UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2006 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number: 0-16120
SECURITY FEDERAL CORPORATION
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(Exact Name of Registrant as Specified in its Charter)
South Carolina 57-08580504
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
238 Richland Avenue West, Aiken, South Carolina 29801
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (803) 641-3000
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Securities registered pursuant to Section 12(b)
of the Act: None
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Securities registered pursuant to Section 12(g)
of the Act: Common Stock, par value
$0.01 per share
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(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. YES NO X
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Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 of Section 15(d) of the Act. YES NO X
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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
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act (Check one):
Large accelerated filer Accelerated filer Non-accelerated filer X
---- ---- ----
Indicate by check mark whether the Registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES NO X
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As of June 15, 2006, there were issued and outstanding 2,546,922 shares of
the registrant's Common Stock. The aggregate market value of the voting stock
held by non-affiliates of the registrant, computed by reference to the average
of the bid and asked price of such stock as of September 30, 2005, was $51.7
million. (The exclusion from such amount of the market value of the shares
owned by any person shall not be deemed an admission by the registrant that
such person is an affiliate of the registrant.)
DOCUMENTS INCORPORATED BY REFERENCE
1. Portions of the Registrant's Annual Report to Stockholders for the Fiscal
Year Ended March 31, 2006. (Parts I and II)
2. Portions of the Registrant's Proxy Statement for the 2006 Annual Meeting
of Stockholders. (Part III)
PART I
Item 1. Business
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Security Federal Corporation
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Security Federal Corporation (the "Company") was incorporated under the
laws of the State of Delaware in July 1987 for the purpose of becoming the
savings and loan holding company for Security Federal Bank ("Security
Federal" or the "Bank") upon the Bank's conversion from mutual to the stock
form (the "Conversion"). Effective August 17, 1998, the Company changed its
state of incorporation from Delaware to South Carolina.
As a South Carolina corporation, the Company is authorized to engage in
any activity permitted by South Carolina General Corporation Law. The Company
is a unitary savings and loan holding company. Through the unitary holding
company structure, it is possible to expand the size and scope of the
financial services offered beyond those currently offered by the Bank. The
holding company structure also provides the Company with greater flexibility
than the Bank would have to diversify its business activities, through
existing or newly formed subsidiaries, or through acquisitions or mergers of
stock thrift institutions as well as other companies. There are no current
arrangements, understandings or agreements regarding any such acquisition.
Future activities of the Company, other than the continuing operations of
Security Federal, will be funded through dividends from Security Federal and
through borrowings from third parties. See "Regulation Savings and Loan
Holding Company Regulation" and "Taxation." Activities of the Company may also
be funded through sales of additional securities or income generated by other
activities of the Company. At this time, there are no plans regarding such
sales of additional securities or such activities.
At March 31, 2006, the Company had assets of approximately $658.7
million, deposits of approximately $479.2 million and shareholders' equity of
approximately $37.6 million.
The executive office of the Company is located at 238 Richland Avenue
West, Aiken, South Carolina 29801, and its telephone number is (803) 641-3000.
Security Federal Bank
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General. Security Federal is a federally chartered stock savings bank
headquartered in Aiken, South Carolina. Security Federal with 11 branch
offices in Aiken and Lexington Counties, was originally chartered under the
name Aiken Building and Loan Association on March 27, 1922. It received its
federal charter and changed its name to Security Federal Savings and Loan
Association of Aiken on March 7, 1962, and later changed its name to Security
Federal Savings Bank of South Carolina, on November 11, 1986. Effective April
8, 1996, the Bank changed its name to Security Federal Bank. The Bank
converted from the mutual to the stock form of organization on October 30,
1987.
In October 1993, Security Federal increased its branch network to nine
offices with the completion of its acquisition of four former NationsBank of
South Carolina, N.A. branches located in Aiken County. In February 1996,
Security Federal opened a new branch office in the Aiken Wal-Mart Superstore.
The Bank opened a branch in West Columbia, Lexington County, South Carolina,
in December 2000, which provided the Bank with the opportunity to expand its
market area. In August 2003, the Bank opened a new branch in Lexington, South
Carolina. During February 2004, the Bank completed the sale of its Denmark,
South Carolina branch office to South Carolina Bank and Trust, N.A. of
Orangeburg, South Carolina. In January 2006, the Bank closed its branch in
the Aiken Wal-Mart Superstore and replaced it with a free standing branch on
an out parcel in the Aiken Exchange Shopping Center.
The principal business of Security Federal is accepting deposits from the
general public and originating mortgage loans to enable borrowers to purchase
or refinance one- to four-family residential real estate. The Bank also makes
multi-family residential and commercial real estate loans, consumer loans and
commercial loans as well as construction loans on single family residences,
multi-family dwellings and projects, commercial real-estate, and loans for the
acquisition, development and construction of residential subdivisions and
commercial projects. Additional
2
financial services are provided by three of the Bank's wholly owned
subsidiaries, Security Federal Insurance, Inc., Security Federal Investments,
Inc. and Security Federal Trust, Inc.
Security Federal's income is derived primarily from interest and fees
earned in connection with its lending activities, and its principal expenses
are interest paid on savings deposits and borrowings and operating expenses.
Recent Developments
-------------------
On June 9, 2006, the Company entered into a Merger Agreement and Plan of
Merger ("Merger Agreement") to acquire Collier Jennings Financial Corporation
and its subsidiaries Collier-Jennings, Inc., The Auto Insurance Store, Inc.,
and Collier-Jennings Premium Pay Plans, Inc. (the "Collier-Jennings
Companies"). The Company had previously announced the signing a letter of
intent on June 5, 2006.
Under the terms of the Merger Agreement, the Company will pay Collier
Jennings Real Estate, LLC, the sole shareholder of the Collier-Jennings
Companies, approximately $1.6 million in a combination of cash and
unregistered shares of common stock of the Company. The cash portion of the
transaction will be approximately $180,000. The closing of the transaction is
subject to customary closing conditions and is expect to occur within the 30
days from the date of the Merger Agreement. Subsequent to the completion of
the merger it is anticipated that the Collier-Jennings Companies will become
subsidiaries of Security Federal Insurance, Inc., which is a wholly-owned
subsidiary of the Bank.
Selected Consolidated Financial Information
-------------------------------------------
This information is incorporated by reference to page 7 of the 2006
Annual Report to Stockholders ("Annual Report").
Yields Earned and Rates Paid
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This information is incorporated by reference to page 15 of the Annual
Report.
Rate/Volume Analysis
--------------------
This information is incorporated by reference to page 14 of the Annual
Report.
Lending Activities
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General. The primary source of revenue for the Bank is interest and fee
income from lending activities. One of the principal lending activities of
the Bank is making conventional first mortgage real estate loans to enable
borrowers to purchase or refinance one- to four-family residential real
property. The Bank also makes multi-family residential and commercial real
estate and consumer and commercial loans. The Bank continues to emphasize the
origination of adjustable rate residential mortgage loans, subject to market
conditions, for retention in its portfolio. In addition, the Bank originates
construction loans on single family residences, multi-family dwellings and
projects, and loans for the acquisition, development and construction of
residential subdivisions and commercial projects.
Residential adjustable rate mortgage loans ("ARMs") constituted
approximately 28.6% of the Bank's total outstanding loan portfolio at March
31, 2006.
The loan-to-value ratio, maturity and other provisions of loans made by
the Bank reflect its policy of making the maximum loan permissible consistent
with applicable regulations, established lending policies and market
conditions. The Bank requires title insurance (or acceptable legal opinions
on smaller loans secured by real estate) and fire insurance, and flood
insurance where applicable, on loans secured by improved real estate.
3
Loan Portfolio Composition. The following table sets forth information concerning the composition of
the Bank's loan portfolio in dollar amounts and in percentages by type of loan, and presents a
reconciliation of total loans receivable before net items.
At March 31,
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2006 2005 2004 2003 2002
--------------- --------------- --------------- --------------- ---------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
TYPE OF LOAN:
------------
Fixed rate loans
----------------
Residential real
estate.......... $ 11,594 3.0% $ 31,336 9.3% $ 43,911 15.8% $ 43,091 16.8% $ 35,012 14.0%
Commercial business
and commercial
real estate..... 99,446 25.4 77,202 22.8 62,799 22.6 53,509 20.8 55,845 22.4
Consumer......... 32,342 8.3 27,047 8.0 26,508 9.5 30,165 11.7 33,185 13.3
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total fixed
rate loans.... 143,382 36.7 135,585 40.1 133,218 47.9 126,765 49.3 124,042 49.7
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Adjustable rate loans
---------------------
Residential real
estate.......... 111,753 28.6 93,564 27.7 67,516 24.3 60,528 23.5 67,220 26.9
Commercial business
and commercial
real estate..... 109,768 28.0 85,015 25.2 58,313 20.9 53,488 20.8 41,551 16.7
Consumer......... 26,271 6.7 23,797 7.0 19,133 6.9 16,429 6.4 16,667 6.7
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total adjustable
rate loans.... 247,792 63.3 202,376 59.9 144,962 52.1 130,445 50.7 125,438 50.3
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans.... 391,174 100.0% 337,961 100.0% 278,180 100.0% 257,210 100.0% 249,480 100.0%
===== ===== ===== ===== =====
Less
----
Loans in
process........ 9,185 14,627 12,356 8,991 11,288
Deferred fees and
discounts...... 175 161 165 152 184
Allowance for
loan losses.... 6,705 6,284 5,764 4,911 3,689
-------- -------- -------- -------- --------
Total loans
receivable... $375,109 $316,889 $259,895 $243,156 $234,319
======== ======== ======== ======== ========
4
The following table sets forth information concerning the composition of the Bank's loan portfolio in
dollar amounts and in percentages by type of loan, and presents a reconciliation of total loans receivable
before net items.
At March 31,
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2006 2005 2004 2003 2002
--------------- --------------- --------------- --------------- ---------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
(Dollars in Thousands)
TYPE OF LOAN:
-------------
Real Estate Loans:
Residential
real estate...... $99,561 25.4% $105,516 31.2% $ 95,863 34.5% $ 86,707 33.7% $ 86,486 34.7%
Residential
construction..... 23,786 6.1 19,384 5.8 15,564 5.6 16,912 6.6 15,746 6.3
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total real estate
loans........... 123,347 31.5 124,900 37.0 111,427 40.1 103,619 40.3 102,232 41.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Commercial business
and commercial
real estate....... 209,214 53.5 162,217 48.0 121,112 43.5 106,997 41.6 97,396 39.0
Consumer loans:
Deposit account... 1,180 0.3 1,145 0.3 1,383 0.5 1,726 0.7 2,160 0.9
Home equity
lines............ 20,059 5.1 16,918 5.0 13,694 4.9 13,140 5.1 12,352 4.9
Consumer first and
second mortgages. 22,144 5.7 22,327 6.6 15,080 5.4 18,551 7.2 20,090 8.1
Other............. 15,230 3.9 10,454 3.1 15,484 5.6 13,177 5.1 15,250 6.1
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total consumer
loans........... 58,613 15.0 50,844 15.0 45,641 16.4 46,594 18.1 49,852 20.0
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans..... 391,174 100.0% 337,961 100.0% 278,180 100.0% 257,210 100.0% 249,480 100.0%
===== ===== ===== ===== =====
Less:
Loans in process... 9,185 14,627 12,356 8,991 11,288
Deferred fees and
discounts......... 175 161 165 152 184
Allowance for
loan losses....... 6,705 6,284 5,764 4,911 3,689
-------- -------- -------- -------- --------
Total loans
receivable.......$375,109 $316,889 $259,895 $243,156 $234,319
======== ======== ======== ======== ========
5
The following schedule illustrates the maturities of Security Federal's
loan portfolio at March 31, 2006. Mortgages which have adjustable or
renegotiable interest rates are shown as maturing in the period when the
contract is due. This schedule does not reflect the effects of possible
prepayments or enforcement of due-on-sale clauses.
At March 31, 2006(2)
------------------------------------------------
Commercial
Business and
Residential Commercial
Real Estate Consumer(1) Real Estate Total
------------ ------------ ----------- --------
(In Thousands)
Six months or less (1)....... $ 9,468 $ 6,375 $ 44,354 $ 60,197
Over six months to one year.. 6,882 2,340 41,053 50,275
Over one year to three years. 1,373 7,720 52,081 61,174
Three to five years.......... 577 9,262 49,453 59,292
Over five to ten years....... 2,874 11,291 9,523 23,688
Over ten years............... 92,988 21,625 12,750 127,363
-------- --------- -------- ---------
Total....................... $114,162 $ 58,613 $209,214 $ 381,988
======== ========= ======== =========
___________
(1) Includes demand loans, loans having no stated maturity, overdraft
loans and equity line of credit loans.
(2) Loan amounts are net of undisbursed funds for loans in process of $9.2
million.
The total amount of loans due after March 31, 2007, which have
predetermined or fixed interest rates is $113.8 million, while the total
amount of loans due after that date which have floating or adjustable interest
rates is $157.7 million.
Loan Originations, Purchases and Sales. The following table shows the loan
origination, purchase, sale and repayment activities of the Bank for the
periods indicated.
Year Ended March 31,
--------------------------------------------
2006 2005 2004 2003 2002
------- ------- ------- ------ -------
(In Thousands)
Originated:
Adjustable rate - residential
real estate..................... $ 45,259 $ 43,578 $ 47,263 $ 45,260 $ 41,672
Fixed rate - residential
real estate (1)................. 28,946 41,746 73,291 92,388 93,602
Consumer......................... 33,621 29,290 26,829 25,439 26,916
Commercial business and
commercial real estate.......... 198,360 134,439 91,562 64,097 50,468
-------- -------- -------- -------- --------
Total consumer/commercial
business real estate........... 231,981 163,729 118,391 89,536 77,384
-------- -------- -------- -------- --------
Total loans originated......... $306,186 $249,053 $238,945 $227,184 $212,658
======== ======== ======== ======== ========
Purchased........................ $ 5,060 $ 6,536 $ 3,500 $ -- $ --
Less:
Sold:
Fixed rate - residential
real estate..................... $ 29,903 $ 25,957 $ 63,497 $ 80,345 $ 84,505
Adjustable rate - residential
real estate..................... -- -- -- -- --
Adjustable rate - commercial
real estate..................... 2,300 -- -- -- --
Principal repayments............. 225,830 169,851 157,979 139,108 123,443
Increase (decrease) in other
items, net...................... (5,007) 2,787 4,230 (1,106) 1,378
Net increase (decrease).......... $ 58,220 $ 56,994 $ 16,739 $ 8,837 $ 3,332
___________
(1) Includes newly originated fixed rate loans held for sale and
construction/permanent loans converted to fixed rate loans and sold.
6
In addition to interest earned on loans, the Bank receives loan
origination fees or "points" for originating loans. Loan points are a
percentage of the principal amount of the mortgage loan which are charged to
the borrower for the creation of the loan.
The Bank's loan origination fees are generally 1% on conventional
residential mortgages, and .05% to 1% on commercial real estate loans and
commercial business loans. The total fee income (including amounts amortized
to income as yield adjustments) for the fiscal year ended March 31, 2006 was
$1.1 million.
Loan origination and commitment fees are volatile sources of income.
These fees vary with the volume and type of loans and commitments made and
purchased and with competitive conditions in mortgage markets, which in turn
are governed by the demand for and availability of money.
The following table shows deferred loan origination fees recognized as
income by the Bank expressed as a percentage of the dollar amount of total
mortgage loans originated (and retained in the Bank's portfolio) and purchased
during the periods indicated and the dollar amount of deferred loan
origination fees at the end of each respective period.
At or for the Year Ended March 31,
------------------------------------
2006 2005 2004
--------- -------- --------
(Dollars in Thousands)
Net deferred loan origination fees
earned during the period (1)........ $ 170 $ 185 $ 188
Mortgage loan origination fees earned
as a percentage of total portfolio
mortgage loans originated during the
period.............................. 0.4% 0.4% 0.3%
Net deferred loan origination fees
in loan portfolio at end of period.. $ 175 $ 161 $ 165
___________
(1) Includes amounts amortized to interest income as yield adjustments. Does
not include fees earned on loans sold.
The Bank also receives other fees and charges related to existing loans,
conversion fees, assumption fees, late charges, and other fees collected in
connection with a change in borrower or other loan modifications.
Security Federal currently sells substantially all conforming fixed-rate
loans with terms of 15 years or greater in the secondary mortgage market.
These loans are sold in order to provide a source of funds and as one of the
strategies available to close the gap between the maturities of the Bank's
interest-earning assets and interest-bearing liabilities. Currently, most
fixed-rate, long-term mortgage loans are being originated based on Federal
National Mortgage Association ("Fannie Mae") and Federal Home Loan Mortgage
Corporation ("Freddie Mac") underwriting standards.
Secondary market sales have been made primarily to Freddie Mac, or other
banks or investors. Freddie Mac is a quasi-governmental agency that purchases
residential mortgage loans from federally insured financial institutions and
certain other lenders. All loans sold to Freddie Mac are without recourse to
Security Federal and generally all other loans sold to other investors are
without recourse. For the past few years, substantially all loans have been
sold on a service released basis.
In fiscal 2006, Security Federal sold $29.9 million in fixed rate
residential loans on a service released basis on the secondary market. Loans
closed but not yet settled with Freddie Mac or other investors, are carried in
the Bank's "loans held for sale" portfolio. At March 31, 2006, the Bank had
$1.3 million of loans held for sale. These loans are fixed rate residential
loans that have been originated in the Bank's name and have closed. Virtually
all of these loans have commitments to be purchased by investors, mainly
Freddie Mac, 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 Bank's customers. Therefore, these loans present very little market
risk for the Bank. The Bank usually delivers to and receives funding from the
investor within 30 days. Security Federal originates all of its loans held
for sale on a "best efforts" basis. Best efforts means that the Bank suffers
no penalty if it is unable to deliver a loan to a potential investor.
7
The Bank also originates and holds adjustable and fixed rate construction
loans. The construction loans are for one year terms. At March 31, 2006, the
Bank held $23.8 million, or 6.1% of the total loan portfolio in construction
loans to individuals in its residential portfolio. At March 31, 2006, the
Bank also held approximately $8.4 million in longer term fixed rate
residential mortgage loans. These loans, which were 2.2% of the entire loan
portfolio at March 31, 2006, had converted from adjustable rate mortgage
("ARM") loans to fixed rate loans during the previous 48 months. These fixed
rate loans had remaining maturities of 10 to 29 years. At March 31, 2006, the
Bank had, in total, approximately $5.4 million of residential ARM loans that
could convert to fixed rate loans, which would need to be converted in the
next 12 months. The Bank no longer originates ARM loans with conversion
features.
Loan Solicitation and Processing. The Bank actively solicits mortgage
loan applications from existing customers, real estate agents, builders, real
estate developers and others. The Bank also receives mortgage loan
applications as a result of customer referrals and from walk-in customers.
Detailed loan applications are obtained to determine the borrower's
creditworthiness and ability to repay. The more significant items on loan
applications are verified through the use of credit reports, financial
statements and confirmations. After analysis of the loan application and
property or collateral involved, including an appraisal of the property
(residential appraisals are obtained through independent fee appraisers), the
lending decision is made in accordance with the underwriting guidelines of the
Bank. These guidelines are generally consistent with Freddie Mac and Fannie
Mae guidelines for residential real estate loans. With respect to commercial
real estate loans, the Bank also reviews the capital adequacy of the business,
the income potential of the property, the ability of the borrower to repay the
loan and honor its other obligations, and general economic and industry
conditions.
Upon receipt of a loan application and all required related information
from a prospective borrower, the loan application is submitted for approval or
rejection. The residential mortgage loan underwriters approve loans which
meet Freddie Mac and Fannie Mae underwriting requirements, not to exceed
$417,000 per loan, Federal Housing Administration ("FHA") loans not to exceed
$200,160, and Veterans' Administration ("VA") loans not to exceed $417,000.
The Chairman, Chief Executive Officer, or President of the Bank approve loans
of $300,000 or less, except as set forth above for conforming conventionally
underwritten, single family mortgage loans, which are approved by the
underwriters. The Senior Business Development officers approve loans up to
$250,000. Commercial, consumer, and all non-conforming real estate loans in
excess of $350,000 require approval of any two of the above and any loan in an
amount in excess of $500,000 must be approved by the Bank's Executive
Committee, which operates as the Bank's Loan Committee. The loan approval
limits shown are the aggregate of all loans to any one borrower or entity, not
including loans that are the borrower's primary residence, and are
conventionally underwritten.
The general policy of Security Federal is to issue loan commitments to
qualified borrowers for a specified time period. These commitments are
generally for a period of 45 days or less. With management approval,
commitments may be extended for a longer period. The total outstanding amount
of residential mortgage loan commitments for portfolio loans issued by
Security Federal as of March 31, 2006, was approximately $351,000 (excluding
undisbursed portions of construction loans in process). Security Federal also
had outstanding commitments available on retail lines of credit (including
home equity and other consumer loans) totaling $31.0 million as of March 31,
2006. See Note 14 of the Notes to Consolidated Financial Statements contained
in the Annual Report.
Permanent Residential Mortgage Lending. Permanent residential real estate
mortgage loans constituted approximately 25.4% of the Bank's total outstanding
loan portfolio at March 31, 2006.
Security Federal offers a variety of ARMs which offer adjustable rates of
interest, payments, loan balances or terms to maturity which vary according to
specified indices. The Bank's ARMs generally have a loan term of 15 to 30
years with initial rate adjustments every one, three, five or seven years
during the term of the loan. After the initial rate adjustment, the loan rate
then adjusts annually. Most of the Bank's ARMs contain a 200 basis point
limit as to the maximum amount of change in the interest rate at any
adjustment period and a 500 or 600 basis point limit over the life of the
loan. The Bank generally originates ARMs to hold in its portfolio. Such
loans are generally made consistent with Freddie Mac and Fannie Mae
guidelines. At March 31, 2006, residential ARMs totaled $111.8 million, or
28.6% of the Bank's loan portfolio. For the year ended March 31, 2006, the
Bank originated $45.3 million in residential real estate loans, 61.0% of which
had adjustable rates of interest.
8
There are unquantifiable risks resulting from possible increased costs to
the borrower as a result of periodic repricing. Despite the benefits of ARMs
to the Bank's asset/liability management program, these loans also pose
potential additional risks, primarily because as interest rates rise, the
underlying payment by the borrower rises, increasing the potential for
default. At the same time, marketability of the underlying property may be
adversely affected by higher interest rates.
When making a one- to four-family residential mortgage loan, the Bank
evaluates both the borrower's creditworthiness and his or her general ability
to make principal and interest payments and the value of the property that
will secure the loan. The Bank generally makes loans on one- to four-family
residential properties in amounts of 95% or less of the appraised value
thereof. Where loans are made in amounts which exceed 80% of the appraised
value of the underlying real estate, the Bank's general policy is to require
private mortgage insurance on the portion of the loan in excess of 80% of the
appraised value. In general, the Bank restricts its residential lending to
South Carolina and the nearby Augusta, Georgia market.
The Bank also provides construction financing for single family dwellings
to owner-occupants. Construction loans are generally made for periods of six
months to one year with either adjustable or fixed rates. At March 31, 2006,
residential construction loans on one- to four-family dwellings to
owner-occupants totaled $23.8 million, or 6.1%, of the Bank's loan portfolio.
On loans of this type, the Bank seeks to evaluate the financial condition and
prior performance of the builder, as well as the factors mentioned above
concerning the creditworthiness of the borrower. On construction loans
offered to individuals (non-builders), the Bank offers a
construction/permanent loan. The construction portion of the loan is an
adjustable rate (typically prime plus .50%) or a fixed rate (typically prime
plus 1.0%) during the construction period. After construction, the loan then
automatically converts to an ARM loan. The borrower also has the option,
after the construction period only, to convert the loan to a fixed rate loan
which the Bank then sells on the secondary market immediately on a service
released basis.
Commercial Business and Commercial Real Estate Loans. The commercial
business and commercial real estate loans originated by the Bank are primarily
secured by business properties, churches, income property developments,
undeveloped land, business equipment, furniture and fixtures, inventory, and
receivables. At March 31, 2006, the Bank had approximately $209.2 million, or
53.5%, of the Bank's total loan portfolio, in commercial business and
commercial real estate loans. Approximately $117.3 million, or 56.1% of
commercial business and commercial real estate loans were secured primarily by
real estate at March 31, 2006. Included in those loans is approximately $14.3
million in construction loans of single family dwellings to builders with a
typical term of one year. Not included in these loans are approximately $15.5
million in acquisition and development loans. Loans secured by commercial
real estate are typically written for terms of 10 to 20 years. Commercial
loans not secured by real estate are typically based on terms of three to 60
months. Fixed rate loans typically balloon at the end of three to seven
years. Adjustable rate loans are usually tied to the prime interest rate or
LIBOR as quoted in the Wall Street Journal, and adjust daily, monthly or
annually. Some adjustable rate loans have interest rate caps, although most
of these loans have a five year balloon.
Commercial business and commercial real estate lending entails significant
additional credit risk when compared to residential lending. Commercial loans
typically involve large loan balances to single borrowers or groups of related
borrowers. The payment experience of these loans is typically dependent upon
the successful operation of the business or real estate project. These risks
can be significantly affected by supply and demand conditions in the market
for office and retail space and for condominiums and apartments and to adverse
conditions in the local economy. Although commercial loans generally involve
more risk than residential loans, they also typically provide a greater yield
and are more sensitive to changes in interest rates.
The underwriting standards employed by the Bank for commercial business
and commercial real estate lending include a determination of the borrower's
current financial condition, ability to pay, past earnings and payment
history. In addition, the current financial condition and payment history of
all principals are reviewed. Typically, the Bank requires the principal or
owners of a business to guarantee all loans made to their business by the
Bank. Although the creditworthiness of the business and its principals is of
primary consideration, the underwriting process also includes a comparison of
the value of the security, if any, in relation to the proposed loan amount.
9
Properties securing commercial loans originated by the Bank are generally
appraised at the time of the loan by appraisers designated by the Bank.
Although the Bank is permitted to invest in loans up to 100% of the appraised
value of a property on a commercial loan, the Bank currently seeks to invest
in loans with a loan to value ratio of 75% to 85%.
At March 31, 2006, the Bank did not have any commercial business or
commercial real estate loans to one borrower in excess of $6.1 million.
Federal law restricts the Bank's permissible lending limits to one borrower to
the greater of $500,000 or 15% of unimpaired capital and surplus. The Bank
has only infrequently made loans to one borrower equal to the amount federal
law allows or approximately $6.7 million as calculated at March 31, 2006.
Consumer Loans. The Bank originates consumer loans for any personal,
family or household purpose, including but not limited to the financing of
home improvements, loans to individuals for residential lots for a future
home, automobiles, boats, mobile homes, recreational vehicles and education.
The Bank also makes consumer first and second mortgage loans secured by
residences. These loans typically do not qualify for sale in the secondary
market, but are generally not considered sub-prime lending. In addition, the
Bank has expanded its home equity lending program. Home equity loans are
secured by mortgage lines on the borrower's principal or second residence. At
March 31, 2006, the Bank had $20.1 million of home equity lines of credit
outstanding and $25.3 million of additional commitments of such lines of
credit. The Bank also makes secured and unsecured lines of credit available.
Although consumer loans involve a higher level of risk than one- to
four-family residential mortgage loans, they generally provide higher yields
and have shorter terms to maturity than one- to four-family residential
mortgage loans. At March 31, 2006, the Bank had total consumer loans of $58.6
million, or 15.0% of the Bank's loan portfolio.
The underwriting standards employed by the Bank for consumer loans include
a determination of the applicant's payment history on other debts and an
assessment of ability to meet existing obligations and payments on the
proposed loan. The stability of the applicant's monthly income is determined
by verification of gross monthly income from primary employment, and from any
verifiable secondary income. Although creditworthiness of the applicant is of
primary consideration, the underwriting process also includes a comparison of
the value of the security, if any, in relation to the proposed loan amount.
The Bank also has a credit card program. As of March 31, 2006, 2,868 Visa
credit cards had been issued by the Bank with total approved credit lines of
$4.4 million, of which $1.5 million was outstanding.
Loan Delinquencies and Defaults
-------------------------------
General. The Bank's collection procedures provide that when a real estate
loan is approximately 20 days past due, the borrower is contacted by mail and
payment is requested. If the delinquency continues, subsequent efforts are
made to contact the delinquent borrower and establish a program to bring the
loan current. In certain instances, the Bank may modify the loan or grant a
limited moratorium on loan payments to enable the borrower to reorganize his
financial affairs. If the loan continues in a delinquent status for 60 days
or more, the Bank generally initiates foreclosure proceedings after the
customer has been notified by certified mail. At March 31, 2006, the Bank had
property acquired as the result of foreclosures and other property repossessed
classified as repossessed assets valued at $91,000.
10
Delinquent Loans. The following table sets forth information concerning
delinquent mortgage and other loans at March 31, 2006. The amounts presented
represent the total remaining principal balances of the related loans (before
specific reserves for losses), rather than the actual payment amounts which
are overdue.
Real Estate Non-Real Estate
-------------------------------- ---------------------------------
Commercial
Residential Commercial Consumer Business
--------------- -------------- -------------- ----------------
Number Amount Number Amount Number Amount Number Amount
------ ------ ------ ------ ------ ------ ------ -------
(Dollars in Thousands, number of loans are actual)
Loans delinquent for:
30 - 59 days............. 13 $ 927 15 $1,144 27 $601 9 $357
60 - 89 days............. 2 182 1 213 2 5 3 207
90 days and over......... 5 412 6 588 8 133 2 58
----- ------ ---- ------ ----- ---- -- -----
Total delinquent loans... 20 $1,521 22 $1,945 37 $739 14 $622
===== ====== ==== ====== ===== ==== === =====
Classified Assets. Federal regulations provide for the classification of
loans and other assets such as debt and equity securities considered to be of
lesser quality as "substandard," "doubtful" or "loss" assets. The regulations
require savings associations to classify their own assets and to establish
prudent general allowances for loan losses for assets classified "substandard"
or "doubtful." For the portion of assets classified as "loss," an institution
is required to either establish specific allowances of 100% of the amount
classified or charge off such amount. In addition, the Office of Thrift
Supervision ("OTS") may require the establishment of a general allowance for
losses based on assets classified as "substandard" and "doubtful" or based on
the general quality of the asset portfolio of an association. See "Regulation
- Federal Regulation of Savings Institutions."Assets which do not currently
expose the savings association to sufficient risk to warrant classification in
one of the aforementioned categories but possess potential weaknesses are
designated "special mention" by management.
At March 31, 2006, approximately $14.1 million of the Bank's loans were
classified "substandard" compared to $12.1 million at March 31, 2005. In
fiscal 2005, the Bank began applying stricter standards in securitizing its
loan portfolio for classification purposes in conjunction with the formation
of a Credit Administration Department. At March 31, 2006, $5.6 million were
classified as "special mention" compared to $2.6 million at March 31, 2005.
The Bank had no loans classified as "doubtful" or "loss" at March 31, 2006.
As of March 31, 2006, there were loans totaling $418,000 which were troubled
debt restructurings within the meaning of Statement of Financial Accounting
Standard ("SFAS") No. 15. The Bank's policy is to classify all troubled debt
restructurings as substandard. The Bank's classification of assets is
consistent with OTS regulatory classifications.
Non-performing Assets. Loans are placed on non-accrual status when the
collection of principal and/or interest becomes doubtful. In addition, all
loans are placed on non-accrual status when the loan becomes 90 days or more
contractually delinquent. All consumer loans more than 90 days delinquent are
charged against the consumer loan allowance for loan losses unless there is
adequate collateral which is in the process of being repossessed or foreclosed
on. At March 31, 2006, the Bank did not have any troubled debt restructurings
which involve forgiving a portion of interest or principal on any loans or
making loans at a rate materially less than market rate. Other loans of
concern are those loans (not delinquent more than 60 days) that management has
determined need to be closely monitored as the potential exists for increased
risk on these loans in the future. Nonperforming loans are reviewed monthly
on a loan by loan basis. Charge-offs, whether partial or in full, associated
with these loans will vary based on estimates of recovery for each loan.
11
The following table sets forth the amounts and categories of risk
elements in the Bank's loan portfolio.
At March 31,
------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
(Dollars in Thousands)
Loans Delinquent 60 to
89 Days:
Residential............... $ 182 $ 73 $ 72 $ 45 $ --
Consumer.................. 5 13 73 435 370
Commercial business and
real estate.............. 420 13 88 311 144
------ ------ ------- ------ ------
Total................... $ 607 $ 99 $ 233 $ 791 $ 514
====== ====== ======= ====== ======
Total as a percentage
of total assets........ 0.09% 0.02% 0.04% 0.18% 0.14%
Non-Accruing Loans Delinquent
90 Days or More:
Residential............... $ 412 $ 569 $ 559 $ 585 $ 761
Consumer.................. 133 140 243 229 350
Commercial business and
real estate.............. 646 1,721 1,242 226 279
------ ------ ------- ------ ------
Total................... $1,191 $2,430 $ 2,044 $1,040 $1,390
====== ====== ======= ====== ======
Total as a percentage of
total assets........... 0.18% 0.42% 0.39% 0.23% 0.37%
Troubled debt
restructurings............. $ 418 $ 434 $ 646(1) $ 674(2) $ 622
Repossessed assets.......... $ 91 $ 53 $ 51 $ 151 $ 98
Allowance for loan losses... $6,705 $6,284 $ 5,764 $4,911 $3,689
___________
(1) $201,000 of troubled debt restructurings are included in non-accruing
loans.
(2) $210,000 of troubled debt restructurings are included in non-accruing
loans.
For the fiscal year ended March 31, 2006, the interest income which would
have been recognized with respect to non-accruing loans, had such loans been
current in accordance with their original terms and with respect to troubled
debt restructurings, had such loans been current in accordance with their
original terms, totaled $111,000 compared to $189,000 for the year ended March
31, 2005.
At March 31, 2006, non-accruing loans totaled $1.2 million, compared to
$2.4 million and $2.0 million at March 31, 2005 and 2004, respectively.
Included in non-accruing loans at March 31, 2006 were five residential real
estate loans totaling $412,000, eight commercial loans totaling $646,000 and
eight consumer loans totaling $133,000. Of the eight consumer loans on
non-accrual status at fiscal year end, no loan exceeded $50,000. Of the eight
commercial loans on non-accrual status at fiscal year end, no loan exceeded
$350,000.
The Bank had six loans totaling $418,000 at fiscal year end which were
troubled debt restructurings compared to seven loans of $434,000 at March 31,
2005. The six troubled debt restructurings were three consumer loans totaling
$337,000 secured by residential dwellings, a $12,000 consumer loan secured by
a second mortgage on a residence, a $53,000 commercial loan secured by two
rental properties, and a $16,000 unsecured commercial loan. None of the above
loans were 30 days delinquent at March 31, 2006.
At March 31, 2006, repossessed assets had an outstanding carrying value
of $91,000 and consisted of two single family dwellings, a vehicle, a mobile
home and equipment.
Provision for Losses on Loans and Repossessed Assets. Security Federal
recognizes that credit losses will be experienced during the course of making
loans and that the risk of loss will vary with, among other things, the type
of loan being made, the creditworthiness of the borrower over the term of the
loan and, in the case of a secured loan, the quality of the underlying
security for the loan.
The Bank seeks to establish and maintain sufficient reserves for
estimated losses on specifically identified loans and real estate where such
losses can be estimated. Additionally, general reserves for estimated
possible losses are
12
established on specified portions of the Bank's portfolio such as consumer
loans and higher risk residential construction mortgage loans based on
management's estimate of the potential loss for loans which normally can be
classified as higher risk. Specific and general reserves are based on, among
other criteria (1) the risk characteristics of the loan portfolio, (2) current
economic conditions on a local as well as a statewide basis, (3) actual losses
experienced historically and (4) the level of reserves for possible losses in
the future. Additionally, a reserve is maintained for uncollected interest on
loans 90 days or more past due.
At March 31, 2006, total reserves relating to loans were $6.7 million.
In determining the adequacy of the reserve for loan losses, management reviews
past experience of loan charge-offs, the level of past due and non-accrual
loans, the size and mix of the portfolio, general economic conditions in the
market area, and individual loans to identify potential credit problems.
Commercial business, commercial real estate and consumer loans have increased
to $267.8 million, or 68.5% of the Bank's total loan portfolio at March 31,
2006, and it is anticipated there will be a continued emphasis on this type of
credit. Although commercial and consumer loans carry a higher level of credit
risk than conventional residential mortgage loans, the level of reserves
reflects management's continuing evaluation of this risk based on upon the
Bank's past loss experience. At fiscal year end, the Bank's ratio of loans
delinquent more than 60 days to total assets was 0.27%. These delinquent
loans are considered to be well secured and are in the process of collection.
Management uses four methods or calculations to estimate the adequacy of the
reserve using the factors mentioned above. The reserve is management's best
estimate for the reserve. There can be no guarantee that the estimate is
adequate or accurate. Management believes that reserves for loan losses are
at a level adequate to provide for inherent loan losses. Although management
believes that it has considered all relevant factors in its estimation of
future losses, future adjustments to reserves may be necessary if conditions
change substantially from the assumptions used in making the original
estimations. Regulators will from time to time evaluate the allowance for
loan losses which is subject to adjustment based upon the information
available to the regulators at the time of their examinations.
Management believes the Bank has no undue concentration of loans in any
one particular industry. At March 31, 2006, the Bank had no allowance for
losses on real estate owned.
The following table sets forth an analysis of the Bank's allowance for
loan losses.
At March 31,
------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
(Dollars in Thousands)
Balance at beginning of
year....................... $6,284 $5,764 $4,911 $3,689 $2,784
Provision charged to
operations................. 660 780 1,200 1,800 1,525
Charge-offs:
Residential real estate.... 25 29 38 17 5
Commercial business and
commercial real estate.... 159 257 164 299 229
Consumer................... 117 157 467 594 584
------ ------ ------ ------ ------
Total charge-offs......... 301 443 669 910 818
------ ------ ------ ------ ------
Recoveries:
Residential real estate.... 4 - -- -- 6
Commercial business and
commercial real estate.... 33 112 16 40 41
Consumer................... 25 71 306 292 151
------ ------ ------ ------ ------
Total recoveries.......... 62 183 322 332 198
------ ------ ------ ------ ------
Balance at end of year...... $6,705 $6,284 $5,764 $4,911 $3,689
====== ====== ====== ====== ======
Ratio of net charge-offs
during the year to average
loans outstanding during
the year................... 0.07% 0.09% 0.14% 0.24% 0.26%
====== ====== ====== ====== ======
13
The distribution of the Bank's allowance for loan losses at the dates indicated is summarized in the
following table. The entire allowance is available to absorb losses from all loan categories.
At March 31,
----------------------------------------------------------------------------------
2006 2005 2004 2003 2002
-------------- ------------- ------------- ------------- -------------
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in Thousands)
Residential........... $ 568 31.5% $ 531 37.0% $ 500 40.1% $ 473 40.3% $ 435 41.0%
Consumer.............. 3,068 15.0 2,876 15.0 2,632 16.4 2,219 18.1 1,405 20.0
Commercial business
and commercial
real estate.......... 3,069 53.5 2,877 48.0 2,632 43.5 2,219 41.6 1,849 39.0
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Total................ $6,705 100.0% $6,284 100.0% $5,764 100.0% $4,911 100.0% $3,689 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
Service Corporation
-------------------
As a federally chartered savings bank, Security Federal is permitted by
OTS regulations to invest up to 3% of its assets in the stock of service
corporations, provided that any investment in excess of 2% of its assets must
be primarily for community, inner-city or community development purposes. At
March 31, 2006, Security Federal's net investment in its service corporations
(including loans to service corporations) totaled $841,000. In addition to
investments in service corporations, federal institutions are permitted to
invest an unlimited amount in operating subsidiaries engaged solely in
activities which a federal savings bank may engage in directly.
Security Federal Insurance, Inc. ("SFINS"), Security Federal Investments,
Inc. ("SFINV") and Security Federal Trust, Inc. ("SFT"). SFINS, SFINV AND
SFT, wholly owned subsidiaries of the Bank, were formed during fiscal 2002 and
began operating during the December 2001 quarter. SFINS is an insurance
agency offering business, health, home and life insurance. SFINV offers
mutual funds, annuities and discount brokerage services. SFT offers a full
range of trust and financial planning services. The operations of SFINS,
SFINV and SFT are included in the Company's Consolidated Financial Statements.
Security Financial Services Corporation ("SFSC"). SFSC was incorporated
in 1975 as a wholly owned subsidiary of the Bank. Its primary activity was
investment brokerage services. SFSC is currently inactive.
Real Estate Partnership. The Company has developed real estate through
two real estate partnerships which it purchased from SFSC at market value in
December 1995. Each project was designed primarily to develop and sell
residential lots in and around the Bank's primary lending area. One project
was completed during fiscal 1998 and the other project was completed during
fiscal 2001. The Company had no investment in the remaining project at March
31, 2005. The Company has no current plans for additional real estate
ventures.
Investment Activities
---------------------
Investment securities. The Bank has authority to invest in various types
of liquid assets, including U.S. Treasury obligations and securities of
various federal agencies, certificates of deposit at insured institutions,
bankers' acceptances and federal funds.
The Bank may also invest a portion of its assets in certain commercial
paper and corporate debt securities. The Bank is also authorized to invest in
mutual funds whose assets conform to the investments that a federal thrift
institution is authorized to make directly. There are various restrictions on
the foregoing investments. For example, the commercial paper must be
appropriately rated by at least two nationally recognized investment rating
services and the corporate debt securities must be appropriately rated by at
least one such service. In addition, the average maturity of an institution's
portfolio of corporate debt securities may not, at any one time, exceed six
years, and the commercial paper must mature within nine months of issuance.
Moreover, an institution's total investment in the commercial paper and
corporate debt securities of any one issuer may not exceed 1% of the
institution's assets except that an institution may invest 5% of its assets in
the shares of any appropriate mutual fund. See "Regulation - Federal
Regulation of Savings Associations."
14
As a member of the Federal Home Loan Bank ("FHLB") System, Security
Federal must maintain minimum levels of investments that are liquid assets as
defined in Federal regulations. See "Regulation Federal Regulation of
Savings Associations Federal Home Loan Bank System." Liquidity may increase
or decrease depending upon the availability of funds and comparative yields on
investments in relation to the return on loans.
Historically, the Bank has maintained its liquid assets above the minimum
requirements imposed by the OTS regulations and at a level believed adequate
to meet requirements of normal daily activities, repayment of maturing debt
and potential deposit outflows. Cash flow projections are regularly reviewed
and updated to assure that adequate liquidity is provided.
The following table sets forth the composition of the Company's portfolio
of securities and other investments, not including mortgage-backed securities.
At March 31,
----------------------------
2006 2005 2004
-------- ------- --------
(In Thousands)
Interest bearing deposit at FHLB............. $ 3,715 $ 164 $ 303
-------- ------- --------
Total...................................... $ 3,715 $ 164 $ 303
======== ======= ========
Investment Securities:
Available for Sale:
FHLB securities............................ $24,005 $4,970 $14,280
Federal Farm Credit Bank securities........ 2,941 -- 2,042
Fannie Mae bonds........................... 979 -- --
Freddie Mac bonds.......................... 230 485 578
Equity Securities.......................... 103 -- --
-------- ------- --------
Total securities available for sale....... 28,258 5,455 16,900
-------- ------- --------
Held to Maturity:
FHLB securities............................ 66,002 67,002 57,944
Federal Farm Credit Bank securities........ 8,986 8,999 13,010
-------- ------- --------
Total securities held to maturity......... 74,988 76,001 70,954
-------- ------- --------
Total securities (1)......................... 103,246 81,456 87,854
FHLB stock................................... 7,150 6,235 4,817
-------- ------- --------
Total securities and FHLB stock (1).......... $110,396 $87,691 $92,671
======== ======= ========
___________
(1) Does not include mortgage-backed securities.
At March 31, 2006, the Company did not have any investment securities
(exclusive of obligations of the U.S. Government and federal agencies) issued
by any one entity with a total book value in excess of 10% of stockholders'
equity.
15
The following table sets forth the maturities or repricing of investment
securities and FHLB stock at March 31,2006, and the weighted average yields of
such securities and FHLB stock (calculated on the basis of the cost and
effective yields weighted for the scheduled maturity of each security).
Callable securities are shown at their likely call dates based on current
interest rates. The table was prepared using amortized cost.
Maturing or Repricing
-------------------------------------------------------------
After One After Five
Within But Within But Within After
One Year Five Years Ten Years Ten Years
------------- ------------- ------------- -------------
Amount Yield Amount Yield Amount Yield Amount Yield
------- ----- ------ ----- ------ ----- ------ -----
(Dollars in Thousands)
U.S. Government
and other
agency
obligations... $12,247 3.15% $72,251 4.00% $18,957 4.11% $ -- --%
FHLB stock (1). -- -- 7,150 5.49 -- -- -- --
------- ---- ------- ---- ------- ---- ----- ----
Total(2)...... $12,247 3.15% $79,401 4.13% $18,957 4.11% $ -- -%
======= ==== ======= ==== ======= ==== ===== ====
___________
(1) FHLB stock has no stated maturity date.
(2) Excludes mortgage-backed securities and equity securities totaling $138.3
million with a yield of 4.18%.
For information regarding the market value of the Bank's securities
portfolios, see Notes 3 and 4 of the Notes to Consolidated Financial
Statements contained in the Annual Report.
Mortgage-backed securities. Security Federal has a portfolio of
mortgage-backed securities which it holds in both an available for sale and a
held to maturity portfolio. Mortgage-backed securities can serve as
collateral for borrowings and, through repayments, as a source of liquidity.
Under the Bank's risk-based capital requirement, mortgage-backed securities
have a risk weight of 20% (or 0% in the case of Government National Mortgage
Association ("Ginnie Mae") securities) in contrast to the 50% risk weight
carried by residential loans. See "Regulation."
The following tables set forth the composition of the mortgage-backed
securities available for sale portfolio at the dates indicated.
At March 31,
--------------------------
2006 2005 2004
------- -------- -------
(In Thousands)
Available for Sale:
Freddie Mac......................... $ 21,196 $ 26,146 $ 18,452
Fannie Mae.......................... 74,498 81,492 91,494
Ginnie Mae.......................... 39,493 51,722 47,566
-------- -------- --------
Total.............................. $135,187 $159,360 $157,512
======== ======== ========
The following table sets forth the composition of the mortgage-backed
securities held to maturity portfolio at the dates indicated.
At March 31,
-----------------------------------
2006 2005 2004
---------- ---------- -----------
Book Value Book Value Book Value
---------- ---------- -----------
(In Thousands)
Held to Maturity
Freddie Mac........................... $ -- $ 260 $ 350
====== ======= =======
At March 31, 2006, the Company did not have any mortgage-backed
securities (exclusive of obligations of agencies of the U.S. Government)
issued by any one entity with a total book value in excess of 10% of
stockholders equity.
16
For information regarding the market values of Security Federal's
mortgage-backed securities portfolio, see Notes 3 and 4 of the Notes to
Consolidated Financial Statements contained in the Annual Report.
The following table sets forth the final maturities or initial
repricings, whichever occurs first, and the weighted average yields of the
mortgage-backed securities at March 31, 2006. Not considered in the
preparation of the table below is the effect of scheduled payments or
anticipated prepayments. The table is prepared using amortized cost.
The Earliest of Maturing or Repricing March 31, 2006
-------------------------------------------------------------------- --------------
Less Than 1 to 5 5 to 10 Over Balance
1 Year Years Years Ten Years Outstanding
-------------- -------------- -------------- -------------- --------------
Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
(Dollars in Thousands)
Fannie Mae...... $ 9,265 4.04% $35,190 4.08% $21,861 4.28% $10,071 4.90% $ 76,387 4.24%
Freddie Mac..... -- -- 12,500 3.83 4,986 4.26 4,480 4.94 21,966 4.15
Ginnie Mae...... 34,238 3.98 4,649 4.20 837 6.01 162 7.64 39,886 4.07
------- ---- ------- ---- ------- ---- ------- ---- -------- -----
Total........... $43,503 3.99% $52,339 4.03% $27,684 4.33% $14,713 4.94% $138,239 4.18%
======= ==== ======= ==== ======= ==== ======= ==== ======== =====
Sources of Funds
----------------
Deposit accounts have traditionally been a principal source of the Bank's
funds for use in lending and for other general business purposes. In addition
to deposits, the Bank derives funds from loan repayments, cash flows generated
from operations (including interest credited to deposit accounts), FHLB of
Atlanta advances, the sale of securities under agreements to repurchase, and
loan sales. Scheduled loan payments are a relatively stable source of funds
while deposit inflows and outflows and the related cost of such funds have
varied widely. FHLB of Atlanta advances and the sale of securities under
agreements to repurchase may be used on a short-term basis to compensate for
seasonal reductions in deposits or deposit inflows at less than projected
levels and may be used on a longer term basis in support of expanded lending
activities. The availability of funds from loan sales is influenced by
general interest rates. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" contained in the Annual Report.
Deposits. The Bank attracts both short-term and long-term deposits from
the general public by offering a wide assortment of account types and rates.
In recent years, market conditions have required the Bank to rely increasingly
on short-term accounts and other deposit alternatives that are more responsive
to market interest rates than the savings accounts and regulated fixed
interest rate, fixed-term certificates that were the Bank's primary source of
deposits before 1978. The Bank offers regular savings accounts, checking
accounts, various money market accounts, fixed interest rate certificates with
varying maturities, negotiated rate $100,000 or above jumbo certificates of
deposit ("Jumbo CDs") and individual retirement accounts.
At March 31, 2006, the Bank had no brokered deposits. In addition, the
Bank believes that, based on its experience over the past several years, its
savings and transaction accounts are stable sources of deposits.
17
The following table sets forth the dollar amount of savings deposits in
the various types of deposit programs for the periods indicated.
At March 31,
------------------------------------------------------
2006 2005 2004
---------------- ---------------- ----------------
Percent Percent Percent
of of of
Amount Total Amount Total Amount Total
------ ----- ------ ----- ------ -----
(Dollars in Thousands)
Interest Rate Range
-------------------
for 2006:
--------
Savings accounts
0 % - 1.51%.......... $ 17,795 3.7% $ 17,744 4.1% $ 17,367 4.5%
NOW and other
transaction accounts
0% - 2.96%........... 105,348 22.0 88,170 20.5 80,739 20.7
Money market funds
1.09% - 3.93%........ 151,494 31.6 164,088 38.1 158,587 40.7
-------- ----- -------- ----- -------- -----
Total non-
certificates....... $274,637 57.3% $270,002 62.7% $256,693 65.9%
======== ===== ======== ===== ======== =====
Certificates:
-------------
0.00-1.99%............ $ 60 --% $ 23,435 5.5% $ 79,434 20.4%
2.00-2.99%............ 26,836 5.6 80,954 18.8 25,508 6.5
3.00-3.99%............ 72,832 15.2 37,001 8.6 8,413 2.2
4.00-4.99%............ 94,241 19.7 9,096 2.1 9,244 2.4
5.00-5.99%............ 10,623 2.2 9,796 2.3 10,214 2.6
6.00-6.99%............ -- -- 3 -- 87 --
-------- ----- -------- ----- -------- -----
Total certificates.. 204,592 42.7 160,285 37.3 132,900 34.1
-------- ----- -------- ----- -------- -----
Total deposits...... $479,229 100.0% $430,287 100.0% $389,593 100.0%
======== ===== ======== ===== ======== =====
The Bank relies to a limited extent upon locally obtained Jumbo CDs to
maintain its deposit levels. At March 31, 2006, Jumbo CDs constituted 12.9%
of the Bank's total deposits. Security Federal has not relied heavily on
Jumbo CDs to manage interest rate sensitivity.
The following table sets forth the deposit flows at the Bank during the
periods indicated.
Years Ended March 31,
----------------------------------
2006 2005 2004
--------- --------- ---------
(Dollars in Thousands)
Opening balance..................... $430,287 $389,593 $358,474
Net deposits........................ 37,500 32,977 24,339
Interest credited................... 11,442 7,717 6,780
-------- -------- --------
Ending balance...................... 479,229 430,287 389,593
-------- -------- --------
Net increase (decrease)............. $ 48,942 $ 40,694 $ 31,119
======== ======== ========
Percent increase (decrease)......... 11.4% 10.4% 8.7%
======== ======== ========
18
The following table shows rate and maturity information for the Bank's
certificates of deposit as of March 31, 2006.
Less
than 2.00- 3.00- 4.00- 5.00- 6.00-
2.00% 2.99% 3.99% 4.99% 5.99% 6.99% Total
----- ----- ----- ----- ----- ----- -----
(In Thousands)
Certificate accounts
maturing in quarter
ending:
June 30, 2006........ $ 60 $10,762 $24,608 $10,431 $ -- $ -- $ 45,861
September 30, 2006... -- 10,352 19,593 22,629 -- -- 52,574
December 31, 2006.... -- 4,788 12,117 28,816 80 -- 45,801
March 31, 2007....... -- 228 5,925 11,303 2,333 -- 19,789
June 30, 2007........ -- 163 2,406 4,244 5,317 -- 12,130
September 30, 2007... -- 224 2,121 6,644 2,743 -- 11,732
December 31, 2007.... -- 54 1,111 2,533 11 -- 3,709
March 31, 2008....... -- 41 1,501 2,315 -- -- 3,857
June 30, 2008........ -- 50 878 506 -- -- 1,434
September 30, 2008... -- 83 618 389 -- -- 1,090
December 31, 2008.... -- 107 584 100 -- -- 791
Thereafter........... -- 35 1,370 4,331 88 -- 5,824
----- ------- ------- ------- ------- ---- --------
Total.............. $ 60 $26,887 $72,832 $94,241 $10,572 $ -- $204,592
===== ======= ======= ======= ======= ==== ========
The following table indicates the amount of the Bank's deposits of
$100,000 or more by time remaining until maturity at March 31, 2006.
Certificates Savings, NOW and
of Deposit Money Market Accounts
---------- ---------------------
(In Thousands)
Maturity Period
---------------
Three months or less............... $ 6,307 $135,200
Over three through six months...... 16,663 --
Over six through twelve month...... 27,017 --
Over twelve months 11,943 --
------- --------
Total............................. $61,930 $135,200
======= ========
Borrowings
----------
As a member of the FHLB of Atlanta, the Bank is required to own capital
stock in the FHLB of Atlanta and is authorized to apply for advances from the
FHLB of Atlanta. Each FHLB credit program has its own interest rate, which
may be fixed or variable, and range of maturities. The FHLB of Atlanta may
prescribe the acceptable uses to which these advances may be put, as well as
limitations on the size of the advances and repayment provisions. See Note 9
of the Notes to Consolidated Financial Statements contained in the Annual
Report for information regarding the maturities and rate structure of the
Bank's FHLB advances. Federal law contains certain collateral requirements
for FHLB advances. See "Regulation - Federal Regulation of Savings
Associations - Federal Home Loan Bank System."
At March 31, 2006, the Bank had $7.3 million in retail repurchase
agreements with an average rate of 4.43%. These repurchase agreements are
included in "Other Borrowings" in the consolidated financial statements and
the following table.
19
The following table sets forth the maximum month-end balance and average
balance of FHLB advances and other borrowings for the periods indicated.
Years Ended March 31,
--------------------------------
2006 2005 2004
-------- -------- ---------
(In Thousands)
Maximum Balance:
FHLB advances........................ $132,513 $115,258 $103,886
Other borrowings..................... 7,290 5,915 6,213
Average Balance:
FHLB advances........................ $121,526 $105,272 $ 72,995
Other borrowings..................... 6,201 5,488 5,361
The following table sets forth information as to the Bank's borrowings
and the weighted average interest rates thereon at the dates indicated.
At March 31,
--------------------------------
2006 2005 2004
-------- -------- ---------
(Dollars in Thousands)
Balance:
FHLB advances..................... $131,363 $112,038 $96,336
Other borrowings.................. 7,290 5,594 5,477
Weighted Average Interest Rate at
Fiscal Year End:
FHLB advances..................... 3.74% 3.41% 3.59%
Other borrowings.................. 4.43 2.54 0.93
During Fiscal Year:
FHLB advances..................... 3.55% 3.54% 3.87%
Other borrowings.................. 3.38 1.53 0.97
Competition
-----------
The Bank serves the counties of Aiken and Lexington, South Carolina
through its eleven branch offices located in Aiken, North Augusta,
Graniteville, Langley, Clearwater, Wagener, Lexington, and West Columbia,
South Carolina.
Security Federal faces strong competition both in originating loans and
in attracting deposits. Competition in originating loans comes primarily from
other thrift institutions, commercial banks, mortgage bankers and credit
unions who also make loans in the Bank's market area. The Bank competes for
loans principally on the basis of the interest rates and loan fees it charges,
the types of loans it makes and the quality of services it provides to
borrowers.
The Bank faces substantial competition in attracting deposits from other
thrift institutions, commercial banks, money market and mutual funds, credit
unions and other investment vehicles. The ability of the Bank to attract and
retain deposits depends on its ability to provide an investment opportunity
that satisfies the requirements of investors as to rate of return, liquidity,
risk and other factors. The Bank attracts a significant amount of deposits
through its branch offices primarily from the communities in which those
branch offices are located. Therefore, competition for those deposits is
principally from other thrift institutions and commercial banks located in the
same communities. The Bank competes for these deposits by offering a variety
of deposit accounts at competitive rates, convenient business hours, and
convenient branch locations with interbranch deposit and withdrawal privileges
at each.
20
The authority to offer money market deposits, and expanded lending and
other powers authorized for thrift institutions by federal law, have resulted
in increased competition for both deposits and loans between thrift
institutions and other financial institutions such as commercial banks and
credit unions.
Personnel
---------
At March 31, 2006, the Bank employed 159 full-time and 23 part-time
employees. The Bank employees are not represented by any collective
bargaining agreement. Management of the Bank considers its relations with its
employees to be good.
Executive Officers of the Registrant
Executive Officers of the Company and the Bank
Age at Position
March 31, -------------------------------------------
Name 2006 Company Bank
------------- ------------ -------------------- ---------------------
Timothy W. Simmons 60 President and Chief Chairman of the Board
Executive Officer and Chief Executive
Officer
T. Clifton Weeks 79 Chairman of the Board
Roy G. Lindburg 45 Treasurer and Chief Treasurer and Chief
Financial Officer Financial Officer
J. Chris Verenes 50 President
Biographical Information
The following is a description of the principal occupation and employment
of the executive officers of the Corporation and the Bank during at least the
past five years:
Timothy W. Simmons has been President of the Company since 1987 and Chief
Executive Officer since June 1994. Mr. Simmons was elected President and
Chief Operating Officer of the Bank in January 1987 and served in these
capacities from March 1987 to December 2001. In May 1988, Mr. Simmons became
Chief Executive Officer of the Bank and in January 2002, he was elected
Chairman of the Bank's Board of Directors.
T. Clifton Weeks has been Chairman of the Board of the Company since July
1987 and was Chief Executive Officer of the Company from July 1987 until June
1994. Mr. Weeks served as Chairman of the Board of the Bank from January 1987
until January 2002 and was Chief Executive Officer of the Bank from 1987 until
May 1988. Prior thereto, he served as President and Managing Officer of the
Bank beginning in 1958.
Roy G. Lindburg has been Treasurer and Chief Financial Officer of the
Company and the Bank since January 1995.
J. Chris Verenes was elected President of the Bank effective January 26,
2004. Prior to that, he held a variety of management positions with
Washington Group International, an engineering and construction company that
manages and operates major government sites throughout the United States for
the Department of Energy. He was Director of Planning and Administration from
2001 to January 2004, Chief of Staff during 2001, Director of Strategic
Programs for the business unit from 2000 to 2001 and Deputy Manager of
Business from 1996 to 2000. Prior to his employment by Washington Group
International, Mr. Verenes served as Controller for Riegel Textile
Corporation, as Director of Control Data and Business and Technology Center,
and as Executive Director of the South Carolina Democratic Party.
21
REGULATION
The following is a brief description of certain laws and regulations
which are applicable to the Company and the Bank. The description of these
laws and regulations, as well as descriptions of laws and regulations
contained elsewhere herein, does not purport to be complete and is qualified
in its entirety by reference to the applicable laws and regulations.
Legislation is introduced from time to time in the United States Congress
that may affect our operations. In addition, the regulations governing us may
be amended from time to time by the OTS. Any such legislation or regulatory
changes in the future could adversely affect us. We cannot predict whether
any such changes may occur.
General
-------
The Bank, as a federally-chartered savings institution, is subject to
extensive regulation, examination and supervision by the OTS, as its primary
federal regulator, and the FDIC, as its deposits insurer. The Bank is a member
of the FHLB System and its deposit accounts are insured up to applicable
limits by the SAIF managed by the FDIC. The Bank must file reports with the
OTS and the FDIC concerning its activities and financial condition in addition
to obtaining regulatory approvals prior to entering into certain transactions
such as mergers with, or acquisitions of, other financial institutions. There
are periodic examinations by the OTS and, under certain circumstances, the
FDIC to evaluate the Bank's safety and soundness and compliance with various
regulatory requirements. This regulatory structure is intended primarily for
the protection of the insurance fund and depositors. The regulatory structure
also gives the regulatory authorities extensive discretion in connection with
their supervisory and enforcement activities and examination policies,
including policies with respect to the classification of assets and the
establishment of adequate loan loss reserves for regulatory purposes. Any
change in such policies, whether by the OTS, the FDIC or Congress, could have
a material adverse impact on the Company and the Bank and their operations.
The Company, as a savings and loan holding company, is required to file
certain reports with, are subject to examination by, and otherwise must comply
with the rules and regulations of the OTS. The Company is also subject to the
rules and regulations of the SEC under the federal securities laws. See "--
Savings and Loan Holding Company Regulations."
Federal Regulation of Savings Institutions
------------------------------------------
Office of Thrift Supervision. The OTS has extensive authority over the
operations of savings institutions. As part of this authority, the Bank is
required to file periodic reports with the OTS and is subject to periodic
examinations by the OTS and the FDIC. The OTS also has extensive enforcement
authority over all savings institutions and their holding companies, including
the Bank and the Company. This enforcement authority includes, among other
things, the ability to assess civil money penalties, issue cease-and-desist or
removal orders and initiate injunctive actions. In general, these enforcement
actions may be initiated for violations of laws and regulations and unsafe or
unsound practices. Other actions or inactions may provide the basis for
enforcement action, including misleading or untimely reports filed with the
OTS. Except under certain circumstances, public disclosure of final
enforcement actions by the OTS is required.
In addition, the investment, lending and branching authority of the Bank
also are prescribed by federal laws, which prohibit the Bank from engaging in
any activities not permitted by these laws. For example, no savings
institution may invest in non-investment grade corporate debt securities. In
addition, the permissible level of investment by federal institutions in loans
secured by non-residential real property may not exceed 400% of total capital,
except with approval of the OTS. Federal savings institutions are also
generally authorized to branch nationwide. The Bank is in compliance with the
noted restrictions.
All savings institutions are required to pay assessments to the OTS to
fund the agency's operations. The general assessments, paid on a semi-annual
basis, are determined based on the savings institution's total assets,
including consolidated subsidiaries. The Bank's OTS assessment for the fiscal
year ended March 31, 2006 was $128,000.
The Bank's general permissible lending limit for loans-to-one-borrower is
equal to the greater of $500,000 or 15% of unimpaired capital and surplus
(except for loans fully secured by certain readily marketable collateral, in
which
22
case this limit is increased to 25% of unimpaired capital and surplus). At
March 31, 2006, the Bank's lending limit under this restriction was $6.7
million and, at that date, the Bank's largest single loan to one borrower was
$6.0 million, which was performing according to its original terms.
The OTS, as well as the other federal banking agencies, has adopted
guidelines establishing safety and soundness standards on such matters as loan
underwriting and documentation, asset quality, earnings standards, internal
controls and audit systems, interest rate risk exposure and compensation and
other employee benefits. Any institution that fails to comply with these
standards must submit a compliance plan.
Federal Home Loan Bank System. The Bank is a member of the FHLB of
Atlanta, which is one of 12 regional FHLBs that administer the home financing
credit function of savings institutions. Each FHLB serves as a reserve or
central bank for its members within its assigned region. It is funded
primarily from proceeds derived from the sale of consolidated obligations of
the FHLB System. It makes loans or advances to members in accordance with
policies and procedures, established by the Board of Directors of the FHLB,
which are subject to the oversight of the Federal Housing Finance Board. All
advances from the FHLB are required to be fully secured by sufficient
collateral as determined by the FHLB. In addition, all long-term advances are
required to provide funds for residential home financing. At March 31, 2006,
the Bank had $131.4 million of outstanding advances from the FHLB of Atlanta
under an available credit facility of $197.6 million, which is limited to
available collateral. See Business - Deposit Activities and Other Sources of
Funds - Borrowings.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Atlanta. At March 31, 2006, the Bank had $7.2 million in FHLB stock,
which was in compliance with this requirement. In past years, the Bank has
received substantial dividends on its FHLB stock. Over the past two fiscal
years these dividends have averaged 3.86% and were 4.15% for the fiscal year
ended March 31, 2006.
Under federal law, the FHLBs are required to provide funds for the
resolution of troubled savings institutions and to contribute to low- and
moderately-priced housing programs through direct loans or interest subsidies
on advances targeted for community investment and low- and moderate-income
housing projects. These contributions have affected adversely the level of
FHLB dividends paid and could continue to do so in the future. These
contributions could also have an adverse effect on the value of FHLB stock in
the future. A reduction in value of the Bank's FHLB stock may result in a
corresponding reduction in the Bank's capital.
Deposit Insurance. The Bank is a member of the SAIF, which is
administered by the FDIC. Deposits are insured up to the applicable limits by
the FDIC and this insurance is backed by the full faith and credit of the
United States. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging
in any activity the FDIC determines by regulation or order to pose a serious
risk to the SAIF. The FDIC also has the authority to initiate enforcement
actions against savings institutions, after giving the OTS an opportunity to
take such action, and may terminate the deposit insurance if it determines
that the institution has engaged in unsafe or unsound practices or is in an
unsafe or unsound condition.
The FDIC's deposit insurance premiums are assessed through a risk-based
system under which all insured depository institutions are placed into one of
nine categories and assessed insurance premiums based upon their level of
capital and supervisory evaluation. Under the system, institutions classified
as well capitalized (i.e., a core capital ratio of at least 5%, a ratio of
Tier 1 or core capital, to risk-weighted assets ("Tier 1 risk-based capital")
of at least 6% and a risk-based capital ratio of at least 10%) and considered
healthy pay the lowest premium while institutions that are less than
adequately capitalized (i.e., core or Tier 1 risk-based capital ratios of less
than 4% or a risk-based capital ratio of less than 8%) and considered of
substantial supervisory concern pay the highest premium. Risk classification
of all insured institutions is made by the FDIC for each semi-annual
assessment period.
The FDIC is authorized to increase assessment rates, on a semi-annual
basis, if it determines that the reserve ratio of the SAIF will be less than
the designated reserve ratio of 1.25% of SAIF insured deposits. In setting
these increased assessments, the FDIC must seek to restore the reserve ratio
to that designated reserve level, or such higher
23
reserve ratio as established by the FDIC. The FDIC may also impose special
assessments on SAIF members to repay amounts borrowed from the United States
Treasury or for any other reason deemed necessary by the FDIC.
Since January 1, 1997, the premium schedule for Bank Insurance Fund
("BIF") and SAIF insured institutions has ranged from 0 to 27 basis points.
However, SAIF and BIF insured institutions are required to pay a Financing
Corporation assessment in order to fund the interest on bonds issued to
resolve thrift failures in the 1980s equal to approximately 1.5 points for
each $100 in domestic deposits annually. These assessments, which may be
revised based upon the level of BIF and SAIF deposits, will continue until the
bonds mature in the year 2017.
The Federal Deposit Insurance Reform Act of 2005 ("The Reform Act"),
which was enacted in 2006, revised the laws governing the federal deposit
insurance system. The Reform Act provides for the consolidation of the BIF and
the SAIF into a combined "Deposit Insurance Fund" and gives the FDIC the
authority to determine insurance premiums based on a number of factors,
primarily the risk of loss that insured institutions pose to the Deposit
Insurance Fund. The legislation eliminates the current minimum 1.25% reserve
ratio for the insurance funds, the mandatory assessments when the ratio fall
below 1.25% and the prohibition on assessing the highest quality banks when
the ratio is above 1.25%. The Reform Act provides the FDIC with flexibility to
adjust the new insurance fund's reserve ratio between 1.15% and 1.5%,
depending on projected losses, economic changes and assessment rates at the
end of a calendar year.
The Reform Act increased deposit insurance coverage limits from $100,000
to $250,000 for certain types of Individual Retirement Accounts, 401(k) plans
and other retirement savings accounts. While it preserved the $100,000
coverage limit for individual accounts and municipal deposits, the FDIC was
furnished with the discretion to adjust all coverage levels to keep pace with
inflation beginning in 2010. Also, institutions that become undercapitalized
will be prohibited from accepting certain employee benefit plan deposits.
At this time, management cannot predict the effect, if any, that the
Reform Act will have on insurance premiums paid by the Bank.
Prompt Corrective Action. The OTS is required to take certain
supervisory actions against undercapitalized savings institutions, the
severity of which depends upon the institution's degree of
undercapitalization. Generally, an institution that has a ratio of total
capital to risk-weighted assets of less than 8%, a ratio of Tier I (core)
capital to risk-weighted assets of less than 4%, or a ratio of core capital to
total assets of less than 4% (3% or less for institutions with the highest
examination rating) is considered to be "undercapitalized." An institution
that has a total risk-based capital ratio less than 6%, a Tier I capital ratio
of less than 3% or a leverage ratio that is less than 3% is considered to be
"significantly undercapitalized" and an institution that has a tangible
capital to assets ratio equal to or less than 2% is deemed to be "critically
undercapitalized." Subject to a narrow exception, the OTS is required to
appoint a receiver or conservator for a savings institution that is
"critically undercapitalized." OTS regulations also require that a capital
restoration plan be filed with the OTS within 45 days of the date a savings
institution receives notice that it is "undercapitalized," "significantly
undercapitalized" or "critically undercapitalized." In addition, numerous
mandatory supervisory actions become immediately applicable to an
undercapitalized institution, including, but not limited to, increased
monitoring by regulators and restrictions on growth, capital distributions and
expansion. "Significantly undercapitalized" and "critically undercapitalized"
institutions are subject to more extensive mandatory regulatory actions. The
OTS also could take any one of a number of discretionary supervisory actions,
including the issuance of a capital directive and the replacement of senior
executive officers and directors.
At March 31, 2006, the Bank was categorized as "well capitalized" under
the prompt corrective action regulations of the OTS.
Qualified Thrift Lender Test. All savings institutions, including the
Bank, are required to meet a qualified thrift lender ("QTL") test to avoid
certain restrictions on their operations. This test requires a savings
institution to have at least 65% of its total assets, as defined by
regulation, in qualified thrift investments on a monthly average for nine out
of every 12 months on a rolling basis. As an alternative, the savings
institution may maintain 60% of its assets in those assets specified in
Section 7701(a)(19) of the Internal Revenue Code ("Code"). Under either test,
such assets primarily consist of residential housing related loans and
investments.
24
A savings institution that fails to meet the QTL is subject to certain
operating restricitons and may be required to convert to a national bank
charter. Recent legislation has expanded the extent to which education loans,
credit card loans and small business loans may be considered "qualified thrift
investments." As of March 31, 2006, the Bank maintained 91.9% of its portfolio
assets in qualified thrift investments and, therefore, met the qualified
thrift lender test.
Capital Requirements. The OTS's capital regulations require federal
savings institutions to meet three minimum capital standards: a 1.5% tangible
capital to total assets ratio, a 4% leverage ratio (3% for institutions
receiving the highest rating on the CAMELS examination rating system) and an
8% risk-based capital ratio. In addition, the prompt corrective action
standards discussed below also establish, in effect, a minimum 2% tangible
capital standard, a 4% leverage ratio (3% for institutions receiving the
highest rating on the CAMELS system) and, together with the risk-based capital
standard itself, a 4% Tier I risk-based capital standard. The OTS regulations
also require that, in meeting the tangible, leverage and risk-based capital
standards, institutions must generally deduct investments in and loans to
subsidiaries engaged in activities as principal that are not permissible for a
national bank.
The risk-based capital standard requires federal savings institutions to
maintain Tier I (core) and total capital (which is defined as core capital and
supplementary capital) to risk-weighted assets of at least 4% and 8%,
respectively. In determining the amount of risk-weighted assets, all assets,
including certain off-balance sheet assets, recourse obligations, residual
interests and direct credit substitutes, are multiplied by a risk-weight
factor of 0% to 100%, assigned by the OTS capital regulation based on the
risks believed inherent in the type of asset. Core (Tier I) capital is defined
as common stockholders' equity (including retained earnings), certain
noncumulative perpetual preferred stock and related surplus and minority
interests in equity accounts of consolidated subsidiaries, less intangibles
other than certain mortgage servicing rights and credit card relationships.
The components of supplementary capital currently include cumulative preferred
stock, long-term perpetual preferred stock, mandatory convertible securities,
subordinated debt and intermediate preferred stock, the allowance for loan and
lease losses limited to a maximum of 1.25% of risk-weighted assets and up to
45% of unrealized gains on available-for-sale equity securities with readily
determinable fair market values. Overall, the amount of supplementary capital
included as part of total capital cannot exceed 100% of core capital.
The OTS also has authority to establish individual minimum capital
requirements in appropriate cases upon a determination that an institution's
capital level is or may become inadequate in light of the particular
circumstances. At March 31, 2006, the Bank met each of these capital
requirements. For additional information, see Note 11 of the Notes to
Consolidated Financial Statements included in the Annual Report.
Limitations on Capital Distributions. OTS regulations impose various
restrictions on savings institutions with respect to their ability to make
distributions of capital, which include dividends, stock redemptions or
repurchases, cash-out mergers and other transactions charged to the capital
account. Generally, savings institutions, such as the Bank, that before and
after the proposed distribution are well-capitalized, may make capital
distributions during any calendar year equal to up to 100% of net income for
the year-to-date plus retained net income for the two preceding years.
However, an institution deemed to be in need of more than normal supervision
by the OTS may have its dividend authority restricted by the OTS. The Bank
may pay dividends to the Company in accordance with this general authority.
Savings institutions proposing to make any capital distribution need not
submit written notice to the OTS prior to such distribution unless they are a
subsidiary of a holding company or would not remain well-capitalized following
the distribution. Savings institutions that do not, or would not meet their
current minimum capital requirements following a proposed capital distribution
or propose to exceed these net income limitations, must obtain OTS approval
prior to making such distribution. The OTS may object to the distribution
during that 30-day period based on safety and soundness concerns. See "-
Capital Requirements."
Activities of Associations and their Subsidiaries. When a savings
institution establishes or acquires a subsidiary or elects to conduct any new
activity through a subsidiary that the association controls, the savings
institution must notify the FDIC and the OTS 30 days in advance and provide
the information each agency may, by regulation, require. Savings institutions
also must conduct the activities of subsidiaries in accordance with existing
regulations and orders.
The OTS may determine that the continuation by a savings institution of
its ownership control of, or its relationship to, the subsidiary constitutes a
serious risk to the safety, soundness or stability of the association or is
25
inconsistent with sound banking practices or with the purposes of the FDIA.
Based upon that determination, the FDIC or the OTS has the authority to order
the savings institution to divest itself of control of the subsidiary. The
FDIC also may determine by regulation or order that any specific activity
poses a serious threat to the SAIF. If so, it may require that no SAIF member
engage in that activity directly.
Transactions with Affiliates. The Bank's authority to engage in
transactions with "affiliates" is limited by OTS regulations and by Sections
23A and 23B of the Federal Reserve Act as implemented by the Federal Reserve
Board's Regulation W. The term "affiliates" for these purposes generally means
any company that controls or is under common control with an institution. The
Company and its non-savings institution subsidiaries would be affiliates of
the Bank. In general, transactions with affiliates must be on terms that are
as favorable to the institution as comparable transactions with
non-affiliates. In addition, certain types of transactions are restricted to
an aggregate percentage of the institution's capital. Collateral in specified
amounts must usually be provided by affiliates in order to receive loans from
an institution. In addition, savings institutions are prohibited from lending
to any affiliate that is engaged in activities that are not permissible for
bank holding companies and no savings institution may purchase the securities
of any affiliate other than a subsidiary.
The Sarbanes-Oxley Act of 2002 generally prohibits a company from making
loans to its executive officers and directors. However, that act contains a
specific exception for loans by a depository institution to its executive
officers and directors in compliance with federal banking laws. Under such
laws, the Bank's authority to extend credit to executive officers, directors
and 10% stockholders ("insiders"), as well as entities such persons control,
is limited. The law restricts both the individual and aggregate amount of
loans the Bank may make to insiders based, in part, on the Bank's capital
position and requires certain Board approval procedures to be followed. Such
loans must be made on terms substantially the same as those offered to
unaffiliated individuals and not involve more than the normal risk of
repayment. There is an exception for loans made pursuant to a benefit or
compensation program that is widely available to all employees of the
institution and does not give preference to insiders over other employees.
There are additional restrictions applicable to loans to executive officers.
Community Reinvestment Act. Under the Community Reinvestment Act, every
FDIC-insured institution has a continuing and affirmative obligation
consistent with safe and sound banking practices to help meet the credit needs
of its entire community, including low and moderate income neighborhoods. The
Community Reinvestment Act does not establish specific lending requirements or
programs for financial institutions nor does it limit an institution's
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the Community
Reinvestment Act. The Community Reinvestment Act requires the OTS, in
connection with the examination of the Bank, to assess the institution's
record of meeting the credit needs of its community and to take such record
into account in its evaluation of certain applications, such as a merger or
the establishment of a branch, by the Bank. An unsatisfactory rating may be
used as the basis for the denial of an application by the OTS. Due to the
heightened attention being given to the Community Reinvestment Act in the past
few years, the Bank may be required to devote additional funds for investment
and lending in its local community. The Bank was examined for Community
Reinvestment Act compliance and received a rating of satisfactory in its
latest examination.
Affiliate Transactions. The Company and the Bank are separate and
distinct legal entities. Various legal limitations restrict the Bank from
lending or otherwise supplying funds to the Company, generally limiting any
single transaction to 10% of the Bank's capital and surplus and limiting all
such transactions to 20% of the Bank's capital and surplus. These
transactions also must be on terms and conditions consistent with safe and
sound banking practices that are substantially the same as those prevailing at
the time for transactions with unaffiliated companies.
Federally insured savings institutions are subject, with certain
exceptions, to certain restrictions on extensions of credit to their parent
holding companies or other affiliates, on investments in the stock or other
securities of affiliates and on the taking of such stock or securities as
collateral from any borrower. In addition, these institutions are prohibited
from engaging in certain tie-in arrangements in connection with any extension
of credit or the providing of any property or service.
Enforcement. The OTS has primary enforcement responsibility over savings
institutions and has the authority to bring action against all
"institution-affiliated parties," including shareholders, and any attorneys,
appraisers
26
and accountants who knowingly or recklessly participate in wrongful action
likely to have an adverse effect on an insured institution. Formal
enforcement action may range from the issuance of a capital directive or cease
and desist order to removal of officers or directors, receivership,
conservatorship or termination of deposit insurance. Civil penalties cover a
wide range of violations and can amount to $25,000 per day, or $1.1 million
per day in especially egregious cases. The FDIC has the authority to
recommend to the Director of the OTS that enforcement action be taken with
respect to a particular savings institution. If action is not taken by the
Director, the FDIC has authority to take such action under certain
circumstances. Federal law also establishes criminal penalties for certain
violations.
Standards for Safety and Soundness. As required by statute, the federal
banking agencies have adopted Interagency Guidelines prescribing Standards for
Safety and Soundness. The guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address
problems at insured depository institutions before capital becomes impaired.
If the OTS determines that a savings institution fails to meet any standard
prescribed by the guidelines, the OTS may require the institution to submit an
acceptable plan to achieve compliance with the standard.
Environmental Issues Associated with Real Estate Lending. The
Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), a federal statute, generally imposes strict liability on all prior
and present "owners and operators" of sites containing hazardous waste.
However, Congress asked to protect secured creditors by providing that the
term "owner and operator" excludes a person whose ownership is limited to
protecting its security interest in the site. Since the enactment of the
CERCLA, this "secured creditor exemption" has been the subject of judicial
interpretations which have left open the possibility that lenders could be
liable for cleanup costs on contaminated property that they hold as collateral
for a loan.
To the extent that legal uncertainty exists in this area, all creditors,
including the Bank, that have made loans secured by properties with potential
hazardous waste contamination (such as petroleum contamination) could be
subject to liability for cleanup costs, which costs often substantially exceed
the value of the collateral property.
Privacy Standards. The Gramm-Leach-Bliley Financial Services
Modernization Act of 1999 ("GLBA"), which was enacted in 1999, modernized the
financial services industry by establishing a comprehensive framework to
permit affiliations among commercial banks, insurance companies, securities
firms and other financial service providers. The Bank is subject to OTS
regulations implementing the privacy protection provisions of the GLBA. These
regulations require the Bank to disclose its privacy policy, including
identifying with whom it shares "non-public personal information," to
customers at the time of establishing the customer relationship and annually
thereafter.
Anti-Money Laundering and Customer Identification. Congress enacted the
Uniting and Strengthening America by Providing Appropriate Tools Required to
Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") on
October 26, 2001 in response to the terrorist events of September 11, 2001.
The USA Patriot Act gives the federal government new powers to address
terrorist threats through enhanced domestic security measures, expanded
surveillance powers, increased information sharing, and broadened anti-money
laundering requirements. In March 2006, Congress re-enacted certain expiring
provisions of the USA Patriot Act.
Savings and Loan Holding Company Regulations
--------------------------------------------
General. The Company is a unitary savings and loan holding company
subject to regulatory oversight of the OTS. Accordingly, the Company is
required to register and file reports with the OTS and is subject to
regulation and examination by the OTS. In addition, the OTS has enforcement
authority over the Company and its non-savings institution subsidiaries which
also permits the OTS to restrict or prohibit activities that are determined to
present a serious risk to the subsidiary savings institution.
Mergers and Acquisitions. The Company must obtain approval from the OTS
before acquiring more than 5% of the voting stock of another savings
institution or savings and loan holding company or acquiring such an
institution or holding company by merger, consolidation or purchase of its
assets. In evaluating an application for the Company to acquire control of a
savings institution, the OTS would consider the financial and managerial
resources and future prospects of the Company and the target institution, the
effect of the acquisition on the risk to the insurance funds, the convenience
and the needs of the community and competitive factors.
27
Activities Restrictions. As a unitary savings and loan holding company,
the Company generally is not subject to activity restrictions. The Company and
its non-savings institution subsidiaries are subject to statutory and
regulatory restrictions on their business activities specified by federal
regulations, which include performing services and holding properties used by
a savings institution subsidiary, activities authorized for savings and loan
holding companies as of March 5, 1987, and non-banking activities permissible
for bank holding companies pursuant to the Bank Holding Company Act of 1956 or
authorized for financial holding companies pursuant to the GLBA.
If the Bank fails the QTL test, the Company must, within one year of that
failure, register as, and will become subject to, the restrictions applicable
to bank holding companies. See "- Federal Regulation of Savings Institutions
- Qualified Thrift Lender Test."
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002
("Sarbanes-Oxley Act") was signed into law on July 30, 2002 in response to
public concerns regarding corporate accountability in connection with the
recent accounting scandals. The stated goals of the Sarbanes-Oxley Act are to
increase corporate responsibility, to provide for enhanced penalties for
accounting and auditing improprieties at publicly traded companies and to
protect investors by improving the accuracy and reliability of corporate
disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally
applies to all companies, both U.S. and non-U.S., that file or are required to
file periodic reports with the Securities and Exchange Commission ("SEC")
under the Securities Exchange Act of 1934, including the Company.
The Sarbanes-Oxley Act includes very specific additional disclosure
requirements and new corporate governance rules, requires the SEC and
securities exchanges to adopt extensive additional disclosure, corporate
governance and related rules. The Sarbanes-Oxley Act represents significant
federal involvement in matters traditionally left to state regulatory systems,
such as the regulation of the accounting profession, and to state corporate
law, such as the relationship between a board of directors and management and
between a board of directors and its committees.
TAXATION
Federal Taxation
----------------
General. The Company and the Bank report their income on a fiscal year
basis using the accrual method of accounting and are subject to federal income
taxation in the same manner as other corporations with some exceptions,
including particularly the Bank's reserve for bad debts discussed below. The
following discussion of tax matters is intended only as a summary and does not
purport to be a comprehensive description of the tax rules applicable to the
Bank or the Company.
Bad Debt Reserve. Historically, savings institutions such as the Bank
which met certain definitional tests primarily related to their assets and the
nature of their business ("qualifying thrift") were permitted to establish a
reserve for bad debts and to make annual additions thereto, which may have
been deducted in arriving at their taxable income. The Bank's deductions with
respect to "qualifying real property loans," which are generally loans secured
by certain interest in real property, were computed using an amount based on
the Bank's actual loss experience, or a percentage equal to 8% of the Bank's
taxable income, computed with certain modifications and reduced by the amount
of any permitted additions to the non-qualifying reserve. Due to the Bank's
loss experience, the Bank generally recognized a bad debt deduction equal to
8% of taxable income.
The thrift bad debt rules were revised by Congress in 1996. The new
rules eliminated the 8% of taxable income method for deducting additions to
the tax bad debt reserves for all thrifts for tax years beginning after
December 31, 1995. These rules also required that all institutions recapture
all or a portion of their bad debt reserves added since the base year (last
taxable year beginning before January 1, 1988). The Bank has no post-1987
reserves subject to recapture. For taxable years beginning after December 31,
1995, the Bank's bad debt deduction will be determined under the experience
method using a formula based on actual bad debt experience over a period of
years. The unrecaptured base year reserves will not be subject to recapture
as long as the institution continues to carry on the business of banking. In
addition, the balance of the pre-1988 bad debt reserves continue to be subject
to provisions of present law referred to below that require recapture in the
case of certain excess distributions to shareholders.
28
Distributions. To the extent that the Bank makes "nondividend
distributions" to the Company, these distributions will be considered to
result in distributions from the balance of its bad debt reserve as of
December 31, 1987 (or a lesser amount if the Bank's loan portfolio decreased
since December 31, 1987) and then from the supplemental reserve for losses on
loans ("Excess Distributions"), and an amount based on the Excess
Distributions will be included in the Bank's taxable income. Nondividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, distributions in redemption of stock and
distributions in partial or complete liquidation. However, dividends paid out
of the Bank's current or accumulated earnings and profits, as calculated for
federal income tax purposes, will not be considered to result in a
distribution from the Bank's bad debt reserve. The amount of additional
taxable income created from an Excess Distribution is an amount that, when
reduced by the tax attributable to the income, is equal to the amount of the
distribution. Thus, if, after the Conversion, the Bank makes a "nondividend
distribution," then approximately one and one-half times the Excess
Distribution would be includable in gross income for federal income tax
purposes, assuming a 34% corporate income tax rate (exclusive of state and
local taxes). See "Regulation" for limits on the payment of dividends by the
Bank. The Bank does not intend to pay dividends that would result in a
recapture of any portion of its tax bad debt reserve.
Corporate Alternative Minimum Tax. The Code imposes a tax on alternative
minimum taxable income ("AMTI") at a rate of 20%. The excess of the tax bad
debt reserve deduction using the percentage of taxable income method over the
deduction that would have been allowable under the experience method is
treated as a preference item for purposes of computing the AMTI. In addition,
only 90% of AMTI can be offset by net operating loss carryovers. AMTI is
increased by an amount equal to 75% of the amount by which the Bank's adjusted
current earnings exceeds its AMTI (determined without regard to this
preference and prior to reduction for net operating losses). For taxable
years beginning after December 31, 1986, and before January 1, 1996, an
environmental tax of 0.12% of the excess of AMTI (with certain modification)
over $2.0 million is imposed on corporations, including the Bank, whether or
not an Alternative Minimum Tax is paid.
Dividends-Received Deduction. The Company may exclude from its income
100% of dividends received from the Bank as a member of the same affiliated
group of corporations. The corporate dividends-received deduction is
generally 70% in the case of dividends received from unaffiliated corporations
with which the Company and the Bank will not file a consolidated tax return,
except that if the Company or the Bank owns more than 20% of the stock of a
corporation distributing a dividend, then 80% of any dividends received may be
deducted.
Audits. The Company, the Bank and its consolidated subsidiaries have
been audited or their books closed without audit by the IRS with respect to
consolidated federal income tax returns through March 31, 1999. See Note __
of the Notes to Consolidated Financial Statements contained in the Annual
Report for additional information regarding income taxes.
State Taxation
--------------
South Carolina has adopted the Code as it relates to savings banks,
effective for taxable years beginning after December 31, 1986. The Bank is
subject to South Carolina income tax at the rate of 6%. The Bank has not been
audited by the State of South Carolina during the past five years.
The Company's income tax returns have not been audited by federal or
state authorities within the last five years. For additional information
regarding income taxes, see Note 10 of the Notes to Consolidated Financial
Statements contained in the Annual Report.
Item 1A. Risk Factors.
-----------------------
An investment in our common stock involves various risks which are
particular to Security Federal Corporation, our industry, and our market area.
Before making an investment decision, you should carefully consider the risks
and uncertainties described below together with all of the other information
included in this report. In addition to the risks and uncertainties described
below, other risks and uncertainties not currently known to us or that we
currently deem to be immaterial also may materially and adversely affect our
business,
29
financial condition and results of operations. The value or market price of
our common stock could decline due to any of these identified or other risks,
and you could lose all or part of your investment.
An economic downturn, especially one affecting Aiken and Lexington Counties in
South Carolina and surrounding areas, could reduce our customer base, our
level of deposits, demand for our financial products, and increase our
delinquency rates on loans.
Unlike larger national or other regional banks that are more
geographically diversified, we provide banking and financial services to
customers located primarily in two counties of South Carolina. Our success
depends on the growth in population, income levels, deposits, and housing
starts in our primary market area. If the communities in our market area do
not continue to expand, our business may not succeed. A local economic
downturn could adversely affect the real estate markets in the communities in
our market area, which would increase our loan losses on residential and
commercial real estate. In that case, our allowance for loan losses may not
be adequate, which would negatively impact our earnings. Further, a
significant decline in general economic conditions, caused by inflation,
recession, acts of terrorism, outbreak of hostilities or other international
or domestic occurrences, unemployment, changes in securities markets or other
factors could impact these state and local markets and, in turn, also have a
material adverse effect on our financial condition and results of operations.
Our loan portfolio in Lexington County and surrounding area is relatively
unseasoned. We also plan to build a branch office in Evans, Georgia, which is
another new lending area. We could experience higher than normal loan losses
in newer loan markets.
Although we have hired experienced lending officers in Lexington County,
that market area is relatively new to us. Many of our loans in that market
are acquisition and development loans and loans to builders for speculative
housing, which have a higher degree of risk than single family permanent
mortgage loans. Although we have not had increased delinquencies in that
market, we have not experienced an economic cycle of declining real estate
values in Lexington County. We also plan to enter the metro Augusta, Georgia
market (Evans), which will be a new market area for us. We plan on hiring
experienced lenders, although this may be difficult because competition for
experienced commercial lenders is fierce. Because these market areas are new
to us, we may experience increased loan losses that would require additional
reserves and which would negatively impact our earnings.
Fluctuations in interest rates could reduce our profitability and affect the
value of our assets.
Our profitability depends substantially upon our net interest income.
Net interest income is the difference between the interest earned on loans and
investments and interest paid on deposits and borrowings. Market interest
rates for loans and deposits are highly sensitive to competition for these
products. We expect that we will periodically experience imbalances in the
interest rate sensitivities of our assets and liabilities and the
relationships of various interest rates to each other. Over any period of
time, our interest-earning assets may be more sensitive to changes in market
interest rates than our interest-bearing liabilities, or vice versa. In
addition, the individual market interest rates underlying our loan and deposit
products may not change to the same degree over a given time period. In any
event, if market interest rates should move contrary to our position, our
earnings may be negatively affected. In addition, loan volume and quality and
deposit volume and mix can be affected by market interest rates. Changes in
levels of market interest rates could materially adversely affect our net
interest spread, asset quality, origination volume and overall profitability.
Interest rates have recently been at historically low levels. However,
since June 30, 2004, the U.S. Federal Reserve has increased its target for the
federal funds rate sixteen times, from 1.00% to 5.00%. While these short-term
market interest rates (which we use as a guide to price our deposits) have
increased the pricing of our loans have more than offset the rise in funding
cost. In a sustained rising interest rate environment the asset yields are
expected to closely match rising funding costs. A sustained falling interest
rate environment would negatively impact margins. Opportunities to reduce
non-maturity deposit rates become more difficult to realize in a protracted
decline in rates, while asset yields come under constant pressure. We
principally manage interest rate risk by managing our volume and mix of our
earning assets and funding liabilities. In a changing interest rate
environment, we may not be able to manage this risk effectively. If we are
unable to manage interest rate risk effectively, our business, financial
condition and results of operations could be materially harmed.
30
An inadequate allowance for loan losses would reduce our earnings.
We are exposed to the risk that our borrowers will be unable to repay
their loans according to their terms and that any collateral securing the
payment of their loans will not be sufficient to assure full repayment. Credit
losses are inherent in the lending business and could have a material adverse
effect on our operating results. Volatility and deterioration in the economy
may also increase our risk for credit losses. We evaluate the collectibility
of our loan portfolio and provide an allowance for loan losses that we believe
is adequate based upon such factors as:
* cash flow of the borrower and/or the project being financed;
* in the case of a collateralized loan, the changes and uncertainties
as to the future value of the collateral;
* the credit history of a particular borrower;
* changes in economic and industry conditions; and
* the duration of the loan.
If our evaluation is incorrect and borrower defaults cause losses
exceeding our allowance for loan losses, our earnings could be materially and
adversely affected. We cannot assure you that our allowance will be adequate
to cover loan losses inherent in our portfolio. We may experience losses in
our loan portfolio or perceive adverse trends that require us to significantly
increase our allowance for loan losses in the future, which would also reduce
our earnings. In addition, Security Federal Bank's regulators, as an integral
part of their examination process, may require us to make additional
provisions for loan losses.
Our funding sources may prove insufficient to replace deposits and support our
future growth.
We rely on customer deposits and advances from the FHLB-Atlanta and other
borrowings to fund our operations. Although we have historically been able to
replace maturing deposits and advances if desired, no assurance can be given
that we would be able to replace such funds in the future if our financial
condition or the financial condition of the FHLB or market conditions were to
change. Our financial flexibility will be severely constrained if we are
unable to maintain our access to funding or if adequate financing is not
available to accommodate future growth at acceptable interest rates. Finally,
if we are required to rely more heavily on more expensive funding sources to
support future growth, our revenues may not increase proportionately to cover
our costs. In this case, our profitability would be adversely affected.
Competition with other financial institutions could adversely affect our
profitability.
The banking and financial services industry is very competitive. Legal
and regulatory developments have made it easier for new and sometimes
unregulated competitors to compete with us. Consolidation among financial
service providers has resulted in fewer very large national and regional
banking and financial institutions holding a large accumulation of assets.
These institutions generally have significantly greater resources, a wider
geographic presence or greater accessibility. Our competitors sometimes are
also able to offer more services, more favorable pricing or greater customer
convenience than we do. In addition, our competition has grown from new banks
and other financial services providers that target our existing or potential
customers. As consolidation continues among large banks, we expect additional
institutions to try to exploit our market.
Technological developments have allowed competitors including some
non-depository institutions, to compete more effectively in local markets and
have expanded the range of financial products, services and capital available
to our target customers. If we are unable to implement, maintain and use such
technologies effectively, we may not be able to offer products or achieve
cost-efficiencies necessary to compete in our industry. In addition, some of
these competitors have fewer regulatory constraints and lower cost structures.
31
We are exposed to a failure or breach of our technology.
As a financial services company, we are heavily dependent on our core
processing system and computer networks to conduct our business. Although we
have policies and procedures designed to prevent or limit the effect of the
failure, interruption or security breach of our information systems, there can
be no assurance that any such failures, interruptions or security breaches
will not occur or, if they do occur, that they will be adequately addressed.
The occurrence of any failures, interruptions or security breaches of our
information systems could damage our reputation, result in a loss of customer
business, subject us to additional regulatory scrutiny, or expose us to civil
litigation and possible financial liability, any of which could have a
material adverse effect on our financial condition and results of operations.
Although we do our own core bank processing in-house, we rely on
third-party service providers for much of our communications, information,
operating and financial control systems technology. If any of our third-party
service providers experience financial, operational or technological
difficulties, or if there is any other disruption in our relationships with
them, we may be required to locate alternative sources of such services, and
we cannot assure that we could negotiate terms that are as favorable to us, or
could obtain services with similar functionality, as found in our existing
systems, without the need to expend substantial resources, if at all. Any of
these circumstances could have an adverse effect on our business.
Our ability to pay dividends is limited and we may be unable to pay future
dividends. This could lead to appreciation of our common stock price as the
sole return on an investor's investment.
Security Federal Corporation is a separate and distinct legal entity from
its subsidiaries. We receive substantially all of our revenue from dividends
from Security Federal Bank. These dividends are the principal source of funds
to pay dividends on our common stock and interest and principal on our debt.
Various federal and/or state laws and regulations limit the amount of
dividends that Security Federal Bank may pay us. Also, our right to
participate in a distribution of assets upon a subsidiary's liquidation or
reorganization is subject to the prior claims of the subsidiary's creditors.
In the event Security Federal Bank is unable to pay dividends to us, we may
not be able to service our debt, pay obligations or pay dividends on our
common stock. The inability to receive dividends from Security Federal Bank
could have a material adverse effect on our business, financial condition and
results of operations. Thus, no assurances can be made that we will continue
to increase or even pay our quarterly dividend.
We may need to raise capital to support our growth. We may not be able to
raise capital at the time we need it.
In order to sustain the high rate of growth we have experienced during
the past few years, we may need to raise additional capital in the near
future. Although there are various ways to raise capital, those methods may
not be available at the time we need to raise additional capital. In the event
we are unable to raise the capital we need, our growth, and future earnings,
would be curtailed.
The integration of the Collier Jennings Companies may be difficult, which
could have a negative impact on earnings.
We recently announced the acquisition of the Collier Jennings Companies,
a local insurance agency. The integration of the Collier-Jennings Companies
may be difficult and may cause us not to realize expected revenue increases,
cost savings, increases in geographic or product presence, and/or other
projected benefits from the acquisition. The process of integrating operations
could cause an interruption of, or loss of momentum in, the activities of our
business. The diversion of management's attention and any delays or
difficulties encountered in connection with the acquisition could have an
adverse effect on our business and results of operations following the
acquisition or otherwise adversely affect our ability to achieve the
anticipated benefits of the acquisition.
We are subject to extensive regulation from numerous governmental agencies,
which could restrict our activities and impose financial requirements or
limitations on the conduct of our business.
We are subject to extensive federal and state regulation and supervision,
primarily through Security Federal Bank. Banking regulations are primarily
intended to protect depositors' funds, federal deposit insurance funds and the
32
banking system as a whole, not shareholders. These regulations affect our
lending practices, capital structure, investment practices, dividend policy
and growth, among other things. Congress and federal regulatory agencies
continually review banking laws, regulations and policies for possible
changes. Changes to statutes, regulations or regulatory policies, including
changes in interpretation or implementation of statutes, regulations or
policies, could affect us in substantial and unpredictable ways. Such changes
could subject us to additional costs, limit the types of financial services
and products we may offer and/or increase the ability of non-banks to offer
competing financial services and products, among other things. Failure to
comply with laws, regulations or policies could result in sanctions by
regulatory agencies, civil money penalties and/or reputation damage, which
could have a material adverse effect on our business, financial condition and
results of operations. While we have policies and procedures designed to
prevent any such violations, there can be no assurance that such violations
will not occur.
We are dependent on key individuals, and the loss of one or more of these key
individuals could limit our growth and adversely affect earnings.
Timothy W. Simmons, our CEO, is a very experienced banker and has
long-standing ties to our community. The loss of our CEO, or other key
personnel, could have a negative impact on earnings. The competition for
seasoned, experienced, banking personnel is highly competitive in South
Carolina. The cost of attaining and retaining these individuals could
increase in the future, which would negatively impact our operations. Our
success depends on our ability to continue to attract, manage and retain other
qualified personnel as we grow. We cannot assure you that we will continue to
attract or retain such personnel.
Changes in accounting standards may affect our performance.
Our accounting policies and methods are fundamental to how we record and
report our financial condition and results of operations. From time to time
there are changes in the financial accounting and reporting standards that
govern the preparation of our financial statements. These changes can be
difficult to predict and can materially impact how we report and record our
financial condition and results of operations. In some cases, we could be
required to apply a new or revised standard retroactively, resulting in
restating prior period financial statements.
Our recent results may not be indicative of future results, and may not be an
adequate measure of the risk of investing in our stock.
We may not be able to sustain our historical growth rate or our recent
growth rates in loans and deposits. If we are unable to sustain our growth,
this would negatively affect our earnings and the value of our common stock.
Item 2. Properties
----------
At March 31, 2006, Security Federal owned the buildings and land for its
main office, five of its branch offices, and the operations center, leased the
land and owned the improvements thereon for one of its offices, and leased
the remaining five offices. The property related to the offices owned by
Security Federal had a depreciated cost (including land) of approximately $5.4
million at March 31, 2006. At March 31, 2006, the aggregate net book value of
leasehold improvements (excluding furniture and equipment) associated with
leased premises was $2.3 million. In addition to the properties related to
current bank offices, Security Federal owned four other properties at March
31, 2006. Two lots owned for future branch sites, one in Aiken County, South
Carolina, and the other in Columbia County, Georgia, had a combined book value
of $1.3 million. Another lot in Aiken County, to be used for a possible new
Operations Center, had a book value of $236,000. The other property
consisting of land and a building, located adjacent to the 1705 Whisky Road
office, is currently leased and had a book value of approximately $295,000 at
March 31, 2006. See Note 6 of the Notes to Consolidated Financial Statements
contained in the Annual Report.
33
The following table sets forth the net book value of the offices owned
(including land) and leasehold improvements on properties leased by Security
Federal at March 31, 2006.
Lease Date
Expir- Facility Gross
Owned or ation Opened/ Square Net Book
Location Leased Date Acquired Footage Value
---------------------------- ------ ----- -------- ------- --------
Main Office:
238 Richland Avenue, W.
Aiken, South Carolina Leased 2013 2006 4,106 $618,000
Full Service Branch Offices
100 Laurens Street, N.W.
Aiken, South Carolina Leased 2013 1959 4,106 621,000
1705 Whiskey Road S.
Aiken, South Carolina Owned N/A 1980 10,000 238,000
313 East Martintown Road
North Augusta, South Carolina Owned (1) N/A 1973 4,356 583,000
1665 Richland Avenue, W.
Aiken, South Carolina Owned N/A 1984 1,942 282,000
Montgomery & Canal Streets
Masonic Shopping Center
Graniteville, South Carolina Leased 2007 1993 (2) 3,576 282,000
2812 Augusta Road
Langley, South Carolina Owned N/A 1993 (2) 2,509 111,000
Highway 125 and Highways 1 and 78
Midland Valley Shopping Center
Clearwater, South Carolina Leased 2003 1993 (2) 2,287 46,000
118 Main Street North
Wagener, South Carolina Owned N/A 1993 (2) 3,600 193,000
1185 Sunset Boulevard
West Columbia, South Carolina Leased 2015 2000 10,000 688,000
2587 Whiskey Road
Aiken, South Carolina Owned N/A 2006 4,000 1,593,000
5446 Sunset Boulevard
Lexington, South Carolina Owned (3) N/A 2003 9,200 1,608,000
Operations Center:
871 East Pine Log Road
Aiken, South Carolina Owned N/A 1988 10,000 789,000
(footnotes on following page)
34
______________
(1) Security Federal has a lease with options through 2063.
(2) Represents acquisition date.
(3) Security Federal has a lease on the land for this office which expires in
2018, but has options through 2063.
Item 3. Legal Proceedings
-----------------
The Company is involved as plaintiff or defendant in various legal
actions arising in the course of its business. It is the opinion of
management, after consultation with counsel, that the resolution of these
legal actions will not have a material adverse effect on the Company's
financial condition and results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
No matter was submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the quarter ended March 31, 2006.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
------------------------------------------------------------------
The information contained in the section captioned "Shareholders
Information - Price Range of Common Stock" and " Dividends" in the Annual
Report is incorporated herein by reference.
Stock Repurchases. The following table sets forth the Company's
repurchases of its outstanding Common Stock during the fourth quarter of the
year ended March 31, 2006.
Total Number
of Shares Maximum
Purchased as Number
Total Part of of Shares that
Number of Average Publicly May Yet Be
Shares Price Paid Announced Purchased
Period Purchased per Share Plans Under the Plans
---------------- ----------- ------------ ------------ -----------------
January 1 -
January 31....... -- $ -- -- 124,365
February 1 -
February 28...... -- -- -- 124,365
March 1 -
March 31......... 1,600 24.00 1,600 122,765
===== ====== ===== =======
Total............. 1,600 $24.00 1,600 122,765
===== ====== ===== =======
These stock repurchases are being conducted pursuant to a repurchase
program announced by the Company in May 2004, for the purchase of up to 5% of
its outstanding shares, or approximately 126,000 shares, subject to market
conditions.
Equity Compensation Plan Information
The equity compensation plan information presented under subparagraph (d)
in Part III, Item 12 of this report is incorporated herein by reference.
35
Item 6. Selected Financial Data
-----------------------
The information contained in the section captioned "Selected Consolidated
Financial and Other Data" in the Annual Report is incorporated herein by
reference.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
---------------------------------------------------------------
The information contained in the section captioned "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
the Annual Report is incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
Market risk is the risk of loss from adverse changes in market prices and
rates. Our market risk arises principally from interest rate risk inherent in
our lending, investing, deposit and borrowings activities. Management
actively monitors and manages its interest rate risk exposure. In addition to
other risks that we manage in the normal course of business, such as credit
quality and liquidity, management considers interest rate risk to be a
significant market risk that could have a potentially have a material effect
on our financial condition and result of operations. The information
contained in the section captioned "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Asset and Liability
Management" in the Annual Report is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
-------------------------------------------
Report of Independent and Registered Accounting Firm*
Consolidated Balance Sheets, March 31, 2006 and 2005*
Consolidated Statements of Income For the Years Ended March 31, 2006,
2005 and 2004*
Consolidated Statements of Changes in Shareholders' Equity and
Comprehensive Income For the Years Ended March 31, 2006, 2005 and
2004*
Consolidated Statements of Cash Flows For the Years Ended March 31,
2006, 2005 and 2004*
Notes to Consolidated Financial Statements*
Quarterly Financial Data (unaudited)*
* Contained in the Annual Report filed as an exhibit hereto and
incorporated herein by reference.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
------------------------------------------------------------------------
None.
Item 9A. Controls and Procedures
-----------------------
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of
the Company's disclosure controls and procedures (as defined in Section
13a-15(e) of the Securities Exchange Act of 1934 (the "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
report. The Company's Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures as currently
in effect are 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 periods
specified in the SEC's rules and forms.
(b) Changes in Internal Controls: In the year ended March 31, 2006, the
Company did not make any significant changes in, nor take any corrective
actions regarding, its internal controls or other factors that could
significantly affect these controls.
36
Item 9B. Other Information
---------------------------
There was no information to be disclosed by the Company in a report on
Form 8-K during the fourth quarter
of fiscal 2006 that was not so disclosed.
PART III
Item 10. Directors and Executive Officers of the Registrant
--------------------------------------------------
The information contained under the section captioned " Proposal I --
Election of Directors" in the Proxy Statement is incorporated herein by
reference.
For information regarding the executive officers of the Company and the
Bank, see the information contained herein under the section captioned "Item
1. Business - Personnel - Executive Officers of the Registrant."
Audit Committee Financial Expert. The Audit Committee of the Company is
composed of Directors Harry O. Weeks (Chairperson), Clyburn and Moore. Each
member of the Audit Committee is "independent" as defined in the Nasdaq Stock
Market listing standards. The Board of Directors has determined there is no
"audit committee financial expert" as defined by the SEC. The Board believes
that the current members of the Audit Committee are qualified to serve based
on their collective experience and background. Each member of the Audit
Committee is independent as that term is used in Item 7(d)(3)(iv) of Schedule
14A promulgated under the Exchange Act.
Code of Ethics. The Board of Directors has adopted a Code of Ethics for
the Company's officers (including its senior financial officers), directors,
and employees. The Code is applicable to the Company's principal executive
officer and senior financial officers, and requires individuals to maintain
the highest standards of professional conduct. A copy of the Code of Ethics
is filed as Exhibit 14 to this Form 10-K and is available upon request from
the Company. Requests should be made to: Secretary, Security Federal
Corporation, P.O. Box 810, Aiken, South Carolina 29802.
Item 11. Executive Compensation
----------------------
The information contained in the section captioned "Executive Officers"
in the Proxy Statement is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
---------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners.
The information contained in the section captioned "Security Ownership of
Certain Beneficial Owners and Management" in the Proxy Statement is
incorporated herein by reference.
(b) Security Ownership of Management.
The information contained in the section captioned "Security Ownership of
Certain Beneficial Owners and Management" in the Proxy Statement is
incorporated herein by reference.
(c) Changes In Control
The Company is not aware of any arrangements, including any pledge by any
person of securities of the Company, the operation of which may at a
subsequent date result in a change in control of the Company.
(d) Equity Compensation Plan Information
Information regarding the Company's equity compensation plans as of March
31, 2006 is incorporated herein by reference to the section captioned
"Executive Compensation" in the Proxy Statement.
37
Item 13. Certain Relationships and Related Transactions
----------------------------------------------
The information contained in the section captioned "Certain Transactions"
in the Proxy Statement is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
--------------------------------------
The information contained under the section captioned "Independent
Auditors" is included in the Company's Proxy Statement and is incorporated
herein by reference.
PART IV
Item 15. Exhibits and Financial Statement Schedules
------------------------------------------
(a) 1. Financial Statements.
---------------------
For a list of the financial statements filed as part of
this report see Part II Item 8.
2. Financial Statement Schedules.
------------------------------
All schedules have been omitted as the required information
is either inapplicable or contained in the Consolidated
Financial Statements or related Notes contained in the
Annual Report filed as an exhibit hereto.
3. Exhibits:
--------
3.1 Articles of Incorporation, as amended (1)
3.2 Bylaws (2)
4 Instruments defining the rights of security holders,
including indentures (3)
10.1 Executive Compensation Plans and Arrangements:
10.2 1993 Salary Continuation Agreements (4)
10.3 Amendment One to 1993 Salary Continuation Agreements (5)
10.4 Form of 2006 Salary Continuation Agreement (6)
10.4 1999 Stock Option Plan (2)
10.5 1987 Stock Option Plan (4)
10.6 2002 Stock Option Plan (7)
10.7 2004 Employee Stock Purchase Plan (8)
10.8 Incentive Compensation Plan (4)
13 Annual Report to Stockholders
14 Code of Ethics
21 Subsidiaries of Registrant
23 Consent of Elliott Davis, LLC
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
___________
(1) Filed on June 26, 1998, as an exhibit to the Company's
Proxy Statement and incorporated herein by reference.
(2) Filed on March 2, 2000, as an exhibit to the Company's
Registration Statement on Form S-8 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.
38
(4) Filed on June 28, 1993, as an exhibit to the Company's
Annual Report on Form 10-KSB and incorporated herein by
reference.
(5) 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.
(6) 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.
(7) Filed on June 19, 2002, as an exhibit to the Company's
Proxy Statement and incorporated herein by reference.
(8) Filed on June 18, 2004, as an exhibit to the Company's
Proxy Statement and incorporated herein by reference.
39
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) 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: June 29, 2006 By: /s/Timothy W. Simmons
--------------------------------------
Timothy W. Simmons
President, Chief Executive Officer and
Director
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
By: /s/Timothy W. Simmons June 29, 2006
-----------------------------------
Timothy W. Simmons
President, Chief Executive Officer and Director
(Principal Executive Officer)
By: /s/Roy G. Lindburg
----------------------------------- June 29, 2006
Roy G. Lindburg
Treasurer, Chief Financial Officer and Director
(Principal Financial and Accounting Officer)
By: /s/T.Clifton Weeks June 29, 2006
-----------------------------------
T. Clifton Weeks
Chairman of the Board and Director
By:/s/J. Chris Verenes June 29, 2006
------------------------------------
J. Chris Verenes
President of the Bank and Director of
the Company and the Bank
By:/s/Gasper L. Toole III June 29, 2006
-------------------------------------
Gasper L. Toole III
Director
By:/s/Harry O. Weeks Jr. June 29, 2006
-------------------------------------
Harry O. Weeks Jr.
Director
By:/s/Robert E. Alexander June 29, 2006
-------------------------------------
Robert E. Alexander
Director
By:/s/Thomas L. Moore June 29, 2006
-------------------------------------
Thomas L. Moore
Director
By:/s/William Clyburn June 29, 2006
--------------------------------------
William Clyburn
Director
INDEX TO EXHIBITS
Exhibit Number
--------------
13 Annual Report to Stockholders
14 Code of Ethics
21 Subsidiaries of the Registrant
23 Consent of Elliott Davis, LLC
31.1 Certification of Chief Executive Officer of Security Federal
Corporation Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
31.2 Certification of Chief Financial Officer of Security Federal
Corporation Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
32 Certification of Chief Executive Officer and Chief Financial
Officer of Security Federal Corporation Pursuant to Section 906
of the Sarbanes-Oxley Act
Exhibit 13
Annual Report to Stockholders
SECURITY
FEDERAL
CORPORATION
==============================================================================
ANNUAL REPORT MARCH 2006
CONTENTS:
Letter to Shareholders 3
Financial Highlights 4
Selected Consolidated Financial and Other Data 7
Management's Discussion and Analysis
of Financial Condition and Results of Operations 8
Report of Elliott Davis, LLC, Independent Auditors 23
Consolidated Balance Sheets 24
Consolidated Statements of Income 25
Consolidated Statements of Shareholders' Equity 26
& Comprehensive Income
Consolidated Statements of Cash Flows 27
Notes to Consolidated Financial Statements 29
Shareholders Information 54
Security Federal Bank Board of Directors 56
Bank Advisory Boards 57
Management Team & Financial Service Subsidiaries 58
Our Locations 59
INVESTING FOR THE FUTURE
J. Chris Verenes, President, Security Federal Bank
Security Federal generated strong results again this year. Earnings increased
8.8% over the previous year as both commercial and consumer loans continue to
show strong growth in all of our markets. Our financial services subsidiaries-
Security Federal Insurance, Security Federal Investments and Security Federal
Trust-also continue to grow and evolve in the Security Federal tradition of
focusing on what is in the best interest of the customer. Our employees have
been the key to our growth.
Security Federal's performance this past year was the result of decisions and
investments made years ago that positioned the bank for today's competitive
environment. The bank has a history of investing in products and services
that serve the real needs of customers. Examples of this include our very
popular Looney Tunes program geared toward providing financial literacy for
elementary school children, and our Financial Counseling service designed to
assist customers with sound budgeting and planning advice. While those
decisions did not provide immediate returns to the bank, over the long run
they have proven to be valuable differentiators for positioning us well in
today's competitive banking environment.
To that end, Security Federal has recently made several other major
investments that we anticipate will place the bank in a strong competitive
position for the next few years. We have purchased property near I-20 in
Aiken that will be the site of our new Operations Center. Construction is
tentatively planned for 2009. Our South Side branch opened in January and
offers the unique service of being open 7 days a week. Our Laurens Street
branch has been renovated and will once again serve as our corporate
headquarters. We are starting construction in July for a major investment in
our first bank in Evans, Georgia. Our full-service, financial center in Evans
is a logical extension of our branch network in the Central Savannah River
Area (CSRA), and should complement our existing North Augusta location. It is
our expectation that we will purchase property this year in the Ballentine,
South Carolina area in preparation for our first Richland County branch. That
investment is the next in a series of planned expansions in the Midlands' area
over the next few years.
In addition to facility enhancements and expansions, we will continue to
invest in our financial services subsidiaries. It is anticipated that the
investment, insurance and trust businesses will be a significant source of
non-interest revenues in the future.
While many of the decisions made several years ago are now bearing fruit, it
is our expectation that the investment seeds being sown today will place
Security Federal Bank in a strong competitive position in the years ahead.
Fellow Shareholders:
In keeping with our conservative but steady growth strategy, Security Federal
Corporation, holding company of Security Federal Bank, is pleased to announce
an increase in operating earnings for the year ending March 31, 2006. The
company reported net income of $3.8 million or $1.51 per share (basic) for the
year ending March 31, 2006, an 8.8% increase from net income of $3.5 million
or $1.39 per share (basic) for the year ending March 31,2005. The increase in
net income is a result of a $2.4 million increase in net interest income, a
$120,000 decrease in the provision for loan losses, and a $136,000 increase in
total other income offset partially by a $2.3 million increase in general and
administrative expenses for the year ending March 31, 2006 when compared to
the year ending March 31, 2005.
Total assets at March 31, 2006 were $658.7 million compared to $586.0 million
at March 31, 2005, an increase of 12.4% for the year. Net loans receivable
increased $58.2 million or 18.4% to $375.1 million at March 31, 2006 from
$316.9 million at March 31, 2005. Total deposits were $479.2 million at March
31, 2006 compared to $430.3 million at March 31, 2005, an increase of 11.4%.
Federal Home Loan Bank Advances and other borrowings increased $21.0 million
or 17.9% to $138.7 million at March 31, 2006 from $117.6 million at March 31,
2005.
Security Federal Bank has eleven full service branches located in Aiken,
Clearwater, Graniteville, Langley, Lexington, North Augusta, Wagener, and West
Columbia, South Carolina. Additional financial services are offered through
the Bank's three wholly owned subsidiaries, Security Federal Insurance,
Security Federal Investments, and Security Federal Trust.
Sincerely, Sincerely,
/s/T. Clifton Weeks /s/Timothy W. Simmons
------------------------------- -----------------------------------
T. Clifton Weeks Timothy W. Simmons
Chairman President & Chief Executive Officer
Robert E. Johnson
In Memoriam
We were deeply saddened to lose a close and respected member of the Security
Federal family. Robert Johnson was one of the founding Directors of Security
Federal Savings and Loan Association of Aiken in August 1958. He also served
as Secretary of the Bank and the Holding Company. In addition to his devotion
and service to the bank, Mr. Johnson had a distinguished and successful career
in law. He was active in his community and in First Baptist Church of Aiken.
We are proud to be part of an organization which he helped lead. All of us
are better because of our association with him. We will miss his common
sense, friendship and unassuming nature.
3
Financial Highlights
------------------------------------------------------------------------------
Years Ended March 31st
2006 2005
Net Income $ 3,812,851 $ 3,505,495
Earnings Per Share - Basic 1.51 1.39
Book Value Per Share 14.82 13.92
Total Interest Income 34,406,635 25,589,649
Total Interest Expense 15,968,927 11,524,745
Net Interest Income Before Provision
For Loan Losses 16,437,708 14,064,904
Provision For Loan Losses 660,000 780,000
Net Income After Provision For Loan Losses 15,777,708 13,284,904
Net Interest Margin 2.76% 2.60%
Total Loans Originated 301,832,000 244,843,000
Adjustable Rate Loans As A Percentage
Of Total Gross Loans 63.3% 59.9%
4
Financial Highlights
------------------------------------------------------------------------------
2006 2005 2004 2003 2002
------ ------ ------ ------ ------
Net Income (In Thousands) $3,813 $3,505 $4,263* $3,231 $2,510
*Includes the sale of the Denmark branch.
2006 2005 2004 2003 2002
------ ------ ------ ------ ------
Total Assets (In Millions) $ 659 $ 586 $ 528 $ 445 $ 376
2006 2005 2004 2003 2002
------ ------ ------ ------ ------
Return on Equity 10.27% 10.28% 13.67% 11.37% 9.97%
Allowance for Loan Losses (1) 2006 2005 2004 2003 2002
------ ------ ------ ------ ------
1.76% 1.94% 2.17% 1.98% 1.55%
(1) Allowance for losses as a percentage of total loans.
5
Financial Highlights
------------------------------------------------------------------------------
2006 2005 2004 2003 2002
------ ------ ------ ------ ------
Book Value Per Share $14.82 $13.92 $13.30 $11.98 $10.18
2006 2005 2004 2003 2002
------ ------ ------ ------ ------
Earnings Per Share - Basic $1.51 $1.39 $ 1.70 $ 1.29 $ 1.00
Security Federal Corporation Stock Prices (at March 31st of each year)
2005 2004 2003 2002 2001 2000 1999
------ ------ ------ ------ ------ ------ ------
23.00 21.00 20.26 21.67 20.00 18.00 15.00
1998 1997 1996 1995 1994 1993 1992
------ ------ ------ ------ ------ ------ ------
7.33 5.17 4.54 3.65 3.37 2.75 2.54
1991 1990 1989 1988 12/1987
------ ------ ------ ------ -------
2.46 2.40 1.83 1.75 1.67
6
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Selected Consolidated Financial and Other Data
At Or For The Year Ended March 31,
-----------------------------------------------------------
2006 2005 2004 2003 2002
--------- --------- -------- -------- --------
Balance Sheet Data (Dollars In Thousands, Except Per Share Data)
----------------------------------------
Total Assets $ 658,678 $ 585,978 $ 528,005 $ 444,904 $ 376,320
Cash And Cash Equivalents 14,351 7,916 6,749 8,239 11,528
Investment And Mortgage-Backed Securities 238,433 241,076 245,715 182,117 18,898
Total Loans Receivable, Net (1) 375,109 316,889 259,895 243,156 234,319
Deposits 479,229 430,287 389,593 358,474 309,038
Advances From Federal Home Loan Bank 131,363 112,038 96,336 49,772 33,108
Total Shareholders' Equity 37,602 35,111 33,472 30,040 25,401
Income Data
----------------------------------------
Total Interest Income 32,407 25,590 23,011 23,660 24,632
Total Interest Expense 15,969 11,525 9,606 10,016 12,211
--------- --------- --------- --------- ---------
Net Interest Income 16,438 14,065 13,405 13,644 12,421
Provision For Loan Losses 660 780 1,200 1,800 1,525
--------- --------- --------- --------- ---------
Net Interest Income After Provision For Loan
Losses 15,778 13,285 12,205 11,844 10,896
Other Income 2,840 2,704 5,235 3,811 3,465
General And Administrative Expense 13,027 10,773 10,725 10,483 10,337
Income Taxes 1,778 1,711 2,452 1,941 1,514
--------- --------- --------- --------- ---------
Net Income $ 3,813 $ 3,505 $ 4,263 $ 3,231 $ 2,510
========= ========= ========= ========= =========
Per Common Share Data
----------------------------------------
Net Income Per Common Share (Basic) $ 1.51 $ 1.39 $ 1.70 $ 1.29 $ 1.00
========= ========= ========= ========= =========
Cash Dividends Declared $ 0.16 $ 0.11 $ 0.08 $ 0.0602 $ 0.0536
========= ========= ========= ========= =========
Other Data
----------------------------------------
Interest Rate Spread Information:
Average During Period 2.48% 2.40% 2.66% 3.19% 3.42%
End Of Period 2.59% 2.45% 2.59% 3.00% 3.48%
Net Interest Margin (Net Interest Income/Average
Earning Assets) 2.76% 2.60% 2.84% 3.46% 3.73%
Average Interest-Earning Assets To Average
Interest-Bearing Liabilities 110.25% 109.07% 109.05% 110.47% 108.80%
Equity To Total Assets 5.71% 5.99% 6.34% 6.75% 6.75%
Non-Performing Assets To Total Assets (2) 0.20% 0.42% 0.40% 0.27% 0.40%
Return On Assets (Ratio Of Net Income To
Average Total Assets) 0.62% 0.63% 0.87% 0.79% 0.71%
Return On Equity (Ratio Of Net Income To
Average Equity) 10.27% 10.28% 13.67% 11.37% 9.97%
Equity To Assets Ratio (Ratio Of Average Equity
To Average Total Assets) 6.03% 6.09% 6.36% 6.90% 7.14%
Dividend Pay-Out Ratio On Common Shares 10.67% 7.96% 4.75% 4.69% 5.37%
Number Of Full-Service Offices 11 11 11 11 11
(1) INCLUDES LOANS HELD FOR SALE.
(2) NON-PERFORMING ASSETS CONSIST OF NON-ACCRUAL LOANS AND REPOSSESSED ASSETS.
7
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
General
The following discussion is presented to provide the reader with an
understanding of the financial condition and results of operations of Security
Federal Corporation and its subsidiaries. The investment and other activities
of the parent company, Security Federal Corporation (the "Company"), have had
no significant impact on the results of operations for the periods presented
in the financial statements. The information presented in the following
discussion of financial results is indicative of the activities of Security
Federal Bank (the "Bank"), a wholly owned subsidiary of the Company. The Bank
is a federally chartered thrift that was founded in 1922. The Bank also has
four wholly owned subsidiaries, Security Federal Insurance Inc. ("SFINS"),
Security Federal Investments Inc. ("SFINV"), Security Federal Trust Inc.
("SFT"), and Security Federal Financial Services Corporation ("SFSC"). SFINS,
SFINV, and SFT were formed in the fiscal year ended March 31, 2002 and began
operating during the December 2001 quarter. SFSC was formed in 1975 and is
currently inactive. Unless the context indicates otherwise, references to the
Company shall include the Bank and its subsidiaries.
The principal business of the Bank is accepting deposits from the general
public and originating consumer and commercial business loans as well as
mortgage loans that enable borrowers to purchase or refinance one to four
family residential real estate. The Bank also originates construction loans
on single-family residences, multi-family dwellings and projects, and
commercial real estate, as well as loans for the acquisition, development and
construction of residential subdivisions and commercial projects.
The Bank's net income is dependent on its interest rate spread which is the
difference between the average yield earned on its loan and investment
portfolios and the average rate paid on its deposits and borrowings. The
Bank's interest spread is influenced by interest rates, deposit flows, and
loan demands. Levels of non-interest income and operating expense are also
significant factors in earnings.
Forward-Looking Statements
This document, including information included or incorporated by reference,
contents, and future filings by the Company on Form 10-K, Form 10-Q, and Form
8-K, and future oral and written statements by the Company and its management
may contain forward-looking statements about the Company and its subsidiaries
which we believe are within the meaning of the Private Securities Litigation
Reform Act of 1995. These forward-looking statements include, without
limitation: statements with respect to anticipated future operating and
financial performance; growth opportunities; interest rates; acquisition and
divestiture opportunities; and synergies, efficiencies, and cost-savings.
Words such as "may," "could," "should," "would," "believe," "anticipate,"
"estimate," "expect," "intend," "plan," and similar expressions are intended
to identify these forward-looking statements. Forward-looking statements by
the Company and its management are based on beliefs, plans, objectives, goals,
expectations, anticipations, estimates, and intentions of management and are
not guarantees of future performance. Factors which could affect results
include interest rate trends, the general economic climate in the Company's
market area and the nation as a whole, the ability of the Company to control
costs and expenses, deposit flows, demand for mortgages and other loans, real
estate values and vacancy rates, competition, pricing, loan delinquency rates
and changes in federal regulation. These factors should be considered in
evaluating "forward-looking statements," and undue reliance should not be
placed on any such statements. The Company disclaims any obligation to update
or revise any forward-looking statements based on the occurrence of future
events, the receipt of new information, or otherwise. The important factors
we discuss below and elsewhere in this document, identified in our filings
with the Securities and Exchange Commission ("SEC"), and presented by our
management from time to time could cause actual results to differ materially
from those indicated by the forward-looking statements made in this document.
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 the Company's financial statements. The significant
accounting policies of the Company are described in Note 1 of the Notes to the
Consolidated Financial Statements.
Certain accounting policies involve significant judgments and assumptions by
management, which have a material impact on the carrying value of certain
assets and liabilities; management considers these accounting policies to be
critical accounting policies. The judgments and assumptions used by
management are based on historical experience and other factors, which are
believed to be reasonable under the circumstances. Because of the nature of
the judgments and assumptions made by management, actual results could differ
from these judgments and estimates that could have a material impact on the
carrying values of assets and liabilities and the results of operations of the
Company.
8
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Critical Accounting Policies, Continued
Of these significant accounting policies, the Company considers its policies
regarding the allowance for loan losses to be its most critical accounting
policy because of the significant degree of management judgment involved in
determining the amount of allowance for loan losses. The Company has
developed policies and procedures for assessing the adequacy of the allowance
for loan losses, recognizing that this process requires a number of
assumptions and estimates with respect to its loan portfolio. The Company's
assessments may be impacted in future periods by changes in economic
conditions, the impact of regulatory examinations, and the discovery of
information with respect to borrowers, which is not known to management at the
time of the issuance of the consolidated financial statements. Refer to the
discussion under the section entitled "Financial Condition" and "Provision for
Loan Losses" section in the "Comparison of the Years Ended March 31, 2006 and
2005" and "Comparison of the Years Ended March 31, 2005 and 2004" herein for a
further discussion of the Company's estimation process and methodology related
to the allowance for loan losses.
Asset and Liability Management
The Bank's program of asset and liability management seeks to limit the Bank's
vulnerability to material and prolonged increases or decreases in interest
rates, or "interest rate risk." The principal determinant of the exposure of
the Bank's earnings to interest rate risk is the timing difference ("gap")
between the repricing or maturity of the Bank's interest-earning assets and
the repricing or maturity of its interest-bearing liabilities. If the
maturities of the Bank's assets and liabilities were perfectly matched and the
interest rates borne by its assets and liabilities were equally flexible and
moved concurrently (neither of which is the case), the impact on net interest
income of any material and prolonged changes in interest rates would be
minimal.
A positive gap position generally has an adverse effect on net interest income
during periods of falling interest rates. A positive one-year gap position
occurs when the dollar amount of rate sensitive assets maturing or repricing
within one year exceeds the dollar amount of rate sensitive liabilities
maturing or repricing during that same one-year period. In a period of
falling interest rates, the interest received on interest earning assets will
increase slower than the interest paid on interest-bearing liabilities,
causing a decrease in net interest income. During periods of rising interest
rates, the interest received on interest earning assets will increase faster
than interest paid on interest-bearing liabilities, thus increasing net
interest income.
A negative gap position generally has an adverse effect on net interest income
during periods of rising interest rates. A negative one-year gap position
occurs when the dollar amount of rate sensitive liabilities maturing or
repricing within one year exceeds the dollar amount of rate sensitive assets
maturing or repricing during that same period. As a result, during periods of
rising interest rates, the interest paid on interest-bearing liabilities will
increase faster than interest received from earning assets, thus reducing net
interest income. The reverse is true in periods of declining interest rates
resulting generally in an increase in net interest income.
The Bank's Board of Directors reviews the Interest Rate Exposure Report
generated for the Bank by the Office of Thrift Supervision. This report
measures the interest rate sensitivity of the Bank's net portfolio value
("NPV") on a quarterly basis under different interest rate scenarios. The
Bank's sensitivity measure is well within the Bank's policy on changes in NPV.
The Bank's asset and liability policies are directed toward maximizing
long-term profitability while managing acceptable interest rate risk within
the Bank's policies.
At March 31, 2006, the positive mismatch of interest-earning assets repricing
or maturing within one year with interest-bearing liabilities repricing or
maturing within one year was $19.5 million or 3.0% of total assets compared to
$20.5 million or 3.5% at March 31, 2005. For more information on the Bank's
repricing position at March 31, 2006, see the tables on pages 11 and 12.
9
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Asset and Liability Management, Continued
During the past year, the Bank originated, for investment purposes,
approximately $45.3 million in adjustable rate residential real estate loans
("ARM's"), which are held for investment and not sold. The Bank's loan
portfolio included $247.8 million of adjustable rate consumer loans,
commercial loans, and mortgage loans or, approximately 63.3% of total gross
loans at March 31, 2006. During fiscal 2006, the Bank originated $232.0
million in consumer and commercial loans, which are usually short term in
nature. The Bank's portfolio of consumer and commercial loans was $267.8
million at March 31, 2006, $213.1 million at March 31, 2005, and $166.8
million at March 31, 2004. Consumer and commercial loans combined were 68.5%
of total loans at March 31, 2006, 63.0% of total loans at March 31, 2005,
59.9% at March 31, 2004.
At March 31, 2006, the Bank held approximately $8.4 million in longer term
fixed rate residential mortgage loans. These loans, which amounted to 2.2% of
the total loan portfolio, had converted from ARM loans to fixed rate loans
during the previous 36 months. These fixed rate loans have remaining
maturities ranging from 10 to 29 years. The Bank has approximately $5.4
million remaining in convertible ARM loans that could convert to fixed rate
loans over the next 12 months. On new originations, the Bank sells virtually
all of its 15 and 30 year fixed rate mortgage loans at origination. In fiscal
2001, the Bank decided to no longer service loans for the Federal Home Loan
Mortgage Corporation ("Freddie Mac") or other institutional investors, because
of the fixed cost of servicing those loans, while the income stream generated
by that portfolio was decreasing as a result of prepayments. Thus, during
fiscal 2006, 2005, 2004, 2003, and 2002, the Bank sold its new fixed rate
residential loan originations exclusively on a service-released basis. Fixed
rate residential loans sold to Freddie Mac and other institutional investors,
on a service-released basis, totaled $29.9 million in fiscal 2006, $26.0
million in fiscal 2005, and $63.5 million in fiscal 2004.
Certificates of deposit of $100,000 or more, referred to as "Jumbo
Certificates," are normally considered to be interest rate sensitive because
of their relatively short maturities. Many financial institutions have used
Jumbo Certificates to manage interest rate sensitivity and liquidity. The
Bank has not relied on Jumbo Certificates for liquidity or asset liability
management. As of March 31, 2006, the Bank had $61.9 million outstanding in
Jumbo Certificates compared to $61.7 million at March 31, 2005. The Bank has
no brokered deposits.
The following table sets forth the maturity schedule of certificates of
deposit with balances of $100,000 or greater at March 31, 2006.
At March 31, 2006
(In Thousands)
-----------------
Within 3 Months $ 6,307
After 3, Within 6 Months 16,663
After 6, Within 12 Months 27,017
After 12 Months 11,943
-------
$61,930
=======
10
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Asset and Liability Management, Continued
The following table sets forth the Bank's interest-bearing liabilities and
interest-earning assets repricing or maturing within one year. The table on
the following page presents the Bank's entire interest-bearing liabilities and
interest-earning assets into repricing or maturity time periods. Both tables
present adjustable rate loans in the periods they are scheduled to reprice and
fixed rate loans are shown in the time frame of corresponding principal
amortization schedules. Adjustable and fixed rate loans are also adjusted for
the Company's estimates of pre-payments. Mortgage-backed securities are shown
at repricing dates, but also include prepayment estimates. Both tables also
assume investments reprice at the earlier of maturity; the likely call date,
if any, based on current interest rates; or the next scheduled interest rate
change, if any. NOW's are assumed to have a decay rate of 20% the first year,
money market accounts to have a decay rate of 65% the first year, and
statement savings accounts to have a decay rate of 20% the first year. The
balance, for all three products, is deemed to reprice in the one to three year
category. Callable fixed rate Federal Home Loan Bank ("FHLB") advances are
included in borrowings, and are deemed to mature at the expected call date or
maturity, based on the stated interest rate of the advance and current market
rates.
At March 31
--------------------
2006 2005
-------- --------
(Dollars In Thousands)
Loans (1) $254,588 $215,751
Mortgage-Backed Securities:
Held To Maturity - 79
Available For Sale 78,367 69,800
Investment Securities:
Held To Maturity 10,000 7,000
Available For Sale 3,475 1,784
Other Interest-Earning Assets 3,715 164
-------- --------
Total Interest Rate Sensitive Assets Repricing
Within 1 Year $350,145 $294,578
-------- --------
Deposits 280,329 217,780
FHLB Advances And Other Borrowed Money 50,290 56,269
-------- --------
Total Interest Rate Sensitive Liabilities Repricing
Within 1 Year $330,619 $274,049
-------- --------
Gap $ 19,526 $ 20,529
======== ========
Interest Rate Sensitive Assets/Interest Rate
Sensitive Liabilities 105.91% 107.49%
Gap As A Percent Of Total Assets 3.0% 3.5%
(1) LOANS ARE NET OF UNDISBURSED FUNDS AND LOANS IN PROCESS.
11
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Asset and Liability Management, Continued
The following table sets forth the interest sensitivity of the Bank's assets
and liabilities at March 31, 2006, on the basis of the factors and assumptions
set forth in the table on the previous page.
(Dollars In Thousands)
< Three 3-12 1-3 3-5 5-10 >10
Months Months Years Years Years Years Total
------- ------ ------- ------- ------- ------- -----
Interest-Earnings Assets
------------------------
Loans (1) $167,726 $ 86,862 $ 83,494 $33,919 $ 6,611 $ 3,377 $381,989
Mortgage-Backed Securities:
Available For Sale, At Fair
Value 22,622 55,745 29,345 14,669 11,353 1,453 135,187
Investment Securities: (2)
Held To Maturity, At Cost 3,000 7,000 28,000 20,000 17,000 - 75,000
Available For Sale, At Fair
Value 1,273 2,202 14,723 6,706 3,251 - 28,155
FHLB Stock, At Cost - - 7,150 - - - 7,150
Other Interest-Earning Assets 3,715 - - - - - 3,715
-------- -------- -------- ------- ------- ------- --------
Total Financial Assets $198,336 $151,809 $162,712 $75,294 $38,215 $ 4,830 $631,196
======== ======== ======== ======= ======= ======= ========
Interest-Bearing Liabilities
----------------------------
Deposits:
Certificate Accounts $ 45,861 $118,163 $ 34,850 $ 5,718 $ - $ - $204,592
NOW Accounts 7,137 7,137 57,096 - - - 71,370
Money Market Accounts 49,236 49,236 53,023 - - - 151,495
Statement Savings
Accounts 1,780 1,779 14,236 - - - 17,795
Borrowings 22,290 28,000 48,000 40,000 363 - 138,653
-------- -------- -------- ------- ------- ------- --------
Total Interest-Bearing
Liabilities $126,304 $204,315 $207,205 $45,718 $ 363 $ - $583,905
======== ======== ======== ======= ======= ======= ========
Current Period Gap $ 72,032 $(52,506) $(44,493) $29,576 $37,852 $ 4,830 $ 47,291
Cumulative Gap $ 72,032 $ 19,526 $(24,967) $ 4,609 $42,461 $47,291 $ 47,291
Cumulative Gap As A
Percent Of Total Assets 10.9% 3.0% (3.8)% 0.7% 6.4% 7.2% 7.2%
(1) LOANS ARE NET OF UNDISBURSED FUNDS AND LOANS IN PROCESS.
(2) CALLABLE SECURITIES ARE SHOWN AT THEIR LIKELY CALL DATES BASED ON MANAGEMENT'S ESTIMATES AT MARCH
31, 2006.
In evaluating the Bank's exposure to interest rate risk, certain shortcomings
inherent in the method of analysis presented in the foregoing tables must be
considered. For example, although certain assets and liabilities may have
similar maturities or periods of repricing, they may react in different
degrees to changes in market interest rates. Additionally, the interest rates
of certain types of assets and liabilities may fluctuate in advance of changes
in market interest rates. Loan repayment rates and withdrawals of deposits
will likely differ substantially from the assumed rates previously set forth
in the event of significant changes in interest rates due to the option of
borrowers to prepay their loans and the ability of depositors to withdraw
funds prior to maturity. Further, certain assets, such as ARMs, have features
that restrict changes in interest rates on a short-term basis as well as over
the life of the asset.
12
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Financial Condition
Total assets at March 31, 2006 were $658.7 million, an increase of $72.7
million or 12.4% from $586.0 million at March 31, 2005. This increase was
primarily the result of an increase in net loans receivable.
Total net loans receivable were $375.1 million at March 31, 2006, an increase
of $58.2 million or 18.4% from $316.9 million at March 31, 2005. Residential
real estate loans held for investment decreased $596,000 or 0.5% to $122.0
million at March 31, 2006. Typically, long term, newly originated fixed rate
mortgage loans are not retained in the portfolio but are sold immediately.
ARMs are typically retained in the portfolio. At March 31, 2006, the Bank
held 90.6% of its residential mortgage loans in ARMs, while it had 9.4% in
fixed rate mortgages. Consumer loans increased $7.8 million or 15.3% while
commercial business and commercial real estate loans increased $47.0 million
or 29.0% to $209.2 million at fiscal year end from $162.2 million at March 31,
2005. A large portion of the increased activity in commercial lending took
place in the Midlands area of South Carolina including Columbia, Lexington,
and West Columbia. A significant portion of these loans is acquisition and
development loans. Loans held for sale, which were $1.3 million at March 31,
2006, decreased $1.0 million from the previous fiscal year end. As a result
of loan growth, total investments and mortgage-backed securities decreased
$2.6 million or 1.1% to 238.0 million at March 31, 2006. Cash and cash
equivalents were $14.4 million at March 31, 2006 compared to $7.9 million at
March 31, 2005. The $6.5 million increase in cash and cash equivalents was
temporary as excess cash is used to reduce short-term debt, fund loan growth,
and make investments or capital improvements. Office property and equipment
increased $3.7 million or 47.4% to $11.7 million in fiscal 2006 as the Bank
constructed a new branch building on the south-side of Aiken, began
renovations on its downtown Aiken branch building, and invested in two lots of
which one will be the site of our Evans, Georgia branch and the other a
possible site for a new operations center. The cash value of Bank Owned Life
Insurance ("BOLI") was $5.0 million at March 31, 2006 while the Company owned
no BOLI at March 31, 2005. BOLI, which earns tax-free yields, is utilized to
partially offset the cost of the Company's employee benefits programs.
Repossessed assets increased $38,000 to $91,000 at March 31, 2006 from $53,000
at March 31, 2005. Repossessed assets at March 31, 2006 consisted of two
single-family dwellings, a vehicle, a mobile home, and equipment.
Non-accrual loans totaled $1.2 million at March 31, 2006 compared to $2.4
million a year earlier. Non-accrual loans averaged $1.6 million in fiscal
2006 compared to $2.3 million during fiscal 2005. The Bank classifies all
loans as non-accrual when they become 90 days or more delinquent. The Bank
had six loans that were troubled debt restructurings totaling $418,000 at
March 31, 2006 compared to six loans totaling $434,000 at March 31, 2005. The
six troubled debt restructurings, which were current in payments on March 31,
2006, consisted of three consumer loans secured by first mortgages on
residential dwellings totaling $337,000, a $12,000 consumer loan secured by a
second mortgage on a residential dwelling, a $53,000 commercial loan secured
by two rental properties, and a $16,000 unsecured commercial loan. All
troubled debt restructurings are also considered impaired. At March 31, 2006,
the Bank held $2.1 million in impaired loans compared to $1.2 million at March
31, 2005.
The Bank reviews its loan portfolio and allowance for loan losses on a monthly
basis. Future additions to the Bank's allowance for loan losses are dependent
on, among other things, the performance of the Bank's loan portfolio, the
economy, changes in real estate values, and interest rates. There can be no
assurance that additions to the allowance will not be required in future
periods. Management continually monitors its loan portfolio for the impact of
local economic changes. The ratio of allowance for loan losses to total loans
was 1.76% at March 31, 2006 compared to 1.94% at March 31, 2005.
Deposits at the Bank increased $48.9 million or 11.4% to $479.2 million at
March 31, 2006 from $430.3 million at March 31, 2005. The Bank was very
successful in attracting certificate of deposit accounts and, to a lesser
extent, demand deposit accounts with aggressive pricing and advertising.
Advances from the FHLB increased to $131.4 million at March 31, 2006 from
$112.0 million a year earlier, an increase of $19.4 million or 17.3%. Other
borrowed money, which consists of retail repurchase agreements, increased $1.7
million or 30.3% to $7.3 million at March 31, 2006 from to $5.6 million at
March 31, 2005.
Total shareholders' equity was $37.6 million at March 31, 2006, an increase of
$2.5 million or 7.1% from $35.1 million a year earlier. The increase was
attributable to net income of $3.8 million, proceeds from the exercise of
stock options of $222,000, and a decrease in the employee stock ownership debt
of $61,000, offset partially by a net increase in accumulated other
comprehensive loss of $1.1 million, the purchase of $74,000 of treasury stock,
and $407,000 in dividends paid.
13
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Results of Operations
The following table presents the dollar amount of changes in interest income
and interest expense for major components of interest-earning assets and
interest-bearing liabilities. The table also distinguishes between the
changes related to higher or lower outstanding balances and the changes due to
the volatility of interest rates. For each category of interest-earning
assets and interest-bearing liabilities, information is provided on changes
attributable to: (1) changes in rate (changes in rate multiplied by prior year
volume); (2) changes in volume (changes in volume multiplied by prior year
rate); and (3) net change (the sum of the prior columns). For purposes of
this table, changes attributable to both rate and volume, which cannot be
segregated, have been allocated proportionately to the change attributable to
volume and the change attributable to rate.
Fiscal Year 2006 Fiscal Year 2005
Compared To 2005 Compared To 2004
----------------------- ------------------------
Volume Rate Net Volume Rate Net
------ ------ ------ ------ ------ ------
(In Thousands)
Interest-Earning Assets:
Loans: (1)
Real Estate Loans $ 551 $ 222 $ 773 $ 542 $(576) $ (34)
Other Loans 3,712 1,893 5,605 1,672 (265) 1,407
------ ------ ------ ------ ----- ------
Total Loans 4,263 2,115 6,378 2,214 (841) 1,373
Mortgage-Backed
Securities (2) (609) 479 (130) 948 158 1,106
Investments (2) 350 185 535 156 (68) 88
Other Interest-Earning
Assets 2 32 34 1 11 12
------ ------ ------ ------ ----- ------
Total Interest-Earning
Assets $4,006 $2,811 $6,817 $3,319 $(740) $2,579
====== ====== ====== ====== ===== ======
Interest-Bearing Liabilities:
Deposits:
Certificate Accounts $ 959 $1,349 $2,308 $ (38) $ 154 $ 116
NOW Accounts 19 333 352 2 (11) (9)
Money Market Accounts (232) 1,295 1,063 669 214 883
Savings Accounts 2 - 2 4 (5) (1)
------ ------ ------ ------ ----- ------
Total Deposits 748 2,977 3,725 637 352 989
Borrowings 602 117 719 1,120 (190) 930
------ ------ ------ ------ ----- ------
Total Interest-Bearing
Liabilities 1,350 3,094 4,444 1,757 162 1,919
------ ------ ------ ------ ----- ------
Effect On Net Income $2,656 $ (283) $2,373 $1,562 $(902) $ 660
====== ====== ====== ====== ===== ======
(1) INTEREST ON NON-ACCRUAL LOANS IS NOT INCLUDED IN INCOME, ALTHOUGH THEIR
LOAN BALANCES ARE INCLUDED IN AVERAGE LOANS OUTSTANDING.
(2) SECURITIES AVAILABLE FOR SALE ARE COMPUTED USING THEIR HISTORICAL COST.
14
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Results of Operations, Continued
The following table presents the total dollar amount of interest income from
average interest-earning assets for the periods indicated and the resultant
yields as well as the interest expense on average interest-bearing liabilities
expressed both in dollars and rates. No tax equivalent adjustments were made.
Averages For Fiscal Years Ended March 31,
---------------------------------------------------------------------------
Yield/ 2006 2005 2004
Rate at ------------------------ ------------------------ ------------------------
March 31, Average Yield/ Average Yield/ Average Yield/
2006 Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------- ------- -------- ------ ------- -------- ------ ------- -------- ------
(Dollars In Thousands)
Interest-Earning
Assets:
Mortgage Loans 5.79% $112,223 $ 6,296 5.61% $102,365 $ 5,523 5.40% $ 92,824 $ 5,557 5.99%
Other Loans 7.48% 232,793 16,904 7.26% 179,251 11,299 6.30% 152,922 9,892 6.47%
---- -------- ------- ---- -------- ------- ---- -------- ------- ----
Total Loans (1) 7.31% 345,016 23,200 6.72% 281,616 16,822 5.97% 245,746 15,449 6.29%
Mortgage-Backed
Securities (2) 4.18% 150,107 5,455 3.63% 167,582 5,585 3.33% 139,025 4,479 3.22%
Investments (2) 4.02% 99,473 3,690 3.71% 89,813 3,155 3.51% 85,480 3,067 3.59%
Other Interest-
Earning Assets 4.74% 1,775 62 3.49% 1,647 28 1.70% 1,542 16 1.04%
---- -------- ------- ---- -------- ------- ---- -------- ------- ----
Total Interest-Earning
Assets 5.82% $596,371 $32,407 5.43% $540,658 $25,590 4.73% $471,793 $23,011 4.88%
==== ======== ======= ==== ======== ======= ==== ======== ======= ====
Interest-Bearing
Liabilities:
Certificate Accounts 3.98% $175,703 $ 5,906 3.36% $142,459 $ 3,598 2.53% 143,986 $ 3,482 2.42%
NOW Accounts 1.45% 63,000 697 1.11% 58,092 345 0.59% 57,825 354 0.61%
Money Market
Accounts 3.50% 156,508 4,664 2.98% 166,735 3,601 2.16% 135,190 2,718 2.01%
Savings Accounts 0.98% 17,969 175 0.98 17,657 173 0.98% 17,291 174 1.01%
---- -------- ------- ---- -------- ------- ---- -------- ------- ----
Total Interest-Bearing
Accounts 3.06% 413,180 11,442 2.77% 384,943 7,717 2.01% 354,292 6,728 1.90%
Other Borrowings 4.43% 6,201 210 3.38% 5,488 84 1.53% 5,361 52 0.97%
FHLB Advances 3.74% 121,526 4,317 3.55% 105,272 3,724 3.54% 72,995 2,826 3.87%
---- -------- ------- ---- -------- ------- ---- -------- ------- ----
Total Interest-Bearing
Liabilities 3.23% $540,907 $15,969 2.95% $495,703 $11,525 2.33% 432,648 $ 9,606 2.22%
==== ======== ======= ==== ======== ======= ==== ======== ======= ====
Net Interest Income $16,438 14,065 $13,405
======= ======= =======
Interest Rate Spread 2.59% 2.48% 2.40% 2.66%
==== ==== ==== ====
Net Yield On Earning
Assets 2.76% 2.60% 2.84%
==== ==== ====
(1) INTEREST ON NON-ACCRUAL LOANS IS NOT INCLUDED IN INCOME, ALTHOUGH THEIR LOAN BALANCES ARE INCLUDED IN
AVERAGE LOANS OUTSTANDING.
(2) SECURITIES AVAILABLE FOR SALE ARE COMPUTED USING THEIR HISTORICAL COST.
15
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Comparison of the Years Ended March 31, 2006 and 2005
General
The Company's earnings were $3.8 million for the year ended March 31, 2006,
compared to $3.5 million for the year ended March 31, 2005. The $307,000 or
8.8% increase in earnings was attributable primarily to an increase in net
interest income offset partially by an increase in general and administrative
expenses.
Net Interest Income
Net interest income increased $2.4 million or 16.9% to $16.4 million in fiscal
2006 from $14.1 million in fiscal 2005. The increase was attributable to an
increase of $55.7 million to $596.4 million in average interest-earning assets
during fiscal 2006. The Bank's interest rate spread increased eight basis
points to 2.48% during fiscal 2006. The yield of average earning assets
increased 70 basis points to 5.43%, while the cost of average interest bearing
liabilities increased 62 basis points to 2.95%. Interest income on loans
increased $6.4 million to $23.2 million during the year ended March 31, 2006
from $16.8 million during fiscal 2005. The increase was attributable to an
increase in average total loans outstanding of $63.4 million and a 75 basis
point increase in the yield earned on the Bank's loans during fiscal 2006.
Interest income on investment securities, mortgage-backed securities, and
other investments increased $439,000 as a result of an increase in yield of 28
basis points in the overall investment portfolio. The aggregate average
balance in the overall investment portfolio, including mortgage-backed
securities, investments, and other interest earning assets, decreased $7.7
million in fiscal 2006 compared to fiscal 2005 to fund loan growth.
Interest expense on deposits increased $3.7 million or 48.3% to $11.4 million
during the year ended March 31, 2006 from $7.7 million during the year ended
March 31, 2005. Average interest bearing deposits increased $28.2 million
while the average cost of those deposits increased 77 basis points during the
year. Interest expense on FHLB advances and other borrowings increased
$719,000 or 18.9% to $4.5 million during fiscal 2006 from $3.8 million during
fiscal 2005. The increase was a result of an increase in average FHLB
advances and other borrowings outstanding during the year of $17.0 million
while the average costs of those borrowings remained relatively stable at
3.54% and 3.44% for fiscal 2006 and 2005, respectively.
Provision for Loan Losses
The Company's provision for loan losses decreased $120,000 to $660,000 during
the year ended March 31, 2006 from $780,000 in fiscal 2005. The amount of the
provision is determined by management's on-going monthly analysis of the loan
portfolio. Management uses three methods to measure the estimate of the
adequacy of the allowance for loan losses. These methods incorporate
percentage of classified loans, five-year averages of historical loan losses
in each loan category and current economic trends, and the assignment of
percentage targets of reserves in each loan category. Management has used all
three methods for the past seven fiscal years.
Non-accrual loans, which are loans delinquent 90 days or more, were $1.2
million at March 31, 2006 compared to $2.4 million at March 31, 2005. Net
charge-offs were $239,000 in fiscal 2006 compared to $260,000 in fiscal 2005.
The ratio of the allowance for loan losses to total loans at March 31, 2006
was 1.76% compared to 1.94% at March 31, 2005. Management believes the
allowance for loan losses is adequate based on its best estimates of the
losses inherent in the loan portfolio, although there can be no guarantee as
to these estimates. In addition, bank regulatory agencies may require
additions 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
would not exceed the allowance for loan losses or that additional increases in
the allowance for loan losses will not be required in the future.
16
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Other Income
Other income increased $136,000 from $2.7 million during fiscal 2005 to $2.8
million during fiscal 2006. Gain on sale of loans increased $32,000 or 7.3%
to $467,000 during fiscal 2006. Service fees on deposit accounts decreased
$94,000 or 7.7% to $1.1 million during fiscal 2006 as a result of an increase
in the average interest rate used to offset commercial analysis charges on
business demand accounts. Other miscellaneous income including trust fees,
life and casualty insurance commissions, annuity and investment brokerage
commissions, credit life insurance, and other miscellaneous income increased
$149,000 or 14.3% to $1.2 million during fiscal 2006 due primarily to an
increase in trust fees. The Bank's three financial subsidiaries, SFINS,
SFINV, and SFT began operating in the latter part of the fiscal year ended
March 31, 2002. SFINS is an insurance agency handling property and casualty
insurance and life and health insurance and became profitable during the
fiscal year ended March 31, 2004. During fiscal 2006, SFINS incurred a slight
loss in fiscal 2006 due to an increase in staff. SFINV markets mutual funds,
discount brokerage, and annuities. SFT is a full-service trust company.
SFINV and SFT have not yet attained profitability.
General and Administrative Expenses
General and administrative expenses increased $2.2 million or 20.9% to $13.0
million during the year ended March 31, 2006 from $10.8 million for the same
period one year earlier. Compensation and employee benefits increased $1.3
million or 21.2% to $7.6 million as a result of the hiring of additional
business development officers, accounting and auditing staff, normal annual
salary adjustments, and an increase in the discretionary contribution to the
Employee Stock Ownership Plan as a result of meeting profitability targets.
Occupancy expense increased $178,000 or 16.4% to $1.3 million as a result of
the depreciation of branch renovations and the leasing of additional office
space. Advertising expense decreased $10,000 or 5.6% to $172,000 while
depreciation and maintenance of equipment expense increased $46,000 or 4.4% to
$1.1 million. FDIC insurance premiums were $58,000 in both fiscal 2006 and
2005. Other miscellaneous expenses, which encompasses repossessed assets
expense, legal, professional, and consulting expenses, stationery and office
supplies, and other sundry expenses increased $717,000 or 33.5% during fiscal
2006 due primarily to increases in audit, legal, and consulting fees to comply
with the ever increasing regulatory burden and an increase in investment
management fees in Security Federal Trust.
Income Taxes
The provision for income taxes increased $67,000 to $1.8 million or 3.9%
during the year ended March 31, 2006 compared to $1.7 million for the year
ended March 31, 2005, a result of an increase in taxable income. The
effective tax rate was 31.8% for fiscal 2006 and 32.8% for fiscal 2005.
17
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Comparison of the Years Ended March 31, 2005 and 2004
General
The Company's earnings were $3.5 million for the year ended March 31, 2005,
compared to $4.3 million for the year ended March 31, 2004. The Bank sold a
branch office in the year ended March 31, 2004, which increased earnings for
that year by $820,000 after tax. Without the branch sale, earnings for fiscal
2005 would have increased $62,000 or 1.8% over the previous year.
Net Interest Income
Net interest income increased $660,000 or 4.9% to $14.1 million in fiscal 2005
from $13.4 million in fiscal 2004. The increase was attributable to an
increase in average interest-earning assets of $68.9 million, despite a
shrinking interest rate spread. The Bank's interest rate spread decreased 26
basis points to 2.40% during fiscal 2005. The yield of average earning assets
decreased 15 basis points to 4.73%, while the cost of average interest-bearing
liabilities increased 11 basis points to 2.33%. Interest income on loans
increased $1.4 million to $16.8 million during the year ended March 31, 2005
from $15.4 million during fiscal 2004. The increase was attributable to an
increase in average total loans outstanding of $35.9 million, offset partially
by a 32 basis point decrease in the overall yield earned on the Bank's loans
during fiscal 2005. Interest income on investment securities, mortgage-backed
securities, and other investments increased $1.2 million as a result of a
$33.0 million, or 14.6% increase in aggregate average balances during fiscal
2005 compared with fiscal 2004. The yields on aggregate investments and
mortgage-backed securities increased four basis points in fiscal 2005 compared
to fiscal 2004.
Interest expense on deposits increased $989,000 or 14.7% to $7.7 million
during the year ended March 31, 2005 from $6.7 million during the year ended
March 31, 2004. Average interest-bearing deposits increased $30.7 million
while the average cost of those deposits increased 11 basis points during the
year. Interest expense on FHLB advances and other borrowings increased
$930,000 or 32.3% to $3.8 million during fiscal 2005 from $2.9 million during
fiscal 2004. The increase was a result of an increase in average FHLB
advances outstanding during the year of $32.4 million offset partially by a
decrease in the weighted average interest rate paid on FHLB advances of 33
basis points to 3.54%.
Provision for Loan Losses
The Company's provision for loan losses decreased $420,000 to $780,000 during
the year ended March 31, 2005 from $1.2 million in fiscal 2004. The amount of
the provision is determined by management's on-going monthly analysis of the
loan portfolio. Management uses three methods to measure the estimate of the
adequacy of the allowance for loan losses. These methods incorporate
percentage of classified loans, five-year averages of historical loan losses
in each loan category and current economic trends, and the assignment of
percentage targets of reserves in each loan category. Management has used all
three methods for the past six fiscal years.
Non-accrual loans, which are loans delinquent 90 days or more, were $2.4
million at March 31, 2005 compared to $2.0 million at March 31, 2004. Net
charge-offs were $260,000 in fiscal 2005 compared to $347,000 in fiscal 2004.
The ratio of the allowance for loan losses to total loans at March 31, 2005
was 1.94% compared to 2.17% at March 31, 2004. Management believes the
allowance for loan losses is adequate based on its best estimates of the
losses inherent in the loan portfolio, although there can be no guarantee as
to these estimates. In addition, bank regulatory agencies may require
additions 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
would not exceed the allowance for loan losses or that additional increases in
the allowance for loan losses will not be required in the future.
18
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Other Income
Other income decreased $2.5 million from $5.2 million during fiscal 2004 to
$2.7 million during fiscal 2005 as a result of the gain on the sale of the
Denmark, South Carolina branch, which took place in fiscal 2004, of $1.5
million before tax and contingencies and a decrease in the gain on sale of
mortgage loans of $894,000. Without the branch sale, other income would have
decreased $1.0 million or 8.9%. Gain on sale of loans decreased to $436,000
during fiscal 2005 from $1.3 million in fiscal 2004 as a result of the general
decline in mortgage loan originations. Loan servicing fees decreased $34,000
or 15.8% to $180,000 during fiscal 2005 as a result of a reduction in late
charge fees collected. Service fees on deposit accounts decreased $125,000 or
9.3% to $1.2 million as a result of an increase in the average interest rate
used to offset commercial analysis charges on business demand accounts. Other
miscellaneous income including trust fees, life and casualty insurance
commissions, annuity and investment brokerage commissions, credit life
insurance, and other miscellaneous income increased $51,000 or 6.3% to
$863,000 during fiscal 2005. The Bank's three financial subsidiaries,
Security Federal Insurance, Inc., Security Federal Investments, Inc., and
Security Federal Trust, Inc., began operating in the latter part of the fiscal
year ended March 31, 2002. Security Federal Insurance, Inc. is an insurance
agency handling property and casualty insurance and life and health insurance.
It became profitable during the fiscal year ended March 31, 2004. Security
Federal Investments, Inc. markets mutual funds, discount brokerage, and
annuities. Security Federal Trust, Inc., is a full-service trust company.
Security Federal Investments, Inc. and Security Federal Trust, Inc. have not
yet attained profitability.
General and Administrative Expenses
General and administrative expenses increased $48,000 or 0.5% to $10.8 million
during the year ended March 31, 2005 from $10.7 million for the same period
one year earlier. Compensation and employee benefits increased $233,000 or
3.9% to $6.3 million as a result of normal annual salary adjustments.
Occupancy expense increased $101,000 or 10.2% to $1.1 million as a result of
the depreciation of renovations of three branch offices and a full year of
depreciation on a branch renovated in fiscal 2004. Advertising expense
decreased $28,000 or 13.4% to $183,000 while depreciation and maintenance of
equipment expense decreased $39,000 or 3.6% to $1.0 million. FDIC insurance
premiums increased $2,000 or 4.0% to $58,000. Other miscellaneous expenses,
which encompasses repossessed assets expense, legal, professional, and
consulting expenses, stationery and office supplies, and other sundry expenses
decreased $220,000 or 9.3% during fiscal 2005.
Income Taxes
The provision for income taxes decreased $741,000 to $1.7 million or 30.1%
during the year ended March 31, 2005 compared to $2.4 million for the year
ended March 31, 2004, a result of a decrease in taxable income. The effective
tax rate was 32.8% for fiscal 2005 and 36.5% for fiscal 2004.
19
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Regulatory Capital
The following table reconciles the Bank's shareholders' equity to its various
regulatory capital positions:
March 31,
-----------------
2006 2005
------- -------
(In Thousands)
Shareholders' Equity (1) (2) $39,473 $35,652
Reduction For Goodwill And Other Intangibles - -
------- -------
Tangible Capital 39,473 35,652
------- -------
Qualifying Core Deposit Intangibles - -
Core Capital 39,473 35,652
------- -------
Supplemental Capital 5,104 4,236
Less Assets Required To Be Deducted 9 30
------- -------
Total Risk-Based Capital $44,568 $39,858
======= =======
(1) FOR FISCAL 2006 AND 2005, EXCLUDES UNREALIZED LOSS OF $2.1 MILLION AND
$942,000, RESPECTIVELY ON AVAILABLE FOR SALE SECURITIES.
(2) FOR FISCAL 2006 AND 2005, EXCLUDES EQUITY OF THE COMPANY.
The following table compares the Bank's capital levels relative to regulatory
requirements at March 31, 2006:
Amount Percent Actual Actual Excess Excess
Required Required Amount Percent Amount Percent
-------- -------- ------ ------- ------ -------
(Dollars In Thousands)
Tangible Capital $13,224 2.0% $39,473 6.0% $26,249 4.0%
Tier 1 Leverage (Core)
Capital 26,431 4.0% 39,473 6.0% 13,042 2.0%
Tier 1 Risk-Based (Core)
Capital 16,328 4.0% 39,473 9.7% 23,145 5.7%
Total Risk-Based Capital 32,669 8.0% 44,568 10.9% 11,899 2.9%
20
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Liquidity and Capital Resources
Liquidity refers to the ability of the Bank to generate sufficient cash flows
to fund current loan demand, repay maturing borrowings, fund maturing deposit
withdrawals, and meet operating expenses. The Bank's primary sources of funds
include loan repayments, loan sales, increased deposits, advances from the
FHLB, and cash flow generated from operations. The need for funds varies
among periods depending on funding needs as well as the rate of amortization
and prepayment on loans. The use of FHLB advances varies depending on loan
demand, deposit inflows, and the use of investment leverage strategies to
increase net interest income.
The principal use of the Bank's funds is the origination of mortgages and
other loans and the purchase of investments and mortgage-backed securities.
Loan originations on loans held for investment were $277.2 million in fiscal
2006 compared to $222.5 million in fiscal 2005 and $180.9 million in fiscal
2004. The bulk of the increase in originations in fiscal 2006, 2005, and 2004
was due primarily to an increase in commercial loan originations, which
increased $63.9, $45.9 million, and $27.5 million, respectively. Purchases of
investments and mortgage-backed securities were $59.4 million in fiscal 2006
compared to $81.3 million in fiscal 2005 and $200.9 million in fiscal 2004.
Another use of the Bank's funds is the building and renovation of branch
offices. The Bank plans to consider expanding its branch network in Aiken and
Lexington Counties and surrounding areas during the next few years.
Outstanding loan commitments for the Bank's residential mortgage loan
portfolio amounted to $351,000 at March 31, 2006 compared to $180,000 at March
31, 2005. Those commitments were for adjustable rate mortgage loans in which
the commitment generally expires in 45 days. In addition, unused lines of
credit on home equity loans, credit cards, and commercial loans amounted to
$70.9 million at March 31, 2006. Home equity loans are made on a floating
rate basis with final maturities of 10 to 15 years. Credit cards are
generally made on a floating rate basis, and are renewed annually or every
other year. Management does not anticipate that the percentage of funds drawn
on unused lines of credit will increase substantially over amounts currently
utilized. In addition to the above commitments, the Bank has undisbursed
loans-in-process of $9.2 million at March 31, 2006, which will disburse over
an average of 90 days. These commitments to originate loans and future
advances of lines of credit are expected to be provided from loan
amortizations and prepayments, deposit inflows, maturing investments, and
short-term borrowing capacity.
The following table sets forth the length of time until maturity for unused
commitments to extend credit and standby letters of credit at March 31, 2006.
After
After One Three Greater
Within Through Through Than
One Three Twelve Within One
(In Thousands) Month Months Months One Year Year Total
------ --------- -------- -------- ------- -------
Unused lines of
credit $3,838 $1,845 $40,131 $45,814 $34,652 $80,466
Standby letters of
credit 412 33 847 1,292 88 1,380
------ ------ ------- ------- ------- -------
Total $4,250 $1,878 $40,978 $47,106 $34,740 $81,846
====== ====== ======= ======= ======= =======
Management believes that future liquidity can be met through the Bank's
deposit base, which increased $48.9 million during fiscal 2006, and from
maturing investments. Also, the Bank has another $66.2 million in unused
borrowing capacity at FHLB at March 31, 2006.
Historically the Bank's cash flow from operating activities has been
relatively stable. The cash flows from investing activities varies with the
need to invest excess funds or utilize leverage strategies with the purchase
of mortgage-backed and investment securities. The cash flows from financing
activities varies with the need for FHLB advances. See "Consolidated
Statements of Cash Flows" in the Consolidated Financial Statements contained
herein.
21
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and
Results of Operation
Contractual Obligations
In the normal course of business, the Company enters into contractual
obligations that meet various business needs. These contractual obligations
include time deposits to customers, borrowings from the FHLB of Atlanta and
lease obligations for facilities. See Notes 8, 9, and 10 of the Notes to the
Consolidated Financial Statements included herein for additional information.
The following table summarizes the Company's long-term contractual obligations
at March 31, 2006:
Less than One to Three to
One Year Three Years Five Years Thereafter Total
--------- ----------- ---------- ---------- --------
(In Thousands)
Time deposits $164,024 $34,850 $ 5,718 $ - $204,592
FHLB Advances 43,000 48,000 40,000 363 131,363
Operating Lease
Obligations 276 550 560 1,539 2,925
Purchase
Obligation -
Building Contract - - - - -
-------- ------- ------- ------ --------
Total $207,300 $83,400 $46,278 $1,902 $338,880
======== ======= ======= ====== ========
Off-Balance Sheet Arrangements
In the normal course of business, the Company makes off-balance sheet
arrangements, including credit commitments to its customers to meet their
financial needs. These arrangements involve, to varying degrees, elements of
credit and interest rate risk not recognized in the consolidated statement of
financial condition. The Bank makes personal, commercial, and real estate
lines of credit available to customers and does issue standby letters of
credit.
Commitments to extend credit to customers are subject to the Bank's normal
credit policies and are essentially the same as those involved in extending
loans to customers. See Note 14 of the Notes to the Consolidated Financial
Statements included herein for additional information.
Impact of Inflation and Changing Prices
The consolidated financial statements, related notes, and other financial
information presented herein have been prepared in accordance with Generally
Accepted Accounting Principles ("GAAP") that require the measurement of
financial position and operating results in terms of historical dollars
without considering changes in relative purchasing power over time due to
inflation. Unlike most industrial companies, substantially all of the assets
and liabilities of a financial institution are monetary in nature. As a
result, interest rates generally have a more significant impact on a financial
institution's performance than does the effect of inflation.
22
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and Board of Directors
Security Federal Corporation and Subsidiaries
Aiken, South Carolina
We have audited the accompanying consolidated balance sheets of Security
Federal Corporation and Subsidiaries as of March 31, 2006 and 2005, and the
related consolidated statements of income, shareholders' equity and
comprehensive income and cash flows for each of the years in the three year
period ended March 31, 2006. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the consolidated financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall consolidated financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Security Federal Corporation and Subsidiaries as of March 31, 2006 and
2005, and the consolidated results of their operations and their cash flows
for each of the years in the three year period ended March 31, 2006, in
conformity with accounting principles generally accepted in the United States
of America.
/s/ Elliott Davis, LLC
Elliott Davis, LLC
Columbia, South Carolina
April 20, 2006
23
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
March 31,
---------------------------
2006 2005
------------ ------------
ASSETS:
Cash And Cash Equivalents $ 14,351,208 $ 7,916,488
Investment And Mortgage-Backed Securities:
Available For Sale: (Amortized Cost of
$166,808,236 and $166,364,642 at March
31, 2006 and 2005, Respectively) 163,445,066 164,814,819
Held To Maturity: (Fair Value of $73,084,450
and $74,770,902 at March 31, 2006 and 2005,
Respectively) 74,987,805 76,260,904
------------ ------------
Total Investment And Mortgage-Backed Securities 238,432,871 241,075,723
------------ ------------
Loans Receivable, Net:
Held For Sale 1,320,644 2,277,762
Held For Investment: (Net of Allowance of
$6,704,734 and $6,284,055 at March 31, 2006
and 2005, Respectively) 373,788,432 314,611,373
------------ ------------
Total Loans Receivable, Net 375,109,076 316,889,135
------------ ------------
Accrued Interest Receivable:
Loans 1,096,014 901,872
Mortgage-Backed Securities 508,432 555,933
Investments 945,620 721,744
------------ ------------
Total Accrued Interest Receivable 2,550,066 2,179,549
------------ ------------
Premises And Equipment, Net 11,662,976 7,914,043
Federal Home Loan Bank Stock, At Cost 7,149,800 6,234,500
Repossessed Assets Acquired In Settlement Of Loans 91,022 53,000
Bank Owned Life Insurance 5,000,001 -
Other Assets 4,330,795 3,716,035
------------ ------------
Total Assets $658,677,815 $585,978,473
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY:
Liabilities:
Deposit Accounts $479,229,339 $430,287,391
Advances From Federal Home Loan Bank 131,363,000 112,038,000
Other Borrowings 7,289,773 5,594,157
Advance Payments By Borrowers For Taxes
And Insurance 501,998 417,410
Other Liabilities 2,691,946 2,530,450
------------ ------------
Total Liabilities 621,076,056 550,867,408
------------ ------------
Commitments (Notes 6 and 14)
Shareholders' Equity:
Serial Preferred Stock, $.01 Par Value;
Authorized 200,000 Shares; Issued And
Outstanding, None - -
Common Stock, $.01 Par Value; Authorized
5,000,000 Shares, Issued And Outstanding
Shares, 2,558,234 And 2,537,378 at March 31,
2006 And 2,543,838 And 2,522,127 at March 31,
2005 25,582 25,438
Additional Paid-In Capital 4,404,110 4,181,804
Treasury Stock, (At Cost 11,312 and 8,077 shares
at March 31, 2006 and 2005, respectively) (238,656) (165,089)
Indirect Guarantee Of Employee Stock Ownership
Trust Debt (215,503) (276,217)
Accumulated Other Comprehensive Loss (2,086,509) (961,504)
Retained Earnings, Substantially Restricted 35,712,735 32,306,633
------------ ------------
Total Shareholders' Equity 37,601,759 35,111,065
------------ ------------
Total Liabilities And Shareholders' Equity $658,677,815 $585,978,473
============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
24
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income
For the Years Ended March 31,
---------------------------------------
2006 2005 2004
----------- ----------- -----------
Interest Income:
Loans $23,199,617 $16,821,470 $15,448,987
Mortgage-Backed Securities 5,455,369 5,584,979 4,479,444
Investment Securities 3,689,641 3,155,436 3,066,824
Other 62,008 27,764 15,750
----------- ----------- -----------
Total Interest Income 32,406,635 25,589,649 23,011,005
----------- ----------- -----------
Interest Expense:
NOW And Money Market Accounts 5,360,351 3,945,513 3,071,306
Passbook Accounts 175,237 173,250 174,353
Certificate Accounts 5,906,157 3,597,761 3,482,214
FHLB Advances And Other Borrowed
Money 4,527,182 3,808,221 2,878,227
----------- ----------- -----------
Total Interest Expense 15,968,927 11,524,745 9,606,100
----------- ----------- -----------
Net Interest Income 16,437,708 14,064,904 13,404,905
Provision For Loan Losses 660,000 780,000 1,200,000
----------- ----------- -----------
Net Interest Income After Provision
For Loan Losses 15,777,708 13,284,904 12,204,905
----------- ----------- -----------
Other Income:
Gain On Sale Of Investment
Securities 48,962 - 7,700
Gain On Sale Of Loans 467,481 435,635 1,329,729
Service Fees On Deposit Accounts 1,132,194 1,226,118 1,351,175
Gain On Sale Of Branch - - 1,521,401
Other 1,191,503 1,042,221 1,024,760
----------- ----------- -----------
Total Other Income 2,840,140 2,703,974 5,234,765
----------- ----------- -----------
General And Administrative Expenses:
Compensation And Employee Benefits 7,579,695 6,255,794 6,023,215
Occupancy 1,263,839 1,086,017 985,378
Advertising 172,409 182,699 210,962
Depreciation And Maintenance Of
Equipment 1,094,149 1,047,815 1,086,930
FDIC Insurance Premiums 57,702 57,830 55,596
Other 2,859,587 2,142,636 2,362,783
----------- ----------- -----------
Total General And Administrative
Expenses 13,027,381 10,772,791 10,724,864
----------- ----------- -----------
Income Before Income Taxes 5,590,467 5,216,087 6,714,806
Provision For Income Taxes 1,777,616 1,710,592 2,451,643
----------- ----------- -----------
Net Income $ 3,812,851 $ 3,505,495 $ 4,263,163
=========== =========== ===========
Net Income Per Common Share (Basic) $ 1.51 $ 1.39 $ 1.70
=========== =========== ===========
Net Income Per Common Share (Diluted) $ 1.48 $ 1.37 $ 1.66
=========== =========== ===========
Cash Dividend Per Share On Common
Stock $ 0.16 $ 0.11 $ 0.08
=========== =========== ===========
Weighted Average Shares Outstanding
(Basic) 2,532,999 2,524,123 2,513,319
=========== =========== ===========
Weighted Average Shares Outstanding
(Diluted) 2,575,061 2,561,437 2,560,710
=========== =========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
25
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income
For the Years Ended March 31, 2006, 2005 and 2004
Accumulated
Additional Indirect Other
Common Paid-In Treasury Guarantee Comprehensive Retained
Stock Capital Stock Of ESOP Debt Income (Loss) Earnings Total
------- ---------- -------- ------------ ------------- -------- -----------
Balance At March 31,
2003 $25,298 $3,995,230 $ - $(444,685) $ 1,444,585 $25,019,525 $30,039,953
Net Income - - - - 4,263,163 4,263,163
Other Comprehensive
Income, Net Of Tax:
Unrealized Holding
Losses On Securities
Available For Sale,
Net Of Taxes - - - - (750,056) - (750,056)
Reclassification
Adjustment For Gains
Included In Net Income,
Net Of Taxes - - - - (4,774) - (4,774)
-----------
Comprehensive Income - - - - - - 3,508,333
Exercise Of Stock
Options 35 18,444 - - - - 18,479
Decrease in Indirect
Guarantee Of ESOP Debt - - - 107,713 - - 107,713
Cash Dividends - - - - - (202,563) (202,563)
------- ---------- --------- --------- ---------- ----------- -----------
Balance At March 31,
2004 $25,333 $4,013,674 $ - $(336,972) $ 689,755 $29,080,125 $33,471,915
======= ========== ========= ========= =========== =========== ===========
------------------------------------------------------------------------------------------------------------
Accumulated
Additional Indirect Other
Common Paid-In Treasury Guarantee Comprehensive Retained
Stock Capital Stock Of ESOP Debt Income (Loss) Earnings Total
------- ---------- -------- ------------ ------------- -------- -----------
Balance At March 31,
2004 $25,333 $4,013,674 $ - $(336,972) $ 689,755 $29,080,125 $33,471,915
Net Income - - - - - 3,505,495 3,505,495
Other Comprehensive
Income, Net Of Tax:
Unrealized Holding
Losses On Securities
Available For Sale,
Net of Taxes - - - - (1,651,259) - (1,651,259)
-----------
Comprehensive Income - - - - - - 1,854,236
Purchase of Treasury
Stock At Cost, 8,077
Shares - - (165,089) - - - (165,089)
Exercise Of Stock Options 105 168,130 - - - - 168,235
Decrease in Indirect
Guarantee Of ESOP Debt - - - 60,755 - - 60,755
Cash Dividends - - - - - (278,987) (278,987)
------- ---------- --------- --------- ---------- ----------- -----------
Balance At March 31,
2005 $25,438 $4,181,804 $(165,089) $(276,217) $ (961,504) $32,306,633 $35,111,065
======= ========== ========= ========= =========== =========== ===========
------------------------------------------------------------------------------------------------------------
Accumulated
Additional Indirect Other
Common Paid-In Treasury Guarantee Comprehensive Retained
Stock Capital Stock Of ESOP Debt Income (Loss) Earnings Total
------- ---------- -------- ------------ ------------- -------- -----------
Balance At March 31,
2005 $25,438 $4,181,804 $(165,089) $(276,217) $ (961,504) $32,306,633 $35,111,065
Net Income - - - - - 3,812,851 3,812,851
Other Comprehensive
Income, Net Of Tax:
Unrealized Holding
Losses On Securities
Available For Sale,
Net Of Taxes - - - - (1,094,649) - (1,094,649)
Reclassification
Adjustment For Gains
Included In Net
Income, Net Of Taxes - - - - (30,356) - (30,356)
-----------
Comprehensive Income - - - - - - 2,687,846
Purchase of Treasury
Stock At Cost, 3,235
Shares (73,567) - - - (73,567)
Exercise Of Stock
Options 144 222,306 - - - - 222,450
Decrease in Indirect
Guarantee Of ESOP Debt - - - 60,714 - - 60,714
Cash Dividends - - - - - (406,749) (406,749)
------- ---------- --------- --------- ---------- ----------- -----------
Balance At March 31,
2006 $25,582 $4,404,110 $(238,656) $(215,503) $(2,086,509) $35,712,735 $37,601,759
======= ========== ========= ========= =========== =========== ===========
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
26
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended March 31,
----------------------------------------
2006 2005 2004
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 3,812,851 $ 3,505,495 $ 4,263,163
Adjustments To Reconcile Net Income
To Net Cash Provided By Operating
Activities:
Depreciation 965,226 859,809 844,641
Discount Accretion And Premium
Amortization 927,981 1,193,221 828,444
Provisions For Losses On Loans And
Real Estate 660,000 780,000 1,200,000
Gain On Sales Of Loans (467,481) (435,635) (1,329,729)
Gain On Sales Of Investment
Securities (48,962) - (7,700)
Loss (Gain) On Sale Of Real Estate 21,416 (50,329) (85,713)
Amortization Of Deferred Fees On
Loans (170,009) (184,642) (187,937)
Loss (Gain) On Disposition Of
Premises And Equipment 32,344 (3,525) (1,815)
Proceeds From Sale Of Loans Held
For Sale 30,370,085 26,392,654 64,827,155
Origination Of Loans For Sale (28,945,486) (26,530,912) (61,530,797)
(Increase) Decrease In Accrued
Interest Receivable:
Loans (194,142) 717 66,894
Mortgage-Backed Securities 47,501 (6,392) (107,641)
Investments (223,876) 56,981 (110,990)
Increase In Advance Payments By
Borrowers 84,588 99,989 37,996
Other, Net 295,799 (1,708,142) 359,259
------------ ------------ ------------
Net Cash Provided By Operating
Activities 7,167,835 3,969,289 9,065,230
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase Of Mortgage-Backed
Securities Available For Sale (31,386,556) (53,211,974) (110,002,424)
Principal Repayments On Mortgage-
Backed Securities Available For
Sale 49,386,450 47,852,116 55,003,975
Principal Repayments On Mortgage-
Backed Securities Held To Maturity 10,407 89,769 591,457
Purchase Of Investment Securities
Held To Maturity - (26,041,400) (90,880,070)
Purchase Of Investment Securities
Available For Sale (28,031,364) (2,015,626) -
Maturities Of Investment Securities
Available For Sale 4,924,531 13,111,305 36,242,259
Maturities Of Investment Securities
Held To Maturity 1,000,000 21,000,000 40,995,331
Proceeds From Sale of Mortgage-
Backed Securities Available For
Sale 3,797,360 - 2,413,515
Proceeds From Sale of Mortgage-
Backed Securities Held To Maturity 249,650 - -
Purchase Of FHLB Stock (6,897,300) (4,967,800) (5,338,000)
Redemption Of FHLB Stock 5,982,000 3,550,100 3,379,800
Increase In Loans Receivable (59,900,035) (56,631,543) (22,245,974)
Proceeds From Sale Of Repossessed
Assets 173,547 432,595 781,537
Purchase And Improvement Of Premises
And Equipment (4,746,502) (2,211,117) (2,419,827)
Proceeds From Sale of Premises and
Equipment - 3,525 1,815
Purchase Of Bank Owned Life Insurance (5,000,001) - -
Net Cash Outflow From Sale of Branch - - (9,930,521)
------------ ------------ ------------
Net Cash Used By Investing
Activities (70,437,813) (59,040,050) (101,407,127)
------------ ------------ ------------
(Continued)
27
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows, Continued
For the Years Ended March 31,
----------------------------------------
2006 2005 2004
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase In Deposit Accounts 48,941,948 40,694,746 43,188,959
Proceeds From FHLB Advances 262,655,000 148,738,000 226,425,000
Repayment Of FHLB Advances (243,330,000) (133,036,000) (179,861,000)
Proceeds (Repayment) Of Other
Borrowings, Net 1,695,616 117,134 1,283,543
Proceeds From Exercise Of Stock
Options 222,450 168,235 18,479
Purchase of Treasury Stock (73,567) (165,089) -
Dividends To Shareholders (406,749) (278,988) (202,563)
------------ ------------ ------------
Net Cash Provided By Financing
Activities 69,704,698 56,238,038 90,852,418
------------ ------------ ------------
Net Increase (Decrease) In Cash And
Cash Equivalents 6,434,720 1,167,277 (1,489,479)
Cash And Cash Equivalents At
Beginning Of Year 7,916,488 6,749,211 8,238,690
------------ ------------ ------------
Cash And Cash Equivalents At End
Of Year $ 14,351,208 $ 7,916,488 $ 6,749,211
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash Paid During The Period For:
Interest $ 15,679,123 $ 11,413,369 $ 9,740,893
============ ============ ============
Income Taxes $ 2,276,825 $ 2,221,012 $ 2,076,388
============ ============ ============
Supplemental Schedule Of Non Cash
Transactions:
Additions To Repossessed Assets $ 232,985 $ 384,397 $ 595,243
============ ============ ============
Decrease In Unrealized Net Gain
On Securities Available For Sale,
Net Of Taxes $ (1,125,005) $ (1,651,259) $ (754,830)
============ ============ ============
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
28
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Significant Accounting Policies
-------------------------------
The following is a description of the more significant accounting and
reporting policies used in the preparation and presentation of the
accompanying consolidated financial statements. All significant intercompany
transactions have been eliminated in consolidation.
(a) Basis of Consolidation and Nature of Operations
-----------------------------------------------
The accompanying consolidated financial statements include the
accounts of Security Federal Corporation (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, Inv. ("SFINV"), Security
Federal Trust Inv. ("SFT"), and Security Financial Services
Corporation ("SFSC"). 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. SFINS, SFINV, and
SFT were formed during fiscal 2002 and began operating during the
December 2001 quarter. SFINS is an insurance agency offering
business, health, home and life insurance. SFINV engages primarily
in investment brokerage services. SFT offers trust, financial
planning and financial management services.
(b) Cash and Cash Equivalents
-------------------------
For purposes of reporting cash flows, cash and cash equivalents
include cash and due from banks, interest-bearing balances in other
banks, and federal funds sold. Cash equivalents have original
maturities of three months or less.
(c) Investment and Mortgage-Backed Securities
-----------------------------------------
Investment securities, including mortgage-backed securities, are
classified in one of three categories: held to maturity, available
for sale, or trading. Management determines the appropriate
classification of debt securities at the time of purchase.
Investment securities are classified as held to maturity when the
Company has the positive intent and ability to hold the securities
to maturity. These securities are recorded at cost and adjusted
for amortization of premiums and accretion of discounts over the
estimated life of the security using a method that approximates a
level yield. Prepayment assumptions on mortgage-backed securities
are anticipated.
Management classifies investment securities that are not considered
to be held to maturity as available for sale. These type of
investments are stated at fair value with unrealized gains and
losses, net of tax, reported in a separate component of
shareholders' equity ("accumulated other comprehensive income
(loss)"). Gains and losses from sales of investment and
mortgage-backed securities available for sale are determined using
the specific identification method. The Company has no trading
securities.
The Bank maintained liquid assets in excess of the amount required
by regulations. Liquid assets consist primarily of cash, time
deposits, and certain investment securities.
(d) Loans Receivable Held for Investment
------------------------------------
Loans are stated at their unpaid principal balance. Interest
income is computed using the simple interest method and is recorded
in the period earned.
(e) Allowance for Loan Losses
-------------------------
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 portfolios,
the relationship of the allowance for loan losses to 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. While
Management uses the best information available to make evaluations,
future adjustments to the allowance may be necessary if economic
conditions differ substantially from the assumptions used in making
these evaluations. Allowances for loan losses are subject to
periodic evaluations by various regulatory authorities and may be
subject to adjustments based upon the information that is available
at the time of their examinations.
29
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Significant Accounting Policies, Continued
------------------------------------------
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 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.
(f) Loans Receivable Held for Sale
------------------------------
Loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated fair value in the
aggregate. Net unrealized losses are provided for in a valuation
allowance by charges to operations.
(g) Repossessed Assets Acquired in Settlement of Loans
--------------------------------------------------
Repossessed assets represent real estate and other assets acquired
through foreclosure or repossession and are initially recorded at
the lower of cost (principal balance of the former mortgage loan
less any specific valuation allowances) or estimated fair value
less costs to sell. Subsequent improvements are capitalized.
Costs of holding real estate, such as property taxes, insurance,
general maintenance and interest expense, are expensed as a period
cost. Fair values are reviewed regularly and allowances for
possible losses are established when the carrying value of the
asset owned exceeds the fair value less estimated costs to sell.
Fair values are generally determined by reference to an outside
appraisal.
(h) Premises and Equipment
----------------------
Premises and equipment are carried at cost, net of accumulated
depreciation. Depreciation of premises and equipment is amortized
on a straight-line method over the estimated useful life of the
related asset. Estimated lives are seven to 30 years for buildings
and improvements and generally three to 10 years for furniture,
fixtures and equipment. Maintenance and repairs are charged to
current expense. The cost of major renewals and improvements are
capitalized.
(i) Income Taxes
------------
Deferred tax expense or benefit is recognized for the net change
during the year in the deferred tax liability or asset. That
amount together with income taxes currently payable is the total
amount of income tax expense or benefit for the year. Deferred
taxes are provided for in differences in financial reporting bases
for assets and liabilities compared with their tax bases.
Generally, a current tax liability or asset is established for
taxes presently payable or refundable and a deferred tax liability
or asset is established for future tax items. A valuation
allowance, if applicable, is established for deferred tax assets
that may not be realized. Tax bad debt reserves in excess of the
base year amount (established as taxable years ending March 31,
1988 or later) would create a deferred tax liability. Deferred
income taxes are provided for in differences between the provision
for loan losses for financial statement purposes and those allowed
for income tax purposes.
(j) Loan Fees and Costs Associated with Originating Loans
-----------------------------------------------------
Loan fees received, net of direct incremental costs of originating
loans, are deferred and amortized over the contractual life of the
related loan. The net fees are recognized as yield adjustments by
applying the interest method. Prepayments are not anticipated.
30
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Significant Accounting Policies, Continued
(k) Interest Income
---------------
Interest on loans is accrued and credited to income monthly based
on the principal balance outstanding and the contractual rate on
the loan. The Company places loans on non-accrual status when they
become greater than 90 days delinquent or when, in the opinion of
management, full collection of principal or interest is unlikely.
The Company provides an allowance for uncollectible accrued
interest on loans that are contractually 90 days delinquent for all
interest accrued prior to the loan being placed on non-accrual
status. The loans are returned to an accrual status when full
collection of principal and interest appears likely.
(l) Advertising Expense
-------------------
Advertising and public relations costs are generally expensed as
incurred. External costs relating to direct mailing costs are
expensed in the period in which the direct mailing are sent.
Advertising and public relations costs of $172,409, $182,699, and
210,962 were included in the Company's results of operations for
2006, 2005, and 2004, respectively.
(m) Fair Value of Financial Instruments
-----------------------------------
The Company discloses the fair value of on- and off-balance sheet
financial instruments when it is practicable to do so. Fair values
are based on quoted market prices, where available, on estimates of
present value, or on other valuation techniques. These estimates
are made at a specific point in time, are subjective in nature, and
involve uncertainties and significant judgment. In addition, the
Company does not disclose the fair value of non-financial
instruments. Accordingly, the aggregate fair values presented do
not represent the underlying fair value of the Company.
Fair value approximates carrying value for the following financial
instruments due to the short-term nature of the instrument: cash
and cash equivalents.
Securities are valued using quoted fair market prices.
Fair value for the Company's off-balance sheet financial
instruments is based on the discounted present value of the
estimated future cash flows.
Fair value for variable rate loans that reprice frequently, loans
held for sale, and loans that mature in less than three months is
based on the carrying value. Fair value for fixed rate mortgage
loans, personal loans, and other loans (primarily commercial)
maturing after three months is based on the discounted present
value of the estimated future cash flows. Discount rates used in
these computations approximate the rates currently offered for
similar loans of comparable terms and credit quality.
Fair value for demand deposit accounts and interest-bearing
accounts with no fixed maturity date is equal to the carrying
value. Certificates of deposit accounts and securities sold under
repurchase agreements maturing within one year are valued at their
carrying value. The fair value of certificates of deposit accounts
and securities sold under repurchase agreements after one year are
estimated by discounting cash flows from expected maturities using
current interest rates on similar instruments. Fair value for
long-term FHLB advances is based on discounted cash flows using the
Company's current incremental borrowing rate. Discount rates used
in these computations approximate rates currently offered for
similar borrowings of comparable terms and credit quality.
31
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Significant Accounting Policies, Continued
------------------------------------------
(n) Stock-Based Compensation
------------------------
At March 31, 2006, the Company sponsored stock-based compensation
plans, which are described more fully in Note 12. The Company has
elected the disclosure - only provision of Statement of Financial
Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation." Accordingly, no compensation cost has been
recognized for the stock option plan. Had compensation cost for
the Company's stock option plan been determined based on the fair
value at the grant date consistent with the provisions of SFAS No.
123, the Company's net income and earnings per share amounts as of
the year ended March 31 would have been reduced to the pro forma
amounts indicated below.
2006 2005 2004
---------- --------- ---------
Net Income, As Reported $3,812,851 3,505,495 4,263,163
Deduct: Total stock-based employee
compensation expense determined under
fair-value based method for all awards,
net of tax $ (365,483) (150,807) (159,187)
Net Income, Pro Forma $3,447,368 3,354,688 4,103,976
Net Income Per Common Share (Basic), As
Reported $ 1.51 1.39 1.70
Net Income Per Common Share (Basic),
Pro Forma $ 1.36 1.33 1.63
Net Income Per Common Share (Diluted),
As Reported $ 1.48 1.37 1.66
Net Income Per Common Share (Diluted),
Pro Forma $ 1.34 1.31 1.60
The Financial Accounting Standards Board ("FASB") recently
published SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS
No. 123(R)"). SFAS No. 123(R), which is effective for fiscal years
beginning after December 15, 2005, will require that the fair value
of share-based payments to employees, including stock options, be
recognized as compensation expense in the statement of income in
the financial statements. Accordingly, the Company will implement
the revised standard on April 1, 2006. Currently, the Company
accounts for its share-based payment transactions under the
provisions of Accounting Principles Board ("APB") Opinion No. 25,
under which it has not recognized any compensation expense for its
stock option grants and related accounting interpretations,
including FASB Interpretation Number 44, "Accounting for Certain
Transactions Involving Stock Compensation" ("FIN No. 44") in
accounting for stock options.
On March 30, 2006, the Board of Directors approved accelerating the
vesting of 98,800 unvested stock options. The accelerated vesting
was effective as of March 30, 2006. All of the other terms and
conditions applicable to the outstanding stock options remained
unchanged.
The decision to accelerate vesting of these options will avoid
recognition of pre-tax compensation expense by the Company upon the
adoption of SFAS 123(R). In the Company's view, the future
compensation expense could outweigh the incentive and retention
value associated with the stock options. The future compensation
expense, net of income taxes, that will be avoided, based upon the
effective date of April 1, 2006, is expected to be approximately
$275,000. The Company believes that the acceleration of vesting
stock options meets the criteria for variable accounting under FIN
No. 44. Based upon past experience, the Company believes the
grantees of these stock options will remain as a director or
employee of the Company.
32
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Significant Accounting Policies, Continued
------------------------------------------
(o) Earnings Per Share
------------------
Net income per share is computed by dividing consolidated net
income by the weighted average number of common shares outstanding
during the period. The treasury stock method is used to compute
the dilutive effect of stock options in the diluted weighted
average number of common shares.
For the Year Ended
------------------------------------------------------------
March 31, 2006 March 31, 2005
------------------------------ -----------------------------
Per Share Per Share
Income Shares Amounts Income Shares Amounts
--------- --------- -------- -------- -------- ---------
Basic EPS $3,812,851 2,532,999 $ 1.51 $3,505,495 2,524,123 $ 1.39
Dilutive effect
of:
Stock Options - 32,666 (0.02) - 22,726 (0.012)
ESOP - 10,396 (0.01) - 14,588 (0.008)
---------- --------- ------ ---------- --------- ------
Diluted EPS $3,812,851 2,576,061 $ 1.48 $3,505,495 2,561,437 $ 1.37
========== ========= ====== ========== ========= ======
For the Year Ended
March 31, 2004
---------------------------------
Per Share
Income Shares amounts
---------- --------- ---------
Basic EPS $4,263,163 2,513,319 $ 1.70
Dilutive effect of:
Stock Options - 28,959 (0.024)
ESOP - 18,432 (0.016)
---------- --------- -------
Diluted EPS $4,263,163 2,560,710 $ 1.66
========== ========= =======
(p) Use of Estimates
----------------
The preparation of financial statements in conformity with GAAP
requires Management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and the disclosure
of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of income and expenses during
the reporting periods. Actual results could differ from those
estimates.
(q) Recently Issued Accounting Standards
------------------------------------
The following is a summary of recent authoritative pronouncements
that affect accounting, reporting, and disclosure of financial
information by the Company:
As discussed previously, SFAS No. 123(R) will require companies to
measure all employee stock-based compensation awards using a fair
value method and record such expense in its financial statements.
In addition, the adoption of SFAS No. 123(R) requires additional
accounting and disclosures related to the income tax and cash flow
effects resulting from share-based payment arrangements. SFAS No.
123(R) is effective beginning as of the first annual reporting
period beginning after December 15, 2005. SFAS No. 123(R) allows
for adoption using either the modified prospective or modified
retrospective methods. As of March 31, 2006, all options granted
were fully vested. The Company anticipates issuing additional
options in the future but does not expect these options to have a
material impact on financial position or results of operations upon
adoption.
33
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Significant Accounting Policies, Continued
------------------------------------------
(q) Recently Issued Accounting Standards
------------------------------------
In April 2005, the Securities and Exchange Commission's ("SEC")
Office of the Chief Accountant and its Division of Corporation
Finance issued Staff Accounting Bulletin ("SAB") No.107 to provide
guidance regarding the application of SFAS No.123(R). SAB No. 107
provides interpretive guidance related to the interaction between
SFAS No.123(R) and certain SEC rules and regulations, as well as
the staff's views regarding the valuation of share-based payment
arrangements for public companies.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets - an amendment of APB Opinion No. 29." The
standard is based on the principle that exchanges of nonmonetary
assets should be measured based on the fair value of the assets
exchanged and eliminates the exception under ABP Opinion No. 29 for
an exchange of similar productive assets and replaces it with an
exception for exchanges of nonmonetary assets that do not have
commercial substance. A nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to
change significantly as a result of the exchange. The standard is
effective for nonmonetary exchanges occurring in fiscal periods
beginning after June 15, 2005. The adoption of SFAS 153 is not
expected to have a material impact on the Company's financial
position or results of operations.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections - a replacement of APB Opinion No. 20 and FASB
Statement No. 3." SFAS No. 154 establishes retrospective
application as the required method for reporting a change in
accounting principle, unless it is impracticable, in which case the
changes should be applied to the latest practicable date presented.
SFAS No. 154 also requires that a correction of an error be
reported as a prior period adjustment by restating prior period
financial statements. SFAS No. 154 is effective for accounting
changes and corrections of errors made in fiscal years beginning
after December 15, 2005.
In March 2004, the FASB issued Emerging Issues Task Force ("EITF")
Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and
its Application to Certain Investments." This issue addresses the
meaning of other-than-temporary impairment and its application to
investments classified as either available for sale or held to
maturity under SFAS No. 115 and it also provides guidance on
quantitative and qualitative disclosures. The disclosure
requirements in paragraph 21 of this Issue were effective for
annual financial statements for fiscal years ending after December
15, 2003 and were adopted by the Company on April 1, 2004.
The recognition and measurement guidance in paragraphs 6-20 of this
Issue was to be applied to other-than-temporary impairment
evaluations in reporting periods beginning after June 15, 2004, but
was delayed by FASB action in October 2004 through the issuance of
a proposed FASB Staff Position ("FSP") on the issue. In July 2005,
the FASB issued FSP FAS 115-1 and FAS 124-1 "The Meaning of
Other-Than-Temporary Impairment and its Application to Certain
Investments." This final guidance eliminated paragraphs 10-18 of
EITF-03-1 (paragraphs 19-20 have no material impact on the
financial position or results of operations of the Company) and
will be effective for other-than-temporary impairment analysis
conducted in periods beginning after December 15, 2005. The Company
has evaluated the impact that the adoption of FSP FAS 115-1 and FAS
124-1 and has concluded that the adoption will not have a material
impact on financial position and results of operations upon
adoption.
In December 2005, the FASB issued FSP SOP 94-6-1, "Terms of Loan
Products that May Give Rise to a Concentration of Credit Risk". The
disclosure guidance in this FSP is effective for interim and annual
periods ending after December 19, 2005. The FSP states that the
terms of certain loan products may increase a reporting entity's
exposure to credit risk and thereby may result in a concentration
of credit risk as that term is used in SFAS No. 107, either as an
individual product type or as a group of products with similar
features. SFAS No. 107 requires disclosures about each significant
concentration, including "information about the (shared) activity,
region, or economic characteristic that identifies the
concentration." The FSP suggests possible shared characteristics on
which significant concentrations may be determined which include,
but are not limited to: borrowers subject to significant payment
increases, loans with terms that permit negative amortization and
loans with high loan-to-value ratios.
This FSP requires entities to provide the disclosures required by
SFAS No. 107 for loan products that are determined to represent a
concentration of credit risk in accordance with the guidance of
this FSP for all periods presented. The Company adopted this
disclosure standard effective December 31, 2005.
34
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Significant Accounting Policies, Continued
------------------------------------------
(q) Recently Issued Accounting Standards
------------------------------------
In February 2006, the FASB issued SFAS No. 155, "Accounting for
Certain Hybrid Financial Instruments an amendment of FASB
Statements No. 133 and 140." This statement amends SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," and
SFAS No. 140, "Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities." This statement resolves
issues addressed in SFAS No. 133 Implementation Issue No. D1,
"Application of Statement 133 to Beneficial Interests in
Securitized Financial Assets." SFAS No. 155 is effective for all
financial instruments acquired or issued after the beginning of an
entity's first fiscal year that begins after September 15, 2006.
The Company does not believe that the adoption of SFAS No. 155 will
have a material impact on its financial position, results of
operations and cash flows.
In March 2006, the FASB issued SFAS No. 156, "Accounting for
Servicing of Financial Assets an amendment of FASB Statement No.
140." This statement amends FASB No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," with respect to the accounting for separately
recognized servicing assets and servicing liabilities. SFAS No. 156
requires an entity to recognize a servicing asset or servicing
liability each time it undertakes an obligation to service a
financial asset by entering into a servicing contract; requires all
separately recognized servicing assets and servicing liabilities to
be initially measured at fair value, if practicable; permits an
entity to choose its subsequent measurement methods for each class
of separately recognized servicing assets and servicing
liabilities; at its initial adoption, permits a one-time
reclassification of available-for-sale securities to trading
securities by entities with recognized servicing rights, without
calling into question the treatment of other available-for-sale
securities under SFAS No. 115, provided that the available-for-sale
securities are identified in some manner as offsetting the entity's
exposure to changes in fair value of servicing assets or servicing
liabilities that a servicer elects to subsequently measure at fair
value; and requires separate presentation of servicing assets and
servicing liabilities subsequently measured at fair value in the
statement of financial position and additional disclosures for all
separately recognized servicing assets and servicing liabilities.
An entity should adopt SFAS No. 156 as of the beginning of its
first fiscal year that begins after September 15, 2006. The Company
does note believe the adoption of SFAS No. 156 will have a
material impact on its financial position, results of operations
and cash flows.
Other accounting standards that have been issued or proposed by the
FASB or other standards-setting bodies that do not require adoption
until a future date are not expected to have a material impact on
the consolidated financial statements upon adoption.
(r) Risks and Uncertainties
-----------------------
In the normal course of its business, the Company encounters two
significant types of risk: economic and regulatory. There are
three main components of economic risk: interest rate risk, credit
risk, and market risk. The Company is subject to interest rate
risk to the degree that its interest-bearing liabilities mature or
reprice at different speeds, or on different bases, than its
interest-earning assets. Credit risk is the risk of default on the
Company's loan portfolio that results from borrowers' inability or
unwillingness to make contractually required payments. Market risk
reflects changes in the value of collateral underlying loans
receivable, the valuation of real estate held by the Company, and
the valuation of loans held for sale and mortgage-backed securities
available for sale. The Company is subject to the regulations of
various government agencies. These regulations can and do change
significantly from period to period. The Company also undergoes
periodic examinations by the regulatory agencies, which may subject
it to further changes with respect to asset valuations, amounts of
required loss allowances, and operating restrictions, resulting
form the regulators' judgments based on information available to
them at the time of their examination.
(s) Reclassifications
-----------------
Certain amounts in prior years' consolidated financial statements
have been reclassified to conform to current year classifications.
35
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(2) Branch Sale
-----------
In February 2004, the Bank sold its Denmark, South Carolina branch to
South Carolina Bank and Trust, N.A. of Orangeburg, South Carolina.
Included in the sale, were approximately $13.6 million in deposits, $1.9
million in loans, and the branch building, furniture, and equipment. The
Bank recorded a $1.5 million in gain on sale of branch, which includes
gains on all the items in the previous sentence. Gain on sale of branch
is included in "Other Income" as a separate line item in the income
statement. The Bank also booked $200,000 as a contingency expense on the
sale, which is included in the line item called "Other Expense" in the
"General and Administrative Expenses" section of the income statement.
The Bank has possible contingent liabilities for three years. The Bank
netted approximately $820,000 after tax and contingencies on the
transaction.
(3) Investment and Mortgage-Backed Securities, Available for Sale
-------------------------------------------------------------
The amortized cost, gross unrealized gains, gross unrealized losses, and
fair values of investment and mortgage-backed securities available for
sale are as follows:
March 31, 2006
-----------------------------------------------------
Gross Gross
Unrealized Unrealized
Amortized Cost Gains Losses Fair Value
-------------- ---------- ---------- -----------
FHLB Securities $ 24,269,864 $ - $ 265,031 $ 24,004,833
Federal Farm Credit
Securities 2,965,989 - 25,049 2,940,940
FNMA Bonds 1,000,000 - 20,620 979,380
FHLMC Bonds 230,693 - 534 230,159
Mortgage-Backed
Securities 138,238,752 126,648 3,178,584 135,186,816
Equity Securities 102,938 - - 102,938
------------ -------- ---------- ------------
$166,808,236 $126,648 $3,489,818 $163,445,066
============ ======== ========== ============
March 31, 2005
-----------------------------------------------------
Gross Gross
Unrealized Unrealized
Amortized Cost Gains Losses Fair Value
-------------- ---------- ---------- -----------
FHLB Securities $ 4,984,803 $ 4,060 $ 19,063 $ 4,969,800
FHLMC Bonds 484,875 588 - 485,463
Mortgage-Backed
Securities 160,894,954 457,081 1,992,479 159,359,556
------------ -------- ---------- ------------
$166,364,632 $461,729 $2,011,542 $164,814,819
============ ======== ========== ============
The amortized cost and fair value of investment and mortgage-backed
securities available for sale at March 31, 2006 are shown below by
contractual maturity. Expected maturities will differ from contractual
maturities because borrowers have the right to prepay obligations with or
without call or prepayment penalties.
Amortized Cost Fair Value
-------------- ----------
Less Than One Year $ 2,102,938 $ 2,093,558
One - Five Years 18,901,245 18,713,093
More Than Five Years 7,565,301 7,451,599
Mortgage-Backed Securities 138,238,752 135,186,816
------------ ------------
$166,808,236 $163,445,066
============ ============
36
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(3) Investment and Mortgage-Backed Securities, Available for Sale, Continued
------------------------------------------------------------------------
At March 31, 2006 and 2005, 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 $56.8 million and $56.0 million and of $43.7 million and
$43.5 million, respectively.
The Bank received approximately $3.8 million, $0, and $2.4 million in
proceeds from sales of available for sale securities with approximately
$42,097, $0, and $7,700 recorded in gross gains and $3,459, $0, and $0 in
gross losses during the years ended March 31, 2006, 2005 and 2004,
respectively.
The following table shows gross unrealized losses and fair value,
aggregated by investment category, and length of time that individual
available for sale securities have been in a continuous unrealized loss
position, at March 31, 2006.
Less than 12 Months 12 Months or More Total
--------------------- ---------------------- -----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
-------- ---------- -------- ---------- --------- ----------
Agency securities $25,576,707 $258,767 $ 1,578,604 $ 52,467 $ 27,155,311 $ 311,234
Mortgage-backed
securities 52,479,646 699,217 71,034,771 2,479,367 123,514,417 3,178,584
Securities classified as available-for-sale are recorded at fair market
value. Approximately 72.5% of the unrealized losses, or 87 individual
securities, consisted of securities in a continuous loss position for 12
months or more. The Company has the ability and intent to hold these
securities until such time as the value recovers or the securities
mature. The Company believes, based on industry analyst reports and
credit ratings, that the deterioration in value is attributable to
changes in market interest rates and is not in the credit quality of the
issuer and therefore, these losses are not considered other-than-
temporary.
37
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(4) Investment and Mortgage-Backed Securities, Held to Maturity
-----------------------------------------------------------
The amortized cost, gross unrealized gains, gross unrealized losses, and
fair values of investment and mortgage-backed securities held to maturity
are as follows:
March 31, 2006
-----------------------------------------------------
Gross Gross
Unrealized Unrealized
Amortized Cost Gains Losses Fair Value
-------------- ---------- ---------- -----------
FHLB Securities $66,002,180 $ - $1,618,360 $64,383,820
Federal Farm Credit
Securities 8,985,625 - 284,995 8,700,630
----------- ------ ---------- -----------
$74,987,805 $ - $1,903,355 $73,084,450
=========== ====== ========== ===========
March 31, 2005
-----------------------------------------------------
Gross Gross
Unrealized Unrealized
Amortized Cost Gains Losses Fair Value
-------------- ---------- ---------- -----------
FHLB Securities 67,002,146 $ - $1,266,080 $65,736,066
Federal Farm Credit
Securities 8,998,701 - 238,681 8,760,020
Mortgage-Backed
Securities 260,057 14,759 - 274,816
----------- ------- ---------- -----------
$76,260,904 $14,759 $1,504,761 $74,770,902
=========== ======= ========== ===========
The amortized cost and fair value of investment and mortgage-backed
securities held to maturity at March 31, 2006, by contractual maturity,
are shown below. Expected maturities will differ from contractual
maturities due to call features on certain investments.
Amortized Cost Fair Value
-------------- -----------
Less Than One Year $ 5,000,000 $ 4,923,740
One - Five Years 31,981,612 31,373,790
More Than Five Years 38,006,193 36,786,920
----------- -----------
$74,987,805 $73,084,450
=========== ===========
At March 31, 2006 and 2005, the amortized cost and fair value of
investment and mortgage-backed held to maturity pledged as collateral for
certain deposit accounts, FHLB advances and other borrowings were $49.0
million and $47.6 million and $51.0 million and $49.9 million,
respectively.
The Bank received approximately $250,000 in proceeds from the sale of
three held to maturity securities with approximately $10,324 recorded in
gross gains and no gross losses during the year ended March 31, 2006.
All three securities had paid down at least ninety percent therefore
meeting the intent of SFAS 115, "Accounting for Certain Investment in
Debt and Equity Securities". There were no sales of held to maturity
securities during the years ended March 31, 2005 and 2004.
38
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(4) Investment and Mortgage-Backed Securities, Held to Maturity, Continued
----------------------------------------------------------------------
The following table shows gross unrealized losses and fair value,
aggregated by investment category, and length of time that individual
held to maturity securities have been in a continuous unrealized loss
position, at March 31, 2006.
Less than 12 Months 12 Months or More Total
--------------------- ---------------------- -----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
-------- ---------- -------- ---------- --------- ----------
Agency securities $9,806,270 $192,909 $63,278,180 $1,710,446 $73,084,450 $ 1,903,355
Approximately 89.9% of the unrealized losses, or 68 individual
securities, consisted of securities in a continuous loss position for 12
months or more. The Company's held-to-maturity portfolio is recorded at
amortized cost. The Company has the ability and intends to hold these
securities to maturity. The Company believes, based on industry analysis
reports and credit ratings, that the deterioration in value is
attributable to changes in market interest rates and not in credit
quality of the issuer and therefore, these losses are not considered
other-than-temporary.
39
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(5) Loans Receivable, Net
---------------------
Loans receivable, net, at March 31 consisted of the following:
2006 2005
------------ ------------
Residential Real Estate Loans $122,026,698 $122,622,347
Consumer Loans 58,612,669 50,844,192
Commercial Business And Real Estate Loans 209,214,332 162,217,200
Loans Held For Sale 1,320,644 2,277,762
------------ ------------
391,173,943 337,961,501
------------ ------------
Less:
Allowance For Loan Losses 6,704,734 6,284,055
Loans In Process 9,185,133 14,626,913
Deferred Loan Fees 175,000 161,398
------------ ------------
16,064,867 21,072,366
------------ ------------
Total Loans Receivable, Net $375,109,076 $316,889,135
============ ============
Changes in the allowance for loan losses for the years ended March 31 are
summarized as follows:
2006 2005 2004
---------- ---------- ----------
Balance At Beginning Of Year $6,284,055 $5,763,935 $4,911,224
Provision For Loan Losses 660,000 780,000 1,200,000
Charge Offs (301,650) (443,132) (669,591)
Recoveries 62,329 183,252 322,302
---------- ---------- ----------
Total Allowance For Loan Losses $6,704,734 $6,284,055 $5,763,935
========== ========== ==========
The following table sets forth the amount of the Company's non-accrual
loans and the status of the related interest income at March 31.
2006 2005
---------- ----------
Non-Accrual Loans $1,191,000 $2,430,000
========== ==========
Interest Income That Would Have Been
Recognized Under Original Terms $ 111,000 $ 189,000
========== ==========
At March 31, 2006 and 2005, impaired loans amounted to $2.1 million and
$1.2 million, respectively. Losses on impaired loans are accounted for
in the allowance for loan loss. For the years ended March 31, 2006 and
2005, the average recorded investment in impaired loans was $1.4 million
and $1.3 million, respectively.
The Bank blanket pledges its portfolio of single-family mortgage loans to
secure FHLB advances.
40
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(6) Premises and Equipment, Net
---------------------------
Premises and equipment, net, at March 31 are summarized as follows:
2006 2005
----------- ----------
Land $ 2,810,406 1,506,053
Buildings And Improvements 8,693,773 7,918,516
Furniture And Equipment 6,270,596 6,210,879
Construction In Progress 1,902,474 129,968
----------- ----------
19,677,249 15,765,416
Less Accumulated Depreciation (8,014,273) (7,851,373)
----------- ----------
Total Premises And Equipment, Net $11,662,976 7,914,043
=========== ==========
Depreciation expense for the years ended March 31, 2006, 2005, and 2004
was approximately $965,000, $860,000, and $845,000, respectively.
The Bank has entered into non-cancelable operating leases related to
buildings and land. At March 31, 2006, future minimum payments under
non-cancelable operating leases with initial or remaining terms of one
year or more are as follows (by fiscal year):
2007 $ 276,498
2008 275,558
2009 274,512
2010 280,073
2011 280,073
Thereafter 1,538,553
----------
$2,925,267
==========
Total rental expense amounted to $295,000, $289,000, and $278,000 for the
years ended March 31, 2006, 2005 and 2004, respectively. Four lease
agreements with monthly expenses of $7,083, $4,334, $750, and $700 have
multiple renewal options totaling 45, 20, 40, and 10 years, respectively.
(7) FHLB Stock
----------
Every federally insured savings institution is required to invest in FHLB
stock. No ready market exists for this stock and it has no quoted fair
value. However, because redemption of this stock has historically been
at par, it is carried at cost.
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 0.20% of total assets at December 31,
2005 and 2004 plus a transaction component which equals 4.5% of
outstanding advances (borrowings) from the FHLB of Atlanta. The Bank is
in compliance with this requirement with an investment in FHLB of Atlanta
stock of $7.1 million and $6.2 million as of March 31, 2006 and 2005,
respectively.
41
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(8) Deposits
--------
Deposits outstanding by type of account are summarized as follows:
At March 31, 2006 At March 31, 2005
-------------------------------------- ---------------------------------
Weighted Interest Rate Weighted Interest Rate
Rate Range Amount Rate Range
------------ -------- ------------- ---------- ------ -------------
Checking Accounts $105,347,713 0.97% 0.00-2.96% $ 88,169,885 0.65% 0.00-2.47%
Money Market Accts. 151,494,548 3.50% 1.09-3.93% 164,088,081 2.57% 1.09-2.72%
Passbook Accounts 17,795,109 0.98% 0.00-1.51% 17,743,659 0.98% 0.00-1.50%
------------ ---- --------- ------------ ---- ---------
Total 274,637,370 2.36% 0.00-3.93% 270,001,625 1.84% 0.00-2.72%
------------ ---- --------- ------------ ---- ---------
Certificate Accounts:
0.00 - 1.99% 59,797 23,435,263
2.00 - 2.99% 26,836,415 80,953,849
3.00 - 3.99% 72,831,817 37,001,344
4.00 - 4.99% 94,240,989 9,095,824
5.00 - 5.99% 10,622,951 9,795,989
6.00 - 6.99% - 3,497
------------ ------------
Total 204,591,969 3.98% 1.74-5.30% 160,285,766 2.92% 0.90-6.55%
------------ ---- --------- ------------ ---- ---------
Total Deposits $479,229,339 3.05% 0.00-5.30% $430,287,391 2.24% 0.00-6.55%
============ ==== ========= ============ ==== =========
The aggregate amount of short-term certificates of deposit with a minimum
denomination of $100,000 was $61.9 million and $61.7 million at March 31,
2006 and 2005, respectively. The amounts and scheduled maturities of all
certificates of deposit at March 31 are as follows:
March 31,
----------------------------
2006 2005
------------ ------------
Within 1 Year $164,023,363 $ 95,707,286
After 1 Year, Within 2 31,427,049 40,973,203
After 2 Years, Within 3 3,423,264 17,811,991
After 3 Years, Within 4 2,104,277 4,680,838
After 4 Years, Within 5 3,614,016 1,112,448
Thereafter - -
------------ ------------
$204,591,969 $160,285,766
============ ============
42
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(9) Advances From Federal Home Loan Bank (FHLB) And Other Borrowings
----------------------------------------------------------------
Advances from the FHLB at March 31 are summarized by year of maturity and
weighted average interest rate below:
2006 2005
----------------------- -----------------------
Weighted Weighted
Year Ending March 31 Amount Rate Amount Rate
------------ --------- ------------- --------
2006 $ - - $ 40,675,000 4.09%
2007 18,000,000 2.83% 18,000,000 2.83%
2008 5,000,000 3.09% 10,000,000 2.96%
2009 20,000,000 3.28% 25,000,000 3.05%
2010 5,000,000 3.09% 5,000,000 3.09%
2011 20,000,000 4.37% -
Thereafter 63,363,000 4.04% 13,363,000 3.21%
------------ ---- ------------ ----
$131,363,000 3.74% $112,038,000 3.41%
============ ==== ============ ====
These advances are secured by a blanket collateral agreement with the
FHLB by pledging the Bank's portfolio of residential first mortgage loans
and investment securities with amortized cost and fair value of $64.5
million and $63.0 million at March 31, 2006 and $51.1 million and $50.2
million at March 31, 2005, respectively. Advances are subject to
prepayment penalties.
The following tables show callable FHLB advances as of the dates
indicated. These advances are also included in the above table. All
callable advances are callable at the option of the FHLB. If an advance
is called, the Bank has the option to payoff the advance without penalty,
re-borrow funds on different terms, or convert the advance to a
three-month floating rate advance tied to LIBOR.
As of March 31, 2006
---------------------------------------------------------------------------
Borrow Date Maturity Date Amount Int. Rate Type Call Dates
----------- ------------- ----------- --------- ----------- ----------
11/07/02 11/07/12 $ 5,000,000 3.354% 1 Time Call 11/07/07
10/24/03 10/24/08 10,000,000 2.705% Multi-Call 10/24/06 and
quarterly
thereafter
02/20/04 02/20/14 5,000,000 3.225% 1 Time Call 02/20/09
04/16/04 04/16/14 3,000,000 3.330% 1 Time Call 04/16/08
09/16/04 09/16/09 5,000,000 3.090% 1 Time Call 09/17/07
06/24/05 06/24/15 5,000,000 3.710% 1 Time Call 06/24/10
06/24/05 06/24/10 5,000,000 4.092% 1 Time Call 06/24/06
07/22/05 07/22/15 5,000,000 3.790% 1 Time Call 07/22/08
10/21/05 10/21/10 5,000,000 3.864% 1 Time Call 10/23/06
11/10/05 11/10/15 5,000,000 4.400% 1 Time Call 11/10/09
11/23/05 11/23/15 5,000,000 3.933% Multi-Call 11/23/07 and
quarterly
thereafter
11/29/05 11/29/13 5,000,000 4.320% 1 Time Call 05/29/09
12/14/05 12/14/11 5,000,000 4.640% 1 Time Call 09/14/09
01/12/06 01/12/16 5,000,000 4.450% 1 Time Call 01/12/11
03/24/06 03/24/16 5,000,000 4.120% Multi-Call 03/26/07
03/24/06 03/25/13 5,000,000 4.580% 1 Time Call 03/25/08
03/01/06 03/03/14 5,000,000 4.720% 1 Time Call 03/03/10
As of March 31, 2005
---------------------------------------------------------------------------
Borrow Date Maturity Date Amount Int. Rate Type Call Dates
----------- ------------- ----------- --------- ----------- ----------
11/10/00 11/10/05 $ 5,000,000 5.85% Multi-Call 5/10/05 and
quarterly
thereafter
09/04/02 09/04/07 5,000,000 2.82% 1 Time Call 09/06/05
11/07/02 11/07/12 5,000,000 3.354% 1 Time Call 11/07/07
10/24/03 10/24/08 10,000,000 2.705% Multi-Call 10/24/06 and
quarterly
thereafter
12/10/03 12/10/08 5,000,000 2.16% Multi-Call 12/12/05 and
quarterly
thereafter
02/20/04 02/20/14 5,000,000 3.225% 1 Time Call 02/20/09
04/16/04 04/16/14 3,000,000 3.33% 1 Time Call 04/16/08
09/16/04 09/16/09 5,000,000 3.09% 1 Time Call 09/17/07
43
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(9) Advances From Federal Home Loan Bank (FHLB) And Other Borrowings,
-----------------------------------------------------------------
Continued
---------
At March 31, 2006 and 2005, the Bank had $66.2 million and $63.5 million
in additional borrowing capacity, respectively at the FHLB.
The Bank had $7.3 million and $5.6 million in other borrowings (non-FHLB
advances) at March 31, 2006 and 2005, respectively. These borrowings
consisted of repurchase agreements with certain commercial demand deposit
customers for sweep accounts. The interest rate paid on these borrowings
floats monthly with the 13 week Treasury bill. At March 31, 2006 and
2005, the interest rate paid on these borrowings was 4.43% and 2.54%,
respectively. The Bank had pledged as collateral for these borrowings
investment securities with amortized costs and fair values of $25.5
million and $24.9 million at March 31, 2006 and $27.7 million and $27.3
million at March 31, 2005, respectively, as collateral for these
borrowings.
44
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(10) Income Taxes
------------
Income tax expense is comprised of the following:
For the Years Ended March 31,
-------------------------------------
2006 2005 2004
---------- --------- ---------
Current:
Federal $1,534,117 1,610,169 2,948,661
State 155,772 163,495 356,824
---------- --------- ---------
Total Current Tax Expense 1,689,889 1,773,664 3,305,485
---------- --------- ---------
Deferred:
Federal 77,600 (55,791) (653,360)
State 10,127 (7,281) (200,482)
---------- --------- ---------
Total Deferred Tax Expense 87,727 (63,072) (853,842)
---------- --------- ---------
Total Income Tax Expense $1,777,616 1,710,592 2,451,643
========== ========= =========
The Company's income taxes differ from those computed at the statutory
federal income tax rate, as follows:
For the Years Ended March 31,
--------------------------------------
2006 2005 2004
---------- --------- ----------
Tax At Statutory Income Tax Rate $1,900,759 1,773,470 $2,283,034
State Tax And Other (123,143) (62,878) 168,609
---------- --------- ----------
Total Income Tax Expense $1,777,616 1,710,592 $2,451,643
========== ========= ==========
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are
presented below.
At March 31,
------------------------
2006 2005
---------- ----------
Deferred Tax Assets:
Provision For Loan Losses $2,545,116 $2,513,622
Goodwill Tax Basis Over Financial Statement Basis 249,495 364,672
Net Fees Deferred For Financial Reporting 187,191 190,053
Unrealized Loss on Securities Available for Sale 1,276,659 588,310
Other 163,664 178,533
---------- ----------
Total Gross Deferred Tax Assets 4,422,125 3,835,190
---------- ----------
Deferred Tax Liabilities:
FHLB Stock Basis Over Tax Basis 126,565 133,367
Depreciation 218,318 211,287
Other 88,484 102,400
---------- ----------
Total Gross Deferred Tax Liability 433,367 447,054
---------- ----------
Net Deferred Tax Asset $3,988,758 $3,388,136
========== ==========
The balance of the change in the net deferred tax asset results from the
current period deferred tax benefit of $63,072. The net deferred tax
asset is included in other assets in the accompanying consolidated
balance sheets.
No valuation allowance for deferred tax assets was required at March 31,
2006 and 2005. The realization of net deferred tax assets may be based
on utilization of carrybacks to prior taxable periods, anticipation of
future taxable income in certain periods, and the utilization of tax
planning strategies. Management has determined that the net deferred tax
asset can be supported based upon these criteria.
45
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(11) Regulatory Matters
------------------
The Bank is subject to various regulatory capital requirements that are
administered by federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and discretionary
actions by regulators that could have a material adverse effect on the
Company. Under 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
classifications are also subject to qualitative judgments by regulators
with regard to components, risk weightings, and other factors.
As of March 31, 2006 and 2005, the Bank was categorized as "well
capitalized" under the regulatory framework for prompt corrective action.
To be categorized as well capitalized, the Bank had to maintain total
risk-based capital, Tier 1 risk-based capital, and Tier 1 leverage ratios
at 10%, 6%, and 5%, respectively. There are no conditions or events that
management believes have changed the Bank's classification.
The Bank's regulatory capital amounts and ratios are as follows as of the
dates indicated:
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Actual Adequacy Provisions
-------------- ------------- --------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in Thousands)
March 31, 2006
Tier 1 Risk-Based Core Capital
(To Risk Weighted Assets) $39,473 9.7% $16,328 4.0% $24,492 6.0%
Total Risk-Based Capital
(To Risk Weighted Assets) 44,568 10.9% 32,669 8.0% 40,836 10.0%
Tier 1 Leverage (Core) Capital
(To Adjusted Tangible Assets) 39,473 6.0% 26,431 4.0% 33,039 5.0%
Tangible Capital
(To Tangible Assets) 39,473 6.0% 13,224 2.0% 33,039 5.0%
March 31, 2005
Tier 1 Risk-Based Core Capital
(To Risk Weighted Assets) $35,652 10.5% $13,555 4.0% $20,332 6.0%
Total Risk-Based Capital
(To Risk Weighted Assets) 39,858 11.8% 27,110 8.0% 33,887 10.0%
Tier 1 Leverage (Core) Capital
(To Adjusted Tangible Assets) 35,652 6.1% 23,472 4.0% 29,341 5.0%
Tangible Capital
(To Tangible Assets) 35,652 6.1% 11,736 2.0% 29,341 5.0%
The payment of dividends by the Company depends primarily on the ability
of the Bank to pay dividends to the Company. The payment of dividends by
the Bank to the Company is subject to substantial restrictions and would
require prior notice to the Office of Thrift Supervision ("OTS").
46
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(12) Employee Benefit Plans
----------------------
The Company is participating in a multiple employer defined contribution
employee benefit plan covering substantially all employees with six
months or more of service. The Company matches a portion of the
employees' contributions and the plan has a discretionary profit sharing
provision. The total employer contributions were $113,000, $36,000, and
$256,000 for the years ended March 31, 2006, 2005, and 2004,
respectively.
The Company has an Employee Stock Ownership Plan ("ESOP") for the
exclusive benefit of employee participants. The discretionary
contributions for the years ended March 31, 2006, 2005, and 2004 were
$231,000, $75,000, and $75,000, respectively. The ESOP from time to time
borrows funds from financial institutions to purchase the Company's
stock. The balance of the loan was $216,000 and $276,000 at March 31,
2006 and 2005, respectively. The Company carries the debt as a liability
and a reduction in equity, although the Company neither endorses nor
guarantees the loan. The loan is repaid by Company contributions to the
trustee, who in turn makes the loan payment to the financial institution.
Certain officers of the Company participate in an incentive stock option
plan. Options are granted at exercise prices not less than the fair
value of the Company's common stock on the date of the grant. The
following is a summary of the activity under the Company's incentive
stock option plan for the years ended March 31, 2006, 2005, and 2004.
2006 2005 2004
--------------- --------------- --------------
Weighted Weighted Weighted
Avg. Avg. Avg.
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ -------- ------ --------
Balance, Beginning of
Year 135,292 $19.09 131,639 $18.23 114,366 $15.77
Options granted 6,500 23.91 32,000 20.89 31,000 22.97
Options exercised 14,396 15.45 10,547 15.95 3,467 5.33
Options forfeited 9,350 19.52 17,800 19.58 10,260 6.51
------- ------- -------
Balance, March 31 118,046 $19.50 135,292 $19.09 131,639 $18.23
======= ======= =======
Options Exercisable 118,046 $19.50 20,672 $15.82 7,547 $15.67
======= ======= =======
Options Available For
Grant 13,750 10,000 23,000
======= ======= =======
At March 31, 2006, the Company had the following options outstanding:
Outstanding
Grant Date Options Option Price Expiration Date
---------- ----------- ------------ --------------------
1/07/97 1,546 $5.33 12/31/05 to 12/31/06
10/19/99 51,000 $16.67 9/30/05 to 9/30/09
1/16/03 1,500 $22.39 12/31/12
9/1/03 3,000 $24.00 8/31/13
12/1/03 3,000 $23.65 11/30/13
1/01/04 8,500 $24.22 12/31/13
3/8/04 13,000 $21.43 2/28/14
6/7/04 2,000 $24.00 5/31/14
1/1/05 26,000 $20.55 12/31/14
1/1/05 2,000 $22.61 12/31/15
1/1/06 6,500 $22.91 12/31/16
47
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(12) Employee Benefit Plans, Continued
---------------------------------
The options listed on the previous page vested immediately on March 30,
2006 as a result of an action taken by the Board of Directors. All
options, issued prior to January 16, 2003, must be exercised within one
year of the original vesting schedule, except those granted during the
year ended March 31, 2004 or later, which may be exercised anytime
between the beginning of the sixth year and the end of the tenth year
after the grant date.
The incentive stock option plan adopted by the Company includes a
provision for tandem stock appreciation rights ("SARs"). Options granted
after March 31, 2002, were not granted in tandem with SAR's, while
options granted before March 31, 2002 were granted in tandem with SAR's.
Upon vesting, these stock appreciation rights are exercisable in lieu
of the stock options granted to the employee. Upon exercise, the
employee chooses the option or SAR feature, and the tandem instrument is
cancelled. The Company accounts for incentive stock options and tandem
SARs under APB Opinion No. 25, "Accounting for Stock Issued to
Employees." APB Opinion No. 25 states that compensation cost for a
combination plan permitting an employee to elect one part should be
measured according to the terms that an employee is mostly likely to
elect based on the facts available each period. Due to the personal
income tax implications of SARs under the Internal Revenue Code,
employees have historically elected to exercise options rather than the
SARs. Accordingly, the Company has elected to measure compensation cost
for stock options as required by APB Opinion No. 25, rather than for
the SARs.
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted
average assumptions for grants: Dividend yield of $0.16, $0.08, and $0.08
per share for options granted during the years ended March 31, 2006,
2005, and 2004, respectively, expected volatility of 39.8% for options
granted in 2006, 21.2% for options granted in 2005, and 21.4% for options
granted in 2004, risk-free interest rate of 4.42% for options granted in
2006, 4.82% for options granted in 2005, and 3.74% to 4.45% for options
granted in 2004, and expected lives of six to ten years.
(13) Bank Owned Life Insurance
-------------------------
On March 31, 2006, the Company purchased bank owned life insurance. The
cash value of the life insurance policies are recorded as a separate line
item in the accompanying balance sheets at $5,000,001 and $0 at March 31,
2006 and 2005, respectively. See Note 19, "Subsequent Events."
48
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(14) Commitments and Contingencies
-----------------------------
In the ordinary course of business, the Company has various outstanding
commitments and contingent liabilities that are not reflected in the
accompanying consolidated financial statements. In addition, the Company
is a defendant in certain claims and legal actions arising in the
ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these
matters is not expected to have a material adverse effect on the
consolidated financial condition of the Company.
In conjunction with its lending activities, the Bank enters into various
commitments to extend credit and issue letters of credit. Loan
commitments (unfunded loans and unused lines of credit) and letters of
credit are issued to accommodate the financing needs of the Bank's
customers. Loan commitments are agreements by the Bank to lend at a
future date, so long as there are no violations of any conditions
established in the agreement. Letters of credit commit the Bank to make
payments on behalf of customers when certain specified events occur.
Financial instruments where the contract amount represents the Bank's
credit risk include commitments under pre-approved but unused lines of
credit of $68.0 million and $55.6 million, undisbursed loans in process
totaled $9.2 million and $14.6 million, and letters of credit of $1.4
million and $1.2 million at March 31, 2006 and 2005, respectively. At
March 31, 2006 and 2005, the fair value of standby letters of credit was
immaterial.
These loan and letter of credit commitments are subject to the same
credit policies and reviews as loans on the balance sheet. Collateral,
both the amount and nature, is obtained based upon management's
assessment of the credit risk. Since many of the extensions of credit
are expected to expire without being drawn, the total commitment amounts
do not necessarily represent future cash requirements. In addition to
these loan commitments noted above, the Bank had unused credit card loan
commitments of $2.9 million and $2.6 million at March 31, 2006 and 2005,
respectively. Outstanding commitments on mortgage loans not yet closed
amounted to $351,000 and $180,000 at March 31, 2006 and 2005,
respectively. These commitments, which are funded subject to certain
limitations, extend over varying periods of time with the majority being
funded within 45 days. At March 31, 2006 and 2005, the Bank had
outstanding commitments to sell approximately $1.3 and $2.3 million of
loans, respectively, which encompassed the Bank's held for sale loans.
The Bank also has commitments to sell mortgage loans not yet closed, on a
best efforts basis. Best efforts means the Bank suffers no penalty if
they are unable to deliver the loans to the potential buyers. The fair
value of the Bank's commitment to originate mortgage loans at committed
interest rates and to sell such loans to permanent investors is
insignificant.
49
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(15) Related Party Transactions
--------------------------
Certain directors, executive officers and companies with which they are
affiliated, are customers of and have banking transactions with the Bank
in the ordinary course of business. These loans were made on
substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable arms-length transactions.
A summary of loan transactions with directors, including their
affiliates, and executive officers follows:
For the years ended March 31,
----------------------------------
2006 2005 2004
-------- -------- --------
Balance, beginning of year $550,010 $528,974 $466,683
New loans 255,278 115,827 196,695
Less loan payments 385,049 94,791 134,404
-------- -------- --------
Balance, end of year $420,239 $550,010 $528,974
======== ======== ========
Loans to all employees, officers, and directors of the Company, in the
aggregate constituted approximately 5.54% and 7.96% of the total
shareholders' equity of the Company at March 31, 2006 and 2005,
respectively. At March 31, 2006 and 2005, deposits from executive
officers and directors of the Bank and Company and their related
interests in aggregate approximated $2.8 million and $2.5 million,
respectively.
The Company rents office space from a company in which a director and an
officer of the Company and the Bank have an ownership interest. The Bank
incurred expenses of $51,000, $41,000, and $30,000 for rent for the years
ended March 31, 2006, 2005 and 2004, respectively. Management is of the
opinion that the transactions with respect to office rent are made on
terms that are comparable to those which would be made with unaffiliated
persons.
50
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(16) Security Federal Corporation Condensed Financial Statements (Parent
-------------------------------------------------------------------
Company Only)
------------
The following is condensed financial information of Security Federal
Corporation (Parent Company only). The primary asset is its investment
in the Bank subsidiary and the principal source of income for the Company
is equity in undistributed earnings from the Bank.
Condensed Balance Sheet Data
At March 31,
-------------------------
2006 2005
----------- -----------
Assets:
Cash $ 294,984 $ 669,550
Investment Securities 102,938 -
Investment In Security Federal Bank 37,387,104 34,690,893
Income Tax Receivable From Bank 41,344 35,947
----------- -----------
Total Assets $37,826,370 $35,396,390
=========== ===========
Liability And Shareholders' Equity:
Accounts Payable $ 9,108 $ 9,108
Indirect Guarantee Of ESOP Debt 215,503 276,217
Shareholders' Equity 37,601,759 35,111,065
----------- -----------
Total Liabilities And Shareholders' Equity $37,826,370 $35,396,390
=========== ===========
Condensed Statements of Income Data
For the Years Ended March 31,
-------------------------------------
2006 2005 2004
---------- ---------- ----------
Income:
Equity In Earnings Of Security
Federal Bank $3,821,229 $3,512,277 $4,260,347
Miscellaneous Income - - 10,000
---------- ---------- ----------
3,821,229 3,512,277 4,270,347
Expenses:
Other Expenses 8,378 6,782 7,184
---------- ---------- ----------
Net Income $3,812,851 $3,505,495 $4,263,163
========== ========== ==========
Condensed Statements of Cash Flow Data
For the Years Ended March 31,
-------------------------------------
2006 2005 2004
---------- ---------- ----------
Operating Activities:
Net Income $ 3,812,851 $ 3,505,495 $ 4,263,163
Adjustments To Reconcile Net Income
To Net Cash Used In Operating
Activities:
Equity In Earnings Of Security
Federal Bank (3,821,229) (3,512,277) (4,260,347)
(Increase) Decrease In Income Taxes
Receivable And Other Assets (5,384) (4,409) 1,644
Decrease In Accounts Payable - - (10,000)
----------- ----------- -----------
Net Cash Used In Operating
Activities (13,762) (11,191) (5,540)
----------- ----------- -----------
Investing Activities:
Purchase Of Investment Securities (102,938)
Dividend Received From Security
Federal Bank - - 1,000,000
----------- ----------- -----------
Net Cash (Used In) Provided By
Investing Activities (102,938) - 1,000,000
----------- ----------- -----------
Financing Activities:
Exercise Of Stock Options 222,450 168,235 18,479
Purchase Of Treasury Stock, At Cost (73,567) (165,089) -
Dividends Paid (406,749) (278,987) (202,563)
----------- ----------- -----------
Net Cash Used In Financing Activities (257,866) (275,841) (184,084)
----------- ----------- -----------
Net Increase (Decrease) In Cash (374,566) (287,032) 810,376
Cash At Beginning Of Year 669,550 956,582 146,206
----------- ----------- -----------
Cash At End Of Year $ 294,984 $ 669,550 $ 956,582
=========== =========== ===========
51
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(17) Carrying Amounts and Fair Value of Financial Instruments
--------------------------------------------------------
The carrying amounts and fair value of financial instruments are
summarized below:
At March 31,
-------------------------------------------
2006 2005
-------------------- --------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
-------- ---------- -------- ----------
(In Thousands)
Financial Assets:
Cash And Cash Equivalents $ 14,351 14,351 $ 7,916 $ 7,916
Investment And Mortgage-Back
Securities $238,433 236,530 $241,076 $239,586
Loans Receivable, Net $375,109 376,221 $316,889 $320,990
FHLB Stock $ 7,150 7,150 $ 6,235 $ 6,235
Financial Liabilities:
Deposits:
Checking, Savings, And
Money Market Accounts $274,637 274,637 $270,002 $270,002
Certificate Accounts $204,592 203,871 $160,286 $159,805
Advances From FHLB $131,363 129,117 $112,038 $111,209
Other Borrowed Money $ 7,290 7,290 $ 5,594 $ 5,594
At March 31, 2006, the Bank had $81.9 million of off-balance sheet
financial commitments. These commitments are to originate loans and
unused consumer lines of credit and credit card lines. Because these
obligations are based on current market rates, if funded, the original
principal is considered to be a reasonable estimate of fair value.
Fair value estimates are made at a specific point in time, 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
values used are provided from the OTS interest rate risk model.
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.
52
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(18) Quarterly Financial Data (Unaudited)
-----------------------------------
Unaudited condensed financial data by quarter for fiscal year 2006 and
2005 is as follows (amounts, except per share data, in thousands):
Quarter ended
---------------------------------------------
June 30, Sept. 30, Dec. 31, Mar. 31,
2005-2006 2005 2005 2005 2006
-------- -------- -------- --------
Interest Income $ 7,412 7,835 8,270 8,889
Interest Expense 3,489 3,784 4,112 4,584
---------- --------- --------- ---------
Net Interest Income 3,923 4,051 4,158 4,305
Provision For Loan Losses 165 165 165 165
---------- --------- --------- ---------
Net Interest Income After
Provision For Loan Losses 3,758 3,886 3,993 4,140
Non-interest Income 690 749 714 687
Non-interest Expense 2,996 3,172 3,204 3,655
---------- --------- --------- ---------
Income Before Income Tax 1,452 1,463 1,503 1,172
Provision For Income taxes 523 514 545 196
---------- --------- --------- ---------
Net Income $ 929 949 958 976
========== ========= ========= =========
Basic Net Income Per Common
Share $ 0.37 0.38 0.38 0.38
========== ========= ========= =========
Diluted Net Income Per
Common Share $ 0.36 0.37 0.37 0.38
========== ========= ========= =========
Basic Weighted Average
Shares Outstanding 2,530,389 2,527,533 2,536,304 2,537,771
========== ========= ========= =========
Diluted Weighted Average
Shares Outstanding 2,556,205 2,585,543 2,570,767 2,591,728
========== ========= ========= =========
Quarter ended
---------------------------------------------
June 30, Sept. 30, Dec. 31, Mar. 31,
2004-2005 2004 2004 2004 2005
-------- -------- -------- --------
Interest Income $ 6,044 $ 6,242 $ 6,471 $ 6,833
Interest Expense 2,596 2,880 2,925 3,123
---------- ---------- ---------- ----------
Net Interest Income 3,448 3,362 3,546 3,710
Provision For Loan Losses 195 195 195 195
---------- ---------- ---------- ----------
Net Interest Income After
Provision For Loan Losses 3,253 3,167 3,351 3,515
Non-interest Income 659 724 706 614
Non-interest Expense 2,694 2,711 2,712 2,655
---------- ---------- ---------- ----------
Income Before Income Tax 1,218 1,180 1,345 1,474
Provision For Income taxes 416 380 433 482
---------- ---------- ---------- ----------
Net Income $ 802 $ 800 $ 912 $ 992
========== ========== ========== ==========
Basic Net Income Per
Common Share $ 0.32 $ 0.32 $ 0.36 $ 0.39
========== ========== ========== ==========
Diluted Net Income Per
Common Share $ 0.31 $ 0.31 $ 0.36 $ 0.39
========== ========== ========== ==========
Basic Weighted Average
Shares Outstanding 2,522,600 2,519,627 2,527,661 2,526,605
========== ========== ========== ==========
Diluted Weighted Average
Shares Outstanding 2,562,892 2,555,774 2,556,839 2,565,645
========== ========== ========== ==========
(19) Subsequent Events
-----------------
Subsequent to March 31, 2006, a supplemental retirement plan for certain
executive officers of Security Federal Bank was created. These benefits
are not qualified under the Internal Revenue Code and they are not
funded. However, certain funding is provided informally and indirectly
by life insurance policies. At March 31, 2006, there was no revenue or
expense recorded for these benefits.
Subsequent to March 31, 2006, the Bank entered into a $2.4 million
contract with an architect and general contractor to design and
construct a three story building located in Evans, Georgia. The Bank
intends to occupy the first floor and lease the second and third
floors. The estimated completion date is April 2007.
53
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
SHAREHOLDERS INFORMATION
ANNUAL MEETING
The annual meeting of shareholders will be held at 2:00 p.m., Thursday, July
20, 2006 at the City of Aiken Municipal Conference Center, 215 The Alley,
Aiken, South Carolina.
STOCK LISTING
The Company's stock is traded on the Over-The-Counter-Bulletin Board under the
symbol "SFDL.OB." The stock began trading on the Bulletin Board in October
2003.
PRICE RANGE OF COMMON STOCK
The table below shows the range of high and low bid prices. These prices
represent actual transactions and do not include retail markups, markdowns or
commissions. Market makers include Sterne, Agee, and Leach, Inc., Morgan
Keegan and Company, Inc., A.G. Edwards and Sons, Inc., Hill, Thompson, and
Magid, and Monroe Securities, Inc.
Quarter Ending High Low
-------------- --------- ---------
06-30-04 $27.00 $19.75
09-30-04 $23.60 $21.50
12-31-04 $21.95 $20.25
03-31-05 $24.00 $19.75
06-30-05 $21.75 $21.75
09-30-05 $29.00 $29.00
12-31-05 $23.50 $23.50
03-31-06 $24.25 $24.25
As of March 31, 2006, the Company had approximately 503 shareholders and
2,558,234 outstanding shares of common stock.
DIVIDENDS
The first quarterly dividend on the stock was paid to shareholders on March
15, 1991. Dividends will be paid upon the determination of the Board of
Directors that such payment is consistent with the long-term interest of the
Company. The factors affecting this determination include the Company's
current and projected earnings, operating results, financial condition,
regulatory restrictions, future growth plans, and other relevant factors. The
Company paid $0.02 per share cash dividends for each of the quarters during
fiscal 2003-2004 and the first quarter of fiscal 2004-2005. The Company paid
$0.03 per share cash dividend in each of the last three quarters of 2004-2005.
The Company paid $0.04 per share cash dividends for each of the quarters
during fiscal 2005-2006.
The ability of the Company to pay dividends depends primarily on the ability
of the Bank to pay dividends to the Company. The Bank may not declare or pay
a cash dividend on its stock or repurchase shares of its stock if the offset
thereof would be to cause its regulatory capital to be reduced below the
amount required for the liquidation account or to meet applicable regulatory
capital requirements. Pursuant to the OTS regulations, Tier 1 associations
(associations that before and after the proposed distribution meet or exceed
their fully phased-in capital requirements) may make capital distributions
during any calendar year equal to 100% of net income for the year-to-date plus
50% of the amount by which the association's total capital exceeds its fully
phased-in capital requirement as measured at the beginning of the capital
year. However, a Tier 1 association deemed to be in need of more than normal
supervision by the OTS may be downgraded to a Tier 2 or Tier 3 association as
a result of such a determination. The Bank is also required to give the OTS
30 days notice prior to the declaration of a dividend. Unlike the Bank, there
is no regulatory restriction on the payment of dividends by the Company;
however, it is subject to the requirements of South Carolina. South Carolina
generally prohibits the Company from paying dividends if, after giving effect
to a proposed dividend: (1) the Company would be unable to pay its debts as
they become due in the normal course of business, or (2) the Company's total
assets would be less than its total liabilities plus the sum that would be
needed to satisfy the preferential rights upon dissolution of shareholders
whose preferential rights are superior to those receiving the dividend.
54
A familiar face.
[picture of
Lynn We are pleased to announce the recent hiring of Ms. Lynn Shepard
Shepard] as Senior Vice President and Senior Operations Officer. Lynn is
a resident of Aiken with over 30 years of banking experience.
Lynn is currently involved with the United Way, Rotary Club, and
Chairman of the AHS Academy of Finance. She is an ordained
deacon and serves as trustee for South Aiken Presbyterian Church
where she is also a member of the choir.
We are very fortunate to have such an experienced and committed
member added to the Security Federal Bank team.
Lynn Shepard
Senior Vice President and
Senior Operations Officer
Shareholders Information
------------------------------------------------------------------------------
Annual and Other Reports
The Company is required to file an annual report on Form 10-K for its fiscal
year ended March 31, 2006 with the Securities and Exchange Commission. Copies
of Form 10-K, Security Federal Corporation's annual report, and the Company's
quarterly reports may be obtained from and inquiries may be addressed to Mrs.
Ruth L. Vance of Security Federal Corporation.
GENERAL TRANSFER SPECIAL
INQUIRIES AGENT COUNSEL
Mrs. Ruth L. Vance Security Federal Breyer & Associates, PC
Security Federal Corporation Suite 785
Corp. 238 Richland Ave., West 8180 Greensboro Drive
238 Richland Ave., West P.O. Box 810 McLean, VA 22102
P.O. Box 810 Aiken, SC 29802-0810
Aiken, SC 29802-0810
Phone: 803-641-3000
Toll free: 866-851-3000
INDEPENDENT
AUDITORS
Elliott Davis, LLC
1901 Main Street
Suite 1650
P.O. Box 2227
Columbia, SC 29202-2227
55
Board of Directors
-----------------------------------------------------------------------------
BOARD OF DIRECTORS
T. Clifton Weeks Sen. Thomas L. Moore Harry O. Weeks, Jr.
Chairman President Business Dev. Executive
Security Federal Corp. Boiler Efficiency, Inc. Hutson-Etherredge Co.
Aiken, SC Clearwater, SC Aiken, SC
Dr. Robert E. Alexander Timothy W. Simmons J. Chris Verenes
Chancellor Emeritus President/CEO President
Univ. of SC at Aiken Security Federal Corp. Security Federal Bank
Aiken, SC Aiken, SC Aiken, SC
Hon. William Clyburn G. L. Toole, III Roy G. Lindburg
Member of the South Carolina Attorney-At-Law Executive Vice President
House of Representatives Aiken, SC Treasurer/CFO
Aiken, SC Security Federal
Corporation
Aiken, SC
------------------------------------------------------------------------------
Directors Emeritus:
Walter E. Brooker, Sr.
President, Brooker's Inc.
Denmark, SC
56
Bank Advisory Boards
------------------------------------------------------------------------------
NORTH AUGUSTA-----------------------------------------------------------------
P. Richard Borden Rev. G.L. Brightharp Helen H. Butler
Owner Owner Retired Banker
Borden Pest Control G.L. Brightharp & Sons Mortuary North Augusta, SC
North Augusta, SC North Augusta, SC
William M. Hixon Sen. Thomas L. Moore John P. Potter
Owner President Director of
Hixon Realty Boiler Efficiency, Inc. Finance
North Augusta, SC Clearwater, SC City of North
Augusta
North Augusta, SC
WAGENER-----------------------------------------------------------------------
M. Judson Busbee Chad G. Ingram Mary T. Lybrand Dr. Michael L. Miller
Owner President Retired Banker Anesthesiologist
Busbee Hardware Gavin Oil Company Wagener, SC Palmetto Health
Wagener, SC Wagener, SC Richland Memorial
Hosp.
Columbia, SC
Richard H. Sumpter
Retired Educator
Wagener, SC
MIDLAND VALLEY----------------------------------------------------------------
Charles A. Hilton Rev. Nathaniel Irvin, Sr. Gloria Busch-Johnson
General Manager Pastor Consultant
Breezy Hill Old Storm Branch Aiken, SC
Water& Sewer Baptist Church
Graniteville, SC Clearwater, SC
Sen. Thomas L. Moore Glenda K. Napier Carlton B. Shealy
President Co-Owner Owner
Boiler Efficiency, Inc. Napier Funeral Home C. Shealy Realty Builders &
Clearwater, SC Graniteville, SC Developers
North Augusta, SC
WEST COLUMBIA-LEXINGTON-------------------------------------------------------
Eleanor Powell Clark Sandra Dooley Parker L. Todd Sease
Owner/Operator Attorney Partner
B & E Enterprises Inc. Dooley, Dooley, Spence, Jumper, Carter, Sease
dba McDonald's Parker & Hipp, PA Architects, PA
Columbia, SC Lexington, SC West Columbia, SC
L. Ed Kirkland, Jr. Sen. Nikki G. Setzler Dianne Light
Owner/Agent Sr. Partner Owner
L. Ed Kirkland & Co., LLC Setzler & Scott, PA Diane's on Devine
Columbia, SC Law Firm & DiPrato's Deli
West Columbia, SC Columbia, SC
Jan Hook-Stamps Donald T. Martin
Owner Controller, CPA
Elante Day Spa Nexsen, Pruet, LLP
West Columbia, SC Columbia, SC
57
Management Team
------------------------------------------------------------------------------
T. Clifton Weeks Chairman of Security Federal Corporation
Timothy W. Simmons Chairman and Chief Executive Officer, Security Federal
Bank
G. L. Toole, III Vice President
Robert E. ALexander Corporate Secretary
J. Chris Verenes President, Security Federal Bank
Roy G. Lindburg Executive Vice President, Treasurer and Chief
Financial Officer
Lynn B. Shepard Senior Vice President - Senior Operations Officer
Sandra M. Bartlett Vice President - Human Resources
Carol P. McCleskey Vice President - Branch Administration
Francis M. Thomas, Jr. Senior Vice President - Aiken Area Executive
Marian A. Shapiro Senior Vice President - Midlands Area Executive
Kathryn Y. Carr Vice President - Special Assets
Audrey Varn Vice President - Senior Trust Officer
Gabriele C. Dukes Vice President - Financial Counseling/Community
Development
Rodney K. Ingle Vice President - Mortgage Loans/Commercial Loans
Janice S. Hauerwas Vice President - Mortgage Loan Originator
Gregory D. Warfield Vice President - Mortgage Loan Originator
William O. Boyte, III Vice President - Construction Lending - Midlands Area
James E. Bristow Vice President - Business Development/Commercial Loans
Paul T. Rideout Vice President - Business Development/Commercial Loans
H. Stanley Price Vice President - Business Development/Commercial Loans
Elsie K. Dicks Vice President - Credit Administration
Laura B. Conway Vice President - Operations
Ronald R. Davis Vice President - Auditing
Rochelle D. Wright Vice President - Information Technology
Andrea P. Haltiwanger Assistant Vice President - Marketing
Sharon M. Swift Assistant Vice President - Training Department
Ruth L. Vance Assistant Vice President - Assistant Secretary
Margaret A. Hurt Assistant Treasurer - Accounting
Matthew B. Fry Assistant Vice President - Auditing
Todd C. Stanford Assistant Vice President - Business Development/
Commercial Loans
Trudy S. Boyd Assistant Vice President - Community Development
Officer
Kathi J. Snipes Assistant Vice President - Financial Counseling
Patricia B. Moseley Assistant Vice President - Loan and Credit Card
Servicing
Ann C. Johnson Assistant Vice President - Purchasing and Facilities
Management
Barbara J. Davis Assistant Vice President - Mortgage Loan Underwriter
Marilyn C. Hensley Assistant Vice President - Special Assets
Jason S. Redd Assistant Vice President - Trust, Investments &
Insurance
SECURITY FEDERAL CORPORATION
------------------------------------------------------------------------------
Security
Federal
Bank
------------------------------------------------------------------------------
v v v
Security Security Security
Federal Federal Federal
--------------- --------------- --------------
Trust, Inc. Investments, Inc. Insurance, Inc.
58
OUR LOCATIONS
[Map appears here]
Branch Locations--------------------------------------------------------------
Whiskey Road, Aiken, SC
Dana S. Hall, Assistant Vice President/Manager
North Augusta, SC
Kathy S. Williamson, Assistant Vice President/Manager
Laurens Street, Aiken, SC
Vicky W. Moseley, Assistant Vice President/Manager
Richland Avenue, Aiken, SC
Nicole W. Simmons, Assistant Vice President/Manager
South Side, Aiken, SC
Shane M. Bagby, Assistant Vice President/Manager
Graniteville, SC
Jason A. Langdale, Manager
Langley, SC
Pat W. Guglieri, Assistant Vice President/Manager
Clearwater, SC
Gail W. Dotson, Assistant Vice President/Manager
Wagener, SC
Scott Tindal, Manager
West Columbia, SC
Mary B. Clark, Assistant Vice President/Manager
Lexington, SC
Nancy P. Hutto, Assistant Vice President/Manager
59
SECURITY FEDERAL CORPORATION
------------------------------------------------------------------------------
238 Richland Ave., West/Aiken, South Carolina 29801
Exhibit 14
Code of Ethics
SECURITY FEDERAL CORPORATION
CODE OF ETHICS
FOR PRINCIPAL EXECUTIVE OFFICER
AND SENIOR FINANCIAL OFFICERS
Introduction
The business of Security Federal Corporation and its subsidiaries
("Security Federal") is built on trust. Our stockholders, customers and
employees depend upon our honesty and integrity. Accordingly, the Board of
Directors of Security Federal has adopted this Code of Ethics ("Code") to
express a code of conduct applicable to our Chairman, Chief Executive Officer,
President, Chief Operating Officer and Chief Financial Officer (collectively,
the "Senior Financial Officers"). This Code does not constitute a new set of
requirements to which the Senior Financial Officers must adhere, but simply
reduces to writing the behavior that has always been required of the Senior
Financial Officers.
The Code sets forth certain standards for the guidance of the Senior
Financial Officers. The Code should be considered as illustrative, but not
regarded as all-inclusive. The Senior Financial Officers are also subject to
Security Federal's Code of Ethics applicable to all officers and employees.
Honest and Ethical Conduct
Each Senior Financial Officer must act honestly and ethically. Senior
Financial Officers should also promote honest and ethical behavior within
Security Federal.
Acting honestly and ethically includes the duty to avoid actual or
apparent conflicts of interest, as well as situations which could result in an
actual or apparent conflict of interest. A conflict of interest may arise
when personal or financial interest is adverse to, or appears adverse to, the
interests of Security Federal. Each Senior Financial Officer should report to
the Audit Committee of the Board of Directors any material transaction or
relationship that reasonably could be expected to result in a conflict of
interest.
In addition to the duty to avoid conflicts of interest, Senior Financial
Officers must treat confidential information properly. All information
obtained by virtue of employment with Security Federal should be held in
strictest confidence. Confidential information must not be disclosed to
anyone except as required for business transactions or as required by law.
When confidential information is disclosed, it must be done in a manner that
does not risk violating confidentiality.
Preparation of Public Documents
Each Senior Financial Officer must ensure that all public documents and
documents filed with the Securities and Exchange Commission which he or she is
involved in preparing or reviewing contain full, fair, accurate, timely and
understandable disclosure. In order to ensure this, the Senior Financial
Officers must maintain the skills relevant to Security Federal's needs. The
Senior Financial Officers are also responsible for establishing and
maintaining appropriate disclosure controls and procedures and internal
controls.
Compliance with Laws, Rules and Regulations
Each Senior Financial Officer must comply with all local, state and
federal laws, rules and regulations. Any Senior Financial Officer engaged in
activities found to be in conflict with and against these laws, rules and
regulations will be subject to termination of employment. The Senior
Financial Officers should also cause other officers and employees to comply
with all local, state and federal laws, rules and regulations.
Administration of the Code
Any violation or suspected violation of this Code of Ethics must be
promptly reported to the Audit Committee of the Board of Directors. Violators
of the Code may be subject to disciplinary action, up to and including
termination of employment. Questions regarding the Code and requests for a
waiver from the Code should be brought to the Audit Committee. The Audit
Committee will administer the Code and will make periodic reports to the Board
of Directors, as necessary.
This Code of Ethics shall be publicly available. Changes to, and waivers
from, the Code shall also be disclosed to the public.
2
Exhibit 21
Subsidiaries of the Registrant
State of Percentage
Parent Subsidiary Incorporation of Ownership
------ ---------- ------------- ------------
Security Federal Security Federal United States 100%
Corporation Bank
Security Federal Bank Security Federal South Carolina 100%
Insurance
Security Federal South Carolina 100%
Investments
Security Federal South Carolina 100%
Trust
Security Financial South Carolina 100%
Services Corporation
Exhibit 23
Consent of Elliott Davis, LLC
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors
Security Federal Corporation
We consent to incorporation by reference in the Registration Statement No.
33-80008, 333-3150 and 333-102337 on Form S-8 of our report dated April 20,
2006, relating to the consolidated balance sheet of Security Federal
Corporation and subsidiaries as of March 31, 2006 and the related consolidated
statements of income, shareholders' equity and cash flows for the year then
ended, which report appears in the March 31, 2006 Annual Report on Form 10-K.
/s/ Elliott Davis, LLC
Columbia South Carolina
June 29, 2006
Exhibit 31.1
Certification Required
by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934
I, Timothy W. Simmons, certify that:
1. I have reviewed this annual report on Form 10-K of Security Federal
Corporation;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: June 29, 2006
/s/Timothy W. Simmons
-------------------------------------
Timothy W. Simmons
President and Chief Executive Officer
Exhibit 31.2
Certification Required
by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934
I, Roy G. Lindburg, certify that:
1. I have reviewed this annual report on Form 10-K of Security Federal
Corporation;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this
report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant's
ability to record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: June 29, 2006
/s/Roy G. Lindburg
-------------------------------------
Roy G. Lindburg
Treasurer and Chief Financial Officer
Exhibit 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
OF SECURITY FEDERAL CORPORATION
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned hereby certify, pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 and in connection with this Annual Report on Form
10-K, that:
1. the report fully complies with the requirements of Sections
13(a) and 15(d) of the Securities Exchange Act of 1934, as
amended, and
2. the information contained in the report fairly presents, in all
material respects, the company's financial condition and
results of operations.
/s/Timothy W. Simmons /s/Roy G. Lindburg
------------------------------------ ------------------------------------
Timothy W. Simmons Roy G. Lindburg
President and Chief Executive Officer Treasurer and Chief Financial Officer
Dated: June 29, 2006