,505,382

14. 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 there were no subsequent events requiring disclosure.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

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

Forward-Looking Statements and “Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995

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 originate loans for sale and sell loans in the secondary market;

•

results of examinations of the Company by the Federal Reserve and our bank subsidiary by the FDIC and the South Carolina 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;


•	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;


•	disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing;


•	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;


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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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


•	our ability to pay dividends on our common stock;


•	adverse changes in the securities markets;


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


•	changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the FASB, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods; 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 2018 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 2019 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 consolidated financial condition, consolidated results of operations, liquidity and stock price performance.

As used throughout this report, the terms "we," "our," or "us" refer to Security Federal Corporation and our consolidated subsidiary, Security Federal Bank.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Financial Condition at September 30, 2019 and December 31, 2018

Assets

Total assets increased $78.6 million or 8.6% to $991.3 million at September 30, 2019 from $912.6 million at December 31, 2018. Changes in total assets were primarily concentrated in the following asset categories:



					Increase (Decrease)
(Dollars in thousands)	9/30/2019		12/31/2018		$			%
Cash and Cash Equivalents	$	13,793	$	12,706	$	1,087		8.6%
Certificates of Deposits with Other Banks	950		1,200		(250		)	(20.8)
Investments and MBS – AFS	438,243		386,256		51,987			13.5
Investments and MBS – HTM	21,417		23,638		(2,221		)	(9.4)
Loans Receivable, Net	453,641		430,054		23,587			5.5
OREO	704		722		(18		)	(2.5)
Operating Lease Right-of-Use Assets	2,811		—		2,811			100.0
Premises and Equipment, Net	26,378		24,175		2,203			9.1
FHLB Stock	2,853		2,204		649			29.4
BOLI	21,367		21,238		129			0.6
Other Assets	4,425		5,495		(1,070		)	(19.5)

Cash and cash equivalents increased $1.1 million or 8.6% to $13.8 million at September 30, 2019 from $12.7 million at December 31, 2018 due to increases in deposits, FHLB Advances and sales of investment securities, which were partially offset by the early repayment of the Company's $2.4 million unsecured term loan from another financial institution during 2019 and the use of excess cash to fund higher yielding interest-earning assets.

Certificates of deposits with other banks decreased $250,000 or 20.8% to $950,000 at September 30, 2019 due to the maturity and redemption of two of the Bank's lower yielding time deposits with other banks during 2019.

Investment and mortgage-backed securities AFS increased $52.0 million or 13.5% to $438.2 million at September 30, 2019 from $386.3 million at December 31, 2018 as purchases of new investment and mortgage backed securities AFS exceeded maturities, principal paydowns, and investments sold during the nine months ended September 30, 2019. Investment and mortgage-backed securities HTM decreased $2.2 million or 9.4% to $21.4 million at September 30, 2019 from $23.6 million at December 31, 2018 as a result of maturities and principal paydowns.

Loans receivable, net, including loans held for sale, increased $23.6 million or 5.5% to $453.6 million at September 30, 2019 from $430.1 million at December 31, 2018 primarily due to an increase in commercial real estate loans, which increased $23.4 million or 8.5% to $299.4 million at September 30, 2019 from $276.0 million at December 31, 2018. Consumer loans decreased $1.6 million or 2.9% to $55.3 million at September 30, 2019 compared to $56.9 million at December 31, 2018. Commercial business loans decreased $1.2 million or 4.1% to $26.9 million at September 30, 2019 from $28.1 million at December 31, 2018. These decreases were partially offset by a $1.8 million or 2.2% increase in residential real estate loans to $85.8 million at September 30, 2019 from $84.0 million at December 31, 2018. Loans held for sale increased $1.9 million or 106.7% to $3.7 million at September 30, 2019 from $1.8 million at December 31, 2018.

Premises and equipment, net increased $2.2 million or 9.1% to $26.4 million at September 30, 2019 from $24.2 million at December 31, 2018 as result of our growth and recent expansion into the Augusta, Georgia market. The Bank’s newest branch, located in Augusta, Georgia, opened during the third quarter of 2019. Another branch in Augusta is under construction and scheduled to open later this year.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Effective January 1, 2019, the Company adopted the amended Leases topic of the ASC 842. As a result of this standard, the Company recognized $3.1 million in right-of-use assets on that date. Currently, the Company has operating leases on six of its facilities that are accounted for under this standard. At September 30, 2019, these assets had a balance of $2.8 million. For additional information regarding the adoption of this topic, refer to Note 13 of the Notes to Consolidated Financial Statements included herein.

FHLB stock increased $649,000 or 29.4% to $2.9 million at September 30, 2019 from $2.2 million at December 31, 2018. 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 and assets have increased, so has its required investment in FHLB stock.

The cash value of BOLI increased $129,000 or 0.6% to $21.4 million at September 30, 2019 from $21.2 million at December 31, 2018 as a result of income recognized during the period due to changes in the cash surrender value of the underlying policies. BOLI, which earns tax-free yields, is utilized to partially offset the cost of the Company’s employee benefits programs and to provide key person insurance on certain officers of the Company.

Other assets decreased $1.1 million or 19.5% to $4.4 million at September 30, 2019 from $5.5 million at December 31, 2018. The decrease was primarily the result of a $2.0 million decrease in net deferred tax assets, which was related to increased unrealized gains in the investment portfolio due to increases in the fair value of investment and mortgage-backed securities AFS at September 30, 2019.

Liabilities

Deposit Accounts

Total deposits increased $47.1 million or 6.1% to $814.6 million at September 30, 2019 from $767.5 million at December 31, 2018. This growth was primarily due to increases in checking and certificate accounts, which increased $21.1 million and $41.6 million, respectively, during the first nine months of 2019. The balance, weighted average rate and change in each deposit category at September 30, 2019 and December 31, 2018 is shown below.



	9/30/19			12/31/18			Increase (Decrease)
(Dollars in thousands)	Balance		Weighted Rate	Balance		Weighted Rate	$			%
Demand Accounts:
Checking	$	240,644	0.05%	$	219,515	0.09%	$	21,129		9.6%
Money Market	242,665		0.77	261,136		0.65	(18,471		)	(7.1)
Savings	51,313		0.16	48,392		0.14	2,921			6.0
Total	$	534,622	0.36%	$	529,043	0.31%	$	5,579		1.1%
Certificate Accounts
0.00 – 0.99%	$	31,807		$	70,855		$	(39,048	)	(55.1)%
1.00 – 1.99%	112,246			120,012			(7,766		)	(6.5)
2.00 – 2.99%	135,946			47,587			88,359			185.7
Total	$	279,999	1.82%	$	238,454	1.37%	$	41,545		17.4%
Total Deposits	$	814,621	0.86%	$	767,497	0.64%	$	47,124		6.1%

Included in certificate accounts were $59.9 million and $33.1 million in brokered deposits at September 30, 2019 and December 31, 2018, respectively, with a weighted average interest rate of 2.04% and 1.86%, respectively. Management utilizes brokered deposits to mitigate interest rate risk and liquidity risk exposure when appropriate.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Advances From FHLB

FHLB advances increased $13.8 million or 40.5% to $47.8 million at September 30, 2019 from $34.0 million at December 31, 2018 to fund growth in the Bank’s loan and investment and mortgage-backed securities AFS portfolios. FHLB advances are summarized by contractual year of maturity and weighted average interest rate in the table below.



	September 30, 2019			December 31, 2018			Increase (Decrease)
Year Due:	Balance		Rate	Balance		Rate	$			%
2019	$	4,000,000	1.62%	$	23,530,000	1.55%	$	(19,530,000	)	(83.0)%
2020	18,800,000		2.01	10,500,000		1.91	8,300,000			79.0
2021	25,000,000		1.97	—		—	25,000,000			100.0
Total Advances	$	47,800,000	1.96%	$	34,030,000	1.66%	$	13,770,000		40.5%

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 $88.2 million and $84.7 million, respectively, at September 30, 2019 and $79.1 million and $71.4 million, respectively, at December 31, 2018.

There were no callable FHLB advances at September 30, 2019. 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 $15.0 million in other borrowings (non-FHLB advances) at September 30, 2019, an increase of $4.3 million or 40.1% from $10.7 million at December 31, 2018. 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. The interest rate paid on the repurchase agreements was 0.50% at September 30, 2019 compared to 0.25% at December 31, 2018.

The Bank had pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $18.7 million and $18.9 million, respectively, at September 30, 2019 and $16.7 million and $16.7 million, respectively, at December 31, 2018.

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 3.82% at September 30, 2019. 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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Equity

Shareholders’ equity increased $11.8 million or 14.6% to $92.3 million at September 30, 2019 from $80.5 million at December 31, 2018. The increase was attributable to net income of $6.2 million combined with a $6.4 million increase in accumulated other comprehensive income, net of tax during the nine months ended September 30, 2019. The increase in net accumulated other comprehensive income was related to the unrecognized gain in value of investment and mortgage-backed securities AFS during the nine months ended September 30, 2019. These increases in shareholders' equity were partially offset by $828,000 in dividends paid to common shareholders during the nine months ended September 30, 2019. Book value per common share was $31.22 at September 30, 2019 compared to $27.26 at December 31, 2018.

Results of Operations for the Three Month Periods Ended September 30, 2019 and 2018

Net Income

Net income increased $112,000 or 5.3% to $2.2 million or $0.71 per diluted common share for the three months ended September 30, 2019 compared to $2.1 million or $0.68 per diluted common share for the three months ended September 30, 2018. The increase in earnings was primarily the result of increases in net interest income and non-interest income combined with a decrease in the provision for loan losses, which were partially offset by an increase in non-interest expense.

Net Interest Income

Net interest income increased $273,000 or 3.9% to $7.3 million during the quarter ended September 30, 2019, compared to $7.1 million for the same period in 2018. During the quarter ended September 30, 2019, average interest earning assets increased $78.1 million or 9.4% to $912.3 million from $834.2 million for the same period in 2018. The increase in average earning assets and the related 13 basis point increase in average yield was partially offset by a higher cost of funds as total interest expense increased $862,000, or 60.3%, to $2.3 million during the quarter ended September 30, 2019 compared to $1.4 million for the same period in 2018. The increase was primarily related to interest expense on deposits, which increased due to the rise in local market interest rates, resulting in a 37 basis point increase in average cost and a $45.7 million increase in average deposits for the third quarter of 2019. Average interest-bearing liabilities increased $65.5 million or 9.2% to $780.8 million for the three months ended September 30, 2019 from $715.3 million for the comparable period in 2018 due to the increase in average deposits and a $24.1 million increase in FHLB advances and other borrowed money. The Company's net interest margin was 3.25% for the quarter ended September 30, 2019 compared to 3.43% for the same quarter in 2018. The Company's net interest spread on a tax equivalent basis decreased 25 basis points to 3.07% for the three months ended September 30, 2019 from 3.32% for the comparable period in 2018.

Interest Income

The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the three months ended September 30, 2019 and 2018:



	Three Months Ended September 30,						Change in Average Balance			Change in Tax Equivalent Interest Income
	2019			2018
(Dollars in thousands)	Average Balance		Yield⁽¹⁾	Average Balance		Yield⁽¹⁾
Loans Receivable, Net	$	451,652	5.64%	$	432,807	5.44%	$	18,845		$	479
Mortgage-Backed Securities	243,003		2.98	195,986		2.76	47,017			457
Investment Securities⁽²⁾	216,458		2.80	197,877		2.68	18,581			192
Overnight Time and Certificates of Deposit	1,157		1.41	7,528		1.34	(6,371		)	(21		)
Total Interest-Earning Assets	$	912,270	4.25%	$	834,197	4.12%	$	78,073		$	1,107

⁽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 21% for the quarters ended September 30, 2019 and 2018. The tax equivalent adjustment relates to the tax exempt municipal bonds and was $57,000 and $85,000 for the quarters ended September 30, 2019 and 2018, respectively.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Total tax equivalent interest income increased $1.1 million or 12.9% to $9.7 million during the quarter ended September 30, 2019 compared to $8.6 million during the same period in 2018. This increase was the result of a $78.1 million increase in average interest-earning assets combined with an increase of 13 basis points in the average yield earned on interest-earning assets. Total interest income on loans increased $479,000 or 8.1% to $6.4 million during the quarter ended September 30, 2019 from $5.9 million during the comparable period in 2018 as the result of a $18.8 million increase in the average loan portfolio balance combined with an increase of 20 basis points in the average yield on loans. Interest income from MBS increased $457,000 or 33.8% to $1.8 million during the quarter ended September 30, 2019 due to a $47.0 million increase in the average balance combined with an increase of 22 basis points in the average MBS portfolio yield. Tax equivalent interest income from investment securities increased $192,000 or 14.5% to $1.5 million during the quarter ended September 30, 2019 due to a $18.6 million increase in the average balance of the investment securities portfolio combined with a 12 basis point increase in the average yield on investment securities.

Interest Expense

The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the three months ended September 30, 2019 and 2018.



	Three Months Ended September 30,							Change in Average Balance			Change in Interest Expense
	2019			2018
(Dollars in thousands)	Average Balance		Cost⁽¹⁾	Average Balance		Cost⁽¹⁾
Now and Money Market Accounts	$	372,976	0.58%	$	360,644	0.36	%	$	12,332		$	216
Savings Accounts	51,034		0.15	48,571		0.12		2,463			5
Certificate Accounts	268,803		1.79	237,851		1.19		30,952			498
FHLB Advances and Other Borrowed Money	76,769		1.83	52,651		1.19		24,118			195
Note Payable	—		—	4,317		4.80		(4,317		)	(52		)
Junior Subordinated Debentures	5,155		4.15	5,155		4.13		—			—
Senior Convertible Debentures	6,044		8.00	6,064		8.00		(20		)	—
Total Interest-Bearing Liabilities	$	780,781	1.17%	$	715,253	0.80	%	$	65,528		$	862

⁽¹⁾ Annualized

Total interest expense increased $862,000 or 60.3% to $2.3 million during the three months ended September 30, 2019 compared to $1.4 million for the same period in 2018 reflecting the rise in market interest rates over the last year. The increase was attributable to a 37 basis point increase in the average cost of interest-bearing liabilities and a $65.5 million increase in the average balance of interest-bearing liabilities. Interest expense on deposits increased $719,000 or 68.7% to $1.8 million during the three months ended September 30, 2019 compared to $1.0 million for the same period in 2018. The increase was attributable to a 37 basis point increase in the average cost of deposit accounts combined with a $45.7 million or 7.1% increase in average interest-bearing deposits to $692.8 million for the three months ended September 30, 2019 compared to $647.1 million for the three months ended September 30, 2018.

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 five year historical loss ratio to each loan category to estimate the inherent loss in these pooled loans.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

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 table below shows the changes in the allowance for loan losses for the quarters ended September 30, 2019 and 2018.



	Three Months Ended September 30,
	2019		2018
Beginning Balance	$	8,753,539	$	8,611,176
Provision for Loan Losses	75,000		150,000
Charge-offs	(102,273)		(172,492)
Recoveries	32,372		13,394
Net (Charge-offs) Recoveries	(69,901)		(159,098)
Ending Balance	$	8,758,638	$	8,602,078

At Period End:	September 30, 2019		September 30, 2018
Allowance For Loan Losses as a % of Gross Loans Receivable ⁽¹⁾	1.9%		2.0%
Allowance For Loan Losses as a % of Impaired Loans	202.6%		68.3%
Impaired Loans	$	4,323,060	$	12,595,869
Gross Loans Receivable, Held For Investment ⁽¹⁾	$	458,717,257	$	431,844,768
Total Loans Receivable, Net	$	453,641,495	$	423,979,788

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

The Company had net charge-offs of $70,000 for the quarter ended September 30, 2019 compared to net charge-offs of $159,000 for the comparable period in 2018. Consistent with the decrease in net charge-offs, the provision for loan losses also decreased to $75,000 for the quarter ended September 30, 2019 compared to $150,000 during the third quarter of 2018. The allowance for loan losses as a percentage of gross loans was 1.9% at September 30, 2019 compared to 2.0% at September 30, 2018.

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.

Management believes the allowance for loan losses is adequate based on its best estimates of the probable losses inherent in the loan portfolio, although there can be no guarantee these estimates will not be proven incorrect in the future. In addition, bank regulatory agencies may require additional provisions to the allowance for loan losses based on their judgments and estimates as part of their examination process. Because the allowance for loan losses is an estimate, there can be no guarantee that actual loan losses will not exceed the allowance for loan losses, or that additional increases in the allowance for loan losses will not be required in the future.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Non-Interest Income

Non-interest income increased $339,000 or 16.4% to $2.4 million for the three months ended September 30, 2019 compared to $2.1 million for the three months ended September 30, 2018. The following table summarizes the changes in non-interest income:



	Three Months Ended September 30,				Increase (Decrease)
	2019		2018		$			%
Gain on Sale of Investment Securities	$	96,057	$	—	$	96,057		100.0	%
Gain on Sale of Loans	580,220		345,396		234,824			68.0
Service Fees on Deposit Accounts	279,360		262,821		16,539			6.3
Commissions From Insurance Agency	201,253		196,817		4,436			2.3
BOLI Income	273,609		135,000		138,609			102.7
Trust Income	270,000		249,000		21,000			8.4
Check Card Fee Income	365,659		320,708		44,951			14.0
Grant Income	55,364		318,102		(262,738		)	1.0
Other	286,935		241,837		45,098			18.6
Total Non-Interest Income	$	2,408,457	$	2,069,681	$	338,776		16.4	%

The increase in non-interest income was primarily attributable to increases in both gain on sale of loans and net gain on the sale of investment securities AFS, partially offset by a decline in grant income due to a difference in timing of receipt of the grant. Gain on sale of loans increased $235,000 or 68.0% to $580,000 for the three months ended September 30, 2019 compared to $345,000 during the same period in 2018 as the volume of loans sold increased. Net gain on sale of investment securities was $96,000 during the quarter ended September 30, 2019 compared to none for the same period last year.

During the third quarter of 2019, the Bank recognized $139,000 in BOLI death benefits in addition to $135,000 in income related to accrued interest credited to the cash surrender value underlying the BOLI policies. The Company did not receive any BOLI death benefit proceeds during the third quarter of 2018. The entire portion of BOLI income recognized in 2018 was related to changes in the cash surrender value of the BOLI policies.

Non-Interest Expense

For the quarter ended September 30, 2019, non-interest expense increased $572,000 or 8.9% to $7.0 million compared to $6.4 million for the same period in 2018. The following table summarizes the changes in non-interest expense:



	Three Months Ended September 30,					Increase (Decrease)
	2019		2018			Amounts			Percent
Compensation and Employee Benefits	$	4,270,515	$	4,032,245		$	238,270		5.9%
Occupancy	599,512		586,527			12,985			2.2
Advertising	190,070		181,663			8,407			4.6
Depreciation and Maintenance of Equipment	644,800		575,750			69,050			12.0
FDIC Insurance Premiums	41,540		72,837			(31,297		)	(43.0)
Net Cost (Recovery) of Operation of OREO	189,467		(203,104		)	392,571			(193.3)
Other	1,053,219		1,171,664			(118,445		)	(10.1)
Total Non-Interest Expense	$	6,989,123	$	6,417,582		$	571,541		8.9%

Compensation and employee benefits expenses increased $238,000 or 5.9% to $4.3 million for the quarter ended September 30, 2019 compared to $4.0 million for the same period last year due to general annual cost of living increases combined with an increase in the number of full time equivalent employees as a result of our growth and expansion into the Augusta, Georgia market.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

The Company had a net cost of $189,000 from the operation of OREO properties during the quarter ended September 30, 2019 compared to a net recovery of $203,000 during the quarter ended September 30, 2018. This includes all expenses associated with OREO including write-down in value and gain or loss on sales incurred during each period. The Company recorded $44,000 in net gain on sales of OREO properties and write-downs of $8,000 during the third quarter of 2019 compared to net gain on sales of $240,000 and write-downs of $6,000 during the third quarter of 2018.

Depreciation and maintenance of equipment expense increased $69,000 reflecting the growth in our branch network. Deposit and FDIC insurance premiums decreased $31,000 as a result of a small bank credit awarded by the FDIC, which was recognized during the quarter ended September 30, 2019. The Bank has $149,000 in small bank credits on future assessments remaining at September 30, 2019, which may be recognized in future periods when allowed by the FDIC upon insurance fund levels being met.

Other non-interest expenses decreased $118,000, or 10.1% to $1.1 million for the three months ended September 30, 2019 compared to $1.2 million for the same period in 2018. Other expenses include legal, professional and consulting expenses, supplies and other miscellaneous expenses.

Provision For Income Taxes

The provision for income taxes increased $3,000 or 0.7% to $475,000 for the quarter ended September 30, 2019 from $471,000 for the same period in 2018. Income before income taxes was $2.7 million for the quarter ended September 30, 2019 compared to $2.6 million for the same period in 2018. The Company’s combined federal and state effective income tax rate for the current quarter was 17.6% compared to 18.3% for the same quarter one year ago as a result of a larger investment in state tax credits made by the Bank during 2019 compared to 2018.

Results of Operations for the Nine Months Ended September 30, 2019 and 2018

Net Income

Net income increased $535,000 or 9.4% to $6.2 million or $1.98 per diluted common share for the nine months ended September 30, 2019 compared to $5.7 million or $1.82 per diluted common share for the same nine month period in 2018. The increase in earnings was primarily due to increases in net interest income and non-interest income. These items were partially offset by an increase in non-interest expense.

Net Interest Income

Net interest income increased $1.3 million or 6.4% to $21.7 million for the nine months ended September 30, 2019 compared to $20.4 million for the same period last year. During the nine months ended September 30, 2019, average interest earning assets increased $57.3 million or 7.0% to $878.6 million from $821.3 million for the nine months ended September 30, 2018. Average interest-bearing liabilities also increased by $40.9 million or 5.8% to $750.5 million for the nine months ended September 30, 2019 from $709.6 million for the same period in 2018. The increase in average earning assets and the related 26 basis point increase in average yield was partially offset by a higher cost of funds as total interest expense increased $2.2 million, or 56.4%, to $6.1 million in the first nine months of 2019 compared to $3.9 million for the same period in 2018. The increase during 2019 was related to interest expense on deposits, which increased due to the rise in market interest rates, resulting in a 39 basis point increase in average cost combined with an increase in average deposits.

The Company's net interest margin decreased to 3.33% for the nine months ended September 30, 2019 compared to 3.36% for the nine months ended September 30, 2018. The net interest spread on a tax equivalent basis decreased nine basis points to 3.17% for the nine months ended September 30, 2019 from 3.26% for the comparable period in 2018.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Interest Income

The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the nine months ended September 30, 2019 and 2018:



	Nine Months Ended September 30,							Change in Average Balance			Increase in Interest Income
	2019				2018
(Dollars in Thousands)	Average Balance		Yield⁽¹⁾		Average Balance		Yield⁽¹⁾
Loans Receivable, Net	$	439,704	5.59	%	$	421,795	5.36%	$	17,909		$	1,454
Mortgage-Backed Securities	222,326		2.99		198,421		2.65	23,905			1,035
Investment Securities⁽²⁾	211,909		2.84		196,191		2.45	15,718			898
Overnight Time & Certificates of Deposit	4,661		2.69		4,882		1.16	(221		)	52
Total Interest-Earning Assets	$	878,600	4.25	%	$	821,289	3.99%	$	57,311		$	3,439

⁽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 21% for the nine months ended September 30, 2019 and 2018. The tax equivalent adjustment relates to the tax exempt municipal bonds and was $201,000 and $253,000 for the nine months ended September 30, 2019 and 2018, respectively.

Total tax equivalent interest income increased $3.4 million or 14.0% to $28.0 million during the nine months ended September 30, 2019 from $24.6 million for the same period in 2018. Total interest income on loans increased $1.5 million or 8.6% to $18.4 million during the nine months ended September 30, 2019 from $17.0 million for the same period in 2018. The increase was a result of a $17.9 million or 4.2% increase in the average loan portfolio to $439.7 million from $421.8 million for the same period in 2018 combined with an increase of 23 basis points in the average yield on loans. Interest income from MBS increased $1.0 million or 26.2% to $5.0 million for the nine months ended September 30, 2019 from $3.9 million for the same period in 2018. The increase was the result of a $23.9 million increase in the average balance of MBS combined with an increase of 34 basis points in the average MBS portfolio yield. Tax equivalent interest income from investment securities increased $898,000 to $4.5 million for the nine months ended September 30, 2019 from $3.6 million for the same period in 2018 due to a $15.7 million increase in the average balance of investment securities combined with an increase of 39 basis points in the average yield earned on investment securities.

Interest Expense

The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the nine months ended September 30, 2019 and 2018:



	Nine Months Ended September 30,								Change in Average Balance			Change in Interest Expense
	2019				2018
(Dollars in Thousands)	Average Balance		Yield⁽¹⁾		Average Balance		Yield⁽¹⁾
Now and Money Market Accounts	$	374,396	0.57%		$	354,309	0.29	%	$	20,087		$	823
Savings Accounts	50,223		0.14		46,216		0.11		4,007			16
Certificates Accounts	257,247		1.65		233,486		1.06		23,761			1,325
FHLB Advances and Other Borrowed Money	56,528		1.59		58,660		1.17		(2,132		)	163
Note Payable	902		5.25		5,709		4.46		(4,807		)	(155		)
Junior Subordinated Debentures	5,155		4.31		5,155		3.81		—			19
Senior Convertible Debentures	6,046		8.00		6,064		8.00		(18		)	(1		)
Total Interest-Bearing Liabilities	$	750,497	1.08	%	$	709,599	0.73	%	$	40,898		$	2,190

⁽¹⁾ Annualized

Interest expense increased $2.2 million or 56.4% to $6.1 million during the nine months ended September 30, 2019 compared to $3.9 million for the same period in 2018. The increase was attributable to a 35 basis point increase in the average cost of interest-bearing liabilities combined with a $40.9 million or 5.8% increase in the average balance of interest-bearing liabilities. Interest

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

expense on deposits increased $2.2 million or 81.1% to $4.8 million during the nine months ended September 30, 2019 compared to $2.7 million for the same period last year. The increase was attributable to a $47.9 million or 7.5% increase in the average balance of interest-bearing deposits to $681.9 million for the nine months ended September 30, 2019 compared to $634.0 million for the nine months ended September 30, 2018 combined with an increase of 39 basis points in the average cost of deposit accounts.

Interest expense on FHLB advances and other borrowings increased $163,000 or 31.8% to $676,000 during the nine months ended September 30, 2019 from $513,000 during the same period in 2018 due to a 42 basis point increase in the average cost of these liabilities, which was partially offset by a $2.1 million or 3.6% decrease in the average balance to $56.5 million during the nine months ended September 30, 2019 from $58.7 million for the same period last year.

Provision for Loan Losses

There was $175,000 in provision for loan losses recorded during the nine months ended September 30, 2019 compared to $150,000 for the same period in 2018. The provision for loan losses increased due to higher net loan receivable balances and loan charge-offs. The Company had net charge-offs of $588,000 for the nine months ended September 30, 2019 compared to net recoveries of $230,000 during the comparable period in 2018. The following table summarizes the changes in the allowance for loan losses for the nine months ended September 30, 2019 and 2018:



	Nine Months Ended September 30,
	2019		2018
Beginning Balance	$	9,171,717	$	8,221,618
Provision for Loan Losses	175,000		150,000
Charge-offs	(831,648)		(319,856)
Recoveries	243,569		550,316
Net (Charge-offs) Recoveries	(588,079)		230,460
Ending Balance	$	8,758,638	$	8,602,078

Non-Interest Income

Non-interest income increased $1.2 million or 21.1% to $7.1 million for the nine months ended September 30, 2019, compared to $5.9 million for the nine months ended September 30, 2018. The following table summarizes the changes in the components of non-interest income:



	Nine Months Ended September 30,				Increase (Decrease)
	2019		2018		$		%
Gain on Sale of Investment Securities	$	1,056,959	$	436,304	$	620,655	142.3	%
Gain on Sale of Loans	1,126,551		999,045		127,506		12.8
Service Fees on Deposit Accounts	785,987		770,493		15,494		2.0
BOLI Income	543,609		405,000		138,609		34.2
Commissions From Insurance Agency	528,246		525,153		3,093		0.6
Trust Income	787,200		725,000		62,200		8.6
Check Card Fee Income	1,063,314		966,365		96,949		10.0
Grant Income	332,393		318,102		14,291		4.5
Other	872,591		712,785		159,806		22.4
Total Non-Interest Income	$	7,096,850	$	5,858,247	$	1,238,603	21.1	%

Net gain on sale of investment securities was $1.1 million during the nine months ended September 30, 2019, an increase of $621,000 or 142.3% compared to a net gain of $436,000 during the same period last year. The Company sold 63 investment securities for proceeds of $70.8 million during the nine months ended September 30, 2019 compared to 23 investment securities sold for proceeds of $28.6 million during the same period last year.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Gain on sale of loans increased $128,000 or 12.8% to $1.1 million for the nine months ended September 30, 2019 compared to $999,000 during the same period in 2018 as the dollar volume of loans sold increased.

BOLI income increased $139,000 or 102.7% to $544,000 during the nine months ended September 30, 2019 from $405,000 for the same period in 2018. The entire increase was related to BOLI death benefit proceeds received during 2019. The Company did not receive any BOLI death benefit proceeds during 2018; all BOLI income recognized was related to changes in the cash surrender value of the policies.

The Company received a Bank Enterprise Award grant from the United States Department of the Treasury in the amount of $233,000 and a Financial Assistance Award grant totaling $99,000 during the nine months ended September 30, 2019 in recognition of its continued commitment to community development in economically distressed areas. Similar grants were received in 2018.

Trust income increased $62,000 or 8.6% due to an increase in assets under management. Check card fee income increased $97,000 or 10.0% reflecting higher transaction volume. Other non-interest income increased $160,000.

Non-Interest Expense

For the nine months ended September 30, 2019, non-interest expense increased $1.8 million or 9.4% to $21.0 million compared to $19.2 million for the same period in 2018. The following table summarizes the changes in the components of non-interest expense:



	Nine Months Ended September 30,						Increase (Decrease)
	2019			2018			$			%
Compensation and Employee Benefits	$	12,587,421		$	11,683,664		$	903,757		7.7	%
Occupancy	1,728,732			1,677,970			50,762			3.0
Advertising	539,234			455,753			83,481			18.3
Depreciation and Maintenance of Equipment	1,894,997			1,673,470			221,527			13.2
FDIC Insurance Premiums	184,022			206,218			(22,196		)	(10.8	)
Net Benefit of Operation of OREO	(62,680		)	(362,864		)	300,184			(82.7	)
Other	4,103,020			3,842,576			260,444			6.8
Total Non-Interest Expense	$	20,974,746		$	19,176,787		$	1,797,959		9.4	%

Compensation and employee benefits expenses were $12.6 million for the nine months ended September 30, 2019, an increase of $904,000 or 7.7% from $11.7 million during the same period last year. The increase was due to general annual cost of living increases combined with an increase in the number of full time employees.

Depreciation and maintenance of equipment increased $222,000 or 13.2% primarily due to additional capital expenses related to our newest branches in Ridge Spring, South Carolina and Augusta, Georgia.

The Company had a net benefit of $63,000 from the operation of OREO properties during the nine months ended September 30, 2019 compared to a net benefit of $363,000 during the nine months ended September 30, 2018. This line item includes all expenses associated with OREO including write-down in value and gain or loss on sales incurred during each period. The Company recorded $182,000 in net gain on sales of OREO properties and write-downs of $22,000 during the first nine months of 2019 compared to net gain on sales of $548,000 and write-downs of $56,000 during the same period in 2018.

Provision For Income Taxes

The provision for income taxes increased $182,000 or 14.0% to $1.5 million for the nine months ended September 30, 2019 from $1.3 million for the same period in 2018. Income before taxes was $7.7 million and $7.0 million for the nine months ended September 30, 2019 and 2018, respectively. The Company’s combined federal and state effective income tax rate was 19.3% for the nine months ended September 30, 2019 compared to 18.7% for the same period in 2018.

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, 2019 loan disbursements exceeded loan repayments resulting in a $23.6 million or 5.5% increase in total net loans receivable. During the same period, deposits increased $47.1 million or 6.1% and FHLB advances increased $13.8 million or 40.5%. The Bank had $244.2 million in additional borrowing capacity at the FHLB at the end of the period. At September 30, 2019, the Bank had $176.8 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, 2019, 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 15.7%, 9.3%, 15.7%, and 16.9%, 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. In addition to the minimum capital requirements, the Bank must maintain a capital conservation buffer, which consists of additional CET1 capital greater than 2.5% of risk weighted assets above the required minimum levels in order to avoid limitations on paying dividends, repurchasing shares and paying discretionary bonuses. At September 30, 2019 the Bank’s conservation buffer was 8.9%.

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 $3.0 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 $3.0 billion or more in assets, at September 30, 2019, it would have exceeded all regulatory capital requirements with CET1, Tier 1 leverage-based capital, Tier 1 risk- based capital and total risk-based capital ratios of 14.6%, 9.1%, 15.5% and 16.7%, respectively.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

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, 2019.



(Dollars in thousands)	One Month or Less		One Through Three Months		Three Through Twelve Months		Total Within One Year		Greater Than One Year		Total
Unused Lines of Credit	$	134	$	1,700	$	33,556	$	35,390	$	63,161	$	98,551
Standby Letters of Credit	—		—		1,146		1,146		214		1,360
Total	$	134	$	1,700	$	34,702	$	36,536	$	63,375	$	99,911

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. There were no material changes in information concerning market risk from the information provided in the Company’s 2018 Form 10-K.

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, 2019 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, 2019 that have materially affected or are reasonably likely to affect our internal controls over financial reporting.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Part II: Other Information

Item 1 Legal Proceedings

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

Item 1A Risk Factors

There have been no material changes in the risk factors previously disclosed in the Company’s 2018 Form 10-K.

Item 2 Unregistered Sales of Equity Securities and Use Of Proceeds

None

Item 3 Defaults Upon Senior Securities

None

Item 4 Mine Safety Disclosures

Not applicable

Item 5 Other Information

None

Item 6 Exhibits



3.1		Articles of Incorporation, as amended (1)
3.2		Amended and Restated Bylaws (2)
4.1		Form of Stock Certificate of the Company and other instruments defining the rights of security holders, including indentures (3)
4.2		Form of Indenture with respect to the Company's 8.0% Convertible Senior Debentures Due 2029 (4)
4.3		Specimen Convertible Senior Debenture Due 2029 (4)
10.1		1993 Salary Continuation Agreements (5)
10.2		Amendment One to 1993 Salary Continuation Agreements (6)
10.3		Form of 2006 Salary Continuation Agreement (7)
10.4		Form of Security Federal Split Dollar Agreement (7)
10.5		1999 Stock Option Plan (8)

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES



10.6		2002 Stock Option Plan (9)
10.7		2006 Stock Option Plan (10)
10.8		2008 Equity Incentive Plan (11)
10.9		Forms of incentive stock option agreement and non-qualified stock option agreement pursuant to the 2006 Stock Option Plan (10)
10.10		2018 Employee Stock Purchase Plan (12)
10.11		Incentive Compensation Plan (5)
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, 2019, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income (Loss); (d) Consolidated Statements of Changes in Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements

_____________


(1)	Filed on June 26, 1998, as an exhibit to the Company’s Proxy Statement and incorporated herein by reference.


(2)	Filed on January 16, 2015 as an exhibit to the Company’s Current Report on Form 8-K dated January 15, 2015 and incorporated herein by reference.


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


(4)	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.


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


(6)	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.


(7)	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.


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


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


(10)	Filed on August 22, 2006, as an exhibit to the Company's Registration Statement on Form S-8 (Registration Statement No. 333-136813) and incorporated herein by reference.


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


(12)	Filed on March 28, 2018, as an exhibit to the Company’s Proxy Statement 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, 2019	By:	/s/J. Chris Verenes
				J. Chris Verenes
				Chief Executive Officer
				Duly Authorized Representative



Date:	November 14, 2019	By:	/s/Jessica T. Cummins
				Jessica T. Cummins
				Chief Financial Officer
				Duly Authorized Representative

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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, 2019, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income (Loss); (d) Consolidated Statements of Changes in Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements