Exhibit 13

Annual Report to Stockholders

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Selected Copnsolidated Financial and Other Data

		At Or For The Year Ended March 31,
		2012		2011		2010		2009		2008
Balance Sheet Data		(Dollars In Thousands, Except Per Share Data)
Total Assets	$	924,637	$	933,544	$	956,002	$	984,662	$	840,030
Cash And Cash Equivalents		9,331		7,836		8,805		6,562		10,539
Certificates Of Deposits With Other Banks		1,727		100		-		-		-
Investment And Mortgage-Backed Securities		421,631		372,418		311,046		314,099		264,312
Total Loans Receivable, Net (1)		428,511		484,471		568,399		611,090		517,932
Deposits		696,201		690,357		694,252		661,714		590,850
Advances From Federal Home Loan Bank		122,070		138,136		164,004		218,998		178,234
Total Shareholders' Equity		80,772		76,012		67,861		67,092		47,496
Income Data
Total Interest Income		38,529		43,742		47,507		48,867		49,632
Total Interest Expense		12,397		16,095		20,136		26,321		29,544
Net Interest Income		26,132		27,647		27,371		22,546		20,088
Provision For Loan Losses		8,650		7,800		8,155		2,825		895
Net Interest Income After Provision For Loan Losses		17,482		19,847		19,216		19,721		19,193
Non-Interest Income		6,942		6,795		6,113		4,496		4,489
General And Administrative Expense		20,717		23,841		22,663		20,499		17,322
Income Taxes		1,912		958		1,060		1,265		2,080
Net Income		1,795		1,843		1,605		2,453		4,280
Preferred Stock Dividends		440		666		900		252		-
Accretion Of Preferred Stock To Redemption Value		-		19		73		20		-
Net Income Available To Common Shareholders	$	1,355	$	1,158	$	632	$	2,181	$	4,280
Per Common Share Data
Net Income Per Common Share (Basic)	$	0.46	$	0.43	$	0.26	$	0.87	$	1.66
Cash Dividends Declared	$	0.32	$	0.32	$	0.32	$	0.32	$	0.28
Other Data
Interest Rate Spread Information:
Average During Period		2.98%		3.06%		2.83%		2.45%		2.44%
End Of Period		3.30%		3.34%		3.21%		2.58%		2.14%
Net Interest Margin (Net Interest Income/Average    Earning Assets)		3.09%		3.17%		2.98%		2.63%		2.69%
Average Interest-Earning Assets To Average Interest-    Bearing Liabilities		107.08%		106.35%		106.64%		105.80%		106.30%
Common Equity To Total Assets		6.36%		5.79%		5.25%		5.02%		5.65%
Non-Performing Assets To Total Assets (2)		3.98%		2.89%		4.39%		1.51%		0.81%
Return On Assets (Ratio Of Net Income To Average    Total Assets)		0.15%		0.12%		0.06%		0.24%		0.54%
Return On Common Equity (Ratio Of Net Income To    Average Common Equity)		2.35%		2.17%		1.27%		4.72%		9.54%
Common Equity To Assets Ratio (Ratio Of Average    Common  Equity To Average Total Assets)		6.22%		5.62%		5.09%		5.10%		5.66%
Dividend Pay-Out Ratio On Common Shares(3)		69.50%		74.13%		124.56%		36.59%		16.90%
Number Of Full-Service Offices		13		13		13		13		13

(1)     INCLUDES LOANS HELD FOR SALE.

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

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

7

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

General

The following discussion is presented to provide the reader with an understanding of the financial condition and the results of operations of Security Federal Corporation and its subsidiaries.  The investment and other activities of the parent company, Security Federal Corporation (the “Company”), have had no significant impact on the results of operations for the periods presented in the Consolidated Financial Statements included herein.  The information presented in the following discussion of financial results is indicative of the activities of Security Federal Bank (“Bank”), a wholly owned subsidiary of the Company.  The Bank was founded in 1922 as a federally chartered stock savings bank. On December 28, 2011, the Bank completed a charter conversion from a federally chartered stock savings bank to a South Carolina chartered commercial bank. In connection with this transaction, the Company reorganized from a savings and loan holding company into a bank holding company.

The Bank also has two wholly owned subsidiaries: Security Federal Insurance Inc. (“SFINS”) and Security Financial Services Corporation (“SFSC”).  SFINS was formed in the fiscal year ended March 31, 2002 and began operating during the December 2001 quarter.  SFINS is an insurance agency offering auto, business, health, and home insurance. SFINS has a wholly owned subsidiary, Collier Jennings Financial Corporation (“Collier Jennings”), which has three wholly owned subsidiaries: Security Federal Auto Insurance, The Auto Insurance Store Inc., and Security Federal Premium Pay Plans Inc.  Security Federal Premium Pay Plans Inc. has one wholly owned premium finance subsidiary and also has an ownership interest in four other premium finance subsidiaries.

SFSC was formed in 1975 and was inactive for several years. During the quarter ended December 31, 2010, it was reactivated and utilitzed to hold and operate a repossessed hotel located in Hardeeville, South Carolina. Subsequently, in fiscal 2012 the hotel was sold and the subsidiary once again returned to inactive status.

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

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

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

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

Forward-Looking Statements

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

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

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

8

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Forward-Looking Statements, Continued

·   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 Board of Governors of the Federal Reserve System (“Federal Reserve”), and our bank subsidiary by the Federal Deposit Insurance Corporation and the South Carolina State 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;

·   further increases in premiums for deposit insurance;

·   our ability to control operating costs and expenses;

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

·   difficulties in reducing risk 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 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 Jumpstart Our Business Startups Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act and the implementing regulations;

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

·   our ability to pay dividends on our common stock;

·   adverse changes in the securities markets;

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

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

·   Future legislative changes and our ability to comply with the requirements of the U.S. 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 our Annual Report on Form 10-K for the year ended March 31, 2012 under Item 1A, “Risk Factors.” Such developments could have an adverse impact on our financial position and our results of operations.

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

9

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Critical Accounting Policies

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

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

The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of the consolidated financial statements.  The Company provides for loan losses using the allowance method.  Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to the allowance for loan losses.

Additions to the allowance for loan losses are provided by charges to operations based on various factors, which, in management’s judgment, deserve current recognition in estimating possible losses.  Such factors considered by management include the fair value of the underlying collateral, stated guarantees by the borrower (if applicable), the borrower’s ability to repay from other economic resources, growth and composition of the loan portfolio, the relationship of the allowance for loan losses to the outstanding loans, loss experience, delinquency trends, and general economic conditions.  Management evaluates the carrying value of the loans periodically and the allowance is adjusted accordingly.

While management uses the best information available to make evaluations, future adjustments may be necessary if economic conditions differ substantially from the assumptions used in making these evaluations.  The allowance for loan losses is subject to periodic evaluations by bank regulatory agencies that may require adjustments to the allowance based upon the information that is available at the time of their examination. For a further discussion of the Company’s estimation process and methodology related to the allowance for loan losses, see the discussion under the section entitled “Comparison of the Years Ended March 31, 2012 and 2011 - Financial Condition” and “-Provision for Loan Losses” and “Comparison of the Years Ended March 31, 2011 and 2010 - Financial Condition” and “-Provision for Loan Losses” included herein.

The Company values an impaired loan at the loan’s fair value if it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement at the present value of expected cash flows, the market price of the loan, if available, or the value of the underlying collateral.  Expected cash flows are required to be discounted at the loan’s effective interest rate.  When the ultimate collectibility of an impaired loan’s principal is in doubt, wholly or partially, all cash receipts are applied to principal.  When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to interest and then to principal.  Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income to the extent that any interest has been foregone.  Further cash receipts are recorded as recoveries of any amounts previously charged off.

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

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

10

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Asset and Liability Management

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

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

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

At March 31, 2012, the mismatch of interest-earning assets repricing or maturing within one year with interest-bearing liabilities repricing or maturing within one year was $34.3 million or 3.7% of total assets compared to $9.9 million or 1.1% at March 31, 2011.  For more information on the Bank’s repricing position at March 31, 2012, see the tables on pages 12 and 13.

During the year ended March 31, 2012, the Bank originated, for investment purposes, $17.1 million in adjustable rate residential real estate loans (“ARM’s”), which are held for investment and are not sold. The Bank’s loan portfolio included $179.4 million of adjustable rate consumer loans, commercial loans, and mortgage loans or 40.3% of total gross loans at March 31, 2012.  During fiscal 2012, the Bank originated $204.9 million in consumer and commercial loans, which are usually short term in nature.  The Bank's portfolio of consumer and commercial loans was $344.6 million at March 31, 2012, $385.3 million at March 31, 2011, and $465.1 million at March 31, 2010.  Consumer and commercial loans combined were 77.4% of total loans at March 31, 2012, 76.8% of total loans at March 31, 2011, and 79.3% of total loans at March 31, 2010.

At March 31, 2012, the Bank held approximately $9.8 million in longer term fixed rate residential mortgage loans.  The majority of these loans, had converted from ARM loans to fixed rate loans during the previous 60 months.  These fixed rate loans have remaining maturities ranging from 10 to 30 years.  As of March 31, 2012, the Bank no longer had any ARM loans that have conversion features to fixed rate loans. On new originations, the Bank sells virtually all of its 15 and 30 year fixed rate mortgage loans at origination. However, occasionally the Bank may be required to repurchase a long term fixed rate residential mortgage loan it originally sold to an institutional investor. Fixed rate residential loans sold to Freddie Mac and other institutional investors, on a service-released basis totaled $37.9 million in fiscal 2012, $74.0 million in fiscal 2011, and $67.8 million in fiscal 2010.  The Bank sells all its fixed rate mortgage loans on a service-released basis.

Certificates of deposit of $100,000 or more, referred to as “Jumbo Certificates,” are normally considered to be interest rate sensitive because of their relatively short maturities.  At March 31, 2012, the Bank had $156.0 million outstanding in Jumbo Certificates compared to $172.2 million at March 31, 2011.  Brokered deposits totaled $34.4 million at March 31, 2012 compared to $39.7 million at March 31, 2011. The majority of the Bank’s deposits are originated within the Bank’s immediate market area.

11

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Asset and Liability Management, Continued

The following table sets forth the maturity schedule of certificates of deposit with balances of $100,000 or greater at March 31, 2012:

		At March 31, 2012
		(In Thousands)
Within 3 Months	$	32,232
After 3 Months, Within 6 Months		24,398
After 6 Months, Within 12 Months		18,946
After 12 Months		80,392
	$	155,968

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

		At March 31
		2012		2011
		(Dollars In Thousands)
Loans (1)	$	267,372	$	307,441
Mortgage-Backed Securities:
Held To Maturity		3,488		2,198
Available For Sale		92,157		67,935
Investment Securities:
Held To Maturity		8,715		1,966
Available For Sale		68,749		48,066
Other Interest-Earning Assets And FHLB Stock		9,048		11,535
Total Interest Rate Sensitive Assets Repricing Within 1 Year	$	449,529	$	439,141
Deposits	$	381,351	$	387,953
FHLB Advances And Other Borrowed Money		33,856		41,301
Total Interest Rate Sensitive Liabilities Repricing Within 1 Year	$	415,207	$	429,254
Gap	$	34,322	$	9,887
Interest Rate Sensitive Assets/Interest Rate Sensitive Liabilities		108.3%		102.30%
Gap As A Percent Of Total Assets		3.7%		1.1%

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

12

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Asset and Liability Management, Continued

The following table sets forth the interest rate sensitivity of the Bank's assets and liabilities at March 31, 2012, on the basis of the factors and assumptions set forth in the table on the previous page.

		Three Months Or Less		Over 3 –12 Months		Over 1 – 3 Years		Over 3 – 5 Years		Over 5 – 10 Years		Over  10 Years		Total
		(Dollars In Thousands)
Interest-Earnings Assets
Loans (1)	$	150,997	$	116,375	$	131,129	$	32,842	$	7,798	$	4,008	$	443,149
Mortgage-Backed Securities:
Held To Maturity, At Cost		933		2,555		5,733		19,823		13,225		1,464		43,733
Available For Sale, At Fair       Value		41,891		50,266		68,780		51,085		21,927		3,905		237,854
Investment Securities: (2)
Held To Maturity, At Cost		1,353		7,362		6,752		6,694		1,195		587		23,943
Available For Sale, At Fair       Value		60,830		7,919		14,087		9,909		20,552		2,804		116,101
FHLB Stock, At Cost		-		8,471		-		-		-		-		8,471
Other Interest-Earning Assets		577		-		1,727		-		-		-		2,304
Total Interest-Earning Assets	$	256,581	$	192,948	$	228,208	$	120,353	$	64,697	$	12,768	$	875,555
Interest-Bearing Liabilities
Deposits:
Certificate Accounts	$	67,576	$	148,162	$	67,725	$	41,443	$	-	$	-	$	324,906
NOW Accounts		3,854		11,562		61,666		-		-		-		77,082
Money Market Accounts		35,871		109,856		78,469		-		-		-		224,196
Statement Savings Accounts		1,118		3,352		17,879		-		-		-		22,349
Borrowings (2)		28,856		5,000		50,270		35,000		17,900		6,084		143,110
Total Interest-Bearing   Liabilities	$	137,275	$	277,932	$	276,009	$	76,443	$	17,900	$	6,084	$	791,643
Current Period Gap	$	119,306	$	(84,984)	$	(47,801)	$	43,910	$	46,797	$	6,684	$	83,912

Cumulative Gap	$	119,306	$	34,322	$	(13,479)	$	30,431	$	77,228	$	83,912	$	83,912
Cumulative Gap As A Percent        Of Total Assets		12.9%		3.7%		(1.5)%		3.3%		8.4%		9.1%		9.1%

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

(2) CALLABLE SECURITIES AND FHLB ADVANCES ARE SHOWN AT THEIR LIKELY CALL DATES BASED ON MANAGEMENT’S ESTIMATES AT MARCH 31, 2012.

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

13

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Financial Condition

Total assets at March 31, 2012 were $924.6 million, a decrease of $8.9 million or 1.0% from $933.5 million at March 31, 2011.  This decrease was primarily the result of a decrease in net loans receivable, offset by an increase in investment and mortgage-backed securities.

Total net loans receivable were $428.5 million at March 31, 2012, a decrease of $56.0 million or 11.6% from $484.5 million at March 31, 2011.  Residential real estate loans held for investment decreased $13.2 million or 11.9% to $97.8 million at March 31, 2012.   Typically, long term, newly originated fixed rate mortgage loans are not retained in the portfolio but are sold immediately.  ARMs are typically retained in the portfolio.  At March 31, 2012, the Bank held 86.6% of its residential mortgage loans in ARMs, while it had 13.4% in fixed rate mortgages.  Consumer loans decreased $6.2 million or 9.5% while commercial business loans decreased $4.0 million or 29.4% and commercial real estate loans decreased $30.6 million or 10.0% to $276.3 million at fiscal year end March 31, 2012 from $307.0 million at March 31, 2011. The decrease in loans held for investment is the result of increased offering rates on new loans, tightened underwriting standards and a general decrease in loan demand.  Loans held for sale, which were $2.7 million at March 31, 2012, decreased $2.5 million from $5.2 million or 48.3% from the previous fiscal year end.

Total investments and mortgage-backed securities increased $49.2 million or 13.2% to $421.6 million at March 31, 2012 from $372.4 million at March 31, 2011.  Cash and cash equivalents increased $1.5 million or 19.1% to $9.3 million at March 31, 2012 compared to $7.8 million at March 31, 2011.   Premises and equipment decreased $1.1 million or 5.4% to $18.7 million at March 31, 2012 as a result of normal annual depreciation of premises and equipment. The Bank did not undertake any significant construction or renovation projects during the years ended March 31, 2012 or 2011. The cash value of Bank Owned Life Insurance (“BOLI”) was $10.8 million at March 31, 2012 compared to $10.4 million at March 31, 2011 reflecting a $420,000 increase as a result of accumulated BOLI earnings. There were no additional BOLI purchases during the fiscal year ended March 31, 2012.  BOLI, which earns tax-free yields, is utilized to partially offset the cost of the Company’s employee benefits programs and to provide key person insurance on certain executive officers of the Company.

The Company’s non-performing assets increased $9.9 million or 36.6% to $36.8 million at March 31, 2012 from $26.9 million at March 31, 2011. The following table sets forth detailed information concerning our non-performing assets for the periods indicated:

	At March 31, 2012		At March 31, 2011		$ Increase	% Increase
	Amount	Percent (1)	Amount	Percent (1)	(Decrease)	(Decrease)
Loans 90 Days Or More Past Due Or   Non-Accrual Loans:
Residential Real Estate	$3,638,929	0.8%	$1,809,881	0.4%	$1,829,048	100.1%
Commercial Business	20,808	-	171,901	-	(151,093)	(87.9)
Commercial Real Estate	18,378,165	4.2	9,337,385	1.9	9,040,780	96.8
Consumer	620,358	0.1	1,194,171	0.2	(573,813)	(48.1)
Total Non-Performing Loans	22,658,260	5.1	12,513,338	2.5	10,144,922	81.1
Other Non-Performing Assets
Repossessed Assets	-	-	27,586	-	(27,586)	(100.0)
Real Estate Owned	14,160,099	3.2	14,406,267	2.9	(246,168)	(1.7)
Total Other Non-Performing Assets	14,160,099	3.2	14,433,853	2.9	(273,754)	(1.9)
Total Non-Performing Assets	$ 36,818,359	8.3%	$ 26,947,191	5.4%	$9,871,168	36.6%
Total Non-Performing Assets As A Percentage Of Total Assets	4.0%		2.9%

(1) PERCENT OF GROSS LOANS RECEIVABLE, NET OF DEFERRED FEES AND LOANS IN PROCESS AND LOANS HELD FOR SALE

The increase in non-performing assets was primarily concentrated in non-performing commercial real estate loans which increased $9.0 million to $18.4 million at March 31, 2012 from $9.3 million at March 31, 2011. The balance in non-performing commercial real estate loans at March 31, 2012 consisted of 39 loans to 26 borrowers with an average loan balance of $471,000. In the prior year, the balance in non-performing commercial real estate loans consisted of 48 loans to 23 borrowers with an average loan balance of $195,000.

14

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Financial Condition, Continued

Included in the commercial real estate category, $8.1 million was concentrated in hotel loans, of which $5.9 million consisted of three loans to one borrower secured by three different hotels all located in Georgia.  The remaining $2.2 million related to one loan to another borrower secured by a hotel located on the coast of South Carolina.

Of the remaining non-performing commercial real estate category, $7.0 million consisted of 12 loans secured by commercial buildings to nine separate borrowers and $876,000 consisted of four loans secured by raw land to three separate borrowers. The majority of the remaining loans in the commercial real estate category were secured by first mortgages on principal residences.

The Company also experienced an increase in non-performing one- to four- family real estate loans which increased $1.8 million to $3.6 million at March 31, 2012 from $1.8 million at March 31, 2011. At March 31, 2012, this balance was comprised of 15 loans with an average balance of $243,000. At March 31, 2011, this balance was comprised of eight loans with an average balance of $226,000.

Repossessed assets acquired in settlement of loans decreased $274,000 to $14.2 million at March 31, 2012 from $14.4 million at March 31, 2011. The Company foreclosed on 35 real estate properties during the year ended March 31, 2012 and sold 25 properties. At March 31, 2012, the balance consisted of the following 50 real estate properties: 17 single-family residences and 17 lots within residential subdivisions located throughout our market area in South Carolina and Georgia; five parcels of land in South Carolina and one in Georgia;  four commercial buildings in the Midlands area of South Carolina and one commercial building in Augusta, Georgia; a 40 lot subdivision development and adjacent 17 acres of land in Columbia, South Carolina; a 233 acre subdivision in Blythewood, South Carolina; a 43 lot subdivision in Elgin, South Carolina; a two rental complex in Columbia, South Carolina; and 34.8 acres of land in Bluffton, South Carolina which was originally acquired as a participation loan from another financial institution.

The Bank reviews its loan portfolio and allowance for loan losses on a monthly basis.  Future additions to the Bank's allowance for loan losses are dependent on, among other things, the performance of the Bank's loan portfolio, the economy, changes in real estate values, and interest rates.  There can be no assurance that additions to the allowance will not be required in future periods. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations. Management continually monitors its loan portfolio for the impact of local economic changes.  The ratio of allowance for loan losses to total loans was 3.32% at March 31, 2012 compared to 2.54% at March 31, 2011. The Bank closely monitors its past due loans.

The cumulative interest not accrued during the year ended March 31, 2012 relating to all non-performing loans totaled $964,000. Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the existing collateral.  In the event an acceptable arrangement cannot be reached, we may have to acquire these properties through foreclosure or other means and subsequently sell, develop, or liquidate them.

The balance of loans in troubled debt restructurings (“TDRs”) increased $5.8 million or 47.5% during the year ended March 31, 2012. The Bank had 28 loans that were TDRs totaling $18.0 million at March 31, 2012 compared to 33 loans totaling $12.2 million at March 31, 2011. The 28 TDRs consisted of one consumer loan secured by a first mortgage on a residential dwelling totaling $73,000, one consumer auto loan totaling $15,000 and one jumbo mortgage loan totaling $710,000. The remaining 25 restructurings consisted of 24 commercial real estate loans to eight separate borrowers and one unsecured commercial loan. The commercial real estate loans were secured primarily by first mortgages on six single family residences and one lot, 11 commercial buildings, two parcels of land and three hotels.  At March 31, 2012, 17 of the TDRs to seven borrowers totaling $11.1 million were delinquent. All of the remaining TDRs were current at March 31, 2012.

15

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Financial Condition, Continued

All TDRs are reviewed for impairment loss.  At March 31, 2012, the Bank held $40.8 million in impaired loans, including $18.0 million in TDRs, compared to $33.3 million of impaired loans, including $12.2 million of TDRs, at March 31, 2011.

In July 2006, the Company acquired Collier Jennings Financial Corporation, an insurance agency specializing in consumer automobile insurance and premium financing. The resulting goodwill and other intangibles were $1.2 million and $100,000, respectively, at March 31, 2012; and $1.2 million and $160,000 at March 31, 2011, respectively.  Collier Jennings is now a subsidiary of Security Federal Insurance Inc.

Deposits at the Bank increased $5.8 million or 0.9% to $696.2 million at March 31, 2012 from $690.4 million at March 31, 2011. The Bank had brokered time deposits of $34.4 million at March 31, 2012 compared to $39.7 million at March 31, 2011. Brokered time deposits are appealing because rates paid on these deposits were typically lower than rates paid on time deposits obtained in the Bank’s primary market areas. Total deposits at March 31, 2012, excluding brokered time deposits, increased $11.1 million or 1.7% to $661.8 million from $650.8 million at March 31, 2011. Brokered time deposits were 4.9% of total deposits at March 31, 2012 and 5.7% of total deposits at March 31, 2011.

Advances from the FHLB decreased $16.1 million or 11.6% to $122.1 million at March 31, 2012 from $138.1 million a year earlier. Other borrowed money, which consists of retail repurchase agreements, decreased $1.4 million or 12.5% to $9.8 million at March 31, 2012 from $11.2 million at March 31, 2011.  The Company issued its only trust preferred security issuance in September 2006.  Gross proceeds of the issuance were $5.2 million and are classified as junior subordinated debentures on the Consolidated Balance Sheet included in the Consolidated Financial Statements contained herein. In December 2009, the Company issued $6.1 million in convertible senior debentures. The debentures will mature on December 1, 2029 and accrue interest at the rate of 8.0% per annum until maturity or earlier redemption or repayment. The debentures are convertible into the Company’s common stock at a conversion price of $20 per share at the option of the holder at any time prior to maturity.

Total shareholders' equity was $80.8 million at March 31, 2012, an increase of $4.8 million or 6.3% from $76.0 million a year earlier. During the year ended March 31, 2012, the Company eliminated its mandatorily redeemable shares of the Company’s common stock as a result of an investor’s purchase of those shares in a private transaction.  In connection with the purchase of those shares, the redemption feature was eliminated.  As a result , the Company no longer had the liability related to those shares on its balance sheet and the Company’s paid in capital increased $1.4 million.

The Company’s net income for the year ended March 31, 2012 was $1.8 million. Preferred stock dividends were $440,000 resulting in net income available to common shareholders of $1.4 million. Other changes in shareholders’ equity during fiscal 2012 were: stock compensation expense of $33,000, a net increase in other comprehensive income of $2.9 million, and $942,000 in dividends paid to common shareholders.

16

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Results of Operations

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

		Fiscal Year 2012 Compared To 2011						Fiscal Year 2011 Compared To 2010
		Volume		Rate		Net		Volume		Rate		Net
		(In Thousands)
Interest-Earning Assets:
Loans: (1)
Mortgage Loans	$	(1,005)	$	150	$	(855)	$	(278)	$	(356)	$	(634)
Other Loans		(3,562)		(360)		(3,922)		(3,454)		2,498		(956)
Total Loans		(4,567)		(210)		(4,777)		(3,732)		2,142		(1,590)
Mortgage-Backed Securities (2)		967		(1,611)		(644)		(670)		(1,628)		(2,298)
Investments (2)(3)		644		(267)		377		811		(686)		125
Other Interest-Earning Assets		1		(3)		(2)		3		1		4
Total Interest-Earning Assets	$	(2,955)	$	(2,091)	$	(5,046)	$	(3,588)	$	(171)	$	(3,759)
Interest-Bearing Liabilities:
Deposits:
Certificate Accounts	$	(849)	$	(1,657)	$	(2,506)	$	(34)	$	(2,957)	$	(2,991)
NOW Accounts		13		(112)		(99)		8		19		27
Money Market Accounts		305		(570)		(265)		290		(837)		(547)
Savings Accounts		4		(17)		(13)		8		(26)		(18)
Total Deposits		(527)		(2,356)		(2,883)		272		(3,801)		(3,529)
Borrowings		(669)		(146)		(815)		(2,290)		1,778		(512)
Total Interest-Bearing Liabilities		(1,196)		(2,502)		(3,698)		(2,018)		(2,023)		(4,041)
Effect On Net Income	$	(1,759)	$	411	$	(1,348)	$	(1,570)	$	1,852	$	282

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

         LOANS OUTSTANDING.

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

(3) TAX EQUIVALENT BASIS IS CALCULATED USING AN EFEECTIVE TAX RATE OF 34% AND WAS $172,205 AND $5,000, RESPECTIVELY FOR THE YEARS ENDED MARCH 31, 2012 AND 2011.

17

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Results of Operations, Continued

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

	Yield/			Averages For Fiscal Years Ended March 31,
	Rate At			2012							2011							2010
	March 31, 2012			Average Balance		Interest		Yield/ Rate			Average Balance		Interest		Yield/ Rate			Average Balance		Interest		Yield/ Rate
				(Dollars In Thousands)
Interest-Earning Assets:
Mortgage Loans		5.07	%	$	103,842	$	5,186		4.99	%	$	116,148	$	6,041		5.20	%	$	121,311	$	6,675		5.50	%
Other Loans		6.60	%		354,753		22,847		6.44	%		419,983		26,769		6.37	%		476,667		27,725		5.82	%
Total Loans (1)		6.25	%		458,595		28,033		6.11	%		536,131		32,810		6.12	%		597,978		34,400		5.75	%
Mortgage-Backed   Securities (2)		3.31	%		257,595		7,661		2.97	%		229,052		8,305		3.63	%		245,173		10,603		4.32	%
Investments (2) (3)		2.55	%		130,690		3,004		2.30	%		103,279		2,627		2.54	%		74,845		2,503		3.34	%
Other Interest-   Earning Assets		0.46	%		4,826		3		0.05	%		3,547		5		0.13	%		1,261		1		0.07	%
Total Interest-Earning   Assets		4.66	%	$	851,706	$	38,701		4.54	%	$	872,009	$	43,747		5.02	%	$	919,257	$	47,507		5.17	%
Interest-Bearing Liabilities:
Certificate Accounts		1.36	%	$	335,736	$	5,040		1.50	%	$	382,508	$	7,546		1.97	%	$	383,769	$	10,537		2.75	%
NOW Accounts		0.13	%		73,202		86		0.12	%		67,934		185		0.27	%		64,722		158		0.24	%
Money Market    Accounts		0.55	%		216,517		1,617		0.75	%		183,128		1,882		1.03	%		161,663		2,429		1.50	%
Savings Accounts		0.20	%		20,858		45		0.22	%		19,374		58		0.30	%		17,440		76		0.44	%
Total Interest-Bearing   Accounts		0.89	%		646,313		6,788		1.05	%		652,944		9,671		1.48	%		627,594		13,200		2.10	%
Other Borrowings		0.25	%		10,424		39		0.37	%		11,714		62		0.53	%		41,749		249		0.60	%
Jr. Subordinated Debt		2.17	%		5,155		167		3.24	%		5,155		233		4.53	%		5,155		239		4.64	%
Sr. Convertible Debt		8.00	%		6,084		487		8.00	%		6,084		487		8.00	%		2,017		162		8.03	%
FHLB Advances		3.62	%		127,417		4,916		3.86	%		144,054		5,642		3.92	%		185,499		6,286		3.39	%
Total Interest-Bearing   Liabilities		1.36	%	$	795,393	$	12,397		1.56	%	$	819,951	$	16,095		1.96	%	$	862,014	$	20,136		2.34	%
Net Interest Income						$	26,304						$	27,652						$	27,371
Interest Rate Spread		3.30	%						2.98	%						3.06	%						2.83	%
Net Yield On Earning   Assets (Net Interest   Margin)									3.09	%						3.17	%						2.98	%

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

         LOANS OUTSTANDING.

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

(3) TAX EQUIVALENT BASIS IS CALCULATED USING AN EFEECTIVE TAX RATE OF 34% AND WAS $172,205 AND $5,000, RESPECTIVELY FOR THE YEARS ENDED MARCH 31, 2012 AND 2011.

18

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Comparison of the Years Ended March 31, 2012 and 2011

General

The Company’s earnings available to common shareholders were $1.4 million for the year ended March 31, 2012, compared to $1.2 million for the year ended March 31, 2011.  The $198,000 or 17.1% increase in earnings was attributable primarily to the decrease in non-interest expenses combined with an increase in non-interest income. These factors were offset slightly by a decrease in net interest income and an increase in the provision for loan losses.

Net Interest Income

Net interest margin on a tax equivalent basis for the year ended March 31, 2012 decreased eight basis points to 3.09% down from 3.17% in the previous year.  As a result, net interest income decreased $1.5 million or 5.5% to $26.1 million for the year ended March 31, 2012 compared to $27.7 million for the previous year. The decrease was attributable to a decrease in interest income offset by a decrease in interest expense. Average interest-earning assets decreased $20.3 million or 2.3% to $851.7 million while average interest-bearing liabilities decreased $24.6 million or 3.0% to $795.4 million. The interest rate spread was 2.98% for the year ended March 31, 2012 compared to 3.06% for the year ended March 31, 2011.

Interest income on loans decreased $4.8 million to $28.0 million during the year ended March 31, 2012 from $32.8 million during fiscal 2011.  The 14.6% decrease was attributable to a decrease in average total loans outstanding of $77.5 million combined with a one basis point decrease in the yield earned on the Bank’s loans during fiscal 2012.  Interest income on investment securities, mortgage-backed securities, and other investments decreased $436,000 as a result of a decrease in the yield earned offset in part by an increase in the aggregate average balance in the overall investment portfolio, including mortgage-backed securities, investments, and other interest-earning assets of $57.2 million.

Interest expense on deposits decreased $2.9 million or 29.8% to $6.8 million during the year ended March 31, 2012.  Average interest bearing deposits decreased $6.6 million while the average cost of those deposits decreased 43 basis points during the year ended March 31, 2012.  Interest expense on FHLB advances and other borrowings decreased $748,000 or 13.1% to $5.0 million during fiscal 2012.  The decrease was a result of a decrease in average FHLB advances and other borrowings outstanding during fiscal 2012 of $17.9 million and a decrease in the average costs of those borrowings of seven basis points to 3.59% in fiscal 2012 compared to 3.66% in fiscal 2011.

Interest expense on junior subordinated debentures was $167,000 for fiscal 2012 compared to $233,000 during fiscal 2011. The average outstanding balance on these debentures remained constant at $5.2 million during both periods while the average cost decreased 129 basis points to 3.24% in fiscal 2012 compared to 4.53% in fiscal 2011. Interest expense on senior convertible debentures was $487,000 for the years ended March 31, 2012 and 2011. The senior convertible debentures were issued during fiscal 2010 and have a fixed rate of 8%.

Provision for Loan Losses

Non-performing assets, which consist of non-accrual loans and repossessed assets, increased $9.9 million or 36.6% to $36.8 million at March 31, 2012 from $26.9 million at March 31, 2011. Non-performing assets were 4.0% of total assets at March 31, 2012 and 2.9% of total assets at March 31, 2011. Consistent with the increase in non-performing assets, the provision for loan losses increased $850,000 to $8.7 million for the year ended March 31, 2012 compared to $7.8 million for the previous year.  Non-accrual loans, which are loans delinquent 90 days or more, were $22.7 million at March 31, 2012 compared to $12.5 million at March 31, 2011.  Net charge-offs were $6.5 million or 1.48% of gross loans in fiscal 2012 compared to $7.6 million or 1.55% of gross loans in fiscal 2011. Management of the Bank continues to be concerned about current market conditions and closely monitors the loan portfolio on an on-going basis to proactively identify any potential problem loans.

The amount of the provision is determined by management’s on-going monthly analysis of the loan portfolio.  Management uses multiple methods to measure the estimate of the adequacy of the allowance for loan losses. These methods incorporate the percentage of classified loans, averages of historical loan losses in each loan category and current economic trends, and the assignment of percentage targets of reserves in each loan category.  The Company considers subjective factors such as changes in local and national economic conditions, industry trends, the composition and volume of the loan portfolio, credit concentrations, lending policies, and the experience and ability of the staff, management, and the Board of Directors.

19

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Provision for Loan Losses, Continued

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

Non-Interest Income

Non-interest income increased $147,000 or 2.2% to $6.9 million during fiscal 2012 compared to $6.8 million for the same period one year earlier. Gain on sale of investments increased $780,000 or 51.3% to $2.3 million during fiscal 2012 from $1.5 million during fiscal 2011.  Based on an analysis of the portfolio, the Company was able to maximize return by selling securities with short average lives as a result of call features or securities with adjustable rates scheduled to reprice down in the near future. Gain on sale of loans decreased $870,000 or 61.9% to $535,000 during fiscal 2012 compared to $1.4 million during fiscal 2011 as a result of a decrease in the volume of fixed rate residential mortgage loans originated and sold. The volume of refinancing activity was at an all time high in fiscal 2011 as a result of the low interest rate environment. Service fees on deposit accounts increased $12,000 or 1.1% to $1.2 million during fiscal 2012 from $1.1 million during fiscal 2011.

Income from insurance agency commissions was $426,000 during fiscal 2012 a decrease of $33,000 or 7.1% compared to $459,000 during fiscal 2011. Trust income increased $17,000 or 3.6% to $476,000 during fiscal 2012 from $459,000 during fiscal 2011. Income from BOLI increased $5,000 or 1.2% to $420,000 during fiscal year 2012 from $415,000 during fiscal 2011.

Mandatorily redeemable financial instrument valuation income was $50,000 for the year ended March 31, 2012 compared to $196,000 for the same period one year earlier. Based on its terms, the mandatorily redeemable financial instrument was redeemable at the greater of $26 per share or one and a half times the book value per common share of the Company. The Company recorded valuation income to properly reflect the fair value of the instrument. During fiscal 2012, the Company eliminated the mandatorily redeemable shares as a result of an investor’s purchase of these shares in a private transaction. In connection with the purchase of these shares, the redemption feature was eliminated. 

Check card fee income increased $95,000 or 13.8% to $788,000 for the year ended March 31, 2012 compared to $692,000 for the prior year. Other miscellaneous income including annuity and investment brokerage commissions, bank credit life insurance on loans, and other miscellaneous income increased $287,000 or 56.8% to $791,000 during fiscal 2012 from $504,000 during fiscal 2011. In connection with its participation in the Treasury’s Bank Enterprise Award program, the Bank received $206,000 in grant income during the quarter ended December 31, 2011 which contributed to the increase in other miscellaneous income.

General and Administrative Expenses

General and administrative expenses decreased $3.1 million or 13.1% to $20.7 million during the year ended March 31, 2012 compared to $23.8 million during the same period one year earlier.  Compensation and employee benefits decreased $838,000 or 7.1% to $11.0 million from $11.8 million for fiscal 2011. As part of the Company’s cost savings strategies and due to the uncertainty in the economy, the Company did not offer annual raises in January 2011. In addition, due to increased efficiency and some attrition, the number of full-time equivalent employees decreased by 12 to 206 full time equivalent employees at March 31, 2012, compared to 218 at March 31, 2011.  Occupancy expense decreased $51,000 or 2.7% to $1.9 million relatively unchanged from fiscal 2011, while advertising expense decreased $6,000 or 1.6% to $387,000 from $393,000 for fiscal 2011. Depreciation and maintenance of equipment expense decreased $112,000 or 6.1% to $1.7 million during the year ended March 31, 2012 compared to $1.8 million in fiscal 2011. These decreases were also a result of the Company’s efforts to reduce expenses during the year.

FDIC insurance premiums decreased $391,000 or 32.1% to $827,000 for the year ended March 31, 2012 compared to $1.2 million in 2011 as a result of a change in the calculation of the assessment base. The calculation changed from a deposit based method to an asset based method.  The Bank’s asset base has decreased.

20

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

General and Administrative Expenses, Continued

Net cost of operation of real estate owned decreased $1.1 million or 47.0% to $1.2 million for the year ended March 31, 2012 compared to $2.3 million in 2011. This decrease was the result of a decrease in foreclosures and a decrease in write downs on repossessed assets during the year. The Bank foreclosed on 35 real estate properties during 2012 compared to 40 real estate properties in 2011. Repossessed assets are recorded at the lower of cost or estimated fair value less costs to sell. As local real estate values declined significantly in the prior year, the Bank was required to write down these properties to their fair values. Write downs on repossessed assets totaled $609,000 for the year ended March 31, 2012 compared to $1.4 million for the year ended March 31, 2011.

Other miscellaneous expenses, which encompass legal, professional, and consulting expenses, stationery and office supplies, and other expenses decreased $601,000 or 14.3% to $3.6 million during fiscal 2012 compared to $4.2 million during fiscal 2011.

Income Taxes

The provision for income taxes increased $953,000 or 99.5% to $1.9 million during the year ended March 31, 2012 compared to $958,000 for the year ended March 31, 2011.  The effective tax rate was 51.6% for fiscal 2012 and 34.2% for fiscal 2011.

On December 28, 2011, the Bank completed a charter conversion from a federally chartered stock savings bank to a South Carolina chartered commercial bank. As a result of this transaction, the Company recognized an additional $625,000 in income tax expense during the year ended March 31, 2012, a one time charge which resulted from a portion of the Company’s deferred tax asset that became unrealizable due to a difference in South Carolina income tax laws for banks versus thrifts. As a result of the conversion from a thrift to a bank, the basis for calculating taxes for South Carolina changed from pre-tax income (which incorporated permanent tax differences) at a rate of 6% to book net income (after applicable federal taxes) at a rate of 4.5%. Going forward as a result of the Bank’s charter conversion, the Company will be subject to this lower state income tax rate and therefore expects to experience lower income tax expense in future periods.

The effective tax rate for the year ended March 31, 2012, excluding the deferred tax asset write-down was 34.7% compared with 34.2% for the same period of the prior year.

21

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Comparison of the Years Ended March 31, 2011 and 2010

General

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

Net Interest Income

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

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

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

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

Provision for Loan Losses

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

Non-Interest Income

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

22

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Non-Interest Income, Continued

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

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

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

General and Administrative Expenses

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

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

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

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

Income Taxes

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

23

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Regulatory Capital

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

		At March 31,
		2012		2011
		(In Thousands)
Bank’s Shareholders’ Equity (1)	$	79,854	$	77,758
Reduction For Goodwill And Other Intangibles		1,299		1,359
Tangible Capital		78,555		76,399
Core Capital		78,555		76,399
Supplemental Capital		5,743		6,219
Total Risk-Based Capital	$	84,298	$	82,618

(1) FOR FISCAL 2012 AND 2011, EXCLUDES UNREALIZED GAIN OF $6.6 MILLION and $3.7 MILLION, RESPECTIVELY, ON AVAILABLE FOR SALE SECURITIES.

The following table compares the Bank's capital levels relative to regulatory requirements at March 31, 2012:

		Amount Required	Percent Required		Actual Amount	Actual Percent		Excess Amount	Excess Percent
		(Dollars In Thousands)
Tangible Capital	$	18,151	2.0%	$	78,555	8.7%	$	60,404	6.7%
Tier 1 Leverage (Core) Capital		36,303	4.0%		78,555	8.7%		42,252	4.7%
Tier 1 Risk-Based (Core) Capital		18,022	4.0%		78,555	17.4%		60,533	13.4%
Total Risk-Based Capital		36,043	8.0%		84,298	18.7%		48,255	10.7%

24

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Liquidity and Capital Resources

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

The principal use of the Bank's funds is the origination of mortgages and other loans and the purchase of investments and mortgage-backed securities.  Loan originations on loans held for investment were $219.5 million in fiscal 2012 compared to $240.2 million in fiscal 2011 and $336.4 million in fiscal 2010.  The decrease in originations in fiscal 2012 was primarily the result of a decrease in mortgage loan originations, which decreased $12.8 million. The decreases in fiscal 2011 and 2010 were primarily the result of a decrease in commercial loan originations which decreased $88.8 million and $61.3 million, respectively. Purchases of investments and mortgage-backed securities were $215.1 million in fiscal 2012 compared to $224.7 million in fiscal 2011 and $150.2 million in fiscal 2010.  Other uses of the Bank’s funds during fiscal 2012 included paying down FHLB advances.

Unused lines of credit on home equity loans, credit cards, and commercial loans amounted to $32.1 million at March 31, 2012.  Home equity loans are made on a floating rate basis with final maturities of 10 to 15 years.  Credit cards are generally made on a floating rate basis, and are renewed annually or every other year.  In addition to the above commitments, the Bank has undisbursed loans-in-process of $1.9 million at March 31, 2012, which will be disbursed over an average of 90 days.  These commitments to originate loans and future advances of lines of credit are expected to be funded from loan amortizations and prepayments, deposit inflows, maturing investments, and short-term borrowing capacity.

The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at March 31, 2012:

(In Thousands)	One Month Or Less	After One  Through     Three   Months	After Three Through Twelve Months	Within One Year	One Year Or Greater	Total
Unused Lines Of Credit	$             -	$         188	$    4,609	$     4,797	$     27,276	$     32,073
Standby Letters Of Credit	20	615	673	1,308	413	1,721
Total	$           20	$        803	$     5,282	$     6,105	$     27,689	$    33,794

Management believes that future liquidity can be met through the Bank's deposit base, which increased $5.8 million during fiscal 2012, and from maturing investments.  In addition, at March 31, 2012 the Bank had another $152.8 million in unused borrowing capacity at the FHLB.

Historically the Bank’s cash flow from operating activities has been relatively stable.  The cash flows from investing activities vary with the need to invest excess funds or utilize leverage strategies with the purchase of mortgage-backed and investment securities.  The cash flows from financing activities vary depending on the need for FHLB and other advances.

25

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Contractual Obligations

In the normal course of business, the Company enters into contractual obligations that meet various business needs.  These contractual obligations include time deposits to customers, borrowings from the FHLB of Atlanta, other borrowings, junior subordinated debentures, senior convertible debentures and lease obligations for facilities.  See Notes 5, 9, 10, 11 and 13 of the Notes to the Consolidated Financial Statements included herein for additional information.  The following table summarizes the Company’s long-term contractual obligations at March 31, 2012. Contractual repayments may differ from actual repayments because some of the obligations may be subject to calls.

		One Year Or Less		Over One to Three Years		Over Three to Five Years		Thereafter		Total
		(In Thousands)
Time deposits	$	215,738	$	67,725	$	41,443	$	-	$	324,906
FHLB Advances		18,900		50,270		35,000		17,900		122,070
Other Borrowings		9,801		-		-		-		9,801
Jr. Sub. Debentures		-		-		-		5,155		5,155
Sr. Conv. Debentures		-		-		-		6,084		6,084
Operating Lease   Obligations		407		828		569		1,322		3,126
Total	$	244,846	$	118,823	$	77,012	$	30,461	$	471,142

Off-Balance Sheet Arrangements

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

Commitments to extend credit to customers are subject to the Bank’s normal credit policies and are essentially the same as those involved in extending loans to customers.  See Note 19 of the Notes to the Consolidated Financial Statements included herein for additional information.

26

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Impact of Inflation and Changing Prices

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

27

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Shareholders and Board of Directors

Security Federal Corporation and Subsidiaries

Aiken, South Carolina

We have audited the accompanying consolidated balance sheets of Security Federal Corporation and Subsidiaries as of March 31, 2012 and 2011, and the related consolidated statements of income, changes in shareholders' equity and comprehensive income and cash flows for each of the three years in the period ended March 31, 2012.  These consolidated financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Security Federal Corporation and Subsidiariesas of March 31, 2012 and 2011, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 31, 2012, in conformity with U.S. generally accepted accounting principles.

Columbia, South Carolina

June 22, 2012

28

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Balance Sheets

		March 31,
		2012		2011
ASSETS:
Cash And Cash Equivalents	$	9,331,372	$	7,835,638
Certificates Of Deposits With Other Banks		1,727,210		100,432
Investment And Mortgage-Backed Securities:
Available For Sale:  (Amortized Cost of $343,421,858 and $333,387,779 at March       31, 2012 and 2011, Respectively)		353,954,857		339,252,790
Held To Maturity:  (Fair Value of $69,965,869 and $34,122,925 at March 31, 2012       and 2011, Respectively)		67,676,210		33,165,125
Total Investments And Mortgage-Backed Securities		421,631,067		372,417,915
Loans Receivable, Net:
Held For Sale		2,671,771		5,166,234
Held For Investment:  (Net of Allowance of $14,615,198 and $12,501,800 at March 31, 2012       and 2011, Respectively)		425,838,835		479,304,382
Total Loans Receivable, Net		428,510,606		484,470,616
Accrued Interest Receivable:
Loans		1,718,252		1,742,281
Mortgage-Backed Securities		987,911		944,667
Investment Securities		793,655		889,297
Total Accrued Interest Receivable		3,499,818		3,576,245
Premises And Equipment, Net		18,726,299		19,800,616
FHLB Stock, At Cost		8,471,100		11,267,485
Repossessed Assets Acquired In Settlement Of Loans		14,160,099		14,433,853
Bank Owned Life Insurance		10,836,305		10,416,305
Intangible Assets, Net		99,477		159,500
Goodwill		1,199,754		1,199,754
Other Assets		6,443,501		7,865,690
Total Assets	$	924,636,608	$	933,544,049
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Liabilities:
Deposit Accounts	$	696,201,056	$	690,357,114
Advances From FHLB		122,069,802		138,136,338
Other Borrowings		9,801,386		11,195,474
Junior Subordinated Debentures		5,155,000		5,155,000
Advance Payments By Borrowers For Taxes And Insurance		350,464		381,488
Mandatorily Redeemable Financial Instruments		-		1,467,312
Senior Convertible Debentures		6,084,000		6,084,000
Other Liabilities		4,203,014		4,755,118
Total Liabilities		843,864,722		857,531,844
Commitments (Notes 5 and 19)
Shareholders' Equity:
Serial Preferred Stock, $.01 Par Value; Authorized 200,000 Shares; Issued And       Outstanding, 22,000 At March 31, 2012 And 2011, Respectively		22,000,000		22,000,000
Common Stock, $.01 Par Value; Authorized 5,000,000 Shares; Issued And       Outstanding Shares, 3,144,934 And 2,944,001, Respectively, At March 31, 2012       And 2011		31,449		30,884
Warrant Issued In Conjunction With Serial Preferred Stock		400,000		400,000
Additional Paid-In Capital		11,626,245		10,176,375
Treasury Stock, At Cost (200,933 Shares At March 31, 2012 And 2011,       Respectively)		(4,330,712)		(4,330,712)
Accumulated Other Comprehensive Income		6,533,573		3,637,675
Retained Earnings, Substantially Restricted		44,511,331		44,097,983
Total Shareholders' Equity		80,771,886		76,012,205
Total Liabilities And Shareholders' Equity	$	924,636,608	$	933,544,049

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

29

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income

		For the Years Ended March 31,
		2012		2011		2010
Interest Income:
Loans	$	28,032,556	$	32,809,913	$	34,399,899
Mortgage-Backed Securities		7,661,454		8,304,884		10,603,186
Investment Securities		2,832,193		2,623,006		2,503,005
Other		2,620		4,537		872
Total Interest Income		38,528,823		43,742,340		47,506,962
Interest Expense:
NOW And Money Market Accounts		1,702,502		2,067,241		2,586,827
Statement Savings Accounts		45,089		58,195		76,359
Certificate Accounts		5,040,071		7,546,064		10,537,020
FHLB Advances And Other Borrowed Money		4,955,443		5,703,534		6,534,398
Senior Convertible Debentures		486,720		486,720		162,240
Junior Subordinated Debentures		167,007		233,361		239,399
Total Interest Expense		12,396,832		16,095,115		20,136,243
Net Interest Income		26,131,991		27,647,225		27,370,719
Provision For Loan Losses		8,650,000		7,800,000		8,155,000
Net Interest Income After Provision For Loan Losses		17,481,991		19,847,225		19,215,719
Non-Interest Income:
Gain On Sale Of Investment Securities		2,300,254		1,520,599		1,213,041
Gain On Sale Of Loans		534,968		1,404,879		1,040,014
Service Fees On Deposit Accounts		1,156,202		1,143,811		1,231,081
Commissions From Insurance Agency		425,967		458,663		456,860
Trust Income		476,000		459,500		455,000
Bank Owned Life Insurance Income		420,000		415,000		360,000
Mandatorily Redeemable Financial Instrument Valuation   Income (Expense)		50,000		196,000		(63,000)
Check Card Fee Income		787,517		692,220		513,381
Other		790,797		504,289		906,206
Total Non-Interest Income		6,941,705		6,794,961		6,112,583
General And Administrative Expenses:
Compensation And Employee Benefits		10,990,812		11,828,376		11,842,024
Occupancy		1,878,754		1,929,946		2,002,233
Advertising		387,079		393,287		404,182
Depreciation And Maintenance Of Equipment		1,720,726		1,832,295		1,782,497
FDIC Insurance Premiums		826,731		1,218,075		1,837,877
Amortization Of Intangibles		60,023		90,000		90,000
Net Cost Of Operation Of Other Real Estate Owned		1,235,272		2,330,410		814,727
Other		3,617,643		4,218,751		3,889,756
Total General And Administrative Expenses		20,717,040		23,841,140		22,663,296
Income Before Income Taxes		3,706,656		2,801,046		2,665,006
Provision For Income Taxes		1,911,281		958,133		1,060,205
Net Income		1,795,375		1,842,913		1,604,801
Preferred Stock Dividends		440,000		666,453		900,000
Accretion Of Preferred Stock To Redemption Value		-		18,816		72,544
Net Income Available To Common Shareholders	$	1,355,375	$	1,157,644	$	632,257
Net Income Per Common Share (Basic)	$	0.46	$	0.43	$	0.26
Net Income Per Common Share (Diluted)	$	0.46	$	0.42	$	0.25
Cash Dividend Per Share On Common Stock	$	0.32	$	0.32	$	0.32
Weighted Average Shares Outstanding (Basic)		2,944,001		2,684,130		2,460,855
Weighted Average Shares Outstanding (Diluted)		2,944,001		2,762,824		2,527,584

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

30

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income

For the Years Ended March 31, 2012, 2011 and 2010

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

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

(Continued)      

31

 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity and Comprehensive Income

For the Years Ended March 31, 2012, 2011 and 2010, Continued

		Preferred Stock		Warrants		Common Stock		Additional Paid – In  Capital		Treasury Stock			Accumulated Other Comprehensive Income		Retained Earnings		Total
Balance At March 31, 2011	$	22,000,000	$	400,000	$	30,884	$	10,176,375	$		(4,330,712)	$	3,637,675	$	44,097,983	$	76,012,205
Net Income		-		-		-		-			-		-		1,795,375		1,795,375
Other Comprehensive Income         Net Of Tax:
Unrealized Holding Gains    On Securities Available    For Sale, Net Of Taxes		-		-		-		-			-		4,322,055		-		4,322,055
Reclassification Adjustment    For Gains Included In Net    Income, Net Of Taxes		-		-		-		-			-		(1,426,157)		-		(1,426,157)
Comprehensive Income		-		-		-		-			-		-		-		4,691,273
Redemption Of Mandatorily    Redeemable Financial    Instrument		-		-		565		1,416,747			-		-		-		1,417,312
Stock Compensation Expense		-		-		-		33,123			-		-		-		33,123
Cash Dividends On  Preferred		-		-		-		-			-		-		(440,000)		(440,000)
Cash Dividends On Common		-		-		-		-			-		-		(942,027)		(942,027)
Balance At March 31, 2012	$	22,000,000	$	400,000	$	31,449	$	11,626,245	$		(4,330,712)	$	6,533,573	$	44,511,331	$	80,771,886

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

32

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

 Consolidated Statements of Cash Flows

		For the Years Ended March 31,
		2012		2011		2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	1,795,375	$	1,842,913	$	1,604,801
Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities:
Depreciation Expense		1,491,028		1,549,477		1,577,968
Amortization Of Intangible Assets		60,023		90,000		90,000
Stock Option Compensation Expense		33,123		34,424		33,124
Discount Accretion And Premium Amortization		5,536,476		3,690,505		1,914,150
Provisions For Losses On Loans		8,650,000		7,800,000		8,155,000
Write Down Of Goodwill		-		-		222,000
Mandatorily Redeemable Financial Instrument    Valuation (Income) Expense		(50,000)		(196,000)		63,000
Income From Bank Owned Life Insurance		(420,000)		(415,000)		(360,000)
Gain On Sales Of Loans		(534,968)		(1,404,879)		(1,040,014)
Gain On Sales Of Mortgage-Backed Securities		(1,255,867)		(1,207,238)		(619,856)
Gain On Sales Of Investment Securities		(1,044,387)		(313,361)		(593,185)
Loss On Sale Of Real Estate Owned		4,230		256,484		103,920
Write Down On Real Estate Owned		608,920		1,409,564		504,580
Amortization Of Deferred Fees On Loans		(18,665)		(11,550)		(128,217)
Gain On Disposition Of Premises And Equipment		-		-		(25)
Proceeds From Sale Of Loans Held For Sale		40,891,379		74,175,983		68,819,036
Origination Of Loans Held For Sale		(37,861,948)		(74,775,875)		(65,228,678)
(Increase) Decrease In Accrued Interest Receivable:
Loans		24,029		45,190		224,496
Mortgage-Backed Securities		(43,244)		19,713		174,531
Investment Securities		93,864		(185,958)		(339,632)
(Decrease) Increase In Advance Payments By Borrowers		(31,024)		54,156		(94,129)
(Increase) Decrease In Prepaid FDIC Assessment		674,171		1,172,294		(3,987,622)
Other, Net		(1,576,174)		444,784		(2,586,265)
Net Cash Provided By Operating Activities		17,026,341		14,075,626		8,508,983
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase Of Mortgage-Backed Securities Available For     Sale		(95,362,225)		(116,717,564)		(80,947,679)
Principal Repayments On Mortgage-Backed Securities     Available For Sale		48,615,134		58,109,556		63,591,884
Maturities Of Mortgage-Backed Securities Available For     Sale		-		-		1,000,000
Purchase Of Mortgage-Backed Securities Held To     Maturity		(26,183,966)		(12,726,562)		-
Principal Repayments On Mortgage-Backed Securities     Held To Maturity		1,241,459		3,725,195		7,486,884
Purchase Of Investment Securities Available For Sale		(75,048,637)		(88,254,904)		(69,209,182)
Maturities Of Investment Securities Available For Sale		30,601,423		31,044,163		18,640,344
Purchase of Investment Securities Held To Maturity		(18,532,549)		(7,043,450)		-
Maturities Of Investment Securities Held To Maturity		8,598,502		1,628,735		4,881,502
Proceeds From Sale of Investment Securities Available     For Sale		28,213,347		16,463,819		27,465,905
Proceeds From Sale of Mortgage-Backed Securities     Available For Sale		50,076,125		48,564,592		30,725,706
Investment In Certificates Of Deposits With Other Banks		(1,625,000)		-		-
Purchase Of FHLB Stock		(34,343)		-		-
Redemption Of FHLB Stock		2,830,728		1,356,915		38,300
Decrease In Loans Receivable		40,557,533		62,562,563		21,540,257
Capital Improvements To Repossessed Assets		(36,877)		(549,458)		-
Proceeds From Sale Of Repossessed Assets		3,974,160		10,804,585		1,177,276
Purchase And Improvement Of Premises And Equipment		(416,712)		(629,609)		(623,964)
Proceeds From Sale of Premises and Equipment		-		-		971
Net Cash Provided (Used) By Investing Activities		(2,531,898)		8,338,576		25,768,204
						(Continued)

33

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows, Continued

		For the Years Ended March 31,
		2012		2011		2010
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (Decrease) In Deposit Accounts		5,843,942		(3,895,323)		32,538,862
Proceeds From FHLB Advances		106,501,384		148,420,000		310,885,319
Repayment Of FHLB Advances		(122,567,920)		(174,287,544)		(365,879,871)
Proceeds From Term Auction Facility Advances		-		-		207,000,000
Repayment Of Term Auction Facility Advances		-		-		(217,000,000)
Repayments Of Other Borrowings, Net		(1,394,088)		(864,996)		(3,995,496)
Proceeds From Issuance Of Preferred Stock		-		22,000,000		-
Proceeds From Issuance Of Common Stock		-		4,829,060		-
Redemption Of Preferred Stock		-		(18,000,000)		-
Proceeds From Senior Convertible Debentures		-		-		6,084,000
Proceeds From Employee Stock Purchase Plan Purchases		-		-		19,800
Dividends To Preferred Stock Shareholders		(440,000)		(726,222)		(900,000)
Dividends To Common Stock Shareholders		(942,027)		(858,184)		(787,550)
Net Cash Used By Financing Activities		(12,998,709)		(23,383,209)		(32,034,936)
Net Increase (Decrease) In Cash And Cash Equivalents		1,495,734		(969,007)		2,242,251
Cash And Cash Equivalents At Beginning Of Year		7,835,638		8,804,645		6,562,394
Cash And Cash Equivalents At End Of Year	$	9,331,372	$	7,835,638	$	8,804,645
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Paid During The Period For:
Interest	$	12,527,487	$	16,377,342	$	20,326,637
Income Taxes	$	2,863,176	$	429,432	$	3,396,162
Supplemental Schedule Of Non Cash Transactions:
Transfers From Loans Receivable	$	4,276,679	$	15,581,977	$	10,573,654
Gains (Losses) On Securities Available For Sale, Net Of   Taxes	$	2,895,898	$	(970,405)	$	798,146

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

34

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(1) Significant Accounting Policies

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

(a) Basis of Consolidation and Nature of Operations

The accompanying consolidated financial statements include the accounts of Security Federal Corporation (the “Company”) and its wholly owned subsidiary, Security Federal Bank (the “Bank”) and the Bank’s wholly owned subsidiaries, Security Federal Insurance, Inc. (“SFINS”) and Security Financial Services Corporation (“SFSC”).  Security Federal Corporation has a wholly owned subsidiary, Security Federal Statutory Trust (the “Trust”), which issued and sold fixed and floating rate capital securities of the Trust.  However, under current accounting guidance, the Trust is not consolidated in the financial statements.  The Bank is primarily engaged in the business of accepting savings and demand deposits and originating mortgage loans and other loans to individuals and small businesses for various personal and commercial purposes.  SFINS was formed during fiscal 2002 and began operating during the December 2001 quarter.  SFINS is an insurance agency offering auto, business, health, and home insurance.  SFINS has a wholly owned subsidiary, Collier Jennings Financial Corporation which has as subsidiaries Collier Jennings Inc., The Auto Insurance Store Inc., and Security Federal Premium Pay Plans Inc. Security Federal Premium Pay Plans Inc. has one wholly owned premium finance subsidiary and also has an ownership interest in four other premium finance subsidiaries.

(b) Cash and Cash Equivalents

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

(c) Investment and Mortgage-Backed Securities

Investment securities, including mortgage-backed securities, are classified in one of three categories: held to maturity, available for sale, or trading.  Management determines the appropriate classification of debt securities at the time of purchase. Investment securities are classified as held to maturity when the Company has the positive intent and ability to hold the securities to maturity.  These securities are recorded at cost and adjusted for amortization of premiums and accretion of discounts over the estimated life of the security using a method that approximates a level yield.  Prepayment assumptions on mortgage-backed securities are anticipated.

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

(d) Loans Receivable Held for Investment

Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balance adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest is recognized over the term of the loan based on the outstanding loan balance. Fees charged for originating loans, if any, are deferred and offset by the deferral of certain direct expenses associated with loans originated. The net deferred fees are recognized as yield adjustments by applying the interest method.

(e) Allowance for Loan Losses

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

Additions to the allowance for loan losses are provided by charges to operations based on various factors, which, in management’s judgment, deserve current recognition in estimating possible losses.  Such factors considered by management include the fair value of the underlying collateral, stated guarantees by the borrower (if applicable), the borrower’s ability to repay from other economic resources, growth and composition of the loan portfolio, the relationship of the allowance for loan losses to the outstanding loans, loss experience, delinquency trends, and general economic conditions.  Management evaluates the carrying value of the loans periodically and the allowance is adjusted accordingly.

35

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(1)           Significant Accounting Policies, Continued

While management uses the best information available to make evaluations, future adjustments may be necessary if economic conditions differ substantially from the assumptions used in making these evaluations.  The allowance for loan losses is subject to periodic evaluations by bank regulatory agencies that may require adjustments to be made to the allowance based upon the information that is available at the time of their examination.

The Company values impaired loans at the loan’s fair value if it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement at the present value of expected cash flows, the market price of the loan, if available, or the value of the underlying collateral.  Expected cash flows are required to be discounted at the loan’s effective interest rate.  When the ultimate collectibility of an impaired loan’s principal is in doubt, wholly or partially, all cash receipts are applied to principal.  When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to interest and then to principal.  Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income to the extent that any interest has been foregone.  Further cash receipts are recorded as recoveries of any amounts previously charged off.

(f) Loans Receivable Held for Sale

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

(g) Repossessed Assets Acquired in Settlement of Loans

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

(h) Premises and Equipment

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

(i) Intangible Assets and Goodwill

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

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

(j) Income Taxes

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

36

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(1)           Significant Accounting Policies, Continued

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

There have been no gross amounts of unrecognized tax benefits or interest or penalties related to uncertain tax positions since adoption. There are no unrecognized tax benefits that would, if recognized, affect the effective tax rate. There are no positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within the next 12 months. Years prior to March 31, 2009 are closed for federal, state and local income tax matters.

(k) Loan Fees and Costs Associated with Originating Loans

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

(l) Interest Income

Interest on loans is accrued and credited to income monthly based on the principal balance outstanding and the contractual rate on the loan.  The Company places loans on non-accrual status when they become greater than 90 days delinquent or when, in the opinion of management, full collection of principal or interest is unlikely.  When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received first to principal and then to interest income. The loans are returned to an accrual status when full collection of principal and interest appears likely.

(m) Advertising Expense

Advertising and public relations costs are generally expensed as incurred.  External costs relating to direct mailing costs are expensed in the period in which the direct mailings are sent.  Advertising and public relations costs of $387,000, $393,000, and $404,000 were included in the Company’s results of operations for the years ended March 31, 2012, 2011, and 2010, respectively.

(n) Stock-Based Compensation

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

(o)      Earnings Per Share

Accounting guidance specifies computation and presentation requirements for both basic EPS and, for entities with complex capital structures, diluted EPS.  Basic EPS is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding.  Diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued.  The dilutive effect of options and warrants outstanding is reflected in diluted earnings per share by application of the treasury stock method. The reverse treasury stock method is used to determine the dilutive effect of the mandatorily redeemable shares outstanding, which were issued by the Company in connection with the acquisition of the Collier-Jennings Companies.

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

37

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(1)           Significant Accounting Policies, Continued

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

	For the Years Ended March 31,
		2012		2011		2010
Earnings Available To Common Shareholders
Net Income	$	1,795,375	$	1,842,913	$	1,604,801
Preferred Stock Dividends		440,000		666,453		900,000
Deemed Dividends On Preferred Stock From Net    Accretion Of Preferred Stock		-		18,816		72,544
Net Income Available To Common Shareholders	$	1,355,375	$	1,157,644	$	632,257

There were no dilutive securities or options for the year ended March 31, 2012, therefore no reconciliation is provided. The following tables show the effects of dilutive options and warrants on the Company’s earnings per share for the periods indicated:

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

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

38

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(1)           Significant Accounting Policies, Continued

The average market price used in calculating the assumed number of dilutive shares issued for the years ended March 31, 2012, 2011, and 2010 was $9.53, $10.64, and $11.69, respectively. As a result of the average stock price being less than the exercise price of all options and warrants in the years ended March 31, 2012, 2011 and 2010, the options are not dilutive in calculating diluted earnings per share for those years.

(p) Use of Estimates

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

(q) Recently Issued Accounting Standards

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

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

Disclosures about Troubled Debt Restructurings (“TDRs”) required by ASU 2010-20 were deferred by the Financial Accounting Standards Board (“FASB”) in ASU 2011-01 issued in January 2011. In April 2011 the FASB issued ASU 2011-02 to assist creditors with their determination of when a restructuring is a TDR. The determination is based on whether the restructuring constitutes a concession and whether the debtor is experiencing financial difficulties as both events must be present.  Disclosures related to TDRs under ASU 2010-20 have been presented in Note 4.

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

In September 2011, the Intangibles topic was again amended to permit an entity to consider qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. This amendment will be effective for the Company on April 1, 2012.

In April 2011, the criteria used to determine effective control of transferred assets in the Transfers and Servicing topic of the ASC was amended by ASU 2011-03. The requirement for the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms and the collateral maintenance implementation guidance related to that criterion were removed from the assessment of effective control. The other criteria to assess effective control were not changed. The amendments are effective for the Company beginning April 1, 2012 but are not expected to have a material effect on the consolidated financial statements.

ASU 2011-04 was issued in May 2011 to amend the Fair Value Measurement topic of the ASC by clarifying the application of existing fair value measurement and disclosure requirements and by changing particular principles or requirements for measuring fair value or for disclosing information about fair value measurements. The amendments were effective for the Company beginning April 1, 2012 but are not expected to have a material effect on the consolidated financial statements.

39

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(1)           Significant Accounting Policies, Continued

The Comprehensive Income topic of the ASC was amended in June 2011. The amendment eliminates the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity and requires consecutive presentation of the statement of net income and other comprehensive income. The amendments will be applicable to the Company on April 1, 2012 and will be applied retrospectively. In December 2011, the topic was further amended to defer the effective date of presenting reclassification adjustments from other comprehensive income to net income on the face of the financial statements. Companies should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect prior to the amendments while FASB redeliberates future requirements.

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

 (r)       Risks and Uncertainties

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

(s) Reclassifications

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

40

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

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

		March 31, 2012
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
FHLB Securities	$	2,634,234	$	64,660	$	-	$	2,698,894
Federal National Mortgage       Association (“FNMA”) and       Federal Home Loan Mortgage       Corporation (“FHLMC”) Bonds		2,926,566		560		5,275		2,921,851
Small Business Administration    (“SBA”) Bonds		85,064,224		1,357,490		142,912		86,278,802
Tax Exempt Municipal Bonds		23,231,375		971,739		77,389		24,125,725
Mortgage-Backed Securities		229,462,521		8,486,387		95,073		237,853,835
Equity Securities		102,938		-		27,188		75,750
	$	343,421,858	$	10,880,836	$	347,837	$	353,954,857
		March 31, 2011
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
FHLB Securities	$	14,428,778	$	125,259	$	344,705	$	14,209,332
Federal Farm Credit (“FFCB”) Securities		1,997,097		9,503		-		2,006,600
FNMA and FHLMC Bonds		11,959,119		-		298,129		11,660,990
SBA Bonds		64,382,588		599,679		272,435		64,709,832
Taxable Municipal Bond		4,556,812		12,039		97,201		4,471,650
Tax Exempt Municipal Bonds		2,027,172		7,771		-		2,034,943
Mortgage-Backed Securities		233,933,275		6,681,694		534,276		240,080,693
Equity Securities		102,938		-		24,188		78,750
	$	333,387,779	$	7,435,945	$	1,570,934	$	339,252,790

FHLB securities, FFCB securities, FNMA and FHLMC bonds, and FNMA and FHLMC mortgage-backed securities are issued by government-sponsored enterprises (“GSEs”).  GSEs are not backed by the full faith and credit of the United States government.  SBA bonds are backed by the full faith and credit of the United States government. Included in the tables above and below in mortgage-backed securities are GNMA mortgage-backed securities, which are also backed by the full faith and credit of the United States government.  At March 31, 2012 and 2011, the Bank held an amortized cost and fair value of $143.8 million and $149.3 million, respectively, and $145.1 million and $148.5 million, respectively, in GNMA mortgage-backed securities included in mortgage-backed securities listed above. All mortgage-backed securities above are either GSEs or GNMA mortgage-backed securities. The balance does not include any private label mortgage-backed securities.

The amortized cost and fair value of investment and mortgage-backed securities available for sale at March 31, 2012 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	$	-	$	-
One – Five Years		7,626,608		7,676,812
Five – Ten Years		51,416,058		52,193,297
After Ten Years		54,916,671		56,230,913
Mortgage-Backed Securities		229,462,521		237,853,835
	$	343,421,858	$	353,954,857

41

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

At March 31, 2012 and 2011, 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 $130.6 million and $137.1 million, respectively, and $131.4 million and $138.0 million, respectively.

The Bank received approximately $78.3 million, $65.0 million and $58.2 million, respectively, in proceeds from sales of available for sale securities during the years ended March 31, 2012, 2011, and 2010. As a result, the Bank recognized $2.3 million in gross gains and no gross losses for the year ended March 31, 2012, $1.5 million in gross gains and no gross losses for the year ended March 31, 2011, and $1.2 million in gross gains and no gross losses for the year ended March 31, 2010.

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

		March 31, 2012
		Less than 12 Months				12 Months or More				Total
		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FNMA And FHLMC Bonds	$	1,921,291	$	5,275	$	-	$	-	$	1,921,291	$	5,275
SBA Bonds		12,508,821		142,912		-		-		12,508,821		142,912
Tax Exempt Municipal Bond		3,390,580		77,389		-		-		3,390,580		77,389
Mortgage-Backed Securities		23,053,784		95,073		-		-		23,053,784		95,073
Equity Securities		-		-		75,750		27,188		75,750		27,188
	$	40,874,476	$	320,649	$	75,750	$	27,188	$	40,950,226	$	347,837

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

Securities classified as available-for-sale are recorded at fair market value.  At March 31, 2012, 7.8% of the unrealized losses, or one individual security, consisted of securities in a continuous loss position for 12 months or more.  At March 31, 2011, 1.5% of the unrealized losses, or one individual security, consisted of securities in a continuous loss position for 12 months or more. 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 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.

42

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

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

		March 31, 2012
		Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLB Securities	$	11,554,627	$	221,726	$	13,517	$	11,762,836
FFCB Securities		1,999,516		6,534		23,410		1,982,640
FNMA and FHLMC Bonds		6,983,004		19,863		49,147		6,953,720
SBA Bonds		3,251,151		305,430		-		3,556,581
Mortgage-Backed Securities		43,732,912		1,822,180		-		45,555,092
Equity Securities		155,000		-		-		155,000
	$	67,676,210	$	2,375,733	$	86,074	$	69,965,869

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

FHLB securities, FFCB securities, and FNMA and FHLMC are issued by GSEs.  Included in the tables above and below in mortgage-backed securities are GNMA mortgage-backed securities, which are also backed by the full faith and credit of the United States government.  At March 31, 2012 and 2011, the Bank held an amortized cost and fair value of $42.2 million and $43.9 million, respectively, and $16.5 million and $16.8 million, respectively, in GNMA mortgage-backed securities included in mortgage-backed securities listed above. All mortgage-backed securities above are either GSEs or GNMA mortgage-backed securities. The balance does not include any private label mortgage-backed securities.

The amortized cost and fair value of investment and mortgage-backed securities held to maturity at March 31, 2012, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities resulting from call features on certain investments.

		Amortized Cost		Fair Value
Less Than One Year	$	-	$	-
One – Five Years		6,367,247		6,582,629
Over Five – Ten Years		8,996,597		9,000,770
More Than Ten Years		8,579,454		8,827,378
Mortgage-Backed Securities		43,732,912		45,555,092
	$	67,676,210	$	69,965,869

At March 31, 2012 and 2011, 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 $11.6 million and $12.1 million, respectively, and $9.4 million and $9.9 million, respectively.

43

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

	March 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	$	4,532,636	$	13,517	$	-	$	-	$	4,532,636	$	13,517
FFCB Securities		976,590		23,410		-		-		976,590		23,410
FNMA And FHLMC Bonds		4,939,150		49,147		-		-		4,939,150		49,147
	$	10,448,376	$	86,074	$	-	$	-	$	10,448,376	$	86,074

The Company had only one held to maturity security that was in an unrealized loss position at March 31, 2011.The fair value of this FHLB security was $1.0 million and the unrealized loss was $694. The security had been in an unrealized loss position for less than 12 months.  The Company’s held-to-maturity portfolio is recorded at amortized cost.  The Company has the ability and intends to hold these securities to maturity. There were no sales of securities held to maturity during the years ended March 31, 2012, 2011 and 2010.

(4)      Loans Receivable, Net

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

		2012		2011
Residential Real Estate Loans	$	97,807,917	$	111,028,021
Consumer Loans		58,685,000		64,862,668
Commercial Business		9,552,575		13,529,957
Commercial Real Estate		276,317,897		306,955,623
Total Loans Held For Investment		442,363,389		496,376,269
Loans Held For Sale		2,671,771		5,166,234
Total Loans Receivable, Gross		445,035,160		501,542,503
Less:
Allowance For Loan Losses		14,615,198		12,501,800
Loans In Process		1,886,652		4,580,059
Deferred Loan Fees		22,704		(9,972)
		16,524,554		17,071,887
Total Loans Receivable, Net	$	428,510,606	$	484,470,616

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

		2012		2011		2010
Balance At Beginning Of Year	$	12,501,800	$	12,307,394	$	10,181,599
Provision For Loan Losses		8,650,000		7,800,000		8,155,000
Charge Offs		(6,643,834)		(8,116,667)		(6,067,509)
Recoveries		107,232		511,073		38,304
Total Allowance For Loan Losses	$	14,615,198	$	12,501,800	$	12,307,394

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 60 days 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.

44

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4)      Loans Receivable, Net, Continued

		March 31, 2012
		Credit Quality Measures
		Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	88,536,685	$	-	$	573,887	$	8,697,345	$	97,807,917
Consumer		57,113,676		159,805		27,604		1,383,915		58,685,000
Commercial Business		8,608,378		446,815		-		497,382		9,552,575
Commercial Real Estate		190,230,745		21,874,264		19,783,230		44,429,658		276,317,897
Total	$	344,489,484	$	22,480,884	$	20,384,721	$	55,008,300	$	442,363,389

		March 31, 2011
		Credit Quality Measures
		Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	104,826,411	$	433,710	$	379,036	$	5,388,864	$	111,028,021
Consumer		61,425,853		97,706		9,180		3,329,929		64,862,668
Commercial Business		12,059,761		6,285		-		1,463,911		13,529,957
Commercial Real Estate		230,031,130		10,786,846		30,462,062		35,675,585		306,955,623
Total	$	408,343,155	$	11,324,547	$	30,850,278	$	45,858,289	$	496,376,269

The following table presents an age analysis of past due balances by category at March 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	$	2,778,235	$	742,345	$	3,638,929	$	7,159,509	$	90,648,408	$	97,807,917
Consumer		659,028		352,421		620,358		1,631,807		57,053,193		58,685,000
Commercial    Business		174,420		209,418		20,808		404,646		9,147,929		9,552,575
Commercial    Real Estate		18,332,136		4,682,891		18,378,165		41,393,192		234,924,705		276,317,897
Total	$	21,943,819	$	5,987,075	$	22,658,260	$	50,589,154	$	391,774,235	$	442,363,389

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

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

45

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4)      Loans Receivable, Net, Continued

At March 31, 2012 and 2011, the Company did not have any loans that were 90 days or more past due and still accruing interest. Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the existing collateral.  In the event an acceptable arrangement cannot be reached, we may have to acquire these properties through foreclosure or other means and subsequently sell, develop, or liquidate them. The following table shows non-accrual loans by category at March 31, 2012 compared to March 31, 2011.

	At March 31, 2012		At March 31, 2011		$	%
	Amount	Percent (1)	Amount	Percent (1)	Increase (Decrease)	Increase (Decrease)
Non-accrual Loans:
Residential Real Estate	$    3,638,929	0.8%	$  1,809,881	0.4%	$  1,829,048	101.1%
Commercial Business	20,808	-	171,901	-	(151,093)	(87.9)
Commercial Real Estate	18,378,165	4.2	9,337,385	1.9	9,040,780	96.8
Consumer	620,358	0.1	1,194,171	0.2	(573,813)	(48.1)
Total Non-accural Loans	$  22,658,260	5.1%	$ 12,513,338	2.5%	$  10,144,922	81.1%

(1) PERCENT OF GROSS LOANS RECEIVABLE, NET OF DEFERRED FEES AND LOANS IN PROCESS AND LOANS HELD FOR SALE.

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

		For the Year Ended March 31, 2012
		Residential Real Estate		Consumer		Commercial Business		Commercial Real Estate		Total
Beginning Balance	$	1,702,864	$	1,122,055	$	924,149	$	8,752,732	$	12,501,800
Provision		789,365		1,570,350		114,169		6,176,116		8,650,000
Charge-Offs		(563,604)		(1,250,573)		(408,138)		(4,421,519)		(6,643,834)
Recoveries		-		56,279		14,675		36,278		107,232
Ending Balance	$	1,928,625	$	1,498,111	$	644,855	$	10,543,607	$	14,615,198

		For the Year Ended March 31, 2011
		Residential Real Estate		Consumer		Commercial Business		Commercial Real Estate		Total
Beginning Balance	$	1,944,257	$	988,634	$	678,728	$	8,695,775	$	12,307,394
Provision		644,032		649,542		539,264		5,967,162		7,800,000
Charge-Offs		(1,009,937)		(584,600)		(320,960)		(6,201,170)		(8,116,667)
Recoveries		124,512		68,479		27,117		290,965		511,073
Ending Balance	$	1,702,864	$	1,122,055	$	924,149	$	8,752,732	$	12,501,800

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
March 31, 2012		Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	155,000	$	1,773,625	$	1,928,625
Consumer		19,568		1,478,543		1,498,111
Commercial Business		148,610		496,245		644,855
Commercial Real Estate		1,313,670		9,229,937		10,543,607
Total	$	1,636,848	$	12,978,350	$	14,615,198

46

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4)      Loans Receivable, Net, Continued

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

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
March 31, 2012		Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	3,544,061	$	94,263,856	$	97,807,917
Consumer		1,849,046		56,835,954		58,685,000
Commercial Business		172,362		9,380,213		9,552,575
Commercial Real Estate		35,231,717		241,086,180		276,317,897
Total	$	40,797,186	$	401,566,203	$	442,363,389

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

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.

47

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4)      Loans Receivable, Net, Continued

The average balance of impaired loans was $34.3 million for year ended March 31, 2012 compared to $37.2 million in the prior year. The following tables are a summary of information related to impaired loans as of March 31, 2012 and 2011.

		March 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	$	2,201,560	$	2,456,960	$	-	$	2,066,066	$	65,818
Consumer Loans		1,829,478		1,879,478		-		2,398,298		86,180
Commercial Business		23,752		47,752		-		294,894		1,677
Commercial Real Estate		27,425,873		29,175,328		-		24,020,047		1,186,679
With An Allowance Recorded:
Residential Real Estate		1,342,501		1,954,501		155,000		586,109		6,137
Consumer Loans		19,568		60,668		19,568		28,181		-
Commercial Business		148,610		148,610		148,610		207,135		5,608
Commercial Real Estate		7,805,844		9,945,912		1,313,670		4,687,210		228,483
Total
Residential Real Estate		3,544,061		4,411,461		155,000		2,652,175		71,955
Consumer Loans		1,849,046		1,940,146		19,568		2,426,479		86,180
Commercial Business		172,362		196,362		148,610		502,029		7,285
Commercial Real Estate		35,231,717		39,121,240		1,313,670		28,707,257		1,415,162
Total	$	40,797,186	$	45,669,209	$	1,636,848	$	34,287,940	$	1,580,582

		March 31, 2011
Impaired Loans		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With No Related Allowance    Recorded:
Residential Real Estate	$	2,278,966	$	2,683,966	$	-	$	1,458,882	$	51,267
Consumer Loans		1,376,161		1,583,160		-		729,889		56,764
Commercial Business		499,481		499,481		-		327,785		14,790
Commercial Real Estate		26,387,167		27,948,568		-		30,244,873		1,361,177
With An Allowance Recorded:
Residential Real Estate		-		-		-		41,879		-
Consumer Loans		60,668		60,668		41,100		124,089		-
Commercial Business		270,530		270,530		240,648		207,073		4,833
Commercial Real Estate		2,424,695		2,614,695		490,728		4,018,967		44,337
Total
Residential Real Estate		2,278,966		2,683,966		-		1,500,761		51,267
Consumer Loans		1,436,829		1,643,828		41,100		853,978		56,764
Commercial Business		770,011		770,011		240,648		534,858		19,623
Commercial Real Estate		28,811,862		30,563,263		490,728		34,263,840		1,405,514
Total	$	33,297,668	$	35,661,068	$	772,476	$	37,153,437	$	1,533,168

48

 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4)      Loans Receivable, Net, Continued

A TDR is a restructuring in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grant a concession to a borrower that it would not otherwise consider.  The Bank grants such concessions to reassess the borrower’s financial status and develop a plan for repayment.  TDRs included in impaired loans at March 31, 2012 and 2011 amounted to $18.0 million and $12.2 milion, respectively.

As a result of adopting the amendments in ASU 2011-02, management reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (April 1, 2011) to determine whether they are considered TDRs under the amended guidance.  Management identified as TDRs certain loans for which the allowance for loan losses had previously been measured under a general allowance methodology. Upon identifying those loans as TDRs, management identified them as impaired under the guidance in ASC 310-10-35. The amendments in ASU 2011-02 require prospective application of the impairment measurement guidance in ASC 310-10-35 for those loans newly identified as impaired. At the end of the first interim period of adoption (September 30, 2011), the recorded investment in loans for which the allowance was previously measured under a general allowance methodology and are now impaired under ASC 310-10-35 was $11.8 million, and the allowance for loan losses associated with those loans, on the basis of a current evaluation of loss was $215,000.

	For the Year Ended March 31, 2012
Troubled Debt Restructurings	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	14		11,988,576		11,988,576
Total	15	$	12,003,934	$	12,003,934

During the year ended March 31, 2012, the Bank modified 15 loans that were considered to be TDRs. The modification for these loans consisted of lowering the interest rate.

During the year ended March 31, 2012, six loans that had been previously restructured were in default. However, there were no loans restructured during the previous twelve months that subsequently defaulted during the year ended March 31, 2012. The Bank considers any loan 30 days or more past due to be in default.

49

 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(5)         Premises and Equipment, Net

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

		2012		2011
Land	$	5,471,503	$	5,471,503
Buildings And Improvements		17,570,577		17,592,015
Furniture And Equipment		11,180,104		10,756,795
Construction In Progress		83,749		97,463
		34,305,933		33,917,776
Less Accumulated Depreciation		(15,579,634)		(14,117,160)
Total Premises And Equipment, Net	$	18,726,299	$	19,800,616

Depreciation expense for the years ended March 31, 2012, 2011, and 2010 was $1.5 million, $1.5 million, and $1.6 million, respectively. The Bank has entered into non-cancelable operating leases related to buildings and land.  At March 31, 2012, future minimum payments under non-cancelable operating leases with initial or remaining terms of one year or more are as follows (by fiscal year):

2013	$	406,798
2014		413,811
2015		413,811
2016		326,835
2017		242,288
Thereafter		1,322,167
	$	3,125,710

Total rental expense amounted to $401,000, $434,000, and $434,000 for the years ended March 31, 2012, 2011 and 2010,respectively.  Four lease agreements with monthly expenses of $6,179, $800, $7,792, and $9,075 have multiple renewal options totaling 30, 10, 40, and 10 years, respectively.

(6)         Intangible Assets and Goodwill

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

		2012		2011
Customer List
Balance At Beginning Of Year	$	149,481	$	178,246
Amortization		50,004		28,765
Balance At End Of Year		99,477		149,481
Employment Contracts
Balance At Beginning Of Year		10,019		71,254
Amortization		10,019		61,235
Balance At End Of Year		-		10,019
Total Intangibles		99,477		159,500
Goodwill		1,199,754		1,199,754
Total	$	1,299,231	$	1,359,254

In accordance with accounting guidance, the Company evaluates its goodwill on an annual basis. The evaluations were performed as of September 30, 2011 and September 30, 2010 for fiscal years ended March 31, 2012 and March 31, 2011, respectively. At the time of the evaluations the Company determined that no impairment existed. Therefore, there was no amortization of goodwill for the years ended March 31, 2012 and 2011. Amortization of the intangibles is scheduled to be as follows for each fiscal year as indicated:

2013	$	50,000
2014		49,477
	$	99,477

50

 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(7)         FHLB Stock

The Bank, as a member of the FHLB of Atlanta, is required to acquire and hold shares of capital stock in the FHLB of Atlanta in an amount equal to a membership component, which is 0.15% of total assets at December 31, 2011 and 2010 plus a transaction component which equals 4.5% of outstanding advances (borrowings) from the FHLB of Atlanta.  The Bank is in compliance with this requirement with an investment in FHLB of Atlanta stock of $8.5 million and $11.3 million as of March 31, 2012 and 2011, respectively. No readily available market exists for this stock and it has no quoted fair value.  However, because redemption of this stock has historically been at par, it is carried at cost.

(8)         Repossessed Assets Acquired In Settlement Of Loans

The Bank owned $14.2 million and $14.4 million in repossessed assets acquired in settlement of loans at March 31, 2012 and 2011, respectively. Transactions in repossessed assets for the years ended March 31, 2012, 2011 and 2010 are summarized below:

	March 31,
		2012		2011		2010
Balance, Beginning Of Year	$	14,433,853	$	10,773,050	$	1,985,172
Additions		4,276,679		15,581,977		10,573,654
Capital Improvements		36,877		549,458		-
Sales		(3,978,390)		(11,061,070)		(1,281,196)
Write Downs		(608,920)		(1,409,562)		(504,580)
Balance, End Of Year	$	14,160,099	$	14,433,853	$	10,773,050

(9)         Deposits

Deposits outstanding by type of account are summarized as follows:

		At March 31, 2012				At March 31, 2011
			Weighted Rate	Interest Rate Range		Amount	Weighted Rate	Interest Rate Range
Checking Accounts	$	124,750,127	0.11%	0.00-0.30%	$	117,077,343	0.09%	0.00-0.60%
Money Market Accounts		224,195,659	0.55%	0.25-0.60%		194,560,099	0.85%	0.30-0.90%
Statement Savings Accounts		22,348,787	0.20%	0.00-0.25%		20,582,505	0.24%	0.00-0.30%
Total		371,294,573	0.38%	0.00-0.60%		332,219,947	0.54%	0.00-0.60%
Certificate Accounts:
0.00 – 1.99%		267,556,217				239,078,153
2.00 – 2.99%		49,260,643				107,386,573
3.00 – 3.99%		2,936,931				3,307,422
4.00 – 4.99%		4,021,999				5,272,507
5.00 – 5.99%		1,130,693				3,092,512
Total		324,906,483	1.36%	0.20-5.50%		358,137,167	1.71%	0.15-5.50%
Total Deposits	$	696,201,056	0.84%	0.00-5.50%	$	690,357,114	1.15%	0.00-5.50%

Included in the certificate accounts above at March 31, 2012 and 2011 were $34.4 million and $39.7 million, respectively, in brokered deposits with a weighted average interest rate of 1.71% and 2.18%, respectively. Of the brokered deposits at March 31, 2012, $12.5 million mature within one year.

The aggregate amount of certificates of deposit with a minimum denomination of $100,000 was $156.0 million and $172.2 million at March 31, 2012 and 2011, respectively.

51

 SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(9)         Deposits, Continued

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

		March 31,
		2012		2011
Within 1 Year	$	215,738,167	$	243,178,999
After 1 Year, Within 2 Years		53,231,294		70,524,910
After 2 Years, Within 3 Years		14,494,174		10,601,023
After 3 Years, Within 4 Years		24,155,416		15,014,756
After 4 Years, Within 5 Years		17,287,432		18,817,479
Thereafter		-		-
	$	324,906,483	$	358,137,167

At March 31, 2012 and 2011, the Bank has $67,000 and $34,000, respectively, in overdrafts that were reclassified to loans.

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

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

		2012			2011
Year Ending March 31		Amount	Weighted Rate		Amount	Weighted Rate
2012	$	-	-%	$	24,950,000	2.22%
2013		18,900,000	2.70%		10,000,000	4.76%
2014		30,000,000	3.45%		30,000,000	3.45%
2015		20,269,802	3.01%		20,286,338	3.01%
2016		20,000,000	4.12%		20,000,000	4.12%
2017		15,000,000	4.66%		15,000,000	4.66%
Thereafter		17,900,000	4.10%		17,900,000	4.10%
	$	122,069,802	3.62%	$	138,136,338	3.57%

These advances are secured by a blanket collateral agreement with the FHLB by pledging the Bank’s portfolio of residential first mortgage loans and investment securities with an amortized cost and fair value of $152.8 million and $162.1 million, respectively, at March 31, 2012 and $168.2 million and $172.9 million, respectively, at March 31, 2011. Advances are subject to prepayment penalties.

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

As of March 31, 2012
Borrow Date	Maturity Date		Amount	Int. Rate	Type	Call Dates
11/23/05	11/23/15	$	5,000,000	3.933%	Multi-Call	05/23/08 and quarterly thereafter
07/11/06	07/11/16		5,000,000	4.800%	Multi-Call	07/11/08 and quarterly thereafter
11/29/06	11/29/16		5,000,000	4.025%	Multi-Call	05/29/08 and quarterly thereafter
05/24/07	05/24/17		7,900,000	4.375%	Multi-Call	05/27/08 and quarterly thereafter
07/25/07	07/25/17		5,000,000	4.396%	Multi-Call	07/25/08 and quarterly thereafter
08/28/08	08/28/13		5,000,000	3.113%	Multi-Call	08/30/10 and quarterly thereafter

52

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

As of March 31, 2011
Borrow Date	Maturity Date		Amount	Int. Rate	Type	Call Dates
11/23/05	11/23/15	$	5,000,000	3.933%	Multi-Call	05/23/08 and quarterly thereafter
07/11/06	07/11/16		5,000,000	4.800%	Multi-Call	07/11/08 and quarterly thereafter
11/29/06	11/29/16		5,000,000	4.025%	Multi-Call	05/29/08 and quarterly thereafter
03/09/07	03/09/12		4,700,000	4.286%	Multi-Call	06/09/10 and quarterly thereafter
05/24/07	05/24/17		7,900,000	4.375%	Multi-Call	05/27/08 and quarterly thereafter
07/25/07	07/25/17		5,000,000	4.396%	Multi-Call	07/25/08 and quarterly thereafter
11/16/07	11/16/11		5,000,000	3.745%	Multi-Call	11/17/08 and quarterly thereafter
08/28/08	08/28/13		5,000,000	3.113%	Multi-Call	08/30/10 and quarterly thereafter

At March 31, 2012 and 2011, the Bank had $152.8 million and $140.9 million in additional borrowing capacity, respectively, at the FHLB.

The Bank had $9.8 million and $11.2 million in other borrowings at March 31, 2012 and 2011, respectively.  These borrowings consist of short-term repurchase agreements with certain commercial demand deposit customers for sweep accounts. The repurchase agreements typically mature within one to three days and the interest rate paid on these borrowings floats monthly with money market type rates. At March 31, 2012 and 2011, the interest rate paid on the repurchase agreements was 0.25% and 0.40%, respectively. The maximum amount outstanding at any one month end during the year ended March 31, 2012 was $11.7 million compared to $12.3 million in 2011. The Bank had pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $17.8 million and $19.0 million, respectively, at March 31, 2012 and $22.7 million and $23.7 million, respectively, at March 31, 2011.

(11)         Junior Subordinated Debentures

On September 21, 2006, Security Federal Statutory Trust (the “Trust”), a wholly-owned subsidiary of the Company, issued and sold fixed and floating rate capital securities of the Trust (the “Capital Securities”), which are reported on the consolidated balance sheet as junior subordinated debentures, generating proceeds of $5.2 million. The Trust loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank.

The Capital Securities accrue and pay distributions annually at a rate per annum equal to 2.174% at March 31, 2012.  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, on or after September 15, 2011.

53

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(12)    Mandatorily Redeemable Financial Instrument

On June 30, 2006, the Company recorded a $1.4 million mandatorily redeemable financial instrument as a result of the acquisition of the Collier-Jennings Companies. The shareholder of Collier-Jennings Companies received cash and was issued stock in the Company to settle the acquisition.  The shares were released to the shareholder of Collier-Jennings Companies over a three-year period.  The stock had a mandatorily redeemable rate at the option of the shareholder of Collier-Jennings Companies in cumulative increments of 20% per year for a five-year period at the greater of $26 per share or one and one-half times the book value per common share of the Company’s stock.

The mandatorily redeemable financial instrument was carried at fair value based on the Company’s book value per common share. The Company recorded a valuation gain of $50,000 during the year ended March 31, 2012 compared to $196,000 during the year ended March 31, 2011 to properly reflect the fair value of the instrument.

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

(13)   Senior Convertible Debentures

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

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

(14)         Income Taxes

Income tax expense is comprised of the following:

		For the Years Ended March 31,
		2012		2011		2010
Current:
Federal	$	1,814,394	$	1,755,393	$	1,879,069
State		226,970		336,011		320,729
Total Current Tax Expense		2,041,364		2,091,404		2,199,798
Deferred:
Federal		(706,857)		(1,025,678)		(1,030,802)
State		576,774		(107,593)		(108,791)
Total Deferred Tax Expense		(130,083)		(1,133,271)		(1,139,593)
Total Income Tax Expense	$	1,911,281	$	958,133	$	1,060,205

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

		For the Years Ended March 31,
		2012		2011		2010
Tax At Statutory Income Tax Rate	$	1,260,263	$	952,356	$	906,102
State Tax And Other		10,480		(23,555)		124,896
Write-down Of State Deferred Tax    Asset		625,000		-		-
Valuation Allowance		15,538		29,332		29,207
Total Income Tax Expense	$	1,911,281	$	958,133	$	1,060,205

54

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(14)         Income Taxes, Continued

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

		At March 31,
		2012		2011
Deferred Tax Assets:
Deferred Compensation	$	491,872	$	479,864
Provision For Loan Losses		5,023,701		4,730,250
Other Real Estate Owned		763,796		915,742
Net Fees Deferred For Financial Reporting		126,811		149,942
Non-accrual Interest		412,775		573,071
Net Operating Losses		220,730		205,192
Other		58,467		94,494
Total Gross Deferred Tax Assets		7,098,152		7,148,555
Less: Valuation Allowance		220,730		205,192
Net Deferred Tax Assets		6,877,422		6,943,363
Deferred Tax Liabilities:
FHLB Stock Basis Over Tax Basis		114,568		126,565
Depreciation		480,812		612,383
Other		73,547		103,614
Intangibles		37,105		59,494
Unrealized Gain on Securities Available for Sale		3,999,426		2,235,538
Total Gross Deferred Tax Liability		4,705,458		3,137,594
Net Deferred Tax Asset	$	2,171,964	$	3,805,769

Deferred tax assets represent the future tax benefit of deductible differences and, if it is more likely than not that a tax asset will not be realized, a valuation allowance is required to reduce the recorded deferred tax assets to net realizable value. As of March 31, 2012, management has determined that it is more likely than not that the total deferred tax asset will be realized except for the deferred tax asset associated with State net operating loss carryforwards, and, accordingly, has established a valuation allowance only for this item. The change in the valuation allowance was $15,538. Net deferred tax assets are included in other assets at March 31, 2012 and 2011. The Company has state net operating losses of $6.7 million and $6.2 million for the years ended March 31, 2012 and 2011, respectively.

During the year ended March 31, 2012, the Company wrote down the state deferred tax asset by $625,000 as a result of the Bank’s conversion from a thrift to a state-chartered commercial bank. This is the result of a difference in South Carolina income tax laws for banks versus thrifts. As a result of the conversion, the basis for calculating taxes for South Carolina changed from pre-tax income (which incorporated permanent tax differences) at a rate of 6% to book net income (after applicable federal taxes) at a rate of 4.5%.

Retained earnings at March 31, 2012 included tax bad debt reserves of approximately $2.2 million, for which no provision for federal income tax has been made. If, in the future, these amounts are used for any purpose other than to absorb bad debt losses, including dividends, stock redemptions, or distributions in liquidation, or the Company ceases to be qualified as a bank, they may be subject to federal income tax at the prevailing corporate tax rate. Tax returns for 2008 and subsequent years are subject to examination by taxing authorities.

55

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(15)         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 March 31, 2012 and 2011, the Bank was categorized as “well capitalized” under the regulatory framework for prompt corrective action.  There are no conditions or events that management believes have changed that classification as of the date of this Annual Report.

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)
March 31, 2012
SECURITY FEDERAL CORP.
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	67,360	14.9%	$	18,031	4.0%	$	N/A	N/A
Total Risk-Based Capital (To Risk Weighted Assets)		83,666	18.6%		36,314	8.0%		N/A	N/A
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)		67,360	7.4%		36,314	4.0%		N/A	N/A
SECURITY FEDERAL BANK
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	78,555	17.4%	$	18,022	4.0%	$	27,033	6.0%
Total Risk-Based Capital (To Risk Weighted Assets)		84,298	18.7%		36,043	8.0%		45,054	10.0%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)		78,555	8.7%		36,303	4.0%		45,379	5.0%
March 31, 2011
SECURITY FEDERAL BANK
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	76,399	15.4%	$	19,900	4.0%	$	29,850	6.0%
Total Risk-Based Capital (To Risk Weighted Assets)		82,618	16.6%		39,801	8.0%		49,751	10.0%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)		76,399	8.3%		37,060	4.0%		46,325	5.0%
Tangible Capital (To Tangible Assets)		76,399	8.3%		18,530	2.0%		46,325	5.0%

Prior to the Company’s conversion on December 28, 2011 to a bank holding company, it was required to only calculate regulatory capital ratios on the bank level and not the holding company.

The payment of dividends by the Company depends primarily on the ability of the Bank to pay dividends to the Company.  The Bank is subject to various general regulatory policies and requirements relating to the payment of dividends. Any restrictions on the ability of the Bank to pay dividends will indirectly restrict the ability of the Company to pay dividends.

56

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(16)         Employee Benefit Plans

The Company is participating in a multiple employer defined contribution employee benefit plan covering substantially all employees with six months or more of service.  The Company matches a portion of the employees’ contributions and the plan has a discretionary profit sharing provision.  The total employer contributions were $188,000, $221,000, and $217,000 for the years ended March 31, 2012, 2011, and 2010, respectively.

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

Participation in the ESPP is voluntary.  Employees are limited to investing $25,000 or 5% of their annual salary, whichever is lower, during the year.  During the year ended March 31, 2012, there were no employee stock purchases within the plan.

Certain officers of the Company participate in a supplemental retirement plan.  These benefits are not qualified under the Internal Revenue Code and they are not funded.  During the years ended March 31, 2012, 2011 and 2010, the Company incurred expenses of $180,000, $282,000 and $304,000, respectively, for this plan.

Certain officers and directors of the Company participate in incentive and non-qualified stock option plans. Prior to fiscal 2010, the Company had three stock option plans that together authorized the Company to grant 150,000 options. In 2008, the 2008 Equity Incentive Plan was approved by stockholders and implemented by the Company with the intention of replacing the previous three option plans. No additional options are to be granted under the old plans and forfeitures under the old plans are not added to the new plan as available options, however, all existing options outstanding under these plans remain in effect. The 2008 Equity Incentive Plan provides for the grant of non-qualified and incentive stock options, stock appreciation rights (“SARS”), and restricted stock awards. Under the 2008 Equity Incentive Plan, 50,000 shares of common stock are reserved for the issuance of stock options and SARS in addition to 50,000 shares subject to restricted stock awards. The plan is administered by a committee appointed by the Board of Directors. The committee determines the specific employees, amount and type of any awards granted. At March 31, 2012 and 2011, there were 50,000 shares available for issuance under this plan.

Options under all plans are granted at exercise prices not less than the fair value of the Company’s common stock on the date of the grant.  The following is a summary of the activity under the Company’s incentive and non-qualified stock option plans for the years ended March 31, 2012, 2011, and 2010:

	2012		2011		2010
	Shares	Weighted Avg. Exercise Price	Shares	Weighted Avg. Exercise Price	Shares	Weighted Avg. Exercise Price
Balance, Beginning of Year	81,400	$22.51	90,900	$22.57	100,500	$22.01
Options Granted	-	-	-	-	-	-
Options Exercised	-	-	-	-	-	-
Options Forfeited	8,500	21.72	8,500	23.09	9,600	16.67
Balance, March 31	72,900	$22.62	81,400	$22.51	90,900	$22.57
Total Intrinsic Value Of Options    Exercised During The Year	-		-		-
Weighted-Average Fair Value Of    Options Granted During The Year	-		-		-
Options Exercisable	43,600	$22.05	49,900	$21.91	50,400	$21.93
Weighted-Average Remaining Life Of    Exercisable Options	2.5 years		3.4 years		4.4 years
Options Available For Grant	50,000		50,000		50,000

During the year ended March 31, 2012, 1,200 stock options with an exercise price of $23.03 vested. No options vested during the years ended March 31, 2011, and 2010. The aggregate intrinsic value of the stock options outstanding and exercisable at March 31, 2012, 2011 and 2010 amounted to $0 for all periods. Total compensation expense related to stock options was $33,000, $34,000, and $33,000 for the periods ended March 31, 2012, 2011 and 2010, respectively.  As of March 31, 2012, there was $145,000 of total unrecognized compensation cost related to non-vested stock options.  The cost is expected to be recognized over a weighted average period of four years.

57

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(16)         Employee Benefit Plans, Continued

There were no stock-based awards granted by the Company, during the years ended March 31, 2012, 2011 or 2010.

At March 31, 2012, the Company had the following options outstanding:

Grant Date	Outstanding Options	Option Price	Expiration Date
09/01/03	2,400	$24.00	08/31/13
12/01/03	3,000	$23.65	11/30/13
01/01/04	5,000	$24.22	12/31/13
03/08/04	7,000	$21.43	03/08/14
06/07/04	2,000	$24.00	06/07/14
01/01/05	19,000	$20.55	12/31/14
01/01/06	4,000	$23.91	01/01/16
08/24/06	6,000	$23.03	08/24/16
05/24/07	2,000	$24.34	05/24/17
07/09/07	1,000	$24.61	07/09/17
10/01/07	2,000	$24.28	10/01/17
01/01/08	15,000	$23.49	01/01/18
05/19/08	2,500	$22.91	05/19/18
07/01/08	2,000	$22.91	07/01/18

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

(17)         Stock Warrants

In conjunction with its participation in the U.S. Department of Treasury’s (“Treasury”) Capital Purchase Program (“CPP”) in 2008, the Company sold a warrant to the Treasury to purchase 137,966 shares of the Company’s common stock. The warrant has a 10-year term and was immediately exercisable upon issuance. At March 31, 2012, the warrant was anti-dilutive. There were no changes in the Company’s stock warrants during the years ended March 31, 2012 and 2011.

(18)         Bank Owned Life Insurance

The cash value of the life insurance policies are recorded as a separate line item in the accompanying balance sheets at $10.8 million, $10.4 million and $10.0 million at March 31, 2012, 2011 and 2010, respectively.  The insurance provides key person life insurance on certain officers of the Company.  The earnings-portion of the insurance policies grows tax deferred and helps offset the cost of the Company’s benefits programs.  The Company recorded earnings of $420,000, $415,000 and $360,000 for the growth in the cash value of life insurance during the years ended March 31, 2012, 2011 and 2010, respectively.

58

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(19)         Commitments and Contingencies

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

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

Financial instruments where the contract amount represents the Bank's credit risk include commitments under pre-approved but unused lines of credit of $24.1 million and $33.1 million, undisbursed loans in process of $1.9 million and $4.6 million, and letters of credit of $1.7 million and $1.5 million at March 31, 2012 and 2011, respectively.

These loan and letter of credit commitments are subject to the same credit policies and reviews as loans on the balance sheet.  Collateral, both the amount and nature, is obtained based upon management's assessment of the credit risk.  Since many of the extensions of credit are expected to expire without being drawn, the total commitment amounts do not necessarily represent future cash requirements.  In addition to these loan commitments noted above, the Bank had unused credit card loan commitments of $4.5 million and $4.4 million at March 31, 2012 and 2011, respectively.  There were no outstanding commitments on mortgage loans not yet closed at March 31, 2012. Outstanding commitments on mortgage loans not yet closed amounted to $431,000 at March 31, 2011.  These commitments, which are funded subject to certain limitations, extend over varying periods of time with the majority being funded within 45 days.  At March 31, 2012 and 2011, the Bank had outstanding commitments to sell approximately $2.7 million and $5.2 million of loans, respectively, which encompassed the Bank’s held for sale loans.  The Bank also has commitments to sell mortgage loans not yet closed, on a best efforts basis.  Best efforts means the Bank suffers no penalty if they are unable to deliver the loans to the potential buyers.  The fair value of the Bank’s commitment to originate mortgage loans at committed interest rates and to sell such loans to permanent investors is insignificant.

(20)         Related Party Transactions

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

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

	For the Years Ended March 31,
		2012		2011		2010
Balance, Beginning of Year	$	356,345	$	460,115	$	1,274,769
New Loans		9,270		43,620		65,933
Less Loan Payments		48,805		147,390		880,587
Balance, End of Year	$	316,810	$	356,345	$	460,115

Loans to all employees, officers, and directors of the Company, in the aggregate constituted approximately 4.9% and 5.1% of the Company’s total shareholders' equity at March 31, 2012 and 2011, respectively.  At March 31, 2012 and 2011, deposits from executive officers and directors of the Bank and Company and their related interests in the aggregate approximated $6.3 million and $4.5 million, respectively.

59

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(20)         Related Party Transactions, Continued

The Company leased office space from two related parties during the year ended March 31, 2012. The first lease is with a company in which a director and an officer of the Company and the Bank have an ownership interest.  The Company incurred expenses of $76,000, $74,000, and $73,000 for rent for the years ended March 31, 2012, 2011, and 2010, respectively, related to this lease.  The Company also leased office space from another officer during the year.  On this lease, the Company incurred rent expense of $6,900 during the year ended March 31, 2012 and $41,400 per year during each of the years ended March 31, 2011 and 2010, respectively. This lease was terminated during the 2012 fiscal year.  Management is of the opinion that the transactions with respect to office rent are made on terms that are comparable to those which would be made with unaffiliated persons.

(21)    Stock Issuance and Exchange

The Company was approved to participate in the Treasury’s Community Development Capital Initiative (“CDCI”).  The CDCI was established by the Treasury under the Troubled Asset Relief Program to invest lower cost capital in Community Development Financial Institutions (“CDFI”), supporting their efforts to provide credit to small businesses and other qualified customers in connection with the downturn in the economy.

In connection with its participation in the CDCI, on September 29, 2010, the Company (i) exchanged all $18.0 million (aggregate liquidation preference amount) of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), previously sold to the Treasury pursuant to the Troubled Asset Relief Program CPP, for $18.0 million (aggregate liquidation preference amount) of the Company’s newly designated Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Stock”), (ii) sold 400,000 shares of its common stock at $10.00 per share in a private offering to board members of the Company for aggregate gross proceeds of $4.0 million; and (iii) received an additional $4.0 million investment from the Treasury through the sale of an additional $4.0 million (aggregate liquidation preference amount) of its Series B Preferred Stock to the Treasury.  The additional $4.0 million investment from the Treasury was contingent upon the Company’s completion of the $4.0 million separate stock offering for the same amount, as required by the Company’s primary regulator at the time, the Office of Thrift Supervision.  The warrant sold by the Company to the Treasury in connection with the Company’s participation in Treasury’s Troubled Asset Relief Program CPP in 2008 remains outstanding.

Participation in the CDCI provided the Company with $8.0 million in additional capital and lowered the cost of the capital received from the Treasury.  The annual dividend rate on the Series A Preferred Stock was 5% and was to have increased to 9% on February 15, 2014.  The annual dividend rate on the Series B Preferred Stock is 2% for the first eight years from the date of issuance, or until September 19, 2018, and 9% thereafter if still then outstanding.  The Company and the Bank must maintain eligibility as a CDFI under Treasury regulations, otherwise, the annual dividend rate on the Series B Preferred Stock will increase to 5% if such eligibility is not corrected within 180 days and will further increase to 9% if not corrected after 270 days.

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

60

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

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

Condensed Balance Sheet Data

		At March 31,
		2012		2011
Assets:
Cash	$	5,471,308	$	5,422,037
Investment Securities, Available For Sale		75,750		78,750
Investment in Security Federal Statutory Trust		155,000		155,000
Loans Receivable, Net		-		1,786,294
Investment In Security Federal Bank		86,405,275		81,411,687
Accounts Receivable And Other Assets		69,787		36,616
Total Assets	$	92,177,120	$	88,890,384
Liabilities And Shareholders’ Equity:
Accounts Payable And Other Liabilities	$	167,534	$	173,167
Other Borrowings		-		-
Junior Subordinated Debentures		5,155,000		5,155,000
Senior Convertible Debentures		6,084,000		6,084,000
Mandatorily Redeemable Financial Instrument		-		1,467,312
Shareholders’ Equity		80,770,586		76,010,905
Total Liabilities And Shareholders’ Equity	$	92,177,120	$	88,890,384

Condensed Statements of Income Data

		For the Years Ended March 31,
		2012		2011		2010
Income:
Equity In Earnings Of Security Federal Bank	$	2,095,707	$	2,029,275	$	2,004,759
Interest Income		78,667		91,806		10,163
Miscellaneous Income		34,338		24,803		7,199
Total Income		2,208,712		2,145,884		2,022,121
Expenses:
Interest Expense		653,727		720,081		474,133
Mandatorily Redeemable Financial Instrument    Valuation (Income) Expense		(50,000)		(196,000)		63,000
Other Expenses		24,329		37,757		38,982
Total Expenses		628,056		561,838		576,115
Income Before Income Taxes		1,580,656		1,584,046		1,446,006
Income Tax Benefit		(214,719)		(258,867)		(158,795)
Net Income		1,795,375		1,842,913		1,604,801
Preferred Stock Dividends		440,000		666,453		900,000
Accretion of Preferred Stock to Redemption Value		-		18,816		72,544
Net Income Available to Common Shareholders	$	1,355,375	$	1,157,644	$	632,257

61

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

Condensed Statements of Cash Flow Data

		For the Years Ended March 31,
		2012		2011		2010
Operating Activities:
Net Income	$	1,795,375	$	1,842,913	$	1,604,801
Adjustments To Reconcile Net Income To Net Cash Provided By (Used     In) Operating Activities:
Equity In Earnings Of Security Federal Bank		(2,095,707)		(2,029,275)		(2,004,759)
Stock Compensation Expense		33,123		34,424		33,124
Mandatorily Redeemable Financial Instrument Valuation (Income)   Expense		(50,000)		(196,000)		63,000
(Increase) Decrease In Accounts Receivable And Other Assets		(32,154)		214		194,933
Increase (Decrease) In Accounts Payable		(5,633)		(1,236)		143,154
Net Cash Provided By (Used In) Operating Activities		(354,996)		(348,960)		34,253
Investing Activities:
Decrease (Increase) In Loans Receivable		1,786,294		(1,786,294)		-
Additional Investment in Security Federal Bank		-		(4,000,000)		-
Net Cash Provided By (Used In) Investing Activities		1,786,294		(5,786,294)		-
Financing Activities:
Employee Stock Purchase Plan Purchases		-		-		19,800
Proceeds From Issuance Of Senior Convertible Debentures		-		-		6,084,000
Proceeds From Issuance Of Common Stock		-		4,829,060		-
Proceeds From Issuance Of Preferred Stock		-		22,000,000		-
Redemption Of Preferred Stock		-		(18,000,000)		-
Repayments On Line of Credit		-		-		(4,787,330)
Dividends Paid To Shareholders-Preferred Stock		(440,000)		(726,222)		(900,000)
Dividends Paid To Shareholders-Common Stock		(942,027)		(858,184)		(787,550)
Net Cash Provided By (Used In) Financing Activities		(1,382,027)		7,244,654		(371,080)
Net Increase (Decrease) In Cash		49,271		1,109,400		(336,827)
Cash At Beginning Of Year		5,422,037		4,312,637		4,649,464
Cash At End Of Year	$	5,471,308	$	5,422,037	$	4,312,637

62

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(23)         Carrying Amounts and Fair Value of Financial Instruments

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

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

Level 1	Valuation is based upon quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as U.S. Treasuries and money market funds.
Level 2	Valuation is based upon quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments, mortgage-backed securities, municipal bonds, corporate debt securities and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes certain derivative contracts and impaired loans.
Level 3	Valuation is generated from model-based techniques that use at least one significant assumption based on unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

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

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. At March 31, 2012, the Company’s investment portfolio was comprised of government and agency bonds, mortgage-backed securities issued by government agencies or government sponsored enterprises, municipal securities, and one equity investment. The portfolio did not contain any private label mortgage-backed securities. Fair value measurement is based upon prices obtained from third party pricing services who use independent pricing models which rely on a variety of factors including reported trades, broker/dealer quotes, benchmark yields, economic and industry events and other relevant market information. As such, these securities are classified as Level 2.

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.

63

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

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

Impaired Loans

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

Fair value is estimated using one of the following methods: fair value of the collateral less estimated costs to 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 March 31, 2012, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. The Company records impaired loans as nonrecurring Level 3.

As of March 31, 2012 and 2011, the recorded investment in impaired loans was $40.8 million and $33.3 million, respectively. The average recorded investment in impaired loans was $34.3 million for year ended March 31, 2012 and $37.2 million for the year ended March 31, 2011.

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.

Goodwill and Other Intangible Assets

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

64

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

Mandatorily Redeemable Financial Instrument

The fair value is determined, in accordance with the underlying agreement at the instrument’s redemption value, as the number of shares issuable pursuant to the agreement at a price per share determined as the greater of a) $26 per share or b) 1.5 times the book value per share of the Company. This instrument is classified as Level 2. The mandatorily redeemable financial instrument was redeemed during the quarter ended June 30, 2011.

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

Assets:	Quoted Market Price In Active Markets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
FHLB Securities	$-	$                 2,698,894	$                                -
FNMA and FHLMC Bonds	-	2,921,851	-
SBA Bonds	-	86,278,802	-
Tax Exempt Municipal Bonds	-	24,125,725	-
Mortgage-Backed Securities	-	237,853,835	-
Equity Securities	-	75,750	-
Total	$     -	$             353,954,857	$                                -

There were no liabilities measured at fair value on a recurring basis as of March 31, 2012. Assets and liabilities measured at fair value on a recurring basis are as follows as of March 31, 2011:

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

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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. The table below presents assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2012 and 2011, aggregated by the level in the fair value hierarchy within which those measurements fall.Other intangible assets are measured on a non-recurring basis at least annually.  Specifically, the valuation of goodwill is performed each year at September 30.

Assets:	Level 1	Level 2	Level 3	Balance At March 31, 2012
Goodwill	$                      -	$                      -	$         1,199,754	$               1,199,754
Mortgage Loans Held For Sale	-	2,671,771	-	2,671,771
Impaired Loans (1)	-	-	39,160,338	39,160,338
Foreclosed Assets	-	-	14,160,099	14,160,099
Total	$                      -	$        2,671,771	$     54,520,191	$            57,191,962

   (1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF $1,636,848.

Assets:	Level 1	Level 2	Level 3	Balance At March 31, 2011
Goodwill	$                      -	$                      -	$         1,199,754	$               1,199,754
Mortgage Loans Held For Sale	-	5,166,234	-	5,166,234
Impaired Loans (1)	-	-	32,525,192	32,525,192
Foreclosed Assets	-	-	14,433,853	14,433,853
Total	$                      -	$        5,166,234	$       48,158,799	$            53,325,033

(1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF $772,476.

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

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

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

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

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

FHLB Stock—The fair value approximates the carrying value.

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

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

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

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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

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

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

The following table is a summary of the carrying value and estimated fair value of the Company’s financial instruments as of March 31, 2012 and 2011 presented in accordance with the applicable accounting guidance.

		March 31, 2012				March 31, 2011
		Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
		(In Thousands)
Financial Assets:
Cash And Cash Equivalents	$	9,331	$	9,331	$	7,836	$	7,836
Certificates of Deposits With Other Banks		1,727		1,727		100		101
Investment And Mortgage-Backed Securities		421,631		423,921		372,418		373,376
Loans Receivable, Net		428,511		427,212		484,471		482,834
FHLB Stock		8,471		8,471		11,267		11,267
Financial Liabilities:
Deposits:
Checking, Savings, And Money Market Accounts	$	371,295	$	371,295	$	332,220	$	332,220
Certificate Accounts		324,906		327,117		358,137		361,110
Advances From FHLB		122,070		131,679		138,136		147,207
Other Borrowed Money		9,801		9,801		11,195		11,195
Senior Convertible Debentures		6,084		6,084		6,084		6,084
Junior Subordinated Debentures		5,155		5,155		5,155		5,155

At March 31, 2012, the Bank had $33.8 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.  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.

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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(24)         Quarterly Financial Data (Unaudited)

Unaudited condensed financial data by quarter for fiscal years 2012 and 2011 is as follows (dollars, except per share data, in thousands):

		Quarter ended
2011-2012		June 30, 2011		Sept. 30, 2011		Dec. 31, 2011		Mar. 31, 2012
Interest Income	$	10,230	$	9,880	$	9,467	$	8,952
Interest Expense		3,349		3,260		2,974		2,814
Net Interest Income		6,881		6,620		6,493		6,138
Provision For Loan Losses		2,300		2,300		2,100		1,950
Net Interest Income After Provision For Loan Losses		4,581		4,320		4,393		4,188
Non-interest Income		1,271		1,492		2,563		1,614
Non-interest Expense		5,160		5,197		5,235		5,125
Income Before Income Tax		692		615		1,721		677
Provision For Income taxes		231		197		1,235		247
Net Income		461		418		486		430
Preferred Stock Dividends		110		110		110		110
Net Income Available To Common Shareholders	$	351	$	308	$	376	$	320
Basic Net Income Per Common Share	$	0.12	$	0.10	$	0.13	$	0.11
Diluted Net Income Per Common Share	$	0.12	$	0.10	$	0.13	$	0.11
Basic Weighted Average Shares Outstanding		2,944,001		2,944,001		2,944,001		2,944,001
Diluted Weighted Average Shares Outstanding		2,944,001		2,944,001		2,944,001		2,944,001

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

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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(25)    Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including estimates inherent in the process of preparing financial statements. Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Management has reviewed all events occurring through the date the financial statements were available to be issued and no subsequent events occurred requiring accrual or disclosure.

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SHAREHOLDERS INFORMATION

ANNUAL MEETING

The annual meeting of shareholders will be held at 2:00 p.m., Thursday, July 19, 2012 at Newberry Hall, 117 Newberry Street Southwest, Aiken, South Carolina.

STOCK LISTING

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

PRICE RANGE OF COMMON STOCK

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

Years Ended March 31		High		Low
2011
06-30-10	$	9.95	$	8.01
09-30-10	$	12.73	$	8.57
12-31-10	$	14.89	$	11.46
03-31-11	$	11.91	$	10.42
2012
06-30-11	$	10.80	$	10.70
09-30-11	$	10.70	$	8.76
12-31-11	$	9.57	$	7.16
03-31-12	$	9.90	$	8.92

As of March 31, 2012, the Company had approximately 289 shareholders and 2,944,001 outstanding shares of common stock.

DIVIDENDS

The first quarterly dividend on the stock was paid to shareholders on March 15, 1991.  Dividends will be paid upon the determination of the Board of Directors that such payment is consistent with the long-term interest of the Company.  The factors affecting this determination include the Company’s current and projected earnings, operating results, financial condition, regulatory restrictions, future growth plans, and other relevant factors. The Company paid $0.04 per share cash dividends for each of the quarters during fiscal 2006, $0.06 per share cash dividends for each of the quarters during fiscal 2007, $0.07 per share cash dividends for each of the quarters during fiscal 2008, and $0.08 per share cash dividends for each of the quarters during fiscal 2009, 2010, 2011 and 2012.

The ability of the Company to pay dividends depends primarily on the ability of the Bank to pay dividends to the Company.  The Bank may not declare or pay a cash dividend on its stock or repurchase shares of its stock if the offset thereof would be to cause its regulatory capital to be reduced below the amount required to meet applicable regulatory capital requirements.  South Carolina banking regulations restrict the amount of dividends that the Bank can pay to the Company, and may require prior approval before declaration and payment of any excess dividend.  Unlike the Bank, there is no regulatory restriction on the payment of dividends by the Company; however, it is subject to the requirements of South Carolina.  South Carolina generally prohibits the Company from paying dividends if, after giving effect to a proposed dividend: (1) the Company would be unable to pay its debts as they become due in the normal course of business, or (2) the Company’s total assets would be less than its total liabilities plus the sum that would be needed to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the dividend. In addition, payment of dividends by the Company is subject to certain limitations resulting from participation in the CPP. The Federal Reserve also has the authority to prohibit the Company from paying a dividend on its common and/or preferred stock. See Note 15 of the Notes to the Consolidated Financial Statements included herein for additional information.

CODE OF ETHICS

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

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