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EX-99.1 - EXHIBIT 99.1 - SECURITY FEDERAL CORPexhibit991-123116.htm
EX-99.2 - EXHIBIT 99.2 - SECURITY FEDERAL CORPexhibit992-123116.htm
EX-32 - EXHIBIT 32 - SECURITY FEDERAL CORPsfdl-ex32x123116.htm
EX-31.2 - EXHIBIT 31.2 - SECURITY FEDERAL CORPsfdl-ex312x123116.htm
EX-31.1 - EXHIBIT 31.1 - SECURITY FEDERAL CORPsfdl-ex311x123116.htm
EX-23 - EXHIBIT 23 - SECURITY FEDERAL CORPexhibit23-123116.htm
EX-21 - EXHIBIT 21 - SECURITY FEDERAL CORPexhibit21-123116.htm
EX-13 - EXHIBIT 13 - SECURITY FEDERAL CORPsfdl-ex13x123116.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
__________________________
FORM 10-K
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2016
 
                                                                       OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
   For the transition period _________ to _________
 
 
 
 
Commission File Number: 0-16120
 
SECURITY FEDERAL CORPORATION
(Exact Name of Registrant as Specified in its Charter)
 
 
 
South Carolina
 
57-08580504
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
238 Richland Avenue Northwest, Aiken, South Carolina
 
29801
(Address of principal executive offices)
 
(Zip Code)
Registrant's telephone number, including area code:
 
(803) 641-3000
 
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
None
 
 
 
Securities registered pursuant to Section 12(g) of the Act:
 
Common Stock, par value $0.01 per share
 
 
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES        NO    X

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES       NO    X    

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes      X       No        

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.       X  

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act (Check one):
Large accelerated filer       
Accelerated filer       
Non-accelerated filer       
Smaller reporting company   X   

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES         NO    X   

As of March 20, 2017, there were issued and outstanding 2,945,474 shares of the registrant's Common Stock, which are traded on the over-the-counter market through the OTC "Electronic Bulletin Board" under the symbol "SFDL."  The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the average of the bid and asked price of such stock as of June 30, 2016, was $39.2 million.  (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)
 
DOCUMENTS INCORPORATED BY REFERENCE

1.
Portions of the Registrant's Annual Report to Stockholders for the Fiscal Year Ended December 31, 2016.  (Part II)
2.
Portions of the Registrant's Proxy Statement for the 2017 Annual Meeting of Stockholders.  (Part III)





Forward-Looking Statements

This Form 10-K, including information included or incorporated by reference, contents, and future filings by Security Federal Corporation ("Company") on 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.  These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of 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." Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance and operations or financial condition, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management's expectations and may, therefore, involve risk and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors, 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 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 ("FDIC") 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, or impose additional requirements or restrictions on us, any of which could adversely affect our liquidity and earnings;
legislative or regulatory changes that adversely affect our business, including the effect of the Dodd-Frank Wall Street Reform and Consumer Protection Act; changes in regulatory policies and principles, or the interpretation of regulatory capital requirements or other rules, including as a result of Basel III;
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 the 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 manage loan delinquency rates;
increased competitive pressures among financial services companies;
changes in consumer spending, borrowing and savings habits;
the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
our ability to pay dividends on our common stock and preferred stock;
adverse changes in the securities markets;

i



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 ("FASB"), 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.

These developments could have an adverse impact on our financial position and our results of operations.

Any of the forward-looking statements that we make may turn out to be wrong because of the inaccurate assumptions we might make because of the factors set forth above or because of other factors we cannot foresee. Because of these and other uncertainties, our actual future results may be materially different from those expressed in any forward-looking statements made by or on our behalf. Therefore, these factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements. We undertake no responsibility to update or revise any of these forward-looking statements.

As used throughout this report, the terms "we," "our," or "us" refer to Security Federal Corporation and our consolidated subsidiary, Security Federal Bank.
 
Available Information

The Company provides a link on its investor information page at www.securityfederalbank.com to the Securities and Exchange Commission's  ("SEC") website (www.sec.gov) for purposes of providing copies of its annual report to shareholders, annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and press releases.  These filings are available free of charge and also can be obtained by calling the SEC at 1-800-SEC-0330.


ii



PART I

Item 1.  Business

Security Federal Corporation

Security Federal Corporation (the "Company") was incorporated under the laws of the State of Delaware in July 1987 for the purpose of becoming the savings and loan holding company for Security Federal Bank ("Security Federal" or the "Bank") upon the Bank's conversion from mutual to stock form (the "Conversion").  Effective August 17, 1998, the Company changed its state of incorporation from Delaware to South Carolina.  On December 28, 2011, the Company reorganized into a bank holding company in connection with the Bank's conversion from a federally chartered stock savings bank to a South Carolina chartered commercial bank. As a result of the reorganization, the Federal Reserve became the Company's primary federal regulator. On January 17, 2013, the Board of Directors of the Company determined to change the Company's fiscal year end from March 31 to December 31. As a result of this change, the Company filed a Transition Report on Form 10-K for the nine-month transition period from April 1, 2012 to December 31, 2012.

As a South Carolina corporation, the Company is authorized to engage in any activity permitted by South Carolina General Corporation Law.  The Company is a one bank holding company.  Through the bank holding company structure, it is possible to expand the size and scope of the financial services offered beyond those currently offered by the Bank.  The holding company structure also provides the Company with greater flexibility than the Bank would have to diversify its business activities, through existing or newly formed subsidiaries, or through acquisitions or mergers of financial institutions as well as other companies.  There are no current arrangements, understandings or agreements regarding any such acquisition.  Future activities of the Company, other than the continuing operations of Security Federal, will be funded through dividends from Security Federal and through borrowings from third parties.  See "Regulation - Regulation of the Company - Dividends" and "Taxation." Activities of the Company may also be funded through sales of additional securities or income generated by other activities of the Company.  At this time, there are no plans regarding sales of additional securities or other activities.

At December 31, 2016, the Company had assets of $812.7 million, deposits of $654.1 million and shareholders' equity of $71.1 million.

The executive office of the Company is located at 238 Richland Avenue Northwest, Aiken, South Carolina 29801, and its telephone number is (803) 641-3000.

Security Federal Bank

General.  Security Federal is a South Carolina chartered commercial bank headquartered in Aiken, South Carolina.  Security Federal, with 14 branch offices in Aiken, Richland and Lexington counties, South Carolina and Columbia County, Georgia, was originally chartered under the name Aiken Building and Loan Association on March 27, 1922.  It received its federal charter and changed its name to Security Federal Savings and Loan Association of Aiken on March 7, 1962, and later changed its name to Security Federal Savings Bank of South Carolina, on November 11, 1986.  Effective April 8, 1996, the Bank changed its name to Security Federal Bank.  The Bank converted from the mutual to the stock form of organization on October 30, 1987.  As mentioned above, effective December 28, 2011, Security Federal converted from a federally chartered stock savings bank to a South Carolina chartered commercial bank. As a result of the conversion to a South Carolina commercial bank, the Bank is regulated by the South Carolina State Board of Financial Institutions ("State Board") and the FDIC.

The principal business of Security Federal is accepting deposits from the general public and originating commercial real estate loans, commercial business loans, consumer loans, as well as mortgage loans to buy 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. In addition, the Bank operates Security Federal Trust and Investments, as a division of the Bank that offers trust, financial planning and financial management services.

Security Federal has one active wholly owned subsidiary, Security Federal Insurance, which is an insurance agency subsidiary that offers auto, business, health and home insurance. Security Federal Insurance also has a wholly owned subsidiary, Collier Jennings Financial Corporation, 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 insurance premium finance subsidiary and also has an ownership interest in four other insurance premium finance subsidiaries. Security Federal also has one inactive subsidiary, Security Financial Services Corporation, which was formed in 1975.

1





Security Federal's income is derived primarily from interest and fees earned in connection with its lending activities, and its principal expenses are interest paid on savings deposits and borrowings and operating expenses.

Selected Consolidated Financial Information.  This information is incorporated by reference to pages 7 and 8 of the Company’s 2016 Annual Report to Shareholders (“Annual Report”).

Rate/Volume Analysis.  This information is incorporated by reference to page 20 of the Annual Report.

Yields Earned and Rates Paid.  This information is incorporated by reference to page 21 of the Annual Report.

Lending Activities

General.  Security Federal's principal lending activities are making loans on commercial real estate and one-to-four family residential real estate. The Bank originates fixed rate residential real estate loans for sale in the secondary market and adjustable rate mortgage loans ("ARMS") to be held in its portfolio.  The Bank also originates construction loans on single family residences, multi-family dwellings and commercial real estate, and loans for the acquisition, development and construction of residential subdivisions and commercial projects.   To a lesser extent, the Bank originates consumer loans and commercial business loans.

The loan-to-value ratio, maturity and other provisions of loans made by the Bank reflect its policy of making the maximum loan permissible consistent with applicable regulations, established lending policies and market conditions.  The Bank requires title insurance (or acceptable legal opinions on smaller loans secured by real estate) and fire insurance, and flood insurance where applicable, on loans secured by improved real estate.



2




Loan Portfolio Composition.  The following table sets forth information concerning the composition of the Bank's loan portfolio, including loans held for sale, in dollar amounts and in percentages by type of loan, and presents a reconciliation of total loans receivable before net items.

 
At December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
(Dollars in Thousands)
TYPE OF LOAN:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential real estate                        
$
72,366

 
19.5
%
 
$
70,762

 
20.7
%
 
$
75,099

 
21.5
%
 
$
77,169

 
20.7
%
 
$
88,895

 
21.6
%
Owner occupied residential construction                    
9,858

 
2.6

 
8,074

 
2.4

 
4,049

 
1.2

 
7,069

 
1.9

 
6,553

 
1.6

Total residential real estate loans
82,224

 
22.1

 
78,836

 
23.1

 
79,148

 
22.7

 
84,238

 
22.6

 
95,448

 
23.2

Commercial loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial business
16,279

 
4.4

 
12,514

 
3.7

 
10,564

 
3.0

 
7,775

 
2.1

 
8,064

 
2.0

Commercial real estate 
208,958

 
56.2

 
187,934

 
55.0

 
196,107

 
56.1

 
220,311

 
59.1

 
241,268

 
58.8

Multi-family                        
13,641

 
3.7

 
12,149

 
3.6

 
13,424

 
3.8

 
8,089

 
2.2

 
9,656

 
2.3

Total commercial loans
238,878

 
64.3

 
212,597

 
62.2

 
220,095

 
62.9

 
236,175

 
63.4

 
258,988

 
63.1

Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Deposit account 
400

 
0.1

 
487

 
0.1

 
627

 
0.2

 
656

 
0.2

 
942

 
0.2

Home equity lines 
24,615

 
6.6

 
24,163

 
7.1

 
24,157

 
6.9

 
25,156

 
6.7

 
26,330

 
6.4

Consumer first and second mortgages
5,527

 
1.5

 
6,959

 
2.0

 
7,905

 
2.3

 
9,385

 
2.5

 
11,393

 
2.8

Premium finance    
4,250

 
1.1

 
3,409

 
1.0

 
3,260

 
0.9

 
2,626

 
0.7

 
2,644

 
0.6

Other   
15,876

 
4.3

 
15,362

 
4.5

 
14,442

 
4.1

 
14,383

 
3.9

 
15,286

 
3.7

Total consumer loans
50,668

 
13.6

 
50,380

 
14.7

 
50,391

 
14.4

 
52,206

 
14.0

 
56,595

 
13.7

Total loans    
371,770

 
100.0
%
 
341,813

 
100.0
%
 
349,634

 
100.0
%
 
372,619

 
100.0
%
 
411,031

 
100.0
%
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans in process   
3,526

 
 
 
2,903

 
 
 
1,379

 
 
 
3,465

 
 
 
2,002

 
 
Deferred fees and discount
165

 
 
 
62

 
 
 
24

 
 
 
(5
)
 
 
 
5

 
 
Allowance for loan losses           
8,356

 
 
 
8,275

 
 
 
8,357

 
 
 
10,242

 
 
 
11,318

 
 
Total loans receivable
$
359,723

 
 
 
$
330,573

 
 
 
$
339,874

 
 
 
$
358,917

 
 
 
$
397,706

 
 



3




The following table sets forth information concerning the composition of the Bank's loan portfolio, including loans held for sale, in dollar amounts and in percentages by type of loan, and presents a reconciliation of total loans receivable before net items.

 
At December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
(Dollars in Thousands)
TYPE OF LOAN:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential real estate              
$
17,336

 
4.7
%
 
$
14,158

 
4.1%

 
$
12,832

 
3.7
%
 
$
11,061

 
3.0
%
 
$
15,479

 
3.8
%
Commercial business and commercial real estate
203,032

 
54.6

 
180,285

 
52.7

 
185,862

 
53.2

 
201,048

 
54.0

 
208,604

 
50.7

Consumer  
22,310

 
6.0

 
22,286

 
6.5

 
21,983

 
6.2

 
22,482

 
6.0

 
24,503

 
6.0

Total fixed rate loans 
$
242,678

 
65.3

 
$
216,729

 
63.4

 
$
220,677

 
63.1

 
$
234,591

 
63.0

 
$
248,586

 
60.5

Adjustable rate loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential real estate   
$
64,888

 
17.5

 
$
64,678

 
18.9

 
$
66,316

 
19.0

 
$
73,177

 
19.6

 
$
79,969

 
19.5

Commercial business and commercial real estate   
35,846

 
9.6

 
32,312

 
9.5

 
34,233

 
9.8

 
35,127

 
9.4

 
50,384

 
12.2

Consumer   
28,358

 
7.6

 
28,094

 
8.2

 
28,408

 
8.1

 
29,724

 
8.0

 
32,092

 
7.8

Total adjustable rate loans
129,092

 
34.7

 
125,084

 
36.6

 
128,957

 
36.9

 
138,028

 
37.0

 
162,445

 
39.5

Total loans     
$
371,770

 
100.0
%
 
$
341,813

 
100.0
%
 
$
349,634

 
100.0
%
 
$
372,619

 
100.0
%
 
$
411,031

 
100.0
%
Less
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans in process 
$
3,526

 
 
 
$
2,903

 
 
 
$
1,379

 
 
 
$
3,465

 
 
 
$
2,002

 
 
Deferred fees and discounts
165

 
 
 
62

 
 
 
24

 
 
 
(5
)
 
 
 
5

 
 
Allowance for loan losses  
8,356

 
 
 
8,275

 
 
 
8,357

 
 
 
10,242

 
 
 
11,318

 
 
Total loans receivable    
$
359,723

 
 
 
$
330,573

 
 
 
$
339,874

 
 
 
$
358,917

 
 
 
$
397,706

 
 

As of December 31, 2016, the total amount of loans due after December 31, 2017, which have predetermined or fixed interest rates was $171.7 million, and the total amount of loans due after that date which have floating or adjustable interest rates was $113.5 million.



4




The following schedule illustrates the maturities of Security Federal's loan portfolio, including loans held for sale, at December 31, 2016.  Mortgages which have adjustable or renegotiable interest rates are shown as maturing in the period when the contract is due.  This schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
 
Residential
Real Estate
 
Owner Occupied Residential
Real Estate
Construction
 
Consumer
 
Commercial Construction
and A&D
 
Commercial
Business
and
Commercial
Real Estate
 
Total Loans
 
(In Thousands)
Six months or less (1)
$
4,198

 
$
7,061

 
$
10,225

 
$
11,612

 
$
12,265

 
$
45,361

Over six months to one year
69

 
2,797

 
1,020

 
11,616

 
25,653

 
41,155

Over one year to three years
929

 

 
5,523

 
5,357

 
75,548

 
87,357

Over three to five years
738

 

 
5,831

 
2,744

 
57,554

 
66,867

Over five to ten years
1,615

 

 
8,529

 
337

 
25,288

 
35,769

Over ten years  
64,817

 

 
19,540

 
144

 
10,760

 
95,261

Total
$
72,366

 
$
9,858

 
$
50,668

 
$
31,810

 
$
207,068

 
$
371,770

___________
(1)
Includes demand loans, loans having no stated maturity, overdraft loans and equity line of credit loans.

The commercial construction and acquisition and development ("A&D") loans category includes all loans made to builders to finance the A&D of residential neighborhoods and also any construction loans made to builders to finance the construction of individual one- to four-family residences. Construction loans made to owners to finance the construction of a residence are included in the owner occupied residential real estate construction loan category.

Loan Originations/ Renewals, Purchases and Sales.  The following table shows the loan origination including renewals of previously funded loans, purchase, sale and repayment activities of the Bank for the periods indicated.
 
Years Ended December 31,
 
Nine Months Ended
December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(In Thousands)
Originated/ Renewed:
 
 
 
 
 
 
 
 
 
Adjustable rate - residential real estate
$
19,851

 
$
14,298

 
$
11,758

 
$
13,021

 
$
6,986

Fixed rate - residential real estate (1)
35,435

 
24,181

 
23,617

 
28,892

 
24,136

Consumer  
18,441

 
11,540

 
10,635

 
10,840

 
7,315

Commercial business and commercial real estate
190,914

 
130,241

 
116,169

 
172,694

 
113,629

Total loans originated/ renewed   
264,641

 
180,260

 
162,179

 
225,447

 
152,066

Loans Purchased
5,005

 

 

 

 

Less:
 
 
 
 
 
 
 
 
 
Loans Sold:
 
 
 
 
 
 
 
 
 
Fixed rate - residential real estate 
33,654

 
23,583

 
22,986

 
32,272

 
22,037

Adjustable rate- residential real estate

 

 

 

 
725

Fixed rate - commercial real estate

 

 

 

 
996

Transfers to OREO
1,026

 
4,363

 
1,638

 
3,861

 
2,456

Principal repayments
205,009

 
160,135

 
160,540

 
227,726

 
159,856

Increase (decrease) in other items, net
807

 
1,481

 
(3,942
)
 
377

 
(3,199
)
Net increase (decrease)   
$
29,150

 
$
(9,302
)
 
$
(19,043
)
 
$
(38,789
)
 
$
(30,805
)

(1) Includes newly originated fixed rate loans held for sale and construction/permanent loans converted to fixed rate loans and sold.



5



In addition to interest earned on loans, the Bank receives loan origination fees or "points" for originating loans.  Loan origination points are a percentage of the principal amount of the loan which are charged to the borrower for the creation of the loan.  The Bank's loan origination fees are generally 1% on conventional residential mortgages, and 0.25% to 1% on commercial real estate loans and commercial business loans.  Total fee income (including amounts amortized to income as yield adjustments) received by the Bank from loan originations was $450,000 for the year ended December 31, 2016.

Loan origination and commitment fees are volatile sources of income.  These fees vary with the volume and type of loans and commitments made and purchased and with competitive conditions in mortgage markets, which in turn are governed by the demand for and availability of money.

The following table shows deferred mortgage loan origination fees recognized as income by the Bank expressed as a percentage of the dollar amount of total mortgage loans originated (and retained in the Bank's portfolio) and purchased during the periods indicated and the dollar amount of deferred loan origination fees at the end of each respective period.
 
Years Ended December 31,
 
2016
 
2015
 
2014
 
2013
 
(Dollars in Thousands)
Net deferred mortgage loan origination fees earned during the period (1)
$
23

 
$
23

 
$
23

 
$
27

 
 
 
 
 
 
 
 
Mortgage loan origination fees earned as a percentage of total portfolio mortgage loans originated during the period
0.1
%
 
0.2
%
 
0.2
%
 
0.2
%
 
 
 
 
 
 
 
 
Net deferred mortgage loan origination fees (costs) in loan portfolio at end of period   
$
(27
)
 
$
18

 
$
23

 
$
30


(1)
Includes amounts amortized to interest income as yield adjustments; does not include fees earned on loans sold.

The Bank also receives other fees and charges related to existing loans, conversion fees, assumption fees, late charges and other fees collected in connection with a change in borrower or other loan modifications.

Security Federal currently sells substantially all conforming fixed rate loans with terms of 15 years or greater in the secondary mortgage market.  These loans are sold in order to provide a source of funds and as one of the strategies available to close the gap between the maturities of the Bank's interest-earning assets and interest-bearing liabilities.  Currently, most fixed rate, long-term mortgage loans are being originated based on Federal National Mortgage Association ("Fannie Mae") and Federal Home Loan Mortgage Corporation ("Freddie Mac") underwriting standards.

Secondary market sales are made to other banks or institutional investors.  Generally all loans sold to investors are without recourse.  For the past several years, substantially all loans have been sold on a servicing released basis. During the year ended December 31, 2016, Security Federal sold $33.7 million in fixed rate residential loans on a servicing released basis in the secondary market.  Loans closed but not yet settled with banks or other investors, are carried in the Bank's "loans held for sale" portfolio.  At December 31, 2016, the Bank had $4.2 million of loans held for sale.  These loans are fixed rate residential loans that have been originated in the Bank'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 after the loan was locked in with the Bank's customers.  Therefore, these loans present very little market risk for the Bank.  The Bank usually delivers loans to, and receives funding from, the investor within 30 days.  Security Federal originates all of its loans held for sale on a "best efforts" basis which means that the Bank suffers no penalty if it is unable to deliver a loan to a potential investor.

Loan Solicitation and Processing.  The Bank actively solicits mortgage loan applications from existing customers, real estate agents, builders, real estate developers and others.  The Bank also receives mortgage loan applications as a result of customer referrals and from walk-in customers. Detailed loan applications are obtained to determine the borrower's creditworthiness and ability to repay.  The more significant items on loan applications are verified through the use of credit reports, financial statements and confirmations.  After analysis of the loan application and property or collateral involved, including an appraisal of the property (residential appraisals are obtained through independent fee appraisers), a lending decision is made in accordance with the underwriting guidelines of the Bank.  These guidelines are generally consistent with Freddie Mac and Fannie Mae guidelines for residential real estate loans.  With respect to commercial real estate loans, the Bank also reviews the capital adequacy of the business, the income potential of the property, the ability of the borrower to repay the loan and honor its other obligations, and general economic and industry conditions.

6



Upon receipt of a loan application and all required related information from a prospective borrower, the loan application is submitted for approval or rejection.  The residential mortgage loan underwriters approve loans which meet Freddie Mac and Fannie Mae underwriting requirements.  The Chairman of the Company, the Chief Executive Officer of the Company and the Bank, the President of the Bank, the Executive Vice President/Business Development, the Senior Vice President/Chief Lending Officer and Senior Vice President/Mortgage Lending individually have the authority to approve loans of $500,000 or less, except as set forth above for conforming conventionally underwritten, single family mortgage loans, which are approved by the underwriters.   Loans in excess of $500,000 and up to $1.0 million require the approval of any three of the following: Chairman of the Company, the Chief Executive Officer of the Company and the Bank, the President of the Bank, the President of the Company, the Executive Vice President/Business Development, the Senior Vice President/Chief Lending Officer, the Vice Chairman of the Executive Committee or the Secretary of the Executive Committee.  Any loan in excess of $1.0 million must be approved by the Bank's Executive Committee, which operates as the Bank's Loan Committee.  The loan approval limits discussed above are the aggregate of all loans to any one borrower or entity, not including loans that are secured by the borrower's primary residence, and are conventionally underwritten.
The general policy of Security Federal is to issue loan commitments to qualified borrowers for a specified term, generally a for a period of 45 days or less.  With management approval, commitments may be extended for up to an additional 45 days.  At December 31, 2016, the Bank had $165,000 in outstanding commitments on mortgage loans not yet closed compared to none at December 31, 2015. Security Federal had outstanding commitments available on all lines of credit (including letters of credit, commercial, undisbursed loans in process, home equity, VISA, and other consumer loans) totaling $80.3 million at December 31, 2016.  See Note 18 of the Notes to Consolidated Financial Statements contained in the Annual Report.

Residential Real Estate Lending.  At December 31, 2016 the Bank had $82.2 million or 22.1% of the Bank's total outstanding loan portfolio in residential real estate loans. These loans can have adjustable or fixed rates and include permanent one- to four-family residential mortgage loans as well as construction loans for single family dwellings to owner-occupants.
Security Federal offers a variety of ARMs which offer adjustable rates of interest, payments, loan balances or terms to maturity which vary according to specified indices.  The Bank's ARMs generally have a loan term of 15 to 30 years with initial rate adjustments every one, three, five or seven years during the term of the loan.  After the initial rate adjustment, the loan rate then adjusts annually.  Most of the Bank's ARMs contain a 200 basis point limit as to the maximum amount of change in the interest rate at any adjustment period and a 500 or 600 basis point limit over the life of the loan. The Bank generally originates ARMs to retain in its portfolio. These loans are generally made consistent with Freddie Mac and Fannie Mae guidelines. During the year ended December 31, 2016, the Bank originated $55.3 million in residential real estate loans, 35.9% of which had adjustable interest rates. At December 31, 2016, residential ARMs totaled $64.9 million or 17.5% of the Bank's loan portfolio. At December 31, 2016, the Bank also held approximately $17.3 million or 4.7% of the loan portfolio in longer term fixed rate residential mortgage loans.  Currently, the Bank sells the majority of its longer term fixed rate mortgage loans at origination.
There are unquantifiable risks resulting from possible increased costs to the borrower as a result of periodic repricing.  Despite the benefits of ARMs to the Bank's asset/liability management program, these loans also pose potential additional risks, primarily because as interest rates rise, the underlying payment by the borrower rises, increasing the potential for default.  At the same time, marketability of the underlying property may be adversely affected by higher interest rates.
When making a one- to four-family residential mortgage loan, the Bank evaluates both the borrower's creditworthiness and his or her general ability to make principal and interest payments, and the value of the property that will secure the loan.  The Bank generally makes loans on one- to four-family residential properties in amounts of 95% or less of the appraised value of the collateral.  When loans are made for amounts which exceed 80% of the appraised value of the underlying real estate, the Bank's general policy is to require private mortgage insurance on the portion of the loan in excess of 80% of the appraised value.  In general, the Bank restricts its residential lending to South Carolina and the nearby Augusta, Georgia market.
Construction loans are generally made for periods of six months to one year with either adjustable or fixed rates.  At December 31, 2016, residential construction loans on one- to four-family dwellings to owner-occupants totaled $9.9 million, or 2.7%, of the Bank's loan portfolio. On loans of this type, the Bank seeks to evaluate the financial condition and prior performance of the builder, as well as the borrower's creditworthiness and his or her general ability to make principal and interest payments, and the value of the property that will secure the loan.  On construction loans offered to individuals (non-builders), the Bank offers a construction/permanent loan.  The one year construction portion of the loan has a fixed rate ranging currently from 2.75% to 6.25% depending on which ARM program the borrower has chosen for the permanent portion of the loan after the construction period.  The borrower pays interest on the loan during the construction phase.  After construction, the loan then automatically converts, depending on the borrower's upfront selection, to a one year ARM, a three year/one year ARM, or a five year/one year ARM loan in which the borrower will pay principal and interest.  The borrower also has the option, after the construction period only, to convert the loan to a fixed rate residential mortgage loan which the Bank immediately sells on the secondary market on a servicing released basis.


7




Commercial Real Estate, Commercial Business and Multi-Family Loans.  The commercial business loans originated by the Bank are primarily secured by business equipment, furniture and fixtures, inventory and receivables, or are unsecured. At December 31, 2016, the Bank had $16.3 million, or 4.4% of its total loan portfolio, in commercial business loans.  A total of $964,000, or 5.9% of these loans were unsecured at December 31, 2016.

The commercial real estate loans originated by the Bank are primarily secured by non-residential commercial properties, churches, hotels, residential developments, single family construction loans to builders for speculative or pre-sold homes, lot loans to builders, income property developments, and undeveloped land.  At December 31, 2016, the Bank had $222.6 million, or 59.9% of its total loan portfolio, in commercial real estate loans and multi-family loans. Included in these loans at December 31, 2016 was $9.6 million in A&D loans with terms of typically two to three years. Also included in commercial real estate loans was $15.1 million in loans for the construction of single family dwellings to builders with a term of typically one year.

The multi-family loans originated by the Bank are primarily secured by commercial residential properties including apartment complexes, condominiums or townhouses, and loans for acquisition and development of, or improvements to multi-family residential properties. At December 31, 2016, the Bank had $13.6 million, or 3.7% of its total loan portfolio, in multi-family loans.

The following table summarizes the Bank's commercial real estate, multi-family, and commercial business loans by geographic market area at December 31, 2016.
 
Aiken County
Area
 
Midlands Area, SC
 
Metro
Augusta, GA
 
Other
 
Total
 
(In Thousands)
Commercial real estate                                                        
$
85,371

 
$
46,976

 
$
44,857

 
$
31,754

 
$
208,958

Multi-family                                                        
5,061

 
5,766

 
1,748

 
1,066

 
13,641

Commercial business                                                        
9,396

 
2,422

 
1,666

 
2,795

 
16,279

Total                                                        
$
99,828

 
$
55,164

 
$
48,271

 
$
35,615

 
$
238,878


Loans secured by commercial real estate are typically written for amortization terms of 10 to 20 years.  Commercial loans not secured by real estate are typically based on terms of three to 60 months.  Both commercial real estate loans and commercial business loans not secured by real estate can be originated on adjustable or fixed rate terms.  Adjustable rates are tied to the prime rate as quoted in The Wall Street Journal and typically adjust on a daily basis.  Since 2009, the Bank has instituted floors of typically 4% to 6% (currently 4%) on newly originated adjustable rate commercial business and commercial real estate loans.  If ceilings are used, the loan will typically require a balloon payment in 60 months or less.  Fixed rate loans on commercial real estate usually require a balloon payment in 36 to 60 months.  Fixed rate loans on non-real estate collateral are generally amortizing in five years or less.

Commercial real estate lending entails significant additional credit risk when compared to residential lending. Commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers.  Because payments on loans secured by commercial properties often depend upon the successful operation and management of the properties, repayment of these loans may be affected by adverse conditions in the real estate market or the economy.  In order to minimize the risks associated with this type of loan, the Bank generally limits the maximum loan-to-value ratio for commercial real estate to 65% to 80%, based on appraisals of the property at the time of the loan by appraisers designated by the Bank, and strictly scrutinizes the credit history, financial condition and cash flow of the borrower, the quality of the collateral and the expertise of management of the property securing the loan. Although the creditworthiness of the business and its principals is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount. A&D loans secured by improved lots generally involve greater risks than residential mortgage lending because these loans are more difficult to evaluate. If the estimate of value proves to be inaccurate, in the event of default and foreclosure, we may be confronted with a property, the value of which is insufficient to assure full payment.

8




Commercial business lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with lending that is secured by real estate. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan-to-collateral values, and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial business loans often have equipment, inventory, accounts receivable or other business assets as collateral, the liquidation of collateral in the event of a borrower default is often not a sufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other conditions. Accordingly, the repayment of a commercial business loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment. The Bank seeks to minimize these risks by strictly scrutinizing the borrower's current financial condition, ability to pay, past earnings and payment history.  In addition, the current financial condition and payment history of all principals are reviewed.  Typically, the Bank requires the principal or owners of a business to guarantee all loans made to their business by the Bank.  Although the creditworthiness of the business and its principals is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.

Federal law restricts the Bank's permissible lending limits to one borrower to the greater of $500,000 or 15% of unimpaired capital and surplus.  At December 31, 2016, the Bank's legal lending limit under this restriction was $14.5 million.  At that date, the Bank's largest loan relationship to a single borrower was $9.2 million.  South Carolina law restricts the Bank's permissible lending limits to one borrower to 10% of unimpaired capital unless prior approval is granted by a two-thirds vote of the Board of Directors, in which case the limit is increased to 15% of unimpaired capital.  The Bank's lending limit at 10% of unimpaired capital was $9.7 million at December 31, 2016.

Consumer Loans.  The Bank originates consumer loans for any personal, family or household purpose, including the financing of home improvements, loans to individuals for residential lots for a future home, automobiles, boats, mobile homes, recreational vehicles and education.  The Bank also makes consumer first and second mortgage loans secured by residences.  These loans typically do not qualify for sale in the secondary market, but are generally not considered sub-prime lending. In addition, the Bank offers home equity lines of credit.  Home equity loans are secured by mortgage liens on the borrower's principal or second residence. Home equity lines are open end lines of credit where the borrowers pay a minimum of interest only monthly on drawn lines.  The terms are for a maximum period of 20 years and the rate is a variable rate tied to prime and floats monthly.  Margins range from zero to one percent.  In 2012, the Bank instituted floors, which currently range from 3.25% to 4.25%, on new originations and a maximum loan-to-value ratio of 80% for first mortgages originated by Security Federal and 60% for first mortgages originated by other lenders. Previously, the maximum loan-to-value ratio was 90%, but was decreased because of the 2008 economic recession.  At December 31, 2016, the Bank had $24.6 million of home equity lines of credit outstanding and $26.0 million of additional commitments of home equity lines of credit.  The Bank also makes secured and unsecured lines of credit available.  Although consumer loans involve a higher level of risk than one- to four-family residential mortgage loans, they generally provide higher yields and have shorter terms to maturity than one- to four-family residential mortgage loans.  At December 31, 2016, the Bank had $50.7 million, or 13.6% of its loan portfolio, in consumer loans.
 
The Bank's underwriting standards for consumer loans include a determination of the applicant's payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan.  The stability of the applicant's monthly income is determined by verification of gross monthly income from primary employment, and from any verifiable secondary income.  Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.

The Bank also has a credit card program.  As of December 31, 2016, the Bank had issued 3,427 Visa credit cards with total approved credit lines of $7.4 million, of which $2.5 million was outstanding on that date.

Loan Delinquencies and Defaults

General.  The Bank's collection procedures provide that when a real estate loan is approximately 20 days past due, the borrower is contacted by mail and payment is requested.  If the delinquency continues for another 10 days, subsequent efforts are made to contact the delinquent borrower and establish a program to bring the loan current.  In certain instances, the Bank may modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his financial affairs.  If the loan continues in a delinquent status for 60 days or more, the Bank generally initiates foreclosure proceedings after the customer has been notified by certified mail.  The Bank institutes the same collection procedure for its commercial real estate loans.  

9





Delinquent Loans.  The following table sets forth information concerning delinquent loans at December 31, 2016.  
 
Real Estate
 
Non-Real Estate
 
 
 
Residential
 
Commercial
 
Consumer
 
Commercial
Business
 
 
 
Number
 
Amount
 
Number
 
Amount
 
Number
 
Amount
 
Number
 
Amount
 
Total
Loans delinquent for:
(Dollars in Thousands)
 
 
30 - 59 days
4

 
$
654

 
11

 
$
1,720

 
42

 
$
625

 
5

 
$
536

 
$
3,535

60 - 89 days

 

 
1

 
256

 
5

 
120

 
2

 
69

 
445

90 days and over
17

 
2,488

 
20

 
2,640

 
8

 
242

 
1

 
145

 
5,515

Total delinquent loans
21

 
$
3,142

 
32

 
$
4,616

 
55

 
$
987

 
8

 
$
750

 
$
9,495


Classified Assets.  Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered to be of lesser quality as "substandard," "doubtful" or "loss" assets.  The regulations require commercial banks to classify their own assets and to establish prudent general allowances for loan losses for assets classified "substandard" or "doubtful."  For the portion of assets classified as "loss," an institution is required to either establish specific allowances of 100% of the amount classified or charge off such amount.  In addition, the State Board and/or FDIC may require the establishment of a general allowance for losses based on assets classified as "substandard" and "doubtful" or based on the general quality of the asset portfolio of a Bank.  See "Regulation - Regulation of the Bank."

The Company uses a risk based approach based on the following credit quality measures consistent with regulatory guidelines 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 to have the least amount of risk in terms of determining the allowance for loan losses. Loans that are graded as substandard are considered to have the most risk. 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 90 days or more past due are automatically classified in this category. The caution and special mention categories fall in between the pass and substandard grades and consist of loans that do not currently expose the Company to sufficient risk to warrant adverse classification but possess weaknesses.

At December 31, 2016, $12.9 million of the total loan balance were classified "substandard" compared to $18.4 million at December 31, 2015. At December 31, 2016, $19.3 million were designated as "special mention" compared to $18.1 million at December 31, 2015. At December 31, 2016, $76.2 million were designated as “caution” compared to $49.1 million at December 31, 2015. The Bank had no loans classified as "doubtful" or "loss" at December 31, 2016 and 2015. According to generally accepted accounting principles, the Bank is required to account for certain loan modifications or restructuring as a “troubled debt restructuring” ("TDRs"). In general, the modification or restructuring of a debt is considered a TDR if the Bank, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that would not otherwise be considered. As of December 31, 2016, there were $4.6 million in TDRs compared to $6.7 million at December 31, 2015.  The Bank's classification of assets is consistent with FDIC regulatory classifications.

Non-performing Assets.  Loans are placed on non-accrual status when the collection of principal and/or interest becomes doubtful.  In addition, all loans are placed on non-accrual status when the loan becomes 90 days or more contractually delinquent.  All consumer loans more than 90 days delinquent are charged against the consumer loan allowance for loan losses unless there is adequate collateral which is in the process of being repossessed or foreclosed on.  At December 31, 2016, the Bank had $4.6 million in TDRs which involved restructuring the borrower's interest rate or principal on a loan or making other concessions on loans at a rate materially less than the market rate.  Other loans of concern are those loans (not delinquent more than 60 days) that management has determined need to be closely monitored as the potential exists for increased risk on these loans in the future.  Non-performing loans are reviewed monthly on a loan by loan basis.  Charge-offs, whether partial or in full, associated with these loans will vary based on estimates of recovery for each loan.


10



The following table sets forth the amounts and categories of risk elements in the Bank's loan portfolio.
 
At December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(Dollars in Thousands)
Loans Delinquent 60 to 89 Days:
 
 
 
 
 
 
 
 
 
Residential Real Estate
$

 
$
1,144

 
$
1,087

 
$
1,363

 
$
1,795

Consumer  
120

 
282

 
91

 
235

 
212

Commercial Business  
69

 

 
100

 

 
36

Commercial Real Estate     
256

 
930

 
1,095

 
2,047

 
4,852

Total  
$
445

 
$
2,356

 
$
2,373

 
$
3,645

 
$
6,895

Total as a percentage of total assets   
0.05
%
 
0.29
%
 
0.29
%
 
0.43
%
 
0.77
%
 
 
 
 
 
 
 
 
 
 
Non-Accruing Loans :
 
 
 
 
 
 
 
 
 
Residential Real Estate
$
2,488

 
$
3,307

 
$
3,061

 
$
4,608

 
$
3,758

Consumer     
242

 
576

 
574

 
398

 
646

Commercial Business  
145

 
178

 
247

 
33

 
87

Commercial Real Estate     
2,640

 
2,973

 
9,860

 
4,973

 
13,913

Total      
$
5,515

 
$
7,034

 
$
13,742

 
$
10,012

 
$
18,404

Total as a percentage of total assets           
0.68
%
 
0.88
%
 
1.66
%
 
1.18
%
 
2.07
%
TDRs  (1)     
$
4,595

 
$
6,714

 
$
9,630

 
$
12,394

 
$
15,941

OREO
$
2,721

 
$
4,361

 
$
3,230

 
$
3,947

 
$
6,754

Allowance for loan losses   
$
8,356

 
$
8,275

 
$
8,357

 
$
10,242

 
$
11,318

(1) Includes six loans with a balance of $1.1 million at December 31, 2016 that are also included in the Non-Accruing Loans section of this table.

Non-performing loans decreased $1.5 million or 21.6% to $5.5 million at December 31, 2016 from $7.0 million at December 31, 2015 primarily due to a decrease in non-performing residential real estate loans, which decreased $819,000 or 24.8% to $2.5 million at December 31, 2016 from $3.3 million at December 31, 2015. The balance in non-performing residential real estate loans at December 31, 2016 consisted of 17 loans to 17 borrowers with an average loan balance of $146,000, the largest of which was $352,000. At December 31, 2015, non-performing residential real estate loans consisted of 24 loans to 24 borrowers with an average loan balance of $138,000, the largest of which was $386,000.
Non-performing commercial real estate loans decreased $333,000 or 11.2% to $2.6 million at December 31, 2016 from $3.0 million at December 31, 2015. The balance in non-performing commercial real estate loans at December 31, 2016 consisted of 20 loans to 17 borrowers with an average loan balance of $132,000 compared to 17 loans to 14 borrowers with an average balance of $175,000 at December 31, 2015. Of the non-performing commercial real estate loans at December 31, 2016, $1.7 million consisted of 11 loans secured by commercial buildings or first mortgages on principal residences throughout the Bank's market area to 9 different borrowers. These loans, even though secured by principal residences, are considered commercial real estate because they were business purpose loans. The remaining non-performing commercial real estate loans at December 31, 2016 consisted of $335,000 for two loans secured by builder lots to two borrowers; $233,000 for six loans secured by raw land to six separate borrowers; and $406,000 for one loan secured by a church building. At December 31, 2016, our largest non-performing commercial real estate loan had a balance of $557,000 and was secured by a commercial building.
Also included in non-accruing loans at December 31, 2016 were eight consumer loans totaling $242,000 and one commercial business loan totaling $145,000.  Of the eight consumer loans on non-accrual status at December 31, 2016, the largest had a balance of $89,000.  
At December 31, 2016, there were no accruing loans equal to or more than 90 days delinquent. For the year ended December 31, 2016, the interest income not recognized that would have been recognized with respect to non-accruing loans, had such loans been current in accordance with their original terms and with respect to TDRs, had such loans been current in accordance with their original terms, totaled $687,000 compared to $679,000 for the year ended December 31, 2015.  For the year ended December 31, 2016 actual interest recorded on these loans was $261,000 compared to $296,000 for the year ended December 31, 2015.


11




Troubled Debt Restructurings. The Bank identifies and reviews all loans to be restructured based on an assessment of the borrower's credit status. This assessment is a continuous process that involves a review of the financial statements and prospects for repayment, payment delinquency, non-accrual status, and risk rating.

Not all loan modifications are TDRs. The Bank designates a loan modification as a TDR when the following two conditions are present: the borrower is experiencing financial difficulty, and because of this difficulty, the Bank grants a concession it would not otherwise consider. Typically these concessions involve a change in the interest rate, maturity date or payment amount or some combination of each. These concessions rarely result in the forgiveness of principal or interest. TDRs are considered impaired and are initially reported as non-performing loans on non-accrual status. Non-performing TDRs may be returned to accrual status when payment in full of all amounts due under the restructured terms is anticipated and the borrower has demonstrated a sustained payment history which is typically six months.

The Bank did not modify any loans that were considered to be TDRs during the year ended December 31, 2016. The Bank had 12 loans totaling $4.6 million at December 31, 2016 which were TDRs modified in prior years, compared to 16 loans totaling $6.7 million at December 31, 2015. The 12 TDRs consisted of one consumer loan secured by a first mortgage on a residential dwelling and two automobiles totaling $60,000; one unsecured consumer loan with a balance of $21,000; and 10 commercial real estate loans to 9 separate borrowers, the largest of which had a balance of $2.5 million at December 31, 2016. The commercial real estate loans were secured primarily by first mortgages on one single family residence, two lots, one commercial building, one hotel, three churches and three parcels of land. 

At December 31, 2016, two TDRs totaling $599,000 that had previously been restructured as TDRs were in default. Neither loan had been restructured within the last 12 months. All of the remaining TDRs were current at December 31, 2016. The Bank considers any loan 30 days or more past due to be in default.

Potential Problem Loans. Potential problem loans include substandard loans that are not already included as non-accrual loans or TDRs and special mention loans where management has become aware of information regarding possible credit issues for borrowers that could potentially cause doubt about their ability to comply with current repayment terms. At December 31, 2016 and 2015, the Bank had identified $26.7 million and $29.5 million, respectively, of potential problem loans through its internal loan review procedures.

Repossessed Assets.  OREO had a balance of $2.7 million at December 31, 2016 and consisted of the following real estate properties: nine single-family residences and 22 lots within residential subdivisions located throughout our market area in South Carolina and Georgia; eight lots within a subdivision and the adjacent 22.96 acres of land in Aiken, South Carolina; four parcels of commercial land and two commercial buildings in Aiken, South Carolina.

Provision for Losses on Loans.  Security Federal recognizes that it will experience credit losses during the course of making loans and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a secured loan, the quality of the underlying security for the loan.  The Bank seeks to establish and maintain sufficient reserves for estimated losses on specifically identified loans and real estate where such losses can be estimated.  Additionally, general reserves for estimated possible losses are established on specified portions of the Bank's portfolio such as consumer loans and higher risk residential construction mortgage loans based on management's estimate of the potential loss for loans which normally can be classified as higher risk.  Specific and general reserves are based on, among other criteria: (1) the risk characteristics of the loan portfolio, (2) current economic conditions on a local as well as a statewide basis, (3) actual losses experienced historically and (4) the level of reserves for possible losses in the future.  

At December 31, 2016, the allowance for loan losses or reserve was $8.4 million.  In determining the adequacy of the reserve for loan losses, management reviews past experience of loan charge-offs, the level of past due and non-accrual loans, the size and mix of the portfolio, general economic conditions in the market area, and individual loans to identify potential credit problems.  Commercial business, commercial real estate and consumer loans were $289.5 million, or 77.9% of the total loan portfolio, at December 31, 2016.  Although these types of loans carry a higher level of credit risk than conventional residential mortgage loans, the level of reserves reflects management's continuing evaluation of this risk based on the Bank's past loss experience.  At December 31, 2016, the Bank's ratio of loans delinquent more than 60 days to total assets was 0.73%.  The reserve is management's best estimate for offsetting risk for our estimated possible losses. There can be no guarantee that the estimate is adequate or accurate.  





12




Management believes that reserves for loan losses are at a level adequate to provide for inherent loan losses.  Although management believes that it has considered all relevant factors in its estimation of future losses, future adjustments to reserves may be necessary if conditions change substantially from the assumptions used in making the original estimations.  Regulators will from time to time evaluate the allowance for loan losses which is subject to adjustment based upon the information available to the regulators at the time of their examinations.

The following table sets forth an analysis of the Bank's allowance for loan losses during the dates indicated.
 
Years Ended December 31,
 
Nine Months Ended December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(Dollars in Thousands)
Balance at beginning of period 
$
8,275

 
$
8,358

 
$
10,242

 
$
11,318

 
$
14,615

Provision for loan losses  
500

 

 
450

 
2,645

 
1,975

Charge-offs:
 
 
 
 
 
 
 
 
 

Residential real estate  
197

 
217

 
359

 
1,118

 
647

Commercial business and commercial real estate
524

 
773

 
2,383

 
3,884

 
6,488

Consumer   
242

 
527

 
372

 
207

 
287

Total charge-offs   
963

 
1,517

 
3,114

 
5,209

 
7,422

Recoveries:
 
 
 

 
 

 
 

 
 

Residential real estate   
11

 
94

 
136

 
273

 
57

Commercial business and commercial real estate
446

 
1,186

 
585

 
1,156

 
2,075

Consumer            
87

 
154

 
59

 
59

 
18

Total recoveries    
544

 
1,434

 
780

 
1,488

 
2,150

Balance at end of period      
$
8,356

 
$
8,275

 
$
8,358

 
$
10,242

 
$
11,318

Ratio of net charge-offs to average loans outstanding during the period (1)    
0.12
%
 
0.02
%
 
0.66
%
 
0.99
%
 
1.72
%

(1) Annualized for the nine month period ended December 31, 2012


The following table summarizes the distribution of the Bank's allowance for loan losses at the dates indicated.  The entire allowance is available to absorb losses from all loan categories.

 
December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
Amount
 
% of Total
Loans
 
Amount
 
% of Total
Loans
 
Amount
 
% of Total
Loans
 
Amount
 
% of Total
Loans
 
Amount
 
% of Total
Loans
 
(Dollars in Thousands)
Residential Real Estate                         
$
1,360

 
16.3
%
 
$
1,323

 
16.0
%
 
$
1,392

 
22.2
%
 
$
1,706

 
22.6
%
 
$
1,522

 
23.2
%
Consumer                          
997

 
11.9

 
1,063

 
12.8

 
887

 
14.5

 
848

 
14.0

 
1,001

 
13.7

Commercial Business
883

 
10.6

 
774

 
9.4

 
159

 
3.0

 
426

 
2.1

 
619

 
2.0

Commercial Real Estate
5,116

 
61.2

 
5,115

 
61.8

 
5,920

 
60.3

 
7,261

 
61.3

 
8,176

 
61.1

Total                          
$
8,356

 
100.0
%
 
$
8,275

 
100.0
%
 
$
8,358

 
100.0
%
 
$
10,241

 
100.0
%
 
$
11,318

 
100.0
%



13




Subsidiaries

At December 31, 2016, Security Federal's net investment in its subsidiaries (including loans to subsidiaries) totaled $5.7 million.  In addition to investments in subsidiaries, federal institutions are permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities which a commercial bank may engage in directly.

Security Federal Insurance, Inc. ("SFINS").  SFINS, a wholly owned subsidiary of the Bank, was formed during the 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, and premium finance.   The operations of SFINS are included in the Company's Consolidated Financial Statements.

Collier Jennings Financial Corporation.  Collier Jennings Financial Corporation is a subsidiary of SFINS, a subsidiary of the Bank, which is described above.  The Company acquired the insurance and insurance premium finance businesses of Collier Jennings Financial Corporation and its subsidiaries, Security Federal Auto Insurance, Inc., The Auto Insurance Store, Inc., and Security Federal Premium Pay Plans, Inc. (the "Collier-Jennings Companies"), effective June 30, 2006.

Investment Activities

Investment securities.  The Bank has authority to invest in various types of liquid assets, including U.S. Treasury obligations and securities of various federal agencies, certificates of deposit at insured institutions, mutual funds, bankers' acceptances and federal funds.  The Bank may also invest a portion of its assets in certain commercial paper and corporate debt securities.  See "Regulation - Regulation of the Bank."

As a member of the Federal Home Loan Bank ("FHLB") System, Security Federal must maintain minimum levels of investments that are liquid assets as defined in Federal regulations.  See "Regulation - Regulation of the Bank - Federal Home Loan Bank System."  Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans.

Historically, the Bank has maintained its liquid assets at a level believed adequate to meet requirements of normal daily activities, repayment of maturing debt and potential deposit outflows.  Management regularly reviews and updates cash flow projections to assure that adequate liquidity is provided.


14




The following table sets forth the fair value of the Company's portfolio of securities and other investments, excluding mortgage-backed securities, at the dates indicated.
 
December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(In Thousands)
 
 
Interest bearing deposit at FHLB       
$
179

 
$
490

 
$
2,252

 
$
321

 
$
226

Certificates of deposits at financial institutions
2,445

 
3,445

 
2,095

 
2,100

 
1,729

Total other investments   
$
2,624

 
$
3,935

 
$
4,347

 
$
2,421

 
$
1,955

 
 
 
 
 
 
 
 
 
 
Investment Securities:
 
 
 
 
 
 
 
 
 
Available for Sale:
 
 
 
 
 
 
 
 
 
FHLB securities    
$
998

 
$
1,932

 
$
13,247

 
$
12,671

 
$
6,165

Federal Farm Credit Bank ("FFCB") bonds

 
1,988

 
5,668

 
5,366

 

Fannie Mae bonds     

 
1,004

 
1,004

 
1,975

 

Small Business Administration ("SBA") bonds     
101,906

 
111,417

 
108,127

 
100,824

 
96,462

Tax exempt municipal bonds    
71,535

 
76,066

 
62,495

 
61,315

 
37,482

Taxable municipal bonds    
1,991

 

 

 

 

Equity securities       
368

 
310

 
307

 
256

 
75

Total securities available for sale     
$
176,798

 
$
192,717

 
$
190,848

 
$
182,407

 
$
140,184

 
 
 
 
 
 
 
 
 
 
Held to Maturity:
 
 
 
 
 
 
 
 
 
FHLB securities                 
$

 
$

 
$

 
$

 
$
7,996

FFCB securities       

 

 

 

 
6,796

Fannie Mae bonds        

 

 

 

 
2,022

Freddie Mac bonds      

 

 

 

 
1,998

SBA bonds        

 

 

 

 
5,866

Equity securities             

 

 

 

 
155

Total securities held to maturity      
$

 
$

 
$

 
$

 
$
24,833

Total securities (1)       
$
176,798

 
$
192,717

 
$
190,848

 
$
182,407

 
$
165,017

 
 
 
 
 
 
 
 
 
 
FHLB stock    
2,777

 
2,215

 
3,145

 
5,017

 
6,179

Total securities and FHLB stock (1)    
$
179,575

 
$
194,932

 
$
193,993

 
$
187,424

 
$
165,023

___________
(1)      Does not include mortgage-backed securities.

At December 31, 2016, the Company did not have any investment securities (exclusive of obligations of the U.S. Government and federal agencies) issued by any one entity with a total book value in excess of 10% of its shareholders' equity. SBA bonds are backed by the full faith and credit of the U.S. government and carry a zero percent risk base when calculating risk based assets for regulatory capital purposes. The FHLB, FFCB, Fannie Mae and Freddie Mac are government sponsored enterprises ("GSEs") and the securities and bonds issued by GSEs are not backed by the full faith and credit of the U.S. government.  





15




The following table sets forth the maturities or repricing of investment securities, not including mortgage-backed securities, and FHLB stock at December 31, 2016, and the weighted average yields of such securities and FHLB stock (calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security).  Tax equivalent yields on tax exempt municipal bonds are calculated using a 34% tax rate.  Callable securities are shown at their likely call dates based on current interest rates.  The table was prepared using amortized cost.  SBA bonds are based on maturity dates without the effect of scheduled payments or anticipated prepayments.
 
Maturing or Repricing
 
December 31, 2016
 
Within One Year
 
After One But Within Five Years
 
After Five But Within Ten Years
 
After Ten Years
 
Balance
Outstanding
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
(Dollars in Thousands)
GSE securities                               
$
998

 
2.05
%
 
$

 
%
 
$

 
%
 
$

 
%
 
$
998

 
2.05
%
SBA bonds                                        
81,810

 
2.00

 
1,750

 
2.68

 
10,176

 
2.72

 
7,545

 
2.66

 
101,281

 
2.14

Tax exempt municipal bonds

 

 
528

 
1.70

 
61,539

 
2.93

 
10,182

 
3.63

 
72,249

 
3.02

Taxable municipal bonds

 

 
2,021

 
2.39

 

 

 

 

 
2,021

 
2.39

FHLB stock (1)                                        
2,215

 
4.78

 

 

 

 

 

 

 
2,215

 
4.78

Other equity securities                                        
250

 
1.93

 

 

 

 

 

 

 
250

 
1.93

Total (2)                                        
$
85,273

 
2.08
%
 
$
4,299

 
2.42
%
 
$
71,715

 
2.90
%
 
$
17,727

 
3.22
%
 
$
179,014

 
2.53
%
___________
(1)   FHLB stock has no stated maturity date.
(2)   Excludes mortgage-backed securities with a total amortized cost of $209.2 million and a yield of 2.26%.

For information regarding the market value of the Bank's securities portfolios, see Notes 2 and 3 of the Notes to Consolidated Financial Statements contained in the Annual Report.

Mortgage-backed Securities.  Security Federal has a portfolio of mortgage-backed securities in its portfolio. Mortgage-backed securities can serve as collateral for borrowings and, through repayments, as a source of liquidity.  Under the Bank's risk-based capital requirement, mortgage-backed securities have a risk weight of 20% (or 0% in the case of Government National Mortgage Association ("Ginnie Mae") securities) compared to the 50% risk weight carried by residential loans.  

The following table sets forth the composition of the mortgage-backed securities available for sale portfolio at fair value and the held to maturity portfolio at amortized cost at the dates indicated.

 
December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(In Thousands)
Available for sale, at fair value:
 
 
 
 
 
 
 
 
 
Freddie Mac                                           
$
32,084

 
$
29,973

 
$
41,348

 
$
40,721

 
$
28,560

Fannie Mae                                           
24,219

 
30,518

 
36,882

 
34,339

 
45,002

Ginnie Mae                                           
109,222

 
118,539

 
160,623

 
173,537

 
141,170

Private Label
19,736

 
3,767

 

 

 

Total                                           
$
185,261

 
$
182,797

 
$
238,853

 
$
248,597

 
$
214,732

Held to maturity, at cost:
 
 
 
 
 
 
 
 
 
Freddie Mac                                           
$
7,836

 
$
7,604

 
$

 
$

 
$
4,060

Fannie Mae                                           
1,436

 
1,761

 

 

 

Ginnie Mae                                           
16,312

 
20,508

 

 

 
47,179

Total                                           
$
25,584

 
$
29,873

 
$

 
$

 
$
51,239


At December 31, 2016, the Company did not have any mortgage-backed securities (exclusive of obligations of agencies of the U.S. Government) issued by any one entity with a total book value in excess of 10% of shareholders equity.

16




Freddie Mac and Fannie Mae mortgage-backed securities are GSE issued securities.  GSE securities are not backed by the full faith and credit of the U.S. government.  The private label CMO securities are issued by non-governmental real estate mortgage investment conduits, which are also not backed by the full faith and credit of the U.S. government.  Ginnie Mae mortgage-backed securities are backed by the full faith and credit of the U.S. government.

For information regarding the market values of Security Federal's mortgage-backed securities portfolio, see Notes 2 and 3 of the Notes to Consolidated Financial Statements contained in the Annual Report.

The following table sets forth the final maturities or initial repricings, whichever occurs first, and the weighted average yields of the mortgage-backed securities at December 31, 2016.  Not considered in the preparation of the table below is the effect of scheduled payments or anticipated prepayments.  The table is prepared using amortized cost.
 
The Earliest of Maturing or Repricing
 
December 31, 2016
 
Less than
1 Year
 
1 to 5
Years
 
5 to 10
Years
 
Over
10 Years
 
Balance
Outstanding
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
Amount
 
Yield
 
(Dollars in Thousands)
Fannie Mae
$
14,625

 
1.17
%
 
$
1,315

 
2.76
%
 
$
3,101

 
3.13
%
 
$
6,100

 
3.19
%
 
$
25,141

 
1.98
%
Freddie Mac
5,029

 
1.43

 
3,574

 
2.62

 
11,548

 
2.51

 
19,730

 
2.78

 
39,881

 
2.52

Ginnie Mae
50,652

 
1.43

 
7,175

 
3.04

 
4,202

 
3.26

 
62,200

 
2.60

 
124,229

 
2.17

Private Label
18,025

 
2.73

 

 

 

 

 
1,966

 
1.60

 
19,991

 
2.62

Total                
$
88,331

 
1.65
%
 
$
12,064

 
2.89
%
 
$
18,851

 
2.78
%
 
$
89,996

 
2.66
%
 
$
209,242

 
2.26
%

Sources of Funds

Deposit accounts have traditionally been a principal source of the Bank's funds for use in lending and for other general business purposes.  In addition to deposits, the Bank derives funds from loan repayments, cash flows generated from operations (including interest credited to deposit accounts), FHLB of Atlanta advances, borrowings from the Federal Reserve Bank of Atlanta ("Federal Reserve"), the sale of securities under agreements to repurchase, and loan sales.  See "- Borrowings" below and Note 10 of the Notes to Consolidated Financial Statements contained in the Annual Report.  Scheduled loan payments are a relatively stable source of funds while deposit inflows and outflows and the related cost of such funds have varied widely.  FHLB of Atlanta advances, borrowings from the Federal Reserve Bank and the sale of securities under agreements to repurchase may be used on a short-term basis to compensate for seasonal reductions in deposits or deposit inflows at less than projected levels and may be used on a longer term basis in support of expanded lending activities.  The availability of funds from loan sales is influenced by gene