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 MARCH 31, 2018
( ) 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.
 
CLASS:
 
OUTSTANDING SHARES AT:
 
SHARES:
 
 
Common Stock, par value $0.01 per share
 
May 14, 2018
 
2,953,424
 




 
 
 
PART I.
FINANCIAL INFORMATION (UNAUDITED)
PAGE NO.
Item 1.
Financial Statements (unaudited):
3
 
Consolidated Balance Sheets at March 31, 2018 and December 31, 2017
3
 
Consolidated Statements of Income for the Three Months Ended March 31, 2018 and 2017
4
 
Consolidated Statements of Comprehensive (Loss) Income for the Three Months Ended March 31, 2018 and 2017
5
 
Consolidated Statements of Changes in Shareholders’ Equity for the Three Months Ended March 31, 2018 and 2017
6
 
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2018 and 2017
7
 
Notes to Consolidated Financial Statements
9
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
32
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
40
Item 4.
Controls and Procedures
40
 
 
 
PART II.
OTHER INFORMATION
 
Item 1.
Legal Proceedings
41
Item 1A.
Risk Factors
41
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
41
Item 3.
Defaults Upon Senior Securities
41
Item 4.
Mine Safety Disclosures
41
Item 5.
Other Information
41
Item 6.
Exhibits
41
 
Signatures
43
 
 
 

SCHEDULES OMITTED

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





SECURITY FEDERAL CORPORATION AND SUBSIDIARIES


Part 1. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets
 
March 31, 2018
 
December 31, 2017
 
(Unaudited)
 
(Audited)
ASSETS:
 
 
 
Cash and Cash Equivalents
$
15,598,549

 
$
10,319,624

Certificates of Deposit with Other Banks
1,950,010

 
1,950,010

Investment and Mortgage-Backed Securities:
 
 
 
Available For Sale ("AFS")
358,852,200

 
384,973,906

Held To Maturity (Fair Value of $23,842,005 and $27,054,934 at March 31, 2018 and December 31, 2017, Respectively)
24,258,599

 
27,080,970

Total Investments and Mortgage-Backed Securities
383,110,799

 
412,054,876

Loans Receivable, Net:
 
 
 
Held For Sale
2,407,478

 
3,051,950

Held For Investment (Net of Allowance of $8,204,016 and $8,221,618 at March 31, 2018 and December 31, 2017, Respectively)
414,057,783

 
387,441,247

Total Loans Receivable, Net
416,465,261

 
390,493,197

Accrued Interest Receivable:
 
 
 
Loans
1,221,584

 
1,067,657

Mortgage-Backed Securities
544,327

 
589,000

Investment Securities
1,591,519

 
1,699,961

Total Accrued Interest Receivable
3,357,430

 
3,356,618

Premises and Equipment, Net
22,840,720

 
22,797,844

Federal Home Loan Bank ("FHLB") Stock, at Cost
2,532,800

 
2,931,900

Other Real Estate Owned ("OREO")
1,073,856

 
1,115,671

Bank Owned Life Insurance ("BOLI")
18,932,893

 
18,797,893

Goodwill
1,199,754

 
1,199,754

Other Assets
4,624,012

 
3,795,212

Total Assets
$
871,686,084

 
$
868,812,599

LIABILITIES AND SHAREHOLDERS’ EQUITY:
 
 
 
Liabilities:
 
 
 
Deposit Accounts
$
716,666,452

 
$
702,106,619

Advance Payments By Borrowers For Taxes and Insurance
427,603

 
269,761

Advances From FHLB
41,000,000

 
51,680,000

Other Borrowings
13,779,454

 
11,307,161

Note Payable
6,200,000

 
8,500,000

Junior Subordinated Debentures
5,155,000

 
5,155,000

Senior Convertible Debentures
6,064,000

 
6,064,000

Other Liabilities
6,093,678

 
5,806,604

Total Liabilities
$
795,386,187

 
$
790,889,145

Shareholders' Equity:
 
 
 
Common Stock, $.01 Par Value; Authorized 5,000,000 Shares; Issued and Outstanding Shares, 3,154,527 and 2,953,324, Respectively, at March 31, 2018 and 3,153,907 and 2,952,974, Respectively, at December 31, 2017
$
31,543

 
$
31,539

Additional Paid-In Capital
12,220,859

 
12,212,844

Treasury Stock, at Cost (200,933 Shares)
(4,330,712
)
 
(4,330,712
)
Accumulated Other Comprehensive Income ("AOCI")
447,409

 
2,932,122

Retained Earnings
67,930,798

 
67,077,661

Total Shareholders' Equity
$
76,299,897

 
$
77,923,454

Total Liabilities and Shareholders' Equity
$
871,686,084

 
$
868,812,599


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

3


SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)
 
Three Months Ended March 31,
 
2018
 
2017
Interest Income:
 
 
 
Loans
$
5,389,487

 
$
4,747,478

Mortgage-Backed Securities
1,315,420

 
1,122,067

Investment Securities
1,060,666

 
1,113,582

Other
8,248

 
20,198

Total Interest Income
7,773,821

 
7,003,325

Interest Expense:
 
 
 
NOW and Money Market Accounts
187,205

 
133,232

Statement Savings Accounts
11,553

 
9,272

Certificate Accounts
537,561

 
425,787

FHLB Advances and Other Borrowed Money
191,022

 
121,284

Note Payable
76,671

 
111,947

Senior Convertible Debentures
121,280

 
121,680

Junior Subordinated Debentures
43,685

 
34,734

Total Interest Expense
1,168,977

 
957,936

Net Interest Income
6,604,844

 
6,045,389

Provision For Loan Losses

 

Net Interest Income After Provision For Loan Losses
6,604,844

 
6,045,389

Non-Interest Income:
 
 
 
Gain on Sale of Investment Securities
436,304

 
583,391

Gain on Sale of Loans
286,003

 
280,368

Service Fees on Deposit Accounts
257,179

 
240,885

Commissions From Insurance Agency
179,225

 
153,992

Trust Income
232,500

 
182,000

BOLI Income
135,000

 
120,000

Check Card Fee Income
307,046

 
270,992

Other
210,763

 
165,721

Total Non-Interest Income
2,044,020

 
1,997,349

Non-Interest Expense:
 
 
 
Compensation and Employee Benefits
3,809,124

 
3,511,487

Occupancy
551,268

 
518,052

Advertising
188,672

 
135,535

Depreciation and Maintenance of Equipment
540,297

 
465,564

Federal Deposit Insurance Corporation ("FDIC") Insurance Premiums
66,786

 
64,674

Net Cost (Benefit) of Operation of OREO
38,733

 
(119,104
)
Other
1,324,066

 
1,252,730

Total Non-Interest Expense
6,518,946

 
5,828,938

Income Before Income Taxes
2,129,918

 
2,213,800

Provision For Income Taxes
399,801

 
585,182

Net Income
$
1,730,117

 
$
1,628,618

Net Income Per Common Share (Basic)
$
0.59

 
$
0.55

Net Income Per Common Share (Diluted)
$
0.56

 
$
0.52

Cash Dividend Per Share on Common Stock
$
0.09

 
$
0.09

Weighted Average Shares Outstanding (Basic)
2,953,180

 
2,944,001

Weighted Average Shares Outstanding (Diluted)
3,257,532

 
3,250,549


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

4


SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive (Loss) Income (Unaudited)
 
Three Months Ended March 31,
 
2018
 
2017
Net Income
$
1,730,117

 
$
1,628,618

Other Comprehensive (Loss) Income
 
 
 
Unrealized (Losses) Gains on Securities:
 
 
 
Unrealized Holding (Losses) Gains on Securities Available For Sale, Net of Taxes of $(896,557) and $539,973 at March 31, 2018 and 2017, Respectively
(2,742,899
)
 
869,685

Reclassification Adjustment for Gains Included in Net Income, Net of Taxes of $109,076 and $221,689 at March 31, 2018 and 2017, Respectively
(327,228
)
 
(361,702
)
Amortization of Unrealized Gains on Available For Sale Securities Transferred to Held To Maturity, Net of Taxes of $(10,865) and $(20,361) at March 31, 2018 and 2017, Respectively
(25,677
)
 
(33,278
)
Other Comprehensive (Loss) Income
(3,095,804
)
 
474,705

Comprehensive (Loss) Income
$
(1,365,687
)
 
$
2,103,323


 
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.


5


SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity (Unaudited)
For the Three Months Ended March 31, 2018 and 2017

 
 
 
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

 

 

 

 

 
1,628,618

 
1,628,618

Other Comprehensive Income, Net of Tax

 

 

 

 
474,705

 

 
474,705

Vesting of Restricted Stock
 
 
25,358

 

 

 

 

 
25,358

Cash Dividends on Common Stock

 

 

 

 

 
(265,092
)
 
(265,092
)
Balance at March 31, 2017
$
31,464

 
$

 
$
12,036,744

 
$
(4,330,712
)
 
$
1,654,791

 
$
63,583,576

 
$
72,975,863



 
 
 
Common
Stock
 
 
Additional
Paid – In
 Capital
 
 
 
Treasury
Stock
 
Accumulated Other Comprehensive Income
 
 
 
Retained
Earnings
 
 
 
 
Total
Balance at December 31, 2017
$
31,539

 
$
12,212,844

 
$
(4,330,712
)
 
$
2,932,122

 
$
67,077,661

 
$
77,923,454

Net Income

 

 

 

 
1,730,117

 
1,730,117

Other Comprehensive Income, Net of Tax

 

 

 
(3,095,804
)
 

 
(3,095,804
)
Reclassification of stranded tax effects from AOCI to Retained Earnings

 

 

 
611,091

 
(611,091
)
 

Stock Options Exercised
4

 
8,015

 

 

 

 
8,019

Cash Dividends on Common Stock

 

 

 

 
(265,889
)
 
(265,889
)
Balance at March 31, 2018
$
31,543

 
$
12,220,859

 
$
(4,330,712
)
 
$
447,409

 
$
67,930,798

 
$
76,299,897


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

6


SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)
 
Three Months Ended March 31,
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net Income
$
1,730,117

 
$
1,628,618

Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities:
 
 
 
Depreciation Expense
358,865

 
330,970

Stock Option Compensation Expense

 
25,358

Discount Accretion and Premium Amortization
1,466,178

 
1,363,031

Earnings on BOLI
(135,000
)
 
(120,000
)
Gain on Sales of Loans
(286,003
)
 
(280,368
)
Gain on Sales of Mortgage-Backed Securities ("MBS")
(181,034
)
 
(284,935
)
Gain on Sales of Investment Securities
(255,270
)
 
(298,456
)
Gain on Sales of OREO
(11,846
)
 
(214,025
)
Write Down on OREO
10,000

 
18,000

Amortization of Deferred Loan Costs
16,384

 
25,899

Proceeds From Sale of Loans Held For Sale
10,210,795

 
10,585,391

Origination of Loans Held For Sale
(9,280,320
)
 
(7,179,868
)
(Increase) Decrease in Accrued Interest Receivable:
 
 
 
Loans
(153,927
)
 
4,670

MBS
44,673

 
34,282

Investment Securities
108,442

 
(105,929
)
Increase in Advance Payments By Borrowers
157,842

 
179,825

Other, Net
438,231

 
808,495

Net Cash Provided By Operating Activities
$
4,238,127

 
$
6,520,958

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchase of MBS AFS
$
(10,238,188
)
 
$
(6,638,366
)
Proceeds from Payments and Maturities of MBS AFS
9,160,773

 
9,239,992

Proceeds from Sale of MBS AFS
17,007,024

 
11,047,043

Proceeds from Payments and Maturities of MBS Held To Maturity ("HTM")
724,785

 
1,003,401

Purchase of Investment Securities AFS
(14,115,856
)
 
(42,474,277
)
Proceeds from Payments and Maturities of Investment Securities AFS
7,736,448

 
5,354,864

Proceeds from Sale of Investment Securities AFS
11,563,456

 
4,256,705

Purchase of Investment Securities HTM

 
(3,997,750
)
Proceeds from Payments and Maturities of Investment Securities HTM
2,000,000

 

Proceeds from Redemption of Certificates of Deposits with Other Banks

 
850,000

Purchase of FHLB Stock
(2,186,200
)
 
(2,222,900
)
Redemption of FHLB Stock
2,585,300

 
2,653,200

Increase in Loans Receivable
(26,711,520
)
 
1,219,032

Proceeds From Sale of OREO
122,261

 
989,846

Purchase and Improvement of Premises and Equipment
(401,741
)
 
(772,043
)
Net Cash Used By Investing Activities
$
(2,753,458
)
 
$
(19,491,253
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Increase in Deposit Accounts
$
14,559,833

 
$
43,576,643

Proceeds from FHLB Advances
80,660,000

 
26,540,000

Repayment of FHLB Advances
(91,340,000
)
 
(36,935,000
)
Increase in Other Borrowings, Net
2,472,293

 
448,601

Repayment of Note Payable
(2,300,000
)
 
(1,000,000
)
Proceeds from Employee Stock Options Exercised
8,019

 

Dividends to Common Stock Shareholders
(265,889
)
 
(265,092
)
Net Cash Provided By Financing Activities
$
3,794,256

 
$
32,365,152

Net Increase in Cash and Cash Equivalents
5,278,925

 
19,394,857

Cash and Cash Equivalents at Beginning of Period
10,319,624

 
9,374,549

Cash and Cash Equivalents at End of Period
$
15,598,549

 
$
28,769,406

 
 
 
 
 

7


SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited) (Continued)
 
 
 
 
 
Three Months Ended March 31,
 
2018
 
2017
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
 
 
 
Cash Paid During The Period For:
 
 
 
Interest
$
1,033,699

 
$
830,766

Income Taxes
$

 
$

Supplemental Schedule of Non Cash Transactions:
 
 
 
Transfers From Loans Receivable to OREO
$
78,600

 
$
128,008

(Decrease) Increase in Unrealized Gains on Securities AFS, Net of Taxes
$
(3,095,804
)
 
$
474,705


SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.


8



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”) 2017 Annual Report to Shareholders which was filed as an exhibit to our Annual Report on Form 10-K for the year ended December 31, 2017 (“2017 10-K”) when reviewing interim financial statements. The unaudited consolidated results of operations for the three months ended March 31, 2018 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 is an insurance agency offering auto, business, health and home insurance.  SFINS has a wholly owned subsidiary, Collier Jennings Financial Corporation, which has as subsidiaries Security Federal Auto Insurance, The Auto Insurance Store Inc., and Security Federal Premium Pay Plans Inc. Security Federal Premium Pay Plans Inc. has one wholly owned premium finance subsidiary and also has an ownership interest in four other premium finance subsidiaries. SFSC is currently inactive. All significant intercompany transactions and balances have been eliminated in consolidation.

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

3. Critical Accounting Policies

The Company has adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements.  Our significant accounting policies are described in the footnotes to the audited consolidated financial statements at December 31, 2017 included in our 2017 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.


9



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 March 31, 2018 and 2017 had an exercise price below the average market price during the three months ended March 31, 2018 and 2017. Therefore, these options were considered to be dilutive to EPS in those periods.
 
The following tables include a summary of the Company's basic and diluted EPS for the periods indicated.
 
Three Months Ended March 31,
 
2018
 
2017
 
Income
 
Shares
 
Per Share Amounts
 
Income
 
Shares
 
Per Share Amounts
Basic EPS
$
1,730,117

 
2,953,180

 
$
0.59

 
$
1,628,618

 
2,944,001

 
$
0.55

Effect of Dilutive Securities:
 
 
 
 
 
 
 
 
 
 
 
Stock Options

 
1,152

 

 

 
2,348

 

Senior Convertible Debentures
90,960

 
303,200

 
(0.03
)
 
75,442

 
304,200

 
(0.03)

Diluted EPS
$
1,821,077

 
3,257,532

 
$
0.56

 
$
1,704,060

 
3,250,549

 
$
0.52


 


10



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements




5. Stock-Based Compensation

Certain officers and directors of the Company participate in incentive and non-qualified stock option plans. Options are granted at exercise prices not less than the fair value of the Company’s common stock on the date of the grant. The following is a summary of the activity under the Company’s stock option plans for the periods presented:
 
Three Months Ended March 31,
 
2018
 
2017
 
Shares
 
Weighted Average Exercise Price
 
Shares
 
Weighted Average Exercise Price
 
 
Balance, Beginning of Period
4,500

 
$22.91
 
21,500

 
$23.57
Options Exercised
350

 
22.91
 

 
Balance, End of Period
4,150

 
$22.91
 
21,500

 
$23.57
 
 
 
 
 
 
 
 
Options Exercisable
4,150

 
 
 
20,600

 
 
 
 
 
 
 
 
 
 
Options Available For Grant
50,000

 
 
 
50,000

 
 
 

At March 31, 2018, the Company had the following options outstanding:

Grant Date
 
Outstanding Options
 
Option Price
 
Expiration Date
05/19/08
 
2,500
 
$22.91
 
05/18/18
 
 
 
 
 
 
 
07/01/08
 
1,650
 
$22.91
 
07/01/18




11



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:
 
March 31, 2018
 
Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Student Loan Pools
$
11,509,602

 
$
11,702

 
$
89,690

 
$
11,431,614

Small Business Administration (“SBA”) Bonds
116,226,896

 
914,781

 
328,335

 
116,813,342

Tax Exempt Municipal Bonds
57,866,536

 
1,231,282

 
445,775

 
58,652,043

Taxable Municipal Bonds
2,015,694

 

 
34,364

 
1,981,330

Mortgage-Backed Securities
170,554,894

 
1,178,301

 
1,914,324

 
169,818,871

Equity Securities
155,000

 

 

 
155,000

Total Available For Sale
$
358,328,622

 
$
3,336,066

 
$
2,812,488

 
$
358,852,200

 
 
 
 
 
 
 
 
 
December 31, 2017
 
Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Student Loan Pools
$
8,522,043

 
$
1,288

 
$
1,546

 
$
8,521,785

SBA Bonds
123,324,802

 
1,113,160

 
189,518

 
124,248,444

Tax Exempt Municipal Bonds
59,623,185

 
2,789,233

 
56,851

 
62,355,567

Taxable Municipal Bonds
2,016,833

 

 
19,703

 
1,997,130

Mortgage-Backed Securities
186,732,705

 
1,936,847

 
973,572

 
187,695,980

Equity Securities
155,000

 

 

 
155,000

Total Available For Sale
$
380,374,568

 
$
5,840,528

 
$
1,241,190

 
$
384,973,906


Student Loan Pools are typically 97% guaranteed by the United States government while SBA bonds are 100% backed by the full faith and credit of the United States government. Included in the tables above and below in mortgage-backed securities are Government National Mortgage Association ("GNMA") mortgage-backed securities, which are also backed by the full faith and credit of the United States government.  At March 31, 2018, AFS GNMA mortgage-backed securities had an amortized cost and fair value of $83.3 million and $83.2 million, respectively, compared to an amortized cost and fair value of $101.3 million and $102.1 million, respectively, at December 31, 2017.

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 March 31, 2018 the Bank held AFS private label CMO mortgage-backed securities with an amortized cost and fair value of $30.3 million and $30.2 million, respectively, compared to an amortized cost and fair value of $26.9 million and $26.9 million, respectively, at December 31, 2017.












12



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 March 31, 2018 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.
 
March 31, 2018
Investment Securities:
Amortized Cost
 
Fair Value
One Year or Less
$
213,937

 
$
213,021

After One – Five Years
12,738,020

 
12,739,270

After Five – Ten Years
41,482,362

 
41,522,064

More Than Ten Years
133,339,409

 
134,558,974

Mortgage-Backed Securities
170,554,894

 
169,818,871

Total Available For Sale
$
358,328,622

 
$
358,852,200


At March 31, 2018 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 $117.7 million and $118 million, respectively, compared to an amortized cost and fair value of $99.2 million and $100.5 million, respectively, at December 31, 2017.

The Bank received $28.6 million and $15.3 million in gross proceeds from sales of available for sale securities during the three months ended March 31, 2018 and 2017, respectively. As a result, the Bank recognized gross gains of $503,000 and $583,000, respectively, with $67,000 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.
 
March 31, 2018
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
Unrealized
Losses
 
Fair
Value
Unrealized
Losses
 
Fair
Value
Unrealized
Losses
Student Loan Pools
$
7,493,392

$
89,690

 
$

$

 
$
7,493,392

$
89,690

SBA Bonds
35,400,695

266,288

 
5,383,454

62,047

 
40,784,149

328,335

Tax Exempt Municipal Bonds
18,123,386

300,371

 
4,216,431

145,404

 
22,339,817

445,775

Taxable Municipal Bonds
1,981,330

34,364

 


 
1,981,330

34,364

Mortgage-Backed Securities
86,647,947

1,407,637

 
23,803,408

506,687

 
110,451,355

1,914,324

 
$
149,646,750

$
2,098,350

 
$
33,403,293

$
714,138

 
$
183,050,043

$
2,812,488

 
December 31, 2017
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
Unrealized
Losses
 
Fair
Value
Unrealized
Losses
 
Fair
Value
Unrealized
Losses
Student Loan Pools
$
7,556,014

$
1,546

 
$

$

 
$
7,556,014

$
1,546

SBA Bonds
24,433,422

151,459

 
5,588,532

38,059

 
30,021,954

189,518

Tax Exempt Municipal Bonds
4,406,162

13,852

 
4,328,229

42,999

 
8,734,391

56,851

Taxable Municipal Bond
1,997,130

19,703

 


 
1,997,130

19,703

Mortgage-Backed Securities
62,574,910

624,772

 
23,612,359

348,800

 
86,187,269

973,572

 
$
100,967,638

$
811,332

 
$
33,529,120

$
429,858

 
$
134,496,758

$
1,241,190



13



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements




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

Securities classified as available for sale are recorded at fair market value.  At March 31, 2018 and December 31, 2017, 25.4% and 34.6% of the unrealized losses, representing 31 and 30 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 three months ended March 31, 2018.

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:
 
March 31, 2018
 
 Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Federal Home Loan Mortgage Corporation ("FHLMC") Bond
$
998,214

 
$

 
$
25,236

 
$
972,978

Mortgage-Backed Securities (1)
23,260,385

 
89,284

 
480,642

 
22,869,027

Total Held To Maturity
$
24,258,599

 
$
89,284

 
$
505,878

 
$
23,842,005

 
 
December 31, 2017
 
 Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
FHLB Bonds
$
2,000,000

 
$

 
$
2,984

 
$
1,997,016

FHLMC Bond
998,102

 

 
12,588

 
985,514

Mortgage-Backed Securities (1)
24,082,868

 
120,843

 
131,307

 
24,072,404

Total Held To Maturity
$
27,080,970

 
$
120,843

 
$
146,879

 
$
27,054,934

(1) COMPRISED OF MORTGAGE-BACKED SECURITIES OF GSEs OR GNMA 
 
The FHLB, FHLMC and the Federal National Mortgage Association ("FNMA") are government sponsored enterprises ("GSEs") and the securities and bonds issued by GSEs are not backed by the full faith and credit of the United States government.  At March 31, 2018, the Bank held an amortized cost and fair value of $15.5 million and $15.2 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 $15.9 million and $15.9 million, respectively, at December 31, 2017. The Company has not invested in any private label mortgage-backed securities classified as held to maturity.

At March 31, 2018, 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 $22.4 million and $22.0 million, respectively, compared to an amortized cost and fair value of $22.3 million at December 31, 2017.


14



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements




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

The amortized cost and fair value of investment and mortgage-backed securities held to maturity at March 31, 2018 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.
 
March 31, 2018
Investment Securities:
Amortized Cost
 
Fair Value
One – Five Years
$
998,214

 
$
972,978

Mortgage-Backed Securities
23,260,385

 
22,869,027

 Total Held to Maturity
$
24,258,599

 
$
23,842,005


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.
 
March 31, 2018
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
Unrealized
Losses
 
Fair
Value
Unrealized
Losses
 
Fair
Value
Unrealized
Losses
FHLMC Bond
$
972,978

$
25,236

 
$

$

 
$
972,978

$
25,236

Mortgage-Backed Securities (1)
18,471,355

422,586

 
1,245,298

58,056

 
19,716,653

480,642

 
$
19,444,333

$
447,822

 
$
1,245,298

$
58,056

 
$
20,689,631

$
505,878

(1) COMPRISED OF MORTGAGE-BACKED SECURITIES OF GSEs OR GNMA 
 
December 31, 2017
 
Less than 12 Months
 
12 Months or More
 
Total
 
Fair
Value
Unrealized
Losses
 
Fair
Value
Unrealized
Losses
 
Fair
Value
Unrealized
Losses
FHLB Bond
$
1,997,016

$
2,984

 
$

$

 
$
1,997,016

$
2,984

FHLMC Bond
985,514

12,588

 


 
985,514

12,588

Mortgage-Backed Securities (1)
17,645,676

103,387

 
1,284,971

27,920

 
18,930,647

131,307

 
$
20,628,206

$
118,959

 
$
1,284,971

$
27,920

 
$
21,913,177

$
146,879

(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.


15



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:
 
March 31, 2018
 
December 31, 2017
Residential Real Estate Loans
$
83,589,911

 
$
81,255,167

Consumer Loans
56,987,930

 
56,761,695

Commercial Business Loans
27,418,240

 
26,777,893

Commercial Real Estate Loans
260,934,120

 
237,814,628

Total Loans Held For Investment
428,930,201

 
402,609,383

Loans Held For Sale
2,407,478

 
3,051,950

Total Loans Receivable, Gross
$
431,337,679

 
$
405,661,333

Less:
 
 
 
Allowance For Loan Losses
8,204,016

 
8,221,618

Loans In Process
6,485,095

 
6,804,533

Deferred Loan Fees
183,307

 
141,985

 
14,872,418

 
15,168,136

Total Loans Receivable, Net
$
416,465,261

 
$
390,493,197


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 March 31, 2018 and December 31, 2017.
March 31, 2018
 
Pass
 
 
Caution
 
Special
Mention
 
 
Substandard
 
 
Total Loans
Residential Real Estate
$
76,150,747

 
$
2,371,703

 
$
1,373,452

 
$
3,694,009

 
$
83,589,911

Consumer
52,494,595

 
2,017,966

 
333,232

 
2,142,137

 
56,987,930

Commercial Business
23,898,935

 
2,159,204

 
741,347

 
618,754

 
27,418,240

Commercial Real Estate
175,923,588

 
52,257,154

 
26,210,285

 
6,543,093

 
260,934,120

Total
$
328,467,865

 
$
58,806,027

 
$
28,658,316

 
$
12,997,993

 
$
428,930,201

December 31, 2017
 
Pass
 
 
Caution
 
Special
Mention
 
 
Substandard
 
 
Total Loans
Residential Real Estate
$
73,225,237

 
$
2,352,536

 
$
1,384,222

 
$
4,293,172

 
$
81,255,167

Consumer
52,249,017

 
1,862,340

 
344,361

 
2,305,977

 
56,761,695

Commercial Business
23,396,550

 
2,066,749

 
767,048

 
547,546

 
26,777,893

Commercial Real Estate
158,232,465

 
53,798,061

 
21,269,279

 
4,514,823

 
237,814,628

Total
$
307,103,269

 
$
60,079,686

 
$
23,764,910

 
$
11,661,518

 
$
402,609,383





16



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 March 31, 2018 and December 31, 2017:
 
March 31, 2018
 
 
30-59 Days
Past Due
 
 
60-89 Days
Past Due
 
90 Days or
More Past Due
 
 
Total Past
Due
 
 
 
Current
 
 
Total Loans
Receivable
Residential Real Estate
$
779,645

 
$

 
$
982,293

 
$
1,761,938

 
$
81,827,973

 
$
83,589,911

Consumer
976,440

 
56,511

 
127,939

 
1,160,890

 
55,827,040

 
56,987,930

Commercial Business
287,093

 
110,527

 
5,000

 
402,620

 
27,015,620

 
27,418,240

Commercial Real Estate
2,718,387

 
2,225,386

 
2,030,087

 
6,973,860

 
253,960,260

 
260,934,120

Total
$
4,761,565

 
$
2,392,424

 
$
3,145,319

 
$
10,299,308

 
$
418,630,893

 
$
428,930,201


 
December 31, 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
$
395,763

 
$

 
$
948,875

 
$
1,344,638

 
$
79,910,529

 
$
81,255,167

Consumer
604,809

 
85,178

 
182,757

 
872,744

 
55,888,951

 
56,761,695

Commercial Business
185,526

 
102,244

 

 
287,770

 
26,490,123

 
26,777,893

Commercial Real Estate
2,207,655

 
364,515

 
1,919,292

 
4,491,462

 
233,323,166

 
237,814,628

Total
$
3,393,753

 
$
551,937

 
$
3,050,924

 
$
6,996,614

 
$
395,612,769

 
$
402,609,383


At March 31, 2018 and December 31, 2017, the Company did not have any loans that were 90 days or more past due and still accruing interest. Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the existing collateral.  In the event an acceptable arrangement cannot be reached, we may have to acquire these properties through foreclosure or other means and subsequently sell, develop, or liquidate them.

The following table shows non-accrual loans by category at March 31, 2018 compared to December 31, 2017:

 
March 31, 2018
 
December 31, 2017
 
$
 
%
 
Amount
 
Percent (1)
 
Amount
 
Percent (1)
 
Increase (Decrease)
 
Increase (Decrease)
Non-accrual Loans:
 
 
 
 
 
 
 
 
 
 
 
Residential Real Estate
$
2,019,106

 
0.5
%
 
$
1,948,524

 
0.5
%
 
$
70,582

 
3.6%
Consumer
322,268

 
0.1

 
318,926

 
0.1

 
$
3,342

 
1.0
Commercial Business
95,001

 

 
109,401

 

 
(14,400
)
 
(13.2)
Commercial Real Estate
4,144,839

 
1.0

 
3,340,904

 
0.8

 
803,935

 
24.1
Total Non-accrual Loans
$
6,581,214

 
1.6
%
 
$
5,717,755

 
1.5
%
 
$
863,459

 
15.1%

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







17



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 months ended March 31, 2018 and 2017:
 
Three Months Ended March 31, 2018
 
Residential
Real Estate
 
 
Consumer
 
Commercial
Business
 
Commercial
Real Estate
 
 
Total
Beginning Balance
$
1,233,843

 
$
1,144,815

 
$
1,011,227

 
$
4,831,733

 
$
8,221,618

Provision for Loan Losses
(15,445
)
 
(112,933
)
 
138,940

 
(10,562
)
 

Charge-Offs
(11,351
)
 
(17,252
)
 
(21,487
)
 

 
(50,090
)
Recoveries
207

 
27,520

 

 
4,761

 
32,488

Ending Balance
$
1,207,254

 
$
1,042,150

 
$
1,128,680

 
$
4,825,932

 
$
8,204,016

 
 
Three Months Ended March 31, 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
110,338

 
100,554

 
87,379

 
(298,271
)
 

Charge-Offs
(6,517
)
 
(23,611
)
 
(5,890
)
 

 
(36,018
)
Recoveries
750

 
27,141

 

 
29,795

 
57,686

Ending Balance
$
1,464,917

 
$
1,100,704

 
$
964,488

 
$
4,847,790

 
$
8,377,899

 
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
March 31, 2018
Individually Evaluated For
Impairment
 
Collectively Evaluated For
Impairment
 
 
Total
Residential Real Estate
$

 
$
1,207,254

 
$
1,207,254

Consumer

 
1,042,150

 
1,042,150

Commercial Business

 
1,128,680

 
1,128,680

Commercial Real Estate
102,756

 
4,723,176

 
4,825,932

Total
$
102,756

 
$
8,101,260

 
$
8,204,016

 
Allowance For Loan Losses
December 31, 2017
Individually Evaluated For
Impairment
 
Collectively Evaluated For
Impairment
 
 
Total
Residential Real Estate
$

 
$
1,233,843

 
$
1,233,843

Consumer

 
1,144,815

 
1,144,815

Commercial Business

 
1,011,227

 
1,011,227

Commercial Real Estate

 
4,831,733

 
4,831,733

Total
$

 
$
8,221,618

 
$
8,221,618





18



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 loans receivable at the dates indicated:
 
Loans Receivable
March 31, 2018
Individually Evaluated For
Impairment
 
Collectively Evaluated For
Impairment
 
 
Total
Residential Real Estate
$
1,685,496

 
$
81,904,415

 
$
83,589,911

Consumer
178,778

 
56,809,152

 
56,987,930

Commercial Business
90,001

 
27,328,239

 
27,418,240

Commercial Real Estate
6,836,118

 
254,098,002

 
260,934,120

Total
$
8,790,393

 
$
420,139,808

 
$
428,930,201

 
Loans Receivable
December 31, 2017
Individually Evaluated For
Impairment
 
Collectively Evaluated For
Impairment
 
 
Total
Residential Real Estate
$
1,883,741

 
$
79,371,426

 
$
81,255,167

Consumer
181,617

 
56,580,078

 
56,761,695

Commercial Business
100,401

 
26,677,492

 
26,777,893

Commercial Real Estate
6,276,547

 
231,538,081

 
237,814,628

Total
$
8,442,306

 
$
394,167,077

 
$
402,609,383


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 $8.9 million for the three months ended March 31, 2018 compared to $8.8 million for the three months ended March 31, 2017.

19



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements




8.    Loans Receivable, Net, Continued

The following tables present information related to impaired loans by loan category at March 31, 2018 and December 31, 2017 and for the three months ended March 31, 2018 and 2017.
 
March 31, 2018
 
December 31, 2017
Impaired Loans
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
 
Recorded
Investment
Unpaid
Principal
Balance
 
Related
Allowance
With No Related Allowance Recorded:
 
 
 
 
 
 
Residential Real Estate
$
1,685,497

$
2,212,677

$

 
$
1,883,741

$
2,333,741

$

Consumer
178,778

246,588


 
181,617

209,427


Commercial Business
90,001

985,001


 
100,401

950,401


Commercial Real Estate
6,582,213

7,973,300


 
6,276,547

7,583,847


With an Allowance Recorded:
 
 
 
 
 
 
 
Commercial Real Estate
253,905

253,905

102,756

 



Total
 
 
 
 
 
 
 
Residential Real Estate
1,685,497

2,212,677


 
1,883,741

2,333,741


Consumer
178,778

246,588


 
181,617

209,427


Commercial Business
90,001

985,001


 
100,401

950,401


Commercial Real Estate
6,836,118

8,227,205

102,756

 
6,276,547

7,583,847


Total
$
8,790,394

$
11,671,471

$
102,756

 
$
8,442,306

$
11,077,416

$


 
Three Months Ended March 31,
 
2018
 
2017
Impaired Loans
Average
Recorded
Investment
Interest
Income
Recognized
 
Average
Recorded
Investment
Interest
Income
Recognized
With No Related Allowance Recorded:
 
 
 
 
 
Residential Real Estate
$
1,757,575

$

 
$
2,243,655

$

Consumer
180,610


 
108,424


Commercial Business
96,401


 
145,401


Commercial Real Estate
6,625,186

37,207

 
5,817,309

38,632

With an Allowance Recorded:
 
 
 
 
 
Consumer


 
60,027


Commercial Real Estate
253,905

340

 
398,329

6,514

Total
 
 
 
 
 
Residential Real Estate
1,757,575


 
2,243,655


Consumer
180,610


 
168,451


Commercial Business
96,401


 
145,401


Commercial Real Estate
6,879,091

37,547

 
6,215,638

45,146

Total
$
8,913,677

$
37,547

 
$
8,773,145

$
45,146

 




20



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") 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.  

At the date of modification, TDRs are initially classified as nonaccrual TDRs. TDR loans are returned to accruing status when there is economic substance to the restructuring, there is documented credit evaluation of the borrower's financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated sustained repayment performance in accordance with the modified terms for a reasonable period of time (generally a minimum of six months).
 
 
 
 
 
 
 
 
 
 
 
 
 
 
TDRs included in impaired loans at March 31, 2018 and December 31, 2017 were $4.1 million and $4.3 million, respectively. There were 0 new TDRs during the three months ended March 31, 2018 and 2017. At March 31, 2018, one TDR loan with a balance of $570,000 was in default. In comparison, at March 31, 2017, two TDR loans totaling $599,000 were in default. None of these TDR loans defaulted during the three months ended March 31, 2018 and 2017. 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.  Further, the borrower must demonstrate the capacity to continue making payments on the loan prior to restoration of accrual status.


9. Regulatory Matters

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

The Company is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. For a bank holding company with less than $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 March 31, 2018, it would have exceeded all regulatory capital requirements.

Based on its capital levels at March 31, 2018, 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 March 31, 2018, 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.

21



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements




9. Regulatory Matters, Continued

The tables below provide the Company’s and the Bank’s regulatory capital requirements and actual results at the dates indicated.
 
Actual
 
For Capital Adequacy
 
To Be "Well-Capitalized"
(Dollars in Thousands)
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
SECURITY FEDERAL CORP.
March 31, 2018
Tier 1 Risk-Based Core Capital
(To Risk Weighted Assets)
$
80,262

 
15.4%
 
$
31,267

 
6.0%
 
N/A
 
N/A
Total Risk-Based Capital
(To Risk Weighted Assets)
86,795

 
16.7%
 
41,689

 
8.0%
 
N/A
 
N/A
Common Equity Tier 1 Capital (To Risk Weighted Assets)
75,262

 
14.4%
 
23,450

 
4.5%
 
N/A
 
N/A
Tier 1 Leverage (Core) Capital
(To Adjusted Tangible Assets)
80,262

 
9.2%
 
34,781

 
4.0%
 
N/A
 
N/A
SECURITY FEDERAL BANK
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Risk-Based Core Capital
(To Risk Weighted Assets)
$
87,987

 
16.9%
 
$
31,258

 
6.0%
 
$
41,677

 
8.0%
Total Risk-Based Capital
(To Risk Weighted Assets)
94,520

 
18.1%
 
41,677

 
8.0%
 
52,096

 
10.0%
Common Equity Tier 1 Capital (To Risk Weighted Assets)
87,987

 
16.9%
 
23,443

 
4.5%
 
33,862

 
6.5%
Tier 1 Leverage (Core) Capital
(To Adjusted Tangible Assets)
87,987

 
10.1%
 
34,775

 
4.0%
 
43,469

 
5.0%
SECURITY FEDERAL CORP.
December 31, 2017
Tier 1 Risk-Based Core Capital
(To Risk Weighted Assets)
$
78,790

 
15.8%
 
$
29,998

 
6.0%
 
 
N/A
 
 
N/A
Total Risk-Based Capital
(To Risk Weighted Assets)
85,066

 
17.0%
 
39,997

 
8.0%
 
 
N/A
 
 
N/A
Common Equity Tier 1 Capital (To Risk Weighted Assets)
73,790

 
14.8%
 
22,498

 
4.5%
 
 
N/A
 
 
N/A
Tier 1 Leverage (Core) Capital
(To Adjusted Tangible Assets)
78,790

 
9.1%
 
34,518

 
4.0%
 
 
N/A
 
 
N/A
SECURITY FEDERAL BANK
 
 
 
 
 
 
 
 
 
 
 
Tier 1 Risk-Based Core Capital
(To Risk Weighted Assets)
$
88,275

 
17.7%
 
$
29,989

 
6.0%
 
$
39,985

 
8.0%
Total Risk-Based Capital
(To Risk Weighted Assets)
94,547

 
18.9%
 
39,985

 
8.0%
 
49,981

 
10.0%
Common Equity Tier 1 Capital (To Risk Weighted Assets)
88,275

 
17.7%
 
22,491

 
4.5%
 
32,488

 
6.5%
Tier 1 Leverage (Core) Capital
(To Adjusted Tangible Assets)
88,275

 
10.2%
 
34,512

 
4.0%
 
43,140

 
5.0%

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 capital conservation buffer requirement began to be phased in on January 1, 2016 when more than 0.625% of risk-weighted assets was required, and increases by 0.625% on each subsequent January 1, until fully implemented to an amount more than 2.5% of risk weighted assets in January 2019. At March 31, 2018 the Bank’s CET1 capital exceeded the required capital conservation buffer of an amount more than 1.875%.


22



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements



10. Carrying Amounts and Fair Value of Financial Instruments

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

Accounting guidance emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, the guidance establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).
Level 1 -
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 March 31, 2018, the Company’s investment portfolio was comprised of government and agency bonds, mortgage-backed securities issued by government agencies or GSEs, private label CMO mortgage-backed securities, municipal securities, and one equity investment. Fair value measurement is based upon prices obtained from third party pricing services that use independent pricing models which rely on a variety of factors including reported trades, broker/dealer quotes, benchmark yields, economic and industry events and other relevant market information. As a result, these securities are classified as Level 2.

Mortgage Loans Held for Sale

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




23



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements



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

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 March 31, 2018, 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 March 31, 2018 and December 31, 2017, the recorded investment in impaired loans was $8.8 million and $8.4 million, respectively.

Foreclosed Assets
Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. Foreclosed assets are recorded as nonrecurring Level 3.
 
Assets measured at fair value on a recurring basis were as follows at March 31, 2018 and December 31, 2017:
 
March 31, 2018
 
December 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
Student Loan Pools
$

 
$
11,431,614

 
$

 
$

 
$
8,521,785

 
$

SBA Bonds

 
116,813,342

 

 

 
124,248,444

 

Tax Exempt Municipal Bonds

 
58,652,043

 

 

 
62,355,567

 

Taxable Municipal Bonds

 
1,981,330

 

 

 
1,997,130

 

Mortgage-Backed Securities

 
169,818,871

 

 

 
187,695,980

 

Equity Securities

 
155,000

 

 

 
155,000

 

Total
$

 
$
358,852,200

 
$

 
$

 
$
384,973,906

 
$


There were no liabilities measured at fair value on a recurring basis at March 31, 2018 or December 31, 2017.

24



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements



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

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. The tables below present assets measured at fair value on a nonrecurring basis at March 31, 2018 and December 31, 2017, aggregated by the level in the fair value hierarchy within which those measurements fall. 
 
March 31, 2018
Assets:
Level 1
 
Level 2
 
Level 3
 
Total
Mortgage Loans Held For Sale
$

 
$
2,407,478

 
$

 
$
2,407,478

Collateral Dependent Impaired Loans (1)

 

 
8,687,637

 
8,687,637

Foreclosed Assets

 

 
1,073,856

 
1,073,856

Total
$

 
$
2,407,478

 
$
9,761,493

 
$
12,168,971

 
December 31, 2017
Assets:
Level 1
 
Level 2
 
Level 3
 
Total
Mortgage Loans Held For Sale
$

 
$
3,051,950

 
$

 
$
3,051,950

Collateral Dependent Impaired Loans (1)

 

 
8,442,306

 
8,442,306

Foreclosed Assets

 

 
1,115,671

 
1,115,671

Total
$

 
$
3,051,950

 
$
9,557,977

 
$
12,609,927

(1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF $102,756 AT MARCH 31, 2018. THERE WERE no SPECIFIC RESERVES AT DECEMBER 31, 2017.  

There were no liabilities measured at fair value on a nonrecurring basis at March 31, 2018 or December 31, 2017.

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis at March 31, 2018, 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
$
8,687,637

Appraised Value
Discount Rates/ Discounts to Appraised Values
0% - 72%
Foreclosed Assets
$
1,073,856

Appraised Value/Comparable Sales
Discount Rates/ Discounts to Appraised Values
 
13% - 100%

For assets and liabilities that are not presented on the balance sheet at fair value, the following methods are used to determine the fair value:
 
Cash and Cash Equivalents—The carrying amount of these financial instruments approximates fair value. All mature within 90 days and do not present unanticipated credit concerns.
 
Certificates of Deposit with Other Banks—Fair value is based on market prices for similar assets.
 
Investment Securities Held to Maturity—Securities held to maturity are valued at quoted market prices or dealer quotes.
 
Loans Receivable, Net—During the first quarter of 2018, the Company adopted ASU 2016-01, “Recognition and Measurement of Financial Assets and Liabilities.” The amendments included within this standard, which are applied prospectively, require the Company to disclose fair value of financial instruments measured at amortized cost on the balance sheet and to measure that fair value using an exit price notion. Prior to adopting the amendments included in the standard, the Company was allowed to measure fair value under an entry price notion. The entry price notion previously applied by the Company used a discounted cash flows technique to calculate the present value of expected future cash flows for a financial instrument. The exit price notion uses the same approach, but also incorporates other factors, such as enhanced credit risk, illiquidity risk and market factors that sometimes exist in exit prices in dislocated markets.


25



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements



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

As of March 31, 2018, the technique used by the Company to estimate the exit price of the loan portfolio consists of similar procedures to those used as of December 31, 2017, but with added emphasis on both illiquidity risk and credit risk not captured by the previously applied entry price notion. The fair value of the Company’s loan portfolio has always included a credit risk assumption in the determination of the fair value of its loans. This credit risk assumption is intended to approximate the fair value that a market participant would realize in a hypothetical orderly transaction. The Company’s loan portfolio is initially fair valued using a segmented approach. The Company divides its loan portfolio into the following categories: commercial real estate, other commercial, residential real estate, consumer and all other loans. The results are then adjusted to account for credit risk as described above. However, under the new guidance, the Company believes a further credit risk discount must be applied through the use of a discounted cash flow model to compensate for illiquidity risk, based on certain assumptions included within the discounted cash flow model, primarily the use of discount rates that better capture inherent credit risk over the lifetime of a loan. This consideration of enhanced credit risk provides an estimated exit price for the Company’s loan portfolio. For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values approximate carrying values.

As of December 31, 2017, the fair value of the Company’s loan portfolio includes a credit risk assumption in the determination of the fair value of its loans. This credit risk assumption is intended to approximate the fair value that a market participant would realize in a hypothetical orderly transaction. The Company’s loan portfolio is initially fair valued using a segmented approach, as described above. For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values approximate carrying values. For other loans, fair values are estimated using discounted cash flow models, using current market interest rates offered for loans with similar terms to borrowers of similar credit quality. The values derived from the discounted cash flow approach for each of the above portfolios are then further discounted to incorporate credit risk. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price as of December 31, 2017.

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.



26



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 March 31, 2018 and December 31, 2017 presented in accordance with the applicable accounting guidance.
 
March 31, 2018
 
Carrying
 
Fair Value
(In Thousands)
Amount
 
Total
 
Level 1
 
Level 2
 
Level 3
Financial Assets:
 
 
 
 
 
 
 
 
 
Cash and Cash Equivalents
$
15,599

 
$
15,599

 
$
15,599

 
$

 
$

Certificates of Deposits with Other Banks
1,950

 
1,950

 

 
1,950

 

Investment and Mortgage-Backed Securities
383,111

 
382,694

 

 
382,694

 

Loans Receivable, Net
416,465

 
410,045

 

 

 
410,045

FHLB Stock
2,533

 
2,533

 
2,533

 

 

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
 
 
  Checking, Savings & Money Market Accounts
$
481,607

 
$
481,607

 
$
481,607

 
$

 
$

  Certificate Accounts
235,059

 
231,974

 

 
231,974

 

Advances from FHLB
41,000

 
40,475

 

 
40,475

 

Other Borrowed Money
13,779

 
13,779

 
13,779

 

 

Note Payable
6,200

 
6,200

 

 
6,200

 

Senior Convertible Debentures
6,064

 
6,064

 

 
6,064

 

Junior Subordinated Debentures
5,155

 
5,155

 

 
5,155

 

 
December 31, 2017
 
Carrying
 
Fair Value
(In Thousands)
Amount
 
Total
 
Level 1
 
Level 2
 
Level 3
Financial Assets:
 
 
 
 
 
 
 
 
 
Cash and Cash Equivalents
$
10,320

 
$
10,320

 
$
10,320

 
$

 
$

Certificates of Deposits with Other Banks
1,950

 
1,950

 

 
1,950

 

Investment and Mortgage-Backed Securities
412,055

 
412,029

 

 
412,029

 

Loans Receivable, Net
390,493

 
386,613

 

 

 
386,613

FHLB Stock
2,932

 
2,932

 
2,932

 

 

 
 
 
 
 
 
 
 
 
 
Financial Liabilities:
 
 
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
 
 
  Checking, Savings & Money Market Accounts
$
472,015

 
$
472,015

 
$
472,015

 
$

 
$

  Certificate Accounts
230,092

 
227,949

 

 
227,949

 

Advances from FHLB
51,680

 
51,318

 

 
51,318

 

Other Borrowed Money
11,307

 
11,307

 
11,307

 

 

Note Payable
8,500

 
8,500

 

 
8,500

 

Senior Convertible Debentures
6,064

 
6,064

 

 
6,064

 

Junior Subordinated Debentures
5,155

 
5,155

 

 
5,155

 


At March 31, 2018, the Bank had $88.8 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.

27



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. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance was effective for the Company for reporting periods beginning after December 15, 2017 and had no significant impact on financial reporting. The Company's revenue is comprised of net interest income and noninterest income. The scope of the guidance explicitly excludes net interest income as well as many other revenues for financial assets and liabilities including loans, leases, securities, and derivatives. Accordingly, the majority of the Company’s revenues were not affected. The Company has performed an assessment of revenue contracts related to revenue streams that are within the scope of the standard. The accounting policies have not changed since the principles of revenue recognition from the Accounting Standards Update ("ASU") are consistent with existing guidance and current practices applied by our businesses. We have not identified material changes to the timing or amount of revenue recognition nor have we identified significant changes in disclosures.

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 were effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company applied 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 require equity investments (except those accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. In addition, the amendments require an entity to disclose the fair value of financial instruments using the exit price notion. Exit price is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company has used the exit price notion in the fair value disclosure of financial instruments in Note 10 of this report. These amendments did not have a material effect on the Company's consolidated financial statements.

In February 2016, the FASB amended the Leases topic of the ASC to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. The amendments will be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The 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.


28



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements



11. Accounting and Reporting Changes, Continued

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 were effective for the Company for reporting periods beginning after December 15, 2017. These amendments did not have a material effect on the Company's consolidated financial statements.

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 were effective for the Company for reporting periods beginning after December 15, 2017. The Company has not had any modifications on share-based payment awards and therefore adoption did not have a material effect on the Company's consolidated financial statements.
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.

In February 2018, FASB issued guidance on, Income Statement - Reporting Comprehensive Income (Topic 220). This guidance was issued to allow a reclassification from accumulated other comprehensive income (“AOCI”) to retained earnings from stranded tax effects resulting from the revaluation of deferred tax assets to the new federal corporate income tax rate of 21% as a result of the Tax Cuts and Jobs Act (“Tax Act”). The guidance is effective for reporting periods beginning after December 15, 2018 with early adoption permitted. The Company elected to early adopt in January 2018 and will apply the provisions retrospectively within its consolidated balance sheets and statements of shareholders' equity. This adoption resulted in a one-time reclassification of the effect of remeasuring deferred tax liabilities related to items, primarily unrealized gains and losses on investments, within AOCI to retained earnings resulting from the change in the U.S. corporate income tax rate. This reclassification resulted in a decrease to AOCI and an increase to retained earnings in the amount of $611,000 for the year ended December 31, 2018, with no net impact to total stockholders' equity.

In March 2018, FASB issued guidance on the income tax accounting implications of the Tax Act, and allows for entities to report provisional amounts for specific income tax effects of the Tax Act for which the accounting under Topic 740 was not yet complete but a reasonable estimate could be determined. A measurement period of one-year is allowed to complete the accounting effects under Topic 740 and revise any previous estimates reported. Any provisional amounts or subsequent adjustments included in an entity’s financial statements during the measurement period should be included in income from continuing operations as an adjustment to tax expense in the reporting period the amounts are determined. The Company adopted this ASU with the provisional adjustments as reported in the Consolidated Financial Statements on Form 10-K as of December 31, 2017. As of March 31, 2018, the Company did not incur any adjustments to the provisional recognition.


29



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements



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


12. Non-Interest Income
The Company adopted the provisions of ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), on January 1, 2018 and all subsequent ASUs that modified Topic 606. Results for reporting periods beginning after December 31, 2017 are presented under Topic 606, while prior period amounts have not been adjusted and continue to be reported in accordance with Topic 605.

The Company has included the following table regarding the Company’s non-interest income for the periods presented. All of the Company’s revenue from contracts with customers within the scope of ASC 606 is recognized in non-interest income, with the exception of gains on the sale of OREO, which are included in non-interest expense when applicable.
 
Three Months Ended March 31,
 
2018
 
2017
Non-interest income:
 
 
 
Service fees on deposit accounts
$
257,179

 
$
240,885

Check card fee income
307,046

 
270,992

Trust income
232,500

 
182,000

Insurance commissions (1)
179,225

 
153,992

Gain on sale of investment securities, net (1)
436,304

 
583,391

Gain on sale of loans, net (1)
286,003

 
280,368

BOLI income (1)
135,000

 
120,000

Other non-interest income (1)
210,763

 
165,721

Total non-interest income
$
2,044,020

 
$
1,997,349

 
 
 
 
(1) Not within scope of ASC 606
 
 
 
The Company recognizes revenue as it is earned and noted no impact to its revenue recognition policies as a result of the adoption of ASU 2014-09. The following is a discussion of key revenues within the scope of the new revenue guidance.
Revenue Recognition
In accordance with Topic 606, revenues are recognized when control of promised goods or services is transferred to customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of Topic 606, the Company performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the Company satisfies a performance obligation. The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of Topic 606, the Company assesses the goods or services that are promised within each contract and identifies those that contain performance obligations, and assesses whether each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.
Deposit Fees
The Bank earns fees from its deposit customers for account maintenance, transaction-based and overdraft services.  Account maintenance fees consist primarily of account fees and analyzed account fees charged on deposit accounts on a monthly basis.  The performance obligation is satisfied and the fees are recognized on a monthly basis as the service period is completed. Transaction-based fees on deposits accounts are charged to deposit customers for specific services provided to the customer, such as non-sufficient funds fees, overdraft fees, and wire fees. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer.

30



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements




12. Non-Interest Income, Continued

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

Trust Income
Trust income includes monthly advisory fees that are based on assets under management and certain transaction fees that are assessed and earned monthly, concurrently with the investment management services provided to the customer. The Bank does not charge performance based fees for its trust services and does not currently have any institutional clients, hedge funds or mutual funds. Although trust income is included within the scope of ASC 606, based on the fees charged by the Bank, we do not anticipate any changes in the accounting for trust income at this time.  

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



13. Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including estimates inherent in the process of preparing financial statements. Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.
Management has reviewed all events occurring through the date the consolidated financial statements were available to be issued and determined that there were no subsequent events that required disclosure.



 

31



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;
disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing;
our ability to retain key members of our senior management team;
costs and effects of litigation, including settlements and judgments;
our ability to manage loan delinquency rates;
increased competitive pressures among financial services companies;
changes in consumer spending, borrowing and savings habits;

32



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 2017 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 2018 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 March 31, 2018 and December 31, 2017

Assets

Total assets increased $2.9 million or 0.3% to $871.7 million at March 31, 2018 from $868.8 million at December 31, 2017. Changes in total assets were primarily concentrated in the following asset categories:
 
 
 
 
 
Increase (Decrease)
 
March 31, 2018
 
December 31, 2017
 
Amount
 
Percent
Cash and Cash Equivalents
$
15,598,549

 
$
10,319,624

 
$
5,278,925

 
51.2%
Investment and Mortgage-Backed Securities – AFS
358,852,200

 
384,973,906

 
(26,121,706
)
 
(6.8)
Investment and Mortgage-Backed Securities – HTM
24,258,599

 
27,080,970

 
(2,822,371
)
 
(10.4)
Loans Receivable, Net
416,465,261

 
390,493,197

 
25,972,064

 
6.7
FHLB Stock
2,532,800

 
2,931,900

 
(399,100
)
 
(13.6)
BOLI
18,932,893

 
18,797,893

 
135,000

 
0.7
Other Assets
4,624,012

 
3,795,212

 
828,800

 
21.8

Investment and mortgage-backed securities AFS decreased $26.1 million or 6.8% to $358.9 million at March 31, 2018 from $385.0 million at December 31, 2017. Investment and mortgage-backed securities HTM decreased $2.8 million or 10.4% to $24.3 million at March 31, 2018 from $27.1 million at December 31, 2017.

Loans receivable, net, including loans held for sale, increased $26.0 million or 6.7% to $416.5 million at March 31, 2018 from $390.5 million at December 31, 2017 as a result of increased loan originations in all loan categories with the exception of loans held for sale, which decreased $644,000 or 21.1% to $2.4 million at March 31, 2018 from $3.1 million at December 31, 2017. Consumer loans increased $226,000 or 0.4% to $57.0 million at March 31, 2018 compared to $56.8 million at December 31, 2017. Commercial business loans increased $640,000 or 2.4% to $27.4 million at March 31, 2018 from $26.8 million at December 31, 2017. Commercial real estate loans increased $23.1 million or 9.7% to $260.9 million at March 31, 2018 from $237.8 million at December 31, 2017. Residential real estate loans increased $2.3 million or 2.9% to $83.6 million at March 31, 2018 from $81.3 million at December 31, 2017.


33



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations

FHLB stock decreased $399,000 or 13.6% to $2.5 million at March 31, 2018 compared to $2.9 million at December 31, 2017 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 $135,000 or 0.7% to $18.9 million at March 31, 2018 compared to $18.8 million at December 31, 2017 due to income recognized during the period related to changes in the cash surrender value of the underlying policies. BOLI, which earns tax-free yields, is utilized to partially offset the cost of the Company’s employee benefits programs and to provide key person insurance on certain officers of the Company.

Other assets increased $829,000 or 21.8% to $4.6 million at March 31, 2018 from $3.8 million at December 31, 2017. The increase was primarily the result of a $1.0 million increase in net deferred taxes, which was related to decreased unrealized gains in the investment portfolio.

Liabilities
Deposit Accounts
Total deposits increased $14.6 million or 2.1% to $716.7 million at March 31, 2018 compared to $702.1 million at December 31, 2017. Checking and certificates of deposit accounted for the majority of the growth, increasing $10.1 million and $14.6 million, respectively, during the first quarter of 2017. The balances, weighted average rates and increases and decreases in deposit accounts were as follows at March 31, 2018 and December 31, 2017:
 
March 31, 2018
 
December 31, 2017
 
Balance Increase (Decrease)
 
Balance
Weighted Rate
 
Balance
Weighted Rate
 
Amount

Percent
Demand Accounts:
 
 
 
 
 
 
 
 
Checking
$
207,487,681

0.04%
 
$
197,434,385

0.04%
 
$
10,053,296

5.1%
Money Market
228,745,154

0.33
 
231,652,920

0.28
 
(2,907,766
)
(1.3)
Savings
45,374,589

0.11
 
42,927,311

0.11
 
2,447,278

5.7
Total
$
481,607,424

0.19%
 
$
472,014,616

0.16%
 
$
9,592,808

2.0%
Certificate Accounts
 
 
 
 
 
 
 
 
0.00 – 0.99%
$
114,010,785

 
 
$
129,354,569

 
 
$
(15,343,784
)
(11.9)%
1.00 – 1.99%
105,643,893

 
 
99,627,750

 
 
6,016,143

6.0
2.00 – 2.99%
15,404,350

 
 
1,109,684

 
 
14,294,666

1,288.2
Total
$
235,059,028

1.02%
 
$
230,092,003

0.90%
 
$
4,967,025

2.2%
Total Deposits
$
716,666,452

0.46%
 
$
702,106,619

0.41%
 
$
14,559,833

2.1%

Included in certificate accounts were $31.4 million and $24.4 million in brokered deposits at March 31, 2018 and December 31, 2017, respectively, with a weighted average interest rate of 1.68% and 1.23%, respectively.

Advances From FHLB
FHLB advances are summarized by contractual year of maturity and weighted average interest rate in the table below:
 
March 31, 2018
 
December 31, 2017
 
Decrease
Year Due:
Balance
Rate
 
Balance
Rate
 
Balance
Percent
2018
$
13,000,000

1.08%
 
$
23,680,000

1.22%
 
$
(10,680,000
)
(45.1)%
2019
20,500,000

1.39
 
20,500,000

1.39
 

2020
7,500,000

1.58
 
7,500,000

1.58
 

Total Advances
$
41,000,000

1.32%
 
$
51,680,000

1.34%
 
$
(10,680,000
)
(20.7)%


34



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations

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 $84.6 million and $77.4 million at March 31, 2018, respectively, and $73.0 million and $66.8 million at December 31, 2017, respectively.
There were no callable FHLB advances at March 31, 2018. 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 $13.8 million in other borrowings (non-FHLB advances) at March 31, 2018, an increase of $2.5 million or 21.9% from $11.3 million at December 31, 2017. These borrowings consist of short-term repurchase agreements with certain commercial demand deposit customers for sweep accounts. The repurchase agreements typically mature within one to three days and the interest rate paid on these borrowings floats monthly with money market type rates. At both March 31, 2018 and December 31, 2017, the interest rate paid on the repurchase agreements was 0.15%.

The Bank had pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $17.4 million and $17.5 million, respectively, at March 31, 2018 and $16.2 million and $16.5 million, respectively, at December 31, 2017.

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 4.20% at March 31, 2018. 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 March 31, 2018, the remaining principal balance on the loan was $6.2 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 March 31, 2018, management believes that 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 3.82% at March 31, 2018. 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.


35



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations

Equity

Shareholders’ equity decreased $1.6 million or 2.1% to $76.3 million at March 31, 2018 from $77.9 million at December 31, 2017 primarily due to a decrease in accumulated other comprehensive income, net of tax, which was partially offset by net income of $1.7 million for the three months ended March 31, 2018. Accumulated other comprehensive income, net of tax, decreased $2.5 million or 84.7% to $447,000 at March 31, 2018 from $2.9 million at December 31, 2017 primarily due to $2.7 million of unrealized losses on securities available for sale, net of tax. The Board of Directors of the Company declared common stock dividends totaling $266,000 during the quarter ended March 31, 2018. Book value per common share was $25.84 at March 31, 2018 compared to $26.39 at December 31, 2017.


36



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 March 31, 2018 and 2017

Net Income

Net income increased $101,000 or 6.2% to $1.7 million or $0.56 per diluted common share for the three months ended March 31, 2018 compared to $1.6 million or $0.52 per diluted common share for the three months ended March 31, 2017. The increase in earnings was primarily the result of an increase in net interest income combined with a decrease in the provision for income tax expense. These items were partially offset by an increase in non-interest expense.
 
Net Interest Income

The net interest spread on a tax equivalent basis increased two basis points to 3.22% for the three months ended March 31, 2018 from 3.20% for the comparable period in 2017. Net interest income increased $559,000 or 9.3% to $6.6 million during the three months ended March 31, 2018, compared to $6.0 million for the same period in 2017. During the three months ended March 31, 2018, average interest earning assets increased $48.5 million or 6.4% to $809.9 million from $761.5 million for the same period in 2017. Average interest-bearing liabilities increased $32.3 million or 4.8% to $705.0 million for the three months ended March 31, 2018 from $672.6 million for the comparable period in 2017.

Interest Income

The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the three months ended March 31, 2018 and 2017:
 
Three Months Ended March 31,
 
Change in Average Balance
Increase (Decrease) in Interest Income
 
2018
 
2017
 
(Dollars in thousands)
Average Balance
Yield(1)
 
Average Balance
Yield(1)
 
Loans Receivable, Net
$
403,092

5.35
%
 
$
359,156

5.29
%
 
$
43,936

$
642

Mortgage-Backed Securities
206,938

2.54
 
204,039

2.20
 
$
2,899

193

Investment Securities(2)
196,231

2.33
 
187,627

2.75
 
$
8,604

(146)

Overnight Time and Certificates of Deposit
3,674

0.90
 
10,640

0.76
 
$
(6,966
)
(12
)
Total Interest-Earning Assets
$
809,935

3.88
%
 
$
761,462

3.77
%
 
$
48,473

$
677

(1) Annualized
(2) Tax equivalent basis recognizes the income tax savings when comparing taxable and tax-exempt assets and was calculated using an effective tax rate of 21% and 34% for the quarters ended March 31, 2018 and 2017, respectively. The tax equivalent adjustment relates to the tax exempt municipal bonds and was $84,415 and $177,592 for the quarters ended March 31, 2018 and 2017, respectively.
 
Total tax equivalent interest income increased $677,000 or 9.4% to $7.9 million during the three months ended March 31, 2018 compared to $7.2 million during the same period in 2017. This increase was primarily the result of a $48.5 million increase in average interest-earning assets combined with an increase of 11 basis points in the average yield. Total interest income on loans increased $642,000 or 13.5% to $5.4 million during the three months ended March 31, 2018 from $4.7 million during the comparable period in 2017. The increase was the result of a $43.9 million or 12.2% increase in the average loan portfolio balance combined with an increase of six basis points in the average yield. Interest income from mortgage-backed securities increased $193,000 or 17.2% to $1.3 million during the three months ended March 31, 2018 due to an increase of 34 basis points in the average portfolio yield combined with a $2.9 million or 1.4% increase in the average balance. Tax equivalent interest income from investment securities decreased $146,000 or 11.3% to $1.1 million during the three months ended March 31, 2018 due to a decrease of 42 basis points in the yield, which was offset by an increase of $8.6 million or 4.6% in the average balance of the investment securities portfolio.


37



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 March 31, 2018 and 2017.
 
Three Months Ended March 31,
 
Change in Average Balance
Increase (Decrease) in Interest Expense
 
2018
 
2017
 
(Dollars in thousands)
Average Balance
Cost(1)
 
Average Balance
Cost(1)
 
Now and Money Market Accounts
$
347,000

0.22
%
 
$
336,536

0.16
%
 
$
10,464

$
54

Savings Accounts
43,772

0.11
 
37,638

0.10
 
6,134

2

Certificate Accounts
230,377

0.93
 
220,644

0.77
 
9,733

112

FHLB Advances and Other Borrowed Money
65,296

1.17
 
53,602

0.91
 
11,694

70

Note Payable
7,307

4.20
 
12,989

3.45
 
(5,682
)
(35
)
Junior Subordinated Debentures
5,155

3.39
 
5,155

2.70
 

9

Senior Convertible Debentures
6,064

8.00
 
6,084

8.00
 
(20
)

Total Interest-Bearing Liabilities
$
704,971

0.61
%
 
$
672,648

0.57
%
 
$
32,323

$
212

(1) Annualized

Total interest expense increased $211,000 or 22.0% to $1.2 million during the three months ended March 31, 2018 compared to $958,000 for the same period in 2017. The increase was attributable to increases in interest rates paid and a $32.3 million or 4.8% increase in the average balance of interest-bearing liabilities. Interest expense on deposits increased $168,000 or 29.6% to $736,000 during the three months ended March 31, 2018 compared to $568,000 for the same period in 2017. The increase was attributable to a nine basis point increase in the average cost of deposit accounts combined with a $26.3 million or 4.4% increase in average interest-bearing deposits to $621.1 million for the three months ended March 31, 2018 compared to $594.8 million for the three months ended March 31, 2017.

Interest expense on FHLB advances and other borrowings increased $70,000 or 57.5% to $191,000 during the three months ended March 31, 2018 from $121,000 for the same period in 2017. The increase was attributable to an increase of 27 basis points in the average cost combined with an $11.7 million or 21.8% increase in the average balance of FHLB advances and other borrowed money to $65.3 million during the three months ended March 31, 2018 from $53.6 million for the same period in 2017.


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.


38



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 $18,000 for the quarter ended March 31, 2018 compared to net recoveries of $22,000 for the comparable period in 2017. There was no provision for loan losses recorded during the quarters ended March 31, 2018 and 2017. The table below summarizes activity associated with the allowance for loan losses for the quarters ended March 31, 2018 and 2017.
 
Three Months Ended March 31,
 
2018
 
2017
Beginning Balance
$
8,221,618

 
$
8,356,231

Provision for Loan Losses

 

Charge-offs
(50,090)

 
(36,018)

Recoveries
32,488

 
57,686

Net
(17,602)

 
$
21,668

Ending Balance
$
8,204,016

 
$
8,377,899

 
 
 
 
Allowance For Loan Losses as a % of Gross Loans Receivable, Held For Investment at the End of the Period
1.9%
 
2.3%
Allowance For Loan Losses as a % of Impaired Loans at the End of the Period
93.3%
 
97.0%
Impaired Loans
$
8,790,393

 
$
8,635,930

Gross Loans Receivable, Held For Investment (1)
$
428,930,201

 
$
363,602,651

Total Loans Receivable, Net
$
416,465,261

 
$
355,224,752

(1) TOTAL LOANS HELD FOR INVESTMENT, NET OF DEFERRED FEES AND LOANS IN PROCESS. 
Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the existing collateral. In the event an acceptable arrangement cannot be reached, we may need to acquire these properties through foreclosure or other means and subsequently sell, develop or liquidate them.

Non-Interest Income
Non-interest income increased $47,000 or 2.3% to $2.0 million for the three months ended March 31, 2018. The following table summarizes the changes in non-interest income:
 
Three Months Ended March 31,
 
Increase (Decrease)

 
2018
2017
 
Amounts
Percent
Gain on Sale of Investment Securities
$
436,304

$
583,391

 
$
(147,087
)
(25.2
)%
Gain on Sale of Loans
286,003

280,368

 
5,635

2.0
Service Fees on Deposit Accounts
257,179

240,885

 
16,294

6.8
Commissions From Insurance Agency
179,225

153,992

 
25,233

16.4
BOLI Income
135,000

120,000

 
15,000

12.5
Trust Income
232,500

182,000

 
50,500

27.7
Check Card Fee Income
307,046

270,992

 
36,054

13.3
Other
210,763

165,721

 
45,042

27.2
Total Non-Interest Income
$
2,044,020

$
1,997,349

 
$
46,671

2.3
 %

39



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations


Non-Interest Expense
For the quarter ended March 31, 2018, non-interest expense increased $690,000 or 11.8% to $6.5 million compared to $5.8 million for the same period in 2017. The following table summarizes the changes in non-interest expense:
 
Three Months Ended March 31,
 
Increase (Decrease)
 
2018
2017
 
Amounts
Percent
Compensation and Employee Benefits
$
3,809,124

$
3,511,487

 
$
297,637

8.5%
Occupancy
551,268

518,052

 
33,216

6.4
Advertising
188,672

135,535

 
53,137

39.2
Depreciation and Maintenance of Equipment
540,297

465,564

 
74,733

16.1
FDIC Insurance Premiums
66,786

64,674

 
2,112

3.3
Net Cost of Operation of OREO
38,733

(119,104
)
 
157,837

(132.5)
Other
1,324,066

1,252,730

 
71,336

5.7
Total Non-Interest Expense
$
6,518,946

$
5,828,938

 
$
690,008

11.8%

Compensation and employee benefits expenses increased $298,000, or 8.5% to $3.8 million for the three months ended March 31, 2018 compared to $3.5 million for the same period last year due to general annual cost of living increases combined with an increase in the number of full time equivalent employees to 221 at March 31, 2018 from 212 at March 31, 2017.

Occupancy expense increased $33,000 or 6.4% while depreciation and maintenance of equipment increased $75,000 or 16.1% during the first quarter of 2018. Both increases are primarily due to the addition of our Evans, Georgia branch, which opened in April 2017.

The Company had a net cost of $39,000 from the operation of OREO properties during the quarter ended March 31, 2018 compared to a net benefit of $119,000 during the quarter ended March 31, 2017. 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 recorded write-downs of $10,000 and gain on sales of OREO of $12,000 during the first quarter of 2018 compared to $18,000 in write-downs and a $214,000 gain on sale of OREO properties during the same period in 2017.

Other expenses increased $71,000, or 5.7% to $1.3 million for the three months ended March 31, 2018 compared to $1.3 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 $185,000 or 31.7% to $400,000 for the three months ended March 31, 2018 from $585,000 for the same period one year ago primarily due to the reduction in federal corporate income tax rates effective January 1, 2018. Income before income taxes was $2.1 million for the three months ended March 31, 2018 compared to $2.2 million for the same three month period in 2017. The Company’s combined federal and state effective income tax rate for the current quarter was 18.8% compared to 26.4% for the same quarter one year ago.

 
 
 
 

40



SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations


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

Liquidity

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

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

During the three months ended March 31, 2018 loan disbursements exceeded loan repayments resulting in a $26.0 million or 6.7% increase in total net loans receivable. Also during the three months ended March 31, 2018, deposits increased $14.6 million or 2.1% and FHLB advances decreased $10.7 million or 20.7%. The Bank had $219.6 million in additional borrowing capacity at the FHLB at the end of the period. At March 31, 2018, the Bank had $143.4 million of certificates of deposit maturing within one year. Based on previous experience, the Bank anticipates a significant portion of these certificates will be renewed on maturity.

At March 31, 2018, 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 16.9%, 10.1%, 16.9%, and 18.1%, respectively. To be categorized as “well capitalized” under the prompt corrective action provisions the Bank must maintain minimum CET1, total risk based capital, Tier 1 risk based capital and Tier 1 leverage capital ratios of 6.5%, 10.0%, 8.0% and 5.0%, respectively.

The Company also exceeded all regulatory capital requirements with CET1, Tier 1 leverage-based capital, Tier 1 risk- based capital and total risk-based capital ratios of 14.4%, 9.2%, 15.4%, and 16.7%, respectively, at March 31, 2018.


Off-Balance Sheet Commitments

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

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at March 31, 2018.
(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
$
233

$
2,930

$
33,616

$
36,779

$
50,877

$
87,656

Standby Letters of Credit

10

964

974

186

1,160

Total
$
233

$
2,940

$
34,580

$
37,753

$
51,063

$
88,816



41


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 months ended March 31, 2018, 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 3.22%.


Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a - 15(e) of the Securities Exchange Act of 1934 (“Act”)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members of the Company’s senior management as of the end of the period covered by this quarterly report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that at March 31, 2018 the Company’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms. There have been no significant changes in our internal controls over financial reporting during the quarter ended March 31, 2018 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.

42


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, 2017.

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

3.2

4.1

Form of Stock Certificate of the Company and other instruments defining the rights of security holders, including indentures (3) P
4.2

4.3

10.1

1993 Salary Continuation Agreements (5) P
10.2

Amendment One to 1993 Salary Continuation Agreements (6) P
10.3

10.4

10.5

10.6

10.7

10.8

10.9

10.1

10.11

Incentive Compensation Plan (5) P
 
 

43


SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

31.1

31.2

32

101

The following materials from Security Federal Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2018, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive (Loss) 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.







44



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:
May 14, 2018
 
By:
/s/J. Chris Verenes
 
J. Chris Verenes
 
Chief Executive Officer
 
Duly Authorized Representative

Date:
May 14, 2018
 
By:
/s/Jessica T. Cummins
 
Jessica T. Cummins
 
Chief Financial Officer
 
Duly Authorized Representative







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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 March 31, 2018, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive (Loss) Income; (d) Consolidated Statements of Changes in Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements




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