-----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, GmS7TQEBs6f5Rbvo27fgxVUSk1XFo7ape6+WWFX8E5MNvGhCgKBAFQNRn9YLv7nH 82RbVlghCZR6jFtRJXKutg== 0000939057-05-000170.txt : 20050629 0000939057-05-000170.hdr.sgml : 20050629 20050629135835 ACCESSION NUMBER: 0000939057-05-000170 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20050331 FILED AS OF DATE: 20050629 DATE AS OF CHANGE: 20050629 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 SEC ACT: 1934 Act SEC FILE NUMBER: 000-16120 FILM NUMBER: 05923779 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 1 k05.txt SECURITY FEDERAL CORPORATION FORM 10-K United States SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended March 31, 2005 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, 2005, there were issued and outstanding 2,535,026 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, 2004, was $29.9 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, 2005. (Parts I and II) 2. Portions of the Registrant's Proxy Statement for the 2005 Annual Meeting of Stockholders. (Part III) PART I Item 1. Business Security Federal Corporation - ---------------------------- Security Federal Corporation (the "Company") was incorporated under the laws of the State of Delaware in July 1987 for the purpose of becoming the savings and loan holding company for Security Federal Bank ("Security Federal" or the "Bank") upon the Bank's conversion from mutual to the stock form (the "Conversion"). Effective August 17, 1998, the Company changed its state of incorporation from Delaware to South Carolina. As a South Carolina corporation, the Company is authorized to engage in any activity permitted by South Carolina General Corporation Law. The Company is a unitary savings and loan holding company. Through the unitary holding company structure, it is possible to expand the size and scope of the financial services offered beyond those currently offered by the Bank. The holding company structure also provides the Company with greater flexibility than the Bank would have to diversify its business activities, through existing or newly formed subsidiaries, or through acquisitions or mergers of stock thrift institutions as well as other companies. There are no current arrangements, understandings or agreements regarding any such acquisition. Future activities of the Company, other than the continuing operations of Security Federal, will be funded through dividends from Security Federal and through borrowings from third parties. See "Regulation - Savings and Loan Holding Company Regulation" and "Taxation." Activities of the Company may also be funded through sales of additional securities or income generated by other activities of the Company. At this time, there are no plans regarding such sales of additional securities or such activities. At March 31, 2005, the Company had assets of approximately $586.0 million, deposits of approximately $430.3 million and shareholders' equity of approximately $35.1 million. The executive office of the Company is located at 1705 Whiskey Road South, Aiken, South Carolina 29803, and its telephone number is (803) 641-3000. Security Federal Bank - --------------------- General. Security Federal is a federally chartered stock savings bank headquartered in Aiken, South Carolina. Security Federal with 11 branch offices in Aiken and Lexington Counties, was originally chartered under the name Aiken Building and Loan Association on March 27, 1922. It received its federal charter and changed its name to Security Federal Savings and Loan Association of Aiken on March 7, 1962, and later changed its name to Security Federal Savings Bank of South Carolina, on November 11, 1986. Effective April 8, 1996, the Bank changed its name to Security Federal Bank. The Bank converted from the mutual to the stock form of organization on October 30, 1987. In October 1993, Security Federal increased its branch network to nine offices with the completion of its acquisition of four former NationsBank of South Carolina, N.A. branches located in Aiken County. In February 1996, Security Federal opened a new branch office in the Aiken Wal-Mart Superstore. The Bank opened a branch in West Columbia, Lexington County, South Carolina, in December 2000, which provided the Bank with the opportunity to expand its market area. In August 2003, the Bank opened a new branch in Lexington, South Carolina. During February 2004, the Bank completed the sale of its Denmark, South Carolina branch office to South Carolina Bank and Trust, N.A. of Orangeburg, South Carolina. In 2004, the Bank opened a full service branch in Irmo, South Carolina. The principal business of Security Federal is accepting deposits from the general public and originating mortgage loans to enable borrowers to purchase or refinance one- to four-family residential real estate. The Bank also makes multi-family residential and commercial real estate loans, consumer loans and commercial loans as well as construction loans on single family residences, multi-family dwellings and projects, commercial real-estate, and loans for the acquisition, development and construction of residential subdivisions and commercial projects. Additional financial services are provided by three of the Bank's wholly owned subsidiaries, Security Federal Insurance, Inc., Security Federal Investments, Inc. and Security Federal Trust, Inc. 1 Security Federal's income is derived primarily from interest and fees earned in connection with its lending activities, and its principal expenses are interest paid on savings deposits and borrowings and operating expenses. Selected Consolidated Financial Information - ------------------------------------------- This information is incorporated by reference to page 7 of the 2005 Annual Report to Stockholders ("Annual Report"). Yields Earned and Rates Paid - ---------------------------- This information is incorporated by reference to page 15 of the Annual Report. Rate/Volume Analysis - -------------------- This information is incorporated by reference to page 14 of the Annual Report. Lending Activities - ------------------ General. The primary source of revenue for the Bank is interest and fee income from lending activities. The principal lending activity of the Bank is making conventional first mortgage real estate loans to enable borrowers to purchase or refinance one- to four-family residential real property. The Bank also makes multi-family residential and commercial real estate and consumer and commercial loans. The Bank continues to emphasize the origination of adjustable rate residential mortgage loans, subject to market conditions, for retention in its portfolio. In addition, the Bank originates construction loans on single family residences, multi-family dwellings and projects, and loans for the acquisition, development and construction of residential subdivisions and commercial projects. Adjustable rate mortgage loans ("ARMs") constituted approximately 27.7% of the Bank's total outstanding loan portfolio at March 31, 2005. The loan-to-value ratio, maturity and other provisions of loans made by the Bank reflect its policy of making the maximum loan permissible consistent with applicable regulations, established lending policies and market conditions. The Bank requires title insurance (or acceptable legal opinions on smaller loans secured by real estate) and fire insurance, and flood insurance where applicable, on loans secured by improved real estate. 2 Loan Portfolio Composition. The following table sets forth information concerning the composition of the Bank's loan portfolio in dollar amounts and in percentages by type of loan, and presents a reconciliation of total loans receivable before net items. At March 31, --------------------------------------------------------------------------------------- 2005 2004 2003 2002 2001 --------------- --------------- --------------- --------------- --------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- (Dollars in Thousands) TYPE OF LOAN: - ------------- Fixed Rate Loans - ---------------- Residential real estate........... $ 31,336 9.3% $43,911 15.8% $ 43,091 16.8% $ 35,012 14.0% $ 34,070 13.9% Commercial busi- ness and commer- cial real estate. 77,202 22.8 62,799 22.6 53,509 20.8 55,845 22.4 42,877 17.5 Consumer.......... 27,047 8.0 26,508 9.5 30,165 11.7 33,185 13.3 32,447 13.3 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total fixed rate loans..... 135,585 40.1 133,218 47.9 126,765 49.3 124,042 49.7 109,394 44.7 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Adjustable rate loans - --------------------- Residential real estate........... 93,564 27.7 67,516 24.3 60,528 23.5 67,220 26.9 89,913 36.7 Commercial busi- ness and commer- cial real estate. 85,015 25.2 58,313 20.9 53,488 20.8 41,551 16.7 31,643 12.9 Consumer.......... 23,797 7.0 19,133 6.9 16,429 6.4 16,667 6.7 13,830 5.7 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total adjustable rate loans..... 202,376 59.9 144,962 52.1 130,445 50.7 125,438 50.3 135,386 55.3 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total loans..... 337,961 100.0% 278,180 100.0% 257,210 100.0% 249,480 100.0% 244,780 100.0% ===== ===== ===== ===== ===== Less - ---- Loans in process.. 14,627 12,356 8,991 11,288 10,739 Deferred fees and discounts........ 161 165 152 184 260 Allowance for loan losses........... 6,284 5,764 4,911 3,689 2,784 Total loans -------- -------- -------- -------- -------- receivable..... $316,889 $259,895 $243,156 $234,319 $230,997 ======== ======== ======== ======== ========
3 The following table sets forth information concerning the composition of the Bank's loan portfolio in dollar amounts and in percentages by type of security, and presents a reconciliation of total loans receivable before net items. At March 31, --------------------------------------------------------------------------------------- 2005 2004 2003 2002 2001 --------------- --------------- --------------- --------------- --------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- (Dollars in Thousands) TYPE OF SECURITY: - ---------------- Real Estate Loans: Residential real estate.......... $105,516 31.2% $ 95,863 34.5% $ 86,707 33.7% $ 86,486 34.7% $104,819 42.8% Residential construction.... 19,384 5.8 15,564 5.6 16,912 6.6 15,746 6.3 19,164 7.8 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total real estate loans.. 124,900 37.0 111,427 40.1 103,619 40.3 102,232 41.0 123,983 50.6 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Commercial business and commercial real estate...... 162,217 48.0 121,112 43.5 106,997 41.6 97,396 39.0 74,520 30.5 Consumer loans: Deposit account.. 1,145 0.3 1,383 0.5 1,726 0.7 2,160 0.9 2,516 1.0 Home equity lines........... 16,918 5.0 13,694 4.9 13,140 5.1 12,352 4.9 10,731 4.4 Consumer first and second mortgages....... 22,327 6.6 15,080 5.4 18,551 7.2 20,090 8.1 20,451 8.3 Other............ 10,454 3.1 15,484 5.6 13,177 5.1 15,250 6.1 12,579 5.2 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total consumer loans......... 50,844 15.0 45,641 16.4 46,594 18.1 49,852 20.0 46,277 18.9 -------- ----- -------- ----- -------- ----- -------- ----- -------- ----- Total loans.. 337,961 100.0% 278,180 100.0% 257,210 100.0% 249,480 100.0% 244,780 100.0% ===== ===== ===== ===== ===== Less: Loans in process.. 14,627 12,356 8,991 11,288 10,739 Deferred fees and discounts........ 161 165 152 184 260 Allowance for loan losses........... 6,284 5,764 4,911 3,689 2,784 Total loans -------- -------- -------- -------- -------- receivable.... $316,889 $259,895 $243,156 $234,319 $230,997 ======== ======== ======== ======== ========
4 The following schedule illustrates the maturities of Security Federal's loan portfolio at March 31, 2005. Mortgages which have adjustable or renegotiable interest rates are shown as maturing in the period when the contract is due. This schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses. At March 31, 2005 ---------------------------------------------------- Commercial Business and Residential Commercial Real Estate (1) Consumer (2) Real Estate Total --------------- ------------ ----------- --------- (In Thousands) Six months or less (3)... $ 12,484 $ 4,803 $ 22,838 $ 40,125 Over six months to one year................ 10,087 1,256 37,857 49,200 Over one year to three years................... 3,281 5,720 33,310 42,311 Three to five years...... 1,738 7,163 51,052 59,953 Over five to ten years... 3,450 15,345 8,263 27,058 Over ten years........... 79,233 16,557 8,897 104,687 -------- -------- -------- -------- Total (4).............. $110,273 $ 50,844 $162,217 $323,334 ======== ======== ======== ======== - --------- (1) Includes multi-family dwellings. (2) Includes home improvement loans and equity line of credit loans. (3) Includes demand loans, loans having no stated maturity and overdraft loans. (4) Loan amounts are net of undisbursed funds for loans in process of $14.6 million. The total amount of loans due after March 31, 2006, which have predetermined or fixed interest rates is $110.1 million, while the total amount of loans due after that date which have floating or adjustable interest rates is $123.9 million. Loan Originations, Purchases and Sales. The following table shows the loan origination, purchase, sale and repayment activities of the Bank for the periods indicated. Year Ended March 31, ------------------------------------------------ 2005 2004 2003 2002 2001 -------- -------- -------- -------- -------- (In Thousands) Originated: Adjustable rate - residential real estate.... $ 43,578 $ 47,263 $ 45,260 $ 41,672 $ 36,998 Fixed rate - residential real estate (1)............ 41,746 73,291 92,388 93,602 35,813 Consumer.................... 29,290 26,829 25,439 26,916 20,297 Commercial business and commercial real estate..... 134,439 91,562 64,097 50,468 31,623 -------- -------- -------- -------- -------- Total consumer/commercial business real estate..... 163,729 118,391 89,536 77,384 51,920 -------- -------- -------- -------- -------- Total loans originated.. $249,053 $238,945 $227,184 $212,658 $124,731 ======== ======== ======== ======== ======== Purchased................... $ 6,536 $ 3,500 $ -- $ -- $ -- Less: Sold: Fixed rate - residential real estate................ $ 25,957 $ 63,497 $ 80,345 $ 84,505 $ 28,547 Adjustable rate - residential real estate.... -- -- -- -- -- Principal repayments........ 169,277 156,012 140,613 123,523 53,683 (Increase) decrease in loans held for sale........ 574 1,967 (1,505) (80) 950 Increase (decrease) in other items, net........... 2,787 4,230 (1,106) 1,378 3,555 Net increase (decrease)..... $ 56,994 $ 16,739 $ 8,837 $ 3,332 $ 37,996 - ----------- (1) Includes newly originated fixed rate loans held for sale, construction/ permanent loans converted to fixed rate loans and sold, and residential lot loans. 5 In addition to interest earned on loans, the Bank receives loan origination fees or "points" for originating loans. Loan points are a percentage of the principal amount of the mortgage loan which are charged to the borrower for the creation of the loan. The Bank's loan origination fees generally range from 1% to 2% on conventional residential mortgages, commercial real estate loans and commercial business loans. The total fee income (including amounts amortized to income as yield adjustments) for the fiscal year ended March 31, 2005 was $725,000. Loan origination and commitment fees are volatile sources of income. These fees vary with the volume and type of loans and commitments made and purchased and with competitive conditions in mortgage markets, which in turn are governed by the demand for and availability of money. The following table shows deferred loan origination fees recognized as income by the Bank expressed as a percentage of the dollar amount of total mortgage loans originated (and retained in the Bank's portfolio) and purchased during the periods indicated and the dollar amount of deferred loan origination fees at the end of each respective period. At or for the Year Ended March 31, ---------------------------------- 2005 2004 2003 ---- ---- ---- (Dollars in Thousands) Net deferred loan origination fees earned during the period (1)............. $185 $188 $209 Mortgage loan origination fees earned as a percentage of total loans originated during the period............. 0.4% 0.3% 0.4% Net deferred loan origination fees in loan portfolio at end of period.......... $161 $165 $152 - ----------- (1) Includes amounts amortized to interest income as yield adjustments. Does not include fees earned on loans sold. The Bank also receives other fees and charges related to existing loans, conversion fees, assumption fees, late charges, and other fees collected in connection with a change in borrower or other loan modifications. Security Federal currently sells substantially all conforming fixed-rate loans with terms of 15 years or greater in the secondary mortgage market. These loans are sold in order to provide a source of funds and as one of the strategies available to close the gap between the maturities of the Bank's interest-earning assets and interest-bearing liabilities. Currently, most fixed-rate, long-term mortgage loans are being originated based on Federal National Mortgage Association ("Fannie Mae") and Federal Home Loan Mortgage Corporation ("Freddie Mac") underwriting standards. Secondary market sales have been made primarily to Freddie Mac, or other banks or investors. Freddie Mac is a quasi-governmental agency that purchases residential mortgage loans from federally insured financial institutions and certain other lenders. All loans sold to Freddie Mac are without recourse to Security Federal and generally all other loans sold to other investors are without recourse. For the past few years, substantially all loans have been sold on a service released basis. Previous to that, some loans sold to Freddie Mac, Fannie Mae and one other investor had been sold service retained, whereby Security Federal would collect a .25% to .375% servicing fee on the principal balance of the loan serviced. However, the pricing on loans sold service released is more favorable to the borrower. As a result of that factor, along with prepayments and refinancings, Security Federal's loan serviced for others portfolio was decreasing in size. Accordingly, because of the fixed costs of servicing that portfolio, Security Federal sold its loan serviced for others portfolio for a before tax, net gain of approximately $400,000 in the last quarter of fiscal 2001. In fiscal 2005, Security Federal sold $26.0 million in fixed rate residential loans on a service released basis on the secondary market. Loans closed but not yet settled with Freddie Mac or other investors, are carried in the Bank's "loans held for sale" portfolio. At March 31, 2005, the Bank had $2.3 million of loans held for sale. These loans are fixed rate residential loans that have been originated in the Bank's name and have closed. Virtually all of these loans have commitments to be purchased by investors, mainly Freddie Mac, and the majority of these loans were locked in by 6 price with the investors on the same day or shortly thereafter that the loan was locked in with the Bank's customers. Therefore, these loans present very little market risk for the Bank. The Bank usually delivers to and receives funding from the investor within 30 days. Security Federal originates all of its loans held for sale on a "best efforts" basis. Best efforts means that the Bank suffers no penalty if it is unable to deliver a loan to a potential investor. The Bank also originates and holds adjustable and fixed rate construction loans and fixed rate lot loans. The construction loans are for one year terms. Lot loans are financed on a two or three year term, or a five year balloon term. At March 31, 2005, the Bank held $19.4 million, or 5.8% of the total loan portfolio in construction loans and $12.2 million, or 3.6% of the total loan portfolio in lot loans, in its residential portfolio. At March 31, 2005, the Bank also held approximately $9.5 million in longer term fixed rate residential mortgage loans. These loans, which were 2.8% of the entire loan portfolio at March 31, 2005, had converted from adjustable rate mortgage ("ARM") loans to fixed rate loans during the previous 36 months. These fixed rate loans had remaining maturities of 10 to 27 years. At March 31, 2005, the Bank had approximately $16.0 million of residential ARM loans that could convert to fixed rate loans over the next 24 months. The Bank no longer originates ARM loans with conversion features. Loan Solicitation and Processing. The Bank actively solicits mortgage loan applications from existing customers, real estate agents, builders, real estate developers and others. The Bank also receives mortgage loan applications as a result of customer referrals and from walk-in customers. Detailed loan applications are obtained to determine the borrower's creditworthiness and ability to repay. The more significant items on loan applications are verified through the use of credit reports, financial statements and confirmations. After analysis of the loan application and property or collateral involved, including an appraisal of the property (residential appraisals are obtained through independent fee appraisers), the lending decision is made in accordance with the underwriting guidelines of the Bank. These guidelines are generally consistent with Freddie Mac and Fannie Mae guidelines for residential real estate loans. With respect to commercial real estate loans, the Bank also reviews the capital adequacy of the business, the income potential of the property, the ability of the borrower to repay the loan and honor its other obligations, and general economic and industry conditions. Upon receipt of a loan application and all required related information from a prospective borrower, the loan application is submitted for approval or rejection. The residential mortgage loan underwriters approve loans which meet Freddie Mac and Fannie Mae underwriting requirements, not to exceed $359.650 per loan, Federal Housing Administration ("FHA") loans not to exceed $172,632, and Veterans' Administration ("VA") loans not to exceed $359,650. The Chairman, Chief Executive Officer, or President of the Bank approve loans of $300,000 or less, except as set forth above for conforming conventionally underwritten, single family mortgage loans, which are approved by the underwriters. The Senior Business Development officers approve loans up to $250,000. Commercial, consumer, and all non-conforming real estate loans in excess of $350,000 require approval of any two of the above and any loan in an amount in excess of $500,000 must be approved by the Bank's Executive Committee, which operates as the Bank's Loan Committee. The loan approval limits shown are the aggregate of all loans to any one borrower or entity, not including loans that are the borrower's primary residence, and are conventionally underwritten. The general policy of Security Federal is to issue loan commitments to qualified borrowers for a specified time period. These commitments are generally for a period of 45 days or less. With management approval, commitments may be extended for a longer period. The total outstanding amount of residential mortgage loan commitments for portfolio loans issued by Security Federal as of March 31, 2005, was approximately $180,000 (excluding undisbursed portions of construction loans in process). Security Federal also had outstanding commitments available on retail lines of credit (including home equity and other consumer loans) totaling $28.3 million as of March 31, 2005. See Note 13 of the Notes to Consolidated Financial Statements contained in the Annual Report. Permanent Residential Mortgage Lending. Residential real estate mortgage loans constituted approximately 31.2% of the Bank's total outstanding loan portfolio at March 31, 2005. Security Federal offers a variety of ARMs which offer adjustable rates of interest, payments, loan balances or terms to maturity which vary according to specified indices. The Bank's ARMs generally have a loan term of 15 to 30 years with initial rate adjustments every one, three, five or seven years during the term of the loan. After the initial rate 7 adjustment, the loan rate then adjusts annually. Most of the Bank's ARMs contain a 200 basis point limit as to the maximum amount of change in the interest rate at any adjustment period and a 500 or 600 basis point limit over the life of the loan. The Bank generally originates ARMs to hold in its portfolio. Such loans are generally made consistent with Freddie Mac and Fannie Mae guidelines. At March 31, 2005, residential ARMs totaled $93.6 million, or 27.7% of the Bank's loan portfolio. For the year ended March 31, 2005, the Bank originated $85.3 million in residential real estate loans, 51.1% of which had adjustable rates of interest. There are unquantifiable risks resulting from possible increased costs to the borrower as a result of periodic repricing. Despite the benefits of ARMs to the Bank's asset/liability management program, these loans also pose potential additional risks, primarily because as interest rates rise, the underlying payment by the borrower rises, increasing the potential for default. At the same time, marketability of the underlying property may be adversely affected by higher interest rates. When making a one- to four-family residential mortgage loan, the Bank evaluates both the borrower's creditworthiness and his or her general ability to make principal and interest payments and the value of the property that will secure the loan. The Bank generally makes loans on one- to four-family residential properties in amounts of 95% or less of the appraised value thereof. Where loans are made in amounts which exceed 80% of the appraised value of the underlying real estate, the Bank's general policy is to require private mortgage insurance on the portion of the loan in excess of 80% of the appraised value. In general, the Bank restricts its residential lending to South Carolina and the nearby Augusta, Georgia market. The Bank also provides construction financing for single family dwellings both to owner-occupants and to builders for resale. Construction loans are generally made for periods of six months to one year with either adjustable or fixed rates. At March 31, 2005, residential construction loans on one- to four-family dwellings totaled $19.4 million, or 5.8%, of the Bank's loan portfolio. On loans of this type, the Bank seeks to evaluate the financial condition and prior performance of the builder, as well as the factors mentioned above concerning the creditworthiness of the borrower. On construction loans offered to individuals (non-builders), the Bank offers a construction/permanent loan. The construction portion of the loan is an adjustable rate (typically prime plus .50%) or a fixed rate (typically prime plus 1.0%) during the construction period. After construction, the loan then automatically converts to an ARM loan. The borrower also has the option, after the construction period only, to convert the loan to a fixed rate loan which the Bank then sells on the secondary market immediately on a service released basis. Commercial Business and Commercial Real Estate Loans. The commercial business and commercial real estate loans originated by the Bank are primarily secured by business properties, churches, income property developments, undeveloped land, business equipment, furniture and fixtures, inventory, and receivables. At March 31, 2005, the Bank had approximately $162.2 million, or 48.0%, of the Bank's total loan portfolio, in commercial business and commercial real estate loans. Approximately $103.4 million, or 63.7% of commercial business and commercial real estate loans were secured primarily by real estate at March 31, 2005. Not included in these loans are approximately $12.7 million in acquisition and development loans. Loans secured by commercial real estate are typically written for terms of 10 to 20 years. Commercial loans not secured by real estate are typically based on terms of three to 60 months. Fixed rate loans typically balloon at the end of three to seven years. Adjustable rate loans are usually tied to the prime interest rate or LIBOR as quoted in the Wall Street Journal, although some adjustable rate loans are tied to LIBOR, and adjust daily, monthly or annually. Some adjustable rate loans have interest rate caps. Most of these loans have a five year balloon. Commercial business and commercial real estate lending entails significant additional credit risk when compared to residential lending. Commercial loans typically involve large loan balances to single borrowers or groups of related borrowers. The payment experience of these loans is typically dependent upon the successful operation of the business or real estate project. These risks can be significantly affected by supply and demand conditions in the market for office and retail space and for condominiums and apartments and to adverse conditions in the local economy. Although commercial loans generally involve more risk than residential loans, they also typically provide a greater yield and are more sensitive to changes in interest rates. The underwriting standards employed by the Bank for commercial business and commercial real estate lending include a determination of the borrower's current financial condition, ability to pay, past earnings and payment history. 8 In addition, the current financial condition and payment history of all principals are reviewed. Typically, the Bank requires the principal or owners of a business to guarantee all loans made to their business by the Bank. Although the creditworthiness of the business and its principals is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount. Properties securing commercial loans originated by the Bank are generally appraised at the time of the loan by appraisers designated by the Bank. Although the Bank is permitted to invest in loans up to 100% of the appraised value of a property on a commercial loan, the Bank currently seeks to invest in loans with a loan to value ratio of 75% to 85%. At March 31, 2005, the Bank did not have any commercial business or commercial real estate loans to one borrower in excess of $5.1 million. Federal law restricts the Bank's permissible lending limits to one borrower to the greater of $500,000 or 15% of unimpaired capital and surplus. The Bank has only infrequently made loans to one borrower equal to the amount federal law allows or approximately $6.0 million as calculated at March 31, 2005. Consumer Loans. The Bank originates consumer loans for any personal, family or household purpose, including but not limited to the financing of home improvements, automobiles, boats, mobile homes, recreational vehicles and education. The Bank also makes consumer first and second mortgage loans secured by residences. These loans typically do not qualify for sale in the secondary market, but are generally not considered sub-prime lending. In addition, the Bank has expanded its home equity lending program. Home equity loans are secured by mortgage lines on the borrower's principal or second residence. At March 31, 2005, the Bank had $16.9 million of home equity lines of credit outstanding and $23.0 million of additional commitments of such lines of credit. The Bank also makes secured and unsecured lines of credit available. Although consumer loans involve a higher level of risk than one- to four-family residential mortgage loans, they generally provide higher yields and have shorter terms to maturity than one- to four- family residential mortgage loans. At March 31, 2005, the Bank had total consumer loans of $50.8 million, or 15.0% of the Bank's loan portfolio. The underwriting standards employed by the Bank for consumer loans include a determination of the applicant's payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant's monthly income is determined by verification of gross monthly income from primary employment, and from any verifiable secondary income. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount. The Bank also has a credit card program. As of March 31, 2005, 1,364 Visa credit cards had been issued by the Bank with total approved credit lines of $3.9 million, of which $1.3 million was outstanding. Loan Delinquencies and Defaults - ------------------------------- General. The Bank's collection procedures provide that when a real estate loan is approximately 20 days past due, the borrower is contacted by mail and payment is requested. If the delinquency continues, subsequent efforts are made to contact the delinquent borrower and establish a program to bring the loan current. In certain instances, the Bank may modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his financial affairs. If the loan continues in a delinquent status for 60 days or more, the Bank generally initiates foreclosure proceedings after the customer has been notified by certified mail. At March 31, 2005, the Bank had property acquired as the result of foreclosures and other property repossessed classified as repossessed assets valued at $53,000. 9 Delinquent Loans. The following table sets forth information concerning delinquent mortgage and other loans at March 31, 2005. The amounts presented represent the total remaining principal balances of the related loans (before specific reserves for losses), rather than the actual payment amounts which are overdue. Real Estate Non-Real Estate ---------------------------- ---------------------------- Commercial Residential Commercial Consumer Business ------------- ------------- ------------- ------------- Number Amount Number Amount Number Amount Number Amount ------ ------ ------ ------ ------ ------ ------ ------ (Dollars in Thousands, number of loans are actual) Loans delinquent for: 30 - 59 days...... 4 $ 383 12 $1,490 64 $ 909 14 $ 665 60 - 89 days...... 1 73 1 13 9 23 -- -- 90 days and over.. 6 569 10 1,547 6 140 3 174 Total delinquent ---- ------ ---- ------ ---- ------ ---- ----- loans........... 11 $1,025 23 $3,050 79 $1,072 17 $ 839 ==== ====== ==== ====== ==== ====== ==== ===== Classified Assets. Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered to be of lesser quality as "substandard," "doubtful" or "loss" assets. The regulations require savings associations to classify their own assets and to establish prudent general allowances for loan losses for assets classified "substandard" or "doubtful." For the portion of assets classified as "loss," an institution is required to either establish specific allowances of 100% of the amount classified or charge off such amount. In addition, the Office of Thrift Supervision ("OTS") may require the establishment of a general allowance for losses based on assets classified as "substandard" and "doubtful" or based on the general quality of the asset portfolio of an association. See "Regulation - - Federal Regulation of Savings Institutions."Assets which do not currently expose the savings association to sufficient risk to warrant classification in one of the aforementioned categories but possess potential weaknesses are designated "special mention" by management. At March 31, 2005, approximately $12.1 million of the Bank's loans were classified "substandard" compared to $5.4 million at March 31, 2004. In fiscal 2005, the Bank began applying stricter standards in securitizing its loan portfolio for classification purposes in conjunction with the formation of a Credit Administration Department. At March 31, 2005, $2.6 million were classified as "special mention" compared to $2.5 million at March 31, 2004. The Bank had no loans classified as "doubtful" or "loss" at March 31, 2005. As of March 31, 2005, there were loans totaling $434,000 which were troubled debt restructurings within the meaning of Statement of Financial Accounting Standard ("SFAS") No. 15. The Bank's policy is to classify all troubled debt restructurings as substandard. The Bank's classification of assets is consistent with OTS regulatory classifications. Non-performing Assets. Loans are placed on non-accrual status when the collection of principal and/or interest becomes doubtful. In addition, all loans are placed on non-accrual status when the loan becomes 90 days or more contractually delinquent. All consumer loans more than 90 days delinquent are charged against the consumer loan allowance for loan losses unless there is adequate collateral which is in the process of being repossessed or foreclosed on. At March 31, 2005, the Bank did not have any troubled debt restructurings which involve forgiving a portion of interest or principal on any loans or making loans at a rate materially less than market rate. Other loans of concern are those loans (not delinquent more than 60 days) that management has determined need to be closely monitored as the potential exists for increased risk on these loans in the future. Nonperforming loans are reviewed monthly on a loan by loan basis. Charge-offs, whether partial or in full, associated with these loans will vary based on estimates of recovery for each loan. 10 The following table sets forth the amounts and categories of risk elements in the Bank's loan portfolio. March 31, ------------------------------------------------ 2005 2004 2003 2002 2001 -------- -------- -------- -------- -------- (Dollars in Thousands) Loans Delinquent 60 to 89 Days: Residential................. $ 73 $ 72 $ 45 $ -- $ -- Consumer.................... 13 73 435 370 320 Commercial business and real estate............ 13 88 311 144 274 ------ ------ ------ ------ ------ Total..................... $ 99 $ 233 $ 791 $ 514 $ 594 ====== ====== ====== ====== ====== Total as a percentage of total assets.......... 0.02% 0.04% 0.18% 0.14% 0.18% Non-Accruing Loans Delinquent 90 Days or More: Residential................. $ 569 $ 559 $ 585 $ 761 $ -- Consumer.................... 140 243 229 350 172 Commercial business and real estate............ 1,721 1,242 226 279 11 ------ ------ ------ ------ ------ Total..................... $2,430 $2,044 $1,040 $1,390 $ 183 ====== ====== ====== ====== ====== Total as a percentage of total assets.......... 0.42% 0.39% 0.23% 0.37% 0.06% Troubled debt restructurings. $ 434 $ 646(1) $ 674(2) $ 622 $ 587 Repossessed assets........... $ 53 $ 51 $ 151 $ 98 $ 130 Allowance for loan losses.... $6,284 $5,764 $4,911 $3,689 $2,784 - ----------- (1) $201,000 of troubled debt restructurings are included in non-accruing loans. (2) $210,000 of troubled debt restructurings are included in non-accruing loans. For the fiscal year ended March 31, 2005, the interest income which would have been recognized with respect to non-accruing loans, had such loans been current in accordance with their original terms and with respect to troubled debt restructurings, had such loans been current in accordance with their original terms, totaled $189,000 compared to $106,000 for the year ended March 31, 2004. At March 31, 2005, non-accruing loans totaled $2.4 million, compared to $2.0 million and $1.0 million at March 31, 2004 and 2003, respectively. Included in non-accruing loans at March 31, 2005 were six residential real estate loans totaling $569,000, 13 commercial loans totaling $1.7 million and six consumer loans totaling $140,000. Of the six consumer loans on non-accrual status at fiscal year end, no loan exceeded $60,000. Of the 13 commercial loans on non-accrual status at fiscal year end, no loan exceeded $450,000. The Bank had six loans totaling $434,000 at fiscal year end which were troubled debt restructurings compared to seven loans of $646,000 at March 31, 2004. The six troubled debt restructurings were three consumer loans totaling $345,000 secured by residential dwellings, a $13,000 consumer loan secured by a second mortgage on a residence, a $56,000 commercial loan secured by two rental properties, and a $20,000 unsecured commercial loan. The $13,000 consumer loan was 30 days delinquent at March 31, 2005. At March 31, 2005, repossessed assets had an outstanding carrying value of $53,000 and consisted of a single family dwelling, acreage, and a developed lot. Provision for Losses on Loans and Repossessed Assets. Security Federal recognizes that credit losses will be experienced during the course of making loans and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a secured loan, the quality of the underlying security for the loan. The Bank seeks to establish and maintain sufficient reserves for estimated losses on specifically identified loans and real estate where such losses can be estimated. Additionally, general reserves for estimated possible losses are 11 established on specified portions of the Bank's portfolio such as consumer loans and higher risk residential construction mortgage loans based on management's estimate of the potential loss for loans which normally can be classified as higher risk. Specific and general reserves are based on, among other criteria (1) the risk characteristics of the loan portfolio, (2) current economic conditions on a local as well as a statewide basis, (3) actual losses experienced historically and (4) the level of reserves for possible losses in the future. Additionally, a reserve is maintained for uncollected interest on loans 90 days or more past due. At March 31, 2005, total reserves relating to loans were $6.3 million. In determining the adequacy of the reserve for loan losses, management reviews past experience of loan charge-offs, the level of past due and non-accrual loans, the size and mix of the portfolio, general economic conditions in the market area, and individual loans to identify potential credit problems. Commercial business, commercial real estate and consumer loans have increased to $213.1 million, or 63.0% of the Bank's total loan portfolio at March 31, 2005, and it is anticipated there will be a continued emphasis on this type of credit. Although commercial and consumer loans carry a higher level of credit risk than conventional residential mortgage loans, the level of reserves reflects management's continuing evaluation of this risk based on upon the Bank's past loss experience. At fiscal year end, the Bank's ratio of loans delinquent more than 60 days to total assets was 0.43%. These delinquent loans are considered to be well secured and are in the process of collection. Management uses four methods or calculations to estimate the adequacy of the reserve using the factors mentioned above. The reserve is management's best estimate for the reserve. There can be no guarantee that the estimate is adequate or accurate. Management believes that reserves for loan losses are at a level adequate to provide for inherent loan losses. Although management believes that it has considered all relevant factors in its estimation of future losses, future adjustments to reserves may be necessary if conditions change substantially from the assumptions used in making the original estimations. Regulators will from time to time evaluate the allowance for loan losses which is subject to adjustment based upon the information available to the regulators at the time of their examinations. Management believes the Bank has no undue concentration of loans in any one particular industry. At March 31, 2005, the Bank had no allowance for losses on real estate owned. The following table sets forth an analysis of the Bank's allowance for loan losses. March 31, ------------------------------------------------ 2005 2004 2003 2002 2001 -------- -------- -------- -------- -------- (Dollars in Thousands) Balance at beginning of year.................... $5,764 $4,911 $3,689 $2,784 $2,121 Provision charged to operations................. 780 1,200 1,800 1,525 925 Charge-offs: Residential real estate.... 29 38 17 5 4 Commercial business and commercial real estate.... 257 164 299 229 86 Consumer................... 157 467 594 584 240 ------ ------ ------ ------ ------ Total charge-offs........ 443 669 910 818 330 ------ ------ ------ ------ ------ Recoveries: Residential real estate.... -- -- -- 6 17 Commercial business........ 112 16 40 41 4 Consumer................... 71 306 292 151 47 ------ ------ ------ ------ ------ Total recoveries......... 183 322 332 198 68 ------ ------ ------ ------ ------ Balance at end of year...... $6,284 $5,764 $4,911 $3,689 $2,784 ====== ====== ====== ====== ====== Ratio of net charge-offs during the year to average loans outstanding during the year................... 0.09% 0.14% 0.24% 0.26% 0.12% ====== ====== ====== ====== ====== 12 The distribution of the Bank's allowance for loan losses at the dates indicated is summarized in the following table. The entire allowance is available to absorb losses from all loan categories. At March 31, ---------------------------------------------------------------------------------- 2005 2004 2003 2002 2001 -------------- ------------- ------------- ------------- ------------- Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans ------ ----- ------ ----- ------ ----- ------ ----- ------ ----- (Dollars in Thousands) Residential............ $ 531 37.0% $ 500 40.1% $ 473 40.3% $ 435 41.0% $ 374 50.6% Consumer............... 2,876 15.0 2,632 16.4 2,219 18.1 1,405 20.0 1,205 18.9 Commercial business and commercial real estate........... 2,877 48.0 2,632 43.5 2,219 41.6 1,849 39.0 1,205 30.5 ------ ----- ------ ----- ------ ----- ------ ----- ------ ----- Total................ $6,284 100.0% $5,764 100.0% $4,911 100.0% $3,689 100.0% $2,784 100.0% ====== ===== ====== ===== ====== ===== ====== ===== ====== =====
Service Corporation - ------------------- As a federally chartered savings bank, Security Federal is permitted by OTS regulations to invest up to 3% of its assets in the stock of service corporations, provided that any investment in excess of 2% of its assets must be primarily for community, inner-city or community development purposes. At March 31, 2005, Security Federal's net investment in its service corporations (including loans to service corporations) totaled $771,000. In addition to investments in service corporations, federal institutions are permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities which a federal savings bank may engage in directly. Security Federal Insurance, Inc. ("SFINS"), Security Federal Investments, Inc. ("SFINV") and Security Federal Trust, Inc. ("SFT"). SFINS, SFINV AND SFT, wholly owned subsidiaries of the Bank, were formed during fiscal 2002 and began operating during the December 2001 quarter. SFINS is an insurance agency offering business, health, home and life insurance. SFINV offers mutual funds, annuities and discount brokerage services. SFT offers a full range of trust and financial planning services. The operations of SFINS, SFINV and SFT are included in the Company's Consolidated Financial Statements. Security Financial Services Corporation ("SFSC"). SFSC was incorporated in 1975 as a wholly owned subsidiary of the Bank. Its primary activity was investment brokerage services. SFSC is currently inactive. Real Estate Partnership. The Company has developed real estate through two real estate partnerships which it purchased from SFSC at market value in December 1995. Each project was designed primarily to develop and sell residential lots in and around the Bank's primary lending area. One project was completed during fiscal 1998 and the other project was completed during fiscal 2001. The Company had no investment in the remaining project at March 31, 2005. The Company has no current plans for additional real estate ventures. Investment Activities - --------------------- Investment securities. The Bank has authority to invest in various types of liquid assets, including U.S. Treasury obligations and securities of various federal agencies, certificates of deposit at insured institutions, bankers' acceptances and federal funds. The Bank may also invest a portion of its assets in certain commercial paper and corporate debt securities. The Bank is also authorized to invest in mutual funds whose assets conform to the investments that a federal thrift institution is authorized to make directly. There are various restrictions on the foregoing investments. For example, the commercial paper must be appropriately rated by at least two nationally recognized investment rating services and the corporate debt securities must be appropriately rated by at least one such service. In addition, the average maturity of an institution's portfolio of corporate debt securities may not, at any one time, exceed six years, and the commercial paper must mature within nine months of issuance. Moreover, an institution's total investment in the commercial paper and corporate debt securities of any one issuer may not exceed 1% of the institution's assets except that an institution may invest 5% of its assets in the shares of any appropriate mutual fund. See "Regulation - Federal Regulation of Savings Associations." 13 As a member of the Federal Home Loan Bank ("FHLB") System, Security Federal must maintain minimum levels of investments that are liquid assets as defined in Federal regulations. See "Regulation Federal Regulation of Savings Associations Federal Home Loan Bank System." Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Historically, the Bank has maintained its liquid assets above the minimum requirements imposed by the OTS regulations and at a level believed adequate to meet requirements of normal daily activities, repayment of maturing debt and potential deposit outflows. Cash flow projections are regularly reviewed and updated to assure that adequate liquidity is provided. The following table sets forth the composition of the Company's portfolio of securities and other investments, not including mortgage-backed securities. At March 31, ----------------------------- 2005 2004 2003 -------- -------- -------- (In Thousands) Interest bearing deposit at FHLB............ $ 164 $ 303 $ 339 -------- -------- -------- Total..................................... $ 164 $ 303 $ 339 ======== ======== ======== Investment Securities: Available for Sale: FHLB securities.......................... $ 4,970 $ 14,280 $ 47,794 Federal Farm Credit Bank securities...... -- 2,042 5,129 Freddie Mac bonds........................ 485 578 816 -------- -------- -------- Total securities available for sale.... 5,455 16,900 53,739 -------- -------- -------- Held to Maturity: FHLB securities.......................... 67,002 57,944 18,990 Fannie Mae securities.................... -- -- 30 Federal Farm Credit Bank securities...... 8,999 13,010 2,006 -------- -------- -------- Total securities held to maturity...... 76,001 70,954 21,026 -------- -------- -------- Total securities (1)........................ 81,456 87,854 74,765 FHLB stock.................................. 6,235 4,817 2,859 -------- -------- -------- Total securities and FHLB stock (1)......... $ 87,691 $ 92,671 $ 77,624 ======== ======== ======== - ----------- (1) Does not include mortgage-backed securities. At March 31, 2005, the Company did not have any investment securities (exclusive of obligations of the U.S. Government and federal agencies) issued by any one entity with a total book value in excess of 10% of stockholders' equity. 14 The following table sets forth the maturities or repricing of investment securities and FHLB stock at March 31, 2005, and the weighted average yields of such securities and FHLB stock (calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security). Callable securities are shown at their likely call dates based on current interest rates. The table was prepared using amortized cost. Maturing or Repricing ------------------------------------------------------------- After One After Five Within But Within But Within After One Year Five Years Ten Years Ten Years ------------- ------------- ------------- ------------- Amount Yield Amount Yield Amount Yield Amount Yield ------ ----- ------ ----- ------ ----- ------ ----- (Dollars in Thousands) U.S. Government and other agency obligations... $9,484 3.22% $65,976 3.50% $6,011 3.85% $ -- --% FHLB stock (1). -- -- 6,235 4.25 -- -- -- -- ------ ---- ------- ---- ------ ---- ------ ---- Total........ $9,484 3.22% $72,211 3.57% $6,011 3.85% $ -- --% ====== ==== ======= ==== ====== ==== ====== ===== - ----------- (1) FHLB stock has no stated maturity date. For information regarding the market value of the Bank's securities portfolios, see Notes 3 and 4 of the Notes to Consolidated Financial Statements contained in the Annual Report. Mortgage-backed securities. Security Federal has a portfolio of mortgage-backed securities which it holds in both an available for sale and a held to maturity portfolio. Mortgage-backed securities can serve as collateral for borrowings and, through repayments, as a source of liquidity. Under the Bank's risk-based capital requirement, mortgage-backed securities have a risk weight of 20% (or 0% in the case of Government National Mortgage Association ("Ginnie Mae") securities) in contrast to the 50% risk weight carried by residential loans. See "Regulation." The following tables set forth the composition of the mortgage-backed securities available for sale portfolio at the dates indicated. At March 31, -------------------------------- 2005 2004 2003 -------- -------- -------- (In Thousands) Available for Sale: Freddie Mac....................... $ 26,146 $ 18,452 $ 15,810 Fannie Mae........................ 81,492 91,494 57,794 Ginnie Mae........................ 51,722 47,566 32,808 -------- -------- -------- Total........................... $159,360 $157,512 $106,412 ======== ======== ======== The following table sets forth the composition of the mortgage-backed securities held to maturity portfolio at the dates indicated. At March 31, ------------------------------------ 2005 2004 2003 ---------- ---------- ---------- Book Value Book Value Book Value ---------- ---------- ---------- (In Thousands) Held to Maturity: Freddie Mac....................... $260 $350 $941 ==== ==== ==== At March 31, 2005, the Company did not have any mortgage-backed securities (exclusive of obligations of agencies of the U.S. Government) issued by any one entity with a total book value in excess of 10% of stockholders equity. 15 For information regarding the market values of Security Federal's mortgage-backed securities portfolio, see Notes 3 and 4 of the Notes to Consolidated Financial Statements contained in the Annual Report. The following table sets forth the final maturities or initial repricings, whichever occurs first, and the weighted average yields of the mortgage-backed securities at March 31, 2005. Not considered in the preparation of the table below is the effect of scheduled payments or anticipated prepayments. The table is prepared using amortized cost. The Earliest of Maturing or Repricing March 31, 2005 -------------------------------------------------------------------- -------------- Less Than 1 to 5 5 to 10 Over Balance 1 Year Years Years Ten Years Outstanding -------------- -------------- -------------- -------------- -------------- Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield ------ ----- ------ ----- ------ ----- ------ ----- ------ ----- (Dollars in Thousands) Fannie Mae...... $ 9,766 3.49% $27,755 3.77% $36,191 4.20% $ 8,789 4.89% $ 82,501 4.04% Freddie Mac..... 134 5.41 13,782 3.90 9,025 4.02 3,855 5.28 26,796 4.15 Ginnie Mae...... 41,239 3.04 9,323 3.76 908 6.02 388 6.97 51,858 3.25 ------- ---- ------- ----- ------- ---- ------- ---- -------- ---- Total........... $51,139 3.13% $50,860 3.80% $46,124 4.20% $13,032 5.07% $161,155 3.80% ======= ==== ======= ==== ======= ==== ======== ==== ======== ====
Sources of Funds - ---------------- Deposit accounts have traditionally been a principal source of the Bank's funds for use in lending and for other general business purposes. In addition to deposits, the Bank derives funds from loan repayments, cash flows generated from operations (including interest credited to deposit accounts), FHLB of Atlanta advances, the sale of securities under agreements to repurchase, and loan sales. Scheduled loan payments are a relatively stable source of funds while deposit inflows and outflows and the related cost of such funds have varied widely. FHLB of Atlanta advances and the sale of securities under agreements to repurchase may be used on a short-term basis to compensate for seasonal reductions in deposits or deposit inflows at less than projected levels and may be used on a longer term basis in support of expanded lending activities. The availability of funds from loan sales is influenced by general interest rates. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in the Annual Report. Deposits. The Bank attracts both short-term and long-term deposits from the general public by offering a wide assortment of account types and rates. In recent years, market conditions have required the Bank to rely increasingly on short-term accounts and other deposit alternatives that are more responsive to market interest rates than the savings accounts and regulated fixed interest rate, fixed-term certificates that were the Bank's primary source of deposits before 1978. The Bank offers regular savings accounts, checking accounts, various money market accounts, fixed interest rate certificates with varying maturities, negotiated rate $100,000 or above jumbo certificates of deposit ("Jumbo CDs") and individual retirement accounts. At March 31, 2005, the Bank had no brokered deposits. In addition, the Bank believes that, based on its experience over the past several years, its savings and transaction accounts are stable sources of deposits. 16 The following table sets forth the dollar amount of savings deposits in the various types of deposit programs for the periods indicated. At March 31, ------------------------------------------------------ 2005 2004 2003 ---------------- ---------------- ---------------- Percent Percent Percent of of of Amount Total Amount Total Amount Total ------ ----- ------ ----- ------ ----- (Dollars in Thousands) Interest Rate Range - ------------------- for 2005: - --------- Savings accounts 0% - 1.50%........... $ 17,744 4.1% $ 17,367 4.5% $ 16,455 4.6% NOW and other trans- action accounts 0% - 2.47%........... 88,170 20.5 80,739 20.7 82,522 23.0 Money market funds 1.09% - 2.72%........ 164,088 38.1 158,587 40.7 102,397 28.6 Total non- -------- ----- -------- ----- -------- ----- certificates...... $270,002 62.7% $256,693 65.9% $201,374 56.2% ======== ===== ======== ===== ======== ===== Certificates: - ------------- 0.00-4.99............. $150,486 35.0% $122,599 31.5% $144,635 40.3% 5.00-6.99%............ 9,799 2.3 10,301 2.6 12,437 3.5 7.00-8.99%............ -- -- -- -- 28 -- -------- ----- -------- ----- -------- ----- Total certificates. 160,285 37.3 132,900 34.1 157,100 43.8 -------- ----- -------- ----- -------- ----- Total deposits..... $430,287 100.0% $389,593 100.0% $358,474 100.0% ======== ===== ======== ===== ======== ===== The Bank relies to a limited extent upon locally obtained Jumbo CDs to maintain its deposit levels. At March 31, 2005, Jumbo CDs constituted 14.3% of the Bank's total deposits. Security Federal has not relied heavily on Jumbo CDs to manage interest rate sensitivity. The following table sets forth the deposit flows at the Bank during the periods indicated. Years Ended March 31, ------------------------------ 2005 2004 2003 -------- -------- -------- (Dollars in Thousands) Opening balance...................... $389,593 $358,474 $309,038 Net deposits......................... 32,977 24,339 41,747 Interest credited.................... 7,717 6,780 7,689 -------- -------- -------- Ending balance....................... 430,287 389,593 358,474 -------- -------- -------- Net increase (decrease).............. $ 40,694 $ 31,119 $ 49,436 ======== ======== ======== Percent increase (decrease).......... 10.4% 8.7% 16.0% ======== ======== ======== 17 The following table shows rate and maturity information for the Bank's certificates of deposit as of March 31, 2005. Less than 2.00- 3.00- 4.00- 5.00- 6.00- 2.00% 2.99% 3.99% 4.99% 5.99% 6.99% Total ----- ----- ----- ----- ----- ----- ----- (In Thousands) Certificate accounts maturing in quarter ending: June 30, 2005...... $13,876 $15,124 $ 43 $ 446 $ 3 $ -- $29,492 September 30, 2005............. 6,814 13,072 10,691 190 13 -- 30,780 December 31, 2005.. 2,513 19,018 476 68 9 -- 22,084 March 31, 2006..... 166 11,655 1,368 26 131 -- 13,346 June 30, 2006...... 69 4,409 13,987 371 -- -- 18,836 September 30, 2006. -- 11,167 2,048 356 -- -- 13,571 December 31, 2006.. -- 4,903 659 1,568 -- -- 7,130 March 31, 2007..... -- 280 255 355 1,495 -- 2,385 June 30, 2007...... -- 244 60 44 5,390 -- 5,738 September 30, 2007. -- 256 462 2,109 2,749 -- 5,576 December 31, 2007.. -- 53 744 2,435 10 -- 3,242 Thereafter......... 769 6,208 1,129 -- -- -- 8,106 ------- ------- ------- ------ ------ ----- -------- Total............ $23,438 $80,950 $37,001 $9,097 $9,800 $ -- $160,286 ======= ======= ======= ====== ====== ===== ======== The following table indicates the amount of the Bank's deposits of $100,000 or more by time remaining until maturity at March 31, 2005. Certificates Savings, NOW and of Deposit Money Market Accounts ---------- --------------------- (In Thousands) Maturity Period - --------------- Three months or less.............. $12,953 $129,868 Over three through six months..... 15,535 -- Over six through twelve month..... 9,539 -- Over twelve months................ 23,652 -- ------- -------- Total.......................... $61,679 $129,868 ======= ======== Borrowings - ---------- As a member of the FHLB of Atlanta, the Bank is required to own capital stock in the FHLB of Atlanta and is authorized to apply for advances from the FHLB of Atlanta. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB of Atlanta may prescribe the acceptable uses to which these advances may be put, as well as limitations on the size of the advances and repayment provisions. See Note 9 of the Notes to Consolidated Financial Statements contained in the Annual Report for information regarding the maturities and rate structure of the Bank's FHLB advances. Federal law contains certain collateral requirements for FHLB advances. See "Regulation - Federal Regulation of Savings Associations - Federal Home Loan Bank System." At March 31, 2005, the Bank had $5.5 million in retail repurchase agreements with an average rate of 2.54%. These repurchase agreements are included in "Other Borrowings" in the consolidated financial statements and the following table. 18 The following table sets forth the maximum month-end balance and average balance of FHLB advances and other borrowings for the periods indicated. Years Ended March 31, ------------------------- 2005 2004 2003 ---- ---- ---- (In Thousands) Maximum Balance: FHLB advances........................... $115,258 $103,886 $57,472 Other borrowings........................ 5,915 6,213 6,735 Average Balance: FHLB advances........................... $105,272 $ 72,995 $42,123 Other borrowings........................ 5,488 5,361 5,663 The following table sets forth information as to the Bank's borrowings and the weighted average interest rates thereon at the dates indicated. At March 31, ------------------------- 2005 2004 2003 ---- ---- ---- (Dollars in Thousands) Balance: FHLB advances........................... $112,038 $96,336 $49,772 Other borrowings........................ 5,594 5,477 4,193 Weighted Average Interest Rate: At Fiscal Year End: FHLB advances........................... 3.41% 3.59% 4.50% Other borrowings........................ 2.54 0.93 1.17 During Fiscal Year: FHLB advances........................... 3.54% 3.87% 5.31% Other borrowings........................ 1.53 0.97 1.57 Competition - ----------- The Bank serves the counties of Aiken and Lexington, South Carolina through its eleven branch offices located in Aiken, North Augusta, Graniteville, Langley, Clearwater, Wagener, Lexington, and West Columbia, South Carolina. Security Federal faces strong competition both in originating loans and in attracting deposits. Competition in originating loans comes primarily from other thrift institutions, commercial banks, mortgage bankers and credit unions who also make loans in the Bank's market area. The Bank competes for loans principally on the basis of the interest rates and loan fees it charges, the types of loans it makes and the quality of services it provides to borrowers. The Bank faces substantial competition in attracting deposits from other thrift institutions, commercial banks, money market and mutual funds, credit unions and other investment vehicles. The ability of the Bank to attract and retain deposits depends on its ability to provide an investment opportunity that satisfies the requirements of investors as to rate of return, liquidity, risk and other factors. The Bank attracts a significant amount of deposits through its branch offices primarily from the communities in which those branch offices are located. Therefore, competition for those deposits is principally from other thrift institutions and commercial banks located in the same communities. The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours, and convenient branch locations with interbranch deposit and withdrawal privileges at each. 19 The authority to offer money market deposits, and expanded lending and other powers authorized for thrift institutions by federal law, have resulted in increased competition for both deposits and loans between thrift institutions and other financial institutions such as commercial banks and credit unions. REGULATION The following is a brief description of certain laws and regulations which are applicable to the Company and the Bank. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations. Legislation is introduced from time to time in the United States Congress that may affect the operations of the Company and the Bank. In addition, the regulations governing the Company and the Bank may be amended from time to time by the OTS. Any such legislation or regulatory changes in the future could have an adverse effect. We cannot predict whether any such changes may occur. General The Bank, as a federally-chartered savings institution, is subject to federal regulation and oversight by the OTS extending to all aspects of its operations. The Bank also is subject to regulation and examination by the Federal Deposit Insurance Corporation ("FDIC"), which insures the deposits of the Bank to the maximum extent permitted by law, and requirements established by the Federal Reserve Board. Federally-chartered savings institutions are required to file periodic reports with the OTS and are subject to periodic examinations by the OTS and the FDIC. The investment and lending authority of savings institutions are prescribed by federal laws and regulations, and these institutions are prohibited from engaging in any activities not permitted by the laws and regulations. This regulation and supervision primarily is intended for the protection of depositors and not for the purpose of protecting shareholders. The OTS regularly examines the Bank and prepares reports for the consideration of the Bank's Board of Directors on any deficiencies that it may find in the Bank's operations. The FDIC also has the authority to examine the Bank in its roles as the administrator of the Savings Association Insurance Fund ("SAIF"). The Bank's relationship with its depositors and borrowers also is regulated to a great extent by both federal and state laws, especially in matters such as the ownership of savings accounts and the form and content of the Bank's mortgage requirements. Any change in these regulations, whether by the FDIC, the OTS or Congress, could have a material adverse impact on the Company, the Bank and their operations. Federal Regulation of Savings Institutions Office of Thrift Supervision. The OTS has extensive authority over the operations of savings institutions. As part of this authority, the Bank is required to file periodic reports with the OTS and is subject to periodic examinations by the OTS and the FDIC. When these examinations are conducted by the OTS and the FDIC, the examiners may require the Bank to provide for higher general or specific loan loss reserves. All savings institutions are subject to a semi-annual assessment, based upon the institution's total assets, to fund the operations of the OTS. The OTS also has extensive enforcement authority over all savings institutions and their holding companies, including the Bank and the Company. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease-and-desist or removal orders and initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OTS. Except under certain circumstances, public disclosure of final enforcement actions by the OTS is required. In addition, the investment, lending and branching authority of the Bank is prescribed by federal laws and it is prohibited from engaging in any activities not permitted by these laws. For example, no savings institution may invest in non-investment grade corporate debt securities. In addition, the permissible level of investment by federal institutions in loans secured by non-residential real property may not exceed 400% of total capital, except with approval of the OTS. 20 Federal savings institutions are also generally authorized to branch nationwide. The Bank is in compliance with the noted restrictions. All savings institutions are required to pay assessments to the OTS to fund the agency's operations. The general assessments, paid on a semi-annual basis, are determined based on the savings institution's total assets, including consolidated subsidiaries. The Bank's OTS assessment for the fiscal year ended March 31, 2005 was $115,000. Federal Home Loan Bank System. The Bank is a member of the FHLB of Atlanta, which is one of 12 regional FHLBs that administer the home financing credit function of savings institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans or advances to members in accordance with policies and procedures, established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing. As a member, the Bank is required to purchase and maintain stock in the FHLB of Atlanta. At March 31, 2005, the Bank had $6.2 million in FHLB stock, which was in compliance with this requirement. In past years, the Bank has received substantial dividends on its FHLB stock. Over the past two fiscal years these dividends have averaged 3.66% and were 3.75% for the fiscal year ended March 31, 2005. Under federal law, the FHLBs are required to provide funds for the resolution of troubled savings institutions and to contribute to low- and moderately-priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have affected adversely the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Bank's FHLB stock may result in a corresponding reduction in the Bank's capital. Deposit Insurance. The Bank is a member of the SAIF, which is administered by the FDIC. Deposits are insured up to the applicable limits by the FDIC and this insurance is backed by the full faith and credit of the United States government. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the SAIF. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OTS an opportunity to take such action, and may terminate the deposit insurance if it determines that an institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition. The FDIC's deposit insurance premiums are assessed through a risk-based system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their level of capital and supervisory evaluation. Under the system, institutions classified as well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1, or core capital, to risk-weighted assets ("Tier 1 risk-based capital") of at least 6% and a risk-based capital ratio of at least 10%) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (i.e., core or Tier 1 risk-based capital ratios of less than 4% or a risk-based capital ratio of less than 8%) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period. The FDIC is authorized to increase assessment rates, on a semi-annual basis, if it determines that the reserve ratio of the SAIF will be less than the designated reserve ratio of 1.25% of SAIF insured deposits. In setting increased assessments, the FDIC must seek to restore the reserve ratio to that designated reserve level, or such higher reserve ratio as established by the FDIC. The FDIC may also impose special assessments on SAIF members to repay amounts borrowed from the United States Treasury or for any other reason deemed necessary by the FDIC. 21 Since January 1, 1997, the premium schedule for Bank Insurance Fund ("BIF") and SAIF insured institutions has ranged from 0 to 27 basis points. However, SAIF and BIF insured institutions are required to pay a Financing Corporation assessment in order to fund the interest on bonds issued to resolve thrift failures in the 1980s equal to approximately 1.50 points for each $100 in domestic deposits annually. These assessments, which may be revised based upon the level of BIF and SAIF deposits, will continue until the bonds mature. Prompt Corrective Action. The OTS is required to take certain supervisory actions against undercapitalized savings institutions, the severity of which depends upon the institution's degree of undercapitalization. Generally, an institution that has a ratio of total capital to risk-weighted assets of less than 8%, a ratio of Tier I (core) capital to risk-weighted assets of less than 4%, or a ratio of core capital to total assets of less than 4% (3% or less for institutions with the highest examination rating) is considered to be "undercapitalized." An institution that has a total risk-based capital ratio less than 6%, a Tier I capital ratio of less than 3% or a leverage ratio that is less than 3% is considered to be "significantly undercapitalized" and an institution that has a tangible capital to assets ratio equal to or less than 2% is deemed to be "critically undercapitalized." Subject to a narrow exception, the OTS is required to appoint a receiver or conservator for a savings institution that is "critically undercapitalized." OTS regulations also require that a capital restoration plan be filed with the OTS within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Compliance with the plan must be guaranteed by any parent holding company in an amount of up to the lesser of 5% of the institution's assets or the amount which would bring the institution into compliance with all capital standards. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OTS also could take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. At March 31, 2005, the Bank was categorized as "well capitalized" under the prompt corrective action regulations of the OTS. Qualified Thrift Lender Test. All savings institutions, including the Bank, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings institution to have at least 65% of its total assets, as defined by regulation, in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings institution may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code ("Code"). Under either test, such assets primarily consist of residential housing related loans and investments. At March 31, 2005, the Bank met the test and its QTL percentage was 97%. Any savings institution that fails to meet the QTL test must convert to a national bank charter, unless it requalifies as a QTL and thereafter remains a QTL. If such an association has not yet requalified or converted to a national bank, its new investments and activities are limited to those permissible for both a savings institution and a national bank, and it is limited to national bank branching rights in its home state. In addition, the association is immediately ineligible to receive any new FHLB borrowings and is subject to national bank limits for payment of dividends. If such association has not requalified or converted to a national bank within three years after the failure, it must divest of all investments and cease all activities not permissible for a national bank. If any association that fails the QTL test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. See "- Savings and Loan Holding Company Regulations." Capital Requirements. Federally-insured savings institutions, such as the Bank, are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings institutions. These capital requirements must be generally as stringent as the comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements in excess of these standards on individual institutions on a case-by-case basis. 22 The OTS capital regulations require tangible capital of at least 1.5% of adjusted total assets, as defined by regulation. Tangible capital generally includes common stockholders' equity and retained income, and certain noncumulative perpetual preferred stock and related income. In addition, all intangible assets, other than a limited amount of purchased mortgage servicing rights, must be deducted from tangible capital for calculating compliance with the requirement. At March 31, 2005, the Bank had no intangible assets in the form of mortgage servicing rights. At March 31, 2005, the Bank had tangible capital of $35.7 million, or 6.1% of tangible assets, which is approximately $26.8 million above the minimum requirement of 1.5% of tangible assets as of that date. The capital standards also require core capital equal to at least 4.0% of adjusted total assets unless an institution's supervisory condition is such to allow it to maintain a 3.0% ratio. Core capital generally consists of tangible capital plus certain intangible assets, including a limited amount of purchased credit card relationships. At March 31, 2005, the Bank's mortgage service rights were subject to these tests. At March 31, 2005, the Bank had core capital equal to $35.7 million, or 6.1% of adjusted total assets, which is $12.2 million above the minimum requirement of 4.0% in effect on that date. The OTS also requires savings institutions to have core capital equal to 4.0% of risk-weighted assets ("Tier 1 risk-based"). At March 31, 2005, the Bank had Tier 1 risk-based capital of $35.7 million or 10.5% of risk-weighted assets, which is approximately $22.1 million above the minimum on that date. The OTS also requires savings institutions to have total capital of at least 8% of risk-weighted assets. Total capital consists of core capital, as defined above, and supplementary capital. Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and general valuation loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital. The OTS is also authorized to require a savings institution to maintain an additional amount of total capital to account for concentration of credit risk and the risk of non-traditional activities. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, are multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the OTS has assigned a risk weight of 50% for prudently underwritten permanent one- to- four family first lien mortgage loans not more than 90 days delinquent and having a loan-to-value ratio of not more than 80% at origination unless insured to such ratio by an insurer approved by Fannie Mae or Freddie Mac. On March 31, 2005, the Bank had total risk-based capital of approximately $39.9 million, including $35.7 million in core capital and $4.2 million in qualifying supplementary capital, and risk-weighted assets of $338.9 million, or total capital of 11.8% of risk-weighted assets. This amount was $12.7 million above the 8% requirement in effect on that date. The OTS and the FDIC are authorized and, under certain circumstances, required to take certain actions against savings institutions that fail to meet their capital requirements. The OTS is generally required to take action to restrict the activities of an "undercapitalized association", which is an institution with less than either a 4.0% core capital ratio, a 4.0% Tier 1 risked-based capital ratio or an 8.0% risk-based capital ratio). Any such institution must submit a capital restoration plan and until the plan is approved by the OTS may not increase its assets, acquire another institution, establish a branch or engage in any new activities, and generally may not make capital distributions. The OTS is authorized to impose the additional restrictions that are applicable to significantly undercapitalized institutions. As a condition to the approval of the capital restoration plan, any company controlling an undercapitalized institution must agree that it will enter into a limited capital maintenance guarantee with respect to the institution's achievement of its capital requirements. Any savings institution that fails to comply with its capital plan or has Tier 1 risk-based or core capital ratios of less than 3.0% or a risk-based capital ratio of less than 6.0% and is considered "significantly undercapitalized" will be made subject to one or more additional specified actions and operating restrictions which may cover all aspects of its operations and may include a forced merger or acquisition of the institution. An institution that becomes "critically undercapitalized" because it has a tangible capital ratio of 2.0% or less is subject to further mandatory restrictions on its activities in addition to those applicable to significantly undercapitalized institutions. In addition, the OTS must 23 appoint a receiver, or conservator with the concurrence of the FDIC, for a savings institution, with certain limited exceptions, within 90 days after it becomes critically undercapitalized. Any undercapitalized institution is also subject to the general enforcement authority of the OTS and the FDIC, including the appointment of a conservator or a receiver. The OTS is also generally authorized to reclassify an institution into a lower capital category and impose the restrictions applicable to such category if the institution is engaged in unsafe or unsound practices or is in an unsafe or unsound condition. The imposition by the OTS or the FDIC of any of these measures on the Bank may have a substantial adverse effect on its operations and profitability. Limitations on Capital Distributions. OTS regulations impose various restrictions on savings institutions with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. Generally, savings institutions, such as the Bank, that before and after the proposed distribution are well-capitalized, may make capital distributions during any calendar year equal to up to 100% of net income for the year-to- date plus retained net income for the two preceding years. However, an institution deemed to be in need of more than normal supervision by the OTS may have its dividend authority restricted by the OTS. The Bank may pay dividends to the Company in accordance with this general authority. Savings institutions proposing to make any capital distribution need not submit written notice to the OTS prior to the distribution unless they are a subsidiary of a holding company or would not remain well-capitalized following the distribution. Savings institutions that do not, or would not meet their current minimum capital requirements following a proposed capital distribution or propose to exceed these net income limitations, must obtain OTS approval prior to making the distribution. The OTS may object to the distribution during that 30-day period based on safety and soundness concerns. See "- Capital Requirements." Activities of Associations and Their Subsidiaries. When a savings institution establishes or acquires a subsidiary or elects to conduct any new activity through a subsidiary that the institution controls, the savings institution must notify the FDIC and the OTS 30 days in advance and provide the information each agency may, by regulation, require. Savings institutions also must conduct the activities of subsidiaries in accordance with existing regulations and orders. The OTS may determine that the continuation by a savings institution of its ownership control of, or its relationship to, the subsidiary constitutes a serious risk to the safety, soundness or stability of the institution or is inconsistent with sound banking practices or with the purposes of the Federal Deposit Insurance Act. Based upon that determination, the FDIC or the OTS has the authority to order the savings institution to divest itself of control of the subsidiary. The FDIC also may determine by regulation or order that any specific activity poses a serious threat to the SAIF. If so, it may require that no SAIF member engage in that activity directly. Transactions with Affiliates. Savings institutions must comply with Sections 23A and 23B of the Federal Reserve Act relative to transactions with affiliates in the same manner and to the same extent as if the savings institution were a Federal Reserve member bank. Generally, transactions between a savings institution or its subsidiaries and its affiliates are required to be on terms as favorable to the association as transactions with non-affiliates. In addition, certain of these transactions, such as loans to an affiliate, are restricted to a percentage of the institution's capital. Affiliates of the Bank include the Company and any company which is under common control with the Bank. In addition, a savings institution may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of most affiliates. The OTS has the discretion to treat subsidiaries of savings institutions as affiliates on a case by case basis. On April 1, 2003, the Federal Reserve's Regulation W, which comprehensively amends sections 23A and 23B of the Federal Reserve Act, became effective. The Federal Reserve Act and Regulation W are applicable to savings institutions such as the Bank. The Regulation unifies and updates staff interpretations issued over the years, incorporates 24 several new interpretative proposals (such as to clarify when transactions with an unrelated third party will be attributed to an affiliate) and addresses new issues arising as a result of the expanded scope of nonbanking activities engaged in by banks and bank holding companies in recent years and authorized for financial holding companies under the Gramm-Leach-Bliley Financial Services Modernization Act of 1999. OTS regulations prohibit a savings institution from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary. Certain transactions with directors, officers or controlling persons are also subject to conflict of interest regulations enforced by the OTS. These conflict of interest regulations and other statutes also impose restrictions on loans to such persons and their related interests. Among other things, such loans must be made on terms substantially the same as for loans to unaffiliated individuals. Community Reinvestment Act. Under the Community Reinvestment Act, every FDIC-insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the Community Reinvestment Act. The Community Reinvestment Act requires the OTS, in connection with the examination of the Bank, to assess the institution's record of meeting the credit needs of its community and to take that record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by the Bank. An unsatisfactory rating may be used as the basis for the denial of an application by the OTS. Due to the heightened attention being given to the Community Reinvestment Act in the past few years, the Bank may be required to devote additional funds for investment and lending in its local community. The Bank was examined for Community Reinvestment Act compliance and received a rating of satisfactory in its latest examination. Affiliate Transactions. The Company and the Bank are separate and distinct legal entities. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company, generally limiting any single transaction to 10% of the Bank's capital and surplus and limiting all such transactions to 20% of the Bank's capital and surplus. These transactions also must be on terms and conditions consistent with safe and sound banking practices that are substantially the same as those prevailing at the time for transactions with unaffiliated companies. Federally insured savings institutions are subject, with certain exceptions, to certain restrictions on extensions of credit to their parent holding companies or other affiliates, on investments in the stock or other securities of affiliates and on the taking of such stock or securities as collateral from any borrower. In addition, these institutions are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or the providing of any property or service. Regulatory and Criminal Enforcement Provisions. The OTS has primary enforcement responsibility over savings institutions and has the authority to bring action against all "institution-affiliated parties," including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers or directors, receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or $1.1 million per day in especially egregious cases. The FDIC has the authority to recommend to the Director of the OTS that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations. Environmental Issues Associated with Real Estate Lending. The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), a federal statute, generally imposes strict liability on all prior and present "owners and operators" of sites containing hazardous waste. However, Congress asked to protect secured creditors by providing that the term "owner and operator" excludes a person whose ownership is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this "secured creditor exemption" has been the subject of 25 judicial interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan. To the extent that legal uncertainty exists in this area, all creditors, including the Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs, which costs often substantially exceed the value of the collateral property. Privacy Standards. On November 12, 1999, the Gramm-Leach-Bliley Financial Services Modernization Act of 1999 ("GLBA") was signed into law. The purpose of this legislation is to modernize the financial services industry by establishing a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms and other financial service providers. The Bank is subject to OTS regulations implementing the privacy protection provisions of the GLBA. These regulations require the Bank to disclose its privacy policy, including identifying with whom it shares "non-public personal information," to customers at the time of establishing the customer relationship and annually thereafter. The regulations also require the Bank to provide its customers with initial and annual notices that accurately reflect its privacy policies and practices. In addition, the Bank is required to provide its customers with the ability to "opt-out" of having the Bank share their non-public personal information with unaffiliated third parties before they can disclose such information, subject to certain exceptions. The Bank is subject to regulatory guidelines establishing standards for safeguarding customer information. These regulations implement certain provisions of the GLBA. The guidelines describe the agencies' expectations for the creation, implementation and maintenance of an information security program, which includes administrative, technical and physical safeguards appropriate to the size and complexity of the institution and the nature and scope of its activities. The standards set forth in the guidelines are intended to insure the security and confidentiality of customer records and information, protect against any anticipated threats or hazards to the security or integrity of such records and protect against unauthorized access to or use of such records or information that could result in substantial harm or inconvenience to any customer. Anti-Money Laundering and Customer Identification. In response to the terrorist events of September 11, 2001, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the "USA Patriot Act") was signed into law on October 26, 2001. The USA Patriot Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. The Bank Secrecy Act, Title III of the USA Patriot Act takes measures intended to encourage information sharing among bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions. Title III and the related OTS regulations impose the following requirements on financial institutions: * establishment of anti-money laundering programs; * establishment of a program specifying procedures for obtaining identifying information from customers seeking to open new accounts, including verifying the identity of customers within a reasonable period of time; * establishment of enhanced due diligence policies, procedures and controls designed to detect and report money laundering; and * prohibitions on correspondent accounts for foreign shell banks and compliance with record keeping obligations with respect to correspondent accounts of foreign banks. Bank regulators are directed to consider a holding company's effectiveness in combating money laundering when ruling on Federal Reserve Act and Bank Merger Act applications. The Bank's policies and procedures have been updated to reflect the requirements of the USA Patriot Act, which had a minimal impact on business and customers. 26 Savings and Loan Holding Company Regulations - -------------------------------------------- General. The Company is a unitary savings and loan holding company subject to regulatory oversight of the OTS. Accordingly, the Company is required to register and file reports with the OTS and is subject to regulation and examination by the OTS. In addition, the OTS has enforcement authority over the Company and its non-savings institution subsidiaries which also permits the OTS to restrict or prohibit activities that are determined to present a serious risk to the subsidiary savings institution. Mergers and Acquisitions. The Company must obtain approval from the OTS before acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company or acquiring such an institution or holding company by merger, consolidation or purchase of its assets. In evaluating an application for the Company to acquire control of a savings institution, the OTS would consider the financial and managerial resources and future prospects of the Company and the target institution, the effect of the acquisition on the risk to the insurance funds, the convenience and the needs of the community and competitive factors. Activities Restrictions. As a unitary savings and loan holding company, the Company generally is not subject to activity restrictions. The Company and its non-savings institution subsidiaries are subject to statutory and regulatory restrictions on their business activities specified by federal regulations, which include performing services and holding properties used by a savings institution subsidiary, activities authorized for savings and loan holding companies as of March 5, 1987, and non-banking activities permissible for bank holding companies pursuant to the Bank Holding Company Act of 1956 or authorized for financial holding companies pursuant to the GLBA. If the Bank fails the QTL test, the Company must, within one year of that failure, register as, and will become subject to, the restrictions applicable to bank holding companies. See "- Federal Regulation of Savings Institutions - - Qualified Thrift Lender Test." Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") was signed into law on July 30, 2002 in response to public concerns regarding corporate accountability in connection with the recent accounting scandals at Enron and WorldCom. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission ("SEC") under the Securities Exchange Act of 1934, including the Company. The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and related rules. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. TAXATION Federal Taxation - ---------------- General. The Company and the Bank report their income on a fiscal year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to the Bank or the Company. Bad Debt Reserve. Historically, savings institutions such as the Bank which met certain definitional tests primarily related to their assets and the nature of their business ("qualifying thrift") were permitted to establish a reserve for bad debts and to make annual additions thereto, which may have been deducted in arriving at their taxable income. 27 The Bank's deductions with respect to "qualifying real property loans," which are generally loans secured by certain interest in real property, were computed using an amount based on the Bank's actual loss experience, or a percentage equal to 8% of the Bank's taxable income, computed with certain modifications and reduced by the amount of any permitted additions to the non-qualifying reserve. Due to the Bank's loss experience, the Bank generally recognized a bad debt deduction equal to 8% of taxable income. The thrift bad debt rules were revised by Congress in 1996. The new rules eliminated the 8% of taxable income method for deducting additions to the tax bad debt reserves for all thrifts for tax years beginning after December 31, 1995. These rules also required that all institutions recapture all or a portion of their bad debt reserves added since the base year (last taxable year beginning before January 1, 1988). The Bank has no post-1987 reserves subject to recapture. For taxable years beginning after December 31, 1995, the Bank's bad debt deduction will be determined under the experience method using a formula based on actual bad debt experience over a period of years. The unrecaptured base year reserves will not be subject to recapture as long as the institution continues to carry on the business of banking. In addition, the balance of the pre-1988 bad debt reserves continue to be subject to provisions of present law referred to below that require recapture in the case of certain excess distributions to shareholders. Distributions. To the extent that the Bank makes "nondividend distributions" to the Company, these distributions will be considered to result in distributions from the balance of its bad debt reserve as of December 31, 1987 (or a lesser amount if the Bank's loan portfolio decreased since December 31, 1987) and then from the supplemental reserve for losses on loans ("Excess Distributions"), and an amount based on the Excess Distributions will be included in the Bank's taxable income. Nondividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of the Bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Bank's bad debt reserve. The amount of additional taxable income created from an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if, after the Conversion, the Bank makes a "nondividend distribution," then approximately one and one-half times the Excess Distribution would be includable in gross income for federal income tax purposes, assuming a 34% corporate income tax rate (exclusive of state and local taxes). See "Regulation" for limits on the payment of dividends by the Bank. The Bank does not intend to pay dividends that would result in a recapture of any portion of its tax bad debt reserve. Corporate Alternative Minimum Tax. The Code imposes a tax on alternative minimum taxable income ("AMTI") at a rate of 20%. The excess of the tax bad debt reserve deduction using the percentage of taxable income method over the deduction that would have been allowable under the experience method is treated as a preference item for purposes of computing the AMTI. In addition, only 90% of AMTI can be offset by net operating loss carryovers. AMTI is increased by an amount equal to 75% of the amount by which the Bank's adjusted current earnings exceeds its AMTI (determined without regard to this preference and prior to reduction for net operating losses). For taxable years beginning after December 31, 1986, and before January 1, 1996, an environmental tax of 0.12% of the excess of AMTI (with certain modification) over $2.0 million is imposed on corporations, including the Bank, whether or not an Alternative Minimum Tax is paid. Dividends-Received Deduction. The Company may exclude from its income 100% of dividends received from the Bank as a member of the same affiliated group of corporations. The corporate dividends-received deduction is generally 70% in the case of dividends received from unaffiliated corporations with which the Company and the Bank will not file a consolidated tax return, except that if the Company or the Bank owns more than 20% of the stock of a corporation distributing a dividend, then 80% of any dividends received may be deducted. Audits. The Company, the Bank and its consolidated subsidiaries have been audited or their books closed without audit by the IRS with respect to consolidated federal income tax returns through March 31, 1999. See Note 10 of the Notes to Consolidated Financial Statements contained in the Annual Report for additional information regarding income taxes. 28 State Taxation - -------------- South Carolina has adopted the Code as it relates to savings banks, effective for taxable years beginning after December 31, 1986. The Bank is subject to South Carolina income tax at the rate of 6%. The Bank has not been audited by the State of South Carolina during the past five years. The Company's income tax returns have not been audited by federal or state authorities within the last five years. For additional information regarding income taxes, see Note 10 of the Notes to Consolidated Financial Statements contained in the Annual Report. Item 2. Properties - ------------------- At March 31, 2005, Security Federal owned the buildings and land for its main office, five of its branch offices, and the operations center, leased the land and owned the improvements thereon for one of its offices, and leased the remaining five offices. The property related to the offices owned by Security Federal had a depreciated cost (including land) of approximately $4.9 million at March 31, 2005. At March 31, 2005, the aggregate net book value of leasehold improvements (excluding furniture and equipment) associated with leased premises was $1.2 million. See Note 6 of the Notes to Consolidated Financial Statements contained in the Annual Report. The following table sets forth the net book value of the offices owned (including land) and leasehold improvements on properties leased by Security Federal at March 31, 2005. Lease Date Expir- Facility Gross Owned or ation Opened/ Square Net Book Location Leased Date Acquired Footage Value - ---------------------------- ------ ---- -------- ------- ----- Main Office: 1705 Whiskey Road S. Aiken, South Carolina Owned N/A 1980 10,000 $276,000 Full Service Branch Offices 100 Laurens Street, N.W. Aiken, South Carolina Leased 2013 1959 4,500 5,200 313 East Martintowne Road North Augusta, South Carolina Owned (1) N/A 1973 4,356 614,000 1665 Richland Avenue, W. Aiken, South Carolina Owned N/A 1984 1,942 294,000 Montgomery & Canal Streets Masonic Shopping Center Graniteville, South Carolina Leased 2007 1993 (2) 3,576 315,000 2812 Augusta Road Langley, South Carolina Owned N/A 1993 (2) 2,509 127,000 Highway 125 and Highways 1 and 78 Midland Valley Shopping Center Clearwater, South Carolina Leased 2003 1993 (2) 2,287 68,000 29 Lease Date Expir- Facility Gross Owned or ation Opened/ Square Net Book Location Leased Date Acquired Footage Value - ---------------------------- ------ ---- -------- ------- ----- 118 Main Street North Wagener, South Carolina Owned N/A 1993(2) 3,600 $ 208,000 Wal-Mart Superstore 2035 Whiskey Road Aiken, South Carolina Leased 2001 1996 517 86,000 1185 Sunset Boulevard West Columbia, South Carolina Leased 2015 2000 10,000 764,000 5446 Sunset Boulevard Lexington, South Carolina Owned (3) N/A 2003 9,200 1,668,000 Operations Center: 871 East Pine Log Road Aiken, South Carolina Owned N/A 1988 10,000 824,000 - ------------- (1) Security Federal has a lease with options through 2063. (2) Represents acquisition date. (3) Security Federal has a lease on the land for this office which expires in 2018, but has options through 2063. Item 3. Legal Proceedings ----------------- The Company is involved as plaintiff or defendant in various legal actions arising in the course of its business. It is the opinion of management, after consultation with counsel, that the resolution of these legal actions will not have a material adverse effect on the Company's financial condition and results of operations. Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the quarter ended March 31, 2005. PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters ------------------------------------------------------------------ and Issuer Purchases of Equity Securities ----------------------------------------- The information contained in the section captioned "Shareholders Information - Price Range of Common Stock" and "- Dividends" in the Annual Report is incorporated herein by reference. Stock Repurchases. The Company repurchased 8,077 shares of its outstanding Common Stock at a cost of $165,089 during the fourth quarter of the year ended March 31, 2005. In May 2004, the Company announced the authorization to purchase up to 5% of its outstanding shares, or approximately 126,000 shares, subject to market conditions. 30 Item 6. Selected Financial Data ----------------------- The information contained in the section captioned "Selected Consolidated Financial and Other Data" in the Annual Report is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and --------------------------------------------------------------- Results of Operations --------------------- The information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report is incorporated herein by reference. Item 7A. Quantitative and Qualitative Disclosures About Market Risk ---------------------------------------------------------- Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises principally from interest rate risk inherent in our lending, investing, deposit and borrowings activities. Management actively monitors and manages its interest rate risk exposure. In addition to other risks that we manage in the normal course of business, such as credit quality and liquidity, management considers interest rate risk to be a significant market risk that could have a potentially have a material effect on our financial condition and result of operations. The information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management" in the Annual Report is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data ------------------------------------------- Report of Independent and Registered Accounting Firm* Consolidated Balance Sheets, March 31, 2005 and 2004* Consolidated Statements of Income For the Years Ended March 31, 2005, 2004 and 2003* Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income For the Years Ended March 31, 2005, 2004 and 2003* Consolidated Statements of Cash Flows For the Years Ended March 31, 2005, 2004 and 2003* Notes to Consolidated Financial Statements* Quarterly Financial Data (unaudited)* * Contained in the Annual Report filed as an exhibit hereto and incorporated herein by reference. Item 9. Changes in and Disagreements With Accountants on Accounting and --------------------------------------------------------------- Financial Disclosure -------------------- None. Item 9A. Controls and Procedures ----------------------- (a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company's disclosure controls and procedures (as defined in Section 13a-15(e) of the Securities Exchange Act of 1934 (the "Act")) was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management as of the end of the period covered by this report. The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. (b) Changes in Internal Controls: In the year ended March 31, 2005, 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. 31 Item 9B. Other Information ----------------- There was no information to be disclosed by the Company in a report on Form 8-K during the fourth quarter of fiscal 2005 that was not so disclosed. PART III Item 10. Directors and Executive Officers of the Registrant -------------------------------------------------- The information contained under the sections captioned "Election of Directors" and "Executive Officers Who Are Not Directors of the Company or the Bank" in the Proxy Statement are incorporated herein by reference. Audit Committee Financial Expert. The Audit Committee of the Company is composed of Directors Harry O. Weeks (Chairperson), Clyburn and Moore. Each member of the Audit Committee is "independent" as defined in the Nasdaq Stock Market listing standards. The Board of Directors has determined there is no "audit committee financial expert" as defined by the SEC. The Board believes that the current members of the Audit Committee are qualified to serve based on their collective experience and background. Each member of the Audit Committee is independent as that term is used in Item 7(d)(3)(iv) of Schedule 14A promulgated under the Exchange Act. Code of Ethics. The Board of Directors adopted a Code of Ethics for the Company's officers (including its senior financial officers), directors, and employees. The Code is applicable to the Company's principal executive officer and senior financial officers, and requires individuals to maintain the highest standards of professional conduct. A copy of the Code of Ethics is available upon request from the Company. Requests should be made to: Secretary, Security Federal Corporation, P.O. Box 810, Aiken, South Carolina 29802. Item 11. Executive Compensation ---------------------- The information contained in the section captioned "Executive Officers" in the Proxy Statement is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management and ------------------------------------------------------------------ Related Stockholder Matters --------------------------- The information contained in the section captioned "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement is incorporated herein by reference. Equity Compensation Plan Information. The following table sets forth certain information with respect to securities to be issued under the Company's equity compensation plans as of March 31, 2005. Number of securities remaining available for Number of future issuance securities to under equity be issued upon Weighted-average compensation exercise of exercise price plans (excluding outstanding of outstanding securities options, warrants options, warrants reflected Plan category and rights and rights in column (a)) - ---------------------- ---------- ---------- -------------- (a) (b) (c) Equity compensation plans approved by security holders...... 135,292 $19.09 17,000 Equity compensation plans not approved by security holders... N/A N/A N/A ------- ------- ------- Total............ 135,292 $19.09 17,000 ======= ======= ======= 32 Item 13. Certain Relationships and Related Transactions ---------------------------------------------- The information contained in the section captioned "Certain Transactions" in the Proxy Statement is incorporated herein by reference. Item 14. Principal Accountant Fees and Services -------------------------------------- The information contained under the section captioned "Independent Auditors" is included in the Company's Proxy Statement and is incorporated herein by reference. PART IV Item 15. Exhibits and Financial Statement Schedules ------------------------------------------ (a) 1. Financial Statements. --------------------- For a list of the financial statements filed as part of this report see Part II - Item 8. 2. Financial Statement Schedules. ------------------------------ All schedules have been omitted as the required information is either inapplicable or contained in the Consolidated Financial Statements or related Notes contained in the Annual Report filed as an exhibit hereto. 3. Exhibits: -------- 3.1 Articles of Incorporation, as amended (1) 3.2 Bylaws (2) 4 Instruments defining the rights of security holders, including indentures (3) 10.1 Executive Compensation Plans and Arrangements: 10.2 Salary Continuation Agreements (4) 10.3 Amendment One to Salary Continuation Agreements (5) 10.4 1999 Stock Option Plan (2) 10.5 1987 Stock Option Plan (4) 10.6 2002 Stock Option Plan (6) 10.7 2004 Employee Stock Purchase Plan (7) 10.8 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. 33 (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. (7) Filed on June 18, 2004, as an exhibit to the Company's Proxy Statement and incorporated herein by reference. 34 SIGNATURES Pursuant to the requirements of section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SECURITY FEDERAL CORPORATION Date: June 29, 2005 By: /s/ Timothy W. Simmons ----------------------------------- Timothy W. Simmons President, Chief Executive Officer and Director (Duly Authorized Representative) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Timothy W. Simmons June 29, 2005 ------------------------------------------------- Timothy W. Simmons President, Chief Executive Officer and Director (Principal Executive Officer) By: /s/ Roy G. Lindburg June_29, 2005 ------------------------------------------------- Roy G. Lindburg Treasurer, Chief Financial Officer and Director (Principal Financial and Accounting Officer) By: /s/ T. Clifton Weeks June 29, 2005 ------------------------------------------------- T. Clifton Weeks Chairman of the Board and Director By: /s/ J. Chris Verenes June_29, 2005 ------------------------------------------------- J. Chris Verenes President of the Bank and Director of the Company and the Bank By: /s/ Gasper L. Toole III June 29, 2005 ------------------------------------------------- Gasper L. Toole III Director By: /s/ Harry O. Weeks Jr. June 29, 2005 ------------------------------------------------- Harry O. Weeks Jr. Director By: /s/ Robert E. Alexander June 29, 2005 ------------------------------------------------- Robert E. Alexander Director By: /s/Thomas L. Moore June 29, 2005 ------------------------------------------------- Thomas L. Moore Director By: /s/William Clyburn June 29, 2005 ------------------------------------------------- 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 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer of Security Federal Corporation Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32 Certification of Chief Executive Officer and Chief Financial Officer of Security Federal Corporation Pursuant to Section 906 of the Sarbanes-Oxley Act Exhibit 13 Annual Report to Stockholders Annual Report March 31st, 2005 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 Doing what is right. Security Federal had another solid year. We increased our lead in market share in Aiken County, and continue to make significant advances in the South Carolina Midlands' market. We will be opening our new Aiken south side branch in December, and have plans to open several new branches in the Midlands in the next three years. Our Financial Services subsidiaries-Insurance, Investments and Trust-are beginning to develop an outstanding reputation. We are committed to growing our Financial Services in the Security Federal tradition-focusing on what is in the best interest of our customer. We are growing, but we realize that we are going to have to continue to develop differentiators that make us stand apart from our competition. Our employees are providing the difference for us-focusing on the customers' needs and doing what's right. We realize that we are going to have to continue to work harder to be successful against the larger banks. We are committed to doing that by continuing to build on the special relationship we have with our customers and by providing localized expertise that larger banks have difficulty providing. We are committed to building on the tradition of service that this bank has provided since 1922. Fellow Shareholders: In keeping with our conservative but steady growth strategy, Security Federal Corporation, holding company of Security Federal Bank, is pleased to announce an increase in operating earnings for the year ending March 31, 2005. Security Federal Corporation announced earnings totaling $3.5 million or $1.39 per share (basic) for the year ending March 31, 2005 compared to $4.3 million or $1.70 per share (basic) for the year ending March 31, 2004. The Bank sold a branch during the year ending March 31, 2004, which increased net income after tax by approximately $820,000 for that year. Excluding the gain from the branch sale, which occurred in February 2004, earnings increased $62,000 or 2% for the year ending March 31, 2005. Comparative earnings per share (basic) were $1.39 and $1.37 for the years ending March 31, 2005 and 2004 respectively. Factors contributing to the increase in earnings included an increase in net interest income of $660,000 or 5% and a decrease in the provision for loan losses of $420,000 or 35%, both of which were partially offset by a decrease in the gain on sale of mortgage loans of $894,000 or 67%. The reduction in the gain on sale of mortgages was a result of the general decline in mortgage loan originations. General and administrative expenses increased $48,000 or less than 1%. Total assets increased 11% to $586.0 million, net loans receivable increased 22% to $316.9 million, and deposits increased 10% to $430.3 million at March 31, 2005 compared to March 31, 2004, respectively. Moving forward, we will continue building on our foundation by leveraging our core market strengths, the quality of our people and the exceptional service they provide to our customers. 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 31st 2005 2004 Net Income $ 3,505,495 $ 4,263,163 Earnings Per Share - Basic 1.39 1.70 Book Value Per Share 13.92 13.30 Total Interest Income 25,589,649 23,011,005 Total Interest Expense 11,524,745 9,606,100 Net Interest Income Before Provision For Loan Losses 14,064,904 13,404,905 Provision For Loan Losses 780,000 1,200,000 Net Income After Provision For Loan Losses 13,284,904 12,204,905 Net Interest Margin 2.60% 2.84% Total Loans Originated 244,843,000 228,263,000 Adjustable Rate Loans As A Percentage Of Total Gross Loans 59.9% 52.1% 4 Financial Highlights - ------------------------------------------------------------------------------ 2005 2004 2003 2002 2001 ------ ------ ------ ------ ------ Net Income (In Thousands) $3,505 $4,263 $3,231 $2,510 $2,127 2005 2004 2003 2002 2001 ------ ------ ------ ------ ------ Total Assets (In Millions) $ 586 $ 528 $ 445 $ 376 $ 331 2005 2004 2003 2002 2001 ------ ------ ------ ------ ------ Return on Equity 10.28% 13.67% 11.37% 9.97% 9.98% Allowance for Loan Losses (1) 2005 2004 2003 2002 2001 ------ ------ ------ ------ ------ 1.94% 2.17% 1.98% 1.55% 1.19% (1) Allowance for losses as a percentage of total loans. 5 Financial Highlights - ------------------------------------------------------------------------------ 2005 2004 2003 2002 2001 ------ ------ ------ ------ ------ Book Value Per Share $13.92 $13.30 $11.98 $10.18 $ 9.43 2005 2004 2003 2002 2001 ------ ------ ------ ------ ------ Earnings Per Share - Basic $1.39 $ 1.70 $ 1.29 $ 1.00 $ 0.85 Security Federal Corporation Stock Prices 3/2005 3/2004 9/2003 3/2003 9/2002 3/2002 9/2001 3/2001 9/2000 3/2000 9/1999 3/1999 9/1998 - ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ 23.00 21.00 24.50 20.26 22.33 21.67 21.00 20.00 18.33 18.00 17.17 15.00 8.33 3/1998 9/1997 3/1997 9/1996 3/1996 9/1995 3/1995 9/1994 3/1994 9/1993 3/1993 9/1992 3/1992 - ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ 7.33 7.33 5.17 4.83 4.54 4.13 3.65 3.53 3.37 2.83 2.75 2.59 2.54 9/1991 3/1991 9/1990 3/1990 9/1989 3/1989 9/1988 3/1988 - ------ ------ ------ ------ ------ ------ ------ ------ 2.46 2.46 2.52 2.40 1.89 1.83 1.42 1.75
6 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Selected Consolidated Financial Statements At Or For The Year Ended March 31, ------------------------------------------------- 2005 2004 2003 2002 2001 -------- -------- -------- -------- -------- Balance Sheet Data (Dollars In Thousands, Except Per Share Data) - -------------------- Total Assets $585,978 $528,005 $444,904 $376,320 $330,642 Cash And Cash Equivalents 7,916 6,749 8,239 11,528 12,616 Investment And Mortgage- Backed Securities 241,076 245,715 182,117 118,898 74,405 Total Loans Receivable, Net (1) 316,889 259,895 243,156 234,319 230,997 Deposits 430,287 389,593 358,474 309,038 257,410 Advances From Federal Home Loan Bank 112,038 96,336 49,772 33,108 42,704 Total Shareholders' Equity 35,111 33,472 30,040 25,401 23,500 Income Data - -------------------- Total Interest Income 25,590 23,011 23,660 24,632 24,153 Total Interest Expense 11,525 9,606 10,016 12,211 13,871 -------- -------- -------- -------- -------- Net Interest Income 14,065 13,405 13,644 12,421 10,282 Provision For Loan Losses 780 1,200 1,800 1,525 925 -------- -------- -------- -------- -------- Net Interest Income After Provision For Loan Losses 13,285 12,205 11,844 10,896 9,357 Other Income 2,704 5,235 3,811 3,465 2,739 General And Administrative Expense 10,773 10,725 10,483 10,337 8,851 Income Taxes 1,711 2,452 1,941 1,514 1,118 -------- -------- -------- -------- -------- Net Income $ 3,505 $ 4,263 $ 3,231 $ 2,510 $ 2,127 ======== ======== ======== ======== ======== Per Common Share Data - --------------------- Net Income Per Common Share (Basic) $ 1.39 $ 1.70 $ 1.29 $ 1.00 $ 0.85 ======== ======== ======== ======== ======== Cash Dividends Declared $ 0.11 $ 0.08 $ 0.0602 $ 0.0536 $ 0.0536 ======== ======== ======== ======== ======== Other Data - -------------------- Interest Rate Spread Information: Average During Period 2.40% 2.66% 3.19% 3.42% 3.00% End Of Period 2.45% 2.59% 3.00% 3.48% 3.11% Net Interest Margin (Net Interest Income/ Average Earning Assets) 2.60% 2.84% 3.46% 3.73% 3.38% Average Interest-Earning Assets To Average Interest- Bearing Liabilities 109.07% 109.05% 110.47% 108.80% 108.39% Equity To Total Assets 5.99% 6.34% 6.75% 6.75% 7.11% Non-Performing Assets To Total Assets (2) 0.42% 0.40% 0.27% 0.40% 0.11% Return On Assets (Ratio Of Net Income To Average Total Assets) 0.63% 0.87% 0.79% 0.71% 0.66% Return On Equity (Ratio Of Net Income To Average Equity) 10.28% 13.67% 11.37% 9.97% 9.98% Equity To Assets Ratio (Ratio Of Average Equity To Average Total Assets) 6.09% 6.36% 6.90% 7.14% 6.62% Dividend Pay-Out Ratio On Common Shares 7.96% 4.75% 4.69% 5.37% 6.33% Number Of Full-Service Offices 11 11 11 11 11 (1) INCLUDES LOANS HELD FOR SALE. (2) NON-PERFORMING ASSETS CONSIST OF NON-ACCRUAL LOANS AND REPOSSESSED ASSETS. 7 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of 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, 2005 and 2004" herein for a further discussion of the Company's estimation process and methodology related to the allowance for loan losses. Asset and Liability Management The Bank's program of asset and liability management seeks to limit the Bank's vulnerability to material and prolonged increases or decreases in interest rates, or "interest rate risk." The principal determinant of the exposure of the Bank's earnings to interest rate risk is the timing difference ("gap") between the repricing or maturity of the Bank's interest-earning assets and the repricing or maturity of its interest-bearing liabilities. If the maturities of the Bank's assets and liabilities were perfectly matched and the interest rates borne by its assets and liabilities were equally flexible and moved concurrently (neither of which is the case), the impact on net interest income of any material and prolonged changes in interest rates would be minimal. A 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, 2005, the negative mismatch of interest-earning assets repricing or maturing within one year with interest-bearing liabilities repricing or maturing within one year was $98.6 million or 16.9% of total assets compared to $87.0 million or 16.5% at March 31, 2004. The increase in the negative gap was attributable to an overall $47.6 million increase in interest-bearing liabilities repricing within one year compared to an increase of $35.9 million in financial assets repricing within one year. Certificates of deposits and Borrowings re-pricing within one year increased $6.1 million and $32.4 million, respectively, at March 31, 2005. In addition, money market, savings, and interest-bearing checking accounts increased a total of $9.0 million. These accounts are assumed to reprice within one year, where in actuality, they may not be quite 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, despite an abundance of adjustable rate commercial loans added to the loan portfolio, 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, 2005, 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 $43.6 million in adjustable rate residential real estate loans ("ARM's"), which are held for investment and not sold. The Bank's loan portfolio included $202.4 million of adjustable rate consumer loans, commercial loans, and mortgage loans or, approximately 59.9% of total gross loans at March 31, 2005. During fiscal 2005, the Bank originated a total of $163.7 million in consumer and commercial loans, which are usually short term in nature. During fiscal 2005, 92.2% of total new loan originations on loans held for investment were comprised of consumer, commercial, and ARM's compared to 93.5% of originations of loans held for investment in fiscal 2004. The Bank's portfolio of consumer and commercial loans was $213.1 million at March 31, 2005, $166.8 million at March 31, 2004, and $153.6 million at March 31, 2003. Consumer and commercial loans combined were 63.0% of total loans at March 31, 2005, 59.9% at March 31, 2004, and 59.7% at March 31, 2003. The Bank originated $15.2 million, $11.8 million, and $10.5 million in fixed rate residential loans as loans held for investment, most of which were residential lot loans with terms of two to five years, in fiscal 2005, 2004, and 2003, respectively. At March 31, 2005, these fixed rate residential lot loans, including fixed rate construction loans with terms of one year or less, amounted to $21.8 million or 6.5% of the total loan portfolio compared to $32.5 million or 11.7% at the end of the previous fiscal year. At March 31, 2005, the Bank held approximately $9.5 million in longer term fixed rate residential mortgage loans. These loans, which amounted to 2.8% of the total loan portfolio, had converted from ARM loans to fixed rate loans during the previous 36 months. These fixed rate loans have remaining maturities ranging from 10 to 27 years. The Bank has approximately $16.4 million remaining in convertible ARM loans that could convert to fixed rate loans over the next 24 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 2005, 2004, 2003, and 2002, the Bank sold its new fixed rate residential loan originations exclusively on a service-released basis. Fixed rate residential loans sold to Freddie Mac and other institutional investors, on a service-released basis, totaled $26.0 million in fiscal 2005, $63.5 million in fiscal 2004, $80.3 million in fiscal 2003, and $84.5 million in fiscal 2002. The decrease in loans sold in fiscal 2005 was due to the general decline in mortgage loan originations. Certificates of deposit of $100,000 or more, referred to as "Jumbo Certificates," are normally considered to be interest rate sensitive because of their relatively short maturities. Many financial institutions have used Jumbo Certificates to manage interest rate sensitivity and liquidity. The Bank has not relied on Jumbo Certificates for liquidity or asset liability management. As of March 31, 2005, the Bank had $61.7 million outstanding in Jumbo Certificates compared to $47.0 million at March 31, 2004. 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, 2005. At March 31, 2005 (In thousands) Within 3 Months $ 12,953 After 3, Within 6 Months 15,535 After 6, Within 12 Months 9,539 After 12 Months 23,652 -------------- $ 61,679 ============== 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 ------------------------ 2005 2004 --------- --------- (Dollars in Thousands) Loans (1) $ 215,751 $ 146,932 Mortgage-Backed Securities: Held To Maturity 79 103 Available For Sale 69,800 68,421 Investment Securities: Held To Maturity 7,000 25,974 Available For Sale 1,784 16,900 Other Interest-Earning Assets 164 303 --------- --------- Total Interest Rate Sensitive Assets Repricing Within 1 Year $ 294,578 $ 258,633 --------- --------- Deposits 336,881 321,785 FHLB Advances And Other Borrowed Money 56,269 23,813 --------- --------- Total Interest Rate Sensitive Liabilities Repricing Within 1 Year $ 393,150 $ 345,598 --------- --------- Gap $ (98,572) $ (86,965) ========= ========= Interest Rate Sensitive Assets/ Interest Rate Sensitive Liabilities 74.93% 74.84% Gap As A Percent Of Total Assets (16.9)% (16.5)% (1) LOANS ARE NET OF UNDISBURSED FUNDS AND LOANS IN PROCESS. 11 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Asset and Liability Management, Continued The following table sets forth the interest sensitivity of the Bank's assets and liabilities at March 31, 2005, on the basis of the factors and assumptions set forth in the table on the previous page. (Dollars in Thousands) < Three 3-12 1-3 3-5 5-10 > 10 Months Months Years Years Years Years Total -------- -------- ------- ------- ------- ------- -------- Interest-Earnings Assets - ------------------------ Loans (1) $ 141,325 $ 74,426 $ 67,496 $ 28,684 $ 7,097 $ 4,306 $323,334 Mortgage-Backed Securities: Held To Maturity, At Cost 21 58 152 29 - - 260 Available For Sale, At Fair Value 29,375 40,425 56,542 18,566 11,966 2,486 159,360 Investment Securities: (2) Held To Maturity, At Cost 1,000 6,000 33,068 27,931 8,002 - 76,001 Available For Sale, At Fair Value 180 1,604 2,855 500 316 - 5,455 FHLB Stock, At Cost - - 6,235 - - - 6,235 Other Interest-Earning Assets 164 - - - - - 164 --------- -------- -------- -------- -------- -------- -------- Total Financial Assets $ 172,065 $122,513 $166,348 $ 75,710 $ 27,381 $ 6,792 $570,809 ========= ======== ======== ======== ======== ======== ======== Interest-Bearing Liabilities - ---------------------------- Deposits: Certificate Accounts $ 29,492 $ 66,215 $ 58,785 $ 5,794 $ - $ - $160,286 NOW Accounts 59,342 - - - - - 59,342 Money Market Accounts 164,088 - - - - - 164,088 Passbook Accounts 17,744 - - - - - 17,744 Borrowings 18,269 38,000 46,000 15,000 363 - 117,632 --------- -------- -------- -------- -------- -------- -------- Total Interest-Bearing Liabilities $ 288,935 $104,215 $104,785 $ 20,794 $ 363 $ - $519,092 ========= ======== ======== ======== ======== ======== ======== Current Period Gap $(116,870) $ 18,298 $ 61,563 $ 54,916 $ 27,018 $ 6,792 $ 51,717 Cumulative Gap $(116,870) $(98,572) $(37,009) $ 17,907 $ 44,925 $ 51,717 $ 51,717 Cumulative Gap As A Percent Of Total Assets (19.9)% (16.8)% (6.3)% 3.1% 7.7% 8.8% 8.8% (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, 2005.
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, 2005 were $586.0 million, an increase of $58.0 million or 11.0% from March 31, 2004. This increase was the result of an increase in net loans receivable offset partially by a slight decrease in total investment and mortgage-backed securities. Total net loans receivable were $316.9 million at March 31, 2005, an increase of $57.0 million or 21.9% from $259.9 million at March 31, 2004. Residential real estate loans increased $12.9 million or 11.8% to $122.6 million at March 31, 2005. 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, 2005, the Bank held 74.9% of its residential mortgage loans in ARMs, while it had 25.1% in fixed rate mortgages. Consumer loans increased $5.2 million or 11.4% while commercial business and commercial real estate loans increased $41.1 million or 33.9% to $162.2 million at fiscal year end from $121.1 million at March 31, 2004. A large portion of the increased activity in commercial lending took place in the Midlands area of South Carolina including Columbia, Lexington, and West Columbia. A significant portion of these loans are acquisition and development loans. Loans held for sale, which were $2.3 million at March 31, 2005, increased $574,000 from the previous fiscal year end. Total investments and mortgage-backed securities decreased $4.6 million or 1.9% to help fund the growth in the loan portfolio. Repossessed assets increased $2,000 to $53,000 at March 31, 2005 from $51,000 at March 31, 2004. Repossessed assets at March 31, 2005 consisted of one single-family dwelling, acreage, and a developed lot. Non-accrual loans totaled $2.4 million at March 31, 2005 compared to $2.0 million a year earlier. Non-accrual loans averaged $2.3 million in fiscal 2005 compared to $1.8 million during fiscal 2004. The Bank classifies all loans as non-accrual when they become 90 days or more delinquent. The Bank had six loans that were troubled debt restructurings totaling $434,000 at March 31, 2005 compared to seven loans totaling $646,000 at March 31, 2004. One $13,000 consumer loan secured by a second mortgage on a residential dwelling was 30 days delinquent at March 31, 2005. The other five troubled debt restructurings, which were current in payments on March 31, 2005, consisted of three consumer loans secured by first mortgages on residential dwellings totaling $345,000, a $56,000 commercial loan secured by two rental properties, and a $20,000 unsecured commercial loan. All troubled debt restructurings are also considered impaired. At March 31, 2005, the Bank held $1.2 million in impaired loans compared to $1.4 million at March 31, 2004. The Bank reviews its loan portfolio and allowance for loan losses on a monthly basis. Future additions to the Bank's allowance for loan losses are dependent on, among other things, the performance of the Bank's loan portfolio, the economy, changes in real estate values, and interest rates. There can be no assurance that additions to the allowance will not be required in future periods. Management continually monitors its loan portfolio for the impact of local economic changes. The ratio of allowance for loan losses to total loans was 1.94% at March 31, 2005 compared to 2.17% at March 31, 2004. Deposits at the Bank increased $40.7 million or 10.5% to $430.3 million at March 31, 2005 from $389.6 million at March 31, 2004. The Bank was very successful in attracting certificate of deposit accounts and, to a lesser extent, money market accounts with aggressive pricing and advertising. Advances from the Federal Home Loan Bank ("FHLB") increased to $112.0 million at March 31, 2005 from $96.3 million a year earlier, an increase of $15.7 million. Other borrowed money, which consists of retail repurchase agreements, increased $117,000 or 2.1% to $5.6 million at March 31, 2005 from to $5.5 million at March 31, 2004. Total shareholders' equity was $35.1 million at March 31, 2005, an increase of $1.6 million or 4.9% from $33.5 million a year earlier. The increase was attributable to net income of $3.5 million, proceeds from the exercise of stock options of $168,000, and a decrease in the employee stock ownership debt of $61,000, offset partially by a net decrease in accumulated other comprehensive income of $1.7 million, the purchase of $165,000 of treasury stock, and $279,000 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 attributable to volume and the change attributable to rate. Fiscal Year 2005 Compared To 2004 Fiscal Year 2004 Compared To 2003 --------------------------------- --------------------------------- Volume Rate Net Volume Rate Net ------ ---- --- ------ ---- --- (In Thousands) Interest-Earning Assets: Loans: (1) Real Estate Loans $ 542 $(576) $ (34) $ 142 $ (864) $ (722) Other Loans 1,672 (265) 1,407 448 (1,206) (758) ------- ----- ------ ------- ------- ------- Total Loans 2,214 (841) 1,373 590 (2,070) (1,480) Mortgage-Backed Securities (2) 948 158 1,106 2,160 (1,134) 1,026 Investments (2) 156 (68) 88 396 (562) (166) Other Interest-Earning Assets 1 11 12 (21) (7) (28) ------- ----- ------ ------- ------- ------- Total Interest-Earning Assets $ 3,319 $(740) $2,579 $ 3,125 $(3,773) $ (648) ======= ===== ====== ======= ======= ======= Interest-Bearing Liabilities: Deposits: Certificate Accounts $ (38) $ 154 $ 116 $ (324) $(1,196) $(1,520) NOW Accounts 2 (11) (9) 32 (10) 22 Money Market Accounts 669 214 883 1,041 (441) 600 Savings Accounts 4 (5) (1) 19 (82) (63) ------- ----- ------ ------- ------- ------- Total Deposits 637 352 989 768 (1,729) (961) Borrowings 1,120 (190) 930 1,310 (759) 551 ------- ----- ------ ------- ------- ------- Total Interest-Bearing Liabilities 1,757 162 1,919 2,078 (2,488) (410) ------- ----- ------ ------- ------- ------- Effect On Net Income $ 1,562 $(902) $ 660 $ 1,047 $(1,285) $ (238) ======= ===== ====== ======= ======= ======= (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/ 2005 2004 2003 Rate At -------------------------- -------------------------- ------------------------- March 31, Average Yield/ Average Yield/ Average Yield/ 2005 Balance Interest Rate Balance Interest Rate Balance Interest Rate -------- ------- -------- ------ ------- -------- ------ ------- -------- ------ (Dollars in Thousands) Interest-Earning Assets: Mortgage Loans 5.28% $102,365 $ 5,523 5.40% $ 92,824 $ 5,557 5.99% $ 90,729 $ 6,279 6.92% Other Loans 7.04% 179,251 11,299 6.30% 152,922 9,892 6.47% 146,581 10,650 7.27% ---- -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Loans(1) 6.32% 281,616 16,822 5.97% 245,746 15,449 6.29% 237,310 16,929 7.13% Mortgage-Backed Securities(2) 3.80% 167,582 5,585 3.33% 139,025 4,479 3.22% 77,911 3,453 4.43% Investments(2) 3.55% 89,813 3,155 3.51% 85,480 3,067 3.59% 75,468 3,233 4.28% Other Interest- Earning Assets 2.78% 1,647 28 1.70% 1,542 16 1.04% 3,478 44 1.27% ---- -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Interest- Earning Assets 5.07% $540,658 $25,590 4.73% $471,793 $23,011 4.88% $394,167 $23,659 6.00% ==== ======== ======= ==== ======== ======= ==== ======== ======= ==== Interest-Bearing Liabilities: Certificate Accounts 2.92% $142,459 $ 3,598 2.53% $143,986 $ 3,482 2.42% $154,614 $ 5,002 3.24% NOW Accounts 0.97% 58,092 345 0.59% 57,825 354 0.61% 52,455 332 0.63% Money Market Accts. 2.57% 166,735 3,601 2.16% 135,190 2,718 2.01% 86,093 2,118 2.46% Savings Accounts 0.98% 17,657 173 0.98% 17,291 174 1.01% 15,859 237 1.49% ---- -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Interest- Bearing Accounts 2.40% 384,943 7,717 2.01% 354,292 6,728 1.90% 309,021 7,689 2.49% Other Borrowings 2.54% 5,488 84 1.53% 5,361 52 0.97% 5,663 89 1.57% FHLB Advances 3.41% 105,272 3,724 3.54% 72,995 2,826 3.87% 42,123 2,238 5.31% ---- -------- ------- ---- -------- ------- ---- -------- ------- ---- Total Interest- Bearing Liabilities 2.62% $495,703 $11,525 2.33% $432,648 $ 9,606 2.22% $356,807 $10,016 2.81% ==== ======== ======= ==== ======== ======= ==== ======== ======= ==== Net Interest Income $14,065 $13,405 $13,643 ======= ======= ======= Interest Rate Spread 2.45% 2.40% 2.66% 3.19% ==== ==== ==== ==== Net Yield On Earning Assets 2.60% 2.84% 3.46% ==== ==== ==== (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, 2005 and 2004 General The Company's earnings were $3.5 million for the year ended March 31, 2005, compared to $4.3 million for the year ended March 31, 2004. The Bank sold a branch office in the year ended March 31, 2004, which increased earnings for that year by $820,000 after tax. Without the branch sale, earnings for fiscal 2005 would have increased $62,000 or 1.8% over the previous year. Net Interest Income Net interest income increased $660,000 or 4.9% to $14.1 million in fiscal 2005 from $13.4 million in fiscal 2004. The increase was attributable to an increase in average interest earning assets of $68.9 million, despite a shrinking interest rate spread. The Bank's interest rate spread decreased 26 basis points to 2.40% during fiscal 2005. The yield of average earning assets decreased 15 basis points to 4.73%, while the cost of average interest bearing liabilities increased 11 basis points to 2.33%. Interest income on loans increased $1.4 million to $16.8 million during the year ended March 31, 2005 from $15.4 million during fiscal 2004. The increase was attributable to an increase in average total loans outstanding of $35.9 million, offset partially by a 32 basis point decrease in the overall yield earned on the Bank's loans during fiscal 2005. Interest income on investment securities, mortgage-backed securities, and other investments increased $1.2 million as a result of a $33.0 million, or 14.6% increase in aggregate average balances during fiscal 2005 compared with fiscal 2004. The yields on aggregate investments and mortgage-backed securities increased four basis points in fiscal 2005 compared to fiscal 2004. Interest expense on deposits increased $989,000 or 14.7% to $7.7 million during the year ended March 31, 2005 from $6.7 million during the year ended March 31, 2004. Average interest bearing deposits increased $30.7 million while the average cost of those deposits increased 11 basis points during the year. Interest expense on FHLB advances and other borrowings increased $930,000 or 32.3% to $3.8 million during fiscal 2005 from $2.9 million during fiscal 2004. The increase was a result of an increase in average FHLB advances outstanding during the year of $32.4 million offset partially by a decrease in the weighted average interest rate paid on FHLB advances of 33 basis points to 3.54%. Provision for Loan Losses The Company's provision for loan losses decreased $420,000 to $780,000 during the year ended March 31, 2005 from $1.2 million in fiscal 2004. The amount of the provision is determined by management's on-going monthly analysis of the loan portfolio. Management uses three methods to measure the estimate of the adequacy of the allowance for loan losses. These methods incorporate percentage of classified loans, five-year averages of historical loan losses in each loan category and current economic trends, and the assignment of percentage targets of reserves in each loan category. Management has used all three methods for the past six fiscal years. Non-accrual loans, which are loans delinquent 90 days or more, were $2.4 million at March 31, 2005 compared to $2.0 million at March 31, 2004. Net charge-offs were $260,000 in fiscal 2005 compared to $347,000 in fiscal 2004. The ratio of the allowance for loan losses to total loans at March 31, 2005 was 1.94% compared to 2.17% at March 31, 2004. Management believes the allowance for loan losses is adequate based on its best estimates of the losses inherent in the loan portfolio, although there can be no guarantee as to these estimates. In addition, bank regulatory agencies may require additions to the allowance for loan losses based on their judgments and estimates as part of their examination process. Because the allowance for loan losses is an estimate, there can be no guarantee that actual loan losses would not exceed the allowance for loan losses or that additional increases in the allowance for loan losses will not be required in the future. 16 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations Other Income Other income decreased $2.5 million from $5.2 million during fiscal 2004 to $2.7 million during fiscal 2005 as a result of the gain on the sale of the Denmark, South Carolina branch, which took place in fiscal 2004, of $1.5 million before tax and contingencies and a decrease in the gain on sale of mortgage loans of $894,000. Without the branch sale, other income would have decreased $1.0 million or 8.9%. Gain on sale of loans decreased to $436,000 during fiscal 2005 from $1.3 million in fiscal 2004 as a result of the general decline in mortgage loan originations. Loan servicing fees decreased $34,000 or 15.8% to $180,000 during fiscal 2005 as a result of a reduction in late charge fees collected. Service fees on deposit accounts decreased $125,000 or 9.3% to $1.2 million as a result of an increase in the average interest rate used to offset commercial analysis charges on business demand accounts. Other miscellaneous income including trust fees, life and casualty commissions, annuity and investment brokerage commissions, credit life insurance, and other miscellaneous income increased $51,000 or 6.3% to $863,000 during fiscal 2005. The Bank's three financial subsidiaries, Security Federal Insurance, Inc., Security Federal Investments, Inc., and Security Federal Trust, Inc., began operating in the latter part of the fiscal year ended March 31, 2002. Security Federal Insurance, Inc. is an insurance agency handling property and casualty insurance and life and health insurance. It became profitable during the fiscal year ended March 31, 2004. Security Federal Investments, Inc. markets mutual funds, discount brokerage, and annuities. Security Federal Trust, Inc., is a full-service trust company. Security Federal Investments, Inc. and Security Federal Trust, Inc. have not yet attained profitability. General and Administrative Expenses General and administrative expenses increased $48,000 or 0.5% to $10.8 million during the year ended March 31, 2005 from $10.7 million for the same period one year earlier. Compensation and employee benefits increased $233,000 or 3.9% to $6.3 million as a result of normal annual salary adjustments. Occupancy expense increased $101,000 or 10.2% to $1.1 million as a result of the depreciation of renovations of three branch offices and a full year of depreciation on a branch renovated in fiscal 2004. Advertising expense decreased $28,000 or 13.4% to $183,000 while depreciation and maintenance of equipment expense decreased $39,000 or 3.6% to $1.0 million. FDIC insurance premiums increased $2,000 or 4.0% to $58,000. Other miscellaneous expenses, which encompasses repossessed assets expense, legal, professional, and consulting expenses, stationery and office supplies, and other sundry expenses decreased $220,000 or 9.3% during fiscal 2005. Income Taxes The provision for income taxes decreased $741,000 to $1.7 million or 30.1% during the year ended March 31, 2005 compared to $2.4 million for the year ended March 31, 2004, a result of a decrease in taxable income. The effective tax rate was 32.8% for fiscal 2005 and 36.5% for fiscal 2004. 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, 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 from $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 from $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 compared to fiscal 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 fiscal 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 fiscal 2003. Interest expense on deposits decreased $961,000 or 12.5% to $6.7 million during the year ended March 31, 2004 from $7.7 million for 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% to $2.9 million 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 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 the assignment of 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 allowace 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 $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 from $1.6 million during 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% to $1.3 million, 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 from $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. Security Federal Investments, Inc. and Security Federal Trust, Inc 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 from $10.5 million during the same period one year earlier primarily as a result of a $200,000 contingency expensed for the sale of the Denmark, South Carolina 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% to $6.0 million as a result of normal annual salary adjustments. Occupancy expense increased $172,000 or 21.1% to $985,000 as a result of 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 from $1.9 million for the year ended March 31, 2003, as a result of an increase in taxable income. The effective tax rate was 36.5% for fiscal 2004 and 37.5% for fiscal 2003. 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, ---------------------- 2005 2004 ------ ------ (In Thousands) Shareholders' Equity (1) (2) $35,652 $32,140 Reduction For Goodwill And Other Intangibles - - ------- ------- Tangible Capital 35,652 32,140 ------- ------- Qualifying Core Deposit Intangibles - - Core Capital 35,652 32,140 ------- ------- Supplemental Capital 4,236 3,412 Less Assets Required To Be Deducted 30 54 ------- ------- Total Risk-Based Capital $39,858 $35,498 ======= ======= (1) FOR FISCAL 2005 AND 2004, EXCLUDES UNREALIZED LOSS OF $962,000 AND UNREALIZED GAIN OF $690,000, RESPECTIVELY ON AVAILABLE FOR SALE SECURITIES. (2) FOR FISCAL 2005 AND 2004, EXCLUDES EQUITY OF THE COMPANY. The following table compares the Bank's capital levels relative to regulatory requirements at March 31, 2005: Amount Percent Actual Actual Excess Excess Required Required Amount Percent Amount Percent -------- -------- ------ ------- ------- ------- (Dollars in Thousands) Tangible Capital $11,736 2.0% $35,652 6.1% $23,916 4.1% Tier 1 Leverage (Core) Capital 23,472 4.0% 35,652 6.1% 12,180 2.1% Tier 1 Risk-Based (Core) Capital 13,555 4.0% 35,652 10.5% 22,097 6.5% Total Risk-Based Capital 27,110 8.0% 39,858 11.8% 12,748 3.8% 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 $229.1 million in fiscal 2005 compared to $180.9 million in fiscal 2004 and $145.3 million in fiscal 2003. The bulk of the increase in originations in fiscal 2005 was due primarily to an increase in commercial loan originations, which increased $45.9 million. Purchases of investments and mortgage-backed securities were $79.3 million in fiscal 2005 compared to $200.9 million in fiscal 2004 and $168.2 million in fiscal 2003. Another use of the Bank's funds is the building and renovation of branch offices. The Bank plans to consider expanding its branch network in Aiken and Lexington Counties during the next few years. Outstanding loan commitments for the Bank's residential mortgage loan portfolio amounted to $180,000 at March 31, 2005 compared to $429,000 at March 31, 2004. 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 $58.2 million at March 31, 2005. 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 $14.6 million at March 31, 2005, 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 $40.7 million during fiscal 2005, and from maturing investments. Also, the Bank has another $63.5 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 varies with the need to invest excess funds or utilize leverage strategies with the purchase of mortgage-backed and investment securities. The cash flows from financing activities varies with the need for FHLB advances. See "Consolidated Statements of Cash Flows" in the Consolidated Financial Statements contained herein. 21 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of 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 the Consolidated Financial Statements included herein for additional information. The following table summarizes the Company's long-term contractual obligations at March 31, 2005: Less than One to Three to One Year Three Years Five Years Thereafter Total --------- ----------- ---------- ---------- -------- (In Thousands) Time deposits $ 95,707 $ 58,785 $ 5,794 $ - $160,286 FHLB Advances 50,675 46,000 15,000 363 112,038 Operating Lease Obligations 273 546 537 1,719 3,075 Purchase Obligation - Building Contract - - - - - -------- -------- ------- ------ -------- Total $146,655 $105,331 $21,331 $2,082 $275,399 ======== ======== ======= ====== ======== 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 the Consolidated Financial Statements included herein for additional information. Impact of Inflation and Changing Prices The consolidated financial statements, related notes, and other financial information presented herein have been prepared in accordance with Generally Accepted Accounting Principles ("GAAP") that require the measurement of financial position and operating results in terms of historical dollars without considering changes in relative purchasing power over time due to inflation. Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than does the effect of inflation. 22 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Shareholders and Board of Directors Security Federal Corporation and Subsidiaries Aiken, South Carolina We have audited the accompanying consolidated balance sheets of Security Federal Corporation and Subsidiaries as of March 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity and comprehensive income and cash flows for each of the years in the three year period ended March 31, 2005. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Security Federal Corporation and Subsidiaries as of March 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each of the years in the three year period ended March 31, 2005, in conformity with accounting principles generally accepted in the United States of America. /s/ Elliott Davis, LLC Elliott Davis, LLC Columbia, South Carolina May 9, 2005 23 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets March 31, ------------------------------ 2005 2004 ------------ ------------- ASSETS: Cash And Cash Equivalents $ 7,916,488 $ 6,749,211 Investment And Mortgage-Backed Securities: Available For Sale: (Amortized Cost of $166,364,642 and $173,300,028 at March 31, 2005 and 2004, Respectively) 164,814,819 174,411,819 Held To Maturity: (Fair Value of $74,770,902 and $71,686,256 at March 31, 2005 and 2004, Respectively) 76,260,904 71,303,507 ------------- ------------- Total Investment And Mortgage-Backed Securities 241,075,723 245,715,326 ------------- ------------- Loans Receivable, Net: Held For Sale 2,277,762 1,703,869 Held For Investment: (Net of Allowance of $6,284,055 and $5,763,935 at March 31, 2005 and 2004, Respectively) 314,611,373 258,190,791 ------------- ------------- Total Loans Receivable, Net 316,889,135 259,894,660 ------------- ------------- Accrued Interest Receivable: Loans 901,872 902,589 Mortgage-Backed Securities 555,933 549,541 Investments 721,744 778,725 ------------- ------------- Total Accrued Interest Receivable 2,179,549 2,230,855 ------------- ------------- Premises And Equipment, Net 7,914,043 6,562,734 Federal Home Loan Bank Stock, At Cost 6,234,500 4,816,800 Repossessed Assets Acquired In Settlement Of Loans 53,000 50,869 Other Assets 3,716,035 1,984,598 ------------- ------------- Total Assets $ 585,978,473 $ 528,005,053 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY: Liabilities: Deposit Accounts $ 430,287,391 $ 389,592,645 Advances From Federal Home Loan Bank 112,038,000 96,336,000 Other Borrowings 5,594,157 5,477,023 Advance Payments By Borrowers For Taxes And Insurance 417,410 317,421 Other Liabilities 2,530,450 2,810,049 ------------- ------------- Total Liabilities 550,867,408 494,533,138 ------------- ------------- 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 2,543,838 And Outstanding Shares, 2,522,127 at March 31, 2005 And 2,533,291 And 2,516,191 at March 31, 2004 25,438 25,333 Additional Paid-In Capital 4,181,804 4,013,674 Treasury Stock, (At Cost 8,077 shares) (165,089) - Indirect Guarantee Of Employee Stock Ownership Trust Debt (276,217) (336,972) Accumulated Other Comprehensive Income (Loss) (961,504) 689,755 Retained Earnings, Substantially Restricted 32,306,633 29,080,125 ------------- ------------- Total Shareholders' Equity 35,111,065 33,471,915 ------------- ------------- Total Liabilities And Shareholders' Equity $ 585,978,473 $ 528,005,053 ============= ============= SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 24 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Income For the Years Ended March 31, -------------------------------------- 2005 2004 2003 ----------- ----------- ----------- Interest Income: Loans $16,821,470 $15,448,987 $16,929,226 Mortgage-Backed Securities 5,584,979 4,479,444 3,453,195 Investment Securities 3,155,436 3,066,824 3,233,033 Other 27,764 15,750 44,379 ----------- ----------- ----------- Total Interest Income 25,589,649 23,011,005 23,659,833 ----------- ----------- ----------- Interest Expense: NOW And Money Market Accounts 3,945,513 3,071,306 2,450,502 Passbook Accounts 173,250 174,353 236,657 Certificate Accounts 3,597,761 3,482,214 5,002,233 FHLB Advances And Other Borrowed Money 3,808,221 2,878,227 2,326,872 ----------- ----------- ----------- Total Interest Expense 11,524,745 9,606,100 10,016,264 ----------- ----------- ----------- Net Interest Income 14,064,904 13,404,905 13,643,569 Provision For Loan Losses 780,000 1,200,000 1,800,000 ----------- ----------- ----------- Net Interest Income After Provision For Loan Losses 13,284,904 12,204,905 11,843,569 ----------- ----------- ----------- Other Income: Gain On Sale Of Investment Securities - 7,700 4,245 Gain On Sale Of Loans 435,635 1,329,729 1,656,152 Loan Servicing Fees 179,656 213,437 208,791 Service Fees On Deposit Accounts 1,226,118 1,351,175 1,272,782 Gain On Sale Of Branch - 1,521,401 - Other 862,565 811,323 669,143 ----------- ----------- ----------- Total Other Income 2,703,974 5,234,765 3,811,113 ----------- ----------- ----------- General And Administrative Expenses: Compensation And Employee Benefits 6,255,794 6,023,215 5,953,904 Occupancy 1,086,017 985,378 813,113 Advertising 182,699 210,962 216,204 Depreciation And Maintenance Of Equipment 1,047,815 1,086,930 1,055,181 Amortization Of Intangibles - - 185,210 FDIC Insurance Premiums 57,830 55,596 52,793 Other 2,142,636 2,362,783 2,206,237 ----------- ----------- ----------- Total General And Administrative Expenses 10,772,791 10,724,864 10,482,642 ----------- ----------- ----------- Income Before Income Taxes 5,216,087 6,714,806 5,172,040 Provision For Income Taxes 1,710,592 2,451,643 1,940,879 ----------- ----------- ----------- Net Income $ 3,505,495 $ 4,263,163 $ 3,231,161 =========== =========== =========== Net Income Per Common Share (Basic) $ 1.39 $ 1.70 $ 1.29 =========== =========== =========== Net Income Per Common Share (Diluted) $ 1.37 $ 1.66 $ 1.26 =========== =========== =========== Cash Dividend Per Share On Common Stock $ 0.11 $ 0.08 $ 0.0602 =========== =========== =========== Weighted Average Shares Outstanding (Basic) 2,524,123 2,513,319 2,508,774 =========== =========== =========== Weighted Average Shares Outstanding (Diluted) 2,561,437 2,560,710 2,558,607 =========== =========== =========== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 25 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income For the Years Ended March 31, 2005, 2004 and 2003 Accumulated Additional Indirect Other Common Paid -In Treasury Guarantee Comprehensive Retained Stock Capital Stock of ESOP Debt Income (Loss) Earnings Total -------- ---------- --------- ------------ ------------- --------- ----------- Balance At March 31,2002 $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 Treasury Guarantee Comprehensive Retained Stock Capital Stock of ESOP Debt Income (Loss) Earnings Total -------- ---------- --------- ------------ ------------- --------- ----------- Balance At March 31, 2003 $25,298 $3,995,230 $ - $(444,685) $1,444,585 $25,019,525 $30,039,953 Net Income - - - - 4,263,163 4,263,163 Other Comprehensive Income, Net Of Tax: Unrealized Holding Losses On Securities Available For Sale - - - (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 ======= ========== ======== ========= ======== =========== =========== - -----------------------------------------------------------------------------------------------------------
Accumulated Additional Indirect Other Common Paid -In Treasury Guarantee Comprehensive Retained Stock Capital Stock of ESOP Debt Income (Loss) Earnings Total -------- ---------- --------- ------------ ------------- --------- ----------- Balance At March 31, 2004 $25,333 $4,013,674 $ - $(336,972) $ 689,755 $29,080,125 $33,471,915 Net Income - - - - - 3,505,495 3,505,495 Other Comprehensive Income, Net Of Tax: Unrealized Holding Losses On Securities Available For Sale - - - - (1,651,259) - (1,651,259) Comprehensive Income - - - - - - 1,854,236 Purchase of Treasury Stock At cost, 8,077 shares (165,089) (165,089) Exercise of Stock Options 105 168,130 168,235 Decrease in Indirect Guarantee Of ESOP Debt - - - 60,755 - - 60,755 Cash Dividends - - - - - (278,987) (278,987) Balance At March 31, ------- ---------- --------- --------- --------- ----------- ----------- 2005 $25,438 $4,181,804 $(165,089) $(276,217) $(961,504) $32,306,633 $35,111,065 ======= ========== ========= ========= ========= =========== =========== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. 26
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Years Ended March 31, ------------------------------------------- 2005 2004 2003 ----------- ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 3,505,495 $ 4,263,163 $ 3,231,161 Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities: Depreciation 859,808 844,641 825,253 Amortization Of Intangibles - - 185,210 Discount Accretion And Premium Amortization 1,193,221 828,444 327,329 Provisions For Losses On Loans And Real Estate 780,000 1,200,000 1,800,000 Gain On Sales Of Loans (435,635) (1,329,729) (1,656,152) Gain On Sales Of Investment Securities - (7,700) (4,245) (Gain) Loss On Sale Of Real Estate (50,329) (85,713) (68,419) Amortization Of Deferred Fees On Loans (184,642) (187,937) (209,430) (Gain) Loss On Disposition Of Premises And Equipment (3,525) (1,815) 1,811 Proceeds From Sale Of Loans Held For Sale 26,392,654 64,827,155 82,001,517 Origination Of Loans For Sale (26,530,912) (61,530,797) (81,849,945) (Increase) Decrease In Accrued Interest Receivable: Loans 717 66,894 273,139 Mortgage-Backed Securities (6,392) (107,641) (158,125) Investments 56,981 (110,990) (17,701) (Decrease) Increase In Advance Payments By Borrowers 99,989 37,996 32,276 Other, Net (1,708,142) 359,259 (749,680) ------------ ------------- ------------ Net Cash Provided By Operating Activities 3,969,288 9,065,230 3,963,999 ------------ ------------- ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase Of Mortgage-Backed Securities Available For Sale (53,211,974) (110,002,424) (80,157,881) Principal Repayments On Mortgage-Backed Securities Available For Sale 47,852,116 55,003,975 30,444,934 Principal Repayments On Mortgage-Backed Securities Held To Maturity 89,769 591,457 431,751 Purchase Of Investment Securities Held To Maturity (26,041,400) (90,880,070) (20,995,471) Purchase Of Investment Securities Available For Sale (2,015,626) - (67,041,485) Maturities Of Investment Securities Available For Sale 13,111,305 36,242,259 75,281,684 Maturities Of Investment Securities Held To Maturity 21,000,000 40,995,331 133,025 Proceeds From Sales Of Investment Securities Available For Sale - - 985,938 Proceeds From Sale of Mortgage- Backed Securities Available For Sale - 2,413,515 - Purchase Of FHLB Stock (4,967,800) (5,338,000) (1,017,500) Redemption Of FHLB Stock 3,550,100 3,379,800 828,200 Increase In Loans Receivable (56,631,543) (22,245,974) (9,796,818) Proceeds From Sale Of Repossessed Assets 432,595 781,537 847,009 Purchase And Improvement Of Premises And Equipment (2,211,117) (2,419,827) (1,187,871) Proceeds From Sale of Premises and Equipment 3,525 1,815 - Net Cash Outflow From Sale of Branch - (9,930,521) - ------------ ------------- ------------ Net Cash Used By Investing Activities (59,040,050) (101,407,127) (71,244,485) ------------ ------------- ------------ (Continued) 27 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows, Continued For the Years Ended March 31, ------------------------------------------ 2005 2004 2003 ----------- ------------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Increase In Deposit Accounts 40,694,746 43,188,959 49,435,999 Proceeds From FHLB Advances 148,738,000 226,425,000 119,200,000 Repayment Of FHLB Advances (133,036,000) (179,861,000) (102,536,000) Proceeds (Repayment) Of Other Borrowings, Net 117,134 1,283,543 (1,975,931) Purchase Of Fractional Shares Due To Stock Split - - (122) Proceeds From Exercise Of Stock Options 168,235 18,479 18,496 Purchase of Treasury Stock (165,089) - - Dividends To Shareholders (278,988) (202,563) (151,677) ------------ ------------ ------------ Net Cash Provided By Financing Activities 56,238,039 90,852,418 63,990,765 ------------ ------------ ------------ Net Increase (Decrease) In Cash And Cash Equivalents 1,167,278 (1,489,479) (3,289,721) Cash And Cash Equivalents At Beginning Of Year 6,749,211 8,238,690 11,528,411 ------------ ------------ ------------ Cash And Cash Equivalents At End Of Year $ 7,916,489 $ 6,749,211 $ 8,238,690 ============ ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash Paid During The Period For: Interest $ 11,413,369 $ 9,740,893 $ 10,246,814 ============ ============ ============ Income Taxes $ 2,221,012 $ 2,076,388 $ 2,710,335 ============ ============ ============ Supplemental Schedule Of Non Cash Transactions: Additions To Repossessed Assets $ 384,397 $ 595,243 $ 874,040 ============ ============ ============ Increase (Decrease) In Unrealized Net Gain On Securities Available For Sale, Net Of Taxes $ (1,651,259) $ (754,830) $ 1,627,920 ============ ============ ============ 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 of investments are stated at fair value with unrealized gains and losses, net of tax, reported in a separate component of shareholders' equity ("accumulated other comprehensive income (loss)"). Gains and losses from sales of investment and mortgage-backed securities available for sale are determined using the specific identification method. The Company has no trading securities. The Bank maintained liquid assets in excess of the amount required by regulations. Liquid assets consist primarily of cash, time deposits, and certain investment securities. (d) Loans Receivable Held for Investment ------------------------------------ Loans are stated at their unpaid principal balance. Interest income is computed using the simple interest method and is recorded in the period earned. (e) Allowance for Loan Losses ------------------------- The Company provides for loan losses using the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to the allowance for loan losses. Additions to the allowance for loan losses are provided by charges to operations based on various factors which, in Management's judgment, deserve current recognition in estimating possible losses. Such factors considered by Management include the fair value of the underlying collateral; stated guarantees by the borrower, if applicable, the borrower's ability to repay from other economic resources, growth and composition of the loan portfolios, the relationship of the allowance for loan losses to outstanding loans, loss experience, delinquency trends, and general economic conditions. Management evaluates the carrying value of the loans periodically and the allowance is adjusted accordingly. While Management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making these evaluations. Allowances for loan losses are subject to periodic evaluations by various regulatory authorities and may be subject to adjustments based upon the information that is available at the time of their examinations. 29 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (1) Significant Accounting Policies, Continued ------------------------------------------ The Company values impaired loans at the loan's fair value if it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement at the present value of expected cash flows, the market price of the loan, if available, or the value of the underlying collateral. Expected cash flows are required to be discounted at the loan's effective interest rate. When the ultimate collectibility of an impaired loan's principal is in doubt, wholly or partially, all cash receipts are applied to principal. When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to interest then to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amounts previously charged off. (f) Loans Receivable Held for Sale ------------------------------ Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses are provided for in a valuation allowance by charges to operations. (g) Repossessed Assets Acquired in Settlement of Loans -------------------------------------------------- Repossessed assets represent real estate and other assets acquired through foreclosure or repossession and are initially recorded at the lower of cost (principal balance of the former mortgage loan less any specific valuation allowances) or estimated fair value less costs to sell. Subsequent improvements are capitalized. Costs of holding real estate, such as property taxes, insurance, general maintenance and interest expense, are expensed as a period cost. Fair values are reviewed regularly and allowances for possible losses are established when the carrying value of the asset owned exceeds the fair value less estimated costs to sell. Fair values are generally determined by reference to an outside appraisal. (h) Premises and Equipment ---------------------- Premises and equipment are carried at cost, net of accumulated depreciation. Depreciation of premises and equipment is amortized on a straight-line method over the estimated useful life of the related asset. Estimated lives are seven to 30 years for buildings and improvements and generally three to 10 years for furniture, fixtures and equipment. Maintenance and repairs are charged to current expense. The cost of major renewals and improvements are capitalized. (i) Income Taxes ------------ Deferred tax expense or benefit is recognized for the net change during the year in the deferred tax liability or asset. That amount together with income taxes currently payable is the total amount of income tax expense or benefit for the year. Deferred taxes are provided for in differences in financial reporting bases for assets and liabilities compared with their tax bases. Generally, a current tax liability or asset is established for taxes presently payable or refundable and a deferred tax liability or asset is established for future tax items. A valuation allowance, if applicable, is established for deferred tax assets that may not be realized. Tax bad debt reserves in excess of the base year amount (established as taxable years ending March 31, 1988 or later) would create a deferred tax liability. Deferred income taxes are provided for in differences between the provision for loan losses for financial statement purposes and those allowed for income tax purposes. (j) Loan Fees and Costs Associated with Originating Loans ----------------------------------------------------- Loan fees received, net of direct incremental costs of originating loans, are deferred and amortized over the contractual life of the related loan. The net fees are recognized as yield adjustments by applying the interest method. Prepayments are not anticipated. 30 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (1) Significant Accounting Policies, Continued (k) Interest Income --------------- Interest on loans is accrued and credited to income monthly based on the principal balance outstanding and the contractual rate on the loan. The Company places loans on non-accrual status when they become greater than 90 days delinquent or when, in the opinion of management, full collection of principal or interest is unlikely. The Company provides an allowance for uncollectible accrued interest on loans that are contractually 90 days delinquent for all interest accrued prior to the loan being placed on non-accrual status. The loans are returned to an accrual status when full collection of principal and interest appears likely. (l) Advertising Expense ------------------- Advertising and public relations costs are generally expensed as incurred. External costs relating to direct mailing costs are expensed in the period in which the direct mailing are sent. Advertising and public relations costs of $182,699, $210,962 and $216,204, were included in the Company's results of operations for 2005, 2004, and 2003, respectively. (m) Fair Value of Financial Instruments ----------------------------------- The Company discloses the fair value of on- and off-balance sheet financial instruments when it is practicable to do so. Fair values are based on quoted market prices, where available, on estimates of present value, or on other valuation techniques. These estimates are made at a specific point in time, are subjective in nature, and involve uncertainties and significant judgment. In addition, the Company does not disclose the fair value of non-financial instruments. Accordingly, the aggregate fair values presented do not represent the underlying fair value of the Company. Fair value approximates carrying value for the following financial instruments due to the short-term nature of the instrument: cash and cash equivalents. Securities are valued using quoted fair market prices. Fair value for the Company's off-balance sheet financial instruments is based on the discounted present value of the estimated future cash flows. Fair value for variable rate loans that reprice frequently, loans held for sale, and loans that mature in less than three months is based on the carrying value. Fair value for fixed rate mortgage loans, personal loans, and other loans (primarily commercial) maturing after three months is based on the discounted present value of the estimated future cash flows. Discount rates used in these computations approximate the rates currently offered for similar loans of comparable terms and credit quality. Fair value for demand deposit accounts and interest-bearing accounts with no fixed maturity date is equal to the carrying value. Certificates of deposit accounts and securities sold under repurchase agreements maturing within one year are valued at their carrying value. The fair value of certificates of deposit accounts and securities sold under repurchase agreements after one year are estimated by discounting cash flows from expected maturities using current interest rates on similar instruments. Fair value for long-term FHLB advances is based on discounted cash flows using the Company's current incremental borrowing rate. Discount rates used in these computations approximate rates currently offered for similar borrowings of comparable terms and credit quality. 31 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (1) Significant Accounting Policies, Continued ------------------------------------------ (n) Stock-Based Compensation ------------------------ At March 31, 2005, the Company sponsored stock-based compensation plans, which are described more fully in Note 12. The Company has elected the disclosure - only provision of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation." Accordingly, no compensation cost has been recognized for the stock option plan. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant date consistent with the provisions of SFAS No. 123, the Company's net income and earnings per share amounts as of the year ended March 31 would have been reduced to the pro forma amounts indicated below. 2005 2004 2003 ---------- --------- ----------- Net Income, As Reported $3,505,495 4,263,163 3,231,161 Deduct: Total stock-based employee compensation expense determined under fair-value based method for all awards, net of tax $ (150,807) (159,187) (135,831) Net Income, Pro Forma $3,354,688 4,103,976 3,095,330 Net Income Per Common Share (Basic), As Reported $ 1.39 1.70 1.29 Net Income Per Common Share (Basic), Pro Forma $ 1.33 1.63 1.23 Net Income Per Common Share (Diluted), As Reported $ 1.37 1.66 1.26 Net Income Per Common Share (Diluted), Pro Forma $ 1.31 1.60 1.21 (o) Earnings Per Share ------------------ Net income per share is computed by dividing consolidated net income by the weighted average number of common shares outstanding during the period. The treasury stock method is used to compute the dilutive effect of stock options in the diluted weighted average number of common shares. 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, 2005 March 31, 2004 ------------------------------ ------------------------------ Per Share Per Share Income Shares Amounts Income Shares Amounts ---------- --------- ------- ---------- --------- ------- Basic EPS $ 3,505,495 2,524,123 $ 1.39 $ 4,263,163 2,513,319 $ 1.70 Dilutive effect of: Stock Options - 22,726 (0.012) - 28,959 (0.024) ESOP - 14,588 (0.008) - 18,432 (0.016) ----------- ---------- ------ ----------- ---------- ------ Diluted EPS $ 3,505,495 2,561,437 $ 1.37 $ 4,263,163 2,560,710 $ 1.66 =========== ========== ====== =========== ========== ====== For the Year Ended March 31, 2003 ------------------------------------ Per share Income Shares amounts ----------- --------- ----------- Basic EPS $3,231,161 2,508,774 $ 1.29 Dilutive effect of: Stock Options - 33,166 (0.02) ESOP - 16,667 (0.01) ----------- --------- ------ Diluted EPS $ 3,231,161 2,558,607 $ 1.26 =========== ========= ====== (p) Use of Estimates ---------------- The preparation of financial statements in conformity with GAAP requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of income and expenses during the reporting periods. Actual results could differ from those estimates. 32 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (1) Significant Accounting Policies, Continued ------------------------------------------ (q) Recently Issued Accounting Standards ------------------------------------ The following is a summary of recent authoritative pronouncements that affect accounting, reporting, and disclosure of financial information by the Company: In April 2005, the Securities and Exchange Commission's ("SEC") Office of the Chief Accountant and its Division of Corporation Finance has released Staff Accounting Bulletin (SAB) No. 107 to provide guidance regarding the application of FASB Statement No. 123 (revised 2004), "Share-Based Payment". Statement No. 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. SAB 107 provides interpretive guidance related to the interaction between Statement No. 123(R) and certain SEC rules and regulations, as well as the staff's views regarding the valuation of share-based payment arrangements for public companies. SAB 107 also reminds public companies of the importance of including disclosures within filings made with the SEC relating to the accounting for share-based payment transactions, particularly during the transition to Statement No. 123(R). In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets, an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions". The amendments made by SFAS No. 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, Accounting Principles Board ("APB") Opinion No. 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. APB Opinion No. 29 provided an exception to its basic measurement principle (fair value) for exchanges of similar productive assets. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date of issuance. The provisions of this statement shall be applied prospectively. The adoption of this statement is not expected to have a material impact on the financial condition or operating results of the Company. In December 2004, the FASB issued SFAS No, 123 (revised 2004), "Share-Based Payments" (SFAS No. 123(R)"). SFAS No. 123(R) will require companies to measure all employee stock-based compensation awards using a fair value method and record such expense in its financial statements. In addition, the adoption of SFAS No. 123(R) requires additional accounting and disclosure related to the income tax and cash flow effects resulting form share-based payments arrangements. SFAS No. 123 (R) is effective beginning as of the first interim or annual reporting period beginning after June 15, 2005. The Company is currently evaluating the impact that the adoption of SFAS No. 123(R) will have on its financial position, results of operations and cash flow. In March 2004, the SEC issued Staff Accounting Bulletin ("SAB") No. 105, "Application of Accounting Principles to Loan Commitments", to inform registrants of the Staff's view that the fair value of the recorded loan commitments should not consider the expected future cash flows related to the associated servicing of the future loan. The provisions of SAB No. 105 must be applied to the loan commitments accounted for as derivatives that are entered into after March 31, 2004. The Staff will not object to the application of existing accounting practices to loan commitments accounted for as derivatives that are entered into on or before March 31, 2004, with appropriate disclosures. The Company adopted the provisions of SAB No. 105 on April 1, 2004. The adoption of SAB No. 105 did not have a material impact on the Company's financial condition or results of operations. 33 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (1) Significant Accounting Policies, Continued ------------------------------------------ In December 2003, the FASB issued FIN No. 46 (revised), "Consolidation of Variable Interest Entities" ("FIN No.46(R)"), which addresses consolidation by business enterprises of variable interest entities. FIN No. 46(R) requires a variable interest entity to be consolidation 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(R) also requires disclosure about variable interest entities that a company is not required to consolidate, but in which it has a significant variable interest. FIN No. 46(R) provides guidance for determining whether an entity qualifies as a variable interest entity by considering, among other considerations, whether the entity lacks sufficient equity holders lack adequate decision-making ability. The consolidation requirements of FIN No. 46(R) applied immediately to variable interest created after January 31, 2003. The consolidation requirements applied to the Company's existing variable entities in the first reporting ending after March 15, 2004. Certain of the disclosure requirements applied to all financial statements issued after December 31, 2003, regardless of when the variable interest entity was established. The adoption of FIN No. 46(R) did not have any impact on the Company's financial position or results of operations. 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 data but for which other-than-temporary impairments has not been recognized. Accordingly the EITF issued EITF No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments". This issue addresses the meaning of other-than- temporary impairments and its application to investments classified as either available-for-sale or held-to-maturity under SFAS No. 115 and provides guidance on quantitative and qualitative disclosures. The disclosure requirements of EITF No. 03-1 are effective for financial statements for fiscal years ending after June 15, 2004. The effective date for the measurement and recognition guidance of EITF No. 03-1 has been delayed. The FASB staff has issued a proposed Board-directed FASB Staff Position ("FSP"), FSP EITF 03-1-a, "Implementation Guidance for the Application of Paragraph 16 of Issue No. 03-1". The proposed FSP would provide implementation guidance with respect to debt securities that are impaired due to interest rates and/or sector spreads and analyzed for other-than- temporary impairments under the measurement and recognition requirements of EITF No. 03-1. The delay of the effective date for the measurement and recognition requirements of EITF No. 03-1 will be superseded concurrent with the final issuance of FSP EITF 03-1-a. Adopting the disclosure provisions of EITF No. 03-1 did not have any 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. 34 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (2) Branch Sale ----------- In February 2004, the Bank sold its Denmark, South Carolina branch to South Carolina Bank and Trust, N.A. of Orangeburg, South Carolina. Included in the sale, were approximately $13.6 million in deposits, $1.9 million in loans, and the branch building, furniture, and equipment. The Bank recorded a $1.5 million in gain on sale of branch, which includes gains on all the items in the previous sentence. Gain on sale of branch is in "Other Income" as a separate line item in the income statement. The Bank also booked $200,000 as a contingency expense on the sale, which is included in the line item called "Other Expense" in the "General and Administrative Expenses" section of the income statement. The Bank has possible contingent liabilities for three years. The Bank netted approximately $820,000 after tax and contingencies on the transaction. (3) Investment and Mortgage-Backed Securities, Available for Sale ------------------------------------------------------------- The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of investment and mortgage-backed securities available for sale are as follows: March 31, 2005 ------------------------------------------------------- Gross Gross Unrealized Unrealized Amortized Cost Gains Losses Fair value -------------- ---------- --------- ------------ FHLB Securities $ 4,984,803 $ 4,060 $ 19,063 $ 4,969,800 FHLMC Bonds 484,875 588 - 485,463 Mortgage-Backed Securities 160,894,954 457,081 1,992,479 159,359,556 ------------- --------- ----------- ------------- $ 166,364,632 $ 461,729 $ 2,011,542 $ 164,814,819 ============= ========= =========== ============= 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 ============= =========== ========= ============= The amortized cost and fair value of investment and mortgage-backed securities available for sale at March 31, 2005 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 $ 1,000,000 $ 1,004,060 1-5 Years 3,463,715 3,464,302 More Than 5 Years 1,005,963 986,901 Mortgage-Backed Securities 160,894,954 159,359,556 -------------- -------------- $ 166,364,632 $ 164,814,819 ============== ============== 35 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (3) Investment and Mortgage-Backed Securities, Available for Sale, Continued ----------------------------------------------------------------------- At March 31, 2005, investment and mortgage-backed securities available for sale of $31.3 million were pledged as collateral for certain deposit accounts. In addition, the Bank had pledged $12.3 million of investment and mortgage-backed securities as collateral for FHLB advances and other borrowings. There were no sales of securities in the year ended March 31, 2005. The Bank received approximately $2.4 million, and $986,000 in proceeds from sales of available for sale securities with approximately $7,700, and $4,200 recorded in gross gains and no gross losses in the years ended March 31, 2004 and 2003, respectively. The following table shows gross unrealized losses and fair value, aggregated by investment category, and length of time that individual available for sale securities have been in a continuous unrealized loss position, at March 31, 2005. Less than 12 Months 12 Months or More Total --------------------- ------------------- --------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ----------- -------- ---------- ------- ----------- -------- Agency securities $ 986,901 $ 19,063 $ - $ - $ 986,901 $ 19,063 Mortgage- backed securities 99,049,697 1,344,661 28,186,471 647,821 127,236,168 1,992,482 Securities classified as available-for-sale are recorded at fair market value. Approximately 32.2% of the unrealized losses, or thirty 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, 2005 ------------------------------------------------------- Gross Gross Unrealized Unrealized Amortized Cost Gains Losses Fair value -------------- ---------- --------- ------------ FHLB Securities $ 67,002,146 $ - $ 1,266,080 $ 65,736,066 Federal Farm Credit Securities 8,998,701 - 238,681 8,760,020 Mortgage- Backed Securities 260,057 14,759 - 274,816 ------------ -------- ----------- ------------ $ 76,260,904 $ 14,759 $ 1,504,761 $ 74,770,902 ============ ======== =========== ============ 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 ============= ========= ======== ============ 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, 2005, 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 32,981,926 32,533,495 More Than 5 Years 43,018,921 41,962,591 Mortgage-Backed Securities 260,057 274,816 ------------- ------------- $ 76,260,904 $ 74,770,902 ============= ============= At March 31, 2005, investment and mortgage-backed securities held to maturity of $9.6 million were pledged as collateral for certain deposit accounts. In addition, the Bank had pledged $41.4 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, 2005. Less than 12 Months 12 Months or More Total --------------------- ------------------- --------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ----------- -------- ---------- ------- ----------- -------- Agency securities $61,890,751 $1,099,878 $9,605,960 $404,884 $71,496,711 $1,504,761 Approximately 26.9% of the unrealized losses, or ten individual securities, consisted of securities 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: 2005 2004 ------------ ----------- Residential Real Estate Loans $ 122,622,347 $ 109,722,301 Consumer Loans 50,844,192 45,641,450 Commercial Business And Real Estate Loans 162,217,200 121,111,848 Loans Held For Sale 2,277,762 1,703,869 ------------- ------------- 337,961,501 278,179,468 ------------- ------------- Less: Allowance For Loan Losses 6,284,055 5,763,935 Loans In Process 14,626,913 12,356,346 Deferred Loan Fees 161,398 164,527 ------------- ------------- 21,072,366 18,284,808 ------------- ------------- Total Loans Receivable, Net $ 316,889,135 $ 259,894,660 ============= ============= 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: 2005 2004 2003 ----------- ----------- ----------- Balance At Beginning Of Year $ 5,763,935 $ 4,911,224 $ 3,689,079 Provision For Loan Losses 780,000 1,200,000 1,800,000 Charge Offs (443,131) (669,591) (909,494) Recoveries 183,252 322,302 331,639 ----------- ----------- ----------- Total Allowance For Loan Losses $ 6,284,055 $ 5,763,935 $ 4,911,224 =========== =========== =========== 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. 2005 2004 ------------ ------------ Non-Accrual Loans $ 2,430,000 $ 2,044,000 ============ ============ Interest Income That Would Have Been Recognized Under Original Terms $ 189,000 $ 106,000 ============ ============ At March 31, 2005 and 2004, impaired loans amounted to $1.2 million and $1.4 million, respectively. Losses on impaired loans are accounted for in the allowance for loan loss. For the years ended March 31, 2005 and 2004, the average recorded investment in impaired loans was $1.3 million for both periods. 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: 2005 2004 ---------- ---------- Land $1,506,053 426,163 Buildings And Improvements 7,918,516 7,254,127 Furniture And Equipment 6,340,847 5,874,011 15,765,416 13,554,301 Less Accumulated Depreciation (7,851,373) (6,991,567) ---------- ---------- Total Premises And Equipment, Net $7,914,043 6,562,734 ========== ========== Depreciation expense for the years ended March 31, 2005, 2004, and 2003 was approximately $860,000, $845,000, and $825,000, respectively. The Bank has entered into non-cancelable operating leases related to buildings and land. At March 31, 2005, future minimum payments under non-cancelable operating leases with initial or remaining terms of one year or more are as follows(by fiscal year): 2006 $ 294,255 2007 273,125 2008 272,794 2009 269,155 2010 268,341 Thereafter 1,719,101 ----------- $ 3,096,771 =========== Total rental expense amounted to $289,000, $278,000, and $209,000 for the years ended March 31, 2005, 2004 and 2003, respectively. Five lease agreements with monthly expenses of $7,083, $4,163, $2,113, $743, and $700 have multiple renewal options totaling 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 a membership component, which is 0.20% of total assets at the prior December 31, plus a transaction component which equals 4.5% of outstanding advances (borrowings) from the FHLB of Atlanta. The Bank is in compliance with this requirement with an investment in FHLB of Atlanta stock of $6.2 million as of March 31, 2005. 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, 2005 At March 31, 2004 --------------------------------- ------------------------------- Interest Interest Weighted Rate Weighted Rate Rate Range Amount Rate Range ------------ ---- ---------- ------------ ---- --------- Checking Accounts $ 88,169,885 0.65% 0.00-2.47% $ 80,738,298 0.47% 0.00-1.74% Money Market Accts. 164,088,081 2.57% 1.09-2.72% 158,587,076 1.97% 1.00-2.03% Passbook Accounts 17,743,659 0.98% 0.00-1.50% 17,367,047 0.98% 0.00-1.50% ------------ ---- --------- ------------ ---- --------- Total 270,001,625 1.84% 0.00-2.72% 256,692,421 1.43% 0.00-2.03% ------------ ---- --------- ------------ ---- --------- Certificate Accounts: 0.00-4.99% 150,486,280 122,599,195 5.00-6.99% 9,799,486 10,301,029 ------------ ------------ Total 160,285,766 2.92% 0.90-6.55% 132,900,224 2.26% 0.90-6.55% ------------ ---- --------- ------------ ---- --------- Total Deposits $430,287,391 2.24% 0.00-6.55% $389,592,645 1.71% 0.00-6.55% ============ ==== ========= ============ ==== ========== The aggregate amount of short-term certificates of deposit with a minimum denomination of $100,000 was $61.7 million and $47.0 million at March 31, 2005 and 2004, respectively. The amounts and scheduled maturities of all certificates of deposit at March 31 are as follows: March 31, ------------------------------- 2005 2004 ------------ ------------ Within 1 Year $ 95,707,286 $ 89,632,381 After 1 Year, Within 2 40,973,203 9,736,807 After 2 Years, Within 3 17,811,991 14,831,103 After 3 Years, Within 4 4,680,838 15,338,730 After 4 Years, Within 5 1,112,448 3,361,203 Thereafter - - ------------ ------------ $160,285,766 $132,900,224 ============ ============ 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: 2005 2004 ----------------------- ----------------------- Weighted Weighted Amount Rate Amount Rate ------------ -------- ------------ -------- Year Ending March 31 2005 $ - - $ 13,336,000 4.92% 2006 40,675,000 4.09% 33,000,000 4.09% 2007 18,000,000 2.83% 10,000,000 2.66% 2008 10,000,000 2.96% 10,000,000 2.96% 2009 25,000,000 3.05% 30,000,000 2.96% Thereafter 18,363,000 3.18% - - ------------ ---- ------------ ---- $112,038,000 3.41% $ 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 $53.6 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, 2005 - ------------------------------------------------------------------------------ Borrow Maturity Int. Date Date Amount Rate Type Call Dates - -------- -------- ----------- ------ ---------- --------------------- 11/10/00 11/10/05 $ 5,000,000 5.85% Multi-Call 5/10/05 and quarterly thereafter 09/04/02 09/04/07 5,000,000 2.82% 1 Time Call 09/06/05 11/07/02 11/07/12 5,000,000 3.354% 1 Time Call 11/07/07 10/24/03 10/24/08 10,000,000 2.705% Multi-Call 10/24/06 and quarterly thereafter 12/10/03 12/10/08 5,000,000 2.16% Multi-Call 12/12/05 and quarterly thereafter 02/20/04 02/20/14 5,000,000 3.225% 1 Time Call 02/20/09 04/16/04 04/16/14 3,000,000 3.33% 1 Time Call 04/16/08 09/16/04 09/16/09 5,000,000 3.09% 1 Time Call 09/17/07 As of March 31, 2004 - ------------------------------------------------------------------------------ Borrow Maturity Int. Date Date Amount 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 At March 31, 2005, the Bank had $63.5 million in additional borrowing capacity at the FHLB. The Bank had $5.6 million and $5.5 million in other borrowings (non-FHLB advances) at March 31, 2005 and 2004, 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, 2005 and 2004, the interest rate paid on these borrowings was 2.54% and 0.93%, respectively. The Bank had pledged $27.3 million in investment securities at March 31, 2005 and $36.4 million at March 31, 2004, 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, ------------------------------------- 2005 2004 2003 ----------- ---------- ---------- Current: Federal $ 1,610,169 2,948,661 2,380,675 State 163,495 356,824 247,582 ----------- ---------- ---------- Total Current Tax Expense 1,773,664 3,305,485 2,628,257 ----------- ---------- ---------- Deferred: Federal (55,791) (653,360) (525,982) State (7,281) (200,482) (161,396) ----------- ---------- ---------- Total Deferred Tax Expense (63,072) (853,842) (687,378) ----------- ---------- ---------- Total Income Tax Expense $ 1,710,592 2,451,643 1,940,879 =========== ========== ========== The Company's income taxes differ from those computed at the statutory federal income tax rate, as follows: For the Years Ended March 31, ------------------------------------- 2005 2004 2003 ----------- ----------- ----------- Tax At Statutory Income Tax Rate $ 1,773,470 $ 2,283,034 $ 1,758,494 State Tax And Other (62,878) 168,609 182,385 ----------- ----------- ----------- Total Income Tax Expense $ 1,710,592 $ 2,451,643 $ 1,940,879 =========== =========== =========== 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, -------------------------- 2005 2004 ---------- ---------- Deferred Tax Assets: Provision For Loan Losses $2,513,622 $2,305,574 Goodwill Tax Basis Over Financial Statement Basis 364,672 466,440 Net Fees Deferred For Financial Reporting 190,053 190,114 Unrealized Loss on Securities Available for Sale 588,310 - Other 178,533 173,311 ---------- ---------- Total Gross Deferred Tax Assets 3,835,190 3,135,439 ---------- ---------- Deferred Tax Liabilities: Unrealized Gain On Securities Available For Sale - 422,036 FHLB Stock Basis Over Tax Basis 133,367 133,367 Depreciation 211,287 265,318 Other 102,400 - ---------- ---------- Total Gross Deferred Tax Liability 447,054 820,721 ---------- ---------- Net Deferred Tax Asset $3,388,136 $2,314,718 ========== ========== The balance of the change in the net deferred tax asset results from the current period deferred tax benefit of $63,072. The net deferred tax asset is included in other assets in the accompanying consolidated balance sheets. No valuation allowance for deferred tax assets was required at March 31, 2005 and 2004. 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, 2005 and 2004, 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, 2005 Tier 1 Risk-Based Core Capital (To Risk Weighted Assets) $35,652 10.5% 13,555 4.0% 20,332 6.0% Total Risk-Based Capital (To Risk Weighted Assets) $39,858 11.8% 27,110 8.0% 33,887 10.0% Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets) $35,652 6.1% 23,472 4.0% 29,341 5.0% Tangible Capital (To Tangible Assets) $35,652 6.1% 11,736 2.0% 29,341 5.0% 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% 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 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 $36,000, $256,000, and $215,000 for the years ended March 31, 2005, 2004, and 2003, 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, 2005, 2004, and 2003 were $75,000, $75,000, and $123,000, respectively. The ESOP from time to time borrows funds from financial institutions to purchase the Company's stock. The balance of the loan was $276,000 and $337,000 at March 31, 2005 and 2004, respectively. The Company carries the debt as a liability and a reduction in equity, although the Company neither endorses nor guarantees the loan. The loan is repaid by Company contributions to the trustee, who in turn makes the loan payment to the financial institution. Certain officers of the Company participate in an incentive stock option plan. Options are granted at exercise prices not less than the fair value of the Company's common stock on the date of the grant. The following is a summary of the activity under the Company's incentive stock option plan for the years ended March 31, 2005, 2004, and 2003. 2005 2004 2003 ----------------- ----------------- ----------------- Weighted Weighted Weighted Avg. Avg. Avg. Exercise Exercise Exercise Shares Price Shares Price Shares Price ----------------- ----------------- ----------------- Balance, Beginning of Year 131,639 $ 18.23 114,366 $ 15.77 122,334 $ 15.31 Options granted 32,000 20.89 31,000 22.97 6,000 22.39 Options exercised 10,547 15.95 3,467 5.33 3,468 5.33 Options forfeited 17,800 19.58 10,260 6.51 10,500 17.62 ------- ------- ------- Balance, March 31 135,292 $ 19.09 131,639 $ 18.23 114,366 $ 15.77 ======= ======= ======= At March 31, 2005, the Company had the following options outstanding: Outstanding Option Earliest Date Grant Date Options Price Exercisable Expiration Date - ---------- ----------- ------ ------------------ -------------------- 1/07/97 3,092 $ 5.33 1/1/05 to 1/1/06 12/31/05 to 12/31/06 10/19/99 68,700 $16.67 4/1/05 to 10/01/08 9/30/05 to 9/30/09 1/16/03 1,500 $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 11,000 $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 6/7/04 2,000 $24.00 6/1/09 to 6/1/13 5/31/14 1/1/05 28,000 $20.55 1/1/10 to 1/1/14 12/31/14 1/1/05 2,000 $22.61 1/1/09 to 12/31/09 12/31/09 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 2,000 shares granted on January 1, 2005 which fully vest on January 1, 2009. 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 10,000 options available for granting at March 31, 2005. 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 2005, 2004 and 2003, expected volatility of 21.2% for options granted in 2005, 21.4% for options granted in 2004, and 10.7% for options granted in 2003, risk-free interest rate of 4.82% for options granted in 2004, 3.74% to 4.45% for options granted in 2004, and 3.35% for options granted in 2003, and expected lives of 6 to10 years. (13) Commitments and Contingencies ----------------------------- In the ordinary course of business, the Company has various outstanding commitments and contingent liabilities that are not reflected in the accompanying consolidated financial statements. In addition, the Company is a defendant in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial condition of the Company. In conjunction with its lending activities, the Bank enters into various commitments to extend credit and issue letters of credit. Loan commitments (unfunded loans and unused lines of credit) and letters of credit are issued to accommodate the financing needs of the Bank's customers. Loan commitments are agreements by the Bank to lend at a future date, so long as there are no violations of any conditions established in the agreement. Letters of credit commit the Bank to make payments on behalf of customers when certain specified events occur. Financial instruments where the contract amount represents the Bank's credit risk include commitments under pre-approved but unused lines of credit of $55.6 million and $39.4 million, undisbursed loans in process totaled $14.6 million and $12.4 million, and letters of credit of $1.2 million and $562,000 at March 31, 2005 and 2004, respectively. At March 31, 2005 and 2004, 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 $2.6 million and $2.5 million at March 31, 2005 and 2004, respectively. Outstanding commitments on mortgage loans not yet closed amounted to $180,000 and $429,000 at March 31, 2005 and 2004, respectively. These commitments, which are funded subject to certain limitations, extend over varying periods of time with the majority being funded within 45 days. At March 31, 2005 and 2004, the Bank had outstanding commitments to sell approximately $2.3 and $1.7 million of loans, respectively which encompassed the Bank's held for sale loans. The Bank also has commitments to sell mortgage loans not yet closed, on a best efforts basis. Best efforts means the Bank suffers no penalty if they are unable to deliver the loans to the potential buyers. The fair value of the Bank's commitment to originate mortgage loans at committed interest rates and to sell such loans to permanent investors is insignificant. 45 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (14) Related Party Transactions -------------------------- At March 31, 2005, 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, 2003,was $519,000. There was $102,000 in additional loans to executive officers and directors whose individual indebtedness exceeded $60,000 during fiscal 2005. Repayments on these loans totaled approximately $100,000. Loans to all employees, officers, and directors of the Company, in the aggregate constituted approximately 7.96% of the total shareholders' equity of the Company at March 31, 2005. At March 31, 2005, deposits from executive officers and directors of the Bank and Company and their related interest in aggregate approximated $2.5 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 $41,000, $30,000, and $29,000 for rent for the years ended March 31, 2005, 2004 and 2003, 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, --------------------------- 2005 2004 ----------- ----------- Assets: Cash $ 669,550 $ 956,582 Investment In Security Federal Bank 34,690,893 32,829,876 Income Tax Receivable From Bank 35,947 31,538 ----------- ----------- Total Assets $35,396,390 $33,817,996 =========== =========== Liability And Shareholders' Equity: Accounts Payable $ 9,108 $ 9,109 Indirect Guarantee of ESOP Debt 276,217 336,972 Shareholders' Equity 35,111,065 33,471,915 ----------- ----------- Total Liabilities And Shareholders' Equity $35,396,390 $33,817,996 =========== =========== Condensed Statements of Income Data For the Years Ended March 31, -------------------------------------- 2005 2004 2003 ---------- ---------- ---------- Income: Equity In Earnings Of Security Federal Bank $3,512,277 $4,260,347 $3,232,989 Miscellaneous Income - 10,000 - ---------- ---------- ---------- 3,512,277 4,270,347 3,232,989 Expenses: Other Expenses 6,782 7,184 1,828 ---------- ---------- ---------- Net Income $3,505,495 $4,263,163 $3,231,161 ========== ========== ========== 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, -------------------------------------- 2005 2004 2003 ---------- ---------- ---------- Operating Activities: Net Income $3,505,495 $4,263,163 $3,231,161 Adjustments To Reconcile Net Income To Net Cash Provided By (Used In) Operating Activities: Equity In Earnings Of Security Federal Bank (3,512,277) (4,260,347) (3,232,989) (Increase) Decrease In Income Taxes Receivable And Other Assets (4,409) 1,644 (1,123) Decrease In Accounts Payable - (10,000) (2,936) ---------- ---------- ---------- Net Cash Provided By (Used In) Operating Activities (11,191) (5,540) (5,887) ---------- ---------- ---------- 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 168,235 18,479 18,496 Purchase of Treasury Stock, At Cost (165,089) - (122) Dividends Paid (278,987) (202,563) (151,677) ---------- ---------- ---------- Net Cash Provided By (Used In) Financing Activities (275,841) (184,084) (133,303) ---------- ---------- ---------- Net Increase (Decrease) In Cash (287,032) 810,376 (139,190) Cash At Beginning Of Year 956,582 146,206 285,396 ---------- ---------- ---------- Cash At End Of Year $ 669,550 $ 956,582 $ 146,206 ========== ========== ========== (16) Carrying Amounts and Fair Value of Financial Instruments -------------------------------------------------------- The carrying amounts and fair value of financial instruments are summarized below: At March 31, --------------------------------------------- 2005 2004 --------------------- --------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value -------- ---------- --------- ---------- (In Thousands) Financial Assets: Cash And Cash Equivalents $ 7,916 $ 7,916 $ 6,749 $ 6,749 Investment And Mortgage- Back Securities $241,076 $239,586 $245,715 $246,098 Loans Receivable, Net $316,889 $320,990 $259,895 $260,042 Federal Home Loan Bank Stock $ 6,235 $ 6,235 $ 4,817 $ 4,817 Financial Liabilities: Deposits: Checking, Savings, and Money Market Accounts $270,002 $270,002 $256,692 $256,692 Certificate Accounts $160,286 $159,805 $132,900 $117,389 Advances From Federal Home Loan Bank $112,038 $111,209 $ 96,336 $104,653 Other Borrowed Money $ 5,594 $ 5,594 $ 5,477 $ 5,477 47 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES Notes To Consolidated Financial Statements (16) Carrying Amounts and Fair Value of Financial Instruments, Continued ------------------------------------------------------------------- At March 31, 2005, the Bank had $74.2 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 2005 and 2004 is as follows (amounts, except per share data, in thousands): Quarter ended ----------------------------------------------------------- 2004-2005 June 30, 2004 Sept. 30, 2004 Dec. 31, 2004 Mar. 31, 2005 ------------- -------------- ------------- ------------- Interest Income $ 6,044 $ 6,242 $ 6,471 $ 6,833 Interest Expense 2,596 2,880 2,925 3,123 ---------- ---------- ---------- ---------- Net Interest Income 3,448 3,362 3,546 3,710 Provision for Loan Losses 195 195 195 195 ---------- ---------- ---------- ---------- Net Interest Income after Provision for Loan Losses 3,253 3,167 3,351 3,515 Non-interest Income 659 724 706 614 Non-interest Expense 2,694 2,711 2,712 2,655 ---------- ---------- ---------- ---------- Income before Income Tax 1,218 1,180 1,345 1,474 Provision for Income taxes 416 380 433 482 ---------- ---------- ---------- ---------- Net Income $ 802 $ 800 $ 912 $ 992 ========== ========== ========== ========== Basic Net Income per Common Share $ 0.32 $ 0.32 $ 0.36 $ 0.39 ========== ========== ========== ========== Diluted Net Income per Common Share $ 0.31 $ 0.31 $ 0.36 $ 0.39 ========== ========== ========== ========== Basic Weighted Average Shares Outstanding 2,522,600 2,519,627 2,527,661 2,526605 ========== ========== ========== ========== Diluted Weighted Average Shares Outstanding 2,562,892 2,555,774 2,556,839 2,565,645 ========== ========== ========== ========== 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 $ 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 ========== ========== ========== ========== 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 21, 2005 at the City of Aiken Municipal Conference Center, 215 The Alley, Aiken, South Carolina. STOCK LISTING The Company's stock is traded on the Over-The-Counter-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 -------------- ------ ------ 06-30-03 $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 06-30-04 $27.00 $19.75 09-30-04 $23.60 $21.50 12-31-04 $21.95 $20.25 03-31-05 $24.00 $19.75 The prices in the table above are adjusted for a 3-for-2 stock split, in the form of a stock dividend, which occurred in the fiscal year ended March 31, 2003. As of March 31, 2005, the Company had approximately 480 shareholders and 2,543,838 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 and the first quarter of fiscal 2004-2005. The Company paid $0.03 per share cash dividend in each of the last three quarters of 2004-2005. The 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. 50 A familiar face. The Board of Directors of Security Federal Corporation is pleased to announce the recent promotion of Roy G. Lindburg to Executive Vice President, Treasurer and Chief Financial Officer of Security Federal Corporation and its subsidiaries. Having already served the bank for over 10 years as Treasurer and CFO, Roy has done an excellent job managing the bank's investment portfolio maximizing the spread between assets and liabilities while maintaining adequate liquidity and minimim interest rate risk. A Certified Public Accountant with over 21 years of banking experience, Roy is a member of the University of South Carolina Aiken School of Business Advisory Board as well as a Member of the South Carolina Bankers Association Asset/Liability Committee. Roy also serves as a Deacon at Grace Brethren Church. We are very fortunate to have such an experienced and committed associate as a key member of our team. Roy G. Lindburg, Executive Vice President, Treasurer and Chief Financial Officer 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, 2005 with the Securities and Exchange Commission. Copies of Form 10-K, Security Federal Corporation's annual report, and the Company's quarterly reports may be obtained from and inquiries may be addressed to Mrs. Ruth L. Vance of Security Federal Corporation. GENERAL TRANSFER SPECIAL INQUIRIES AGENT COUNSEL Mrs. Ruth L. Vance Security Federal Breyer & Associates, PC Security Federal Corporation Suite 785 Corp. 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: 866-851-3000 INDEPENDENT AUDITORS Elliott Davis, LLC 211 York Street, N.E. Suite One P.O. Box 930 Aiken, SC 29802-0930 51 Board of Directors - ----------------------------------------------------------------------------- BOARD OF DIRECTORS T. Clifton Weeks Sen. Thomas L. Moore Harry O. Weeks, Jr. Chairman President Business Dev. Executive Security Federal Corp. Boiler Efficiency, Inc. Hutson-Etherredge Co. Aiken, SC Clearwater, SC Aiken, SC Dr. Robert E. Alexander Timothy W. Simmons J. Chris Verenes Chancellor Emeritus President/CEO President Univ. of SC at Aiken Security Federal Corp. Security Federal Bank Aiken, SC Aiken, SC Aiken, SC Hon. William Clyburn G. L. Toole, III Roy G. Lindburg Member of the South Carolina Attorney-At-Law Executive Vice President House of Representatives Aiken, SC Treasurer/CFO Aiken, SC Security Federal Corporation Aiken, SC - ------------------------------------------------------------------------------ Directors 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 Board - ------------------------------------------------------------------------------ NORTH AUGUSTA----------------------------------------------------------------- P. Richard Borden Rev. G.L. Brightharp Helen H. Butler Owner Owner Retired Banker Borden Pest Control G.L. Brightharp & Sons Mortuary North Augusta, SC North Augusta, SC North Augusta, SC William M. Hixon Sen. Thomas L. Moore John P. Potter Owner President Director of Hixon Realty Boiler Efficiency, Inc. Finance North Augusta, SC Clearwater, SC City of North Augusta North Augusta, SC WAGENER----------------------------------------------------------------------- M. Judson Busbee Chad G. Ingram Mary T. Lybrand Michael L. Miller Owner Vice President Retired Banker Anesthesiologist Busbee Hardware New World Enterprises Wagener, SC Palmetto Health Wagener, SC Wagener, SC Richland Memorial Hosp. Columbia, SC Richard H. Sumpter Retired Educator Wagener, SC MIDLAND VALLEY---------------------------------------------------------------- Charles A. Hilton Rev. Nathaniel Irvin, Sr. Gloria Busch-Johnson General Manager Pastor Consultant Breezy Hill Old Storm Branch Aiken, SC Water& Sewer Baptist Church Graniteville, SC Clearwater, SC Sen. Thomas L. Moore Glenda K. Napier Carlton B. Shealy President Co-Owner Owner Boiler Efficiency, Inc. Napier Funeral Home C. Shealy Realty Builders & Clearwater, SC Graniteville, SC Developers North Augusta, SC WEST COLUMBIA-LEXINGTON------------------------------------------------------- Eleanor Powell Clark Sandra Dooley Parker L. Todd Sease Owner/Operator Attorney Partner B & E Enterprises Inc. Dooley, Dooley, Spence, Jumper, Carter, Sease dba McDonald's Parker & Hipp, PA Architects, PA Columbia, SC Lexington, SC West Columbia, SC L. Ed Kirkland, Jr. Sen. Nikki G. Setzler Dianne Light Owner/Agent Sr. Partner Owner L. Ed Kirkland & Co., LLC Setzler & Scott, PA Diane's on Devine Columbia, SC Law Firm & Dipmato's Deli West Columbia, SC Columbia, SC Jan Hook-Stamps Donald T. Martin Owner Controller, CPA Southern Anesthesia & Nexsen, Pruet, Jacobs Surgical Co. Pollard, LLP West Columbia, SC Columbia, SC 53 Management Team - ------------------------------------------------------------------------------ T. Clifton Weeks Chairman of Security Federal Corporation Timothy W. Simmons Chairman and Chief Executive Officer, Security Federal Bank G. L. Toole, III Vice President Robert E. Johnson Corporate Secretary J. Chris Verenes President, Security Federal Bank Roy G. Lindburg Executive Vice President, Treasurer and Chief Financial Officer Joseph C. Taylor Vice President, Senior 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 - Branch Administration Audrey Varn Vice President, Senior Trust Officer Matthew B. Fry Audit Department Manager Gabriele C. Dukes Vice President - Financial Counseling/Community Development Rodney K. Ingle Vice President - Business Development/Commercial Loans Janice S. Hauerwas Vice President - Mortgage Loan Originator Gregory D. Warfield Vice President - Mortgage Loan Originator William O. Boyte, III Vice President - Construction Lending - Midlands Area James E. Bristow Vice President - Business Development/Commercial Loans Paul T. Rideout Vice President - Business Development/Commercial Loans H. Stanley Price Vice President - Business Development/Commercial Loans Elsie K. Dicks Vice President - Credit Administration Etta A. Petroff Assistant Vice President - Mortgage Loan Production/Secondary Marketing Andrea P. Haltiwanger Assistant Vice President - 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 Barbara J. Davis Assistant Vice President - Mortgage Loan Underwriter Marilyn C. Hensley Assistant Vice President - Special Assets Jason S. Redd Assistant Vice President - Trust, Investments & Insurance Branch Locations-------------------------------------------------------------- Whiskey Road, Aiken, SC Dana S. Hall, Assistant Vice President/Manager North Augusta, SC Kathy S. Williamson, Assistant Vice President/Manager Laurens Street, Aiken, SC Vicky W. Moseley, Assistant Vice President/Manager Richland Avenue, Aiken, SC Nicole W. Simmons, Assistant Vice President/Manager Wal-Mart, Aiken, SC Tonya Key, Manager Graniteville, SC Shane M. Bagby, 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 Nancy P. Hutto, Assistant Vice President/Manager 54 Family Tree - ------------------------------------------------------------------------------ Security Federal Corporation ----------- Security Federal Bank - ------------------------------------------------------------------------------ Security Security Security Federal Federal Federal --------------- --------------- -------------- Trust, Inc. Investments, Inc. Insurance, Inc. 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 Bank Security Federal Insurance South Carolina 100% Security Federal Investments South Carolina 100% Security Federal Trust South Carolina 100% Security Financial Services South Carolina 100% Corporation Exhibit 23 Consent of Elliott Davis, LLC CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors Security Federal Corporation We consent to incorporation by reference in the Registration Statement No. 33-80008, 333-3150 and 333-102337 on Form S-8 of our report dated May 9, 2005, relating to the consolidated balance sheet of Security Federal Corporation and subsidiaries as of March 31, 2005 and the related consolidated statements of income, shareholders' equity and cash flows for the year then ended, which report appears in the March 31, 2005 annual report on Form 10-K. /s/ Elliott Davis, LLC Columbia, South Carolina June 23, 2005 Exhibit 31.1 Certification Required by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934 I, Timothy W. Simmons, certify that: 1. I have reviewed this annual report on Form 10-K of Security Federal Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: June 29, 2005 /s/Timothy W. Simmons ------------------------------ Timothy W. Simmons President and Chief Executive Officer Exhibit 31.2 Certification Required by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934 I, Roy G. Lindburg, certify that: 1. I have reviewed this annual report on Form 10-K of Security Federal Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: June 29, 2005 /s/Roy G. Lindburg ------------------------------ Roy G. Lindburg Treasurer and Chief Financial Officer Exhibit 32 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER OF SECURITY FEDERAL CORPORATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The undersigned hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and in connection with this Annual Report on Form 10-K, that: 1. the report fully complies with the requirements of Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, and 2. the information contained in the report fairly presents, in all material respects, the company's financial condition and results of operations. /s/Timothy W. Simmons /s/Roy G. Lindburg - ------------------------------------- ------------------------------------- Timothy W. Simmons Roy G. Lindburg President and Chief Executive Officer Treasurer and Chief Financial Officer Dated: June 29, 2005 -----END PRIVACY-ENHANCED MESSAGE-----