Exhibit 13

Annual Report to Stockholders

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Selected Consolidated Financial and Other Data

	At Or For The Year Ended March 31,
	2011			2010			2009			2008			2007
Balance Sheet Data	(Dollars In Thousands, Except Per Share Data)
Total Assets	$	933,544		$	$$956,002		$	984,662		$	840,030		$	738,110
Cash And Cash Equivalents		7,836			8,805			6,562			10,539			13,438
Investment And Mortgage-Backed Securities		372,418			311,046			314,099			264,312			249,905
Total Loans Receivable, Net (1)		484,471			568,399			611,090			517,932			436,038
Deposits		690,357			694,252			661,714			590,850			523,738
Advances From Federal Home Loan Bank		138,136			164,004			218,998			178,234			153,049
Total Shareholders' Equity		76,012			67,861			67,092			47,496			42,693
Income Data
Total Interest Income		43,742			47,507			48,867			49,632			42,098
Total Interest Expense		16,095			20,136			26,321			29,544			23,933
Net Interest Income		27,647			27,371			22,546			20,088			18,165
Provision For Loan Losses		7,800			8,155			2,825			895			600
Net Interest Income After Provision For Loan Losses		19,847			19,216			19,721			19,193			17,565
Non-Interest Income		6,795			6,113			4,496			4,489			3,861
General And Administrative Expense		23,841			22,663			20,499			17,322			15,157
Income Taxes		958			1,060			1,265			2,080			2,142
Net Income		1,843			1,605			2,453			4,280			4,127
Preferred Stock Dividends		666			900			252			-			-
Accretion Of Preferred Stock To Redemption Value		19			73			20			-			-
Net Income Available to Common Shareholders	$	1,158		$	632		$	2,181		$	4,280		$	4,127
Per Common Share Data
Net Income Per Common Share (Basic)	$	0.43		$	0.26		$	0.87		$	1.66		$	1.59
Cash Dividends Declared	$	0.32		$	0.32		$	0.32		$	0.28		$	0.24
Other Data
Interest Rate Spread Information:
Average During Period		3.06	%		2.83	%		2.45	%		2.44	%		2.47	%
End Of Period		3.34	%		3.21	%		2.58	%		2.14	%		2.51	%
Net Interest Margin (Net Interest Income/Average    Earning Assets)		3.17	%		2.98	%		2.63	%		2.69	%		2.76	%
Average Interest-Earning Assets To Average Interest-    Bearing Liabilities		106.35	%		106.64	%		105.80	%		106.30	%		108.00	%
Common Equity To Total Assets		5.79	%		5.25	%		5.02	%		5.65	%		5.78	%
Non-Performing Assets To Total Assets (2)		2.89	%		4.39	%		1.51	%		0.81	%		0.15	%
Return On Assets (Ratio Of Net Income To Average    Total Assets)		0.12	%		0.06	%		0.24	%		0.54	%		0.59	%
Return On Common Equity (Ratio Of Net Income To    Average Common Equity)		2.17	%		1.27	%		4.72	%		9.54	%		10.24	%
Common Equity To Assets Ratio (Ratio Of Average    Common  Equity To Average Total Assets)		5.62	%		5.09	%		5.10	%		5.66	%		5.78	%
Dividend Pay-Out Ratio On Common Shares(3)		74.132	%		124.56	%		36.59	%		16.90	%		15.11	%
Number Of Full-Service Offices		13			13			13			13			11

(1)       INCLUDES LOANS HELD FOR SALE.

(2)       NON-PERFORMING ASSETS CONSIST OF NON-ACCRUAL LOANS AND REPOSSESSED ASSETS.

(3)       RATIO OF DIVIDENDS PAID ON COMMON SHARES TO NET INCOME AVAILABLE TO COMMON SHAREHOLDERS

7 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

The following discussion is presented to provide the reader with an understanding of the financial condition and the results of operations of Security Federal Corporation and its subsidiaries.  The investment and other activities of the parent company, Security Federal Corporation (the “Company”), have had no significant impact on the results of operations for the periods presented in the financial statements.  The information presented in the following discussion of financial results is indicative of the activities of Security Federal Bank (“Bank”), a wholly owned subsidiary of the Company.  The Bank is a federally chartered stock savings bank that was founded in 1922.  The Bank also has two wholly owned subsidiaries: Security Federal Insurance Inc. (“SFINS”) and Security Financial Services Corporation (“SFSC”).

SFINS was formed in the fiscal year ended March 31, 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 (“Collier Jennings”), which has three wholly owned subsidiaries Security Federal Auto Insurance, The Auto Insurance Store Inc., and Security Federal Premium Pay Plans Inc.  Security Federal Premium Pay Plans Inc. has one wholly owned premium finance subsidiary and also has an ownership interest in four other premium finance subsidiaries.

SFSC was formed in 1975 and was inactive for several years. During the quarter ended December 31, 2010, it was reactivated and utilitzed to hold and operate a repossessed hotel located in Hardeeville, South Carolina.

In addition to the Bank, Security Federal Corporation has another wholly owned subsidiary, Security Federal Statutory Trust (the “Trust”), which issued and sold fixed and floating rate capital securities of the Trust. Under current accounting guidance, however, the Trust is not consolidated in the Company’s financial statements.  Unless the context indicates otherwise, references to the Company shall include the Bank and its subsidiaries.

Prior to April 1, 2009, the Bank had two additional subsidiaries: Security Federal Investments, Inc. (“SFINV”) and Security Federal Trust Inc. (“SFT”). SFINV provided primarily investment brokerage services.  SFT offered trust, financial planning and financial management services. On April 1, 2009, the assets and operations of SFINV and SFT were dissolved into the Bank. The services of these two entities are now offered through the trust and investment divisions of the Bank.

The principal business of the Bank is accepting deposits from the general public and originating consumer and commercial business loans as well as mortgage loans that enable borrowers to purchase or refinance one-to-four family residential real estate.  The Bank also originates construction loans on single-family residences, multi-family dwellings and projects, and commercial real estate, as well as loans for the acquisition, development and construction of residential subdivisions, and commercial projects.

The Bank's net income is dependent on its interest rate spread which is the difference between the average yield earned on its loan and investment portfolios and the average rate paid on its deposits and borrowings.  The Bank’s interest spread is influenced by interest rates, deposit flows, and loan demands.  Levels of non-interest income and operating expense are also significant factors in earnings.

8 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This document, including information included or incorporated by reference, contents, and future filings by the Company on Form 10-K, Form 10-Q, and Form 8-K, and future oral and written statements by the Company and its management may contain forward-looking statements about the Company and its subsidiaries which we believe are within the meaning of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements often include the words “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook” or similar expressions or future or conditional verbs such as “may,” “will,” “should,” “would” and “could.” These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated, including, but not limited to:

·   the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be affected by deterioration in the housing and commercial real estate markets;

·   changes in general economic conditions, either nationally or in our market areas;

·   changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources;

·   fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas;

·   secondary market conditions for loans and our ability to sell loans in the secondary market;

·   results of examinations of us by the Office of Thrift Supervision (“OTS”), the Office of the Comptroller of the Currency (as successor to the OTS), the Federal Deposit Insurance Corporation (“FDIC”) or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;

·   legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, or  the interpretation of regulatory capital or other rules;

·   our ability to attract and retain deposits;

·   further increases in premiums for deposit insurance;

·   our ability to control operating costs and expenses;

·   the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;

·   difficulties in reducing risks associated with the loans on our balance sheet;

·   staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;

·   computer systems on which we depend could fail or experience a security breach;

·   our ability to retain key members of our senior management team;

·   costs and effects of litigation, including settlements and judgments;

·   our ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may in the future acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;

·   increased competitive pressures among financial services companies;

·   changes in consumer spending, borrowing and savings habits;

·   the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;

·   our ability to pay dividends on our common stock;

·   adverse changes in the securities markets;

·   inability of key third-party providers to perform their obligations to us;

·   changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods;

·   future legislative changes and our ability to comply with the requirements of the U.S. Treasury Community Development Capital Initiative (“CDCI”); and

·   other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the other risks described elsewhere in this document.

9 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements, Continued

Some of these and other factors are discussed in our Annual Report on Form 10-K for the year ended March 31, 2011 under Item 1A, “Risk Factors.” Such developments could have an adverse impact on our financial position and our results of operations.

Any forward-looking statements are based upon management’s beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference in this document or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this document might not occur, and you should not put undue reliance on any forward-looking statements.

Critical Accounting Policies

The Company has adopted various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of the Company’s financial statements.  The significant accounting policies of the Company are described in Note 1 of the Notes to the Consolidated Financial Statements included herein.

Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities; management considers these accounting policies to be critical accounting policies.  The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances.  Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company.

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 portfolio, 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.  The allowance for loan losses is subject to periodic evaluations by bank regulatory agencies that may require adjustments to the allowance based upon the information that is available at the time of their examination. For a further discussion of the Company’s estimation process and methodology related to the allowance for loan losses, see the discussion under the section entitled “Comparison of the Years Ended March 31, 2011 and 2010 - Financial Condition” and “-Provision for Loan Losses” and “Comparison of the Years Ended March 31, 2010 and 2009 - Financial Condition” and “-Provision for Loan Losses” included herein.

The Company values an impaired loan 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.

The Company uses assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax liabilities and assets for events recognized differently in its financial statements and income tax returns, and income tax expense. Determining these amounts requires analysis of certain transactions and interpretation of tax laws and regulations. The Company exercises considerable judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments and estimates are reevaluated on a continual basis as regulatory and business factors change.

10 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Policies, Continued

No assurance can be given that either the tax returns submitted by the Company or the income tax reported on the Consolidated Financial Statements will not be adjusted by either adverse rulings by the United States Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service.

Asset and Liability Management

The Bank’s program of asset and liability management seeks to limit the Bank’s vulnerability to material and prolonged increases or decreases in interest rates, or "interest rate risk."  The principal determinant of the exposure of the Bank's earnings to interest rate risk is the timing difference (“gap”) between the repricing or maturity of the Bank's interest-earning assets and the repricing or maturity of its interest-bearing liabilities.  If the maturities of the Bank's assets and liabilities were perfectly matched and the interest rates borne by its assets and liabilities were equally flexible and moved concurrently (neither of which is the case), the impact on net interest income of any material and prolonged changes in interest rates would be minimal.

A positive gap position generally has an adverse effect on net interest income during periods of falling interest rates.  A positive one-year gap position occurs when the dollar amount of rate sensitive assets maturing or repricing within one year exceeds the dollar amount of rate sensitive liabilities maturing or repricing during that same one-year period.  As a result, in a period of falling interest rates, the interest received on interest-earning assets will increase slower than the interest paid on interest-bearing liabilities, causing a decrease in net interest income.  During periods of rising interest rates, the interest received on interest-earning assets will increase faster than interest paid on interest-bearing liabilities, thus increasing net interest income.

A negative gap position generally has an adverse effect on net interest income during periods of rising interest rates.  A negative one-year gap position occurs when the dollar amount of rate sensitive liabilities maturing or repricing within one year exceeds the dollar amount of rate sensitive assets maturing or repricing during that same period.  As a result, during periods of rising interest rates, the interest paid on interest-bearing liabilities will increase faster than interest received from interest-earning assets, thus reducing net interest income.  The reverse is true in periods of declining interest rates, as discussed above, which generally results in an increase in net interest income.

The Bank’s Board of Directors reviews the Interest Rate Exposure Report generated for the Bank by the Office of Thrift Supervision (“OTS”).  This report measures the interest rate sensitivity of the Bank’s net portfolio value (“NPV”) on a quarterly basis under different interest rate scenarios.  The Bank’s sensitivity measure is well within the Bank’s policy on changes in NPV.  The Bank's asset and liability policies are directed toward maximizing long-term profitability while managing acceptable interest rate risk within the Bank’s policies.

At March 31, 2011, the mismatch of interest-earning assets repricing or maturing within one year with interest-bearing liabilities repricing or maturing within one year was $9.9 million or 1.1% of total assets compared to a negative mismatch of ($7.4) million or (0.8)% at March 31, 2010.  For more information on the Bank’s repricing position at March 31, 2011, see the tables on pages 12 and 13.

During the year ended March 31, 2011, the Bank originated, for investment purposes, $26.5 million in adjustable rate residential real estate loans (“ARM’s”), which are held for investment and are not sold. The Bank’s loan portfolio included $205.6 million of adjustable rate consumer loans, commercial loans, and mortgage loans or 41.0% of total gross loans at March 31, 2011.  During fiscal 2011, the Bank originated $212.8 million in consumer and commercial loans, which are usually short term in nature.  The Bank's portfolio of consumer and commercial loans was $385.3 million at March 31, 2011, $465.1 million at March 31, 2010, and $494.5 million at March 31, 2009.  Consumer and commercial loans combined were 76.8% of total loans at March 31, 2011, 79.3% of total loans at March 31, 2010, and 78.8% at March 31, 2009.

At March 31, 2011, the Bank held approximately $8.7 million in longer term fixed rate residential mortgage loans.  The majority of these loans, had converted from ARM loans to fixed rate loans during the previous 60 months.  These fixed rate loans have remaining maturities ranging from 10 to 30 years.  As of March 31, 2011, the Bank no longer had any ARM loans that have conversion features to fixed rate loans. On new originations, the Bank sells virtually all of its 15 and 30 year fixed rate mortgage loans at origination. However, occasionally the Bank may be required to repurchase a long term fixed rate residential mortgage loan it originally sold to an institutional investor. Fixed rate residential loans sold to Freddie Mac and other institutional investors, on a service-released basis totaled $74.0 million in fiscal 2011, $67.8 million in fiscal 2010, and $45.3 million in fiscal 2009.  The Bank sells all its fixed rate mortgage loans on a service-released basis.

11 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Asset and Liability Management, Continued

Certificates of deposit of $100,000 or more, referred to as “Jumbo Certificates,” are normally considered to be interest rate sensitive because of their relatively short maturities.  At March 31, 2011, the Bank had $172.2 million outstanding in Jumbo Certificates compared to $195.9 million at March 31, 2010.  Brokered deposits totaled $39.7 million at March 31, 2011 compared to $34.4 million at March 31, 2010. The majority of the Bank’s deposits are originated within the Bank’s immediate market area.

The following table sets forth the maturity schedule of certificates of deposit with balances of $100,000 or greater at March 31, 2011:

	At March 31, 2011
	(In Thousands)
Within 3 Months	$	29,914
After 3 Months, Within 6 Months		39,369
After 6 Months, Within 12 Months		36,468
After 12 Months		66,470
	$	172,221

The following table sets forth the Bank’s interest-bearing liabilities and interest-earning assets repricing or maturing within one year.  The table on the following page presents the Bank's entire interest-bearing liabilities and interest-earning assets into repricing or maturity time periods.  Both tables present adjustable rate loans in the periods they are scheduled to reprice and fixed rate loans are shown in the time frame of corresponding principal amortization schedules.  Adjustable and fixed rate loans are also adjusted for the Company’s estimates of pre-payments.  Mortgage-backed securities are shown at repricing dates, but also include prepayment estimates.  Both tables also assume investments reprice at the earlier of maturity; the likely call date, if any, based on current interest rates; or the next scheduled interest rate change, if any.  NOW accounts are assumed to have a decay rate of 20% the first year, money market accounts to have a decay rate of 65% the first year, and statement savings accounts to have a decay rate of 20% the first year.  The balance, for all three products, is deemed to reprice in the one to three year category.  Callable fixed rate Federal Home Loan Bank (“FHLB”) advances are included in borrowings, and are deemed to mature at the expected call date or maturity, based on the stated interest rate of the advance and current market rates.  Junior subordinated debentures are shown at their repricing date or call date.

	At March 31
	2011			2010
	(Dollars In Thousands)
Loans (1)	$	307,441		$	402,832
Mortgage-Backed Securities:
Held To Maturity		2,198			871
Available For Sale		67,935			36,890
Investment Securities:
Held To Maturity		1,966			3,117
Available For Sale		48,066			21,339
Other Interest-Earning Assets And FHLB Stock		11,535			12,791
Total Interest Rate Sensitive Assets Repricing Within 1 Year	$	439,141		$	477,840
Deposits	$	387,953		$	439,474
FHLB Advances And Other Borrowed Money		41,301			45,738
Total Interest Rate Sensitive Liabilities Repricing Within 1 Year	$	429,254		$	485,212
Gap	$	9,887		$	(7,372	)
Interest Rate Sensitive Assets/Interest Rate Sensitive Liabilities		102.30	%		98.48	%
Gap As A Percent Of Total Assets		1.1	%		(0.8	)%

(1) LOANS ARE  NET OF UNDISBURSED FUNDS AND LOANS IN PROCESS.

12 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Asset and Liability Management, Continued

The following table sets forth the interest rate sensitivity of the Bank's assets and liabilities at March 31, 2011, on the basis of the

factors and assumptions set forth in the table on the previous page.

		Three Months Or Less		Over 3 –12 Months		Over 1 – 3 Years		Over 3 – 5 Years		Over 5 – 10 Years		Over  10 Years		Total
		(Dollars In Thousands)
Interest-Earnings Assets
Loans (1)	$	150,460	$	156,981	$	126,929	$	42,843	$	12,690	$	7,059	$	496,962
Mortgage-Backed Securities:
Held To Maturity, At Cost		362		1,836		7,451		4,765		2,727		1,973		19,114
Available For Sale, At Fair    Value		21,372		46,563		75,339		53,341		39,036		4,430		240,081
Investment Securities: (2)
Held To Maturity, At Cost		280		1,686		10,047		1,628		295		116		14,052
Available For Sale, At Fair    Value		30,280		17,786		28,341		12,408		9,618		739		99,172
FHLB Stock, At Cost		-		11,267		-		-		-		-		11,267
Other Interest-Earning Assets		268		-		100		-		-		-		368
Total Interest-Earning Assets	$	203,022	$	236,119	$	248,207	$	114,985	$	64,366	$	14,317	$	881,016
Interest-Bearing Liabilities
Deposits:
Certificate Accounts	$	73,730	$	169,449	$	81,126	$	33,832	$	-	$	-	$	358,137
NOW Accounts		3,548		10,645		56,772		-		-		-		70,965
Money Market Accounts		31,130		95,334		68,096		-		-		-		194,560
Statement Savings Account		1,029		3,088		16,466		-		-		-		20,583
Borrowings (2)		19,023		22,278		40,000		40,286		32,900		6,084		160,571
Total Interest-Bearing    Liabilities	$	128,460	$	300,794	$	262,460	$	74,118	$	32,900	$	6,084	$	804,816
Current Period Gap	$	74,562	$	(64,675)	$	(14,253)	$	40,867	$	31,466	$	8,233	$	76,200

Cumulative Gap	$	74,562	$	9,887	$	(4,366)	$	36,501	$	67,967	$	76,200	$	76,200
Cumulative Gap As A Percent    Of Total Assets		8.0%		1.1%		(0.5)%		4.0%		7.3%		8.2%		8.2%

(1) LOANS ARE NET OF UNDISBURSED FUNDS AND LOANS IN PROCESS.

(2) CALLABLE SECURITIES AND FHLB ADVANCES ARE SHOWN AT THEIR LIKELY CALL DATES BASED ON MANAGEMENT’S ESTIMATES AT MARCH 31, 2011.

In evaluating the Bank's exposure to interest rate risk, certain shortcomings inherent in the method of analysis presented in the foregoing tables must be considered.  For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates.  Additionally, the interest rates of certain types of assets and liabilities may fluctuate in advance of changes in market interest rates.  Loan repayment rates and withdrawals of deposits will likely differ substantially from the assumed rates previously set forth in the event of significant changes in interest rates due to the option of borrowers to prepay their loans and the ability of depositors to withdraw funds prior to maturity.  Further, certain assets, such as ARMs, have features that restrict changes in interest rates on a short-term basis as well as over the life of the asset.

13 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Financial Condition

Total assets at March 31, 2011 were $933.5 million, a decrease of $22.5 million or 2.3% from $956.0 million at March 31, 2010.  This decrease was primarily the result of a decrease in net loans receivable.

Total net loans receivable were $484.5 million at March 31, 2011, a decrease of $83.9 million or 14.8% from $568.4 million at March 31, 2010.  Residential real estate loans held for investment decreased $7.2 million or 6.1% to $111.0 million at March 31, 2011.   Typically, long term, newly originated fixed rate mortgage loans are not retained in the portfolio but are sold immediately.  ARMs are typically retained in the portfolio.  At March 31, 2011, the Bank held 90.8% of its residential mortgage loans in ARMs, while it had 9.2% in fixed rate mortgages.  Consumer loans decreased $3.7 million or 5.3% while commercial business loans decreased $4.3 million or 24.1% and commercial real estate loans decreased $71.8 million or 19.0% to $307.0 million at fiscal year end March 31, 2011 from $378.7 million at March 31, 2010. The decrease in loans held for investment is the result of increased offering rates on new loans, tightened underwriting standards and a general decrease in loan demand.  Loans held for sale, which were $5.2 million at March 31, 2011, increased $2.0 million from $3.2 million from the previous fiscal year end.

Total investments and mortgage-backed securities increased $61.4 million or 19.7% to $372.4 million at March 31, 2011 from $311.0 at March 31, 2010.  Cash and cash equivalents were $7.8 million at March 31, 2011 compared to $8.8 million at March 31, 2010.   Premises and equipment decreased $920,000 or 4.4% to $19.8 million in fiscal 2011 as a result of normal annual depreciation of premises and equipment. The Bank did not undertake any significant construction or renovation projects during the years ended March 31, 2011 or 2010. The cash value of Bank Owned Life Insurance (“BOLI”) was $10.4 million at March 31, 2011 compared to $10.0 million at March 31, 2010 reflecting a $415,000 increase as a result of accumulated BOLI earnings. There were no additional BOLI purchases during the fiscal year ended March 31, 2011.  BOLI, which earns tax-free yields, is utilized to partially offset the cost of the Company’s employee benefits programs and to provide key person insurance on certain executive officers of the Company.

The Company’s non-performing assets decreased $15.1 million or 35.8% to $26.9 million at March 31, 2011 from $42.0 million at March 31, 2010. The decrease was primarily concentrated in non-performing commercial real estate loans which decreased $16.1 million to $9.3 million at March 31, 2011 from $25.5 million at March 31, 2010. The balance in non-performing commercial real estate loans at March 31, 2011 consisted of 48 loans to 23 borrowers with an average loan balance of $195,000. In the prior year, the balance in non-performing commercial real estate loans consisted of 58 loans to 29 borrowers with an average loan balance of $439,000. The following table sets forth detailed information concerning our non-performing assets for the periods indicated:

	At March 31, 2011						At March 31, 2010						$ Increase			% Increase
	Amount			Percent (1)			Amount			Percent (1)			(Decrease)			(Decrease)
Loans 90 days or more past due or non-accrual loans:
Residential real estate	$	1,809,881			0.4	%	$	4,344,060			0.8	%	$	(2,534,179	)		58.3	%
Commercial business		171,901			-			699,182			0.1			(527,281	)		(75.4	)
Commercial real estate		9,337,385			1.9			25,479,420			4.4			(16,142,035	)		(63.4	)
Consumer		1,194,171			0.2			703,288			0.1			490,883			69.8
Total non-performing loans		12,513,338			2.5			31,225,950			5.4			(18,712,612	)		(59.9	)
Other non-performing assets
Repossessed assets		27,586			-			43,106			-			(15,520	)		(36.0	)
Real estate owned		14,406,267			2.9			10,729,944			1.9			3,676,323			34.3
Total other non-performing assets		14,433,853			2.9			10,773,050			1.9			3,660,803			34.0
Total non-performing assets	$	26,947,191			5.4	%	$	41,999,000			7.3	%	$	(15,051,809	)		(35.8	)%
Total non-performing assets as a percentage of total assets		2.9	%					4.4	%

(1) Percent of gross loans receivable, net of deferred fees and loans in process and loans held for sale

14 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Financial Condition, Continued

Of the commercial real estate category $3.0 million was concentrated in construction loans and land acquisition and development type loans (“A&D loans”). This balance consisted of $685,000 in A&D loans to one borrower for the development of a residential subdivision in the Midlands area of South Carolina and $2.4 million in loans to eight separate borrowers secured by builder lots or speculative houses in varying degrees of completion throughout South Carolina.

Of the remaining non-performing commercial real estate category, $2.0 million consisted of 10 loans secured by commercial buildings to six separate borrowers and $1.0 million consisted of three loans secured by raw land to three separate borrowers. The majority of the remaining loans in the commercial real estate category were secured by first mortgages on principal residences.

The Company also experienced a decrease in non-performing one- to four- family real estate loans which decreased $2.5 million to $1.8 million at March 31, 2011 from $4.3 million at March 31, 2010. At March 31, 2011, this balance was comprised of eight loans with an average balance of $226,000.

Repossessed assets acquired in settlement of loans increased $3.7 million to $14.4 million at March 31, 2011 from $10.8 million at March 31, 2010. The Company foreclosed on 40 real estate properties during the year ended March 31, 2011 and sold 29 properties. At March 31, 2011, the balance consisted of the following 40 real estate properties: 15 single-family residences and 14 lots within residential subdivisions located throughout our market area in South Carolina and Georgia; three parcels of land in South Carolina; one mobile home including small acreage in Lexington County, South Carolina; two commercial buildings in the Midlands area of South Carolina and one commercial building in Augusta, Georgia; a 55 lot subdivision development and adjacent 17 acres of land in Columbia, South Carolina; a 229.24 acre subdivision in Blythewood, South Carolina; one motel in Hardeeville, South Carolina; and 34.8 acres of land in Blufton, South Carolina also originally acquired as a participation loan from another financial institution. In addition to the properties listed above, the balance also included $28,000 in various other repossessed assets that were not real estate.

The Bank reviews its loan portfolio and allowance for loan losses on a monthly basis.  Future additions to the Bank's allowance for loan losses are dependent on, among other things, the performance of the Bank's loan portfolio, the economy, changes in real estate values, and interest rates.  There can be no assurance that additions to the allowance will not be required in future periods. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations. Management continually monitors its loan portfolio for the impact of local economic changes.  The ratio of allowance for loan losses to total loans was 2.54% at March 31, 2011 compared to 2.13% at March 31, 2010. The Bank monitors past due loans closely.

The cumulative interest not accrued during the year ended March 31, 2011 relating to all non-performing loans totaled $887,000. Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the existing collateral.  In the event an acceptable arrangement cannot be reached, we may have to acquire these properties through foreclosure or other means and subsequently sell, develop, or liquidate them.

The balance of loans in troubled debt restructurings (“TDRs”) increased during the year ended March 31, 2011. The Bank had 33 loans that were TDRs totaling $12.2 million at March 31, 2011 compared to five loans totaling $336,000 at March 31, 2010. The 33 TDRs consisted of five consumer loans to five separate borrowers secured by first mortgages on residential dwellings totaling $295,000. The remaining 28 restructurings consisted of 28 commercial real estate loans to six separate borrowers. These commercial real estate loans were secured primarily by first mortgages on 12 single family residences, six commercial buildings, and three parcels of land.  Three of the TDRs to one borrower totaling $1.5 million were delinquent at March 31, 2011. All of the remaining TDRs were current at March 31, 2011.

15 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Financial Condition, Continued

All TDRs are reviewed for impairment loss.  At March 31, 2011, the Bank held $33.3 million in impaired loans, including $12.2 million in TDRs, compared to $35.3 million of impaired loans, including $336,000 of TDRs, at March 31, 2010. The Bank had specific reserves totaling $772,000 related to $2.8 million in impaired loans at March 31, 2011 compared to $2.0 million in specific reserves related to $10.9 million in impaired loans at March 31, 2010.

In July 2006, the Company acquired Collier Jennings Financial Corporation, an insurance agency specializing in consumer automobile insurance and premium financing. The resulting goodwill and other intangibles were $1.2 million and $160,000, respectively, at March 31, 2011; and $1.2 million and $250,000 at March 31, 2010, respectively.  Collier Jennings is now a subsidiary of Security Federal Insurance Inc.

Deposits at the Bank decreased $3.9 million or 0.6% to $690.4 million at March 31, 2011 from $694.3 million at March 31, 2010. The Bank had brokered time deposits of $39.7 million at March 31, 2011 compared to $34.4 million at March 31, 2010. Brokered time deposits were appealing because rates paid on these deposits were typically significantly lower than rates paid on time deposits obtained in the Bank’s primary market areas. Total deposits, excluding brokered time deposits, decreased $9.1 million or 1.4%. Brokered time deposits were 5.7% of total deposits at March 31, 2011 and 5.0% of total deposits at March 31, 2010.

Advances from the FHLB decreased $25.9 million or 15.8% to $138.1 million at March 31, 2011 from $164.0 million a year earlier. Other borrowed money, which consists of retail repurchase agreements, decreased $865,000 or 7.2% to $11.2 million at March 31, 2011 from $12.1 million at March 31, 2010.  The Company issued its first trust preferred security issuance in September 2006.  Gross proceeds of the issuance were $5.2 million and are classified as junior subordinated debentures on the Consolidated Balance Sheet included in the Consolidated Financial Statements contained herein. In December 2009, the Company issued $6.1 million in convertible senior debentures. The debentures will mature on December 1, 2029 and accrue interest at the rate of 8.0% per annum until maturity or earlier redemption or repayment. The debentures are convertible into the Company’s common stock at a conversion price of $20 per share at the option of the holder at any time prior to maturity.

Total shareholders' equity was $76.0 million at March 31, 2011, an increase of $8.2 million or 12.0% from $67.9 million a year earlier. During the year ended March 31, 2011, the Company raised $4.8 million through the issuance of capital stock and exchanged $18.0 million in preferred shares issued through the U.S. Treasury’s (the “Treasury”) Capital Purchase Program (“CPP”) for $22.0 million in preferred shares issued through the Treasury’s CDCI for a net increase of $4.0 million in preferred shares. See Note 21 of the Notes to the Consolidated Financial Statements included herein for additional information.

The Company’s net income for the year was $1.8 million. Preferred stock dividends were $666,000 and accretion of preferred stock to its redemption value was $19,000 for the year resulting in net income available to common shareholders of $1.2 million. Other changes in shareholders’ equity were: stock compensation expense of $34,000, a net decrease in other comprehensive income of $970,000, and $858,000 in dividends paid to common shareholders.

16 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations

The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities.  The table also distinguishes between the changes related to higher or lower outstanding balances and the changes related to the volatility of interest rates.  For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (1) changes in rate (changes in rate multiplied by prior year volume); (2) changes in volume (changes in volume multiplied by prior year rate); and (3) net change (the sum of the prior columns).  For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change attributable to volume and the change attributable to rate. Changes in income are calculated on a tax equivalent basis using a 34% federal income tax rate.

	Fiscal Year 2011 Compared To 2010									Fiscal Year 2010 Compared To 2009
	Volume			Rate			Net			Volume			Rate			Net
	(In Thousands)
Interest-Earning Assets:
Loans: (1)
Mortgage Loans	$	(278	)	$	(356	)	$	(634	)	$	(340	)	$	(556	)	$	(896	)
Other Loans		(3,454	)		2,498			(956	)		1,985			(2,180	)		(195	)
Total Loans		(3,732	)		2,142			(1,590	)		1,645			(2,736	)		(1,091	)
Mortgage-Backed Securities (2)		(670	)		(1,628	)		(2,298	)		1,239			(1,074	)		165
Investments (2)		811			(686	)		125			348			(773	)		(425	)
Other Interest-Earning Assets		3			1			4			(3	)		(6	)		(9	)
Total Interest-Earning Assets	$	(3,588	)	$	(171	)	$	(3,759	)	$	3,229		$	(4,589	)	$	(1,360	)
Interest-Bearing Liabilities:
Deposits:
Certificate Accounts	$	(34	)	$	(2,957	)	$	(2,991	)	$	1,295		$	(4,883	)	$	(3,588	)
NOW Accounts		8			19			27			16			(132	)		(116	)
Money Market Accounts		290			(837	)		(547	)		392			(1,479	)		(1,087	)
Savings Accounts		8			(26	)		(18	)		9			(46	)		(37	)
Total Deposits		272			(3,801	)		(3,529	)		1,712			(6,540	)		(4,828	)
Borrowings		(2,290	)		1,778			(512	)		(225	)		(1,132	)		(1,357	)
Total Interest-Bearing Liabilities		(2,018	)		(2,023	)		(4,041	)		1,487			(7,672	)		(6,185	)
Effect On Net Income	$	(1,570	)	$	1,852		$	282		$	1,742		$	3,083		$	4,825

(1) INTEREST ON NON-ACCRUAL LOANS IS NOT INCLUDED IN INCOME, ALTHOUGH THEIR LOAN BALANCES ARE INCLUDED IN AVERAGE LOANS OUTSTANDING.

(2) SECURITIES AVAILABLE FOR SALE ARE COMPUTED USING THEIR HISTORICAL COST.

17 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Results of Operations, Continued

The following table presents the total dollar amount of interest income from average interest-earning assets for the periods indicated and the resultant yields, as well as the interest expense on average interest-bearing liabilities expressed both in dollars and rates.

	Yield/ Rate At March 31, 2011		Averages For Fiscal Years Ended March 31,
			2011					2010					2009
			Average Balance		Interest	Yield/ Rate		Average Balance		Interest	Yield/ Rate		Average Balance		Interest	Yield/ Rate
			(Dollars In Thousands)
Interest-Earning Assets:
Mortgage Loans	5.35%	$	116,148	$	6,041	5.20%	$	121,311	$	6,675	5.50%	$	127,205	$	7,571	5.95%
Other Loans	6.57%		419,983		26,769	6.37%		476,667		27,725	5.82%		443,589		27,920	6.29%
Total Loans (1)	6.28%		536,131		32,810	6.12%		597,978		34,400	5.75%		570,794		35,491	6.22%
Mortgage-Backed    Securities (2)	3.71%		229,052		8,305	3.63%		245,173		10,603	4.32%		217,989		10,438	4.79%
Investments (2) (3)	2.90%		103,279		2,627	2.54%		74,845		2,503	3.34%		66,280		2,928	4.42%
Other Interest-Earning    Assets	0.48%		3,547		5	0.13%		1,261		1	0.07%		2,378		10	0.42%
Total Interest-Earning    Assets	5.04%	$	872,009	$	43,747	5.02%	$	919,257	$	47,507	5.17%	$	857,441	$	48,867	5.70%
Interest-Bearing Liabilities:
Certificate Accounts	1.71%	$	382,508	$	7,546	1.97%	$	383,769	$	10,537	2.75%	$	349,161	$	14,125	4.05%
NOW Accounts	0.22%		67,934		185	0.27%		64,722		158	0.24%		60,930		274	0.45%
Money Market    Accounts	0.85%		183,128		1,882	1.03%		161,663		2,429	1.50%		143,110		3,516	2.46%
Savings Accounts	0.24%		19,374		58	0.30%		17,440		76	0.44%		16,107		113	0.70%
Total Interest-Bearing    Accounts	1.24%		652,944		9,671	1.48%		627,594		13,200	2.10%		569,308		18,028	3.17%
Other Borrowings	0.40%		11,714		62	0.53%		41,749		249	0.60%		14,758		387	2.62%
Jr. Subordinated Debt	4.45%		5,155		233	4.53%		5,155		239	4.64%		5,155		290	5.64%
Sr. Convertible Debt	8.00%		6,084		487	8.00%		2,017		162	8.03%		-		-	-
FHLB Advances	3.57%		144,054		5,642	3.92%		185,499		6,286	3.39%		221,204		7,616	3.44%
Total Interest-Bearing    Liabilities	1.70%	$	819,951	$	16,095	1.96%	$	862,014	$	20,136	2.34%	$	810,425	$	26,321	3.25%
Net Interest Income				$	27,652				$	27,371				$	22,546
Interest Rate Spread	3.34%					3.06%					2.83%					2.45%
Net Yield On Earning    Assets (Net Interest    Margin)						3.17%					2.98%					2.63%

(1) INTEREST ON NON-ACCRUAL LOANS IS NOT INCLUDED IN INCOME, ALTHOUGH THEIR LOAN BALANCES ARE INCLUDED IN AVERAGE LOANS OUTSTANDING.

(2) SECURITIES AVAILABLE FOR SALE ARE COMPUTED USING THEIR HISTORICAL COST.

(3) TAX EQUIVALENT BASIS IS CALCULATED USING AN EFEECTIVE TAX RATE OF 34% AND AMOUNTED TO $5,000 FOR THE YEAR ENDED MARCH 31, 2011.

18 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Comparison of the Years Ended March 31, 2011 and 2010

General

The Company’s earnings available to common shareholders were $1.2 million for the year ended March 31, 2011, compared to $632,000 for the year ended March 31, 2010.  The $525,000 or 83.1% increase in earnings was attributable primarily to the increase in net interest margin combined with a decrease in the provision for loan losses and a decrease in preferred stock dividends. An increase in non-interest income also contributed to the increase in earnings.

Net Interest Income

Net interest margin on a tax equivalent basis for the year ended March 31, 2011 increased 19 basis points to 3.17% up from 2.98% in the previous year.  As a result, net interest income increased $276,000 or 1.0% to $27.7 million for the year ended March 31, 2011 compared to $27.4 million for the previous year. The increase was attributable to a decrease in interest expense offset by a decrease in interest income. Average interest-earning assets decreased $47.2 million to $872.0 million while average interest-bearing liabilities decreased $42.1 million to $820.0 million. The interest rate spread was 3.06% for the year ended March 31, 2011 compared to 2.83% for the year ended March 31, 2010.

Interest income on loans decreased $1.6 million to $32.8 million during the year ended March 31, 2011 from $34.4 million during fiscal 2010.  The 4.6% decrease was attributable to a decrease in average total loans outstanding of $61.8 million offset in part by a 47 basis point increase in the yield earned on the Bank’s loans during fiscal 2011.  Interest income on investment securities, mortgage-backed securities, and other investments decreased $2.2 million as a result of a decrease in the yield earned offset in part by an increase in the aggregate average balance in the overall investment portfolio, including mortgage-backed securities, investments, and other interest-earning assets of $14.6 million.

Interest expense on deposits decreased $3.5 million or 26.7% to $9.7 million during the year ended March 31, 2011.  Average interest bearing deposits increased $25.4 million while the average cost of those deposits decreased 62 basis points during the year ended March 31, 2011.  Interest expense on FHLB advances and other borrowings decreased $831,000 or 12.7% to $5.7 million during fiscal 2011.  The decrease was a result of a decrease in average FHLB advances and other borrowings outstanding during fiscal 2011 of $71.5 million offset by an increase in the average costs of those borrowings of 78 basis points to 3.66% in fiscal 2011 compared to 2.88% in fiscal 2010.

Interest expense on junior subordinated debentures was $233,000 for fiscal 2011 compared to $239,000 during fiscal 2010. The average outstanding balance on these debentures remained constant at $5.2 million during both periods while the average cost decreased 11 basis points to 4.53% in fiscal 2011 compared to 4.64% in fiscal 2010. Interest expense on senior convertible debentures increased $324,000 to $487,000 as a result of an increase in the average balance of $4.1 million to $6.1 million. The senior convertible debentures were issued during fiscal 2010 and have a fixed rate of 8%.

Provision for Loan Losses

Non-performing assets, which consist of non-accrual loans and repossessed assets, decreased $15.1 million to $26.9 million at March 31, 2011 from $42.0 million at March 31, 2010. Non-performing assets were 2.9% of total assets at March 31, 2011 and 4.4% of total assets at March 31, 2010. Consistent with the decrease in non-performing assets, the provision for loan losses decreased $355,000 to $7.8 million for the year ended March 31, 2011 compared to $8.2 million for the previous year.  Non-accrual loans, which are loans delinquent 90 days or more, were $12.5 million at March 31, 2011 compared to $31.2 million at March 31, 2010.  Net charge-offs were $7.6 million or 1.55% of gross loans in fiscal 2011 compared to $6.0 million or 1.04% of gross loans in fiscal 2010. Management of the Bank continues to be concerned about current market conditions and closely monitors the loan portfolio on an on-going basis to proactively identify any potential problem loans.

19 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Provision for Loan Losses, Continued

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 the percentage of classified loans, 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, management, and the Board of Directors.

Management believes the allowance for loan losses is adequate based on its best estimates of the losses inherent in the loan portfolio, although there can be no guarantee as to these estimates.  In addition, bank regulatory agencies may require additional provisions to the allowance for loan losses based on their judgments and estimates as part of their examination process.  Because the allowance for loan losses is an estimate, there can be no guarantee that actual loan losses would not exceed the allowance for loan losses, or that additional increases in the allowance for loan losses will not be required in the future.

Non-Interest Income

Non-interest income increased $682,000 or 11.2% to $6.8 million during fiscal 2011. Gain on sale of investments increased $308,000 or 25.4% to $1.5 million during fiscal 2011 from $1.2 million during fiscal 2010. Gain on sale of loans increased $365,000 or 35.1% to $1.4 million during fiscal 2011 compared to $1.0 million during fiscal 2010 as a result of an increase in the origination and sale of fixed rate residential mortgage loans.  Service fees on deposit accounts decreased $87,000 or 7.1% to $1.1 million during fiscal 2011.

Income from insurance agency commissions was $459,000 during fiscal 2011 compared to $457,000 during fiscal 2010. Trust income increased $5,000 or 1.0% to $460,000 during fiscal 2011. Income from BOLI increased $55,000 or 15.3% to $415,000 during fiscal year 2011.

Mandatorily redeemable financial instrument valuation income was $196,000 for the year ended March 31, 2011 compared to an expense of $63,000 for the same period one year earlier. Based on its terms, the mandatorily redeemable financial instrument is redeemable at the greater of $26 per share or one and a half times the book value per common share of the Company. The Company recorded valuation income to properly reflect the fair value of the instrument at March 31, 2011 based on the book value. Subsequent to March 31, 2011, the Company eliminated the mandatorily redeemable shares as a result of an investor’s purchase of these shares in a private transaction. In connection with the purchase of these shares, the redemption feature was eliminated. See Note 25 of the Notes to the Consolidated Financial Statements included herein.

Other miscellaneous income including annuity and investment brokerage commissions, Bank credit life insurance on loans, and other miscellaneous income decreased $402,000 or 44.4% to $504,000 during fiscal 2011.

General and Administrative Expenses

General and administrative expenses increased $1.2 million or 5.2% to $23.8 million during the year ended March 31, 2011 compared to $22.7 million during the same period one year earlier.  Compensation and employee benefits decreased $14,000 or 0.1% to $11.8 million as the result of a decrease in the number of employees employed by the Company. At March 31, 2011, the Company had 218 full time equivalents compared to 226 at March 31, 2010.  Occupancy expense decreased $72,000 or 3.6% to $1.9 million while advertising expense decreased $11,000 or 2.7% to $393,000 from $404,000. These decreases were a result of the Company’s efforts to reduce expenses during the year. Depreciation and maintenance of equipment expense remained relatively unchanged at $1.8 million during the years ended March 31, 2011 and 2010, representing a slight increase of $50,000 or 2.8%.

FDIC insurance premiums decreased $620,000 or 33.7% to $1.2 million for the year ended March 31, 2011 compared to $1.8 million in 2010 as a result of a decrease in the Bank’s deposits combined with a decrease in the Bank’s growth rate. The FDIC used an annual growth factor estimate of 5% when they originally calculated the prepaid assessment the Bank paid in 2010.

20 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

General and Administrative Expenses,  Continued

Net cost of operation of other real estate owned increased $1.5 million or 186.0% to $2.3 million for the year ended March 31, 2011 compared to $815,000 in 2010. This increase was the result of an increase in foreclosures and an increase in write downs on repossessed assets during the year. The Bank foreclosed on 40 real estate properties during 2011 compared to 25 real estate properties in 2010. Repossessed assets are recorded at the lower of cost or estimated fair value less costs to sell. As local real estate values decline, the Bank is required to write down these properties to their fair values. Write downs on repossessed assets totaled $1.4 million for the year ended March 31, 2011.

Other miscellaneous expenses, which encompass legal, professional, and consulting expenses, stationery and office supplies, and other expenses increased $329,000 or 8.5% to $4.2 million during fiscal 2011 compared to $3.9 million during fiscal 2010. This increase is a result of increased expenses associated with loan collection and workout efforts.

Income Taxes

The provision for income taxes decreased $102,000 or 9.6% to $958,000 during the year ended March 31, 2011 compared to $1.1 million for the year ended March 31, 2010.  The effective tax rate was 34.2% for fiscal 2011 and 39.8% for fiscal 2010.

21 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Comparison of the Years Ended March 31, 2010 and 2009

General

The Company’s earnings available to common shareholders were $632,000 for the year ended March 31, 2010, compared to $2.2 million for the year ended March 31, 2009.  The $1.5 million or 71.0% decrease in earnings was attributable primarily to the increase in the allowance for loan losses through additional charges to the provision for loan losses coupled with an increase in general and administrative expenses attributable to increased FDIC insurance premiums. These factors were offset by an increase in the Company’s net interest margin.

Net Interest Income

Net interest margin for the year ended March 31, 2010 increased 35 basis points to 2.98% up from 2.63% in the previous year.  As a result, net interest income increased $4.8 million or 21.4% to $27.4 million for the year ended March 31, 2010 compared to $22.6 million for the previous year. The increase was attributable to a decrease in interest expense offset in part by a decrease in interest income. Average interest-earning assets increased $61.8 million to $919.3 million while average interest-bearing liabilities increased $51.6 million to $862.0 million. The interest rate spread was 2.83% for the year ended March 31, 2010 compared to 2.45% for the year ended March 31, 2009.

Interest income on loans decreased $1.1 million to $34.4 million during the year ended March 31, 2010 from $35.5 million during fiscal 2009.  The decrease was attributable to a 47 basis point decrease in the yield earned on the Bank’s loans during fiscal 2010 offset in part by an increase in average total loans outstanding of $27.2 million.  Interest income on investment securities, mortgage-backed securities, and other investments decreased $269,000 as a result of an increase in the aggregate average balance in the overall investment portfolio, including mortgage-backed securities, investments, and other interest-earning assets of $34.6 million offset by a decrease in the yield.

Interest expense on deposits decreased $4.8 million or 26.8% to $13.2 million during the year ended March 31, 2010.  Average interest bearing deposits increased $58.3 million while the average cost of those deposits decreased 107 basis points during the year ended March 31, 2010.  Interest expense on FHLB advances and other borrowings decreased $1.5 million or 18.4% to $6.5 million during fiscal 2010.  The decrease was a result of a decrease in average FHLB advances and other borrowings outstanding during fiscal 2010 of $8.7 million while the average costs of those borrowings decreased 51 basis points to 2.88% in fiscal 2010 compared to 3.39% in fiscal 2009.  Interest expense on junior subordinated debentures was $239,000 for fiscal 2010 compared to $290,000 during fiscal 2009. The average outstanding balance on these debentures remained constant at $5.2 million during both periods while the average cost decreased 100 basis points to 4.64% in fiscal 2010 compared to 5.64% in fiscal 2009. Interest expense on senior convertible debentures was $162,000 and the average balance was $2.0 million. The senior convertible debentures were issued during fiscal 2010.

Provision for Loan Losses

The Company’s provision for loan losses increased $5.3 million to $8.2 million during the year ended March 31, 2010 from $2.8 million in fiscal 2009.The increase in the provision for loan losses reflected the Company’s concern for the condition of the local and national economy coupled with an increase in non-performing assets.  Non-accrual loans, which are loans delinquent 90 days or more, were $31.2 million at March 31, 2010 compared to $12.9 million at March 31, 2009.  Non-performing assets, which include non-accrual loans and repossessed assets, increased $27.1 million to $42.0 million at March 31, 2010 from $14.9 million at March 31, 2009. Non-performing assets were 4.4% of total assets at March 31, 2010 and 1.5% of total assets at March 31, 2009. Net charge-offs were $6.0 million or 1.04% of gross loans in fiscal 2010 compared to $710,000 or 0.11% of gross loans in fiscal 2009. Management of the Bank continues to be concerned about current market conditions and closely monitors the loan portfolio on an on-going basis to proactively identify any potential problem loans.

22 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Non-Interest Income

Non-interest income increased $1.6 million to $6.1 million during fiscal 2010. Gain on sale of investments increased $1.1 million to $1.2 million during fiscal 2010 from $127,000 during fiscal 2009. Gain on sale of loans increased $412,000 to $1.0 million during fiscal 2010 compared to $628,000 during fiscal 2009 as a result of an increase in the origination and sale of fixed rate residential mortgage loans.  Service fees on deposit accounts increased $88,000 or 7.7% to $1.2 million during fiscal 2010.

Income from insurance agency commissions was $457,000 during fiscal 2010 compared to $625,000 during fiscal 2009. Other agency income from Collier Jennings increased $138,000 to $472,000 during fiscal 2010 from $334,000 during fiscal 2009 as a result of growth and expansion of the Bank’s insurance subsidiary.  Trust income increased $24,000 or 5.6% to $455,000 during fiscal 2010. Income from BOLI increased $2,000 or 0.4% to $360,000 during fiscal year 2010. Other miscellaneous income including annuity and investment brokerage commissions, Bank credit life insurance on loans, and other miscellaneous income increased $95,000 or 11.7% to $906,000 during fiscal 2010

General and Administrative Expenses

General and administrative expenses increased $2.1 million or 10.4% to $22.6 million during the year ended March 31, 2010 compared to $20.5 million during the same period one year earlier.  The increase is primarily the result of an increase in FDIC insurance premiums incurred during the period. For the year ended March 31, 2010, the Company expensed $1.8 million in FDIC insurance premiums, an increase of $1.1 million or 153.8% from $724,000 for the prior year. The majority of the increase was the result of a one time special assessment and additional provisions imposed by the FDIC on all FDIC insured deposit institutions to help replenish the government’s Deposit Insurance Fund.

Compensation and employee benefits increased $166,000 or 1.4% to $11.8 million as the result of annual cost of living salary adjustments offset by a decrease in the number of employees employed by the Company.  Occupancy expense increased $15,000 or 0.8% to $2.0 million. Depreciation and maintenance of equipment expense increased $151,000 or 9.3% to $1.8 million. Advertising expense decreased $138,000 or 25.4% from $542,000 to $404,000 as a result of the Company’s efforts to reduce expenses during the year.

Mandatorily redeemable financial instrument valuation expense was $63,000 for the year ended March 31, 2010 compared to $183,000 for the same period one year earlier. Based on its terms, the mandatorily redeemable financial instrument is redeemable at the greater of $26 per share or one and a half times the book value per common share of the Company which equated to $30.33 at March 31, 2010. The Company recorded a valuation expense to properly reflect the fair value of the instrument at March 31, 2010 based on the book value.

Other miscellaneous expenses, which encompasses legal, professional, and consulting expenses, stationery and office supplies, and other expenses increased $350,000 or 9.9% during fiscal 2010. This increase is a result of fees associated with the Company’s senior convertible debt offering combined with costs required to insure compliance with increased regulation and legislation that is present in the current environment.

Income Taxes

The provision for income taxes decreased $204,000 or 16.2% to $1.1 million during the year ended March 31, 2010 compared to $1.3 million for the year ended March 31, 2009.  The effective tax rate was 39.8% for fiscal 2010 and 34.0% for fiscal 2009.

23 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Regulatory Capital

The following table reconciles the Bank's shareholders' equity to its various regulatory capital positions:

	At March 31,
	2011		2010
	(In Thousands)
Bank’s Shareholders’ Equity (1)	$	77,758	$	71,729
Reduction For Goodwill And Other Intangibles		1,359		1,449
Tangible Capital		76,399		70,280
Core Capital		76,399		70,280
Supplemental Capital		6,219		7,296
Total Risk-Based Capital	$	82,618	$	77,576

(1) FOR FISCAL 2011 AND 2010, EXCLUDES UNREALIZED GAIN OF $3.7 MILLION and $4.6 MILLION, RESPECTIVELY, ON AVAILABLE FOR SALE SECURITIES.

The following table compares the Bank's capital levels relative to regulatory requirements at March 31, 2011:

	Amount Required		Percent Required			Actual Amount		Actual Percent			Excess Amount		Excess Percent
	(Dollars In Thousands)
Tangible Capital	$	18,530		2.0	%	$	76,399		8.3	%	$	57,869		6.3	%
Tier 1 Leverage (Core) Capital		37,060		4.0	%		76,399		8.3	%		39,339		4.3	%
Tier 1 Risk-Based (Core) Capital		19,900		4.0	%		76,399		15.4	%		56,499		11.4	%
Total Risk-Based Capital		39,801		8.0	%		82,618		16.6	%		42,817		8.6	%

24 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Liquidity and Capital Resources

Liquidity refers to the ability to generate sufficient cash flows to fund current loan demand, repay maturing borrowings, fund maturing deposit withdrawals, and meet operating expenses.  The Bank's primary sources of funds include loan repayments, loan sales, increased deposits, advances from the FHLB, and cash flow generated from operations.  The need for funds varies among periods depending on funding needs as well as the rate of amortization and prepayment on loans.  The use of FHLB and other advances and borrowings varies depending on loan demand, deposit inflows, and the use of investment leverage strategies to increase net interest income.

The principal use of the Bank's funds is the origination of mortgages and other loans and the purchase of investments and mortgage-backed securities.  Loan originations on loans held for investment were $240.2 million in fiscal 2011 compared to $336.4 million in fiscal 2010 and $415.3 million in fiscal 2009.  The decrease in originations in fiscal 2011 and fiscal 2010 was primarily the result of a decrease in commercial loan originations, which decreased $88.8 million and $61.3 million, respectively. In fiscal 2009 loan originations increased $38.7 million.  Purchases of investments and mortgage-backed securities were $224.7 million in fiscal 2011 compared to $150.2 million in fiscal 2010 and $144.3 million in fiscal 2009.  Other uses of the Bank’s funds included paying down FHLB Advances.

Unused lines of credit on home equity loans, credit cards, and commercial loans amounted to $37.9 million at March 31, 2011.  Home equity loans are made on a floating rate basis with final maturities of 10 to 15 years.  Credit cards are generally made on a floating rate basis, and are renewed annually or every other year.  In addition to the above commitments, the Bank has undisbursed loans-in-process of $4.6 million at March 31, 2011, which will be disbursed over an average of 90 days.  These commitments to originate loans and future advances of lines of credit are expected to be funded from loan amortizations and prepayments, deposit inflows, maturing investments, and short-term borrowing capacity.

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at March 31, 2011:

(In Thousands)	One Month Or Less		After One  Through  Three  Months		After Three Through Twelve Months		Within One Year		One Year Or Greater		Total
Unused Lines Of Credit	$	1,137	$	1,259	$	5,686	$	8,082	$	29,852	$	37,934
Standby Letters Of Credit		-		101		1,327		1,428		26		1,454
Total	$	1,137	$	1,360	$	7,013	$	9,510	$	29,878	$	39,388

Management believes that future liquidity can be met through the Bank's deposit base, which decreased $3.9 million during fiscal 2011, and from maturing investments.  In addition, at March 31, 2011 the Bank had another $140.9 million in unused borrowing capacity at the FHLB.

Historically the Bank’s cash flow from operating activities has been relatively stable.  The cash flows from investing activities vary with the need to invest excess funds or utilize leverage strategies with the purchase of mortgage-backed and investment securities.  The cash flows from financing activities vary depending on the need for FHLB and other advances. During the 2011 fiscal year, the Company received $4.8 million through the issuance of common stock and $4.0 million through a preferred stock exchange. See Note 21 of the Notes to the Consolidated Financial Statements included herein and the "Consolidated Statements of Cash Flows" in the Consolidated Financial Statements for additional information.  See contained herein.

25 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Contractual Obligations

In the normal course of business, the Company enters into contractual obligations that meet various business needs.  These contractual obligations include time deposits to customers, borrowings from the FHLB of Atlanta, other borrowings, junior subordinated debentures, senior convertible debentures and lease obligations for facilities.  See Notes 5, 9, 10, 11 and 13 of the Notes to the Consolidated Financial Statements included herein for additional information.  The following table summarizes the Company’s long-term contractual obligations at March 31, 2011. Contractual repayments may differ from actual because some of the obligations may be subject to calls.

	One Year Or Less		Over One to Three Years		Over Three to Five Years		Thereafter		Total
	(In Thousands)
Time deposits	$	243,179	$	81,126	$	33,832	$	-	$	358,137
FHLB Advances		24,950		40,000		40,286		32,900		138,136
Other Borrowings		11,195		-		-		-		11,195
Jr. Sub. Debentures		-		-		-		5,155		5,155
Sr. Conv. Debentures		-		-		-		6,084		6,084
Operating Lease Obligations		404		816		736		1,564		3,520
Total	$	279,728	$	121,942	$	74,854	$	45,703	$	522,227

Off-Balance Sheet Arrangements

In the normal course of business, the Company makes off-balance sheet arrangements, including credit commitments to its customers to meet their financial needs.  These arrangements involve, to varying degrees, elements of credit and interest rate risk not recognized in the consolidated statement of financial condition.  The Bank makes personal, commercial, and real estate lines of credit available to customers and does issue standby letters of credit.

Commitments to extend credit to customers are subject to the Bank’s normal credit policies and are essentially the same as those involved in extending loans to customers.  See Note 18 of the Notes to the Consolidated Financial Statements included herein for additional information.

Impact of Inflation and Changing Prices

The Consolidated Financial Statements, related notes, and other financial information presented herein have been prepared in accordance with Generally Accepted Accounting Principles (“GAAP”) that require the measurement of financial position and operating results in terms of historical dollars without considering changes in relative purchasing power over time due to inflation.  Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature.  As a result, interest rates generally have a more significant impact on a financial institution's performance than does the effect of inflation.

26 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Shareholders and Board of Directors

Security Federal Corporation and Subsidiaries

Aiken, South Carolina

We have audited the accompanying consolidated balance sheets of Security Federal Corporation and Subsidiaries as of March 31, 2011 and 2010, and the related consolidated statements of income, changes in shareholders' equity and comprehensive income and cash flows for each of the three years in the period ended March 31, 2011.  These consolidated financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal controls over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Security Federal Corporation and Subsidiariesas of March 31, 2011 and 2010, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 31, 2011, in conformity with U.S. generally accepted accounting principles.

/s/ Elliott Davis LLC

Columbia, South Carolina

June 20, 2011

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

		March 31,
		2011		2010
ASSETS:
Cash And Cash Equivalents	$	7,835,638	$	8,804,645
Certificates Of Deposits With Other Banks		100,432		-
Investment And Mortgage-Backed Securities:
Available For Sale:  (Amortized Cost of $333,387,779 and $284,831,441 at March    31, 2011 and 2010, Respectively)		339,252,790		292,261,039
Held To Maturity:  (Fair Value of $34,122,925 and $19,854,106 at March 31, 2011    and 2010, Respectively)		33,165,125		18,785,380
Total Investments And Mortgage-Backed Securities		372,417,915		311,046,419
Loans Receivable, Net:
Held For Sale		5,166,234		3,161,463
Held For Investment:  (Net of Allowance of $12,501,800 and $12,307,394 at March    31, 2011 and 2010, Respectively)		479,304,382		565,237,372
Total Loans Receivable, Net		484,470,616		568,398,835
Accrued Interest Receivable:
Loans		1,742,281		1,787,471
Mortgage-Backed Securities		944,667		964,380
Investment Securities		889,297		703,339
Total Accrued Interest Receivable		3,576,245		3,455,190
Premises And Equipment, Net		19,800,616		20,720,484
Federal Home Loan Bank Stock, At Cost		11,267,485		12,624,400
Repossessed Assets Acquired In Settlement Of Loans		14,433,853		10,773,050
Bank Owned Life Insurance		10,416,305		10,001,305
Intangible Assets, Net		159,500		249,500
Goodwill		1,199,754		1,199,754
Other Assets		7,865,690		8,728,076
Total Assets	$	933,544,049	$	956,001,658
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Liabilities:
Deposit Accounts	$	690,357,114	$	694,252,437
Advances From Federal Home Loan Bank		138,136,338		164,003,882
Other Borrowings		11,195,474		12,060,470
Junior Subordinated Debentures		5,155,000		5,155,000
Advance Payments By Borrowers For Taxes And Insurance		381,488		327,332
Mandatorily Redeemable Financial Instruments		1,467,312		1,663,312
Senior Convertible Debentures		6,084,000		6,084,000
Other Liabilities		4,755,118		4,594,606
Total Liabilities		857,531,844		888,141,039
Commitments (Notes 5 and 19)
Shareholders' Equity:
Serial Preferred Stock, $.01 Par Value; Authorized 200,000 Shares; Issued And         Outstanding, 22,000 and 18,000, respectively, at March 31, 2011 And March 31,         2010		22,000,000		17,692,609
Common Stock, $.01 Par Value; Authorized 5,000,000 Shares; Issued And         Outstanding Shares, 3,144,934 And 2,944,001, Respectively, at March 31, 2011         And 2,662,028 And 2,461,095, Respectively, at March 31, 2010		30,884		26,055
Warrant Issued In Conjunction With Serial Preferred Stock		400,000		400,000
Additional Paid-In Capital		10,176,375		5,352,144
Treasury Stock, At Cost (200,933 Shares at March 31, 2011 And 2010,         Respectively)		(4,330,712)		(4,330,712)
Accumulated Other Comprehensive Income		3,637,675		4,608,080
Retained Earnings, Substantially Restricted		44,097,983		44,112,443
Total Shareholders' Equity		76,012,205		67,860,619
Total Liabilities And Shareholders' Equity	$	933,544,049	$	956,001,658

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

28 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income

		For the Years Ended March 31,
		2011		2010		2009
Interest Income:
Loans	$	32,809,913	$	34,399,899	$	35,491,100
Mortgage-Backed Securities		8,304,884		10,603,186		10,437,935
Investment Securities		2,623,006		2,503,005		2,928,145
Other		4,537		872		10,095
Total Interest Income		43,742,340		47,506,962		48,867,275
Interest Expense:
NOW And Money Market Accounts		2,067,241		2,586,827		3,789,877
Statement Savings Accounts		58,195		76,359		112,982
Certificate Accounts		7,546,064		10,537,020		14,124,818
FHLB Advances And Other Borrowed Money		5,703,534		6,534,398		8,003,354
Senior Convertible Debentures		486,720		162,240		-
Junior Subordinated Debentures		233,361		239,399		290,488
Total Interest Expense		16,095,115		20,136,243		26,321,519
Net Interest Income		27,647,225		27,370,719		22,545,756
Provision For Loan Losses		7,800,000		8,155,000		2,825,000
Net Interest Income After Provision For Loan Losses		19,847,225		19,215,719		19,720,756
Non-Interest Income:
Gain On Sale Of Investment Securities		1,520,599		1,213,041		126,527
Gain On Sale Of Loans		1,404,879		1,040,014		627,787
Service Fees On Deposit Accounts		1,143,811		1,231,081		1,143,147
Commissions From Insurance Agency		458,663		456,860		624,613
Trust Income		459,500		455,000		431,000
Bank Owned Life Insurance Income		415,000		360,000		358,492
Mandatorily Redeemable Financial Instrument Valuation   Income (Expense)		196,000		(63,000)		(183,000)
Check Card Fee Income		692,220		513,381		372,567
Other		504,289		906,206		811,645
Total Non-Interest Income		6,794,961		6,112,583		4,312,778
General And Administrative Expenses:
Compensation And Employee Benefits		11,828,376		11,842,024		11,675,548
Occupancy		1,929,946		2,002,233		1,987,317
Advertising		393,287		404,182		541,882
Depreciation And Maintenance Of Equipment		1,832,295		1,782,497		1,631,627
FDIC Insurance Premiums		1,218,075		1,837,877		724,227
Amortization Of Intangibles		90,000		90,000		90,000
Net Cost Of Operation Of Other Real Estate Owned		2,330,410		814,727		125,358
Other		4,218,751		3,889,756		3,539,785
Total General And Administrative Expenses		23,841,140		22,663,296		20,315,744
Income Before Income Taxes		2,801,046		2,665,006		3,717,790
Provision For Income Taxes		958,133		1,060,205		1,264,417
Net Income		1,842,913		1,604,801		2,453,373
Preferred Stock Dividends		666,453		900,000		252,500
Accretion Of Preferred Stock To Redemption Value		18,816		72,544		20,065
Net Income Available To Common Shareholders	$	1,157,644	$	632,257	$	2,180,808
Net Income Per Common Share (Basic)	$	0.43	$	0.26	$	0.87
Net Income Per Common Share (Diluted)	$	0.42	$	0.25	$	0.87
Cash Dividend Per Share On Common Stock	$	0.32	$	0.32	$	0.32
Weighted Average Shares Outstanding (Basic)		2,684,130		2,460,855		2,501,596
Weighted Average Shares Outstanding (Diluted)		2,762,824		2,527,584		2,519,470

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

29

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income

For the Years Ended March 31, 2011, 2010 and 2009

	Preferred Stock		Warrants		Common Stock		Additional Paid – In  Capital		Treasury Stock				Accumulated Other Comprehensive Income			Retained 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		-		-		-		-			-			-			2,453,373			2,453,373
Other Comprehensive Income,    Net Of Tax:
Unrealized Holding Gains    On Securities Available    For Sale, Net Of Taxes		-		-		-		-			-			1,492,790			-			1,492,790
Reclassification Adjustment    For Gains Included In Net    Income, Net Of Taxes		-		-		-		-			-			(78,393	)		-			(78,393	)
Comprehensive Income		-		-		-		-			-			-			-			3,867,770
Purchase Of Treasury Stock         At Cost, 84,098 Shares		-		-		-		-			(1,561,266	)		-			-			(1,561,266	)
Issuance Of Preferred Stock And Related Warrants		17,600,000		400,000		-		-			-			-			-			18,000,000
Accretion Of Preferred Stock To Redemption Value		20,065		-		-		-			-			-			(20,065	)		-
Exercise Of Stock Options		-		-		60		99,960			-			-			-			100,020
Employee Stock Purchase Plan Purchases		-		-		55		94,498			-			-			-			94,553
Stock Compensation Expense		-		-		-		32,691			-			-			-			32,691
Cash Dividends On  Preferred		-		-		-		-			-			-			(140,000	)		(140,000	)
Cash Dividends On Common		-		-		-		-			-			-			(797,883	)		(797,883	)
Balance At March 31, 2009	$	17,620,065	$	400,000	$	26,040	$	5,299,235		$	(4,330,712	)	$	3,809,934		$	44,267,736		$	67,092,298

	Preferred Stock		Warrants		Common Stock		Additional Paid – In  Capital		Treasury Stock				Accumulated Other Comprehensive Income			Retained Earnings			Total
Balance At March 31, 2009	$	17,620,065	$	400,000	$	26,040	$	5,299,235		$	(4,330,712	)	$	3,809,934		$	44,267,736		$	67,092,298
Net Income		-		-		-		-			-			-			1,604,801			1,604,801
Other Comprehensive Income,    Net Of Tax:
Unrealized Holding Gains    On Securities Available    For Sale, Net Of Taxes		-		-		-		-			-			1,550,231			-			1,550,231
Reclassification Adjustment    For Gains Included In Net    Income, Net Of Taxes		-		-		-		-			-			(752,085	)		-			(752,085	)
Comprehensive Income		-		-		-		-			-			-			-			2,402,947
Accretion Of Preferred Stock To Redemption Value		72,544		-		-		-			-			-			(72,544	)		-
Employee Stock Purchase Plan Purchases		-		-		15		19,785			-			-			-			19,800
Stock Compensation Expense		-		-		-		33,124			-			-			-			33,124
Cash Dividends On  Preferred		-		-		-		-			-			-			(900,000	)		(900,000	)
Cash Dividends On Common		-		-		-		-			-			-			(787,550	)		(787,550	)
Balance At March 31, 2010	$	17,692,609	$	400,000	$	26,055	$	5,352,144		$	(4,330,712	)	$	4,608,080		$	44,112,443		$	67,860,619

(Continued)

30 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income

For the Years Ended March 31, 2011, 2010 and 2009, Continued

	Preferred Stock			Warrants		Common Stock		Additional Paid – In  Capital		Treasury Stock				Accumulated Other Comprehensive Income			Retained Earnings			Total
Balance At March 31, 2010	$	17,692,609		$	400,000	$	26,055	$	5,352,144		$	(4,330,712	)	$	4,608,080		$	44,112,443		$	67,860,619
Net Income		-			-		-		-			-			-			1,842,913			1,842,913
Other Comprehensive Income,    Net Of Tax:
Unrealized Holding Losses    On Securities Available    For Sale, Net Of Taxes		-			-		-		-			-			(27,634	)		-			(27,634	)
Reclassification Adjustment    For Gains Included In Net    Income, Net Of Taxes		-			-		-		-			-			(942,771	)		-			(942,771	)
Comprehensive Income		-			-		-		-			-			-			-			872,508
Common Stock Issuance		-			-		4,829		4,824,231			-			-			-			4,829,060
Preferred Stock Issuance		22,000,000			-		-		-			-			-			-			22,000,000
Preferred Stock Redemption		(17,711,425	)		-		-		-			-			-			(288,575	)		(18,000,000	)
Accretion Of Preferred Stock To Redemption Value		18,816			-		-		-			-			-			(18,816	)		-
Stock Compensation Expense		-			-		-		-			-			-			34,424			34,424
Cash Dividends On  Preferred		-			-		-		-			-			-			(726,222	)		(726,222	)
Cash Dividends On Common		-			-		-		-			-			-			(858,184	)		(858,184	)
Balance At March 31, 2011	$	22,000,000		$	400,000	$	30,884	$	10,176,375		$	(4,330,712	)	$	3,637,675		$	44,097,983		$	76,012,205

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

31 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

 Consolidated Statements of Cash Flows

		For the Years Ended March 31,
		2011		2010		2009
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	1,842,913	$	1,604,801	$	2,453,373
Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities:
Depreciation Expense		1,549,477		1,577,968		1,491,922
Amortization Of Intangible Assets		90,000		90,000		90,000
Stock Option Compensation Expense		34,424		33,124		32,691
Discount Accretion And Premium Amortization		3,690,505		1,914,150		564,876
Provisions For Losses On Loans		7,800,000		8,155,000		2,825,000
Write Down Of Goodwill		-		222,000		-
Mandatorily Redeemable Financial Instrument    Valuation (Income) Expense		(196,000)		63,000		183,000
Gain On Sales Of Loans		(1,404,879)		(1,040,014)		(627,787)
Gain On Sales Of Mortgage-Backed Securities		(1,207,238)		(619,856)		-
Gain On Sales Of Investment Securities		(313,361)		(593,185)		(126,527)
Loss On Sale Of Real Estate Owned		256,484		103,920		21,940
Write Down On Real Estate Owned		1,409,564		504,580		-
Amortization Of Deferred Fees On Loans		(11,550)		(128,217)		(130,099)
(Gain) loss On Disposition Of Premises And Equipment		-		(25)		61
Proceeds From Sale Of Loans Held For Sale		74,175,983		68,819,036		45,900,664
Origination Of Loans Held For Sale		(74,775,875)		(65,228,678)		(48,688,963)
(Increase) Decrease In Accrued Interest Receivable:
Loans		45,190		224,496		(59,101)
Mortgage-Backed Securities		19,713		174,531		(316,532)
Investment Securities		(185,958)		(339,632)		401,039
(Decrease) Increase In Advance Payments By Borrowers		54,156		(94,129)		(199,006)
(Increase) Decrease In Prepaid FDIC Assessment		1,172,294		(3,987,622)		-
Other, Net		29,784		(2,946,265)		(650,831)
Net Cash Provided By Operating Activities		14,075,626		8,508,983		3,165,720
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase Of Mortgage-Backed Securities Available For    Sale		(116,717,564)		(80,947,679)		(100,017,227)
Principal Repayments On Mortgage-Backed Securities    Available For Sale		58,109,556		63,591,884		44,254,746
Maturities Of Mortgage-Backed Securities Available For    Sale		-		1,000,000		-
Purchase Of Mortgage-Backed Securities Held To    Maturity		(12,726,562)		-		-
Principal Repayments On Mortgage-Backed Securities    Held To Maturity		3,725,195		7,486,884		1,526,959
Purchase Of Investment Securities Available For Sale		(88,254,904)		(69,209,182)		(16,742,367)
Maturities Of Investment Securities Available For Sale		31,044,163		18,640,344		25,543,010
Purchase of Investment Securities Held To Maturity		(7,043,450)		-		(27,618,762)
Maturities Of Investment Securities Held To Maturity		1,628,735		4,881,502		14,983,444
Proceeds From Sale of Investment Securities Available    For Sale		16,463,819		27,465,905		7,135,335
Proceeds From Sale of Mortgage-Backed Securities    Available For Sale		48,564,592		30,725,706		2,993,520
Purchase Of FHLB Stock		-		-		(11,401,000)
Redemption Of FHLB Stock		1,356,915		38,300		8,235,400
(Increase) Decrease In Loans Receivable		62,562,563		21,540,257		(94,155,147)
Capital Improvements To Repossessed Assets		(549,458)		-		17,381
Proceeds From Sale Of Repossessed Assets		10,804,585		1,177,276		460,767
Purchase And Improvement Of Premises And Equipment		(629,609)		(623,964)		(1,624,687)
Proceeds From Sale of Premises and Equipment		-		971		1,650
Increase In Bank Owned Life Insurance		-		-		(1,330,492)
Net Cash Provided (Used) By Investing Activities		8,338,576		25,768,204		(147,737,470)
						(Continued)

32 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows, Continued

		For the Years Ended March 31,
		2011		2010		2009
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (Decrease) In Deposit Accounts		(3,895,323)		32,538,862		70,863,367
Proceeds From FHLB Advances		148,420,000		310,885,319		333,080,000
Repayment Of FHLB Advances		(174,287,544)		(365,879,871)		(292,315,573)
Proceeds From Term Auction Facility Advances		-		207,000,000		-
Repayment Of Term Auction Facility Advances		-		(217,000,000)		-
Proceeds (Repayments) Of Other Borrowings, Net		(864,996)		(3,995,496)		13,271,872
Proceeds From Issuance Of Preferred Stock		22,000,000		-		18,000,000
Proceeds From Issuance Of Common Stock		4,829,060		-		-
Redemption Of Preferred Stock		(18,000,000)		-		-
Proceeds From Senior Convertible Debentures		-		6,084,000		-
Proceeds From Employee Stock Purchase Plan Purchases		-		19,800		94,553
Proceeds From Exercise Of Stock Options		-		-		100,020
Purchase Of Treasury Stock		-		-		(1,561,266)
Dividends To Preferred Stock Shareholders		(726,222)		(900,000)		(140,000)
Dividends To Common Stock Shareholders		(858,184)		(787,550)		(797,883)
Net Cash Provided (Used) By Financing Activities		(23,383,209)		(32,034,936)		140,595,090
Net Increase (Decrease) In Cash And Cash Equivalents		(969,007)		2,242,251		(3,976,660)
Cash And Cash Equivalents At Beginning Of Year		8,804,645		6,562,394		10,539,054
Cash And Cash Equivalents At End Of Year	$	7,835,638	$	8,804,645	$	6,562,394
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Paid During The Period For:
Interest	$	16,377,342	$	20,326,637	$	26,572,297
Income Taxes	$	429,432	$	3,396,162	$	1,869,900
Supplemental Schedule Of Non Cash Transactions:
Transfers From Loans Receivable	$	15,581,977	$	10,573,654	$	1,718,164
Gains (Losses) On Securities Available For Sale, Net Of Taxes	$	(970,405)	$	798,146	$	1,414,397

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

33 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(1) Significant Accounting Policies

The following is a description of the more significant accounting and reporting policies used in the preparation and presentation of the accompanying consolidated financial statements.  All significant intercompany transactions have been eliminated in consolidation.

(a) Basis of Consolidation and Nature of Operations

The accompanying consolidated financial statements include the accounts of Security Federal Corporation (the “Company”) and its wholly owned subsidiary, Security Federal Bank (the “Bank”) and the Bank’s wholly owned subsidiaries, Security Federal Insurance, Inc. (“SFINS”) 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 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 was 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. Security Federal Premium Pay Plans Inc. has one wholly owned premium finance subsidiary and also has an ownership interest in four other premium finance subsidiaries.

(b) Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, interest-bearing balances in other banks, and federal funds sold.  Cash equivalents have original maturities of three months or less.

(c) Investment and Mortgage-Backed Securities

Investment securities, including mortgage-backed securities, are classified in one of three categories: held to maturity, available for sale, or trading.  Management determines the appropriate classification of debt securities at the time of purchase.

Investment securities are classified as held to maturity when the Company has the positive intent and ability to hold the securities to maturity.  These securities are recorded at cost and adjusted for amortization of premiums and accretion of discounts over the estimated life of the security using a method that approximates a level yield.  Prepayment assumptions on mortgage-backed securities are anticipated.

Management classifies investment securities that are not considered to be held to maturity as available for sale.  This type of investment is stated at fair value with unrealized gains and losses, net of tax, reported in a separate component of shareholders' equity (“accumulated other comprehensive income (loss)”).  Gains and losses from sales of investment and mortgage-backed securities available for sale are determined using the specific identification method.  The Company has no trading securities.

(d) Loans Receivable Held for Investment

Loans are stated at their unpaid principal balance.  Interest income is computed using the simple interest method and is recorded in the period earned.

(e) Allowance for Loan Losses

The Company provides for loan losses using the allowance method.  Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to the allowance for loan losses.

Additions to the allowance for loan losses are provided by charges to operations based on various factors, which, in management’s judgment, deserve current recognition in estimating possible losses.  Such factors considered by management include the fair value of the underlying collateral, stated guarantees by the borrower (if applicable), the borrower’s ability to repay from other economic resources, growth and composition of the loan portfolio, 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.

34 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(1)           Significant Accounting Policies, Continued

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.  The allowance for loan losses is subject to periodic evaluations by bank regulatory agencies that may require adjustments to be made to the allowance based upon the information that is available at the time of their examination.

The Company values impaired loans at the loan’s fair value if it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement at the present value of expected cash flows, the market price of the loan, if available, or the value of the underlying collateral.  Expected cash flows are required to be discounted at the loan’s effective interest rate.  When the ultimate collectibility of an impaired loan’s principal is in doubt, wholly or partially, all cash receipts are applied to principal.  When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to interest 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.

(f) Loans Receivable Held for Sale

Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate.  Net unrealized losses are provided for in a valuation allowance by charges to operations.

(g) Repossessed Assets Acquired in Settlement of Loans

Repossessed assets represent real estate and other assets acquired through foreclosure or repossession and are initially recorded at the lower of cost (principal balance of the former mortgage loan less any specific valuation allowances) or estimated fair value less costs to sell.  Subsequent improvements are capitalized.  Costs of holding real estate, such as property taxes, insurance, general maintenance and interest expense, are expensed as a period cost.  Fair values are reviewed regularly and allowances for possible losses are established when the carrying value of the asset owned exceeds the fair value less estimated costs to sell.  Fair values are generally determined by reference to an outside appraisal.

(h) Premises and Equipment

Premises and equipment are carried at cost, net of accumulated depreciation.  Depreciation of premises and equipment is amortized on a straight-line method over the estimated useful life of the related asset.  Estimated lives are seven to 40 years for buildings and improvements and generally three to 10 years for furniture, fixtures and equipment.  Maintenance and repairs are charged to current expense.  The cost of major renewals and improvements are capitalized.

(i) Intangible Assets and Goodwill

Intangible Assets consist of the customer list and employment contracts resulting from the Company’s acquisition of Collier Jennings Financial Corporation in July 2006.  The goodwill also is a result of the excess of the cost over the fair value of net assets resulting from the Collier Jennings acquisition.

Intangible assets are amortized over their estimated economic lives using methods that reflect the pattern in which the economic benefits are utilized.  Goodwill is reviewed for impairment annually or whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable.

(j) Income Taxes

Income tax expense or benefit is recognized for the net change during the year in the deferred tax liability or asset.  That amount together with income taxes currently payable is the total amount of income tax expense or benefit for the year.  Deferred taxes are provided for by the differences in financial reporting bases for assets and liabilities compared with their tax bases.  Generally, a current tax liability or asset is established for taxes presently payable or refundable and a deferred tax liability or asset is established for future tax items.  A valuation allowance, if applicable, is established for deferred tax assets that may not be realized.  Tax bad debt reserves in excess of the base year amount (established as taxable years ending March 31, 1988 or later) would create a deferred tax liability.  Deferred income taxes are provided for in differences between the provision for loan losses for financial statement purposes and those allowed for income tax purposes.

35 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(1)           Significant Accounting Policies, Continued

On April 1, 2007, the Company adopted accounting guidance which prescribes a threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosures. There was no cumulative effect adjustment upon adoption.

There have been no gross amounts of unrecognized tax benefits or interest or penalties related to uncertain tax positions since adoption. There are no unrecognized tax benefits that would, if recognized, affect the effective tax rate. There are no positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within the next 12 months. Years prior to March 31, 2006 are closed for federal, state and local income tax matters.

(k) Loan Fees and Costs Associated with Originating Loans

Loan fees received, net of direct incremental costs of originating loans, are deferred and amortized over the contractual life of the related loan.  The net fees are recognized as yield adjustments by applying the interest method.  Prepayments are not anticipated.

(l) Interest Income

Interest on loans is accrued and credited to income monthly based on the principal balance outstanding and the contractual rate on the loan.  The Company places loans on non-accrual status when they become greater than 90 days delinquent or when, in the opinion of management, full collection of principal or interest is unlikely.  The Company provides an allowance for uncollectible accrued interest on loans that are contractually 90 days delinquent for all interest accrued prior to the loan being placed on non-accrual status.  The loans are returned to an accrual status when full collection of principal and interest appears likely.

(m) Advertising Expense

Advertising and public relations costs are generally expensed as incurred.  External costs relating to direct mailing costs are expensed in the period in which the direct mailings are sent.  Advertising and public relations costs of $393,000, $404,000, and $542,000 were included in the Company’s results of operations for the years ended March 31, 2011, 2010, and 2009, respectively.

(n) Stock-Based Compensation

The Company accounts for compensation costs under its stock option plans using the fair value method. This method requires the measurement of the cost of employee services received in exchange for an award of equity instruments based upon the fair value of the award on the grant date. The cost of the award is recognized in the income statement over the vesting period of the award.

(o)      Earnings Per Share

Accounting guidance 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 available to common shareholders 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 and warrants outstanding is reflected in diluted earnings per share by application of the treasury stock method. The reverse treasury stock method is used to determine the dilutive effect of the mandatorily redeemable shares outstanding, which were issued by the Company in connection with the acquisition of the Collier-Jennings Companies.

Net income available to common shareholders represents consolidated net income adjusted for preferred dividends declared, accretion of discounts and amortization of premiums on preferred stock issuances and cumulative dividends related to the current dividend period that have not been declared as of period end.

36 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(1)           Significant Accounting Policies, Continued

The following tables provide a reconciliation of net income to net income available to common shareholders for the periods presented:

	For the Years Ended March 31,
	2011		2010		2009
Earnings available to common shareholders
Net Income	$	1,842,913	$	1,604,801	$	2,453,373
Preferred Stock Dividends		666,453		900,000		252,500
Deemed Dividends On Preferred Stock From Net    Accretion of Preferred Stock		18,816		72,544		20,065
Net Income Available To Common Shareholders	$	1,157,644	$	632,257	$	2,180,808

The following table shows the effect of dilutive options and warrants on the Company’s earnings per share for the periods indicated:

	For the Year Ended
	March 31, 2011
	Income		Shares		Per Share Amounts
Basic EPS	$	1,157,644		2,684,130	$	0.43
Effect of Diluted Securities:
Mandatorily Redeemable        Shares		-		78,694		(0.01	)
Senior Convertible Debentures		-		-		-
Stock Options & Warrants		-		-		-
Diluted EPS	$	1,157,644		2,762,824	$	0.42

	For the Year Ended
	March 31, 2010
	Income		Shares		Per Share Amounts
Basic EPS	$	632,257		2,460,855	$	0.26
Effect of Diluted Securities:
Mandatorily Redeemable        Shares		-		66,729		(0.01	)
Senior Convertible Debentures		-		-		-
Stock Options & Warrants		-		-		-
Diluted EPS	$	632,257		2,527,584	$	0.25

	For the Year Ended
	March 31, 2009
	Income		Shares		Per Share Amounts
Basic EPS	$	2,180,808		2,501,596	$	0.87
Dilutive effect of:
Stock Options And    Warrants		-		-		-
Mandatorily    Redeemable Shares		-		17,874		-
Diluted EPS	$	2,180,808		2,519,470	$	0.87

37 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(1)           Significant Accounting Policies, Continued

The average market price used in calculating the assumed number of dilutive shares issued for the years ended March 31, 2011, 2010, and 2009 was $10.64, $11.69, and $19.58, respectively. As a result of the average stock price being less than the exercise price of all options and warrants in the years ended March 31, 2011, 2010 and 2009, the options are not dilutive in calculating diluted earnings per share for those years.

(p) Use of Estimates

The preparation of financial statements in conformity with Generally Accepted Accounting Principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of income and expenses during the reporting periods.  Actual results could differ from those estimates.

(q) Recently Issued Accounting Standards

The following is a summary of recent authoritative pronouncements that could affect accounting, reporting, and disclosure of financial information by the Company:

In July 2010, the Receivables topic of the Accounting Standards Codification (“ASC”) was amended by Accounting Standards Update (“ASU”) 2010-20 to require expanded disclosures related to a company’s allowance for credit losses and the credit quality of its financing receivables. The amendments require the allowance disclosures to be provided on a disaggregated basis.  The Company is required to include these disclosures in their interim and annual financial statements.  See Note 4 included herein.

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which significantly changes the regulation of financial institutions and the financial services industry.  The Dodd-Frank Act includes several provisions that will affect how community banks, thrifts, and small bank and thrift holding companies will be regulated in the future.  Among the more significant changes made by the Dodd-Frank Act, effective July 21, 2011 (with a possible delay of up to six months), the Office of Thrift Supervision (“OTS”) will cease to exist as a separate entity and will be merged and become a separate division of the Office of the Comptroller of the Currency, which currently oversees national banks. In addition, beginning in 2011, all financial institution holding companies will be regulated by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). In addition, the provisions of the Dodd-Frank relax rules regarding interstate branching, allow financial institutions to pay interest on business checking accounts, change the scope of federal deposit insurance coverage, and impose new capital requirements on bank and thrift holding companies.  The Dodd-Frank Act also establishes the Bureau of Consumer Financial Protection as an independent entity within the Federal Reserve, which will be given the authority to promulgate consumer protection regulations applicable to all entities offering consumer financial services or products, including banks.  Additionally, the Dodd-Frank Act includes a series of provisions covering mortgage loan origination standards affecting originator compensation, minimum repayment standards, and pre-payments.  Management is actively reviewing the provisions of the Dodd-Frank Act and assessing its probable impact on the Company’s and the Bank’s business, financial condition, and results of operations.

In August 2010, two updates were issued to amend various Securities and Exchange Commission (“SEC”)  rules and schedules pursuant to Release No. 33-9026: Technical Amendments to Rules, Forms, Schedules and Codification of Financial Reporting Policies and based on the issuance of SEC Staff Accounting Bulletin 112.  The amendments related primarily to business combinations and removed references to “minority interest” and added references to “controlling” and “noncontrolling interests(s)”.  The updates were effective upon issuance but had no material impact on the Company’s consolidated financial statements.

38 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(1)           Significant Accounting Policies, Continued

Disclosures about TDRs required by ASU 2010-20 were deferred by the Financial Accounting Standards Board (“FASB”) in ASU 2011-01 issued in January 2011. In April 2011 FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a TDR.   The determination is based on whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties as both events must be present. Disclosures related to TDRs under ASU 2010-20 will be effective for reporting periods beginning after June 15, 2011.

In December 2010, the Intangibles topic of the ASC was amended to modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. Any resulting goodwill impairment should be recorded as a cumulative-effect adjustment to beginning retained earnings upon adoption.  Impairments occurring subsequent to adoption should be included in earnings.  The amendment is effective for the Company beginning January 1, 2011. Early adoption is not permitted.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting authorities are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

 (r)         Risks and Uncertainties

In the normal course of its business, the Company encounters two significant types of risk: economic and regulatory.  There are three main components of economic risk: interest rate risk, credit risk, and market risk.  The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different bases, than its interest-earning assets.  Credit risk is the risk of default on the Company’s loan portfolio that results from borrowers’ inability or unwillingness to make contractually required payments.  Market risk reflects changes in the value of collateral underlying loans receivable, the valuation of real estate held by the Company, and the valuation of loans held for sale and mortgage-backed securities available for sale.  The Company is subject to the regulations of various government agencies.  These regulations can and do change significantly from period to period.  The Company also undergoes periodic examinations by the bank regulatory agencies, which may subject it to further changes with respect to asset valuations, amounts of required loss allowances, and operating restrictions, resulting from the regulators’ judgments based on information available to them at the time of their examination.

(s) Reclassifications

Certain amounts in prior years’ consolidated financial statements have been reclassified to conform to current year classifications.

39 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(2)      Investment and Mortgage-Backed Securities, Available for Sale

The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of investment and mortgage-backed securities available for sale are as follows:

	March 31, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
FHLB Securities	$	14,428,778	$	125,259	$	344,705	$	14,209,332
Federal Farm Credit Securities		1,997,097		9,503		-		2,006,600
Federal National Mortgage       Association (“FNMA”) and Federal       Home Loan Mortgage Corporation       (“FHLMC”) Bonds		11,959,119		-		298,129		11,660,990
Small Business Administration    (“SBA”) Bonds		64,382,588		599,679		272,435		64,709,832
Taxable Municipal Bond		4,556,812		12,039		97,201		4,471,650
Tax Exempt Municipal Bonds		2,027,172		7,771		-		2,034,943
Mortgage-Backed Securities		233,933,275		6,681,694		534,276		240,080,693
Equity Securities		102,938		-		24,188		78,750
	$	333,387,779	$	7,435,945	$	1,570,934	$	339,252,790
	March 31, 2010
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
FHLB Securities	$	9,209,585	$	204,066	$	43,750	$	9,369,901
Federal Farm Credit Securities		4,173,462		40,079		4,869		4,208,672
FNMA and FHLMC Bonds		5,993,806		-		30,536		5,963,270
SBA Bonds		36,955,783		313,976		83,698		37,186,061
Taxable Municipal Bond		3,192,950		32,976		-		3,225,926
Mortgage-Backed Securities		225,202,917		7,396,067		363,925		232,235,059
Equity Securities		102,938		-		30,788		72,150
	$	284,831,441	$	7,987,164	$	557,566	$	292,261,039

FHLB securities, Federal Farm Credit securities, FNMA bonds, and FNMA and FHLMC mortgage-backed securities are issued by government-sponsored enterprises (“GSEs”).  GSEs are not backed by the full faith and credit of the United States government.  SBA bonds are backed by the full faith and credit of the United States government. Included in the tables above and below in mortgage-backed securities are GNMA mortgage-backed securities, which are also backed by the full faith and credit of the United States government.  At March 31, 2011 and 2010, the Bank held an amortized cost and fair value of $145.1 million and $148.5 million, respectively, and $129.1 million and $132.4 million, respectively, in GNMA mortgage-backed securities included in mortgage-backed securities listed above. All mortgage-backed securities above are either GSEs or GNMA mortgage-backed securities. The balance does not include any private label mortgage-backed securities.

The amortized cost and fair value of investment and mortgage-backed securities available for sale at March 31, 2011 are shown below by contractual maturity.

40 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(2)      Investment and Mortgage-Backed Securities, Available for Sale, Continued

Expected maturities will differ from contractual maturities because borrowers have the right to prepay obligations with or without call or prepayment penalties.

	Amortized Cost		Fair Value
Less Than One Year	$	1,185,271	$	1,220,810
One – Five Years		8,470,565		8,536,060
Five – Ten Years		43,968,101		43,847,166
After Ten Years		45,830,567		45,568,061
Mortgage-Backed Securities		233,933,275		240,080,693
	$	333,387,779	$	339,252,790

At March 31, 2011 and 2010, the amortized cost and fair value of investment and mortgage-backed securities available for sale pledged as collateral for certain deposit accounts, FHLB advances and other borrowings were $131.4 million and $138.0 million, and $187.8 million and $194.2 million, respectively.

The Bank received approximately $65.0 million, $58.2 million and $10.1 million, respectively, in proceeds from sales of available for sale securities during the years ended March 31, 2011, 2010, and 2009. As a result, the Bank recognized approximately $1.5 million in gross gains and no gross losses for the year ended March 31, 2011, $1.2 million in gross gains and no gross losses for the year ended March 31, 2010 and $149,000 in gross gains and $22,000 in gross losses for the year ended March 31, 2009.

The following tables show gross unrealized losses and fair value, aggregated by investment category, and length of time that individual available for sale securities have been in a continuous unrealized loss position for the periods indicated.

March 31, 2011	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Securities	$	11,316,397	$	344,705	$	-	$	-	$	11,316,397	$	344,705
FNMA and FHLMC Bonds		11,660,990		298,129		-		-		11,660,990		298,129
SBA Bonds		22,878,098		272,435		-		-		22,878,098		272,435
Taxable Municipal Bond		2,452,620		97,201						2,452,620		97,201
Mortgage-Backed Securities		49,991,656		534,276		-		-		49,991,656		534,276
Equity Securities		-		-		78,750		24,188		78,750		24,188
	$	98,299,761	$	1,546,746	$	78,750	$	24,188	$	98,378,511	$	1,570,934

March 31, 2010	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Securities	$	2,956,250	$	43,750	$	-	$	-	$	2,956,250	$	43,750
Federal Farm Credit Securities		1,037,500		4,869		-		-		1,037,500		4,869
Mortgage-Backed Securities		36,866,308		363,925		-		-		36,866,308		363,925
FNMA and FHLMC Bonds		4,963,270		30,536		-		-		4,963,270		30,536
SBA Bonds		10,464,706		83,698		-		-		10,464,706		83,698
Equity Securities		-		-		72,150		30,788		72,150		30,788
	$	56,288,034	$	526,778	$	72,150	$	30,788	$	56,360,184	$	557,566

Securities classified as available-for-sale are recorded at fair market value.  At March 31, 2011, 1.5% of the unrealized losses, or one individual security, consisted of securities in a continuous loss position for 12 months or more.  At March 31, 2010, approximately 5.5% of the unrealized losses, or one individual security, consisted of securities in a continuous loss position for 12 months or more. The Company has the ability and intent to hold these securities until such time as the value recovers or the securities mature.  The Company believes, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and is not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary. The Company reviews its investment securities portfolio at least quarterly and more frequently when economic conditions warrant, assessing whether there is any indication of other-than-temporary impairment (“OTTI”). Factors considered in the review include estimated future cash flows, length of time and extent to which market value has been less than cost, the financial condition and near term prospects of the issuer, and our intent and ability to retain the security to allow for an anticipated recovery in market value.

41 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(2)      Investment and Mortgage-Backed Securities, Available for Sale, Continued

If the review determines that there is OTTI, then an impairment loss is recognized in earnings equal to the entire difference between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made, or may recognize a portion in other comprehensive income. The fair value of investments on which OTTI is recognized then becomes the new cost basis of the investment.

(3)       Investment and Mortgage-Backed Securities, Held to Maturity

The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of investment and mortgage-backed securities held to maturity are as follows:

	March 31, 2011
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLB Securities	$	10,040,055	$	297,670	$	694	$	10,337,031
SBA Bonds		3,856,483		242,167		-		4,098,650
Mortgage-Backed Securities		19,113,587		418,657		-		19,532,244
Equity Securities		155,000		-		-		155,000
	$	33,165,125	$	958,494	$	694	$	34,122,925

	March 31, 2010
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLB Securities	$	4,000,000	$	284,070	$	-	$	4,284,070
SBA Bonds		4,481,515		262,584		-		4,744,099
Mortgage-Backed Securities		10,148,865		522,072		-		10,670,937
Equity Securities		155,000		-		-		155,000
	$	18,785,380	$	1,068,726	$	-	$	19,854,106

FHLB securities, FNMA and FHLMC mortgage-backed securities are issued by GSEs.  GSEs are not backed by the full faith and credit of the United States government.  SBA bonds are backed by the full faith and credit of the United States government. Included in the tables above and below in mortgage-backed securities are GNMA mortgage-backed securities, which are also backed by the full faith and credit of the United States government.  At March 31, 2011 and 2010, the Bank held an amortized cost and fair value of $16.5 million and $16.8 million, respectively, and $5.6 million and $5.9 million, respectively, in GNMA mortgage-backed securities included in mortgage-backed securities listed above. All mortgage-backed securities above are either GSEs or GNMA mortgage-backed securities. The balance does not include any private label mortgage-backed securities.

The amortized cost and fair value of investment and mortgage-backed securities held to maturity at March 31, 2011, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities resulting from call features on certain investments.

	Amortized Cost		Fair Value
Less Than One Year	$	-	$	-
One – Five Years		6,979,674		7,295,577
Over Five – Ten Years		3,047,334		3,058,760
More Than Ten Years		4,024,530		4,236,344
Mortgage-Backed Securities		19,113,587		19,532,244
	$	33,165,125	$	34,122,925

At March 31, 2011 and 2010, the amortized cost and fair value of investment and mortgage-backed securities held to maturity pledged as collateral for certain deposit accounts, FHLB advances and other borrowings were $9.4 million and $9.9 million and $15.7 million and $16.6 million, respectively.

42 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(3)       Investment and Mortgage-Backed Securities, Held to Maturity, Continued

The Company had only one held to maturity security that was in an unrealized loss position at March 31, 2011. The fair value of this FHLB security was $1.0 million and the unrealized loss was $1,000. The security had been in an unrealized loss position for less than 12 months. The Company did not have any securities in an unrealized loss position at March 31, 2010. The Company’s held-to-maturity portfolio is recorded at amortized cost.  The Company has the ability and intends to hold these securities to maturity. There were no sales of securities held to maturity during the years ended March 31, 2011, 2010 or 2009.

(4)      Loans Receivable, Net

Loans receivable, net, at March 31 consisted of the following:

	2011			2010
Residential Real Estate Loans	$	111,028,021		$	118,256,972
Consumer Loans		64,862,668			68,526,203
Commercial Business		13,529,957			17,813,383
Commercial Real Estate		306,955,623			378,719,217
Loans Held For Sale		5,166,234			3,161,463
		501,542,503			586,477,238
Less:
Allowance For Loan Losses		12,501,800			12,307,394
Loans In Process		4,580,059			5,619,822
Deferred Loan Fees		(9,972	)		151,187
		17,071,887			18,078,403
Total Loans Receivable, Net	$	484,470,616		$	568,398,835

Changes in the allowance for loan losses for the years ended March 31 are summarized as follows:

	2011			2010			2009
Balance At Beginning Of Year	$	12,307,394		$	10,181,599		$	8,066,762
Provision For Loan Losses		7,800,000			8,155,000			2,825,000
Charge Offs		(8,116,667	)		(6,067,509	)		(745,275	)
Recoveries		511,073			38,304			35,112
Total Allowance For Loan Losses	$	12,501,800		$	12,307,394		$	10,181,599

The Company uses a risk based approach based on the following credit quality measures when analyzing the loan portfolio: pass, watch, special mention, and substandard. These indicators are used to rate the credit quality of loans for the purposes of determining the Company’s allowance for loan losses. Pass loans are loans that are performing and are deemed adequately protected by the net worth of the borrower or the underlying collateral value. These loans are considered the least risky in terms of determining the allowance for loan losses. Substandard loans are considered the most risky category. These loans typically have an identified weakness or weaknesses and are inadequately protected by the net worth of the borrower or collateral value. All loans 60 days or more past due are automatically classified in this category. The other two categories fall in between these two grades. The following table lists the loan grades used by the Company as credit quality indicators and the balance in each category at March 31, 2011, excluding loans held for sale.

	Credit Quality Measures
	Pass		Watch		Special Mention		Substandard		Total Loans
Residential Real Estate	$	104,826,411	$	433,710	$	379,036	$	5,388,864	$	111,028,021
Consumer		61,425,853		97,706		9,180		3,329,929		64,862,668
Commercial Business		12,059,761		6,285		-		1,463,911		13,529,957
Commercial Real Estate		230,031,130		10,786,846		30,462,062		35,675,585		306,955,623
Total	$	408,343,155	$	11,324,547	$	30,850,278	$	45,858,289	$	496,376,269

43 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4)      Loans Receivable, Net, Continued

The following table presents an age analysis of past due balances by category at March 31, 2011.

	30-59 Days Past Due		60-89 Days Past Due		90 Day or More Past Due		Total Past Due		Current		Total Loans Receivable
Residential    Real Estate	$	1,799,800	$	-	$	1,809,881	$	3,609,681	$	107,418,340	$	111,028,021
Consumer		2,673,973		196,958		1,194,171		4,065,102		60,797,566		64,862,668
Commercial    Business		93,579		133,399		171,901		398,879		13,131,078		13,529,957
Commercial    Real Estate		19,441,992		2,708,373		9,337,385		31,487,750		275,467,873		306,955,623
Total	$	24,009,344	$	3,038,730	$	12,513,338	$	39,561,412	$	456,814,857	$	496,376,269

At March 31, 2011, the Company did not have any loans that were 90 days or more past due and still accruing interest. Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the existing collateral.  In the event an acceptable arrangement cannot be reached, we may have to acquire these properties through foreclosure or other means and subsequently sell, develop, or liquidate them. The following table shows non-accrual loans by category at March 31, 2011 compared to March 31, 2010.

	At March 31, 2011					At March 31, 2010					$				%
	Amount		Percent (1)			Amount		Percent (1)			Increase (Decrease)			Increase (Decrease)
Non-accrual loans:
Residential real estate	$	1,809,881		0.4	%	$	4,344,060		0.8	%	$	(2,534,179	)		(58.3	)%
Commercial business		171,901		-			699,182		0.1			(527,281	)		(75.4	)
Commercial real estate		9,337,385		1.9			25,479,420		4.4			(16,142,035	)		(63.4	)
Consumer		1,194,171		0.2			703,288		0.1			490,883			69.8
Total non-accural loans	$	12,513,338		2.5	%	$	31,225,950		5.4	%	$	(18,712,612	)		(59.9	)%

(1) Percent of gross loans receivable, net of deferred fees and loans in process and loans held for sale

The following table presents information related to impaired loans evaluated individually for impairment and collectively evaluated for impairment in the allowance for loan losses.

		Allowance For Loan Losses
March 31, 2011		Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	-	$	1,702,864	$	1,702,864
Consumer		41,100		1,080,955		1,122,055
Commercial Business		240,648		683,501		924,149
Commercial Real Estate		490,728		8,262,004		8,752,732
Total	$	772,476	$	11,729,324	$	12,501,800

		Loans Receivable
March 31, 2011		Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	2,278,966	$	108,749,055	$	111,028,021
Consumer		1,436,829		63,425,839		64,862,668
Commercial Business		770,011		12,759,946		13,529,957
Commercial Real Estate		28,811,862		278,143,761		306,955,623
Total	$	33,297,668	$	463,078,601	$	496,376,269

44 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4)      Loans Receivable, Net, Continued

Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired management measures impairment and records the loan at fair value. Fair value is estimated using one of the following methods: fair value of the collateral less estimated costs to sale, discounted cash flows, or market value of the loan based on similar debt. The fair value of the collateral less estimated costs to sell is the most frequently used method. Typically, the Company reviews the most recent appraisal and if it is over 24 months old will request a new third party appraisal. Depending on the particular circumstances surrounding the loan, including the location of the collateral, the date of the most recent appraisal and the value of the collateral relative to the recorded investment in the loan, management may order an independent appraisal immediately or, in some instances, may elect to perform an internal analysis.

The average balance of impaired loans was $37.2 million for year ended March 31, 2011 compared to $33.6 million in the prior year. The following table is a summary of information related to impaired loans as of March 31, 2011.

Impaired Loans		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance    recorded:
Residential Real Estate	$	2,278,966	$	2,683,966	$	-	$	1,458,882	$	51,267
Consumer Loans		1,376,161		1,583,160		-		729,889		56,764
Commercial Business		499,481		499,481		-		327,785		14,790
Commercial Real Estate		26,387,167		27,948,568		-		30,244,873		1,361,177
With an allowance recorded:
Residential Real Estate		-		-		-		41,879		-
Consumer Loans		60,668		60,668		41,100		124,089		-
Commercial Business		270,530		270,530		240,648		207,073		4,833
Commercial Real Estate		2,424,695		2,614,695		490,728		4,018,967		44,337
Total
Residential Real Estate		2,278,966		2,683,966		-		1,500,761		51,267
Consumer Loans		1,436,829		1,643,828		41,100		853,978		56,764
Commercial Business		770,011		770,011		240,648		534,858		19,623
Commercial Real Estate		28,811,862		30,563,263		490,728		34,263,840		1,405,514

The following table presents the loans individually evaluated and considered impaired at March 31. Impairment includes performing troubled debt restructurings.

	2011		2010
Total Loans Considered Impaired At Year End	$	33,297,668	$	35,298,754
Impaired Loans For Which There Is A Related Specific Reserve For Loan Loss:
Outstanding Loan Balance	$	2,755,893	$	10,885,245
Related Specific Reserve	$	772,476	$	2,015,000
Impaired Loans With No Related Specific Reserve	$	30,541,775	$	24,413,509
Average Impaired Loans	$	37,153,438	$	33,633,408

TDRs included in impaired loans at March 31, 2011 and 2010 amounted to $12.2 million and $336,000, respectively. Interest earned during fiscal 2011, 2010 and 2009 on these loans amounted to $649,348, $105,677 and $34,031, respectively.

45 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(5)       Premises and Equipment, Net

Premises and equipment, net, at March 31 are summarized as follows:

	2011			2010
Land	$	5,471,503		$	5,471,503
Buildings And Improvements		17,592,015			17,277,914
Furniture And Equipment		10,756,795			10,313,133
Construction In Progress		97,463			286,842
		33,917,776			33,349,392
Less Accumulated Depreciation		(14,117,160	)		(12,628,908	)
Total Premises And Equipment, Net	$	19,800,616		$	20,720,484

Depreciation expense for the years ended March 31, 2011, 2010, and 2009 was $1.5 million, $1.6 million, and $1.5 million, respectively. The Bank has entered into non-cancelable operating leases related to buildings and land.  At March 31, 2011, future minimum payments under non-cancelable operating leases with initial or remaining terms of one year or more are as follows (by fiscal year):

2012	$	404,213
2013		404,451
2014		411,463
2015		411,463
2016		324,487
Thereafter		1,563,869
	$	3,519,946

Total rental expense amounted to $434,000, $434,000, and $441,000 for the years ended March 31, 2011, 2010 and 2009, respectively.  Four lease agreements with monthly expenses of $6,179, $800, $7,792, and $8,250 have multiple renewal options totaling 30, 10, 45, and 20 years, respectively.

(6)       Intangible Assets and Goodwill

Intangible assets and goodwill are the result of the Collier Jennings acquisition in July 2006.  Changes in intangible assets and goodwill for the years ended March 31 consisted of the following:

	2011		2010
Customer List
Balance At Beginning Of Year	$	178,246	$	241,246
Amortization		50,000		50,000
Write Down Due To Sale of South    Augusta Office Location		-		13,000
Balance At End Of Year		128,246		178,246
Employment Contracts
Balance At Beginning Of Year		71,254		111,254
Amortization		40,000		40,000
Balance At End Of Year		31,254		71,254
Total Intangibles		159,500		249,500
Goodwill		1,199,754		1,199,754
Total	$	1,359,254	$	1,449,254

In accordance with accounting guidance, the Company evaluates its goodwill on an annual basis. The evaluations were performed as of September 30, 2010 and September 30, 2009 for fiscal years ended March 31, 2011 and March 31, 2010, respectively. At the time of the evaluations the Company determined that no impairment existed. Therefore, there was no amortization of goodwill for the years ended March 31, 2011 and 2010. Amortization of the intangibles is scheduled to be as follows for each fiscal year as indicated:

2012	$	90,000
2013		69,500
	$	159,500

46

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(7)       FHLB Stock

Every federally insured savings institution is required to invest in FHLB stock.  No readily available market exists for this stock and it has no quoted fair value.  However, because redemption of this stock has historically been at par, it is carried at cost.

The Bank, as a member of the FHLB of Atlanta, is required to acquire and hold shares of capital stock in the FHLB of Atlanta in an amount equal to a membership component, which is 0.15% of total assets at December 31, 2010 and 2009 plus a transaction component which equals 4.5% of outstanding advances (borrowings) from the FHLB of Atlanta.  The Bank is in compliance with this requirement with an investment in FHLB of Atlanta stock of $11.3 million and $12.6 million as of March 31, 2011 and 2010, respectively.

(8)       Repossessed Assets Acquired In Settlement Of Loans

The Bank owned $14.4 million and $10.8 million in repossessed assets acquired in settlement of loans at March 31, 2011 and 2010, respectively. Transactions in repossessed assets for the years ended March 31, 2011 and 2010 are summarized below:

	March 31,
	2011			2010
Balance, beginning of year	$	10,773,050		$	1,985,172
Additions		15,581,977			10,573,654
Capital Improvements		549,458			-
Sales		(11,061,070	)		(1,281,196	)
Write Downs		(1,409,562	)		(504,580	)
Balance, end of year	$	14,433,853		$	10,773,050

(9)       Deposits

Deposits outstanding by type of account are summarized as follows:

		At March 31, 2011								At March 31, 2010
				Weighted Rate			Interest Rate Range			Amount		Weighted Rate			Interest Rate Range
Checking Accounts		$	117,077,343		0.09	%		0.00-0.60	%	$	109,086,367		0.20	%		0.00-1.04	%
Money Market Accts.			194,560,099		0.85	%		0.30-0.90	%		173,904,664		1.28	%		0.00-1.39	%
Statement Savings  Accounts			20,582,505		0.24	%		0.00-0.30	%		18,991,543		0.39	%		0.00-0.50	%
Total			332,219,947		0.54	%		0.00-0.60	%		301,982,574		0.83	%		0.00-1.39	%
Certificate Accounts:
	0.00 – 1.99%		239,078,153								118,796,507
	2.00 – 2.99%		107,386,573								255,352,355
	3.00 – 3.99%		3,307,422								4,571,860
	4.00 – 4.99%		5,272,507								8,818,487
	5.00 – 5.99%		3,092,512								4,730,654
Total			358,137,167		1.71	%		0.15-5.50	%		392,269,863		2.15	%		0.15-5.50	%
Total Deposits		$	690,357,114		1.15	%		0.00-5.50	%	$	694,252,437		1.58	%		0.00-5.50	%

Included in the certificate accounts above at March 31, 2011 and 2010 were $39.7 million and $34.4 million, respectively, in brokered deposits with a weighted average interest rate of 2.18% and 2.07%, respectively. Of the brokered deposits at March 31, 2011, $12.5 million mature within one year.

The aggregate amount of certificates of deposit with a minimum denomination of $100,000 was $172.2 million and $195.9 million at March 31, 2011 and 2010, respectively.

47 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(9)       Deposits, Continued

The amounts and scheduled maturities of all certificates of deposit at March 31 are as follows:

	March 31,
	2011		2010
Within 1 Year	$	243,178,999	$	309,313,273
After 1 Year, Within 2 Years		70,524,910		47,747,609
After 2 Years, Within 3 Years		10,601,023		18,670,608
After 3 Years, Within 4 Years		15,014,756		6,965,710
After 4 Years, Within 5 Years		18,817,479		9,572,663
Thereafter		-		-
	$	358,137,167	$	392,269,863

At March 31, 2011 and 2010, the Bank has $34,000 and $104,000, respectively, in overdrafts that were reclassified to loans.

(10)    Advances From Federal Home Loan Bank (FHLB) And Other Borrowings

Advances from the FHLB at March 31 are summarized by year of maturity and weighted average interest rate below:

	2011					2010
Year Ending March 31	Amount		Weighted Rate			Amount		Weighted Rate
2011	$	-		-		$	31,100,000		2.54	%
2012		24,950,000		2.22	%		34,700,000		3.66	%
2013		10,000,000		4.76	%		10,000,000		4.76	%
2014		30,000,000		3.45	%		20,000,000		3.84	%
2015		20,286,338		3.01	%		15,303,882		3.44	%
2016		20,000,000		4.12	%		20,000,000		4.12	%
Thereafter		32,900,000		4.36	%		32,900,000		4.36	%
	$	138,136,338		3.57	%	$	164,003,882		3.71	%

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 an amortized cost and fair value of $168.2 million and $172.9 million, respectively, at March 31, 2011 and $130.8 million and $136.0 million, respectively, at March 31, 2010. Advances are subject to prepayment penalties.

The following tables show callable FHLB advances as of the dates indicated.  These advances are also included in the above table.  All callable advances are callable at the option of the FHLB.  If an advance is called, the Bank has the option to payoff the advance without penalty, re-borrow funds on different terms, or convert the advance to a three-month floating rate advance tied to LIBOR.

As of March 31, 2011
Borrow Date	Maturity Date		Amount	Int. Rate	Type	Call Dates
11/23/05	11/23/15	$	5,000,000	3.933%	Multi-Call	05/23/08 and quarterly thereafter
06/02/06	06/02/16		5,000,000	5.160%	1 Time Call	06/02/11
07/11/06	07/11/16		5,000,000	4.800%	Multi-Call	07/11/08 and quarterly thereafter
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	06/09/10 and quarterly thereafter
05/24/07	05/24/17		7,900,000	4.375%	Multi-Call	05/27/08 and quarterly thereafter
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
08/28/08	08/28/13		5,000,000	3.113%	Multi-Call	08/30/10 and quarterly thereafter
08/28/08	08/28/18		5,000,000	3.385%	1 Time Call	08/29/11

48 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(10)         Advances From Federal Home Loan Bank (FHLB) And Other Borrowings, Continued

As of March 31, 2010
Borrow Date	Maturity Date		Amount		Int. Rate	Type	Call Dates
06/24/05	06/24/15	$	5,000,000	3	3.710%	1 Time Call	06/24/10
11/23/05	11/23/15		5,000,000		3.933%	Multi-Call	05/25/08 and quarterly thereafter
01/12/06	01/12/16		5,000,000		4.450%	1 Time Call	01/12/11
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
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	06/09/10 and quarterly thereafter
05/24/07	05/24/17		7,900,000		4.375%	Multi-Call	05/27/08 and quarterly thereafter
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
08/28/08	08/28/13		5,000,000		3.113%	Multi-Call	08/30/10 and quarterly thereafter
08/28/08	08/28/18		5,000,000		3.385%	1 Time Call	08/29/11

At March 31, 2011 and 2010, the Bank had $140.9 million and $124.1 million in additional borrowing capacity, respectively, at the FHLB.

The Bank had $11.2 million and $12.1 million in other borrowings at March 31, 2011 and 2010, respectively.  These borrowings consist of short-term repurchase agreements with certain commercial demand deposit customers for sweep accounts. 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 March 31, 2011 and 2010 the interest rate paid on the repurchase agreements was 0.40% and 0.80%, respectively. The maximum amount outstanding at any one month end during the year ended March 31, 2011 was $12.3 million compared to $12.5 million in 2010. The Bank had pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $22.7 million and $23.7 million, respectively, at March 31, 2011 and $20.6 million and $21.3 million, respectively, at March 31, 2010.

 (11)    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 $5.2 million. The Trust loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank.

The Capital Securities accrue and pay distributions annually at a rate per annum equal to a blended rate of 4.45% at March 31, 2011.  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 2.01% at March 31, 2011. The distribution rate payable on the Capital Securities is cumulative and payable quarterly in arrears. The Company has the right, subject to events of default, to defer payments of interest on the Capital Securities for a period not to exceed 20 consecutive quarterly periods, provided that no extension period may extend beyond the maturity date of December 15, 2036. The Company has no current intention to exercise its right to defer payments of interest on the Capital Securities.

The Capital Securities mature or are mandatorily redeemable upon maturity on December 15, 2036, and or upon earlier optional redemption as provided in the indenture. The Company has the right to redeem the Capital Securities in whole or in part, on or after September 15, 2011. The Company may also redeem the capital securities prior to such dates upon occurrence of specified conditions and the payment of a redemption premium.

49 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(12)    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 Collier-Jennings Companies received cash and was issued stock in the Company to settle the acquisition.  The shares were released to the shareholder of Collier-Jennings Companies over a three-year period.  The stock is mandatorily redeemable at the option of the shareholder of Collier-Jennings Companies in cumulative increments of 20% per year for a five-year period at the greater of $26 per share or one and one-half times the book value per common share of the Company’s stock.

The mandatorily redeemable financial instrument is carried at fair value. At March 31, 2011 and 2010, the fair value was $1.5 million and $1.7 million, respectively, based on the Company’s book value per common share. The Company recorded a valuation gain of $196,000 during the year ended March 31, 2011 compared to a valuation expense of $63,000 during the year ended March 31, 2010 to properly reflect the fair value of the instrument.

On April 11, 2011, the Company eliminated the mandatorily redeemable shares of the Company’s common stock as a result of an investor’s purchase of these shares in a private transaction.  In connection with the purchase of these shares, the redemption feature was eliminated.  As a result, the Company no longer has the liability related to these shares on its balance sheet and the Company’s capital increased by $1.5 million subsequent to March 31, 2011.

(13) Senior Convertible Debentures

Effective December 1, 2009, the Company issued $6.1 million in convertible senior debentures. The debentures will mature on December 1, 2029 and accrue interest at the rate of 8.0% per annum until maturity or earlier redemption or repayment. Interest on the debentures is payable on June 1 and December 1 of each year, and commenced June 1, 2010. The debentures are convertible into the Company’s common stock at a conversion price of $20 per share at the option of the holder at any time prior to maturity.

The debentures are redeemable, in whole or in part, at the option of the Company at any time on or after December 1, 2019, at a price equal to 100% of the principal amount of the debentures to be purchased plus any accrued and unpaid interest to, but excluding, the date of redemption. The debentures are unsecured general obligations of the Company ranking equal in right of payment to all of our present and future unsecured indebtedness that is not expressly subordinated.

50 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(14)     Income Taxes

Income tax expense is comprised of the following:

	For the Years Ended March 31,
	2011			2010			2009
Current:
Federal	$	1,755,393		$	1,879,069		$	1,613,555
State		336,011			320,729			359,275
Total Current Tax Expense		2,091,404			2,199,798			1,972,830
Deferred:
Federal		(1,025,678	)		(1,030,802	)		(589,881	)
State		(107,593	)		(108,791	)		(118,532	)
Total Deferred Tax Expense		(1,133,271	)		(1,139,593	)		(708,413	)
Total Income Tax Expense	$	958,133		$	1,060,205		$	1,264,417

The Company's income taxes differ from those computed at the statutory federal income tax rate, as follows:

	For the Years Ended March 31,
	2011			2010		2009
Tax At Statutory Income Tax Rate	$	952,356		$	906,102	$	1,264,049
State Tax And Other		(23,555	)		124,896		(27,680	)
Valuation Allowance		29,332			29,207		28,048
Total Income Tax Expense	$	958,133		$	1,060,205	$	1,264,417

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented below.

	At March 31,
	2011		2010
Deferred Tax Assets:
Deferred Compensation	$	479,864	$	372,663
Provision For Loan Losses		4,730,250		4,671,808
Other Real Estate Owned		915,742		189,979
Net Fees Deferred For Financial Reporting		149,942		154,841
Non-accrual Interest		573,071		342,434
Net Operating Losses		205,192		175,860
Other		94,494		117,590
Total Gross Deferred Tax Assets		7,148,555		6,025,175
Less: Valuation Allowance		205,192		175,860
Net Deferred Tax Assets		6,943,363		5,849,315
Deferred Tax Liabilities:
FHLB Stock Basis Over Tax Basis		126,565		126,565
Depreciation		612,383		588,685
Other		103,614		132,966
Intangibles		59,494		93,063
Unrealized Gain on Securities Available for Sale		2,235,538		2,831,963
Total Gross Deferred Tax Liability		3,137,594		3,773,242
Net Deferred Tax Asset	$	3,805,769	$	2,076,073

Deferred tax assets represent the future tax benefit of deductible differences and, if it is more likely than not that a tax asset will not be realized, a valuation allowance is required to reduce the recorded deferred tax assets to net realizable value. As of March 31, 2011, management has determined that it is more likely than not that the total deferred tax asset will be realized except for the deferred tax asset associated with State net operating loss carryforwards, and, accordingly, has established a valuation allowance only for this item. Net deferred tax assets are included in other assets at March 31, 2011 and 2010. The Company has state net operating losses of $6.2 million and $5.3 million for the years ended March 31, 2011 and 2010, respectively.

51 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(15)     Regulatory Matters

The Bank is subject to various regulatory capital requirements that are administered by federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that could have a material adverse effect on the Company.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.

The Bank’s capital amounts and classifications are also subject to qualitative judgments by regulators with regard to components, risk weightings, and other factors.

As of March 31, 2011 and 2010, the Bank was categorized as “well capitalized” under the regulatory framework for prompt corrective action.  To be categorized as well capitalized, the Bank had to maintain total risk-based capital, Tier 1 risk-based capital, and Tier 1 leverage ratios at 10%, 6%, and 5%, respectively.  There are no conditions or events that management believes have changed the Bank’s classification.

The Bank’s regulatory capital amounts and ratios are as follows as of the dates indicated:

	Actual					For Capital Adequacy					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in Thousands)
March 31, 2011
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	76,399		15.4	%	$	19,900		4.0	%	$	29,850		6.0	%
Total Risk-Based Capital (To Risk Weighted Assets)		82,618		16.6	%		39,801		8.0	%		49,751		10.0	%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)		76,399		8.3	%		37,060		4.0	%		46,325		5.0	%
Tangible Capital (To Tangible Assets)		76,399		8.3	%		18,530		2.0	%		46,325		5.0	%
March 31, 2010
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	70,280		12.1	%	$	23,274		4.0	%	$	34,911		6.0	%
Total Risk-Based Capital (To Risk Weighted Assets)		77,576		13.3	%		46,548		8.0	%		58,185		10.0	%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)		70,280		7.4	%		37,987		4.0	%		47,484		5.0	%
Tangible Capital (To Tangible Assets)		70,280		7.4	%		18,993		2.0	%		47,484		5.0	%

The payment of dividends by the Company depends primarily on the ability of the Bank to pay dividends to the Company.  The payment of dividends by the Bank to the Company is subject to substantial restrictions and would require prior notice to the OTS.

(16)     Employee Benefit Plans

The Company is participating in a multiple employer defined contribution employee benefit plan covering substantially all employees with six months or more of service.  The Company matches a portion of the employees’ contributions and the plan has a discretionary profit sharing provision.  The total employer contributions were $221,000, $217,000, and $198,000 for the years ended March 31, 2011, 2010, and 2009, respectively.

The Company has an Employee Stock Purchase Plan (“ESPP”).  The ESPP allows employees of the Company to purchase stock quarterly through a payroll deduction at a discount calculated as 15% of the market value with a floor equal to the Company’s book value.  The ESPP, which was approved by stockholders in July 2005, became effective in January 2007.

52 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(16)     Employee Benefit Plans, Continued

Participation in the ESPP is voluntary.  Employees are limited to investing $25,000 or 5% of their annual salary, whichever is lower, during the year.  During the year ended March 31, 2011, there were no employee stock purchases within the plan.

Certain officers of the Company participate in a supplemental retirement plan.  These benefits are not qualified under the Internal Revenue Code and they are not funded.  During the years ended March 31, 2011, 2010 and 2009, the Company incurred expenses of $282,000, $304,000 and $287,000, respectively, for this plan.

Certain officers and directors of the Company participate in incentive and non-qualified stock option plans. Prior to fiscal 2010, the Company had three stock option plans that together authorized the Company to grant 150,000 options. In 2008, the 2008 Equity Incentive Plan was approved by stockholders and implemented by the Company with the intention of replacing the previous three option plans. No additional options are to be granted under the old plans and forfeitures under the old plans are not added to the new plan as available options, however all existing options outstanding under these plans remain in effect. The 2008 Equity Incentive Plan provides for the grant of non-qualified and incentive stock options, stock appreciation rights (“SARS”), and restricted stock awards. Under the 2008 Stock Option Plan, 50,000 shares are reserved for the issuance of stock options and stock appreciation rights in addition to 50,000 shares subject to restricted stock awards. The plan is administered by a Committee appointed by the Board of Directors. The Committee determines the specific employees, amount and type of any awards granted. At March 31, 2011 and 2010, there were 50,000 shares available for issuance under this plan.

Options under all plans are granted at exercise prices not less than the fair value of the Company’s common stock on the date of the grant.  The following is a summary of the activity under the Company’s incentive and non-qualified stock option plans for the years ended March 31, 2011, 2010, and 2009:

	2011				2010				2009
	Shares		Weighted Avg. Exercise Price		Shares		Weighted Avg. Exercise Price		Shares		Weighted Avg. Exercise Price
Balance, Beginning of Year		90,900	$	22.57		100,500	$	22.01	$	111,100	$	21.55
Options Granted		-		-		-		-		4,500		22.91
Options Exercised		-		-		-		-		6,000		16.67
Options Forfeited		9,500		23.09		9,600		16.67		9,100		20.32
Balance, March 31		81,400	$	22.51		90,900	$	22.57		100,500	$	22.01
Total Intrinsic Value Of Options    Exercised During The Year		-				-			$	21,030
Weighted-Average Fair Value Of    Options Granted During The Year		-				-			$	5.54
Options Exercisable		49,900	$	21.91		50,400	$	21.93		60,000	$	21.09
Weighted- Average Remaining Life Of    Exercisable Options	3.4 years				4.4 years				4.6 years
Options Available For Grant		50,000				50,000				50,000

No additional stock options vested during the years ended March 31, 2011, 2010, and 2009. The aggregate intrinsic value of the stock options outstanding and exercisable at March 31, 2011, 2010 and 2009 amounted to $0 for all periods. Total compensation expense related to stock options was $34,000, $33,000, and $33,000 for the periods ended March 31, 2011, 2010 and 2009, respectively.  As of March 31, 2011, there was $178,000 of total unrecognized compensation cost related to non-vested stock options.  The cost is expected to be recognized over a weighted average period of five years.

53 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(16)     Employee Benefit Plans, Continued

The following table summarizes the stock-based awards granted by the Company, the fair market value of each award granted as estimated on the date of grant using the Black-Scholes option-pricing model, and the weighted average assumptions used for such grants for the periods indicated:

	For Awards Granted During The Year Ended March 31,
	2011	2010	2009
Awards Granted	-	-	4,500
Dividend Yield	-	-	1.77%
Weighted Average Expected     Volatility	-	-	17.89%
Risk-free Interest Rate	-	-	3.77%
Expected Life	-	-	9.00

At March 31, 2011, the Company had the following options outstanding:

Grant Date	Outstanding Options	Option Price	Expiration Date
09/01/03	2,400	$24.00	08/31/13
12/01/03	3,000	$23.65	11/30/13
01/01/04	5,000	$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	4,000	$23.91	01/01/16
08/24/06	5,000	$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	17,000	$23.49	01/01/18
05/19/08	2,500	$22.91	05/19/18
07/01/08	2,000	$22.91	07/01/18

All options granted prior to March 31, 2006 are 100% vested. Options granted after March 31, 2006 generally vest 20% per year every year beginning in the sixth year after the grant date.  Those options granted after March 31, 2006 may be exercised as they vest in years six through ten, or until the end of year ten after the grant date.

(17)     Stock Warrants

In conjunction with its participation in the U.S. Treasury’s (“Treasury”) Capital Purchase Program in 2008, the Company sold a warrant to the Treasury to purchase 137,966 shares of the Company’s common stock. The warrant has a 10-year term and was immediately exercisable upon issuance. At March 31, 2011, the warrant was anti-dilutive. There were no changes in the Company’s stock warrants during the year ended March 31, 2011 and 2010.

54 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(18)     Bank Owned Life Insurance

The cash value of the life insurance policies are recorded as a separate line item in the accompanying balance sheets at $10.4 million, $10.0 million and $9.6 million at March 31, 2011, 2010 and 2009, respectively.  The insurance provides key person life insurance on certain officers of the Company.  The earnings-portion of the insurance policies grows tax deferred and helps offset the cost of the Company’s benefits programs.  The Company recorded earnings of $415,000, $360,000 and $358,000 for the growth in the cash value of life insurance during the years ended March 31, 2011, 2010 and 2009, respectively.

(19)     Commitments and Contingencies

In the ordinary course of business, the Company has various outstanding commitments and contingent liabilities that are not reflected in the accompanying consolidated financial statements.  In addition, the Company is a defendant in certain claims and legal actions arising in the ordinary course of business.  In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial condition of the Company.

In conjunction with its lending activities, the Bank enters into various commitments to extend credit and issue letters of credit.  Loan commitments (unfunded loans and unused lines of credit) and letters of credit are issued to accommodate the financing needs of the Bank's customers.  Loan commitments are agreements by the Bank to lend at a future date, so long as there are no violations of any conditions established in the agreement.  Letters of credit commit the Bank to make payments on behalf of customers when certain specified events occur.

Financial instruments where the contract amount represents the Bank's credit risk include commitments under pre-approved but unused lines of credit of $33.1 million and $45.1 million, undisbursed loans in process of $4.6 million and $5.6 million, and letters of credit of $1.5 million and $649,000 at March 31, 2011 and 2010, respectively.

These loan and letter of credit commitments are subject to the same credit policies and reviews as loans on the balance sheet.  Collateral, both the amount and nature, is obtained based upon management's assessment of the credit risk.  Since many of the extensions of credit are expected to expire without being drawn, the total commitment amounts do not necessarily represent future cash requirements.  In addition to these loan commitments noted above, the Bank had unused credit card loan commitments of $4.4 million and $4.6 million at March 31, 2011 and 2010, respectively.  Outstanding commitments on mortgage loans not yet closed amounted to $431,000 and $494,000 at March 31, 2011 and 2010, respectively.  These commitments, which are funded subject to certain limitations, extend over varying periods of time with the majority being funded within 45 days.  At March 31, 2011 and 2010, the Bank had outstanding commitments to sell approximately $5.2 million and $3.2 million of loans, respectively, which encompassed the Bank’s held for sale loans.  The Bank also has commitments to sell mortgage loans not yet closed, on a best efforts basis.  Best efforts means the Bank suffers no penalty if they are unable to deliver the loans to the potential buyers.  The fair value of the Bank’s commitment to originate mortgage loans at committed interest rates and to sell such loans to permanent investors is insignificant.

(20)    Related Party Transactions

Certain directors, executive officers and companies with which they are affiliated are customers of and have banking transactions with the Bank in the ordinary course of business. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable arms-length transactions.

A summary of loan transactions with directors, including their affiliates, and executive officers follows:

	For the Years Ended March 31,
	2011		2010		2009
Balance, Beginning of Year	$	460,115	$	1,274,769	$	1,172,101
New Loans		43,620		65,933		161,819
Less Loan Payments		147,390		880,587		59,151
Balance, End of Year	$	356,345	$	460,115	$	1,274,769

55 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(20)     Related Party Transactions, Continued

Loans to all employees, officers, and directors of the Company, in the aggregate constituted approximately 5.1% and 8.2% of the Company’s total shareholders' equity at March 31, 2011 and 2010, respectively.  At March 31, 2011 and 2010, deposits from executive officers and directors of the Bank and Company and their related interests in the aggregate approximated $4.5 million and $4.7 million, respectively.

The Company leased office space from two related parties during the year ended March 31, 2011. The first lease is with a company in which a director and an officer of the Company and the Bank have an ownership interest.  The Company incurred expenses of $74,000, $73,000, and $74,000 for rent for the years ended March 31, 2011, 2010, and 2009, respectively, related to this lease.  The Company also leases office space from another officer.  On this lease, the Company incurred rent expense of $41,400 per year during each of the years ended March 31, 2011, 2010 and 2009, respectively.   Management is of the opinion that the transactions with respect to office rent are made on terms that are comparable to those which would be made with unaffiliated persons.

(21)    Stock Issuance and Exchange

The Company was approved to participate in the Treasury’s CDCI.  The CDCI was established by the Treasury to invest lower cost capital in Community Development Financial Institutions (“CDFI”), supporting their efforts to provide credit to small businesses and other qualified customers during this challenging economic period.

In connection with its participation in the CDCI, on September 29, 2010, the Company (i) exchanged all $18.0 million aggregate liquidation preference amount of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), previously sold to the Treasury pursuant to the Troubled Asset Relief Program Capital Purchase Program (“CPP”), for $18.0 million aggregate liquidation amount of the Company’s newly designated Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Stock”), (ii) sold 400,000 shares of its common stock at $10.00 per share in a private offering to board members of the Company as a result of a required match, for aggregate gross proceeds of $4.0 million; and (iii) received an additional $4.0 million investment from the Treasury through the sale of an additional $4.0 million aggregate liquidation preference amount of Series B Preferred Stock to the Treasury.  The additional $4.0 million investment from the Treasury was contingent upon the Company’s completion of the $4.0 million separate stock offering for the same amount, as required by the Company’s primary regulator, the OTS.

Participation in the CDCI provided the Company with $8.0 million in additional capital and lowered the cost of the capital received from the Treasury.  The annual dividend rate on the Series A Preferred Stock was 5% and was to have increased to 9% on February 15, 2014.  The annual dividend rate on the Series B Preferred Stock will be 2% for the first eight years from the date of issuance and 9% thereafter if still then outstanding.  The Company and Security Federal Bank must maintain eligibility as a CDFI under Treasury regulations, otherwise, the annual dividend rate on the Series B Preferred Stock will increase to 5% if it is not corrected within 180 days and will further increase to 9% if not corrected after 270 days.

In addition, on December 22, 2010, the Company sold 82,906 shares of its common stock, $0.01 par value per share, through a private placement. The purchase price was $10.00 per share and the net proceeds received from the sale of these shares was $829,060. This was the final phase in the Company’s current plan to raise additional capital.

56 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(22)     Security Federal Corporation Condensed Financial Statements (Parent Company Only)

The following is condensed financial information of Security Federal Corporation (Parent Company only).  The primary asset is its investment in the Bank subsidiary and the principal source of income for the Company is equity in undistributed earnings from the Bank.

Condensed Balance Sheet Data

	At March 31,
	2011		2010
Assets:
Cash	$	5,422,037	$	4,312,637
Investment Securities, Available For Sale		78,750		72,150
Investment in Security Federal Statutory Trust		155,000		155,000
Loans Receivable, Net		1,786,294		-
Property and Equipment, Net		-		1,665
Investment In Security Federal Bank		81,411,687		76,357,173
Accounts Receivable And Other Assets		36,616		37,409
Total Assets	$	88,890,384	$	80,936,034
Liability And Shareholders’ Equity:
Accounts Payable And Other Liabilities	$	173,167	$	173,103
Other Borrowings		-		-
Junior Subordinated Debentures		5,155,000		5,155,000
Senior Convertible Debentures		6,084,000		6,084,000
Mandatorily Redeemable Financial Instrument		1,467,312		1,663,312
Shareholders’ Equity		76,010,905		67,860,619
Total Liabilities And Shareholders’ Equity	$	88,890,384	$	80,936,034

Condensed Statements of Income Data

	For the Years Ended March 31,
	2011			2010			2009
Income:
Equity In Earnings Of Security Federal Bank	$	2,029,275		$	2,004,759		$	2,852,426
Interest Income		91,806			10,163			8,734
Miscellaneous Income		24,803			7,199			158
Total Income		2,145,884			2,022,121			2,861,318
Expenses:
Interest Expense		720,081			474,133			440,409
Mandatorily Redeemable Financial Instrument    Valuation (Income) Expense		(196,000	)		63,000			183,000
Other Expenses		37,757			38,982			29,119
Total Expenses		561,838			576,115			652,528
Income Before Income Taxes		1,584,046			1,446,006			2,208,790
Income Tax Benefit		(258,867	)		(158,795	)		(244,583	)
Net Income		1,842,913			1,604,801			2,453,373
Preferred Stock Dividends		666,453			900,000			252,500
Accretion of Preferred Stock to Redemption Value		18,816			72,544			20,065
Net Income Available to Common Shareholders	$	1,157,644		$	632,257		$	2,180,808

57 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(22)         Security Federal Corporation Condensed Financial Statements (Parent Company Only), Continued

Condensed Statements of Cash Flow Data

	For the Years Ended March 31,
	2011			2010			2009
Operating Activities:
Net Income	$	1,842,913		$	1,604,801		$	2,453,373
Adjustments To Reconcile Net Income To Net Cash Provided By (Used     In) Operating Activities:
Equity In Earnings Of Security Federal Bank		(2,029,275	)		(2,004,759	)		(2,852,426	)
Stock Compensation Expense		34,424			33,124			32,691
Mandatorily Redeemable Financial Instrument Valuation (Income) Expense		(196,000	)		63,000			183,000
(Increase) Decrease In Accounts Receivable And Other Assets		214			194,933			(142,780	)
Increase (Decrease) In Accounts Payable		(1,236	)		143,154			(16,931	)
Net Cash Provided By (Used In) Operating Activities		(348,960	)		34,253			(343,073	)
Investing Activities:
Increase In Loans Receivable		(1,786,294	)		-			-
Additional Investment in Security Federal Bank		(4,000,000	)		-			(13,000,00	)
Net Cash Used In Investing Activities		(5,786,294	)		-			(13,000,000	)
Financing Activities:
Exercise Of Stock Options		-			-			100,020
Employee Stock Purchase Plan Purchases		-			19,800			94,553
Purchase Of Treasury Stock, At Cost		-			-			(1,561,266	)
Proceeds From Issuance Of Senior Convertible Debentures		-			6,084,000			-
Proceeds From The Issuance Of Common Stock		4,829,060			-			-
Proceeds From The Issuance Of Preferred Stock		22,000,000			-			18,000,000
Redemption Of Preferred Stock		(18,000,000	)		-			-
Proceeds From (Repayments) Line of Credit		-			(4,787,330	)		1,787,330
Dividends Paid To Shareholders- Preferred Stock		(726,222	)		(900,000	)		(140,000	)
Dividends Paid To Shareholders- Common Stock		(858,184	)		(787,550	)		(797,883	)
Net Cash Provided By (Used In) Financing Activities		7,244,654			(371,080	)		17,482,754
Net Increase (Decrease) In Cash		1,109,400			(336,827	)		4,139,681
Cash At Beginning Of Year		4,312,637			4,649,464			509,783
Cash At End Of Year	$	5,422,037		$	4,312,637		$	4,649,464

58 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(23)         Carrying Amounts and Fair Value of Financial Instruments

Effective April 1, 2008, the Company adopted accounting guidance which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value under generally accepted accounting principles. This guidance applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.

Accounting guidance emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, the guidance establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

Level 1	Valuation is based upon quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. 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	Valuation is based upon quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. 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	Valuation is generated from model-based techniques that use at least one significant assumption based on unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

The following is a description of the valuation methodologies used for assets and liabilities recorded at fair value.

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. At March 31, 2011, the Company’s investment portfolio was comprised of government and agency bonds, mortgage-backed securities issued by government agencies or government sponsored enterprises, municipal securities and one equity investment. The portfolio did not contain any private label mortgage-backed securities. Fair value measurement is based upon prices obtained from third party pricing services who use independent pricing models which rely on a variety of factors including reported trades, broker/dealer quotes, benchmark yields, economic and industry events and other relevant market information. As such, these securities are classified as Level 2.

59 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(23)     Carrying Amounts and Fair Value of Financial Instruments, Continued

Mortgage Loans Held for Sale

The Company originates fixed rate residential loans on a servicing released basis in the secondary market. Loans closed but not yet settled with Freddie Mac or other investors, are carried in the Company’s loans held for sale portfolio.  These loans are fixed rate residential loans that have been originated in the Company’s name and have closed.  Virtually all of these loans have commitments to be purchased by investors and the majority of these loans were locked in by price with the investors on the same day or shortly thereafter that the loan was locked in with the Company’s customers.

Therefore, these loans present very little market risk for the Company.  The Company usually delivers to, and receives funding from, the investor within 30 days.  Commitments to sell these loans to the investor are considered derivative contracts and are sold to investors on a “best efforts" basis. The Company is not obligated to deliver a loan or pay a penalty if a loan is not delivered to the investor. As a result of the short-term nature of these derivative contracts, the fair value of the mortgage loans held for sale in most cases is the same as the value of the loan amount at its origination. These loans are classified as Level 2.

Impaired Loans

The Company does not record loans held for investment at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established as necessary. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired management measures impairment.

Fair value is estimated using one of the following methods: fair value of the collateral less estimated costs to sale, discounted cash flows, or market value of the loan based on similar debt. The fair value of the collateral less estimated costs to sell is the most frequently used method. Typically, the Company reviews the most recent appraisal and if it is over 24 months old will request a new third party appraisal. Depending on the particular circumstances surrounding the loan, including the location of the collateral, the date of the most recent appraisal and the value of the collateral relative to the recorded investment in the loan, management may order an independent appraisal immediately or, in some instances, may elect to perform an internal analysis. Specifically as an example, in situations where the collateral on a nonperforming commercial real estate loan is out of the Company’s primary market area, management would typically order an independent appraisal immediately, at the earlier of the date the loan becomes nonperforming or immediately following the determination that the loan is impaired. However, as a second example, on a nonperforming commercial real estate loan where management is familiar with the property and surrounding areas and where the original appraisal value far exceeds the recorded investment in the loan, management may perform an internal analysis whereby the previous appraisal value would be reviewed and adjusted for current conditions including recent sales of similar properties in the area and any other relevant economic trends. These valuations are reviewed at a minimum on a quarterly basis.

Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At March 31, 2011, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

As of March 31, 2011 and March 31, 2010, the recorded investment in impaired loans was $33.3 million and $35.3 million, respectively. The average recorded investment in impaired loans was $37.2 million for year ended March 31, 2011 and $33.6 million for the year ended March 31, 2010.

60 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(23)     Carrying Amounts and Fair Value of Financial Instruments, Continued

Foreclosed Assets

Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2.

When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the asset as nonrecurring Level 3.

Goodwill and Other Intangible Assets

Goodwill and identified intangible assets are subject to impairment testing. The Company’s approach to testing for impairment is to compare the business unit’s carrying value to the implied fair value based on a multiple of revenue approach. Impairment testing is performed annually as of September 30th or when events or circumstances occur indicating that goodwill of the reporting unit might be impaired.  In the event the fair value is determined to be less than the carrying value, the asset is recorded at fair value as determined by the valuation model. As such, goodwill and other intangible assets subjected to nonrecurring fair value adjustments are classified as Level 3.

Mandatorily Redeemable Financial Instrument

The fair value is determined, in accordance with the underlying agreement at the instrument’s redemption value, as the number of shares issuable pursuant to the agreement at a price per share determined as the greater of a) $26 per share or b) 1.5 times the book value per share of the Company. This instrument is classified as Level 2.

Assets and liabilities measured at fair value on a recurring basis are as follows as of March 31, 2011:

Assets:		Quoted Market Price In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
FHLB Securities	$	-	$	14,209,332	$	-
Federal Farm Credit Securities		-		2,006,600		-
Federal National Mortgage       Association (“FNMA”) and       Federal Home Loan Mortgage       Corporation (“FHLMC”) Bonds		-		11,660,990		-
Small Business Administration    (“SBA”) Bonds		-		64,709,832		-
Taxable Municipal Securities		-		4,471,650		-
Tax Exempt Municipal Securities		-		2,034,943		-
Mortgage-Backed Securities		-		240,080,693		-
Equity Securities		-		78,750		-
Total	$	-	$	339,252,790	$	-
Liabilities:
Mandatorily Redeemable Financial    Instrument	$	-	$	1,467,312	$	-
Total	$	-	$	1,467,312	$	-

61 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(23)     Carrying Amounts and Fair Value of Financial Instruments, Continued

Assets and liabilities measured at fair value on a recurring basis are as follows as of March 31, 2010:

Assets:		Quoted Market Price In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
FHLB Securities	$	-	$	9,369,901	$	-
Federal Farm Credit Securities		-		4,208,672		-
FNMA and FHLMC Bonds		-		5,963,270		-
SBA Bonds		-		37,186,061		-
Taxable Municipal Bond		-		3,225,926		-
Mortgage-Backed Securities		-		232,235,059		-
Equity Securities		-		72,150		-
Total	$	-	$	292,261,039	$	-
Liabilities:
Mandatorily Redeemable Financial    Instrument	$	-	$	1,663,312	$	-
Total	$	-	$	1,663,312	$	-

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. The table below presents assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2011, aggregated by the level in the fair value hierarchy within which those measurements fall.Other intangible assets are measured on a non-recurring basis at least annually.  Specifically, the valuation of goodwill is performed each year at September 30.

Assets:	Level 1	Level 2	Level 3	Balance At March 31, 2011
Goodwill	$                      -	$                      -	$         1,199,754	$               1,199,754
Mortgage Loans Held For Sale	-	5,166,234	-	5,166,234
Impaired Loans (1)	-	31,995,829	529,363	32,525,192
Foreclosed Assets	-	14,433,853	-	14,433,853
Total	$                      -	$      51,595,916	$     1,729,117	$          53,325,033

(1) Impaired loans are reported net of specific reserves of $772,476.

The table below presents assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2010, aggregated by the level in the fair value hierarchy within which those measurements fall.

Assets:	Level 1	Level 2	Level 3	Balance At March 31, 2010
Goodwill	$                      -	$                      -	$         1,199,754	$               1,199,754
Mortgage Loans Held For Sale	-	3,161,463	-	3,161,463
Impaired Loans (1)	-	19,735,647	13,548,107	33,283,754
Foreclosed Assets	-	8,738,965	2,034,085	10,773,050
Total	$                      -	31,636,075	$      16,781,946	$             48,418,021

(1) Impaired loans are reported net of specific reserves of $2.0 million.

62 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(23)     Carrying Amounts and Fair Value of Financial Instruments, Continued

For assets and liabilities that are not presented on the balance sheet at fair value, the following methods are used to determine the fair value:

Cash and cash equivalents—The carrying amount of these financial instruments approximates fair value. All mature within 90 days and do not present unanticipated credit concerns.

Certificates of deposits with other banks—Fair value is based on market prices for similar assets.

Investment securities held to maturity—Securities held to maturity are valued at quoted market prices or dealer quotes.

Loans—The fair value of loans are estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. As discount rates are based on current loan rates as well as management estimates, the fair values presented may not be indicative of the value negotiated in an actual sale.

FHLB Stock—The fair value approximates the carrying value.

Deposits—The fair value of demand deposits, savings accounts, and money market accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposits is estimated by discounting the future cash flows using rates currently offered for deposits of similar remaining maturities.

 Federal Home Loan Bank Advances—Fair value is estimated based on discounted cash flows using current market rates for borrowings with similar terms.

Other Borrowed Money—The carrying value of these short term borrowings approximates fair value.

Senior Convertible Debentures— The fair value is estimated by discounting the future cash flows using the current rates at which similar debenture offerings with similar terms and maturities would be issued by similar institutions. As discount rates are based on current debenture rates as well as management estimates, the fair values presented may not be indicative of the value negotiated in an actual sale.

Junior Subordinated Debentures—The carrying value of junior subordinated debentures approximates fair value.

The following table is a summary of the carrying value and estimated fair value of the Company’s financial instruments as of March 31, 2011 and March 31, 2010 presented in accordance with the applicable accounting guidance.

		March 31, 2011				March 31, 2010
		Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
		(In Thousands)
Financial Assets:
Cash And Cash Equivalents	$	7,836	$	7,836	$	8,805	$	8,805
Certificates of Deposits With Other Banks		100		101		-		-
Investment And Mortgage-Backed Securities		372,418		373,376		311,046		312,115
Loans Receivable, Net		484,471		482,834		568,399		578,851
FHLB Stock		11,267		11,267		12,624		12,624
Financial Liabilities:
Deposits:
Checking, Savings, And Money Market Accounts	$	332,220	$	332,220	$	301,983	$	301,983
Certificate Accounts		358,137		361,110		392,270		398,206
Advances From FHLB		138,136		147,207		164,004		172,983
Other Borrowed Money		11,195		11,195		12,060		12,060
Senior Convertible Debentures		6,084		6,084		6,084		6,084
Junior Subordinated Debentures		5,155		5,155		5,155		5,155

At March 31, 2011, the Bank had $39.4 million of off-balance sheet financial commitments.  These commitments are to originate loans and unused consumer lines of credit and credit card lines.  Because these obligations are based on current market rates, if funded, the original principal is considered to be a reasonable estimate of fair value.

63 

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(23)     Carrying Amounts and Fair Value of Financial Instruments, Continued

Fair value estimates are made on a specific date, based on relevant market data and information about the financial instrument.  These estimates do not reflect any premium or discount that could result from offering for sale the Bank’s entire holdings of a particular financial instrument.  Because no active market exists for a significant portion of the Bank’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, current interest rates and prepayment trends, risk characteristics of various financial instruments, and other factors.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision.  Changes in any of these assumptions used in calculating fair value would also significantly affect the estimates. Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.  For example, the Bank has significant assets and liabilities that are not considered financial assets or liabilities including deposit franchise values, loan servicing portfolios, deferred tax liabilities, and premises and equipment.

In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of these estimates. The Company has used management’s best estimate of fair value on the above assumptions.  Thus, the fair values presented may not be the amounts, which could be realized, in an immediate sale or settlement of the instrument.  In addition, any income taxes or other expenses that would be incurred in an actual sale or settlement are not taken into consideration in the fair value presented.

(24)     Quarterly Financial Data (Unaudited)

Unaudited condensed financial data by quarter for fiscal years 2011 and 2010 is as follows (dollars, except per share data, in thousands):

		Quarter ended
2010-2011		June 30, 2010		Sept. 30, 2010		Dec. 31, 2010		Mar. 31, 2011
Interest Income	$	11,351	$	11,031	$	10,559	$	10,801
Interest Expense		4,427		4,322		3,881		3,465
Net Interest Income		6,924		6,709		6,678		7,336
Provision For Loan Losses		1,900		2,150		1,900		1,850
Net Interest Income After Provision For Loan Losses		5,024		4,559		4,778		5,486
Non-interest Income		1,378		1,953		1,744		1,576
Non-interest Expense		5,539		5,758		5,838		6,563
Income Before Income Tax		863		755		684		499
Provision For Income taxes		322		298		230		108
Net Income		541		457		454		391
Preferred Stock Dividends		225		221		110		110
Accretion Of Preferred Stock To Redemption    Value		19		-		-		-
Net Income Available To Common Shareholders	$	297	$	236	$	344	$	281
Basic Net Income Per Common Share	$	0.12	$	0.10	$	0.12	$	0.10
Diluted Net Income Per Common Share	$	0.12	$	0.09	$	0.12	$	0.09
Basic Weighted Average Shares Outstanding		2,461,095		2,469,791		2,869,205		2,944,001
Diluted Weighted Average Shares Outstanding		2,559,475		2,550,097		2,931,633		3,017,521

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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(24)         Quarterly Financial Data (Unaudited), Continued

		Quarter ended
2009-2010		June 30, 2009		Sept. 30, 2009		Dec. 31, 2009		Mar. 31, 2010
Interest Income	$	12,065	$	11,772	$	12,245	$	11,425
Interest Expense		5,736		5,167		4,733		4,500
Net Interest Income		6,329		6,605		7,512		6,925
Provision For Loan Losses		1,400		1,600		2,475		2,680
Net Interest Income After Provision For Loan Losses		4,929		5,005		5,037		4,245
Non-interest Income		1,504		1,421		1,497		1,727
Non-interest Expense		5,838		5,412		5,577		5,873
Income Before Income Tax		595		1,014		957		99
Provision For Income taxes		223		432		395		11
Net Income		372		582		562		88
Preferred Stock Dividends		225		225		225		225
Accretion Of Preferred Stock To Redemption    Value		18		18		17		18
Net Income Available To Common Shareholders	$	129	$	339	$	320	$	(155)
Basic Net Income Per Common Share	$	0.05	$	0.14	$	0.13	$	(0.06)
Diluted Net Income Per Common Share	$	0.05	$	0.13	$	0.13	$	(0.06)
Basic Weighted Average Shares Outstanding		2,460,137		2,461,092		2,461,095		2,461,095
Diluted Weighted Average Shares Outstanding		2,503,777		2,521,157		2,543,389		2,544,857

(25) Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including estimates inherent in the process of preparing financial statements. Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.

On April 11, 2011, the Company eliminated the mandatorily redeemable shares of the Company’s common stock as a result of an investor’s purchase of these shares in a private transaction.  In connection with the purchase of these shares, the redemption feature was eliminated.  As a result, the Company no longer has the liability related to these shares on its balance sheet and the Company’s capital increased by $1.5 million.

Management has reviewed all other events occurring through the date the financial statements were available to be issued and no additional subsequent events occurred requiring accrual or disclosure.

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SHAREHOLDERS INFORMATION

ANNUAL MEETING

The annual meeting of shareholders will be held at 2:00 p.m., Thursday, July 21, 2011 at Newberry Hall, 117 Newberry Street Southwest, Aiken, South Carolina.

STOCK LISTING

The Company’s stock is traded on the Over-The-Counter-Bulletin Board under the symbol “SFDL.OB.”  The stock began trading on the Bulletin Board in October 2003.

PRICE RANGE OF COMMON STOCK

The table below shows the range of high and low bid prices.  These prices represent actual transactions and do not include retail markups, markdowns or commissions.  Market makers include Sterne, Agee, and Leach, Inc., Morgan Keegan and Company, Inc., A.G. Edwards and Sons, Inc., and Monroe Securities, Inc.

Years Ended March 31		High		Low
2010:
06-30-09	$	15.50	$	11.05
09-30-09	$	13.25	$	11.00
12-31-09	$	13.10	$	8.50
03-31-10	$	11.00	$	9.86
2011
06-30-10	$	9.95	$	8.01
09-30-10	$	12.73	$	8.57
12-31-10	$	14.89	$	11.46
03-31-11	$	11.91	$	10.42

As of March 31, 2011, the Company had approximately 296 shareholders and 2,944,001 outstanding shares of common stock.

DIVIDENDS

The first quarterly dividend on the stock was paid to shareholders on March 15, 1991.  Dividends will be paid upon the determination of the Board of Directors that such payment is consistent with the long-term interest of the Company.  The factors affecting this determination include the Company’s current and projected earnings, operating results, financial condition, regulatory restrictions, future growth plans, and other relevant factors. The Company paid $0.04 per share cash dividends for each of the quarters during fiscal 2006, $0.06 per share cash dividends for each of the quarters during fiscal 2007, $0.07 per share cash dividends for each of the quarters during fiscal 2008, and $0.08 per share cash dividends for each of the quarters during fiscal 2009, 2010 and 2011.

The ability of the Company to pay dividends depends primarily on the ability of the Bank to pay dividends to the Company.  The Bank may not declare or pay a cash dividend on its stock or repurchase shares of its stock if the offset thereof would be to cause its regulatory capital to be reduced below the amount required for the liquidation account or to meet applicable regulatory capital requirements.  Pursuant to the OTS regulations, Tier 1 associations (associations that before and after the proposed distribution meet or exceed their fully phased-in capital requirements) may make capital distributions during any calendar year equal to 100% of net income for the year-to-date plus 50% of the amount by which the association’s total capital exceeds its fully phased-in capital requirement as measured at the beginning of the capital year.  However, a Tier 1 association deemed to be in need of more than normal supervision by the OTS may be downgraded to a Tier 2 or Tier 3 association as a result of such a determination.  The Bank is also required to give the OTS 30 days notice prior to the declaration of a dividend.  Unlike the Bank, there is no regulatory restriction on the payment of dividends by the Company; however, it is subject to the requirements of South Carolina.  South Carolina generally prohibits the Company from paying dividends if, after giving effect to a proposed dividend: (1) the Company would be unable to pay its debts as they become due in the normal course of business, or (2) the Company’s total assets would be less than its total liabilities plus the sum that would be needed to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the dividend. In addition, payment of dividends by the Company is subject to certain limitations resulting from participation in the CPP. See Note 20 of the Notes to the Consolidated Financial Statements included herein for additional information.

CODE OF ETHICS

A copy of the Company’s Code of Ethics may be obtained at the Company’s internet website at www.securityfederalbank.com.

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