10-Q 1 q306.txt SECURITY FEDERAL CORPORATION FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10 - Q (Mark one) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2005 ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD: FROM: TO: ------------------ ----------------- COMMISSION FILE NUMBER: 0-16120 SECURITY FEDERAL CORPORATION South Carolina 57-0858504 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 1705 WHISKEY ROAD, AIKEN, SOUTH CAROLINA 29801 (Address of Principal Executive Office And Zip code) (803) 641-3000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] ------- ------- Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "large accelerated filer" and "accelerated filer" in Rule 12b-2 of the Exchange Act. Large accelerated filed [ ] Accelerated filer [ ] Non-accelerated filer [X] Indicate by check mark whether the registrant is a shell company (defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X] ------ ------ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. CLASS: OUTSTANDING SHARES AT: SHARES: ---------------- ----------------------- ------------------ Common Stock, par January 31, 2006 2,537,010 value $0.01 per share INDEX ------------------------------------------------------------------------------ PART I. FINANCIAL INFORMATION (UNAUDITED) PAGE NO. Item 1. Financial Statements (Unaudited): Consolidated Balance Sheets at December 31, 2005 and March 31, 2005 1 Consolidated Statements of Income for the Three and Nine Months Ended December 31, 2005 and 2004 2 Consolidated Statements of Shareholders' Equity and Comprehensive Income at December 31, 2004 and 2005 4 Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2005 and 2004 5 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13 Item 3. Quantitative and Qualitative Disclosures about Market Risk 21 Item 4. Controls and Procedures 21 ------------------------------------------------------------------------------ PART II. OTHER INFORMATION Item 1. Legal Proceedings 22 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 22 Item 3. Defaults Upon Senior Securities 22 Item 4. Submission of Matters to a Vote of Security Holders 22 Item 5. Other Information 22 Item 6. Exhibits 22 Signatures 23 ------------------------------------------------------------------------------ SCHEDULES OMITTED All schedules other than those indicated above are omitted because of the absence of the conditions under which they are required or because the information is included in the consolidated financial statements and related notes. Part I. Financial Information Item 1. Financial Statements (Unaudited) Security Federal Corporation and Subsidiaries Consolidated Balance Sheets December 31, March 31, 2005 2005 ------------ ------------ (Unaudited) (Audited) Assets: Cash And Cash Equivalents $16,462,283 $7,916,488 Investment And Mortgage-Backed Securities: Available For Sale: (Amortized cost of $162,259,854 at December 31, 2005 and $166,364,642 at March 31, 2005) 159,265,454 164,814,819 Held To Maturity: (Fair value of $73,258,830 at December 31, 2005 and $74,770,902 at March 31, 2005) 74,991,809 76,260,904 ------------- ------------- Total Investment And Mortgage-Backed Securities 234,257,263 241,075,723 ------------- ------------- Held For Sale 714,034 2,277,762 Held For Investment: (Net of allowance of $6,570,931 at December 31, 2005 and $6,284,055 at March 31, 2005) 354,572,533 314,611,373 ------------- ------------- Total Loans Receivable, Net 355,286,567 316,889,135 ------------- ------------- Accrued Interest Receivable: Loans 1,138,126 901,872 Mortgage-Backed Securities 509,055 555,933 Investments 773,453 721,744 Premises And Equipment, Net 9,501,767 7,914,043 Federal Home Loan Bank Stock, At Cost 7,083,900 6,234,500 Repossessed Assets Acquired In Settlement Of Loans 145,870 53,000 Other Assets 3,792,050 3,716,035 ------------- ------------- Total Assets $ 628,950,334 $ 585,978,473 ============= ============= Liabilities And Shareholders' Equity Liabilities: Deposit Accounts $ 450,172,398 $ 430,287,391 Advances From Federal Home Loan Bank 132,513,000 112,038,000 Other Borrowed Money 6,060,935 5,594,157 Advance Payments By Borrowers For Taxes And Insurance 567,629 417,410 Other Liabilities 2,671,473 2,530,450 ------------- ------------- Total Liabilities $ 591,985,435 $ 550,867,408 ------------- ------------- Shareholders' Equity: Serial Preferred Stock, $.01 Par Value; Authorized Shares - 200,000; Issued And Outstanding Shares - None $ - $ - Common Stock, $.01 Par Value; Authorized Shares - 5,000,000; Issued - 2,546,722 And Outstanding Shares - 2,537,178 At December 31, 2005 And 2,543,838 And 2,522,127 At March 31, 2005 25,564 25,438 Additional Paid-In Capital 4,374,122 4,181,804 Treasury Stock, (At Cost, 9,712 and 8,077 Shares, Respectively) (200,256) (165,089) Indirect Guarantee Of Employee Stock Ownership Trust Debt (215,503) (276,217) Accumulated Other Comprehensive Loss (1,857,726) (961,504) Retained Earnings, Substantially Restricted 34,838,698 32,306,633 ------------- ------------- Total Shareholders' Equity $ 36,964,899 $ 35,111,065 ------------- ------------- Total Liabilities And Shareholders' Equity $ 628,950,334 $ 585,978,473 ============= ============= See accompanying notes to consolidated financial statements. 1 Security Federal Corporation and Subsidiaries Consolidated Statements of Income (Unaudited) Three Months Ended December 31, ------------------------------- 2005 2004 -------------- ------------- Interest Income: Loans $ 5,963,727 $ 4,306,895 Mortgage-Backed Securities 1,333,025 1,401,716 Investment Securities 962,379 756,877 Other 10,835 5,851 -------------- ------------ Total Interest Income 8,269,966 6,471,339 -------------- ------------ Interest Expense: NOW And Money Market Accounts 1,358,825 1,032,212 Passbook Accounts 43,143 42,547 Certificate Accounts 1,523,634 937,371 Advances And Other Borrowed Money 1,186,344 913,355 -------------- ------------ Total Interest Expense 4,111,946 2,925,485 -------------- ------------ Net Interest Income 4,158,020 3,545,854 Provision For Loan Losses 165,000 195,000 -------------- ------------ Net Interest Income After Provision For Loan Losses 3,993,020 3,350,854 -------------- ------------ Other Income: Gain On Sale Of Loans 121,138 88,265 Loan Servicing Fees 53,606 47,997 Service Fees On Deposit Accounts 303,173 327,062 Other 236,412 242,996 -------------- ------------ Total Other Income 714,329 706,320 -------------- ------------ General And Administrative Expenses: Salaries And Employee Benefits 1,847,482 1,444,615 Occupancy 331,501 268,749 Advertising 44,402 53,785 Depreciation And Maintenance Of Equipment 274,324 244,000 FDIC Insurance Premiums 14,561 14,444 Other 692,196 686,852 -------------- ------------ Total General And Administrative Expenses 3,204,466 2,712,445 -------------- ------------ Income Before Income Taxes 1,502,883 1,344,729 Provision For Income Taxes 544,908 432,878 -------------- ------------ Net Income $ 957,975 $ 911,851 ============== ============ Basic Net Income Per Common Share $ 0.38 $ 0.36 ============== ============ Diluted Net Income Per Common Share $ 0.37 $ 0.36 ============== ============ Cash Dividend Per Share On Common Stock $ 0.04 $ 0.03 ============== ============ Basic Weighted Average Shares Outstanding 2,536,304 2,527,661 ============== ============ Diluted Weighted Average Shares Outstanding 2,570,767 2,556,839 ============== ============ See accompanying notes to consolidated financial statements. 2 Security Federal Corporation and Subsidiaries Consolidated Statements of Income (Unaudited) Nine Months Ended December 31, -------------------------------- 2005 2004 ------------ -------------- Interest Income: Loans $ 16,751,933 $ 12,158,605 Mortgage-Backed Securities 4,084,033 4,170,928 Investment Securities 2,634,484 2,408,801 Other 47,122 18,580 ------------ ------------- Total Interest Income 23,517,572 18,756,914 ------------ ------------- Interest Expense: NOW And Money Market Accounts 3,905,361 2,895,348 Passbook Accounts 132,262 129,515 Certificate Accounts 4,077,011 2,559,988 Advances And Other Borrowed Money 3,270,366 2,816,492 ------------ ------------- Total Interest Expense 11,385,000 8,401,343 ------------ ------------- Net Interest Income 12,132,572 10,355,571 Provision For Loan Losses 495,000 585,000 ------------ ------------- Net Interest Income After Provision For Loan Losses 11,637,572 9,770,571 ------------ ------------- Other Income: Gain On Sale of Investments 48,962 - Gain On Sale Of Loans 374,701 327,088 Loan Servicing Fees 154,365 135,103 Service Fees On Deposit Accounts 875,237 952,426 Other 700,121 675,066 ------------ ------------- Total Other Income 2,153,386 2,089,683 ------------ ------------- General And Administrative Expenses: Salaries And Employee Benefits 5,443,785 4,629,528 Occupancy 962,678 792,457 Advertising 113,392 128,310 Depreciation And Maintenance Of Equipment 784,443 781,022 FDIC Insurance Premiums 43,247 43,341 Other 2,024,699 1,742,929 ------------ ------------- Total General And Administrative Expenses 9,372,244 8,117,587 ------------ ------------- Income Before Income Taxes 4,418,714 3,742,667 Provision For Income Taxes 1,581,817 1,228,783 ------------ ------------- Net Income $ 2,836,897 $ 2,513,884 ============ ============= Basic Net Income Per Common Share $ 1.12 $ 1.00 ============ ============= Diluted Net Income Per Common Share $ 1.11 $ 0.98 ============ ============= Cash Dividend Per Share On Common Stock $ 0.12 $ 0.08 ============ ============= Basic Weighted Average Shares Outstanding 2,531,885 2,523,296 ============ ============= Diluted Weighted Average Shares Outstanding 2,565,949 2,558,502 ============ ============= See accompanying notes to consolidated financial statements. 3 Security Federal Corporation and Subsidiaries Consolidated Statements of Shareholders' Equity and Comprehensive Income (Unaudited) Accumulated Indirect Other Additional Guarantee Comprehen- Common Paid-In Treasury of sive Income Retained Stock Capital Stock ESOP Debt (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 - - - - - 2,513,884 2,513,884 Other Comprehensive Income, Net Of Tax: Unrealized Holding Losses On Securities Available For Sale - - - - (914,913) - (914,913) ----------- Comprehensive Income - - - - - - 1,598,971 Decrease In Indirect Guarantee Of ESOP Debt - - - 60,755 - - 60,755 Exercise Of Stock Options 105 168,130 - - - - 168,235 Cash Dividends - - - - - (202,914) (202,914) -------- ---------- - - --------- --------- ----------- ----------- Balance At December 31, 2004 $ 25,438 $4,181,804 $ - $(276,217) $(225,158) $31,391,095 $35,096,962 ======== ========== === ========= ========= =========== ===========
Accumulated Indirect Other Additional Guarantee Comprehen- Common Paid-In Treasury of sive Income Retained Stock Capital Stock ESOP Debt (Loss) Earnings Total -------- ---------- -------- ---------- ----------- ----------- ----------- Balance At March 31, 2005 $25,438 $4,181,804 $(165,089) $(276,217) $(961,504) $32,306,633 $35,111,065 Net Income - - - - - 2,836,897 2,836,897 Other Comprehensive Income, Net Of Tax: Unrealized Holding Losses On Securities Available For Sale - - - - (865,866) - (865,866) Plus Reclassification Adjustments For Gains Included In Net Income - - - - (30,356) - (30,356) ----------- Comprehensive Income - - - - - - 1,940,675 Purchase Of Treasury Stock At Cost, 1,635 shares - - (35,167) - - - (35,167) Exercise Of Stock Options 126 192,318 - - - - 192,444 Decrease In Indirect Guarantee Of ESOP Debt - - - 60,714 - - 60,714 Cash Dividends - - - - - (304,832) (304,832) -------- ---------- --------- -------- ---------- ----------- ----------- Balance At December 31, 2005 $ 25,564 $4,374,122 $(200,256) $(215,503)$(1,857,726) $34,838,698 $36,964,899 ======== ========== ========= ========= =========== =========== =========== See accompanying notes to consolidated financial statements.
4 Security Federal Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended December 31, -------------------------------- 2005 2004 ----------- ------------ Cash Flows From Operating Activities: Net Income $ 2,836,897 $ 2,513,884 Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities: Depreciation Expense 731,381 630,742 Discount Accretion And Premium Amortization 762,876 929,109 Provisions For Losses On Loans And Real Estate 495,000 585,000 Gain On Sale Of Loans (374,701) (327,088) Gain On Sale Of Mortgage Backed Securities Available For Sale (48,962) - Loss (Gain) On Sale Of Real Estate 21,416 (53,661) Amortization Of Deferred Fees On Loans (139,852) (143,244) Proceeds From Sale Of Loans Held For Sale 24,294,189 19,590,174 Origination Of Loans For Sale (22,355,760) (18,982,328) (Increase) Decrease In Accrued Interest Receivable: Loans (236,254) 23,813 Mortgage-Backed Securities 46,878 (24,904) Investments (51,709) 145,173 Increase (Decrease) In Advance Payments By Borrowers 150,219 (77,620) Loss (Gain) on Disposition of Premises and Equipment 4,469 (3,525) Other, Net 674,086 (684,252) ------------ ------------ Net Cash Provided By Operating Activities 6,810,173 4,121,273 ------------ ------------ Cash Flows From Investing Activities: Principal Repayments On Mortgage-Backed Securities Available For Sale 39,543,268 37,602,571 Principal Repayments On Mortgage-Backed Securities Held To Maturity 10,407 79,558 Purchase Of Investment Securities Available For Sale (20,046,195) - Purchase Of Investment Securities Held To Maturity - (22,042,025) Purchase Of Mortgage-Backed Securities Available For Sale (24,569,383) (49,526,672) Maturities Of Investment Securities Available For Sale 4,674,853 10,000,000 Maturities of Investment Securities Held To Maturity 1,000,000 19,000,000 Proceeds From Sale Of Mortgage-Backed Securities Available For Sale 3,797,360 - Proceeds From Sale Of Mortgage-Backed Securities Held To Maturity 249,650 - Purchase Of FHLB Stock (4,697,800) (3,910,900) Redemption Of FHLB Stock 3,848,400 2,702,900 Increase In Loans To Customers (40,527,093) (36,558,688) Proceeds From Sale Of Repossessed Assets 96,499 335,427 Purchase And Improvement Of Premises And Equipment (2,323,574) (1,945,254) Proceeds from Sale of Premises And Equipment - 3,525 ------------ ------------ Net Cash Used By Investing Activities (38,943,608) (44,259,558) ------------ ------------ Cash Flows From Financing Activities: Increase In Deposit Accounts 19,885,007 26,572,741 Proceeds From FHLB Advances 181,395,000 100,943,000 Repayment Of FHLB Advances (160,920,000) (86,866,000) Net Proceeds (Repayments) Of Other Borrowings 466,778 (189,458) Dividends To Shareholders (304,832) (202,914) Purchase Of Treasury Stock (35,167) - Proceeds From Exercise of Stock Options 192,444 168,235 ------------ ------------ Net Cash Provided By Financing Activities 40,679,230 40,425,604 ------------ ------------ (Continued) 5 Security Federal Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended December 31, -------------------------------- 2005 2004 ------------- ------------- Increase In Cash And Cash Equivalents 8,545,795 287,319 Cash And Cash Equivalents At Beginning Of Period 7,916,488 6,749,211 ----------- ----------- Cash And Cash Equivalents At End Of Period $16,462,283 $ 7,036,530 =========== =========== Supplemental Disclosure Of Cash Flows Information: Cash Paid During The Period For Interest $11,161,678 $ 8,322,953 Cash Paid During The Period For Income Taxes $ 1,742,825 $ 1,699,012 Additions To Repossessed Acquired Through Foreclosure $ 210,785 $ 358,397 Increase In Unrealized Net Loss On Securities Available For Sale, Net Of Taxes $ (896,222) $ (914,913) See accompanying notes to consolidated financial statements. 6 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) 1. Basis of Presentation The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and accounting principles generally accepted in the United States of America; therefore, they do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows. Such statements are unaudited but, in the opinion of management, reflect all adjustments, which are of a normal recurring nature and necessary for a fair presentation of results for the selected interim periods. Users of financial information produced for interim periods are encouraged to refer to the footnotes contained in the audited financial statements appearing in Security Federal Corporation's (the "Company") 2005 Annual Report to Shareholders when reviewing interim financial statements. The results of operations for the nine-month period ended December 31, 2005 are not necessarily indicative of the results that may be expected for the entire fiscal year. This Quarterly Report on Form 10-Q contains certain forward-looking statements with respect to the financial condition, results of operations, and business of the Company. These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those anticipated by such forward-looking statements include, but are not limited to, changes in interest rates, the demand for loans, the regulatory environment, general economic conditions and inflation, and the securities markets. Management cautions readers of this Form 10-Q not to place undue reliance on the forward- looking statements contained herein. 2. Principles of Consolidation The accompanying unaudited consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Security Federal Bank (the "Bank"), and the Bank's wholly owned subsidiaries, Security Federal Insurance, Inc. ("SFINS"), Security Federal Investments, Inc. ("SFINV"), Security Federal Trust, Inc. ("SFT"), and Security Financial Services Corporation ("SFSC"). The Bank is primarily engaged in the business of accepting savings and demand deposits and originating mortgage and other loans to individuals and small businesses for various personal and commercial purposes. SFINS, SFINV, and SFT were formed during the year ended March 31, 2002 and began operation during the December 2001 quarter. SFINS is an insurance agency offering business, health, home and life insurance. SFINV engages primarily in investment brokerage services. SFT offers trust, financial planning and financial management services. SFSC is currently inactive. 3. Loans Receivable, Net Loans receivable, net, at December 31, 2005 and March 31, 2005 consisted of the following: Loans held for sale were $714,034 and $2,277,762 at December 31, 2005 and March 31, 2005, respectively. Loans Held For Investment: December 31, 2005 March 31, 2005 ------------------- ------------------ Residential Real Estate $ 122,703,867 $ 122,622,347 Consumer 56,819,276 50,844,192 Commercial Business And Real Estate 191,357,758 162,217,200 ------------- ------------- 370,880,901 335,683,739 ------------- ------------- Less: Allowance For Possible Loan Losses 6,570,931 6,284,055 Loans In Process 9,574,921 14,626,913 Deferred Loan Fees 162,516 161,398 ------------- ------------- 16,308,368 21,072,366 ------------- ------------- $ 354,572,533 $ 314,611,373 ============= ============= The following is a reconciliation of the allowance for loan losses for the nine months ending: December 31, 2005 December 31, 2004 --------------------- ------------------- Beginning Balance $ 6,284,055 $ 5,763,935 Provision 495,000 585,000 Charge-offs (263,752) (229,538) Recoveries 55,628 133,298 -------------- -------------- Ending Balance $ 6,570,931 $ 6,252,695 ============== ============== 7 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 4. Securities Investment and Mortgage-Backed Securities, Held to Maturity ----------------------------------------------------------- The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of investment and mortgage-backed securities held to maturity are as follows: Gross Gross December 31, 2005 Amortized Unrealized Unrealized ------------------ Cost Gains Losses Fair Value ------------ ---------- ---------- ----------- US Government And Agency Obligations $ 74,991,809 - 1,732,979 73,258,830 ============ ======== =========== ============ March 31, 2005 -------------- US Government And Agency Obligations $ 76,000,847 $ - $ 1,504,761 $ 74,496,086 Mortgage-Backed Securities 260,057 14,759 - 274,816 ------------ -------- ----------- ------------ Total $ 76,260,904 $ 14,759 $ 1,504,761 $ 74,770,902 ============ ======== =========== ============ Investment And Mortgage-Backed Securities, Available For Sale ------------------------------------------------------------- The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of investment and mortgage-backed securities available for sale are as follows: Gross Gross December 31, 2005 Amortized Unrealized Unrealized ------------------ Cost Gains Losses Fair Value ------------ ---------- ---------- ----------- US Government And Agency Obligations $ 20,837,147 $ 2,500 $ 212,949 $ 20,626,698 Mortgage-Backed Securities 141,422,707 144,542 2,928,493 138,638,756 ------------ --------- ----------- ------------ Total $162,259,854 $ 147,042 $ 3,141,442 $159,265,454 ============ ========= =========== ============ March 31, 2005 -------------- US Government And Agency Obligations $ 5,469,678 $ 4,648 $ 19,063 $ 5,455,263 Mortgage-Backed Securities 160,894,954 457,081 1,992,479 159,359,556 ------------ --------- ----------- ------------ Total $166,364,632 $ 461,729 $ 2,011,542 $164,814,819 ============ ========= =========== ============ 8 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 5. Deposit Accounts A summary of deposit accounts by type with weighted average rates is as follows: December 31, 2005 March 31, 2005 ------------------- --------------------- Balance Rate Balance Rate Demand Accounts: ------------------- --------------------- Checking $ 96,577,795 0.91% $ 88,169,885 0.65% Money Market 153,400,713 3.09% 164,088,081 2.57% Regular Savings 17,269,681 0.98% 17,743,659 0.98% ------------ ------------ Total Demand Accounts 267,248,189 2.16% 270,001,625 1.84% ------------ ------------ Certificate Accounts: 0 - 4.99% 173,158,740 150,486,280 5.00 - 6.99% 9,765,469 9,799,486 ------------ ------------ Total Certificate Accounts 182,924,209 3.67% 160,285,766 2.92% ------------ ------------ Total Deposit Accounts $450,172,398 2.77% $430,287,391 2.24% ============ ============ 6. Advances From Federal Home Loan Bank ("FHLB") FHLB advances are summarized by year of maturity and weighted average interest rate in the table below: December 31, 2005 March 31, 2005 ---------------------- --------------------- Fiscal Year Due: Balance Rate Balance Rate ---------------------- --------------------- 2006 $ 15,000,000 2.85% $ 40,675,000 4.09% 2007 24,150,000 3.24% 18,000,000 2.83% 2008 5,000,000 3.09% 10,000,000 2.96% 2009 20,000,000 3.28% 25,000,000 3.05% 2010 5,000,000 3.09% 5,000,000 3.09% Thereafter 63,363,000 3.95% 13,363,000 3.21% ------------ ------------ Total Advances $132,513,000 3.53% $112,038,000 3.41% ============ ============ 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 $64.7 million in investment securities at December 31, 2005. Advances are subject to prepayment penalties. The following table shows callable FHLB advances as of the dates indicated. These advances are also included in the above table. All callable advances are callable at the option of the FHLB. If an advance is called, the Bank has the option to payoff the advance without penalty, re-borrow funds on different terms, or convert the advance to a three-month floating rate advance tied to LIBOR. As of December 31, 2005 ------------------------------------------------------------------------------------------------------------ Borrow Date Maturity Date Amount Int. Rate Type Call Dates ------------ --------------- --------- ----------- --------- --------------------------------- 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 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 06/24/05 06/24/15 5,000,000 3.71% 1 Time Call 06/24/10 06/24/05 06/24/10 5,000,000 3.7215% 1 Time Call 06/26/06 07/22/05 07/22/15 5,000,000 3.79% 1 Time Call 07/22/08 10/21/05 10/21/10 5,000,000 3.4306% 1 Time Call 10/23/06 11/01/05 11/10/15 5,000,000 4.40% 1 Time Call 11/10/09 11/22/05 11/23/15 5,000,000 3.9325% Multi-call 11/23/07 and quarterly thereafter 11/29/05 11/29/13 5,000,000 4.32% 1 Time Call 05/29/09 12/14/05 12/14/11 5,000,000 4.64% 1 Time Call 09/14/09 9
Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued As of March 31, 2005 ------------------------------------------------------------------------------------------------------------ Borrow Date Maturity Date Amount Int. Rate Type Call Dates ------------ --------------- --------- ----------- --------- --------------------------------- 11/10/00 11/10/05 5,000,000 5.85% Multi-Call 05/10/05 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 3.35% 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 2.14% 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 09/19/09 5,000,000 3.09% 1 Time Call 09/17/07
7. Regulatory Matters The following table reconciles the Bank's shareholders' equity to its various regulatory capital positions: December 31, March 31, 2005 2005 (In Thousands) ----------------------------- Bank's Shareholders' Equity $ 36,636 $ 34,690 Unrealized Loss On Available For Sale Of Securities, Net Of Tax 1,858 962 Reduction For Goodwill And Other Intangibles - - -------- -------- Tangible Capital 38,494 35,652 Qualifying Core Deposits And Intangible Assets - - -------- -------- Core Capital 38,494 35,652 Supplemental Capital 4,700 4,236 Assets Required To Be Deducted (9) (30) -------- -------- Risk-Based Capital $ 43,185 $ 39,858 ======== ======== The following table compares the Bank's capital levels relative to the applicable regulatory requirements at December 31, 2005: (Dollars in Thousands) --------------------------------------------------------- Amt. % Actual Actual Excess Excess Required Required Amt. % Amt. % --------------------------------------------------------- Tangible Capital $12,612 2.0% $38,494 6.10% $25,882 4.10% Tier 1 Leverage (Core) Capital 25,223 4.0% 38,494 6.10% 13,271 2.10% Total Risk-Based Capital 30,081 8.0% 43,185 11.48% 13,104 3.48% Tier 1 Risk-Based (Core) Capital 15,041 4.0% 38,494 10.24% 23,453 6.24% 8. Earnings Per Share The Company calculates earnings per share ("EPS") in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share." SFAS No. 128 specifies the computation, presentation and disclosure requirements for earnings per share ("EPS") for entities with publicly held common stock or potential common stock such as options, warrants, convertible securities or contingent stock agreements if those securities trade in a public market. This standard specifies computation and presentation requirements for both basic EPS and, for entities with complex capital structures, diluted EPS. Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding. Diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. The dilutive effect of options outstanding under the Company's stock option plan is reflected in diluted earnings per share by application of the treasury stock method. 10 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued The following table provides a reconciliation of the numerators and denominators of the basic and diluted EPS computations: For the Quarter Ended ---------------------------------------------- December 31, 2005 ---------------------------------------------- Income (Numerator) Shares Amount (Denominator) Per Share ---------- ------------- --------- Basic EPS $ 957,975 2,536,304 $ 0.38 Effect of Diluted Securities: Stock Options - 24,919 (.007) ESOP - 9,544 (.003) ---------- ------------- -------- Diluted EPS $ 957,975 2,570,767 $ 0.37 ========== ============= ======== For the Quarter Ended ---------------------------------------------- December 31, 2004 ---------------------------------------------- Income (Numerator) Shares Amount (Denominator) Per Share ---------- ------------- --------- Basic EPS $ 911,851 2,527,661 $ 0.36 Effect of Diluted Securities: Stock Options - 15,449 - ESOP - 13,729 - ---------- ------------- -------- Diluted EPS $ 911,851 2,556,839 $ 0.36 ========== ============= ======== For the Nine Months Ended ---------------------------------------------- December 31, 2005 ---------------------------------------------- Income (Numerator) Shares Amount (Denominator) Per Share ---------- ------------- --------- Basic EPS $ 2,836,897 2,531,885 $ 1.12 Effect of Diluted Securities: Stock Options - 24,471 (0.007) ESOP - 9,593 (0.003) ----------- ------------- -------- Diluted EPS $ 2,836,897 2,565,949 $ 1.11 =========== ============= ======== For the Nine Months Ended ---------------------------------------------- December 31, 2004 ---------------------------------------------- Income (Numerator) Shares Amount (Denominator) Per Share ---------- ------------- --------- Basic EPS $ 2,513,884 2,523,296 $ 1.00 Effect of Diluted Securities: Stock Options - 22,490 (0.013) ESOP - 12,716 (0.007) ----------- ------------- -------- Diluted EPS $ 2,513,884 2,558,502 $ 0.98 =========== ============= ======== 11 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 9. Stock-Based Compensation The Company has a stock-based employee compensation plan which is accounted for under the recognition and measurement principles of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. No stock-based employee compensation cost is reflected in net income, as all stock options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share as if we had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation for the three months and nine months ended December 31, 2005 and 2004, respectively. Three Months Ended Nine Months Ended December 31, December 31, 2005 2004 2005 2004 --------- --------- ---------- ---------- Net income, as reported $ 957,975 $ 911,851 $2,836,897 $2,513,884 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effect $ (30,570) $ (57,124) $ (91,710) $ (171,372) Net Income, Pro Forma $ 927,405 $ 854,727 $2,745,187 $2,342,512 Basic earnings share: As Reported $ .38 $ .36 $ 1.12 $ 1.00 Pro Forma $ .37 $ .34 $ 1.08 $ .93 Diluted earnings share: As reported $ .37 $ .36 $ 1.11 $ .98 Pro forma $ .36 $ .33 $ 1.07 $ .92 12 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Safe Harbor Statement Certain matters in this Quarterly Report on Form 10-Q for the quarter ended December 31, 2005 constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements relate to, among others, expectations of the business environment in which the Company operates, projections of future performance, perceived opportunities in the market, potential future credit experience, and statements regarding the Company's mission and vision. These forward-looking statements are based upon current management expectations, and may, therefore, involve risks and uncertainties. The Company's actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide range of factors including, but not limited to, the general business environment, interest rates, the South Carolina real estate market, the demand for loans, competitive conditions between banks and non-bank financial services providers, regulatory changes, and other risks detailed in the Company's reports filed with the SEC, including the Annual Report on Form 10-K for the fiscal year ended March 31, 2005. Forward-looking statements are effective only as of the date that they are made and the Company assumes no obligation to update this information. Highlights Total assets of the Company increased $43.0 million or 7.3% from $586.0 million to $629.0 million during the nine months ended December 31, 2005 primarily as a result of an increase of $8.5 million or 108.0% in cash and cash equivalents, an increase of $38.4 million or 12.1% in net loans receivable, and an increase of $1.6 million or 20.1% in net premises and equipment. The increases were offset partially by a decrease of $6.8 million or 2.8% in investments and mortgage-backed securities. During the nine months ended December 31, 2005, residential real estate loans, net of loans in process, increased $5.1 million or 4.8% commercial loans increased $29.1 million or 17.9%, while consumer loans increased $6.0 million or 11.8%. Loans held for sale decreased $1.5 million or 68.7% during the same period. Repossessed assets increased $93,000 to $146,000 during the nine months ended December 31, 2005. Non-accrual loans totaled $1.7 million at December 31, 2005 compared to $2.4 million at March 31, 2005. The Bank classifies all loans as non-accrual when they become 90 days or more delinquent. At December 31, 2005, the Bank held $1.3 million in impaired loans compared to $1.2 million at March 31, 2005. The Bank includes troubled debt restructuring ("TDR") within the meaning of SFAS No. 114, in impaired loans. At December 31, 2005, the Bank had six loans totaling $425,000 in TDR's compared to six loans totaling $434,000 at March 31, 2005. Included in the six TDR loans at December 31, 2005 is a $204,000 commercial loan secured by equipment and a $57,000 consumer loan secured by residential dwellings, which are both over 30 days past due. The other four TDR's consisted of a $12,000 consumer loan secured by a second mortgage on a residential dwelling, an $80,000 consumer loan secured by a residential dwelling, a $18,000 unsecured commercial loan, and a $54,000 commercial loan secured by two rental properties, all of which were current as of December 31, 2005. Deposits increased $19.9 million or 4.6% to $450.2 million during the nine months ended December 31, 2005 as a result of competitive rates offered by the Bank. FHLB advances increased $20.5 million or 18.3% to $132.5 million during the same period. Other borrowings, consisting of commercial repurchase sweep accounts, increased $467,000 or 8.3% to $6.1 million during the nine-month period. The Board of Directors of the Company declared the 58th, 59th, and 60th consecutive quarterly dividend of $0.04, $0.04, $0.04 per share, in April, July, and October 2005, respectively, which totaled $305,000. The employee stock ownership trust of the Company paid $61,000 of principal on the employee stock ownership plan loan during the nine-month period. Unrealized net losses on securities available for sale, net of tax, increased $896,000 during the nine months ended December 31, 2005 as a result of an increase in interest rates. The Company's net income for the nine-month period ended December 31, 2005 was $2.8 million. These items, in total, increased shareholders' equity by $1.9 million or 5.3% to $37.0 million during the nine months ended December 31, 2005. Book value per share was $14.57 at December 31, 2005 compared to $13.92 at March 31, 2005. 13 Security Federal Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources In accordance with Office of Thrift Supervision ("OTS") regulations, the Company is required to maintain sufficient liquidity to operate in a safe and sound manner. The Company's current liquidity level is deemed adequate to meet the requirements of normal operations, potential deposit outflows, and loan demand while still allowing for optimal investment of funds and return on assets. Loan repayments and maturities of investments are a significant source of funds, whereas loan disbursements and the purchase of investments are a primary use of the Company's funds. During the nine months ended December 31, 2005 loan disbursements exceeded loan repayments resulting in a $38.4 million or 12.1% increase in total net loans receivable. Deposits and other borrowings are also an important source of funds for the Company. During the nine months ended December 31, 2005, deposits increased $19.9 million and FHLB advances increased $20.5 million. The Bank had $52.4 million in additional borrowing capacity at the FHLB at the end of the period. At December 31, 2005, the Bank had $139.5 million of certificates of deposit maturing within one year. Based on previous experience, the Bank anticipates a significant portion of these certificates will be renewed. Through its operations, the Bank has made contractual commitments to extend credit in the ordinary course of its business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. At December 31, 2005, the Bank had $30.0 million in unused consumer lines of credit, including home equity lines and unsecured lines, $33.9 million in unused commercial lines of credit, and $1.1 million in letters of credit committed to customers. The majority of the $65.0 million in unused credit will not be drawn upon at the same time. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, by the Bank upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. The Bank manages the credit risk on these commitments by subjecting them to normal underwriting and risk management processes. The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at December 31, 2005. After After One Three Greater Within Through Through Than (Dollars One Three Twelve Within One in thousands) Month Months Months One Year Year Total ------ ------ ------ -------- ---- ----- Unused lines of credit $1,917 $3,244 $22,354 27,515 $36,401 $63,916 Standby letters of credit 192 238 620 1,050 - 1,050 ------ ------ ------- ------- ------- ------- Total $2,109 $3,482 $22,974 $28,565 $36,401 $64,966 ====== ====== ======= ======= ======= ======= Historically, the Company's cash flows from operating activities have been relatively stable. The cash flow from investing activities have had a trend of increasing outflows as a result of increases in purchases of mortgage-backed and investment securities and loan originations. The cash flows from financing activities have had a trend of increased inflows as a result of increases in deposits and FHLB advances. Management believes that the Company's liquidity will continue to be supported by the Company's deposit base and borrowing capacity during the next year. 14 Security Federal Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations 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 Consolidated Financial Statements. The Company's significant accounting policies are described in the footnotes to the audited Consolidated Financial Statements included in its Annual Report on Form 10-K for the year ended March 31, 2005. Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities. Management considers these accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which management believes to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates, which could have a material impact on the Company's carrying values of assets and liabilities and results of operations. The allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of the Company's consolidated financial statements. The Company provides for loan losses using the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to the allowance for loan losses. Additions to the allowance for loan losses are provided by charges to operations based on various factors, which, in management's judgment, deserve current recognition in estimating possible losses. Such factors considered by management include the fair value of the underlying collateral, stated guarantees by the borrow, if applicable, the borrower's ability to repay from other economic resources, growth and composition of the loan portfolios, the relationship of the allowance for loan losses to the outstanding loans, loss experience, delinquency trends, and general economic conditions. Management evaluates the carrying value of the loans periodically and the allowance is adjusted accordingly. While management uses the best information available to make evaluations, future adjustments may be necessary if economic conditions differ substantially from the assumptions used in making these evaluations. Allowance for loan losses are subject to periodic evaluations by various authorities and may be subject to adjustments based upon the information that is available at the time of their examination. The Company values impaired loans at the loan's fair value if it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement at the present value of expected cash flows, the market price of the loan, if available, or the value of the underlying collateral. Expected cash flows are required to be discounted at the loan's effective interest rate. When the ultimate collectibility of an impaired loan's principal is in doubt, wholly or partially, all cash receipts are applied to principal. When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to interest then to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amounts previously charged off. Accounting and Reporting Changes The following is a summary of recent authoritative pronouncements that affect accounting, reporting, and disclosure of financial information by the Company: In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 123 (revised 2004), "Share-Based Payment" ("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 disclosures related to the income tax and cash flow effects resulting from share-based payment arrangements. SFAS No. 123(R) is effective beginning as of the first annual reporting period beginning after December 15, 2005. SFAS No. 123(R) allows for adoption using either the modified prospective or modified retrospective methods. The Company anticipates using the modified prospective method when this statement is adopted in the first quarter of 2006. The Company has evaluated the impact upon adoption of SFAS No. 123(R) and has concluded that the adoption will result in additional charges to earnings of approximately $100,000 for the year ending March 31, 2007. In April 2005, the Securities and Exchange Commission's Office of the Chief Accountant and its Division of Corporation Finance issued Staff Accounting Bulletin ("SAB") No.107 to provide guidance regarding the application of SFAS No.123(R). SAB No. 107 provides interpretive guidance related to the interaction between SFAS 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. 15 Security Federal Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations Accounting and Reporting Changes, Continued SAB No. 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 SFAS No.123(R). In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary Assets an amendment of APB Opinion No. 29." The standard is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged and eliminates the exception under ABP Opinion No. 29 for an exchange of similar productive assets and replaces it with an exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The standard is effective for nonmonetary exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption of SFAS 153 is not expected to have a material impact on the Company's financial position or results of operations. In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections a replacement of APB Opinion No. 20 and FASB Statement No. 3". SFAS No. 154 establishes retrospective application as the required method for reporting a change in accounting principle, unless it is impracticable, in which case the changes should be applied to the latest practicable date presented. SFAS No. 154 also requires that a correction of an error be reported as a prior period adjustment by restating prior period financial statements. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. In March 2004, the FASB issued Emerging Issues Task Force ("EITF") Issue 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 impairment and its application to investments classified as either available for sale or held to maturity under SFAS No. 115 and it also provides guidance on quantitative and qualitative disclosures. The disclosure requirements in paragraph 21 of this Issue were effective for annual financial statements for fiscal years ending after December 15, 2003 and were adopted by the Company effective December 31, 2003. The recognition and measurement guidance in paragraphs 6-20 of this Issue was to be applied to other-than-temporary impairment evaluations in reporting periods beginning after June 15, 2004, but was delayed by FASB action in October 2004 through the issuance of a proposed FASB Staff Position ("FSP") on the issue. In July 2005, the FASB issued FSP FAS 115-1 and FAS 124-1--"The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments." This final guidance eliminated paragraphs10-18 of EITF-03-1 (paragraphs 19-20 have no material impact on the financial position or results of operations of the Company) and will be effective for other-than-temporary impairment analysis conducted in periods beginning after December 15, 2005. The Company has evaluated the impact that the adoption of FSP FAS 115-1 and FAS 124-1 and has concluded that the adoption will not have a material impact on financial position and results of operations upon adoption. In December 2005, the FASB issued FSP SOP 94-6-1, "Terms of Loan Products that May Give Rise to a Concentration of Credit Risk." The disclosure guidance in this FSP is effective for interim and annual periods ending after December 19, 2005. The FSP states that the terms of certain loan products may increase a reporting entity's exposure to credit risk and thereby may result in a concentration of credit risk as that term is used in SFAS No. 107, either as an individual product type or as a group of products with similar features. SFAS No. 107 requires disclosures about each significant concentration, including "information about the (shared) activity, region, or economic characteristic that identifies the concentration." The FSP suggests possible shared characteristics on which significant concentrations may be determined which include, but are not limited to: borrowers subject to significant payment increases, loans with terms that permit negative amortization and loans with high loan-to-value ratios. This FSP requires entities to provide the disclosures required by SFAS No. 107 for loan products that are determined to represent a concentration of credit risk in accordance with the guidance of this FSP for all periods presented. The Company adopted this disclosure standard effective December 31, 2005. 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. 16 Security Federal Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations Impact of Inflation and Changing Prices The consolidated financial statements, related notes, and other financial information presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in relative purchasing power over time due to inflation. Unlike industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than does inflation. See "Item 3. Quantitative and Qualitative Disclosures about Market Risk" for additional discussions of changes in interest rates. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2005 ------------------------------------------------------------------ Net Income Net income was $958,000 for the three months ended December 31, 2005, representing an increase in earnings of $46,000 or 5.1% from $912,000 for the same period in 2004. The primary reasons for the increased earnings were an increase in net interest income offset partially by increases in general and administrative expenses and the provision for income taxes. Net Interest Income Net interest income increased $612,000 or 17.3% to $4.2 million during the three months ended December 31, 2005 compared to $3.5 million for the same period in 2004. The increase is attributable to an increase in interest income offset in part by an increase in interest expense. Average interest earning assets increased $55.7 million while average interest-bearing liabilities increased $48.3 million. The interest rate spread increased 10 basis points to 2.52% during the three months ended December 31, 2005 compared to 2.42% for the same period in 2004. Interest income on loans increased $1.7 million or 38.5% to $6.0 million during the three months ended December 31, 2005 as a result of the average loan portfolio balance increasing by $62.6 million to $349.2 million and the yield in the loan portfolio increasing 82 basis points. Because of a 24 basis point increase in the yield in the investment portfolio, interest income from investment, mortgage-backed, and other securities increased $142,000 or 6.6% to $2.3 million despite a decrease in the average balance of the investment portfolio of $6.9 million. Total interest income increased $1.8 million or 27.8% to $8.3 million for the three months ended December 31, 2005 from $6.5 million for the same period in 2004. Total interest expense increased $1.2 million or 40.6% to $4.1 million during the three months ended December 31, 2005 compared to $2.9 million for the same period one-year earlier. Interest expense on deposits increased $913,000 or 45.4% to $2.9 million during the period from $2.0 million for the same period in 2004. Average interest bearing deposits during the three months ended December 31, 2005 grew $22.3 million to $411.3 million compared to $389.0 million in the three months ended December 31, 2004 while the cost of deposits increased 78 basis points. Interest expense on advances and other borrowings increased $273,000 or 29.9% to $1.2 million as the cost of debt outstanding increased 16 basis points during the 2005 period compared to 2004 while average total borrowings outstanding increased approximately $26.0 million. Provision for Loan Losses The Bank's provision for loan losses was $165,000 during the three months ended December 31, 2005 compared to $195,000 for the quarter ended December 31, 2004. The amount of the provision is determined by management's on-going monthly analysis of the loan portfolio. Non-accrual loans, which are loans delinquent 90 days or more, were $1.7 million at December 31, 2005 compared to $2.4 million at March 31, 2005. The ratio of allowance for loan losses to the Company's total loans was 1.82% at December 31, 2005 compared to 1.94% at March 31, 2005. Net charge-offs were $127,000 during the three months ended December 31, 2005 compared to $25,000 during the same period in 2004. 17 Security Federal Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2005, CONTINUED ----------------------------------------------------------------------------- Other Income Total other income increased $8,000 or 1.1% to $714,000 during the three months ended December 31, 2005 compared to $706,000 for the same period a year ago, primarily as a result of increases in gain on sale of loans and loan servicing fees offset partially by decreases in service fees on deposit accounts and other income. Gain on sale of loans increased $33,000 or 37.2% to $121,000 compared to the same period one year ago as the origination and sale of fixed rate mortgages increased. Loan servicing fees increased $6,000 or 11.7% to $54,000 while service fees on deposit accounts decreased $24,000 or 7.3% to $303,000 compared to the same period one year ago. Other miscellaneous income including credit life insurance commissions, net gain on sale of repossessed assets, safe deposit rental income, annuity and stock brokerage commissions, trust fees, and other miscellaneous fees decreased $7,000 or 2.7% to $236,000 during the three months ended December 31, 2005 compared to the same period one year ago. General and Administrative Expenses General and administrative expenses increased $492,000 or 18.1% to $3.2 million during the three months ended December 31, 2005 compared to $2.7 million for the same period in 2004. Salaries and employee benefits expense increased $403,000 or 27.9% to $1.8 million. Occupancy expense increased $63,000 or 23.4% to $332,000 primarily as a result of branch renovations, additional office space being rented and increases in landscaping costs. Advertising expense decreased $9,000 or 17.5% to $44,000. Depreciation and maintenance of equipment expense increased $30,000 or 12.4% to $274,000 during the three months ended December 31, 2005 compared to the same period in 2004. FDIC insurance premiums remained the same at $14,000 during the quarters ending December 2005 and 2004. Other miscellaneous expense, consisting of legal, professional, and consulting expenses, stationery and office supplies, and other sundry expenses, increased $5,000 or 0.78% to $692,000 for the three months ended December 31, 2005 compared to the three months ended December 31, 2004. 18 Security Federal Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED DECEMBER 31, 2005 ----------------------------------------------------------------- Net Income Net income was $2.8 million for the nine months ended December 31, 2005, representing an increase in earnings of $323,000 or 12.9% from $2.5 million for the same period in 2004. The primary reasons for the increased earnings were an increase in net interest income offset partially by increases in general and administrative expenses and the provision for income taxes. Net Interest Income Net interest income increased $1.8 million or 17.2% to $12.1 million during the nine months ended December 31, 2005 compared to the same period one year ago. The increase is attributable to an increase in interest income offset in part by an increase in interest expense. Average interest earning assets increased $41.9 million while average interest-bearing liabilities increased $44.6 million. The interest rate spread increased 20 basis points to 2.51% during the nine months ended December 31, 2005 compared to 2.31% for the same period in 2004. Interest income on loans increased $4.6 million or 37.8% to $16.8 million during the nine months ended December 31, 2005 compared to the same period one year ago as a result of the average loan portfolio balance increasing by $50.9 million to $335.8 and the yield in the loan portfolio increasing 96 basis points. Because of a 21 basis point increase in the yield in the investment portfolio, interest income from investment, mortgage-backed, and other securities increased 167,000 or 2.5% to $6.8 million despite a decrease in the average balance of the investment portfolio of $9.0 million. Total interest income increased $4.8 million or 25.4% to $23.5 million for the nine months ended December 31, 2005 from $18.8 million for the same period in 2004. Total interest expense increased $3.0 million or 35.5% to $11.4 million during the nine months ended December 31, 2005 compared to $8.4 million for the same period one-year earlier. Interest expense on deposits increased $2.5 million or 45.3% to $8.1 million during the period compared to $5.6 million for the same period in 2004. Average interest bearing deposits during the nine months ended December 31, 2005 grew $29.5 million to $410.9 million compared to $381.4 million for the nine months ended December 31, 2004 while the cost of deposits increased 68 basis points. Interest expense on advances and other borrowings increased $454,000 or 16.1% to $3.3 million as the average total borrowings outstanding increased approximately $15.1 million while the cost of debt outstanding decreased seven basis points during the nine months ended December 31, 2005 compared to the same period one year ago. Provision for Loan Losses The Bank's provision for loan losses was $495,000 during the nine months ended December 31, 2005 compared to $585,000 for the nine months ended December 31, 2004. The amount of the provision is determined by management's on-going monthly analysis of the loan portfolio. Non-accrual loans, which are loans delinquent 90 days or more, were $1.7 million at December 31, 2005 compared to $2.4 million at March 31, 2005. The ratio of allowance for loan losses to the Company's total loans was 1.82% at December 31, 2005 compared to 1.94% at March 31, 2005. Net charge-offs were $208,000 during the nine months ended December 31, 2005 compared to $96,000 during the same period in 2004. Other Income Total other income increased $64,000 or 3.0% to $2.2 million during the nine months ended December 31, 2005 compared to $2.1 million for the same period a year ago, primarily as a result of increases in gain on sale of investments, gain on sale of loans, loan servicing fees and other income offset partially by a decrease in service fees on deposit accounts. Gain on sale of investments was $49,000 during the nine months ended December 31, 2005 compared to no gain for the same period one year ago. Gain on sale of loans increased $48,000 or 14.6% to $375,000 compared to the same period one year ago as the origination and sale of fixed rate mortgages increased. Loan servicing fees increased $19,000 or 14.3% to $154,000 while service fees on deposit accounts decreased $77,000 or 8.1% to $875,000 compared to the same period one year ago. Other miscellaneous income including credit life insurance commissions, net gain on sale of repossessed assets, safe deposit rental income, annuity and stock brokerage commissions, trust fees, and other miscellaneous fees increased $25,000 or 3.7% to $700,000 during the nine months ended December 31, 2005 compared to the same period one year ago. 19 Security Federal Corporation and Subsidiaries Management's Discussion and Analysis of Financial Condition and Results of Operations RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED DECEMBER 31, 2005, CONTINUED ---------------------------------------------------------------------------- General and Administrative Expenses General and administrative expenses increased $1.3 million or 15.5% to $9.4 million during the nine months ended December 31, 2005 compared to the same period in 2004. Salaries and employee benefits expense increased $814,000 or 17.6% to $5.4 million. Occupancy expense increased $170,000 or 21.5% to $963,000 primarily as a result of branch renovations, additional office space being rented and increases in landscaping costs. Advertising expense decreased $15,000 or 11.6% to $113,000. Depreciation and maintenance of equipment expense increased $3,000 or 0.44% to $784,000 during the current nine-month period compared to the same period last year. FDIC insurance premiums remained the same at $43,000. Other miscellaneous expense, consisting of legal, professional, and consulting expenses, stationery and office supplies, and other sundry expenses, increased $282,000 or 16.2% to $2.0 million for the nine months ended December 31, 2005 compared to the nine months ended December 31, 2004. 20 Security Federal Corporation and Subsidiaries Item 3. Quantitative and Qualitative Disclosures about Market Risk Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises principally from interest rate risk inherent in its lending, investment, deposit and borrowing activities. Management actively monitors and manages its interest rate risk exposure. Although the Company manages other risks such as credit quality and liquidity risk in the normal course of business, management considers interest rate risk to be its most significant market risk that could potentially have the largest material effect on the Company's financial condition and results of operations. Other types of market risks such as foreign currency exchange rate risk and commodity price do not arise in the normal course of the Company's business activities. The Company's profitability is affected by fluctuations in the market interest rate. Management's goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase or decrease in interest rates may adversely impact the Company's earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same rate, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using a test that measures the impact on net interest income and net portfolio value of an immediate change in interest rates in 100 basis point increments and by measuring the Bank's interest sensitivity gap ("Gap"). Net portfolio value is defined as the net present value of assets, liabilities, and off-balance sheet contracts. Gap is the amount of interest sensitive assets repricing or maturing over the next twelve months compared to the amount of interest sensitive liabilities maturing or repricing in the same time period. Recent net portfolio value reports furnished by the OTS indicate that the Bank's interest rate risk sensitivity has increased slightly over the past year. For the three and nine month periods ended December 31, 2005, the Bank's interest rate spread, defined as the average yield on interest bearing assets less the average rate paid on interest bearing liabilities was 2.52% and 2.51%, respectively. As of the year ended March 31, 2005, the interest rate spread was 2.45%. The interest rate spread increased due growth in interest earning assets, specifically variable rate loans outpacing growth in interest earning liabilities. The steady increase in the prime rate also helped the interest rate spread. If interest rates were to increase suddenly and significantly, the Bank's net interest income and net interest spread would be compressed significantly. Item 4. Controls and Procedures An evaluation of the Company's disclosure controls and procedures (as defined in Sections 13a - 15(e) of the Securities Exchange Act of 1934) was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management as of the end of the period covered by this quarterly report. The Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission's rules and forms. In the quarter ended December 31, 2005, the Company did not make any significant changes in its internal control over financial reporting that has materially affected, or is reasonably likely to materially, affect these controls. While the Company believes the present design of its disclosure controls and procedures is effective to achieve its goal, future events affecting its business may cause the Company to modify its disclosure controls and procedures. The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all error and fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected. 21 Security Federal Corporation and Subsidiaries Part II: Other Information Item 1 Legal Proceedings ----------------- The Company is not engaged in any legal proceedings of a material nature at the present time. From time to time, the Company is a party to legal proceedings in the ordinary course of business wherein it enforces its security interest in mortgage loans it has made. Item 2 Unregistered Sales of Equity Securities and Use Of Proceeds ----------------------------------------------------------- Stock Repurchases. On May 17, 2005, the Company's Board of Directors authorized a 5% repurchase plan, or 126,000 shares of the Company's outstanding common stock. As of December 31, 2005, 1,635 shares have been repurchased under this program. The Company did not repurchase any shares of its outstanding Common Stock during the three months ended December 31, 2005. Item 3 Defaults Upon Senior Securities ------------------------------- None Item 4 Submission Of Matters To A Vote Of Security Holders --------------------------------------------------- None Item 5 Other Information ----------------- None Item 6 Exhibits -------- 3.1 Articles Of Incorporation (1) 3.2 Articles Of Amendment, Dated August 28, 1998, To Articles Of Incorporation (2) 3.3 Bylaws (3) 10.1 Salary Continuation Agreements (4) 10.2 Amendment One To Salary Continuation Agreements (5) 10.3 Stock Option Plan (4) 10.4 1999 Stock Option Plan (6) 10.5 2002 Stock Option Plan (7) 10.6 Form of Incentive Stock Option Award Agreement (8) 10.7 Form of Non-Qualified Stock Option Award Agreement (8) Incentive Compensation Plan (4) 31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act. 31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act. 32 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act. (1) Filed as an exhibit to the Company's June 23, 1998 proxy statement and incorporated herein by reference. (2) Filed as an exhibit to the Company's Form 10-QSB for the quarter ended September 30, 1998 and incorporated herein by reference. 22 Security Federal Corporation and Subsidiaries Exhibits, Continued (3) Filed as an exhibit to the Company's Form 8-K filed September 1, 1998 and incorporated herein by reference. (4) Filed as an exhibit to the Company's Annual Report on Form 10-KSB for the year ended March 31, 1993 and incorporated herein by reference. (5) Filed as an exhibit to the Company's Quarterly Report on Form 10-QSB for the quarter ended December 30, 1993 and incorporated herein by reference. (6) Filed as an exhibit to the Company's Registration Statement on Form S-8 filed March 2, 2002 and incorporated herein by reference. (7) Filed as an exhibit to the Company's June 19, 2002 proxy statement and incorporated herein by reference. (8) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2005 and incorporated herein by reference. Signatures Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to the signed on its behalf by the undersigned thereunto duly authorized. SECURITY FEDERAL CORPORATION Date: February 13, 2006 By: /s/ Timothy W. Simmons -------------------- --------------------------------------- Timothy W. Simmons President and Chief Executive Officer Principal Executive Officer Date: February 13, 2006 By: /s/ Roy G. Lindburg -------------------- --------------------------------------- Roy G. Lindburg Treasurer/CFO Principal Financial and Accounting Officer 23 EXHIBIT INDEX ------------- 31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act. 31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act. 32 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act. 24 EXHIBIT 31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 25 Certification I, Timothy W. Simmons, President and Chief Executive Officer of Security Federal Corporation, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Security Federal Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the period presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: February 13, 2006 /s/ Timothy W. Simmons -------------------------------------- Timothy W. Simmons President and Chief Executive Officer 26 EXHIBIT 31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 26 Certification I, Roy G. Lindburg, Chief Financial Officer of Security Federal Corporation, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Security Federal Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the period presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: February 13, 2006 /s/ Roy G. Lindburg -------------------------------- Roy G. Lindburg Chief Financial Officer 28 EXHIBIT 32 Certification Pursuant to Section 906 of the Sarbanes Oxley Act CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER OF SECURITY FEDERAL CORPORATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 The undersigned hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and in connection with this Quarterly Report on Form 10-Q that: 1. the report fully complies with the requirements of Section 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, and 2. the information contained in the report fairly presents, in all material respects, the company's financial condition and results of operations. /s/ Timothy W. Simmons /s/ Roy G. Lindburg --------------------------- --------------------------- Timothy W. Simmons Roy G. Lindburg Chief Executive Officer Chief Financial Officer Dated: February 13, 2006