10-Q 1 q307.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, 2006 ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD: FROM: TO: --------------- ---------------- COMMISSION FILE NUMBER: 0-16120 SECURITY FEDERAL CORPORATION South Carolina 57-0858504 (State or other jurisdiction of (IRS Employer incorporation or organization Identification No.) 1705 WHISKEY ROAD, AIKEN, SOUTH CAROLINA 29801 (Address of Principal Executive Office) (Zip code) (803) 641-3000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ----- ----- Indicate by check mark whether the registrant is 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, 2007 2,609,601 value $0.01 per share INDEX ============================================================================== PART I. FINANCIAL INFORMATION (UNAUDITED) PAGE NO. Item 1. Financial Statements (Unaudited): Consolidated Balance Sheets at December 31, 2006 and March 31, 2006 1 Consolidated Statements of Income for the Three and Nine Months Ended December 31, 2006 and 2005 2 Consolidated Statements of Shareholders' Equity and Comprehensive Income at December 31, 2005 and 2006 4 Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2006 and 2005 5 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 16 Item 3. Quantitative and Qualitative Disclosures about Market Risk 28 Item 4. Controls and Procedures 28 ============================================================================== PART II. OTHER INFORMATION Item 1. Legal Proceedings 29 Item 1A. Risk Factors 29 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 29 Item 3. Defaults Upon Senior Securities 29 Item 4. Submission of Matters to a Vote of Security Holders 29 Item 5 Other Information 29 Item 6. Exhibits 30 Signatures 31 ============================================================================== 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, 2006 March 31, 2006 -------------------- ---------------- Assets: (Unaudited) (Audited) Cash And Cash Equivalents $ 10,694,191 $ 14,351,208 Investment And Mortgage-Backed Securities: Available For Sale: (Amortized cost of $180,261,315 at December 31, 2006 and $166,808,236 at March 31, 2006) 178,496,125 163,445,066 Held To Maturity: (Fair value of $65,028,212 at December 31, 2006 and $73,084,450 at March 31, 2006) 65,980,541 74,987,805 -------------------- ---------------- Total Investment And Mortgage-Backed Securities 244,476,666 238,432,871 -------------------- ---------------- Loans Receivable, Net: Held For Sale 4,548,662 1,320,644 Held For Investment:(Net of allowance of $7,133,315 at December 31, 2006 and $6,704,734 at March 31, 2006) 416,934,692 373,788,432 -------------------- ---------------- Total Loans Receivable, Net 421,483,354 375,109,076 -------------------- ---------------- Accrued Interest Receivable: Loans 1,484,714 1,096,014 Mortgage-Backed Securities 546,965 508,432 Investments 1,081,033 945,620 Premises And Equipment, Net 14,597,007 11,662,976 Federal Home Loan Bank Stock, At Cost 7,933,400 7,149,800 Bank Owned Life Insurance 5,721,583 5,000,001 Repossessed Assets Acquired In Settlement Of Loans - 91,022 Goodwill 1,197,954 - Other Assets 5,407,999 4,330,795 -------------------- ---------------- Total Assets $ 714,624,866 $ 658,677,815 ==================== ================ Liabilities And Shareholders' Equity Liabilities: Deposit Accounts $ 507,562,059 $ 479,229,339 Advances From Federal Home Loan Bank 148,353,041 131,363,000 Other Borrowed Money 6,862,120 7,289,773 Advance Payments By Borrowers For Taxes And Insurance 299,780 501,998 Mandatorily Redeemable Financial Instrument 1,417,312 - Junior Subordinated Debentures 5,155,000 - Other Liabilities 3,407,746 2,691,946 -------------------- ---------------- Total Liabilities $ 673,057,058 $ 621,076,056 -------------------- ---------------- 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 - 2,635,942 And Outstanding Shares - 2,616,077 At December 31, 2006 And 2,558,234 And 2,537,378 At March 31, 2006 25,794 25,582 Additional Paid-In Capital 4,801,947 4,404,110 Treasury Stock, (At Cost, 19,865 and 11,312 Shares, Respectively) (437,055) (238,656) Indirect Guarantee Of Employee Stock Ownership Trust Debt - (215,503) Accumulated Other Comprehensive Loss (1,095,078) (2,086,509) Retained Earnings, Substantially Restricted 38,272,200 35,712,735 -------------------- ---------------- Total Shareholders' Equity $ 41,567,808 $ 37,601,759 -------------------- ---------------- Total Liabilities And Shareholders' Equity $ 714,624,866 $ 658,677,815 ==================== ================ See accompanying notes to consolidated financial statements. 1 Security Federal Corporation and Subsidiaries Consolidated Statements of Income (Unaudited) Three Months Ended December 31, --------------------------------- 2006 2005 -------------- ------------ Interest Income: Loans $ 7,986,476 $ 6,017,333 Mortgage-Backed Securities 1,456,544 1,333,025 Investment Securities 1,314,913 962,379 Other 29,551 10,835 -------------- ------------ Total Interest Income 10,787,484 8,323,572 -------------- ------------ Interest Expense: NOW And Money Market Accounts 1,684,765 1,358,825 Passbook Accounts 41,189 43,143 Certificate Accounts 2,846,184 1,523,634 Advances And Other Borrowed Money 1,715,572 1,186,344 Junior Subordinated Debentures 91,983 - -------------- ------------ Total Interest Expense 6,379,693 4,111,946 -------------- ------------ Net Interest Income 4,407,791 4,211,626 Provision For Loan Losses 150,000 165,000 -------------- ------------ Net Interest Income After Provision For Loan Losses 4,257,791 4,046,626 -------------- ------------ Other Income: Gain On Sale Of Loans 88,137 121,138 Service Fees On Deposit Accounts 296,135 303,173 Income From Cash Value Of Life Insurance 62,037 - Commissions On Insurance 198,772 6,966 Other Agency Income 46,494 - Trust Income 110,211 81,579 Other 212,558 147,867 -------------- ------------ Total Other Income 1,014,344 660,723 -------------- ------------ General And Administrative Expenses: Salaries And Employee Benefits 2,361,104 1,847,482 Occupancy 359,530 331,501 Advertising 98,672 44,402 Depreciation And Maintenance Of Equipment 300,211 274,324 FDIC Insurance Premiums 4,624 14,561 Other 692,571 692,196 -------------- ------------ Total General And Administrative Expenses 3,816,712 3,204,466 -------------- ------------ Income Before Income Taxes 1,455,423 1,502,883 Provision For Income Taxes 478,638 544,908 -------------- ------------ Net Income $ 976,785 $ 957,975 ============== ============ Basic Net Income Per Common Share $ 0.37 $ 0.38 ============== ============ Diluted Net Income Per Common Share $ 0.37 $ 0.37 ============== ============ Cash Dividend Per Share On Common Stock $ 0.06 $ 0.04 ============== ============ Basic Weighted Average Shares Outstanding 2,617,037 2,536,304 ============== ============ Diluted Weighted Average Shares Outstanding 2,625,945 2,570,767 ============== ============ See accompanying notes to consolidated financial statements. 2 Security Federal Corporation and Subsidiaries Consolidated Statements of Income (Unaudited) Nine Months Ended December 31, ------------------------------- 2006 2005 ------------- -------------- Interest Income: Loans $ 22,679,587 $ 16,906,298 Mortgage-Backed Securities 4,223,959 4,084,033 Investment Securities 3,646,142 2,634,484 Other 62,023 47,122 ------------- -------------- Total Interest Income 30,611,711 23,671,937 ------------- -------------- Interest Expense: NOW And Money Market Accounts 4,982,221 3,905,361 Passbook Accounts 125,095 132,262 Certificate Accounts 7,437,930 4,077,011 Advances And Other Borrowed Money 4,690,964 3,270,366 Junior Subordinated Debentures 101,985 - ------------- -------------- Total Interest Expense 17,338,195 11,385,000 ------------- -------------- Net Interest Income 13,273,516 12,286,937 Provision For Loan Losses 450,000 495,000 ------------- -------------- Net Interest Income After Provision For Loan Losses 12,823,516 11,791,937 ------------- -------------- Other Income: Gain On Sale of Investments - 48,962 Gain On Sale Of Loans 295,390 374,701 Service Fees On Deposit Accounts 865,638 875,237 Income From Cash Value Of Life Insurance 180,582 - Commissions On Insurance 413,407 15,870 Other Agency Income 140,802 - Trust Income 327,767 260,172 Other 539,354 424,079 ------------- -------------- Total Other Income 2,762,940 1,999,021 ------------- -------------- General And Administrative Expenses: Salaries And Employee Benefits 6,789,633 5,443,785 Occupancy 1,027,793 962,678 Advertising 234,622 113,392 Depreciation And Maintenance Of Equipment 908,006 784,443 FDIC Insurance Premiums 33,586 43,247 Other 1,995,577 2,024,699 ------------- -------------- Total General And Administrative Expenses 10,989,217 9,372,244 ------------- -------------- Income Before Income Taxes 4,597,239 4,418,714 Provision For Income Taxes 1,571,083 1,581,817 ------------- -------------- Net Income $ 3,026,156 $ 2,836,897 ============= ============== Basic Net Income Per Common Share $ 1.17 $ 1.12 ============= ============== Diluted Net Income Per Common Share $ 1.16 $ 1.11 ============= ============== Cash Dividend Per Share On Common Stock $ 0.18 $ 0.12 ============= ============== Basic Weighted Average Shares Outstanding 2,588,864 2,531,885 ============= ============== Diluted Weighted Average Shares Outstanding 2,600,966 2,565,949 ============= ============== 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, 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 ======== ========== ======= ========= =========== =========== ===========
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, 2006 $ 25,582 $4,404,110 $(238,656) $(215,503) $(2,086,509) $35,712,735 $ 37,601,759 Net Income - - - - - 3,026,156 3,026,156 Other Comprehensive Income, Net Of Tax: Unrealized Holding Gains On Securities Available For Sale - - - - 991,431 - 991,431 Comprehensive Income - - - - - - 4,017,587 Purchase Of Treasury Stock At Cost, 8,553 shares - - (198,399) - - - (198,399) Decrease In Indirect Guarantee Of ESOP Debt - - - 215,503 - - 215,503 Exercise Of Stock Options 212 393,033 - - - - 393,245 Stock Compensation Expense - 4,804 - - - - 4,804 Cash Dividends - - - - - (466,691) (466,691) -------- ---------- --------- -------- ----------- ----------- ------------ Balance At December 31, 2006 $ 25,794 $4,801,947 $(437,055) $ - $(1,095,078) $38,272,200 $ 41,567,808 ======== ========== ========= ======== =========== =========== ============ See accompanying notes to consolidated financial statements.
4 Security Federal Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended December 31, ----------------------------------- 2006 2005 --------------- -------------- Cash Flows From Operating Activities: Net Income $ 3,026,156 $ 2,836,897 Adjustments To Reconcile Net Income To Net Cash Provided (Used) By Operating Activities: Depreciation And Amortization Expense 745,479 731,381 Amortization Of Intangible Assets 45,000 - Stock Option Compensation Expense 4,804 - Discount Accretion And Premium Amortization 321,311 762,876 Provisions For Losses On Loans And Real Estate 450,000 495,000 Gain On Sale Of Loans (295,390) (374,701) Gain On Sale Of Mortgage Backed Securities Available For Sale - (48,962) Loss (Gain) On Sale Of Real Estate (48,678) 21,416 Amortization Of Deferred Fees On Loans (227,638) (139,852) Loss on Disposition of Premises and Equipment 215 4,469 Proceeds From Sale Of Loans Held For Sale 17,846,130 24,294,189 Origination Of Loans For Sale (20,778,758) (22,355,760) (Increase) Decrease In Accrued Interest Receivable: Loans (388,700) (236,254) Mortgage-Backed Securities (38,533) 46,878 Investments (135,413) (51,709) Increase (Decrease) In Advance Payments By Borrowers (202,218) 150,219 Other, Net (578,090) 674,086 --------------- -------------- Net Cash Provided (Used) By Operating Activities (254,323) 6,810,173 --------------- -------------- Cash Flows From Investing Activities: Principal Repayments On Mortgage-Backed Securities Available For Sale 27,419,083 39,543,268 Principal Repayments On Mortgage-Backed Securities Held To Maturity - 10,407 Purchase Of Investment Securities Available For Sale (18,941,966) (20,046,195) Purchase Of Mortgage-Backed Securities Available For Sale (26,982,890) (24,569,383) Maturities Of Investment Securities Available For Sale 4,738,645 4,674,853 Maturities of Investment Securities Held To Maturity 9,000,000 1,000,000 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 (5,482,400) (4,697,800) Redemption Of FHLB Stock 4,698,800 3,848,400 Increase In Loans To Customers (43,368,622) (40,527,093) Proceeds From Sale Of Repossessed Assets 139,700 96,499 Purchase And Improvement Of Premises And Equipment (3,679,725) (2,323,574) Purchase Of Bank Owned Life Insurance (721,582) - --------------- -------------- Net Cash Used By Investing Activities (53,180,957) (38,943,608) --------------- -------------- Cash Flows From Financing Activities: Increase In Deposit Accounts 28,332,720 19,885,007 Proceeds From FHLB Advances 222,223,450 181,395,000 Repayment Of FHLB Advances (205,233,409) (160,920,000) Net (Repayments) Proceeds Of Other Borrowings (427,653) 466,778 Proceeds From Junior Subordinated Debentures 5,155,000 - Dividends To Shareholders (466,691) (304,832) Purchase Of Treasury Stock (198,399) (35,167) Proceeds From Exercise of Stock Options 393,245 192,444 --------------- -------------- Net Cash Provided By Financing Activities 49,778,263 40,679,230 --------------- -------------- (Continued) 5 Security Federal Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended December 31, ----------------------------------- 2006 2005 --------------- -------------- (Decrease) Increase In Cash And Cash Equivalents (3,657,017) 8,545,795 Cash And Cash Equivalents At Beginning Of Period 14,351,208 7,916,488 ---------------- -------------- Cash And Cash Equivalents At End Of Period $ 10,694,191 $ 16,462,283 ================ ============== Supplemental Disclosure Of Cash Flows Information: Cash Paid During The Period For Interest $ 16,896,006 $ 11,161,678 Cash Paid During The Period For Income Taxes $ 1,117,000 $ 1,742,825 Additions To Repossessed Acquired Through Foreclosure $ - $ 210,785 Decrease (Increase) In Unrealized Net Loss On Securities Available For Sale, Net Of Taxes $ 991,431 $ (896,222) Issuance Of A Mandatorily Redeemable Financial Instrument Through The Issuance Of Common Stock 1,417,312 - 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") 2006 Annual Report to Shareholders when reviewing interim financial statements. The results of operations for the nine month period ended December 31, 2006 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. Critical Accounting Policies The Company has adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to the audited consolidated financial statements at March 31, 2006 included in our 2006 Annual Report to Stockholders, which was filed as an exhibit to our Annual Report on Form 10-K for the year ended March 31, 2006. Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on our carrying values of assets and liabilities and our results of operations. The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of the consolidated financial statements. The 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. 7 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited) 3. Critical 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 and then to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amounts previously charged off. 4. Acquisition On June 30, 2006, the Company completed the acquisition of the insurance and premium finance businesses of Collier-Jennings Financial Corporation and it subsidiaries Collier-Jennings, Inc., The Auto Insurance Store, Inc., and Collier-Jennings Premium Pay Plans, Inc (the "Collier-Jennings Companies"). The purpose of the acquisition was to expand the insurance services and increase non-interest income. The shareholder of the Collier-Jennings Companies received $180,000 in cash and 54,512 shares of the Company's common stock valued at $26 per share for an approximate purchase price of $1,597,312. The Company will release the shares to the shareholder of the Collier-Jennings Companies over a three-year period. The stock is mandatorily redeemable by the shareholder of Collier-Jennings Companies at his option in cumulative increments of 20% per year for a five-year period at the greater of $26 per share or one and one-half times the book value of the Company's stock. A summary of the purchase price of the transaction is as follows: The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at June 30, 2006, the date of acquisition, including subsequent adjustments to the allocation of the purchase price. Cash And Cash Equivalents $ 43,192 Accounts Receivable 784,247 Premises And Equipment 41,696 Other Assets 56,289 Intangible Assets 600,000 Goodwill 1,197,954 -------------- Total Assets Acquired 2,723,378 -------------- Notes Payable 386,185 Other Liabilities 739,881 Total Liabilities Assumed 1,126,066 -------------- Net Assets Acquired $ 1,597,312 ============== 5. 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 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. 8 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 5. Earnings Per Share, 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, 2006 ---------------------------------------------- Income (Numerator) Shares Amount (Denominator) Per Share ---------- ------------- --------- Basic EPS $ 976,785 2,617,037 $ 0.37 Effect of Diluted Securities: Stock Options - 8,908 - ---------- ------------- --------- Diluted EPS $ 976,785 2,625,945 $ 0.37 ========== ============= ========= 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 Nine Months Ended ---------------------------------------------- December 31, 2006 ---------------------------------------------- Income (Numerator) Shares Amount (Denominator) Per Share ---------- ------------- --------- Basic EPS $3,026,156 2,588,864 $ 1.17 Effect of Diluted Securities: Stock Options - 12,102 (.01) ---------- ------------- --------- Diluted EPS $3,026,156 2,600,966 $ 1.16 ========== ============= ========= 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 ========== ============= ========= 9 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 6. Stock-Based Compensation On April 1, 2006, the Company adopted the fair value recognition provisions of Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 123R, "Accounting for Stock-Based Compensation," to account for compensation costs under its stock option plans. The Company previously utilized the intrinsic value method under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees (as amended)" ("APB 25"). Under the intrinsic value method prescribed by APB 25, no compensation costs were recognized for the Company's stock options because the option exercise price in its plans equals the market price on the date of grant. Prior to January 1, 2006, the Company only disclosed the pro forma effects on net income and earnings per share as if the fair value recognition provisions of SFAS 123R had been utilized. In adopting SFAS No. 123, the Company elected to use the modified prospective method to account for the transition from the intrinsic value method to the fair value recognition method. Under the modified prospective method, compensation cost is recognized from the adoption date forward for all new stock options granted and for any outstanding unvested awards as if the fair value method had been applied to those awards as of the date of grant. The following table illustrates the effect on net income and earnings per share as if the fair value based method had been applied to all outstanding and unvested awards in each period. Three Months Ended Nine Months Ended December 31, December 31, --------------------- ---------------------- 2006 2005 2006 2005 --------- --------- ---------- ---------- Net income, as reported $ 976,785 $ 957,975 $3,026,156 $2,836,897 Add: Stock-based compensation expense included in reported net income, net of related tax effects 2,883 - 4,804 - Deduct: Stock-based compensation expense determined under fair market value based method on all awards, net of related tax effects (2,883) (30,570) (4,804) (91,710) --------- --------- ---------- ---------- Pro forma net income including stock-based compensation cost based on fair-value method $ 976,785 $ 927,405 $3,026,156 $2,745,187 ========= ========= ========== ========== Earnings per share: Basic - as reported $ 0.37 $ 0.38 $ 1.17 $ 1.12 Basic - pro forma $ 0.37 $ 0.37 $ 1.17 $ 1.08 Diluted - as reported $ 0.37 $ 0.37 $ 1.17 $ 1.11 Diluted - pro forma $ 0.37 $ 0.36 $ 1.17 $ 1.07 The following is a summary of the activity under the Company's incentive stock option plan. Three Months Ended Nine Months Ended December 31, 2006 December 31, 2006 --------------------- ----------------------- Weighted Weighted Average Average Exercise Exercise Shares Price Shares Price --------------------- ----------------------- Balance, Beginning of Period/Year 111,446 $ 20.19 118,046 $ 19.50 Options granted - - 13,500 23.03 Options exercised 3,596 11.79 23,196 16.95 Options forfeited 6,750 18.90 7,250 19.27 -------- -------- Balance, December 31, 2006 101,100 $ 20.58 101,100 $ 20.58 ======== ======== Options Exercisable 87,600 $ 20.20 87,600 $ 20.20 ======== ======== Options Available For Grant 57,500 57,500 ======== ======== 10 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 6. Stock-Based Compensation, Continued The following table summarizes the stock-based awards granted by the Company, the fair market value of each award granted as estimated on the date of grant using the Black-Scholes option-pricing model, and the weighted average assumptions used for such grants for the periods indicated For Awards For Awards Granted During Granted During The Three Month The Nine Month Period Ended Period Ended December 31, December 31, -------------------- ------------------- 2006 2005 2006 2005 --------- ------- ------- -------- Awards granted - - 13,500 - Dividend Yield - - 1.03% - Expected Volatility - - 30.21% - Risk-free interest rate - - 4.36% - Expected life - - 9.01 - At December 31, 2006, the Company had the following options outstanding: Outstanding Grant Date Options Option Price Expiration Date ------------- -------------- ----------------- ------------------- 10/19/99 30,600 $16.67 9/30/05 to 9/30/09 9/1/03 3,000 $24.00 8/31/13 12/1/03 3,000 $23.65 11/30/13 1/01/04 7,000 $24.22 12/31/13 3/8/04 13,000 $21.43 2/28/14 6/7/04 2,000 $24.00 5/31/14 1/1/05 21,000 $20.55 12/31/14 1/1/05 2,000 $22.61 12/31/15 1/1/06 6,000 $23.91 12/31/16 8/24/06 13,500 $23.03 8/24/16 11 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 7. Accounting and Reporting Changes The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and / or disclosure of financial information by the Company. In February 2006, FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140." This Statement amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," and SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This Statement resolves issues addressed in SFAS No. 133 Implementation Issue No. D1, "Application of Statement 133 to Beneficial Interests in Securitized Financial Assets." SFAS No. 155 permits fair value re-measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest only-strips and principal-only strips are not subject to the requirements of Statement 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends Statement 140 to eliminate the prohibition on a qualifying special purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity's first fiscal year that begins after September 15, 2006. The Company does not believe that the adoption of SFAS No. 155 will have a material impact on its financial position, results of operations and cash flows. In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of Financial Assets-an amendment of FASB Statement No. 140." This Statement amends FASB No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," with respect to the accounting for separately recognized servicing assets and servicing liabilities. SFAS No. 156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract; requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable; permits an entity to choose its subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities; at its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under Statement 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity's exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value; and requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. An entity should adopt SFAS No. 156 as of the beginning of its first fiscal year that begins after September 15, 2006. The Company does not believe the adoption of SFAS No. 156 will have a material impact on its financial position, results of operations and cash flows. In July 2006, the FASB issued FASB Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes". FIN 48 clarifies the accounting for uncertainty in income taxes recognized in enterprises' financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes". FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently analyzing the effects of FIN 48. In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements." SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This standard does not require any new fair value measurements, but rather eliminates inconsistencies found in various prior pronouncements. SFAS 157 is effective for the Company on January 1, 2008 and is not expected to have a significant impact on the Company's financial statements. 12 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 7. Accounting and Reporting Changes, Continued In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans," which amends SFAS No. 87 and SFAS No. 106 to require recognition of the over-funded or under-funded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS No. 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS No. 87 and SFAS No. 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date the date at which the benefit obligation and plan assets are measured is required to be the company's fiscal year end. SFAS No. 158 is effective for publicly held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. The Company does not have a defined benefit pension plan. Therefore SFAS No. 158 will not impact the Company's financial condition or results of operations. In September, 2006, The FASB ratified the consensuses reached by the FASB's Emerging Issues Task Force ("EITF") relating to EITF 06-4 "Accounting for the Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements". EITF 06-4 addresses employer accounting for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods should recognize a liability for future benefits in accordance with SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," or Accounting Principles Board ("APB") Opinion No. 12, "Omnibus Opinion 1967". EITF 06-4 is effective for fiscal years beginning after December 15, 2006. Entities should recognize the effects of applying EITF 06-4 through either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings or to other components of equity or net assets in the statement of financial position as of the beginning of the year of adoption or (b) a change in accounting principle through retrospective application to all prior periods. The Company does not believe the adoption of EITF 06-4 will have a material impact on its financial position, results of operations and cash flows. In September 2006, the FASB ratified the consensus reached related to EITF 06-5, "Accounting for Purchases of Life Insurance Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance." EITF 06-5 states that a policyholder should consider any additional amounts included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized under the insurance contract. EITF 06-5 also states that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF 06-5 is effective for fiscal years beginning after December 15, 2006. The Company does not believe the adoption of EITF 06-5 will have a material impact on its financial position, results of operations and cash flows. In September 2006, the SEC issued Staff Accounting Bulleting No. 108 ("SAB 108"). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, companies might evaluate the materiality of financial statement misstatements using either the income statement or balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a company's balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. The Company has analyzed SAB 108 and determined that upon adoption it will have no impact on the reported results of operations or financial conditions. Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company's financial position, results of operations and cash flows. 13 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 8. Securities 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, 2006 Amortized Unrealized Unrealized ------------------ Cost Gains Losses Fair Value ------------ ---------- ---------- ----------- US Government and Agency Obligations $ 42,681,560 $ 14,079 $ 188,673 $ 42,506,966 Mortgage-Backed Securities 137,476,817 169,149 1,760,907 135,885,059 Equity Securities 102,938 1,162 - 104,100 ------------ --------- ---------- ------------ Total $180,261,315 $ 184,390 $1,949,580 $178,496,125 ============ ========= ========== ============ March 31, 2006 -------------- US Government and Agency Obligations $ 28,466,546 $ - $ 311,234 $ 28,155,312 Mortgage-Backed Securities 138,238,752 126,648 3,178,584 135,186,816 Equity Securities 102,938 - - 102,938 ------------ --------- ---------- ------------ Total $166,808,236 $ 126,648 $3,489,818 $163,445,066 ============ ========= ========== ============ 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, 2006 Amortized Unrealized Unrealized ----------------- Cost Gains Losses Fair Value ------------ ---------- ---------- ------------ US Government and Agency Obligations $ 65,980,541 $ 12,820 $ 965,149 $ 65,028,212 ============ ========== ========== ============ March 31, 2006 -------------- US Government and ------------ ---------- ---------- ------------ Agency Obligations $ 74,987,805 $ - $1,903,355 $ 73,084,450 ============ ========== ========== ============ 14 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 9. Loans Receivable, Net Loans receivable, net, at December 31, 2006 and March 31, 2006 consisted of the following: December 31, 2006 March 31, 2006 --------------------- ----------------- Residential Real Estate $ 126,507,744 $ 122,026,298 Consumer 64,814,782 58,612,669 Commercial Business & Real Estate 238,785,530 209,214,332 Loans Held For Sale 4,548,662 1,320,644 434,656,718 391,173,943 --------------------- ----------------- Less: Allowance For Possible Loan Loss 7,133,315 6,704,734 Loans In Process 5,776,071 9,185,133 Deferred Loan Fees 263,978 175,000 13,173,364 16,064,867 --------------------- ----------------- $ 421,483,354 $ 375,109,076 ===================== ================= 15 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, 2006 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 Securities and Exchange Commission, including the Annual Report on Form 10-K for the fiscal year ended March 31, 2006. Forward-looking statements are effective only as of the date that they are made and the Company assumes no obligation to update this information Comparison Of Financial Condition At December 31, 2006 and March 31, 2006 General - Total assets increased $55.9 million or 8.5% to $714.6 million at December 31, 2006 from $658.7 million at March 31, 2006. The primary reason for the growth in total assets was a $46.4 million or 12.4% increase in net loans receivable to $421.5 million. For the nine months ended December 31, 2006, the demand for loans was funded with decreased cash and cash equivalents of $3.7 million or 25.5%, increased deposits of $28.3 million or 5.9% and advances from the Federal Home Loan Bank ("FHLB") of $17.0 million or 12.9%. Assets - The increases and decreases in total assets were primarily concentrated in the following asset categories: Increase (Decrease) December 31, March 31, -------------------- 2006 2006 Amount Percent ----------- ----------- ----------- ------- Cash And Cash Equivalents $10,694,191 $14,351,208 $(3,657,017) (25.5)% Investment And Mortgage- Backed Securities Available For Sale 178,496,125 163,445,066 15,051,059 9.2 Investment And Mortgage- Backed Securities Held To Maturity 65,980,541 74,987,805 (9,007,264) (12.0) Loan Receivable, Net 421,483,354 375,109,076 46,374,278 12.4 Premises And Equipment, Net 14,597,007 11,662,976 2,934,031 25.2 FHLB Stock, At Cost 7,933,400 7,149,800 783,600 11.0 Bank Owned Life Insurance 5,721,583 5,000,001 721,582 14.4 Goodwill 1,197,954 - 1,197,954 100.0 Other Assets 5,407,999 4,330,795 1,077,204 24.9 Cash and cash equivalents decreased $3.7 million to $10.7 million at December 31, 2006 from $14.4 million at March 31, 2006. The reason for the decrease is the Company used cash and cash equivalents to fund loans. Investments and mortgage-backed securities increased $6.0 million or 2.5% to $244.5 million at December 31, 2006 from $238.4 million at March 31, 2006. The increase in investments and mortgage-backed securities is attributable to purchases and an increase in market value on mortgage-backed securities and investments. 16 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued Loans receivable, net increased $46.4 million or 12.4% to $421.5 million at December 31, 2006 from $375.1 million at March 31, 2006. Residential real estate loans increased $4.5 million to $126.5 million at December 31, 2006 from $122.0 million at March 31, 2006. Consumer loans increased $6.2 million to $64.8 million at December 31, 2006 from $58.6 million at March 31, 2006. The increase in consumer loans is attributable to a special rate promotion that was being advertised in print media. Commercial business and real estate loans increased $29.6 million to $238.8 million at December 31, 2006 from $209.2 million at March 31, 2006. The increase in commercial loans was attributable to the Company's continued focus on originating this type of loan. Loans held for sale increased $3.2 million to $4.5 million at December 31, 2006 from $1.3 million at March 31, 2006. The increase is attributable to the lag between the time a mortgage loan is originated and sold to an investor. Premises and equipment, net increased $2.9 million to $14.6 million at December 31, 2006 from $11.7 million at March 31, 2006. The majority of the increase is for furniture and equipment for our main office and the acquisition of land in Ballentine, South Carolina and northeast Richland County for future branch offices. FHLB stock, at cost, increased $784,000 to $7.9 million at December 31, 2006 from $7.1 million at March 31, 2006. The increase is attributable to a FHLB requirement that the Company maintain stock equal to 0.20% of total assets at December 31, 2006 plus a transaction component, which equals 4.5% of outstanding advances (borrowings) from the FHLB of Atlanta. Bank owned life insurance increased $722,000 to $5.7 million at December 31, 2006 from $5.0 million at March 31, 2006. The Company purchased additional life insurance to provide key man life insurance for additional officers and the cash surrender value continues to increase. Goodwill was $1.2 million at December 31, 2006 compared to zero at March 31, 2006. Goodwill is related to the acquisition of the Collier-Jennings Companies. Other assets increased $1.1 to $5.4 million at December 31, 2006 from $4.3 million at March 31, 2006. The majority of the increase is the result of the acquisition of the Collier-Jennings Companies. Accounts receivable, intangible assets-net associated with the acquisition of the Collier-Jennings Companies are included in other assets. Liabilities Deposit Accounts Balance ------------------- December 31, 2006 March 31, 2006 Increase (Decrease) ----------------- ------------------ ------------------- Weighted Weighted Balance Rate Balance Rate Amount Percent ------------ ---- ------------ ---- ----------- ------- Demand Accounts: Checking $100,787,190 0.80% $105,347,713 0.97% $(4,560,523) (4.3)% Money Market 142,821,464 4.15 151,494,548 3.50 (8,673,084) (5.7) Regular Savings 16,097,801 0.98 17,795,109 0.98 (1,697,308) (9.5) ------------ ---- ------------ ---- ----------- ------ Total 259,706,455 2.65 274,637,370 2.36 (14,930,915) (5.4) ------------ ---- ------------ ---- ----------- ------ Certificate Accounts 0.00 - 1.99% - 59,797 (59,797) (100.0) 2.00 - 2.99% 1,938,491 26,836,415 (24,897,924) (92.8) 3.00 - 3.99% 34,825,565 72,831,817 (38,006,252) (52.2) 4.00 - 4.99% 57,365,265 94,240,989 (36,875,724) (39.1) 5.00 - 5.99% 153,726,283 10,622,951 143,103,332 1,447.1 ------------ ---- ------------ ---- ----------- ------ Total 247,855,604 4.92 204,591,969 3.98 43,263,635 21.2 ------------ ---- ------------ ---- ----------- ------ Total Deposits $507,562,059 3.76% $479,229,339 3.05% $28,332,720 5.9% ============ ==== ============ ==== =========== ====== 17 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued Advances From FHLB - FHLB advances are summarized by year of maturity and weighted average interest rate in the table below: Balance -------------------- December 31, 2006 March 31, 2006 Increase (Decrease) ------------------ ------------------ -------------------- Fiscal Year Due: Balance Rate Balance Rate Balance Percent ------------ ---- ------------ ---- ------------ ------- 2007 10,000,000 4.07% 18,000,000 2.83% $ (8,000,000) (44.4)% 2008 10,000,000 4.31 5,000,000 3.09 5,000,000 100.0 2009 25,000,000 4.76 20,000,000 3.28 5,000,000 25.0 2010 5,000,000 3.09 5,000,000 3.09 - - 2011 10,000,000 4.76 20,000,000 4.37 (10,000,000) (50.0) Thereafter 88,353,041 4.22 63,363,000 4.04 24,990,041 39.4 ------------ ------------ ----------- ----- Total Advances $148,353,041 4.31% $131,363,000 3.74% $16,990,041 12.9% ============ ============ =========== ===== These advances are secured by a blanket collateral agreement with the FHLB by pledging the Bank's portfolio of residential first mortgage loans and investment securities with approximate amortized cost and fair value of $80.8 million and $79.6 million at December 31, 2006. 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, 2006 -------------------------------------------------------------------------------------------------- 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 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 3.330 1 Time Call 04/16/08 09/16/04 09/16/09 5,000,000 3.090 1 Time Call 09/17/07 06/24/05 06/24/15 5,000,000 3.710 1 Time Call 06/24/10 07/22/05 07/22/15 5,000,000 3.790 1 Time Call 07/22/08 11/10/05 11/10/15 5,000,000 4.400 1 Time Call 11/10/09 11/23/05 11/23/15 5,000,000 3.933 Multi-Call 11/23/07 and quarterly thereafter 11/29/05 11/29/13 5,000,000 4.320 1 Time Call 05/29/09 12/14/05 12/14/11 5,000,000 4.640 1 Time Call 09/14/09 01/12/06 01/12/16 5,000,000 4.450 1 Time Call 01/12/11 03/01/06 03/03/14 5,000,000 4.720 1 Time Call 03/03/10 03/24/06 03/24/16 5,000,000 4.120 Multi-Call 03/26/07 and quarterly thereafter 03/24/06 03/25/13 5,000,000 4.580 1 Time Call 03/25/08 04/21/06 04/22/13 5,000,000 4.530 Multi-Call 04/23/07 and quarterly thereafter 06/02/06 06/02/16 5,000,000 5.160 1 Time Call 06/02/11 07/11/06 07/11/08 5,000,000 4.800 Multi-Call 07/11/08 and quarterly thereafter 10/25/06 12/25/11 5,000,000 4.830 1 Time Call 10/27/08 11/29/06 11/29/16 5,000,000 4.025 Multi-Call 11/29/07
18 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued As of March 31, 2006 -------------------------------------------------------------------------------------------------- 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 3.330 1 Time Call 04/16/08 09/16/04 09/16/09 5,000,000 3.090 1 Time Call 09/17/07 06/24/05 06/24/15 5,000,000 3.710 1 Time Call 06/24/10 06/24/05 06/24/10 5,000,000 4.092 1 Time Call 06/24/06 07/22/05 07/22/15 5,000,000 3.790 1 Time Call 07/22/08 10/21/05 10/21/10 5,000,000 3.864 1 Time Call 10/23/06 11/10/05 11/10/15 5,000,000 4.400 1 Time Call 11/10/09 11/23/05 11/23/15 5,000,000 3.933 Multi-Call 11/23/07 and quarterly thereafter 11/29/05 11/29/13 5,000,000 4.320 1 Time Call 05/29/09 12/14/05 12/14/11 5,000,000 4.640 1 Time Call 09/14/09 01/12/06 01/12/16 5,000,000 4.450 1 Time Call 01/12/11 03/24/06 03/24/16 5,000,000 4.120 Multi-Call 03/26/07 and quarterly thereafter 03/24/06 03/25/13 5,000,000 4.580 1 Time Call 03/25/08 03/01/06 03/03/14 5,000,000 4.720% 1 Time Call 03/03/10
Mandatorily Redeemable Financial Instrument - On June 30, 2006, the Company recorded a $1.4 million mandatorily redeemable financial instrument as a result of the acquisition of the Collier-Jennings Companies. See Note 4, "Acquisition". The shareholder of Collier-Jennings Companies received cash and was issued stock in the Company to settle the acquisition. The Company will release the shares to the shareholder of Collier-Jennings Companies over a three-year period. The stock is mandatorily redeemable by the shareholder of Collier-Jennings Companies in cumulative increments of 20% per year for a five-year period at the greater of $26 per share or one and one-half times the book value of the Company's stock. Junior Subordinated Debentures - On September 21, 2006, Security Federal Statutory Trust (the "Trust"), a wholly-owned subsidiary of the Company, issued and sold fixed and floating rate capital securities of the Trust (the "Capital Securities"), which are reported on the consolidated balance sheet as junior subordinated debentures, generating proceeds of $5.0 million. The Trust loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank. The debentures qualify as Tier 1 capital under Federal Reserve Board guidelines. The Capital Securities accrue and pay distributions annually at a rate per annum equal to a blended rate of 6.97% at December 31, 2006. One-half of the Capital Securities issued in the transaction has a fixed rate of 6.88% and the remaining half has a floating rate of three-month LIBOR plus 170 basis points, which was 7.06% at December 31, 2006. The distribution rate payable on the Capital Securities is cumulative and payable quarterly in arrears. The Company has the right, subject to events of default, to defer payments of interest on the Capital Securities for a period not to exceed 20 consecutive quarterly periods, provided that no extension period may extend beyond the maturity date of December 15, 2036. The Company has no current intention to exercise its right to defer payments of interest on the Capital Securities. The Capital Securities mature or are mandatorily redeemable upon maturity on December 15, 2036, and or upon earlier optional redemption as provided in the indenture. The Company has the right to redeem the Capital Securities in whole or in part, on or after September 15, 2011. The Company may also redeem the capital securities prior to such dates upon occurrence of specified conditions and the payment of a redemption premium Equity - Shareholders' equity increased $4.0 million or 10.6% to $41.6 million at December 31, 2006 from $37.6 million at March 31, 2006. The employee stock ownership trust of the Company paid $216,000 of principal on the employee stock ownership plan loan during the nine-month period. Accumulated Other Comprehensive Loss, net of tax, decreased $991,000 to $1.1 million during the nine months ended December 31, 2006. The Company's net income for the nine-month period was $3.0 million. The Board of Directors of the Company declared the 62nd, 63rd, and 64th consecutive quarterly dividend, which was $.06 per share, in April, July, and October 2006, which totaled $467,000. Book value per share was $15.89 at December 31, 2006 compared to $14.82 at March 31, 2006. 19 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31,2006 AND 2005 ------------------------------------------------------------------------------ Net Income - Net income increased $19,000 or 2.0% to $977,000 for the three months ended December 31, 2006 compared to $958,000 for the three months ended December 31, 2005. The primary reason for the increased earnings was increases in net interest income and non-interest income and a decrease in provision for income taxes offset partially by an increase in non-interest expenses. Net Interest Income - Net interest income increased $196,000 or 4.7% to $4.4 million during the three months ended December 31, 2006, compared to $4.2 million for the same period in 2005, as a result of an increase in interest income offset in part by an increase in interest expense. During the three months ended December 31, 2006, average interest earning assets increased $73.0 million to $670.6 million while average interest-bearing liabilities increased $76.5 million to $621.5 million. The interest rate spread decreased 19 basis points to 2.33% during the three months ended December 31, 2006 compared to the same period in 2005. The Company's net interest margin was 2.63% and 2.78% for the quarters ended December 31, 2006 and 2005, respectively. Interest Income - Total interest income increased $2.5 million or 29.6% to $10.8 million during the three months ended December 31, 2006 from $8.3 million for the same period in 2005. Total interest income on loans increased $2.0 million or 32.7% to $8.0 million during the three months ended December 31, 2006 as a result of the average loan portfolio balance increasing $70.3 million and the yield in the loan portfolio increasing 79 basis points. Interest income from mortgage-backed securities increased $124,000 or 9.3% as a result of an increase in yield offset partially by a $13.5 million decrease in the average balance of the portfolio. Interest income from investment securities increased $353,000 or 36.6% as a result of an increase in the yield and average balance of the investment securities portfolio. The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the three months ended December 31, 2006 and 2005: Three Months Ended December 31, ----------------------------------------------- 2006 2005 ---------------- --------------- Increase/ (Decrease) In Interest And Dividend Average Average Income Balance Yield Balance Yield From 2005 ------------ ----- ------------ ----- ---------- Loans Receivable, Net $419,446,443 7.62% $349,191,412 6.83% $1,969,143 Mortgage-Backed Securities 132,975,594 4.38 146,468,249 3.64 123,519 Investments 115,919,130 4.43 100,926,978 3.75 352,534 Overnight Time 2,080,466 5.15 941,216 4.60 15,951 Security Federal Statutory Trust 155,000 6.98 - - 2,765 ------------ ---- ------------ ---- ---------- Total Interest- Earning Assets $670,576,633 6.43% $597,527,855 5.54% $2,463,912 ============ ==== ============ ==== ========== Interest Expense - Total interest expense increased $2.3 million or 55.2% to $6.4 million during the three months ended December 31, 2006 compared to $4.1 million for the same period one-year earlier. The increase in total interest expense is attributable to the increases in short-term interest rates, interest-bearing deposits, and borrowings. Interest expense on deposits increased $1.6 million or 56.3% during the period as average interest bearing deposits grew $49.2 million compared to the average balance in the three months ended December 31, 2005 while the cost of deposits increased 112 basis points. Interest expense on advances and other borrowings increased $529,000 or 44.6% as the cost of debt outstanding increased 85 basis points during the 2006 period compared to 2005 while average total borrowings outstanding increased approximately $22.1 million. Interest expense on junior subordinated debentures was $92,000 for the three months ended December 31, 2006 compared to zero for the same period one year ago. The junior subordinated debentures are the result of the Company's $5.0 million trust preferred securities offering. 20 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the three months ended December 31, 2006 and 2005: Three Months Ended December 31, ----------------------------------------------------- 2006 2005 ------------------ ------------------- Increase/ (Decrease) In Interest Average Average Expense Balance Yield Balance Yield From 2005 ------------ ----- ------------ ----- ---------- Now And Money Market Accounts $207,023,453 3.26% $219,249,269 2.48% $ 325,940 Passbook Accounts 16,683,742 0.99 17,474,460 0.99 (1,954) Certificates Accounts 236,810,841 4.81 174,577,508 3.49 1,322,550 FHLB Advances And Other Borrowed Money 155,837,665 4.40 133,752,546 3.55 529,228 Junior Subordinated Debentures 5,155,000 6.98 - - 91,983 Total Interest-Bearing ------------ ---- ------------ ---- ---------- Liabilities $621,510,701 4.10% $545,053,783 3.02% $2,267,747 ============ ==== ============ ==== ========== Provision for Loan Losses - 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 seven fiscal years. The Bank's provision for loan losses was $150,000 during the three months ended December 31, 2006 compared to $165,000 for the quarter ended December 31, 2005. The $15,000 or 9.1% decrease reflects the Company's current credit quality and reduction in classified assets, impaired loans and net charge-offs. The following table details selected activity associated with the allowance for loan losses for the three months ended December 31, 2006 and 2005. December 31, 2006 December 31, 2005 ----------------- ----------------- Beginning Balance $ 6,994,623 $ 6,532,667 Provision 150,000 165,000 Charge-offs (35,912) (142,533) Recoveries 24,604 15,797 ---------------- ---------------- Ending Balance $ 7,133,315 $ 6,570,931 ================ ================ Allowance For Loan Losses As A Percentage Of Gross Loans Receivable And Loans Held For Sale At The End Of The Period 1.66% 1.82% Allowance For Loan Losses As A Percentage Of Impaired Loans At The End Of The Period 451.86% 489.06% Impaired Loans 1,578,672 1,343,591 Nonaccrual Loans And 90 Days Or More Past Due Loans As A Percentage Of Gross Loans Receivable And Loans Held For Sale At The End Of The Period 0.25% 0.46% Loans Receivable, Net $ 421,483,354 $ 355,286,567 21 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued Non-Interest Income - Non-interest income increased $354,000 or 53.5% to $1.0 million for the three months ended December 31, 2006 from $661,000 for the same period one year ago. The following table provides a detailed analysis of the changes in the components of non-interest income: Three Months Ended December 31, Increase/(Decrease) ------------------ ------------------ 2006 2005 Amounts Percent ------ ------ ------- ------- Gain On Sale Of Loans 88,137 121,138 (33,001) (27.2)% Service Fees On Deposit Accounts 296,135 303,173 (7,038) (2.3) Income From Cash Value Of Life Insurance 62,037 - 62,037 100.0 Commissions On Insurance 198,772 6,966 191,806 2,753.5 Other Agency Income 46,494 - 46,494 100.0 Trust Income 110,211 81,579 28,632 35.1 Other 212,558 147,867 64,691 43.8 ---------- -------- --------- ----- Total non-interest income $1,014,344 $660,723 $ 353,621 53.5% ========== ======== ========= ===== Income from cash value of life insurance was $62,000 for the three months ended December 31, 2006 compared to no income during the same period one year ago. This increase is the result of the Company's purchase of bank owned life insurance for certain officers of the Company. Commissions on insurance and other agency income increased $192,000 as a result of the Collier-Jennings Companies acquisition. Other miscellaneous income including credit life insurance commissions, safe deposit rental income, annuity and stock brokerage commissions, trust fees, and other miscellaneous fees, increased $64,000 to $213,000 during the three months ended December 31, 2006 compared to the same period one year ago. Non-Interest Expense - Non-interest expense increased $612,000 or 19.1% to $3.8 million for the three months ended December 31, 2006 from $3.2 million for the same period one year ago. The following table provides a detailed analysis of the changes in the components of non-interest expense: Three Months Ended December 31, Increase/(Decrease) ------------------ ------------------ 2006 2005 Amounts Percent ------ ------ ------- ------- Salaries And Employee Benefits $2,361,104 $1,847,482 $ 513,622 27.8% Occupancy 359,530 331,501 28,029 8.5 Advertising 98,672 44,402 54,270 122.2 Depreciation And Maintenance Of Equipment 300,211 274,324 25,887 9.4 FDIC Insurance Premiums 4,624 14,561 (9,937) (68.2) Other 692,571 692,196 375 0.1 ---------- ---------- --------- ----- Total Non-Interest Expenses $3,816,712 $3,204,466 $ 612,246 19.1% ========== ========== ========= ===== Salary and employee benefits increased $514,000 to $2.4 million for the three months ended December 31, 2006 from $1.8 million for the same period one year ago. The majority of the increase is the result of hiring additional staff to handle the Company's growth and increased regulatory reporting requirements and integrating the Collier-Jennings Companies' employees. Advertising expense increased $54,000 to $99,000 for the three months ended December 31, 2006 from $44,000 for the same period one year ago. The increase is attributable to the Company using more print media advertising to attract deposits and consumer loans. Provision For Income Taxes - Provision for income taxes decreased $66,000 or 12.2% to $479,000 for the three months ended December 31, 2006 from $545,000 for the same period one year ago. Income before income taxes was $1.5 million for the three months ended December 31, 2006 and 2005, respectively. The Company's combined federal and state effective income tax rate for the current quarter was 33.0% compared to 36.3% for the same quarter one year ago. 22 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued COMPARISON OF THE RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED DECEMBER 31, 2006 AND 2005 ----------------------------------------------------------------------------- Net Income - Net income increased $189,000 or 6.7% to $3.0 million for the nine months ended December 31, 2006 compared to $2.8 million for the nine months ended December 31, 2005. The primary reason for the increased earnings was an increase in net interest income and non-interest income offset partially by an increase in non-interest expenses. Net Interest Income - Net interest income increased $987,000 or 8.0% to $13.3 million during the nine months ended December 31, 2006, compared to $12.3 million for the same period in 2005, as a result of an increase in interest income offset in part by an increase in interest expense. Average interest earning assets increased $63.7 million to $649.9 million while average interest-bearing liabilities increased $66.6 million to $601.5 million. The interest rate spread decreased seven basis points to 2.44% during the nine months ended December 31, 2006 compared to the same period in 2005. The Company's net interest margin decreased four basis points to 2.72% for the nine months ended December 31, 2006 from 2.76% for the same period last year. Interest Income - Total interest income increased $6.9 million or 29.3% to $30.6 million during the nine months ended December 31, 2006 from $23.7 million for the same period in 2006. Total interest income on loans increased $5.8 million or 34.2% to $22.7 million during the nine months ended December 31, 2006 as a result of the average loan portfolio balance increasing $66.3 million and the yield in the loan portfolio increasing 87 basis points. Interest income from mortgage-backed securities increased $140,000 or 3.4% as a result of an increase in the yield in the mortgage-backed portfolio despite a decrease in the average balance of the portfolio of $19.5 million. Interest income from investment securities increased $1.0 million or 38.4% as a result of an increase in the yield and average balance of the investment securities portfolio. The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the nine months ended December 31, 2006 and 2005: Nine Months Ended December 31, ----------------------------------------------------- 2006 2005 ------------------ ------------------- Increase/ (Decrease) In Interest And Dividend Average Average Income Balance Yield Balance Yield From 2005 ------------ ----- ------------ ----- ---------- Loans Receivable, Net $402,113,832 7.52% $335,809,808 6.65% $5,773,289 Mortgage-Backed Securities 133,593,423 4.22 153,107,695 3.56 139,926 Investments 112,544,965 4.32 95,390,254 3.68 1,011,658 Overnight Time 1,561,374 5.03 1,871,946 3.36 11,835 Security Federal Statutory Trust 58,550 6.98 - - 3,066 Total Interest-Earning ------------ ---- ------------ ---- ---------- Assets $649,872,144 6.28% $586,179,703 5.35% $6,939,774 ============ ==== ============ ==== ========== 23 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued Interest Expense - Total interest expense increased $6.0 million or 52.3% to $17.3 million during the nine months ended December 31, 2006 compared to $11.4 million for the same period one year earlier. The increase in total interest expense is attributable to the increases in short-term interest rates, and the increase in the amount of interest-bearing deposits, and borrowings. Interest expense on deposits increased $4.4 million or 54.6% during the period as average interest bearing deposits grew $39.1 million compared to the average balance in the nine months ended December 31, 2005 while the cost of interest bearing deposits increased 109 basis points. Interest expense on advances and other borrowings increased $1.4 million or 43.4% as the cost of debt outstanding increased 68 basis points during the nine months ended December 31, 2006 compared to the same period in 2005 while average total borrowings outstanding increased approximately $25.5 million. Interest expense on junior subordinated debentures was $102,000 for the nine months ended December 31, 2006 compared to zero for the same period one year ago. The junior subordinated debentures are the result of the Company's $5.0 million trust preferred securities offering. The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the nine months ended December 31, 2006 and 2005: Nine Months Ended December 31, ----------------------------------------------------- 2006 2005 ------------------ ------------------- Increase/ (Decrease) In Interest Average Average Expense Balance Yield Balance Yield From 2005 ------------ ----- ------------ ----- ---------- Now And Money Market Accounts $210,937,813 3.15% $225,023,479 2.42% $1,076,860 Passbook Accounts 16,926,574 0.99 17,892,564 0.99 (7,167) Certificates Accounts 222,170,422 4.46 167,980,767 3.10 3,360,919 FHLB Advances And Other Borrowed Money 149,495,522 4.19 124,007,336 3.51 1,420,598 Junior Subordinated Debentures 1,947,000 6.98 - - 101,985 Total Interest-Bearing ------------ ---- ------------ ---- ---------- Liabilities $601,477,331 3.84% $534,904,146 2.84% $5,953,195 ============ ==== ============ ==== ========== 24 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued Provision for Loan Losses - 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 seven fiscal years. The Bank's provision for loan losses was $450,000 during the nine months ended December 31, 2006 compared to $495,000 for the nine months ended December 31, 2005. The $45,000 or 9.1% decrease reflects the Company's current credit quality and reduction in classified assets, impaired loans and net charge-offs. The following table details selected activity associated with the allowance for loan losses for the nine months ended December 31, 2006 and 2005 December 31, 2006 December 31, 2005 ----------------- ----------------- Beginning Balance $ 6,704,734 $ 6,284,055 Provision 450,000 495,000 Charge-offs (111,191) (263,752) Recoveries 89,772 55,628 ----------------- ----------------- Ending Balance $ 7,133,315 $ 6,570,931 ================= ================= Allowance For Loan Losses As A Percentage Of Gross Loans Receivable And Loans Held For Sale At The End Of The Period 1.66% 1.82% Allowance For Loan Losses As A Percentage Of Impaired Loans At The End Of The Period 451.86% 489.06% Impaired Loans 1,578,672 1,343,591 Nonaccrual Loans And 90 Days Or More Past Due Loans As A Percentage Of Gross Loans Receivable And Loans Held For Sale At The End Of The Period 0.51% 0.46% Loans Receivable, Net $ 421,483,354 $ 355,286,567 Non-Interest Income - Non-interest income increased $764,000 or 38.2% to $2.8 million for the nine months ended December 31, 2006 from $2.0 million for the same period one year ago. The following table provides a detailed analysis of the changes in the components of non-interest income: Nine Months Ended Increase/ December 31, (Decrease) ---------------------- ------------------- 2006 2005 Amounts Percent ---------- ---------- --------- -------- Gain On Sale Of Investments, Net $ - $ 48,962 $ (48,962) (100.0)% Gain On Sale Of Loans 295,390 374,701 (79,311) (21.2) Service Fees On Deposit Accounts 865,638 875,237 (9,599) (1.1) Income From Cash Value Of Life Insurance 180,582 - 180,582 100.0 Commissions On Insurance 413,407 15,870 397,537 2,505.0 Other Agency Income 140,802 - 140,802 100.0 Trust Income 327,767 260,172 67,595 26.0 Other 539,354 424,079 115,275 27.2 ---------- ---------- --------- ------ Total non-interest income $2,762,940 $1,999,021 $ 763,919 38.2% ========== ========== ========= ====== Income from cash value of life insurance was $181,000 for the nine months ended December 31, 2006 compared to no income during the same period one year ago. This increase is the result of the Company purchasing bank owned life insurance for certain officers of the Company. Commissions on insurance and other agency income increased $398,000 as a result of the Collier-Jennings Companies acquisition. Other miscellaneous income including credit life insurance commissions, safe deposit rental income, annuity and stock brokerage commissions, and other miscellaneous fees, increased $115,000 to $539,000 during the nine months ended December 31, 2006 compared to the same period one year ago. 25 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued Non-Interest Expense - Non-interest expense increased $1.6 million or 17.3% to $11.0 million for the nine months ended December 31, 2006 from $9.4 million for the same period one year ago. The following table provides a detailed analysis of the changes in the components of non-interest expense: Nine Months Ended Increase/ December 31, (Decrease) ----------------------- --------------------- 2006 2005 Amounts Percent ----------- ---------- ---------- --------- Salaries And Employee Benefits $ 6,789,633 $5,443,785 $1,345,848 24.7% Occupancy 1,027,793 962,678 65,115 6.8 Advertising 234,622 113,392 121,230 106.9 Depreciation And Maintenance Of Equipment 908,006 784,443 123,563 15.8 FDIC Insurance Premiums 33,586 43,247 (9,661) (22.3) Other 1,995,577 2,024,699 (29,122) (1.4) ----------- ---------- ---------- --------- Total Non-Interest Expenses $10,989,217 $9,372,244 1,616,973 17.3% =========== ========== ========= ========= Salary and employee benefits increased $1.4 to $6.8 million for the nine months ended December 31, 2006 from $5.4 million for the same period one year ago. The majority of the increase is the result of hiring additional staff to handle the Company's growth and increased regulatory reporting requirements and integrating the Collier-Jennings Companies' employees. Advertising expense increased $121,000 to $235,000 for the nine months ended December 31, 2006 from $114,000 for the same period one year ago. The increase is attributable to the Company using more print media advertising to attract deposits and consumer loans. Provision For Income Taxes - Provision for income taxes decreased $11,000 or 0.7% to $1.6 million for the nine months ended December 31, 2006 from $1.6 million for the same period one year ago. Income before income taxes was $4.6 million for the nine months ended December 31, 2006 compared to $4.4 million for the nine months ended December 31, 2005. The Company's combined federal and state effective income tax rate for the nine months ended December 31, 2006 was 34.2% compared to 35.8% for the same period one year ago. Liquidity Commitments, Capital Resources , and Impact of Inflation and Changing Prices Liquidity - The Company actively analyzes and manages the Bank's liquidity with the objective of maintaining an adequate level of liquidity and to ensure the availability of sufficient cash flows to support loan growth, fund deposit withdrawals, fund operations, and satisfy other financial commitments. See the "Consolidated Statements of Cash Flows" contained in Item 1 Financial Statements, herein. The primary sources of funds are customer deposits, loan repayments, loan sales, maturing investment securities, and advances from the FHLB. The sources of funds, together with retained earnings and equity, are used to make loans, acquire investment securities and other assets, and fund continuing operations. While maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage repayments are greatly influenced by the level of interest rates, economic conditions, and competition. Management believes that the Company's current liquidity position and its forecasted operating results are sufficient to fund all of its existing commitments. During the nine months ended December 31, 2006 loan disbursements exceeded loan repayments resulting in a $46.4 million or 12.4% increase in total net loans receivable. During the nine months ended December 31, 2006, deposits increased $28.3 million and FHLB advances increased $17.0 million. The Bank had $65.9 million in additional borrowing capacity at the FHLB at the end of the period. At December 31, 2006, the Bank had $225.1 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. The Company has plans to expand its branch network, which could cause earnings to level off or decline for a period of time. The leveling off or decline in earnings will be attributed the lag that exists from the time a branch is built to when it becomes profitable. In the next twelve months, we anticipate investing $5.0 to $6.0 million in land, buildings, and equipment. In the next twenty-four months, we anticipate investing $8.0 to $10.0 million in land, buildings, and equipment. The anticipated costs could be affected by increased construction costs, weather delays, and/or other uncertainties. 26 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued Off-Balance Sheet Commitments - The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally include commitments to originate mortgage, commercial and consumer loans, and involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company's maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount of those instruments. Since some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments. Collateral is not required to support commitments. The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at December 31, 2006. 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 $5,864 $ 4,375 $33,151 $ 43,390 $35,794 $79,184 Standby letters of credit - 46 448 494 - 494 ------ ------- ------- -------- ------- ------- Total $5,864 $ 4,421 $33,599 $ 43,884 $35,794 $79,678 ====== ======= ======= ======== ======= ======= 27 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 manage its interest rate risk exposure. Although the Company manages other risks such as credit quality and liquidity risk in the normal course of business, management considers interest rate risk to be its most significant market risk that could potentially have the largest material effect on the Company's financial condition and results of operations. Other types of market risks such as foreign currency exchange rate risk and commodity price do not arise in the normal course of the Company's business activities. The Company's profitability is affected by fluctuations in the market interest rate. Management's goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase or decrease in interest rates may adversely impact the Company's earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same rate, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using a test that measures the impact on net interest income and net portfolio value of an immediate change in interest rates in 100 basis point increments and by measuring the Bank's interest sensitivity gap ("Gap"). Net portfolio value is defined as the net present value of assets, liabilities, and off-balance sheet contracts. Gap is the amount of interest sensitive assets repricing or maturing over the next twelve months compared to the amount of interest sensitive liabilities maturing or repricing in the same time period. Recent net portfolio value reports furnished by the OTS indicate that the Bank's interest rate risk sensitivity has increased slightly over the past year. The Bank has rated favorably compared to thrift peers concerning interest rate sensitivity. For the nine months ended December 31, 2006, 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 2.44%. For the year ended March 31, 2006, the interest rate spread was 2.48%. The interest rate spread decreased due to the rates paid on deposits outpacing the rates received on loans. The rate differential was offset partially by the growth of loan receivables. Loan receivables earn a higher yield than investment securities. However, if interest rates were to increase suddenly and significantly, the Bank's net interest income and net interest spread would be compressed. Item 4. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company's disclosure controls and procedures (as defined in Rule 13a - 15(e) of the Securities Exchange Act of 1934 ("Act")) was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management as of the end of the period covered by this quarterly report. The Company's Chief Executive Officer and Chief Financial Officer concluded that at December 31, 2006 the Company's disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission's rules and forms. (b) Changes in Internal Controls: In the quarter ended December 31, 2006, 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. 28 Security Federal Corporation and Subsidiaries Part II: Other Information Item 1 Legal Proceedings ----------------- The Company is not engaged in any legal proceedings of a material nature at the present time. From time to time, the Company is a party to legal proceedings in the ordinary course of business wherein it enforces its security interest in mortgage loans it has made. Item 1A Risk Factors ------------ There have been no material changes in the risk factors previously disclosed in the Company's Annual Report on Form 10-K for the year ended March 31, 2006. Item 2 Unregistered sales of Equity Securities and Use Of Proceeds ----------------------------------------------------------- (c) Total Number of (d)Maximum Shares Number of Purchased Shares that (a) Total as Part of- May Yet Be Number of (b)Average Publicly Purchased Shares Price Paid Announced Under the Period Purchased Per Share Program Program October 1- October 31, 2006 - - - 111,088 November 1 - November 30, 2006 438 $23.75 438 110,650 December 1 - December 31, 2006 4,515 23.25 4,515 106,135 ----------------------------------------------------- Total 4,953 $23.29 4,953 106,135 ===================================================== In May 2004, 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, 2006, 19,865 shares have been repurchased under this program. The Company repurchased 4,953 shares of its outstanding Common Stock during the three months ended December 31, 2006. Item 3 Defaults Upon Senior Securities ------------------------------- None Item 4 Submission Of Matters To A Vote Of Security Holders --------------------------------------------------- None Item 5 Other Information ----------------- None 29 Security Federal Corporation and Subsidiaries Part II: Other Information, Continued Item 6 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 1993 Salary Continuation Agreements (4) 10.3 Amendment One to 1993 Salary Continuation Agreement (5) 10.4 Form of 2006 Salary Continuation Agreement(6) 10.4 1999 Stock Option Plan (2) 10.5 1987 Stock Option Plan (4) 10.6 2002 Stock Option Plan (7) 10.7 2004 Employee Stock Purchase Plan (8) 10.8 Incentive Compensation Plan (4) 10.9 Form of Security Federal Bank Salary Continuation Agreement (9) 10.10 Form of Security Federal Split Dollar Agreement (9) 14 Code of Ethics (10) 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 on June 26, 1998, as an exhibit to the Company's Proxy Statement and incorporated herein by reference. (2) Filed on March 2, 2000, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference. (3) Filed on August 12, 1987, as an exhibit to the Company's Registration Statement on Form 8-A and incorporated herein by reference. (4) Filed on June 28, 1993, as an exhibit to the Company's Annual Report on Form 10-KSB and incorporated herein by reference. (5) Filed as an exhibit to the Company's Quarterly Report on Form 10-QSB for the quarter ended September 30, 1993 and incorporated herein by reference. (6) Filed on May 24, 2006 as an exhibit to the Company's Current Report on Form 8-K dated May 18, 2006 and incorporated herein by reference. (7) Filed on June 19, 2002, as an exhibit to the Company's Proxy Statement and incorporated herein by reference. (8) Filed on June 18, 2004, as an exhibit to the Company's Proxy Statement and incorporated herein by reference. (9) Filed on May 24, 2006 as an exhibit to the Current Report on Form 8-K and incorporated herein by reference. (10) Filed on June 29, 2006 as an exhibit to the Company's Annual Report on Form 10-K and incorporated herein by reference. 30 Security Federal Corporation and Subsidiaries 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, 2007 By:/s/Timothy W. Simmons ---------------------- --------------------------------- Timothy W. Simmons President Duly Authorized Representative Date: February 13, 2007 By:/s/Roy G. Lindburg ---------------------- --------------------------------- Roy G. Lindburg Treasurer/CFO Duly Authorized Representative 31 EXHIBIT 31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 32 Certification I, Timothy W. Simmons, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Security Federal Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the period presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control 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, 2007 /s/ Timothy W. Simmons -------------------------------------- Timothy W. Simmons President and Chief Executive Officer 33 EXHIBIT 31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 34 Certification I, Roy G. Lindburg, certify that: 1. I have reviewed this Quarterly Report on Form 10-Q of Security Federal Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the period presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control 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, 2007 /s/ Roy G. Lindburg -------------------------------- Roy G. Lindburg Chief Financial Officer 35 EXHIBIT 32 Certification Pursuant to Section 906 of the Sarbanes Oxley Act 36 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 financial condition and results of operations of Security Federal Corporation. /s/Timothy W. Simmons /s/Roy G. Lindburg ------------------------------ ------------------------------ Timothy W. Simmons Roy G. Lindburg Chief Executive Officer Chief Financial Officer Dated: February 13, 2007 37