Edgar Filing: SECURITY FEDERAL CORP

OUTSTANDING SHARES AT:

Common Stock, par value $0.01 per share

November 13, 2017

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10 – Q

(Mark one)

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2017

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

FOR THE TRANSITION PERIOD:



FROM:		TO:

COMMISSION FILE NUMBER: 000-16120

SECURITY FEDERAL CORPORATION

(Exact name of registrant as specified in its charter)



	South Carolina		57-0858504
	(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

238 RICHLAND AVENUE NORTHWEST, AIKEN, SOUTH CAROLINA 29801

(Address of principal executive office and Zip Code)

(803) 641-3000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes [X] No [ ]

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



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

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



YES				NO

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.




PART I.	FINANCIAL INFORMATION (UNAUDITED)	PAGE NO.
Item 1.	Financial Statements (unaudited):	3
	Consolidated Balance Sheets at September 30, 2017 and December 31, 2016	3
	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2017 and 2016	4
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2017 and 2016	5
	Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2017 and 2016	6
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2017 and 2016	7
	Notes to Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	48
Item 4.	Controls and Procedures	48

PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	49
Item 1A.	Risk Factors	49
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	49
Item 3.	Defaults Upon Senior Securities	49
Item 4.	Mine Safety Disclosures	49
Item 5.	Other Information	49
Item 6.	Exhibits	49
	Signatures	51

SCHEDULES OMITTED

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Part 1. Financial Information

Item 1. Financial Statements

Consolidated Balance Sheets



	September 30, 2017			December 31, 2016
	(Unaudited)			(Audited)
ASSETS:
Cash and Cash Equivalents	$	15,158,779		$	9,374,549
Certificates of Deposit with Other Banks	1,350,005			2,445,005
Investment and Mortgage-Backed Securities:
Available For Sale	388,643,233			362,059,429
Held To Maturity (Fair Value of $25,568,343 and $25,371,052 at September 30, 2017 and December 31, 2016, Respectively)	25,337,966			25,583,956
Total Investments and Mortgage-Backed Securities	413,981,199			387,643,385
Loans Receivable, Net:
Held For Sale	1,270,410			4,243,907
Held For Investment (Net of Allowance of $8,169,188 and $8,356,231 at September 30, 2017 and December 31, 2016, Respectively)	374,441,058			355,478,939
Total Loans Receivable, Net	375,711,468			359,722,846
Accrued Interest Receivable:
Loans	936,428			1,038,444
Mortgage-Backed Securities	587,965			605,474
Investment Securities	1,716,518			1,407,923
Total Accrued Interest Receivable	3,240,911			3,051,841
Premises and Equipment, Net	22,865,424			21,197,684
Federal Home Loan Bank ("FHLB") Stock, at Cost	2,473,700			2,776,500
Other Real Estate Owned ("OREO")	1,907,637			2,721,214
Bank Owned Life Insurance ("BOLI")	18,665,893			17,101,045
Goodwill	1,199,754			1,199,754
Other Assets	4,593,887			5,447,746
Total Assets	$	861,148,657		$	812,681,569
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Liabilities:
Deposit Accounts	$	701,613,360		$	654,103,278
Advance Payments By Borrowers For Taxes and Insurance	669,491			260,580
Advances From FHLB	41,000,000			48,395,000
Other Borrowings	12,355,812			9,338,148
Note Payable	9,700,000			13,000,000
Junior Subordinated Debentures	5,155,000			5,155,000
Senior Convertible Debentures	6,064,000			6,084,000
Other Liabilities	6,679,470			5,233,289
Total Liabilities	$	783,237,133		$	741,569,295
Shareholders' Equity:
Common Stock, $.01 Par Value; Authorized 5,000,000 Shares; Issued and Outstanding Shares, 3,146,407 and 2,945,474, Respectively	$	31,464		$	31,464
Additional Paid-In Capital	12,036,744			12,036,744
Treasury Stock, at Cost (200,933 Shares)	(4,330,712		)	(4,330,712		)
Unvested Restricted Stock	—			(25,358		)
Accumulated Other Comprehensive Income	3,739,788			1,180,086
Retained Earnings	66,434,240			62,220,050
Total Shareholders' Equity	$	77,911,524		$	71,112,274
Total Liabilities and Shareholders' Equity	$	861,148,657		$	812,681,569

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)



	Three Months Ended September 30,				Nine Months Ended September 30,
	2017		2016		2017			2016
Interest Income:
Loans	$	5,146,669	$	4,912,317	$	14,849,109		$	14,378,826
Mortgage-Backed Securities	1,274,753		1,192,792		3,552,887			3,672,252
Investment Securities	1,324,104		1,042,765		3,729,992			3,245,857
Other	6,295		4,944		34,804			14,057
Total Interest Income	7,751,821		7,152,818		22,166,792			21,310,992
Interest Expense:
NOW and Money Market Accounts	151,874		102,321		426,080			309,757
Statement Savings Accounts	10,726		8,984		30,000			25,468
Certificate Accounts	503,505		407,283		1,401,910			1,239,282
FHLB Advances and Other Borrowed Money	164,544		132,889		409,655			561,316
Note Payable	105,762		—		328,613			—
Senior Convertible Debentures	121,396		121,680		364,756			365,040
Junior Subordinated Debentures	38,975		31,445		110,863			91,002
Total Interest Expense	1,096,782		804,602		3,071,877			2,591,865
Net Interest Income	6,655,039		6,348,216		19,094,915			18,719,127
Provision For Loan Losses	100,000		—		100,000			—
Net Interest Income After Provision For Loan Losses	6,555,039		6,348,216		18,994,915			18,719,127
Non-Interest Income:
Gain on Sale of Investment Securities	79,363		360,425		707,902			772,143
Gain on Sale of Loans	373,636		256,918		894,053			657,473
Service Fees on Deposit Accounts	274,717		266,960		776,469			772,341
Commissions From Insurance Agency	172,074		149,529		451,311			441,519
Trust Income	186,000		197,000		554,000			521,000
BOLI Income	788,133		132,000		1,028,133			396,000
Check Card Fee Income	282,686		247,331		838,302			742,583
Grant Income	—		—		—			265,496
Other	205,524		170,519		542,250			504,200
Total Non-Interest Income	2,362,133		1,780,682		5,792,420			5,072,755
Non-Interest Expense:
Compensation and Employee Benefits	3,872,102		3,167,112		10,916,386			9,675,430
Occupancy	569,024		502,352		1,661,661			1,469,602
Advertising	120,033		100,251		391,742			343,034
Depreciation and Maintenance of Equipment	569,839		510,645		1,541,460			1,486,060
Federal Deposit Insurance Corporation ("FDIC") Insurance Premiums	64,518		62,163		168,707			322,653
Net Cost (Benefit) of Operation of OREO	105,172		25,991		(96,730		)	(647,990		)
Prepayment Penalties on FHLB Advances	—		260,594		—			789,306
Other	1,268,449		1,065,209		3,681,552			3,485,289
Total Non-Interest Expense	6,569,137		5,694,317		18,264,778			16,923,384
Income Before Income Taxes	2,348,035		2,434,581		6,522,557			6,868,498
Provision For Income Taxes	445,133		654,850		1,513,090			1,805,750
Net Income	1,902,902		1,779,731		5,009,467			5,062,748
Preferred Stock Dividends	—		110,000		—			330,000
Net Income Available to Common Shareholders	$	1,902,902	$	1,669,731	$	5,009,467		$	4,732,748
Net Income Per Common Share (Basic)	$	0.65	$	0.57	$	1.70		$	1.61
Net Income Per Common Share (Diluted)	$	0.61	$	0.54	$	1.61		$	1.53
Cash Dividend Per Share on Common Stock	$	0.09	$	0.08	$	0.27		$	0.24
Weighted Average Shares Outstanding (Basic)	2,945,474		2,944,001		2,945,215			2,944,001
Weighted Average Shares Outstanding (Diluted)	3,252,436		3,248,526		3,251,666			3,248,474

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Unaudited)



	Three Months Ended September 30,
	2017			2016
Net Income	$	1,902,902		$	1,779,731
Other Comprehensive Loss
Unrealized Gains (Losses) on Securities:
Unrealized Holding Losses on Securities Available For Sale, Net of Taxes of $(39,600) and $(774,093) at September 30, 2017 and 2016, Respectively	(64,802		)	(1,263,332		)
Reclassification Adjustment for Gains Included in Net Income, Net of Taxes of $30,158 and $136,962 at September 30, 2017 and 2016, Respectively	(49,205		)	(223,463		)
Amortization of Unrealized Gains on Available For Sale Securities Transferred to Held To Maturity, Net of Taxes of $(14,084) and $(20,270) at September 30, 2017 and 2016, Respectively	(23,019		)	(33,128		)
Other Comprehensive Loss	(137,026		)	(1,519,923		)
Comprehensive Income	$	1,765,876		$	259,808



	Nine Months Ended September 30,
	2017			2016
Net Income	$	5,009,467		$	5,062,748
Other Comprehensive Income
Unrealized Gains on Securities:
Unrealized Holding Gains on Securities Available For Sale, Net of Taxes of $1,892,760 and $1,861,700 at September 30, 2017 and 2016, Respectively	3,080,485			3,044,091
Reclassification Adjustment for Gains Included in Net Income, Net of Taxes of $269,003 and $293,415 at September 30, 2017 and 2016, Respectively	(438,899		)	(478,728		)
Amortization of Unrealized Gains on Available For Sale Securities Transferred to Held To Maturity, Net of Taxes of $(50,102) and $(55,872) at September 30, 2017 and 2016, Respectively	(81,884		)	(91,314		)
Other Comprehensive Income	2,559,702			2,474,049
Comprehensive Income	$	7,569,169		$	7,536,797

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity (Unaudited)

For the Nine Months Ended September 30, 2017 and 2016



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



	Common Stock		Unvested Restricted Stock			Additional Paid – In Capital		Treasury Stock			Accumulated Other Comprehensive Income		Retained Earnings			Total
Balance at December 31, 2016	$	31,464	$	(25,358	)	$	12,036,744	$	(4,330,712	)	$	1,180,086	$	62,220,050		$	71,112,274
Net Income	—		—			—		—			—		5,009,467			5,009,467
Other Comprehensive Income, Net of Tax	—		—			—		—			2,559,702		—			2,559,702
Vesting of Restricted Stock	—		25,358			—		—			—		—			25,358
Cash Dividends on Common Stock	—		—			—		—			—		(795,277		)	(795,277		)
Balance at September 30, 2017	$	31,464	$	—		$	12,036,744	$	(4,330,712	)	$	3,739,788	$	66,434,240		$	77,911,524

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)



	Nine Months Ended September 30,
	2017			2016
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	5,009,467		$	5,062,748
Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities:
Depreciation Expense	1,101,900			1,053,224
Stock Option Compensation Expense	25,358			5,976
Discount Accretion and Premium Amortization	4,190,700			4,038,220
Provisions for Losses on Loans	100,000			—
Earnings on BOLI	(374,000		)	(396,000		)
Income Recognized From BOLI Death Benefit	(654,133		)	—
Gain on Sales of Loans	(894,053		)	(657,473		)
Gain on Sales of Mortgage-Backed Securities	(250,149		)	(55,958		)
Gain on Sales of Investment Securities	(457,752		)	(716,185		)
Gain on Sale of Premises and Equipment	(1,900		)	—
Gain on Sales of OREO	(321,687		)	(841,728		)
Write Down on OREO	68,121			40,000
Amortization of Deferred Loan Costs	127,058			88,054
Proceeds From Sale of Loans Held For Sale	33,301,781			23,896,772
Origination of Loans Held For Sale	(29,434,231		)	(24,920,171		)
Decrease (Increase) in Accrued Interest Receivable:
Loans	102,016			38,341
Mortgage-Backed Securities	17,509			(14,884		)
Investment Securities	(308,595		)	90,706
Increase in Advance Payments By Borrowers	408,911			379,234
Other, Net	594,400			2,244,880
Net Cash Provided By Operating Activities	$	12,350,721		$	9,335,756

CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of Mortgage-Backed Securities Available For Sale ("AFS")	$	(42,875,234	)	$	(37,793,135	)
Proceeds from Payments and Maturities of Mortgage-Backed Securities AFS	28,487,010			23,942,058
Proceeds From Sale of Mortgage-Backed Securities AFS	19,003,897			3,082,591
Purchase of Mortgage-Backed Securities Held To Maturity ("HTM")	—			(1,507,125		)
Proceeds from Payments and Maturities of Mortgage-Backed Securities HTM	2,836,011			3,496,657
Purchase of Investment Securities AFS	(75,688,312		)	(30,233,311		)
Proceeds from Payments and Maturities of Investment Securities AFS	17,854,087			18,402,244
Proceeds From Sale of Investment Securities AFS	27,825,020			18,410,863
Purchase of Investment Securities HTM	(3,997,750		)	—
Proceeds from Payments and Maturities of Investment Securities HTM	1,000,000			—
Proceeds From Redemption of Certificates of Deposits with Other Banks	1,095,000			—
Purchase of FHLB Stock	(5,129,700		)	(5,014,800		)
Redemption of FHLB Stock	5,432,500			4,554,900
Purchase of BOLI	(2,000,000		)	—
Proceeds From BOLI Death Benefit	1,463,285			—
Increase in Loans Receivable	(19,680,925		)	(19,976,753		)
Proceeds From Sale of OREO	1,558,891			3,159,524
Purchase and Improvement of Premises and Equipment	(2,769,640		)	(1,599,727		)
Proceeds From Sale of Premises and Equipment	1,900			—
Net Cash Used By Investing Activities	$	(45,583,960	)	$	(21,076,014	)

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES



Consolidated Statements of Cash Flows (Unaudited) (Continued)

	Nine Months Ended September 30,
	2017			2016
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (Decrease) in Deposit Accounts	$	47,510,082		$	(1,798,293	)
Proceeds from FHLB Advances	157,576,000			251,755,000
Repayment of FHLB Advances	(164,971,000		)	(240,395,000		)
Increase in Other Borrowings, Net	3,017,664			6,185,542
Repayment of Note Payable	(3,300,000		)	—
Purchase of Senior Convertible Debentures	(20,000		)	—
Dividends to Preferred Stock Shareholders	—			(330,000		)
Dividends to Common Stock Shareholders	(795,277		)	(706,914		)
Net Cash Provided By Financing Activities	$	39,017,469		$	14,710,335
Net Increase in Cash and Cash Equivalents	5,784,230			2,970,077
Cash and Cash Equivalents at Beginning of Period	9,374,549			8,381,951
Cash and Cash Equivalents at End of Period	$	15,158,779		$	11,352,028

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Paid During The Period For:
Interest	$	2,937,283		$	2,565,836
Income Taxes	$	1,162,000		$	572,242
Supplemental Schedule of Non Cash Transactions:
Transfers From Loans Receivable to OREO	$	491,748		$	323,730

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

1. Basis of Presentation

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and accounting principles generally accepted in the United States of America ("U.S. GAAP"); therefore, they do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows. Such statements are unaudited but, in the opinion of management, reflect all adjustments, which are of a normal recurring nature and necessary for a fair presentation of results for the selected interim periods. Users of financial information produced for interim periods are encouraged to refer to the footnotes contained in the audited consolidated financial statements appearing in Security Federal Corporation’s (the “Company”) 2016 Annual Report to Shareholders which was filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2016 (“2016 10-K”) when reviewing interim financial statements. The unaudited consolidated results of operations for the nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

2. Principles of Consolidation

The accompanying unaudited consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Security Federal Bank (the “Bank”) and the Bank’s wholly owned subsidiaries, Security Federal Insurance, Inc. (“SFINS”) and Security Financial Services Corporation (“SFSC”). SFINS was formed during fiscal 2002 and began operating during the December 2001 quarter and is an insurance agency offering auto, business, and home insurance. SFINS has a wholly owned subsidiary, Collier Jennings Financial Corporation, which has as subsidiaries Security Federal Auto Insurance, The Auto Insurance Store Inc., and Security Federal Premium Pay Plans Inc. Security Federal Premium Pay Plans Inc. has one wholly owned premium finance subsidiary and also has an ownership interest in four other premium finance subsidiaries. SFSC was formed in 1975 and is currently inactive. All significant intercompany transactions and balances have been eliminated in consolidation.

The Company has a wholly owned subsidiary, Security Federal Statutory Trust (the “Trust”), which issued and sold fixed and floating rate capital securities of the Trust. However, under current accounting guidance, the Trust is not consolidated in the Company’s financial statements. The Bank is primarily engaged in the business of accepting savings and demand deposits and originating mortgage loans and other loans to individuals and small businesses for various personal and commercial purposes.

3. Critical Accounting Policies

The Company has adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to the audited consolidated financial statements at December 31, 2016 included in our 2016 Annual Report to Shareholders. Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities, and, as such, have a greater possibility of producing results that could be materially different than originally reported. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on our carrying values of assets and liabilities and our results of operations.

The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of the consolidated financial statements. The impact of an unexpected and sudden large loss could deplete the allowance and potentially require increased provisions to replenish the allowance, which would negatively affect earnings. The Company provides for loan losses using the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to the allowance for loan losses. Additions to the allowance for loan losses are provided by charges to operations based on various factors, which, in management’s judgment, deserve current recognition in estimating possible losses. Such factors considered by management include the fair value of the underlying collateral, stated guarantees by the borrower (if applicable), the borrower’s ability to repay from other economic resources, growth and composition of the loan portfolio, the relationship of the allowance for loan losses to the outstanding loans, loss experience, delinquency trends, and general economic conditions. Management evaluates the carrying value of the loans periodically and the allowance is adjusted accordingly.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

3. Critical Accounting Policies, Continued

While management uses the best information available to make evaluations, future adjustments may be necessary if economic conditions differ substantially from the assumptions used in making these evaluations. The allowance for loan losses is subject to periodic evaluations by our bank regulatory agencies, including the Board of Governors of the Federal Reserve System ("Federal Reserve"), the FDIC and the South Carolina Board of Financial Institutions, that may require adjustments to be made to the allowance based upon the information that is available at the time of their examination.

The Company values impaired loans at the loan’s fair value if it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement at the present value of expected cash flows, the market price of the loan, if available, or the value of the underlying collateral. Expected cash flows are required to be discounted at the loan’s effective interest rate. When the ultimate collectibility of an impaired loan’s principal is in doubt, wholly or partially, all cash receipts are applied to principal. When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to interest and then to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amounts previously charged off.

The Company uses assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax liabilities and assets for events recognized differently in its financial statements and income tax returns, and income tax expense. Determining these amounts requires analysis of certain transactions and interpretation of tax laws and regulations. The Company exercises considerable judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments and estimates are reevaluated on a continual basis as regulatory and business factors change. No assurance can be given that either the tax returns submitted by us or the income tax reported on the Consolidated Financial Statements will not be adjusted by either adverse rulings by the United States Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service.

4. Earnings Per Common Share

Accounting guidance specifies the computation, presentation and disclosure requirements for earnings per share (“EPS”) for entities with publicly held common stock or potential common stock such as options, warrants, convertible securities or contingent stock agreements if those securities trade in a public market. Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding. Diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive common shares had been issued. The dilutive effect of options outstanding under the Company’s stock option plan is reflected in diluted EPS by application of the treasury stock method. All of the options outstanding at September 30, 2017 had an exercise price below the average market price during the three and nine months ended September 30, 2017. Therefore, these options were considered to be dilutive to EPS in those periods. None of the options outstanding at September 30, 2016 had an exercise price below the average market price during the three or nine month periods ended September 30, 2016. Therefore, these options were not deemed to be dilutive to EPS in those periods.

Net income available to common shareholders represents consolidated net income adjusted for preferred dividends declared, accretions of discounts and amortization of premiums on preferred stock issuances and cumulative dividends related to the current dividend period that have not been declared as of period end. The following table provides a reconciliation of net income to net income available to common shareholders for the periods presented:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2017		2016		2017		2016
Earnings Available To Common Shareholders:
Net Income	$	1,902,902	$	1,779,731	$	5,009,467	$	5,062,748
Preferred Stock Dividends	—		110,000		—		330,000
Net Income Available To Common Shareholders	$	1,902,902	$	1,669,731	$	5,009,467	$	4,732,748

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

4. Earnings Per Common Share, Continued

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



	Three Months Ended September 30,
	2017						2016
	Income		Shares	Per Share Amounts			Income		Shares	Per Share Amounts
Basic EPS	$	1,902,902	2,945,474	$	0.65		$	1,669,731	2,944,001	$	0.57
Effect of Dilutive Securities:
Stock Options	—		3,762	(0.01		)	—		—	—
Senior Convertible Debentures	75,266		303,200	(0.03)			75,442		304,200	(0.03)
Unvested Restricted Stock	—		—	—			—		325	—
Diluted EPS	$	1,978,168	3,252,436	$	0.61		$	1,745,173	3,248,526	$	0.54



	Nine Months Ended September 30,
	2017						2016
	Income		Shares	Per Share Amounts			Income		Shares	Per Share Amounts
Basic EPS	$	5,009,467	2,945,215	$	1.70		$	4,732,748	2,944,001	$	1.61
Effect of Dilutive Securities:
Stock Options	—		3,251	(0.01		)	—		—	—
Senior Convertible Debentures	226,149		303,200	(0.08)			226,325		304,200	(0.07)
Unvested Restricted Stock	—		—	—			—		273	(0.01		)
Diluted EPS	$	5,235,616	3,251,666	$	1.61		$	4,959,073	3,248,474	$	1.53

5. Stock-Based Compensation

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



	Three Months Ended September 30,
	2017			2016
	Shares		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
	Shares		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
Balance, Beginning of Period	19,500		$23.49	25,000		$23.50
Options Forfeited	(1,000	)	24.61	(3,500	)	23.03
Balance, End of Period	18,500		$23.43	21,500		$23.57

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

5. Stock-Based Compensation, Continued



	Nine Months Ended September 30,
	2017			2016
	Shares		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
	Shares		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
Balance, Beginning of Period	21,500		$23.57	29,500		$23.55
Options Forfeited	(3,000	)	24.43	(8,000	)	23.47
Balance, End of Period	18,500		$23.43	21,500		$23.57

Options Exercisable	18,500			17,800

Options Available For Grant	50,000			50,000

At September 30, 2017, the Company had the following options outstanding:



Grant Date	Outstanding Options	Option Price	Expiration Date
10/01/07	2,000	$24.28	10/01/17

01/01/08	12,000	$23.49	01/01/18

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

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of investment and mortgage-backed securities available for sale at the dates indicated were as follows:



	September 30, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Federal Home Loan Mortgage Corporation (“FHLMC”) Bond	$	968,436	$	—	$	2,790	$	965,646
Small Business Administration (“SBA”) Bonds	123,756,916		1,186,563		139,930		124,803,549
Tax Exempt Municipal Bonds	78,068,936		3,175,211		429,120		80,815,027
Taxable Municipal Bonds	2,017,913		—		5,323		2,012,590
Mortgage-Backed Securities	177,751,622		2,548,619		465,620		179,834,621
State Tax Credit	56,800		—		—		56,800
Equity Securities	155,000		—		—		155,000
Total Available For Sale	$	382,775,623	$	6,910,393	$	1,042,783	$	388,643,233

	December 31, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLB Bonds	$	998,001	$	—	$	1	$	998,000
SBA Bonds	101,280,921		909,361		284,223		101,906,059
Tax Exempt Municipal Bonds	72,248,915		1,185,753		1,899,519		71,535,149
Taxable Municipal Bonds	2,021,192		—		30,062		1,991,130
Mortgage-Backed Securities	183,657,697		2,575,616		972,222		185,261,091
Equity Securities	250,438		117,562		—		368,000
Total Available For Sale	$	360,457,164	$	4,788,292	$	3,186,027	$	362,059,429

The FHLMC and FHLB are government sponsored enterprises ("GSEs") and the securities and bonds issued by GSEs are not backed by the full faith and credit of the United States government. SBA bonds are backed by the full faith and credit of the United States government. Included in the tables above and below in mortgage-backed securities are Government National Mortgage Association ("GNMA") mortgage-backed securities, which are also backed by the full faith and credit of the United States government. At September 30, 2017 the Bank held AFS GNMA mortgage-backed securities with an amortized cost and fair value of $93.0 million and $94.2 million, respectively, compared to an amortized cost and fair value of $107.9 million and $109.2 million, respectively, at December 31, 2016.

Also included in mortgage-backed securities in the tables above and below are private label collateralized mortgage obligation ("CMO") securities, which are issued by non-governmental real estate mortgage investment conduits and are not backed by the full faith and credit of the United States government. At September 30, 2017 the Bank held AFS private label CMO mortgage-backed securities with both an amortized cost and fair value of $31.2 million compared to an amortized cost and fair value of $20.0 million and $19.7 million, respectively, at December 31, 2016.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

The amortized cost and fair value of investment and mortgage-backed securities available for sale at September 30, 2017 are shown below by contractual maturity. Expected maturities will differ from contractual maturities because borrowers have the right to prepay obligations with or without call or prepayment penalties. Since mortgage-backed securities are not due at a single maturity date, they are disclosed separately, rather than allocated over the maturity groupings set forth in the table below.



	September 30, 2017
Investment Securities:	Amortized Cost		Fair Value
One Year or Less	$	190,589	$	190,501
After One – Five Years	14,816,156		14,930,955
After Five – Ten Years	47,080,250		47,638,450
More Than Ten Years	142,937,006		146,048,706
Mortgage-Backed Securities	177,751,622		179,834,621
Total Available For Sale	$	382,775,623	$	388,643,233

At September 30, 2017 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 $97.6 million and $99.5 million, respectively, compared to an amortized cost and fair value of $75.3 million and $76.9 million, respectively, at December 31, 2016.

The Bank received $29.3 million and $6.9 million in gross proceeds from sales of available for sale securities during the three months ended September 30, 2017 and 2016, respectively. As a result, the Bank recognized gross gains of $241,000 and $360,000, respectively, and gross losses of $162,000 and $0, respectively, for the same periods.

During the nine months ended September 30, 2017 and 2016, the Bank received $46.8 million and $21.5 million, respectively, in gross proceeds from sales of available for sale securities. As a result, the Bank recognized gross gains of $870,000 and $772,000, respectively, with $162,000 and $0 gross losses recognized for the same periods.

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



	September 30, 2017
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLMC Bond	$	965,646	$	2,790	$	—	$	—	$	965,646	$	2,790
SBA Bonds	22,776,378		102,708		6,857,393		37,222		29,633,771		139,930
Tax Exempt Municipal Bonds	6,094,283		73,787		10,341,319		355,333		16,435,602		429,120
Taxable Municipal Bonds	2,012,590		5,323		—		—		2,012,590		5,323
Mortgage-Backed Securities	46,108,221		323,710		13,021,339		141,910		59,129,560		465,620
	$	77,957,118	$	508,318	$	30,220,051	$	534,465	$	108,177,169	$	1,042,783

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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



	December 31, 2016
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Securities	$	998,000	$	1	$	—	$	—	$	998,000	$	1
SBA Bonds	28,490,243		228,432		8,212,824		55,791		36,703,067		284,223
Tax Exempt Municipal Bonds	47,405,066		1,899,519		—		—		47,405,066		1,899,519
Taxable Municipal Bond	1,991,130		30,062		—		—		1,991,130		30,062
Mortgage-Backed Securities	62,738,366		916,699		5,600,262		55,523		68,338,628		972,222
	$	141,622,805	$	3,074,713	$	13,813,086	$	111,314	$	155,435,891	$	3,186,027

Securities classified as available for sale are recorded at fair market value. At September 30, 2017 and December 31, 2016, 51.3% and 3.5% of the unrealized losses, representing 28 and 15 individual securities, respectively, consisted of securities in a continuous loss position for 12 months or more. The Company has the ability and intent to hold these securities until such time as the value recovers or the securities mature. The Company believes, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and is not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary. The Company reviews its investment securities portfolio at least quarterly and more frequently when economic conditions warrant, assessing whether there is any indication of other-than-temporary impairment (“OTTI”).

Factors considered in the review include estimated future cash flows, length of time and extent to which market value has been less than cost, the financial condition and near term prospects of the issuer, and our intent and ability to retain the security to allow for an anticipated recovery in market value. If the review determines that there is OTTI, then an impairment loss is recognized in earnings equal to the entire difference between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made, or the Company may recognize a portion in other comprehensive income. The fair value of investments on which OTTI is recognized then becomes the new cost basis of the investment. There was no OTTI recognized during the nine months ended September 30, 2017.

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

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



	September 30, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLB Bonds	$	2,000,000	$	—	$	2,040	$	1,997,960
FHLMC Bonds	997,997		1,707		—		999,704
Mortgage-Backed Securities ⁽¹⁾	22,339,969		249,124		18,414		22,570,679
Total Held To Maturity	$	25,337,966	$	250,831	$	20,454	$	25,568,343

	December 31, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Mortgage-Backed Securities (1)	$	25,583,956	$	63,342	$	276,246	$	25,371,052
Total Held To Maturity	$	25,583,956	$	63,342	$	276,246	$	25,371,052

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

At September 30, 2017, the Bank held an amortized cost and fair value of $13.9 million and $14.1 million, respectively, in GNMA mortgage-backed securities classified as held to maturity, which are included in the table above, compared to an amortized cost and fair value of $16.3 million and $16.2 million, respectively, at December 31, 2016. The Company has not invested in any private label mortgage-backed securities classified as held to maturity.

At September 30, 2017, the amortized cost and fair value of mortgage-backed securities held to maturity that were pledged as collateral for certain deposit accounts, FHLB advances and other borrowings were $23.4 million and $23.7 million, respectively, compared to an amortized cost and fair value of $23.2 million and $23.0 million, respectively, at December 31, 2016.

The amortized cost and fair value of investment and mortgage-backed securities held to maturity at September 30, 2017 are shown below by contractual maturity. Expected maturities will differ from contractual maturities because borrowers have the right to prepay obligations with or without call or prepayment penalties. Since mortgage-backed securities are not due at a single maturity date, they are disclosed separately, rather than allocated over the maturity groupings set forth in the table below.



	September 30, 2017
Investment Securities:	Amortized Cost		Fair Value
One – Five Years	$	2,997,997	$	2,997,664
Mortgage-Backed Securities	22,339,969		22,570,679
Total Held to Maturity	$	25,337,966	$	25,568,343

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



	September 30, 2017
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Bonds	$	1,997,960	$	2,040	$	—	$	—	$	1,997,960	$	2,040
Mortgage-Backed Securities ⁽¹⁾	889,172		811		1,424,142		17,603		2,313,314		18,414
	$	2,887,132	$	2,851	$	1,424,142	$	17,603	$	4,311,274	$	20,454

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



	December 31, 2016
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-Backed Securities ⁽¹⁾	$	15,447,596	$	276,246	$	—	$	—	$	15,447,596	$	276,246
	$	15,447,596	$	276,246	$	—	$	—	$	15,447,596	$	276,246

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

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net

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



	September 30, 2017		December 31, 2016
Residential Real Estate Loans	$	79,106,075	$	77,979,909
Consumer Loans	56,864,234		50,667,894
Commercial Business Loans	23,496,773		16,279,177
Commercial Real Estate Loans	228,182,149		222,599,294
Total Loans Held For Investment	387,649,231		367,526,274
Loans Held For Sale	1,270,410		4,243,907
Total Loans Receivable, Gross	$	388,919,641	$	371,770,181
Less:
Allowance For Loan Losses	8,169,188		8,356,231
Loans In Process	4,935,647		3,526,064
Deferred Loan Fees	103,338		165,040
	13,208,173		12,047,335
Total Loans Receivable, Net	$	375,711,468	$	359,722,846

The Company uses a risk based approach based on the following credit quality measures when analyzing the loan portfolio: pass, caution, special mention, and substandard. These indicators are used to rate the credit quality of loans for the purposes of determining the Company’s allowance for loan losses. Pass loans are loans that are performing and are deemed adequately protected by the net worth of the borrower or the underlying collateral value. These loans are considered to have the least amount of risk in terms of determining the allowance for loan losses. Loans that are graded as substandard are considered to have the most risk. These loans typically have an identified weakness or weaknesses and are inadequately protected by the net worth of the borrower or collateral value. All loans 90 days or more past due are automatically classified in this category. The caution and special mention categories fall in between the pass and substandard grades and consist of loans that do not currently expose the Company to sufficient risk to warrant adverse classification but possess weaknesses.

The tables below summarize the balance within each risk category by loan type, excluding loans held for sale, at September 30, 2017 and December 31, 2016.



September 30, 2017	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	70,517,818	$	2,020,878	$	1,378,317	$	5,189,062	$	79,106,075
Consumer	52,443,484		1,738,094		254,190		2,428,466		56,864,234
Commercial Business	20,293,905		1,799,445		732,917		670,506		23,496,773
Commercial Real Estate	145,016,591		61,842,493		15,929,625		5,393,440		228,182,149
Total	$	288,271,798	$	67,400,910	$	18,295,049	$	13,681,474	$	387,649,231



December 31, 2016	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	70,503,057	$	665,235	$	1,082,928	$	5,728,689	$	77,979,909
Consumer	46,818,650		2,591,860		6,357		1,251,027		50,667,894
Commercial Business	14,731,698		1,002,170		50,081		495,228		16,279,177
Commercial Real Estate	127,068,983		71,927,031		18,153,718		5,449,562		222,599,294
Total	$	259,122,388	$	76,186,296	$	19,293,084	$	12,924,506	$	367,526,274

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net, Continued

The following tables present an age analysis of past due balances, including loans on non-accrual status, by category at September 30, 2017 and December 31, 2016:



	September 30, 2017
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans Receivable
Residential Real Estate	$	206,120	$	—	$	2,551,216	$	2,757,336	$	76,348,739	$	79,106,075
Consumer	865,261		15,856		453,189		1,334,306		55,529,928		56,864,234
Commercial Business	204,739		32,265		217,700		454,704		23,042,069		23,496,773
Commercial Real Estate	2,019,717		17,037		4,298,231		6,334,985		221,847,164		228,182,149
Total	$	3,295,837	$	65,158	$	7,520,336	$	10,881,331	$	376,767,900	$	387,649,231



	December 31, 2016
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans Receivable
Residential Real Estate	$	653,858	$	—	$	2,488,158	$	3,142,016	$	74,837,893	$	77,979,909
Consumer	625,178		119,640		241,571		986,389		49,681,505		50,667,894
Commercial Business	536,492		69,256		145,401		751,149		15,528,028		16,279,177
Commercial Real Estate	1,719,758		256,285		2,639,837		4,615,880		217,983,414		222,599,294
Total	$	3,535,286	$	445,181	$	5,514,967	$	9,495,434	$	358,030,840	$	367,526,274

At September 30, 2017 and December 31, 2016, the Company did not have any loans that were 90 days or more past due and still accruing interest. Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the existing collateral. In the event an acceptable arrangement cannot be reached, we may have to acquire these properties through foreclosure or other means and subsequently sell, develop, or liquidate them.

The following table shows non-accrual loans by category at September 30, 2017 compared to December 31, 2016:



	September 30, 2017				December 31, 2016				$		%
	Amount		Percent ⁽¹⁾		Amount		Percent ⁽¹⁾		Increase (Decrease)		Increase (Decrease)
Non-accrual Loans:
Residential Real Estate	$	2,551,216	0.67	%	$	2,488,158	0.68	%	$	63,058	2.5%
Consumer	453,189		0.12		241,571		0.07		$	211,618	87.6
Commercial Business	217,700		0.06		145,401		0.04		72,299		49.7
Commercial Real Estate	4,298,231		1.12		2,639,837		0.73		1,658,394		62.8
Total Non-accrual Loans	$	7,520,336	1.97	%	$	5,514,967	1.52	%	$	2,005,369	36.4%

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net, Continued

The following tables show the activity in the allowance for loan losses by category for the three and nine months ended September 30, 2017 and 2016:



	Three Months Ended September 30, 2017
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,450,176		$	1,122,473		$	880,642		$	4,749,341		$	8,202,632
Provision for Loan Losses	80,766			110,023			(842		)	(89,947		)	100,000
Charge-Offs	(114,869		)	(82,087		)	—			(62,482		)	(259,438		)
Recoveries	1,014			15,392			—			109,588			125,994
Ending Balance	$	1,417,087		$	1,165,801		$	879,800		$	4,706,500		$	8,169,188



	Nine Months Ended September 30, 2017
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,360,346		$	996,620		$	882,999		$	5,116,266		$	8,356,231
Provision for Loan Losses	241,112			234,342			2,690			(378,144		)	100,000
Charge-Offs	(186,372		)	(123,942		)	(5,889		)	(198,482		)	(514,685		)
Recoveries	2,001			58,781			—			166,860			227,642
Ending Balance	$	1,417,087		$	1,165,801		$	879,800		$	4,706,500		$	8,169,188



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



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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net, Continued

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



	Allowance For Loan Losses
September 30, 2017	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	—	$	1,417,087	$	1,417,087
Consumer	—		1,165,801		1,165,801
Commercial Business	—		879,800		879,800
Commercial Real Estate	—		4,706,500		4,706,500
Total	$	—	$	8,169,188	$	8,169,188



	Allowance For Loan Losses
December 31, 2016	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	—	$	1,360,346	$	1,360,346
Consumer	1,699		994,921		996,620
Commercial Business	—		882,999		882,999
Commercial Real Estate	12,590		5,103,676		5,116,266
Total	$	14,289	$	8,341,942	$	8,356,231

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



	Loans Receivable
September 30, 2017	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	2,260,496	$	76,845,579	$	79,106,075
Consumer	224,894		56,639,340		56,864,234
Commercial Business	145,401		23,351,372		23,496,773
Commercial Real Estate	7,259,347		220,922,802		228,182,149
Total	$	9,890,138	$	377,759,093	$	387,649,231



	Loans Receivable
December 31, 2016	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	2,181,740	$	75,798,169	$	77,979,909
Consumer	170,552		50,497,342		50,667,894
Commercial Business	145,401		16,133,776		16,279,177
Commercial Real Estate	5,830,341		216,768,953		222,599,294
Total	$	8,328,034	$	359,198,240	$	367,526,274

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net, Continued

Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired management measures the impairment and records the loan at fair value. Fair value is estimated using one of the following methods: fair value of the collateral less estimated costs to sell, discounted cash flows, or market value of the loan based on similar debt. The fair value of the collateral less estimated costs to sell is the most frequently used method. Typically, the Company reviews the most recent appraisal and, if it is over 24 months old, will request a new third party appraisal. Depending on the particular circumstances surrounding the loan, including the location of the collateral, the date of the most recent appraisal and the value of the collateral relative to the recorded investment in the loan, management may order an independent appraisal immediately or, in some instances, may elect to perform an internal analysis. The average balance of impaired loans was $10.3 million for the three months ended September 30, 2017 compared to $10.6 million for the three months ended September 30, 2016.

The following tables present information related to impaired loans by loan category at September 30, 2017 and December 31, 2016 and for the three and nine months ended September 30, 2017 and 2016.



	September 30, 2017						December 31, 2016
Impaired Loans	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
With No Related Allowance Recorded:
Residential Real Estate	$	2,260,496	$	2,720,495	$	—	$	2,181,740	$	2,263,240	$	—
Consumer	224,894		252,704		—		110,114		118,414		—
Commercial Business	145,401		995,401		—		145,401		995,401		—
Commercial Real Estate	7,259,347		8,740,948		—		5,424,701		7,207,688		—
With an Allowance Recorded:
Consumer	—		—		—		60,438		60,438		1,699
Commercial Real Estate	—		—		—		405,640		418,654		12,590
Total
Residential Real Estate	2,260,496		2,720,495		—		2,181,740		2,263,240		—
Consumer	224,894		252,704		—		170,552		178,852		1,699
Commercial Business	145,401		995,401		—		145,401		995,401		—
Commercial Real Estate	7,259,347		8,740,948		—		5,830,341		7,626,342		12,590
Total	$	9,890,138	$	12,709,548	$	—	$	8,328,034	$	11,063,835	$	14,289

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net, Continued



	Three Months Ended September 30,
	2017				2016
Impaired Loans	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With No Related Allowance Recorded:
Residential Real Estate	$	2,613,299	$	2,226	$	3,319,559	$	—
Consumer	240,005		—		128,751		—
Commercial Business	145,401		—		296,401		—
Commercial Real Estate	7,331,736		44,296		6,180,761		67,380
With an Allowance Recorded:
Consumer	—		—		61,581		772
Commercial Real Estate	—		—		641,743		28,534
Total
Residential Real Estate	2,613,299		2,226		3,319,559		—
Consumer	240,005		—		190,332		772
Commercial Business	145,401		—		296,401		—
Commercial Real Estate	7,331,736		44,296		6,822,504		95,914
Total	$	10,330,441	$	46,522	$	10,628,796	$	96,686



	Nine Months Ended September 30,
	2017				2016
Impaired Loans	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With No Related Allowance Recorded:
Residential Real Estate	$	2,939,263	$	25,339	$	3,469,066	$	8,282
Consumer	294,002		—		294,714		—
Commercial Business	145,401		—		301,881		—
Commercial Real Estate	7,517,744		159,584		8,589,845		192,017
With an Allowance Recorded:
Consumer	—		—		62,322		3,470
Commercial Real Estate	—		—		652,867		28,534
Total
Residential Real Estate	2,939,263		25,339		3,469,066		8,282
Consumer	294,002		—		357,036		3,470
Commercial Business	145,401		—		301,881		—
Commercial Real Estate	7,517,744		159,584		9,242,712		220,551
Total	$	10,896,410	$	184,923	$	13,370,695	$	232,303

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

8. Loans Receivable, Net, Continued

In the course of resolving delinquent loans, the Bank may choose to restructure the contractual terms of certain loans. A troubled debt restructuring ("TDR") is a restructuring in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a borrower that it would not otherwise consider (Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 310-40). The concessions granted on TDRs generally include terms to reduce the interest rate, extend the term of the debt obligation, or modify the payment structure on the debt obligation. The Bank grants such concessions to reassess the borrower’s financial status and develop a plan for repayment. TDRs included in impaired loans at September 30, 2017 and December 31, 2016 were $4.2 million and $4.6 million, respectively, and the Bank had no commitments at these dates to lend additional funds on these loans.

Loans on nonaccrual status at the date of modification are initially classified as nonaccrual TDRs. Loans on accruing status at the date of concession are initially classified as accruing TDRs if the loan is reasonably assured of repayment and performance is expected in accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the concession date if reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. Nonaccrual TDRs are returned to accruing status when there is economic substance to the restructuring, there is documented credit evaluation of the borrower's financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated sustained repayment performance in accordance with the modified terms for a reasonable period of time (generally a minimum of six months).

The Bank did not modify any loans that were considered to be TDRs during the nine months ended September 30, 2017 and 2016. At September 30, 2017, two loans totaling $611,000 that had previously been restructured as TDRs were in default, neither of which had been restructured within the last 12 months. One of these loans, with a balance of $41,000, defaulted during the nine month period ended September 30, 2017. In comparison, at September 30, 2016, six loans totaling $765,000 that had previously been restructured as TDRs were in default, and three of the loans, with a balance of $637,000 defaulted during the nine month period ended September 30, 2016. The Bank considers any loan 30 days or more past due to be in default.

Our policy with respect to accrual of interest on loans restructured as a TDR follows relevant supervisory guidance. That is, if a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is probable. If a borrower was materially delinquent on payments prior to the restructuring but shows capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual going forward. Lastly, if the borrower does not perform under the restructured terms, the loan is placed on nonaccrual status.

We closely monitor these loans and will cease accruing interest on them if management believes that the borrowers may not continue performing based on the restructured note terms. If, after previously being classified as a TDR, a loan is restructured a second time, then that loan is automatically placed on nonaccrual status. Our policy with respect to nonperforming loans requires the borrower to make a minimum of six consecutive payments in accordance with the modified loan terms before that loan can be placed back on accrual status. In addition to this payment history, the borrower must demonstrate an ability to continue making payments on the loan prior to restoration of accrual status.

9. Regulatory Matters

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

The Company is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. For a bank holding company with less than $1.0 billion in assets, the capital guidelines apply on a bank only basis and the Federal Reserve expects the holding company's subsidiary banks to be well-capitalized under the prompt corrective action regulations. If Security Federal Corporation was subject to regulatory guidelines for bank holding companies with $1.0 billion or more in assets, at September 30, 2017, it would have exceeded all regulatory capital requirements.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

9. Regulatory Matters, Continued

Based on its capital levels at September 30, 2017, the Bank exceeded all regulatory capital requirements as of that date. Consistent with the Bank's goals to operate a sound and profitable organization, it is the Bank's policy to maintain a "well-capitalized" status under the regulatory capital categories of the FDIC. Based on capital levels at September 30, 2017, the Bank was considered to be "well-capitalized" under applicable regulatory requirements. Management monitors the capital levels to provide for current and future business opportunities and to maintain the Bank's "well-capitalized" status. The following tables provide the Company’s and the Bank’s regulatory capital requirements and actual results at the dates indicated below:



	Actual			For Capital Adequacy			To Be "Well-Capitalized"
(Dollars in Thousands)	Amount		Ratio	Amount		Ratio	Amount		Ratio
SECURITY FEDERAL CORP.	September 30, 2017
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	77,970	15.5%	$	30,227	6.0%	N/A		N/A
Total Risk-Based Capital (To Risk Weighted Assets)	84,289		16.7%	40,303		8.0%	N/A		N/A
Common Equity Tier 1 Capital (To Risk Weighted Assets)	72,970		14.5%	22,670		4.5%	N/A		N/A
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	77,970		9.1%	34,398		4.0%	N/A		N/A
SECURITY FEDERAL BANK
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	88,802	17.6%	$	30,218	6.0%	$	40,290	8.0%
Total Risk-Based Capital (To Risk Weighted Assets)	95,121		18.9%	40,290		8.0%	50,363		10.0%
Common Equity Tier 1 Capital (To Risk Weighted Assets)	88,802		17.6%	22,663		4.5%	32,736		6.5%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	88,802		10.3%	34,393		4.0%	42,992		5.0%

SECURITY FEDERAL CORP.	December 31, 2016
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	73,787	16.6%	$	26,714	6.0%	N/A		N/A
Total Risk-Based Capital (To Risk Weighted Assets)	79,383		17.8%	35,618		8.0%	N/A		N/A
Common Equity Tier 1 Capital (To Risk Weighted Assets)	68,787		15.4%	20,035		4.5%	N/A		N/A
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	73,787		9.1%	32,548		4.0%	N/A		N/A
SECURITY FEDERAL BANK
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	88,139	19.8%	$	26,694	6.0%	$	35,592	8.0%
Total Risk-Based Capital (To Risk Weighted Assets)	93,735		21.1%	35,592		8.0%	44,490		10.0%
Common Equity Tier 1 Capital (To Risk Weighted Assets)	88,139		19.8%	20,021		4.5%	28,919		6.5%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	88,139		10.8%	32,587		4.0%	40,734		5.0%

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

9. Regulatory Matters, Continued

In addition to the minimum common equity Tier 1 ("CET1"), Tier 1 and total capital ratios, the Bank now has to maintain a capital conservation buffer consisting of additional CET1 capital above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of retained income that could be utilized for such actions. The new capital conservation buffer requirement began to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and increases each year until fully implemented to an amount equal to 2.5% of risk weighted assets in January 2019. At September 30, 2017 the Bank’s CET1 capital exceeded the required capital conservation buffer of 1.25%.

10. Carrying Amounts and Fair Value of Financial Instruments

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

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



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

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

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. At September 30, 2017, the Company’s investment portfolio was comprised of government and agency bonds, mortgage-backed securities issued by government agencies or GSEs, private label CMO mortgage-backed securities, municipal securities, one state tax credit, and one equity investment. Fair value measurement is based upon prices obtained from third party pricing services that use independent pricing models which rely on a variety of factors including reported trades, broker/dealer quotes, benchmark yields, economic and industry events and other relevant market information. As a result, these securities are classified as Level 2.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

Mortgage Loans Held for Sale

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

The Company usually delivers a commitment to, and receives funding from, the investor within 30 days. Commitments to sell these loans to the investor are considered derivative contracts and are sold to investors on a “best efforts" basis. The Company is not obligated to deliver a loan or pay a penalty if a loan is not delivered to the investor. As a result of the short-term nature of these derivative contracts, the fair value of the mortgage loans held for sale in most cases is the same as the value of the loan amount at its origination. These loans are classified as Level 2.

Impaired Loans

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

Fair value is estimated using one of the following methods: fair value of the collateral less estimated costs to sell, discounted cash flows, or market value of the loan based on similar debt. The fair value of the collateral less estimated costs to sell is the most frequently used method. Typically, the Company reviews the most recent appraisal and if it is over 24 months old will request a new third party appraisal. Depending on the particular circumstances surrounding the loan, including the location of the collateral, the date of the most recent appraisal and the value of the collateral relative to the recorded investment in the loan, management may order an independent appraisal immediately or, in some instances, may elect to perform an internal analysis. Specifically as an example, in situations where the collateral on a nonperforming commercial real estate loan is out of the Company’s primary market area, management would typically order an independent appraisal immediately, at the earlier of the date the loan becomes nonperforming or immediately following the determination that the loan is impaired. However, as a second example, on a nonperforming commercial real estate loan where management is familiar with the property and surrounding areas and where the original appraisal value far exceeds the recorded investment in the loan, management may perform an internal analysis whereby the previous appraisal value would be reviewed and adjusted for current conditions including recent sales of similar properties in the area and any other relevant economic trends. These valuations are reviewed at a minimum on a quarterly basis.

Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2017, our impaired loans were generally evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. The Company records impaired loans as nonrecurring Level 3. At September 30, 2017 and December 31, 2016, the recorded investment in impaired loans was $9.9 million and $8.3 million, respectively.

Foreclosed Assets

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

Assets measured at fair value on a recurring basis were as follows at September 30, 2017 and December 31, 2016:



	September 30, 2017						December 31, 2016
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
FHLB Securities	$	—	$	—	$	—	$	—	$	998,000	$	—
FHLMC Bond	—		965,646		—		—		$	—	—
SBA Bonds	—		124,803,549		—		—		101,906,059		—
Tax Exempt Municipal Bonds	—		80,815,027		—		—		71,535,149		—
Taxable Municipal Bonds	—		2,012,590		—		—		1,991,130		—
Mortgage-Backed Securities	—		179,834,621		—		—		185,261,091		—
State Tax Credit	—		56,800		—		—		—		—
Equity Securities	—		155,000		—		—		368,000		—
Total	$	—	$	388,643,233	$	—	$	—	$	362,059,429	$	—

There were no liabilities measured at fair value on a recurring basis at September 30, 2017 or December 31, 2016.

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. The tables below present assets measured at fair value on a nonrecurring basis at September 30, 2017 and December 31, 2016, aggregated by the level in the fair value hierarchy within which those measurements fall.



	September 30, 2017
Assets:	Level 1		Level 2		Level 3		Total
Mortgage Loans Held For Sale	$	—	$	1,270,410	$	—	$	1,270,410
Collateral Dependent Impaired Loans ⁽¹⁾	—		—		9,890,138		9,890,138
Foreclosed Assets	—		—		1,907,637		1,907,637
Total	$	—	$	1,270,410	$	11,797,775	$	13,068,185



	December 31, 2016
Assets:	Level 1		Level 2		Level 3		Total
Mortgage Loans Held For Sale	$	—	$	4,243,907	$	—	$	4,243,907
Collateral Dependent Impaired Loans ⁽¹⁾	—		—		8,313,745		8,313,745
Foreclosed Assets	—		—		2,721,214		2,721,214
Total	$	—	$	4,243,907	$	11,034,959	$	15,278,866

^{(1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF}^$14,289^{AT DECEMBER 31, 2016. THERE WERE NO SPECIFIC RESERVES AT SEPTEMBER 30, 2017.}

There were no liabilities measured at fair value on a nonrecurring basis at September 30, 2017 or December 31, 2016.

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis at September 30, 2017, the significant unobservable inputs used in the fair value measurements were as follows:



			Valuation	Significant
Level 3 Assets	Fair Value		Technique	Unobservable Inputs	Range
Collateral Dependent Impaired Loans	$	9,890,138	Appraised Value	Discount Rates/ Discounts to Appraised Values	0% - 72%
Foreclosed Assets	$	1,907,637	Appraised Value/Comparable Sales	Discount Rates/ Discounts to Appraised Values	13% - 100%

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

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

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

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

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

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

FHLB Stock—The fair value approximates the carrying value. No ready market exists for this stock, and it has no quoted market value; however, redemption of this stock has historically been at par value. Accordingly, par value is deemed to be a reasonable estimate of fair value.

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

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

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

Note Payable—The carrying value of the note payable approximates fair value.

Senior Convertible Debentures— The fair value is estimated by discounting the future cash flows using the current rates at which similar debenture offerings with similar terms and maturities would be issued by similar institutions. As discount rates are based on current debenture rates as well as management estimates, the fair values presented may not be indicative of the value negotiated in an actual sale.

Junior Subordinated Debentures—The carrying value of junior subordinated debentures approximates fair value.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

The following tables provide a summary of the carrying value and estimated fair value of the Company’s financial instruments at September 30, 2017 and December 31, 2016 presented in accordance with the applicable accounting guidance.



	September 30, 2017
	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash and Cash Equivalents	$	15,159	$	15,159	$	15,159	$	—	$	—
Certificates of Deposits with Other Banks	1,350		1,350		—		1,350		—
Investment and Mortgage-Backed Securities	413,981		414,212		—		414,212		—
Loans Receivable, Net	375,711		374,295		—		—		374,295
FHLB Stock	2,474		2,474		2,474		—		—
Financial Liabilities:
Deposits:
Checking, Savings & Money Market Accounts	$	463,741	$	463,741	$	463,741	$	—	$	—
Certificate Accounts	237,873		236,225		—		236,225		—
Advances from FHLB	41,000		40,775		—		40,775		—
Other Borrowed Money	12,356		12,356		12,356		—		—
Note Payable	9,700		9,700		—		9,700		—
Senior Convertible Debentures	6,064		6,064		—		6,064		—
Junior Subordinated Debentures	5,155		5,155		—		5,155		—



	December 31, 2016
	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash and Cash Equivalents	$	9,375	$	9,375	$	9,375	$	—	$	—
Certificates of Deposits with Other Banks	2,445		2,445		—		2,445		—
Investment and Mortgage-Backed Securities	387,643		387,430		—		387,430		—
Loans Receivable, Net	359,723		357,457		—		—		357,457
FHLB Stock	2,777		2,777		2,777		—		—
Financial Liabilities:
Deposits:
Checking, Savings & Money Market Accounts	$	438,559	$	438,559	$	438,559	$	—	$	—
Certificate Accounts	215,545		214,149		—		214,149		—
Advances from FHLB	48,395		48,153		—		48,153		—
Other Borrowed Money	9,338		9,338		9,338		—		—
Note Payable	13,000		13,000		—		13,000		—
Senior Convertible Debentures	5,155		5,155		—		5,155		—
Junior Subordinated Debentures	6,084		6,084		—		6,084		—

At September 30, 2017, the Bank had $104.4 million of off-balance sheet financial commitments. These commitments are to originate loans and unused consumer lines of credit and credit card lines. Because these obligations are based on current market rates, if funded, the original principal amount is considered to be a reasonable estimate of fair value.

Fair value estimates are made on a specific date, based on relevant market data and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the Bank’s entire holdings of a particular financial instrument.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

Because no active market exists for a significant portion of the Bank’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, current interest rates and prepayment trends, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in any of these assumptions used in calculating fair value would also significantly affect the estimates. Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Bank has significant assets and liabilities that are not considered financial assets or liabilities including deposit franchise values, loan servicing portfolios, deferred tax liabilities, and premises and equipment.

In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates. The Company has used management’s best estimate of fair value on the above assumptions. Thus, the fair values presented may not be the amounts, which could be realized, in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses that would be incurred in an actual sale or settlement are not taken into consideration in the fair value presented.

11. Accounting and Reporting Changes

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

In May 2014, the FASB issued guidance to change the recognition of Revenue from Contracts with Customers topic of the ASC. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. This guidance also includes expanded disclosure requirements that result in an entity providing users of financial statements with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from the entity’s contracts with customers. The guidance will be effective for the Company for reporting periods beginning after December 15, 2017. The Company will apply the guidance using a modified retrospective approach. As a bank holding company, key revenue sources, such as interest income have been identified as out of the scope of this new guidance. The Company’s preliminary analysis suggests that the adoption of this accounting standard is not expected to have a material impact on the Company’s consolidated financial statements. New accounting guidance related to the adoption of this standard continues to be released by the FASB, which could impact the Company’s preliminary analysis of materiality and may change the preliminary conclusions reached as to the application of this new guidance.

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

In February 2016, the FASB amended the Leases topic of the ASC to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. The amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The effect of the adoption will depend on leases at time of adoption. Once adopted, we expect to report higher assets and liabilities as a result of including right-of-use assets and lease liabilities related to certain banking offices and certain equipment under noncancelable operating lease agreements, however, based on current leases the adoption is not expected to have a material impact on the Company's consolidated financial statements.

In March 2016, the FASB amended the Revenue from Contracts with Customers topic of the ASC to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The effective date and impact on the Company's consolidated financial statements for this update are the same as those described in the Revenue from Contracts with Customers topic issued in May 2014 and August 2015 discussed above.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

11. Accounting and Reporting Changes, Continued

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

In April 2016, the FASB amended the Revenue from Contracts with Customers topic of the ASC to clarify guidance related to identifying performance obligations and accounting for licenses of intellectual property. The effective date and impact on the Company's consolidated financial statements for this guidance are the same as those described in the Revenue from Contracts with Customers topic issued in May 2014 and August 2015 discussed above.

In May 2016, the FASB amended the Revenue from Contracts with Customers topic of the ASC to clarify guidance related to collectability, noncash consideration, presentation of sales tax, and transition. The effective date and impact on the Company's consolidated financial statements for this guidance are the same as those described in the Revenue from Contracts with Customers topic issued in May 2014 and August 2015 discussed above.

In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The guidance significantly changes the impairment model for most financial assets that are measured at amortized cost and certain other instruments from an incurred loss model to an expected loss model. The amendments will be effective for the Company for reporting periods beginning after December 15, 2019. Early adoption is permitted for all entities beginning after December 15, 2018, including interim periods within those fiscal years. The Company is in the process of identifying required changes to the loan loss estimation models and processes and evaluating the impact of this new guidance. Once adopted, we expect our allowance for loan losses to increase, however, until our evaluation is complete the magnitude of the increase will be unknown.

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

In January 2017, the FASB amended the Codification for SEC staff announcements made at recent Emerging Issues Task Force (EITF) meetings. The SEC guidance that specifically relates to the Company’s consolidated financial statements was from the September 2016 meeting, where the SEC staff expressed their expectations about the extent of disclosures registrants should make about the effects of the new FASB guidance as well as any amendments issued prior to adoption, in particular on revenue, leases and credit losses on financial instruments in accordance with Staff Accounting Bulletin Topic 11.M. Entities are required to disclose the effect that recently issued accounting standards will have on their financial statements when adopted in a future period. In cases where a company cannot reasonably estimate the impact of the adoption, then additional qualitative disclosures should be considered. The Company has adopted the amendments in this guidance and appropriate disclosures have been included in this Note for each recently issued accounting standard.

In March 2017, the FASB issued guidance on Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The guidance shortens the amortization period for certain callable debt securities held at a premium. The amendments will be effective for the Company for reporting periods beginning after December 15, 2018. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In May 2017, the FASB amended the requirements in the Compensation-Stock Compensation topic of the ASC related to changes to the terms or conditions of a share-based payment award. The amendments provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The amendments will be effective for the Company for reporting periods beginning after December 15, 2017. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

11. Accounting and Reporting Changes, Continued

In August 2017, the FASB amended the hedge accounting recognition and presentation requirements in ASC 815 to (1) improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities by better aligning the entity’s financial reporting for hedging relationships with those risk management activities and (2) reduce the complexity of and simplify the application of hedge accounting by preparers. The amendments permit hedge accounting for hedging relationships involving nonfinancial risk and interest rate risk by removing certain limitations in cash flow and fair value hedging relationships. In addition, the amendments require an entity to present the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported. The amendments are effective for reporting periods beginning after December 15, 2018 and early adoption is permitted. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

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

12. Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including estimates inherent in the process of preparing financial statements. Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.

Management has reviewed all events occurring through the date the consolidated financial statements were available to be issued and determined that there were no subsequent events that required disclosure.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

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

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

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

•

the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be affected by deterioration in the housing and commercial real estate markets which may lead to increased losses and non-performing assets in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our allowance for loan losses;


•	changes in general economic conditions, either nationally or in our market areas;


•	changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources;


•	fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas;


•	secondary market conditions for loans and our ability to sell loans in the secondary market;

•

results of examinations of the Company by the Federal Reserve and our bank subsidiary by the FDIC and the South Carolina State Board of Financial Institutions, or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements or restrictions on us, any of which could adversely affect our liquidity and earnings;


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


•	our ability to attract and retain deposits;


•	increases in premiums for deposit insurance;


•	our ability to control operating costs and expenses;


•	our ability to implement our business strategies;


•	the use of estimates in determining the fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;


•	difficulties in reducing risks associated with the loans on our balance sheet;


•	staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;


•	computer systems on which we depend could fail or experience a security breach;


•	our ability to retain key members of our senior management team;


•	costs and effects of litigation, including settlements and judgments;


•	our ability to manage loan delinquency rates;


•	increased competitive pressures among financial services companies;


•	changes in consumer spending, borrowing and savings habits;

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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


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


•	our ability to pay dividends on our common stock;


•	adverse changes in the securities markets;


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


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


•	other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in this document.

Some of these and other factors are discussed in the Company's 2016 Form 10-K under Item 1A, “Risk Factors.” Such developments could have an adverse impact on our consolidated financial position and results of operations.

Any of the forward-looking statements that we make in this quarterly report on Form 10-Q and in other public reports and statements we make may turn out to be inaccurate as a result of our beliefs and assumptions we make in connection with the factors set forth above or because of other unidentified and unpredictable factors. Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements and you should not rely on such statements. The Company undertakes no obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. These risks could cause our actual results for 2017 and beyond to differ materially from those expressed in any forward-looking statements by or on behalf of us, and could negatively affect the Company’s consolidated financial condition, consolidated results of operations, liquidity and stock price performance.

Financial Condition at September 30, 2017 and December 31, 2016

Assets

Total assets increased $48.5 million or 6.0% to $861.1 million at September 30, 2017 from $812.7 million at December 31, 2016. Changes in total assets were primarily concentrated in the following asset categories:



					Increase (Decrease)
	September 30, 2017		December 31, 2016		Amount			Percent
Cash and Cash Equivalents	$	15,158,779	$	9,374,549	$	5,784,230		61.7%
Certificates of Deposits with Other Banks	1,350,005		2,445,005		(1,095,000		)	(44.8)
Investment and Mortgage-Backed Securities – AFS	388,643,233		362,059,429		26,583,804			7.3
Investment and Mortgage-Backed Securities – HTM	25,337,966		25,583,956		(245,990		)	(1.0)
Loans Receivable, Net	375,711,468		359,722,846		15,988,622			4.4
OREO	1,907,637		2,721,214		(813,577		)	(29.9)
Premises and Equipment, Net	22,865,424		21,197,684		1,667,740			7.9
FHLB Stock	2,473,700		2,776,500		(302,800		)	(10.9)
BOLI	18,665,893		17,101,045		1,564,848			9.2
Other Assets	4,593,887		5,447,746		(853,859		)	(15.7)

Cash and cash equivalents increased $5.8 million or 61.7% to $15.2 million at September 30, 2017 from $9.4 million at December 31, 2016. Certificates of deposits with other banks decreased $1.1 million or 44.8% to $1.4 million at September 30, 2017. The decrease was due to the maturity and redemption of six of the Bank's lower yield time deposits with other banks during the first nine months of 2017.

Investment and mortgage-backed securities available for sale increased $26.6 million or 7.3% to $388.6 million at September 30, 2017 from $362.1 million at December 31, 2016. Investment and mortgage-backed securities held to maturity decreased $246,000 or 1.0% to $25.3 million at September 30, 2017 from $25.6 million at December 31, 2016. The Bank purchased 64 investment and mortgage-backed securities classified as available for sale for $118.6 million and three investment securities classified as held to maturity for $4.0 million during the first nine months of 2017.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Loans receivable, net, increased $16.0 million or 4.4% to $375.7 million at September 30, 2017 from $359.7 million at December 31, 2016 as a result of increased loan originations in all loan categories with the exception of loans held for sale, which decreased $3.0 million or 70.1% to $1.3 million at September 30, 2017 from $4.2 million at December 31, 2016. Consumer loans increased $6.2 million or 12.2% to $56.9 million at September 30, 2017 compared to $50.7 million at December 31, 2016. Commercial business loans increased $7.2 million or 44.3% to $23.5 million at September 30, 2017 from $16.3 million at December 31, 2016. Commercial real estate loans increased $5.6 million or 2.5% to $228.2 million at September 30, 2017 from $222.6 million at December 31, 2016. Residential real estate loans increased $1.1 million or 1.4% to $79.1 million at September 30, 2017 from $78.0 million at December 31, 2016.

OREO decreased $814,000 or 29.9% to $1.9 million at September 30, 2017 from $2.7 million at December 31, 2016. The decrease was due to the sale of 11 OREO properties during the nine months ended September 30, 2017, with a total book value of $1.2 million, offset slightly by the addition of five OREO properties with a book value of $486,000. At September 30, 2017, OREO consisted of the following real estate properties: five single-family residences and 27 lots within residential subdivisions located throughout our market areas in South Carolina and Georgia; five parcels of commercial land in South Carolina; and two commercial buildings in South Carolina.

Premises and equipment, net increased $1.7 million or 7.9% to $22.9 million at September 30, 2017 from $21.2 million at December 31, 2016. The increase was primarily due to additions related to the construction of the Bank's new branch in Evans, Georgia, which opened in April 2017.

FHLB stock decreased $303,000 or 10.9% to $2.5 million at September 30, 2017 compared to $2.8 million at December 31, 2016 as a result of stock redemptions by the FHLB of Atlanta. The Bank, as a member of the FHLB of Atlanta, is required to acquire and hold shares of capital stock in the FHLB of Atlanta in an amount equal to a membership component, which is 0.09% of total assets, plus a transaction component, which is 4.25% of outstanding advances (borrowings) from the FHLB of Atlanta. As the Bank's total advances have decreased, so has its required investment in FHLB stock.

The cash value of BOLI increased $1.6 million or 9.2% to $18.7 million at September 30, 2017 compared to $17.1 million at December 31, 2016 primarily due to the purchase of 15 additional policies for a total of $2.0 million during the first nine months of 2017. BOLI, which earns tax-free yields, is utilized to partially offset the cost of the Company’s employee benefits programs and to provide key person insurance on certain officers of the Company.

Other assets decreased $854,000 or 15.7% to $4.6 million at September 30, 2017 from $5.4 million at December 31, 2016. The decrease was primarily the result of a $1.6 million decrease in net deferred taxes, which was related to increased unrealized gains in the investment portfolio. The decrease in net deferred taxes was offset partially by increases of $444,000 and $320,000 in principal payments receivable on investment securities and prepaid assets, respectively, during, the same period.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Liabilities

Deposit Accounts

Total deposits increased $47.5 million or 7.3% to $701.6 million at September 30, 2017 compared to $654.1 million at December 31, 2016. Checking and certificate deposits accounted for the majority of the growth, increasing $25.2 million and $22.3 million, respectively, during 2017. The balances, weighted average rates and increases and decreases in deposit accounts were as follows at September 30, 2017 and December 31, 2016:



	September 30, 2017			December 31, 2016			Balance Increase (Decrease)
	Balance		Weighted Rate	Balance		Weighted Rate	Amount			Percent
Demand Accounts:
Checking	$	193,586,490	0.03%	$	171,133,555	0.02%	$	22,452,935		13.1%
Money Market	227,880,092		0.23	230,902,038		0.20	(3,021,946		)	(1.3)
Statement Savings Accounts	42,273,930		0.11	36,522,989		0.10	5,750,941			15.7
Total	$	463,740,512	0.14%	$	438,558,582	0.12%	$	25,181,930		5.7%
Certificate Accounts
0.00 – 0.99%	$	137,325,410		$	148,370,515		$	(11,045,105	)	(7.4)%
1.00 – 1.99%	99,395,482			66,532,221			32,863,261			49.4
2.00 – 2.99%	1,151,956			641,960			509,996			79.4
Total	$	237,872,848	0.88%	$	215,544,696	0.78%	$	22,328,152		10.4%
Total Deposits	$	701,613,360	0.39%	$	654,103,278	0.34%	$	47,510,082		7.3%

Included in the certificate accounts above were $31.5 million and $40.3 million in brokered deposits at September 30, 2017 and December 31, 2016, respectively, with a weighted average interest rate of 1.21% and 1.14%, respectively.

Advances From FHLB

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



	September 30, 2017			December 31, 2016			Increase (Decrease)
Year Due:	Balance		Rate	Balance		Rate	Balance			Percent
2017	$	—	—%	$	15,395,000	0.76%	$	(15,395,000	)	(100.0)%
2018	13,000,000		1.08	18,000,000		1.06	(5,000,000		)	(27.8)
2019	20,500,000		1.39	12,000,000		1.31	8,500,000			70.8
2020	7,500,000		1.58	3,000,000		1.38	4,500,000			150.0
Total Advances	$	41,000,000	1.32%	$	48,395,000	1.05%	$	(7,395,000	)	(15.3)%

Advances are secured by a blanket collateral agreement with the FHLB pledging the Bank’s portfolio of residential first mortgage loans and investment securities with an amortized cost and fair value of $74.5 million and $69.5 million at September 30, 2017, respectively, and $73.3 million and $71.1 million at December 31, 2016, respectively.

There were no callable FHLB advances at September 30, 2017. Callable advances are callable at the option of the FHLB. If an advance is called, the Bank has the option to pay off the advance without penalty, re-borrow funds on different terms, or convert the advance to a three-month floating rate advance tied to LIBOR.

Other Borrowings

The Bank had $12.4 million in other borrowings (non-FHLB advances) at September 30, 2017, an increase of $3.0 million or 32.3% from $9.3 million at December 31, 2016. These borrowings consist of short-term repurchase agreements with certain commercial demand deposit customers for sweep accounts. The repurchase agreements typically mature within one to three days and the interest rate paid on these borrowings floats monthly with money market type rates. At both September 30, 2017 and December 31, 2016, the interest rate paid on the repurchase agreements was 0.15%.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

The Bank had pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $16.9 million and $17.3 million, respectively, at September 30, 2017 and $17.6 million and $17.9 million, respectively, at December 31, 2016.

Note Payable

On October 31, 2016, the Company repurchased all 22,000 shares of its Series B Preferred Stock from the United States Department of the Treasury ("Treasury") for $21.4 million. In connection with the funding of this repurchase, the Company obtained a $14.0 million unsecured term loan from another financial institution. The loan accrues and pays interest quarterly at a floating rate of the Wall Street Journal Prime index minus 30 basis points, which was equal to 3.95% at September 30, 2017. The unpaid principal balance is payable in 11 consecutive quarterly payments of $437,500 each, with a balloon payment equal to the entire remaining principal balance due on October 1, 2019. At September 30, 2017, the remaining principal balance on the loan was $9.7 million.

The note has the following covenants with which the Bank must maintain compliance: the Bank must maintain a "Well Capitalized" rating in accordance with regulatory standards, a Risk-Based Capital Ratio of not less than 12.00%, a “Modified” Texas Ratio of not more than 30.00%, and an annual return on assets of at least 0.60%. The Bank is also required to maintain a loan loss reserve an amount deemed adequate by all federal and state regulatory authorities. Management of the Bank reviews these covenants quarterly for compliance. At September 30, 2017, the Bank was in compliance with all of these covenants.

Junior Subordinated Debentures

On September 21, 2006, Security Federal Statutory Trust (the Trust), issued and sold fixed and floating rate capital securities of the Trust (the “Capital Securities”). The Trust used the net proceeds from the sale of the Capital Securities to purchase a like amount of junior subordinated debentures (the “Debentures”) of the Company which are reported on the Consolidated Balance Sheets as junior subordinated debentures. The Capital Securities accrue and pay distributions at a floating rate of three month LIBOR plus 170 basis points annually which was equal to 3.02% at September 30, 2017. The distribution rate payable on the Capital Securities is cumulative and payable quarterly in arrears. The Capital Securities mature or are mandatorily redeemable upon maturity on December 15, 2036, or upon earlier optional redemption as provided in the indenture. The Company has the right to redeem the Capital Securities in whole or in part.

Convertible Debentures

Effective December 1, 2009, the Company issued $6.1 million in convertible senior debentures. The debentures will mature on December 1, 2029 and accrue interest at the rate of 8.0% per annum until maturity or earlier redemption or repayment. Interest on the debentures is payable on June 1 and December 1 of each year and commenced on June 1, 2010. The debentures are convertible into the Company’s common stock at a conversion price of $20 per share at the option of the holder at any time prior to maturity. The debentures are redeemable, in whole or in part, at the option of the Company at any time on or after December 1, 2019, at a price equal to 100% of the principal amount of the debentures to be purchased plus any accrued and unpaid interest to, but excluding, the date of redemption. The debentures are unsecured general obligations of the Company ranking equal in right of payment to all of our present and future unsecured indebtedness that is not expressly subordinated.

Equity

Shareholders’ equity increased $6.8 million or 9.6% to $77.9 million at September 30, 2017 from $71.1 million at December 31, 2016 primarily due to net income and increased accumulated other comprehensive income, net of tax. The Company’s net income available for common shareholders was $5.0 million for the nine months ended September 30, 2017. Accumulated other comprehensive income, net of tax, comprised primarily of unrealized gains on securities available for sale, net of tax, increased $2.6 million or 216.9% to $3.7 million at September 30, 2017 from $1.2 million at December 31, 2016. The Board of Directors of the Company declared common stock dividends totaling $795,000 during the nine months ended September 30, 2017. Book value per common share was $26.45 at September 30, 2017 compared to $24.14 at December 31, 2016.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Results of Operations for the Three Month Periods Ended September 30, 2017 and 2016

Net Income Available to Common Shareholders

Net income available to common shareholders increased $233,000 or 14.0% to $1.9 million or $0.61 per diluted common share for the three months ended September 30, 2017 compared to $1.7 million or $0.54 per diluted common share for the three months ended September 30, 2016. The increase in net income available to common shareholders for the three month period was primarily the result of increases in net interest income and non-interest income combined with the absence of preferred stock dividends. These items were partially offset by increases in the provision for loan losses and non-interest expense.

Net Interest Income

The net interest spread on a tax equivalent basis decreased four basis points to 3.35% for the three months ended September 30, 2017 from 3.39% for the comparable period in 2016. Net interest income increased $307,000 or 4.8% to $6.7 million during the three months ended September 30, 2017, compared to $6.3 million for the same period in 2016. During the three months ended September 30, 2017, average interest earning assets increased $43.0 million or 5.7% to $798.4 million from $755.4 million for the same period in 2016. Average interest-bearing liabilities increased $48.2 million or 5.5% to $700.7 million for the three months ended September 30, 2017 from $652.5 million for the comparable period in 2016.

Interest Income

The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the three months ended September 30, 2017 and 2016:



	Three Months Ended September 30,								Change in Average Balance			Increase (Decrease) in Interest Income
	2017				2016
(Dollars in thousands)	Average Balance		Yield⁽¹⁾		Average Balance		Yield⁽¹⁾
Loans Receivable, Net	$	372,993	5.52	%	$	347,681	5.65	%	$	25,312		$	234
Mortgage-Backed Securities	206,353		2.47		219,616		2.17		$	(13,263	)	82
Investment Securities⁽²⁾	216,271		2.80		184,332		2.66		$	31,939		287
Overnight Time and Certificates of Deposit	2,783		0.90		3,726		0.53		$	(943	)	1
Total Interest-Earning Assets	$	798,400	3.98	%	$	755,355	3.89	%	$	43,045		$	604

⁽¹⁾ Annualized

⁽²⁾ Tax equivalent basis recognizes the income tax savings when comparing taxable and tax-exempt assets and was calculated using an effective tax rate of 34%. The tax equivalent adjustment relates to the tax exempt municipal bonds and the state tax credit and was $188,924 and $183,850 for the quarters ended September 30, 2017 and 2016, respectively.

Total tax equivalent interest income increased $604,000 or 8.2% to $7.9 million during the three months ended September 30, 2017 compared to $7.3 million during the same period in 2016. This increase was primarily the result of a $43.0 million or 5.7% increase in average interest-earning assets combined with an increase of nine basis points in the average yield. Total interest income on loans increased $234,000 or 4.8% to $5.1 million during the three months ended September 30, 2017 from $4.9 million during the comparable period in 2016. The increase was the result of a $25.3 million or 7.3% increase in the average loan portfolio balance, which was partially offset by a 13 basis point decrease in the average yield. Interest income from mortgage-backed securities increased $82,000 or 6.9% to $1.3 million during the three months ended September 30, 2017 due to an increase of 30 basis points in the average portfolio yield offset by a $13.3 million or 6.0% decrease in the average balance. Tax equivalent interest income from investment securities increased $287,000 or 23.3% to $1.5 million during the three months ended September 30, 2017 due to a $31.9 million or 17.3% increase in the average balance of the investment securities portfolio combined with a 14 basis point increase in the yield.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Interest Expense

The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the three months ended September 30, 2017 and 2016.



	Three Months Ended September 30,								Change in Average Balance			Increase (Decrease) in Interest Expense
	2017				2016
(Dollars in thousands)	Average Balance		Cost⁽¹⁾		Average Balance		Cost⁽¹⁾
Now and Money Market Accounts	$	343,898	0.18	%	$	328,233	0.12	%	$	15,665		$	50
Statement Savings Accounts	41,551		0.10		35,673		0.10		$	5,878		2
Certificate Accounts	232,619		0.87		222,077		0.73		$	10,542		96
FHLB Advances and Other Borrowed Money	60,930		1.08		55,272		0.96		$	5,658		32
Note Payable	10,477		4.04		—		—		$	10,477		106
Junior Subordinated Debentures	5,155		3.02		5,155		2.44		$	—		8
Senior Convertible Debentures	6,069		8.00		6,084		8.00		$	(15	)	—
Total Interest-Bearing Liabilities	$	700,699	0.63	%	$	652,494	0.49	%	$	48,205		$	294

⁽¹⁾ Annualized

Total interest expense increased $294,000 or 36.3% to $1.1 million during the three months ended September 30, 2017 compared to $805,000 for the same period in 2016. The increase in total interest expense was attributable to increases in interest rates paid and a $48.2 million or 7.4% increase in the average balance of interest-bearing liabilities. Interest expense on deposits increased $148,000 or 28.4% to $666,000 during the three months ended September 30, 2017 compared to $519,000 for the same period in 2016. The increase was attributable to an eight basis point increase in the average cost of deposit accounts combined with a $32.1 million or 5.5% increase in average interest-bearing deposits to $618.1 million for the three months ended September 30, 2017 compared to $586.0 million for the three months ended September 30, 2016.

Interest expense on FHLB advances and other borrowings increased $32,000 or 23.8% to $165,000 during the three months ended September 30, 2017 from $133,000 for the same period in 2016. The increase was attributable to an increase of 12 basis points in the average cost combined with a $5.7 million or 10.2% increase in the average balance of FHLB advances and other borrowed money to $60.9 million during the three months ended September 30, 2017 from $55.3 million for the same period in 2016.

Provision for Loan Losses

The amount of the provision is determined by management’s on-going monthly analysis of the loan portfolio and the adequacy of the allowance for loan losses. The Company has policies and procedures in place for evaluating and monitoring the overall credit quality of the loan portfolio and for timely identification of potential problem loans including internal and external loan reviews. The adequacy of the allowance for loan losses is reviewed monthly by the Asset Classification Committee and quarterly by the Board of Directors.

Management’s monthly review of the adequacy of the allowance includes three main components. The first component is an analysis of loss potential in various homogeneous segments of the loan portfolio based on historical trends and the risk inherent in each loan category. Currently, management applies a four year historical loss ratio to each loan category to estimate the inherent loss in these pooled loans.

The second component of management’s monthly analysis is the specific review and evaluation of significant problem credits identified through the Company’s internal monitoring system. These loans are evaluated for impairment and recorded in accordance with accounting guidance. For each loan deemed impaired, management calculates a specific reserve for the amount in which the recorded investment in the loan exceeds the fair value. This estimate is based on a thorough analysis of the most probable source of repayment, which is typically liquidation of the collateral underlying the loan.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

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

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

The Company had net charge-offs of $133,000 for the quarter ended September 30, 2017 compared to net charge-offs of $284,000 for the same three month period in 2016. There was $100,000 in provision for loan losses recorded during the quarter ended September 30, 2017 compared to no provision for the same quarter in 2016.

The table below summarizes activity associated with the allowance for loan losses for the quarters ended September 30, 2017 and 2016:



	Three Months Ended September 30,
	2017		2016
Beginning Balance	$	8,202,632	$	8,395,214
Provision for Loan Losses	100,000		—
Charge-offs	(259,438)		(323,247)
Recoveries	125,994		39,144
Ending Balance	$	8,169,188	$	8,111,111

Allowance For Loan Losses as a % of Gross Loans Receivable, Held For Investment at the End of the Period	2.1%		2.3%
Allowance For Loan Losses as a % of Impaired Loans at the End of the Period	82.6%		83.2%
Impaired Loans	$	9,890,138	$	9,751,765
Gross Loans Receivable, Held For Investment ⁽¹⁾	$	382,610,246	$	355,786,250
Total Loans Receivable, Net	$	375,711,468	$	351,818,570

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

Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the existing collateral. In the event an acceptable arrangement cannot be reached, we may need to acquire these properties through foreclosure or other means and subsequently sell, develop or liquidate them.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Non-Interest Income

Non-interest income increased $581,000 or 32.7% to $2.4 million for the three months ended September 30, 2017, compared to $1.8 million for the three months ended September 30, 2016. The following table summarizes the changes in non-interest income:



	Three Months Ended September 30,				Increase (Decrease)
	2017		2016		Amounts			Percent
Gain on Sale of Investment Securities	$	79,363	$	360,425	$	(281,062	)	(78.0	)%
Gain on Sale of Loans	373,636		256,918		116,718			45.4
Service Fees on Deposit Accounts	274,717		266,960		7,757			2.9
Commissions From Insurance Agency	172,074		149,529		22,545			15.1
BOLI Income	788,133		132,000		656,133			497.1
Trust Income	186,000		197,000		(11,000		)	(5.6)
Check Card Fee Income	282,686		247,331		35,355			14.3
Other	205,524		170,519		35,005			20.5
Total Non-Interest Income	$	2,362,133	$	1,780,682	$	581,451		32.7	%

Net gain on sale of investment securities was $79,000 during the quarter ended September 30, 2017, a decrease of $281,000 or 78.0% compared to $360,000 for the same period last year. The decrease resulted from gross losses of $162,000 on the sale of investment securities during the quarter ended September 30, 2017 compared to no gross loss during the third quarter of 2016. Gain on sale of loans increased $117,000 or 45.4% as the dollar volume of loans sold increased due to the increase in originations of loans held for sale.

BOLI income increased $656,000 or 497.1% to $788,000 during the quarter ended September 30, 2017 from $132,000 for the same period in 2016. During the third quarter of 2017, the Bank recognized $654,000 in death benefits in addition to $134,000 in income related to accrued interest credited to the cash surrender value underlying the BOLI policies. The Company did not receive any life insurance proceeds during the third quarter of 2016. The entire portion of income recognized in 2016 was related to changes in the cash surrender value of the policies.

Non-Interest Expense

For the quarter ended September 30, 2017, non-interest expense increased $875,000 or 15.4% to $6.6 million compared to $5.7 million for the same period in 2016. The following table summarizes the changes in non-interest expense:



	Three Months Ended September 30,				Increase (Decrease)
	2017		2016		Amounts			Percent
Compensation and Employee Benefits	$	3,872,102	$	3,167,112	$	704,990		22.3%
Occupancy	569,024		502,352		66,672			13.3
Advertising	120,033		100,251		19,782			19.7
Depreciation and Maintenance of Equipment	569,839		510,645		59,194			11.6
FDIC Insurance Premiums	64,518		62,163		2,355			3.8
Net Cost of Operation of OREO	105,172		25,991		79,181			304.6
Prepayment Penalties on FHLB Advances	—		260,594		(260,594		)	(100.0)
Other	1,268,449		1,065,209		203,240			19.1
Total Non-Interest Expense	$	6,569,137	$	5,694,317	$	874,820		15.4%

Compensation and employee benefits expenses increased $705,000, or 22.3% to $3.9 million for the three months ended September 30, 2017 compared to $3.2 million for the same period last year due to general annual cost of living increases combined with an increase in full time employees.

Occupancy expense increased $67,000 or 13.3% due to the addition of our Evans, Georgia branch, which opened in April 2017.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

The Company had a net cost of $105,000 from the operation of OREO properties during the quarter ended September 30, 2017 compared to a net cost of $26,000 during the quarter ended September 30, 2016. This amount includes all expenses associated with OREO including write-down in value and gain or loss on sales incurred during each period. The Company had write-downs of $50,000 during the third quarter of 2017 compared to no write-downs for the same period in 2016.

The Company did not prepay any FHLB advances during the three months ended September 30, 2017, and, therefore, incurred no prepayment penalties during the period. In comparison, the Company prepaid one FHLB advance during the same three month period in 2016 and incurred a prepayment penalty of $261,000. The Company elected to prepay this higher rate advance in order to reduce interest expense in future periods and improve net interest spread.

Other expenses increased $203,000, or 19.1% to $1.3 million for the three month period ended September 30, 2017 compared to $1.1 million for the same period in the prior year. Other expenses include legal, professional and consulting expenses, supplies and other miscellaneous expenses.

Provision For Income Taxes

The provision for income taxes decreased $210,000 or 32.0% to $445,000 for the three months ended September 30, 2017 from $655,000 for the same period one year ago. Income before income taxes was $2.3 million for the three months ended September 30, 2017 compared to $2.4 million for the same three month period in 2016. The Company’s combined federal and state effective income tax rate for the current quarter was 19.0% compared to 26.9% for the same quarter one year ago.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Results of Operations for the Nine Month Periods Ended September 30, 2017 and 2016

Net Income Available to Common Shareholders

Net income available to common shareholders increased $277,000 or 5.8% to $5.0 million for the nine months ended September 30, 2017 when compared to the same nine month period in 2016. The increase in net income available to common shareholders for the nine month period was primarily the result of increases in net interest income and non-interest income combined with the absence of preferred stock dividends. These items were partially offset by increases in the provision for loan losses and non-interest expense.

Net Interest Income

The net interest spread on a tax equivalent basis decreased seven basis points to 3.28% for the nine months ended September 30, 2017 from 3.35% for the comparable period in 2016. Net interest income increased $376,000 or 2.0% to $19.1 million for the nine months ended September 30, 2017. During the nine months ended September 30, 2017, average interest earning assets increased $31.3 million or 4.2% to $781.9 million from $750.7 million for the nine months ended September 30, 2016. Average interest-bearing liabilities also increased by $37.9 million or 5.8% to $687.9 million for the nine months ended September 30, 2017 from $650.0 million for the same period in 2016.

Interest Income

The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the nine months ended September 30, 2017 and 2016:



	Nine Months Ended September 30,								Change in Average Balance			Increase (Decrease) in Interest Income
	2017				2016
(Dollars in Thousands)	Average Balance		Yield⁽¹⁾		Average Balance		Yield⁽¹⁾
Loans Receivable, Net	$	363,918	5.44	%	$	339,587	5.65	%	$	24,331		$	470
Mortgage-Backed Securities	203,907		2.32		219,104		2.23		(15,197		)	(119)
Investment Securities⁽²⁾	207,925		2.74		187,918		2.69		20,007			493
Overnight Time & Certificates of Deposit	6,178		0.75		4,062		0.46		2,116			21
Total Interest-Earning Assets	$	781,928	3.87	%	$	750,671	3.88	%	$	31,257		$	865

⁽¹⁾ Annualized

⁽²⁾ Tax equivalent basis recognizes the income tax savings when comparing taxable and tax-exempt assets and was calculated using an effective tax rate of 34%. The tax equivalent adjustment relates to the tax exempt municipal bonds and state tax credit and was $550,269 and $540,948 for the nine months ended September 30, 2017 and 2016, respectively.

Total tax equivalent interest income increased $865,000 or 4.0% to $22.7 million during the nine months ended September 30, 2017 from $21.9 million for the same period in 2016. This increase was primarily the result of a $31.3 million or 4.2% increase in average interest earning assets, which was partially offset by a decline of one basis point in the average yield on interest-earning assets. Total interest income on loans increased $470,000 or 3.3% to $14.8 million during the nine months ended September 30, 2017 from $14.4 million for the same period in 2016. The increase was a result of a $24.3 million or 7.2% increase in the average loan portfolio to $363.9 million from $339.6 million for the same period in 2016, which was partially offset by a decrease of 21 basis points in the average yield on loans. Interest income from mortgage-backed securities decreased $119,000 or 3.3% to $3.6 million for the nine months ended September 30, 2017 from $3.7 million for the same period in 2016 as a result of a $15.2 million or 6.9% decrease in the average balance of mortgage-backed securities, which was partially offset by an increase of nine basis points in the average yield. Tax equivalent interest income from investment securities increased $493,000 or 13.0% to $4.3 million for the nine months ended September 30, 2017 from $3.8 million for the same period in 2016 due to a $20.0 million increase in the average balance of investment securities combined with an increase of six basis points in the average yield.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Interest Expense

The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the nine months ended September 30, 2017 and 2016:



	Nine Months Ended September 30,								Change in Average Balance			Increase (Decrease) in Interest Expense
	2017				2016
(Dollars in Thousands)	Average Balance		Yield⁽¹⁾		Average Balance		Yield⁽¹⁾
Now and Money Market Accounts	$	340,876	0.17%		$	327,971	0.13	%	$	12,905		$	116
Statement Savings Accounts	39,796		0.10		33,970		0.10		5,826			5
Certificates Accounts	227,674		0.82		230,563		0.72		(2,889		)	163
FHLB Advances and Other Borrowed Money	56,486		0.97		46,227		1.62		10,259			(152		)
Note Payable	11,809		3.71		—		—		11,809			329
Junior Subordinated Debentures	5,155		2.87		5,155		2.35		—			20
Senior Convertible Debentures	6,079		8.00		6,084		8.00		(5		)	—
Total Interest-Bearing Liabilities	$	687,875	0.60	%	$	649,970	0.53	%	$	37,905		$	481

⁽¹⁾ Annualized

Interest expense increased $481,000 or 18.5% to $3.1 million during the nine months ended September 30, 2017 compared to $2.6 million for the same period in 2016. The increase in total interest expense was attributable to increases in interest rates paid combined with a $37.9 million or 5.8% increase in the average balance of interest-bearing liabilities. Interest expense on deposits increased $283,000 or 18.0% to $1.9 million during the nine months ended September 30, 2017 compared to $1.6 million for the same period last year. The increase was attributable to a six basis point increase in the average cost of deposit accounts combined with a $15.8 million or 2.7% increase in average interest-bearing deposits to $608.3 million for the nine months ended September 30, 2017 compared to $592.5 million for the nine months ended September 30, 2016.

Interest expense on FHLB advances and other borrowings decreased $152,000 or 27.0% to $410,000 during the nine months ended September 30, 2017 from $561,000 during the same period in 2016 due to a decrease of 65 basis points in the average cost. This decrease was partially offset by a $10.3 million or 22.2% increase in the balance of FHLB advances and other borrowed money to $56.5 million during the nine months ended September 30, 2017 from $46.2 million for the same period last year.

Provision for Loan Losses

There was $100,000 in provision for loan losses for the nine months ended September 30, 2017 compared to no provision expense for the same period in 2016. The Company had net charge-offs of $287,000 for the nine months ended September 30, 2017 compared to net charge-offs of $164,000 during the comparable period in 2016. The following table summarizes the changes in the allowance for loan losses for the nine months ended September 30, 2017 and 2016:



	Nine Months Ended September 30,
	2017		2016
Beginning Balance	$	8,356,231	$	8,275,133
Provision for Loan Losses	100,000		—
Charge-offs	(514,685)		(679,746)
Recoveries	227,642		515,724
Ending Balance	$	8,169,188	$	8,111,111

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Non-Interest Income

Non-interest income increased $720,000 or 14.2% to $5.8 million for the nine months ended September 30, 2017, compared to $5.1 million for the nine months ended September 30, 2016. The following table summarizes the changes in the components of non-interest income:



	Nine Months Ended September 30,				Increase (Decrease)
	2017		2016		Amounts			Percent
Gain on Sale of Investment Securities	$	707,902	$	772,143	$	(64,241	)	(8.3	)%
Gain on Sale of Loans	894,053		657,473		236,580			36.0
Service Fees on Deposit Accounts	776,469		772,341		4,128			0.5
BOLI Income	1,028,133		396,000		632,133			159.6
Commissions From Insurance Agency	451,311		441,519		9,792			2.2
Trust Income	554,000		521,000		33,000			6.3
Check Card Fee Income	838,302		742,583		95,719			12.9
Grant Income	—		265,496		(265,496		)	(100.0)
Other	542,250		504,200		38,050			7.5
Total Non-Interest Income	$	5,792,420	$	5,072,755	$	719,665		14.2	%

Net gain on sale of investment securities was $708,000 during the nine months ended September 30, 2017, a decrease of $64,000 or 8.3% compared to a net gain of $772,000 during the same period last year. The decrease resulted from gross losses of $162,000 on the sale of investment securities during the nine months ended September 30, 2017 compared to no gross loss during the comparable period of 2016.

Gain on sale of loans increased $237,000 or 36.0% to $894,000 for the nine months ended September 30, 2017 compared to $657,000 during the same period in 2016 as the dollar volume of loans sold increased due to the increase in originations of loans held for sale.

BOLI income increased $656,000 or 497.1% to $1.0 million during the nine months ended September 30, 2017 from $396,000 for the same period in 2016. During the nine months ended September 30, 2017, the Bank recognized $654,000 in death benefits in addition to $374,000 in income related to accrued interest credited to the cash surrender value underlying the BOLI policies. The Company did not receive any life insurance proceeds during 2016; all BOLI income recognized was related to changes in the cash surrender value of the policies.

These increases were partially offset by a $265,000 decrease in grant income. The Company received a Bank Enterprise Award (“BEA”) grant from the US Treasury in 2016 in recognition of its continued commitment to community development in economically distressed areas. Our commitment to these areas has continued in 2017 and we anticipate receiving another comparable BEA grant later this year.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Non-Interest Expense

For the nine months ended September 30, 2017, non-interest expense increased $1.3 million or 7.9% to $18.3 million compared to $16.9 million for the same period in 2016. The following table summarizes the changes in the components of non-interest expense:



	Nine Months Ended September 30,						Increase (Decrease)
	2017			2016			Amounts			Percent
Compensation and Employee Benefits	$	10,916,386		$	9,675,430		$	1,240,956		12.8	%
Occupancy	1,661,661			1,469,602			192,059			13.1
Advertising	391,742			343,034			48,708			14.2
Depreciation and Maintenance of Equipment	1,541,460			1,486,060			55,400			3.7
FDIC Insurance Premiums	168,707			322,653			(153,946		)	(47.7)
Net Benefit of Operation of OREO	(96,730		)	(647,990		)	551,260			(85.1)
Prepayment Penalties on FHLB Advances	—			789,306			(789,306		)	(100.0)
Other	3,681,552			3,485,289			196,263			5.6
Total Non-Interest Expense	$	18,264,778		$	16,923,384		$	1,341,394		7.9	%

Compensation and employee benefits expenses were $10.9 million for the nine months ended September 30, 2017, an increase of $1.2 million or 12.8% from $9.7 million during the same period last year. The increase was due to general annual cost of living increases combined with the addition of several new hires during the nine months ended September 30, 2017. The Company had 223 full time equivalent employees at September 30, 2017 compared to 204 at September 30, 2016.

The Company had a net benefit of $97,000 from the operation of OREO properties during the nine months ended September 30, 2017 compared to a net benefit of $674,000 during the nine months ended September 30, 2016. The majority of the prior year net benefit was related to the sale of one OREO property in February 2016, which resulted in a $739,000 gain that offset the cost of operating OREO properties during the nine months ended September 30, 2016.

The Company did not prepay any FHLB advances during the nine months ended September 30, 2017, and, therefore, incurred no prepayment penalties during the period. In comparison, the Company prepaid three FHLB advances during the nine months ended September 30, 2016 and incurred prepayment penalties of $789,000. The Company elected to prepay these higher rate advances in order to reduce interest expense in future periods and improve net interest spread.

Provision For Income Taxes

The provision for income taxes decreased $293,000 or 16.2% to $1.5 million for the nine months ended September 30, 2017 from $1.8 million for the same period in 2016. Income before taxes was $6.5 million and $6.9 million for the nine months ended September 30, 2017 and 2016, respectively. The Company’s combined federal and state effective income tax rate was 23.2% for the nine months ended September 30, 2017 compared to 26.3% for the same period in 2016.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

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

Liquidity

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

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

During the nine months ended September 30, 2017 loan disbursements exceeded loan repayments resulting in a $16.0 million or 4.4% increase in total net loans receivable. During the nine months ended September 30, 2017, deposits increased $47.5 million or 7.3% and FHLB advances decreased $7.4 million or 15.3%. The Bank had $216.0 million in additional borrowing capacity at the FHLB at the end of the period. At September 30, 2017, the Bank had $138.9 million of certificates of deposit maturing within one year. Based on previous experience, the Bank anticipates a significant portion of these certificates will be renewed on maturity.

At September 30, 2017, the Bank exceeded all regulatory capital requirements with Common Equity Tier 1 Capital (CET1), Tier 1 leverage-based capital, Tier 1 risk-based capital, and total risk-based capital ratios of 17.6%, 10.3%, 17.6%, and 18.9%, respectively. To be categorized as “well capitalized” under the prompt corrective action provisions the Bank must maintain minimum CET1, total risk based capital, Tier 1 risk based capital and Tier 1 leverage capital ratios of 6.5%, 10.0%, 8.0% and 5.0%, respectively.

The Company also exceeded all regulatory capital requirements with CET1, Tier 1 leverage-based capital, Tier 1 risk- based capital and total risk-based capital ratios of 14.5%, 9.1%, 15.5%, and 16.7%, respectively, at September 30, 2017.

Off-Balance Sheet Commitments

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

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at September 30, 2017.



(Dollars in thousands)	One Month or Less		After One Through Three Months		After Three Through Twelve Months		Total Within One Year		Greater Than One Year		Total
Unused Lines of Credit	$	521	$	3,356	$	33,095	$	36,972	$	66,288	$	103,260
Standby Letters of Credit	—		177		974		1,151		—		1,151
Total	$	521	$	3,533	$	34,069	$	38,123	$	66,288	$	104,411

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

The Company’s profitability is affected by fluctuations in the market interest rate. Management’s goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase or decrease in interest rates may adversely impact the Company’s earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same rate, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using a test that measures the impact on net interest income and net portfolio value of an immediate change in interest rates in 100 basis point increments. Net portfolio value is defined as the net present value of assets, liabilities, and off-balance sheet contracts.

For the three and nine months ended September 30, 2017, the Bank's interest rate spread, defined as the average yield on interest bearing assets less the average rate paid on interest bearing liabilities was 3.35% and 3.28%, respectively.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a - 15(e) of the Securities Exchange Act of 1934 (“Act”)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members of the Company’s senior management as of the end of the period covered by this quarterly report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that at September 30, 2017 the Company’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms. There have been no significant changes in our internal controls over financial reporting during the quarter ended September 30, 2017 that have materially affected or are reasonably likely to affect our internal controls over financial reporting.

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Part II: Other Information

Item 1 Legal Proceedings

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

Item 1A Risk Factors

There have been no material changes in the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

Item 2 Unregistered Sales of Equity Securities and Use Of Proceeds

None

Item 3 Defaults Upon Senior Securities

None

Item 4 Mine Safety Disclosures

Not applicable

Item 5 Other Information

None

Item 6 Exhibits



3.1		Articles of Incorporation, as amended (1)
3.2		Amended and Restated Bylaws (2)
4.1		Form of Stock Certificate of the Company and other instruments defining the rights of security holders, including indentures (3) P
4.2		Form of Indenture with respect to the Company's 8.0% Convertible Senior Debentures Due 2029 (4)
4.3		Specimen Convertible Senior Debenture Due 2029 (4)
10.1		1993 Salary Continuation Agreements (5) P
10.2		Amendment One to 1993 Salary Continuation Agreements (6) P
10.3		Form of 2006 Salary Continuation Agreement (7)
10.4		Form of Security Federal Split Dollar Agreement (7)
10.5		1999 Stock Option Plan (8)
10.6		2002 Stock Option Plan (9)
10.7		2006 Stock Option Plan (10)
10.8		2008 Equity Incentive Plan (11)
10.9		Form of incentive stock option agreement and non-qualified stock option agreement pursuant to the 2006 Stock Option Plan (10)
10.1		2004 Employee Stock Purchase Plan (12)
10.11		Incentive Compensation Plan (5) P

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES



10.12		Form of Compensation Modification Agreement (13)
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
32		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
101		The following materials from Security Federal Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income; (d) Consolidated Statements of Changes in Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements

_____________


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


(2)	Incorporated by reference to the Company’s Current Report on Form 8-K filed on January 16, 2015.


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


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


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


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


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


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


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


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


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


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


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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

Signatures

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

SECURITY FEDERAL CORPORATION



Date:	November 13, 2017	By:	/s/J. Chris Verenes
				J. Chris Verenes
				Chief Executive Officer
				Duly Authorized Representative



Date:	November 13, 2017	By:	/s/Jessica T. Cummins
				Jessica T. Cummins
				Chief Financial Officer
				Duly Authorized Representative

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

EXHIBIT INDEX

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

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

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

101 The following materials from Security Federal Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2017, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income; (d) Consolidated Statements of Changes in Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements