10-Q 1 q109.txt SECURITY FEDERAL CORPORATION FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (Mark one) (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2008 (_) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD: FROM: _______________ TO: _______________ COMMISSION FILE NUMBER: 0-16120 SECURITY FEDERAL CORPORATION (Exact name of registrant as specified in its charter) South Carolina 57-0858504 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 1705 WHISKEY ROAD, AIKEN, SOUTH CAROLINA 29801 (Address of Principal Executive Office) (Zip code) (803) 641-3000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer or a smaller reporting company. See definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. Large accelerated filed [ ] Accelerated filer [ ] Non-accelerated filer [ ] Smaller reporting company [ X ] Indicate by check mark whether the registrant is a shell company (defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practical date. CLASS: OUTSTANDING SHARES AT: SHARES: ----------------------- ---------------------- ---------- Common Stock, par value July 31, 2008 2,524,406 $0.01 per share INDEX =============================================================================== PART I. FINANCIAL INFORMATION (UNAUDITED) PAGE NO. Item 1. Financial Statements (Unaudited): Consolidated Balance Sheets at June 30, 2008 and March 31, 2008 1 Consolidated Statements of Income for the Three Months Ended June 30, 2008 and 2007 2 Consolidated Statements of Shareholders' Equity and Comprehensive Income at June 30, 2008 and 2007 3 Consolidated Statements of Cash Flows for the Three Months Ended June 30, 2008 and 2007 4 Notes to Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 14 Item 3. Quantitative and Qualitative Disclosures about Market Risk 23 Item 4T. Controls and Procedures 23 =============================================================================== PART II. OTHER INFORMATION Item 1. Legal Proceedings 24 Item 1A. Risk Factors 24 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 25 Item 3. Defaults Upon Senior Securities 25 Item 4. Submission of Matters to a Vote of Security Holders 25 Item 5. Other Information 25 Item 6. Exhibits 26 Signatures 27 =============================================================================== 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 June 30, 2008 March 31, 2008 ------------- -------------- Assets: (Unaudited) (Audited) Cash And Cash Equivalents $ 11,012,237 $ 10,539,054 Investment And Mortgage-Backed Securities: Available For Sale: (Amortized cost of $252,999,005 at June 30, 2008 and $240,295,683 at March 31, 2008) 250,990,200 244,157,872 Held To Maturity: (Fair value of $15,282,840 at June 30, 2008 and $20,506,250 at March 31, 2008) 15,155,000 20,154,618 ------------- -------------- Total Investment And Mortgage-Backed Securities 266,145,200 264,312,490 ------------- -------------- Loans Receivable, Net: Held For Sale 3,550,781 2,295,721 Held For Investment: (Net of allowance of $8,246,496 at June 30, 2008 and $8,066,762 at March 31, 2008) 531,311,109 515,635,984 ------------- -------------- Total Loans Receivable, Net 534,861,890 517,931,705 Accrued Interest Receivable: ------------- -------------- Loans 1,823,446 1,952,866 Mortgage-Backed Securities 897,023 822,379 Investments 586,480 764,746 Premises And Equipment, Net 21,975,557 21,544,380 Federal Home Loan Bank Stock ("FHLB"), At Cost 11,224,000 9,497,100 Bank Owned Life Insurance 8,396,559 8,310,813 Repossessed Assets Acquired In Settlement Of Loans 454,790 767,096 Intangible Assets, Net 420,000 442,500 Goodwill 1,197,954 1,197,954 Other Assets 4,380,011 1,947,403 ------------- -------------- Total Assets $ 863,375,147 $ 840,030,486 ============= ============== Liabilities And Shareholders' Equity Liabilities: Deposit Accounts $ 577,327,950 $ 590,850,208 Advances From FHLB 216,610,143 178,234,007 Other Borrowed Money 14,582,524 12,784,094 Advance Payments By Borrowers For Taxes And Insurance 735,022 620,467 Mandatorily Redeemable Financial Instrument 1,417,312 1,417,312 Junior Subordinated Debentures 5,155,000 5,155,000 Other Liabilities 3,148,236 3,472,985 ------------- -------------- Total Liabilities $ 818,976,187 $ 792,534,073 ------------- -------------- Shareholders' Equity: Serial Preferred Stock, $.01 Par Value; Authorized Shares-200,000; Issued And Outstanding Shares-None $ - $ - Common Stock, $.01 Par Value; Authorized Shares-5,000,000; Issued-2,650,441 And Outstanding Shares-2,529,706 At June 30, 2008 And 2,649,027 And 2,532,192 At March 31, 2008 25,939 25,925 Additional Paid-In Capital 5,107,563 5,072,086 Treasury Stock, (At Cost, 120,735 and 116,835 Shares at June 30, 2008 and March 31, 2008, Respectively) (2,859,318) (2,769,446) Accumulated Other Comprehensive Income (Loss) (1,246,887) 2,395,537 Retained Earnings, Substantially Restricted 43,371,663 42,772,311 ------------- -------------- Total Shareholders' Equity $ 44,398,960 $ 47,496,413 ------------- -------------- Total Liabilities And Shareholders' Equity $ 863,375,147 $ 840,030,486 ============= ============= See accompanying notes to consolidated financial statements. Security Federal Corporation and Subsidiaries Consolidated Statements of Income (Unaudited) Three Months Ended June 30, --------------------------- 2008 2007 Interest Income: -------- -------- Loans $8,541,735 $8,791,579 Mortgage-Backed Securities 2,395,382 1,541,710 Investment Securities 888,901 1,553,520 Other 5,179 19,596 ---------- ---------- Total Interest Income 11,831,197 11,906,405 ---------- ---------- Interest Expense: NOW And Money Market Accounts 924,090 1,654,839 Passbook Accounts 33,503 41,815 Certificate Accounts 3,662,926 3,242,849 Advances And Other Borrowed Money 2,011,765 1,898,333 Junior Subordinated Debentures 74,119 90,824 ---------- ---------- Total Interest Expense 6,706,403 6,928,660 ---------- ---------- Net Interest Income 5,124,794 4,977,745 Provision For Loan Losses 225,000 150,000 Net Interest Income After Provision For ---------- ---------- Loan Losses 4,899,794 4,827,745 Non-Interest Income: ---------- ---------- Gain On Sale of Investments 101,405 - Gain On Sale Of Loans 118,683 176,121 Service Fees On Deposit Accounts 281,153 327,322 Income From Cash Value Of Life Insurance 85,746 62,037 Commissions On Insurance 168,992 145,673 Other Agency Income 46,937 29,258 Trust Income 105,000 98,775 Other 213,291 221,412 ---------- ---------- Total Non-Interest Income 1,121,207 1,060,598 ---------- ---------- General And Administrative Expenses: Salaries And Employee Benefits 2,784,235 2,570,279 Occupancy 497,320 422,511 Advertising 140,821 102,273 Depreciation And Maintenance Of Equipment 426,924 319,525 Federal Deposit Insurance Corporation Insurance Premiums 155,810 15,327 Amortization of Intangibles 22,500 22,500 Other 794,380 799,030 ---------- ---------- Total General And Administrative Expenses 4,821,990 4,251,445 ---------- ---------- Income Before Income Taxes 1,199,011 1,636,898 Provision For Income Taxes 397,106 540,867 ---------- ---------- Net Income $ 801,905 $1,096,031 ========== ========== Basic Net Income Per Common Share $ 0.32 $ 0.42 ========== ========== Diluted Net Income Per Common Share $ 0.32 $ 0.42 ========== ========== Cash Dividend Per Share On Common Stock $ 0.08 $ 0.07 ========== ========== Basic Weighted Average Shares Outstanding 2,531,679 2,609,409 ========== ========== Diluted Weighted Average Shares Outstanding 2,532,377 2,618,889 ========== ========== See accompanying notes to consolidated financial statements. 2 Security Federal Corporation and Subsidiaries Consolidated Statements of Shareholders' Equity and Comprehensive Income (Unaudited) Accumulated Additional Other Common Paid-In Treasury Comprehensive Retained Stock Capital Stock 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 - - - - 1,096,031 1,096,031 Other Comprehensive Income, Net Of Tax: Unrealized Holding Losses On Securities Available For Sale, Net Of Taxes - - - (931,559) - (931,559) ---------- Comprehensive Income - - - - - 164,472 Purchase Of Treasury Stock At Cost, 3,162 shares - - (77,320) - - (77,320) Employee Stock Purchase Plan 13 25,356 - - - 25,369 Stock Compensation Expense - 2,882 - - - 2,882 Cash Dividends - - - - (182,663) (182,663) ------- --------- ------- --------- ---------- ---------- Balance At June 30, 2007 $ 25,827 $ 4,878,267 $(728,540) $(1,678,875) $40,129,269 $42,625,948 ======= ========= ======= ========= ========== ========== Accumulated Additional Other Common Paid-In Treasury Comprehensive Retained Stock Capital Stock Income (Loss) Earnings Total ------ --------- -------- ------------ -------- ------- Balance At March 31, 2008 $ 25,925 $ 5,072,086 $(2,769,446) $2,395,537 $42,772,311 $47,496,413 Net Income - - - - 801,905 801,905 Other Comprehensive Income, Net Of Tax: Unrealized Holding Losses On Securities Available For Sale, Net Of Taxes - - - (3,579,553) - (3,579,553) Reclassification Adjustment For Gains Included In Net Income, Net Of Taxes - - - (62,871) - (62,871) ---------- Comprehensive Loss - - - - - (2,840,519) Purchase Of Treasury Stock At Cost, 3,900 shares - - (89,872) - - (89,872) Employee Stock Purchase Plan Purchases 14 27,629 - - - 27,643 Stock Compensation Expense - 7,848 - - - 7,848 Cash Dividends - - - - (202,553) (202,553) ------- --------- ------- --------- ---------- ---------- Balance At June 30, 2008 $ 25,939 $ 5,107,563 $(2,859,318) $(1,246,887) $ 43,371,663 $ 44,398,960 ======= ========= ========= ========= ========== ========== See accompanying notes to consolidated financial statements. 3
Security Federal Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) Three Months Ended June 30, -------------------------- 2008 2007 ------ ------ Cash Flows From Operating Activities: Net Income $ 801,905 $ 1,096,031 Adjustments To Reconcile Net Income To Net Cash Provided (Used) By Operating Activities: Depreciation And Amortization Expense 368,771 264,573 Amortization Of Intangible Assets 22,500 22,500 Stock Option Compensation Expense 7,848 2,882 Discount Accretion And Premium Amortization 106,619 68,173 Provisions For Losses On Loans And Real Estate 225,000 150,000 Gain On Sale of Investments Available For Sale (120,491) - Loss On Sale of Mortgage-Backed Securities Available For Sale 19,087 - Gain On Sale Of Loans (118,683) (176,121) Gain On Sale Of Real Estate (13,694) (13,391) Capital Improvements Repossessed Assets (20,000) - Amortization Of Deferred Fees On Loans (27,043) (29,030) Proceeds From Sale Of Loans Held For Sale 8,542,717 11,324,649 Origination Of Loans For Sale (9,679,094) (10,672,758) (Increase) Decrease In Accrued Interest Receivable: Loans 129,420 (70,332) Mortgage-Backed Securities (74,644) 10,393 Investments 178,266 (43,744) Increase In Advance Payments By Borrowers 114,555 166,967 Other, Net (528,787) (287,360) --------- --------- Net Cash Provided (Used) By Operating Activities (65,748) 1,813,432 --------- --------- Cash Flows From Investing Activities: Principal Repayments On Mortgage-Backed Securities Available For Sale 13,840,922 9,730,754 Purchase Of Investment Securities Available For Sale (5,635,679) (15,579,736) Purchase Of Mortgage-Backed Securities Available For Sale (36,375,912) (4,982,301) Maturities Of Investment Securities Available For Sale 8,075,718 3,323,609 Maturities of Investment Securities Held To Maturity 5,000,000 8,000,000 Proceeds From Sale of Investment Securities Available For Sale 6,108,615 - Proceeds From Sale of Mortgage-Backed Securities Available For Sale 1,277,417 - Purchase Of FHLB Stock (3,837,500) (2,355,600) Redemption Of FHLB Stock 2,110,600 1,959,800 Increase In Loans To Customers (15,873,082) (26,994,431) Proceeds From Sale Of Repossessed Assets 346,000 49,000 Purchase And Improvement Of Premises And Equipment (799,948) (1,884,501) Purchase Of Bank Owned Life Insurance (85,746) (2,262,037) ---------- ---------- Net Cash Used By Investing Activities (25,848,595) (30,995,443) ---------- ---------- Cash Flows From Financing Activities: Increase (Decrease) In Deposit Accounts (13,522,258) 13,222,409 Proceeds From FHLB Advances 104,880,000 81,300,000 Repayment Of FHLB Advances (66,503,864) (65,603,787) Net Proceeds Of Other Borrowings 1,798,430 236,035 Dividends To Shareholders (202,553) (182,663) Purchase Of Treasury Stock (89,872) (77,320) Proceeds From Employee Stock Purchases 27,643 25,369 ---------- ---------- Net Cash Provided By Financing Activities 26,387,526 28,920,043 ---------- ---------- (Continued) See accompanying notes to consolidated financial statements. 4 Security Federal Corporation and Subsidiaries Consolidated Statements of Cash Flows (Unaudited)- Continued Three Months Ended June 30, -------------------------- 2008 2007 ------ ------ Increase (Decrease) In Cash And Cash Equivalents 473,183 (261,968) Cash And Cash Equivalents At Beginning Of Period 10,539,054 13,438,129 ----------- ----------- Cash And Cash Equivalents At End Of Period $11,012,237 $13,176,161 =========== =========== Supplemental Disclosure Of Cash Flows Information: Cash Paid During The Period For Interest $ 6,960,918 $ 6,987,289 Cash Paid During The Period For Income Taxes $ 305,822 $ 30,000 Additions To Repossessed Acquired Through Foreclosure $ 20,000 $ 88,976 Increase In Unrealized Net Loss On Securities Available For Sale, Net Of Taxes $(3,642,424) $ (931,559) See accompanying notes to consolidated financial statements. 5 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 2008 Annual Report to Shareholders when reviewing interim financial statements. The results of operations for the three month period ended June 30, 2008 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 consolidated financial statements include the accounts of Security Federal Corporation (the "Company") and its wholly owned subsidiary, Security Federal Bank (the "Bank") and the Bank's wholly owned subsidiaries, Security Federal Insurance, Inc. ("SFINS"), Security Federal Investments, Inc. ("SFINV"), Security Federal Trust Inc. ("SFT"), and Security Financial Services Corporation ("SFSC"). Security Federal Corporation has a wholly owned subsidiary, Security Federal Statutory Trust (the "Trust"), which issued and sold fixed and floating rate capital securities of the Trust. However, under current accounting guidance, the Trust is not consolidated in the Company's financial statements. The Bank is primarily engaged in the business of accepting savings and demand deposits and originating mortgage loans and other loans to individuals and small businesses for various personal and commercial purposes. SFINS, SFINV, and SFT were formed during fiscal 2002 and began operating during the December 2001 quarter. SFINS is an insurance agency offering auto, business, health, and home insurance. SFINS has a wholly owned subsidiary, Collier Jennings Financial Corporation which has as subsidiaries Collier Jennings Inc., The Auto Insurance Store Inc., and Security Federal Premium Pay Plans Inc. SFINV engages primarily in investment brokerage services. SFT offers trust, financial planning and financial management services. SFSC is currently an inactive subsidiary. 3. Critical Accounting Policies The Company has adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to the audited consolidated financial statements at March 31, 2008 included in our 2008 Annual Report to Stockholders, which was filed as an exhibit to our Annual Report on Form 10-K for the year ended March 31, 2008. Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on our carrying values of assets and liabilities and our results of operations. The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of the consolidated financial statements. The Company provides for loan losses using the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to the allowance for loan losses. Additions to the allowance for loan losses are provided by charges to operations based on various factors, which, in management's judgment, deserve current recognition in estimating possible losses. Such factors considered by management include the fair value of the underlying collateral, stated guarantees by the borrower (if applicable), the borrower's ability to repay from other economic resources, growth and composition of the loan portfolios, the relationship of the allowance for loan losses to 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. 6 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. 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. The following table provides a reconciliation of the numerators and denominators of the basic and diluted EPS computations: For the Quarter Ended ---------------------------------------------------------- June 30, 2008 ---------------------------------------------------------- Income (Numerator) Amount Shares (Denominator) Per Share ------------------------- ------------------- --------- Basic EPS $ 801,905 2,531,679 $ 0.32 Effect of Diluted Securities: Stock Options - 698 - ----------------------- ----------------- --------- Diluted EPS $ 801,905 2,532,377 $ 0.32 ======================= ================= ========= For the Quarter Ended ---------------------------------------------------------- June 30, 2007 ---------------------------------------------------------- Income (Numerator) Amount Shares (Denominator) Per Share ------------------------- ------------------- --------- Basic EPS $ 1,096,031 2,609,409 $ 0.42 Effect of Diluted Securities: Stock Options - 9,480 - ----------------------- ----------------- --------- Diluted EPS $ 1,096,031 2,618,889 $ 0.42 ======================= ================= ========= 7 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 5. Stock-Based Compensation Certain officers and directors of the Company participate in an incentive and non-qualified 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 stock option plans for the quarter ended June 30, 2008: Weighted Average Exercise Shares Price ---------------------------- Balance, Beginning of Period 111,100 $ 21.55 Options granted 2,500 22.91 Options exercised - - Options forfeited - - ---------- Balance, June 30 113,600 $ 21.58 ========== Options Exercisable 74,100 $ 20.60 ========== Options Available For Grant 124,801 ========== At June 30, 2008, the Company had the following options outstanding: Outstanding Grant Date Options Option Price Expiration Date ---------- ----------- ------------ --------------- 10/19/99 20,100 $16.67 09/30/05 to 09/30/09 09/01/03 3,000 $24.00 08/31/13 12/01/03 3,000 $23.65 11/30/13 01/01/04 6,500 $24.22 12/31/13 03/08/04 13,000 $21.43 03/08/14 06/07/04 2,000 $24.00 06/07/14 01/01/05 20,500 $20.55 12/31/14 01/01/06 6,000 $23.91 01/01/16 08/24/06 14,000 $23.03 08/24/16 05/24/07 2,000 $24.34 05/24/17 07/09/07 1,000 $24.61 07/09/17 10/01/07 2,000 $24.28 10/01/17 01/01/08 18,000 $23.49 01/01/18 05/19/08 2,500 $22.91 05/18/18 8 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 6. Fair Value Measurements Effective April 1, 2008, the Company adopted SFAS No. 157, "Fair Value Measurements" ("SFAS 157") which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. SFAS 157 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available-for-sale investment securities) or on a nonrecurring basis (for example, impaired loans). SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value: Level 1 Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as U.S. Treasuries and money market funds. Level 2 Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments, mortgage-backed securities, municipal bonds, corporate debt securities and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes certain derivative contracts and impaired loans. Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. For example, this category generally includes certain private equity investments, retained residual interests in securitizations, residential mortgage servicing rights, and highly-structured or long-term derivative contracts. Assets and liabilities measured at fair value on a recurring basis are as follows as of June 30, 2008: Quoted Market Price In Significant Other Significant Active Markets Observable Inputs Unobservable (Level 1) (Level 2) Inputs (Level 3) Available-For-Sale ---------------- -------------- ----------- Investment And Mortgage- Backed Securities $ - $ 250,990,200 $ - Mortgage Loans Held For Sale - 3,550,781 - ---------------- -------------- ---------- Total $ - $ 254,540,981 $ - ================ ============== ========== The Company has no liabilities carried at fair value or measured at fair value on a nonrecurring basis. 9 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 6. Fair Value Measurements, Continued The Company is predominantly an asset based lender with real estate serving as collateral on a substantial majority of loans. Loans which are deemed to be impaired are primarily valued on a nonrecurring basis at the fair values of the underlying real estate collateral. Such fair values are obtained using independent appraisals, which the Company considers to be level 2 inputs. The aggregate carrying amount of impaired loans at March 31, 2008 was $3.5 million. Financial Accounting Standards Board ("FASB") Staff Position No. FAS 157-2 delays the implementation of SFAS 157 until the first quarter of 2009 with respect to goodwill, other intangible assets, real estate and other assets acquired through foreclosure and other non-financial assets measured at fair value on a nonrecurring basis. The Company has no assets or liabilities whose fair values are measured using level 3 inputs that require disclosure as of June 30, 2008. 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 December 2007, the FASB issued SFAS No. 141(R), "Business Combinations," ("SFAS 141(R)") which replaces SFAS 141. SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for acquisitions by the Company taking place on or after April 1, 2009. Early adoption is prohibited. Accordingly, the Company is required to record and disclose business combinations following existing accounting guidance until April 1, 2009. The Company will assess the impact of SFAS 141(R) if and when a future acquisition occurs. In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51" ("SFAS 160"). SFAS 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Before this statement, limited guidance existed for reporting noncontrolling interests (minority interest). Specifically, SFAS 160 requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financials statements and separate from the parent's equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. SFAS 160 clarifies that changes in a parent's ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires that a parent recognize gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date. SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interests. SFAS 160 is effective for the Company on April 1, 2009. Earlier adoption is prohibited. The Company is currently evaluating the impact, if any, the adoption of SFAS 160 will have on its financial position, results of operations and cash flows. In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities" ("SFAS 161"). SFAS 161 requires enhanced disclosures about an entity's derivative and hedging activities and thereby improving the transparency of financial reporting. It is intended to enhance the current disclosure framework in SFAS No. 133 by requiring that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. This disclosure better conveys the purpose of derivative use in terms of the risks that the entity is intending to manage. SFAS 161 is effective for the Company on April 1, 2009. This pronouncement does not impact accounting measurements but will result in additional disclosures if the Company is involved in material derivative and hedging activities at that time. 10 Security Federal Corporation and Subsidiaries Notes to Consolidated Financial Statements (Unaudited), Continued 7. Accounting and Reporting Changes, Continued In February 2008, the FASB issued FASB Staff Position No. 140-3, "Accounting for Transfers of Financial Assets and Repurchase Financing Transactions" ("FSP 140-3"). FSP 140-3 provides guidance on accounting for a transfer of a financial asset and the transferor's repurchase financing of the asset. This FSP presumes that an initial transfer of a financial asset and a repurchase financing are considered part of the same arrangement (linked transaction) under SFAS No. 140. However, if certain criteria are met, the initial transfer and repurchase financing are not evaluated as a linked transaction and are evaluated separately under Statement 140. FSP 140-3 will be effective for financial statements issued for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years and earlier application is not permitted. Accordingly, this FSP is effective for the Company on April 1, 2009. The Company is currently evaluating the impact, if any, the adoption of FSP 140-3 will have on its financial position, results of operations and cash flows. In April 2008, the FASB issued FASB Staff Position No. 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP 142-3"). This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, "Goodwill and Other Intangible Assets". The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS 141(R), "Business Combinations," and other U.S. generally accepted accounting principles. This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years and early adoption is prohibited. Accordingly, this FSP is effective for the Company on April 1, 2009. The Company does not believe the adoption of FSP 142-3 will have a material impact on its financial position, results of operations or cash flows. In May, 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles," ("SFAS 162"). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). SFAS 162 will be effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board's amendments to AU Section 411, "The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles." The FASB has stated that it does not expect SFAS 162 will result in a change in current practice. The application of SFAS 162 will have no effect on the Company's financial position, results of operations or cash flows. The FASB issued FASB Staff Position No. APB 14-1, "Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)," ("FSP APB 14-1"). The Staff Position specifies that issuers of convertible debt instruments that may be settled in cash upon conversion should separately account for the liability and equity components in a manner that will reflect the entity's nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 provides guidance for initial and subsequent measurement as well as derecognition provisions. The Staff Position is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is not permitted. The Company is currently analyzing the effect, if any, the adoption of this Staff Position will have on the Company's financial position, results of operations or cash flows. In June, 2008, the FASB issued FASB Staff Position No. EITF 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities," ("FSP EITF 03-6-1"). The Staff Position provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities and must be included in the earnings per share computation. FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior-period earnings per share data presented must be adjusted retrospectively. Early application is not permitted. The adoption of this Staff Position will have no material effect on the Company's financial position, results of operations or cash flows. Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company's financial position, results of operations and cash flows. 11 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 June 30, 2008 Amortized Unrealized Unrealized ------------- Cost Gains Losses Fair Value --------- ---------- ---------- ---------- FHLB Securities $28,637,576 $ 106,504 $ 255,322 $28,488,759 Federal Farm Credit Securities 10,699,502 16,292 143,708 10,572,086 FNMA Bonds 2,000,000 - 34,380 1,965,620 Mortgage-Backed Securities 211,558,989 620,543 2,303,546 209,875,985 Equity Securities 102,938 - 15,188 87,750 ----------- ------- --------- ----------- Total $252,999,005 $ 743,339 $2,752,144 $250,990,200 =========== ======= ========= =========== Gross Gross March 31, 2008 Amortized Unrealized Unrealized -------------- Cost Gains Losses Fair Value --------- ---------- ---------- ---------- FHLB Securities $ 31,891,456 $ 625,583 $ - $ 32,517,039 Federal Farm Credit Securities 14,849,646 323,594 - 15,173,240 FNMA Bonds 2,997,470 7,840 - 3,005,310 Mortgage-Backed Securities 190,454,173 3,023,143 104,283 193,373,033 Equity Securities 102,938 - 13,688 89,250 ----------- ------- --------- ----------- Total $240,295,683 $3,980,160 $ 117,971 $244,157,872 =========== ========= ========= =========== FHLB securities, Federal Farm Credit securities, Federal National Mortgage Association ("FNMA") FNMA bonds, and FNMA and Federal Home Loan Mortgage Corporation ("FHLMC") mortgage-backed securities are issued by government- sponsored enterprises ("GSE's"). GSE's are not backed by the full faith and credit of the United States government. Included in the tables above in mortgage-backed securities are Government National Mortgage Association ("GNMA") mortgage-backed securities, which are backed by the full faith and credit of the United States government. At June 30, 2008, the bank held an amortized cost and fair value of $97.5 million and $96.5 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 June 30, 2008 Amortized Unrealized Unrealized ------------- Cost Gains Losses Fair Value --------- ---------- ---------- ---------- FHLB Securities $13,000,000 $ 119,390 $ 3,120 $13,116,270 Federal Farm Credit Securities 2,000,000 11,570 - 2,011,570 Equity Securities 155,000 - - 155,000 ---------- --------- --------- ---------- Total $15,155,000 $ 130,960 $ 3,120 $15,282,840 ========== ========= ========= ========== Gross Gross March 31, 2008 Amortized Unrealized Unrealized -------------- Cost Gains Losses Fair Value --------- ---------- ---------- ---------- FHLB Securities $17,999,618 $ 320,072 $ - $18,319,690 Federal Farm Credit Securities 2,000,000 31,560 - 2,031,560 Equity Securities 155,000 - - 155,000 ---------- --------- --------- ---------- Total $20,154,618 $ 351,632 $ - $20,506,250 ========== ========= ========= ========== 12 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 GSE's. These enterprises are not backed by the full faith and credit of the United States government. 9. Loans Receivable, Net Loans receivable, net, at June 30, 2008 and March 31, 2008 consisted of the following: June 30, 2008 March 31, 2008 ------------- -------------- Residential Real Estate $ 131,835,370 $ 131,863,466 Consumer 66,763,097 66,832,377 Commercial Business And Real Estate 349,840,672 333,386,661 Loans Held For Sale 3,550,781 2,295,721 ----------- ----------- 551,989,920 534,378,225 ----------- ----------- Less: Allowance For Possible Loan Loss 8,246,496 8,066,762 Loans In Process 8,569,191 8,064,728 Deferred Loan Fees 312,343 315,030 ----------- ----------- 17,128,030 16,446,520 ----------- ----------- $ 534,861,890 $ 517,931,705 =========== =========== 13 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 June 30, 2008 constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements relate to, among others, expectations of the business environment in which the Company operates, projections of future performance, perceived opportunities in the market, potential future credit experience, and statements regarding the Company's mission and vision. These forward-looking statements are based upon current management expectations, and may, therefore, involve risks and uncertainties. The Company's actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide range of factors including, but not limited to, the general business environment, interest rates, the South Carolina real estate market, the demand for loans, competitive conditions between banks and non-bank financial services providers, regulatory changes, and other risks detailed in the Company's reports filed with the SEC, including the Annual Report on Form 10-K for the year ended March 31, 2008. 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 June 30, 2008 and March 31, 2008 General - Total assets increased $23.3 million or 2.8% to $863.4 million at June 30, 2008 from $840.0 million at March 31, 2008. The primary reason for the growth in total assets was a $16.9 million or 3.3% increase in net loans receivable to $534.9 million and a $6.8 million or 2.8% increase in investment and mortgage-backed securities- available for sale to $251.0 million. For the quarter ended June 30, 2008, the demand for loans was funded with maturities of investment and mortgage-backed securities- held to maturity of $5.0 million and an increase in advances from the FHLB of $38.4 million or 21.5% to $216.6 million. Assets - The increases and decreases in total assets were primarily concentrated in the following asset categories: Increase (Decrease) June 30, March 31, ------------------ 2008 2008 Amount Percent ------- -------- ------ ------- Cash And Cash Equivalents $11,012,237 $10,539,054 $473,183 4.5% Investment And Mortgage- Backed Securities- Available For Sale 250,990,200 244,157,872 6,832,328 2.8 Investment And Mortgage- Backed Securities-Held To Maturity 15,155,000 20,154,618 (4,999,618) (24.8) Loan Receivable, Net 534,861,890 517,931,705 16,930,185 3.3 Premises And Equipment, Net 21,975,557 21,544,380 431,177 2.0 FHLB Stock, At Cost 11,224,000 9,497,100 1,726,900 18.2 Repossessed Assets Acquired In Settlement of Loans 454,790 767,096 (312,306) (40.7) Other Assets 4,380,011 1,947,403 2,432,608 124.9 Investments and mortgage-backed securities available for sale increased $6.8 million or 2.8% to $251.0 million at June 30, 2008 from $244.2 million at March 31, 2008. The increase in investments and mortgage-backed securities available for sale is attributable to additional purchases slightly offset by paydowns on mortgage-backed securities and calls and maturities on investments. 14 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued Loans receivable, net increased $16.9 million or 3.3% to $534.9 million at June 30, 2008 from $517.9 million at March 31, 2008. Residential real estate loans decreased $28,000 to $131.8 million at June 30, 2008 from $131.9 million at March 31, 2008. Consumer loans remained relatively unchanged at $66.8 million at June 30, 2008 compared to March 31, 2008, decreasing $69,000 during the current quarter. Commercial business and real estate loans increased $16.5 million to $349.8 million at June 30, 2008 from $333.4 million at March 31, 2008. The increase in commercial and business real estate loans was attributable to the Company's continued focus on originating this type of lending. Loans held for sale increased $1.3 million to $3.6 million at June 30, 2008 from $2.3 million at March 31, 2008. Premises and equipment, net increased $431,000 to $22.0 million at June 30, 2008 from $21.5 million at March 31, 2008. The majority of the increase was for the relocation of our Clearwater branch office and for renovations to our Operations Center in Aiken, South Carolina. FHLB stock, at cost, increased $1.7 million to $11.2 million at June 30, 2008 from $9.5 million at March 31, 2008. The increase is attributable to a FHLB requirement that the Company maintain stock equal to 0.20% of total assets at June 30, 2008 plus a transaction component, which equals 4.5% of outstanding advances (borrowings) from the FHLB of Atlanta. Repossessed assets acquired in settlement of loans decreased $312,000 to $455,000 at June 30, 2008 from $767,000 at March 31, 2008. The Company sold two properties and did not repossess any additional assets during the period. At June 30, 2008, the balance consisted of the following four properties: two lots within one subdivision of Aiken, South Carolina; one lot within a subdivision of Columbia, South Carolina; and a single-family residence in Augusta, Georgia. Other assets increased $2.4 million to $4.4 million at June 30, 2008 from $2 million at March 31, 2008. The majority of this increase is the result of an increase in the deferred tax asset attributable to a decrease in the market value of available for sale securities. Liabilities Deposit Accounts Balance ------------------ June 30, 2008 March 31, 2008 Increase(Decrease) ------------------ ------------------ ----------------- Weighted Weighted Balance Rate Balance Rate Amount Percent Demand Accounts: ----------- ---- ----------- ---- ------- ------- Checking $102,022,969 0.26% $100,585,610 0.47% $ 1,437,359 1.4 % Money Market 144,460,586 2.17 143,225,218 2.84 1,235,368 0.9 Regular Savings 16,683,008 0.73 15,966,557 0.97 716,451 4.5 ----------- ---- ----------- ---- ---------- ---- Total 263,166,563 1.34 259,777,385 1.87 3,389,178 1.3 ----------- ---- ----------- ---- ---------- ---- Certificate Accounts 0.00 - 1.99% 1,444,713 - 1,444,713 100.0 2.00 - 2.99% 27,920,687 14,047,109 13,873,578 98.8 3.00 - 3.99% 85,174,658 59,526,823 25,647,835 43.1 4.00 - 4.99% 62,347,041 68,149,323 (5,802,282) (8.5) 5.00 - 5.99% 137,274,288 189,349,568 (52,075,280) (27.5) ----------- ---- ----------- ---- ---------- ---- Total 314,161,387 4.41 331,072,823 4.75 (16,911,436) (5.1) ----------- ---- ----------- ---- ---------- ---- Total Deposits $577,327,950 3.01% $590,850,208 3.46% $(13,522,258) (2.3)% =========== ==== =========== ==== ========== ==== 15 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 ----------------- June 30, 2008 March 31, 2008 Increase(Decrease) ------------- -------------- ----------------- Balance Rate Balance Rate Balance Percent ------- ---- ------- ---- ------- ------- Fiscal Year Due: 2009 $83,680,000 2.58% $42,300,000 3.28% $41,380,000 97.8% 2010 10,000,000 4.88 10,000,000 4.88 - - 2011 15,000,000 4.87 15,000,000 4.87 - - 2012 24,700,000 4.56 24,700,000 4.56 - - 2013 10,000,000 4.76 10,000,000 4.76 - - Thereafter 73,230,143 4.28 76,234,007 4.25 (3,003,864) (3.9) ----------- ----------- ---------- ---- Total Advances $216,610,143 3.75% $178,234,007 4.18% $38,376,136 21.5% =========== =========== ========== ==== 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 $146.3 million and $146.4 million, respectively, at June 30, 2008. 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 June 30, 2008 --------------------------------------------------------------------- Borrow Maturity Date Date Amount Int.Rate Type Call Dates --------- -------- ---------- -------- ---- ---------- 02/20/04 02/20/14 $5,000,000 3.225% 1 Time Call 02/20/09 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 3.9325% Multi-Call 08/25/08 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 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 08/29/08 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 09/09/08 and quarterly thereafter 05/24/07 05/24/17 7,900,000 4.375% Multi-Call 08/27/08 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 11/16/07 11/16/11 5,000,000 3.745% Multi-Call 11/17/08 and quarterly thereafter 16 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued As of March 31, 2008 --------------------------------------------------------------------- Borrow Maturity Date Date Amount Int.Rate Type Call Dates --------- -------- ------ -------- ---- ---------- 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 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 05/25/08 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 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 05/29/08 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 06/09/08 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 11/16/07 11/16/11 5,000,000 3.745% Multi-Call 11/17/08 and quarterly thereafter Other Borrowings - The Bank had $14.6 million and $12.8 million in other borrowings (non-FHLB advances) at June 30, 2008 and March 31, 2008, respectively. These borrowings consist of short-term repurchase agreements with certain commercial demand deposit customers for sweep accounts and the current balance on a revolving line of credit with another financial institution. At June 30, 2008 and March 31, 2008, short-term repurchase agreements were $11.6 million and $9.8 million, respectively. The repurchase agreements typically mature within one to three days and the interest rate paid on these borrowings floats monthly with money market type rates. At June 30, 2008 and March 31, 2008, the interest rate paid on the repurchase agreements was 2.08% and 3.01%, respectively. The Bank had pledged as collateral for these repurchase agreements investment securities with amortized costs and fair values of $27.0 million and $27.4 million at June 30, 2008. In December 2007, the Company entered into a line of credit in the amount of $10.0 million with another financial institution. At June 30, 2008 and March 31, 2008, the balance on the line of credit was $3.0 million. The unsecured line of credit has an interest rate equal to one month LIBOR plus 2.5% and matures on December 1, 2008. 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. The shareholder of the Collier-Jennings Companies received cash and was issued stock in the Company to settle the acquisition. The Company will release the shares to the shareholder of the Collier-Jennings Companies over a three-year period. The stock is mandatorily redeemable by the shareholder of the 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. At June 30, 2008, the shareholder had not elected to redeem any of the shares. Junior Subordinated Debentures - On September 21, 2006, Security Federal Statutory Trust (the "Trust"), a wholly-owned subsidiary of the Company, issued and sold fixed and floating rate capital securities of the Trust (the "Capital Securities"), which are reported on the consolidated balance sheet as junior subordinated debentures, generating proceeds of $5.0 million. The Trust loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank. The debentures qualify as Tier 1 capital under Federal Reserve Board guidelines. The Capital Securities accrue and pay distributions annually at a rate per annum equal to a blended rate of 5.68% at June 30, 2008. One-half of the Capital Securities issued in the transaction has a fixed rate of 6.88% and the remaining half has a floating rate of three-month LIBOR plus 170 basis points, which was 4.48% at June 30, 2008. The distribution rate payable on the Capital Securities is cumulative and payable quarterly in arrears. 17 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued The Company has the right, subject to events of default, to defer payments of interest on the Capital Securities for a period not to exceed 20 consecutive quarterly periods, provided that no extension period may extend beyond the maturity date of December 15, 2036. The Company has no current intention to exercise its right to defer payments of interest on the Capital Securities. The Capital Securities mature or are mandatorily redeemable upon maturity on December 15, 2036, and or upon earlier optional redemption as provided in the indenture. The Company has the right to redeem the Capital Securities in whole or in part, on or after September 15, 2011. The Company may also redeem the capital securities prior to such dates upon occurrence of specified conditions and the payment of a redemption premium. Equity - Shareholders' equity decreased $3.1 million or 6.5% to $44.4 million at June 30, 2008 from $47.5 million at March 31, 2008. Accumulated other comprehensive income (loss), net of tax, decreased $3.6 million to a loss of $1.2 million at June 30, 2008. The Company's net income for the three-month period was $802,000. The Board of Directors of the Company declared the 70th consecutive quarterly dividend, which was $0.08 per share, in April 2008, and totaled $203,000. Book value per share was $17.55 at June 30, 2008 and $18.76 at March 31, 2008. COMPARISON OF THE RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2008 AND 2007 ------------------------------------------------------------------------------- Net Income - Net income decreased $294,000 or 26.8% to $802,000 for the three months ended June 30, 2008 compared to $1.1 million for the three months ended June 30, 2007. The decrease in net income is primarily the result of the Federal Reserve's recent decrease in interest rates in conjunction with the Company's decision to increase the provision for loan losses and an increase in general and administrative expenses attributable to costs associated with the Company's recent expansion. These factors were offset slightly by an increase in non-interest income. Net Interest Income - Net interest income increased $147,000 or 3.0% to $5.1 million during the three months ended June 30, 2008, compared to $5.0 million for the same period in 2007, as a result of a decrease in interest expense offset in part by a decrease in interest income. During the three months ended June 30, 2008, average interest earning assets increased $87.4 million to $797.6 million while average interest-bearing liabilities increased $89.3 million to $752.2 million. The interest rate spread decreased 16 basis points to 2.37% during the three months ended June 30, 2008 compared to the same period in 2007. The recent precipitous decrease in the prime interest rate continued to negatively impact the Company's margin during the quarter ended June 30, 2008. Net interest margin decreased 23 basis points to 2.57% as of June 30, 2008 from 2.80% for the comparable quarter in the previous year. Interest Income - Total interest income decreased $75,000 or 0.6% to $11.8 million during the three months ended June 30, 2008 from $11.9 million for the same period in 2007. Total interest income on loans decreased $250,000 or 2.8% to $8.5 million during the three months ended June 30, 2008 as a result of the yield in the loan portfolio decreasing 139 basis points offset by the average loan portfolio balance increasing $80.3 million. Interest income from mortgage-backed securities increased $854,000 or 55.4% as a result of a 21 basis point increase in yield and a $65.4 million increase in the average balance of the portfolio. Interest income from investment securities decreased $665,000 or 42.8% as a result of a decrease in average balance of the investment securities portfolio offset slightly by an increase in the yield. 18 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the three months ended June 30, 2008 and 2007: Three Months Ended June 30, ------------------------------------------------ 2008 2007 ------------ ------------ Increase(Decrease) In Interest And Average Average Dividend Income Balance Yield Balance Yield From 2007 ------- ----- ------- ----- --------- Loans Receivable, Net $527,101,104 6.48% $446,807,518 7.87% $(249,844) Mortgage-Backed Securities 199,929,297 4.79 134,517,110 4.58 853,672 Investment Securities 69,564,979 5.11 127,450,266 4.88 (664,619) Other 987,149 2.10 1,403,243 5.59 (14,417) Total Interest-Earning ----------- ---- ----------- ---- -------- Assets $797,582,529 5.93% $710,178,137 6.71% $ (75,208) =========== ==== =========== ==== ======== Interest Expense - Total interest expense decreased $222,000 or 3.2% to $6.7 million during the three months ended June 30, 2008 compared to $6.9 million for the same period one-year earlier. The decrease in total interest expense is attributable to the decreases in interest rates and interest-bearing deposits offset slightly by an increase in other borrowings. Interest expense on deposits decreased $319.0 million or 6.5% to $462.1 million during the period as average interest bearing deposits grew $59.7 million to $545.4 million compared to $485.7 million for the three months ended June 30, 2007 while the cost of deposits decreased 68 basis points to 3.39%. Interest expense on advances and other borrowings increased $113,000 or 6.0% as the cost of debt outstanding decreased 42 basis points during the 2008 period compared to 2007 while average total borrowings outstanding increased approximately $29.6 million. Interest expense on junior subordinated debentures was $74,000 for the three months ended June 30, 2008 compared to $91,000 for the same period one year ago while the average balance remained constant at $5.2 million for the three months ended June 30, 2008 and 2007. The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the three months ended June 30, 2008 and 2007: Three Months Ended June 30, ---------------------------------------------------- 2008 2007 --------------- --------------- Increase (Decrease)In Average Average Interest Expense Balance Yield Balance Yield From 2007 ------- ----- ------- ----- ---------- Now And Money Market Accounts $206,443,306 1.79% $207,334,992 3.19% $ (730,749) Passbook Accounts 16,414,938 0.82 17,117,174 0.98 (8,312) Certificate Accounts 322,502,428 4.54 261,200,638 4.97 420,077 FHLB Advances And Other Borrowed Money 201,686,231 3.99 172,121,258 4.41 113,432 Junior Subordinated Debentures 5,155,000 5.75 5,155,000 7.05 (16,705) Total Interest-Bearing ---------- ---- ----------- ---- -------- Liabilities $752,201,903 3.57% $662,929,062 4.18% $ (222,257) =========== ==== =========== ==== ======== 19 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 multiple 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. The Company considers subjective factors such as changes in local and national economic conditions, industry trends, the composition and volume of the loan portfolio, credit concentrations, lending policies, and the experience and ability of the staff and Board of Directors. Problems associated with deteriorating asset quality continued to plague the industry during the quarter as a result of the sub prime lending and credit crisis. Although the Company did not participate in sub prime lending, it was indirectly impacted by these events and the general condition of the national economy. Additions to the allowance for loan losses were $225,000 for the quarter ended June 30, 2008 compared to $150,000 for the same quarter in the prior year. This increase reflects the Company's concern for deteriorating economic conditions in the local economy coupled with an increase in non-performing assets within its loan portfolio. The following table details selected activity associated with the allowance for loan losses for the three months ended June 30, 2008 and 2007: June 30, 2008 June 30, 2007 ------------- ------------- Beginning Balance $ 8,066,762 $ 7,296,791 Provision 225,000 150,000 Charge-offs (50,186) (29,120) Recoveries 4,920 13,021 ------------- ------------- Ending Balance $ 8,246,496 $ 7,430,692 ============= ============= Allowance For Loan Losses As A Percentage Of Gross Loans Receivable And Loans Held For Sale At The End Of The Period 1.52% 1.58% Allowance For Loan Losses As A Percentage Of Impaired Loans At The End Of The Period 241.87% 721.79% Impaired Loans 3,409,465 1,029,475 Nonaccrual Loans And 90 Days Or More Past Due Loans As A Percentage Of Gross Loans Receivable And Loans Held For Sale At The End Of The Period 1.24% 0.39% Loans Receivable, Net $534,861,890 $462,347,074 Non-performing assets, which consisted of 47 non-accrual loans and four repossessed properties, increased $385,000 to $7.2 million at June 30, 2008 from $6.8 million at March 31, 2008. Despite the increase in non-performing assets, the Company maintained relatively low and stable trends related to net charge-offs. Annualized net charge-offs as a percent of gross loans were 0.03% at June 30, 2008 compared to 0.02% at March 31, 2008 and 0.01% at June 30, 2007. In addition, non-performing assets comprised less than 1% of total assets at June 30, 2008 and March 31, 2008, respectively. Non-Interest Income - Non-interest income remained relatively unchanged at $1.1 million for the three months ended June 30, 2008, increasing $61,000 or 5.7% from 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 June 30, Increase (Decrease) --------------------------- ------------------- 2008 2007 Amounts Percent ------ ------ ------- ------- Gain On Sale Of Investments $ 101,405 $ - $ 101,405 100.0% Gain On Sale Of Loans 118,683 176,121 (57,438) (32.6) Service Fees On Deposit Accounts 281,153 327,322 (46,169) (14.1) Income From Cash Value Of Life Insurance 85,746 62,037 23,709 38.2 Commissions On Insurance 168,992 145,673 23,319 16.0 Other Agency Income 46,937 29,258 17,679 60.4 Trust Income 105,000 98,775 6,225 6.3 Other 213,291 221,412 (8,121) (3.7) ---------- ---------- --------- ----- Total Non-Interest Income $1,121,207 $1,060,598 $ 60,609 5.7% ========== ========== ========= ===== 20 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued Gain on sale of investments was $101,405 for the three months ended June 30, 2008, compared to no gain in the same period one year earlier. The gain resulted from the sale of seven investments during the three month period. No securities were sold during the same quarter of the previous year. Gain on sale of loans decreased $57,000 to $119,000 during the three months ended June 30, 2008 compared to the same period one year ago as a result of a decrease in the origination and sale of fixed rate residential mortgage loans. Service fees on deposit accounts decreased $46,000 to $281,000 for the quarter ended June 30, 2008 compared to the same quarter in 2007 as a result of a decrease in deposit account balances. Commissions on insurance and other agency income increased $41,000 to $167,000 for the quarter ended June 30, 2008 compared to the same quarter in 2007 as a result of the growth and expansion of the insurance subsidiary. Other miscellaneous income including credit life insurance commissions, safe deposit rental income, annuity and stock brokerage commissions, trust fees, and other miscellaneous fees, decreased $8,000 to $213,000 during the three months ended June 30, 2008 compared to the same period one year ago. General And Administrative Expenses - General and administrative expenses increased $571,000 or 13.4% to $4.8 million for the three months ended June 30, 2008 from $4.3 million for the same period one year ago. The following table provides a detailed analysis of the changes in the components of general and administrative expenses: Three Months Ended June 30, Increase (Decrease) --------------------------- ------------------- 2008 2007 Amounts Percent ------ ------ ------- ------- Salaries And Employee Benefits $2,784,235 $2,570,279 $ 213,956 8.32% Occupancy 497,320 422,511 74,809 17.7 Advertising 140,821 102,273 38,548 37.7 Depreciation And Maintenance Of Equipment 426,924 319,525 107,399 33.6 FDIC Insurance Premiums 155,810 15,327 140,483 916.6 Amortization of Intangibles 22,500 22,500 - - Other 794,380 799,030 (4,650) (0.6) Total General And --------- --------- -------- ------ Administrative Expenses $4,821,990 $4,251,445 $ 570,545 13.4% ========= ========= ======== ====== Salary and employee benefits increased $214,000 or 8.3% to $2.8 million for the three months ended June 30, 2008 from $2.6 million for the same period one year ago and occupancy increased $75,000 or 17.7% to 497,000 for the three months ended June 30, 2008 from $423,000 for the same period one year ago. The increase in salary and employee benefits as well as occupancy is a result of increased personnel and property costs related to the Company's recent expansion into two new market areas: Richland and Lexington Counties in South Carolina and Columbia County, Georgia. Depreciation and maintenance expense increased $107,000 or 33.6% to $427,000 for the three months ended June 30, 2008 from $320,000 for the same period one year ago primarily as a result of the Company's recent expansion and additional locations. FDIC insurance premiums increased $140,000 or 916.6% to $156,000 for the three month period ended June 30, 2008 when compared to the same period a year ago. Prior to the quarter ended June 30, 2008, the Bank was benefiting from a One-Time Credit assessment made available by the Federal Deposit Insurance Reform Act of 2005. The credit assessment amount was applied to reduce the Bank's quarterly deposit insurance assessments. The Bank exhausted this credit during the quarter ended June 30, 2008. Advertising expense increased $39,000 or 37.7% to $141,000 for the three months ended June 30, 2008 from $102,000 for the same period one year ago. The increase is attributable to the Company using more print media advertising to attract deposit customers. Overall, non-interest expenses increased $571,000 or 13.4% for the three months ended June 30, 2008 when compared to the same period one year ago. Provision For Income Taxes - Provision for income taxes decreased $144,000 or 26.6% to $397,000 for the three months ended June 30, 2008 from $541,000 for the same period one year ago. Income before income taxes was $1.2 million and $1.6 million for the three months ended June 30, 2008 and 2007, respectively. The Company's combined federal and state effective income tax rate for the current quarter was 33.1% compared to 33.0% for the same quarter one year ago. 21 Security Federal Corporation and Subsidiaries Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations, Continued 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 three months ended June 30, 2008 loan disbursements exceeded loan repayments resulting in a $16.9 million or 3.3% increase in total net loans receivable. During the three months ended June 30, 2008, deposits decreased $13.5 million and FHLB advances increased $38.4 million. The Bank had $28.0 million in additional borrowing capacity at the FHLB at the end of the period and $7.0 million borrowing capacity on a line of credit with another financial institution. At June 30, 2008, the Bank had $297.6 million of certificates of deposit maturing within one year. Based on previous experience, the Bank anticipates a significant portion of these certificates will be renewed. The Company has plans to expand its branch network, which could cause earnings to level off or decline for a period of time. The leveling off or decline in earnings will be attributed the lag that exists from the time a branch is built to when it becomes profitable. In the next twelve months, we anticipate investing $2.0 to $3.0 million in land, buildings, and equipment. In the next twenty-four months we anticipate investing $5.0 million to $6.0 million in land, buildings, and equipment. The anticipated costs could be affected by increased construction costs, weather delays, economic conditions 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 June 30, 2008. After After One Three Greater Within Through Through Within Than One Three Twelve One One (Dollars in thousands) Month Months Months Year Year Total ----- ------ ------ ------ ------ ------- Unused lines of credit $1,424 $ 4,740 $34,367 $40,531 $40,596 $81,127 Standby letters of credit 3 21 480 504 28 532 ----- ------ ------ ------ ------ ------- Total $1,427 $ 4,761 $34,847 $41,035 $40,624 $81,659 ===== ====== ====== ====== ====== ======= 22 Security Federal Corporation and Subsidiaries Item 3. Quantitative and Qualitative Disclosures about Market Risk Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises principally from interest rate risk inherent in its lending, investment, deposit and borrowing activities. Management actively monitors and manages its interest rate risk exposure. Although the Company manages other risks such as credit quality and liquidity risk in the normal course of business, management considers interest rate risk to be its most significant market risk that could potentially have the largest material effect on the Company's financial condition and results of operations. Other types of market risks such as foreign currency exchange rate risk and commodity price do not arise in the normal course of the Company's business activities. The Company's profitability is affected by fluctuations in the market interest rate. Management's goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase or decrease in interest rates may adversely impact the Company's earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same rate, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using a test that measures the impact on net interest income and net portfolio value of an immediate change in interest rates in 100 basis point increments and by measuring the Bank's interest sensitivity gap ("Gap"). Net portfolio value is defined as the net present value of assets, liabilities, and off-balance sheet contracts. Gap is the amount of interest sensitive assets repricing or maturing over the next twelve months compared to the amount of interest sensitive liabilities maturing or repricing in the same time period. Recent net portfolio value reports furnished by the OTS indicate that the Bank's interest rate risk sensitivity has increased slightly over the past year. The Bank has rated favorably compared to thrift peers concerning interest rate sensitivity. For the three months ended June 30, 2008, 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 2.37%. For the year ended March 31, 2008, the interest rate spread was 2.44%. The Federal Reserve's recent interest rate decreases resulted in lower yields on adjustable rate assets while intense competition in the marketplace continued to affect interest rates paid on deposit accounts. In addition, the Bank's liabilities tend to re-price at a more gradual rate than its assets. Item 4T. 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 June 30, 2008 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 June 30, 2008, 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. 23 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, 2008 except that the following risk factors are added to those previously contained in the Form 10-K: Our business is subject to general economic risks that could adversely impact our results of operations and financial condition. * Changes in economic conditions, particularly a further economic slowdown in Aiken, Richland, and Lexington Counties in South Carolina and Columbia County in Georgia, could hurt our business. Our business is directly affected by market conditions, trends in industry and finance, legislative and regulatory changes, and changes in governmental monetary and fiscal policies and inflation, all of which are beyond our control. In 2007, the housing and real estate sectors experienced an economic slowdown that has continued into 2008. Further deterioration in economic conditions, in particular within our primary market area real estate markets, could result in the following consequences, among others, any of which could hurt our business materially: o loan delinquencies may increase; o problem assets and foreclosures may increase; o demand for our products and services may decline; and o collateral for loans made by us, especially real estate, may decline in value, in turn reducing a customer's borrowing power and reducing the value of assets and collateral securing our loans. * Downturns in the real estate markets in our primary market area could hurt our business. Our business activities and credit exposure are primarily concentrated in Aiken, Richland, and Lexington Counties in South Carolina and Columbia County in Georgia. While we do not have any sub-prime loans, our construction and land loan portfolios, our commercial and multifamily loan portfolios and certain of our other loans have been affected by the downturn in the residential real estate market. We anticipate that further declines in the estate markets in our primary market area will hurt our business. As of June 30, 2008, substantially all of our loan portfolio consisted of loans secured by real estate located in Aiken, Richland, and Lexington Counties in South Carolina and Columbia County in Georgia. If real estate values continue to decline the collateral for our loans will provide less security. As a result, our ability to recover on defaulted loans by selling the underlying real estate will be diminished, and we would be more likely to suffer losses on defaulted loans. The events and conditions described in this risk factor could therefore have a material adverse effect on our business, results of operations and financial condition. * We may suffer losses in our loan portfolio despite our underwriting practices. We seek to mitigate the risks inherent in our loan portfolio by adhering to specific underwriting practices. Although we believe that our underwriting criteria are appropriate for the various kinds of loans we make, we may incur losses on loans that meet our underwriting criteria, and these losses may exceed the amounts set aside as reserves in our allowance for loan losses. Recent negative developments in the financial industry and credit markets may continue to adversely impact our financial condition and results of operations. Negative developments beginning in the latter half of 2007 in the sub-prime mortgage market and the securitization markets for such loans, together with substantially increased oil prices and other factors, have resulted in uncertainty in the financial markets in general and a related general economic downturn, which have continued in 2008. 24 Security Federal Corporation and Subsidiaries Part II: Other Information, Continued Many lending institutions, including us, have experienced substantial declines in the performance of their loans, including construction and land loans, multifamily loans, commercial loans and consumer loans. Moreover, competition among depository institutions for deposits and quality loans has increased significantly. In addition, the values of real estate collateral supporting many construction and land, commercial and multifamily and other commercial loans and home mortgages have declined and may continue to decline. Bank and holding company stock prices have been negatively affected, as has the ability of banks and holding companies to raise capital or borrow in the debt markets compared to recent years. These conditions may have a material adverse effect on our financial condition and results of operations. In addition, as a result of the foregoing factors, there is a potential for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and bank regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of formal enforcement orders. Negative developments in the financial industry and the impact of new legislation in response to those developments could restrict our business operations, including our ability to originate or sell loans, and adversely impact our results of operations and financial condition. Liquidity risk could impair our ability to fund operations and jeopardize our financial condition. Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities or the terms of which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets. Item 2 Unregistered sales of Equity Securities and Use Of Proceeds ----------------------------------------------------------- (c)Total (d)Maximum Number of Number of Shares Shares Purchased that May as Part of Yet Be Number of (b)Average Publicly Purchased Shares Price Paid Announced Under the Period Purchased per Share Program Program April 1-April 30, 2008 700 $22.94 700 8,465 May 1-May 31, 2008 1,000 23.06 1,000 7,465 June 1-June 30, 2008 2,200 23.07 2,200 5,265 ---------------------------------------------------- Total 3,900 $23.04 3,900 5,265 ==================================================== 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 June 30, 2008, 120,735 shares have been repurchased under this program. The Company repurchased 3,900 shares of its outstanding Common Stock during the three months ended June 30, 2008. Item 3 Defaults Upon Senior Securities ------------------------------- None Item 4 Submission Of Matters To A Vote Of Security Holders --------------------------------------------------- None Item 5 Other Information ----------------- None 25 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) 10.11 2008 Equity Incentive Plan (10) 14 Code of Ethics (11) 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 20, 2008, as an exhibit to the Company's Proxy Statement and incorporated herein by reference. (11) Filed on June 27, 2008 as an exhibit to the Company's Annual Report on Form 10-K and incorporated herein by reference. 26 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: August 14, 2008 By:/s/Timothy W. Simmons --------------- -------------------------------- Timothy W. Simmons President Duly Authorized Representative Date: August 14, 2008 By:/s/Roy G. Lindburg --------------- -------------------------------- Roy G. Lindburg CFO Duly Authorized Representative 27 EXHIBIT 31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 28 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: August 14, 2008 /s/Timothy W. Simmons --------------------------- Timothy W. Simmons President and Chief Executive Officer 29 EXHIBIT 31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act 30 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: August 14, 2008 /s/Roy G. Lindburg --------------------------------- Roy G. Lindburg Chief Financial Officer 31 EXHIBIT 32 Certification Pursuant to Section 906 of the Sarbanes Oxley Act 32 CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER OF SECURITY FEDERAL CORPORATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 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, 2008 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: August 14, 2008 33