10-Q 1 q208.txt SECURITY FEDERAL CORPORATION FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10 - Q (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007 [ ] 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.) 238 RICHLAND AVENUE, WEST, AIKEN, SOUTH CAROLINA 29801 (Address of Principal Executive Office And Zip code) (803) 641-3000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "large accelerated filer" and "accelerated filer" in Rule 12b-2 of the Exchange Act. Large accelerated filed [ ] Accelerated filer [ ] Non-accelerated filer [X] Indicate by check mark whether the registrant is a shell corporation (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 October 31, 2007 2,589,344 value $0.01 per share INDEX ------------------------------------------------------------------------------- PART I. FINANCIAL INFORMATION (UNAUDITED) PAGE NO. Item 1. Financial Statements (Unaudited): Consolidated Balance Sheets at September 30, 2007 and March 31, 2007 1 Consolidated Statement of Income for the Three and Six Months Ended September 30, 2007 and 2006 2 Consolidated Statements of Shareholders' Equity and Comprehensive Income at September 30, 2007 and 2006 4 Consolidated Statements of Cash Flows for the Six Months Ended September 30, 2007 and 2006 5 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 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 2. Unregistered Sales of Equity Securities and Use of Proceeds 29 Item 3. Defaults Upon Senior Securities 29 Item 4. Submission of Matters to 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 Security Federal Corporation and Subsidiaries Consolidated Balance Sheets September 30, 2007 March 31, 2007 Assets: ------------------ -------------- (Unaudited) (Audited) Cash And Cash Equivalents $ 11,814,949 $ 13,438,129 Investment And Mortgage-Backed Securities: Available For Sale:(Amortized cost of $201,102,488 at September 30, 2007 and $186,970,867 at March 31, 2007) 200,436,474 185,766,296 Held To Maturity:(Fair value of $53,825,070 at September 30, 2007 and $63,441,641 at March 31, 2007) 54,142,926 64,138,589 ----------- ----------- Total Investment And Mortgage-Backed Securities 254,579,400 249,904,885 Loans Receivable, Net: ----------- ----------- Held For Sale 1,348,642 1,529,748 Held For Investment:(Net of allowance of $7,564,211 at September 30, 2007 and $7,296,791 at March 31, 2007) 485,796,297 434,508,612 ----------- ----------- Total Loans Receivable, Net 487,144,939 436,038,360 Accrued Interest Receivable: ----------- ----------- Loans 1,882,771 1,459,193 Mortgage-Backed Securities 572,134 550,682 Investments 1,442,174 1,181,639 Premises And Equipment, Net 18,858,741 15,895,192 Federal Home Loan Bank Stock, At Cost 9,347,300 8,209,200 Bank Owned Life Insurance 8,132,821 5,783,620 Repossessed Assets Acquired In Settlement Of Loans 522,856 24,909 Intangible Assets, Net 487,500 532,500 Goodwill 1,197,954 1,197,954 Other Assets 3,558,180 3,893,928 ----------- ----------- Total Assets $ 799,541,719 $ 738,110,191 =========== =========== Liabilities And Shareholders' Equity Liabilities: Deposit Accounts $ 555,598,721 $ 523,737,592 Advances From Federal Home Loan Bank 179,141,678 153,049,272 Other Borrowed Money 8,934,719 8,088,194 Advance Payments By Borrowers For Taxes And Insurance 908,095 486,101 Mandatorily Redeemable Financial Instrument 1,417,312 1,417,312 Junior Subordinated Debentures 5,155,000 5,155,000 Other Liabilities 3,884,351 3,483,512 ----------- ----------- Total Liabilities 755,039,876 695,416,983 ----------- ----------- 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 And Outstanding Shares (2,646,619 And 2,595,594, Respectively, At September 30, 2007; And 2,637,942 And 2,609,116, Respectively, At March 31, 2007 25,901 25,814 Additional Paid-In Capital 5,009,076 4,850,029 Treasury Stock, (At Cost, 51,025 and 28,826 Shares, at September 30, 2007 and March 31, 2007, Respectively) (1,194,543) (651,220) Accumulated Other Comprehensive Loss (413,303) (747,316) Retained Earnings, Substantially Restricted 41,074,712 39,215,901 ----------- ----------- Total Shareholders' Equity 44,501,843 42,693,208 ----------- ----------- Total Liabilities And Shareholders' Equity $ 799,541,719 $ 738,110,191 =========== =========== See accompanying notes to consolidated financial statements. Security Federal Corporation and Subsidiaries Consolidated Statements of Income (Unaudited) Three Months Ended September 30, ------------------------------- 2007 2006 Interest Income: ------ ------ Loans $ 9,416,586 $ 7,756,318 Mortgage-Backed Securities 1,557,696 1,324,065 Investment Securities 1,663,976 1,184,887 Other 8,305 17,989 ----------- ----------- Total Interest Income 12,646,563 10,283,259 ----------- ----------- Interest Expense: NOW And Money Market Accounts 1,672,887 1,716,286 Passbook Accounts 41,134 42,030 Certificate Accounts 3,627,239 2,436,345 Advances And Other Borrowed Money 2,053,365 1,539,665 Junior Subordinated Debentures 92,252 10,002 ----------- ----------- Total Interest Expense 7,486,877 5,744,328 ----------- ----------- Net Interest Income 5,159,686 4,538,931 Provision For Loan Losses 150,000 150,000 Net Interest Income After Provision For ----------- ----------- Loan Losses 5,009,686 4,388,931 Non- Interest Income: Gain On Sale Of Loans 105,450 93,998 Service Fees On Deposit Accounts 323,423 291,635 Income From Cash Value Of Life Insurance 87,164 62,037 Commissions From Insurance Agency 173,488 209,246 Other Agency Income 26,910 10,426 Trust Income 139,850 121,556 Other 193,085 123,822 ----------- ----------- Total Non-Interest Income 1,049,370 912,720 ----------- ----------- General And Administrative Expenses: Salaries And Employee Benefits 2,627,272 2,303,160 Occupancy 445,602 350,668 Advertising 87,148 61,301 Depreciation And Maintenance Of Equipment 337,091 316,326 FDIC Insurance Premiums 14,870 14,820 Amortization of Intangibles 22,500 22,500 Other 846,518 660,426 ----------- ----------- Total General And Administrative Expenses 4,381,001 3,729,201 ----------- ----------- Income Before Income Taxes 1,678,055 1,572,450 Provision For Income Taxes 550,479 545,451 ----------- ----------- Net Income $ 1,127,576 $ 1,026,999 =========== =========== Basic Net Income Per Common Share $ 0.43 $ 0.39 =========== =========== Diluted Net Income Per Common Share $ 0.43 $ 0.39 =========== =========== Cash Dividend Per Share On Common Stock $ 0.07 $ 0.06 =========== =========== Basic Weighted Average Shares Outstanding 2,602,072 2,610,605 =========== =========== Diluted Weighted Average Shares Outstanding 2,610,567 2,622,996 =========== =========== See accompanying notes to consolidated financial statements. 2 Security Federal Corporation and Subsidiaries Consolidated Statements of Income (Unaudited) Six Months Ended September 30, ----------------------------- 2007 2006 Interest Income: ------ ------ Loans $ 18,208,165 $ 14,776,993 Mortgage-Backed Securities 3,099,406 2,767,415 Investment Securities 3,217,496 2,331,229 Other 27,902 32,472 ---------- ---------- Total Interest Income 24,552,969 19,908,109 ---------- ---------- Interest Expense: NOW And Money Market Accounts 3,327,726 3,297,456 Passbook Accounts 82,949 83,906 Certificate Accounts 6,870,088 4,591,746 Advances And Other Borrowed Money 3,951,698 2,975,392 Junior Subordinated Debentures 183,077 10,002 ---------- ---------- Total Interest Expense 14,415,538 10,958,502 ---------- ---------- Net Interest Income 10,137,431 8,949,607 Provision For Loan Losses 300,000 300,000 Net Interest Income After Provision For ---------- ---------- Loan Losses 9,837,431 8,649,607 Non- Interest Income: ---------- ---------- Gain On Sale Of Loans 281,571 207,253 Service Fees On Deposit Accounts 650,745 569,503 Income From Cash Value Of Life Insurance 149,201 118,545 Commissions From Insurance Agency 319,161 214,635 Other Agency Income 56,168 10,426 Trust Income 238,625 217,556 Other 414,497 326,796 ---------- ---------- Total Non- Interest Income 2,109,968 1,664,714 ---------- ---------- General And Administrative Expenses: Salaries And Employee Benefits 5,197,551 4,428,529 Occupancy 868,113 668,263 Advertising 189,421 135,950 Depreciation And Maintenance Of Equipment 656,616 607,795 FDIC Insurance Premiums 30,197 28,962 Amortization of Intangibles 45,000 22,500 Other 1,645,548 1,280,506 ---------- ---------- Total General And Administrative Expenses 8,632,446 7,172,505 ---------- ---------- Income Before Income Taxes 3,314,953 3,141,816 Provision For Income Taxes 1,091,346 1,092,445 ---------- ---------- Net Income $ 2,223,607 $ 2,049,371 ========== ========== Basic Net Income Per Common Share $ 0.85 $ 0.80 ========== ========== Diluted Net Income Per Common Share $ 0.85 $ 0.79 ========== ========== Cash Dividend Per Share On Common Stock $ 0.14 $ 0.12 ========== ========== Basic Weighted Average Shares Outstanding 2,609,576 2,574,778 ========== ========== Diluted Weighted Average Shares Outstanding 2,616,718 2,587,472 ========== ========== See accompanying notes to consolidated financial statements. 3 Security Federal Corporation and Subsidiaries Consolidated Statements of Shareholders' Equity and Comprehensive Income (Unaudited) Accumulated Additional Indirect Other Common Paid - In Treasury Guarantee of Comprehensive Retained Stock Capital Stock ESOP Debt Income (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 - - - - 2,049,371 2,049,371 Other Comprehensive Income, Net Of Tax: Unrealized Holding Gains On Securities Available For Sale - - - - 590,364 - 590,364 --------- Comprehensive Income - - - - - - 2,639,735 Purchase Of Treasury Stock --------- At Cost, 3,600 shares (83,022) - - - (83,022) Decrease In Indirect Guarantee Of ESOP Debt - - - 215,503 - - 215,503 Exercise Of Stock Options 176 350,656 - - - - 350,832 Stock Compensation Expense - 1,921 - - - - 1,921 Cash Dividends - - - - - (309,627) (309,627) ----- --------- -------- ------------ ------------- -------- ------- Balance At September 30, 2006 $ 25,758 $4,756,687 $(321,678) $ - $ (1,496,145) $37,452,479 $40,417,101 Accumulated Additional Indirect Other Common Paid - In Treasury Guarantee of Comprehensive Retained Stock Capital Stock ESOP Debt Income (Loss) Earnings Total ----- --------- -------- ------------ ------------- -------- ------- Balance At March 31, 2007 $ 25,814 $ 4,850,029 $(651,220) $ - $ (747,316) $39,215,901 $42,693,208 Net Income - - - - - 2,223,607 2,223,607 Other Comprehensive Income, Net Of Tax: Unrealized Holding Gains On Securities Available For Sale - - - - 334,013 - 334,013 Comprehensive Income - - - - - - 2,557,620 Purchase Of Treasury Stock At Cost, 22,199 shares - - (543,323) - - - (543,323) Employee Stock Purchase Plan Purchases 24 48,094 - - - - 48,118 Exercise Of Stock Options 63 104,958 - - - - 105,021 Stock Compensation Expense - 5,995 - - - - 5,995 Cash Dividends - - - - - (364,796) (364,796) ----- --------- -------- ------------ ------------- -------- ------- Balance At September 30, 2007 $ 25,901 $ 5,009,076$(1,194,543) $ - $ (413,303) $41,074,712 $44,501,843 ====== ========= ========= =========== =========== ========== ==========
See accompanying notes to consolidated financial statements. 4 Security Federal Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Six Months Ended September 30, ----------------------------- 2007 2006 Cash Flows From Operating Activities: ------ ------ Net Income $ 2,223,607 $ 2,049,371 Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities: Depreciation Expense 520,001 479,490 Amortization Of Intangible Assets 45,000 22,500 Stock Option Compensation Expense 5,995 1,921 Discount Accretion And Premium Amortization 112,308 225,592 Provisions For Losses On Loans And Real Estate 300,000 300,000 Gain On Sale Of Loans (281,571) (207,253) Gain On Sale Of Real Estate (23,404) (48,678) Amortization Of Deferred Fees On Loans (54,515) (105,427) Proceeds From Sale Of Loans Held For Sale 17,446,108 12,465,483 Origination Of Loans For Sale (16,983,431) (12,017,749) (Increase) Decrease In Accrued Interest Receivable: Loans (423,578) (253,918) Mortgage-Backed Securities (21,452) 2,457 Investments (260,535) (58,888) Increase In Advance Payments By Borrowers 421,994 355,850 Loss On Disposition of Premises and Equipment - 215 Other, Net 532,044 (1,085,177) ---------- ---------- Net Cash Provided By Operating Activities 3,558,571 2,125,789 ---------- ---------- Cash Flows From Investing Activities: Principal Repayments On Mortgage-Backed Securities Available For Sale 18,400,859 19,367,854 Purchase Of Investment Securities Available For Sale (22,552,547) (7,971,845) Purchase Of Mortgage-Backed Securities Available For Sale (17,778,773) (13,227,369) Maturities Of Investment Securities Available For Sale 7,682,194 1,513,036 Maturities Of Investment Securities Held To Maturity 10,000,000 6,000,000 Purchase Of FHLB Stock (5,496,400) (3,432,000) Redemption Of FHLB Stock 4,358,300 3,026,200 Increase In Loans To Customers (52,144,992) (31,829,824) Proceeds From Sale Of Repossessed Assets 137,279 139,700 Purchase And Improvement Of Premises And Equipment (3,483,550) (2,107,377) Purchase Of Bank Owned Life Insurance (2,349,201) (659,545) ---------- ---------- Net Cash Used By Investing Activities (63,226,831) (29,181,170) ---------- ---------- Cash Flows From Financing Activities: Increase In Deposit Accounts 31,861,129 7,836,129 Proceeds From FHLB Advances 203,400,000 138,579,250 Repayment Of FHLB Advances (177,307,594) (129,985,459) Net (Repayment)Proceeds Of Other Borrowings 846,525 (505,726) Proceeds From Junior Subordinated Debentures - 5,155,000 Dividends To Shareholders (364,796) (309,627) Purchase Of Treasury Stock (543,323) (83,022) Proceeds From Employee Stock Purchases 48,118 - Proceeds From Exercise of Stock Options 105,021 350,832 ---------- ---------- Net Cash Provided By Financing Activities 58,045,080 21,037,377 ---------- ---------- (Continued) 5 Security Federal Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Six Months Ended September 30, ----------------------------- 2007 2006 ---------- ---------- Net Decrease In Cash And Cash Equivalents (1,623,180) (6,018,004) Cash And Cash Equivalents At Beginning Of Period 13,438,129 14,351,208 ---------- ---------- Cash And Cash Equivalents At End Of Period $ 11,814,949 $ 8,333,204 ========== ========== Supplemental Disclosure Of Cash Flows Information: Cash Paid During The Period For Interest $ 14,266,412 $ 10,726,724 Cash Paid During The Period For Income Taxes $ 1,304,290 $ 579,000 Additions To Repossessed Acquired Through Foreclosure $ 611,833 $ - Decrease In Unrealized Net Loss On Securities Available For Sale, Net Of Taxes $ 334,013 $ 590,364 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") 2007 Annual Report to Shareholders when reviewing interim financial statements. The results of operations for the six-month period ended September 30, 2007 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. The Company's significant accounting policies are described in the footnotes to the audited consolidated financial statements at March 31, 2007 included in it's 2007 Annual Report to Stockholders, which was filed as an exhibit to the Annual Report on Form 10-K for the year ended March 31, 2007. Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities. The Company considers these accounting policies to be critical accounting policies. The judgments and assumptions the Company uses are based on historical experience and other factors, which the Company believes 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 the carrying values of assets and liabilities and the 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. 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 -------------------------------------------------------- September 30, 2007 -------------------------------------------------------- Income (Numerator) Amount Shares (Denominator) Per Share ------------------------- -------------------- --------- Basic EPS $ 1,127,576 2,602,072 $ 0.43 Effect of Diluted Securities: Stock Options - 8,495 - ------------------------- -------------------- --------- Diluted EPS $ 1,127,576 2,610,567 $ 0.43 ========================= ==================== ========= For the Quarter Ended -------------------------------------------------------- September 30, 2006 -------------------------------------------------------- Income (Numerator) Amount Shares (Denominator) Per Share ------------------------- -------------------- --------- Basic EPS $ 1,026,999 2,610,605 $ 0.39 Effect of Diluted Securities: Stock Options - 12,391 - ------------------------- -------------------- --------- Diluted EPS $ 1,026,999 2,622,996 $ 0.39 ========================= ==================== ========= For the Six Months Ended -------------------------------------------------------- September 30, 2007 -------------------------------------------------------- Income (Numerator) Amount Shares (Denominator) Per Share ------------------------- -------------------- --------- Basic EPS $ 2,223,607 2,609,576 $ 0.85 Effect of Diluted Securities: Stock Options - 7,142 - ------------------------- -------------------- --------- Diluted EPS $ 2,223,607 2,616,718 $ 0.85 ========================= ==================== ========= For the Six Months Ended -------------------------------------------------------- September 30, 2006 -------------------------------------------------------- Income (Numerator) Amount Shares (Denominator) Per Share ------------------------- -------------------- --------- Basic EPS $ 2,049,371 2,574,778 $ 0.80 Effect of Diluted Securities: Stock Options - 12,694 (0.01) ------------------------- -------------------- --------- Diluted EPS $ 2,049,371 2,587,472 $ 0.79 ========================= ==================== ========= 9 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 6. Stock-Based Compensation Certain officers of the Company participate in an incentive stock option plan. Options are granted at exercise prices not less than the fair value of the Company's common stock on the date of the grant. The following is a summary of the activity under the Company's incentive stock option plan for the three months and six months ended September 30, 2007: Three Months Ended Six Months Ended September 30, 2007 September 30, 2007 --------------------- --------------------- Weighted Weighted Average Average Shares Exercise Price Shares Exercise Price ------ -------------- ------ -------------- Balance, Beginning of Period/Year 99,100 $20.55 99,600 $20.55 Options granted 3,000 24.43 3,000 24.43 Options exercised (6,300) 16.67 (6,300) 16.67 Options forfeited (4,700) 16.67 (5,200) 17.40 ------- ------- Balance, September 30, 2007 91,100 $21.09 91,100 $21.09 ======= ======= Options Exercisable 74,100 74,100 ======= ======= Options Available For Grant 95,733 95,733 ======= ======= 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 Granted During For Awards Granted During The Three Month Period Ended The Six Month Period Ended September 30, September 30, -------------------------- -------------------------- 2007 2006 2007 2006 ------ ------ ------ ------ Awards granted 3,000 13,500 3,000 13,500 Dividend Yield 1.52% 1.03% 1.52% 1.03% Expected Volatility 23.90% 30.21% 23.90% 30.21% Risk-free interest rate 5.03% 4.36% 5.03% 4.36% Expected life 9.00 9.01 9.00 9.01 10 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 6. Stock-Based Compensation, Continued At September 30, 2007, the Company had the following options outstanding: Outstanding Grant Date Options Option Price Expiration Date ------------ ----------- ------------ --------------------- 10/19/99 20,100 $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 6,500 $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 20,500 $20.55 12/31/14 1/1/06 6,000 $23.91 12/31/16 8/24/06 14,000 $23.03 8/24/16 5/24/07 2,000 $24.34 5/24/17 7/9/07 1,000 $24.61 7/9/17 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 September 2006, the FASB issued SFAS No. 157 which provides enhanced guidance for using fair value to measure assets and liabilities. The standard also requires expanded disclosures about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years and is not expected to have a significant impact on the Company's financial statements. In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans" ("SFAS 158"), which amends SFAS 87 and SFAS 106 to require recognition of the overfunded or underfunded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 87 and SFAS 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 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 158 will not impact o the Company's financial conditions or results of operations. 11 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 7. Accounting and Reporting Changes, Continued In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115." This statement permits, but does not require, entities to measure many financial instruments at fair value. The objective is to provide entities with an opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Entities electing this option will apply it when the entity first recognizes an eligible instrument and will report unrealized gains and losses on such instruments in current earnings. This statement 1) applies to all entities, 2) specifies certain election dates, 3) can be applied on an instrument-by-instrument basis with some exceptions, 4) is irrevocable and 5) applies only to entire instruments. One exception is demand deposit liabilities, which are explicitly excluded as qualifying for fair value. With respect to SFAS 115, available-for-sale and held-to-maturity securities at the effective date are eligible for the fair value option at that date. If the fair value option is elected for those securities at the effective date, cumulative unrealized gains and losses at that date shall be included in the cumulative-effect adjustment and thereafter, such securities will be accounted for as trading securities. SFAS 159 is effective for the Company on January 1, 2008. Earlier adoption is permitted in 2007 if the Company also elects to apply the provisions of SFAS 157. The Company did not early adopt SFAS No. 159 and believes that it is unlikely that it will expand its use of fair value accounting upon the January 1, 2008 effective date. 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, 2007. Entities should recognize the effects of applying this Issue 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's split dollar life insurance arrangements do not provide a benefit that extends into postretirement periods. Therefore EITF 06-4 will not have an impact on the Company's consolidated financial statements. 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, 2007. Although the Company does not believe the adoption of EITF 06-5 will have a material impact on the Company's consolidated financial statements, management is currently analyzing the impact of adoption. 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 or cash flows. 12 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 September 30, 2007 Amortized Unrealized Unrealized ------------------ Cost Gains Losses Fair Value --------- ---------- ---------- ---------- FHLB Securities $49,641,785 $ 107,994 $ 148,337 $49,601,442 Federal Farm Credit Securities 13,085,937 38,547 30,654 13,093,830 FNMA Bonds 2,875,470 943 23,936 2,852,477 FHLMC Bonds 8,654 - 14 8,640 Mortgage-Backed Securities 135,387,704 432,245 1,040,664 134,779,285 Equity Securities 102,938 - 2,138 100,800 ----------- ---------- ---------- ----------- Total $201,102,488 $ 579,729 $1,245,743 $200,436,474 =========== ========== ========== =========== Gross Gross March 31, 2007 Amortized Unrealized Unrealized -------------- Cost Gains Losses Fair Value --------- ---------- ---------- ---------- FHLB Securities $38,487,381 $ 17,627 $ 131,886 $38,373,122 Federal Farm Credit Securities 9,217,205 8,580 11,504 9,214,281 FNMA Bonds 2,942,530 - 12,141 2,930,389 FHLMC Bonds 64,071 - 94 63,977 Mortgage-Backed Securities 136,156,742 276,292 1,352,007 135,081,027 Equity Securities 102,938 562 - 103,500 ----------- ---------- ---------- ----------- Total $186,970,867 303,061 1,507,632 $185,766,296 =========== ========== ========== =========== FHLB securities, Federal Farm Credit securities, FNMA bonds, FHLMC bonds and FNMA and FHLMC mortgage- backed securities are issued by government-sponsored enterprises ("GSEs"). GSEs are not backed by the full faith and credit of the United States government. Included in the tables above in mortgage-backed securities are GNMA mortgage-backed securities, which are backed by the full faith and credit of the United States government. At September 30, 2007, the bank held an amortized cost and fair value of $50.3 million and $50.5 million, respectively in GNMA mortgage-backed securities included in mortgage-backed securities listed above. Investment and Mortgage-Backed Securities, Held to Maturity ----------------------------------------------------------- The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of investment and mortgage-backed securities held to maturity are as follows: Gross Gross September 30, 2007 Amortized Unrealized Unrealized ------------------ Cost Gains Losses Fair Value --------- ---------- ---------- ---------- FHLB Securities $46,997,554 $ 33,770 $ 265,014 $46,766,310 Federal Farm Credit Securities 6,990,372 - 86,612 6,903,760 Equity Securities 155,000 - - 155,000 ----------- ---------- ---------- ----------- Total $54,142,926 $ 33,770 $ 351,626 $53,825,070 =========== ========== ========== =========== Gross Gross March 31, 2007 Amortized Unrealized Unrealized -------------- Cost Gains Losses Fair Value --------- ---------- ---------- ---------- FHLB Securities 55,994,852 $ 21,560 $ 573,841 $55,442,571 Federal Farm Credit Securities 7,988,737 - 144,667 7,844,070 Equity Securities 155,000 - - 155,000 ----------- ---------- ---------- ----------- Total $64,138,589 $ 21,560 $ 718,508 $63,441,641 =========== ========== ========== =========== 13 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 8. Securities, Continued FHLB securities and Federal Farm Credit securities are issued by GSEs. These enterprises are not backed by the full faith and credit of the United States government. 9. Loans Receivable, Net Loans receivable, net, at September 30, 2007 and March 31, 2007 consisted of the following: September 30, 2007 March 31, 2007 ------------------ -------------- Residential Real Estate $ 131,661,463 $ 125,512,411 Consumer 66,476,147 63,809,478 Commercial Business & Real Estate 301,932,098 259,207,877 Loans Held For Sale 1,348,642 1,529,748 ----------- ----------- 501,418,350 450,059,514 ----------- ----------- Less: Allowance For Possible Loan Loss 7,564,211 7,296,791 Loans In Process 6,401,739 6,443,372 Deferred Loan Fees 307,461 280,991 ----------- ----------- 14,273,411 14,021,154 ----------- ----------- $ 487,144,939 $ 436,038,360 =========== =========== 14 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 September 30, 2007 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, 2007. 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 September 30, 2007 and March 31, 2007 General - Total assets increased $61.4 million or 8.3% to $799.5 million at September 30, 2007 from $738.1 million at March 31, 2007. The primary reason for the growth in total assets was a $51.1 million or 11.7% increase in net loans receivable to $487.1 million. For the six months ended September 30, 2007, the demand for loans was funded with decreased cash and cash equivalents of $1.6 million or 12.1%, decreased investments and mortgage-backed securities, held to maturity of $10.0 million or 15.6%, increased deposits of $31.9 million or 6.1%, increased advances from the Federal Home Loan Bank ("FHLB") of $26.1 million or 17.0% and an increase in other borrowed money of $847,000 or 10.5%. Assets - The increases and decreases in total assets were primarily concentrated in the following asset categories: Increase (Decrease) ------------------- September 30, March 31, 2007 2007 Amount Percent ------ ------ ------ ------- Cash And Cash Equivalents $11,814,949 $13,438,129 $(1,623,180) (12.1)% Investment And Mortgage- Backed Securities - Available For Sale 200,436,474 185,766,296 14,670,178 7.9 Investment And Mortgage- Backed Securities - Held To Maturity 54,142,926 64,138,589 (9,995,663) (15.6) Loan Receivable, Net 487,144,939 436,038,360 51,106,579 11.7 Premises And Equipment, Net 18,858,741 15,895,192 2,963,549 18.6 FHLB Stock, At Cost 9,347,300 8,209,200 1,138,100 13.9 Bank Owned Life Insurance 8,132,821 5,783,620 2,349,201 40.6 Repossessed Assets Acquired in Settlement of Loans $ 522,856 $ 24,909 $ 497,947 1,999.1% Cash and cash equivalents decreased $1.6 million to $11.8 million at September 30, 2007 from $13.4 million at March 31, 2007. The reason for the decrease is the Company used cash and cash equivalents to fund loans. Investments and mortgage-backed securities increased $4.7 million or 1.9% to $254.6 million at September 30, 2007 from $249.9 million at March 31, 2007. The increase in investments and mortgage-backed securities is attributable to additional purchases of mortgage- backed securities and investments and an increase in the market value of these investments. This is offset partially by paydowns on mortgage-backed securities and calls and maturities on mortgage-backed securities and investments. 15 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued Loans receivable, net increased $51.1 million or 11.7% to $487.1 million at September 30, 2007 from $436.0 million at March 31, 2007. Residential real estate loans increased $6.1 million to $131.7 million at September 30, 2007 from $125.5 million at March 31, 2007. Consumer loans increased $2.7 million to $66.5 million at September 30, 2007 from $63.8 million at March 31, 2007. 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 $42.7 million to $301.9 million at September 30, 2007 from $259.2 million at March 31, 2007. The increase in commercial loans was attributable to the Company's continued focus on originating this type of loan. Loans held for sale decreased $181,000 to $1.3 million at September 30, 2007 from $1.5 million at March 31, 2007. Premises and equipment, net increased $3.0 million to $18.9 million at September 30, 2007 from $15.9 million at March 31, 2007. The majority of the increase is for furniture and equipment for our Whiskey Road branch office in Aiken, South Carolina, and for the ongoing construction of future office sites in downtown Columbia, South Carolina and Evans, Georgia. FHLB stock, at cost increased $1.1 million to $9.3 million at September 30, 2007 from $8.2 million at March 31, 2007. 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 $2.3 million to $8.1 million at September 30, 2007 from $5.8 million at March 31, 2007. The Company purchased additional life insurance to provide key man life insurance for additional officers and the cash surrender value continues to increase. Repossessed Assets Acquired in Settlement of Loans increased $498,000 to $523,000 at September 30, 2007 from $25,000 at March 31, 2007. The increase is the result of three properties that were foreclosed on during the period. Liabilities Deposit Accounts Balance ------------------ September 30, 2007 March 31, 2007 Increase (Decrease) ---------------- ---------------- ------------------ Weighted Weighted Balance Rate Balance Rate Amount Percent ------- ---- ------- ---- ------ ------- Demand Accounts: Checking $100,292,511 0.68% $105,515,095 0.63% $(5,222,584) (4.9)% Money Market 142,824,607 4.14 145,491,774 4.14 (2,667,167) (1.8) Regular Savings 15,940,565 0.98 17,458,680 0.98 (1,518,115) (8.7) ----------- ---- ----------- ---- ---------- ----- Total 259,057,683 2.60 268,465,549 2.55 (9,407,866) (3.5) ----------- ---- ----------- ---- ---------- ----- Certificate Accounts 0.00 - 1.99% - - - 2.00 - 2.99% 2,074,615 2,971,616 (897,001) (30.2) 3.00 - 3.99% 33,204,707 36,044,826 (2,840,119) (7.9) 4.00 - 4.99% 22,851,091 35,617,605 (12,766,514) (35.8) 5.00 - 5.99% 238,410,625 180,637,996 57,772,629 32.0 ----------- ---- ----------- ---- ---------- ----- Total 296,541,038 5.09 255,272,043 4.99 41,268,995 16.2 ----------- ---- ----------- ---- ---------- ----- Total Deposits $555,598,721 3.93% $523,737,592 3.74% $31,861,129 6.1% =========== ==== =========== ==== ========== ===== 16 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 ------------------ September 30, 2007 March 31, 2007 Increase (Decrease) ---------------- ---------------- ------------------ Fiscal Year Due: Balance Rate Balance Rate Amount Percent ------- ---- ------- ---- ------ ------- 2008 $18,200,000 4.68% $10,000,000 4.25% $8,200,000 82.0% 2009 25,000,000 4.78 25,000,000 4.75 - - 2010 10,000,000 4.88 5,000,000 3.09 5,000,000 100.0 2011 15,000,000 4.87 10,000,000 4.76 5,000,000 50.0 2012 19,700,000 4.77 19,700,000 4.47 - - Thereafter 91,241,678 4.25 83,349,272 4.20 7,892,406 9.5 ----------- ---- ----------- ---- ---------- ---- Total Advances $179,141,678 4.51% $153,049,272 4.36% $26,092,406 17.0% =========== ==== =========== ==== ========== ==== 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 $114.5 million and $113.9 million at September 30, 2007. Advances are subject to prepayment penalties. The following table shows callable FHLB advances as of the dates indicated. These advances are also included in the above table. All callable advances are callable at the option of the FHLB. If an advance is called, the Bank has the option to payoff the advance without penalty, re-borrow funds on different terms, or convert the advance to a three-month floating rate advance tied to LIBOR. As of September 30, 2007 ------------------------------------------------------------------------------ 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 03/25/13 5,000,000 4.580 1 Time Call 03/25/08 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 and quarterly thereafter 01/19/07 07/21/14 5,000,000 4.885 1 Time Call 07/21/11 03/09/07 03/09/12 4,700,000 4.286 Multi- Call 06/11/07 and quarterly thereafter 05/24/07 05/24/17 7,900,000 4.375 Multi- Call 05/27/08 and quarterly thereafter 06/29/07 06/29/12 5,000,000 4.945 1 Time Call 06/29/09 07/25/07 07/25/17 $ 5,000,000 4.396% Multi- Call 07/25/08 and quarterly thereafter 17 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued As of March 31, 2007 ------------------------------------------------------------------------------ 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 06/26/07 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 06/26/07 and quarterly thereafter 06/02/06 06/02/16 5,000,000 5.160 1 Time Call 06/02/11 07/11/06 07/11/16 5,000,000 4.800 Multi-Call 07/11/08 and quarterly thereafter 10/25/06 10/25/11 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 and quarterly thereafter 01/19/07 07/21/14 5,000,000 4.885 1 Time Call 07/21/11 03/09/07 03/09/12 $4,700,000 4.286% Multi-Call 06/11/07 and quarterly thereafter Other Borrowed Money - Other borrowed money consists of short- term retail repurchase agreements and a revolving line of credit with another financial institution. The retail repurchase agreements typically mature within one to three days and have interest rates that float with market rates. The unsecured line of credit has an interest rate equal to LIBOR plus 2.5% and matures on September 27, 2008. Other borrowed money increased $847,000 or 10.5% to $8.9 million at September 30, 2007 from $8.1 million at March 31, 2007. The weighted average interest rate of these repurchase agreements was 4.41% at September 30, 2007 and 2006. As of September 30, 2007, the line of credit had a balance of $1.0 million and no balance at September 30, 2006. The weighted average interest rate was 7.63% at September 30, 2007. 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 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"), 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 Capital Securities in the transaction accrue and pay distributions annually at a rate per annum equal to a blended rate of 7.14% at September 30, 2007. One-half of the offering 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 7.39% at September 30, 2007. 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 18 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued 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 $1.8 million or 4.2% to $44.5 million at September 30, 2007 from $42.7 million at March 31, 2007. Accumulated Other Comprehensive Loss, net of tax, decreased $334,000 to $413,000 during the six months ended September 30, 2007. The Company's net income for the six-month period was $2.2 million. The Board of Directors of the Company declared the 66th and 67th consecutive quarterly dividend, which was $.07 per share, in March and August 2007, which totaled $365,000. Book value per share was $17.15 at September 30, 2007 compared to $16.36 at March 31, 2007. COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, ------------------------------------------------------------------------------- 2007 AND 2006 ------------- Net Income - Net income increased $101,000 or 9.8% to $1.1 million for the three months ended September 30, 2007 compared to $1.0 million for the three months ended September 30, 2006. 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 $621,000 or 13.7% to $5.2 million during the three months ended September 30, 2007, compared to $4.5 million for the same period in 2006, as a result of an increase in interest income offset in part by an increase in interest expense. Average interest earning assets increased $96.8 million to $740.4 million while average interest-bearing liabilities increased $98.1 million to $693.4 million. The interest rate spread decreased two basis points to 2.51% during the three months ended September 30, 2007 compared to the same period in 2006. The Company's net interest margin was 2.79% and 2.82% for the quarters ended September 30, 2007 and 2006, respectively. Interest Income - Total interest income increased $2.4 million or 23.0% to $12.6 million during the three months ended September 30, 2007 from $10.3 million for the same period in 2006. Total interest income on loans increased $1.7 million or 21.4% to $9.4 million during the three months ended September 30, 2007 as a result of the average loan portfolio balance increasing $74.2 million and the yield in the loan portfolio increasing 19 basis points. Interest income from mortgage-backed securities increased $234,000 or 17.6% as a result of an increase in the average balance of the portfolio of $2.2 million and the yield in the portfolio increasing 64 basis points. Interest income from investment securities increased $479,000 or 40.4% 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 three months ended September 30, 2007 and 2006: Three Months Ended September 30, -------------------------------------------------- 2007 2006 -------------- ------------- Increase(Decrease) In Interest And Average Average Dividend Income Balance Yield Balance Yield From 2006 ------- ----- ------- ----- --------- Loans Receivable, Net $475,966,703 7.91% $401,747,357 7.72% $ 1,660,268 Mortgage-Backed Securities 133,221,287 4.68 131,036,771 4.04 233,631 Investments 130,132,175 5.11 109,458,948 4.33 479,089 Overnight Time 1,058,156 3.14 1,374,907 5.23 (9,684) ----------- ---- ----------- --------- Total Interest- Earning Assets $740,378,321 6.83% $643,617,983 6.39% $2,363,304 =========== ==== =========== ==== ========= 19 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 $1.7 million or 30.3% to $7.5 million during the three months ended September 30, 2007 compared to $5.7 million for the same period one-year earlier. The increase in total interest expense is attributable to increases in interest rates paid, interest-bearing deposits, and borrowings. Interest expense on deposits increased $1.1 million or 27.3% during the period as average interest bearing deposits grew $59.4 million compared to the average balance in the three months ended September 30, 2006. In addition, the cost of deposits increased 46 basis points. Interest expense on advances and other borrowings increased $514,000 or 33.4% as the cost of debt outstanding increased 35 basis points during the 2007 quarter ended September 30, 2007 compared to the same quarter in 2006. Average total borrowings outstanding increased $34.1 million during the same period. Interest expense on junior subordinated debentures was $92,000 for the three months ended September 30, 2007 compared to $10,000 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 three months ended September 30, 2007 and 2006: Three Months Ended September 30, -------------------------------------------------- 2007 2006 -------------- ------------- Increase(Decrease) Average Average In Interest Expense Balance Yield Balance Yield From 2006 ------- ----- ------- ----- --------- Now And Money Market Accounts $205,810,833 3.25% $211,401,478 3.25% $ (43,399) Passbook Accounts 16,655,588 0.99 16,965,702 0.99 (896) Certificates Accounts 284,506,447 5.10 219,210,108 4.45 1,190,894 FHLB Advances And Other Borrowed Money 181,321,298 4.53 147,195,359 4.18 513,700 Junior Subordinated Debentures 5,155,000 7.16 572,778 6.98 82,250 Total Interest-Bearing ----------- ---- ----------- ---- --------- Liabilities $693,449,166 4.32% $595,345,425 3.86% $1,742,549 =========== ==== =========== ==== ========= 20 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 $150,000 during the three months ended September 30, 2007 and 2006. The following table details selected activity associated with the allowance for loan losses for the three months ended September 30, 2007 and 2006: September 30, 2007 September 30, 2006 ------------------ ------------------ Beginning Balance $ 7,430,692 $ 6,853,908 Provision 150,000 150,000 Charge-offs (39,290) (45,659) Recoveries 22,809 36,374 ------------------ ------------------ Ending Balance $ 7,564,211 $ 6,994,623 ================== ================== Allowance For Loan Losses As A Percentage Of Gross Loans Receivable And Loans Held For Sale At The End Of The Period 1.52% 1.69% Allowance For Loan Losses As A Percentage Of Impaired Loans At The End Of The Period 780.91% 516.15% Impaired Loans 968,641 1,355,141 Nonaccrual Loans And 90 Days Or More Past Due Loans As A Percentage Of Loans Receivable And Loans Held For Sale At The End Of The Period 0.40% 0.25% Loans Receivable, Net $ 487,144,939 $ 406,503,846 Non-Interest Income - Non-interest income increased $137,000 or 15.0% to $1.0 million for the three months ended September 30, 2007 from $913,000 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 September 30, Increase (Decrease) ------------------------------- ------------------ 2007 2006 Amounts Percent ------ ------ ------- ------- Gain On Sale Of Loans $ 105,450 $ 93,998 $ 11,452 12.2% Service Fees On Deposit Accounts 323,423 291,635 31,788 10.9 Income From Cash Value Of Life Insurance 87,164 62,037 25,127 40.5 Commissions From Insurance Agency 173,488 209,246 (35,758) (17.1) Other Agency Income 26,910 10,426 16,484 158.1 Trust Income 139,850 121,556 18,294 15.0 Other 193,085 123,822 69,263 55.9 --------- ------- ------- ------ Total non-interest income $1,049,370 $912,720 $136,650 15.0% ========= ======= ======= ===== Gain on sale of loans increased $11,000 to $105,000 during the three months ended September 30, 2007 when compared to the same period one year ago due to an increase in the origination and sale of fixed rate residential mortgage loans. Service fees on deposit accounts increased $32,000 to $323,000 for the quarter ended September 30, 2007 compared to the same quarter in 2006. This increase is primarily due to an increase in the average balance in deposit accounts during the period. Income from cash value of life insurance was $87,000 for the three months ended September 30, 2007 compared to $62,000 during the same period one year ago. This increase is due to additional purchases of life insurance and an increase in the cash surrender value of the current policies. 21 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued Commissions from insurance agency income decreased $36,000 to $173,000 during the three months ended September 30, 2007 when compared to the same period one year ago. The decrease can be attributed primarily to changes in South Carolina insurance laws enacted during the period that negatively impacted revenue, in addition to a decrease in the commissions percentages earned from the insurance companies. The Company anticipated these change and is in the process of integrating and expanding its product lines and network to seek to increase future earnings. Other agency income and trust income increased $35,000 to $167,000 during the three months ended September 30, 2007 when compared to the same period one year ago. Other miscellaneous income including credit life insurance commissions, safe deposit rental income, annuity and stock brokerage commissions, trust fees, and other miscellaneous fees, increased $69,000 to $193,000 during the three months ended September 30, 2007 compared to the same period one year ago. Non-Interest Expense - Non-interest expense increased $652,000 or 17.5% to $4.4 million for the three months ended September 30, 2007 from $3.7 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 September 30, Increase (Decrease) ------------------------------- ------------------ 2007 2006 Amounts Percent ------ ------ ------- ------- Salaries And Employee Benefits $2,627,272 $2,303,160 $324,112 14.1% Occupancy 445,602 350,668 94,934 27.1 Advertising 87,148 61,301 25,847 42.2 Depreciation And Maintenance Of Equipment 337,091 316,326 20,765 6.6 FDIC Insurance Premiums 14,870 14,820 50 0.3 Amortization of Intangibles 22,500 22,500 - - Other 846,518 660,426 186,092 28.2 --------- --------- ------- ----- Total Non-Interest Expenses $4,381,001 $3,729,201 $651,800 17.5% ========= ========= ======= ===== Salary and employee benefits increased $324,000 to $2.6 million for the three months ended September 30, 2007 from $2.3 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 including absorbing the Collier-Jennings Companies' employees and increased regulatory reporting requirements. Occupancy increased to 27.1% to $446,000 for the three months ended September 30, 2007 from $351,000 for the same period one year ago. Advertising expense increased $26,000 to $87,000 for the three months ended September 30, 2007 from $61,000 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. Other non- interest expenses increased $186,000 or 28.2% to $847,000 for the three months ended September 30, 2007 when compared to the same period one year ago. Provision For Income Taxes - Provision for income taxes increased $5,000 or 0.9% to $550,000 for the three months ended September 30, 2007 from $545,000 for the same period one year ago. Income before income taxes was $1.7 million for the three months ended September 30, 2007 compared to $1.6 million for the three months ended September 30, 2006. The Company's combined federal and state effective income tax rate for the current quarter was 32.8% compared to 34.7% for the same quarter one year ago. 22 COMPARISON OF THE RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED SEPTEMBER -------------------------------------------------------------------------- 30, 2007 AND 2006 ----------------- Net Income - Net income increased $174,000 or 8.5% to $2.2 million for the six months ended September 30, 2007 compared to $2.0 million for the six months ended September 30, 2006. 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 $1.2 million or 13.3% to $10.1 million during the six months ended September 30, 2007, compared to $8.9 million for the same period in 2006, as a result of an increase in interest income offset in part by an increase in interest expense. Average interest earning assets increased $85.9 million to $725.4 million while average interest-bearing liabilities increased $87.1 million to $678.4 million. The interest rate spread was 2.52% during the six months ended September 30, 2007 and 2006. The Company's net interest margin remained constant at 2.80% for the six months ended September 30, 2007 and 2006. Interest Income - Total interest income increased $4.6 million or 23.3% to $24.6 million during the six months ended September 30, 2007 from $19.9 million for the same period in 2006. Total interest income on loans increased $3.4 million or 23.2% to $18.2 million during the six months ended September 30, 2007 as a result of the average loan portfolio balance increasing $68.1 million and the yield in the loan portfolio increasing 38 basis points. Interest income from mortgage-backed securities increased $332,000 or 12.0% 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 $35,000. Interest income from investment securities increased $886,000 or 38.0% 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 six months ended September 30, 2007 and 2006: Six Months Ended September 30, ---------------------------------------------- 2007 2006 ------------- -------------- Increase(Decrease) In Interest And Average Average Dividend Income Balance Yield Balance Yield From 2006 ------- ----- ------- ----- --------- Loans Receivable, Net $461,466,930 7.89% $393,415,196 7.51% $3,431,172 Mortgage-Backed Securities 133,869,199 4.63 133,904,026 4.13 331,991 Investments 128,795,008 5.00 110,857,274 4.21 886,267 Overnight Time 1,229,756 4.54 1,271,278 5.11 (4,570) Total Interest-Earning ----------- ---- ----------- ---- --------- Assets $725,360,893 6.77% $639,447,774 6.23% $4,644,860 =========== ==== =========== ==== ========= 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 $3.5 million or 31.5% to $14.4 million during the six months ended September 30, 2007 compared to $11.0 million for the same period one year earlier. The increase in total interest expense is attributable to the increases in short-term interest rates paid, and the increase in the amount of interest-bearing deposits, and borrowings. Interest expense on deposits increased $2.3 million or 28.9% during the period as average interest bearing deposits grew $51.6 million compared to the average balance in the six months ended September 30, 2006. In addition the cost of deposits increased 55 basis points during the period. Interest expense on advances and other borrowings increased $976,000 or 32.8% as the cost of debt outstanding increased 40 basis points during the six months ended September 30, 2007 compared to the same period in 2006 while average borrowings outstanding increased approximately $30.6 million. Interest expense on junior subordinated debentures was $183,000 for the six months ended September 30, 2007 compared to $10,000 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 six months ended September 30, 2007 and 2006: Six Months Ended September 30, ---------------------------------------------- 2007 2006 ------------- -------------- Increase(Decrease) In Interest Average Average Expense Balance Yield Balance Yield From 2006 ------- ----- ------- ----- --------- Now And Money Market Accounts $206,568,748 3.22% 212,905,689 3.10% $ 30,270 Passbook Accounts 16,885,120 0.98 17,048,654 0.98 (957) Certificates Accounts 272,917,219 5.03 214,810,211 4.28 2,278,342 FHLB Advances And Other Borrowed Money 176,912,171 4.47 146,307,123 4.07 976,306 Junior Subordinated Debentures 5,155,000 7.10 286,389 6.99 173,075 Total Interest-Bearing ----------- ---- ----------- ---- --------- Liabilities $678,438,258 4.25% 591,358,066 3.71% $3,457,036 =========== ==== =========== ==== ========= 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 $300,000 during the six months ended September 30, 2007 and 2006. The following table details selected activity associated with the allowance for loan losses for the six months ended September 30, 2007 and 2006: September 30, 2007 September 30, 2006 ------------------ ------------------ Beginning Balance $ 7,296,791 $ 6,704,734 Provision 300,000 300,000 Charge-offs (68,411) (75,278) Recoveries 35,831 65,167 ------------------ ------------------ Ending Balance $ 7,564,211 $ 6,994,623 ================== ================== Allowance For Loan Losses As A Percentage Of Gross Loans Receivable And Loans Held For Sale At The End Of The Period 1.52% 1.69% Allowance For Loan Losses As A Percentage Of Impaired Loans At The End Of The Period 780.91% 516.15% Impaired Loans 968,641 1,355,141 Nonaccrual Loans And 90 Days Or More Past Due Loans As A Percentage Of Loans Receivable And Loans Held For Sale At The End Of The Period 0.40% 0.25% Loans Receivable, Net $ 487,144,939 $ 406,503,846 Non-Interest Income - Non-interest income increased $445,000 or 20.6% to $2.1 million for the six months ended September 30, 2007 from $1.7 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: Six Months Ended September 30, Increase ----------------------------- ---------------- 2007 2006 Amounts Percent ------ ------ ------- ------- Gain On Sale Of Loans $ 281,571 $ 207,253 $ 74,318 35.9% Service Fees On Deposit Accounts 650,745 569,503 81,242 14.3 Income From Cash Value Of Life Insurance 149,201 118,545 30,656 25.9 Commissions From Insurance Agency 319,161 214,635 104,526 48.7 Other Agency Income 56,168 10,426 45,742 438.7 Trust Income 238,625 217,556 21,069 9.7 Other 414,497 326,796 87,701 26.8 --------- --------- ------- ----- Total non-interest income $ 2,109,968 $1,664,714 $ 445,254 26.7% ========= ========= ======= ===== Gain on sale of loans increased $74,000 to $282,000 during the six months ended September 30, 2007 when compared to the same period one year ago. This increase is due to the increase in the origination and sale of fixed rate residential mortgage loans that is the result of a low interest rate environment where increases are anticipated. Service fees on deposit accounts increased $81,000 to $651,000 for the six months ended September 30, 2007 compared to the same period in 2006. Commissions from insurance agency and other agency income increased $150,000 during the six months ended September 30, 2007 when compared to the same period one year ago. This increase is due to the acquisition of the Collier Jennings' Companies which took place at the end of the first quarter in 2006, offset partially by decreases in second quarter earnings when compared to the same quarter in the prior year. The decreases in second quarter earnings are due to changes in South Carolina insurance laws that negatively impacted revenue and a decrease in commission percentages earned. Other miscellaneous income including credit life insurance commissions, safe deposit rental income, annuity and stock brokerage commissions, trust fees, and other miscellaneous fees, increased $88,000 to $414,000 during the six months ended September 30, 2007 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 $1.5 million or 20.4% to $8.6 million for the six months ended September 30, 2007 from $7.2 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: Six Months Ended September 30, Increase ----------------------------- ---------------- 2007 2006 Amounts Percent ------ ------ ------- ------- Salaries And Employee Benefits $ 5,197,551 $ 4,428,529 $ 769,022 17.4% Occupancy 868,113 668,263 199,850 29.9 Advertising 189,421 135,950 53,471 39.3 Depreciation And Maintenance Of Equipment 656,616 607,795 48,821 8.0 FDIC Insurance Premiums 30,197 28,962 1,235 4.3 Amortization of Intangibles 45,000 22,500 22,500 100.0 Other 1,645,548 1,280,506 365,042 28.5 --------- --------- --------- ----- Total Non-Interest Expenses $ 8,632,446 $ 7,172,505 $ 1,459,941 20.4% ========= ========= ========= ===== Salary and employee benefits increased $769,000 to $5.2 million for the six months ended September 30, 2007 from $4.4 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 including absorbing the Collier-Jennings Companies' employees and increased regulatory reporting requirements. Without the acquisition of the Collier- Jennings Companies, salary and employee benefits would have increased approximately $584,000 or 13.5%. Occupancy also increased due to the acquisition of the Collier- Jennings Companies and additional facilities. Advertising expense increased $53,000 to $189,000 for the six months ended September 30, 2007 from $136,000 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 $1,000 or 0.1% to $1.1 million for the six months ended September 30, 2007 from $1.1 million for the same period one year ago. Income before income taxes was $3.3 million for the six months ended September 30, 2007 compared to $3.1 million for the six months ended September 30, 2006. The Company's combined federal and state effective income tax rate for the six month ended September 30, 2007 was 32.9% compared to 34.8% 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 six months ended September 30, 2007 loan disbursements exceeded loan repayments resulting in a $51.1 million or 11.7% increase in total net loans receivable. During the six months ended September 30, 2007, deposits increased $31.9 million, the Bank drew $1 million on a line of credit with another financial institution and FHLB advances increased $26.1 million. The Bank had $174.3 million in additional borrowing capacity at the FHLB at the end of the period. At September 30, 2007, the Bank had $279.3 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. 26 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued The Company plans to continue 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 to the lag that exists from the time a branch is built to when it becomes profitable. By the end of this fiscal year, we anticipate having invested $6.0 to $8.0 million in land, buildings, and equipment. Within 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. 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 September 30, 2007: After After One Three Greater Within Through Through Than One Three Twelve Within One (Dollars in thousands) Month Months Months One Year Year Total ------ ------- ------ -------- ------ ----- Unused lines of credit $3,285 $2,745 $41,852 $47,882 $49,205 $97,087 Standby letters of credit 92 99 710 901 40 941 ----- ----- ------ ------ ------ ------ Total $3,377 $2,844 $42,562 $48,783 $49,245 $98,028 ===== ===== ====== ====== ====== ====== 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 manages its interest rate risk exposure. Although the Company manages other risks such as credit quality and liquidity risk in the normal course of business, management considers interest rate risk to be its most significant market risk that could potentially have the largest material effect on the Company's financial condition and results of operations. Other types of market risks such as foreign currency exchange rate risk and commodity price do not arise in the normal course of the Company's business activities. The Company's profitability is affected by fluctuations in the market interest rate. Management's goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase or decrease in interest rates may adversely impact the Company's earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same rate, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using a test that measures the impact on net interest income and net portfolio value of an immediate change in interest rates in 100 basis point increments and by measuring the Bank's interest sensitivity gap ("Gap"). Net portfolio value is defined as the net present value of assets, liabilities, and off-balance sheet contracts. Gap is the amount of interest sensitive assets repricing or maturing over the next twelve months compared to the amount of interest sensitive liabilities maturing or repricing in the same time period. Recent net portfolio value reports furnished by the OTS indicate that the Bank's interest rate risk sensitivity has increased slightly over the past year. The Bank has rated favorably compared to thrift peers concerning interest rate sensitivity. For the six months ended September 30, 2007, the Bank's interest rate spread, defined as the average yield on interest bearing assets less the average rate paid on interest bearing liabilities was 2.52%. As of the year ended March 31, 2007, the interest rate spread was 2.51%. The interest rate spread increased due to 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 September 30, 2007 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 September 30, 2007, 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, 2007. Item 2 Unregistered sales of Equity Securities and Use Of Proceeds ----------------------------------------------------------- (c)Total Number (d)Maximum Number (a)Total of Shares of Shares that Number of (b)Average Purchased as May Yet Be Shares Price Paid Part of Publicly Purchased Under Period Purchased per Share Announced Program the Program -------- --------- --------- ----------------- ----------- July 1 - July 31, 2007 1,281 $24.56 1,281 92,731 August 1 - August 30, 2007 6,050 $24.52 6,050 86,681 September 1 - September 30, 2007 11,706 $24.45 11,706 74,975 -------------------------------------------------- Total 19,037 $24.48 19,037 74,975 ================================================== 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 September 30, 2007, 51,025 shares have been repurchased under this program. The Company repurchased 19,037 any shares of its outstanding Common Stock during the three months ended September 30, 2007. Item 3 Defaults Upon Senior Securities ------------------------------- None Item 4 Submission Of Matters To A Vote Of Security Holders --------------------------------------------------- The election of directors was presented for vote to the shareholders at the Annual Meeting held July 19, 2007. Votes for G.L. Toole III were as follows: 2,113,602 votes for, 18,900 withheld. Votes for Thomas L. Moore were as follows: 2,120,402 votes for, 12,100 votes withheld. Votes for J. Chris Verenes were as follows: 2,112,602 votes for, 19,900 votes withheld. Directors continuing in office are Harry O. Weeks, Jr., Robert E. Alexander, William Clyburn, Roy G. Lindburg, Timothy W. Simmons, and Clifton Weeks. 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 1993 Salary Continuation Agreements (4) 10.2 Amendment One to 1993 Salary Continuation Agreement (5) 10.3 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 27, 2007 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: November 14, 2007 By: /s/Timothy W. Simmons ------------------ ------------------------------- Timothy W. Simmons President Duly Authorized Representative Date: November 14, 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: November 14, 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: November 14, 2007 /s/Roy G. Lindburg ----------------------- Roy G. Lindburg Chief Financial Officer 35 EXHIBIT 32 Certification Pursuant to Section 906 of the Sarbanes Oxley Act CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER OF SECURITY FEDERAL CORPORATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. Section 1350), each of the undersigned hereby certifies in his capacity as an officer of Security Federal Corporation (the "Company") and in connection with the Company's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2007 that: 1. the Report fully complies with the requirements of Section 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, and 2. the information contained in the Report fairly presents, in all material respects, the Company's financial condition and results of operations as of the dates and for the periods presented in the financial statements included in the Report. /s/Timothy W. Simmons /s/Roy G. Lindburg -------------------------- ------------------------------ Timothy W. Simmons Roy G. Lindburg Chief Executive Officer Chief Financial Officer Dated: November 14, 2007