-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LOEj8vRrvp8ap+coRz61xIxMg267I275VPRgpKGdrJei7Q1yFss+gKs2v8SyPrbG ggbbZVLnslWS48xd61JyJQ== 0000939057-04-000285.txt : 20040901 0000939057-04-000285.hdr.sgml : 20040901 20040901134723 ACCESSION NUMBER: 0000939057-04-000285 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20040331 FILED AS OF DATE: 20040901 DATE AS OF CHANGE: 20040901 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SECURITY FEDERAL CORPORATION CENTRAL INDEX KEY: 0000818677 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTION, FEDERALLY CHARTERED [6035] IRS NUMBER: 570858504 STATE OF INCORPORATION: SC FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-16120 FILM NUMBER: 041010548 BUSINESS ADDRESS: STREET 1: 1705 WHISKEY RD.S. CITY: AIKEN STATE: SC ZIP: 29803 BUSINESS PHONE: 8036413070 MAIL ADDRESS: STREET 1: PO BOX 810 CITY: AIKEN STATE: SC ZIP: 29802 10-K/A 1 fm10ka.txt SECURITY FEDERAL CORPORATION FORM 10-K/A SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------------- FORM 10-K/A AMENDMENT NO. 1 TO FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended March 31, 2004 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------ ------------ Commission File Number: 0-16120 SECURITY FEDERAL CORPORATION - ----------------------------------------------------------------------------- (Exact Name of Registrant as Specified in its Charter) South Carolina 57-08580504 - --------------------------------------------- ----------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 1705 Whiskey Road South, Aiken, South Carolina 29803 - --------------------------------------------- ----------------------- (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (803) 641-3000 ----------------------- Securities registered pursuant to Section 12(b) of the Act: None ----------------------- Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.01 per share ----------------------- (Title of Class) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes No X --------- ---------- As of June 15, 2004, there were issued and outstanding 2,533,291 shares of the registrant's Common Stock. The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the average of the bid and asked price of such stock as of September 30, 2003, was $44.9 million. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.) DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Registrant's Annual Report to Stockholders for the Fiscal Year Ended March 31, 2004. (Parts I and II) 2. Portions of the Registrant's Proxy Statement for the 2004 Annual Meeting of Stockholders. (Part III) EXPLANATORY NOTE This Amendment No. 1 on Form 10-K/A ("Amendment") amends the registrant's Annual Report on Form 10-K for the fiscal year ended March 31, 2004 ("Original Report"), and is being filed solely to include the Report of Independent Registered Public Accounting Firm in Exhibit 13. The Report of Independent Registered Public Accounting Firm was issued as of April 30, 2004 and appeared in the printed Annual Report to Shareholders, but was inadvertently omitted in the electronic version of the Original Report filed with the Securities and Exchange Commission ("SEC") on June 25, 2004. The information contained in the Original Report has not been updated to reflect events and circumstances occurring since its original filing. Such matters have been or will be addressed in reports filed with the SEC (other than this Amendment) subsequent to the date of the Original Report. Pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as amended, the registrant has restated in its entirety only the item of the Original Report affected by this Amendment. PART IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ---------------------------------------------------------------- (a) 1. Financial Statements. -------------------- For a list of the financial statements filed as part of this report see Part II - Item 8 of the Original Report. 2. Financial Statement Schedules. ----------------------------- All schedules have been omitted as the required information is either inapplicable or contained in the Consolidated Financial Statements or related Notes contained in the Annual Report filed as an exhibit hereto. 3. Exhibits: -------- 3.1 Articles of Incorporation, as amended (1) 3.2 Bylaws (2) 4 Instruments defining the rights of security holders, including indentures (3) 10 Executive Compensation Plans and Arrangements: Salary Continuation Agreements (4) Amendment One to Salary Continuation Agreements (5) 1999 Stock Option Plan (2) 1987 Stock Option Plan (4) 2002 Stock Option Plan (6) Incentive Compensation Plan (4) 13 Annual Report to Stockholders 21 Subsidiaries of Registrant 23 Consent of Elliott Davis, LLC 31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 32 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act ---------------- (1) Filed on June 26, 1998, as an exhibit to the Company's Proxy Statement and incorporated herein by reference. (2) Filed on March 2, 2000, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference. (3) Filed on August 12, 1987, as an exhibit to the Company's Registration Statement on Form 8-A and incorporated herein by reference. (4) Filed on June 28, 1993, as an exhibit to the Company's Annual Report on Form 10-KSB and incorporated herein by reference. (5) Filed as an exhibit to the Company's Quarterly Report on Form 10-QSB for the quarter ended September 30, 1993 and incorporated herein by reference. (6) Filed on June 19, 2002, as an exhibit to the Company's Proxy Statement and incorporated herein by reference. (b) Reports on Form 8-K. During the three months ended March 31, 2004, the Company filed three Current Reports on Form 8-K on the following dates: 1. January 12, 2004 to report the appointment of J. Chris Verenes, President of the Company's financial institution subsidiary, Security Federal Bank, and its subsidiaries Security Federal Trust, Inc., Security Federal Investments, Inc. and Security Federal Insurance, Inc. 2. January 23, 2004 to report earnings for the quarter ended December 31, 2003. 3. February 19, 2004 to report the sale of its Denmark, South Carolina branch office to South Carolina Bank and Trust, N. A. of Orangeburg, South Carolina. SIGNATURES Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SECURITY FEDERAL CORPORATION Date: August 26, 2004 By: /s/ Timothy W. Simmons ------------------------------------- Timothy W. Simmons President, Chief Executive Officer and Director (Duly Authorized Representative) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Timothy W. Simmons August 26, 2004 -------------------------------------- Timothy W. Simmons President, Chief Executive Officer and Director (Principal Executive Officer) By: /s/ Roy G. Lindburg August 26, 2004 -------------------------------------- Roy G. Lindburg Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer) By: /s/ T. Clifton Weeks August 26, 2004 -------------------------------------- T. Clifton Weeks Chairman of the Board and Director By: /s/ J. Chris Verenes August 26, 2004 -------------------------------------- J. Chris Verenes President of the Bank and Director of the Company and the Bank By: /s/ Gasper L. Toole III August 26, 2004 -------------------------------------- Gasper L. Toole III Director By: August __, 2004 -------------------------------------- Harry O. Weeks Jr. Director By: /s/ Robert E. Alexander August 26, 2004 -------------------------------------- Robert E. Alexander Director By: August __, 2004 -------------------------------------- Thomas L. Moore Director By: August __, 2004 -------------------------------------- William Clyburn Director INDEX TO EXHIBITS Exhibit Number - -------------- 13 Annual Report to Stockholders 21 Subsidiaries of the Registrant 23 Consent of Elliott Davis, LLC 31.1 Certification of Chief Executive Officer of Security Federal Corporation Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer of Security Federal Corporation Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer of Security Federal Corporation Pursuant to Section 906 of the Sarbanes-Oxley Act Exhibit 13 Annual Report to Stockholders Annual Report March 31st, 2004 Security Federal Corporation CONTENTS Letter to Shareholders 3 Financial Highlights 4-6 Selected Consolidated Financial and Other Data 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 8 Report of Elliott Davis, LLC, Independent Auditors 23 Consolidated Balance Sheets 24 Consolidated Statements of Income 25 Consolidated Statements of Shareholders' Equity 26 & Comprehensive Income Consolidated Statements of Cash Flows 27-28 Notes to Consolidated Financial Statements 29-49 Shareholders Information 50-51 Security Federal Bank Board of Directors 52-54 & Management Team Security Federal Bank's Financial Service Subsidiaries 55 BUILDING COMMUNITY In addition to meeting and exceeding many of its financial goals for the fiscal year ending 2004, Security Federal Corporation achieved several objectives designed to further enhance its customer base and promote solid growth. In September, the bank celebrated the grand opening of a new banking branch in Lexington, South Carolina that further expands our service reach to customers in the greater Columbia area. In January, the Board of Directors appointed J. Chris Verenes as President of Security Federal Bank and its subsidiaries - with a strong background in finance, accounting, strategic planning, business development, marketing and government affairs, Chris has already proven to be a positive addition to the leadership team. In an effort to better serve customers and keep pace with new banking trends, the bank updated its website to support online transaction services including money transfer, bill paying, account access and check viewing. Now customers can access their accounts 24 hours a day, seven days a week. Lastly, the popular Looney Tunes Savings Club was expanded to serve over 4700 elementary and middle school students in 17 schools. Created to teach fiscal skills and promote financial responsibility, it has also been an excellent vehicle for introducing services to families in our banking communities. For over 80 years Security Federal's tradition of providing exceptional customer service continues to be a strong and prosperous business strategy. 2 Fellow Shareholders: Building our continued commitment to put customers first we are pleased to report that Security Federal Corporation achieved record earnings for the seventh consecutive year. Security Federal Corporation announced earnings totaling $4.3 million or $1.70 per share (basic) for the year ending March 31, 2004 compared to $3.2 million or $1.29 per share (basic) for the year ending March 31, 2003, an increase in earnings of 32%. A portion of the increase in earnings was the result of the sale of the Denmark, SC branch, which increased net income after tax and contingencies by approximately $820,000. Excluding the gain from the branch sale, which occurred in February 2004, earnings were a record $3.4 million $1.37 per share (basic) for they year ending March 31, 2004, an increase of 6.6%. Total assets increased 19% to $528.0 million, net loans receivable increased 6.9% to $259.9 million, and deposits increased 8.7% to $389.6 million at March 31, 2004 compared to March 31, 2003. Putting customers first, building on solid business basics and honoring a tradition of personal accountability have once again produced a prosperous year. Thank you for your being a part of our continued success. Sincerely, Sincerely, /s/T. Clifton Weeks /s/Timothy W. Simmons T. Clifton Weeks Timothy W. Simmons Chairman President & Chief Executive Officer 3 FINANCIAL HIGHLIGHTS Years Ended March 31, 2004 2003 Net Income $4,263,163 $3,231,161 Earnings Per Share - Basic 1.70 1.29 Book Value Per Share 13.30 11.98 Total Interest Income 23,011,005 23,659,833 Total Interest Expense 9,606,100 10,016,264 Net Interest Income Before Provision For Loan Losses 13,404,905 13,643,569 Provision For Loan Losses 1,200,000 1,800,000 Net Income After Provision For Loan Losses 12,204,905 11,843,569 Net Interest Margin 2.84% 3.46% Total Loans Originated 228,263,000 208,506,000 Adjustable Rate Loans As A Percentage Of Total Gross Loans 52.1% 50.7% 4 FINANCIAL HIGHLIGHTS 2004 2003 2002 2001 2000 ------ ------ ------ ------ ------ Net Income (In Thousands) $4,263 $3,231 $2,510 $2,127 $2,021 2004 2003 2002 2001 2000 ------ ------ ------ ------ ------ Total Assets (In Millions) $ 528 $ 445 $ 376 $ 331 $ 305 2004 2003 2002 2001 2000 ------ ------ ------ ------ ------ Return on Equity 13.67% 11.37% 9.97% 9.98% 10.41% Allowance for Loan Losses (1) 2004 2003 2002 2001 2000 ------ ------ ------ ------ ------ 2.17% 1.98% 1.55% 1.19% 1.09% (1) Allowance for losses as a percentage of total loans. 5 FINANCIAL HIGHLIGHTS 2004 2003 2002 2001 2000 ------ ------ ------ ------ ------ Book Value Per Share $13.30 $11.98 $10.18 $ 9.43 $ 7.89 2004 2003 2002 2001 2000 ------ ------ ------ ------ ------ Earnings Per Share - Basic $ 1.70 $ 1.29 $ 1.00 $ 0.85 $ 0.80 Security Federal Corporation Stock Prices 3/2004 9/2003 3/2003 9/2002 3/2002 9/2001 3/2001 9/2000 3/2000 9/1999 3/1999 9/1998 3/1998 - ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ 21.00 24.50 20.26 22.33 21.67 21.00 20.00 18.33 18.00 17.17 15.00 8.33 7.33 9/1997 3/1997 9/1996 3/1996 9/1995 3/1995 9/1994 3/1994 9/1993 3/1993 9/1992 3/1992 9/1991 - ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ 7.33 5.17 4.83 4.54 4.13 3.65 3.53 3.37 2.83 2.75 2.59 2.54 2.46 3/1991 9/1990 3/1990 9/1989 3/1989 9/1988 3/1988 10/1987 - ------ ------ ------ ------ ------ ------ ------ ------- 2.46 2.52 2.40 1.89 1.83 1.42 1.75 1.67
6 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Selected Consolidated Financial and Other Data At Or For The Year Ended March 31, ---------------------------------------------------- 2004 2003 2002 2001 2000 -------- -------- -------- -------- -------- Balance Sheet Data (Dollars In Thousands, Except Per Share Data) - ----------------------- Total Assets $528,005 $444,904 $376,320 $330,642 $304,802 Cash And Cash Equivalents 6,749 8,239 11,528 12,616 7,417 Investment And Mortgage- Backed Securities 245,715 182,117 118,898 74,405 91,531 Total Loans Receivable, Net (1) 259,895 243,156 234,319 230,997 193,001 Deposits 389,593 358,474 309,038 257,410 228,823 Advances From Federal Home Loan Bank 96,336 49,772 33,108 42,704 50,611 Total Shareholders' Equity 33,472 30,040 25,401 23,500 19,759 Income Data - ----------------------- Total Interest Income 23,011 23,660 24,632 24,153 19,805 Total Interest Expense 9,606 10,016 12,211 13,871 10,378 -------- -------- -------- -------- -------- Net Interest Income 13,405 13,644 12,421 10,282 9,427 Provision For Loan Losses 1,200 1,800 1,525 925 750 -------- -------- -------- -------- -------- Net Interest Income After Provision For Loan Losses 12,205 11,844 10,896 9,357 8,677 Other Income 5,235 3,811 3,465 2,739 2,296 General And Administrative Expense 10,725 10,483 10,337 8,851 7,845 Income Taxes 2,452 1,941 1,514 1,118 1,107 -------- -------- -------- -------- -------- Net Income $ 4,263 $ 3,231 $ 2,510 $ 2,127 $ 2,021 ======== ======== ======== ======== ======== Per Common Share Data - ----------------------- Net Income Per Common Share (Basic) $ 1.70 $ 1.29 $ 1.00 $ 0.85 $ 0.80 ======== ======== ======== ======== ======== Cash Dividends Declared $ 0.08 $ 0.0602 $ 0.0536 $ 0.0536 $ 0.0536 ======== ======== ======== ======== ======== Other Data - ----------------------- Interest Rate Spread Information: Average During Period 2.66% 3.19% 3.42% 3.00% 3.19% End Of Period 2.59% 3.00% 3.48% 3.11% 2.90% Net Interest Margin (Net Interest Income/Average Earning Assets) 2.84% 3.46% 3.73% 3.38% 3.54% Average Interest-Earning Assets To Average Interest-Bearing Liabilities 109.05% 110.47% 108.80% 108.39% 109.11% Equity To Total Assets 6.34% 6.75% 6.75% 7.11% 6.48% Non-Performing Assets To Total Assets (2) 0.40% 0.27% 0.40% 0.11% 0.40% Return On Assets (Ratio Of Net Income To Average Total Assets) 0.87% 0.79% 0.71% 0.66% 0.72% Return On Equity (Ratio Of Net Income To Average Equity) 13.67% 11.37% 9.97% 9.98% 10.41% Equity To Assets Ratio (Ratio Of Average Equity To Average Total Assets) 6.36% 6.90% 7.14% 6.62% 6.93% Dividend Pay-Out Ratio On Common Shares 4.75% 4.67% 5.31% 6.31% 6.70% Number Of Full-Service Offices 11 11 11 11 10 (1) INCLUDES LOANS HELD FOR SALE. (2) NON-PERFORMING ASSETS CONSIST OF NON-ACCRUAL LOANS AND REPOSSESSED ASSETS. 7 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations General The following discussion is presented to provide the reader with an understanding of the financial condition and results of operations of Security Federal Corporation and its subsidiaries. The investment and other activities of the parent company, Security Federal Corporation (the "Company"), have had no significant impact on the results of operations for the periods presented in the financial statements. The information presented in the following discussion of financial results is indicative of the activities of Security Federal Bank (the "Bank"), a wholly owned subsidiary of the Company. The Bank is a federally chartered thrift that was founded in 1922. The Bank also has three wholly owned subsidiaries, Security Federal Insurance Inc., Security Federal Investments Inc., and Security Federal Trust Inc. that were formed in the fiscal year ended March 31, 2002. Unless the context indicates otherwise, references to the Company shall include the Bank and its subsidiaries. The principal business of the Bank is accepting deposits from the general public and originating consumer and commercial business loans as well as mortgage loans that enable borrowers to purchase or refinance one to four family residential real estate. The Bank also originates construction loans on single-family residences, multi-family dwellings and projects, and commercial real estate, as well as loans for the acquisition, development and construction of residential subdivisions and commercial projects. The Bank's net income is dependent on its interest rate spread which is the difference between the average yield earned on its loan and investment portfolios and the average rate paid on its deposits and borrowings. The Bank's interest spread is impacted by interest rates, deposit flows, and loan demands. Levels of non-interest income and operating expense are also significant factors in earnings. Forward-Looking Statements This document, including information included or incorporated by reference, contents, and future filings by the Company on Form 10-K, Form 10-Q, and Form 8-K, and future oral and written statements by the Company and its management may contain forward-looking statements about the Company and its subsidiaries which we believe are within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, without limitation: statements with respect to anticipated future operating and financial performance; growth opportunities; interest rates; acquisition and divestiture opportunities; and synergies, efficiencies, and cost-savings. Words such as "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan," and similar expressions are intended to identify these forward-looking statements. Forward-looking statements by the Company and its management are based on beliefs, plans, objectives, goals, expectations, anticipations, estimates, and intentions of management and are not guarantees of future performance. Factors which could affect results include interest rate trends, the general economic climate in the Company's market area and the nation as a whole, the ability of the Company to control costs and expenses, deposit flows, demand for mortgages and other loans, real estate values and vacancy rates, competition, pricing, loan delinquency rates and changes in federal regulation. These factors should be considered in evaluating "forward-looking statements," and undue reliance should not be placed on any such statements. The Company disclaims any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information, or otherwise. The important factors we discuss below and elsewhere in this document, identified in our filings with the Securities and Exchange Commission ("SEC"), and presented by our management from time to time could cause actual results to differ materially from those indicated by the forward-looking statements made in this document. Critical Accounting Policies The Company has adopted various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of the Company's financial statements. The significant accounting policies of the Company are described in Note 1 of the Notes to the Consolidated Financial Statements. Certain accounting policies involve significant judgements and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgements and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgements and assumptions made by management, actual results could differ from these judgements and estimates that could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company. 8 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Critical Accounting Policies, Continued Of these significant accounting policies, the Company considers its policies regarding the allowance for loan losses to be its most critical accounting policy because of the significant degree of management judgement involved in determining the amount of allowance for loan losses. The Company has developed policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. The Company's assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations, and the discovery of information with respect to borrowers, which is not known to management at the time of the issuance of the consolidated financial statements. Refer to the discussion under the section entitled "Financial Condition" and "The Provision for Loan Losses" section in the "Comparison of the Years Ended March 31, 2004 and 2003" herein for a further discussion of the Company's estimation process and methodology related to the allowance for loan losses. Asset and Liability Management The Bank's program of asset and liability management seeks to limit the Bank's vulnerability to material and prolonged increases or decreases in interest rates, or "interest rate risk." The principal determinant of the exposure of the Bank's earnings to interest rate risk is the timing difference ("gap") between the repricing or maturity of the Bank's interest-earning assets and the repricing or maturity of its interest-bearing liabilities. If the maturities of the Bank's assets and liabilities were perfectly matched and the interest rates borne by its assets and liabilities were equally flexible and moved concurrently (neither of which is the case), the impact on net interest income of any material and prolonged changes in interest rates would be minimal. A negative gap position generally has an adverse effect on net interest income during periods of rising interest rates. A negative one-year gap position occurs when the dollar amount of rate sensitive liabilities maturing or repricing within one year exceeds the dollar amount of rate sensitive assets maturing or repricing during that same period. As a result, during periods of rising interest rates, the interest paid on interest-bearing liabilities will increase faster than interest received from earning assets, thus reducing net interest income. The reverse is true in periods of declining interest rates resulting generally in an increase in net interest income. The Bank's Board of Directors reviews the Interest Rate Exposure Report generated for the Bank by the Office of Thrift Supervision. This report measures the interest rate sensitivity of the Bank's net portfolio value (NPV) on a quarterly basis under different interest rate scenarios. The Bank's sensitivity measure is well within the Bank's policy on changes in NPV. The Bank's asset and liability policies are directed toward maximizing long term profitability while managing acceptable interest rate risk within the Bank's policies. At March 31, 2004, the negative mismatch of interest-earning assets repricing or maturing within one year with interest-bearing liabilities repricing or maturing within one year was $87.0 million or 16.5% of total assets compared to $52.8 million or 11.9% at March 31, 2003. The increase in the negative gap was attributable to an overall 12.9% increase in interest-bearing liabilities repricing within one year compared to a smaller increase of 2.1% in financial assets repricing within one year. The increase in interest-bearing liabilities increasing within one year occurred as a result of increases in money market, savings, and interest -bearing checking accounts totaling $55.3 million. These accounts are assumed to reprice within one year, where in actuality, they may not entirely be that interest rate sensitive. Many financial institutions use decay rates that spread those accounts out over several interest rate time periods. Financial assets repricing within one year had only a modest increase as a result of a rise in short-term treasury rates which lengthened the anticipated call dates on the Company's callable investments. For more information on the Bank's repricing position at March 31, 2004, see the tables on pages 11 and 12. 9 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Asset and Liability Management, Continued During the past year, the Bank originated, for investment purposes, approximately $47.3 million in adjustable rate residential real estate loans, which are held for investment and not sold. The Bank's loan portfolio included $130.4 million of adjustable rate consumer loans, commercial loans, and mortgage loans or, approximately 52.1% of total gross loans at March 31, 2004. The Bank also originated a total of $121.9 million in consumer and commercial loans, which are usually short term in nature. During fiscal 2004, 93.5% of total new loan originations on loans held for investment were comprised of consumer, commercial, and adjustable rate mortgage loans ("ARMs") compared to 92.7% of originations of loans held for investment in fiscal 2003. The Bank's portfolio of consumer and commercial loans was $166.8 million at March 31, 2004, $153.6 million at March 31, 2003, and $147.2 million at March 31, 2002. Consumer and commercial loans combined were 59.9% of total loans at March 31, 2004, 59.7% at March 31, 2003, and 59.0% at March 31, 2002. The Bank originated $11.8 million, $10.5 million, and $9.1 million in fixed rate residential loans, most of which were residential lot loans with terms of two to five years, in fiscal 2004, 2003, and 2002, respectively. At March 31, 2004, these fixed rate residential lot loans, including construction loans with terms of one year or less, amounted to $32.5 million or 11.7% of the total loan portfolio compared to $32.7 million or 12.7% at the end of the previous fiscal year. At March 31, 2003, the Bank held approximately $11.4 million in longer term fixed rate residential mortgage loans. These loans, which amounted to 4.1% of the total loan portfolio, had converted from ARM loans to fixed rate loans during the previous 24 months. These fixed rate loans have remaining maturities ranging from 10 to 29 years. The Bank has approximately $16.4 million remaining in convertible ARM loans that could convert to fixed rate loans over the next 36 months. On new originations, the Bank sells virtually all of its 15 and 30 year fixed rate mortgage loans at origination. In fiscal 2001, the Bank decided to no longer service loans for the Federal Home Loan Mortgage Corporation ("Freddie Mac") or other institutional investors, because of the fixed cost of servicing those loans, while the income stream generated by that portfolio was decreasing as a result of prepayments. Thus, during fiscal 2004, 2003, and 2002, the Bank sold its new fixed rate residential loan originations exclusively on a service-released basis. Fixed rate residential loans sold to Freddie Mac and other institutional investors, on a service-released basis, totaled $63.5 million in fiscal 2004, $80.3 million in fiscal 2003, and $84.5 million in fiscal 2002. Certificates of deposit of $100,000 or more "Jumbo Certificates" are normally considered to be interest rate sensitive because of their relatively short maturities. Many financial institutions have used Jumbo Certificates to manage interest rate sensitivity and liquidity. The Bank has not relied on Jumbo Certificates for liquidity or asset liability management. As of March 31, 2004, the Bank had $47.0 million outstanding in Jumbo Certificates compared to $44.4 million at March 31, 2003. The Bank has no brokered deposits. The following table sets forth the maturity schedule of certificates of deposit with balances of $100,000 or greater at March 31, 2004. At March 31, 2004 (In thousands) Within 3 Months $ 9,803 After 3, Within 6 Months 14,513 After 6, Within 12 Months 7,015 After 12 Months 15,711 --------- $ 47,042 ========= 10 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Asset and Liability Management, Continued The following table sets forth the Bank's interest-bearing liabilities and interest-earning assets repricing or maturing within one year. The table on the following page presents the Bank's entire interest-bearing liabilities and interest-earning assets into repricing or maturity time periods. Both tables present adjustable rate loans in the periods they are scheduled to reprice, not mature. Both tables also assume investments reprice at the earlier of maturity; the likely call date, if any, based on current interest rates; or the next scheduled interest rate change, if any. NOW accounts, money market accounts, and regular savings accounts are deemed to reprice in the less than three-months category. At March 31 ---------------------- 2004 2003 -------- -------- (Dollars in Thousands) Loans (1) $146,932 $143,398 Mortgage-Backed Securities: Held To Maturity 103 187 Available For Sale 68,421 56,054 Investment Securities: Held To Maturity 25,974 16,159 Available For Sale 16,900 37,116 Other Interest-Earning Assets 303 339 -------- -------- Total Interest Rate Sensitive Assets Repricing Within 1 Year $258,633 $253,253 -------- -------- Deposits 321,785 295,145 FHLB Advances And Other Borrowed Money 23,813 10,893 -------- -------- Total Interest Rate Sensitive Liabilities Repricing Within 1 Year $345,598 $306,038 -------- -------- Gap $(86,965) $(52,785) ======== ======== Interest Rate Sensitive Assets/Interest Rate Sensitive Liabilities 74.84% 82.75% Gap As A Percent Of Total Assets (16.5)% (11.9)% (1) LOANS ARE NET OF UNDISBURSED FUNDS AND LOANS IN PROCESS. 11 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Asset and Liability Management, Continued The following table sets forth the interest sensitivity of the Bank's assets and liabilities at March 31, 2004, on the basis of the factors and assumptions set forth in the table on the previous page. < Three 3 - 12 1 - 3 3 - 5 5 - 10 > 10 Years Months Months Years Years Years Years Total --------- -------- -------- -------- -------- -------- -------- Interest-Earnings Assets Loans (1) $ 86,619 $ 60,313 $ 77,671 $ 25,236 $ 10,092 $ 5,892 $265,823 Mortgage-Backed Securities: Held To Maturity, At Cost 29 74 197 50 - - 350 Available For Sale, At Fair Value 22,038 46,383 49,318 20,853 16,424 2,496 157,512 Investment Securities: (2) Held To Maturity, At Cost 5,000 20,974 34,975 7,976 2,029 - 70,954 Available For Sale, At Fair Value 4,633 12,267 - - - - 16,900 FHLB Stock, At Cost - - 4,817 - - - 4,817 Other Interest-Earning Assets 303 - - - - - 303 --------- -------- -------- -------- -------- -------- -------- Total Financial Assets $ 118,622 $140,011 $166,978 $ 54,115 $ 28,545 $ 8,388 $516,659 ========= ======== ======== ======== ======== ======== ======== Interest-Bearing Liabilities Deposits: Certificate Accounts $ 34,890 $ 54,742 $ 24,568 $ 18,700 $ - $ - $132,900 NOW Accounts 56,199 - - - - - 56,199 Money Market Accounts 158,587 - - - - - 158,587 Passbook Accounts 17,367 - - - - - 17,367 Borrowings 13,777 10,036 58,000 20,000 - - 101,813 --------- -------- -------- -------- -------- -------- -------- Total Interest-Bearing Liabilities $ 280,820 $ 64,778 $ 82,568 $ 38,700 $ - $ - $466,866 ========= ======== ======== ======== ======== ======== ======== Current Period Gap $(162,198) $ 75,233 $ 84,410 $ 15,415 $ 28,545 $ 8,388 $ 49,793 Cumulative Gap $(162,198) $(86,965) $ (2,555) $ 12,860 $ 41,405 $ 49,793 $ 49,793 Cumulative Gap As A Percent Of Total Assets (30.7)% (16.5)% (0.5)% 2.4% 7.9% 9.4% 9.4% (1) LOANS ARE NET OF UNDISBURSED FUNDS AND LOANS IN PROCESS. (2) CALLABLE SECURITIES ARE SHOWN AT THEIR LIKELY CALL DATES BASED ON MANAGEMENT'S ESTIMATES AT MARCH 31, 2004.
In evaluating the Bank's exposure to interest rate risk, certain shortcomings inherent in the method of analysis presented in the foregoing tables must be considered. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Additionally, the interest rates of certain types of assets and liabilities may fluctuate in advance of changes in market interest rates. Loan repayment rates and withdrawals of deposits will likely differ substantially from the assumed rates previously set forth in the event of significant changes in interest rates due to the option of borrowers to prepay their loans and the ability of depositors to withdraw funds prior to maturity. Further, certain assets, such as ARMs, have features that restrict changes in interest rates on a short-term basis as well as over the life of the asset. 12 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Financial Condition Total assets at March 31, 2004 were $528.0 million, an increase of $83.1 million or 18.7% from March 31, 2003. This increase was the result of a modest increase in net loans receivable and a significant increase in total investment and mortgage-backed securities. The Bank sold its Denmark, South Carolina branch office in February 2004. See Note 2 of the Notes to Consolidated Financial Statements included herein for additional information. The Denmark branch was the Bank's only branch in Bamberg County. The Bank plans to explore expanding its branch network in Aiken and Lexington Counties during the next few years. Total net loans receivable were $259.9 million at March 31, 2004, an increase of $16.7 million or 6.9% from $243.2 million at March 31, 2003. Residential real estate loans increased $9.8 million or 9.8% to $109.7 million at March 31, 2004. Typically, long term, newly originated fixed rate mortgage loans are not retained in the portfolio but are sold immediately. ARMs are typically retained in the portfolio. At March 31, 2004, the Bank held 60.6% of its residential mortgage loans in ARMs, while it had 39.4% in fixed rate mortgages. Consumer loans decreased $953,000 or 2.0% while commercial business and commercial real estate loans increased to $121.1 million at fiscal year end from $107.0 million at March 31, 2003; an increase of $14.1 million or 13.2%. Loans held for sale, which were $1.7 million at March 31, 2004, decreased $2.0 million from the previous fiscal year end. Total investments and mortgage-backed securities increased $63.6 million or 34.9% as a result of the modest growth in net loans receivable, strong deposit growth, and arbitrage strategies with FHLB advances. Repossessed assets decreased $101,000 to $51,000 at March 31, 2004 from $152,000 at March 31, 2003. Repossessed assets at March 31, 2004 consisted of four automobiles. Non-accrual loans totaled $2.0 million at March 31, 2004 compared to $1.0 million a year earlier. Non-accrual loans averaged 1.8 million in fiscal 2004 compared to $1.1 million during fiscal 2003. The Bank classifies all loans as non-accrual when they become 90 days or more delinquent. The Bank had seven loans totaling $646,000 at March 31, 2004 that were troubled debt restructurings compared to four loans of $674,000 at March 31, 2003. One $9,000 commercial loan was 30 days delinquent and a $201,000 commercial loan was on non-accrual. The seven troubled debt restructurings consisted of three consumer loans secured by residential dwellings totaling $355,000, a $9,000 commercial loan secured by a second mortgage on a residence, a $58,000 commercial loan secured by two rental properties, a $23,000 unsecured commercial loan and a $201,000 commercial loan secured by commercial real estate. All troubled debt restructurings are also considered impaired. At March 31, 2004, the Bank held $1.4 million in impaired loans compared to $1.2 million at March 31, 2003. The Bank reviews its loan portfolio and allowance for loan losses on a monthly basis. Future additions to the Bank's allowance for loan losses are dependent on, among other things, the performance of the Bank's loan portfolio, the economy, changes in real estate values, and interest rates. There can be no assurance that additions to the allowance will not be required in future periods. Management continually monitors its loan portfolio for the impact of local economic changes. The ratio of allowance for loan losses to total loans was 2.17% at March 31, 2004 compared to 1.98% at March 31, 2003. Deposits at the Bank increased $31.1 million or 8.7% to $389.6 million at March 31, 2004 from $358.5 million at March 31, 2003. The Bank had tremendous success in attracting money market accounts and certificate of deposit accounts with aggressive pricing and advertising. Advances from the Federal Home Loan Bank ("FHLB") increased to $96.3 million at March 31, 2004 from $49.8 million a year earlier, an increase of $46.5 million. The Bank utilized the majority of the increase in advances to use arbitrage strategies with investments. Other borrowed money, which consists of retail repurchase agreements, increased $1.3 million to $5.5 million at March 31, 2004 compared to $4.2 million at March 31, 2003. Total shareholders' equity was $33.5 million at March 31, 2004, an increase of $3.5 million or 11.4% compared to $30.0 million a year earlier. The increase was attributable to net income of $4.3 million and a decrease in the employee stock ownership debt of $108,000, offset partially by a net decrease in accumulated other comprehensive income of $755,000 and $203,000 in dividends paid. 13 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table also distinguishes between the changes related to higher or lower outstanding balances and the changes due to the volatility of interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (1) changes in rate (changes in rate multiplied by prior year volume); (2) changes in volume (changes in volume multiplied by prior year rate); and (3) net change (the sum of the prior columns). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate. Fiscal Year 2004 Compared To 2003 Fiscal Year 2003 Compared To 2002 ---------------------------------- ------------------------------------ Volume Rate Net Volume Rate Net ------- -------- -------- --------- -------- ------- (In Thousands) Interest-Earning Assets: Loans: (1) Real Estate Loans $ 142 $ (864) $ (722) $ (1,059) $ (495) $ (1,554) Other Loans 448 (1,206) (758) (2,316) 1,336 (980) ------- -------- -------- -------- -------- -------- Total Loans 590 (2,070) (1,480) (3,375) 841 (2,534) Mortgage-Backed Securities (2) 2,160 (1,134) 1,026 1,312 (612) 700 Investments (2) 396 (562) (166) 1,423 (527) 896 Other Interest-Earning Assets (21) (7) (28) 21 (55) (34) ------- -------- -------- -------- -------- -------- Total Interest-Earning Assets $ 3,125 $ (3,773) $ (648) $ (619) $ (353) $ (972) ======= ======== ======== ======== ======== ======== Interest-Bearing Liabilities: Deposits: Certificate Accounts $ (324) $ (1,196) $ (1,520) $ 352 $ (2,743) $ (2,391) NOW Accounts 32 (10) 22 32 (24) 8 Money Market Accounts 1,041 (441) 600 796 (661) 135 Savings Accounts 19 (82) (63) 46 (92) (46) ------- -------- -------- -------- -------- -------- Total Deposits 768 (1,729) (961) 1,226 (3,520) (2,294) Borrowings 1,310 (759) 551 420 (322) 98 ------- -------- -------- -------- -------- -------- Total Interest-Bearing Liabilities 2,078 (2,488) (410) 1,646 (3,842) (2,196) ------- -------- -------- -------- -------- -------- Effect On Net Income $ 1,047 $ (1,285) $ (238) $ (2,265) $ 3,489 $ 1,224 ======= ======== ======== ======== ======== ======== (1) INTEREST ON NON-ACCRUAL LOANS IS NOT INCLUDED IN INCOME, ALTHOUGH THEIR LOAN BALANCES ARE INCLUDED IN AVERAGE LOANS OUTSTANDING. (2) SECURITIES AVAILABLE FOR SALE ARE COMPUTED USING THEIR HISTORICAL COST. 14
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations, Continued The following table presents the total dollar amount of interest income from average interest-earning assets for the periods indicated and the resultant yields as well as the interest expense on average interest-bearing liabilities expressed both in dollars and rates. No tax equivalent adjustments were made. Averages For Fiscal Years Ended March 31, ----------------------------------------------------------------------------------- Yield/ 2004 2003 2002 Rate At -------------------------- -------------------------- ------------------------- March 31, Average Yield/ Average Yield/ Average Yield/ 2004 Balance Interest Rate Balance Interest Rate Balance Interest Rate -------- ------- -------- ------ ------- -------- ------ ------- -------- ------ (Dollars in Thousands) Interest-Earning Assets: Mortgage Loans 5.47% $ 92,824 $ 5,557 5.99% $ 90,729 $ 6,279 6.92% $105,676 $ 7,833 7.41% Other Loans 6.01% 152,922 9,892 6.47% 146,581 10,650 7.27% 130,359 11,630 8.92% ---- -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Loans (1) 5.80% 245,746 15,449 6.29% 237,310 16,929 7.13% 236,035 19,463 8.25% Mortgage-Backed Securities (2) 3.79% 139,025 4,479 3.22% 77,911 3,453 4.43% 50,045 2,753 5.50% Investments (2) 3.46% 85,480 3,067 3.59% 75,468 3,233 4.28% 43,924 2,337 5.32% Other Interest- Earning Assets 1.21% 1,542 16 1.04% 3,478 44 1.27% 2,598 79 3.04% ---- -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Interest- Earning Assets 4.77% $471,793 $23,011 4.88% $394,167 $23,659 6.00% $332,602 $24,632 7.41% ==== ======== ======= ==== ======== ======= ==== ======== ======= ==== Interest- Bearing Liabilities: Certificate Accounts 2.26% $143,986 $ 3,482 2.42% $154,614 $ 5,002 3.24% $147,263 $ 7,393 5.02% NOW Accounts 0.65% 57,825 354 0.61% 52,455 332 0.63% 47,691 324 0.68% Money Market Accts. 1.97% 135,190 2,718 2.01% 86,093 2,118 2.46% 57,804 1,983 3.43% Savings Accounts 0.98% 17,291 174 1.01% 15,859 237 1.49% 13,418 283 2.11% ---- -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Interest- Bearing Accounts 1.83% 354,292 6,728 1.90% 309,021 7,689 2.49% 266,176 9,983 3.75% Other Borrowings 0.93% 5,361 52 0.97% 5,663 89 1.57% 4,187 115 2.75% FHLB Advances 3.59% 72,995 2,826 3.87% 42,123 2,238 5.31% 35,351 2,114 5.98% ---- -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Interest- Bearing Liabilities 2.18% $432,648 $ 9,606 2.22% $356,807 $10,016 2.81% $305,714 $12,212 3.99% ==== ======== ======= ==== ======== ======= ==== ======== ======= ==== Net Interest Income $13,405 $13,643 $12,420 ======= ======= ======= Interest Rate Spread 2.59% 2.66% 3.19% 3.42% ==== ==== ==== ==== Net Yield On Earning Assets 2.84% 3.46% 3.73% ==== ==== ==== (1) INTEREST ON NON-ACCRUAL LOANS IS NOT INCLUDED IN INCOME, ALTHOUGH THEIR LOAN BALANCES ARE INCLUDED IN AVERAGE LOANS OUTSTANDING. (2) SECURITIES AVAILABLE FOR SALE ARE COMPUTED USING THEIR HISTORICAL COST. 15
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Comparison of the Years Ended March 31, 2004 and 2003 General The Company earned record net income of $4.3 million for the year ended March 31, 2004, an increase of $1.0 million or 31.9% over net income of for the year ended March 31, 2003. This marked the seventh consecutive year of record earnings. The primary reason for the increased earnings was a branch sale that netted $820,000 after tax and contingencies and a decrease in the provision for loan losses of $600,000 offset in part by a decrease of $326,000 in the gain on sale of mortgage loans and an increase of $242,000 in general and administrative expenses. Without the branch sale, earnings for fiscal 2004 would have been a record $3.4 million or a 6.6% increase from the previous year. Net Interest Income Net interest income decreased $239,000 or 1.8% to $13.4 million in fiscal 2004 compared to $13.6 million in fiscal 2003. The decrease was attributable to a shrinking interest rate spread. The Bank's interest rate spread decreased 53 basis points to 2.66% during fiscal 2004. The yield of average earning assets decreased 112 basis points to 4.88%, while the cost of average interest bearing liabilities decreased 59 basis points to 2.22%. Interest income on loans decreased $1.5 million to $15.4 million during the year ended March 31, 2004 compared to $16.9 million during fiscal 2003. The decrease was attributable to the decrease in overall interest rates charged on the Bank's loans during fiscal 2004 and a decrease in the yields earned on average total loans of 0.84%. Average total loan balances during fiscal 2004 and 2003 increased $8.4 million. Interest income on investment securities, mortgage-backed securities, and other investments increased $832,000 as a result of a $69.2 million, or 44.1% increase in aggregate average balances during fiscal 2004 compared with 2003. Consistent with general market conditions, the yields on aggregate investments and mortgage-backed securities decreased by 94 basis points in fiscal 2004 compared to 2003. Interest expense on deposits decreased $961,000 or 12.5% during the year ended March 31, 2004 compared to the year ended March 31, 2003. Average interest bearing deposits increased $45.3 million while the average cost of those deposits decreased 59 basis points during the year. Interest expense on FHLB advances and other borrowings increased $551,000 or 23.7% during fiscal 2004 compared to 2003. The increase was a result of an increase in average FHLB advances outstanding during the year of $30.9 million offset partially by a decrease in the weighted average interest rate paid on FHLB advances of 144 basis points. Provision for Loan Losses The Company's provision for loan losses decreased $600,000 to $1.2 million during the year ended March 31, 2004 from $1.8 million in fiscal 2003. During fiscal year 2003, the bank's internal review mechanism had identified several loans as potential problem loans. Management provided extra funding to the allowance for loan losses to cover these loans. The amount of the provision is determined by management's on-going monthly analysis of the loan portfolio. Management uses three methods to measure the estimate of the adequacy of the allowance for loan losses. These methods incorporate percentage of classified loans, five-year averages of historical loan losses in each loan category, and current economic trends, and assign percentage targets of reserves in each loan category. Management has used all three methods for the past five fiscal years. Non-accrual loans, which are loans delinquent 90 days or more, were $2.0 million at March 31, 2004 compared to $1.0 million at March 31, 2003. Net charge-offs were $347,000 in fiscal 2004 compared to $578,000 in fiscal 2003. The ratio of the allowance for loan losses to total loans at March 31, 2004 was 2.17% compared to 1.98% at March 31, 2003. Management believes the allowance for loan losses is adequate based on its best estimates of the losses inherent in the loan portfolio, although there can be no guarantee as to these estimates. In addition, bank regulatory agencies may require additions to the allowance for loan losses based on their judgments and estimates as part of their examination process. Because the allowance for loan losses is an estimate, there can be no guarantee that actual loan losses would not exceed the allowance for loan losses or that additional increases in the allowance for loan losses will not be required in the future. 16 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Other Income Other income increased $1.4 million from $3.8 million during fiscal 2003 to $5.2 million during fiscal 2004 as a result of the before tax and contingencies gain on the sale of the Denmark, South Carolina branch of $1.5 million. Without the branch sale, other income would have decreased $98,000 or 2.6%. Gain on sale of loans decreased $326,000 to $1.3 million during fiscal 2004 compared to fiscal 2003 a result of a decline in re-finances in the mortgage industry. Loan servicing fees increased $5,000 or 2.2% during fiscal 2004. Service fees on deposit accounts increased $78,000 or 6.2% a result of growth in demand deposit accounts. Other miscellaneous income including trust fees, life and casualty insurance commissions, annuity and investment brokerage commissions, credit life insurance, and other miscellaneous income increased $142,000 or 21.3% to $811,000 during fiscal 2004 compared to $669,000 during fiscal 2003. The Bank's three financial subsidiaries, Security Federal Insurance, Inc., Security Federal Investments, Inc., and Security Federal Trust, Inc., began operating in the latter part of the fiscal year ended March 31, 2002. Security Federal Insurance, Inc. is an insurance agency handling property and casualty insurance and life and health insurance. It became profitable during the fiscal year ended March 31, 2004. Security Federal Investments, Inc. markets mutual funds, discount brokerage, and annuities. Security Federal Trust, Inc., is a full-service trust company. Both companies have not yet attained profitability. General and Administrative Expenses General and administrative expenses increased $242,000 or 2.3% to $10.7 million during the year ended March 31, 2004 compared to $10.5 million during the same period one year earlier primarily a result of a $200,000 contingency expensed for the sale of the Denmark, South Caroline branch office. Without that expense, general and administrative expenses would have increased only $42,000 or 0.4%. Compensation and employee benefits increased $69,000 or 1.2% a result of normal annual salary adjustments. Occupancy expense increased $172,000 or 21.1% due to the opening of the new Lexington, South Carolina branch office. Advertising expense decreased $5,000 while depreciation and maintenance of equipment expense increased $32,000 or 3.0% and FDIC insurance premiums increased $3,000 or 5.3% to $56,000. Amortization of intangibles expense decreased $185,000 to zero for fiscal 2004. At March 31, 2004, the Company has no intangible assets on its balance sheet. Excluding the branch sale contingency expense of $200,000, other miscellaneous expenses, which encompasses repossessed assets expense, legal, professional, and consulting expenses, stationery and office supplies, and other sundry expenses decreased $43,000 or 1.9% during fiscal 2004. Income Taxes The provision for income taxes increased $511,000 to $2.4 million during the year ended March 31, 2004 compared to $1.9 million for the year ended March 31, 2003 a result of an increase in taxable income. The effective tax rate was 36.5% for fiscal 2004 and 37.5% for fiscal 2003. 17 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Comparison of the Years Ended March 31, 2003 and 2002 General The Company earned record net income of $3.2 million for the year ended March 31, 2003, an increase of $722,000 or 28.8% over net income of $2.5 million for the year ended March 31, 2002. This marked the sixth consecutive year of record earnings. The primary reason for the increased earnings was an increase in net interest income and other income offset in part by increases in the provision for loan losses. Net Interest Income Net interest income increased $1.2 million to $13.6 million in fiscal 2003 compared to $12.4 million in fiscal 2002. The increase was a result of a $61.6 million increase in total average interest-earning assets in 2003 compared with 2002. The Bank's net yield on earning assets decreased 27 basis points during the year primarily as a result of the decline in market interest rates in calendar year 2002; however the effect of the decrease on net interest income was more than offset by the 18.5% increase in total average interest-bearing assets. Interest income on loans decreased $2.5 million during the year ended March 31, 2003 compared to fiscal 2002. The decrease was attributable to the decrease in overall interest rates charged on the Bank's loans during fiscal 2003 and a decrease in the yields earned on average total loans of 1.12%. Average total loan balances during fiscal 2003 and 2002 were relatively stable. Interest income on investment securities, mortgage-backed securities, and other investments increased $1.6 million as a result of a $60.3 million, or 62.4% increase in aggregate average balances during fiscal 2003 compared with 2002. Consistent with general market conditions, the yields on aggregate investments and mortgage-backed securities decreased by 1.06% in fiscal 2003 compared to 2002. Interest expense on deposits decreased $2.3 million during the year ended March 31, 2003 compared to the year ended March 31, 2002. Average interest bearing deposits increased $42.8 million while the average cost of those deposits decreased 1.26% during the year. Interest expense on FHLB advances and other borrowings increased $98,000 during fiscal 2003 compared to 2002. The increase was as a result of an increase in the average of other borrowings and FHLB advances outstanding during the year of $8.2 million offset partially by a decrease in interest rates on FHLB advances of 67 basis points. The total average cost of borrowings decreased 77 basis points in fiscal 2003 compared to fiscal 2002. Provision for Loan Losses The Company's provision for loan losses increased $275,000 to $1.8 million during the year ended March 31, 2003. The amount of the provision is determined by management's on-going monthly analysis of the loan portfolio. Management uses three methods to measure the estimate of the adequacy of the allowance for loan losses. These methods incorporate percentage of classified loans, five-year averages of historical loan losses in each loan category, and current economic trends, and assign percentage targets of reserves in each loan category. Management has used all three methods for the past four fiscal years. Non-accrual loans, which are loans delinquent 90 days or more, were $1.0 million at March 31, 2003 compared to $1.4 million at March 31, 2002. Net charge-offs were $578,000 in fiscal 2003 compared to $620,000 in fiscal 2002. The ratio of the allowance for loan losses to total loans at March 31, 2003 was 1.98% compared to 1.55% at March 31, 2002. Management felt it prudent to increase the provision due to the predicted general slowing of the national economy, the cyclical nature of economic business trends, the growing percentage of commercial loans in the portfolio compared to residential mortgage loans, and the entrance into a new loan market for the Bank the prior year. Management believes the allowance for loan losses is adequate based on its best estimates of the losses inherent in the loan portfolio, although there can be no guarantee as to these estimates. In addition, bank regulatory agencies may require additions to the allowance for loan losses based on their judgments and estimates as part of their examination process. Because the allowance for loan losses is an estimate, there can be no guarantee that actual loan losses would not exceed the allowance for loan losses or that additional increases in the allowance for loan losses will not be required in the future. 18 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Other Income Other income increased $346,000 or 10.0% from $3.5 million during fiscal 2002 to $3.8 million during fiscal 2003. Gain on sale of loans increased $134,000 to $1.7 million during fiscal 2003 compared to $1.5 million during fiscal 2002. Proceeds of loans held for sale decreased $4.0 million in fiscal year 2003 compared to the previous year; however, a concerted effort to better manage the Bank's secondary market sales resulted in better pricing in fiscal year 2003 compared to 2002. Loan servicing fees increased $11,000. Service fees on deposit accounts increased $106,000 as a result the growth in demand deposit accounts. Other miscellaneous income including credit life insurance, annuity, and investment brokerage commissions, and other miscellaneous income increased $122,000 or 22.3% during fiscal 2003. General and Administrative Expenses General and administrative expenses increased $146,000 or 1.4% to $10.5 million during the year ended March 31, 2003 compared to $10.3 million during the same period one year earlier. Compensation and employee benefits increased $149,000 or 2.6% as a result of normal annual salary adjustments. Occupancy expense increased $6,000 or less than 1.0%. Advertising expense increased $41,000 during fiscal 2003 due to the promotion of the Bank's financial service subsidiaries and the advertisement of the Bank's deposit rates. Depreciation and maintenance of equipment expense decreased $45,000 or 4.1%. Other miscellaneous expenses encompassing repossessed assets expense, legal, professional, and consulting expenses, stationery and office supplies, and other sundry expenses increased $271,000 or 14.0% during fiscal 2003 primarily as a result of slight increases in most of the above mentioned expenses. Income Taxes The provision for income taxes increased $427,000 during the year ended March 31, 2003 compared to the year ended March 31, 2002 as a result of an increase in taxable income. The effective tax rate was 37.5% for fiscal 2003 and 37.6% for fiscal 2002. 19 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Regulatory Capital The following table reconciles the Bank's shareholders' equity to its various regulatory capital positions: March 31, ------------------------ 2004 2003 -------- -------- (In Thousands) Shareholders' Equity (1) (2) $ 32,140 $ 28,879 Reduction For Goodwill And Other Intangibles - - -------- -------- Tangible Capital 32,140 28,879 -------- -------- Qualifying Core Deposit Intangibles - - Core Capital 32,140 28,879 -------- -------- Supplemental Capital 3,412 3,064 Less Assets Required To Be Deducted 54 152 -------- -------- Total Risk-Based Capital $ 35,498 $ 31,791 ======== ======== (1) FOR FISCAL 2004 AND 2003, EXCLUDES UNREALIZED GAINS OF $690,000 AND $1.4 MILLION, RESPECTIVELY ON AVAILABLE FOR SALE SECURITIES. (2) FOR FISCAL 2004 AND 2003, EXCLUDES EQUITY OF THE COMPANY. The following table compares the Bank's capital levels relative to regulatory requirements at March 31, 2004: Amount Percent Actual Actual Excess Excess Required Required Amount Percent Amount Percent -------- -------- ------ ------- ------- ------- (Dollars in Thousands) Tangible Capital $ 10,546 2.0% $ 32,140 6.1% $ 21,594 4.1% Tier 1 Leverage (Core) Capital 21,093 4.0% 32,140 6.1% 11,047 2.1% Tier 1 Risk-Based (Core) Capital 10,917 4.0% 32,140 11.8% 21,223 7.8% Total Risk-Based Capital 21,834 8.0% 35,498 13.0% 13,664 5.0% 20 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources Liquidity refers to the ability of the Bank to generate sufficient cash flows to fund current loan demand, repay maturing borrowings, fund maturing deposit withdrawals, and meet operating expenses. The Bank's primary sources of funds include loan repayments, loan sales, increased deposits, advances from the FHLB, and cash flow generated from operations. The need for funds varies among periods depending on funding needs as well as the rate of amortization and prepayment on loans. The use of FHLB advances varies depending on loan demand, deposit inflows, and the use of investment leverage strategies to increase net interest income. The principal use of the Bank's funds is the origination of mortgages and other loans and the purchase of investments and mortgage-backed securities. Loan originations on loans held for investment were $180.9 million in fiscal 2004 compared to $145.3 million in fiscal 2003 and $128.3 million in fiscal 2002. Purchases of investments and mortgage-backed securities were $200.9 million in fiscal 2004 compared to $168.2 million in fiscal 2003 and $104.0 million in fiscal 2002. Outstanding loan commitments for the Bank's residential mortgage loan portfolio amounted to $429,000 at March 31, 2004 compared to $200,000 at March 31, 2003. Those commitments were for adjustable rate mortgage loans in which the commitment generally expires in 45 days. In addition, unused lines of credit on home equity loans, credit cards, and commercial loans amounted to $41.9 million at March 31, 2004. Home equity loans are made on a floating rate basis with final maturities of 10 to 15 years. Credit cards are generally made on a floating rate basis, and are renewed annually or every other year. Management does not anticipate that the percentage of funds drawn on unused lines of credit will increase substantially over amounts currently utilized. In addition to the above commitments the Bank has undisbursed loans-in-process of $12.4 million at March 31, 2004 which will disburse over an average of 90 days. These commitments to originate loans and future advances of lines of credit are expected to be provided from loan amortizations and prepayments, deposit inflows, maturing investments and short-term borrowing capacity. Management believes that liquidity during fiscal 2005 can be met through the Bank's deposit base, which increased $31.1 million during fiscal 2004, and from maturing investments. Also, the Bank has another $35.7 million in unused borrowing capacity at FHLB. Historically the Bank's cash flow from operating activities has been relatively stable. The cash flows from investing activities have had a trend of increasing outflows as a result of increases in purchases of mortgage-backed and investment securities. The cash flows from financing activities have had a trend of increased inflows as a result of increases in FHLB advances. See "Consolidated Statements of Cash Flows" in the Consolidated Financial Statements. 21 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Contractual Obligations In the normal course of business, the Company enters into contractual obligations that meet various business needs. These contractual obligations include time deposits to customers, borrowings from the FHLB of Atlanta and lease obligations for facilities. See Notes 6, 8, and 9 of the Notes to Consolidated Financial Statements included herein for additional information. The following table summarizes the Company's long-term contractual obligations at March 31, 2004: Less than One to Three to One Year Three Years Five Years Thereafter Total --------- ----------- ---------- ---------- -------- (In Thousands) Time deposits $ 89,632 $ 24,568 $ 18,700 $ - $132,900 FHLB Advances 13,336 43,000 30,000 10,000 96,336 Operating Lease Obligations 278 527 497 1,980 3,282 Purchase Obligation - Building Contract - - - - - -------- -------- -------- -------- -------- Total $103,246 $ 68,095 $ 49,197 $ 11,980 $232,518 ======== ======== ======== ======== ======== Off-Balance Sheet Arrangements In the normal course of business, the Company makes off-balance sheet arrangements, including credit commitments to its customers to meet their financial needs. These arrangements involve, to varying degrees, elements of credit and interest rate risk not recognized in the consolidated statement of financial condition. The bank makes personal, commercial, and real estate lines of credit available to customers and does issue standby letters of credit. Commitments to extend credit to customers are subject to the Bank's normal credit policies and are essentially the same as those involved in extending loans to customers. See Note 13 of the Notes to Consolidated Financial Statements included herein for additional information. Impact of Inflation and Changing Prices The consolidated financial statements, related notes, and other financial information presented herein have been prepared in accordance with Generally Accepted Accounting Principles ("GAAP") that require the measurement of financial position and operating results in terms of historical dollars without considering changes in relative purchasing power over time due to inflation. Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than does the effect of inflation. 22 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Shareholders and Board of Directors Security Federal Corporation and Subsidiaries Aiken, South Carolina We have audited the accompanying consolidated balance sheets of Security Federal Corporation and Subsidiaries as of March 31, 2004 and 2003, and the related consolidated statements of income, shareholders' equity and cash flows for each of the years in the three year period ended March 31, 2004. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Security Federal Corporation and Subsidiaries as of March 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the years in the three year period ended March 31, 2004, in conformity with accounting standards generally accepted in the United States of America. /s/ Elliott Davis, LLC Elliot Davis, LLC Columbia, South Carolina April 30, 2004 23 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets March 31, --------------------------- 2004 2003 ------------ ------------ ASSETS: Cash And Cash Equivalents $ 6,749,211 $ 8,238,690 Investment And Mortgage-Backed Securities: Available For Sale: (Amortized Cost of $173,300,028 and $157,821,789 at March 31, 2004 and 2003, Respectively) 174,411,819 160,150,262 Held To Maturity: (Fair Value of $71,686,256 and $22,040,207 at March 31, 2004 and 2003, Respectively) 71,303,507 21,966,533 ------------ ------------ Total Investment And Mortgage-Backed Securities 245,715,326 182,116,795 ------------ ------------ Loans Receivable, Net: Held For Sale 1,703,869 3,670,498 Held For Investment: (Net of Allowance of $5,763,935 and $4,911,224 at March 31, 2004 and 2003, Respectively) 258,190,791 239,485,158 ------------ ------------ Total Loans Receivable, Net 259,894,660 243,155,656 ------------ ------------ Accrued Interest Receivable: Loans 902,589 976,134 Mortgage-Backed Securities 549,541 441,900 Investments 778,725 667,735 ------------ ------------ Total Accrued Interest Receivable 2,230,855 2,085,769 ------------ ------------ Premises And Equipment, Net 6,562,734 5,219,947 Federal Home Loan Bank Stock, At Cost 4,816,800 2,858,600 Repossessed Assets Acquired In Settlement Of Loans 50,869 151,450 Other Assets 1,984,598 1,077,078 ------------ ------------ Total Assets $528,005,053 $444,903,985 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY: Liabilities: Deposit Accounts $389,592,645 $358,473,601 Advances From Federal Home Loan Bank 96,336,000 49,772,000 Other Borrowings 5,477,023 4,193,480 Advance Payments By Borrowers For Taxes And Insurance 317,421 279,425 Other Liabilities 2,810,049 2,145,526 ------------ ------------ Total Liabilities 494,533,138 414,864,032 ------------ ------------ Commitments (Notes 6 and 13) Shareholders' Equity: Serial Preferred Stock, $.01 Par Value; Authorized 200,000 Shares; Issued And Outstanding, None - - Common Stock, $.01 Par Value; Authorized 5,000,000 Shares, Issued 2,533,291 And Outstanding Shares, 2,516,191 at March 31, 2004 And 2,529,824 And 2,507,717 at March 31, 2003 25,333 25,298 Additional Paid-In Capital 4,013,674 3,995,230 Indirect Guarantee Of Employee Stock Ownership Trust Debt (336,972) (444,685) Accumulated Other Comprehensive Income 689,755 1,444,585 Retained Earnings, Substantially Restricted 29,080,125 25,019,525 ------------ ------------ Total Shareholders' Equity 33,471,915 30,039,953 ------------ ------------ Total Liabilities And Shareholders' Equity $528,005,053 $444,903,985 ============ ============ SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 24 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Income For the Years Ended March 31, ---------------------------------------- 2004 2003 2002 ------------ ------------ ------------ Interest Income: Loans $15,448,987 $16,929,226 $19,462,998 Mortgage-Backed Securities 4,479,444 3,453,195 2,752,563 Investment Securities 3,066,824 3,233,033 2,337,395 Other 15,750 44,379 79,319 ------------ ------------ ------------ Total Interest Income 23,011,005 23,659,833 24,632,275 ------------ ------------ ------------ Interest Expense: NOW And Money Market Accounts 3,071,306 2,450,502 2,307,002 Passbook Accounts 174,353 236,657 282,646 Certificate Accounts 3,482,214 5,002,233 7,392,855 FHLB Advances And Other Borrowed Money 2,878,227 2,326,872 2,229,154 ------------ ------------ ------------ Total Interest Expense 9,606,100 10,016,264 12,211,657 ------------ ------------ ------------ Net Interest Income 13,404,905 13,643,569 12,420,618 Provision For Loan Losses 1,200,000 1,800,000 1,525,000 ------------ ------------ ------------ Net Interest Income After Provision For Loan Losses 12,204,905 11,843,569 10,895,618 ------------ ------------ ------------ Other Income: Gain On Sale Of Investment Securities 7,700 4,245 29,817 Gain On Sale Of Loans 1,329,729 1,656,152 1,522,535 Loan Servicing Fees 213,437 208,791 198,124 Service Fees On Deposit Accounts 1,351,175 1,272,782 1,166,958 Gain On Sale Of Branch 1,521,401 - - Other 811,323 669,143 547,305 ------------ ------------ ------------ Total Other Income 5,234,765 3,811,113 3,464,739 ------------ ------------ ------------ General And Administrative Expenses: Compensation And Employee Benefits 6,023,215 5,953,904 5,805,020 Occupancy 985,378 813,113 807,430 Advertising 210,962 216,204 175,256 Depreciation And Maintenance Of Equipment 1,086,930 1,055,181 1,100,237 Amortization Of Intangibles - 185,210 465,240 FDIC Insurance Premiums 55,596 52,793 48,442 Other 2,362,783 2,206,237 1,934,847 ------------ ------------ ------------ Total General And Administrative Expenses 10,724,864 10,482,642 10,336,472 ------------ ------------ ------------ Income Before Income Taxes 6,714,806 5,172,040 4,023,885 Provision For Income Taxes 2,451,643 1,940,879 1,514,299 ------------ ------------ ------------ Net Income $ 4,263,163 $ 3,231,161 $ 2,509,586 ============ ============ ============ Net Income Per Common Share (Basic) $ 1.70 $ 1.29 $ 1.00 ============ ============ ============ Net Income Per Common Share (Diluted) $ 1.66 $ 1.26 $ 0.98 ============ ============ ============ Cash Dividend Per Share On Common Stock $ 0.08 $ 0.0602 $ 0.0536 ============ ============ ============ Weighted Average Shares Outstanding (Basic) 2,513,319 2,508,774 2,506,709 ============ ============ ============ Weighted Average Shares Outstanding (Diluted) 2,560,710 2,558,607 2,560,368 ============ ============ ============ SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 25 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity and Comprehensive Income For the Years Ended March 31, 2004, 2003 and 2002 - ----------------------------------------------------------------------------------------------------------- Accumulated Additional Indirect Other Common Paid - In Guarantee Comprehensive Retained Stock Capital of ESOP Debt Income (Loss) Earnings Total -------- ---------- ------------- ------------- --------- ---------- Balance At March 31, 2001 $16,842 $3,985,312 $ (415,000) $ 348,015 $19,565,195 $23,500,364 Net Income - - - - 2,509,586 2,509,586 Other Comprehensive Income, Net Of Tax: Unrealized Holding Losses On Securities Available For Sale - - - (511,671) - (511,671) Reclassification Adjustment For Gains Included In Net Income - - - (19,679) - (19,679) ----------- Comprehensive Income - - - - - 1,978,236 Decrease in Indirect Guarantee of ESOP Debt - - 56,703 - - 56,703 Cash Dividends - - - - (134,740) (134,740) ------- ---------- ---------- ----------- ----------- ----------- Balance At March 31, 2002 $16,842 $3,985,312 $ (358,297) $ (183,335) $21,940,041 $25,400,563 ======= ========== ========== =========== =========== ===========
- ----------------------------------------------------------------------------------------------------------- Accumulated Additional Indirect Other Common Paid - In Guarantee Comprehensive Retained Stock Capital of ESOP Debt Income (Loss) Earnings Total -------- ---------- ------------- ------------- --------- ---------- Balance At March 31, 2002 $16,842 $3,985,312 $ (358,297) $ (183,335) $21,940,041 $25,400,563 Net Income - - - - 3,231,161 3,231,161 Other Comprehensive Income, Net Of Tax: Unrealized Holding Gains On Securities Available For Sale - - - 1,630,552 - 1,630,552 Reclassification Adjustment For Gains Included In Net Income - - - (2,632) - (2,632) ----------- Comprehensive Income - - - - - 4,859,081 Exercise of Stock Options 23 18,473 18,496 3-For- 2 Stock Split 8,433 (8,555) (122) Increase in Indirect Guarantee of ESOP Debt - - (86,388) - - (86,388) Cash Dividends - - - - (151,677) (151,677) ------- ---------- ---------- ----------- ----------- ----------- Balance At March 31, 2003 $25,298 $3,995,230 $ (444,685) $ 1,444,585 $25,019,525 $30,039,953 ======= ========== ========== =========== =========== ===========
- ----------------------------------------------------------------------------------------------------------- Accumulated Additional Indirect Other Common Paid - In Guarantee Comprehensive Retained Stock Capital of ESOP Debt Income (Loss) Earnings Total -------- ---------- ------------- ------------- --------- ---------- Balance At March 31, 2003 $25,298 $3,995,230 $ (444,685) $ 1,444,585 $25,019,525 $30,039,953 Net Income - - - - 4,263,163 4,263,163 Other Comprehensive Income, Net Of Tax: Unrealized Holding Gains On Securities Available For Sale - - - (750,056) - (750,056) Reclassification Adjustment For Gains Included In Net Income - - - (4,774) - (4,774) ----------- Comprehensive Income - - - - - 3,508,333 Exercise of Stock Options 35 18,444 18,479 Decrease in Indirect Guarantee of ESOP Debt - - 107,713 - - 107,713 Cash Dividends - - - - (202,563) (202,563) ------- ---------- ---------- ----------- ----------- ----------- Balance At March 31, 2004 $25,333 $4,013,674 $ (336,972) $ 689,755 $29,080,125 $33,471,915 ======= ========== ========== =========== =========== =========== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
26 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Years Ended March 31, ------------------------------------------- 2004 2003 2002 ------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 4,263,163 $ 3,231,161 $ 2,509,586 Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities: Depreciation 844,641 825,253 959,341 Amortization Of Intangibles - 185,210 465,240 Discount Accretion And Premium Amortization 828,444 327,329 178,126 Provisions For Losses On Loans And Real Estate 1,200,000 1,800,000 1,525,000 Gain On Sales Of Loans (1,329,729) (1,656,152) (1,522,535) Gain On Sales Of Investment Securities (7,700) (4,245) (29,817) (Gain) Loss On Sale Of Real Estate (85,713) (68,419) 13,681 Amortization Of Deferred Fees On Loans (187,937) (209,430) (223,581) (Gain) Loss On Disposition Of Premises And Equipment (1,815) 1,811 (330) Proceeds From Sale Of Loans Held For Sale 64,827,155 82,001,517 86,027,850 Origination Of Loans For Sale (61,530,797) (81,849,945) (84,455,282) (Increase) Decrease In Accrued Interest Receivable: Loans 66,894 273,139 98,905 Mortgage-Backed Securities (107,641) (158,125) (103,798) Investments (110,990) (17,701) (77,960) (Decrease) Increase In Advance Payments By Borrowers 37,996 32,276 (135,329) Other, Net 359,259 (749,680) (1,098,713) ------------- ------------- ------------- Net Cash Provided By Operating Activities 9,065,230 3,963,999 4,130,384 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase Of Mortgage-Backed Securities Available For Sale (110,002,424) (80,157,881) (40,134,586) Principal Repayments On Mortgage-Backed Securities Available For Sale 55,003,975 30,444,934 17,931,424 Principal Repayments On Mortgage-Backed Securities Held To Maturity 591,457 431,751 740,244 Purchase Of Investment Securities Held To Maturity (90,880,070) (20,995,471) - Purchase Of Investment Securities Available For Sale - (67,041,485) (63,835,317) Maturities Of Investment Securities Available For Sale 36,242,259 75,281,684 34,642,931 Maturities Of Investment Securities Held To Maturity 40,995,331 133,025 102,351 Proceeds From Sales Of Investment Securities Available For Sale - 985,938 2,003,738 Proceeds From Sale of Mortgage- Backed Securities Available For Sale 2,413,515 - 3,075,600 Purchase Of FHLB Stock (5,338,000) (1,017,500) - Redemption Of FHLB Stock 3,379,800 828,200 761,700 Increase In Loans Receivable (22,245,974) (9,796,818) (5,075,962) Proceeds From Sale Of Repossessed Assets 781,537 847,009 468,475 Purchase And Improvement Of Premises And Equipment (2,419,827) (1,187,871) (555,524) Proceeds From Sale of Premises and Equipment 1,815 - 330 Net Cash Outflow From Sale of Branch (9,930,521) - - ------------- ------------- ------------- Net Cash Used By Investing Activities (101,407,127) (71,244,485) (49,874,596) ------------- ------------- ------------- (Continued) 27 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows, Continued For the Years Ended March 31, ------------------------------------------- 2004 2003 2002 ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Increase In Deposit Accounts 43,188,959 49,435,999 51,627,185 Proceeds From FHLB Advances 226,425,000 119,200,000 75,075,000 Repayment Of FHLB Advances (179,861,000) (102,536,000) (84,671,000) Proceeds (Repayment) Of Other Borrowings, Net 1,283,543 (1,975,931) 2,760,049 Purchase Of Fractional Shares Due To Stock Split - (122) - Proceeds From Exercise Of Stock Options 18,479 18,496 - Dividends To Shareholders (202,563) (151,677) (134,740) ------------- ------------- ------------- Net Cash Provided By Financing Activities 90,852,418 63,990,765 44,656,494 ------------- ------------- ------------- Net Decrease In Cash And Cash Equivalents (1,489,479) (3,289,721) (1,087,718) Cash And Cash Equivalents At Beginning Of Year 8,238,690 11,528,411 12,616,129 ------------- ------------- ------------- Cash And Cash Equivalents At End Of Year $ 6,749,211 $ 8,238,690 $ 11,528,411 ============= ============= ============= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash Paid During The Period For: Interest $ 9,740,893 $ 10,246,814 $ 12,780,647 ============= ============= ============= Income Taxes $ 2,076,388 $ 2,710,335 $ 1,994,513 ============= ============= ============= Supplemental Schedule Of Non Cash Transactions: Additions To Repossessed Assets $ 595,243 $ 874,040 $ 402,656 ============= ============= ============= Increase (Decrease) In Unrealized Net Gain On Securities Available For Sale, Net Of Taxes $ (754,830) $ 1,627,920 $ (531,350) ============= ============= ============= SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 28 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (1) Significant Accounting Policies ------------------------------- The following is a description of the more significant accounting and reporting policies used in the preparation and presentation of the accompanying consolidated financial statements. All significant intercompany transactions have been eliminated in consolidation. (a) Basis of Consolidation and Nature of Operations ----------------------------------------------- The accompanying consolidated financial statements include the accounts of Security Federal Corporation (the "Company") and its wholly owned subsidiary, Security Federal Bank (the "Bank") and the Bank's wholly owned subsidiaries, Security Federal Insurance ("SFINS"), Security Federal Investments ("SFINV"), Security Federal Trust ("SFT"), and Security Financial Services Corporation ("SFSC"). The Bank is primarily engaged in the business of accepting savings and demand deposits and originating mortgage loans and other loans to individuals and small businesses for various personal and commercial purposes. SFINS, SFINV, and SFT were formed during fiscal 2002 and began operating during the December 2001 quarter. SFINS is an insurance agency offering business, health, home and life insurance. SFINV engages primarily in investment brokerage services. SFT offers trust, financial planning and financial management services. (b) Cash and Cash Equivalents ------------------------- For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, interest-bearing balances in other banks, and federal funds sold. Cash equivalents have original maturities of three months or less. (c) Investment and Mortgage-Backed Securities ----------------------------------------- Investment securities, including mortgage-backed securities, are classified in one of three categories: held to maturity, available for sale, or trading. Management determines the appropriate classification of debt securities at the time of purchase. Investment securities are classified as held to maturity when the Company has the positive intent and ability to hold the securities to maturity. These securities are recorded at cost and adjusted for amortization of premiums and accretion of discounts over the estimated life of the security using a method that approximates a level yield. Prepayment assumptions on mortgage-backed securities are anticipated. Management classifies investment securities that are not considered to be held to maturity as available for sale. These type investments are stated at fair value with unrealized gains and losses, net of tax, reported in a separate component of shareholders' equity ("accumulated other comprehensive income (loss)"). Gains and losses from sales of investment and mortgage-backed securities available for sale are determined using the specific identification method. The Company has no trading securities. The Bank maintained liquid assets in excess of the amount required by regulations. Liquid assets consist primarily of cash, time deposits, and certain investment securities. (d) Loans Receivable Held for Investment ------------------------------------ Loans are stated at their unpaid principal balance. Interest income is computed using the simple interest method and is recorded in the period earned. (e) Allowance for Loan Losses ------------------------- The Company provides for loan losses using the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to the allowance for loan losses. Additions to the allowance for loan losses are provided by charges to operations based on various factors which, in Management's judgment, deserve current recognition in estimating possible losses. Such factors considered by Management include the fair value of the underlying collateral; stated guarantees by the borrower, if applicable, the borrower's ability to repay from other economic resources, growth and composition of the loan portfolios, the relationship of the allowance for loan losses to outstanding loans, loss experience, delinquency trends, and general economic conditions. Management evaluates the carrying value of the loans periodically and the allowance is adjusted accordingly. While Management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making these evaluations. Allowances for loan losses are subject to periodic evaluations by various regulatory authorities and may be subject to adjustments based upon the information that is available at the time of their examinations. 29 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (1) Significant Accounting Policies, Continued ------------------------------------------ The Company values impaired loans at the loan's fair value if it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement at the present value of expected cash flows, the market price of the loan, if available, or the value of the underlying collateral. Expected cash flows are required to be discounted at the loan's effective interest rate. When the ultimate collectibility of an impaired loan's principal is in doubt, wholly or partially, all cash receipts are applied to principal. When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to interest then to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amounts previously charged off. (f) Loans Receivable Held for Sale ------------------------------ Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses are provided for in a valuation allowance by charges to operations. (g) Repossessed Assets Acquired in Settlement of Loans -------------------------------------------------- Repossessed assets represent real estate and other assets acquired through foreclosure or repossession and are initially recorded at the lower of cost (principal balance of the former mortgage loan less any specific valuation allowances) or estimated fair value less costs to sell. Subsequent improvements are capitalized. Costs of holding real estate, such as property taxes, insurance, general maintenance and interest expense, are expensed as a period cost. Fair values are reviewed regularly and allowances for possible losses are established when the carrying value of the asset owned exceeds the fair value less estimated costs to sell. Fair values are generally determined by reference to an outside appraisal. (h) Premises and Equipment ---------------------- Premises and equipment are carried at cost, net of accumulated depreciation. Depreciation of premises and equipment is amortized on a straight-line method over the estimated useful life of the related asset. Estimated lives are seven to 30 years for buildings and improvements and generally five to 10 years for furniture, fixtures and equipment. Maintenance and repairs are charged to current expense. The cost of major renewals and improvements are capitalized. (i) Income Taxes ------------ Deferred tax expense or benefit is recognized for the net change during the year in the deferred tax liability or asset. That amount together with income taxes currently payable is the total amount of income tax expense or benefit for the year. Deferred taxes are provided for in differences in financial reporting bases for assets and liabilities compared with their tax bases. Basically, a current tax liability or asset is established for taxes presently payable or refundable and a deferred tax liability or asset is established for future tax items. A valuation allowance, if applicable, is established for deferred tax assets that may not be realized. Tax bad debt reserves in excess of the base year amount (established as taxable years ending March 31, 1988 or later) would create a deferred tax liability. Deferred income taxes are provided for in differences between the provision for loan losses for financial statement purposes and those allowed for income tax purposes. (j) Loan Fees and Costs Associated with Originating Loans ----------------------------------------------------- Loan fees received, net of direct incremental costs of originating loans, are deferred and amortized over the contractual life of the related loan. The net fees are recognized as yield adjustments by applying the interest method. Prepayments are not anticipated. 30 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (1) Significant Accounting Policies, Continued ------------------------------------------ (k) Intangible Assets ----------------- Goodwill, which represents the excess of purchase price over fair value of net assets acquired, is amortized on a straight-line basis over the expected periods to be benefited. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the goodwill balance over its remaining life can be recovered through projected undiscounted future results. The amount of goodwill impairment, if any, is measured based on projected discounted future results using a discount rate reflecting the Company's average cost of funds. Deposit based premiums, representing the cost of acquiring deposits from other financial institutions, are included in the balance sheet as "Other Assets" and are amortized by charges to operations over the expected periods to be benefited. The effective amortization period for intangible assets is approximately 10 years. The balance of intangible assets was zero at March 31, 2004 and March 31, 2003. (l) Interest Income --------------- Interest on loans is accrued and credited to income monthly based on the principal balance outstanding and the contractual rate on the loan. The Company places loans on non-accrual status when they become greater than 90 days delinquent or when, in the opinion of management, full collection of principal or interest is unlikely. The Company provides an allowance for uncollectible accrued interest on loans that are contractually 90 days delinquent for all interest accrued prior to the loan being placed on non-accrual status. The loans are returned to an accrual status when full collection of principal and interest appears likely. (m) Advertising Expense ------------------- Advertising and public relations costs are generally expensed as incurred. External costs relating to direct mailing costs are expensed in the period in which the direct mailing are sent. Advertising and public relations costs of $210,962 and $216,204 and $175,256, were included in the Company's results of operations for 2004, 2003, and 2002, respectively. (n) Fair Value of Financial Instruments ----------------------------------- The Company discloses the fair value of on- and off-balance sheet financial instruments when it is practicable to do so. Fair values are based on quoted market prices, where available, on estimates of present value, or on other valuation techniques. These estimates are made at a specific point in time, are subjective in nature, and involve uncertainties and significant judgment. In addition, the Company does not disclose the fair value of non-financial instruments. Accordingly, the aggregate fair values presented do not represent the underlying fair value of the Company. Fair value approximates carrying value for the following financial instruments due to the short-term nature of the instrument: cash and cash equivalents. Securities are valued using quoted fair market prices. Fair value for the Company's off-balance sheet financial instruments is based on the discounted present value of the estimated future cash flows. Fair value for variable rate loans that reprice frequently, loans held for sale, and loans that mature in less than three months is based on the carrying value. Fair value for fixed rate mortgage loans, personal loans, and other loans (primarily commercial) maturing after three months is based on the discounted present value of the estimated future cash flows. Discount rates used in these computations approximate the rates currently offered for similar loans of comparable terms and credit quality. Fair value for demand deposit accounts and interest-bearing accounts with no fixed maturity date is equal to the carrying value. Certificates of deposit accounts and securities sold under repurchase agreements maturing within one year are valued at their carrying value. The fair value of certificates of deposit accounts and securities sold under repurchase agreements after one year are estimated by discounting cash flows from expected maturities using current interest rates on similar instruments. Fair value for long-term FHLB advances is based on discounted cash flows using the Company's current incremental borrowing rate. Discount rates used in these computations approximate rates currently offered for similar borrowings of comparable terms and credit quality. 31 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (1) Significant Accounting Policies, Continued ------------------------------------------ (o) Stock-Based Compensation ------------------------ At March 31, 2004, the Company sponsored stock-based compensation plans, which are described more fully in Note 12. The Company has elected the disclosure - only provision of SFAS No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation cost has been recognized for the stock option plan. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant date consistent with the provisions of SFAS No. 123, the Company's net income and earnings per share amounts as of the year ended March 31 would have been reduced to the pro forma amounts indicated below. 2004 2003 2002 ---------- --------- --------- Net Income, As Reported $4,263,163 3,231,161 2,509,586 Deduct: Total stock-based employee compensation expense determined under fair-value based method for all awards $ (241,193) (205,804) (111,908) Net Income, Pro Forma $4,021,970 3,025,357 2,397,678 Net Income Per Common Share (Basic), As Reported $ 1.70 1.29 1.00 Net Income Per Common Share (Basic), Pro Forma $ 1.60 1.21 0.96 Net Income Per Common Share (Diluted), As Reported $ 1.66 1.26 0.98 Net Income Per Common Share (Diluted), Pro Forma $ 1.57 1.18 0.94 (p) Earnings Per Share ------------------ Net income per share is computed by dividing consolidated net income by the weighted average number of common shares outstanding during the period. The treasury stock method is used to compute the dilutive effect of stock options in the diluted weighted average number of common shares. All per share data has been restated to reflect the 3-for-2 stock split that occurred during the year ended March 31, 2003. For the Year Ended March 31, 2004 March 31, 2003 ------------------------------ ------------------------------ Per share Per share Income Shares amounts Income Shares amounts ---------- --------- ------- ---------- --------- ------- Basic EPS $4,263,163 2,513,319 $ 1.70 $3,231,161 2,508,774 $ 1.29 Dilutive effect of: Stock Options - 28,959 (0.024) - 33,166 (0.02) ESOP - 18,432 (0.016) - 16,667 (0.01) ---------- --------- ------- ---------- --------- ------- Diluted EPS $4,263,163 2,560,710 $ 1.66 $3,231,161 2,558,607 $ 1.26 ========== ========== For the Year Ended March 31, 2002 ----------------------------------- Per share Income Shares amounts ---------- --------- ------- Basic EPS $2,509,586 2,506,709 $ 1.00 Dilutive effect of: Stock Options - 34,068 (0.01) ESOP - 19,591 (0.01) ---------- --------- ------- Diluted EPS $2,509,586 2,560,368 $ 0.98 ========== (p) Use of Estimates ---------------- The preparation of financial statements in conformity with Generally Accepted Accounting Principles ("GAAP") requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of income and expenses during the reporting periods. Actual results could differ from those estimates. 32 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (1) Significant Accounting Policies, Continued ------------------------------------------ (q) Recently Issued Accounting Standards ------------------------------------ In December 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for Stock-based Compensation Transition and Disclosure," an amendment of FASB Statement No. 123, "Accounting for Stock-based Compensation", to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and Accounting Pronouncement Board ("APB") Opinion No. 28, "Interim Financial Reporting", to require disclosure in the summary of significant accounting policies of the effects of an entity's accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While SFAS No. 148 does not amend SFAS No. 123 to require companies to account for employee stock options using the fair value method, the disclosure provisions of SFAS No. 148 applicable to all companies with stock-based employee compensation, regardless of whether they account for compensation using the fair value method of SFAS No. 123 or the intrinsic value method of APB Opinion No. 25. The provisions of SFAS No. 148 are effective for annual financial statements for fiscal years ending December 15, 2002, and for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts and loan commitments that relate to the origination of mortgage loans held for sale, and for hedging activities under SFAS No. 133. SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003. The adoption of SFAS No. 149 did not have any impact on the financial condition or operating results of the Company. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 is generally effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the interim period after June 15, 2003. The adoption of SFAS No. 150 did not have any impact on the financial condition or operating results of the Company. In November 2002, the FASB issued Interpretation ("FIN") No. 45. "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". FIN No. 45 requires a company, at the time it issues a guarantee, to recognize an initial liability for the fair value of obligations assumed under the guarantee and elaborates on existing disclosure requirements related to guarantees and warranties. The initial recognition requirements of FIN No. 45 are effective for guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of periods ending after December 15, 2002. The adoption of FIN No. 45 did not have any effect on the Company's financial position or results of operations. In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities." FIN No. 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns, or both. FIN No. 46 also requires disclosures about variable interest entities that a company is not required to consolidate, but in which has a significant variable interest. FIN No. 46 provides guidance for determining whether an entity qualifies as a variable interest entity by considering, among other considerations, whether the entity lacks sufficient equity or its equity holders lack adequate decision-making ability. The consolidation requirements of FIN No. 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to existing entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The adoption of FIN No. 46 did not have any effect on the Company's financial position or results of operations. 33 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (1) Significant Accounting Policies, Continued ------------------------------------------ In March 2004, the FASB issued an exposure draft on "Share-Based Payment". The proposed Statement addresses the accounting for transactions in which an enterprise receives employee services in exchange for a) equity instruments of the enterprise or b) liabilities that are based on the fair value of the enterprise's equity instruments or that may be settled by the issuance of such equity instruments. This proposed Statement would eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25, "Accounting for Stock Issued to Employees", and generally would require instead that such transactions be accounted for using a fair-value-based method. This Statement, if approved, will be effective for awards that are granted, modified, or settled in fiscal years beginning after a) December 15, 2004 for public entities and nonpublic entities that used the fair-value-based method of accounting under the original provisions of Statement 123 for recognition or pro forma disclosure proposes and b) December 15, 2005 for all other nonpublic entities. Earlier application is encouraged provided that financial statements for those earlier years have not yet been issued. Retrospectively application of this Statement is not permitted. The adoption of this Statement, if approved, is expected to have an impact on the Company's financial position or results of operations. Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. (r) Risks and Uncertainties ----------------------- In the normal course of its business, the Company encounters two significant types of risk: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk, and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different bases, than its interest-earning assets. Credit risk is the risk of default on the Company's loan portfolio that results from borrowers' inability or unwillingness to make contractually required payments. Market risk reflects changes in the value of collateral underlying loans receivable, the valuation of real estate held by the Company, and the valuation of loans held for sale and mortgage-backed securities available for sale. The Company is subject to the regulations of various government agencies. These regulations can and do change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loss allowances, and operating restrictions, resulting form the regulators' judgements based on information available to them at the time of their examination. (s) Reclassifications ----------------- Certain amounts in prior years' consolidated financial statements have been reclassified to conform to current year classifications. (2) Branch Sale ----------- In February 2004, Security Federal Bank sold its Denmark, South Carolina branch to South Carolina Bank and Trust, N.A. of Orangeburg, South Carolina. Included in the sale, were approximately $13.6 million in deposits, $1.9 million in loans, and the branch building, furniture, and equipment. Security Federal Bank recorded a $1.5 million in gain on sale of branch, which includes gains on all the items in the previous sentence. Gain on sale of branch is included in "Other Income" as a separate line item in the income statement. Security Federal Bank also booked $200,000 as a contingency expense on the sale, which is included in the line item called "Other Expense" in the "General and Administrative Expenses" section of the income statement. The Bank has possible contingent liabilities for three years. Security Federal netted approximately $820,000 after tax and contingencies on the transaction. 34 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (3) Investment and Mortgage-Backed Securities, Available for Sale ------------------------------------------------------------- The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of investment and mortgage-backed securities available for sale are as follows: March 31, 2004 ------------------------------------------------------- Gross Gross Unrealized Unrealized Amortized Cost Gains Losses Fair value -------------- ---------- --------- ------------ FHLB Securities $ 14,019,302 $ 260,728 $ - $ 14,280,030 Federal Farm Credit Securities 2,019,623 22,567 - 2,042,190 FHLMC Bonds 564,643 13,043 - 577,686 Mortgage-Backed Securities 156,696,460 1,437,219 621,766 157,511,913 ------------ ---------- --------- ------------ $173,300,028 $1,733,557 $ 621,766 $174,411,819 ============ ========== ========= ============ March 31, 2003 ------------------------------------------------------- Gross Gross Unrealized Unrealized Amortized Cost Gains Losses Fair value -------------- ---------- --------- ------------ FHLB Securities $ 47,062,029 $ 744,865 $ 13,094 $ 47,793,800 Federal Farm Credit Securities 5,062,776 66,304 - 5,129,080 FHLMC Bonds 804,637 11,114 - 815,751 Mortgage-Backed Securities 104,892,347 1,637,286 118,002 106,411,631 ------------ ---------- --------- ------------ $157,821,789 $2,459,569 $ 131,096 $160,150,262 ============ ========== ========= ============ The amortized cost and fair value of investment and mortgage-backed securities available for sale at March 31, 2004 are shown below by contractual maturity. Expected maturities will differ from contractual maturities because borrowers have the right to prepay obligations with or without call or prepayment penalties. Amortized Cost Fair value -------------- ------------ Less Than 1 Year $ 2,000,000 $ 2,064,070 1 - 5 Years 8,578,695 8,739,576 More Than 5 Years 6,024,873 6,096,260 Mortgage-Backed Securities 156,696,460 157,511,913 ------------ ------------ $173,300,028 $174,411,819 ============ ============ At March 31, 2004, investment and mortgage-backed securities available for sale of $43.2 million were pledged as collateral for certain deposit accounts. In addition, the Bank had pledged $57.2 million of investment and mortgage-backed securities as collateral for FHLB advances and other borrowings. The Bank received approximately $2.4 million, $986,000, and $5.1 million in proceeds from sales of available for sale securities with approximately $7,700, $4,200, and $29,800 recorded in gross gains and no gross losses in the years ended March 31, 2004, 2003 and 2002, respectively. 35 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (3) Investment and Mortgage-Backed Securities, Available for Sale, Continued ------------------------------------------------------------------------ The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual available for sale securities have been in a continuous unrealized loss position, at March 31, 2004. Less than 12 Months 12 Months or More Total --------------------- ------------------- --------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ----------- -------- ---------- ------- ----------- -------- Mortgage- backed securities $60,202,930 $602,149 $2,044,437 $19,617 $62,247,367 $621,766 Securities classified as available-for-sale are recorded at fair market value. Approximately 3.2% of the unrealized losses, or two individual securities, consisted of securities in a continuous loss position for twelve 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 in 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. (4) Investment and Mortgage-Backed Securities, Held to Maturity ----------------------------------------------------------- The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of investment and mortgage-backed securities held to maturity are as follows: March 31, 2004 ------------------------------------------------------- Gross Gross Unrealized Unrealized Amortized Cost Gains Losses Fair value -------------- ---------- --------- ------------ FHLB Securities $ 57,943,983 $ 315,901 $ 86,661 $58,173,223 Federal Farm Credit Securities 13,009,727 132,504 1,881 13,140,350 Mortgage-Backed Securities 349,797 22,886 - 372,683 ----------- -------- -------- ----------- $ 71,303,507 $ 471,291 $ 88,542 $71,686,256 =========== ======== ======== =========== March 31, 2003 ------------------------------------------------------- Gross Gross Unrealized Unrealized Amortized Cost Gains Losses Fair value -------------- ---------- --------- ------------ FHLB Securities 18,989,813 $ 15,661 $ 14,071 $18,991,403 Federal Farm Credit Securities 2,005,459 20,481 - 2,025,940 FNMA Securities $ 30,331 11 - 30,342 Mortgage-Backed Securities 940,930 51,592 - 992,522 ----------- -------- -------- ----------- $21,966,533 $ 87,745 $ 14,071 $22,040,207 =========== ======== ======== =========== 36 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (4) 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, 2004, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities due to call features on certain investments. Amortized Cost Fair value -------------- ------------ Less Than 1 Year $ - $ - 1 - 5 Years 28,959,255 29,203,490 More Than 5 Years 41,994,455 42,110,083 Mortgage-Backed Securities 349,797 372,683 ----------- ----------- $71,303,507 $71,686,256 =========== =========== At March 31, 2004, investment and mortgage-backed securities held to maturity of $10.0 million were pledged as collateral for certain deposit accounts. In addition, the Bank had pledged $33.0 million of investment and mortgage-backed securities as collateral for FHLB advances and other borrowings. The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual held to maturity securities have been in a continuous unrealized loss position, at March 31, 2004. Less than 12 Months 12 Months or More Total --------------------- ------------------- --------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ----------- -------- ---------- ------- ----------- -------- FHLB $9,935,020 $88,542 $ - $ - $9,935,020 $88,542 No individual securities were in a continuous loss position for twelve months or more. The Company's held-to-maturity portfolio is recorded at amortized cost. The Company has the ability and intends to hold these securities to maturity. The Company believes, based on industry analysis reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and not in credit quality of the issuer and therefore, these losses are not considered other-than- temporary. (5) Loans Receivable, Net --------------------- Loans receivable, net, at March 31 consisted of the following: 2004 2003 ------------ ------------ Residential Real Estate Loans $109,722,301 $ 99,948,293 Consumer Loans 45,641,450 46,594,413 Commercial Business And Real Estate Loans 121,111,848 106,996,940 Loans Held For Sale 1,703,869 3,670,498 ------------ ------------ 278,179,468 257,210,144 ------------ ------------ Less: Allowance For Loan Losses 5,763,935 4,911,224 Loans In Process 12,356,346 8,990,687 Deferred Loan Fees 164,527 152,577 ------------ ------------ 18,284,808 14,054,488 ------------ ------------ Total Loans Receivable, Net $259,894,660 $243,155,656 ============ ============ 37 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (5) Loans Receivable, Net, Continued -------------------------------- Changes in the allowance for loan losses for the years ended March 31 are summarized as follows: 2004 2003 2002 ---------- ---------- ---------- Balance At Beginning Of Year $4,911,224 $3,689,079 $2,784,117 Provision For Loan Losses 1,200,000 1,800,000 1,525,000 Charge Offs (669,591) (909,494) (817,680) Recoveries 322,302 331,639 197,642 ---------- ---------- ---------- Total Allowance For Loan Losses $5,763,935 $4,911,224 $3,689,079 ========== ========== ========== The following table sets forth the amount of the Company's non-accrual loans and the status of the related interest income at March 31. 2004 2003 ---------- ---------- Non-Accrual Loans $2,044,000 $1,040,000 ========== ========== Interest Income That Would Have Been Recognized Under Original Terms $ 105,893 $ 44,173 ========== ========== Loans serviced for others at March 31, 2004, 2003, and 2002, were approximately $0, $646,000, and $671,000, respectively. On January 31, 2001, the Company sold the mortgage loan servicing for others to another bank. The gain on sale of servicing was $400,000. The Company sub-serviced the mortgage loans for the buyer of the servicing, until the transfer date of April 15, 2001. At March 31, 2004 and 2003, impaired loans amounted to $1.4 and $1.2 million, respectively. Losses on impaired loans are accounted for in the allowance for loan loss. For the years ended March 31, 2004 and 2003, the average recorded investment in impaired loans was $1.3 and $1.0 million, respectively. The Bank blanket pledges its portfolio of single family mortgage loans to secure FHLB advances. 38 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (6) Premises and Equipment, Net --------------------------- Premises and equipment, net, at March 31 are summarized as follows: 2004 2003 ----------- ---------- Land $ 426,163 496,163 Buildings And Improvements 7,254,127 5,420,768 Furniture And Equipment 5,874,011 5,295,138 Construction In Progress - 397,080 ----------- ---------- 13,554,301 11,609,149 Less Accumulated Depreciation (6,991,567) (6,389,202) ----------- ---------- Total Premises And Equipment, Net $ 6,562,734 5,219,947 =========== ========== The construction in progress at March 31, 2003 was for a new branch facility in the city of Lexington, South Carolina that was completed and began operations in August 2003. Depreciation expense for the years ended March 31, 2004, 2003, and 2002 was approximately $845,000, $825,000, and $959,000, respectively. The Bank has entered into non-cancelable operating leases related to buildings and land. At March 31, 2004, future minimum payments under non-cancelable operating leases with initial or remaining terms of one year or more are as follows (by fiscal year): 2005 $ 278,193 2006 273,967 2007 252,837 2008 250,737 2009 246,742 Thereafter 1,979,859 ---------- $3,282,335 ========== Total rental expense amounted to $278,000, $209,000, and $190,000 for the years ended March 31, 2004, 2003 and 2002, respectively. Five lease agreements with monthly expenses of $7,083, $2,472, $2,113, $743, and $700 have renewal options of 45, 10, 10, 40, and 20 years, respectively. (7) FHLB Stock ---------- Every federally insured savings institution is required to invest in FHLB stock. No ready market exists for this stock and it has no quoted fair value. However, because redemption of this stock has historically been at par, it is carried at cost. The Bank, as a member of the FHLB of Atlanta, is required to acquire and hold shares of capital stock in the FHLB of Atlanta in an amount equal to the greater of: (1) 1.0% of the aggregate outstanding principal amount of residential mortgage loans, home purchase contracts, and similar obligations at the beginning of each year; or, (2) 1/20th of its advances (borrowings) from the FHLB of Atlanta. The Bank is in compliance with this requirement with an investment in FHLB of Atlanta stock of $4.8 million as of March 31, 2004. 39 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (8) Deposits -------- Deposits outstanding by type of account are summarized as follows: At March 31, 2004 At March 31, 2003 ------------------------------ ------------------------------- Interest Interest Weighted Rate Weighted Rate Rate Range Amount Rate Range ---------- -------- --------- ---------- -------- --------- Checking Accounts $ 80,738,298 0.47% 0.00-1.74% $ 82,521,610 0.50% 0.00-1.98% Money Market Accts. 158,587,076 1.97% 1.00-2.03% 102,396,950 2.21% 1.09-2.32% Passbook Accounts 17,367,047 0.98% 0.00-1.50% 16,455,391 1.23% 0.00-2.50% ------------ ---- --------- ------------ ---- --------- Total 256,692,421 1.43% 0.00-2.03% 201,373,951 1.43% 0.00-2.50% ------------ ---- --------- ------------ ---- --------- Certificate Accounts: 0.00 - 4.99% 122,599,195 144,633,770 5.00 - 6.99% 10,301,029 12,437,463 7.00 - 8.99% - 28,417 ------------ ------------ Total 132,900,224 2.26% 0.90-6.55% 157,099,650 2.92% 1.21-7.02% ------------ ---- --------- ------------ ---- --------- Total Deposits $389,592,645 1.71% 0.00-6.55% $358,473,601 2.08% 0.00-7.02% ============ ==== ========= ============ ==== ========= The aggregate amount of short-term certificates of deposit with a minimum denomination of $100,000 was $47.0 million and $44.4 million at March 31, 2004 and 2003, respectively. The amounts and scheduled maturities of all certificates of deposit at March 31 are as follows: March 31, ---------------------------- 2004 2003 ------------ ------------ Within 1 Year $ 89,632,381 $118,710,363 After 1 Year, Within 2 9,736,807 13,749,850 After 2 Years, Within 3 14,831,103 3,160,787 After 3 Years, Within 4 15,338,730 5,272,712 After 4 Years, Within 5 3,361,203 16,205,938 Thereafter - - ------------ ------------ $132,900,224 $157,099,650 ============ ============ 40 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (9) Advances From Federal Home Loan Bank (FHLB) And Other Borrowings ---------------------------------------------------------------- Advances from the FHLB at March 31 are summarized by year of maturity and weighted average interest rate below: 2004 2003 ------------------------- ------------------------- Year Ending March 31 Amount Weighted Rate Amount Weighted Rate ----------- ------------- ----------- ------------- 2004 $ - - $ 1,700,000 1.48% 2005 13,336,000 4.92% 10,072,000 6.14% 2006 33,000,000 4.09% 23,000,000 4.93% 2007 10,000,000 2.66% - - 2008 10,000,000 2.96% 10,000,000 2.96% Thereafter 30,000,000 2.96% 5,000,000 3.35% ----------- ---- ----------- ---- $96,336,000 3.59% $49,772,000 4.50% =========== ==== =========== ==== These advances are secured by a blanket collateral agreement with the FHLB by pledging the Bank's portfolio of residential first mortgage loans and approximately $53.7 million of investment securities. Advances are subject to prepayment penalties. The following tables show callable FHLB advances as of the dates indicated. These advances are also included in the above table. All callable advances are callable at the option of the FHLB. If an advance is called, the Bank has the option to payoff the advance without penalty, re-borrow funds on different terms, or convert the advance to a three-month floating rate advance tied to LIBOR. As of March 31, 2004 - ---------------------------------------------------------------------------- Borrow Date Maturity Date Amount Int. Rate Type Call Dates - ----------- ------------- ----------- --------- ---------- ------------ 11/10/00 11/10/05 $ 5,000,000 5.85% Multi-Call 5/10/04 and quarterly thereafter 09/04/02 09/04/07 5,000,000 2.82% 1 Time Call 09/04/05 11/07/02 11/07/12 5,000,000 3.354% 1 Time Call 11/07/07 03/10/03 03/10/06 5,000,000 1.15% Multi-Call 06/10/04 and quarterly thereafter 10/24/03 10/24/08 10,000,000 2.705% Multi-Call 10/24/06 and quarterly thereafter 12/10/03 12/10/08 5,000,000 2.16% Multi-Call 12/12/05 and quarterly thereafter 02/20/04 02/20/14 5,000,000 3.225% 1 Time Call 02/20/09 As of March 31, 2003 - ---------------------------------------------------------------------------- Borrow Date Maturity Date Amount Int. Rate Type Call Dates - ----------- ------------- ----------- --------- ---------- ------------ 11/10/00 11/10/05 $ 5,000,000 5.85% Multi-Call 5/10/03 and quarterly thereafter 09/04/02 09/04/07 5,000,000 2.82% 1 Time Call 09/04/05 11/07/02 11/07/12 5,000,000 3.354% 1 Time Call 11/07/07 03/10/03 03/10/06 5,000,000 1.15% Multi-Call 03/10/04 and quarterly thereafter At March 31, 2004, the Bank had $35.7 million in additional borrowing capacity at the FHLB. The Bank had $5.5 million and $4.2 million in other borrowings (non-FHLB advances) at March 31, 2004 and 2003, respectively. These borrowings consisted of repurchase agreements with certain commercial demand deposit customers for sweep accounts. The interest rate paid on these borrowings floats monthly with the 13 week Treasury bill. At March 31, 2004 and 2003, the interest rate paid on these borrowings was 0.93% and 1.17%, respectively. The Bank had pledged $36.4 million in investment securities at March 31, 2004 and $5.1 million at March 31, 2003, respectively, as collateral for these borrowings. 41 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (10) Income Taxes ------------ Income tax expense is comprised of the following: For the Years Ended March 31, ---------------------------------- 2004 2003 2002 ---------- --------- --------- Current: Federal $2,948,661 2,380,675 1,799,303 State 356,824 247,582 200,700 ---------- --------- --------- Total Current Tax Expense 3,305,485 2,628,257 2,000,003 ---------- --------- --------- Deferred: Federal (653,360) (525,982) (348,904) State (200,482) (161,396) (136,800) ---------- --------- --------- Total Deferred Tax Expense (853,842) (687,378) (485,704) ---------- --------- --------- Total Income Tax Expense $2,451,643 1,940,879 1,514,299 ========== ========= ========= The Company's income taxes differ from those computed at the statutory federal income tax rate, as follows: For the Years Ended March 31, ----------------------------------- 2004 2003 2002 ---------- ---------- ---------- Tax At Statutory Income Tax Rate $2,283,034 $1,758,494 $1,368,121 State Tax And Other 168,609 182,385 146,178 ---------- ---------- ---------- Total Income Tax Expense $2,451,643 $1,940,879 $1,514,299 ========== ========== ========== The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below. At March 31, 2004 2003 ---------- ---------- Deferred Tax Assets: Provision For Loan Losses $2,305,574 $1,964,489 Goodwill Tax Basis Over Financial Statement Basis 466,440 568,208 Net Fees Deferred For Financial Reporting 190,114 185,108 Other 173,311 86,292 ---------- ---------- Total Gross Deferred Tax Assets 3,135,439 2,804,097 ---------- ---------- Deferred Tax Liabilities: Unrealized Gain On Securities Available For Sale 422,036 883,888 FHLB Stock Basis Over Tax Basis 133,367 133,367 Depreciation 265,318 192,599 Other - 133,367 ---------- ---------- Total Gross Deferred Tax Liability 820,721 1,343,221 ---------- ---------- Net Deferred Tax Asset $2,314,718 $1,460,876 ========== ========== The balance of the change in the net deferred tax asset results from the current period deferred tax expense of $853,842. The net deferred tax asset is included in other assets in the accompanying consolidated balance sheets. No valuation allowance for deferred tax assets was required at March 31, 2004 and 2003. The realization of net deferred tax assets may be based on utilization of carrybacks to prior taxable periods, anticipation of future taxable income in certain periods, and the utilization of tax planning strategies. Management has determined that the net deferred tax asset can be supported based upon these criteria. 42 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (11) Regulatory Matters ------------------ The Bank is subject to various regulatory capital requirements that are administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that could have a material adverse effect on the Company. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classifications are also subject to qualitative judgements by regulators with regard to components, risk weightings, and other factors. As of March 31, 2004 and 2003, the Bank was categorized as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank had to maintain total risk-based capital, Tier 1 risk-based capital, and Tier 1 leverage ratios at 10%, 6%, and 5%, respectively. There are no conditions or events that management believes have changed the Bank's classification. The Bank's regulatory capital amounts and ratios are as follows as of the dates indicated: To Be Well Capitalized Under For Prompt Corrective Capital Action Actual Adequacy Provisions ------------ ------------- ------------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- (Dollars in Thousands) March 31, 2004 Tier 1 Risk-Based Core Capital (To Risk Weighted Assets) $32,140 11.8% 10,917 4.0% 16,376 6.0% Total Risk-Based Capital (To Risk Weighted Assets) $35,498 13.0% 21,834 8.0% 27,293 10.0% Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets) $32,140 6.1% 21,093 4.0% 26,366 5.0% Tangible Capital (To Tangible Assets) $32,140 6.1% 10,546 2.0% 26,366 5.0% March 31, 2003 Tier 1 Risk-Based Core Capital (To Risk Weighted Assets) $28,879 11.8% 9,806 4.0% 14,709 6.0% Total Risk-Based Capital (To Risk Weighted Assets) $31,791 13.0% 19,612 8.0% 24,515 10.0% Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets) $28,879 6.5% 17,762 4.0% 22,203 5.0% Tangible Capital (To Tangible Assets) $28,879 6.5% 8,881 2.0% 22,203 5.0% The payment of dividends by the Company depends primarily on the ability of the Bank to pay dividends to the Company. The payment of dividends by the Bank to the Company is subject to substantial restrictions and would require prior notice to the Office of Thrift Supervision ("OTS"). 43 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (12) Employee Benefit Plans ---------------------- The Company is participating in a multiple employer defined contribution employee benefit plan covering substantially all employees with six months or more of service. The Company matches a portion of the employees' contributions and the plan has a discretionary profit sharing provision. The total employer contributions were $256,000, $215,000, and $207,000 for the years ended March 31, 2004, 2003, and 2002, respectively. The Company has an Employee Stock Ownership Plan ("ESOP") for the exclusive benefit of employee participants. The discretionary contributions for the years ended March 31, 2004, 2003, and 2002 were $0, $123,000, and $109,000, respectively. The ESOP from time to time borrows funds from financial institutions to purchase the Company's stock. The balance of the loan was $337,000 and $445,000 at March 31, 2004 and 2003, respectively. The Company carries the debt as a liability and a reduction in equity, although the Company neither endorses nor guarantees the loan. The loan is repaid by Company contributions to the trustee, who in turn makes the loan payment to the financial institution. The Company plans to terminate the ESOP during fiscal 2005 and concentrate contributions to the defined benefit plan, due to the high costs of administration of the ESOP. Certain officers of the Company participate in an incentive stock option plan. Options are granted at exercise prices not less than the fair value of the Company's common stock on the date of the grant. The following is a summary of the activity under the Company's incentive stock option plan for the years ended March 31, 2004, 2003, and 2002. 2004 2003 2002 ----------------- ----------------- ----------------- Weighted Weighted Weighted Avg. Avg. Avg. Exercise Exercise Exercise Shares Price Shares Price Shares Price ----------------- ----------------- ----------------- Balance, Beginning of Year 114,366 $ 15.77 122,334 $ 15.31 123,834 $ 15.24 Options granted 31,000 22.97 6,000 22.39 3,000 20.00 Options exercised 3,467 5.33 3,468 5.33 - - Options forfeited 11,760 11.12 10,500 17.62 4,500 16.67 ------- ------- ------- Balance, March 31 130,139 $ 18.18 114,366 $ 15.77 122,334 $ 15.31 ======= ======= ======= At March 31, 2004, the Company had the following options outstanding: Outstanding Earliest Date Grant Date Options Option Price Exercisable Expiration Date - ---------- ----------- ------------ -------------- ----------------- 1/07/97 4,639 $ 5.33 1/1/04 to 1/1/06 12/31/04 to 12/31/06 10/19/99 79,500 $16.67 10/1/04 to 10/01/08 9/30/05 to 9/30/09 10/19/99 6,000 $18.33 10/01/03 9/30/04 4/17/01 3,000 $20.00 5/1/06 to 5/1/10 4/30/07 to 4/30/11 1/16/03 6,000 $22.39 1/1/08 to 1/1/12 12/31/12 9/1/03 3,000 $24.00 9/1/08 to 9/1/12 8/31/13 12/1/03 3,000 $23.65 12/1/08 to 12/1/12 11/30/13 1/01/04 12,000 $24.22 1/1/09 to 1/1/13 12/31/13 3/8/04 13,000 $21.43 3/1/09 to 3/1/13 2/28/14 44 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (12) Employee Benefit Plans, Continued --------------------------------- The options listed on the previous page vest over ten years with the first vesting earned after five years and 20% vesting earned evenly in years six through ten except for the 6,000 shares granted on 10/19/99 which fully vest on 10/1/03. All options, issued prior to January 16, 2003, which vest must be exercised within one year of vesting, except those granted during the year ended March 31, 2004 or later, which may be exercised anytime between the beginning of the sixth year and the end of the tenth year after the grant date. There were 17,000 options available for granting at March 31, 2004. The incentive stock option plan adopted by the Company includes a provision for tandem stock appreciation rights ("SARs"). Options granted after March 31, 2002, were not granted in tandem with SAR's, while options granted before March 31, 2002 were granted in tandem with SAR's. Upon vesting, these stock appreciation rights are exercisable in lieu of the stock options granted to the employee. Upon exercise, the employee chooses the option or SAR feature, and the tandem instrument is cancelled. The Company accounts for incentive stock options and tandem SARs under Accounting Principles Board ("APB") Option No. 25, "Accounting for Stock Issued to Employees". APB No. 25 states that compensation cost for a combination plan permitting an employee to elect one part should be measured according to the terms that an employee is mostly likely to elect based on the facts available each period. Due to the personal income tax implications of SARs under the Internal Revenue Code, employees have historically elected to exercise options rather than the SARs. Accordingly, the Company has elected to measure compensation cost for stock options as required by APB No. 25, rather than for the SARs. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for grants: Dividend yield of $.08 per share for options granted during the years ended 2004, 2003 and 2002, expected volatility of 21.4% for options granted in 2004, 10.7% for options granted in 2003, and 30% for options granted in 2002, risk-free interest rate of 3.78% to 4.45% for options granted in 2004, 3.35% for options granted in 2003, and 5.9% for options granted in 2002, and expected lives of 6-10 years. (13) Commitments ----------- In conjunction with its lending activities, the Bank enters into various commitments to extend credit and issue letters of credit. Loan commitments (unfunded loans and unused lines of credit) and letters of credit are issued to accommodate the financing needs of the Bank's customers. Loan commitments are agreements by the Bank to lend at a future date, so long as there are no violations of any conditions established in the agreement. Letters of credit commit the Bank to make payments on behalf of customers when certain specified events occur. Financial instruments where the contract amount represents the Bank's credit risk include commitments under pre-approved but unused lines of credit of $39.4 million and $30.9 million, undisbursed loans in process totaled $12.4 million and $9.0 million, and letters of credit of $562,000 and $728,000 at March 31, 2004 and 2003, respectively. At March 31, 2004 and 2003, the fair value of standby letters of credit was immaterial. These loan and letter of credit commitments are subject to the same credit policies and reviews as loans on the balance sheet. Collateral, both the amount and nature, is obtained based upon management's assessment of the credit risk. Since many of the extensions of credit are expected to expire without being drawn, the total commitment amounts do not necessarily represent future cash requirements. In addition to these loan commitments noted above, the Bank had unused credit card loan commitments of $2.5 million and $2.4 million at March 31, 2004 and 2003, respectively. Outstanding commitments on mortgage loans not yet closed amounted to $429,000 and $200,000 at March 31, 2004 and 2003, respectively. Such commitments, which are funded subject to certain limitations, extend over varying periods of time with the majority being funded within 45 days. At March 31, 2004 and 2003, the Bank had outstanding commitments to sell approximately $1.7 and $3.7 million of loans, which encompassed the Bank's held for sale loans. The Bank also has commitments to sell mortgage loans not yet closed, on a best efforts basis. Best efforts means the Bank suffers no penalty if they are unable to deliver the loans to the potential buyers. The fair value of the Bank's commitment to originate mortgage loans at committed interest rates and to sell such loans to permanent investors is insignificant. 45 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (14) Related Party Transactions -------------------------- At March 31, 2004, the total aggregate indebtedness to the Bank by executive officers and directors of the Bank and Company, whose individual indebtedness exceeded $60,000, at any time over the period since April 1, 2002,was $517,000. There was $137,000 in additional loans to executive officers and directors whose individual indebtedness exceeded $60,000 during fiscal 2004. Repayments on these loans totaled approximately $103,000. Loans to all employees, officers, and directors of the Company, in the aggregate constituted approximately 6.51% of the total shareholders' equity of the Company at March 31, 2004. At March 31, 2004, deposits from executive officers and directors of the Bank and Company and their related interest in aggregate approximated $2.4 million. The Company rents office space from a company in which a director and an officer of the Company and the Bank have an ownership interest. The Bank incurred expenses of $30,000, $29,000, and $29,000 for rent for the years ended March 31, 2004, 2003 and 2002, respectively. Management is of the opinion that the transactions with respect to office rent are made on terms that are comparable to those which would be made with unaffiliated persons. (15) Security Federal Corporation Condensed Financial Statements (Parent ------------------------------------------------------------------- Company Only) ------------ The following is condensed financial information of Security Federal Corporation (Parent Company only). The primary asset is its investment in the Bank subsidiary and the principal source of income for the Company is equity in undistributed earnings from the Bank. Condensed Balance Sheet Data At March 31, -------------------------- 2004 2003 ----------- ----------- Assets: Cash $ 956,582 $ 146,206 Investment In Security Federal Bank 32,829,876 30,324,359 Income Tax Receivable From Bank 31,538 33,181 ----------- ----------- Total Assets $33,817,996 $30,503,746 =========== =========== Liability And Shareholders' Equity: Accounts Payable $ 9,109 $ 19,108 Indirect Guarantee of ESOP Debt 336,972 444,685 Shareholders' Equity 33,471,915 30,039,953 ----------- ----------- Total Liabilities And Shareholders' Equity $33,817,996 $30,503,746 =========== =========== Condensed Statements of Income Data For the Years Ended March 31, -------------------------------------- 2004 2003 2002 ---------- ---------- ---------- Income: Equity In Earnings Of Security Federal Bank $4,260,347 $3,232,989 $2,510,729 Miscellaneous Income 10,000 - 406 ---------- ---------- ---------- 4,270,347 3,232,989 2,511,135 Expenses: Other Expenses 7,184 1,828 1,549 ---------- ---------- ---------- Net Income $4,263,163 $3,231,161 $2,509,586 ========== ========== ========== 46 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (15) Security Federal Corporation Condensed Financial Statements (Parent ------------------------------------------------------------------- Company Only), Continued ------------------------ Condensed Statements of Cash Flow Data For the Years Ended March 31, -------------------------------------- 2004 2003 2002 ---------- ---------- ---------- Operating Activities: Net Income $ 4,263,163 $ 3,231,161 $ 2,509,586 Adjustments To Reconcile Net Income To Net Cash Provided By (Used In) Operating Activities: Equity In Earnings Of Security Federal Bank (4,260,347) (3,232,989) (2,510,729) Equity In Earnings (Loss) Of Real Estate Partnership - - - Recovery of Previously Recognized Loss - - - (Increase) Decrease In Income Taxes Receivable And Other Assets 1,644 (1,123) (700) Decrease In Accounts Payable (10,000) (2,936) - ----------- ----------- ----------- Net Cash Provided By (Used In) Operating Activities (5,540) (5,887) (1,843) ----------- ----------- ----------- Investing Activities: Dividend Received From Security Federal Bank $ 1,000,000 - - ----------- ----------- ----------- Net Cash Provided By Investing Activities $ 1,000,000 - - ----------- ----------- ----------- Financing Activities: Exercise of Stock Options 18,479 18,496 - Purchase of Fractional Shares Due To Stock Split - (122) - Dividends Paid (202,563) (151,677) (134,740) ----------- ----------- ----------- Net Cash Provided By (Used In) Financing Activities (184,084) (133,303) (134,740) Net Increase (Decrease) In Cash 810,376 (139,190) (136,583) Cash At Beginning Of Year 146,206 285,396 421,979 ----------- ----------- ----------- Cash At End Of Year $ 956,582 $ 146,206 $ 285,396 =========== =========== =========== (16) Carrying Amounts and Fair Value of Financial Instruments -------------------------------------------------------- The carrying amounts and fair value of financial instruments are summarized below: At March 31, --------------------------------------------- 2004 2003 --------------------- --------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value -------- ---------- --------- ---------- (In Thousands) Financial Assets: Cash And Cash Equivalents $ 6,749 $ 6,749 $ 8,239 $ 8,239 Investment And Mortgage-Back Securities $244,604 $246,098 $179,788 $182,190 Loans Receivable, Net $259,895 $260,042 $243,156 $250,022 Federal Home Loan Bank Stock $ 4,817 $ 4,817 $ 2,859 $ 2,859 Financial Liabilities: Deposits: Checking, Savings, and Money Market Accounts $256,692 $256,692 $201,374 $201,374 Certificate Accounts $132,900 $117,389 $157,100 $160,818 Advances From Federal Home Loan Bank $ 96,336 $104,653 $ 49,772 $ 51,792 Other Borrowed Money $ 5,477 $ 5,477 $ 4,193 $ 4,193 47 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (16) Carrying Amounts and Fair Value of Financial Instruments, Continued ------------------------------------------------------------------- At March 31, 2004, the Bank had $54.9 million of off-balance sheet financial commitments. These commitments are to originate loans and unused consumer lines of credit and credit card lines. Because these obligations are based on current market rates, if funded, the original principal is considered to be a reasonable estimate of fair value. Fair value estimates are made at a specific point in time, based on relevant market data and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the Bank's entire holdings of a particular financial instrument. Because no active market exists for a significant portion of the Bank's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, current interest rates and prepayment trends, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in any of these assumptions used in calculating fair value would also significantly affect the estimates. Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, the Bank has significant assets and liabilities that are not considered financial assets or liabilities including deposit franchise values, loan servicing portfolios, deferred tax liabilities, and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates. The values used are provided from the Office of Thrift Supervison's interest rate risk model. The Company has used management's best estimate of fair value on the above assumptions. Thus, the fair values presented may not be the amounts, which could be realized, in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses that would be incurred in an actual sale or settlement are not taken into consideration in the fair value presented. 48 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (17) Quarterly Financial Data (Unaudited) ----------------------------------- Unaudited condensed financial data by quarter for fiscal year 2004 and 2003 is as follows (amounts, except per share data, in thousands): Quarter ended ----------------------------------------------------------- 2003-2004 June 30, 2003 Sept. 30, 2003 Dec. 31, 2003 Mar. 31, 2004 ------------- -------------- ------------- ------------- Interest Income $ 5,614 $ 5,504 $ 5,883 $ 6,010 Interest Expense 2,388 2,298 2,413 2,507 ---------- ---------- ---------- ---------- Net Interest Income 3,226 3,206 3,470 3,503 Provision for Loan Losses 300 300 300 300 ---------- ---------- ---------- ---------- Net Interest Income after Provision for Loan Losses 2,926 2,906 3,170 3,203 Non-interest Income 1,200 1,059 796 2,180 Non-interest Expense 2,649 2,577 2,560 2,938 ---------- ---------- ---------- ---------- Income before Income Tax 1,477 1,388 1,406 2,445 Provision for Income taxes 554 498 503 897 ---------- ---------- ---------- ---------- Net Income $ 923 $ 890 $ 903 $ 1,548 ========== ========== ========== ========== Basic Net Income per Common Share $ 0.37 $ 0.35 $ 0.36 $ 0.62 ========== ========== ========== ========== Diluted Net Income per Common Share $ 0.36 $ 0.35 $ 0.35 $ 0.60 ========== ========== ========== ========== Basic Weighted Average Shares Outstanding 2,510,526 2,512,600 2,513,958 2,516,191 ========== ========== ========== ========== Diluted Weighted Average Shares Outstanding 2,558,299 2,568,601 2,561,891 2,554,050 ========== ========== ========== ========== Quarter ended ----------------------------------------------------------- 2002-2003 June 30, 2002 Sept. 30, 2002 Dec. 31, 2002 Mar. 31, 2003 ------------- -------------- ------------- ------------- Interest Income $ 6,002 $ 6,001 $ 5,972 $ 5,685 Interest Expense 2,512 2,538 2,547 2,419 ---------- ---------- ---------- ---------- Net Interest Income 3,490 3,463 3,425 3,266 Provision for Loan Losses 450 450 450 450 ---------- ---------- ---------- ---------- Net Interest Income after Provision for Loan Losses 3,040 3,013 2,975 2,816 Noninterest Income 799 882 1,108 1,022 Noninterest Expense 2,684 2,579 2,597 2,623 ---------- ---------- ---------- ---------- Income before Income Tax 1,155 1,316 1,486 1,215 Provision for Income taxes 438 502 559 442 ---------- ---------- ---------- ---------- Net Income $ 717 $ 814 $ 927 $ 773 ========== ========== ========== ========== Basic Net Income per Common Share $ 0.29 $ 0.32 $ 0.37 $ 0.31 ========== ========== ========== ========== Diluted Net Income per $ 0.28 $ 0.32 $ 0.36 $ 0.30 ========== ========== ========== ========== Basic Weighted Average Shares Outstanding 2,507,573 2,509,707 2,509,484 2,508,331 ========== ========== ========== ========== Diluted Weighted Average Shares Outstanding 2,564,795 2,565,969 2,559,299 2,555,176 ========== ========== ========== ========== 49 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES SHAREHOLDERS INFORMATION ANNUAL MEETING The annual meeting of shareholders will be held at 2:00 p.m., Thursday, July 22, 2004 at the City of Aiken Municipal Conference Center, 215 The Alley, Aiken, SC. STOCK LISTING The Company's stock is traded on the Over-The-Counter-Bulleting Board under the symbol "SFDL". The stock began trading on the Bulletin Board in October 2003. PRICE RANGE OF COMMON STOCK The table below shows the range of high and low bid prices. These prices represent actual transactions and do not include retail markups, markdowns or commissions. Market makers include Sterne, Agee, and Leach, Inc., Trident Securities, Inc., A.G. Edwards and Sons, Inc., Hill, Thompson, and Magid, and Monroe Securities, Inc. Quarter Ending High Low -------------- ------- ------- 06-30-02 $ 24.00 $ 21.67 09-30-02 $ 22.99 $ 22.11 12-31-02 $ 22.31 $ 21.33 03-31-03 $ 21.33 $ 20.00 06-30-03 $ 20.98 $ 20.98 09-30-03 $ 24.50 $ 22.25 12-31-03 $ 25.50 $ 23.25 03-31-04 $ 25.40 $ 19.75 The prices in the table above are adjusted for a 3-for-2 stock split which occurred in the fiscal year ended March 31, 2003. As of March 31, 2004, the Company had approximately 475 shareholders and 2,533,291 outstanding shares of common stock. DIVIDENDS The first quarterly dividend on the stock was paid to shareholders on March 15, 1991. Dividends will be paid upon the determination of the Board of Directors that such payment is consistent with the long-term interest of the Company. The factors affecting this determination include the Company's current and projected earnings, operating results, financial condition, regulatory restrictions, future growth plans, and other relevant factors. The Company declared and paid dividends of $0.0133 per share for each of the four quarters of the fiscal year ended March 31, 2002. In fiscal year ended March 31, 2003, the Company paid cash dividends of $0.0133 for the first three quarters of the fiscal year. After the 3-for-2 stock split which occurred during the quarter ended March 31, 2003, the Company paid $0.02 per share cash dividend for that quarter. The cash dividends are stated on a post split basis. The Company paid $0.02 per share cash dividends for each of the quarters during fiscal 2003-2004. The ability of the Company to pay dividends depends primarily on the ability of the Bank to pay dividends to the Company. The Bank may not declare or pay a cash dividend on its stock or repurchase shares of its stock if the offset thereof would be to cause its regulatory capital to be reduced below the amount required for the liquidation account or to meet applicable regulatory capital requirements. Pursuant to the OTS regulations, Tier 1 Associations (associations that before and after the proposed distribution meet or exceed their fully phased-in capital requirements) may make capital distributions during any calendar year equal to 100% of net income for the year-to-date plus 50% of the amount by which the association's total capital exceeds its fully phased-in capital requirement as measured at the beginning of the capital year. However, a Tier 1 Association deemed to be in need of more than normal supervision by the OTS may be downgraded to a Tier 2 or Tier 3 Association as a result of such a determination. The Bank is also required to give the OTS 30 days notice prior to the declaration of a dividend. Unlike the Bank, there is no regulatory restriction on the payment of dividends by the Company. However, it is subject to the requirements of South Carolina. South Carolina generally prohibits the Company from paying dividends if, after giving effect to a proposed dividend: (1) the Company would be unable to pay its debts as they become due in the normal course of business, or (2) the Company's total assets would be less than its total liabilities plus the sum that would be needed to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the dividend. The ability of the Company to pay dividends depends primarily on the ability of the Bank to pay dividends to the Company. 50 SHAREHOLDER INFORMATION ANNUAL AND OTHER REPORTS The Company is required to file an annual report on Form 10-K for its fiscal year ended March 31, 2004 with the Securities and Exchange Commission. Copies of Form 10-K, Security Federal Corporation's annual report, and the Company's quarterly reports may be obtained from and inquiries may be addressed to Mrs. Ruth L. Vance of Security Federal Corporation. GENERAL INQUIRIES TRANSFER AGENT SPECIAL COUNSEL Mrs. Ruth L. Vance Security Federal Breyer & Associates, PC Security Federal Corporation Suite 785 Corp. 1705 Whiskey Road, S 8180 Greensboro Drive 1705 Whiskey Road, S P.O. Box 810 McLean, VA 22102 P.O. Box 810 Aiken, SC 29802-0810 Aiken, SC 29802-0810 Phone: 803-641-3000 Toll free: 866-581-3000 INDEPENDENT AUDITORS Elliott Davis, LLC 211 York Street, N.E. Suite One P.O. Box 930 Aiken, SC 29802-0930 51 BOARD OF DIRECTORS T. Clifton Weeks Sen. Thomas L. Moore Harry O. Weeks, Jr. Chairman President Business Dev. Executive Security Federal Corporation Boiler Efficiency, Inc. Hutson-Etherredge Co. Aiken, SC Clearwater, SC Aiken, SC Dr. Robert E. Alexander Timothy W. Simmons J. Chris Verenes Chancellor Emeritus President/CEO President Univ. of SC at Aiken Security Federal Corp. Security Federal Bank Aiken, SC Aiken, SC Aiken, SC Hon. William Clyburn G. L. Toole, III Advisor for Community Attorney-At-Law Alliances Aiken, SC WSRC Aiken, SC Directors Emeriti: Walter E. Brooker, Sr. President, Brooker's Inc. Denmark, SC Robert E. Johnson Corporate Secretary Attorney-At-Law (Retired) Aiken, SC 52 BANK ADVISORY BOARDS NORTH AUGUSTA P. Richard Borden Rev. G.L. Brightharp Helen H. Butler Owner Owner Retired Banker Borden Pest Control G.L. Brightharp & Sons Mortuary North Augusta, SC North Augusta, SC North Augusta, SC Sen. Thomas L. Moore John P. Potter President Director of Finance Boiler Efficiency, Inc. City of North Augusta Clearwater, SC North Augusta, SC WAGENER M. Judson Busbee Chad G. Ingram Mary T. Lybrand Michael L. Miller Owner Vice President Retired Banker Anesthesiologist Busbee Hardware New World Enterprises Wagener, SC Palmetto Health Wagener, SC Wagener, SC Richland Memorial Hospital Columbia, SC Richard H. Sumpter Retired Educator Wagener, SC MIDLAND VALLEY Charles A. Hilton Rev. Nathaniel Irvin, Sr. Gloria Busch-Johnson General Manager Pastor Consultant Breezy Hill Old Storm Branch Aiken, SC Water& Sewer Baptist Baptist Church Graniteville, SC Clearwater, SC Sen. Thomas L. Moore Glenda K. Napier Carlton B. Shealy President Co-Owner Owner Boiler Efficiency, Inc. Napier Funeral Home C. Shealy Realty Builders & Clearwater, SC Graniteville, SC Developers North Augusta, SC WEST COLUMBIA Eleanor Powell Clark Dr. G. Tripp Jones L. Ed Kirkland, Jr. Owner/Operator Physician Owner/Agent B & E Enterprises Inc. SC Oncology Associates L. Ed Kirkland & Co., LLC dba McDonald's West Columbia, SC Columbia, SC Columbia, SC Dianne Light Donald T. Martin Sandra Dooley Parker Owner Controller, CPA Attorney Diane's on Devine Nexsen, Pruet, Jacobs Dooley, Dooley, Spence, & Dipmato's Deli & Pollard, LLP Parker & Hipp, PA Columbia, SC West Columbia, SC Lexington, SC L. Todd Sease Sen. Nikki G. Setzler Jan Hook-Stamps Partner Sr. Partner Owner Jumper, Carter, Sease Setzler & Scott, PA Southern Anesthesia & Architects, PA Law Firm Surgical Co. Columbia, SC West Columbia, SC West Columbia, SC 53 MANAGEMENT TEAM T. Clifton Weeks Chairman of Security Federal Corporation Timothy W. Simmons Chairman and Chief Executive Officer G. L. Toole, III Vice President Robert E. Johnson Corporate Secretary J. Chris Verenes President Roy G. Lindburg Treasurer and Chief Financial Officer Floyd J. Blackmon Senior Vice President and Chief Operations Officer Francis M. Thomas, Jr. Senior Vice President - Aiken Area Executive Marian A. Shapiro Senior Vice President - Midlands Area Executive Sandra M. Bartlett Vice President - Human Resources Kathryn Y. Carr Vice President - Special Assets Carol P. McCleskey Vice President and Branch Coordinator Harley G. Henkes Internal Auditor and Compliance/Security Officer Gabriele C. Dukes Vice President - Financial Counseling/Community Development Rodney K. Ingle Vice President - Business Development/Commercial Loans Joseph C. Taylor Vice President - Operations Officer Audrey Varn Vice President - Trust Administration Janice S. Hauerwas Vice President - Mortgage Loan Originator Gregory D. Warfield Vice President - Mortgage Loan Originator James E. Bristow Vice President - Business Development/Commercial Loans Lawrence M. Moran Vice President - Business Development/Commercial Loans Paul T. Rideout Vice President - Business Development/Commercial Loans Etta A. Petroff Assistant Vice President - Mortgage Loan Production/ Secondary Marketing Ruth L. Vance Assistant Secretary and Assistant Vice President Margaret A. Hurt Assistant Treasurer - Accounting Laura B. Conway Assistant Vice President - Operations Kathi J. Snipes Assistant Vice President - Financial Counseling Patricia B. Moseley Assistant Vice President - Loan and Credit Card Servicing Ann C. Johnson Assistant Vice President - Purchasing and Facilities Management Elsie K. Dicks Assistant Vice President - Credit Administration Barbara J. Davis Assistant Vice President - Mortgage Loan Underwriter S. Kevin Price Assistant Vice President - Community Development Jason S. Redd Assistant Vice President - Trust, Investment & Insurance BRANCH LOCATIONS Whiskey Road, Aiken, SC Dana S. Hall, Assistant Vice President/Manager North Augusta, SC S. Elaine Ivey, Assistant Vice President/Manager Laurens Street, Aiken, SC Vicky W. Moseley, Assistant Vice President/Manager Richland Avenue, Aiken, SC Nicole W. Simmons, Assistant Vice President/Manager Wal-Mart, Aiken, SC Tonya Key, Manager Graniteville, SC Kathy S. Williamson, Assistant Vice President/Manager Langley, SC Pat W. Guglieri, Assistant Vice President/Manager Clearwater, SC Gail W. Dotson, Assistant Vice President/Manager Wagener, SC Sharon M. Swift, Assistant Vice President/Manager West Columbia, SC Mary B. Clark, Assistant Vice President/Manager Lexington, SC Geena B. Copeland, Assistant Vice President/Manager 54 SECURITY FEDERAL TRUST, INC. offers expert administrative, investment, record-keeping and fiduciary services. SECURITY FEDERAL INSURANCE, INC. offers a complete range of insurance from the best underwriters in the industry to provide property and casualty, life, disability, group health and long term care insurance coverage. SECURITY FEDERAL INVESTMENTS, INC. offers advice-driven, personalized investment services to help customers achieve their financial goals. 55 Exhibit 21 Subsidiaries of the Registrant State of Percentage Parent Subsidiary Incorporation of Ownership - ------ ---------- ------------- ------------ Security Federal Corporation Security Federal Bank United States 100% Security Federal Security Federal Bank Insurance South Carolina 100% Security Federal Investments South Carolina 100% Security Federal Trust South Carolina 100% Security Financial South Carolina 100% Services Corporation Exhibit 23 Consent of Elliott Davis, LLC CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM -------------------------------------------------------- The Board of Directors Security Federal Corporation We consent to incorporation by reference in the Registration Statements on Form S-8 (Nos. 333-102337 and 333-31500) of our report dated April 30, 2004, relating to the consolidated balance sheet of Security Federal Corporation and subsidiaries as of March 31, 2004 and the related consolidated statements of income, shareholders' equity and cash flows for the year then ended, which report appears in the March 31, 2004 Annual Report on Form 10-K, and Amendment No. 1 on Form 10-K/A. /s/Elliott Davis, LLC Columbia, South Carolina September 1, 2004 Exhibit 31.1 Certification Required by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934 I, Timothy W. Simmons, certify that: 1. I have reviewed this annual report on Form 10-K of Security Federal Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 26, 2004 /s/ Timothy W. Simmons -------------------------------------- Timothy W. Simmons President and Chief Executive Officer Exhibit 31.2 Certification Required by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934 I, Roy G. Lindburg, certify that: 1. I have reviewed this annual report on Form 10-K of Security Federal Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 26, 2004 /s/ Roy G. Lindburg -------------------------------------- Roy G. Lindburg Treasurer and Chief Financial Officer Exhibit 32 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER OF SECURITY FEDERAL CORPORATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The undersigned hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and in connection with this Annual Report on Form 10-K, that: 1. the report fully complies with the requirements of Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, and 2. the information contained in the report fairly presents, in all material respects, the company's financial condition and results of operations. /s/ Timothy W. Simmons /s/ Roy G. Lindburg - ------------------------------------- ------------------------------------- Timothy W. Simmons Roy G. Lindburg President and Chief Executive Officer Treasurer and Chief Financial Officer Dated: August 26, 2004 -----END PRIVACY-ENHANCED MESSAGE-----