UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10 – Q

(Mark one)

(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2013

( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD:

FROM: TO:

COMMISSION FILE NUMBER: 0-16120

SECURITY FEDERAL CORPORATION

(Exact name of registrant as specified in its charter)

South Carolina	57-0858504
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

238 RICHLAND AVENUE, WEST, AIKEN, SOUTH CAROLINA 29801

(Address of principal executive office and Zip Code)

(803) 641-3000

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES X NO

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filed [ ]	Accelerated filer [ ]
Non-accelerated filer [ ]	Smaller reporting company [ X ]

Indicate by check mark whether the registrant is a shell corporation (defined in Rule 12b-2 of the Exchange Act).

YES NO X

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

CLASS:	OUTSTANDING SHARES AT:	SHARES:
Common Stock, par value $0.01 per share	November 11, 2013	2,944,001

PART I.	FINANCIAL INFORMATION (UNAUDITED)	PAGE NO.
Item 1.	Financial Statements (Unaudited):	3
	Consolidated Balance Sheets at September 30, 2013 and December 31, 2012	3
	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2013 and 2012	4
	Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2013 and 2012	5
	Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2013 and 2012	6
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2013 and 2012	7
	Notes to Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	34
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	47
Item 4.	Controls and Procedures	48
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	48
Item 1A.	Risk Factors	48
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	48
Item 3.	Defaults Upon Senior Securities	48
Item 4.	Mine Safety Disclosures	48
Item 5.	Other Information	48
Item 6.	Exhibits	48
	Signatures	51

SCHEDULES OMITTED

All schedules other than those indicated above are omitted because of the absence of the conditions under which they are required or because the information is included in the consolidated financial statements and related notes.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Part 1. Financial Information

Item 1. Financial Statements

Consolidated Balance Sheets

	September 30, 2013			December 31, 2012
ASSETS:	Unaudited			Audited
Cash And Cash Equivalents	$	10,379,990		$	7,903,950
Certificates Of Deposit With Other Banks	1,479,931			1,728,567
Investment And Mortgage-Backed Securities:
Available For Sale:  (Amortized Cost Of $425,477,772 And $342,936,153 At September 30, 2013 And December 31, 2012, Respectively)	426,846,798			354,916,216
Held To Maturity:  (Fair Value Of $0 And $79,671,886 At September 30, 2013 And December 31, 2012, Respectively)	—			76,072,262
Total Investments And Mortgage-Backed Securities	426,846,798			430,988,478
Loans Receivable, Net:
Held For Sale	1,385,925			4,770,760
Held For Investment:  (Net Of Allowance Of $10,649,331 and $11,318,371 At September 30, 2013 And December 31, 2012, Respectively)	363,537,170			392,935,060
Total Loans Receivable, Net	364,923,095			397,705,820
Accrued Interest Receivable:
Loans	1,224,486			1,242,072
Mortgage-Backed Securities	744,005			901,423
Investment Securities	1,300,106			1,131,262
Total Accrued Interest Receivable	3,268,597			3,274,757
Premises And Equipment, Net	17,481,412			17,917,897
Federal Home Loan Bank ("FHLB") Stock, At Cost	4,674,700			6,178,700
Repossessed Assets Acquired In Settlement Of Loans	3,492,365			6,754,425
Bank Owned Life Insurance	11,396,305			11,151,305
Intangible Assets, Net	24,471			61,974
Goodwill	1,199,754			1,199,754
Other Assets	7,271,219			5,488,960
Total Assets	$	852,438,637		$	890,354,587
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Liabilities:
Deposit Accounts	$	669,353,020		$	676,338,653
Advances From FHLB	78,144,371			105,257,182
Other Borrowings	9,872,619			9,317,244
Junior Subordinated Debentures	5,155,000			5,155,000
Advance Payments By Borrowers For Taxes And Insurance	604,370			189,424
Senior Convertible Debentures	6,084,000			6,084,000
Other Liabilities	5,735,519			5,420,600
Total Liabilities	774,948,899			807,762,103
Shareholders' Equity:
Serial Preferred Stock, $.01 Par Value; Authorized 200,000 Shares; Issued And Outstanding, 22,000 Shares At September 30, 2013 And December 31, 2012, Respectively	22,000,000			22,000,000
Common Stock, $.01 Par Value; Authorized 5,000,000 Shares; Issued 3,144,934 Shares At September 30, 2013 And At December 31, 2012	31,449			31,449
Warrant Issued In Conjunction With Serial Preferred Stock	—			400,000
Additional Paid-In Capital	11,974,968			11,630,717
Treasury Stock, At Cost (200,933 Shares At September 30, 2013 And December 31, 2012, Respectively)	(4,330,712		)	(4,330,712		)
Accumulated Other Comprehensive Income	849,100			7,431,310
Retained Earnings	46,964,933			45,429,720
Total Shareholders' Equity	77,489,738			82,592,484
Total Liabilities And Shareholders' Equity	$	852,438,637		$	890,354,587

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

3

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income (Unaudited)

	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Interest Income:
Loans	$	5,375,962	$	5,979,342	$	16,485,033	$	18,657,143
Mortgage-Backed Securities	1,360,586		1,642,163		3,943,033		5,179,079
Investment Securities	966,936		647,720		2,655,352		1,857,233
Other	2,219		2,233		6,262		4,983
Total Interest Income	7,705,703		8,271,458		23,089,680		25,698,438
Interest Expense:
NOW And Money Market Accounts	186,183		291,387		630,239		940,945
Statement Savings Accounts	6,932		10,914		27,720		32,325
Certificate Accounts	601,056		944,296		2,015,069		3,100,579
FHLB Advances And Other Borrowed Money	854,292		1,066,410		2,753,183		3,371,197
Senior Convertible Debentures	121,680		121,680		365,040		365,040
Junior Subordinated Debentures	25,952		28,378		77,549		85,782
Total Interest Expense	1,796,095		2,463,065		5,868,800		7,895,868
Net Interest Income	5,909,608		5,808,393		17,220,880		17,802,570
Provision For Loan Losses	600,000		300,000		2,645,381		2,975,000
Net Interest Income After Provision For Loan Losses	5,309,608		5,508,393		14,575,499		14,827,570
Non-Interest Income:
Gain On Sale Of Investment Securities	419,360		324,835		1,173,140		963,454
Gain On Sale Of Loans	227,332		177,524		622,960		453,634
Service Fees On Deposit Accounts	303,350		291,753		845,444		847,580
Commissions From Insurance Agency	103,330		131,761		348,292		357,704
Trust Income	135,000		120,000		405,000		366,000
Bank Owned Life Insurance Income	78,000		105,000		261,000		315,000
Check Card Fee Income	222,252		196,943		640,374		600,126
Community Development Financial Institution ("CDFI") Financial Award Income	97,000		—		733,071		—
Other	152,467		129,873		396,695		372,414
Total Non-Interest Income	1,738,091		1,477,689		5,425,976		4,275,912
Non-Interest Expense:
Compensation And Employee Benefits	2,677,608		2,709,998		8,267,433		8,064,121
Occupancy	484,857		505,208		1,447,835		1,440,485
Advertising	79,130		97,221		256,861		256,472
Depreciation And Maintenance Of Equipment	412,020		412,000		1,220,952		1,245,320
Federal Deposit Insurance Corporation ("FDIC") Insurance Premiums	191,535		152,494		555,733		476,943
Amortization Of Intangibles	12,501		12,501		37,503		37,503
Net Cost Of Operation Of Other Real Estate Owned	506,174		1,321,254		1,243,935		2,375,109
Prepayment Penalties on FHLB Advances	191,181		—		429,523		—
Other	1,109,892		860,407		3,109,619		2,598,207
Total General And Administrative Expenses	5,664,898		6,071,083		16,569,394		16,494,160
Income Before Income Taxes	1,382,801		914,999		3,432,081		2,609,322
Provision For Income Taxes	360,970		245,209		860,319		778,857
Net Income	1,021,831		669,790		2,571,762		1,830,465
Preferred Stock Dividends	110,000		110,000		330,000		330,000
Net Income Available To Common Shareholders	$	911,831	$	559,790	$	2,241,762	$	1,500,465
Net Income Per Common Share (Basic)	$	0.31	$	0.19	$	0.76	$	0.51
Net Income Per Common Share (Diluted)	$	0.31	$	0.19	$	0.76	$	0.51
Cash Dividend Per Share On Common Stock	$	0.08	$	0.08	$	0.24	$	0.24
Weighted Average Shares Outstanding (Basic)	2,944,001		2,944,001		2,944,001		2,944,001
Weighted Average Shares Outstanding (Diluted)	2,944,001		2,944,001		2,944,001		2,944,001

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

4

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

	Three Months Ended September 30,
	2013			2012
Net Income	$	1,021,831		$	669,790
Other Comprehensive Income (Loss)
Unrealized Gains (Losses) On Securities:
Unrealized Holding Gains (Losses) On Securities Available For Sale, Net Of Taxes Of $752,070 And $654,071 At September 30, 2013 And 2012, Respectively	(1,230,443		)	1,268,566
Reclassification Adjustment For Gains Included In Net Income, Net Of Taxes Of $159,357 And $123,437 At September 30, 2013 And 2012, Respectively	(260,003		)	(201,398		)
Other Comprehensive Income (Loss)	(1,490,446		)	1,067,168
Comprehensive Income (Loss)	$	(468,615	)	$	1,736,958

	Nine Months Ended September 30,
	2013			2012
Net Income	$	2,571,762		$	1,830,465
Other Comprehensive Income (Loss)
Unrealized Gains (Losses) On Securities:
Unrealized Holding Gains (Losses) On Securities Available For Sale, Net Of Taxes Of $4,113,767 And $1,076,420 At September 30, 2013 And 2012, Respectively	(6,720,796		)	2,353,605
Reclassification Adjustment For Gains Included In Net Income, Net Of Taxes Of $445,793 And $366,113 At September 30, 2013 And 2012, Respectively	(727,347		)	(597,341		)
Held To Maturity Transfer To Available For Sale, Net Of Taxes Of $530,733 And $0 At September 30, 2013 And 2012, Respectively	865,933			—
Other Comprehensive Income (Loss)	(6,582,210		)	1,756,264
Comprehensive Income (Loss)	$	(4,010,448	)	$	3,586,729

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

5

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity (Unaudited)

For the Nine Months Ended September 30, 2013 and 2012

	Preferred  Stock		Warrants		Common Stock		Additional Paid – In  Capital		Treasury Stock			Accumulated Other  Comprehensive Income		Retained Earnings			Total
Balance at December 31, 2011	$	22,000,000	$	400,000	$	31,449	$	11,617,964	$	(4,330,712	)	$	6,416,277	$	44,426,903		$	80,561,881
Net Income	—		—		—		—		—			—		1,830,465			1,830,465
Other Comprehensive Income, Net Of Tax	—		—		—		—		—			1,756,264		—			1,756,264
Stock Compensation Expense	—		—		—		24,843		—			—		—			24,843
Cash Dividends On  Preferred	—		—		—		—		—			—		(330,000		)	(330,000		)
Cash Dividends On Common	—		—		—		—		—			—		(706,559		)	(706,559		)
Balance at September 30, 2012	$	22,000,000	$	400,000	$	31,449	$	11,642,807	$	(4,330,712	)	$	8,172,541	$	45,220,809		$	83,136,894

	Preferred Stock		Warrants			Common Stock		Additional Paid – In  Capital			Treasury Stock			Accumulated Other Comprehensive Income			Retained Earnings			Total
Balance at December 31, 2012	$	22,000,000	$	400,000		$	31,449	$	11,630,717		$	(4,330,712	)	$	7,431,310		$	45,429,720		$	82,592,484
Net Income	—		—			—		—			—			—			2,571,762			2,571,762
Other Comprehensive Loss, Net Of Tax	—		—			—		—			—			(6,582,210		)	—			(6,582,210		)
Stock Compensation Expense	—		—			—		(5,749		)	—			—			—			(5,749		)
Redemption of Warrant Issued In Conjunction With Serial Preferred Stock	—		(400,000		)	—		350,000			—			—			—			(50,000		)
Cash Dividends On  Preferred	—		—			—		—			—			—			(330,000		)	(330,000		)
Cash Dividends On Common	—		—			—		—			—			—			(706,549		)	(706,549		)
Balance at September 30, 2013	$	22,000,000	$	—		$	31,449	$	11,974,968		$	(4,330,712	)	$	849,100		$	46,964,933		$	77,489,738

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

6

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

	Nine Months Ended September 30,
	2013			2012
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	2,571,762		$	1,830,465
Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities:
Depreciation Expense	947,448			1,077,793
Amortization Of Intangible Assets	37,503			37,503
Stock Option Compensation Expense	(5,749		)	24,843
Discount Accretion And Premium Amortization	5,485,576			5,411,461
Provisions For Losses On Loans	2,645,381			2,975,000
Income From Bank Owned Life Insurance	(261,000		)	(315,000		)
Gain On Sales Of Loans	(622,960		)	(453,634		)
Gain On Sales Of Mortgage-Backed Securities	(791,003		)	(598,128		)
Gain On Sales Of Investment Securities	(382,137		)	(365,326		)
(Gain) Loss On Sale Of Real Estate Owned	(80,001		)	1,211
Write Down On Real Estate Owned	1,124,378			1,906,500
Amortization Of Deferred Fees On Loans	(3,255		)	(8,034		)
Gain On Disposition Of Premises And Equipment	431			—
Proceeds From Sale Of Loans Held For Sale	27,252,344			25,129,543
Origination Of Loans Held For Sale	(23,244,549		)	(23,214,551		)
(Increase) Decrease In Accrued Interest Receivable:
Loans	17,586			495,105
Mortgage-Backed Securities	157,418			11,508
Investment Securities	(168,844		)	110,821
Increase In Advance Payments By Borrowers	414,946			359,740
Other, Net	2,576,122			(800,787		)
Net Cash Provided By Operating Activities	17,671,397			13,616,033
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase Of Mortgage-Backed Securities Available For Sale	(64,782,671		)	(68,509,386		)
Principal Repayments On Mortgage-Backed Securities Available For Sale	45,539,786			40,121,950
Purchase Of Mortgage-Backed Securities Held To Maturity	—			(11,873,409		)
Principal Repayments On Mortgage-Backed Securities Held To Maturity	942,806			1,114,545
Purchase Of Investment Securities Available For Sale	(60,296,593		)	(50,564,039		)
Maturities Of Investment Securities Available For Sale	16,419,156			20,905,948
Purchase of Investment Securities Held To Maturity	(1,000,000		)	(12,219,647		)
Maturities Of Investment Securities Held To Maturity	3,501,978			12,034,447
Proceeds From Sale of Investment Securities Available For Sale	16,947,896			8,511,730
Proceeds From Sale of Mortgage-Backed Securities Available For Sale	31,945,850			28,399,986
Proceeds From Redemption of Certificates Of Deposits With Other Banks	250,000			—
Purchase Of FHLB Stock	(2,696,106		)	(284,687		)
Redemption Of FHLB Stock	4,200,106			2,288,787
Decrease In Loans Receivable	23,717,082			35,904,577
Capital Improvements To Repossessed Assets	—			(36,877		)
Proceeds From Sale Of Repossessed Assets	5,256,365			3,173,750
Purchase And Improvement Of Premises And Equipment	(513,144		)	(76,047		)
Proceeds From Sale of Premises and Equipment	1,750			—
Net Cash Provided By Investing Activities	19,434,261			8,891,628

7

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

	Nine months Ended September 30,
	2013			2012
	Continued
CASH FLOWS FROM FINANCING ACTIVITIES:
Decrease In Deposit Accounts	$	(6,985,633	)	$	(2,542,439	)
Proceeds From FHLB Advances	77,900,000			54,700,001
Repayment Of FHLB Advances	(105,012,811		)	(67,112,559		)
Increase in Other Borrowings, Net	555,375			94,528
Dividends To Preferred Stock Shareholders	(330,000		)	(330,000		)
Repayment Of Warrant Issued In Conjunction With Preferred Stock	(50,000		)	—
Dividends To Common Stock Shareholders	(706,549		)	(706,559		)
Net Cash Used By Financing Activities	(34,629,618		)	(15,897,028		)
Net Increase In Cash And Cash Equivalents	2,476,040			6,610,633
Cash And Cash Equivalents At Beginning Of Period	7,903,950			7,797,544
Cash And Cash Equivalents At End Of Period	$	10,379,990		$	14,408,177
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Paid During The Period For:
Interest	$	5,921,035		$	7,970,642
Income Taxes	$	358,419		$	1,343,816
Supplemental Schedule Of Non Cash Transactions:
Transfers From Loans Receivable To Other Real Estate Owned	$	3,038,682		$	2,416,928
Transfers From Investment Securities Held To Maturity To Available For Sale	$	49,907,323		$	—
Transfers From Mortgage-Backed Securities Held To Maturity To Available For Sale	$	22,100,000		$	—

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

8

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

1. Basis of Presentation

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and accounting principles generally accepted in the United States of America; therefore, they do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows.  Such statements are unaudited but, in the opinion of management, reflect all adjustments, which are of a normal recurring nature and necessary for a fair presentation of results for the selected interim periods.  Users of financial information produced for interim periods are encouraged to refer to the footnotes contained in the audited financial statements appearing in Security Federal Corporation’s (the “Company”) 2012 Annual Report to Shareholders which was filed as an exhibit to our Annual Report on Form 10-KT for the transitional nine months ended December 31, 2012 (“2012 10-KT”) when reviewing interim financial statements.  The Company changed its fiscal year from March 31 to December 31 effective January 17, 2013. The results of operations for the nine month period ended September 30, 2013 are not necessarily indicative of the results that may be expected for the entire fiscal year.

2. Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Security Federal Bank (the “Bank”) and the Bank’s wholly owned subsidiaries, Security Federal Insurance, Inc. (“SFINS”) and Security Financial Services Corporation (“SFSC”). SFINS was formed during fiscal 2002 and began operating during the December 2001 quarter and 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 Security Federal Insurance Technologies, Inc. and Security Federal Premium Pay Plans Inc. (the “Collier Jennings Companies”). 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 utilized to hold and operate a repossessed hotel located in Hardeeville, South Carolina. Subsequently, in fiscal 2012 the hotel was sold and the subsidiary once again returned to inactive status.

The Company has a wholly owned subsidiary, Security Federal Statutory Trust (the “Trust”), which issued and sold fixed and floating rate capital securities of the Trust.  However, under current accounting guidance, the Trust is not consolidated in the Company’s financial statements.  The Bank is primarily engaged in the business of accepting savings and demand deposits and originating mortgage loans and other loans to individuals and small businesses for various personal and commercial purposes.

3. Critical Accounting Policies

The Company has adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements.  Our significant accounting policies are described in the footnotes to the audited consolidated financial statements at December 31, 2012 included in our 2012 Annual Report to Shareholders.  Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities, and, as such, have a greater possibility of producing results that could be materially different than originally reported.  We consider these accounting policies to be critical accounting policies.  The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances.  Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on our carrying values of assets and liabilities and our results of operations.

The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of the consolidated financial statements.  The impact of an unexpected and sudden large loss could deplete the allowance and potentially require increased provisions to replenish the allowance, which would negatively affect earnings. 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.

9

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

3. Critical 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 our bank regulators, including the Board of Governors of the Federal Reserve System ("Federal Reserve"), the FDIC and the South Carolina Board of Financial Institutions, and may be subject to adjustments based upon the information that is available at the time of their examination. For additional information see the risk factor entitled: “Our provision for loan losses and net loan charge offs have remained at elevated levels and we may be required to make further increases in our provisions for loan losses and to charge off additional loans in the future, which could adversely affect our results of operations-,” in Item 1A. Risk Factors of our 2012 Form 10-KT. 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.

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. No assurance can be given that either the tax returns submitted by us 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.

4. Earnings Per Common Share

Accounting guidance specifies the computation, presentation and disclosure requirements for earnings per share (“EPS”) for entities with publicly held common stock or potential common stock such as options, warrants, convertible securities or contingent stock agreements if those securities trade in a public market. Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding.  Diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive common shares had been issued.  The dilutive effect of options outstanding under the Company’s stock option plan is reflected in diluted earnings per share by application of the treasury stock method.

Net income available to common shareholders represents consolidated net income adjusted for preferred dividends declared, accretions 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.

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

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,
	2013		2012		2013		2012
Earnings Available To Common Shareholders:
Net Income		$1,021,831		$669,790		$2,571,762		$1,830,465
Preferred Stock Dividends	110,000		110,000		330,000		330,000
Net Income Available To Common Shareholders		$911,831		$559,790		$2,241,762		$1,500,465

There were no dilutive securities or options for the three months and nine months ended September 30, 2013 or 2012.    

10

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

5. Stock-Based Compensation

Certain officers and directors of the Company participate in an incentive and non-qualified stock option plan. Options are granted at exercise prices not less than the fair value of the Company’s common stock on the date of the grant. The following is a summary of the activity under the Company’s stock option plans for the periods presented:

	Three Months Ended September 30, 2013			Nine Months Ended September 30, 2013
	Shares		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
Balance, Beginning of Period	68,400		$22.63	68,400		$22.63
Options Granted	—		—	—		—
Options Exercised	—		—	—		—
Options Forfeited	(3,400	)	24.06	(3,400	)	24.06
Balance, End Of Period	65,000		$22.55	65,000		$22.55
Options Exercisable	45,400
Options Available For Grant	50,000

	Three Months Ended September 30, 2012			Nine Months Ended September 30, 2012
	Shares		Weighted Average Exercise Price	Shares		Weighted Average Exercise Price
Balance, Beginning of Period	72,900		$22.62	74,900		$22.61
Options Granted	—		—	—		—
Options Exercised	—		—	—		—
Options Forfeited	(4,500	)	22.58	(6,500	)	22.46
Balance, End Of Period	68,400		$22.63	68,400		$22.63
Options Exercisable	43,400
Options Available For Grant	50,000

11

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

5. Stock-Based Compensation, Continued

At September 30, 2013, the Company had the following options outstanding:

Grant Date	Outstanding Options	Option Price	Expiration Date
12/01/03	3,000	$23.65	11/30/13
01/01/04	4,000	$24.22	12/31/13
03/08/04	7,000	$21.43	03/08/14
06/07/04	2,000	$24.00	06/07/14
01/01/05	18,000	$20.55	12/31/14
01/01/06	4,000	$23.91	01/01/16
08/24/06	3,500	$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	14,000	$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

None of the options outstanding at September 30, 2013 or 2012 had an exercise price below the average market price during the three or nine month periods ended September 30, 2013 or 2012. Therefore these options were not deemed to be dilutive to earnings per share in those periods.

6. Stock Warrants

In conjunction with its participation in the U.S. Department of the Treasury’s (“U.S. Treasury”)Capital Purchase Program, the Company sold a warrant to the U.S. Treasury to purchase 137,966 shares of the Company’s common stock at $19.57 per share. The warrant had a 10-year term and was immediately exercisable upon issuance.

On July 31, 2013, the Company repurchased its outstanding warrant at a fair market value of $50,000 from the U.S. Treasury. As a result of the transaction the warrant was canceled which reduced warrants outstanding by $400,000 and increased additional paid in capital by $350,000.

12

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

7. 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:

	September 30, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
FHLB Securities	$	15,932,195	$	12,474	$	898,379	$	15,046,290
Federal Farm Credit Bank ("FFCB") Securities	5,750,000		—		336,342		5,413,658
Fannie Mae ("FNMA") And Freddie Mac ("FHLMC") Bonds	3,008,579		—		33,719		2,974,860
Small Business Administration    (“SBA”) Bonds	99,318,089		2,074,749		367,610		101,025,228
Tax Exempt Municipal Bonds	59,329,205		470,378		2,886,122		56,913,461
Mortgage-Backed Securities	241,881,766		6,339,618		3,000,433		245,220,951
Equity Securities	257,938		—		5,588		252,350
	$	425,477,772	$	8,897,219	$	7,528,193	$	426,846,798
	December 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
FHLB Securities	$	6,115,036	$	53,954	$	4,320	$	6,164,670
SBA Bonds	94,152,203		2,466,354		156,287		96,462,270
Tax Exempt Municipal Bonds	35,772,115		1,770,567		60,534		37,482,148
Mortgage-Backed Securities	206,793,861		8,030,008		91,966		214,731,903
Equity Securities	102,938		—		27,713		75,225
	$	342,936,153	$	12,320,883	$	340,820	$	354,916,216

FHLB securities, 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 September 30, 2013 the Bank held an amortized cost and fair value of $165.5 million and $169.1 million, respectively, in GNMA mortgage-backed securities included in mortgage-backed securities listed above compared to an amortized cost and fair value of $135.3 million and $141.2 million, respectively, at December 31, 2012. All mortgage-backed securities above are either GSEs or GNMA mortgage-backed securities. The Company has not invested in any private label mortgage-backed securities.

Market interest rates increased sharply in June 2013 as a result of a discussions by the Federal Reserve of reducing its monthly purchases of bonds and mortgage-backed securities sooner than expected. Long term interest rates were especially affected by this. As a result, the market values in our investment and mortgage-backed securities portfolio were negatively impacted.

13

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

7. Investment and Mortgage-Backed Securities, Available For Sale, Continued

The amortized cost and fair value of investment and mortgage-backed securities available for sale at September 30, 2013 are shown below by contractual maturity.  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	$	303,707	$	306,647
One – Five Years	14,618,573		14,974,880
Over Five – Ten Years	72,154,975		72,232,540
More Than Ten Years	96,518,751		94,111,780
Mortgage-Backed Securities	241,881,766		245,220,951
	$	425,477,772	$	426,846,798

At September 30, 2013 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 $116.0 million and $118.3 million, respectively, compared to an amortized cost and fair value of $108.9 million and $114.4 million, respectively at December 31, 2012.

The Bank received $48.9 million and $36.9 million, respectively, in gross proceeds from sales of available for sale securities during the nine months ended September 30, 2013 and 2012. As a result, the Bank recognized gross gains of $1.3 million and $963,000, respectively, for the nine months ended September 30, 2013 and 2012. The Bank recognized gross losses of $101,000 and $0, respectively, for the nine months ended September 30, 2013 and 2012. The Bank received $17.1 million and $15.6 million, respectively, in gross proceeds from sales of available for sale securities during the three months ended September 30, 2013 and 2012. As a result, the Bank recognized gross gains of $520,000 and $325,000, respectively, and gross losses of $101,000 and $0, respectively for the three months ended September 30, 2013 and 2012.

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

	September 30, 2013
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Securities	$	14,035,810	$	898,379	$	—	$	—	$	14,035,810	$	898,379
FFCB Securities	5,413,658		336,342						5,413,658		336,342
FNMA And FHLMC Bonds	2,974,860		33,719						2,974,860		33,719
SBA Bonds	16,378,637		367,610		—		—		16,378,637		367,610
Tax Exempt Municipal Bond	41,157,516		2,886,122		—		—		41,157,516		2,886,122
Mortgage-Backed Securities	77,393,890		2,857,409		3,202,789		143,024		80,596,679		3,000,433
Equity Securities	—		—		97,350		5,588		97,350		5,588
	$	157,354,371	$	7,379,581	$	3,300,139	$	148,612	$	160,654,510	$	7,528,193

14

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

7. Investment and Mortgage-Backed Securities, Available For Sale, Continued

	December 31, 2012
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Securities	$	995,680	$	4,320	$	—	$	—	$	995,680	$	4,320
SBA Bonds	4,583,177		119,825		1,833,076		36,462		6,416,253		156,287
Tax Exempt Municipal Bond	4,538,734		60,534		—		—		4,538,734		60,534
Mortgage-Backed Securities	16,259,037		91,966		—		—		16,259,037		91,966
Equity Securities	—		—		75,225		27,713		75,225		27,713
	$	26,376,628	$	276,645	$	1,908,301	$	64,175	$	28,284,929	$	340,820

Securities classified as available for sale are recorded at fair market value.  At September 30, 2013 and December 31, 2012, 2.0% and 18.8% of the unrealized losses, representing three and two individual securities, respectively, 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.

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 we 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.

8. Investment and Mortgage-Backed Securities, Held to Maturity

On June 30, 2013, the Company transferred all of its investment and mortgage-backed securities classified as held to maturity to available for sale. Based on changes in the current rate environment, management elected this change in an effort to more effectively manage the investment portfolio, including subsequently selling some securities that were formerly classified as held to maturity. The amortized cost of the securities that were transferred totaled $72.0 million and the net unrealized gain related to these securities totaled $1.4 million on the date of the transfer. As a result of the transfer and subsequent sales, the Company believes it has tainted its held to maturity classification and judgment will be required in the future in determining when circumstances have changed such that management can assert with a great degree of credibility that it has the intent and ability to hold debt securities to maturity. Based on this guidance, the Company does not expect to classify any securities as held to maturity within the near future.

15

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

8. Investment and Mortgage-Backed Securities, Held to Maturity, Continued

The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of investment and mortgage-backed securities held to maturity were as follows at December 31, 2012:

	December 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLB Securities	$	7,996,378	$	123,702	$	21,160	$	8,098,920
FFCB Securities	6,796,255		2,070		23,727		6,774,598
FNMA and FHLMC Bonds	4,019,931		29,029		4,560		4,044,400
SBA Bonds	5,865,767		315,841		6,139		6,175,469
Mortgage-Backed Securities	51,238,931		3,280,100		95,532		54,423,499
Equity Securities	155,000		—		—		155,000
	$	76,072,262	$	3,750,742	$	151,118	$	79,671,886

Included in the tables above and below in mortgage-backed securities are GNMA mortgage-backed securities, which are backed by the full faith and credit of the United States government.  At December 31, 2012, the Bank held an amortized cost and fair value of $47.2 million and $50.4 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 Company has not invested in any private label mortgage-backed securities. At December 31, 2012, 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 $12.2 million and $12.8 million, respectively at December 31, 2012.

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.

	December 31, 2012
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Securities	$	1,978,840	$	21,160	$	—	$	—	$	1,978,840	$	21,160
FFCB Securities	5,772,528		23,727		—		—		5,772,528		23,727
FNMA And FHLMC Bonds	1,021,910		4,560		—		—		1,021,910		4,560
SBA Bonds	3,249,478		6,139		—		—		3,249,478		6,139
Mortgage-Backed Securities	7,659,461		95,532		—		—		7,659,461		95,532
	$	19,682,217	$	151,118	$	—	$	—	$	19,682,217	$	151,118

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 nine months ended September 30, 2013 and 2012.

16

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9.    Loans Receivable, Net

Loans receivable, net, consisted of the following as of the dates shown:

	September 30, 2013			December 31, 2012
Residential Real Estate Loans	$	83,706,115		$	90,677,625
Consumer Loans	53,038,081			56,595,093
Commercial Business	7,079,274			8,063,901
Commercial Real Estate	232,912,073			250,924,094
Total Loans Held For Investment	376,735,543			406,260,713
Loans Held For Sale	1,385,925			4,770,760
Total Loans Receivable, Gross	378,121,468			411,031,473
Less:
Allowance For Loan Losses	10,649,331			11,318,371
Loans In Process	2,559,695			2,002,595
Deferred Loan Fees (Costs)	(10,653		)	4,687
	13,198,373			13,325,653
Total Loans Receivable, Net	$	364,923,095		$	397,705,820

Changes in the allowance for loan losses for the three and nine months ended September 30, 2013 and 2012 are summarized as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
Balance At Beginning Of Period	$	11,007,279		$	12,684,327		$	11,318,371		$	14,261,374
Provision For Loan Losses	600,000			300,000			2,645,381			2,975,000
Charge Offs	(1,002,990		)	(1,411,300		)	(3,470,300		)	(5,850,835		)
Recoveries	45,042			73,132			155,879			260,620
Total Allowance For Loan Losses	$	10,649,331		$	11,646,159		$	10,649,331		$	11,646,159

The Company uses a risk based approach based on the following credit quality measures when analyzing the loan portfolio: pass, caution, 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 90days or more past due are automatically classified in this category. The other two categories fall in between these two grades.

The following tables list the loan grades used by the Company as credit quality indicators and the balance in each category at the dates presented, excluding loans held for sale.

	Credit Quality Measures
September 30, 2013	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	76,141,552	$	482,578	$	405,792	$	6,676,193	$	83,706,115
Consumer	51,218,363		740,157		165,670		913,891		53,038,081
Commercial Business	6,127,742		239,892		544,313		167,327		7,079,274
Commercial Real Estate	136,918,099		45,623,322		19,270,017		31,100,635		232,912,073
Total	$	270,405,756	$	47,085,949	$	20,385,792	$	38,858,046	$	376,735,543

17

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9.    Loans Receivable, Net, Continued

	Credit Quality Measures
December 31, 2012	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	82,565,630	$	222,046	$	293,079	$	7,596,870	$	90,677,625
Consumer	54,899,665		152,368		184,731		1,358,329		56,595,093
Commercial Business	7,256,607		151,521		514,253		141,520		8,063,901
Commercial Real Estate	162,570,021		32,049,447		17,417,778		38,886,848		250,924,094
Total	$	307,291,923	$	32,575,382	$	18,409,841	$	47,983,567	$	406,260,713

The following table presents an age analysis of past due balances by category at September 30, 2013:

	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans Receivable
Residential    Real Estate	$	—	$	841,302	$	3,933,183	$	4,774,485	$	78,931,630	$	83,706,115
Consumer	726,439		129,080		500,801		1,356,320		51,681,761		53,038,081
Commercial    Business	177,434		32,643		700		210,777		6,868,497		7,079,274
Commercial    Real Estate	7,527,051		4,531,168		7,703,099		19,761,318		213,150,755		232,912,073
Total	$	8,430,924	$	5,534,193	$	12,137,783	$	26,102,900	$	350,632,643	$	376,735,543

The following table presents an age analysis of past due balances by category at December 31, 2012:

	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans Receivable
Residential    Real Estate	$	—	$	1,794,644	$	3,757,801	$	5,552,445	$	85,125,180	$	90,677,625
Consumer	1,862,611		211,756		646,136		2,720,503		53,874,590		56,595,093
Commercial    Business	445,113		36,079		86,991		568,183		7,495,718		8,063,901
Commercial    Real Estate	2,432,423		4,852,227		13,913,190		21,197,840		229,726,254		250,924,094
Total	$	4,740,147	$	6,894,706	$	18,404,118	$	30,038,971	$	376,221,742	$	406,260,713

At September 30, 2013 and December 31, 2012, 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.

18

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9.    Loans Receivable, Net, Continued

The following table shows non-accrual loans by category at June 30, 2013 compared to December 31, 2012:

	At September 30, 2013				At December 31, 2012				$			%
	Amount		Percent (1)		Amount		Percent (1)		Increase (Decrease)			Increase (Decrease)
Non-accrual Loans:
Residential Real Estate	$	3,933,183	1.1	%	$	3,757,801	0.9	%	$	175,382		4.7	%
Commercial Business	700		—		86,991		—		(86,291		)	(99.2	)
Commercial Real Estate	7,703,099		2.1		13,913,190		3.4		(6,210,091		)	(44.6	)
Consumer	500,801		0.1		646,136		0.2		(145,335		)	(22.5	)
Total Non- accrual Loans	$	12,137,783	3.2	%	$	18,404,118	4.5	%	$	(6,266,335	)	(34.0	)%

^{(1) PERCENT OF TOTAL LOANS HELD FOR INVESTMENT, NET OF DEFERRED FEES AND LOANS IN PROCESS.} 

The following tables show the activity in the allowance for loan losses by category for the periods indicated:

	For the Three Months Ended September 30, 2013
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,665,871		$	888,913		$	488,554		$	7,963,941		$	11,007,279
Provision	175,482			(26,974		)	(66,101		)	517,593			600,000
Charge-Offs	(212,876		)	(27,916		)	—			(762,198		)	(1,002,990		)
Recoveries	—			18,953			10,219			15,870			45,042
Ending Balance	$	1,628,477		$	852,976		$	432,672		$	7,735,206		$	10,649,331

	For the Three Months Ended September 30, 2012
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	2,030,522		$	1,251,799		$	473,224		$	8,928,782		$	12,684,327
Provision	50,497			(80,555		)	(9,339		)	339,397			300,000
Charge-Offs	(192,026		)	(113,799		)	(28,736		)	(1,076,739		)	(1,411,300		)
Recoveries	330			2,901			4,087			65,814			73,132
Ending Balance	$	1,889,323		$	1,060,346		$	439,236		$	8,257,254		$	11,646,159

	For the Nine Months Ended September 30, 2013
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,521,559		$	1,001,271		$	618,919		$	8,176,622		$	11,318,371
Provision	431,317			(42,636		)	(201,148		)	2,457,848			2,645,381
Charge-Offs	(324,399		)	(143,991		)	(4,436		)	(2,997,474		)	(3,470,300		)
Recoveries	—			38,332			19,337			98,210			155,879
Ending Balance	$	1,628,477		$	852,976		$	432,672		$	7,735,206		$	10,649,331

19

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9.    Loans Receivable, Net, Continued

	For the Nine Months Ended September 30, 2012
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	2,416,356		$	996,780		$	720,405		$	10,127,833		$	14,261,374
Provision	147,559			1,327,579			(68,840		)	1,568,702			2,975,000
Charge-Offs	(684,681		)	(1,296,004		)	(217,466		)	(3,652,684		)	(5,850,835		)
Recoveries	10,089			31,991			5,137			213,403			260,620
Ending Balance	$	1,889,323		$	1,060,346		$	439,236		$	8,257,254		$	11,646,159

The following tables present information related to impaired loans evaluated individually for impairment and collectively evaluated for impairment in the allowance for loan losses:

	Allowance For Loan Losses
September 30, 2013	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	107,000	$	1,521,477	$	1,628,477
Consumer	—		852,976		852,976
Commercial Business	—		432,672		432,672
Commercial Real Estate	332,000		7,403,206		7,735,206
Total	$	439,000	$	10,210,331	$	10,649,331

	Allowance For Loan Losses
December 31, 2012	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	—	$	1,521,559	$	1,521,559
Consumer	—		1,001,271		1,001,271
Commercial Business	—		618,919		618,919
Commercial Real Estate	440,000		7,736,622		8,176,622
Total	$	440,000	$	10,878,371	$	11,318,371

20

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9.    Loans Receivable, Net, Continued

The following tables present information related to impaired loans evaluated individually for impairment and collectively evaluated for impairment in loans receivable for the periods indicated:

	Loans Receivable
September 30, 2013	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	4,120,500	$	79,585,615	$	83,706,115
Consumer	389,735		52,648,346		53,038,081
Commercial Business	20,611		7,058,663		7,079,274
Commercial Real Estate	29,170,177		203,741,896		232,912,073
Total	$	33,701,023	$	343,034,520	$	376,735,543

	Loans Receivable
December 31, 2012	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	4,500,902	$	86,176,723	$	90,677,625
Consumer	322,588		56,272,505		56,595,093
Commercial Business	7,853		8,056,048		8,063,901
Commercial Real Estate	35,115,195		215,808,899		250,924,094
Total	$	39,946,538	$	366,314,175	$	406,260,713

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 $36.1 million for nine months ended September 30, 2013 compared to $39.4 million for the nine months ended September 30, 2012.

21

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9.    Loans Receivable, Net, Continued

The following tables are a summary of information related to impaired loans as of and for the three months ended September 30, 2013 and 2012.

			At				For The Three Months Ended September 30,
	September 30, 2013						2013				2012
Impaired Loans	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Invesment		Interest Income Recognized		Average Recorded Invesment		Interest Income Recognized
With No Related Allowance Recorded:
Residential Real Estate	$	3,714,628	$	4,117,557	$	—	$	3,834,984	$	9,662	$	2,714,824	$	13,904
Consumer Loans	389,735		453,735		—		397,003		1,783		863,939		620
Commercial Business	20,611		20,611		—		21,438		226		16,220		207
Commercial Real Estate	28,175,429		33,729,063		—		28,838,663		271,472		33,178,350		276,147
With An Allowance Recorded:
Residential Real Estate	405,872		405,872		107,000		405,872		—		1,196,138		—
Consumer Loans	—		—		—		—		—		13,233		178
Commercial Business	—		—		—		—		—		49,537		—
Commercial Real Estate	994,748		1,442,740		332,000		1,151,053		8,326		4,161,122		2,643
Total
Residential Real Estate	4,120,500		4,523,429		107,000		4,240,856		9,662		3,910,962		13,904
Consumer Loans	389,735		453,735		—		397,003		1,783		877,172		798
Commercial Business	20,611		20,611		—		21,438		226		65,757		207
Commercial Real Estate	29,170,177		35,171,803		332,000		29,989,716		279,798		37,339,472		278,790
Total	$	33,701,023	$	40,169,578	$	439,000	$	34,649,013	$	291,469	$	42,193,363	$	293,699

22

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9.    Loans Receivable, Net, Continued

	For The nine months Ended September 30,
	2013				2012
Impaired Loans	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With No Related Allowance    Recorded:
Residential Real Estate	$	3,911,750	$	20,289	$	2,388,929	$	92,425
Consumer Loans	394,775		7,494		1,467,255		11,201
Commercial Business	23,745		335		110,021		368
Commercial Real Estate	30,090,250		1,031,806		30,054,920		1,204,035
With An Allowance Recorded:
Residential Real Estate	405,872		—		957,060		6,137
Consumer Loans	—		—		17,066		178
Commercial Business	—		—		110,326		956
Commercial Real Estate	1,278,434		23,274		4,292,826		188,164
Total
Residential Real Estate	4,317,622		20,289		3,345,989		98,562
Consumer Loans	394,775		7,494		1,484,321		11,379
Commercial Business	23,745		335		220,347		1,324
Commercial Real Estate	31,368,684		1,055,080		34,347,746		1,392,199
Total	$	36,104,826	$	1,083,198	$	39,398,403	$	1,503,464

23

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9.    Loans Receivable, Net, Continued

	December 31, 2012
Impaired Loans	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With No Related Allowance    Recorded:
Residential Real Estate	$	4,500,902	$	4,611,873	$	—	$	4,531,543	$	130,896
Consumer Loans	322,588		386,588		—		342,916		28,419
Commercial Business	7,853		7,853		—		12,236		—
Commercial Real Estate	31,808,577		35,373,833		—		32,963,079		1,036,344
With An Allowance Recorded:
Residential Real Estate	—		—		—		—		—
Consumer Loans	—		—		—		—		—
Commercial Business	—		—		—		—		—
Commercial Real Estate	3,306,618		4,766,031		440,000		3,705,660		—
Total
Residential Real Estate	4,500,902		4,611,873		—		4,531,543		130,896
Consumer Loans	322,588		386,588		—		342,916		28,419
Commercial Business	7,853		7,853		—		12,236		—
Commercial Real Estate	35,115,195		40,139,864		440,000		36,668,739		1,036,344
Total	$	39,946,538	$	45,146,178	$	440,000	$	41,555,434	$	1,195,659

In the course of resolving delinquent loans, the Bank may choose to restructure the contractual terms of certain loans. A troubled debt restructuring ("TDR") is a restructuring in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a borrower that it would not otherwise consider (Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 310-40).  The concessions granted on TDRs generally include terms to reduce the interest rate, extend the term of the debt obligation, or modify the payment structure on the debt obligation. The Bank grants such concessions to reassess the borrower’s financial status and develop a plan for repayment.  TDRs included in impaired loans at September 30, 2013 and December 31, 2012 were $12.2 million and $15.9 million, respectively.

Loans on nonaccrual status at the date of modification are initially classified as nonaccrual TDRs. Loans on accruing status at the date of concession are initially classified as accruing TDRs if the note is reasonably assured of repayment and performance is expected in accordance with its modified terms. Such loans may be designated as nonaccrual loans subsequent to the concession date if reasonable doubt exists as to the collection of interest or principal under the restructuring agreement. Nonaccrual TDRs are returned to accruing status when there is economic substance to the restructuring, there is documented credit evaluation of the borrower's financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated sustained repayment performance in accordance with the modified terms for a reasonable period of time (generally a minimum of six months).

24

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

9.    Loans Receivable, Net, Continued

There were no loan modifications during the three months ended September 30, 2013 or 2012 that were TDRs. The following table is a summary of loans restructured as TDRs during the periods indicated:

	For the nine months Ended September 30, 2013					For the nine months Ended September 30, 2012
Troubled Debt Restructurings	Number of Contracts	Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		Number of Contracts	Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Residential Real Estate	—	$	—	$	—	—	$	—	$	—
Consumer Loans	—	—		—		1	15,358		15,358
Commercial Business	—	—		—		—	—		—
Commercial Real Estate	4	1,651,023		1,651,023		9	7,871,114		7,871,114
Total	4	$	1,651,023	$	1,651,023	10	$	7,886,472	$	7,886,472

During the nine months ended September 30, 2013, the Bank modified four loans that were considered to be a TDR. The Banklowered the interest rate on these loans to enable the customer to begin making monthly principal and interest payments. During the three and nine months ended September 30, 2013, one loan for $142,000 that had been previously restructured within the last twelve months defaulted. The Bank considers any loan 30 days or more past due to be in default. During the nine months ended September 30, 2012, seven loans with a recorded investment of $4.1 million that had been restructured during the previous 12 months subsequently defaulted during the period. Of these seven loans, three with a recorded investment of $333,000 defaulted during the three months ended September 30, 2012.

Our policy with respect to accrual of interest on loans restructured in a TDR follows relevant supervisory guidance.  That is, if a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is likely.  If a borrower was materially delinquent on payments prior to the restructuring but shows capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual going forward.  Lastly, if the borrower does not perform under the restructured terms, the loan is placed on nonaccrual status.

We will continue to closely monitor these loans and will cease accruing interest on them if management believes that the borrowers may not continue performing based on the restructured note terms.  If, after previously being classified as a TDR, a loan is restructured a second time, then that loan is automatically placed on nonaccrual status.  Our policy with respect to nonperforming loans requires the borrower to make a minimum of six consecutive payments in accordance with the loan terms before that loan can be placed back on accrual status.  Further, the borrower must show capacity to continue performing into the future prior to restoration of accrual status.

25

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

10. Regulatory Matters

The Federal Reserve and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders' equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. The Bank is required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio.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.  As of September 30, 2013 and December 31, 2012, the Bank was categorized as “well capitalized” under the regulatory framework for prompt corrective action.  The Company and 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)
September 30, 2013
SECURITY FEDERAL CORP.
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	69,223	17.4	%	$	15,956	4.0	%	N/A		N/A
Total Risk-Based Capital (To Risk Weighted Assets)	83,475		20.9	%	31,913		8.0	%	N/A		N/A
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	69,223		8.1	%	34,371		4.0	%	N/A		N/A
SECURITY FEDERAL BANK
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	80,916	20.3	%	$	15,946	4.0	%	$	23,919	6.0	%
Total Risk-Based Capital (To Risk Weighted Assets)	85,969		21.6	%	31,892		8.0	%	39,865		10.0	%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	80,916		9.5	%	34,232		4.0	%	42,790		5.0	%
December 31, 2012
SECURITY FEDERAL CORP.
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	68,639	16.5	%	$	16,619	4.0	%	N/A		N/A
Total Risk-Based Capital (To Risk Weighted Assets)	84,148		20.3	%	33,237		8.0	%	N/A		N/A
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	68,639		7.7	%	35,552		4.0	%	N/A		N/A
SECURITY FEDERAL BANK
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	80,822	19.5	%	$	16,606	4.0	%	$	24,909	6.0	%
Total Risk-Based Capital (To Risk Weighted Assets)	86,012		20.7	%	33,212		8.0	%	41,515		10.0	%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	80,822		9.1	%	35,541		4.0	%	44,426		5.0	%

26

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

11. Carrying Amounts and Fair Value of Financial Instruments

The Company has 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.
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 September 30, 2013, the Company’sinvestment portfolio was comprised of government and agency bonds, mortgage-backed securities issued by government agencies or GSEs, municipal securities, and two equity investments. 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.

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.

27

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

11. Carrying Amounts and Fair Value of Financial Instruments, Continued

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 sell, 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 September 30, 2013, most 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. The Company records impaired loans as nonrecurring Level 3.

As of September 30, 2013 and December 31, 2012, the recorded investment in impaired loans was $33.7 million and $39.9 million, respectively.

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 3. 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.

Assets measured at fair value on a recurring basis are as follows as of September 30, 2013:

Assets:	Quoted Market Price In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
FHLB Securities	$	—	$	15,046,290	$	—
FFCB Securities	—		5,413,658		—
FNMA And FHLMC Bonds	—		2,974,860		—
SBA Bonds	—		101,025,228		—
Tax Exempt Municipal Bonds	—		56,913,461		—
Mortgage-Backed Securities	—		245,220,951		—
Equity Securities	—		252,350		—
Total	$	—	$	426,846,798	$	—

28

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

11. Carrying Amounts and Fair Value of Financial Instruments, Continued

Assets measured at fair value on a recurring basis are as follows as of December 31, 2012:

Assets:	Quoted Market Price In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
FHLB Securities	$	—	$	6,164,670	$	—
SBA Bonds	—		96,462,270		—
Tax Exempt Municipal Bonds	—		37,482,148		—
Mortgage-Backed Securities	—		214,731,903		—
Equity Securities	—		75,225		—
Total	$	—	$	354,916,216	$	—

There were no liabilities measured at fair value on a recurring basis as of September 30, 2013 or December 31, 2012.

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 measured at fair value on a nonrecurring basis as of September 30, 2013 and December 31, 2012, aggregated by the level in the fair value hierarchy within which those measurements fall. There were no liabilities measured at fair value on a nonrecurring basis as of September 30, 2013 and December 31, 2012.

Assets:	Level 1		Level 2		Level 3		Balance At September 30, 2013
Mortgage Loans Held For Sale	$	—	$	1,385,925	$	—	$	1,385,925
Collateral Dependent Impaired Loans	—		—		33,262,023		33,262,023
Foreclosed Assets	—		—		3,492,365		3,492,365
Total	$	—	$	1,385,925	$	36,754,388	$	38,140,313

^{(1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF $439,000}  

Assets:	Level 1		Level 2		Level 3		Balance At December 31, 2012
Mortgage Loans Held For Sale	$	—	$	4,770,760	$	—	$	4,770,760
Collateral Dependent Impaired Loans (1)	—		—		39,506,538		39,506,538
Foreclosed Assets	—		—		6,754,425		6,754,425
Total	$	—	$	4,770,760	$	46,260,963	$	51,031,723

^{(1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF $440,000}

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of September 30, 2013, the significant unobservable inputs used in the fair value measurements were as follows:

	Fair Value			Significant
	September 30,		Valuation	Unobservable
	2013		Technique	Inputs	Range
Collateral Dependent Impaired Loans	$	33,262,023	Appraised Value	Discount Rates/ Discounts to Appraised Values	0% - 70%
Foreclosed Assets	3,492,365		Appraised Value/Comparable Sales	Discount Rates/ Discounts to Appraised Values	0% - 83%

29

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

11. 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.

FHLB Advances—Fair value is estimated based on discounted cash flows using current market rates for advances 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.

30

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

11. Carrying Amounts and Fair Value of Financial Instruments, Continued

The following tables are a summary of the carrying value and estimated fair value of the Company’s financial instruments as of September 30, 2013 and December 31, 2012 presented in accordance with the applicable accounting guidance.

	September 30, 2013
	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash And Cash Equivalents	$	10,380	$	10,380	$	10,380	$	—	$	—
Certificates Of Deposits With Other Banks	1,480		1,480		—		1,480		—
Investment And Mortgage-Backed Securities	426,847		426,847		—		426,847		—
Loans Receivable, Net	364,923		365,955		—		—		365,955
FHLB Stock	4,675		4,675		4,675		—		—
Financial Liabilities:
Deposits:
Checking, Savings, And Money Market     Accounts	$	406,479	$	406,479	$	406,479	$	—	$	—
Certificate Accounts	262,874		264,241		—		264,241		—
Advances From FHLB	78,144		83,721		—		83,721		—
Other Borrowed Money	9,873		9,873		9,873		—		—
Senior Convertible Debentures	6,084		6,084		—		6,084		—
Junior Subordinated Debentures	5,155		5,155		—		5,155		—

	December 31, 2012
	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash And Cash Equivalents	$	7,904	$	7,904	$	7,904	$	—	$	—
Certificates Of Deposits With Other Banks	1,729		1,729		—		1,729		—
Investment And Mortgage-Backed Securities	430,988		434,588		—		434,588		—
Loans Receivable, Net	397,706		397,360		—		—		397,360
FHLB Stock	6,179		6,179		6,179		—		—
Financial Liabilities:
Deposits:
Checking, Savings, And Money Market     Accounts	$	383,534	$	383,534	$	383,534	$	—	$	—
Certificate Accounts	292,804		295,734		—		295,734		—
Advances From FHLB	105,257		113,471		—		113,471		—
Other Borrowed Money	9,317		9,317		9,317		—		—
Senior Convertible Debentures	6,084		6,084		—		6,084		—
Junior Subordinated Debentures	5,155		5,155		—		5,155		—

At September 30, 2013, the Bank had $33.0 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.

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.  

31

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

11. Carrying Amounts and Fair Value of Financial Instruments, Continued

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.

12. Accounting and Reporting Changes

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

In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-02 “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income”. This ASU requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under US GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under US GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under US GAAP that provide additional detail about these amounts. The new guidance was effective prospectively for reporting periods beginning after December 15, 2012. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements

In July 2013, the FASB issued Accounting Standards Update No. 2013-11, Presentation of Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (Topic 740). ASU No. 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. No new recurring disclosures are required. The amendments are effective for annual and interim reporting periods beginning on or after December 15, 2013 and are to be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The adoption of ASU No. 2013-11 is not expected to have a material impact on the Company's consolidated financial statements.

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.

32

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

13.     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.

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

33

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements and “Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995

This report contains forward-looking statements, which can be identified by the use of words such as “believes,” “intends,” “expects,” “anticipates,” “estimates” or similar expressions. Forward-looking statements include, but are not limited to:

• statements of our goals, intentions and expectations;

• statements regarding our business plans, prospects, growth and operating strategies;

• statements regarding the quality of our loan and investment portfolios; and

• estimates of our risks and future costs and benefits.

These forward-looking statements are subject to significant risks and uncertainties. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:

• 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 impacted 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 the Company by the Federal Reserve, and our bank subsidiary by the FDIC and the South Carolina Board of Financial Institutions 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;

• increases in premiums for deposit insurance;

• our ability to control operating costs and expenses;

• our ability to implement our business strategies

• 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 have acquired or 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 impact of new legislation, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and the implementing regulations, and the recently issued Basel III regulatory capital requirements;

• 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 FASB, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods;

34

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

• Future legislative changes and our ability to continue to comply with the requirements of the U.S. Department of Treasury’s Community Development Capital Initiative; 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.

Some of these and other factors are discussed in the Company's 2012 Form 10-KT under Item 1A, “Risk Factors.” Such developments could have an adverse impact on our financial position and our results of operations.

Any of the forward-looking statements that we make in this quarterly report and in other public statements we make may turn out to be inaccurate as a result of our beliefs and assumptions we make in connection with the factors set forth above or because of other unidentified and unpredictable factors. Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements and you should not rely on such statements. The Company undertakes no obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. These risks could cause our actual results for 2013 and beyond to differ materially from those expressed in any forward-looking statements by or on behalf of us, and could negatively affect the Company’s financial condition, liquidity and operating and stock price performance.

Financial Condition At September 30, 2013 and December 31, 2012

General – Total assets decreased $37.9 million or 4.3% to $852.4 million at September 30, 2013 from $890.4 million at December 31, 2012. The primary reason for the decrease in total assets was a decrease in net loans receivable and repossessed assets.

Assets – The increases and decreases in total assets were primarily concentrated in the following asset categories:

						Increase (Decrease)
		September 30, 2013		December 31, 2012		Amount		Percent
Cash And Cash Equivalents	$	10,379,990	$	7,903,950	$	2,476,040		31.3%
Investment And Mortgage-    Backed Securities –    Available For Sale		426,846,798		354,916,216		71,930,582		20.3
Investment And Mortgage-    Backed Securities – Held    To Maturity		—		76,072,262		(76,072,262	)	(100.0)
Loans Receivable, Net		364,923,095		397,705,820		(32,782,725	)	(8.2)
Repossessed Assets    Acquired In    Settlement Of Loans		3,492,365		6,754,425		(3,262,060	)	(48.3)
FHLB Stock		4,674,700		6,178,700		(1,504,000	)	(24.3)
Other Assets		7,271,219		5,488,960		1,782,259		32.5

Cash and cash equivalents increased $2.5 million or 31.3% to $10.4 million at September 30, 2013 from $7.9 million at December 31, 2012.

Investment and mortgage-backed securities available for sale increased $71.9 million or 20.3% to $426.8 million at September 30, 2013 from $354.9 million at December 31, 2012. On June 30, 2013, the Company transferred all of its investment and mortgage-backed securities classified as held to maturity to available for sale. The amortized cost of the securities that were transfered totaled $72.0 million and the unrealized gain related to these securities totaled $1.4 million on the date of the transfer. The Company also sold 22 securities during the nine months ended September 30, 2013.

Investment and mortgage-backed securities held to maturity decreased to none at September 30, 2013 from $76.1 million at December 31, 2013 as a result of the transfer mentioned above as well as principal repayments on mortgage-backed securities. As a result of the transfer and subsequent sales, the Company believes it has tainted its held to maturity classification and judgment will be required in the future in determining when circumstances have changed such that management can assert with a great degree of credibility that it has the intent and ability to hold debt securities to maturity. Based on this guidance, the Company does not expect to classify any securities as held to maturity within the near future.

35

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Loans receivable, net, decreased $32.8 million or 8.2% to $364.9 million at September 30, 2013 from $397.7 million at December 31, 2012. This decrease was a result of increased loan paydowns combined with lower loan demand from creditworthy borrowers. Residential real estate loans decreased $7.0 million or 7.7% to $83.7 million at September 30, 2013 from $90.7 million at December 31, 2012. Consumer loans decreased $3.6 million or 6.3% to $53.0 million at September 30, 2013 compared to $56.6 million at December 31, 2012. Commercial real estate loans and commercial business loans decreased $18.0 million and $985,000, respectively, to $232.9 million and $7.1 million, respectively, at September 30, 2013 from $250.9 million and $8.1 million, respectively, at December 31, 2012. Loans held for sale decreased $3.4 million or 70.9% to $1.4 million at September 30, 2013 from $4.8 million at December 31, 2012.

Repossessed assets acquired in settlement of loans decreased $3.3 million or 48.3% to $3.5 million at September 30, 2013 from $6.8 million at December 31, 2012. At September 30, 2013, the balance of repossessed assets consisted of the following real estate properties: six single-family residences and 11 lots within residential subdivisions located throughout our market areas in South Carolina and Georgia; three parcels of land in South Carolina; one commercial building in South Carolina; eight lots within a subdivision and adjacent 22.96 acres of land in Aiken, South Carolina; and 34.8 acres of land in Bluffton, South Carolina which was originally acquired as a participation loan from another financial institution.

FHLB stock decreased $1.5 million or 24.3% to $4.7 million at September 30, 2013 compared to $6.2 million at December 31, 2012 as a result of stock redemption. 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 plus a transaction component which equals 4.5% of outstanding advances (borrowings) from the FHLB of Atlanta. As total assets and total advances have decreased, so has the Bank’s required investment in FHLB stock.

Other assets increased $1.8 million or 32.5% to $7.3 million at September 30, 2013 compared to $5.5 million at December 31, 2012 as a result of an increase in the net deferred tax asset related to available for sale securities of $4.0 million offset partially by a decrease in prepaid FDIC premiums of $1.8 million. The unrealized gain on investment securities available for sale decreased$10.6 million during the nine months ended September 30, 2013 as a result of an increase in market rates. The increase in the deferred tax asset represents the tax impact of this change.

Liabilities

Deposit Accounts – The balances, weighted average rates and increases and decreases in deposit accounts were as follows:

								Balance
		September 30, 2013			December 31, 2012			Increase (Decrease)
		Balance	Weighted Rate		Balance	Weighted Rate		Amount	Percent
Demand Accounts:
Checking	$	140,136,294	0.04%	$	126,740,707	0.06%	$	13,395,587	10.57%
Money Market		241,699,252	0.28		234,382,412	0.38		7,316,840	3.12
Statement Savings    Accounts		24,643,763	0.10		22,411,240	0.20		2,232,523	9.96
Total		406,479,309	0.18		383,534,359	0.26		22,944,950	5.98
Certificate Accounts
0.00 – 1.99%		230,477,749			255,422,955			(24,945,206)	(9.77)
2.00 – 2.99%		30,165,359			32,975,486			(2,810,127)	(8.52)
3.00 – 3.99%		1,637,935			2,380,728			(742,793)	(31.20)
4.00 – 4.99%		592,668			1,523,474			(930,806)	(61.10)
5.00 – 5.99%		—			501,651			(501,651)	(100.00)
Total		262,873,711	0.88		292,804,294	1.11		(29,930,583)	(10.22)
Total Deposits	$	669,353,020	0.46%	$	676,338,653	0.63%	$	(6,985,633)	(1.03)%

36

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Included in the certificate accounts above were $25.6 million and $22.6 million in brokered deposits at September 30, 2013 and December 31, 2012, respectively, with a weighted average interest rate of 1.23% and 1.47%, respectively.

Advances From FHLB – FHLB advances are summarized by contractual year of maturity and weighted average interest rate in the table below:

								Balance
		September 30, 2013			December 31, 2012			Decrease
Fiscal Year Due:		Balance	Rate		Balance	Rate		Balance	Percent
2013	$	—	0.00%	$	22,100,000	2.92%	$	(22,100,000)	(100.00)%
2014		25,244,371	3.06		30,257,182	3.33		(5,012,811)	(16.57)
2015		15,000,000	4.01		15,000,000	4.01		—	0.00
2016		20,000,000	4.61		20,000,000	4.60		—	0.00
2017		12,900,000	4.38		12,900,000	4.38		—	0.00
Thereafter		5,000,000	3.39		5,000,000	3.39		—	—
Total Advances	$	78,144,371	3.88%	$	105,257,182	3.72%	$	(27,112,811)	(25.76)%

During the nine months ended September 30, 2013, as part of the Company's strategy to lower cost of funds, management elected to prepay $25.0 million in higher rate advances. Advances are secured by a blanket collateral agreement with the FHLB pledging the Bank’s portfolio of residential first mortgage loans and investment securities with an amortized cost and fair value of $117.0 million and $110.2 million at September 30, 2013 and $135.7 million and $129.4 million at December 31, 2012, respectively. Advances are subject to prepayment penalties.

The following table shows at September 30, 2013 FHLB advances that are callable 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, reborrow funds on different terms, or convert the advance to a three-month floating rate advance tied to LIBOR.

As of September 30, 2013
Borrow Date	Maturity Date	Amount	Int. Rate		Type	Call Dates
11/23/05	11/23/15	5,000,000	3.993	%	Multi-Call	5/23/08 and quarterly thereafter
07/11/06	07/11/16	5,000,000	4.800		Multi-Call	7/11/08 and quarterly thereafter
11/29/06	11/29/16	5,000,000	4.025		Multi-Call	5/29/08 and quarterly thereafter
05/24/07	05/24/17	7,900,000	4.375		Multi-Call	5/27/08 and quarterly thereafter
07/25/07	07/25/17	5,000,000	4.396		Multi-Call	7/25/08 and quarterly thereafter

Other Borrowings – The Bank had $9.9 million and $9.3 million in other borrowings (non-FHLB advances) at September 30, 2013 and December 31, 2012, 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 September 30, 2013 and December 31, 2012, the interest rate paid on the repurchase agreements was 0.15% and 0.20% respectively. The Bank had pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $15.2 million and $15.6 million, respectively, at September 30, 2013 and $15.4 million and $16.3 million, respectively, at December 31, 2012.

Junior Subordinated Debentures – On September 21, 2006, Security Federal Statutory Trust (the Trust), issued and sold fixed and floating rate capital securities of the Trust (the “Capital Securities”). The Trust used the net proceeds from the sale of the Capital Securities to purchase a like amount of junior subordinated debentures (the “Debentures”) of the Company which are reported on the Consolidated Balance Sheets as junior subordinated debentures, generating proceeds of $5.0 million. The Company used the proceeds for general corporate purposes, primarily to provide capital to the Bank. The Capital Securities qualify as Tier 1 capital under Federal Reserve guidelines. The Debentures are the sole assets of the Trust. The Company’s obligations under the Debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the Trust.

37

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

The Capital Securities accrue and pay distributions annually at a rate per annum equal to 1.95% at September 30, 2013. Prior to September 2011, one-half of the Capital Securities issued in the transaction had a fixed rate of 6.88% and the remaining half had a floating rate of three-month LIBOR plus 170 basis points. After September 2011, the rate is a floating rate of three month LIBOR plus 170 basis points as the fixed rate portion was converted to the floating rate. 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.

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 on 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.

Equity – Shareholders’ equity decreased $5.1 million or 6.2% to $77.5 million at September 30, 2013 from $82.6 million at December 31, 2012. Accumulated other comprehensive income, net of tax, comprised primarily of unrealized losses on securities available for sale, net of tax, decreased $6.6 million or 88.6% to $849,000 at September 30, 2013. Long term interest rates increased sharply in June 2013 as a result of concerns the FRB could reduce its monthly purchases of bonds and mortgage-backed securities sooner than expected. As a result, the market values of municipal bonds, mortgage-backed securities, and other investments, due to their longer term nature, were negatively impacted. In addition, on July 31, 2013, the Company repurchased its outstanding warrant to purchase 137,966 shares of the Company’s common stock at $19.57 per share from the U.S. Treasury at a fair market value of $50,000. As a result of the transaction the warrant was canceled which reduced warrants outstanding by $400,000 and increased additional paid in capital by $350,000.

The Company’s net income available for common shareholders was $2.2 million for the nine months ended September 30, 2013, after payment of $330,000 in preferred stock dividends. The Board of Directors of the Company declared common stock dividends totaling $707,000 during the nine months ended September 30, 2013. Book value per common share was $18.85 at September 30, 2013 and $20.45 at December 31, 2012.

Results of Operations for the Three Month Periods Ended September 30, 2013 and 2012

Net Income Available to Common Shareholders - Net income available to common shareholders increased $352,000 or 62.9% to $912,000 or $0.31 per diluted common share for the three months ended September 30, 2013 compared to $560,000 or $0.19 per diluted common share for the three months ended September 30, 2012. The increase in net income was primarily the result of a $260,000 increase in non-interest income and a $406,000 decline in general and administrative expense offset partially by a $199,000 decrease in net interest income after the provision for loan losses.

Net Interest Income - The net interest margin increased 21 basis points to 3.04% for the three months ended September 30, 2013 from 2.83% for the comparable period in 2012 as the decline in the average cost of interest-bearing liabilities outpaced the decline in the average yield earned on interest-earning assets. Net interest income increased $101,000 or 1.7% to $5.9 million during the three months ended September 30, 2013, compared to $5.8 million for the same period in 2012. During the three months ended September 30, 2013, average interest earning assets decreased $28.1 million or 3.4% to $804.4 million while average interest-bearing liabilities decreased $48.8 million or 6.3% to $723.5 million.

38

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Interest Income - Total tax equivalent interest income decreased $458,000 or 5.5% to $7.9 million during the three months ended September 30, 2013 from $8.4 million for the same period in 2012. This decrease was primarily the result of the decrease in interest-earning assets. Total interest income on loans decreased $603,000 or 10.1% to $5.4 million during the three months ended September 30, 2013 from $6.0 million during the comparable period in 2012 as a result of the average loan portfolio balance decreasing $40.3 million or 9.8% to $369.7 million combined with the yield on the loan portfolio decreasing one basis point to 5.82%. Interest income from mortgage-backed securities decreased $282,000 or 17.2% to $1.4 million from $1.6 million for the same period in 2012 as a result of a 26 basis point decrease in the portfolio yield combined with a $20.5 million decrease in the average balance. Tax equivalent interest income from investment securities increased $427,000 or 58.0% to $1.2 million as a result of an increase of 57 basis points in the yield combined with an increase of $33.7 million in the average balance of the investment securities portfolio.

The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the three months ended September 30, 2013 and 2012:

	Three Months Ended September 30,
	2013				2012
		Average Balance	Yield(1)			Average Balance	Yield(1)			Increase (Decrease) In Interest And Dividend Income From 2012
Loans Receivable, Net	$	369,685,192	5.82	%	$	409,960,775	5.83	%	$	(603,380)
Mortgage-Backed Securities		245,876,609	2.21			266,336,834	2.47			(281,577)
Investment Securities(2)		183,338,969	2.54			149,601,065	1.97			426,917
Overnight Time And    Certificates of Deposit		5,487,687	0.16			6,561,662	0.14			(14	)
Total Interest-Earning Assets	$	804,388,457	3.93	%	$	832,460,336	4.02	%	$	(458,054)

⁽¹⁾ Annualized

⁽²⁾Tax equivalent basis is calculated using an effective tax rate of 34% and amounted to $196,678 and $88,977 for the quarters

ended September 30, 2013 and 2012, respectively.

Interest Expense - Total interest expense decreased $667,000 or 27.1% to $1.8 million during the three months ended September 30, 2013 compared to $2.5 million for the same period last year. The decrease in total interest expense was attributable to decreases in interest rates paid and a $48.8 million decrease in the average balance of interest-bearing liabilities. Interest expense on deposits decreased $452,000 or 36.3% to $794,000 during the three months ended September 30, 2013 compared to $1.2 million for the same period last year. The decrease was attributable to a 26 basis point decrease in the cost of deposit accounts combined with a $26.1 million decrease in average interest-bearing deposits to $616.8 million for the three month period ended September 30, 2013 when compared to $642.8 million for the three month period ended September 30, 2012. The decrease was concentrated in the certificate accounts, which decreased $41.1 million or 13.4% to $266.4 million during the three months ended September 30, 2013 compared to $307.5 million for the same period in 2012. The Bank has been competing less aggressively for time deposits in its local area and focusing instead on core deposits, or non time deposits.

Interest expense on FHLB advances and other borrowings decreased $212,000 or 19.9% to $854,000 during the three months ended September 30, 2013 from $1.1 million for the same period in 2012. The average balance of FHLB advances and other borrowed money decreased $22.7 million or 19.2% to $95.4 million during the three months ended September 30, 2013 from $118.2 million for the same period last year. During the three months ended September 30, 2013, as part of the Company's strategy to lower cost of funds, management elected to prepay $25.0 million in higher rate advances. The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the three months ended September 30, 2013 and 2012.

39

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

	Three Months Ended September 30,
	2013			2012
		Average Balance	Yield(1)		Average Balance	Yield(1)		Decrease In Interest Expense From 2012
Now And Money Market    Accounts	$	325,852,310	0.23%	$	313,228,039	0.37%	$	(105,204	)
Statement Savings Accounts		24,556,885	0.11		22,143,684	0.20		(3,982	)
Certificates Accounts		266,366,465	0.90		307,476,207	1.23		(343,240	)
FHLB Advances And    Other Borrowed Money		95,442,908	3.58		118,153,324	3.61		(212,118	)
Junior Subordinated Debentures		5,155,000	2.01		5,155,000	2.20		(2,426	)
Senior Convertible Debentures		6,084,000	8.00		6,084,000	8.00		—
Total Interest-Bearing Liabilities	$	723,457,568	0.99%	$	772,240,254	1.28%	$	(666,970	)

⁽¹⁾ Annualized

Provision for Loan Losses - The amount of the provision is determined by management’s on-going monthly analysis of the loan portfolio and the adequacy of the allowance for loan losses. The Company has policies and procedures in place for evaluating andmonitoring the overall credit quality of the loan portfolio and for timely identification of potential problem loans including internal and external loan reviews. The adequacy of the allowance for loan losses is reviewed monthly by the Asset Classification Committee and quarterly by the Board of Directors.

Management’s monthly review of the adequacy of the allowance includes three main components. The first component is an analysis of loss potential in various homogeneous segments of the portfolio based on historical trends and the risk inherent in each category. Previously, management applied a five year historical loss ratio to each loan category to estimate the inherent loss in these pooled loans. However, as a result of the decline in economic conditions and the unprecedented increases in delinquencies and charge offs experienced by the industry, the Company no longer considers five year historical losses relevant indicators of future losses. Management began applying 12 to 24 month historical loss ratios to each loan category to more accurately project losses in the near future.

The second component of management’s monthly analysis is the specific review and evaluation of significant problem credits identified through the Company’s internal monitoring system. These loans are evaluated for impairment and recorded in accordance with accounting guidance. For each loan deemed impaired, management calculates a specific reserve for the amount in which the recorded investment in the loan exceeds the fair value. This estimate is based on a thorough analysis of the most probable source of repayment, which is typically liquidation of the collateral.

The third component is an analysis of changes in qualitative factors that may affect the portfolio, including but not limited to: relevant economic trends that could impact borrowers’ ability to repay, industry trends, changes in the volume and composition of the portfolio, credit concentrations, or lending policies and the experience and ability of the staff and Board of Directors. Management also reviews and incorporates certain ratios such as percentage of classified loans, average historical loan losses by loan category, delinquency percentages, and the assignment of percentage targets of reserves in each loan category when evaluating the allowance.

Once the analysis is completed, the three components are combined and compared to the allowance amount. Based on this, charges are made to the provision as needed.

Net charge-offs were $958,000 or 0.26% of gross loans during the three months ended September 30, 2013 compared to $1.3 million or .33% of gross loans for the same three month period in 2012. Management of the Bank continues to be concerned about current market conditions and closely monitors the loan portfolio on an on-going basis to be proactive in identifying any potential problem loans.

40

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

The provision for loan losses was $600,000 for the quarter ended September 30, 2013 compared to $300,000 for the same quarterin the prior year. The following table details selected activity associated with the allowance for loan losses for the three months ended September 30, 2013 and 2012:

		Three Months Ended September 30,
		2013			2012
Beginning Balance	$	11,007,279		$	12,684,327
Provision		600,000			300,000
Charge-offs		(1,002,990)			(1,411,300)
Recoveries		45,042			73,132
Ending Balance	$	10,649,331		$	11,646,159
Allowance For Loan Losses As A Percentage Of Gross Loans Receivable, Held For Investment At The End Of The Period		2.83	%		2.83	%
Allowance For Loan Losses As A Percentage Of Impaired Loans At   The End Of The Period		31.60	%		26.99	%
Gross Loans Receivable, Held For Investment And Held For Sale	$	378,121,468		$	416,406,309
Total Loans Receivable, Net	$	364,923,095		$	403,049,461

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 need to acquire these properties through foreclosure or other means and subsequently sell, develop or liquidate them.

Non-Interest Income - Non-interest income increased $260,000 or 17.6% to $1.7 million for the three months ended September30, 2013, compared to $1.5 million for the three months ended September 30, 2012. The following table provides a detailed analysis of the changes in the components of non-interest income:

	Three Months Ended September 30,				Increase (Decrease)
		2013		2012		Amounts		Percent
Gain On Sale Of Investments	$	419,360	$	324,835	$	94,525		29.1%
Gain On Sale Of Loans		227,332		177,524		49,808		28.1
Service Fees On Deposit Accounts		303,350		291,753		11,597		4.0
Income From Cash Value Of    Life Insurance		78,000		105,000		(27,000	)	(25.7)
Commissions From Insurance Agency		103,330		131,761		(28,431	)	(21.6)
Trust Income		135,000		120,000		15,000		12.5
Check Card Fee Income		222,252		196,943		25,309		12.9
CDFI Financial Award Income		97,000		—		97,000		100.0
Other		152,467		129,873		22,594		17.4
Total Non-Interest Income	$	1,738,091	$	1,477,689	$	260,402		17.6%

Gain on sale of investments was $419,000 during the quarter ended September 30, 2013 an increase of $95,000 or 29.1% compared to $325,000 for the same period last year. The gain resulted from the sale of 10 investments during the period. Gain on sale of loans increased $50,000 or 28.1% to $227,000 during the three months ended September 30, 2013 compared to $178,000 for the same period last year. Management was able to maximize gain on sale of loans by raising the rates on these loans and therefore increasing the price.

CDFI financial award income increased $97,000 or 100.0% during the three months ended September 30, 2013, compared to the same period in 2012. The increase is due to a Community Development Financial Assistance ("CDFA") award the Bank received in recognition of its commitment to community development. The Bank used the CDFA award to fund a new Small Business Microloan program which provides small, short-term loans to small businesses. These microloans help boost the local economy

41

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

by enabling small businesses to obtain credit not otherwise available to them. The Bank received a total award of $1.5 million to be recognized on a pro-rata basis as the microloans are funded.

General And Administrative Expenses –For the quarter ended September 30, 2013, non-interest expense decreased $406,000 or 6.7% to $5.7 million compared to $6.1 million for the same period in 2012. The decrease in non-interest expense was primarily a result of a decrease in the net cost of operation of other real estate owned. The following table provides a detailed analysis of the changes in the components of general and administrative expenses:

	Three Months Ended September 30,				Increase (Decrease)
		2013		2012		Amounts		Percent
Compensation And Employee Benefits	$	2,677,608	$	2,709,998	$	(32,390	)	(1.2)%
Occupancy		484,857		505,208		(20,351	)	(4.0)
Advertising		79,130		97,221		(18,091	)	(18.6)
Depreciation And Maintenance Of Equipment		412,020		412,000		20		0.0
FDIC Insurance Premiums		191,535		152,494		39,041		25.6
Amortization of Intangibles		12,501		12,501		—		—
Net Cost Of Operation Of Other Real Estate Owned		506,174		1,321,254		(815,080	)	(61.7)
Prepayment Penalties on FHLB Advances		191,181		—		191,181		100.0
Other		1,109,892		860,407		249,485		29.0
Total General And Administrative    Expenses	$	5,664,898	$	6,071,083	$	(406,185	)	(6.7)%

Compensation and employee benefits expenses decreased $32,000 or 1.2% to $2.7 million for the three months ended September30, 2013 compared to $2.7 million during the same period last year while occupancy and advertising decreased $20,000 or 4.0% and $18,000 or 18.6%, respectively during the same period. The decreases are a result of the Company's focus on reducing operating expenses.

Net cost of operation of other real estate owned decreased $815,000 or 61.7% to $506,000 during the quarter ended September 30, 2013 from $1.3 million during the quarter ended September 30, 2012. This amount includes all expenses associated with other real estate owned including write-down in value and gain or loss on sales incurred during the period. Other real estate owned was$3.5 million at September 30, 2013 compared to $11.0 million at September 30, 2012.

The Company incurred a prepayment penalty of $191,000 for paying down FHLB advances during the three months ended September 30, 2013. The Company elected to prepay these higher rate advances to lower cost of funds. The Company did not prepay any advances during the three months ended September 30, 2012.

Other expenses increased $249,000, or 29.0% to $1.1 million for the three month period ended September 30, 2013 compared to $860,000 for the same period in the prior year. Other expenses include legal, professional, and consulting expenses, stationary and office supplies and other miscellaneous expenses. During 2013, the Bank hired a consultant that specializes in reducing operating expense and increasing fee income. Although this resulted in increased consulting fees during the current quarter, management believes this expense will be offset by the benefits realized in future periods.

Provision For Income Taxes – The provision for income taxes increased $116,000 or 47.2% to $361,000 for the three months ended September 30, 2013 from $245,000 for the same period one year ago. Income before income taxes was $1.4 million and $915,000 for the three months ended September 30, 2013 and 2012, respectively. The Company’s combined federal and state effective income tax rate for the current quarter was 26.1% compared to 26.8% for the same quarter one year ago.

Results of Operations for the Nine Month Periods Ended September 30, 2013 and 2012

Net Income Available to Common Shareholders - Net income available to common shareholders increased $741,000 or 49.4% to $2.2 million or $0.76 per diluted common share for the nine months ended September 30, 2013 compared to $1.5 million or $0.51 per diluted common share for the nine months ended September 30, 2012. The increase in net income was primarily the

42

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

result of a $1.2 million increase in non-interest income offset partially by a $252,000 decrease in net interest income after the provision for loan losses.

Net Interest Income - The net interest margin increased four basis points to 2.90% for the nine months ended September 30, 2013 from 2.86% for the comparable period in 2012. Despite the increase in margin, the significant decrease in the volume of interest earning assets, particularly loans, resulted in a decrease in net interest income. Net interest income decreased $582,000 or 3.3% to $17.2 million during the nine months ended September 30, 2013, compared to $17.8 million for the same period in 2012. During the nine months ended September 30, 2013, average interest earning assets decreased $28.7 million or 3.4% to $812.1 million while average interest-bearing liabilities decreased $46.6 million or 6.0% to $735.8 million from $782.4 million for the nine months ended September 30, 2012.

Interest Income - Total interest income decreased $2.6 million or 10.2% to $23.1 million during the nine months ended September 30, 2013 from $25.7 million for the same period in 2012. This decrease was the result of the decrease in interest-earning assets and the yield on those assets. Total interest income on loans decreased $2.2 million or 11.6% to $16.5 million during the nine months ended September 30, 2013 from $18.7 million for the same period in 2012 as a result of the average loan portfolio balance decreasing $41.8 million or 9.9% to $381.4 million from $423.2 million for the same period in 2012 and the yield on the loan portfolio decreasing 12 basis points to 5.76%. Interest income from mortgage-backed securities decreased $1.2 million or 23.9% to $3.9 million as a result of a 46 basis point decrease in the portfolio yield combined with a $19.0 million or 7.1% decrease in the average balance. Tax equivalent interest income from investment securities increased $1.0 million or 48.8% to $3.1 million as a result of an increase of 41 basis points in the yield combined with an increase of $32.1 million or 22.0% in the average balance of the investment securities portfolio.

The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the nine months ended September 30, 2013 and 2012:

	Nine Months Ended September 30,
	2013				2012
		Average Balance	Yield(1)			Average Balance	Yield(1)			Increase (Decrease) In Interest And Dividend Income From 2012
Loans Receivable, Net	$	381,399,510	5.76	%	$	423,211,566	5.88	%	$	(2,172,110)
Mortgage-Backed Securities		247,102,910	2.13			266,126,387	2.59			(1,236,046)
Investment Securities(2)		177,810,780	2.31			145,698,032	1.90			1,012,369
Overnight Time And    Certificates of Deposit		5,741,907	0.15			5,723,097	0.12			1,279
Total Interest-Earning Assets	$	812,055,107	3.86	%	$	840,759,082	4.11	%	$	(2,394,508)

⁽¹⁾ Annualized

⁽²⁾Tax equivalent basis is calculated using an effective tax rate of 34% and was $431,429 and $217,179 for the nine

months ended September 30, 2013 and 2012, respectively.

Interest Expense - Total interest expense decreased $2.0 million or 25.7% to $5.9 million during the nine months ended September 30, 2013 compared to $7.9 million for the same period last year. The decrease in total interest expense was attributable to decreases in interest rates paid and a $46.6 million decrease in the average balance of interest-bearing liabilities. Interest expense on deposits decreased $1.4 million or 34.4% to $2.7 million during the nine months ended September 30, 2013 compared to $4.1 million for the same period last year. The decrease was attributable to a 27 basis point decrease in the cost of deposit accounts combined with a $27.5 million decrease in average interest-bearing deposits to $620.0 million for the nine month period ended September 30, 2013 when compared to $647.5 million for the nine month period ended September 30, 2012. The decrease was concentrated in the certificate accounts, which decreased $42.6 million to $274.6 million during the nine months ended September 30, 2013 compared to the same period in 2012. Interest expense on advances and other borrowings decreased $618,000 or 18.3% to $2.8 million during the nine months ended September 30, 2013. The average balance of FHLB advances and other borrowed money decreased $19.1 million or 15.4% to $104.6 million during the nine months ended September 30, 2013 from $123.6 million for the same period last year. During the nine months ended September 30, 2013, as part of the Company's strategy to lower cost of funds, management elected to prepay $25.0 million in higher rate advances.

43

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the nine months ended September 30, 2013 and 2012:

	Nine months Ended September 30,
	2013				2012
		Average Balance	Yield(1)			Average Balance	Yield(1)			Decrease In Interest Expense From 2012
Now And Money Market    Accounts	$	321,456,199	0.26%		$	308,489,022	0.41	%	$	(310,706	)
Statement Savings Accounts		23,966,047	0.15			21,856,999	0.20			(4,605	)
Certificates Accounts		274,567,650	0.98			317,147,942	1.30			(1,085,510	)
FHLB Advances And    Other Borrowed Money		104,555,567	3.58			123,644,519	3.64			(618,014	)
Junior Subordinated Debentures		5,155,000	2.01			5,155,000	2.22			(8,233	)
Senior Convertible Debentures		6,084,000	8.00			6,084,000	8.00			—
Total Interest-Bearing Liabilities	$	735,784,463	1.06	%	$	782,377,482	1.35	%	$	(2,027,068	)

⁽¹⁾ Annualized

Provision for Loan Losses - The provision for loan losses was $2.6 million for the nine months ended September 30, 2013compared to $3.0 million for the same period in the prior year. Non-performing assets, which consist of non-accrual loans and repossessed assets decreased $9.6 million or 37.9% to $15.6 million at September 30, 2013 from $25.2 million at December 31, 2012 and decreased $22.8 million from $38.4 million at September 30, 2012. Net charge-offs were $3.3 million or 1.18% of gross loans during the three months ended September 30, 2013 compared to $5.6 million or 1.36% of gross loans for the same three month period in 2012.The following table details selected activity associated with the allowance for loan losses for the nine months ended September 30, 2013 and 2012:

		Nine months Ended September 30,
		2013		2012
Beginning Balance	$	11,318,371	$	14,261,374
Provision		2,645,381		2,975,000
Charge-offs		(3,470,300)		(5,850,835)
Recoveries		155,879		260,620
Ending Balance	$	10,649,331	$	11,646,159

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 need to acquire these properties through foreclosure or other means and subsequently sell, develop or liquidate them.

Non-Interest Income - Non-interest income increased $1.2 million or 26.9% to $5.4 million for the three months ended September30, 2013, compared to $4.3 million for the three months ended September 30, 2012. The following table provides a detailed analysis of the changes in the components of non-interest income:

44

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

	Nine months Ended September 30,				Increase (Decrease)
		2013		2012		Amounts		Percent
Gain On Sale Of Investments	$	1,173,140	$	963,454	$	209,686		21.8%
Gain On Sale Of Loans		622,960		453,634		169,326		37.3
Service Fees On Deposit Accounts		845,444		847,580		(2,136	)	(0.3)
Income From Cash Value Of    Life Insurance		261,000		315,000		(54,000	)	(17.1)
Commissions From Insurance    Agency		348,292		357,704		(9,412	)	(2.6)
Trust Income		405,000		366,000		39,000		10.7
Check Card Fee Income		640,374		600,126		40,248		6.7
CDFI Financial Award Income		733,071		—		733,071		100.0
Other		396,695		372,414		24,281		6.5
Total Non-Interest Income	$	5,425,976	$	4,275,912	$	1,150,064		26.9%

Gain on sale of investments was $1.2 million during the nine months ended September 30, 2013 an increase of $210,000 or 21.8% compared to $963,000 during the same period last year. The gain resulted from the sale of 22 investments during the period. Gain on sale of loans increased $169,000 or 37.3% to $623,000 during the nine months ended September 30, 2013 compared to $454,000 for the same period last year. Management was able to maximize gain on sale of loans by raising the rates slightly on these loans and therefore increasing the price.

CDFI financial award income increased $733,000 or 100.0% during the nine months ended September 30, 2013 compared to the same period in 2012 due to a CDFA award the Bank received in recognition of its commitment to community development. The Bank did not recognize any grant income during the nine months ended September 30, 2012. The CDFA award totaled $1.5 million. The remaining $767,000 will be recognized as the microloans are funded.

General And Administrative Expenses –For the nine months ended September 30, 2013, non-interest expense increased $75,000 or 0.5% to $16.6 million compared to $16.5 million for the same period in 2012. The increase in non-interest expense was primarily a result of an increase in other expenses of $511,000 and prepayment penalties on FHLB advances of $430,000 during the nine months ended September 30, 2013 offset partially by a decrease in the net cost of operation of other real estate of $1.1 million. The following table provides a detailed analysis of the changes in the components of general and administrative expenses:

	Nine months Ended September 30,				Increase (Decrease)
		2013		2012		Amounts		Percent
Compensation And Employee Benefits	$	8,267,433	$	8,064,121	$	203,312		2.5%
Occupancy		1,447,835		1,440,485		7,350		0.5
Advertising		256,861		256,472		389		0.2
Depreciation And Maintenance Of Equipment		1,220,952		1,245,320		(24,368	)	(2.0)
FDIC Insurance Premiums		555,733		476,943		78,790		16.5
Amortization of Intangibles		37,503		37,503		—		—
Net Cost Of Operation Of Other Real Estate Owned		1,243,935		2,375,109		(1,131,174	)	(47.6)
Prepayment Penalties on FHLB Advances		429,523		—		429,523		100.0
Other		3,109,619		2,598,207		511,412		19.7
Total General And Administrative    Expenses	$	16,569,394	$	16,494,160	$	75,234		0.5%

Other expenses increased $511,000, or 19.7% to $3.1 million for the nine month period ended September 30, 2013 compared to$2.6 million for the same period in the prior year. Other expenses include legal, professional, and consulting expenses, stationary and office supplies and other miscellaneous expenses. During the nine months ended September 30, 2013, the Bank hired a consultant that specializes in reducing operating expense and increasing fee income. Although this resulted in increased consulting fees during the current nine month period, management believes this expense will be offset by the benefits realized in future periods.

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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

The Company incurred a prepayment penalty of $430,000 for paying down FHLB advances during the nine months ended September 30, 2013. As part of the Company's strategy to lower cost of funds, management elected to prepay some higher rate advances.

Net cost of operation of other real estate owned decreased $1.1 million or 47.6% to $1.2 million for the nine months endedSeptember 30, 2013 from $2.4 million during the nine months ended September 30, 2012. Other real estate owned was $3.5 million at September 30, 2013 compared to $11.0 million at September 30, 2012.

Compensation and employee benefits expenses were at $8.3 million for the nine months ended September 30, 2013, increasing $203,000 or 2.5% from $8.1 million during the same period last year as a result of normal cost of living increases.

Provision For Income Taxes – The provision for income taxes increased $81,000 or 10.5% to $860,000 for the nine months ended September 30, 2013 from $779,000 for the same period one year ago. Income before income taxes was $3.4 million and $2.6 million for the nine months ended September 30, 2013 and 2012, respectively. The Company’s combined federal and state effective income tax rate for the nine months ended September 30, 2013 was 25.1% compared to 29.8% for the same quarter one year ago. The decrease in the effective income tax rate is the result of an increase in tax- exempt municipal income.

Liquidity Commitments, Capital Resources, and Impact of Inflation and Changing Prices

Liquidity – The Company actively analyzes and manages the Bank’s liquidity with the objective of maintaining an adequate level of liquidity and to ensure the availability of sufficient cash flows to support loan growth, fund deposit withdrawals, fund operations, and satisfy other financial commitments. See the “Consolidated Statements of Cash Flows” contained in Item 1 – Financial Statements, herein.

The primary sources of funds are customer deposits, loan repayments, loan sales, maturing investment securities, and advances from the FHLB. The sources of funds, together with retained earnings and equity, are used to make loans, acquire investment securities and other assets, and fund continuing operations. While maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage repayments are greatly influenced by the level of interest rates, economic conditions, and competition. Management believes that the Company’s current liquidity position and its forecasted operating results are sufficient to fund all of its existing commitments.

During the nine months ended September 30, 2013 loan repayments exceeded loan disbursements resulting in a $32.8 million or 8.2% decrease in total net loans receivable. During the nine months ended September 30, 2013, deposits decreased $7.0 million and FHLB advances decreased $27.1 million. The Bank had $182.0 million in additional borrowing capacity at the FHLB at the end of the period. At September 30, 2013, the Bank had $156.5 million of certificates of deposit maturing within one year. Based on previous experience, the Bank anticipates a significant portion of these certificates will be renewed on maturity.

At September 30, 2013, the Bank was categorized as “well capitalized” under the regulatory framework for prompt corrective action with total risk based, Tier 1 risk based and Tier 1 leverage ratios of 21.56%, 20.30% and 9.46%, respectively. To becategorized as “well capitalized” the Bank must maintain minimum total risk based, Tier 1 risk based and Tier 1 leverage ratios of 10%, 6% and 5%, respectively. There are no current conditions or events that management believes would change the Company’s or the Bank’s category.

Off-Balance Sheet Commitments – The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally include commitments to originate mortgage, commercial and consumer loans, and involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company’s maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount of those instruments. Since some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments. Collateral is not required to support commitments.

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at September 30, 2013.

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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

(Dollars in thousands)	Within One Month		After One Through Three Months		After Three Through Twelve Months		Within One Year		Greater Than One Year		Total
Unused Lines Of Credit	$	105	$	160	$	4,379	$	4,644	$	26,064	$	30,708
Standby Letters Of Credit	493		63		1,718		2,274		—		2,274
Total	$	598	$	223	$	6,097	$	6,918	$	26,064	$	32,982

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises principally from interest rate risk inherent in its lending, investment, deposit and borrowing activities. Management actively monitors and manages its interest rate risk exposure. Although the Company manages other risks such as credit quality and liquidity risk in the normal course of business, management considers interest rate risk to be its most significant market risk that could potentially have the largest material effect on the Company’s financial condition and results of operations. Other types of market risks such as foreign currency exchange rate risk and commodity price do not arise in the normal course of the Company’s business activities.

The Company’sprofitability is affected by fluctuations in the market interest rate. Management’s goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase or decrease in interest rates may adversely impact the Company’s earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same rate, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using a test that measures the impact on net interest income and net portfolio value of an immediate change in interest rates in 100 basis point increments and by measuring the Bank’s interest sensitivity gap (“Gap”). Net portfolio value is defined as the net present value of assets, liabilities, and off-balance sheet contracts. Gap is the amount of interest sensitive assets repricing or maturing over the next twelve months compared to the amount of interest sensitive liabilities maturing or repricing in the same time period.

For the nine months ended September 30, 2013, the Bank's interest rate spread, defined as the average yield on interest bearing assets less the average rate paid on interest bearing liabilities was 2.80%.

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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a - 15(e) of the Securities Exchange Act of 1934 (“Act”)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members of the Company’s senior management as of the end of the period covered by this quarterly report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that at September 30, 2013 the Company’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms. There have been no significant changes in our internal controls over financial reporting during the quarter ended September 30, 2013 that have materially affected or are reasonably likely to affect our internal controls over financial reporting.

The Company does not expect that its disclosure controls and procedures will prevent all error and or fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.

Part II: Other Information

Item 1    Legal Proceedings

The Company is not engaged in any legal proceedings of a material nature at the present time. From time to time, the Company is a party to legal proceedings in the ordinary course of business wherein it enforces its security interest in mortgage loans it has made.

Item 1A    Risk Factors

There have been no material changes in the risk factors previously disclosed in the Company’s Annual Report on Form 10-KT for the year ended December 31, 2012.

Item 2    Unregistered Sales of Equity Securities and Use Of Proceeds

None

Item 3    Defaults Upon Senior Securities

None

Item 4    Mine Safety Disclosures

Not applicable

Item 5    Other Information

None

Item 6    Exhibits

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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

3.1 Articles of Incorporation, as amended (1)

3.2 Articles of Amendment, including Certificate of Designation relating to the Company’s Fixed Rate Cumulative Perpetual Preferred Stock Series B (2)

3.3 Amended and Restated Bylaws (3)

4.1 Form of Stock Certificate of the Company and other instruments defining the rights of security holders, including indentures (4)

4.2 Form of Stock Certificate for the Series B Preferred Shares (2)

4.3 Warrant to purchase shares of the Company’s common stock dated December 19, 2008 (5)

4.4 Form of Indenture with respect to the Company’s 8.0% Convertible Senior Debentures Due 2029 (6)

4.5 Specimen Convertible Senior Debenture Due 2029 (6)

4.6 Letter Agreement dated September 29, 2010 between Security Federal Corporation and the United States Department of the Treasury, including the Exchange Agreement – Standard Terms, with respect to the exchange of the Series A Fixed Rate Cumulative Perpetual Preferred Stock for the Series B Fixed Rate Cumulative Perpetual Preferred Stock (2)

4.7 Letter Agreement dated September 29, 2010 between Security Federal Corporation and the United States Department of the Treasury, including the Securities Purchase Agreement – Standard Terms, with respect to the purchase of the Series B Fixed Rate Cumulative Perpetual Preferred Stock (2)

10.1 1993 Salary Continuation Agreements (7)

10.2 Amendment One to 1993 Salary Continuation Agreements (8)

10.3 Form of 2006 Salary Continuation Agreement (9)

10.4 1999 Stock Option Plan (10)

10.5 2002 Stock Option Plan (11)

10.6 2006 Stock Option Plan (12)

10.7 2008 Equity Incentive Plan (13)

10.8 Form of incentive stock option agreement and non-qualified stock option agreement pursuant to the 2006 Stock Option Plan (12)

10.9 2004 Employee Stock Purchase Plan (14)

10.10 Incentive Compensation Plan (7)

10.11 Form of Security Federal Bank Salary Continuation Agreement (9)

10.12 Form of Security Federal Split Dollar Agreement (9)

10.13 Form of Compensation Modification Agreement (5)

14 Code of Ethics (15)

25 Form T-1; Statement Eligibility of Trustee (6)

31.1 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act

31.2 Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act

32 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act

101 The following materials from Security Federal Corporation’s Quarterly Report on Form 10-Q for the quarter     ended September 30, 2013, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets;     (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income (Loss); (d) Consolidated Statements of Changes in Shareholders’Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements (16)

_____________

(1) Filed on June 26, 1998, as an exhibit to the Company’s Proxy Statement and incorporated herein by reference.

(2) Incorporated by reference to the Company’s Current Report on Form 8-K filed on September 30, 2010.    

(3) Incorporated by reference to the Company’s Current Report on Form 8-K filed on December 19, 2011.

(4) Filed on August 12, 1987, as an exhibit to the Company’s Registration Statement on Form 8-A and incorporated herein by reference.

(5) Incorporated by reference to the Company’s Current Report on Form 8-K filed on December 23, 2008.

(6) Filed on July 13, 2009 as an exhibit to the Company’s Registration Statement on Form S-1 (File No. 333-160553) and incorporated herein by reference.

(7) Filed on June 28, 1993, as an exhibit to the Company’s Annual Report on Form 10-KSB and incorporated herein by reference.

(8) Filed as an exhibit to the Company’s Quarterly Report on Form 10-QSB for the quarter ended September 30, 1993 and incorporated herein by reference.

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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

(9) Filed on May 24, 2006 as an exhibit to the Company’s Current Report on Form 8-K dated May 18, 2006 and incorporated herein by reference.

(10) Filed on March 2, 2000, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference

(11) Filed on January 3, 2003, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference.

(12) Filed on August 22, 2006, as an exhibit to the Company's Registration Statement on Form S-8 (Registration Statement No. 333-136813) and incorporated herein by reference.

(13) Filed on November 12, 2008, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference.

(14) Filed on June 18, 2004, as an exhibit to the Company’s Proxy Statement and incorporated herein by reference.

(15) Filed on June 29, 2006, as an exhibit to the Company’s Annual Report on Form 10-K and incorporated herein by reference.

(16) Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section

18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those     sections.

50

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

Signatures

Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

SECURITY FEDERAL CORPORATION

Date:	November 13, 2013	By:	/s/J. Chris Verenes
				J. Chris Verenes
				President & Chief Executive Officer
				Duly Authorized Representative

Date:	November 13, 2013	By:	/s/Roy G. Lindburg
				Roy G. Lindburg
				Chief Financial Officer
				Duly Authorized Representative

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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

EXHIBIT INDEX

31.1 Certifications of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act

31.2 Certifications of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act

32 Certifications of the Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act

101 The following materials from Security Federal Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income (Loss); (d) Consolidated Statements of Changes in Shareholders’Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements

52