SFDL-EX13 -12.31.13

EX-13 2 sfdl-ex13x123113.htm EXHIBIT 13 SFDL-EX13 -12.31.13

Exhibit 13

Annual Report to Stockholders

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Selected Consolidated Financial and Other Data



	At Or For The Year Ended December 31,			At Or For The Nine Months Ended December 31,			At Or For The Year Ended March 31,
	2013			2012			2012			2011			2010
Balance Sheet Data	(Dollars In Thousands, Except Per Share Data)
Total Assets	$	849,248		$	890,355		$	924,637		$	933,544		$	956,002
Cash And Cash Equivalents	7,630			7,904			9,331			7,836			8,805
Certificates Of Deposit With Other Banks	2,100			1,729			1,727			100			—
Investment And Mortgage-Backed Securities	431,003			430,988			421,631			372,418			311,046
Total Loans Receivable, Net ⁽¹⁾	358,917			397,706			428,511			484,471			568,399
Deposits	658,697			676,339			696,201			690,357			694,252
Advances From Federal Home Loan Bank	87,740			105,257			122,070			138,136			164,004
Total Shareholders' Equity	77,990			82,592			80,772			76,012			67,861
Income Data
Total Interest Income	$	30,447		$	24,791		$	38,529		$	43,742		$	47,507
Total Interest Expense	7,533			7,460			12,397			16,095			20,136
Net Interest Income	22,914			17,331			26,132			27,647			27,371
Provision For Loan Losses	2,645			1,975			8,650			7,800			8,155
Net Interest Income After Provision For Loan Losses	20,269			15,356			17,482			19,847			19,216
Non-Interest Income	6,896			4,365			6,942			6,795			6,113
General And Administrative Expense	22,033			17,062			20,717			23,841			22,663
Income Taxes	1,341			704			1,912			958			1,060
Net Income	3,791			1,955			1,795			1,843			1,605
Preferred Stock Dividends	440			330			440			666			900
Accretion Of Preferred Stock To Redemption Value	—			—			—			19			73
Net Income Available To Common Shareholders	$	3,351		$	1,625		$	1,355		$	1,158		$	632
Per Common Share Data
Net Income Per Common Share (Basic)	$	1.14		$	0.55		$	0.46		$	0.43		$	0.26
Cash Dividends	$	0.32		$	0.24		$	0.32		$	0.32		$	0.32
Other Data
Interest Rate Spread Information:
Average During Period ⁽⁴⁾	2.81		%	2.70		%	2.98		%	3.06		%	2.83		%
End Of Period	3.19		%	3.16		%	3.30		%	3.34		%	3.21		%
Net Interest Margin (Net Interest Income/Average Earning Assets)⁽⁴⁾	2.91		%	2.80		%	3.09		%	3.17		%	2.98		%
Average Interest-Earning Assets To Average Interest-Bearing Liabilities	110.71		%	108.08		%	107.08		%	106.35		%	106.64		%
Common Equity To Total Assets	6.59		%	6.81		%	6.36		%	5.79		%	5.25		%
Non-Performing Assets To Total Assets ⁽²⁾	1.64		%	2.83		%	3.98		%	2.89		%	4.39		%
Return On Assets (Ratio Of Net Income To Average Total Assets) ⁽⁴⁾	0.38		%	0.24		%	0.15		%	0.12		%	0.06		%
Return On Common Equity (Ratio Of Net Income To Average Common Equity) ⁽⁴⁾	5.79		%	3.62		%	2.35		%	2.17		%	1.27		%
Common Equity To Assets Ratio (Ratio Of Average Common Equity To Average Total Assets)	6.64		%	6.69		%	6.22		%	5.62		%	5.09		%
Dividend Pay-Out Ratio On Common Shares⁽³⁾	28.11		%	43.48		%	69.50		%	74.13		%	124.56		%
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}

^{(4) ANNUALIZED FOR THE NINE MONTH TRANSITION PERIOD ENDED DECEMBER 31, 2012.}

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 mutual building and loan association. In 1987, the Bank converted to 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.

As a result of the Company's reorganization, in order to better align the financial reporting periods for the Company and the Bank with regulatory reporting periods, the Company elected to change its fiscal year end from March 31 to December 31. This change was effective for the reporting period ended December 31, 2012, and as a result, the Company filed a transition period annual report on Form 10-KT with the Securities and Exchange Commission for the nine month period ended December 31, 2012. The Company's current fiscal year end was December 31, 2013, and the Company will file its annual report on Form 10-K for the year ended December 31, 2013.

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 is currently inactive.

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.

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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Forward-Looking Statements

This document, including information included or incorporated by reference, contents, and future filings by the Company on Form 10-K, Form 10-Q, and Form 8-K, and future oral and written statements by the Company and its management may contain forward-looking statements 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 which may lead to increased losses and non-performing assets in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our loan loss reserves;


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


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


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


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

•

results of examinations of the Company by the 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 requirements, including changes as a result of Basel III, or other rules, and any changes in rules applicable to institutions participating in the U. S. Department of Treasury Community Development Capital Initiative;


•	our ability to attract and retain deposits;


•	increases in premiums for deposit insurance;


•	our ability to control operating costs and expenses;


•	our ability to implement our business strategies;


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


•	difficulties in reducing 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;

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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


•	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 and preferred 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; 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 December 31, 2013 under Item 1A, “Risk Factors.” Such developments could have an adverse impact on our financial position and our results of operations.

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

Critical Accounting Policies

The Company has adopted various accounting policies which govern the application of accounting principles generally accepted in the United States in the preparation of the Company’s 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.

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 “Financial Condition” and “Comparison of

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

the Year Ended December 31, 2013 and 2012-Provision for Loan Losses” and “Comparison of the Nine Months Ended December 31, 2012 and 2011 - 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.

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 decrease faster 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 December 31, 2013, the Bank's one-year gap position was a negative mismatch. Liabilities repricing exceeded assets repricing by $17.1 million or 2.0% of total assets compared to a positive mismatch, or assets repricing exceeding liabilities repricing by $108.1 million or 12.1% at December 31, 2012. For more information on the Bank’s repricing position at December 31, 2013, see the tables on pages 12 and 13.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

During the year ended December 31, 2013, Bank originated, for investment purposes, $13.0 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 $138.0 million of adjustable rate consumer loans, commercial loans, and mortgage loans or 37.0% of total loans at December 31, 2013. During the year ended December 31, 2013, the Bank originated $183.5 million in new and renewed consumer and commercial loans, which are usually short term in nature. The Bank's portfolio of consumer and commercial loans was $288.4 million at December 31, 2013, $315.6 million at December 31, 2012, and $344.6 million at March 31, 2012. Consumer and commercial loans combined were 77.4% of total loans at December 31, 2013, 76.8% of total loans at December 31, 2012, and 77.5% of total loans at March 31, 2012.

At December 31, 2013, the Bank held approximately $8.7 million in longer term fixed rate residential mortgage loans. The majority of these loans, had converted from ARM loans to fixed rate loans during the previous 60 months. These fixed rate loans have remaining maturities ranging from 10 to 30 years. As of December 31, 2013, the Bank no longer had any ARM loans that permit conversion to fixed rate loans. Currently, the Bank sells virtually all of its 15 and 30 year fixed rate mortgage loans at origination. 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 $33.1 million during the year ended December 31, 2013; $22.5 million during the nine months ended December 31, 2012; and $37.9 million during the year ended March 31, 2012. 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 December 31, 2013, the Bank had $129.9 million outstanding in Jumbo Certificates compared to $139.9 million at December 31, 2012. Brokered deposits totaled $25.6 million at December 31, 2013 compared to $22.6 million at December 31, 2012. The majority of the Bank’s deposits are originated within the Bank’s immediate market area.

The following table sets forth the maturity schedule of certificates of deposit with balances of $100,000 or greater at December 31, 2013:



	At December 31, 2013
	(In Thousands)
Within 3 Months	$	24,127
After 3 Months, Within 6 Months	21,462
After 6 Months, Within 12 Months	27,952
After 12 Months	56,356
	$	129,897

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

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 December 31,
	2013			2012
	(Dollars In Thousands)
Loans ⁽¹⁾	$	202,062		$	317,154
Mortgage-Backed Securities:
Held To Maturity	—			3,901
Available For Sale	91,856			90,946
Investment Securities:
Held To Maturity	—			5,865
Available For Sale	73,946			75,332
Other Interest-Earning Assets And FHLB Stock	5,338			6,405
Total Interest Rate Sensitive Assets Repricing Within 1 Year	$	373,202		$	499,603
Deposits	$	342,303		$	354,970
FHLB Advances And Other Borrowed Money	47,998			36,572
Total Interest Rate Sensitive Liabilities Repricing Within 1 Year	$	390,301		$	391,542
Gap	$	(17,099	)	$	108,061
Interest Rate Sensitive Assets/Interest Rate Sensitive Liabilities	95.6		%	127.6		%
Gap As A Percent Of Total Assets	(2.0		)%	12.1		%


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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

The following table sets forth the interest rate sensitivity of the Bank's assets and liabilities at December 31, 2013, 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⁾	$	107,136		$	94,926		$	120,759		$	37,428		$	5,807		$	3,098		$	369,154
Mortgage-Backed Securities:
Held To Maturity, At Cost	—			—			—			—			—			—			—
Available For Sale, At Fair Value	70,449			21,407			53,812			48,722			47,798			6,409			248,597
Investment Securities:
Held To Maturity, At Cost	—			—			—			—			—			—			—
Available For Sale, At Fair Value	63,139			10,807			20,929			20,905			64,393			2,234			182,407
FHLB Stock, At Cost	—			5,017			—			—			—			—			5,017
Other Interest-Earning Assets	321			—			2,100			—			—			—			2,421
Total Interest-Earning Assets	$	241,045		$	132,157		$	197,600		$	107,055		$	117,998		$	11,741		$	807,596

Interest-Bearing Liabilities
Deposits:
Certificate Accounts	$	48,384		$	115,296		$	67,573		$	25,630		$	—		$	—		$	256,883
NOW Accounts	4,329			12,986			69,257			—			—			—			86,572
Money Market Accounts	38,501			117,910			84,221			—			—			—			240,632
Statement Savings Accounts	1,224			3,673			19,589			—			—			—			24,486
Borrowings ⁽²⁾	30,258			17,740			35,000			17,900			—			6,084			106,982
Total Interest-Bearing Liabilities	$	122,696		$	267,605		$	275,640		$	43,530		$	—		$	6,084		$	715,555

Current Period Gap	$	118,349		$	(135,448	)	$	(78,040	)	$	63,525		$	117,998		$	5,657		$	92,041
Cumulative Gap	$	118,349		$	(17,099	)	$	(95,139	)	$	(31,614	)	$	86,384		$	92,041		$	92,041
Cumulative Gap As A Percent Of Total Assets	13.3		%	(2.0		)%	(10.7		)%	(3.6		)%	9.7		%	10.3		%	10.3		%


⁽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 DECEMBER 31, 2013.}

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Financial Condition

Total assets at December 31, 2013 were $849.2 million, a decrease of $41.1 million or 4.6% from $890.4 million at December 31, 2012. This decrease was primarily the result of a decrease in net loans receivable and to a lesser extent, repossessed assets acquired in the settlement of loans.

Total net loans receivable were $358.9 million at December 31, 2013, a decrease of $38.8 million or 9.8% from $397.7 million at December 31, 2012. Residential real estate loans held for investment decreased $7.7 million or 8.5% to $83.0 million at December 31, 2013. 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 December 31, 2013, the Bank held 86.9% of its residential mortgage loans in ARMs, while it had 13.1% in fixed rate mortgages. Consumer loans decreased $4.4 million or 7.8% to $52.2 million while commercial business loans decreased $289,000 or 3.6% to $7.8 million and commercial real estate loans decreased $22.5 million or 9.0% to $228.4 million at fiscal year end December 31, 2013 from $250.9 million at December 31, 2012. The decrease in loans held for investment was the result of tightened underwriting standards and a general decrease in loan demand. Loans held for sale, which were $1.2 million at December 31, 2013, decreased $3.5 million or 74.1% from $4.8 million at December 31, 2012.

Total investments and mortgage-backed securities remained virtually unchanged at $431.0 million at both December 31, 2013 and December 31, 2012. All of these securities were classified as available for sale at December 31, 2013, as all investment and mortgage-backed securities were transferred from held to maturity to available for sale during 2013. Cash and cash equivalents decreased $274,000 or 3.5% to $7.6 million at December 31, 2013 compared to $7.9 million at December 31, 2012. Premises and equipment decreased $675,000 or 3.8% to $17.2 million at December 31, 2013 compared to $17.9 million at December 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 year ended December 31, 2013 or the 12 months ended December 31, 2012. The cash value of Bank Owned Life Insurance (“BOLI”) was $11.5 million at December 31, 2013 compared to $11.2 million at December 31, 2012 reflecting a $323,000 or 2.9% increase as a result of accumulated BOLI earnings. There were no additional BOLI purchases during the year ended December 31, 2013. 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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

The Company’s non-performing assets decreased $11.2 million or 44.5% to $14.0 million at December 31, 2013 from $25.2 million at December 31, 2012. The following table sets forth detailed information concerning our non-performing assets for the periods indicated:



	At December 31, 2013					At December 31, 2012					$ Increase			% Increase
	Amount			Percent ⁽¹⁾		Amount			Percent ⁽¹⁾		(Decrease)			(Decrease)
Loans 90 Days Or More Past Due Or Non-Accrual Loans:
Residential Real Estate	$	4,607,613		1.3	%	$	3,757,801		0.9	%	$	849,812		22.6	%
Commercial Business	33,055			—		86,991			—		(53,936		)	(62.0	)
Commercial Real Estate	4,972,667			1.4		13,913,190			3.4		(8,940,523		)	(64.3	)
Consumer	399,062			0.1		646,136			0.2		(247,074		)	(38.2	)

Total Non-Performing Loans	10,012,397			2.7	%	18,404,118			4.5	%	(8,391,721		)	(45.6	)%
Other Non-Performing Assets
Real Estate Owned	3,947,226			1.1		6,754,425			1.7		(2,807,199		)	(41.6	)
Total Other Non-Performing Assets	3,947,226			1.1	%	6,754,425			1.7	%	(2,807,199		)	(41.6	)%
Total Non-Performing Assets	$	13,959,623		3.8	%	$	25,158,543		6.2	%	$	(11,198,920	)	(44.5	)%
Total Non-Performing Assets As A Percentage Of Total Assets	1.6		%			2.8		%

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

The decrease in non-performing assets was primarily concentrated in non-performing commercial real estate loans which decreased $8.9 million to $5.0 million at December 31, 2013 from $13.9 million at December 31, 2012. The balance in non-performing commercial real estate loans at December 31, 2013 consisted of 37 loans to 19 borrowers with an average loan balance of $134,000. At December 31, 2012, the balance in non-performing commercial real estate loans consisted of 51 loans to 32 borrowers with an average loan balance of $273,000.

Of the non-performing commercial real estate loans, $1.6 million consisted of eight loans secured by commercial buildings to eight different borrowers; $1.4 million consisted of 12 loans secured by builder lots or speculative houses in varying degrees of completion throughout South Carolina and Georgia to three separate borrowers; $681,000 consisted of three loans to two separate borrowers related to the acquisition and development of two subdivisions; and $610,000 consisted of six loans secured by raw land to four separate borrowers. The majority of the remaining non-performing loans in the commercial real estate category were secured by first mortgages on principal residences throughout the Bank's market area.

Non-performing residential real estate loans increased $850,000 to $4.6 million at December 31, 2013 from $3.8 million at December 31, 2012. The balance in non-performing residential real estate loans at December 31, 2013 consisted of 29 loans to 29 borrowers with an average loan balance of $159,000. The balance in non-performing residential real estate loans at December 31, 2012 consisted of 26 loans to 25 borrowers with an average loan balance of $145,000.

Real estate owned decreased $2.8 million or 41.6% to $3.9 million at December 31, 2013 compared to $6.8 million at December 31, 2012. At December 31, 2013, the balance of repossessed assets consisted of the following real estate properties: 10 single-family residences and 10 lots within residential subdivisions located throughout our market area in South Carolina and Georgia; four parcels of land in South Carolina; eight lots within a subdivision and adjacent 22.96 acres of land in Aiken, South Carolina; and 34.8 acres of land in Bluffton, South Carolina which was originally acquired as a participation loan from another financial institution.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

FHLB stock decreased $1.2 million or 18.8% to $5.0 million at December 31, 2013 compared to $6.2 million at December 31, 2012 as a result of stock redemptions. The Bank, as a member of the FHLB of Atlanta, is required to acquire and hold shares of capital stock in the FHLB of Atlanta in an amount equal to a membership component, which is 0.15% of total assets plus a transaction component which equals 4.5% of outstanding advances (borrowings) from the FHLB of Atlanta. As total assets and total advances have decreased, so has the Bank’s required investment in FHLB stock.

Other assets increased $2.1 million or 37.5% to $7.5 million at December 31, 2013 compared to $5.5 million at December 31, 2012 as a result of an increase in the net deferred tax asset related to available for sale securities of $4.3 million offset partially by a decrease in prepaid FDIC premiums of $1.8 million. The unrealized gain on investment securities available for sale decreased $11.2 million during the twelve months ended December 31, 2013 as a result of an increase in market rates. The increase in the deferred tax asset represents the tax impact of this change.

The Bank reviews its loan portfolio and allowance for loan losses on a monthly basis. Future additions to the Bank's allowance for loan losses are dependent on, among other things, the performance of the Bank's loan portfolio, the economy, changes in real estate values, and interest rates. There can be no assurance that additions to the allowance will not be required in future periods. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations. Management continually monitors its loan portfolio for the impact of local economic changes. The ratio of allowance for loan losses to total loans was 2.78% and 2.80% at December 31, 2013 and 2012, respectively. The Bank closely monitors its past due loans.

The cumulative interest not accrued during the year ended December 31, 2013 and the nine months ended December 31, 2012 relating to all non-performing loans totaled $480,000 and $771,000, respectively. Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the underlying 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 $2.0 million or 19.1% during the year ended December 31, 2013. The Bank had 22 loans that were TDRs totaling $12.4 million at December 31, 2013 compared to 23 loans totaling $15.9 million at December 31, 2012. The 22 TDRs consisted of one consumer loan secured by a first mortgage on a residential dwelling and two automobiles totaling $69,000, one consumer auto loan totaling $9,000 and one commercial line of credit totaling $33,000, secured by a residential vehicle. The remaining 19 restructurings consisted of 18 commercial real estate loans to 10 separate borrowers and one unsecured commercial business loan. The commercial real estate loans were secured primarily by first mortgages on three single family residences, nine commercial buildings, three hotels, one church and two parcels of land. At December 31, 2013, five of the TDRs to three borrowers totaling $855,000 were delinquent. All of the remaining TDRs were current at December 31, 2013.

All TDRs are reviewed for impairment loss. At December 31, 2013, the Bank held $31.4 million in impaired loans, including $12.4 million in TDRs, compared to $39.9 million of impaired loans, including $15.9 million of TDRs, at December 31, 2012.

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 $12,000, respectively, at December 31, 2013; and $1.2 million and $62,000 at December 31, 2012, respectively. Collier Jennings is now a subsidiary of Security Federal Insurance Inc.

Deposits at the Bank decreased $17.6 million or 2.6% to $658.7 million at December 31, 2013 from $676.3 million at December 31, 2012, as time deposits decreased $35.9 million. The Bank had brokered time deposits of $25.6 million at December 31, 2013 compared to $22.6 million at December 31, 2012. 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 December 31, 2013,

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

excluding brokered time deposits, decreased $20.7 million or 3.2% to $633.1 million from $653.8 million at December 31, 2012. Brokered time deposits were 3.9% of total deposits at December 31, 2013 and 3.3% of total deposits at December 31, 2012.

Advances from the FHLB decreased $17.5 million or 16.6% to $87.7 million at December 31, 2013 from $105.3 million at December 31, 2012. During the year ended December 31, 2013, as part of the Company's strategy to lower its cost of funds, management elected to prepay $30.0 million in higher rate advances. Other borrowed money, which consists of retail repurchase agreements, decreased $1.3 million or 14.1% to $8.0 million at December 31, 2013 from $9.3 million at December 31, 2012.

The Company issued its only trust preferred security in September 2006. Gross proceeds of the issuance were $5.2 million and are classified as junior subordinated debentures on the Consolidated Balance Sheets included in the Consolidated Financial Statements contained herein. In December 2009, the Company issued $6.1 million in convertible senior debentures. The debentures 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. 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.

Total shareholders' equity was $78.0 million at December 31, 2013, a decrease of $4.6 million or 5.6% from $82.6 million at December 31, 2012. The Company’s net income for the year ended December 31, 2013 was $3.8 million. Preferred stock dividends were $440,000 resulting in net income available to common shareholders of $3.4 million. Other changes in shareholders’ equity during the period were: a net decrease in other comprehensive income of $7.0 million, representing the unrecognized decline in value of investment and mortgage-backed securities, a net decrease of $50,000 related to the redemption of the warrant issued in conjunction with preferred stock, and $942,000 in dividends paid to common shareholders.

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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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



	Year Ended December 31, 2013 Compared To Twelve Months Ended December 31, 2012									Nine Months Ended December 31, 2012 Compared To Nine Months Ended December 31, 2011
	Volume			Rate			Net			Volume			Rate			Net
	(In Thousands)
Interest-Earning Assets:
Loans: ⁽¹⁾
Mortgage Loans	$	(491	)	$	(252	)	$	(743	)	$	(466	)	$	(266	)	$	(732	)
Other Loans	(1,857		)	(316		)	(2,173		)	(2,834		)	(1,145		)	(3,979		)
Total Loans	(2,348		)	(568		)	(2,916		)	(3,300		)	(1,411		)	(4,711		)
Mortgage-Backed Securities ⁽²⁾	(459		)	(929		)	(1,388		)	350			(1,691		)	(1,341		)
Investments ⁽²⁾⁽³⁾	686			610			1,296			529			(651		)	(122		)
Other Interest-Earning Assets	(2		)	3			1			1			6			7
Total Interest-Earning Assets	$	(2,123	)	$	(884	)	$	(3,007	)	$	(2,420	)	$	(3,747	)	$	(6,167	)
Interest-Bearing Liabilities:
Deposits:
Certificate Accounts	$	(482	)	$	(913	)	$	(1,395	)	$	(447	)	$	(992	)	$	(1,439	)
NOW Accounts	14			(125		)	(111		)	9			(66		)	(57		)
Money Market Accounts	25			(293		)	(268		)	154			(779		)	(625		)
Savings Accounts	4			(13		)	(9		)	3			(5		)	(2		)
Total Deposits	(439		)	(1,344		)	(1,783		)	(281		)	(1,842		)	(2,123		)
Borrowings	(740		)	(218		)	(958		)	(783		)	76			(707		)
Total Interest-Bearing Liabilities	(1,179		)	(1,562		)	(2,741		)	(1,064		)	(1,766		)	(2,830		)
Effect On Net Interest Income	$	(944	)	$	678		$	(266	)	$	(1,356	)	$	(1,981	)	$	(3,337	)

^{(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 $604,054 AND $315,568, RESPECTIVELY FOR YEAR ENDED DECEMBER 31, 2013 AND TWELVE MONTHS ENDED DECEMBER 31, 2012.}

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

The following tables present 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/ Rate		Averages For The Year Ended December 31, 2013 And The Twelve Months Ended December 31, 2012
	At		2013						2012
	December 31, 2013		Average Balance		Interest		Annualized Yield/Rate		Average Balance		Interest		Annualized Yield/Rate
			(Dollars In Thousands)
Interest-Earning Assets:
Mortgage Loans	4.54	%	$	85,973	$	3,894	4.53	%	$	96,564	$	4,637	4.80	%
Other Loans	5.97	%	291,024		17,689		6.08	%	321,639		19,862		6.18	%
Total Loans ⁽¹⁾	5.65	%	376,997		21,583		5.72	%	418,203		24,499		5.86	%
Mortgage-Backed Securities⁽²⁾	2.61	%	246,921		5,267		2.13	%	266,431		6,655		2.50	%
Investments ^{(2) (3)}	3.02	%	180,588		4,193		2.32	%	148,856		2,897		1.95	%
Other Interest-Earning Assets	0.44	%	5,035		8		0.16	%	5,578		7		0.13	%
Total Interest-Earning Assets	4.07	%	$	809,541	$	31,051	3.84	%	$	839,068	$	34,058	4.06	%
Interest-Bearing Liabilities:
Certificate Accounts	0.83	%	$	271,002	$	2,566	0.95	%	$	312,609	$	3,961	1.27	%
NOW Accounts	0.07	%	84,230		58		0.07	%	77,530		169		0.22	%
Money Market Accounts	0.28	%	238,693		755		0.32	%	232,671		1,022		0.44	%
Savings Accounts	0.10	%	24,112		34		0.14	%	21,934		43		0.20	%
Total Interest-Bearing Accounts	0.48	%	618,037		3,413		0.55	%	644,744		5,195		0.81	%
Other Borrowings	0.15	%	9,270		19		0.20	%	9,614		25		0.26	%
Junior Subordinated Debt	1.94	%	5,155		103		2.00	%	5,155		113		2.19	%
Senior Convertible Debt	8.00	%	6,084		487		8.00	%	6,084		487		8.00	%
FHLB Advances	3.23	%	92,658		3,511		3.79	%	112,572		4,453		3.96	%
Total Interest-Bearing Liabilities	0.88	%	$	731,204	$	7,533	1.03	%	$	778,169	$	10,273	1.32	%
Net Interest Income					$	23,518					$	23,785
Interest Rate Spread	3.19	%					2.81	%					2.74	%
Net Yield On Earning Assets (Net Interest Margin)							2.91	%					2.83	%

^{(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 $604,054 AND $315,568, RESPECTIVELY FOR THE YEAR ENDED DECEMBER 31, 2013 AND TWELVE MONTHS ENDED DECEMBER 31, 2012.}

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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



	Averages For The Nine Months Ended December 31,
	2012						2011
	Average Balance		Interest		Annualized Yield/Rate		Average Balance		Interest		Annualized Yield/Rate
	(Dollars In Thousands)
Interest-Earning Assets:
Mortgage Loans	$	95,887	$	3,392	4.72	%	$	105,552	$	3,941	4.98	%
Other Loans	315,615		14,515		6.13	%	361,321		17,500		6.46	%
Total Loans ⁽¹⁾	411,502		17,907		5.80	%	466,873		21,441		6.12	%
Mortgage-Backed Securities ⁽²⁾	267,026		4,883		2.44	%	255,238		5,889		3.08	%
Investments ^{(2) (3)}	152,726		2,255		1.97	%	128,551		2,347		2.43	%
Other Interest-Earning Assets	5,165		6		0.17	%	4,178		2		0.05	%
Total Interest-Earning Assets	$	836,419	$	25,051	3.99	%	$	854,840	$	29,679	4.63	%
Interest-Bearing Liabilities:
Certificate Accounts	$	308,059	$	2,838	1.23	%	$	338,808	$	3,917	1.54	%
NOW Accounts	78,919		64		0.11	%	73,161		106		0.19	%
Money Market Accounts	233,398		769		0.44	%	211,902		1,239		0.78	%
Savings Accounts	22,217		33		0.20	%	20,784		35		0.22	%
Total Interest-Bearing Accounts	642,593		3,704		0.77	%	644,655		5,297		1.10	%
Other Borrowings	9,669		18		0.25	%	10,746		31		0.39	%
Jr. Subordinated Debt	5,155		84		2.17	%	5,155		138		3.57	%
Sr. Convertible Debt	6,084		365		8.00	%	6,084		365		8.00	%
FHLB Advances	110,380		3,289		3.97	%	130,112		3,752		3.85	%
Total Interest-Bearing Liabilities	$	773,881	$	7,460	1.29	%	$	796,752	$	9,583	1.60	%
Net Interest Income			$	17,591					$	20,096
Interest Rate Spread					2.70	%					3.03	%
Net Yield On Earning Assets (Net Interest Margin)					2.80	%					3.13	%

^{(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 $260,766 AND $102,000, RESPECTIVELY FOR THE NINE MONTHS ENDED DECEMBER 31, 2012 AND 2011.}

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Comparison of the Year Ended December 31, 2013 and Twelve Months Ended December 31, 2012

General

The following tables provide selected historical consolidated financial and operating data of the Company at the dates and for the periods indicated. In conjunction with the data provided in the following tables and in order to more fully understand our historical consolidated financial and operating data, you should also read our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and the accompanying notes included in this report. For comparative income statement information for the year ended December 31, 2013 and the twelve months ended December 31, 2012, see Note 1(b) of the Notes to Consolidated Financial Statements included herein.

As previously announced, our Board of Directors approved a change in fiscal year end from March 31 to December 31, effective for the reporting period ended December 31, 2012. As a result of this change, the Company's prior year Annual Report on Form 10-KT was a transition report and included financial information for the nine-month transition period from April 1, 2012 to December 31, 2012 (the “Transition Period”). The comparative financial information provided for the year ended December 31, 2012 is unaudited and includes all normal recurring adjustments necessary for a fair statement of the results for that period.

The Company’s earnings available to common shareholders were $3.4 million for the year ended December 31, 2013, compared to $1.9 million for the twelve months ended December 31, 2012. The $1.5 million or 72.3% increase in earnings was attributable primarily to the decrease in the provision for loan losses combined with an increase in non-interest income. These factors were offset slightly by a decrease in net interest income.

Net Interest Income

Net interest margin on a tax equivalent basis for the year ended December 31, 2013 increased eight basis points to 2.91% from 2.83% for the twelve months ended December 31, 2012. Despite the increase in margin, the significant decrease in the volume of interest earning assets, particularly loans, resulted in a decrease in net interest income. Net interest income decreased $555,000 or 2.4% to $22.9 million for the year ended December 31, 2013 compared to $23.5 million for the twelve months ended December 31, 2012. The decrease was attributable to a decrease in interest income offset by a decrease in interest expense. Average interest-earning assets decreased $29.5 million or 3.5% to $809.5 million while average interest-bearing liabilities decreased $47.0 million or 6.0% to $731.2 million. The interest rate spread was 2.81% for the year ended December 31, 2013 compared to 2.74% for the twelve months ended December 31, 2012.

Interest income on loans decreased $4.8 million to $21.6 million during the year ended December 31, 2013 from $24.5 million during the twelve months ended December 31, 2012. The 11.9% decrease was attributable to a decrease in average total loans outstanding of $41.2 million combined with a 14 basis point decrease in the yield earned on the Bank’s loans during the year ended December 31, 2013. Tax equivalent interest income on investment securities, mortgage-backed securities, and other investments decreased $91,000 as a result of a decrease in the yield earned offset in part by an increase in the aggregate average balance in the investment portfolio, including mortgage-backed securities, investments, and other interest-earning assets of $37.0 million.

Interest expense on deposits decreased $1.8 million or 34.3% to $3.4 million during the year ended December 31, 2013. Average interest bearing deposits decreased $26.7 million while the average cost of those deposits decreased 26 basis points during the year ended December 31, 2013. Interest expense on FHLB advances and other borrowings decreased $958,000 or 21.2% to $3.5 million during 2013. The decrease was a result of a decrease in average FHLB advances and other borrowings outstanding during the year ended December 31, 2013 of $20.3 million and a decrease in the average costs of those borrowings of 21 basis points to 3.46% compared to 3.67% during the twelve months ended December 31, 2012. During the year ended December 31, 2013, as part of the Company's strategy to lower cost of funds, management elected to prepay $30.0 million in higher rate advances.

Interest expense on junior subordinated debentures was $103,000 for the year ended December 31, 2013 compared to $113,000 during the year ended December 31, 2012. The average outstanding balance on these debentures remained constant at $5.2 million during both periods while the average cost decreased 19 basis points to 2.00% during the year ended December 31, 2013 compared to 2.19% for the twelve months ended December 31, 2012. Interest expense on senior convertible debentures was $487,000 for the year ended December 31, 2013 and the twelve months ended December 31, 2012. The senior convertible debentures were issued during December 2009 and have a fixed rate of 8%.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Provision for Loan Losses

Non-performing assets, which consist of non-accrual loans and repossessed assets, decreased $11.2 million or 44.5% to $14.0 million at December 31, 2013 from $25.2 million at December 31, 2012. Consistent with the decrease in non-performing assets, the provision for loan losses was $2.6 million for the year ended December 31, 2013, a $1.3 million or 32.6% decrease from $3.9 million for the twelve months ended December 31, 2012. Net charge offs were 1.01% of gross loans during the year ended December 31, 2013 compared to 1.69% for the twelve months ended December 31, 2012 and the allowance for loan losses represented 275.2% of net charge offs during the year ended December 31, 2013 compared to 166.0% of net charge offs during the twelve months ended December 31, 2012.

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

Management believes the allowance for loan losses is adequate based on its best estimates of the losses inherent in the loan portfolio, although there can be no guarantee as to these estimates. In addition, bank regulatory agencies may require additional provisions to the allowance for loan losses based on their judgments and estimates as part of their examination process. Because the allowance for loan losses is an estimate, there can be no guarantee that actual loan losses will 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 $917,000 or 15.3% to $6.9 million for the year ended December 31, 2013 from $6.0 million for the comparable twelve month period in 2012. The increase is a result of income related to a grant the Bank received in recognition of its commitment to community development. During the year ended December 31, 2013, the Company recognized $929,000 in grant income in connection with this award compared to no income for the twelve months ended December 31, 2012.

Gain on sale of investments decreased $155,000 or 10.4% to $1.3 million during fiscal 2013 from $1.5 million during the twelve months ended December 31, 2012. Gain on sale of loans increased $138,000 or 21.4% to $780,000 during the year ended December 31, 2013 compared to $642,000 during the twelve months ended December 31, 2012. Management was able to maximize gain on sale of loans by raising the rates slightly on these loans and therefore increasing the price. Service fees on deposit accounts remained relatively unchanged at $1.2 million during the year ended December 31, 2013 and the twelve months ended December 31, 2012.

Income from insurance agency commissions was $453,000 during fiscal 2013, a decrease of $11,000 or 2.3% compared to $464,000 during the twelve months ended December 31, 2012. Trust income increased $14,000 or 2.8% to $520,000 during the year ended December 31, 2013 from $506,000 during the twelve months ended December 31, 2012. Income from BOLI decreased $81,000 or 19.3% to $339,000 during fiscal year 2013 from $420,000 during the twelve months ended December 31, 2012 as a result of a decrease in the portfolio yield of those assets.

Check card fee income increased $39,000 or 4.8% to $853,000 for the year ended December 31, 2013 compared to $814,000 for the same period in the prior year. Other miscellaneous income including annuity and investment brokerage commissions, bank credit life insurance on loans, and other miscellaneous income increased $48,000 or 9.6% to $543,000 during the year ended December 31, 2013 from $495,000 during the same period in 2012.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

the period as these loans are funded. The Bank recognized $929,000 in grant income related to this award during the year ended December 31, 2013.

General and Administrative Expenses

General and administrative expenses decreased $154,000 or 0.7% to $22.0 million during the year ended December 31, 2013 compared to $22.2 million during the same period one year earlier. The decrease in non-interest expense was primarily a result of a decrease in the net costs associated with the operation of real estate owned including write downs on these properties offset by increases in prepayment penalties on FHLB advances and other expenses.

Compensation and employee benefits increased $246,000 or 2.3% to $11.0 million from $10.7 million for the twelve months ended December 31, 2012 as a result of normal cost of living increases combined with the addition of one full-time equivalent employee. The number of full-time equivalent employees increased by one to 197 full time equivalent employees at December 31, 2013 compared to 196 full time equivalent employees at December 31, 2012. Occupancy expense increased $28,000 or 1.4% to $2.0 million from $1.9 million for the twelve months ended December 31, 2012, while depreciation and maintenance of equipment expense decreased $102,000 or 6.0% to $1.6 million for the year ended December 31, 2013 compared to $1.7 million for the same period in 2012. Advertising expense decreased $25,000 or 6.7% to $356,000 for the year ended December 31, 2013 from $381,000 for the twelve months ended December 31, 2012.

Net cost of operation of other real estate owned decreased $1.6 million or 50.0% to $1.6 million for the year ended December 31, 2013 from $3.2 million for the same period in 2012. Other real estate owned was $3.9 million at December 31, 2013 compared to $6.8 million at December 31, 2012. This decrease was the result of a decrease in foreclosures and a decrease in write downs on real estate owned during the year. Real estate owned is recorded at the lower of cost or estimated fair value less costs to sell. As local real estate values declined significantly in the prior years, the Bank was required to write down these properties to their fair values. Write downs on real estate owned totaled $1.4 million for the year ended December 31, 2013 compared to $3.1 million for the twelve months ended December 31, 2012.

The Company incurred prepayment penalties of $589,000 for paying down FHLB advances during the year ended December 31, 2013. As part of the Company's strategy to lower cost of funds, management elected to prepay some higher rate advances.

Other expenses increased $592,000, or 16.5% to $4.2 million for the year ended December 31, 2013 compared to $3.6 million for the same period in the prior year. Other expenses include legal, professional, and consulting expenses, stationary and office supplies and other miscellaneous expenses. During fiscal 2013, the Bank hired a consultant that specializes in reducing operating expense and increasing fee income. Although this resulted in increased consulting fees during the year, management believes this expense will be offset by the benefits realized in future periods.

Income Taxes

The provision for income taxes increased $389,000 or 40.9% to $1.3 million during the year ended December 31, 2013 compared to $951,000 for the twelve months ended December 31, 2012. The effective tax rate was 26.1% for 2013 and 28.5% for 2012.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Comparison of the Nine Months Ended December 31, 2012 and 2011

General

The following discussion provides selected historical consolidated financial and operating data of the Company at the dates and for the periods indicated. In conjunction with the data provided in the section and in order to more fully understand our historical consolidated financial and operating data, you should also read our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and the accompanying notes included in this report. For comparative income statement information for the nine months ended December 31, 2012 and 2011, see Note 1(b) of the Notes to Consolidated Financial Statements included herein.

The Company’s earnings available to common shareholders were $1.6 million for the nine months ended December 31, 2012, compared to $1.0 million for the same period in 2011. The $590,000 or 56.9% increase in earnings was attributable primarily to the decrease in provision for loan losses and income taxes partially offset by a decrease in net interest income and an increase in general and administrative expenses.

Net Interest Income

Net interest margin on a tax equivalent basis for the nine months ended December 31, 2012 decreased 29 basis points to 2.80% down from 3.09% in the previous year. As a result, net interest income decreased $2.7 million or 13.3% to $17.3 million for the nine months ended December 31, 2012 compared to $20.0 million for the same period in 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 $18.4 million or 2.2% to $836.4 million while average interest-bearing liabilities decreased $22.9 million or 2.9% to $773.9 million. The interest rate spread was 2.70% for the nine months ended December 31, 2012 compared to 3.03% for the nine months ended December 31, 2011.

Interest income on loans decreased $3.5 million to $17.9 million during the nine months ended December 31, 2012 from $21.4 million during the same period in 2011. The 16.5% decrease was attributable to a decrease in average total loans outstanding of $55.4 million combined with a 32 basis point decrease in the yield earned on the Bank’s loans during the nine months ended December 31, 2012. Interest income on investment securities, mortgage-backed securities, and other investments decreased $1.3 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 $37.0 million.

Total interest expense decreased $2.1 million or 22.2% to $7.5 million during the nine months ended December 31, 2012 compared to $9.6 million for the same period one year earlier. The decrease in total interest expense is attributable to the decreases in interest rates paid, reflecting a lower market interest rate environment, and a decrease in the amount of interest-bearing certificate accounts and borrowings. Interest expense on total deposits decreased $1.6 million or 30.1% during the period as average interest bearing deposits decreased $2.1 million to $642.6 million compared to the average balance of $644.7 million for the nine months ended December 31, 2011, and the cost of deposits decreased 33 basis points. The decrease in the cost of deposits was primarily a result of maturing certificates that repriced at lower rates during the period. Interest expense on advances and other borrowings decreased $477,000 or 12.6% to $3.3 million compared to $3.8 million for the same period in 2011 as the average borrowings outstanding decreased $20.8 million offset slightly by an eight basis point increase in the cost of debt outstanding during the nine months ended December 31, 2012.

Interest expense on senior convertible debentures was $365,000 for each of the nine months ended December 31, 2012 and 2011. The Company issued $6.1 million in fixed 8% senior convertible debentures on December 1, 2009. Interest expense on junior subordinated debentures was $84,000 for the nine months ended December 31, 2012 compared to $138,000 for the same period one year ago. The average outstanding balance on these debentures remained constant at $5.2 million during both periods while the average cost decreased 140 basis points to 2.17% in 2012 compared to 3.57% in 2011.

Provision for Loan Losses

Non-performing assets, which consist of non-accrual loans and repossessed assets, decreased $8.5 million or 25.3% to $25.2 million at December 31, 2012 from $33.7 million at December 31, 2011. Non-performing assets were 2.8% of total assets at December 31, 2012 and 3.7% of total assets at December 31, 2011. Consistent with the decrease in non-performing assets, the provision for loan losses decreased $4.7 million or 70.5% to $2.0 million for the nine months ended December 31, 2012 compared

to $6.7 million for the same period in the previous year. Non-accrual loans, which are loans delinquent 90 days or more, were $18.4 million at December 31, 2012. Net charge-offs were $5.3 million or 1.30% of gross loans during the nine months ended December 31, 2012 compared to $4.9 million or 1.09% of gross loans for the nine month period in 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 be proactive in identifying any potential problem loans.

Non-Interest Income

Non-interest income decreased $962,000 or 18.1% to $4.4 million during the nine months ended December 31, 2012 compared to $5.3 million for the same period one year earlier. Gain on sale of investments decreased $820,000 or 46.4% to $945,000 during the nine months ended December 31, 2012 from $1.8 million during 2011. The gain resulted from the sale of 65 investments during the period. 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. The Company sold 51 securities during the nine month period ended December 31, 2011.

Gain on sale of loans increased $107,000 or 27.3% to $499,000 for the nine months ended December 31, 2012 compared to $392,000 during the same period in 2011 as a result of an increase in the volume of fixed rate residential mortgage loans originated and sold. The volume of refinancing activity continues to increase as a result of the low interest rate environment and the establishment of government programs designed to help borrowers refinance.

Income from insurance agency commissions was $346,000 for the nine months ended December 31, 2012 an increase of $38,000 or 12.4% compared to $308,000 during the same period in 2011. Trust income increased $30,000 or 8.6% to $380,000 during the nine months ended December 31, 2012 from $350,000 during the nine month period ended December 31, 2011. The Bank has focused on promoting insurance product sales and trust revenue as a way to increase non-interest income. Income from BOLI remained constant at $315,000 for the nine months ended December 31, 2012 and 2011.

The Company recorded mandatorily redeemable financial instrument valuation income of $50,000 for nine months ended December 31, 2011 compared to no income for the same period in 2012. 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. On April 11, 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. As a result, the Company no longer has the liability related to these shares on its Consolidated Balance Sheets.

Check card fee income increased $27,000 or 4.5% to $616,000 for the nine months ended December 31, 2012 compared to $589,000 for the same period in the prior year. Other miscellaneous income including annuity and investment brokerage commissions, bank credit life insurance on loans, and other miscellaneous income decreased $296,000 or 43.5% to $383,000 during the nine months ended December 31, 2012 from $679,000 during the nine month period in 2011. In connection with its participation in the Treasury’s Bank Enterprise Award program, the Bank received $206,000 in grant income during the nine months ended December 31, 2011 which contributed to the increase in other miscellaneous income in the prior period.

During the quarter ended December 31, 2012, the U.S. Treasury's Community Development Financial Institutions Fund ("CDFI Fund") awarded the Bank a grant totaling $1.5 million in recognition of its commitment to community development. The award is part of a CDFI program that recognizes organizations who serve low income and distressed communities. As part of the award, the Bank has committed to establish a small business micro lending program that lends specifically in low to moderate income areas. The Bank is required to lend $1.2 million over a five year period to qualifying customers and will recognize the grant income over the period as these loans are funded. Of the remaining grant money, $73,000 has been designated for general and administrative expenses associated with the program and $145,000 has been designated for provision expense associated with the loans. These amounts will be recognized as income in the first quarter of fiscal 2013 as the program is established. As of December 31, 2012, the Bank had not recognized any income associated with the grant award.

General and Administrative Expenses

General and administrative expenses increased $1.5 million or 9.4% to $17.1 million for the nine months ended December 31, 2012 compared to $15.6 million during the same period one year earlier. The increase in non-interest expense is primarily a result of an increase in the net costs associated with the operation of foreclosed properties including write downs on these properties.

Excluding these costs, non-interest expense would have decreased $452,000 or 3.1% for the nine months ended December 31, 2012.

Compensation and employee benefits decreased $273,000 or 3.3% to $8.0 million for the nine months ended December 31, 2012 from $8.3 million for the nine months ended December 31, 2011. Due to increased efficiency and some attrition, the number of full-time equivalent employees decreased by 15 to 196 full time equivalent employees at December 31, 2012, compared to 211 at December 31, 2011. Occupancy expense increased $64,000 or 4.4% to $1.5 million from $1.4 million for the same period in 2011, while advertising expense decreased $6,000 or 1.9% to $304,000 from $310,000 for 2011. Depreciation and maintenance of equipment expense decreased $20,000 or 1.6% to $1.3 million during the nine months ended December 31, 2012 relatively unchanged from the same period in 2011.

FDIC insurance premiums decreased $174,000 or 25.3% to $514,000 for the nine months ended December 31, 2012 compared to $688,000 during the comparable period 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.

Net cost of operation of real estate owned increased $1.9 million or 233.4% to $2.7 million for the nine months ended December 31, 2012 compared to $824,000 during the comparable period in 2011. This increase was primarily the result of an increase in write downs on repossessed assets during the year. 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 $2.9 million for the nine months ended December 31, 2012 compared to $409,000 for the nine months ended December 31, 2011.

Other miscellaneous expenses, which encompass legal, professional, and consulting expenses, stationery and office supplies, and other expenses decreased $32,000 or 1.2% to $2.7 million relatively unchanged from the nine months ended December 31, 2011.

Income Taxes

The provision for income taxes decreased $960,000 or 57.7% to $704,000 for the nine months ended December 31, 2012 compared to $1.7 million for the nine months ended December 31, 2011. The effective tax rate was 26.5% in 2012 and 54.9% for 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 nine months ended December 31, 2011, 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. The effective tax rate for the nine months ended December 31, 2011, excluding the deferred tax asset write-down was 34.3%.

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.

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 December 31,
	2013		2012
	(In Thousands)
Bank’s Shareholders’ Equity ⁽¹⁾	$	84,642	$	82,084
Disallowed Deferred Tax Asset	1,806		—
Reduction For Goodwill And Other Intangibles	1,212		1,262
Tangible Capital	81,624		80,822
Core Capital	81,624		80,822
Supplemental Capital	5,028		5,190
Total Risk-Based Capital	$	86,652	$	86,012


⁽¹⁾	^{THE YEAR ENDED DECEMBER 31, 2013 AND THE NINE MONTHS ENDED DECEMBER 31, 2012 EXCLUDES UNREALIZED GAIN OF $474,000 and $7.4 MILLION, RESPECTIVELY, ON AVAILABLE FOR SALE SECURITIES.}

The following table compares the Bank's capital levels relative to regulatory requirements at December 31, 2013:



	Amount Required	Percent Required		Actual Amount	Actual Percent		Excess Amount	Excess Percent
	(Dollars In Thousands)
Tier 1 Leverage (Core) Capital	34,069	4.0	%	81,624	9.6	%	47,555	5.6	%
Tier 1 Risk-Based (Core) Capital	15,883	4.0	%	81,624	20.6	%	65,741	16.6	%
Total Risk-Based Capital	31,767	8.0	%	86,652	21.8	%	54,885	13.8	%

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



	Amount Required	Percent Required		Actual Amount	Actual Percent		Excess Amount	Excess Percent
	(Dollars In Thousands)
Tier 1 Leverage (Core) Capital	35,541	4.0	%	80,822	9.1	%	45,281	5.1	%
Tier 1 Risk-Based (Core) Capital	16,606	4.0	%	80,822	19.5	%	64,216	15.5	%
Total Risk-Based Capital	33,212	8.0	%	86,012	20.7	%	52,800	12.7	%

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. Originations of new loans and renewals of previously funded loans on loans held for investment were $193.2 million during the year ended December 31, 2013 compared to $130.0 million during the nine months ended December 31, 2012 and $219.5 million during the year ended March 31 2012. The increase in originations and renewals during the year ended December 31, 2013 was primarily the result of an increase in commercial loan originations, which increased $59.1 million. Purchases of investments and mortgage-backed securities were $162.5 million during the year ended December 31, 2013 compared to $125.7 million during the nine months ended December 31, 2012, and $215.1 million during the year ended March 31, 2012. Other uses of the Bank's funds during the year ended December 31, 2013 included paying down FHLB advances.

Unused lines of credit on home equity loans, credit cards, and commercial loans amounted to $30.8 million at December 31, 2013. Home equity loans are made on a floating rate basis with final maturities of 10 to 15 years. Credit cards are made on a fixed rate basis, currently at 9.99% and are renewed annually or every other year. In addition to the above commitments, the Bank has undisbursed loans-in-process of $3.5 million at December 31, 2013, 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 December 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	$	48	$	148	$	4,712	$	4,908	$	25,846	$	30,754
Standby Letters Of Credit	—		537		1,673		2,210		10		2,220
Total	$	48	$	685	$	6,385	$	7,118	$	25,856	$	32,974

Management believes that future liquidity can be met through the Bank's deposit base, which decreased $17.6 million during the year ended December 31, 2013, and from maturing investments. In addition, at December 31, 2013 the Bank had another $167.9 million in unused borrowing capacity at the FHLB.

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

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 December 31, 2013. 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	$	163,681	$	67,573	$	25,630	$	—	$	256,884
FHLB Advances	34,840		35,000		17,900		—		87,740
Other Borrowings	8,003		—		—		—		8,003
Jr. Sub. Debentures	—		—		—		5,155		5,155
Sr. Conv. Debentures	—		—		—		6,084		6,084
Operating Lease Obligations	416		620		351		1,028		2,415
Total	$	206,940	$	103,193	$	43,881	$	12,267	$	366,281

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.

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.

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 December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income (loss), changes in shareholders' equity and cash flows for the year ended December 31, 2013, the nine months ended December 31, 2012 and the year 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 audits 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 Subsidiaries as of December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for the year ended December 31, 2013, the nine months ended December 31, 2012 and the year ended March 31, 2012, in conformity with U.S. generally accepted accounting principles.

Columbia, South Carolina

March 24, 2014

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES



Consolidated Balance Sheets	December 31, 2013			December 31, 2012

ASSETS:
Cash And Cash Equivalents	$	7,629,771		$	7,903,950
Certificates Of Deposit With Other Banks	2,100,395			1,728,567
Investment And Mortgage-Backed Securities:
Available For Sale: (Amortized Cost of $430,241,854 and $342,936,153 at December 31, 2013 and 2012, Respectively)	431,003,452			354,916,216
Held To Maturity: (Fair Value of $0 and $79,671,886 at December 31, 2013 and 2012, Respectively)	—			76,072,262
Total Investments And Mortgage-Backed Securities	431,003,452			430,988,478
Loans Receivable, Net:
Held For Sale	1,234,158			4,770,760
Held For Investment: (Net of Allowance of $10,241,970 and $11,318,371 at December 31, 2013 and December 31, 2012, Respectively)	357,682,507			392,935,060
Total Loans Receivable, Net	358,916,665			397,705,820
Accrued Interest Receivable:
Loans	1,031,747			1,242,072
Mortgage-Backed Securities	732,100			901,423
Investment Securities	1,393,156			1,131,262
Total Accrued Interest Receivable	3,157,003			3,274,757
Premises And Equipment, Net	17,243,390			17,917,897
FHLB Stock, At Cost	5,016,600			6,178,700
Real Estate Owned	3,947,226			6,754,425
Bank Owned Life Insurance	11,474,305			11,151,305
Intangible Assets, Net	11,970			61,974
Goodwill	1,199,754			1,199,754
Other Assets	7,547,528			5,488,960
Total Assets	$	849,248,059		$	890,354,587
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Liabilities:
Deposit Accounts	$	658,696,772		$	676,338,653
Advances From FHLB	87,740,058			105,257,182
Other Borrowings	8,002,739			9,317,244
Junior Subordinated Debentures	5,155,000			5,155,000
Advance Payments By Borrowers For Taxes And Insurance	255,364			189,424
Senior Convertible Debentures	6,084,000			6,084,000
Other Liabilities	5,324,046			5,420,600
Total Liabilities	771,257,979			807,762,103
Commitments (Notes 5 and 19)
Shareholders' Equity:
Serial Preferred Stock, $.01 Par Value; Authorized 200,000 Shares; Issued And Outstanding, 22,000 At December 31, 2013 and 2012, Respectively	22,000,000			22,000,000
Common Stock, $.01 Par Value; Authorized 5,000,000 Shares; Issued 3,144,934 Shares At December 31, 2013 And 2012, Respectively	31,449			31,449
Warrant Issued In Conjunction With Serial Preferred Stock	—			400,000
Additional Paid-In Capital	11,978,137			11,630,717
Treasury Stock, At Cost (200,933 Shares At December 31, 2013 and 2012, Respectively)	(4,330,712		)	(4,330,712		)
Accumulated Other Comprehensive Income	472,406			7,431,310
Retained Earnings	47,838,800			45,429,720
Total Shareholders' Equity	77,990,080			82,592,484
Total Liabilities And Shareholders' Equity	$	849,248,059		$	890,354,587

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES



Consolidated Statements of Income	For The Year Ended		For The Nine Months Ended		For The Year Ended
	December 31, 2013		December 31, 2012		March 31, 2012
Interest Income:
Loans	$	21,583,028	$	17,907,415	$	28,032,556
Mortgage-Backed Securities	5,267,280		4,882,993		7,661,454
Investment Securities	3,588,794		1,994,411		2,832,193
Other	8,265		6,405		2,620
Total Interest Income	30,447,367		24,791,224		38,528,823
Interest Expense:
NOW And Money Market Accounts	813,278		832,856		1,702,502
Statement Savings Accounts	33,897		32,720		45,089
Certificate Accounts	2,566,220		2,838,292		5,040,071
FHLB Advances And Other Borrowed Money	3,529,553		3,306,898		4,955,443
Senior Convertible Debentures	486,720		365,040		486,720
Junior Subordinated Debentures	103,268		84,010		167,007
Total Interest Expense	7,532,936		7,459,816		12,396,832
Net Interest Income	22,914,431		17,331,408		26,131,991
Provision For Loan Losses	2,645,381		1,975,000		8,650,000
Net Interest Income After Provision For Loan Losses	20,269,050		15,356,408		17,481,991
Non-Interest Income:
Gain On Sale Of Investment Securities	1,325,823		945,476		2,300,254
Gain On Sale Of Loans	779,554		498,879		534,968
Service Fees On Deposit Accounts	1,152,875		880,209		1,156,202
Commissions From Insurance Agency	453,446		346,015		425,967
Trust Income	520,000		380,000		476,000
Bank Owned Life Insurance Income	339,000		315,000		420,000
Mandatorily Redeemable Financial Instrument Valuation Income	—		—		50,000
Check Card Fee Income	853,027		615,815		787,517
Community Development Financial Institution Award	929,346		—		—
Other	542,733		383,460		790,797
Total Non-Interest Income	6,895,804		4,364,854		6,941,705
General And Administrative Expenses:
Compensation And Employee Benefits	10,964,366		7,978,054		10,990,812
Occupancy	1,970,403		1,498,858		1,878,754
Advertising	355,678		303,754		387,079
Depreciation And Maintenance Of Equipment	1,598,067		1,271,609		1,720,726
FDIC Insurance Premiums	746,389		514,065		826,731
Amortization Of Intangibles	50,004		37,503		60,023
Net Cost Of Operation Of Other Real Estate Owned	1,582,168		2,745,667		1,235,272
Prepayment Penalties on FHLB Advances	589,023		—		—
Other	4,177,210		2,713,044		3,617,643
Total General And Administrative Expenses	22,033,308		17,062,554		20,717,040
Income Before Income Taxes	5,131,546		2,658,708		3,706,656
Provision For Income Taxes	1,340,384		703,759		1,911,281
Net Income	3,791,162		1,954,949		1,795,375
Preferred Stock Dividends	440,000		330,000		440,000
Net Income Available To Common Shareholders	$	3,351,162	$	1,624,949	$	1,355,375
Net Income Per Common Share (Basic)	$	1.14	$	0.55	$	0.46
Net Income Per Common Share (Diluted)	$	1.12	$	0.55	$	0.46
Cash Dividend Per Share On Common Stock	$	0.32	$	0.24	$	0.32
Weighted Average Shares Outstanding (Basic)	2,944,001		2,944,001		2,944,001
Weighted Average Shares Outstanding (Diluted)	3,248,201		2,944,001		2,944,001

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss)



	Year Ended December 31,			Nine Months Ended December 31,			Year Ended March 31,
	2013			2012			2012
Net Income	$	3,791,162		$	1,954,949		$	1,795,375
Other Comprehensive Income (Loss)
Unrealized Gains On Securities:
Unrealized Holding Gains (Losses) On Securities Available For Sale, Net Of Taxes Of $4,286,481 and $909,507 At December 31, 2013 And 2012, Respectively; and $2,649,001 At March 31, 2012	(7,002,827		)	1,483,932			4,322,055
Reclassification Adjustment For Gains Included In Net Income, Net Of Taxes Of $503,813 And $359,281 At December 31, 2013 And 2012, Respectively; And $874,097 At March 31, 2012	(822,010		)	(586,195		)	(1,426,157		)
Held To Maturity Transfer To Available For Sale, Net Of Taxes Of $530,733 And $0 At December 31, 2013 and 2012, Respectively And $0 At March 31, 2012	865,933			$	—		$	—
Other Comprehensive Income (Loss)	$	(6,958,904	)	$	897,737		$	2,895,898
Comprehensive Income (Loss)	$	(3,167,742	)	$	2,852,686		$	4,691,273

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity

For the Year Ended December 31, 2013, the Nine Months Ended December 31, 2012, and the Year Ended March 31, 2012



	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:	—		—		—		—		—			2,895,898		—			2,895,898
Redemption Of Mandatorily Redeemable Financial Instrument	—		—		565		1,416,747		—			—		—			1,417,312
Stock Compensation Expense	—		—		—		33,123		—			—		—			33,123
Cash Dividends On Preferred Stock	—		—		—		—		—			—		(440,000		)	(440,000		)
Cash Dividends On Common Stock	—		—		—		—		—			—		(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



	Preferred Stock		Warrants		Common Stock		Additional Paid – In Capital		Treasury Stock			Accumulated Other Comprehensive Income		Retained Earnings			Total
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
Net Income	—		—		—		—		—			—		1,954,949			1,954,949
Other Comprehensive Income, Net Of Tax:	—		—		—		—		—			897,737		—			897,737
Stock Compensation Expense	—		—		—		4,472		—			—		—			4,472
Cash Dividends On Preferred Stock	—		—		—		—		—			—		(330,000		)	(330,000		)
Cash Dividends On Common Stock	—		—		—		—		—			—		(706,560		)	(706,560		)
Balance at December 31, 2012	$	22,000,000	$	400,000	$	31,449	$	11,630,717	$	(4,330,712	)	$	7,431,310	$	45,429,720		$	82,592,484

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity

For the Year Ended December 31, 2013, the Nine Months Ended December 31, 2012, and the Year Ended March 31, 2012, Continued



	Preferred Stock		Warrants			Common Stock		Additional Paid – In Capital			Treasury Stock			Accumulated Other Comprehensive Income			Retained Earnings			Total
Balance at December 31, 2012	$	22,000,000	$	400,000		$	31,449	$	11,630,717		$	(4,330,712	)	$	7,431,310		$	45,429,720		$	82,592,484
Net Income	—		—			—		—			—			—			3,791,162			3,791,162
Other Comprehensive Loss, Net Of Tax	—		—			—		—			—			(6,958,904		)	—			(6,958,904		)
Stock Compensation Expense	—		—			—		(2,580		)	—			—			—			(2,580		)
Redemption Of Warrant Issued In Conjunction With Preferred Stock	—		(400,000		)	—		350,000			—			—			—			(50,000		)
Cash Dividends On Preferred Stock	—		—			—		—			—			—			(440,000		)	(440,000		)
Cash Dividends On Common Stock	—		—			—		—			—			—			(942,082		)	(942,082		)
Balance at December 31, 2013	$	22,000,000	$	—		$	31,449	$	11,978,137		$	(4,330,712	)	$	472,406		$	47,838,800		$	77,990,080

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows



	For the Year Ended			For the Nine Months Ended			For the Year Ended
	December 31, 2013			December 31, 2012			March 31, 2012
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	3,791,162		$	1,954,949		$	1,795,375
Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities:
Depreciation Expense	1,243,839			1,055,662			1,491,028
Amortization Of Intangible Assets	50,004			37,503			60,023
Stock Option Compensation Expense	(2,580		)	4,472			33,123
Discount Accretion And Premium Amortization	7,162,479			5,712,398			5,536,476
Provisions For Losses On Loans	2,645,381			1,975,000			8,650,000
Mandatorily Redeemable Financial Instrument Valuation Income	—			—			(50,000		)
Income From Bank Owned Life Insurance	(339,000		)	(315,000		)	(420,000		)
Gain On Sales Of Loans	(779,554		)	(498,879		)	(534,968		)
Gain On Sales Of Mortgage-Backed Securities	(1,104,491		)	(804,959		)	(1,255,867		)
Gain On Sales Of Investment Securities	(221,332		)	(140,517		)	(1,044,387		)
(Gain) Loss On Sale Of Real Estate Owned	(101,645		)	(694,650		)	4,230
Write Down On Real Estate Owned	1,394,378			2,933,000			608,920
Amortization Of Deferred Costs (Fees) On Loans	6,589			(8,994		)	(18,665		)
Proceeds From Sale Of Loans Held For Sale	33,207,780			22,536,178			40,891,379
Origination Of Loans Held For Sale	(28,891,624		)	(24,136,288		)	(37,861,948		)
(Increase) Decrease In Accrued Interest Receivable:
Loans	210,325			476,180			24,029
Mortgage-Backed Securities	169,323			86,488			(43,244		)
Investment Securities	(261,894		)	(337,607		)	93,864
Increase (Decrease) In Advance Payments By Borrowers	65,940			(161,040		)	(31,024		)
Decrease In Prepaid FDIC Assessment	1,781,476			359,681			674,171
Other, Net	335,386			1,261,763			(1,576,174		)
Net Cash Provided By Operating Activities	20,361,942			11,295,340			17,026,341
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase Of Mortgage-Backed Securities Available For Sale	(88,844,145		)	(57,808,416		)	(95,362,225		)
Principal Repayments On Mortgage-Backed Securities Available For Sale	56,166,594			43,332,870			48,615,134
Purchase Of Mortgage-Backed Securities Held To Maturity	—			(9,130,181		)	(26,183,966		)
Principal Repayments On Mortgage-Backed Securities Held To Maturity	942,806			1,144,542			1,241,459
Purchase Of Investment Securities Available For Sale	(72,626,491		)	(44,272,326		)	(75,048,637		)
Maturities Of Investment Securities Available For Sale	22,028,941			14,662,340			30,601,423
Purchase of Investment Securities Held To Maturity	(1,000,000		)	(14,513,829		)	(18,532,549		)
Maturities Of Investment Securities Held To Maturity	3,501,978			13,592,535			8,598,502
Proceeds From Sale of Investment Securities Available For Sale	21,957,851			5,441,135			28,213,347
Proceeds From Sale of Mortgage-Backed Securities Available For Sale	40,802,371			34,874,060			50,076,125
Investment In Certificates Of Deposits With Other Banks	(370,000		)	—			(1,625,000		)
Purchase Of FHLB Stock	(4,950,606		)	(657,887		)	(34,343		)
Redemption Of FHLB Stock	6,112,706			2,950,287			2,830,728
Decrease In Loans Receivable	28,739,400			28,481,291			40,557,533
Capital Improvements To Repossessed Assets	—			—			(36,877		)
Proceeds From Sale Of Repossessed Assets	5,375,648			7,623,802			3,974,160
Purchase And Improvement Of Premises And Equipment	(567,582		)	(247,260		)	(416,712		)
Net Cash Provided (Used) By Investing Activities	17,269,471			25,472,963			(2,531,898		)

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES



	For the Year Ended			For the Nine Months Ended			For the Year Ended
	December 31, 2013			December 31, 2012			March 31, 2012
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase (Decrease) In Deposit Accounts	(17,641,881		)	(19,862,403		)	5,843,942
Proceeds From FHLB Advances	150,800,000			60,400,000			106,501,384
Repayment Of FHLB Advances	(168,317,124		)	(77,212,620		)	(122,567,920		)
Repayments Of Other Borrowings, Net	(1,314,505		)	(484,142		)	(1,394,088		)
Repayment Of Warrant Issued In Conjunction With Preferred Stock	(50,000		)	—			—
Dividends To Preferred Stock Shareholders	(440,000		)	(330,000		)	(440,000		)
Dividends To Common Stock Shareholders	(942,082		)	(706,560		)	(942,027		)
Net Cash Used By Financing Activities	(37,905,592		)	(38,195,725		)	(12,998,709		)
Net Increase (Decrease) In Cash And Cash Equivalents	(274,179		)	(1,427,422		)	1,495,734
Cash And Cash Equivalents At Beginning Of Year	7,903,950			9,331,372			7,835,638
Cash And Cash Equivalents At End Of Year	$	7,629,771		$	7,903,950		$	9,331,372
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Paid During The Period For:
Interest	$	7,728,772		$	7,692,965		$	12,527,487
Income Taxes	$	448,419		$	274,656		$	2,863,176
Supplemental Schedule Of Non Cash Transactions:
Transfers From Loans Receivable	$	3,861,182		$	2,456,478		$	4,276,679
Unrealized Gains (Losses) On Securities Available For Sale, Net Of Taxes	$	(6,958,904	)	$	897,737		$	2,895,898

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

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 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.


(b)	Change in Fiscal Year

The Company's Board of Directors approved a change in the Company's fiscal year end from March 31 to December 31, effective December 31, 2012. As a result of this change, the consolidated financial statements for the prior period include the Company's financial results for the nine month transition period from April 1, 2012 to December 31, 2012. The following table presents certain comparative transition period condensed financial information for the periods ended December 31, 2013 and 2012.



	For the Year Ended December 31,				For the Nine Months Ended December 31,
	2013		2012		2013		2012
			(Unaudited)		(Unaudited)
Interest Income	$	30,447,367	$	33,742,799	$	22,743,098	$	24,791,224
Interest Expense	7,532,936		10,273,737		5,419,314		7,459,816
Net Interest Income	22,914,431		23,469,062		17,323,784		17,331,408
Provision For Loan Losses	2,645,381		3,925,000		1,500,000		1,975,000
Net Interest Income After Provision For Loan Losses	20,269,050		19,544,062		15,823,784		15,356,408
Non-Interest Income	6,895,804		5,979,341		4,950,822		4,364,854
General And Administrative Expenses	22,033,308		22,187,423		16,520,424		17,062,554
Income Before Income Taxes	5,131,546		3,335,980		4,254,182		2,658,708
Provision For Income Taxes	1,340,384		951,084		1,134,389		703,759
Net Income	3,791,162		2,384,896		3,119,793		1,954,949
Preferred Stock Dividends	440,000		440,000		330,000		330,000
Net Income Available To Common Shareholders	$	3,351,162	$	1,944,896	$	2,789,793	$	1,624,949

Net Income Per Common Share (Basic)	$1.14		$0.66		$0.95		$0.55
Net Income Per Common Share (Diluted)	$1.12		$0.66		$0.95		$0.55
Cash Dividend Per Share On Common Stock	$0.32		$0.32		$0.24		$0.24

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements


(1)	Significant Accounting Policies, Continued


(c)	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.


(d)	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”). Gains and losses from sales of investment and mortgage-backed securities available for sale are determined using the specific identification method. The Company had no investment or trading securities.


(e)	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.


(f)	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. 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.


(g)	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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements


(1)	Significant Accounting Policies, Continued


(h)	Real Estate Owned and Other

Real estate owned represents real estate and other assets acquired through foreclosure or repossession and are initially recorded at the 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.


(i)	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.


(j)	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.


(k)	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.

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 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, 2010 are closed for federal, state and local income tax matters.


(l)	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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements


(1)	Significant Accounting Policies, Continued


(m)	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.


(n)	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 $355,678, $303,754, and $387,079 were included in the Company’s results of operations for the year ended December 31, 2013, the nine months ended December 31, 2012 and the year ended March 31, 2012, respectively.


(o)	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.


(p)	Earnings Per Share

Accounting guidance specifies computation and presentation requirements for both basic earnings per share ("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.

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



	For the Year Ended December 31,		For the Nine Months Ended December 31,		For the Year Ended March 31,
	2013		2012		2012
Earnings Available To Common Shareholders
Net Income	$	3,791,162	$	1,954,949	$	1,795,375
Preferred Stock Dividends	440,000		330,000		440,000
Net Income Available To Common Shareholders	$	3,351,162	$	1,624,949	$	1,355,375

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements


(1)	Significant Accounting Policies, Continued

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



	For the Year Ended December 31,
	2013
	Income		Shares	Per Share Amounts
Basic EPS	$	3,351,162	2,944,001	$	1.14
Effect of Dilutive Securities:
Senior Convertible Debentures	301,766		304,200	$	(0.02	)
Diluted EPS	$	3,652,928	3,248,201	$	1.12

There were no dilutive securities or options for the nine months ended December 31, 2012 or the year ended March 31, 2012, therefore no reconciliation is provided.

The average market price used in calculating the assumed number of dilutive shares issued for the year ended December 31, 2013, for the nine months ended December 31, 2012 and the year ended March 31, 2012 was $11.37,$8.63, and $9.53 respectively. As a result of the average stock price being less than the exercise price of all options and warrants in year ended December 31, 2013, the nine months ended December 31, 2012 and the year ended March 31, 2012, the options are not dilutive in calculating diluted earnings per share for those periods.


(q)	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.


(r)	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 2012, the Intangibles topic was amended to permit an entity to consider qualitative factors to determine whether it is more likely than not that indefinite-lived intangible assets are impaired. If it is determined to be more likely than not that indefinite-lived intangible assets are impaired, then the entity is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount. The amendments were effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The amendments did not have a material effect on the Company’s financial statements.

The Comprehensive Income topic of the Accounting Standards Codification ("ASC") was amended in June 2011. The amendment eliminated the option to present other comprehensive income as a part of the statement of changes in stockholders’ equity and required consecutive presentation of the statement of net income and other comprehensive income. The amendments were applicable to the Company April 1, 2012 and have been 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 while the Financial Accounting Standards Board ("FASB") redeliberated the presentation requirements for the reclassification adjustments. In February 2013, the FASB further amended the Comprehensive Income topic clarifying the conclusions from such redeliberations. Specifically, the amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments do require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements


(1)	Significant Accounting Policies, Continued

In addition, in certain circumstances an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income.

The amendments were effective for the Company on a prospective basis for reporting periods beginning after December 15, 2012. These amendments did not have a material effect on the Company’s financial statements.

In April 2013, the FASB issued guidance addressing application of the liquidation basis of accounting. The guidance is intended to clarify when an entity should apply the liquidation basis of accounting. In addition, the guidance provides principles for the recognition and measurement of assets and liabilities and requirements for financial statements prepared using the liquidation basis of accounting. The amendments will be effective for entities that determine liquidation is imminent during annual reporting periods beginning after December 15, 2013, and interim reporting periods therein and those requirements should be applied prospectively from the day that liquidation becomes imminent. Early adoption is permitted. The Company does not expect these amendments to have any effect on its financial statements.

In July 2013, the FASB issued guidance to eliminate the diversity in practice regarding presentation of unrecognized tax benefits in the statement of financial position. Under the clarified guidance, an unrecognized tax benefit, or a portion of an unrecognized tax benefit, will be presented in the financial statements as a reduction to a deferred tax asset unless certain criteria are met. The requirements should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The amendments will be effective for the Company for reporting periods beginning after December 15, 2013. The Company does not expect these amendments to have a material effect on its financial statements.

In December 2013, the FASB amended the Master Glossary of the FASB Codification to define “Public Business Entity” to minimize the inconsistency and complexity of having multiple definitions of, or a diversity in practice as to what constitutes, a nonpublic entity and public entity within U.S. GAAP. The amendment does not affect existing requirements, however will be used by the FASB, the Private Company Council (“PCC”), and the Emerging Issues Task Force (“EITF”) in specifying the scope of future financial accounting and reporting guidance. The Company does not expect this amendment to have any effect on its financial statements.

In January 2014, the FASB amended the Receivables-Troubled Debt Restructurings by Creditors subtopic of the Codification to address the reclassification of consumer mortgage loans collateralized by residential real estate upon foreclosure. The amendments clarify the criteria for concluding that an in substance repossession or foreclosure has occurred, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan. The amendments also outline interim and annual disclosure requirements. The amendments will be effective for the Company for interim and annual reporting periods beginning after December 15, 2014. Companies are allowed to use either a modified retrospective transition method or a prospective transition method when adopting this update. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements


(1)	Significant Accounting Policies, Continued

(s) 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.


(t)	Reclassifications

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

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:



	December 31, 2013
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
FHLB Securities	$	13,538,723	$	25,695	$	893,968	$	12,670,450
Federal Farm Credit Bank ("FFCB") Securities	5,750,000		—		383,820		5,366,180
Federal National Mortgage Association ("FNMA") Bonds	1,993,473		—		18,543		1,974,930
Small Business Administration (“SBA”) Bonds	99,228,708		1,914,720		319,443		100,823,985
Tax Exempt Municipal Bonds	63,590,959		410,151		2,685,988		61,315,122
Mortgage-Backed Securities	245,882,053		5,843,365		3,128,883		248,596,535
Equity Securities	257,938		—		1,688		256,250
	$	430,241,854	$	8,193,931	$	7,432,333	$	431,003,452

	December 31, 2012
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
FHLB Securities	$	6,115,036	$	53,954	$	4,320	$	6,164,670
SBA Bonds	94,152,203		2,466,354		156,287		96,462,270
Tax Exempt Municipal Bonds	35,772,115		1,770,567		60,534		37,482,148
Mortgage-Backed Securities	206,793,861		8,030,008		91,966		214,731,903
Equity Securities	102,938		—		27,713		75,225
	$	342,936,153	$	12,320,883	$	340,820	$	354,916,216

FHLB securities, FFCB securities, FNMA bonds, and FNMA and FHLMC mortgage-backed securities are issued by government-sponsored enterprises (“GSEs”). GSEs are not backed by the full faith and credit of the United States government. SBA bonds are backed by the full faith and credit of the United States government. Included in the tables above and below in mortgage-backed securities are GNMA mortgage-backed securities, which are also backed by the full faith and credit of the United States government. At December 31, 2013 and 2012, the Bank held an amortized cost and fair value of $170.4 million and $135.3 million, respectively, and $173.5 million and $143.8 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 Company has not invested in any private label mortgage-backed securities.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

The amortized cost and fair value of investment and mortgage-backed securities available for sale at December 31, 2013 are shown below by contractual maturity. Expected maturities will differ from contractual maturities because borrowers have the right to prepay obligations with or without call or prepayment penalties.



	Amortized Cost		Fair Value
Less Than One Year	$	229,940	$	231,902
One – Five Years	14,130,674		14,458,222
Five – Ten Years	69,085,158		69,191,949
After Ten Years	100,914,029		98,524,844
Mortgage-Backed Securities	245,882,053		248,596,535
	$	430,241,854	$	431,003,452

At December 31, 2013 and 2012, 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 $118.3 million and $121.1 million, respectively, and $108.9 million and $114.4 million, respectively.

The Bank received $62.8 million, $40.3 million and $78.3 million, respectively, in proceeds from sales of available for sale securities during the year ended December 31, 2013, the nine months ended December 31, 2012, and the year ended March 31, 2012, respectively. As a result, the Bank recognized $1.6 million in gross gains and $279,000 gross losses for the year ended December 31, 2013, $945,000 in gross gains and no gross losses for the nine months ended December 31, 2012, and $2.3 million in gross gains and no gross losses for the year ended March 31, 2012.

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



	December 31, 2013
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLB Securities	$	10,288,110	$	651,608	$	1,757,640	$	242,360	$	12,045,750	$	893,968
FFCB Securities	4,435,070		314,930		931,110		68,890		5,366,180		383,820
FNMA Bonds	1,974,930		18,543		—		—		1,974,930		18,543
SBA Bonds	12,183,961		288,678		3,541,453		30,765		15,725,414		319,443
Tax Exempt Municipal Bonds	39,848,206		2,556,014		2,008,272		129,974		41,856,478		2,685,988
Mortgage-Backed Securities	88,516,030		2,756,216		6,436,369		372,667		94,952,399		3,128,883
Equity Securities	—		—		101,250		1,688		101,250		1,688
	$	157,246,307	$	6,585,989	$	14,776,094	$	846,344	$	172,022,401	$	7,432,333

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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



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

Securities classified as available-for-sale are recorded at fair market value. At December 31, 2013, 11.4% of the unrealized losses, or eleven individual securities, consisted of securities in a continuous loss position for 12 months or more. At December 31, 2012, 18.8% of the unrealized losses, or two individual securities, 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.

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

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

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



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

Included in the tables above and below in mortgage-backed securities are GNMA mortgage-backed securities, which are backed by the full faith and credit of the United States government. At December 31, 2012, the Bank held an amortized cost and fair value of $47.2 million and $50.4 million, respectively, in GNMA mortgage-backed securities included in mortgage-backed securities listed above. All mortgage-backed securities above are either GSEs or GNMA mortgage-backed securities. The Company has not invested in any private label mortgage-backed securities. At December 31, 2012, the amortized cost and fair value of investment and mortgage-backed securities held to maturity pledged as collateral for certain deposit accounts, FHLB advances and other borrowings were $12.2 million and $12.8 million, respectively at December 31, 2012.



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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4) Loans Receivable, Net

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



	December 31, 2013			December 31, 2012
Residential Real Estate Loans	$	83,004,482		$	90,677,625
Consumer Loans	52,205,901			56,595,093
Commercial Business	7,775,098			8,063,901
Commercial Real Estate	228,399,555			250,924,094
Total Loans Held For Investment	371,385,036			406,260,713
Loans Held For Sale	1,234,158			4,770,760
Total Loans Receivable, Gross	372,619,194			411,031,473
Less:
Allowance For Loan Losses	10,241,970			11,318,371
Loans In Process	3,465,072			2,002,595
Deferred Loan Fees	(4,513		)	4,687
	13,702,529			13,325,653
Total Loans Receivable, Net	$	358,916,665		$	397,705,820

Changes in the allowance for loan losses for the years ended December 31, 2013 and March 31, 2012 and the nine months ended December 31, 2012 are summarized as follows:



	Year Ended December 31,			Nine Months Ended December 31,			Year Ended March 31,
	2013			2012			2012
Balance At Beginning Of Period	$	11,318,371		$	14,615,198		$	12,501,800
Provision For Loan Losses	2,645,381			1,975,000			8,650,000
Charge Offs	(5,209,830		)	(7,422,393		)	(6,643,834		)
Recoveries	1,488,048			2,150,566			107,232
Total Allowance For Loan Losses	$	10,241,970		$	11,318,371		$	14,615,198

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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4) Loans Receivable, Net, Continued

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



	Credit Quality Measures
December 31, 2013	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	74,505,587	$	890,902	$	403,138	$	7,204,855	$	83,004,482
Consumer	50,370,640		843,799		143,649		847,813		52,205,901
Commercial Business	6,807,620		368,019		524,928		74,531		7,775,098
Commercial Real Estate	135,793,150		43,252,464		25,581,235		23,772,706		228,399,555
Total	$	267,476,997	$	45,355,184	$	26,652,950	$	31,899,905	$	371,385,036



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

The following table presents an age analysis of past due balances by category at December 31, 2013.



	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans Receivable
Residential Real Estate	$	—	$	1,363,132	$	4,607,613	$	5,970,745	$	77,033,737	$	83,004,482
Consumer	1,494,429		234,878		399,062		2,128,369		50,077,532		52,205,901
Commercial Business	115,186		—		33,055		148,241		7,626,857		7,775,098
Commercial Real Estate	5,103,522		2,046,666		4,972,667		12,122,855		216,276,700		228,399,555
Total	$	6,713,137	$	3,644,676	$	10,012,397	$	20,370,210	$	351,014,826	$	371,385,036

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



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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4) Loans Receivable, Net, Continued

At December 31, 2013 and 2012, the Company did not have any loans that were 90 days or more past due and still accruing interest. Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the existing collateral. In the event an acceptable arrangement cannot be reached, we may have to acquire these properties through foreclosure or other means and subsequently sell, develop, or liquidate them. The following table shows non-accrual loans by category at December 31, 2013 compared to 2012.



	At December 31, 2013				At December 31, 2012				$			%
	Amount		Percent ⁽¹⁾		Amount		Percent ⁽¹⁾		Increase (Decrease)			Increase (Decrease)
Non-accrual Loans:
Residential Real Estate	$	4,607,613	1.3	%	$	3,757,801	0.9	%	$	849,812		22.6	%
Commercial Business	33,055		—		86,991		—		(53,936		)	(62.0	)
Commercial Real Estate	4,972,667		1.4		13,913,190		3.4		(8,940,523		)	(64.3	)
Consumer	399,062		0.1		646,136		0.2		(247,074		)	(38.2	)
Total Non- accrual Loans	$	10,012,397	2.7	%	$	18,404,118	4.5	%	$	(8,391,721	)	(45.6	)%

^{(1) PERCENT OF GROSS LOANS RECEIVABLE HELD FOR INVESTMENT, 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 December 31, 2013
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,521,559		$	1,001,271		$	618,919		$	8,176,622		$	11,318,371
Provision	1,030,237			(5,306		)	(187,377		)	1,807,827			2,645,381
Charge-Offs	(1,118,168		)	(207,230		)	(31,831		)	(3,852,601		)	(5,209,830		)
Recoveries	273,015			59,042			26,947			1,129,044			1,488,048
Ending Balance	$	1,706,643		$	847,777		$	426,658		$	7,260,892		$	10,241,970



	For the Nine Months Ended December 31, 2012
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,928,625		$	1,498,111		$	644,855		$	10,543,607		$	14,615,198
Provision	183,236			(227,872		)	175,141			1,844,495			1,975,000
Charge-Offs	(647,161		)	(286,612		)	(209,898		)	(6,278,722		)	(7,422,393		)
Recoveries	56,859			17,644			8,821			2,067,242			2,150,566
Ending Balance	$	1,521,559		$	1,001,271		$	618,919		$	8,176,622		$	11,318,371

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4) Loans Receivable, Net, Continued

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
December 31, 2013	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	158,791	$	1,547,852	$	1,706,643
Consumer	103,109		744,668		847,777
Commercial Business	—		426,658		426,658
Commercial Real Estate	840,658		6,420,234		7,260,892
Total	$	1,102,558	$	9,139,412	$	10,241,970



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

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
December 31, 2013	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	4,838,236	$	78,166,246	$	83,004,482
Consumer	275,491		51,930,410		52,205,901
Commercial Business	19,775		7,755,323		7,775,098
Commercial Real Estate	26,221,312		202,178,243		228,399,555
Total	$	31,354,814	$	340,030,222	$	371,385,036



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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4) Loans Receivable, Net, Continued

Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired management measures impairment and records the loan at fair value. Fair value is estimated using one of the following methods: fair value of the collateral less estimated costs to sale, discounted cash flows, or market value of the loan based on similar debt. The fair value of the collateral less estimated costs to sell is the most frequently used method. Typically, the Company reviews the most recent appraisal and if it is over 24 months old will request a new third party appraisal. Depending on the particular circumstances surrounding the loan, including the location of the collateral, the date of the most recent appraisal and the value of the collateral relative to the recorded investment in the loan, management may order an independent appraisal immediately or, in some instances, may elect to perform an internal analysis. The average balance of impaired loans was $33.6 million for year ended December 31, 2013 compared to $41.6 million for the nine months ended December 31, 2012.

The following tables are a summary of information related to impaired loans as of December 31, 2013 and 2012.



	December 31, 2013
Impaired Loans	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With No Related Allowance Recorded:
Residential Real Estate	$	3,936,316	$	4,588,645	$	—	$	4,044,142	$	31,704
Consumer Loans	106,197		106,198		—		104,539		953
Commercial Business	19,775		19,775		—		19,896		389
Commercial Real Estate	21,810,347		26,775,853		—		23,618,648		886,737
With An Allowance Recorded:
Residential Real Estate	901,920		901,920		158,791		909,473		—
Consumer Loans	169,294		169,294		103,109		170,499		5,173
Commercial Business	—		—		—		—		—
Commercial Real Estate	4,410,965		4,954,058		840,658		4,707,658		251,505
Total
Residential Real Estate	4,838,236		5,490,565		158,791		4,953,615		31,704
Consumer Loans	275,491		275,492		103,109		275,038		6,126
Commercial Business	19,775		19,775		—		19,896		389
Commercial Real Estate	26,221,312		31,729,911		840,658		28,326,306		1,138,242
Total	$	31,354,814	$	37,515,743	$	1,102,558	$	33,574,855	$	1,176,461

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4) Loans Receivable, Net, Continued



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

In the course of resolving delinquent loans, the Bank may choose to restructure the contractual terms of certain loans. A troubled debt restructuring ("TDR") is a restructuring in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a borrower that it would not otherwise consider (FASB ASC Topic 310-40). The concessions granted on TDRs generally include terms to reduce the interest rate, extend the term of the debt obligation, or modify the payment structure on the debt obligation. The Bank grants such concessions to reassess the borrower’s financial status and develop a plan for repayment. TDRs included in impaired loans at December 31, 2013 and 2012 amounted to $12.4 million and $10.4 million, respectively.

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4) Loans Receivable, Net, Continued

The following table is a summary of loans restructured as TDRs during the periods indicated:



	For the Year Ended December 31, 2013
Troubled Debt Restructurings	Number of Contracts	Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Residential Real Estate	—	$	—	$	—
Consumer Loans	—	—		—
Commercial Business	1	32,850		32,850
Commercial Real Estate	4	1,409,693		1,409,693
Total	5	1,442,543		1,442,543



	For the Nine Months Ended December 31, 2012					For the Year Ended March 31, 2012
Troubled Debt Restructurings	Number of Contracts	Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		Number of Contracts	Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Residential Real Estate	—	$	—	$	—	—	$	—	$	—
Consumer Loans	—	—		—		1	15,358		15,358
Commercial Business	—	—		—		—	—		—
Commercial Real Estate	1	257,452		257,452		14	11,988,576		11,988,576
Total	1	257,452		257,452		15	$	12,003,934	$	12,003,934

During the year ended December 31, 2013, the Bank modified five loans that were considered to be TDRs. The Bank lowered the interest rate on each of these loans and changed the payment to interest only on for an agreed upon period on three of these loans. During the year ended December 31, 2012, the Bank modified 1 loan that was considered to be a TDR. The Bank lowered the interest rate on the loan and changed the payment to interest only. The following table is a summary of TDRs restructured in the last 12 months that subsequently defaulted during the period:



	For the Year Ended December 31, 2013
Troubled Debt Restructurings That Subsequently Defaulted During the Period	Number of Contracts	Recorded Investment
Residential Real Estate	—	$	—
Consumer Loans	—	—
Commercial Business	—	—
Commercial Real Estate	1	146,267
Total	1	$	146,267

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(4) Loans Receivable, Net, Continued



	For the Nine Months Ended December 31, 2012			For the Year Ended March 31, 2012
Troubled Debt Restructurings That Subsequently Defaulted During the Period	Number of Contracts	Recorded Investment		Number of Contracts	Recorded Investment
Residential Real Estate	—	$	—	—	$	—
Consumer Loans	—	—		—	—
Commercial Business	—	—		—	—
Commercial Real Estate	4	880,745		—	—
Total	4	$	880,745	—	$	—

At December 31, 2013, five loans that had been previously restructured were in default, one of which defaulted during the year and had been restructured in the last 12 months. During the nine months ended December 31, 2012, 6 loans that had been previously restructured were in default. The Bank considers any loan 30 days or more past due to be in default.

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

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(5) Premises and Equipment, Net

Premises and equipment, net, are summarized as follows for the dates indicated:



	December 31,
	2013			2012
Land	$	5,471,503		$	5,471,503
Buildings And Improvements	17,635,363			17,591,652
Furniture And Equipment	10,395,793			10,684,296
Construction In Progress	206,163			77,058
Total Premises And Equipment	33,708,822			33,824,509
Less Accumulated Depreciation	(16,465,432		)	(15,906,612		)
Total Premises And Equipment, Net	$	17,243,390		$	17,917,897

Depreciation expense for the year ended December 31, 2013, the nine months ended December 31, 2012, and for the year ended March 31, 2012 was $1.2 million, $1.1 million, and $1.5 million, respectively. The Bank has entered into non-cancelable operating leases related to buildings and land. At December 31, 2013, future minimum payments under non-cancelable operating leases with initial or remaining terms of one year or more are as follows (by fiscal year):



2014	$	416,435
2015	358,451
2016	260,909
2017	222,762
2018	128,360
Thereafter	1,028,198
Total Future Minimum Payments	$	2,415,115

Total rental expense amounted to $415,000, $306,000, and $401,000 for the year ended December 31, 2013, for the nine months ended December 31, 2012 and for the year ended March 31, 2012, respectively. Four lease agreements with monthly expenses of $6,593, $800, $8,571, and $9,075 have multiple renewal options totaling 30, 10, 35, and 10 years, respectively.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(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 periods indicated consisted of the following:



	December 31,
	2013		2012
Customer List
Balance At Beginning Of Year	$	61,974	$	99,477
Amortization	50,004		37,503
Balance At End Of Year	11,970		61,974
Total Intangibles	11,970		61,974
Goodwill	1,199,754		1,199,754
Total	$	1,211,724	$	1,261,728

In accordance with accounting guidance, the Company evaluates its goodwill on an annual basis. The evaluations were performed as of September 30, 2013 and September 30, 2012 for fiscal years ended December 31, 2013 and 2012, respectively. At the time of the evaluations the Company determined that no impairment existed. Therefore, there was no amortization of goodwill for the year ended December 31, 2013 or for the nine months ended December 31, 2012. Amortization of the intangibles is scheduled to be as follows for each fiscal year as indicated:



2014	11,970
Total	$	11,970

(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 September 30, 2013 and 2012 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 $5.0 million and $6.2 million as of December 31, 2013 and 2012, 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 $3.9 million and $6.8 million in repossessed assets acquired in settlement of loans at December 31, 2013 and 2012, respectively. Transactions in repossessed assets for the year ended December 31, 2013, the nine months ended December 31, 2012 and the year ended March 31, 2012 are summarized below:



	December 31,			December 31,			March 31,
	2013			2012			2012
Balance, Beginning Of Period	$	6,754,425		$	14,160,099		$	14,433,853
Additions	3,861,182			2,456,478			4,276,679
Capital Improvements	—			—			36,877
Sales	(5,274,003		)	(6,929,152		)	(3,978,390		)
Write Downs	(1,394,378		)	(2,933,000		)	(608,920		)
Balance, End Of Period	$	3,947,226		$	6,754,425		$	14,160,099

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(9) Deposits

Deposits outstanding by type of account are summarized as follows:



	At December 31, 2013					At December 31, 2012
			Weighted Rate		Interest Rate Range			Weighted Rate		Interest Rate Range
Checking Accounts	$	136,695,876	0.04	%	0.00-0.15%	$	126,740,707	0.06	%	0.00-0.20%
Money Market Accounts	240,631,708		0.28	%	0.10-0.30%	234,382,412		0.38	%	0.20-0.40%
Statement Savings Accounts	24,485,648		0.10	%	0.00-0.10%	22,411,240		0.20	%	0.00-0.20%
Total	$	401,813,232	0.19	%	0.00-0.30%	$	383,534,359	0.26	%	0.00-0.40%

Certificate Accounts:
0.00 – 1.99%	226,750,180					255,422,955
2.00 – 2.99%	28,848,252					32,975,486
3.00 – 3.99%	1,285,108					2,380,728
4.00 – 4.99%	—					1,523,474
5.00 – 5.99%	—					501,651
Total	256,883,540		0.83	%	0.05-3.25%	292,804,294		1.11	%	0.15-5.22%
Total Deposits	$	658,696,772	0.44	%	0.00-3.25%	$	676,338,653	0.63	%	0.00-5.22%

Included in the certificates above were $25.6 million and $22.6 million in brokered deposits at December 31, 2013 and 2012, respectively, with a weighted average interest rate of 1.23% and 1.47%, respectively. Of the brokered deposits at December 31, 2013, $2.5 million mature within one year.

The aggregate amount of certificates of deposit with a minimum denomination of $100,000 was $129.9 million and $139.9 million at December 31, 2013 and 2012, respectively.

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



	December 31,		December 31,
	2013		2012
Within 1 Year	$	163,680,585	$	182,062,395
After 1 Year, Within 2 Years	45,089,513		55,389,195
After 2 Years, Within 3 Years	22,483,793		22,172,081
After 3 Years, Within 4 Years	8,996,498		24,584,913
After 4 Years, Within 5 Years	16,633,151		8,595,710
Thereafter	—		—
	$	256,883,540	$	292,804,294

At December 31, 2013 and 2012, the Bank has $133,000 and $72,000, respectively, in overdrafts that were reclassified to loans.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

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



	December 31, 2013
Year Ending December 31	Amount		Weighted Rate
2014	$	34,840,058	1.64	%
2015	15,000,000		4.01	%
2016	20,000,000		4.61	%
2017	12,900,000		4.38	%
2018	5,000,000		3.39	%
Thereafter	—		—	%
	$	87,740,058	3.23	%



	December 31, 2012
Year Ending December 31	Amount		Weighted Rate
2013	$	22,100,000	2.92	%
2014	30,257,182		3.33	%
2015	15,000,000		4.01	%
2016	20,000,000		4.60	%
2017	12,900,000		4.38	%
Thereafter	5,000,000		3.39	%
	$	105,257,182	3.72	%

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 $111.6 million and $102.7 million, respectively, at December 31, 2013 and $135.7 million and $129.4 million, respectively, at December 31, 2012. 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 December 31, 2013
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

During the year ended December 31, 2013, the Bank prepaid six FHLB advances totaling $30.0 million and incurred$589,000 in prepayment penalties related to these prepayments. The Bank did not prepay any FHLB advances during the nine months ended December 31, 2012 or the year ended March 31, 2012.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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



As of December 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

At December 31, 2013 and December 31, 2012, the Bank had $167.9 million and $165.9 million in additional borrowing capacity, respectively, at the FHLB.

The Bank had $8.0 million and $9.3 million in other borrowings at December 31, 2013 and December 31, 2012, respectively. These borrowings consist of short-term repurchase agreements with certain commercial demand deposit customers for sweep accounts. The repurchase agreements typically mature within one to three days and the interest rate paid on these borrowings floats monthly with money market type rates. At December 31, 2013 and December 31, 2012, the interest rate paid on the repurchase agreements was 0.15% and 0.20%, respectively. The maximum amount outstanding at any one month end during the year ended December 31, 2013 was $9.9 million compared to $10.2 million during the nine months ended December 31, 2012. The Bank had pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $14.8 million and $15.4 million, respectively at December 31, 2013 and $15.4 million and $16.3 million, respectively, at December 31, 2012.

(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 quarterly at a rate per annum equal to 1.94% at December 31, 2013 and 2.01% at December 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, 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.

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 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 $1.4 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 Year Ended December 31,		For the Nine Months Ended December 31,			For the Year Ended March 31,
	2013		2012			2012
Current:
Federal	$	380,143	$	348,588		$	1,814,394
State	164,491		91,108			226,970
Total Current Tax Expense	544,634		439,696			2,041,364
Deferred:
Federal	784,814		266,784			(706,857		)
State	10,936		(2,721		)	576,774
Total Deferred Tax Expense	795,750		264,063			(130,083		)
Total Income Tax Expense	$	1,340,384	$	703,759		$	1,911,281

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(14) Income Taxes, Continued

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



	For the Year Ended December 31,			For the Nine Months Ended December 31,			For the Year Ended March 31,
	2013			2012			2012
Tax At Statutory Income Tax Rate	$	1,744,725		$	903,960		$	1,260,263
State Tax And Other	(379,689		)	(212,308		)	10,480
Write-down Of State Deferred Tax Asset	—			—			625,000
Valuation Allowance	(24,652		)	12,107			15,538
Total Income Tax Expense	$	1,340,384		$	703,759		$	1,911,281

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 December 31,
	2013			2012
Deferred Tax Assets:
Deferred Compensation	$	565,577		$	528,847
Provision For Loan Losses	3,519,305			3,891,083
Other Real Estate Owned	1,125,986			1,452,449
Net Fees Deferred For Financial Reporting	120,984			121,842
Non-accrual Interest	167,315			411,761
Net Operating Losses	208,185			232,837
Other	47,725			61,129
Total Gross Deferred Tax Assets	5,755,077			6,699,948
Less: Valuation Allowance	(208,185		)	(232,837		)
Net Deferred Tax Assets	5,546,892			6,467,111
Deferred Tax Liabilities:
FHLB Stock Basis Over Tax Basis	114,682			114,576
Depreciation	281,880			362,221
Other	67,881			63,695
Intangibles	4,465			19,292
Unrealized Gain on Securities Available for Sale	289,192			4,548,752
Total Gross Deferred Tax Liability	758,100			5,108,536
Net Deferred Tax Asset	$	4,788,792		$	1,358,575

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 December 31, 2013, 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 $(24,652). Net deferred tax assets are included in other assets at December 31, 2013 and 2012. The Company had state net operating losses of $6.3 million and $7.1 million for the year ended December 31, 2013 and 2012, respectively.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(14) Income Taxes, Continued

Retained earnings at December 31, 2013 included tax bad debt reserves of $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 2010 and subsequent years are subject to examination by taxing authorities.

As of December 31, 2013, the Company had no material unrecognized tax benefits or accrued interest and penalties. It is the Company's policy to account for interest and penalties accrued relative to unrecognized tax benefits as a component of income tax expense.

(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 December 31, 2013 and 2012, 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:

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(15) Regulatory Matters, Continued



	Actual				For Capital Adequacy				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
	(Dollars in Thousands)
December 31, 2013
SECURITY FEDERAL CORP.
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	70,598	17.8	%	$	15,894	4.0	%	N/A		N/A
Total Risk-Based Capital (To Risk Weighted Assets)	84,529		21.3	%	31,788		8.0	%	N/A		N/A
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	70,598		8.3	%	34,079		4.0	%	N/A		N/A

SECURITY FEDERAL BANK
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	81,624	20.6	%	$	15,883	4.0	%	$	23,825	6.0	%
Total Risk-Based Capital (To Risk Weighted Assets)	86,652		21.8	%	31,767		8.0	%	39,709		10.0	%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	81,624		9.6	%	34,069		4.0	%	42,586		5.0	%

December 31, 2012
SECURITY FEDERAL CORP.
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	68,639	16.5	%	$	16,619	4.0	%	N/A		N/A
Total Risk-Based Capital (To Risk Weighted Assets)	84,148		20.3	%	33,237		8.0	%	N/A		N/A
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	68,639		7.7	%	35,552		4.0	%	N/A		N/A

SECURITY FEDERAL BANK
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	80,822	19.5	%	$	16,606	4.0	%	$	24,909	6.0	%
Total Risk-Based Capital (To Risk Weighted Assets)	86,012		20.7	%	33,212		8.0	%	41,515		10.0	%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	80,822		9.1	%	35,541		4.0	%	44,426		5.0	%

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 $189,000 for the year ended December 31, 2013, $145,000 for the nine months ended December 31, 2012 and $188,000 for the year ended March 31, 2012.

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 December 31, 2013, 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 year ended December 31, 2013, the nine months ended December 31, 2012 and the year ended March 31, 2012, the Company incurred expenses of $172,000, $144,000, and $180,000, 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 December 31, 2013 and 2012, 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 year ended December 31, 2013, the nine months ended December 31, 2012 and for the year ended March 31, 2012:



	December 31,						March 31,
	2013			2012			2012
	Shares	Weighted Avg. Exercise Price		Shares	Weighted Avg. Exercise Price		Shares	Weighted Avg. Exercise Price
Balance, Beginning of Period	68,400	$	22.63	72,900	$	22.62	81,400	$	22.51
Options Granted	—	—		—	—		—	—
Options Exercised	—	—		—	—		—	—
Options Forfeited	6,900	23.87		4,500	22.58		8,500	21.72
Balance, End of Period	61,500	$	22.49	68,400	$	22.63	72,900	$	22.62

Total Intrinsic Value Of Options Exercised During The Year	—			—			—
Weighted-Average Fair Value Of Options Granted During The Year	—			—			—
Options Exercisable	42,300	$	22.03	43,800	$	22.14	43,600	$	22.05
Weighted-Average Remaining Life Of Exercisable Options	1.3 years			1.8 years			2.5 years
Options Available For Grant	50,000			50,000			50,000

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(16) Employee Benefit Plans, Continued

During the year ended December 31, 2013, 2,600 options with a weighted average exercise price of $23.50 vested. During the nine months ended December 31, 2012, 2,200 stock options with an exercise price of $23.61 vested. During the year ended March 31, 2012, 1,200 options with a weighted average exercise price of $23.03 vested. The aggregate intrinsic value of the stock options outstanding and exercisable at December 31, 2013 and 2012 and March 31, 2012 amounted to $0 for all periods. Total compensation expense related to stock options was $(2,600), $4,000, and $33,000 for the year ended December 31, 2013, for the nine months ended December 31, 2012 and the year ended March 31, 2012, respectively. As of December 31, 2013, there was $38,419 of total unrecognized compensation cost related to non-vested stock options. The cost is expected to be recognized over a weighted average period of three years.

There were no stock-based awards granted by the Company, during the year ended December 31, 2013, the nine months ended December 31, 2012, or the year ended March 31, 2012. At December 31, 2013, the Company had the following options outstanding:



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

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 had a 10-year term and was immediately exercisable upon issuance.

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

(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 $11.5 million, $11.2 million and $10.4 million at December 31, 2013 and 2012 and March 31, 2012, 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 $339,000, $315,000 and $420,000 for the growth in the cash value of life insurance during the year ended December 31, 2013, during the nine months ended December 31, 2012 and during the year ended March 31, 2012, respectively.

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 $30.8 million and $30.1 million, undisbursed loans in process of $3.5 million and $2.0 million, and letters of credit of $2.2 million and $6.1 million at December 31, 2013 and 2012, 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 at December 31, 2013 and 2012. There were no outstanding commitments on mortgage loans not yet closed at December 31, 2013 and 2012. These commitments, which are funded subject to certain limitations, extend over varying periods of time with the majority being funded within 45 days. At December 31, 2013 and 2012, the Bank had outstanding commitments to sell approximately $1.2 million and $4.8 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 Year Ended December 31,		For the Nine Months Ended December 31,		For the Year Ended March 31,
	2013		2012		2012
Balance, Beginning of Period	$	273,330	$	315,338	$	356,345
New Loans	10,956		5,364		7,798
Less Loan Payments	53,564		47,372		48,805
Balance, End of Period	$	230,722	$	273,330	$	315,338

Loans to all employees, officers, and directors of the Company, in the aggregate constituted approximately 5.7% and 5.4% of the Company’s total shareholders' equity at December 31, 2013 and 2012, respectively. At December 31, 2013 and 2012, deposits from executive officers and directors of the Bank and Company and their related interests in the aggregate approximated $6.8 million and $4.1 million, respectively.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(20) Related Party Transactions, Continued

The Company leased office space from a related party during the year ended December 31, 2013. The lease is with a company in which the related party, who is both a director and an officer of the Company, has an ownership interest. The Company incurred expenses of $79,000, $58,000, and $76,000 for rent for the year ended December 31, 2013, the nine months ended December 31, 2012 and the year ended March 31, 2012, respectively, related to this lease. Management is of the opinion that the transactions with respect to office rent were 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 remained outstanding after the exchange.

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.

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 December 31,		At December 31,
	2013		2012
Assets:
Cash	$	3,880,433	$	4,098,035
Investment Securities, Available For Sale	101,250		75,225
Investment in Security Federal Statutory Trust	155,000		155,000
Investment In Security Federal Bank	85,115,889		89,532,985
Accounts Receivable And Other Assets	20,167		13,766
Total Assets	$	89,272,739	$	93,875,011
Liabilities And Shareholders’ Equity:
Accounts Payable And Other Liabilities	$	44,959	$	44,827
Junior Subordinated Debentures	5,155,000		5,155,000
Senior Convertible Debentures	6,084,000		6,084,000
Shareholders’ Equity	77,988,780		82,591,184
Total Liabilities And Shareholders’ Equity	$	89,272,739	$	93,875,011

Condensed Statements of Income Data



	For the Year Ended December 31,			For the Nine Months Ended December 31,			For the Year Ended March 31,
	2013			2012			2012
Income:
Equity In Earnings Of Security Federal Bank	$	2,558,986		$	2,229,630		$	2,095,707
Dividend Income From Security Federal Bank	1,600,000			—			—
Interest Income	—			22,941			78,667
Miscellaneous Income	15,771			—			34,338
Total Income	4,174,757			2,252,571			2,208,712
Expenses:
Interest Expense	589,988			449,049			653,727
Mandatorily Redeemable Financial Instrument Valuation Income	—			—			(50,000		)
Other Expenses	18,223			16,814			24,329
Total Expenses	608,211			465,863			628,056
Income Before Income Taxes	3,566,546			1,786,708			1,580,656
Income Tax Benefit	(224,616		)	(168,241		)	(214,719		)
Net Income	3,791,162			1,954,949			1,795,375
Preferred Stock Dividends	440,000			330,000			440,000
Net Income Available to Common Shareholders	$	3,351,162		$	1,624,949		$	1,355,375

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 Year Ended December 31,			For the Nine Months Ended December 31,			For the Year Ended March 31,
	2013			2012			2012
Operating Activities:
Net Income	$	3,791,162		$	1,954,949		$	1,795,375
Adjustments To Reconcile Net Income To Net Cash Used In Operating Activities:
Equity In Earnings Of Security Federal Bank	(2,558,986		)	(2,229,630		)	(2,095,707		)
Stock Compensation Expense	(2,580		)	4,472			33,123
Mandatorily Redeemable Financial Instrument Valuation Income	—			—			(50,000		)
(Increase) Decrease In Accounts Receivable And Other Assets	(15,248		)	56,203			(32,154		)
Increase (Decrease) In Accounts Payable	132			(122,707		)	(5,633		)
Net Cash Provided (Used) In Operating Activities	1,214,480			(336,713		)	(354,996		)
Investing Activities:
Decrease In Loans Receivable	—			—			1,786,294
Net Cash Provided By Investing Activities	—			—			1,786,294
Financing Activities:
Repayment Of Warrant Issued In Conjunction With Preferred Stock	(50,000		)	—			—
Dividends Paid To Shareholders-Preferred Stock	(440,000		)	(330,000		)	(440,000		)
Dividends Paid To Shareholders-Common Stock	(942,082		)	(706,560		)	(942,027		)
Net Cash Used In Financing Activities	(1,432,082		)	(1,036,560		)	(1,382,027		)
Net Increase (Decrease) In Cash	(217,602		)	(1,373,273		)	49,271
Cash At Beginning Of Period	4,098,035			5,471,308			5,422,037
Cash At End Of Period	$	3,880,433		$	4,098,035		$	5,471,308

(23) Carrying Amounts and Fair Value of Financial Instruments

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

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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



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

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

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. At December 31, 2013, 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 equity investments. The portfolio did not contain any private label mortgage-backed securities. Fair value measurement is based upon prices obtained from third party pricing services that use independent pricing models which rely on a variety of factors including reported trades, broker/dealer quotes, benchmark yields, economic and industry events and other relevant market information. As such, these securities are classified as Level 2.

Mortgage Loans Held for Sale

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

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

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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

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 December 31, 2013, 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 December 31, 2013 and 2012, the recorded investment in impaired loans was $31.4 million and $39.9 million, respectively. The average recorded investment in impaired loans was $33.6 million for year ended December 31, 2013 and $41.6 million for the nine months ended December 31, 2012.

Foreclosed Assets

Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 3. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the asset as nonrecurring Level 3.

Assets measured at fair value on a recurring basis are as follows as of December 31, 2013:



Assets:	Quoted Market Price In Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
FHLB Securities	$	—	$	12,670,450	$	—
FFCB Securities			5,366,180
FNMA Bonds			1,974,930
SBA Bonds	—		100,823,985		—
Tax Exempt Municipal Bonds	—		61,315,122		—
Mortgage-Backed Securities	—		248,596,535		—
Equity Securities	—		256,250		—
Total	$	—	$	431,003,452	$	—

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

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



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

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

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. The table below presents assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2013 and 2012, aggregated by the level in the fair value hierarchy within which those measurements fall.



Assets:	Level 1		Level 2		Level 3		At December 31, 2013
Mortgage Loans Held For Sale	$	—	$	1,234,158	$	—	$	1,234,158
Collateral Dependent Impaired Loans ⁽¹⁾	—		—		30,252,256		30,252,256
Foreclosed Assets	—		—		3,947,226		3,947,226
Total	$	—	$	1,234,158	$	34,199,482	$	35,433,640

^{(1) IMPAIRED LOANS ARE REPORTED NET OF SPECIFIC RESERVES OF}^$1,103,000



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

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of December 31, 2013, the significant unobservable inputs used in the fair value measurements were as follows:



	Fair Value			Significant
	December 31,		Valuation	Unobservable
	2013		Technique	Inputs	Range
Collateral Dependent Impaired Loans	$	30,252,256	Appraised Value	Discount Rates/ Discounts to Appraised Values	0% - 90%
Foreclosed Assets	3,947,226		Appraised Value/Comparable Sales	Discount Rates/ Discounts to Appraised Values	7% - 99%

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

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

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

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

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

FHLB Stock—The fair value approximates the carrying value.

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

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

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

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

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

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



	December 31, 2013
	Carrying	Fair Value
(In Thousands)	Amount	Total		Level 1		Level 2		Level 3
Financial Assets:
Cash And Cash Equivalents	7,630	$	7,630	$	7,630	$	—	$	—
Certificates of Deposits With Other Banks	2,100	2,100		—		2,100		—
Investment And Mortgage-Backed Securities	431,003	431,003		—		431,003		—
Loans Receivable, Net	358,917	356,623		—		—		356,623
FHLB Stock	5,017	5,017		5,017		—		—

Financial Liabilities:
Deposits:
Checking, Savings, And Money Market Accounts	401,813	$	401,813	$	401,813	$	—	$	—
Certificate Accounts	256,884	257,883		—		257,883		—
Advances From FHLB	87,740	92,608		—		92,608		—
Other Borrowed Money	8,003	8,003		8,003		—		—
Senior Convertible Debentures	5,155	5,155		—		5,155		—
Junior Subordinated Debentures	6,084	6,084		—		6,084		—



	December 31, 2012
	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash And Cash Equivalents	$	7,904	$	7,904	$	7,904	$	—	$	—
Certificates of Deposits With Other Banks	1,729		1,729		—		1,729		—
Investment And Mortgage-Backed Securities	430,988		434,588		—		434,588		—
Loans Receivable, Net	397,706		397,360		—		—		397,360
FHLB Stock	6,179		6,179		6,179		—		—

Financial Liabilities:
Deposits:
Checking, Savings, And Money Market Accounts	$	383,534	$	383,534	$	383,534	$	—	$	—
Certificate Accounts	292,804		295,734		—		295,734		—
Advances From FHLB	105,257		113,471		—		113,471		—
Other Borrowed Money	9,317		9,317		9,317		—		—
Senior Convertible Debentures	5,155		5,155		—		5,155		—
Junior Subordinated Debentures	6,084		6,084		—		6,084		—

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

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

At December 31, 2013, the Bank had $33.0 million of off-balance sheet financial commitments. These commitments are to originate loans and unused consumer lines of credit and credit card lines. Because these obligations are based on current market rates, if funded, the original principal is considered to be a reasonable estimate of fair value.

Fair value estimates are made on a specific date, based on relevant market data and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the Bank’s entire holdings of a particular financial instrument. 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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes To Consolidated Financial Statements

(24) Quarterly Financial Data (Unaudited)

Unaudited condensed financial data by quarter for the year ended December 31, 2013 and the nine months ended December 31, 2012 is as follows (dollars, except per share data, in thousands):



	Quarter ended
Year Ended December 31, 2013	March 31, 2013		June 30, 2013		Sept. 30, 2013		Dec. 31, 2013
Interest Income	$	7,704	$	7,680	$	7,706	$	7,357
Interest Expense	2,114		1,959		1,796		1,664
Net Interest Income	5,590		5,721		5,910		5,693
Provision For Loan Losses	1,145		900		600		—
Net Interest Income After Provision For Loan Losses	4,445		4,821		5,310		5,693
Non-interest Income	1,945		1,743		1,738		1,470
Non-interest Expense	5,513		5,392		5,665		5,464
Income Before Income Tax	877		1,172		1,383		1,699
Provision For Income taxes	206		293		361		480
Net Income	671		879		1,022		1,219
Preferred Stock Dividends	110		110		110		110
Net Income Available To Common Shareholders	$	561	$	769	$	912	$	1,109
Basic Net Income Per Common Share	$	0.19	$	0.26	$	0.31	$	0.38
Diluted Net Income Per Common Share	$	0.19	$	0.26	$	0.31	$	0.38
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
Nine Months Ended December 31, 2012	June 30, 2012		Sept. 30, 2012		Dec. 31, 2012
Interest Income	$	8,476	$	8,271	$	8,044
Interest Expense	2,619		2,463		2,378
Net Interest Income	5,857		5,808		5,666
Provision For Loan Losses	725		300		950
Net Interest Income After Provision For Loan Losses	5,132		5,508		4,716
Non-interest Income	1,184		1,478		1,703
Non-interest Expense	5,298		6,071		5,693
Income Before Income Tax	1,018		915		726
Provision For Income taxes	287		245		172
Net Income	731		670		554
Preferred Stock Dividends	110		110		110
Net Income Available To Common Shareholders	$	621	$	560	$	444
Basic Net Income Per Common Share	$	0.21	$	0.19	$	0.15
Diluted Net Income Per Common Share	$	0.21	$	0.19	$	0.15
Basic Weighted Average Shares Outstanding	2,944,001		2,944,001		2,944,001
Diluted Weighted Average Shares Outstanding	2,944,001		2,944,001		2,944,001

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.

SHAREHOLDERS INFORMATION

ANNUAL MEETING

The annual meeting of shareholders will be held at 11:00 a.m., Thursday, April 17, 2014 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 Cantor Fitzgerald, Stifel Nicolaus, Knight Equity Markets, and Monroe Securities, Inc.



	High	Low
Nine Months Ended December 31, 2012
06/30/2012	$9.75	$8.50
09/30/2012	$9.00	$8.50
12/31/2012	$8.80	$7.00

Year Ended December 31, 2013
03/31/2013	$11.00	$8.10
06/30/2013	$12.80	$10.25
09/30/2013	$14.00	$12.10
12/31/2013	$13.30	$11.20

As of December 31, 2013, the Company had approximately 278 shareholders of record, not including shares held in street name, 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 subsequent quarters beginning in the first quarter of fiscal 2009.

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.