10-Q 1 q204.txt SECURITY FEDERAL CORPORATION FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (Mark one) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004 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 South Carolina 57-0858504 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 1705 WHISKEY ROAD, AIKEN, SOUTH CAROLINA 29801 (Address of Principal Executive Office) (Zip code) (803) 641-3000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO -------- --------- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). YES NO X -------- --------- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. CLASS: OUTSTANDING SHARES AT: SHARES: -------------------- ---------------------- ----------- Common Stock, par value $0.01 per share October 31, 2004 2,539,891 INDEX ------------------------------------------------------------------------------ PART I. FINANCIAL INFORMATION (UNAUDITED) PAGE NO. Item 1. Financial Statements (Unaudited): Consolidated Balance Sheets at September 30, 2004 and March 31, 2004 1 Consolidated Statement of Income for the Three and Six Months Ended September 30, 2004 and 2003 2 Consolidated Statements of Shareholders' Equity and Comprehensive Income at September 30, 2003and 2004 4 Consolidated Statements of Cash Flows for the Six Months Ended September 30, 2004 and 2003 5 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Item 3. Quantitative and Qualitative Disclosures about Market Risk 19 Item 4. Controls and Procedures 19 ------------------------------------------------------------------------------ PART II. OTHER INFORMATION Other Information 20 Signatures 21 ------------------------------------------------------------------------------ SCHEDULES OMITTED All schedules other than those indicated above are omitted because of the absence of the conditions under which they are required or because the information is included in the consolidated financial statements and related notes. Part I. Financial Information Item 1. Financial Statements (Unaudited) Security Federal Corporation and Subsidiaries Consolidated Balance Sheets September 30, 2004 March 31, 2004 ------------------ -------------- Assets: (Unaudited) (Audited) Cash And Cash Equivalents $ 8,863,658 $ 6,749,211 Investment And Mortgage-Backed Securities: Available For Sale: (Amortized cost of $174,857,857 at September 30, 2004 and $173,300,028 at March 31, 2004) 175,192,638 174,411,819 Held To Maturity: (Fair value of $71,147,966 at September 30, 2004 and $71,686,256 at March 31, 2004) 71,222,565 71,303,507 ------------ ------------ Total Investment And Mortgage-Backed Securities 246,415,203 245,715,326 ------------ ------------ Loans Receivable, Net: Held For Sale 1,587,308 1,703,869 Held For Investment: (Net of allowance of $6,083,146 at September 30, 2004 and $5,763,935 at March 31, 2004) 277,671,865 258,190,791 ------------ ------------ Total Loans Receivable, Net 279,259,173 259,894,660 ------------ ------------ Accrued Interest Receivable: Loans 860,080 902,589 Mortgage-Backed Securities 574,064 549,541 Investments 736,876 778,725 Premises And Equipment, Net 7,831,656 6,562,734 Federal Home Loan Bank Stock, At Cost 4,968,200 4,816,800 Repossessed Assets Acquired In Settlement Of Loans 97,000 50,869 Other Assets 3,164,259 1,984,598 ------------ ------------ Total Assets $552,770,169 $528,005,053 ============ ============ Liabilities And Shareholders' Equity Liabilities: Deposit Accounts $408,416,610 $389,592,645 Advances From Federal Home Loan Bank 100,481,000 96,336,000 Other Borrowed Money 5,914,754 5,477,023 Advance Payments By Borrowers For Taxes And Insurance 623,272 317,421 Other Liabilities 2,698,571 2,810,049 ------------ ------------ Total Liabilities $518,134,207 $494,533,138 ------------ ------------ Shareholders' Equity: Serial Preferred Stock, $.01 Par Value; Authorized Shares - 200,000; Issued And Outstanding Shares - None $ - $ - Common Stock, $.01 Par Value; Authorized Shares 5,000,000; Issued - 2,539,291 And Outstanding Shares - 2,525,562 At September 30, 2004 And 2,533,291 And 2,516,191 At March 31, 2004 25,393 25,333 Additional Paid-In Capital 4,123,594 4,013,674 Indirect Guarantee Of Employee Stock Ownership Trust Debt (276,217) (336,972) Accumulated Other Comprehensive Income (Loss) 207,698 689,755 Retained Earnings, Substantially Restricted 30,555,494 29,080,125 ------------ ------------ Total Shareholders' Equity $ 34,635,962 $ 33,471,915 ------------ ------------ Total Liabilities And Shareholders' Equity $552,770,169 $528,005,053 ============ ============ See accompanying notes to consolidated financial statements. 1 Security Federal Corporation and Subsidiaries Consolidated Statements of Income (Unaudited) Three Months Ended September 30, -------------------------------- 2004 2003 -------------- -------------- Interest Income: Loans $ 4,016,449 $ 3,860,169 Mortgage-Backed Securities 1,890,851 961,039 Investment Securities 328,646 677,782 Other 6,129 4,813 ----------- ----------- Total Interest Income 6,242,075 5,503,803 ----------- ----------- Interest Expense: NOW And Money Market Accounts 968,523 709,868 Passbook Accounts 43,569 43,322 Certificate Accounts 851,749 916,115 Advances And Other Borrowed Money 1,016,367 628,088 ----------- ----------- Total Interest Expense 2,880,208 2,297,393 ----------- ----------- Net Interest Income 3,361,867 3,206,410 Provision For Loan Losses 195,000 300,000 ----------- ----------- Net Interest Income After Provision For Loan Losses 3,166,867 2,906,410 ----------- ----------- Other Income: Gain On Sale Of Loans 116,398 413,685 Loan Servicing Fees 43,469 52,424 Service Fees On Deposit Accounts 311,684 339,684 Other 252,857 253,011 ----------- ----------- Total Other Income 724,408 1,058,804 ----------- ----------- General And Administrative Expenses: Salaries And Employee Benefits 1,586,088 1,428,376 Occupancy 269,173 237,859 Advertising 42,903 77,648 Depreciation And Maintenance Of Equipment 261,098 273,885 FDIC Insurance Premiums 14,192 14,072 Other 537,910 545,601 ----------- ----------- Total General And Administrative Expenses 2,711,364 2,577,441 ----------- ----------- Income Before Income Taxes 1,179,911 1,387,773 Provision For Income Taxes 379,905 497,912 ----------- ----------- Net Income $ 800,006 $ 889,861 =========== =========== Basic Net Income Per Common Share $ 0.32 $ 0.35 =========== =========== Diluted Net Income Per Common Share $ 0.31 $ 0.35 =========== =========== Cash Dividend Per Share On Common Stock $ 0.03 $ 0.02 =========== =========== Basic Weighted Average Shares Outstanding 2,519,627 2,512,600 =========== =========== Diluted Weighted Average Shares Outstanding 2,555,774 2,568,601 =========== =========== See accompanying notes to consolidated financial statements. 2 Security Federal Corporation and Subsidiaries Consolidated Statements of Income (Unaudited) Six Months Ended September 30, ------------------------------ 2004 2003 ------------- ------------ Interest Income: Loans $ 7,851,710 $ 7,815,674 Mortgage-Backed Securities 2,769,212 1,883,118 Investment Securities 1,651,924 1,409,165 Other 12,729 9,581 ----------- ----------- Total Interest Income 12,285,575 11,117,538 ----------- ----------- Interest Expense: NOW And Money Market Accounts 1,863,136 1,374,260 Passbook Accounts 86,968 88,978 Certificate Accounts 1,622,617 1,973,215 Advances And Other Borrowed Money 1,903,137 1,249,071 ----------- ----------- Total Interest Expense 5,475,858 4,685,524 ----------- ----------- Net Interest Income 6,809,717 6,432,014 Provision For Loan Losses 390,000 600,000 ----------- ----------- Net Interest Income After Provision For Loan Losses 6,419,717 5,832,014 ----------- ----------- Other Income: Gain On Sale Of Loans 238,823 1,056,236 Loan Servicing Fees 87,106 101,611 Service Fees On Deposit Accounts 625,364 691,296 Other 432,070 410,225 ----------- ----------- Total Other Income 1,383,363 2,259,368 ----------- ----------- General And Administrative Expenses: Salaries And Employee Benefits 3,184,913 3,041,032 Occupancy 523,708 456,919 Advertising 74,525 104,180 Depreciation And Maintenance Of Equipment 537,022 537,716 FDIC Insurance Premiums 28,897 27,667 Other 1,056,077 1,059,315 ----------- ----------- Total General And Administrative Expenses 5,405,142 5,226,829 ----------- ----------- Income Before Income Taxes 2,397,938 2,864,553 Provision For Income Taxes 795,905 1,052,033 ----------- ----------- Net Income $ 1,602,033 $ 1,812,520 =========== =========== Basic Net Income Per Common Share $ 0.64 $ 0.72 =========== =========== Diluted Net Income Per Common Share $ 0.63 $ 0.71 =========== =========== Cash Dividend Per Share On Common Stock $ 0.05 $ 0.04 =========== =========== Basic Weighted Average Shares Outstanding 2,521,114 2,511,563 =========== =========== Diluted Weighted Average Shares Outstanding 2,559,333 2,563,450 =========== =========== See accompanying notes to consolidated financial statements. 3 Security Federal Corporation and Subsidiaries Consolidated Statements of Shareholders' Equity and Comprehensive Income (Unaudited) Accumulated Additional Indirect Other Common Paid-In Guarantee of Comprehensive Retained Stock Capital ESOP Debt Income (Loss) Earnings Total ------ ---------- ---------- ------------- ---------- ---------- Beginning Balance At March 31, 2003 $25,298 $3,995,230 $(444,685) $ 1,444,585 $25,019,525 $30,039,953 Net Income - - - - 1,812,520 1,812,520 Other Comprehensive Income, Net Of Tax: Unrealized Holding Losses On Securities Available For Sale - - - (1,280,584) - (1,280,584) ----------- Comprehensive Income 531,936 Decrease In Indirect Guarantee of ESOP Debt 107,713 - - 107,713 Exercise of Stock Options 19 10,214 10,233 Cash Dividends ($.04 per share) - - - - (101,231) (101,231) ------- ---------- --------- ----------- ----------- ----------- Balance at September 30, 2003 $25,317 $4,005,444 $(336,972) $ 164,001 $26,730,814 $30,588,604 ======= ========== ========= =========== =========== =========== Beginning Balance At March 31, 2004 $25,333 $4,013,674 $(336,972) $ 689,755 $29,080,125 $33,471,915 Net Income - - - - 1,602,033 1,602,033 Other Comprehensive Income, Net Of Tax: Unrealized Holding Losses On Securities Available For Sale - - - (482,057) - (482,057) ----------- Comprehensive Income 1,119,976 Decrease In Indirect Guarantee of ESOP Debt - - 60,755 - - 60,755 Exercise Of Stock Options 60 109,920 109,980 Cash Dividends ($.05 per share) - - - - (126,664) (126,664) ------- ---------- --------- ----------- ----------- ----------- Balance at September 30, 2004 $25,393 $4,123,594 $(276,217) $ 207,698 $30,555,494 $34,635,962 ======= ========== ========= =========== =========== =========== See accompanying notes to consolidated financial statements. 4
Security Federal Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Six Months Ended September 30, ------------------------------ 2004 2003 ------------ ------------- Cash Flows From Operating Activities: Net Income $ 1,602,033 $ 1,812,520 Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities: Depreciation Expense 430,528 404,527 Discount Accretion And Premium Amortization 627,920 371,748 Provisions For Losses On Loans And Real Estate 390,000 600,000 Gain On Sale Of Loans (238,823) (1,056,236) Gain On Sale Of Real Estate (31,773) (41,496) Amortization Of Deferred Fees On Loans (99,639) (105,060) Proceeds From Sale Of Loans Held For Sale 13,442,690 49,676,277 Origination Of Loans For Sale (13,087,306) (46,098,909) (Increase) Decrease In Accrued Interest Receivable: Loans 42,509 69,283 Mortgage-Backed Securities (24,523) (78,466) Investments 41,849 (26,551) Increase In Advance Payments By Borrowers 305,851 286,090 Gain on Disposition of Premises and Equipment (3,325) (150) Other, Net (935,431) (1,459,054) ------------ ------------ Net Cash Provided (Used) By Operating Activities 2,462,560 4,354,523 ------------ ------------ Cash Flows From Investing Activities: Principal Repayments On Mortgage-Backed Securities Available For Sale 26,013,326 34,006,208 Principal Repayments On Mortgage-Backed Securities Held To Maturity 71,484 491,582 Purchase Of Investment Securities Held To Maturity (11,991,800) (62,945,138) Purchase Of Mortgage-Backed Securities Available For Sale (37,197,817) (71,060,405) Maturities Of Investment Securities Available For Sale 9,000,000 26,214,104 Maturities of Investment Securities Held To Maturity 12,000,000 22,030,331 Purchase Of FHLB Stock (2,132,500) (2,281,700) Redemption Of FHLB Stock 1,981,100 1,351,300 (Increase) Decrease In Loans To Customers (19,957,332) 2,014,023 Proceeds From Sale Of Repossessed Assets 171,539 463,746 Purchase And Improvement Of Premises And Equipment (1,699,450) (1,662,580) Proceeds from Sale of Premises And Equipment 3,325 150 ------------ ------------ Net Cash Used By Investing Activities (23,738,125) (51,378,379) ------------ ------------ Cash Flows From Financing Activities: Increase In Deposit Accounts 18,823,965 25,451,829 Proceeds From FHLB Advances 68,328,000 89,875,000 Repayment Of FHLB Advances (64,183,000) (70,318,000) Net Proceeds Of Other Borrowings 437,731 1,744,120 Dividends To Shareholders (126,664) (101,231) Proceeds From Exercise of Stock Options 109,980 10,233 ------------ ------------ Net Cash Provided By Financing Activities 23,390,012 46,661,951 ------------ ------------ (Continued) 5 Security Federal Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Six Months Ended September 30, ------------------------------ 2004 2003 ------------ ------------- Net Increase In Cash And Cash Equivalents 2,114,447 (361,905) Cash And Cash Equivalents At Beginning Of Period 6,749,211 8,238,690 ------------ ------------ Cash And Cash Equivalents At End Of Period $ 8,863,658 $ 7,876,785 ============ ============ Supplemental Disclosure Of Cash Flows Information: Cash Paid During The Period For Interest $ 5,453,627 $ 4,824,535 Cash Paid During The Period For Income Taxes $ 1,257,012 $ 935,888 Additions To Repossessed Acquired Through Foreclosure $ 185,897 $ 343,800 Increase (Decrease) In Unrealized Net Gain On Securities Available For Sale, Net Of Taxes $ (482,057) $ (1,280,584) See accompanying notes to consolidated financial statements. 6 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) 1. Basis of Presentation The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and accounting principles generally accepted in the United States of America; therefore, they do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows. Such statements are unaudited but, in the opinion of management, reflect all adjustments, which are of a normal recurring nature and necessary for a fair presentation of results for the selected interim periods. Users of financial information produced for interim periods are encouraged to refer to the footnotes contained in the audited financial statements appearing in our 2004 Annual Report to Shareholders when reviewing interim financial statements. The results of operations for the six-month period ended September 30, 2004 are not necessarily indicative of the results that may be expected for the entire fiscal year. This Quarterly Report on Form 10-Q contains certain forward-looking statements with respect to the financial condition, results of operations, and business of Security Federal Corporation. These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those anticipated by such forward-looking statements include, but are not limited to, changes in interest rates, the demand for loans, the regulatory environment, general economic conditions and inflation, and the securities markets. Management cautions readers of this Form 10-Q not to place undue reliance on the forward-looking statements contained herein. 2. Principles of Consolidation The accompanying unaudited consolidated financial statements include the accounts of Security Federal Corporation (the "Company") and its wholly owned subsidiary, Security Federal Bank (the "Bank"), and the Bank's wholly owned subsidiaries, Security Federal Insurance, Inc. ("SFINS"), Security Federal Investments, Inc. ("SFINV"), Security Federal Trust, Inc. ("SFT"), and Security Financial Services Corporation ("SFSC"). The Bank is primarily engaged in the business of accepting savings and demand deposits and originating mortgage 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 operation 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. SFSC is currently inactive. 3. Loans Receivable, Net Loans receivable, net, at September 30, 2004 and March 31, 2004 consisted of the following: Loans held for sale were $1,587,308 and $1,703,869 at September 30, 2004 and March 31, 2004, respectively. Loans Held For Investment: September 30, 2004 March 31, 2004 ------------------ -------------- Residential Real Estate $ 117,324,774 $ 109,722,301 Consumer 48,381,215 45,641,450 Commercial Business & Real Estate 134,208,380 121,111,848 ------------- ------------- 299,914,369 276,475,599 ------------- ------------- Less: Allowance For Possible Loan Loss 6,083,146 5,763,935 Loans In Process 15,995,508 12,356,346 Deferred Loan Fees 163,850 164,527 ------------- ------------- 22,242,504 18,284,808 ------------- ------------- $ 277,671,865 $ 258,190,791 ============= ============= The following is a reconciliation of the allowance for loan losses for the six months ending: September 30, 2004 March 31, 2004 ------------------ -------------- Beginning Balance $ 5,763,935 $ 4,911,224 Provision 390,000 600,000 Charge-offs (190,831) (238,893) Recoveries 120,042 104,631 ------------- ------------- Ending Balance $ 6,083,146 $ 5,376,962 ============= ============= 7 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 4. Securities 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: Gross Gross September 30, 2004 Amortized Unrealized Unrealized ------------------ Cost Gains Losses Fair Value --------- ---------- ---------- ----------- US Government and Agency Obligations $70,944,225 $ 195,893 $ 290,327 $70,849,791 Mortgage-Backed Securities 278,340 19,835 - 298,175 ----------- --------- --------- ----------- Total $71,222,565 $ 215,728 $ 290,327 $71,147,966 =========== ========= ========= =========== March 31, 2004 -------------- US Government and Agency Obligations $70,953,710 $ 448,405 $ 88,542 $71,313,573 Mortgage-Backed Securities 349,797 22,886 - 372,683 ----------- --------- --------- ----------- Total $71,303,507 $ 471,291 $ 88,542 $71,686,256 =========== ========= ========= =========== 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: Gross Gross September 30, 2004 Amortized Unrealized Unrealized ------------------ Cost Gains Losses Fair Value --------- ---------- ---------- ----------- US Government and Agency Obligations $ 7,578,161 $ 67,307 $ - $ 7,645,468 Mortgage-Backed Securities 167,279,696 1,060,936 793,462 167,547,170 ------------ ---------- --------- ------------ Total $174,857,857 $1,128,243 $ 793,462 $175,192,638 ============ ========== ========= ============ March 31, 2004 -------------- US Government and Agency Obligations $ 16,603,568 $ 296,338 $ - $ 16,899,906 Mortgage-Backed Securities 156,696,460 1,437,219 621,766 157,511,913 ------------ ---------- --------- ------------ Total $173,300,028 $1,733,557 $ 621,766 $174,411,819 ============ ========== ========= ============ 8 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 5. Deposit Accounts A summary of deposit accounts by type with weighted average rates is as follows: September 30, 2004 March 31, 2004 -------------------- -------------------- Demand Accounts: Balance Rate Balance Rate ------------ ---- ------------ ---- Checking $ 80,738,953 0.53% $ 80,738,298 0.47% Money Market 166,842,803 2.14% 158,587,076 1.97% Regular Savings 17,538,212 0.99% 17,367,047 0.98% ------------ ------------ Total Demand Accounts 265,119,968 1.57% 256,692,421 1.43% ------------ ------------ Certificate Accounts: 0 - 4.99% 133,199,076 122,599,195 5.00 - 6.99% 10,097,566 10,301,029 ------------ ------------ Total Certificate Accounts 143,296,642 2.52% 132,900,224 2.26% ------------ ------------ Total Deposit Accounts $408,416,610 1.90% $389,592,645 1.71% ============ ============ 6. Advances From Federal Home Loan Bank ("FHLB") FHLB advances are summarized by year of maturity and weighted average interest rate in the table below: September 30, 2004 March 31, 2004 -------------------- -------------------- Fiscal Year Due: Balance Rate Balance Rate ------------ ---- ------------ ---- 2005 $ 6,118,000 5.74% $13,336,000 4.92% 2006 33,000,000 4.18% 33,000,000 4.09% 2007 13,000,000 2.61% 10,000,000 2.66% 2008 10,000,000 2.96% 10,000,000 2.96% 2009 20,000,000 2.80% 20,000,000 2.80% Thereafter 18,363,000 3.18% 10,000,000 3.29% ------------ ----------- Total Advances $100,481,000 3.49% $96,336,000 3.59% ============ =========== 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 $52.4 million in investment securities at September 30, 2004. Advances are subject to prepayment penalties. The following table shows 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 September 30, 2004 ----------------------------------------------------------------------------------------------------------- Borrow Date Maturity Date Amount Int. Rate Type Call Dates ----------- ------------- ---------- --------- ----------- --------------------------------- 11/10/00 11/10/05 $ 5,000,000 5.85% Multi-Call 11/10/04 and quarterly thereafter 09/04/02 09/04/07 5,000,000 2.82% 1 Time Call 09/06/05 11/07/02 11/07/12 5,000,000 3.354% 1 Time Call 11/07/07 10/24/03 10/24/08 10,000,000 2.705% Multi-call 10/24/06 and quarterly thereafter 12/10/03 12/10/08 5,000,000 2.16% Multi-call 12/12/05 and quarterly thereafter 02/20/04 02/20/14 5,000,000 3.225% 1 Time Call 02/20/09 04/16/04 04/16/14 3,000,000 3.33% 1 Time Call 04/16/08 09/16/04 09/16/09 5,000,000 3.09% 1 Time Call 09/17/07 9
Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 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 05/10/04 and quarterly thereafter 09/04/02 09/04/07 5,000,000 2.82% 1 Time Call 09/06/05 11/07/02 11/07/12 5,000,000 3.35% 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 2.14 1 Time Call 02/20/09
7. Regulatory Matters The following table reconciles the Bank's shareholders' equity to its various regulatory capital positions: September 30, 2004 March 31, 2004 ------------------ -------------- (In Thousands) Bank's Shareholders' Equity $ 33,953 $ 32,830 Unrealized Loss (Gain) On Available For Sale Of Securities, Net Of Tax (208) (690) Reduction For Goodwill And Other Intangibles - - -------- -------- Tangible Capital 33,745 32,140 Qualifying Core Deposits And Intangible Assets - - -------- -------- Core Capital 33,745 32,140 Supplemental Capital 3,702 3,412 Assets Required To Be Deducted (46) (54) -------- -------- Risk-Based Capital $ 37,401 $ 35,498 ======== ======== The following table compares the Bank's capital levels relative to the applicable regulatory requirements at September 30, 2004: (Dollars in Thousands) ---------------------------------------------------------------------------------- Amt. Required % Required Actual Amt. Actual % Excess Amt. Excess % ---------------------------------------------------------------------------------- Tangible Capital $11,046 2.0% $33,745 6.11% $22,699 4.11% Tier 1 Leverage (Core) Capital 22,092 4.0% 33,745 6.11% 11,653 2.11% Total Risk-Based Capital 23,690 8.0% 37,401 12.63% 13,711 4.63% Tier 1 Risk-Based (Core) Capital 11,840 4.0% 33,745 11.40% 21,905 7.40%
8. Earnings Per Share The Company calculates earnings per share ("EPS") in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." SFAS No. 128 specifies the computation, presentation and disclosure requirements for earnings per share ("EPS") for entities with publicly held common stock or potential common stock such as options, warrants, convertible securities or contingent stock agreements if those securities trade in a public market. This standard specifies computation and presentation requirements for both basic EPS and, for entities with complex capital structures, diluted EPS. Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding. Diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. The dilutive effect of options outstanding under the Company's stock option plan is reflected in diluted earnings per share by application of the treasury stock method. 10 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued The following table provides a reconciliation of the numerators and denominators of the basic and diluted EPS computations: For the Quarter Ended -------------------------------------------------------- September 30, 2004 -------------------------------------------------------- Income (Numerator) Amount Shares (Denominator) Per Share ------------------ -------------------- ----------- Basic EPS $ 800,006 2,519,627 $ 0.32 Effect of Diluted Securities: Stock Options - 22,417 (0.006) ESOP - 13,730 (0.004) ---------- --------- ------- Diluted EPS $ 800,006 2,555,774 $ 0.31 ========== ========= ======= For the Quarter Ended -------------------------------------------------------- September 30, 2003 -------------------------------------------------------- Income (Numerator) Amount Shares (Denominator) Per Share ------------------ -------------------- ----------- Basic EPS $ 889,861 2,512,600 $ 0.35 Effect of Diluted Securities: Stock Options - 38,090 - ESOP - 17,911 - ---------- --------- ------- Diluted EPS $ 889,861 2,568,601 $ 0.35 ========== ========= ======= For the Six Months Ended -------------------------------------------------------- September 30, 2004 -------------------------------------------------------- Income (Numerator) Amount Shares (Denominator) Per Share ------------------ -------------------- ----------- Basic EPS $1,602,033 2,521,114 $ 0.64 Effect of Diluted Securities: Stock Options - 26,009 (0.007) ESOP - 12,210 (0.003) ---------- --------- ------- Diluted EPS $1,602,033 2,559,333 $ 0.63 ========== ========= ======= For the Six Months Ended -------------------------------------------------------- September 30, 2003 -------------------------------------------------------- Income (Numerator) Amount Shares (Denominator) Per Share ------------------ -------------------- ----------- Basic EPS $1,812,520 2,511,563 $ 0.72 Effect of Diluted Securities: Stock Options - 33,238 (0.006) ESOP - 18,649 (0.004) ---------- --------- ------- Diluted EPS $1,812,520 2,563,450 $ 0.71 ========== ========= ======= 11 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 9. Stock-Based Compensation The Company has a stock-based employee compensation plan which is accounted for under the recognition and measurement principles of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation cost is reflected in net income, as all stock options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share as if we had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation for the six months and three months ended September 30, 2004 and 2003, respectively. Three Months Ended Six Months Ended September 30, September 30, ------------------- ------------------- 2004 2003 2004 2003 ------- ------ ------ ------ Net income, as reported $ 800,006 $ 889,861 $1,602,033 $1,812,520 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effect $ (57,124) $ (65,114) $ (114,248) $ (130,228) Net Income, Pro Forma $ 742,882 $ 824,747 $1,487,785 $1,682,292 Basic earnings share: As Reported $ .32 $ .35 $ .64 $ .72 Pro Forma $ .30 $ .33 $ .59 $ .67 Diluted earnings share: As reported $ .31 $ .35 $ .63 $ .71 Pro forma $ .29 $ .33 $ .58 $ .66 12 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Changes in Financial Condition Total assets of the Company increased $24.8 million or 4.7% during the six months ended September 30, 2004 primarily as a result of an increase of $2.1 million or 31.3% in cash and cash equivalents and an increase of $19.4 million or 7.5% increase in net loans receivable. Residential real estate loans, net of loans in process, increased $4.0 million or 4.1% during the six months ended September 30, 2004, commercial loans increased $13.1 million or 10.8%, while consumer loans increased $2.7 million or 6.0%. Loans held for sale decreased $117,000 or 6.9% during the same period. Repossessed assets increased $46,000 to $97,000 during the six months ended September 30, 2004. Non-accrual loans totaled $2.5 million at September 30, 2004 compared to $2.0 million at March 31, 2004. The Bank classifies all loans as non-accrual when they become 90 days or more delinquent. At September 30, 2004, the Bank held $1.3 million in impaired loans compared to $1.4 million at March 31, 2004. The Bank includes troubled debt restructuring ("TDR") within the meaning of SFAS No. 114 in impaired loans. At September 30, 2004, the Bank had six loans totaling $445,000 in TDR's compared to seven loans totaling $646,000 at March 31, 2004. A commercial loan TDR of $212,000 secured by equipment, and a $14,000 consumer loan TDR secured by a second mortgage on a residential dwelling, were 30 days delinquent. The other four TDR's consisted of two consumer loans totaling $141,000 secured by residential dwellings, a $21,000 unsecured commercial loan, and a $57,000 commercial loan secured by two rental properties, all of which were current as of September 30, 2004. Deposits increased $18.8 million or 4.8% to $408.4 million during the six months ended September 30, 2004 as a result of competitive rates offered by the Bank. FHLB advances increased $4.1 million or 4.3% to $100.5 million during the same period. Other borrowings, consisting of commercial repurchase sweep accounts, increased $438,000 or 8.0% to $5.9 million during the six-month period. The Board of Directors of the Company declared the 54th and 55th consecutive quarterly dividend of $.02 and $.03 per share, in April and July 2004, respectively, which totaled $127,000. The employee stock ownership trust of the Company paid $61,000 of principal on the employee stock ownership plan loan during the six-month period. Unrealized net gains on securities available for sale, net of tax, decreased $482,000 during the six months ended September 30, 2004 due to an increase in interest rates. The Company's net income for the six-month period was $1.6 million. These items, in total, increased shareholders' equity by $1.2 million or 3.5% during the six months ended September 30, 2004. Book value per share was $13.71 at September 30, 2004 compared to $13.30 at March 31, 2004. Liquidity and Capital Resources In accordance with Office of Thrift Supervision ("OTS") regulations, the Company is required to maintain sufficient liquidity to operate in a safe and sound manner. The Company's current liquidity level is deemed adequate to meet the requirements of normal operations, potential deposit outflows, and loan demand while still allowing for optimal investment of funds and return on assets. Loan repayments and maturities of investments are a significant source of funds, whereas loan disbursements and the purchase of investments are a primary use of the Company's funds. During the six months ended September 30, 2004, loan disbursements exceeded loan repayments resulting in a $19.4 million or 7.5% increase in total net loans receivable. Deposits and other borrowings are also an important source of funds for the Company. During the six months ended September 30, 2004, deposits increased $18.8 million and FHLB advances increased $4.1 million. The Bank had $65.3 million in additional borrowing capacity at the FHLB at the end of the period. At September 30, 2004, the Bank had $82.7 million of certificates of deposit maturing within one year. Based on previous experience, the Bank anticipates a significant portion of these certificates will be renewed. 13 Security Federal Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources, Continued Through its operations, the Bank has made contractual commitments to extend credit in the ordinary course of its business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. At September 30, 2004, the Bank had $26.7 million in unused consumer lines of credit, including home equity lines and unsecured lines. The Bank also had $21.6 million in unused commercial lines of credit and $682,000 in letters of credit committed to customers. The majority of the $49.0 million will not be drawn at the same time. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, by the Bank upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. The Bank manages the credit risk on these commitments by subjecting them to normal underwriting and risk management processes. Historically, the Company's cash flows from operating activities have been relatively stable. The cash flow from investing activities have had a trend of increasing outflows due to 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. Management believes that the Company's liquidity will continue to be supported by the Company's deposit base and borrowing capacity during the next year. Critical Accounting Policies We have adopted various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to the audited consolidated financial statements at March 31, 2004 as filed in our annual report on Form 10-K. Certain accounting policies involve significant judgements and assumptions by us which have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on our carrying values of assets and liabilities and our results of operations. We believe the allowance for loan losses is a critical accounting policy that requires the most significant judgements and estimates used in preparation of our consolidated financial statements. 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 borrow, 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 the outstanding loans, loss experience, delinquency trends, and general economic conditions. Management evaluates the carrying value of the loans periodically and the allowance is adjusted accordingly. While Management uses the best information available to make evaluations, future adjustments may be necessary if economic conditions differ substantially from the assumptions used in making these evaluations. Allowance for loan losses are subject to periodic evaluations by various authorities and may be subject to adjustments based upon the information that is available at the time of their examination. The Company values impaired loans at the loan's fair value if it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement at the present value of expected cash flows, the market price of the loan, if available, or the value of the underlying collateral. Expected cash flows are required to be discounted at the loan's effective interest rate. When the ultimate collectibility of an impaired loan's principal is in doubt, wholly or partially, all cash receipts are applied to principal. When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to interest 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. 14 Security Federal Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations Accounting and Reporting Changes In November 2003, the Emerging Issues Task Force ("EITF") reached a consensus that certain quantitative and qualitative disclosures should be required for debt and marketable equity securities classified as available for sale or held to maturity under SFAS No. 115 and SFAS No. 124 that are impaired at the balance sheet date but which other-than-temporary impairments has not been recognized. Accordingly EITF issued EITF No. 03-1, "The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments." The issue addresses the meaning of other-than-temporary impairments and its application to investments classified as either available for sale or held to maturity under SFAS No. 115 and provides guidance determining the amount of impairment and additional quantitative and qualitative disclosures. The guidance for determining the amount of impairment was scheduled to be effective for periods ending after June 15, 2004, but has been delayed indefinitely pending implementation guidance by the FASB. The disclosure provisions of EITF No. 03-1 were effective for fiscal years ending after December 15, 2003. Adopting the disclosure provisions of EITF No. 03-1 did not have any impact on the Company's financial position or results of operations. 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 the 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, was scheduled to 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 disclosures purposes and b) December 15, 2005 for all other nonpublic entities. On October 16, 2004, the FASB delayed the effective date of this proposal by six months and anticipates it will be effective by the third quarter of 2005. Retrospective application of this Statement is not permitted. The adoption of this Statement, if approved, could 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. 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, which 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 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 inflation. See "Item 3. Quantitative and Qualitative Disclosures about Market Risk" for additional discussions of changes in interest rates. 15 Security Federal Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004 ------------------------------------------------------------------- Net Income Net income was $800,000 for the three months ended September 30, 2004, representing a decrease in earnings of $90,000 or 10.1% from $890,000 for the same period in 2003. The primary reason for the decreased earnings was a decrease in the gain on sale of mortgage loans offset partially by an increase in net interest income and a decrease in the provision for loan losses. Net Interest Income Net interest income increased $155,000 or 4.9% to $3.4 million during the three months ended September 30, 2004 as a result of an increase in interest income offset in part by an increase in interest expense. Average interest earning assets increased $81.9 million while average interest-bearing liabilities increased $142.8 million. The interest rate spread decreased 31 basis points to 2.32% during the three months ended September 30, 2004 compared to the same period in 2003. Interest income on loans increased $156,000 or 4.1% to $4.0 million during the three months ended September 30, 2004 as a result of the average loan portfolio balance increasing by $32.5 million despite the yield in the loan portfolio decreasing 54 basis points Interest income from investment, mortgage-backed, and other securities increased $582,000 or 35.4% as a result of an increase in the average balance of the portfolio of $49.4 million and an increase in the yield in the portfolio of 30 basis points. Total interest income increased 738,000 or 13.4% to $6.2 million for the three months ended September 30, 2004 from $5.5 million for the same period in 2003. Total interest expense increased $583,000 or 25.4% to $2.9 million during the three months ended September 30, 2004 compared to $2.3 million for the same period one-year earlier. Interest expense on deposits increased $195,000 or 11.7% during the period as average interest bearing deposits grew $31.0 million compared to the average balance in the three months ended September 30, 2003 while the cost of deposits decreased 63 basis points. Interest expense on advances and other borrowings increased $388,000 or 61.8% as the cost of debt outstanding decreased 36 basis points during the 2004 period compared to 2003 while average total borrowings outstanding increased approximately $48.9 million. Provision for Loan Losses The Bank's provision for loan losses was $195,000 during the three months ended September 30, 2004 compared to $300,000 for the quarter ended September 30, 2003. The amount of the provision is determined by management's on-going monthly analysis of the loan portfolio. Non-accrual loans, which are loans delinquent 90 days or more, were $2.5 million at September 30, 2004 compared to $2.0 million at March 31, 2004. The ratio of allowance for loan losses to the Company's total loans was 2.13% at September 30, 2004 compared to 2.17% at March 31, 2004. Net charge-offs were $33,000 during the three months ended September 30, 2004 compared to $46,000 during the same period in 2003. Other Income Total other income decreased $334,000 or 31.6% to $724,000 during the three months ended September 30, 2004 compared to the same period a year ago, primarily as a result of a decrease in the gain on sale of loans. Gain on sale of loans decreased $297,000 or 71.9% to $116,000 during the period as the origination and sale of fixed rate mortgages decreased. Loan servicing fees decreased $9,000 to $43,000 while service fees on deposit accounts decreased $28,000 or 8.2% to $312,000. Other miscellaneous income including credit life insurance commissions, net gain on sale of repossessed assets, safe deposit rental income, annuity and stock brokerage commissions, trust fees, and other miscellaneous fees had no change during the three months ended September 30, 2004 compared to the same period last year. 16 Security Federal Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004, CONTINUED ------------------------------------------------------------------------------ General and Administrative Expenses General and administrative expenses increased $134,000 or 5.2% to $2.7 million during the three months ended September 30, 2004 compared to the same period in 2003. Salaries and employee benefits expense increased $158,000 or 11.0%. Occupancy expense increased $31,000 or 13.2% due primarily to the new Lexington branch office, which opened in August 2003. Advertising expense decreased $35,000 to $43,000. Depreciation and maintenance of equipment expense decreased $13,000 or 4.7% during the quarterly period. FDIC insurance premiums remained the same at $14,000 during the quarters ending September 2004 and 2003. Other miscellaneous expense, consisting of legal, professional, and consulting expenses, stationery and office supplies, and other sundry expenses, decreased $7,000 or 1.4% for the three months ended September 30, 2004 compared to the three months ended September 30, 2003. RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED SEPTEMBER 30, 2004 ----------------------------------------------------------------- Net Income Net income was $1.6 million for the six months ended September 30, 2004, representing a decrease in earnings of $210,000 or 11.6% from $1.8 million for the same period in 2003. The primary reason for the decreased earnings was a decrease on the gain on sale of mortgage loans offset partially by an increase in net interest income and a decrease in the provision for loan losses. Net Interest Income Net interest income increased $378,000 or 5.9% to $6.8 million during the six months ended September 30, 2004 as a result of an increase in interest income offset in part by an increase in interest expense. Average interest earning assets increased $147.2 million while average interest-bearing liabilities increased $139.4 million. The interest rate spread decreased 96 basis points to 2.39% during the six months ended September 30, 2004 compared to the same period in 2003. Interest income on loans increased $36,000 to $7.9 million during the six months ended September 30, 2004 as a result of the average loan portfolio balance increasing by $31.0 million despite the yield in the loan portfolio decreasing 146 basis points. Interest income from investment, mortgage-backed, and other securities increased $1.1 million or 34.3% as a result of an increase in the average balance of the portfolio of $116.2 million despite a decrease in the yield in the portfolio of 118 basis points. Total interest income increased $1.2 million or 10.5% to $12.3 million for the six months ended September 30, 2004 from $11.1 millionfor the same period in 2003. Total interest expense increased $790,000 or 16.9% to $5.5 million during the six months ended September 30, 2004 compared to $4.7 million for the same period one-year earlier. Interest expense on deposits increased $136,000 or 4.0% during the period as average interest bearing deposits grew $72.03 million compared to the average balance in the six months ended September 30, 2003 while the cost of deposits decreased 70 basis points. Interest expense on advances and other borrowings increased $654,000 or 52.4% as the cost of debt outstanding decreased 182 basis points during the 2004 period compared to 2003 while average total borrowings outstanding increased approximately $67.4 million. Provision for Loan Losses The Bank's provision for loan losses was $390,000 during the six months ended September 30, 2004 compared to $600,000 for the quarter ended September 30, 2003. The amount of the provision is determined by management's on-going monthly analysis of the loan portfolio. Non-accrual loans, which are loans delinquent 90 days or more, were $2.5 million at September 30, 2004 compared to $2.0 million at March 31, 2004. The ratio of allowance for loan losses to the Company's total loans was 2.13% at September 30, 2004 compared to 2.17% at March 31, 2004. Net charge-offs were $71,000 during the six months ended September 30, 2004 compared to $134,000 during the same period in 2003. 17 Security Federal Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED SEPTEMBER 30, 2004, CONTINUED ---------------------------------------------------------------------------- Other Income Total other income decreased $876,000 or 38.8% to $1.4 million during the six months ended September 30, 2004 compared to the same period a year ago, primarily as a result of a decrease in the gain on sale of loans. Gain on sale of loans decreased $817,000 or 77.4% to $239,000 during the period as the origination and sale of fixed rate mortgages decreased. Loan servicing fees decreased $15,000 to $87,000 while service fees on deposit accounts decreased $66,000 or 9.5% to $625,000. Other miscellaneous income including credit life insurance commissions, net gain on sale of repossessed assets, safe deposit rental income, annuity and stock brokerage commissions, trust fees, and other miscellaneous fees increased $22,000 or 5.3% to $432,000 during the six months ended September 30, 2004. General and Administrative Expenses General and administrative expenses increased $178,000 or 3.4% to $5.4 million during the six months ended September 30, 2004 compared to the same period in 2003. Salaries and employee benefits expense increased $144,000 or 4.7%. Occupancy expense increased $67,000 or 14.6% primarily attributable to the new Lexington branch office, which opened in August 2003. Advertising expense decreased $30,000 or 28.5% to $75,000. Depreciation and maintenance of equipment expense decreased $1,000 during the six month period compared to the same period last year. FDIC insurance premiums increased $1,000 or 4.5% to $29,000. Other miscellaneous expense, consisting of legal, professional, and consulting expenses, stationery and office supplies, and other sundry expenses, decreased $3,000 or 0.3% for the six months ended September 30, 2004 compared to the three months ended September 30, 2003. 18 Security Federal Corporation and Subsidiaries Item 3. Quantitative and Qualitative Disclosures about Market Risk Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises principally from interest rate risk inherent in its lending, investment, deposit and borrowing activities. Management actively monitors and manages its interest rate risk exposure. Although the Company manages other risks such as credit quality and liquidity risk in the normal course of business, management considers interest rate risk to be its most significant market risk that could potentially have the largest material effect on the Company's financial condition and results of operations. Other types of market risks such as foreign currency exchange rate risk and commodity price do not arise in the normal course of the Company's business activities. The Company's profitability is affected by fluctuations in the market interest rate. Management's goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase or decrease in interest rates may adversely impact the Company's earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same rate, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using a test that measures the impact on net interest income and net portfolio value of an immediate change in interest rates in 100 basis point increments and by measuring the Bank's interest sensitivity gap ("Gap"). Net portfolio value is defined as the net present value of assets, liabilities, and off-balance sheet contracts. Gap is the amount of interest sensitive assets repricing or maturing over the next twelve months compared to the amount of interest sensitive liabilities maturing or repricing in the same time period. Recent net portfolio value reports furnished by the OTS indicate that the Bank's interest rate risk sensitivity has increased slightly over the past year. The Bank has rated favorably compared to thrift peers concerning interest rate sensitivity. For the three and six month periods ended September 30, 2004, the Bank's interest rate spread, defined as the average yield on interest bearing assets less the average rate paid on interest bearing liabilities was 2.32% and 2.39%, respectively. As of the year ended March 31, 2004, the interest rate spread was 2.59%. The interest rate spread decreased due to interest bearing liabilities, specifically certificates of deposits, re-pricing faster than interest earning assets. If interest rates were to increase suddenly and significantly, the Bank's net interest income and net interest spread would be compressed significantly. Item 4. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company's disclosure controls and procedures (as defined in Sections 13a - 15(e) and 15d-15(e) of the Securities Exchange Act of 1934) was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management as of the end of the period covered by this quarterly report. The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission's rules and forms. (b) Changes in Internal Controls: In the quarter ended September 30, 2004, the Company did not make any significant changes in, nor take any corrective actions regarding, its internal controls or other factors that could significantly affect these controls. 19 Security Federal Corporation and Subsidiaries Part II: Other Information Item 1 - Legal Proceedings ----------------- The Company is not engaged in any legal proceedings of a material nature at the present time. From time to time, the Company is a party to legal proceedings in the ordinary course of business wherein it enforces its security interest in mortgage loans it has made. Item 2 - Unregistered Sales of Equity Securities and Use Of Proceeds ----------------------------------------------------------- Stock Repurchases. The Company did not repurchase any shares of its outstanding Common Stock during the three months ended September 30, 2004. In addition, The Company has no publicly announced plans to repurchase its common stock. Item 3 - Defaults Upon Senior Securities ------------------------------- None Item 4 - Submission Of Matters To A Vote Of Security Holders --------------------------------------------------- The election of directors was presented for vote to the shareholders at the Annual Meeting held July 22, 2004. Votes for Gasper L. Toole were as follows: 2,004,178 votes for, 12,600 withheld. Votes for Thomas L. Moore were as follows: 2,006,578 votes for, 10,200 votes withheld. Votes for J. Chris Verenes were as follows: 2,004,178 votes for, 12,600 votes withheld. Directors continuing in office are T. Clifton Weeks, Timothy W. Simmons, Harry O. Weeks, Jr., Robert E. Alexander and William Clyburn. Item 5 - Other Information ----------------- None Item 6 - Exhibits -------- (a) Exhibits: 3.1 Articles Of Incorporation (1) 3.2 Articles Of Amendment, Dated August 28, 1998, To Articles Of Incorporation 3.3 Bylaws (2) 10 Executive Compensation Plans And Arrangements: Salary Continuation Agreements (3) Amendment One To Salary Continuation Agreements (4) Stock Option Plan (3) 1999 Stock Option Plan (5) 2002 Stock Option Plan (6) Incentive Compensation Plan (3) 31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act. 31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act. 32 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act. (1) Filed as an exhibit to the Company's June 23, 1998 proxy statement and incorporated herein by reference. (2) Filed as an exhibit to the Company's Form 8-K filed September 1, 1998 and incorporated herein by reference. 20 Security Federal Corporation and Subsidiaries Exhibits, Continued (3) Filed as an exhibit to the Company's Annual Report on Form 10-KSB for the year ended March 31, 1993 and incorporated herein by reference. (4) Filed as an exhibit to the Company's Quarterly Report on Form 10-QSB for the quarter ended December 30, 1993 and incorporated herein by reference. (5) Filed as an exhibit to the Company's Registration Statement on Form S-8 filed March 2, 2002 and incorporated herein by reference. (6) Filed as an exhibit to the Company's June 19, 2002 proxy statement and incorporated herein by reference. Signatures Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to the signed on its behalf by the undersigned thereunto duly authorized. SECURITY FEDERAL CORPORATION Date: November 10, 2004 By: /s/ Timothy W. Simmons -------------------- ------------------------------ Timothy W. Simmons President Duly Authorized Representative Date: November 10, 2005 By: /s/ Roy G. Lindburg -------------------- ------------------------------ Roy G. Lindburg Treasurer/CFO Duly Authorized Representative 21 EXHIBIT 31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 22 Certification I, Timothy W. Simmons, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q 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 period 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 ver financial reporting, to the registrant's auditors and the audit committee of the 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: November 10, 2004 /s/ Timothy W. Simmons ------------------------------------- Timothy W. Simmons President and Chief Executive Officer 23 EXHIBIT 31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 24 Certification I, Roy G. Lindburg, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q 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 period 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 ver financial reporting, to the registrant's auditors and the audit committee of the 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: November 10, 2004 /s/ Roy G. Lindburg -------------------------------- Roy G. Lindburg Chief Financial Officer 25 EXHIBIT 32 Certification Pursuant to Section 906 of the Sarbanes Oxley Act 26 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 Quarterly Report on Form 10-Q that: 1. the report fully complies with the requirements of Section 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 Chief Executive Officer Chief Financial Officer Dated: November 10, 2004