SECURITY FEDERAL CORP - FORM 10-K - EX-13 - EXHIBIT 13

Attached files

file	filename
EX-32 - EXHIBIT 32 - SECURITY FEDERAL CORP	sfdl-20191231xex32.htm
EX-31.2 - EXHIBIT 31.2 - SECURITY FEDERAL CORP	sfdl-20191231xex312.htm
EX-31.1 - EXHIBIT 31.1 - SECURITY FEDERAL CORP	sfdl-20191231xex311.htm
EX-23 - EXHIBIT 23 - SECURITY FEDERAL CORP	sfdl-20191231exhibit23.htm
EX-21 - EXHIBIT 21 - SECURITY FEDERAL CORP	sfdl-20191231exhibit21.htm
EX-4.2 - EXHIBIT 4.2 - SECURITY FEDERAL CORP	sfdl-20191231xex42.htm
10-K - 10-K - SECURITY FEDERAL CORP	sfdl-20191231x10k.htm

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

The following table provides selected consolidated financial and operating data of Security Federal Corporation 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.



	Years Ended December 31,
	2019		2018		2017		2016			2015
Balance Sheet Data at End of Period	(Dollars in Thousands, Except Per Share Data)
Total Assets	$	963,228	$	912,614	$	868,813	$	812,682		$	799,728
Cash and Cash Equivalents	12,536		12,706		10,320		9,375			8,382
Certificates of Deposit with Other Banks	950		1,200		1,950		2,445			3,445
Investment and Mortgage-Backed Securities	433,892		409,894		412,055		387,643			405,387
Total Loans Receivable, Net ⁽¹⁾	452,859		430,054		390,493		359,723			330,573
Deposits	771,407		767,497		702,107		654,103			652,097
Total Shareholders' Equity	91,758		80,518		77,923		71,112			90,967
Income Data
Total Interest Income	$	36,934	$	33,072	$	29,787	$	28,388		$	27,906
Total Interest Expense	8,311		5,449		4,175		3,516			4,199
Net Interest Income	28,623		27,623		25,612		24,872			23,707
Provision For Loan Losses	375		925		300		500			—
Net Interest Income After Provision For Loan Losses	28,248		26,698		25,312		24,372			23,707
Non-Interest Income	9,097		7,669		7,344		6,401			7,007
Non-Interest Expense	27,871		25,590		24,302		22,928			22,531
Income Taxes ⁽²⁾	1,680		1,570		2,435		1,920			2,067
Net Income	7,794		7,207		5,919		5,925			6,116
Preferred Stock Dividends	—		—		—		(423		)	(440		)
Gain on Redemption of Preferred Stock	—		—		—		660			—
Net Income Available To Common Shareholders	$	7,794	$	7,207	$	5,919	$	6,162		$	5,676
Per Common Share Data
Net Income Per Common Share (Basic)	$	2.64	$	2.44	$	2.01	$	2.09		$	1.93
Cash Dividends	$	0.40	$	0.36	$	0.36	$	0.32		$	0.32

^{(1) INCLUDES LOANS HELD FOR SALE}


⁽²⁾	^{FOR THE YEAR ENDED DECEMBER 31, 2017, INCLUDES $606,000 FOR THE DEFERRED TAX ASSET WRITEDOWN DUE TO THE COMPREHENSIVE TAX LEGISLATION ENACTED ON DECEMBER 22, 2017, COMMONLY REFERRED TO AS THE TAX CUTS AND JOBS ACT (THE "TAX ACT").}

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Selected Consolidated Financial and Other Data



	Years Ended December 31,
	2019		2018		2017		2016		2015
Other Data
Interest Rate Spread Information:
Average During Period	3.10	%	3.27	%	3.27	%	3.33	%	3.15	%
End of Period	2.86	%	3.33	%	3.19	%	3.18	%	3.15	%
Net Interest Margin (Net Interest Income / Average Earning Assets)	3.26	%	3.38	%	3.34	%	3.40	%	3.23	%
Average Interest-Earning Assets to Average Interest-Bearing Liabilities	116.83	%	116.01	%	113.80	%	115.08	%	114.60	%
Common Equity to Total Assets	9.53	%	8.82	%	8.97	%	8.75	%	8.62	%
Non-Performing Assets to Total Assets ⁽³⁾	0.43	%	0.85	%	0.79	%	1.01	%	1.42	%
Return on Assets	0.80	%	0.81	%	0.69	%	0.74	%	0.69	%
Return on Common Equity	8.90	%	9.30	%	7.87	%	8.45	%	8.46	%
Average Common Equity to Average Assets Ratio	9.05	%	8.69	%	8.77	%	8.82	%	8.17	%
Dividend Payout Ratio on Common Shares⁽⁴⁾	14.41	%	14.76	%	17.92	%	15.16	%	16.61	%
Number of Full-Service Offices	17		16		15		14		14

^{(3) NON-PERFORMING ASSETS CONSIST OF NON-ACCRUAL LOANS AND OTHER REAL ESTATE OWNED ("OREO")}

^{(4) RATIO OF DIVIDENDS PAID ON COMMON SHARES TO NET INCOME AVAILABLE TO COMMON SHAREHOLDERS}

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

General

The following discussion and analysis 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. Because we conduct all of our material business operations through Security Federal Bank (the "Bank"), a wholly owned subsidiary of the Company, the following discussion of financial results are primarily indicative of the activities of the Bank. 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.

The Bank also has three wholly owned subsidiaries: Security Federal Insurance Inc. (“SFINS”), Security Federal Investments, Inc. ("SFINV"), and Security Financial Services Corporation (“SFSC”). 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. SFINV was formed to hold investment securities and allow for better management of the securities portfolio. SFSC is currently inactive.

In addition to the Bank, the Company 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 commercial real estate, as well as loans for the acquisition, development and construction of residential subdivisions, and commercial projects. The Bank also provides trust services and it offers property, casualty and health insurance products through its subsidiary, Security Federal Insurance Inc.

The Bank's net income depends primarily 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. When the rate earned on interest-earning assets equals or exceeds the rate paid on interest-bearing liabilities, this positive interest rate spread will generate net interest income. 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. 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 or financial items, 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 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 allowance for loan losses;


•	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 originate and 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 the Bank 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;


•	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 risks associated with the loans on our balance sheet;


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


•	disruptions, security breaches, or other adverse events, failures or interruptions in, or attacks on, our information technology systems or on the third-party vendors who perform several of our critical processing;

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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


•	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;


•	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 ("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, including the potential effects of coronavirus on international trade (including supply chains and export levels),


•	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, 2019 under Item 1A, “Risk Factors.” Such developments could have an adverse impact on our financial position and our results of operations.

Any of the forward-looking statements that we make may turn out to be inaccurate as a result of our beliefs and assumptions we make in connection with the factors set forth above or because of other unidentified and unpredictable factors. Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements and you should not rely on such statements. The Company undertakes no obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. These risks could cause our actual results for 2020 and beyond to differ materially from those expressed in any forward-looking statements by or on behalf of us, and could negatively affect the Company’s consolidated financial condition and consolidated results of operations, liquidity and stock price performance.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Critical Accounting Policies

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

Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities; management considers these accounting policies to be critical accounting policies. The judgments, estimates 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, estimates and assumptions made by management, actual results could differ from these judgments, estimates and assumptions, 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, estimates and assumptions used in preparation of the Consolidated Financial Statements. The impact of an unexpected large loss could deplete the allowance and potentially require increased provisions to replenish the allowance, which would negatively affect earnings. The Company provides for loan losses using the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to the allowance for loan losses. Additions to the allowance for loan losses are provided by charges to operations based on various factors, which, in management’s judgment, deserve current recognition in estimating possible losses. Such factors considered by management include the fair value of the underlying collateral, stated guarantees by the borrower (if applicable), the borrower’s ability to repay from other economic resources, growth and composition of the loan portfolio, the relationship of the allowance for loan losses to the outstanding loans, loss experience, delinquency trends, and general economic conditions. Management evaluates the carrying value of the loan portfolio monthly and adjusts the allowance accordingly. While management uses the best information available to make evaluations, future adjustments may be necessary if economic conditions differ substantially from the assumptions used in making these evaluations. The allowance for loan losses is subject to periodic evaluations by bank regulatory agencies that may require adjustments to the allowance based upon the information that is available at the time of their examination. For a further discussion of the Company’s estimation process and methodology related to the allowance for loan losses, see the discussion under the section entitled “Financial Condition” and “Comparison of the Years Ended December 31, 2019 and 2018-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 contractual terms of the original 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 payments received are applied to principal. Once the recorded principal balance has been reduced to zero, any additional payments received are applied to interest income to the extent that any interest has been foregone. Any additional payments received are recorded as recoveries of any amounts previously charged off. When the repayment of the loan is not in doubt, payments are applied under the contractual terms of the loan agreement first to interest and then to principal.

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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Asset and Liability Management

The objective of the Bank’s program of asset and liability management is to limit the Bank’s vulnerability to material and prolonged increases or decreases in interest rates, or "interest rate risk." As a financial institution, interest rate risk is the Company’s most significant market risk. The earnings and economic value of our shareholders’ equity varies in relation to changes in interest rates and the corresponding impact on the market values of our assets and liabilities. The Bank has an Asset Liability Management Committee (“ALCO”) who monitors the Bank’s asset liability strategy.

The asset/liability management process is designed to achieve relatively stable net interest margins and assure liquidity by coordinating the volumes, maturities or re-pricing opportunities of interest-earning assets, deposits and borrowed funds. It is the responsibility of the ALCO to determine and achieve the most appropriate volume and mix of interest-earning assets and interest-bearing liabilities, as well as ensure an adequate level of liquidity and capital, within the context of corporate performance goals. The ALCO meets regularly to review interest rate risk and liquidity in relation to present and potential market conditions and evaluate funding and balance sheet management strategies to ensure the level of risk is consistent with our asset/liability objectives.

Simulation is the principal tool used by the Bank in its ongoing effort to measure interest rate risk. Simulation involves the use of a financial modeling system that provides reports showing the current and future impact of changes in interest rates, strategies and tactics. The Bank uses two dynamic methods; net interest income (“NII”) simulation and economic value of equity (“EVE”) analysis. The NII simulation models the impact that changes in interest rates will have on our earnings while EVE models the impact those changes will have on the net present value of our asset and liability portfolios. These models take into account our contractual agreements with regard to investments, loans, deposits, and borrowings but also include assumptions surrounding market and customer behavior under different rate scenarios. The assumptions we use are based upon a combination of proprietary and market data that reflect historical results and current market conditions. These assumptions relate to interest rates, prepayments, deposit decay rates and the market value of certain assets and liabilities under the various interest rate scenarios. We use market data to determine prepayments and maturities of loans, investments and borrowings and use our own assumptions on deposit decay rates except for time deposits. Time deposits are modeled to reprice to market rates upon their stated maturities. We also assume that non-maturity deposits can be maintained with rate adjustments not directly proportionate to the change in market interest rates, based upon our historical deposit rates. We have demonstrated in the past that the tiering structure of our deposit accounts during changing rate environments results in relatively lower volatility and less than market rate changes in our interest expense for deposits. These assumptions are based upon our analysis of our customer base, competitive factors, and historical experience. While these models are dependent on the accuracy of the assumptions that underlie the process, we believe that such modeling provides a better illustration of our sensitivity to interest rate risk than does a traditional static gap analysis. These tools provide our ALCO with the capability to estimate and manage the amount of earnings at risk in future periods and in selected interest rate risk environments.

NII Simulation- The Bank’s primary focus is on NII simulation. Using NII simulation, the Bank measures earnings exposure over both a twelve and twenty-four month period under multiple instantaneous rate shock scenarios. The Bank’s policy provides the maximum acceptable negative impact on net interest income and return on assets over each time horizon associated with each respective change in interest rates. Our ALCO monitors compliance with these policy limits and reports them to the Board of Directors quarterly.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

The following table indicates the NII simulation scenarios modeled and the applicable policy parameters.



Change in Market Rates	Maximum Allowable Change in NII Over		Maximum Allowable Change in ROA Over
(in Basis Points)	12 Months	24 Months	12 Months	24 Months
400	(20)%	(20)%	(40)%	(40)%
300	(15)%	(15)%	(30)%	(30)%
200	(10)%	(10)%	(20)%	(20)%
100	(7.5)%	(7.5)%	(10)%	(10)%
—	—%	—%	—%	—%
(100)	(7.5)%	(7.5)%	(10)%	(10)%
(200)	(10)%	(10)%	(20)%	(20)%
(300)	(15)%	(15)%	(30)%	(30)%
(400)	(20)%	(20)%	(40)%	(40)%

EVE simulation- The EVE analysis serves as an indicator of the extent to which the present value of our capital could change, given potential changes in interest rates. The difference represented by the present value of assets minus the present value of liabilities is defined as the economic value of equity. This measure assumes a static balance sheet and does not incorporate any growth assumptions, but does assume loan prepayments and certain other cash flows occur. It provides a measure of rate risk extending beyond the twelve or twenty - four month time horizon contained in the NII simulation analyses. While an instantaneous and severe shift in interest rates is used in this analysis to provide an estimate of exposure under an extremely adverse scenario, a gradual shift in interest rates would have a much more modest impact. Since EVE measures the discounted present value of cash flows over the estimated lives of instruments, the change in EVE does not directly correlate to the degree that earnings would be impacted over a shorter time horizon, i.e., the next fiscal year. Further, EVE does not take into account factors such as future balance sheet growth, changes in product mix, change in yield curve relationships, and changing product spreads that could mitigate the adverse impact of changes in interest rates.

The following table indicates the EVE simulation scenarios modeled and the applicable policy parameters.



Change in Market Rates (In Basis Points)		Maximum Change in Economic Value of Equity
400		(40)%
300		(30)%
200		(20)%
100		(10)%
—		—%
(100)		(10)%
(200)		(20)%
(300)		(30)%
(400)		(40)%

In evaluating the Bank's exposure to interest rate risk, certain shortcomings inherent in the method of analysis described above are considered. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual occurrences to differ from underlying assumptions. For example, loan repayment rates and withdrawals of deposits will likely differ substantially from the assumptions used in the simulation models 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. In addition, this analysis does not consider any strategic changes to our balance sheet which management may consider as a result of changes in market conditions.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Financial Condition - Assets

Total assets increased $50.6 million or 5.5% to $963.2 million at December 31, 2019 from $912.6 million at December 31, 2018. This increase was primarily due to increases in investments mortgage-backed securities and net loans receivable.

Cash and cash equivalents decreased $170,000 or 1.3% to $12.5 million at December 31, 2019 compared to $12.7 million at December 31, 2018. Total investments and mortgage-backed securities increased $24.2 million or 5.9% to $433.9 million at December 31, 2019 from $409.7 million at December 31, 2018 as a result of purchases of investment and mortgage-backed securities exceeding maturities, principal paydowns, and securities sold during the year. The Bank purchased 89 investment and mortgage-backed securities for a total purchase price of $190.8 million during the year ended December 31, 2019 compared to purchases of 68 investment and mortgage-backed securities for a total purchase price of $114.6 million during the prior year.

Total net loans receivable increased $22.8 million or 5.3% to $452.9 million at December 31, 2019 from $430.1 million at December 31, 2018 primarily as a result of increases in commercial real estate and residential real estate loans. Commercial real estate loans held for investment increased $27.6 million or 10.0% to $303.6 million at December 31, 2019 from $276.0 million at December 31, 2018. Residential real estate loans held for investment increased $2.4 million or 2.9% to $86.4 million at December 31, 2019 from $84.0 million at December 31, 2018. During the year ended December 31, 2019, the Bank originated $25.6 million in adjustable rate residential real estate loans (“ARMs”) for investment purposes. Loans held for sale, comprised of fixed rate residential loans, increased $2.2 million or 123.9% to $4.0 million at December 31, 2019 from $1.8 million at December 31, 2018.

At December 31, 2019, the Bank’s residential real estate loans held for investment included $15.3 million in longer term fixed rate residential mortgage loans. Typically, long term, newly originated fixed rate residential real estate loans are not retained in the portfolio but are sold immediately in contrast to ARMs, which are typically retained in the portfolio. The Bank sells all its fixed rate residential loans on a service-released basis. Fixed rate residential loans sold to institutional investors, on a service-released basis totaled $61.9 million during the year ended December 31, 2019, $44.1 million during the year ended December 31, 2018 and $40.8 million during the year ended December 31, 2017. At December 31, 2019, the Bank held $71.1 million or 78.7% of its residential real estate loans held for investment in ARMs and $19.3 million, or 21.3%, in fixed rate residential loans. The Bank's remaining loan portfolio included $95.0 million of adjustable rate and $287.1 million of fixed rate consumer, commercial business and commercial real estate loans, or 20.1% and 60.8% of total loans, respectively, at December 31, 2019.

During the year ended December 31, 2019, the Bank originated $280.6 million in new and renewed consumer and commercial loans. The Bank's portfolio of consumer and commercial loans was $382.1 million at December 31, 2019, $361.0 million at December 31, 2018, and $321.4 million at December 31, 2017. Consumer loans decreased $577,000 or 1.0% to $56.3 million at December 31, 2019 from $56.9 million at December 31, 2018. Commercial business loans decreased $5.9 million or 20.8% to $22.2 million at December 31, 2019 from $28.1 million at December 31, 2018 while commercial real estate loans increased $27.6 million or 10.0% to $303.6 million at December 31, 2019 from $276.0 million at December 31, 2018. Consumer and commercial loans combined were 80.9%, 80.8% and 79.2% of total loans at December 31, 2019, 2018 and 2017, respectively.

Premises and equipment increased $3.0 million or 12.6% to $27.2 million at December 31, 2019 compared to $24.2 million at December 31, 2018. The increase is primarily due to additional capitalized costs related to our two newest branches in the metro Augusta, Georgia area, one of which opened in September 2019 and the second branch is scheduled to open in 2021.

Other assets decreased $1.9 million or 33.8% to $3.7 million at December 31, 2019 compared to $5.6 million at December 31, 2018 primarily due to a $1.4 million decrease in net deferred tax assets. Other comprehensive income representing the net unrealized gain on investment securities available for sale increased $4.5 million during the year ended December 31, 2019 due to a decrease in longer term market rates. The majority of the decrease in net deferred tax assets represents the tax impact of this change.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Financial Condition - Non-Performing Assets

The Company’s non-performing assets, which consist of non-accrual loans and OREO, decreased $3.7 million or 47.1% to $4.1 million at December 31, 2019 from $7.8 million at December 31, 2018. Non-performing assets represented 0.4% and 0.9% of total assets at December 31, 2019 and 2018, respectively. The following table summarizes our non-performing assets for those periods.



	At December 31, 2019				At December 31, 2018				$			%
	Amount			Percent ⁽¹⁾	Amount			Percent ⁽¹⁾	Change			Change
Loans 90 Days or More Past Due or Non-Accrual Loans:
Residential Real Estate	$	1,520,485		0.3%	$	2,084,870		0.5%	$	(564,385	)	(27.1	)%
Commercial Business	122,605			—	124,458			—	(1,853		)	(1.5	)
Commercial Real Estate	1,474,036			0.3	3,564,494			0.8	(2,090,458		)	(58.6	)
Consumer	319,280			0.1	1,274,673			0.3	(955,393		)	(75.0	)
Total Non-Performing Loans	3,436,406			0.7%	7,048,495			1.6%	(3,612,089		)	(51.2	)%

Other Non-Performing Assets:
OREO	677,740			0.2%	722,422			0.2%	(44,682		)	(6.2	)%
Total Other Non-Performing Assets	677,740			0.2%	722,422			0.2%	(44,682		)	(6.2	)%
Total Non-Performing Assets	$	4,114,146		0.9%	$	7,770,917		1.8%	$	(3,656,771	)	(47.1	)%
Total Non-Performing Assets as a Percentage of Total Assets	0.4		%		0.9		%

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

The largest decrease in non-performing loans was in the non-performing commercial real estate loans category, which decreased $2.1 million or 58.6% to $1.5 million at December 31, 2019 from $3.6 million at December 31, 2018. The balance in non-performing commercial real estate loans at December 31, 2019 consisted of 14 loans to nine borrowers with an average loan balance of $105,000 compared to 18 loans to 15 borrowers with an average loan balance of $198,000 at December 31, 2018.

Non-performing loans within the residential real estate loan category decreased $564,000 or 27.1% to $1.5 million at December 31, 2019 from $2.1 million at December 31, 2018. Non-performing residential real estate loans at December 31, 2019 consisted of 12 loans to 12 borrowers with an average loan balance of $127,000, the largest of which was $341,000, compared to 14 loans to 14 borrowers with an average loan balance of $149,000 at December 31, 2018.

Non-performing consumer loans decreased $955,000 or 75.0% to $319,000 at December 31, 2019 compared to $1.3 million at December 31, 2018. Non-performing consumer loans at December 31, 2019 consisted of 10 loans to 10 borrowers with an average loan balance of $32,000, the largest of which was $68,000, compared to 12 loans to 12 borrowers with an average loan balance of $106,000, the largest of which was $843,000, at December 31, 2018.

The cumulative interest not accrued during the years ended December 31, 2019 and 2018 relating to all non-performing loans totaled $468,000 and $760,000, 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”) decreased $544,000 or 39.8% during the year ended December 31, 2019. The Bank had five TDRs totaling $825,000 at December 31, 2019 compared to seven TDRs totaling $1.4 million at December 31, 2018. The five TDRs consisted of four commercial real estate loans to three separate borrowers, the largest of which had a balance of $451,000 and one unsecured consumer loan with a balance of $7,000 at December 31, 2019. The commercial real estate loans were secured by first mortgages on one single family residence and three churches. At December 31, 2019, two of the TDRs totaling $36,000 were non-accruing.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

All TDRs are reviewed for impairment loss and included in impaired loans until paid off. At December 31, 2019, the Bank had $3.2 million of impaired loans, including $825,000 in TDRs, compared to $9.4 million of impaired loans, including $1.4 million in TDRs, at December 31, 2018.

OREO decreased $45,000 or 6.2% to $678,000 at December 31, 2019 from $722,000 at December 31, 2018. At December 31, 2019, the balance of OREO consisted of the following real estate properties: 14 acres of residential land, five acres of commercial land, and one commercial strip center located within our market area in South Carolina.

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.

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 the allowance for loan losses to total loans was 2.01% and 2.10% at December 31, 2019 and 2018, respectively. The Bank closely monitors its past due loans.

Financial Condition - Liabilities and Shareholders Equity

Deposits at the Bank increased $3.9 million or 0.5% to $771.4 million at December 31, 2019 from $767.5 million at December 31, 2018. The majority of the Bank’s deposits are originated within the Bank’s immediate market area. The Bank had brokered time deposits of $34.6 million and $33.1 million at December 31, 2019 and 2018, respectively. The Bank uses brokered time deposits to manage interest rate risk because they are accessible in bulk at rates typically only slightly higher than those in our market areas. In addition, a portion of these brokered time deposits give the Bank a call option that allows the Bank the choice to redeem them early should rates change. Total deposits at December 31, 2019, excluding brokered time deposits, increased $2.4 million or 0.3% to $736.8 million from $734.4 million at December 31, 2018. Brokered time deposits were 4.5% of total deposits at December 31, 2019 and 4.3% of total deposits at December 31, 2018.

Advances from the FHLB increased $4.1 million or 12.1% to $38.1 million at December 31, 2019 from $34.0 million at December 31, 2018. Other borrowings (non-FHLB advances) increased $881,000 or 8.2% to $11.6 million at December 31, 2019 from $10.7 million at December 31, 2018. 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. The interest rate paid on the repurchase agreements was 0.50% at December 31, 2019 compared to 0.25% at December 31, 2018. The Bank has pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $20.4 million and $20.5 million, respectively, at December 31, 2019 and $16.2 million and $16.5 million, respectively, at December 31, 2018.

In September 2006, Security Federal Statutory Trust issued and sold capital securities of the Trust (the “Capital Securities”). The Trust used the net proceeds from the sale of the Capital Securities to purchase a like amount of junior subordinated debentures (the “Debentures”) of the Company which are reported on the Consolidated Balance Sheet as junior subordinated debentures. The Capital Securities accrue and pay distributions at a floating rate of three month LIBOR plus 170 basis points annually which was equal to 3.59% at December 31, 2019. The distribution rate payable on the Capital Securities is cumulative and payable quarterly in arrears. 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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

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. Since December 1, 2019, the Company has the right to redeem the debentures, in whole or in part, at the option of the Company, 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.

On January 2, 2020, the Company announced its intention to redeem all of the convertible debentures on March 2, 2020. Subsequent to the announcement, $5.9 million was converted into 295,600 common shares by holders of the debt. The Company redeemed the remaining $132,000 for cash on March 2, 2020.

In October 2016, the Company obtained a $14.0 million term loan from another financial institution. The Company used the net proceeds from the loan for the sole purpose of financing a portion of the Company's redemption of its Series B Fixed Rate Cumulative Perpetual Preferred Stock ("Series B Preferred Stock"). The Company repaid the remaining balance of the note prior to its maturity date of October 1, 2019. For additional information regarding this loan, refer to Note 11 of the Notes to Consolidated Financial Statements included herein.

On November 22, 2019, the Company sold and issued to certain institutional investors $17.5 million in aggregate principal amount of 5.25% fixed-to-floating rate subordinated notes due 2029 (the “10-Year Notes”) and $12.5 million in aggregate principal amount of 5.25% fixed-to-floating rate subordinated notes due 2034 (the “15-Year Notes”, and together with the 10-Year Notes, the “Notes”). The 10-Year Notes have a stated maturity of November 22, 2029, and bear interest at a fixed rate of 5.25% per year, from and including November 22, 2019 but excluding November 22, 2024. From and including November 22, 2024 to but excluding the maturity date or early redemption date, the interest rate shall reset semi-annually to an interest rate equal to the then-current three-month LIBOR rate plus 369 basis points. The 15-Year Notes have a stated maturity of November 22, 2034, and bear interest at a fixed rate of 5.25% per year, from and including November 22, 2019 but excluding November 22, 2029. From and including November 22, 2029 to but excluding the maturity date or early redemption date, the interest rate for the 15-Year Notes shall reset semi-annually to an interest rate equal to the then-current three-month LIBOR rate plus 357 basis points. The Notes are payable semi-annually in arrears on June 1 and December 1 of each year commencing June 1, 2020.

The Notes are not subject to redemption at the option of the holder and may be redeemed by the Company only under certain limited circumstances prior to November 22, 2024, with respect to the 10-Year Notes, and November 22, 2029, with respect to the 15-Year Notes. The Company may redeem the 10-Year Notes and the 15-Year Notes at its option, in whole at any time, or in part from time to time, after November 22, 2024 and November 22, 2029, respectively. The Notes are unsecured, subordinated obligations of the Company and rank junior in right to payment to the Company’s current and future senior indebtedness, and each Note is equal in right to payment with respect to the other Notes. The Company used the net proceeds from the sale of the Notes to fund the redemption of the convertible senior debentures and for general corporate purposes.

For additional information regarding the Notes, refer to Note 14 of the Notes to Consolidated Financial Statements included herein.

Total shareholders' equity increased $11.2 million or 14.0% to $91.8 million at December 31, 2019 from $80.5 million at December 31, 2018. The increase was primarily due to net income of $7.8 million combined with a $4.5 million increase in accumulated other comprehensive income, net of tax. The increase in accumulated other comprehensive income was related to the unrecognized gain in value of investment and mortgage-backed securities during 2019. These increases to shareholders equity were offset by $1.1 million in dividends paid to common shareholders for the year ended December 31, 2019. Book value per common share was $31.01 at December 31, 2019 compared to $27.26 at December 31, 2018.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Results of Operations

The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table also distinguishes between the changes related to higher or lower outstanding balances and the changes related to the volatility of interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (1) changes in rate (multiplied by prior year volume); (2) 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 federal income tax rate of 21% for the years ended December 31, 2019 and 2018 and 34% for the year ended December 31, 2017.



	Year Ended December 31, 2019 Compared to Year Ended December 31, 2018								Year Ended December 31, 2018 Compared to Year Ended December 31, 2017
	Volume			Rate			Net		Volume			Rate			Net
	(In Thousands)
Interest-Earning Assets:
Loans: ⁽¹⁾
Residential Mortgage	$	44		$	252		$	296	$	175		$	285		$	460
Other Loans	1,083			387			1,470		2,794			(423		)	2,371
Total Loans	1,127			639			1,766		2,969			(138		)	2,831
Mortgage-Backed Securities ⁽²⁾	689			532			1,221		(90		)	725			635
Investments ⁽²⁾	413			349			762		(256		)	(313		)	(569		)
Other Interest-Earning Assets	(15		)	44			29		(4		)	34			30
Total Interest-Earning Assets	$	2,214		$	1,564		$	3,778	$	2,619		$	308		$	2,927
Interest-Bearing Liabilities:
Deposits:
Certificate Accounts	$	262		$	1,403		$	1,665	$	48		$	676		$	724
NOW Accounts	7			53			60		5			11			16
Money Market Accounts	45			791			836		20			544			564
Savings Accounts	5			15			20		6			6			12
Total Deposits	319			2,262			2,581		79			1,237			1,316
Borrowings	47			233			280		(154		)	113			(41		)
Total Interest-Bearing Liabilities	366			2,495			2,861		(75		)	1,350			1,275
Effect on Net Interest Income	$	1,848		$	(931	)	$	917	$	2,694		$	(1,042	)	$	1,652

^{(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.}

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

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.



		For the Year Ended December 31,
	Yield/ Rate at	2019						2018
	December 31, 2019	Average Balance		Interest		Annualized Yield/Rate		Average Balance		Interest		Annualized Yield/Rate
		(Dollars In Thousands)
Interest-Earning Assets:
Residential Mortgage	5.16%	$	79,334	$	4,114	5.19	%	$	78,427	$	3,818	4.87	%
Other Loans	5.24%	364,527		20,555		5.64	%	345,263		19,085		5.53	%
Total Loans ⁽¹⁾	5.23%	443,861		24,669		5.56	%	423,690		22,903		5.41	%
Mortgage-Backed Securities⁽²⁾	2.89%	224,860		6,658		2.96	%	200,845		5,437		2.71	%
Investments ^{(2) (3)}	2.29%	213,492		5,758		2.70	%	197,816		4,996		2.53	%
Other Interest-Earning Assets	1.42%	4,087		102		2.50	%	4,998		73		1.46	%
Total Interest-Earning Assets	3.90%	$	886,300	$	37,187	4.20	%	$	827,349	$	33,409	4.04	%
Interest-Bearing Liabilities:
Certificate Accounts	1.71%	$	256,194	$	4,309	1.68	%	$	234,788	$	2,644	1.13	%
NOW Accounts	0.11%	122,453		137		0.11	%	114,270		77		0.07	%
Money Market Accounts	0.72%	254,723		1,923		0.75	%	244,669		1,087		0.44	%
Savings Accounts	0.16%	50,635		74		0.15	%	46,920		54		0.12	%
Total Interest-Bearing Deposits	0.77%	684,005		6,443		0.94	%	640,647		3,862		0.60	%
Other Borrowings	0.50%	14,182		70		0.49	%	13,230		32		0.24	%
Note Payable	—%	675		36		5.33	%	5,089		232		4.56	%
Junior Subordinated Debt	3.59%	5,155		216		4.19	%	5,155		201		3.90	%
Senior Convertible Debt	8.00%	6,045		483		7.99	%	6,064		484		7.98	%
Subordinated Debt	5.25%	2,630		171		6.50	%	—		—		—	%
FHLB Advances	1.94%	45,900		892		1.94	%	42,970		639		1.49	%
Total Interest-Bearing Liabilities	1.04%	$	758,592	$	8,311	1.10	%	$	713,155	$	5,450	0.76	%
Net Interest Income				$	28,876					$	27,959
Interest Rate Spread	2.86%					3.10	%					3.28	%
Net Yield on Earning Assets (Net Interest Margin)						3.26	%					3.38	%

^{(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 RECOGNIZES THE INCOME TAX SAVINGS WHEN COMPARING TAXABLE AND TAX-EXEMPT ASSETS AND WAS CALCULATED USING AN EFFECTIVE TAX RATE OF 21% FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018. THE TAX-EQUIVALENT ADJUSTMENT RELATES TO THE TAX EXEMPT MUNICIPAL BONDS AND WAS $253,153 AND $337,312 FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018, RESPECTIVELY.}

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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



		For the Year Ended December 31,
	Yield/ Rate at	2018						2017
	December 31, 2018	Average Balance		Interest		Annualized Yield/Rate		Average Balance		Interest		Annualized Yield/Rate
		(Dollars In Thousands)
Interest-Earning Assets:
Residential Mortgage	5.11%	$	78,427	$	3,818	4.87	%	$	74,673	$	3,358	4.50	%
Other Loans	5.48%	345,263		19,085		5.53	%	294,756		16,714		5.67	%
Total Loans (1)	5.42%	423,690		22,903		5.41	%	369,429		20,072		5.43	%
Mortgage-Backed Securities(2)	2.87%	200,845		5,437		2.71	%	204,622		4,802		2.35	%
Investments (2) (3)	2.73%	197,816		4,996		2.53	%	207,344		5,565		2.68	%
Other Interest-Earning Assets	2.33%	4,998		73		1.46	%	5,445		43		0.79	%
Total Interest-Earning Assets	4.13%	$	827,349	$	33,409	4.04	%	$	786,840	$	30,482	3.87	%
Interest-Bearing Liabilities:
Certificate Accounts	1.37%	$	234,788	$	2,644	1.13	%	$	229,167	$	1,920	0.84	%
NOW Accounts	0.05%	114,270		77		0.07	%	106,178		61		0.06	%
Money Market Accounts	0.65%	244,669		1,087		0.44	%	235,906		523		0.22	%
Savings Accounts	0.14%	46,920		54		0.12	%	40,496		42		0.10	%
Total Interest-Bearing Deposits	0.67%	640,647		3,862		0.60	%	611,747		2,546		0.42	%
Other Borrowings	0.25%	13,230		32		0.24	%	11,525		20		0.17	%
Note Payable	4.95%	5,089		232		4.56	%	11,107		420		3.78	%
Junior Subordinated Debt	4.49%	5,155		201		3.90	%	5,155		151		2.93	%
Senior Convertible Debt	8.00%	6,064		484		7.98	%	6,075		486		8.00	%
FHLB Advances	1.66%	42,970		639		1.49	%	45,798		552		1.21	%
Total Interest-Bearing Liabilities	0.80%	$	713,155	$	5,450	0.76	%	$	691,407	$	4,175	0.60	%
Net Interest Income				$	27,959					$	26,307
Interest Rate Spread	3.33%					3.28	%					3.27	%
Net Yield on Earning Assets (Net Interest Margin)						3.38	%					3.34	%

^{(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 RECOGNIZES THE INCOME TAX SAVINGS WHEN COMPARING TAXABLE AND TAX-EXEMPT ASSETS AND WAS CALCULATED USING AN EFFECTIVE TAX RATE OF 21% AND 34% FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017, RESPECTIVELY. THE TAX-EQUIVALENT ADJUSTMENT RELATES TO THE TAX EXEMPT MUNICIPAL BONDS AND WAS $337,312 AND $695,322 FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017, RESPECTIVELY.}

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Comparison of the Years Ended December 31, 2019 and 2018

Net Income

Net income increased $587,000 or 8.1% to $7.8 million or $2.50 per diluted common share for the year ended December 31, 2019, compared to $7.2 million or $2.32 per diluted common share for the year ended December 31, 2018. The increase in earnings in 2019 was primarily due to increases in net interest income and non-interest income combined with a decrease in the provision for loan losses. These items were partially offset by an increase in non-interest expense.

Net Interest Income

Net interest income increased $1.0 million or 3.6% to $28.6 million for the year ended December 31, 2019, compared to $27.6 million in 2018. Net interest margin on a tax equivalent basis decreased 12 basis points to 3.26% for the year ended December 31, 2019 from 3.38% for the year ended December 31, 2018. The decrease in net interest margin was primarily the result of increases in average interest bearing liabilities and the average cost of funds, which were partially offset by increases in average interest earning assets and the average yield earned on these assets.

Total average interest-earning assets increased $59.0 million or 7.1% to $886.3 million for the year ended December 31, 2019 from $827.3 million for the year ended December 31, 2018 with a 16 basis point increase in the average yield. Average interest-bearing liabilities increased $45.4 million or 6.4% to $758.6 million for the year ended December 31, 2019 from $713.2 million for the year ended December 31, 2018 with a 34 basis point increase in the average cost. The interest rate spread on a tax equivalent basis decreased 17 basis points to 3.10% for the year ended December 31, 2019 from 3.27% in 2018.

Total interest income increased $3.9 million or 11.7% to $36.9 million for the year ended December 31, 2019, compared to $33.1 million for the year ended December 31, 2018, primarily due to increased interest income from loans. Interest income from loans increased $1.8 million or 7.7% to $24.7 million for the year ended December 31, 2019 compared to $22.9 million for the year ended December 31, 2018. The increase was attributable to a $20.2 million increase in average total loans outstanding combined with a 15 basis point increase in the average yield earned on the Bank’s loans during the year ended December 31, 2019.

Total tax equivalent interest income on investment securities, mortgage-backed securities, and other investments increased $2.0 million due to an increase of 23 basis points in the average yield earned on these assets combined with a $38.8 million, or 9.6%, increase in the aggregate average balance of these interest earning assets.

Total interest expense increased $2.9 million or 52.5% to $8.3 million for the year ended December 31, 2019, compared to $5.4 million for the year ended December 31, 2018. The largest increase was in interest expense on deposits, which increased $2.6 million or 66.8% to $6.4 million in 2019 compared to $3.9 million in 2018. Average interest bearing deposits increased $43.4 million or 6.4% to $684.0 million during the year ended December 31, 2019 compared to $640.6 million during 2018, while the average cost of those deposits increased 34 basis points to 0.94% during 2019 from 0.60% in 2018.

Interest expense on FHLB advances and all other borrowings increased $281,000 or 17.7% to $1.9 million during the year ended December 31, 2019 from $1.6 million during the prior year. The increase was attributable to a $2.1 million, or 2.9% decrease in the average balance of these liabilities combined with an increase of 21 basis points in the average cost to 2.50% in 2019 from 2.19% during 2018.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Provision for Loan Losses

The provision for loan losses decreased $550,000 to $375,000 for the year ended December 31, 2019 compared to $925,000 for the year ended December 31, 2018 primarily due to the decreases in substandard loans and non-performing assets, which consist of non-performing loans and OREO, during the period. Substandard loans decreased $6.1 million or 41.7%, to $8.5 million at December 31, 2019 from $14.6 million at December 31, 2018. Non-performing assets decreased $3.7 million, or 47.1%, to $4.1 million at December 31, 2019 from $7.8 million at December 31, 2018. Non-performing assets represented 0.43% and 0.85% of total assets at December 31, 2019 and 2018, respectively.

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

Management’s monthly review of the adequacy of the allowance includes three main components. The first component is an analysis of loss potential in various homogeneous segments of the portfolio based on historical trends and the risk inherent in each category. The historical loss periods used to calculate these ratios can range from one to five years depending on which period is deemed a more relevant indicator of future losses. Currently, management applies a five-year historical loss ratio to each loan category to estimate the inherent loss in these pooled loans.

The second component of management’s monthly analysis is the specific review and evaluation of significant problem credits identified through the Company’s internal monitoring system, including but not limited to classified loans, non-accrual loans and TDRs. These loans are evaluated for impairment and recorded in accordance with accounting guidance. All TDRs and substantially all non-accrual loans are individually for impairment. In accordance with our policy, non-accrual commercial loans with a balance less than $200,000 and non-accrual consumer loans with a balance less than $100,000 are deemed immaterial and therefore excluded from the individual impairment review. For each loan deemed impaired, management calculates a specific reserve for the amount in which the recorded investment in the loan exceeds the fair value. This estimate is based on a thorough analysis of the most probable source of repayment, which is typically liquidation of the collateral.

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

Management believes the allowance for loan losses at December 31, 2019, 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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Non-Interest Income

Non-interest income increased $1.4 million or 18.6% to $9.1 million for the year ended December 31, 2019 from $7.7 million for the year ended December 31, 2018. The largest increases were in gain on sale of investment securities and gain on sale of loans.

Gain on sale of investment securities increased $246,000 or 42.9% to $819,000 during the year ended December 31, 2019 from $573,000 for the same period in 2018. The Company sold 88 available for sale investment securities for a total gross gain of $1.5 million and gross losses of $636,000 during 2019 compared to 28 available for sale investment securities and 1,842 shares of common stock in another company for a total gross gain of $732,000 and gross losses of $159,000, respectively, in 2018.

Gain on sale of loans increased $478,000 or 38.2% to $1.7 million for the year ended December 31, 2019 compared to $1.3 million in 2018 due to an increase in loans sold to investors. The Company sold 290 loans to investors with a total balance of $61.9 million in 2019 compared to 251 loans to investors with a total balance of $44.1 million during 2018.

Income from BOLI increased $139,000 or 25.7% to $679,000 during the year ended December 31, 2019 from $540,000 during the year ended December 31, 2018. During 2019, the Bank recognized $139,000 in death benefits in addition to $540,000 in income related to an increase in the cash surrender value of the BOLI policies. All BOLI income recognized in 2018 was related to an increase in the cash surrender value of the BOLI policies.

Trust income increased $87,000 or 9.0% to $1.1 million during the year ended December 31, 2019 from $974,000 during 2018 due to an increase in assets under management. Check card fee income increased $164,000 or 12.8% to $1.4 million for the year ended December 31, 2019 compared to $1.3 million in 2018 reflecting higher transaction volume.

The Bank received $478,000 and $343,000 in grant income during the years ended December 31, 2019 and 2018, respectively. A portion of the grant income received in 2019 and the majority received in 2018 was awarded by the Bank Enterprise Award (BEA) Program in recognition of the Bank’s investments in distressed communities and its continued commitment to community development. The amount of the award increases as the Bank’s investment in these areas increases, but is also subject to changes in program funding levels from the federal government.

During the year ended December 31, 2018, the U.S. Treasury's Community Development Financial Institutions ("CDFI") Fund awarded the Bank a grant totaling $500,000, in partnership with a local energy company, to assist homeowners in low to moderate income areas by providing low-cost financing for energy efficiency upgrades. The grant income is recognized during the period in which the loans are funded to qualifying applicants. The Bank recognized $245,000 in grant income related to this award during the year ended December 31, 2019, which is included in the total grant income above. At December 31, 2019, $143,000 in income remains to be recognized as these loans are funded.

Other non-interest income including annuity and investment brokerage commissions, bank credit life insurance on loans, and other miscellaneous income increased $177,000 or 18.4% to $1.1 million in 2019 from $961,000 during 2018.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

Non-Interest Expense

Non-interest expense increased $2.3 million or 8.9% to $27.9 million during the year ended December 31, 2019 compared to $25.6 million during 2018. The increase in non-interest expense was primarily due to increases in compensation and employee benefits expense and depreciation and maintenance expense, which were partially offset by a decrease in FDIC insurance premiums during 2019.

Compensation and employee benefits increased $1.3 million or 8.6% to $16.8 million during the year ended December 31, 2019 from $15.5 million for the year ended December 31, 2018 due to general annual cost of living increases combined with a slight increase in full time employees as a result of our recent expansion in the Augusta market.

Depreciation and maintenance of equipment increased $294,000 or 12.7% to $2.6 million for the year ended December 31, 2019 compared to $2.3 million in 2018 due to additional capital expenses related to our newest branch in Augusta, Georgia, which opened in September 2019.

Net cost of operation of OREO includes all expenses associated with OREO properties, including write-downs in value and gain or loss on sales during the period. For the years ended December 31, 2019 and 2018, the net gain on OREO sales exceeded write-downs and other costs, resulting in net recoveries of $66,000 and $362,000, respectively, from the operation of OREO. The net gain on OREO sales was $185,000 during 2019 compared to $589,000 in 2018. The Company wrote down $22,000 in the value of OREO properties during 2019 compared to $56,000 in 2018.

FDIC insurance premiums decreased $194,000 or 69.8% to $84,000 in 2019 compared to $278,000 in 2018 as a result of a small bank credit awarded by the FDIC, which was recognized during the 3rd and 4th quarters of 2019. The Bank has $49,000 in small bank credits on future assessments remaining at December 31, 2019, which may be recognized in future periods.

Other non-interest expenses increased $176,000 or 3.5% to $5.3 million for the year ended December 31, 2019 compared to $5.1 million during 2018. Other expenses include legal, professional, consulting and other miscellaneous expenses.

Provision for Income Taxes

The provision for income taxes increased $110,000 or 7.0% to $1.7 million during the year ended December 31, 2019 compared to $1.6 million for the year ended December 31, 2018 due to higher pre-tax income. The Company's combined federal and state effective tax rate was 17.7% for 2019 compared to 17.9% for 2018.

Comparison of the Years Ended December 31, 2018 and 2017

A comparison of our operating results for the 2018 and 2017 fiscal years may be found under the heading “Comparison of Operating Results for the Years Ended December 31, 2018 and 2017” contained in Part II, Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

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.



	December 31,
	2019		2018
	(In Thousands)
Bank’s Shareholders’ Equity ⁽¹⁾	$	102,480	$	90,388
Reduction for Goodwill	1,200		1,200
Tangible Capital	101,280		89,188
Core Capital	101,280		89,188
Supplemental Capital	6,990		6,904
Total Risk-Based Capital	$	108,270	$	96,092


⁽¹⁾	^{EXCLUDES UNREALIZED (LOSSES) GAINS ON INVESTMENT SECURITIES OF $4.5 MILLION and $(28,000) AT DECEMBER 31, 2019 AND 2018, RESPECTIVELY.}

The Bank is subject to minimum capital requirements imposed by the FDIC. Based on capital levels at December 31, 2019, the Bank was considered to be well capitalized. At December 31, 2019, the Bank exceeded all regulatory capital requirements with Tier 1 leverage-based capital, Tier 1 risk-based capital, total risk-based capital, and common equity Tier 1 (CET1) capital ratios of 10.4%, 18.2%, 19.4%, and 18.2%, respectively.

CET1 consists of Tier 1 capital less all capital components that are not considered common equity. In addition, Tier 1 capital includes accumulated other comprehensive income (loss), which includes all unrealized gains and losses on available for sale debt and equity securities. In addition to the FDIC’s minimum capital ratios, the Bank is required to maintain a capital conservation buffer consisting of additional CET 1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses. At December 31, 2019, the Bank’s capital conservation buffer was 11.4%.

For additional information regarding the Bank's and Company's regulatory capital compliance, see the discussion included in Note 16 of the Notes to Consolidated Financial Statements included herein.

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 deposits, scheduled loan and investment and mortgage-backed securities repayments, including interest payments, maturities and sales of loans and investment and mortgage-backed securities, 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 $309.3 million during the year ended December 31, 2019 compared to $249.4 million during the year ended December 31, 2018 and $211.7 million during the year ended December 31, 2017. Purchases of investments and mortgage-backed securities were $190.8 million during the year ended December 31, 2019 compared to $114.8 million during the year ended December 31, 2018 and $166.6 million during the year ended December 31, 2017. Other uses of the Bank's funds during the year ended December 31, 2019 included paying down the note payable and dividend payments to shareholders.

Unused lines of credit on home equity loans, credit cards, and commercial loans amounted to $108.0 million at December 31, 2019. Home equity loans are made on a floating rate basis with final maturities of 15 to 20 years. The Bank issues fixed rate credit cards, currently at 9.99%, and variable rate rewards credit cards with a floating rate equal to prime plus 9.99%. Credit cards are renewed every three years. In addition to the above commitments, the Bank had undisbursed loans-in-process of $10.0 million at December 31, 2019, 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 summarizes the length of time until maturity for unused commitments to extend credit and standby letters of credit at December 31, 2019:



(In Thousands)	One Month or Less		After One Through Three Months		After Three Through Twelve Months		Total Within One Year		Over One Year		Total
Unused Lines of Credit	$	1,185	$	5,543	$	38,326	$	45,054	$	62,972	$	108,026
Standby Letters of Credit	389		200		649		1,238		213		1,451
Total	$	1,574	$	5,743	$	38,975	$	46,292	$	63,185	$	109,477

Management believes that future liquidity can be met through the Bank's deposit base, which had a balance of $771.4 million at December 31, 2019, and from investment sales and maturities.

At December 31, 2019, the Bank had $144.2 million outstanding in certificates of deposit of $100,000 or more, referred to as “Jumbo Certificates,” compared to $151.5 million at December 31, 2018. Brokered deposits totaled $34.6 million at December 31, 2019 compared to $33.1 million at December 31, 2018. Total certificates of deposit scheduled to mature in one year or less at December 31, 2019 totaled $149.5 million.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

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

The following table summarizes the maturity schedule of jumbo certificates at December 31, 2019:



	(In Thousands)
Within 3 Months	$	27,763
After 3 Months, Within 6 Months	19,686
After 6 Months, Within 12 Months	42,120
After 12 Months	54,676
	$	144,245

Management’s policy is to maintain deposit rates at levels that are competitive with other local financial institutions. Based on historical experience, we believe that a significant portion of maturing certificates of deposit will remain with the Bank. In addition, at December 31, 2019 the Bank had $259.2 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 sales of investments and 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 advances and other borrowings.

Security Federal Corporation is a separate legal entity from Security Federal Bank and must provide for its own liquidity and pay its own operating expenses. Sources of capital and liquidity for Security Federal Corporation include distributions from Security Federal Bank and the issuance of debt or equity securities, although there are regulatory restrictions on the ability of the Security Federal Bank to pay dividends. At December 31, 2019, Security Federal Corporation (on an unconsolidated basis) had liquid assets of $25.7 million.

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.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders and the Board of Directors

Security Federal Corporation and Subsidiaries

Aiken, South Carolina

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Security Federal Corporation and its Subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes to the consolidated financial statements (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and 2017, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting 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.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

We have served as the Company's auditor since 1998.

/s/ Elliott Davis, LLC

Columbia, South Carolina

March 20, 2020

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES



Consolidated Balance Sheets	December 31,
	2019			2018
ASSETS:
Cash and Cash Equivalents	$	12,536,311		$	12,705,910
Certificates of Deposit with Other Banks	950,005			1,200,010
Investment and Mortgage-Backed Securities:
Available For Sale ("AFS")	414,644,840			386,100,837
Held To Maturity (Fair Value of $19,805,841 and $23,249,400 at December 31, 2019 and 2018, Respectively)	19,246,935			23,638,013
Total Investments and Mortgage-Backed Securities	433,891,775			409,738,850
Loans Receivable, Net:
Held For Sale	3,990,606			1,781,985
Held For Investment (Net of Allowance of $9,225,574 and $9,171,717 at December 31, 2019 and 2018, Respectively)	448,868,129			428,271,532
Total Loans Receivable, Net	452,858,735			430,053,517
Accrued Interest Receivable:
Loans	1,211,826			1,257,683
Mortgage-Backed Securities	551,214			591,849
Investment Securities	1,635,497			1,877,844
Total Accrued Interest Receivable	3,398,537			3,727,376
Operating Lease Right-of-Use Assets	2,718,676			—
Premises and Equipment, Net	27,219,883			24,174,707
Federal Home Loan Bank ("FHLB") Stock, at Cost	2,536,500			2,204,000
Other Real Estate Owned ("OREO")	677,740			722,442
Bank Owned Life Insurance ("BOLI")	21,501,647			21,237,893
Goodwill	1,199,754			1,199,754
Other Assets	3,737,978			5,649,800
Total Assets	$	963,227,541		$	912,614,259
LIABILITIES AND SHAREHOLDERS’ EQUITY:
Liabilities:
Deposit Accounts	$	771,407,482		$	767,496,707
Advance Payments By Borrowers For Taxes and Insurance	207,582			258,505
Advances From FHLB	38,138,000			34,030,000
Other Borrowings	11,579,819			10,698,429
Note Payable	—			2,362,500
Junior Subordinated Debentures	5,155,000			5,155,000
Senior Convertible Debentures	6,044,000			6,064,000
Subordinated Debentures	30,000,000			—
Operating Lease Liabilities	2,733,531			—
Other Liabilities	6,204,122			6,030,685
Total Liabilities	871,469,536			832,095,826
Commitments (Notes 5 and 19)
Shareholders' Equity:
Common Stock, $.01 Par Value; Authorized 5,000,000 Shares; Issued and Outstanding Shares, 3,157,787 and 2,956,854, Respectively, at December 31, 2019 and 3,154,829 and 2,953,896, Respectively, at December 31, 2018	31,578			31,548
Additional Paid-In Capital	12,308,179			12,235,341
Treasury Stock, at Cost (200,933 Shares)	(4,330,712		)	(4,330,712		)
Accumulated Other Comprehensive Income (Loss)	4,467,527			(27,909		)
Retained Earnings	79,281,433			72,610,165
Total Shareholders' Equity	91,758,005			80,518,433
Total Liabilities and Shareholders' Equity	$	963,227,541		$	912,614,259

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES




Consolidated Statements of Income	Years Ended December 31,
	2019			2018			2017
Interest Income:
Loans	$	24,669,073		$	22,903,299		$	20,072,107
Mortgage-Backed Securities	6,657,925			5,437,099			4,802,240
Investment Securities	5,504,563			4,658,194			4,869,996
Other	102,550			73,483			42,562
Total Interest Income	36,934,111			33,072,075			29,786,905
Interest Expense:
NOW and Money Market Accounts	2,060,844			1,164,373			584,425
Statement Savings Accounts	73,961			54,173			41,819
Certificate Accounts	4,308,596			2,643,555			1,920,182
FHLB Advances and Other Borrowings	961,947			670,486			571,810
Note Payable	35,515			231,958			419,732
Senior Convertible Debentures	483,520			483,520			486,031
Subordinated Debentures	170,625			—			—
Junior Subordinated Debentures	216,492			201,354			151,302
Total Interest Expense	8,311,500			5,449,419			4,175,301
Net Interest Income	28,622,611			27,622,656			25,611,604
Provision for Loan Losses	375,000			925,000			300,000
Net Interest Income After Provision For Loan Losses	28,247,611			26,697,656			25,311,604
Non-Interest Income:
Gain on Sale of Investment Securities	819,053			573,266			494,146
Gain on Sale of Loans	1,728,741			1,250,530			1,179,837
Service Fees on Deposit Accounts	1,069,470			1,060,159			1,048,345
Commissions From Insurance Agency	674,991			682,367			584,020
Trust Income	1,061,200			974,000			796,000
BOLI Income	678,609			540,000			1,160,133
Check Card Fee Income	1,449,416			1,284,954			1,138,501
Grant Income	478,049			343,078			227,282
Other	1,137,614			960,792			716,019
Total Non-Interest Income	9,097,143			7,669,146			7,344,283
Non-Interest Expense:
Compensation and Employee Benefits	16,838,702			15,504,020			14,375,064
Occupancy	2,354,347			2,228,521			2,180,404
Advertising	796,213			546,799			596,440
Depreciation and Maintenance of Equipment	2,601,104			2,307,555			2,057,038
FDIC Insurance Premiums	84,022			278,287			185,541
Net (Recovery) Cost of Operation of OREO	(65,772		)	(361,513		)	9,729
Other	5,262,101			5,086,386			4,897,871
Total Non-Interest Expense	27,870,717			25,590,055			24,302,087
Income Before Income Taxes	9,474,037			8,776,747			8,353,800
Provision For Income Taxes	1,679,550			1,569,526			1,829,267
Write-Down of Deferred Tax Assets	—			—			606,193
Net Income	7,794,487			7,207,221			5,918,340
Net Income Per Common Share (Basic)	$	2.64		$	2.44		$	2.01
Net Income Per Common Share (Diluted)	$	2.50		$	2.32		$	1.91
Cash Dividend Per Share On Common Stock	$	0.40		$	0.36		$	0.36
Weighted Average Shares Outstanding (Basic)	2,955,737			2,953,446			2,945,918
Weighted Average Shares Outstanding (Diluted)	3,257,937			3,256,646			3,250,069

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

For the Years Ended December 31, 2019, 2018 and 2017




	2019			2018			2017

Net Income	$	7,794,487		$	7,207,221		$	5,918,340
Other Comprehensive Income (Loss)
Unrealized Gains (Losses) on Securities:
Unrealized Holding Gains (Losses) on Securities Available For Sale, Net of Taxes of $1,675,405; $(1,001,537) and $1,330,097 at December 31, 2019, 2018 and 2017, Respectively	5,133,884			(3,065,211		)	2,161,122
Reclassification Adjustment for Gains Included in Net Income, Net of Taxes of $204,763; $143,317 and $187,775 at December 31, 2019, 2018 and 2017, Respectively	(614,290		)	(429,949		)	(306,371		)
Amortization of Unrealized Gains on Available For Sale Securities Transferred to Held To Maturity, Net of Taxes of $(8,053); $(27,626) and $(62,847) at December 31, 2019, 2018 and 2017, Respectively	(24,158		)	(75,962		)	(102,715		)
Other Comprehensive Income (Loss)	4,495,436			(3,571,122		)	1,752,036
Comprehensive Income	$	12,289,923		$	3,636,099		$	7,670,376

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Changes in Shareholders' Equity

For the Years Ended December 31, 2019, 2018 and 2017



	Common Stock		Unvested Restricted Stock			Additional Paid – In Capital		Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Retained Earnings			Total
Balance, December 31, 2016	$	31,464	$	(25,358	)	$	12,036,744	$	(4,330,712	)	$	1,180,086		$	62,220,050		$	71,112,274
Net Income	—		—			—		—			—			5,918,340			5,918,340
Other Comprehensive Income, Net of Tax	—		—			—		—			1,752,036			—			1,752,036
Vesting of Restricted Stock	—		25,358			—		—			—			—			25,358
Stock Options Exercised	75		—			176,100		—			—			—			176,175
Cash Dividends on Common Stock	—		—			—		—			—			(1,060,729		)	(1,060,729		)
Balance, December 31, 2017	$	31,539	$	—		$	12,212,844	$	(4,330,712	)	$	2,932,122		$	67,077,661		$	77,923,454
Net Income	—		—			—		—			—			7,207,221			7,207,221
Other Comprehensive Loss, Net of Tax:	—		—			—		—			(3,571,122		)	—			(3,571,122		)
Reclassification of Stranded Tax Effects	—		—			—		—			611,091			(611,091		)	—
Employee Stock Purchases	4		—			12,192		—			—			—			12,196
Stock Options Exercised	5		—			10,305		—			—			—			10,310
Cash Dividends on Common Stock	—		—			—		—			—			(1,063,626		)	(1,063,626		)
Balance, December 31, 2018	$	31,548	$	—		$	12,235,341	$	(4,330,712	)	$	(27,909	)	$	72,610,165		$	80,518,433
Net Income	—		—			—		—			—			7,794,487			7,794,487
Other Comprehensive Income, Net of Tax	—		—			—		—			4,495,436			—			4,495,436
Employee Stock Purchases	20		—			52,848		—			—			—			52,868
Redemption of Convertible Debentures	10		—			19,990		—			—			—			20,000
Cash Dividends on Common Stock	—		—			—		—			—			(1,123,219		)	(1,123,219		)
Balance, December 31, 2019	$	31,578	$	—		$	12,308,179	$	(4,330,712	)	$	4,467,527		$	79,281,433		$	91,758,005

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows



	For the Years Ended December 31,
	2019			2018				2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income	$	7,794,487		$	7,207,221			$	5,918,340
Adjustments to Reconcile Net Income to Net Cash Provided By Operating Activities:
Depreciation Expense	1,589,671			1,487,734				1,467,402
Stock Option Compensation Expense	—			—				25,358
Discount Accretion and Premium Amortization, Net	5,290,316			5,705,663				5,678,074
Provisions for Loan Losses	375,000			925,000				300,000
Earnings on BOLI	(540,000		)	(540,000		)		(506,000		)
Income Recognized From BOLI Death Benefit	(138,609		)	—				(654,133		)
Gain on Sales of Loans	(1,728,741		)	(1,250,530		)		(1,179,837		)
Loss (Gain) on Sales of Mortgage-Backed Securities ("MBS")	139,390			(139,739		)		(246,212		)
Gain on Sales of Investment Securities	(958,443		)	(204,185		)		(248,469		)
Gain on Sales of Other Investments	—			(229,342		)		—
Gain on Sales of OREO	(184,864		)	(588,720		)		(359,629		)
Write Down on OREO	22,000			56,000				158,121
Amortization of Deferred Costs on Loans	202,684			110,036				159,284
Proceeds From Sale of Loans Held For Sale	61,466,054			46,595,060				43,156,408
Origination of Loans Held For Sale	(61,945,934		)	(44,074,565		)		(40,784,614		)
Decrease (Increase) in Accrued Interest Receivable:
Loans	45,857			(190,026		)		(29,213		)
MBS	40,635			(2,849		)		16,474
Investment Securities	242,347			(177,883		)		(292,038		)
(Decrease) Increase in Advance Payments By Borrowers	(50,923		)	(11,256		)		9,181
Amortization of Operating Lease Right-of-Use ("ROU") Assets	371,836			—			—	—
Other, Net	233,478			(177,273		)		978,912
Net Cash Provided By Operating Activities	12,266,241			14,500,346				13,567,409
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of MBS Available For Sale ("AFS")	(106,828,636		)	(55,486,020		)		(63,945,253		)
Proceeds from Payments and Maturities of MBS AFS	32,283,649			37,491,568				38,559,363
Proceeds from Sale of MBS AFS	61,306,939			18,081,756				20,549,491
Purchase of MBS Held To Maturity ("HTM")	—			(1,989,922		)		(2,917,426		)
Proceeds from Payments and Maturities of MBS HTM	3,165,575			3,119,612				3,892,085
Purchase of Investment Securities AFS	(83,980,247		)	(57,280,900		)		(95,561,763		)
Proceeds from Payments and Maturities of Investment Securities AFS	35,243,895			31,024,291				24,035,102
Proceeds from Sale of Investment Securities AFS	35,174,873			15,198,888				51,788,340
Purchase of Investment Securities HTM	—			—				(3,997,750		)
Proceeds from Payments and Maturities of Investment Securities HTM	1,000,000			2,000,000				1,000,000
Investment in Certificates of Deposits with Other Banks	—			—				(600,005		)
Redemption of Certificates of Deposits with Other Banks	250,005			750,000				1,095,000
Purchase of FHLB Stock	(11,907,800		)	(5,717,400		)		(7,019,800		)
Redemption of FHLB Stock	11,575,300			6,445,300				6,864,400
Purchase of BOLI	—			(1,900,000		)		(2,000,000		)
Proceeds from BOLI Death Benefit	414,855			—				1,463,285
Increase in Loans Receivable	(22,007,081		)	(42,300,871		)		(33,002,340		)
Proceeds from Sale of OREO	1,040,366			1,361,499				2,387,799
Purchase and Improvement of Premises and Equipment	(4,634,847		)	(2,864,597		)		(3,065,662		)
Net Cash Used By Investing Activities	(47,903,154		)	(52,066,796		)		(60,475,134		)

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES




	For the Years Ended December 31,
	2019			2018			2017
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in Deposit Accounts	3,910,775			65,390,088			48,003,341
Proceeds from FHLB Advances	342,223,000			204,923,000			227,436,000
Repayment of FHLB Advances	(338,115,000		)	(222,573,000		)	(224,151,000		)
Repayment of Note Payable, Net	(2,362,500		)	(6,137,500		)	(4,500,000		)
Proceeds from (Repayments of) Other Borrowings, Net	881,390			(608,732		)	1,969,013
Purchase of Senior Convertible Debentures	—			—			(20,000		)
Proceeds from Issuance of Subordinated Debentures	30,000,000			—			—
Proceeds from Employee Stock Options Exercised	—			10,310			176,175
Proceeds from Employee Stock Purchases	52,868			12,196			—
Dividends to Common Stock Shareholders	(1,123,219		)	(1,063,626		)	(1,060,729		)
Net Cash Provided By Financing Activities	35,467,314			39,952,736			47,852,800
Net (Decrease) Increase in Cash and Cash Equivalents	(169,599		)	2,386,286			945,075
Cash and Cash Equivalents at Beginning of Year	12,705,910			10,319,624			9,374,549
Cash and Cash Equivalents at End of Year	$	12,536,311		$	12,705,910		$	10,319,624
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash Paid During the Period For:
Interest	$	7,882,527		$	5,574,723		$	4,128,260
Income Taxes	$	1,764,541		$	1,521,811		$	1,667,673
Supplemental Schedule of Non Cash Transactions:
Transfers from Loans Receivable to OREO	$	832,800		$	435,550		$	580,748
Increase (Decrease) in Unrealized Gains on Securities AFS, Net of Taxes	$	4,495,436		$	(3,571,122	)	$	1,752,036
Initial Recognition of Lease ROU Assets	$	3,090,512		$	—		$	—
Initial Recognition of Lease Liability	$	3,090,512		$	—		$	—
Redemption of Convertible Debentures	$	20,000		$	—		$	—

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.

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”), Security Federal Investments, Inc. ("SFINV") 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 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. SFINV was formed to hold investment securities and allow for better management of the securities portfolio. SFSC is currently inactive.

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.

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 a level yield basis. Callable debt securities held at a premium are amortized until the earliest call date. Prepayment assumptions on mortgage-backed securities are anticipated.

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

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.

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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements


(1)	Significant Accounting Policies, Continued

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

The Company values impaired loans at the loan’s fair value if it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement at the present value of expected cash flows, the market price of the loan, if available, or the value of the underlying collateral less estimated selling costs. In accordance with our policy, non-accrual commercial loans with a balance less than $200,000 and non-accrual consumer loans with a balance less than $100,000 are deemed immaterial and therefore excluded from the individual impairment review. 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.

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.

Other Real Estate Owned

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.

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 7 to 40 years for buildings and improvements and generally 3 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.

Intangible Assets and Goodwill

The Company's goodwill is a result of the excess of the cost over the fair value of net assets resulting from the Company's acquisition of Collier Jennings Financial Corporation in July 2006. Goodwill is reviewed for impairment annually or whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Intangible assets are amortized over their estimated economic lives using methods that reflect the pattern in which the economic benefits are utilized. The intangible assets, which consisted of the customer list and employment contracts resulting from the Company’s acquisition of Collier Jennings Financial Corporation, were fully amortized at December 31, 2019.

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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements


(1)	Significant Accounting Policies, Continued

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 December 31, 2016 are closed for federal, state and local income tax matters.

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.

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.

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 $796,000, $547,000, and $596,000 were included in the Company’s results of operations for the years ended December 31, 2019, 2018 and 2017, respectively.

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.

Net Income Per Common Share

Accounting guidance specifies computation and presentation requirements for both basic net income per common 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 following tables show the effect of dilutive options on the Company’s net income per common share.



	Year Ended December 31, 2019
	Income		Shares	Per Share
Basic EPS	$	7,794,487	2,955,737	$	2.64
Effect of Dilutive Securities:
Senior Convertible Debentures	362,640		302,200	(0.14		)
Diluted EPS	$	8,157,127	3,257,937	$	2.50

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements


(1)	Significant Accounting Policies, Continued



	Year Ended December 31, 2018						Year Ended December 31, 2017
	Income		Shares	Per Share			Income		Shares	Per Share
Basic EPS	$	7,207,221	2,953,446	$	2.44		$	5,918,340	2,945,918	$	2.01
Effect of Dilutive Securities:
Stock Options	—		0	—			—		951	—
Senior Convertible Debentures	362,640		303,200	(0.12		)	301,339		303,200	(0.10		)
Diluted EPS	$	7,569,861	3,256,646	$	2.32		$	6,219,679	3,250,069	$	1.91

There were no stock options outstanding as of December 31, 2019 and 2018; and therefore, no dilutive options in the calculation of diluted EPS for those periods. The average market price used in calculating the assumed number of dilutive shares issued for the year ended December 31, 2017 was $29.05.

Use of Estimates

The preparation of financial statements in conformity with U.S. 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.

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 February 2016, the FASB amended the Leases topic of the ASC to revise certain aspects of recognition, measurement, presentation, and disclosure of leasing transactions. In July 2018, the FASB further amended the Leases Topic of the ASC to make narrow amendments to clarify how to apply certain aspects of the new leases standard. The amendments also give entities another additional and optional method for transition to the new guidance and to provide lessors with a practical expedient. The amendments were effective for reporting periods beginning after December 15, 2018. The Company adopted the new standard and recorded a right-of-use asset and lease liability of $3.1 million effective January 1, 2019. Additional disclosures required by the ASC have been included in "Note 5 - Premises and Equipment, Net and Leases."

In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The guidance significantly changes the impairment model for most financial assets that are measured at amortized cost and certain other instruments from an incurred loss model to an expected loss model. The amendments will be effective for the Company for reporting periods beginning after December 15, 2022. Early adoption is permitted. The Company is in the process of identifying required changes to the loan loss estimation models and processes and evaluating the impact of this new guidance. Once adopted, we expect our allowance for loan losses to increase, however, until our evaluation is complete the magnitude of the increase will be unknown.

In March 2017, the FASB issued guidance on Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The guidance shortens the amortization period for certain callable debt securities held at a premium. The amendments were effective for the Company for reporting periods beginning after December 15, 2018. The adoption of these amendments did not have a material effect on its consolidated financial statements.

In June 2018, the FASB amended the Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. The amendments expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. Previously, these awards were recorded at the fair value of consideration received or the fair value of the equity instruments issued and was measured as the earlier of the commitment date or date performance was completed. The guidance requires the awards to be measured at the grant-date fair value of the equity instrument. This ASU became effective for reporting periods beginning after December 15, 2018. The adoption of these amendments did not have a material effect on the Company's consolidated financial statements.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(1) Significant Accounting Policies, Continued

Recently Issued Accounting Standards

In August 2018, the FASB amended the Fair Value Measurement Topic of the ASC to remove, modify, and add certain fair value disclosure requirements based on the concepts in the FASB Concepts Statement, Conceptual Framework for Financial Reporting-Chapter 8: Notes to Financial Statements. The amendments are effective for reporting periods beginning after December 15, 2019. Early adoption is permitted. An entity is permitted to early adopt any removed or modified disclosures upon issuance of this guidance and delay adoption of the additional disclosures until their effective date. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In March 2019, the FASB issued guidance to address concerns by lessors that are not manufacturers or dealers when assessing the fair value of underlying assets under the leases standard discussed above and to clarify that lessees and lessors are exempt from a certain interim disclosure requirement associated with adopting the new standard. The amendments are effective for the Company for reporting periods beginning after December 15, 2019. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In April 2019, the FASB issued guidance to provide entities that have certain financial instruments measured at amortized cost that have credit losses, to irrevocably elect the fair value option in Subtopic 825-10, upon adoption of the June 2016 guidance related to accounting for credit losses and modifying the impairment model for certain debt securities. The fair value option applies to available-for-sale debt securities. This guidance should be applied at adoption on a modified-retrospective basis as a cumulative-effect adjustment to the opening balance of retained earnings in the statement of financial condition. The Company does not expect these amendments to have a material effect on its consolidated financial statements.

In December 2019, the FASB issued guidance simplifying the accounting for income taxes by removing certain exceptions to the general principles in Topic 740, Income Taxes. The amendments also improve consistent application or and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. This ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The Company does not expect the adoption of ASU 2019-12 to have a material impact on its consolidated financial statements.

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

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 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.

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 at the dates indicated are as follows:



	December 31, 2019
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
Student Loan Pools	$	41,088,231	$	—	$	856,401	$	40,231,830
Small Business Administration (“SBA”) Bonds	111,927,938		622,105		656,944		111,893,099
Tax Exempt Municipal Bonds	43,153,086		4,088,408		—		47,241,494
Taxable Municipal Bonds	15,169,737		35,359		364,686		14,840,410
Mortgage-Backed Securities	197,356,288		3,664,621		582,902		200,438,007
	$	408,695,280	$	8,410,493	$	2,460,933	$	414,644,840
	December 31, 2018
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair value
Student Loan Pools	$	12,934,037	$	20,713	$	69,249	$	12,885,501
SBA Bonds	125,777,016		560,352		890,837		125,446,531
Tax Exempt Municipal Bonds	60,141,164		1,518,974		329,769		61,330,369
Taxable Municipal Bonds	1,998,258		3,546		23,919		1,977,885
Mortgage-Backed Securities	185,291,038		1,073,432		1,903,919		184,460,551
	$	386,141,513	$	3,177,017	$	3,217,693	$	386,100,837

Student Loan Pools are typically 97% guaranteed by the United States government while SBA bonds are 100% backed by the full faith and credit of the United States government. Included in the tables above and below in mortgage-backed securities are Government National Mortgage Association ("GNMA") mortgage-backed securities, which are also backed by the full faith and credit of the United States government. At December 31, 2019, the Bank held an amortized cost and fair value of $63.2 million and $63.9 million, respectively, in GNMA mortgage-backed securities compared to an amortized cost and fair value of $80.4 million and $80.2 million, respectively, at December 31, 2018. Also included in mortgage-backed securities in the tables above and below are private label collateralized mortgage obligation ("CMO") securities, which are issued by non-governmental real estate mortgage investment conduits and are not backed by the full faith and credit of the United States government. At December 31, 2019 the Bank held an amortized cost and fair value of $15.8 million and $16.1 million, respectively, in private label CMO mortgage-backed securities, compared to an amortized cost and fair value of $29.7 million and $29.5 million, respectively, at December 31, 2018.

The amortized cost and fair value of investment and mortgage-backed securities available for sale at December 31, 2019 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. Since mortgage-backed securities are not due at a single maturity date, they are disclosed separately, rather than allocated over the maturity groupings below.



	Amortized Cost		Fair Value
Due in less than one year	$	18,237	$	18,134
Due in one year to five years	6,314,205		6,342,172
Due in five to ten years	57,236,558		57,209,659
Due in ten years or more	147,769,992		150,636,868
Mortgage-Backed Securities	197,356,288		200,438,007
	$	408,695,280	$	414,644,840

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 pledged as collateral for certain deposit accounts, FHLB advances and other borrowings were $171.4 million and $173.1 million, respectively, at December 31, 2019 and $111.8 million and $111.7 million, respectively, at December 31, 2018.

The Bank received $96.5 million, $33.3 million and $72.3 million in gross proceeds from sales of available for sale securities during the years ended December 31, 2019, 2018 and 2017, respectively. As a result, the Bank recognized gross gains of $1.5 million, $732,000 and $1.0 million, respectively, and gross losses of $636,000, $159,000 and $510,000, respectively, during the years ended December 31, 2019, 2018 and 2017.

The tables below summarize gross unrealized losses and the related 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, 2019
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Student Loan Pools	$	30,079,497	$	534,048	$	10,152,333	$	322,353	$	40,231,830	$	856,401
SBA Bonds	13,844,666		106,110		47,395,036		550,834		61,239,702		656,944
Taxable Municipal Bonds	13,810,279		364,686		—		—		13,810,279		364,686
Mortgage-Backed Securities	55,326,064		480,958		7,975,863		101,944		63,301,927		582,902
	$	113,060,506	$	1,485,802	$	65,523,232	$	975,131	$	178,583,738	$	2,460,933



	December 31, 2018
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Student Loan Pools	$	8,384,145	$	69,249	$	—	$	—	$	8,384,145	$	69,249
SBA Bonds	59,496,936		479,955		25,054,861		410,882		84,551,797		890,837
Tax Exempt Municipal Bonds	4,585,849		91,281		9,626,613		238,488		14,212,462		329,769
Taxable Municipal Bonds	—		—		980,520		23,919		980,520		23,919
Mortgage-Backed Securities	38,168,598		249,050		81,947,249		1,654,869		120,115,847		1,903,919
	$	110,635,528	$	889,535	$	117,609,243	$	2,328,158	$	228,244,771	$	3,217,693

Securities classified as available-for-sale are recorded at fair market value. At December 31, 2019 and 2018, 39.6% and 72.4% of the unrealized losses, representing 69 and 92 individual securities, respectively, consisted of securities in a continuous loss position for 12 months or more. The Company has the ability and intent to hold these securities until such time as the value recovers or the securities mature. The Company believes, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and is not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary. The Company reviews its investment securities portfolio at least quarterly and more frequently when economic conditions warrant, assessing whether there is any indication of other-than-temporary impairment (“OTTI”).

Factors considered in the Company's review of its investment securities portfolio 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 the Company may recognize a portion of the impairment in other comprehensive income. The fair value of investments on which OTTI is recognized then becomes the new cost basis of the investment. There was no OTTI recognized during the years ended December 31, 2019, 2018 and 2017.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

At December 31, 2019, the Company's entire held to maturity portfolio was comprised of mortgage-backed securities. The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of held to maturity securities at December 31, 2019 and 2018 were as follows:



	December 31, 2019
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Mortgage-Backed Securities ⁽¹⁾	$	19,246,935	$	560,067	$	1,161	$	19,805,841
Total Held To Maturity	$	19,246,935	$	560,067	$	1,161	$	19,805,841

	December 31, 2018
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
FHLMC Bond	$	998,541	$	—	$	20,564	$	977,977
Mortgage-Backed Securities ⁽¹⁾	22,639,472		78,281		446,330		22,271,423
Total Held To Maturity	$	23,638,013	$	78,281	$	466,894	$	23,249,400

^{(1) COMPRISED OF GSES OR GNMA MORTGAGE-BACKED SECURITIES}

The Company’s held to maturity portfolio is recorded at amortized cost. The Company has the ability and intent to hold these securities to maturity. At December 31, 2019, the Bank held an amortized cost and fair value of $11.3 million and $11.6 million, respectively, in GNMA mortgage-backed securities classified as held to maturity compared to an amortized cost and fair value of $13.3 million and $13.1 million, respectively, at December 31, 2018. The Company has not invested in any private label mortgage-backed securities classified as held to maturity.

At December 31, 2019, the amortized cost and fair value of mortgage-backed securities held to maturity that were pledged as collateral for certain deposit accounts, FHLB advances and other borrowings were $17.5 million and $18.0 million, respectively, compared to an amortized cost and fair value of $19.8 million and $19.4 million, respectively, at December 31, 2018. The following tables show gross unrealized losses, fair value and length of time that individual held to maturity securities were in a continuous unrealized loss position at December 31, 2019 and 2018.



	December 31, 2019
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Mortgage-Backed Securities ⁽¹⁾	$	—	$	—	$	820,313	$	1,161	$	820,313	$	1,161
	$	—	$	—	$	820,313	$	1,161	$	820,313	$	1,161

	December 31, 2018
	Less than 12 Months				12 Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
FHLMC Bond	$	—	$	—	$	977,977	$	20,564	$	977,977	$	20,564
Mortgage-Backed Securities ⁽¹⁾	—		—		16,855,973		446,330		16,855,973		446,330
	$	—	$	—	$	17,833,950	$	466,894	$	17,833,950	$	466,894

^{(1) COMPRISED OF GSES OR GNMA MORTGAGE-BACKED SECURITIES}

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(4) Loans Receivable, Net

Loans receivable, net, at December 31, 2019 and 2018 are summarized below.



	December 31,
	2019				2018
	Balance		% of Total Gross Loans		Balance		% of Total Gross Loans
Residential Real Estate Loans	$	86,404,304	18.4	%	$	83,965,416	18.9	%
Consumer Loans	56,331,013		12.0	%	56,907,555		12.8	%
Commercial Business Loans	22,234,189		4.8	%	28,086,686		6.3	%
Commercial Real Estate Loans	303,550,905		64.8	%	275,960,438		62.0	%
Total Loans Held For Investment	468,520,411		100.0	%	444,920,095		100.0	%
Loans Held For Sale	3,990,606				1,781,985
Total Loans Receivable, Gross	472,511,017				446,702,080
Less:
Allowance For Loan Losses	9,225,574				9,171,717
Loans in Process	9,957,140				7,225,271
Deferred Loan Fees	469,568				251,575
	19,652,282				16,648,563
Total Loans Receivable, Net	$	452,858,735			$	430,053,517

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 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.

The following tables summarize the loan grades used by the Company to measure the credit quality of gross loans receivable, excluding those held for sale, by loan segment at December 31, 2019 and 2018.



December 31, 2019	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	76,674,539	$	4,612,182	$	1,155,802	$	3,961,781	$	86,404,304
Consumer	44,294,400		9,617,301		624,248		1,795,064		56,331,013
Commercial Business	16,140,592		5,486,393		301,462		305,742		22,234,189
Commercial Real Estate	230,810,756		56,025,352		14,285,015		2,429,782		303,550,905
Total	$	367,920,287	$	75,741,228	$	16,366,527	$	8,492,369	$	468,520,411



December 31, 2018	Pass		Caution		Special Mention		Substandard		Total Loans
Residential Real Estate	$	75,558,544	$	3,369,776	$	958,354	$	4,078,742	$	83,965,416
Consumer	46,948,251		6,899,912		567,682		2,491,710		56,907,555
Commercial Business	22,670,318		4,708,036		339,533		368,799		28,086,686
Commercial Real Estate	204,197,354		45,653,796		18,492,785		7,616,503		275,960,438
Total	$	349,374,467	$	60,631,520	$	20,358,354	$	14,555,754	$	444,920,095

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(4) Loans Receivable, Net, Continued

The following tables present an age analysis of past due balances by category at December 31, 2019 and 2018.



	December 31, 2019
	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	$	—	$	355,290	$	144,209	$	499,499	$	85,904,805	$	86,404,304
Consumer	422,443		217,542		81,736		721,721		55,609,292		56,331,013
Commercial Business	147,959		76,515		20,316		244,790		21,989,399		22,234,189
Commercial Real Estate	3,849,424		—		1,352,716		5,202,140		298,348,765		303,550,905
Total	$	4,419,826	$	649,347	$	1,598,977	$	6,668,150	$	461,852,261	$	468,520,411



	December 31, 2018
	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	$	—	$	332,000	$	497,713	$	829,713	$	83,135,703	$	83,965,416
Consumer	555,798		247,894		1,120,462		1,924,154		54,983,401		56,907,555
Commercial Business	205,613		106,163		18,648		330,424		27,756,262		28,086,686
Commercial Real Estate	1,556,863		424,103		1,634,770		3,615,736		272,344,702		275,960,438
Total	$	2,318,274	$	1,110,160	$	3,271,593	$	6,700,027	$	438,220,068	$	444,920,095

At December 31, 2019 and 2018, 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, 2019 compared to 2018.



	December 31, 2019				December 31, 2018				Decrease
	Amount		Percent ⁽¹⁾		Amount		Percent ⁽¹⁾		$			%
Non-accrual Loans:
Residential Real Estate	$	1,520,485	0.3	%	$	2,084,870	0.5	%	$	(564,385	)	(27.1	)%
Consumer	319,280		0.1		1,274,673		0.3		(955,393		)	(75.0	)
Commercial Business	122,605		—		124,458		—		(1,853		)	(1.5	)
Commercial Real Estate	1,474,036		0.3		3,564,494		0.8		(2,090,458		)	(58.6	)
Total Non-accrual Loans	$	3,436,406	0.7	%	$	7,048,495	1.6	%	$	(3,612,089	)	(51.2	)%

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

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(4) Loans Receivable, Net, Continued

The following tables show the allowance for loan losses by loan category for the years ended December 31, 2019, 2018 and 2017.



	For the Year Ended December 31, 2019
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,191,443		$	1,203,593		$	923,600		$	5,853,081		$	9,171,717
Provision	227,624			324,394			(392,817		)	215,799			375,000
Charge-Offs	(34,599		)	(432,003		)	(1,132		)	(517,583		)	(985,317		)
Recoveries	6,126			114,865			15,113			528,070			664,174
Ending Balance	$	1,390,594		$	1,210,849		$	544,764		$	6,079,367		$	9,225,574



	For the Year Ended December 31, 2018
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,233,843		$	1,144,815		$	1,011,227		$	4,831,733		$	8,221,618
Provision	2,411			173,235			(55,109		)	804,463			925,000
Charge-Offs	(46,419		)	(224,954		)	(32,518		)	(351,894		)	(655,785		)
Recoveries	1,608			110,497			—			568,779			680,884
Ending Balance	$	1,191,443		$	1,203,593		$	923,600		$	5,853,081		$	9,171,717



	For the Year Ended December 31, 2017
	Residential Real Estate			Consumer			Commercial Business			Commercial Real Estate			Total
Beginning Balance	$	1,360,346		$	996,620		$	882,999		$	5,116,266		$	8,356,231
Provision	82,909			257,180			261,599			(301,688		)	300,000
Charge-Offs	(211,780		)	(184,161		)	(133,371		)	(301,260		)	(830,572		)
Recoveries	2,368			75,176			—			318,415			395,959
Ending Balance	$	1,233,843		$	1,144,815		$	1,011,227		$	4,831,733		$	8,221,618

The following tables summarize the impaired loans evaluated individually and collectively for impairment within the allowance for loan losses and loans receivable balances at December 31, 2019 and 2018.



	Allowance For Loan Losses						Loans Receivable
December 31, 2019	Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total		Individually Evaluated For Impairment		Collectively Evaluated For Impairment		Total
Residential Real Estate	$	—	$	1,390,594	$	1,390,594	1,086,433		$	85,317,871	$	86,404,304
Consumer	—		1,210,849		1,210,849		184,402		56,146,611		56,331,013
Commercial Business	—		544,764		544,764		64,406		22,169,783		22,234,189
Commercial Real Estate	—		6,079,367		6,079,367		1,894,642		301,656,263		303,550,905
Total	$	—	$	9,225,574	$	9,225,574	$	3,229,883	$	465,290,528	$	468,520,411

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 total impaired loans was $6.4 million for year ended December 31, 2019 compared to $11.0 million for the year ended December 31, 2018.

The following tables present information related to impaired loans by loan category as of and for the years ended December 31, 2019, 2018 and 2017.



	December 31, 2019
Impaired Loans	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With No Related Allowance Recorded:
Residential Real Estate	$	1,086,433	$	1,086,433	$	—	$	1,322,609	$	—
Consumer	184,402		192,702		—		1,106,795		—
Commercial Business	64,406		959,406		—		71,422		—
Commercial Real Estate	1,894,642		2,066,862		—		3,893,786		54,372
Total
Residential Real Estate	1,086,433		1,086,433		—		1,322,609		—
Consumer	184,402		192,702		—		1,106,795		—
Commercial Business	64,406		959,406		—		71,422		—
Commercial Real Estate	1,894,642		2,066,862		—		3,893,786		54,372
Total	$	3,229,883	$	4,305,403	$	—	$	6,394,612	$	54,372

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(4) Loans Receivable, Net, Continued



	December 31, 2018
Impaired Loans	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With No Related Allowance Recorded:
Residential Real Estate	$	1,700,861	$	1,700,861	$	—	$	1,743,906	$	31,853
Consumer	986,380		994,680		—		502,479		—
Commercial Business	77,206		972,206		—		85,020		—
Commercial Real Estate	5,084,458		6,116,761		—		8,052,817		212,186
With an Allowance Recorded:
Consumer	73,662		73,662		73,662		6,139		—
Commercial Real Estate	1,441,558		1,441,558		665,000		636,387		84,881
Total
Residential Real Estate	1,700,861		1,700,861		—		1,743,906		31,853
Consumer	1,060,042		1,068,342		73,662		508,618		—
Commercial Business	77,206		972,206		—		85,020		—
Commercial Real Estate	6,526,016		7,558,319		665,000		8,689,204		297,067
Total	$	9,364,125	$	11,299,728	$	738,662	$	11,026,748	$	328,920



	December 31, 2017
Impaired Loans	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With No Related Allowance Recorded:
Residential Real Estate	$	1,883,741	$	2,333,741	$	—	$	2,889,065	$	24,273
Consumer	181,617		209,427		—		279,183		—
Commercial Business	100,401		950,401		—		141,940		—
Commercial Real Estate	6,276,547		7,583,847		—		7,483,035		189,373
Total
Residential Real Estate	1,883,741		2,333,741		—		2,889,065		24,273
Consumer	181,617		209,427		—		279,183		—
Commercial Business	100,401		950,401		—		141,940		—
Commercial Real Estate	6,276,547		7,583,847		—		7,483,035		189,373
Total	$	8,442,306	$	11,077,416	$	—	$	10,793,223	$	213,646

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(4) Loans Receivable, Net, Continued

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.

At the date of modification, TDRs are initially classified as nonaccrual TDRs. They 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).

The Bank had five TDRs with a total balance of $825,000 included in impaired loans at December 31, 2019 compared to seven TDRs totaling $1.4 million at December 31, 2018. There were no TDRs restructured during the years ended December 31, 2019, 2018 and 2017. At December 31, 2019, there were no TDRs in default. At December 31, 2018 and 2017, one previously restructured loan with a balance of $374,000 and two previously restructured loans with a total balance of $610,000, respectively, were in default, none of which had been restructured during the same period. 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 as 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 probable. 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 become current and then 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 and Leases

Premises and equipment, net, are summarized as follows:



	December 31,
	2019			2018
Land	$	7,708,424		$	6,693,927
Buildings and Improvements	25,336,734			23,319,946
Furniture and Equipment	12,748,562			11,878,563
Construction in Progress	1,751,176			1,391,986
Total Premises and Equipment	47,544,896			43,284,422
Less: Accumulated Depreciation	(20,325,013		)	(19,109,715		)
Total Premises and Equipment, Net	$	27,219,883		$	24,174,707

Construction in progress of $1.8 million at December 31, 2019 primarily included building and construction costs associated with our newest branch in Augusta, Georgia, scheduled for opening in 2021. At December 31, 2019 the estimated additional costs to complete and equip the branch were approximately $2.0 million. Depreciation expense on premises and equipment was $1.6 million, $1.5 million and $1.5 million for the years ended December 31, 2019, 2018 and 2017, respectively.

Effective January 1, 2019 the Company adopted ASC 842 “Leases.” Currently, the Company has operating leases on six of its branches that are accounted for under this standard. As a result of this standard, the Company recognized both a right-of-use (ROU) asset and lease liability of $3.1 million effective January 1, 2019. During the year ended December 31, 2019, the Company made cash payments in the amount of $444,000 for operating leases. The lease expense recognized during this period amounted to $458,000 and the lease liability was reduced by $358,000. At December 31, 2019, the Company had ROU assets of $2.7 million and a lease liability of $2.7 million recorded on its consolidated balance sheet. The remaining weighted average lease term is seven years and the weighted average discount rate used is 3.2%.

At December 31, 2019, future undiscounted lease payments for operating leases with initial terms of one year or more were as follows:



Year ended December 31,
2020	435,553
2021	426,040
2022	437,463
2023	449,271
2024	450,657
Thereafter	869,050
Total undiscounted lease payments	3,068,034
Less: effect of discounting	334,503
Present value of estimated lease payments (lease liability)	$	2,733,531

Total rental expense was $460,000, $454,000, and $409,000 for the years ended December 31, 2019, 2018 and 2017, respectively. Five lease agreements with monthly expenses of $7,350, $900, $7,900, $9,950, and $10,600 have multiple renewal options totaling 30, 10, 15, 45, and 20 years, respectively.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(6) Goodwill

Goodwill was recorded in connection with the Company's acquisition of Collier Jennings Financial Corporation in July 2006. The goodwill balance of $1.2 million remained unchanged at both December 31, 2019 and 2018. In accordance with accounting guidance, the Company evaluates its goodwill on an annual basis. The evaluations were performed as of September 30, 2019 and 2018 for the years ended December 31, 2019 and 2018, respectively. At the time of the evaluations the Company determined that no impairment existed. Therefore, there was no write-down of goodwill for the years ended December 31, 2019 and 2018.

(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 was 0.09% of total assets at both December 31, 2019 and 2018, plus a transaction component equal to 4.25% of outstanding advances (borrowings) from the FHLB of Atlanta at December 31, 2019 and 2018. The Bank is in compliance with this requirement with an investment in FHLB of Atlanta stock of $2.5 million and $2.2 million at December 31, 2019 and 2018, 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) Other Real Estate Owned

The Bank owned $678,000 and $722,000 in OREO at December 31, 2019 and 2018, respectively. Transactions in OREO for the years ended December 31, 2019, 2018 and 2017 are summarized below.



	2019			2018			2017
Balance, beginning of year	$	722,442		$	1,115,671		$	2,721,214
Additions	832,800			435,550			580,748
Sales	(855,502		)	(772,779		)	(2,028,170		)
Write-downs	(22,000		)	(56,000		)	(158,121		)
Balance, end of year	$	677,740		$	722,442		$	1,115,671

There were no mortgage loans collateralized by residential real estate property in the process of foreclosure at December 31, 2019 compared to $320,000 at December 31, 2018.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(9) Deposits

Deposits outstanding at December 31, 2019 and 2018 are summarized below by account type.



	December 31, 2019				December 31, 2018
	Balance		Weighted Rate	Interest Rate Range	Balance		Weighted Rate	Interest Rate Range
Checking Accounts	$	260,135,924	0.11%	0.00-1.98%	$	219,515,207	0.09%	0.00-1.98%
Money Market Accounts	230,693,518		0.72%	0.00-1.48%	261,136,008		0.65%	0.00-2.23%
Savings Accounts	51,124,806		0.16%	0.00-1.00%	48,391,799		0.14%	0.00-0.14%
Total	$	541,954,248	0.36%	0.00-1.98%	$	529,043,014	0.31%	0.00-2.23%
Certificate Accounts:
0.00 – 0.99%	$	28,599,107			$	70,854,896
1.00 – 1.99%	122,164,536				120,011,938
2.00 – 2.99%	78,689,591				47,586,859
Total	$	229,453,234	1.71%	0.45-2.96%	$	238,453,693	1.37%	0.35-2.86%
Total Deposits	$	771,407,482	0.76%	0.00-2.96%	$	767,496,707	0.64%	0.00-2.86%

Included in the certificates above were $34.6 million and $33.1 million in brokered deposits at December 31, 2019 and 2018, respectively, with a weighted average interest rate of 1.87% and 1.86%, respectively. Of the $34.6 million in brokered deposits at December 31, 2019, $2.0 million mature within one year. At December 31, 2019 and 2018, the Bank had $141,000 and $59,000, respectively, in overdrafts that were reclassified to loans.

The aggregate amount of certificates of deposit with a minimum denomination of $100,000 was $144.2 million and $151.5 million at December 31, 2019 and 2018, respectively. Certificate of deposits that met or exceeded the FDIC insurance limit of $250,000 were $77.5 million and $89.2 million at December 31, 2019 and 2018, respectively.

The amounts and scheduled maturities of all certificates of deposit were as follows at December 31, 2019 and 2018:



	December 31,
	2019		2018
Within 1 Year	$	149,481,000	$	160,771,824
After 1 Year, Within 2 Years	42,689,147		43,330,060
After 2 Years, Within 3 Years	18,737,910		23,990,251
After 3 Years, Within 4 Years	3,272,862		6,358,577
After 4 Years, Within 5 Years	15,272,315		3,488,598
Thereafter	—		514,383
Total Certificates of Deposits	$	229,453,234	$	238,453,693

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(10) Advances From Federal Home Loan Bank and Other Borrowings

Advances from the FHLB are summarized by year of maturity and weighted average interest rate at December 31, 2019 below.



	Amount		Weighted Rate
2020	$	13,138,000	1.88%
2021	25,000,000		1.97%
Total	$	38,138,000	1.94%

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 $100.5 million and $96.7 million, respectively, at December 31, 2019 and $79.1 million and $71.4 million, respectively, at December 31, 2018.

FHLB advances are subject to prepayment penalties. During the years ended December 31, 2019, 2018 and 2017, the Bank prepaid no FHLB advances. 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. The Bank did not have any callable FHLB advances at December 31, 2019.

At December 31, 2019 and 2018, the Bank had $259.2 million and $236.6 million in additional borrowing capacity, respectively, at the FHLB.

The Bank had $11.6 million and $10.7 million in other borrowings at December 31, 2019 and 2018, 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, 2019 and 2018, the interest rate paid on the repurchase agreements was 0.50% and 0.25%, respectively. The maximum amount outstanding at any one month end during the year ended December 31, 2019 was $15.8 million compared to $14.3 million during the year ended December 31, 2018. The Bank had pledged as collateral for these repurchase agreements investment and mortgage-backed securities with amortized costs and fair values of $20.4 million and $20.5 million, respectively, at December 31, 2019 and $16.2 million and $16.5 million, respectively, at December 31, 2018.

(11) Note Payable

On October 31, 2016, the Company repurchased all 22,000 shares of its Series B Preferred Stock from the United States Department of the Treasury ("Treasury") for a total payment amount of $21.4 million. In connection with this repurchase, the Company obtained a $14.0 million unsecured term loan from another financial institution. The loan accrued and paid interest on a quarterly basis at a floating rate, which was calculated as the previous quarter end Wall Street Journal Prime index minus 30 basis points. The remaining balance of this loan was repaid prior to its maturity date of October 1, 2019.

(12) 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 floating rate of three month LIBOR plus 170 basis points which was a rate per annum equal to 3.59% and 4.49% at December 31, 2019 and 2018, respectively. 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 had the right to redeem the Capital Securities in whole or in part since September 15, 2011.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(13) Senior Convertible Debentures

Effective December 1, 2009, the Company issued $6.1 million in 8.0% convertible senior debentures with a maturity date of December 1, 2029. Since December 1, 2019, the Company had the right to redeem the debentures, in whole or in part, at the option of the Company, 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.

(14) Subordinated Debentures

The Notes have been structured to qualify as Tier 2 capital for the Company under applicable regulatory guidelines. The Company used the net proceeds from the sale of the Notes to fund the redemption of the convertible senior debentures and for general corporate purposes to support future growth.

(15) Income Taxes

Income tax expense was comprised of the following for the dates indicated below:



	Years Ended December 31,
	2019			2018			2017
Current:
Federal	$	1,437,595		$	1,454,049		$	1,500,337
State	145,412			202,292			209,396
Total Current Tax Expense	1,583,007			1,656,341			1,709,733
Deferred:
Federal	105,960			(79,034		)	736,390
State	(9,417		)	(7,781		)	(10,663		)
Total Deferred Tax Expense (Benefit)	96,543			(86,815		)	725,727
Total Income Tax Expense	$	1,679,550		$	1,569,526		$	2,435,460

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(15) Income Taxes, Continued

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



	Years Ended December 31,
	2019			2018			2017
Tax at Statutory Income Tax Rate	$	1,989,548		$	1,843,117		$	2,840,292
State Tax and Other	100,820			157,417			44,764
Tax Exempt Interest	(291,768		)	(338,497		)	(730,477		)
Life Insurance	(142,508		)	(113,400		)	(394,445		)
Valuation Allowance	23,458			20,889			69,133
Impact of Federal Rate Change on Deferred Taxes	—			—			606,193
Total Income Tax Expense	$	1,679,550		$	1,569,526		$	2,435,460

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2019 and 2018 are presented below. Net deferred tax assets were included in other assets at December 31, 2019 and 2018.



	December 31,
	2019			2018
Deferred Tax Assets:
Deferred Compensation	$	587,322		$	498,764
Provision for Loan Losses	2,000,131			1,978,481
Other Real Estate Owned	—			18,283
Net Fees Deferred for Financial Reporting	76,262			73,892
Net Operating Losses	356,759			333,301
Other	126,492			240,724
Total Gross Deferred Tax Assets	3,146,966			3,143,445
Less: Valuation Allowance	(356,759		)	(333,301		)
Net Deferred Tax Assets	2,790,207			2,810,144
Deferred Tax Liabilities:
FHLB Stock Basis Over Tax Basis	72,208			71,717
Depreciation	585,520			507,601
Prepaid Expenses	35,033			36,837
Unrealized Gain on Securities Available for Sale	1,473,077			10,487
Total Gross Deferred Tax Liability	2,165,838			626,642
Net Deferred Tax Asset	$	624,369		$	2,183,502

The Company measures deferred tax assets and liabilities using enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. 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, 2019, 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 approximately $23,000. The Company had state net operating losses attributable to the non-bank entities of $9.0 million and $8.4 million for the years ended December 31, 2019 and 2018, respectively.

Retained earnings at December 31, 2019 included tax bad debt reserves of $2.1 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 holding company, they may be subject to federal income tax at the prevailing corporate tax rate. At December 31, 2019, 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. Tax returns for 2016 and subsequent years are subject to examination by taxing authorities.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(16) Regulatory Matters

The Bank, as a state-chartered, federally insured savings bank, is subject to the capital requirements established by the FDIC. Under the FDIC's capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors.

The Company is a bank holding company registered with the Federal Reserve. Bank holding companies are subject to capital adequacy requirements of the Federal Reserve under the Bank Holding Company Act of 1956, as amended, and the regulations of the Federal Reserve. For a bank holding company with less than $3.0 billion in assets, the capital guidelines apply on a bank only basis and the Federal Reserve expects the holding company's subsidiary banks to be well-capitalized under the prompt corrective action regulations. If Security Federal Corporation was subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets, at December 31, 2019, it would have exceeded all regulatory capital requirements with Common Equity Tier 1 ("CET1") capital, Tier 1 leverage-based capital, Tier 1 risk-based capital and total risk-based capital ratios of 15.4%, 9.6%, 16.3% and 23.0%, respectively.

Based on its capital levels at December 31, 2019, the Bank exceeded all regulatory capital requirements as of that date. Consistent with the Bank's goals to operate a sound and profitable organization, it is the Bank's policy to maintain a "well-capitalized" status under the regulatory capital categories of the FDIC. Based on capital levels at December 31, 2019, the Bank was considered to be "well-capitalized" under applicable regulatory requirements. Management monitors the capital levels to provide for current and future business opportunities and to maintain the Bank's "well-capitalized" status.

The tables below provide the Bank’s regulatory capital requirements and actual results at December 31, 2019 and 2018.



	Actual				For Capital Adequacy				To Be Well Capitalized
(Dollars in Thousands)	Amount		Ratio		Amount		Ratio		Amount		Ratio
December 31, 2019
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	101,280	18.2	%	$	33,418	6.0	%	$	44,558	8.0	%
Total Risk-Based Capital (To Risk Weighted Assets)	108,270		19.4	%	44,558		8.0	%	55,697		10.0	%
Common Equity Tier 1 Capital (To Risk Weighted Assets)	101,280		18.2	%	25,064		4.5	%	36,203		6.5	%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	101,280		10.4	%	39,134		4.0	%	48,917		5.0	%
December 31, 2018
Tier 1 Risk-Based Core Capital (To Risk Weighted Assets)	$	89,188	16.2	%	$	33,005	6.0	%	$	44,007	8.0	%
Total Risk-Based Capital (To Risk Weighted Assets)	96,092		17.5	%	44,007		8.0	%	55,009		10.0	%
Common Equity Tier 1 Capital (To Risk Weighted Assets)	89,188		16.2	%	24,754		4.5	%	35,756		6.5	%
Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets)	89,188		9.8	%	36,486		4.0	%	45,608		5.0	%

In addition to the minimum capital requirements, the Bank must maintain a capital conservation buffer, consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses. At December 31, 2019 the Bank’s conservation buffer was 11.4%.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(17) 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. Total employer contributions were $273,000, $263,000 and $232,000 for the years ended December 31, 2019, 2018 and 2017, respectively.

The Company has an Employee Stock Purchase Plan (“ESPP”). The ESPP allows employees of the Company to purchase stock quarterly through a payroll deduction at a discount calculated as 15% of the market value with a floor equal to the Company’s book value. The ESPP, which was approved by stockholders in April 2018, became effective July 1, 2018. 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. At December 31, 2019, there were 29 employees participating.

The Company implemented an Incentive Compensation Plan (the "Plan") during the year ended December 31, 2014. Incentive awards are based on the financial and operating performance of the Company as well as other participant specific objectives. The Plan allows employees of the Company to earn up to 7.5 days of their annual salary for successfully completing specific goals established by the participants and their respective supervisors plus an additional 2.5 days of their annual salary if the Company meets an annual predetermined net operating income amount determined by the Board of Directors. The Company also implemented an Incentive Compensation Plan for executive level officers (the "Executive Plan"). Under this plan incentive awards are based on contributions to performance as measured by critical operating and financial ratios, and other participant specific objectives. The Company has to meet the annual predetermined net operating income amount determined by the Board of Directors for any incentive awards to be paid under the Executive Plan. If the Company does not meet the required net income amount, no incentives are paid regardless of the executive's performance on individual objectives or entity wide objectives.

In 2016, the Company implemented a Quarterly Branch Incentive Compensation Plan, and all branch employees were moved from the Plan to the Branch Incentive Plan. This plan is for retail branch employees only and pays incentive on a quarterly basis based on specific performance goals established for each branch location. Participation in all three plans is voluntary. During the years ended December 31, 2019 and 2018, the Company incurred expenses of $100,000 and $240,000, respectively, related to these incentive plans.

Certain officers of the Company participate in a supplemental retirement plan. These benefits are not qualified under the Internal Revenue Code and they are not funded. During the years ended December 31, 2019, 2018 and 2017, the Company incurred expenses of $496,000, $396,000, and $318,000, respectively, for this plan.

Certain officers and directors of the Company participate in incentive and non-qualified stock option plans. In 2008, the 2008 Equity Incentive Plan (the "2008 Plan") was approved by stockholders and implemented by the Company. The 2008 Plan provided for the grant of non-qualified and incentive stock options, stock appreciation rights (“SARS”), and restricted stock awards. Under the 2008 Plan, 50,000 shares of common stock were reserved for the issuance of stock options and SARS in addition to 50,000 shares subject to restricted stock awards. Options are granted at exercise prices not less than the fair value of the Company’s common stock on the date of the grant. The 2008 Plan expired during the year ended December 31, 2018. Since that date, there are no shares available for issuance under this plan for stock options or SARS. There were no stock options granted by the Company during the years ended December 31, 2019, 2018 and 2017.

At December 31, 2019, the Company had no options outstanding.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(17) Employee Benefit Plans, Continued

The following is a summary of the activity under the Company’s incentive and non-qualified stock option plans for the years ended December 31, 2018 and 2017:



	Years Ended December 31,
	2018			2017
	Shares	Weighted Avg. Exercise Price		Shares	Weighted Avg. Exercise Price
Balance, Beginning of Period	4,500	$	22.91	21,500	$	23.57
Options Exercised	450	22.91		7,500	23.49
Options Forfeited	4,050	22.91		9,500	23.95
Balance, End of Period	—	$	—	4,500	$	22.91
Options Exercisable	—	$	—	4,500	$	22.91
Weighted-Average Remaining Life of Exercisable Options	—			0.4 years
Options Available for Grant	—			50,000

During the years ended December 31, 2019 and 2018, no options vested. During the year ended December 31, 2017, 3,300 options with a weighted average exercise price of $23.33 vested. The aggregate intrinsic value of the stock options outstanding and exercisable was $0 at December 31, 2019, 2018 and 2017 and there was no compensation expense related to stock options during those years. As of December 31, 2019, there was no unrecognized compensation cost related to non-vested stock options.

(18) Bank Owned Life Insurance

BOLI provides key person life insurance on certain officers of the Company. The cash value of the life insurance policies are recorded as a separate line item in the accompanying balance sheets at $21.5 million and $21.2 million at December 31, 2019 and 2018, respectively. 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 $540,000, $540,000 and $506,000 for the growth in the cash value of life insurance during the years ended December 31, 2019, 2018 and 2017, respectively. In addition to the earnings above, the Company received $139,000 and $654,000 in death benefits during the years ended December 31, 2019 and 2017, respectively. There were no death benefits received during the year ended December 31, 2018.

(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 $108.0 million and $83.7 million and letters of credit of $1.5 million and $1.6 million at December 31, 2019 and 2018, respectively.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(19) Commitments and Contingencies, Continued

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.

Included in the loan commitments noted above were unused credit card loan commitments of $6.2 million and $5.6 million and undisbursed loans in process of $10.0 million and $7.2 million at December 31, 2019 and 2018, respectively. The Bank also had $282,000 in outstanding commitments on mortgage loans approved but not yet closed at December 31, 2019 compared to none at December 31, 2018. 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, 2019 and 2018, the Bank had outstanding commitments to sell approximately $4.0 million and $1.8 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:



	Years Ended December 31,
	2019			2018			2017
Balance, Beginning of Period	$	32,961		$	94,292		$	141,972
New Loans	417,590			674			1,078
Less Loan Payments	(19,035		)	(62,005		)	(48,758		)
Balance, End of Period	$	431,516		$	32,961		$	94,292

Loans to all employees, officers, and directors of the Company, in the aggregate constituted approximately 4.5% and 3.9% of the Company’s total shareholders' equity at December 31, 2019 and 2018, respectively. Deposits from executive officers and directors of the Company and the Bank and their related interests were approximately $15.9 million at $14.9 million at December 31, 2019 and 2018 and have substantially the same terms, including interest rates, as those prevailing at the time with other non-related depositors.

The Company leased office space from a related party during the years ended December 31, 2019, 2018 and 2017. The lease is with a company in which the related party, who is a director of the Company, has an ownership interest. The Company incurred rent expense of $87,600, $85,000 and $83,000 for the years ended December 31, 2019, 2018 and 2017, 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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(21) 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



	December 31,
	2019		2018
Assets:
Cash	$	25,685,744	$	3,619,418
Investment in Security Federal Statutory Trust	155,000		155,000
Investment in Security Federal Bank	106,947,285		90,359,718
Accounts Receivable and Other Assets	386,889		14,492
Total Assets	$	133,174,918	$	94,148,628
Liabilities and Shareholders’ Equity:
Accounts Payable and Other Liabilities	$	219,213	$	49,995
Long-term Debt	41,199,000		13,581,500
Shareholders’ Equity	91,756,705		80,517,133
Total Liabilities and Shareholders’ Equity	$	133,174,918	$	94,148,628

Condensed Statements of Income Data



	Years Ended December 31,
	2019			2018			2017
Income:
Equity in Earnings of Security Federal Bank	$	2,092,130		$	1,523,443		$	136,682
Dividend Income from Security Federal Bank	6,400,000			6,400,000			6,400,000
Gain on Sale of Investments	—			—			118,725
Miscellaneous Income	62,390			21,235			15,807
Total Income	8,554,520			7,944,678			6,671,214
Expenses:
Interest Expense	906,152			916,832			1,057,065
Other Expenses	39,331			11,099			14,349
Total Expenses	945,483			927,931			1,071,414
Income Before Income Taxes	7,609,037			7,016,747			5,599,800
Income Tax Benefit	(185,450		)	(190,474		)	(318,540		)
Net Income	$	7,794,487		$	7,207,221		$	5,918,340

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

Condensed Statements of Cash Flow Data



	Years Ended December 31,
	2019			2018			2017
Operating Activities:
Net Income	$	7,794,487		$	7,207,221		$	5,918,340
Adjustments to Reconcile Net Income to Net Cash Provided By Operating Activities:
Equity in Earnings of Security Federal Bank	(2,092,130		)	(1,523,443		)	(136,682		)
Deferred Compensation Expense	—			—			25,358
(Increase) Decrease in Accounts Receivable and Other Assets	(372,398		)	13,666			3,117
Increase (Decrease) in Accounts Payable	169,218			1,635			(33,612		)
Net Cash Provided By Operating Activities	5,499,177			5,699,079			5,776,521
Investing Activities:
Capital Pushdown to Security Federal Bank	(10,000,000		)	—			—
Proceeds from Sale of Investments	—			—			95,438
Net Cash (Used) Provided By Investing Activities	(10,000,000		)	—			95,438
Financing Activities:
Redemption of Convertible Debentures	—			—			(20,000		)
Proceeds from Stock Options Exercised	—			10,310			176,175
Employee Stock Plan Purchases	52,868			12,196			—
Proceeds from Subordinated Debentures	30,000,000			—			—
Repayment of Note Payable	(2,362,500		)	(6,137,500		)	(4,500,000		)
Dividends Paid to Shareholders-Common Stock	(1,123,219		)	(1,063,626		)	(1,060,729		)
Net Cash Provided (Used) By Financing Activities	26,567,149			(7,178,620		)	(5,404,554		)
Net Increase (Decrease) in Cash	22,066,326			(1,479,541		)	467,405
Cash at Beginning of Period	3,619,418			5,098,959			4,631,554
Cash at End of Period	$	25,685,744		$	3,619,418		$	5,098,959

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(22) Carrying Amounts and Fair Value of Financial Instruments

GAAP requires the Company to disclose fair value of financial instruments measured at amortized cost on the balance sheet and to measure that fair value using an exit price notion, the price that would be received for an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date under current market conditions.

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



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

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

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. At December 31, 2019, the Company’s investment portfolio was comprised of student loan pools, government and agency bonds, mortgage-backed securities issued by government agencies or GSEs, private label CMO mortgage-backed securities and municipal 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 institutional 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.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

Impaired Loans

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

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

Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2019, most of the total impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. The Company records impaired loans as nonrecurring Level 3. As of December 31, 2019 and 2018, the recorded investment in impaired loans was $3.2 million and $9.4 million, respectively. The average recorded investment in impaired loans was $6.4 million and $11.0 million for the years ended December 31, 2019 and 2018, respectively.

Foreclosed Assets

Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, they 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 less estimated selling costs. The Company records all foreclosed assets as nonrecurring level 3.

The tables below present the balances of assets measured at fair value on a recurring basis at December 31, 2019 and 2018:



	December 31, 2019						December 31, 2018
	Level 1		Level 2		Level 3		Level 1		Level 2		Level 3
Student Loan Pools	$	—	$	40,231,830	$	—	$	—	$	12,885,501	$	—
SBA Bonds	—		111,893,099		—		—		125,446,531		—
Tax Exempt Municipal Bonds	—		47,241,494		—		—		61,330,369		—
Taxable Municipal Bonds	—		14,840,410		—		—		1,977,885		—
Mortgage-Backed Securities	—		200,438,007		—		—		184,460,551		—
Total	$	—	$	414,644,840	$	—	$	—	$	386,100,837	$	—

There were no liabilities measured at fair value on a recurring basis as of December 31, 2019 and 2018.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. The table below presents assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2019 and 2018, aggregated by the level in the fair value hierarchy within which those measurements fall.



	December 31, 2019
Assets	Level 1		Level 2		Level 3		Total
Mortgage Loans Held For Sale	$	—	$	3,990,606	$	—	$	3,990,606
Collateral Dependent Impaired Loans ⁽¹⁾	—		—		3,222,746		3,222,746
Foreclosed Assets	—		—		677,740		677,740
Total	$	—	$	3,990,606	$	3,900,486	$	7,891,092
	December 31, 2018
Assets	Level 1		Level 2		Level 3		Total
Mortgage Loans Held For Sale	$	—	$	1,781,985	$	—	$	1,781,985
Collateral Dependent Impaired Loans ⁽¹⁾	—		—		8,613,570		8,613,570
Foreclosed Assets	—		—		722,442		722,442
Total	$	—	$	1,781,985	$	9,336,012	$	11,117,997

(1) REPORTED NET OF SPECIFIC RESERVES OF $0 AND $738,662 AT DECEMBER 31, 2019 AND 2018, RESPECTIVELY.

There were no liabilities measured at fair value on a nonrecurring basis as of December 31, 2019 and 2018.

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis, the significant unobservable inputs used in the fair value measurements were as follows as of December 31, 2019 and 2018:



	Valuation	Significant	2019	2018
Level 3 Assets	Technique	Unobservable Inputs	Range	Range
Collateral Dependent Impaired Loans	Appraised Value	Discount Rates/ Discounts to Appraised Values	8% - 92%	7% - 97%
Foreclosed Assets	Appraised Value/Comparable Sales	Discount Rates/ Discounts to Appraised Values	18% - 42%	16% - 100%

For assets and liabilities not presented on the balance sheet at fair value, the following methods are used to determine 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 Receivable, Net—The fair value of loans are estimated using an exit price notion. The exit price notion uses a discounted cash flows technique to calculate the present value of expected future cash flows for a financial instrument and also incorporates other factors, such as enhanced credit risk, illiquidity risk and market factors that sometimes exist in exit prices in dislocated markets. The credit risk assumption is intended to approximate the fair value that a market participant would realize in a hypothetical orderly transaction. The Company’s loan portfolio is initially fair valued using a segmented approach. The Company divides its loan portfolio into the following categories: commercial real estate, other commercial, residential real estate, consumer and all other loans. The results are then adjusted to account for credit risk as described above. A further credit risk discount must be applied through the use of a discounted cash flow model to compensate for illiquidity risk, based on certain assumptions included within the discounted cash flow model, primarily the use of discount rates that better capture inherent credit risk over the lifetime of a loan. This consideration of enhanced credit risk provides an estimated exit price for the Company’s loan portfolio. For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values approximate carrying values.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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

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 using discounted cash flows with current market rates for borrowings with similar terms.

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

Note Payable—The carrying value of the note payable 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.

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

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

The following tables summarize the carrying value and estimated fair value of the Company’s financial instruments as of December 31, 2019 and 2018 presented in accordance with the applicable accounting guidance.



	December 31, 2019
	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash and Cash Equivalents	$	12,536	$	12,536	$	12,536	$	—	$	—
Certificates of Deposits with Other Banks	950		950		—		950		—
Investment and Mortgage-Backed Securities	433,892		434,451		—		434,451		—
Loans Receivable, Net	452,859		450,796		—		—		450,796
FHLB Stock	2,537		2,537		2,537		—		—

Financial Liabilities:
Deposits:
Checking, Savings and Money Market Accounts	$	541,954	$	541,954	$	541,954	$	—	$	—
Certificate Accounts	229,453		229,363		—		229,363		—
Advances From FHLB	38,138		38,233		—		38,233		—
Other Borrowed Money	11,580		11,580		11,580		—		—
Subordinated Debentures	30,000		30,000		—		30,000		—
Junior Subordinated Debentures	5,155		5,155		—		5,155		—
Senior Convertible Debentures	6,044		6,044		—		6,044		—

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

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



	December 31, 2018
	Carrying		Fair Value
(In Thousands)	Amount		Total		Level 1		Level 2		Level 3
Financial Assets:
Cash and Cash Equivalents	$	12,706	$	12,706	$	12,706	$	—	$	—
Certificates of Deposits with Other Banks	1,200		1,200		—		1,200		—
Investment and Mortgage-Backed Securities	409,739		409,350		—		409,350		—
Loans Receivable, Net	430,054		421,379		—		—		421,379
FHLB Stock	2,204		2,204		2,204		—		—

Financial Liabilities:
Deposits:
Checking, Savings and Money Market Accounts	$	529,043	$	529,043	$	529,043	$	—	$	—
Certificate Accounts	238,454		236,103		—		236,103		—
Advances From FHLB	34,030		33,771		—		33,771		—
Other Borrowed Money	10,698		10,698		10,698		—		—
Note Payable	2,363		2,363		—		2,363		—
Junior Subordinated Debentures	5,155		5,155		—		5,155		—
Senior Convertible Debentures	6,064		6,064		—		6,064		—

At December 31, 2019, the Bank had $85.3 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

(23) Quarterly Financial Data (Unaudited)

Unaudited condensed financial data by quarter for the years ended December 31, 2019 and 2018 is as follows (dollars, except per share data, in thousands):



	Quarter ended
	3/31/2019		6/30/2019		9/30/2019		12/31/2019
Interest Income	$	9,031	$	9,128	$	9,641	$	9,134
Interest Expense	1,774		2,009		2,291		2,237
Net Interest Income	7,257		7,119		7,350		6,897
Provision for Loan Losses	100		—		75		200
Net Interest Income After Provision for Loan Losses	7,157		7,119		7,275		6,697
Non-interest Income	2,196		2,492		2,408		2,000
Non-interest Expense	6,744		7,241		6,989		6,896
Income Before Income Tax	2,609		2,370		2,694		1,801
Provision for Income Taxes	520		486		475		199
Net Income	$	2,089	$	1,884	$	2,219	$	1,602
Basic Net Income Per Common Share	$	0.71	$	0.64	$	0.75	$	0.54
Diluted Net Income Per Common Share	$	0.67	$	0.61	$	0.71	$	0.51
Basic Weighted Average Shares Outstanding	2,954,515		2,955,650		2,956,156		2,956,600
Diluted Weighted Average Shares Outstanding	3,256,715		3,257,850		3,258,356		3,258,800



	Quarter ended
	3/31/2018		6/30/2018		9/30/2018		12/31/2018
Interest Income	$	7,774	$	8,029	$	8,507	$	8,763
Interest Expense	1,169		1,286		1,430		1,565
Net Interest Income	6,605		6,743		7,077		7,198
Provision For Loan Losses	—		—		150		775
Net Interest Income After Provision for Loan Losses	6,605		6,743		6,927		6,423
Non-interest Income	2,044		1,744		2,070		1,811
Non-interest Expense	6,519		6,240		6,418		6,413
Income Before Income Tax	2,130		2,247		2,579		1,821
Provision for Income Taxes	400		427		471		271
Net Income	$	1,730	$	1,820	$	2,108	$	1,550
Basic Net Income Per Common Share	$	0.59	$	0.62	$	0.71	$	0.52
Diluted Net Income Per Common Share	$	0.56	$	0.59	$	0.68	$	0.50
Basic Weighted Average Shares Outstanding	2,953,180		2,953,412		2,953,424		2,953,763
Diluted Weighted Average Shares Outstanding	3,257,532		3,257,017		3,256,624		3,256,963

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(24) Non-Interest Income

The Company adopted the provisions of ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), on January 1, 2018 and all subsequent ASUs that modified Topic 606. Results for reporting periods beginning after December 31, 2017 are presented under Topic 606, while prior period amounts have not been adjusted and continue to be reported in accordance with Topic 605. The following table presents the Company's non-interest income for the years ended December 31, 2019, 2018 and 2017. All of the Company’s revenue from contracts with customers within the scope of ASC 606 is recognized in non-interest income, with the exception of gains on the sale of OREO, which are included in non-interest expense when applicable.



	Year Ended December 31,
	2019		2018		2017
Non-interest income:
Service fees on deposit accounts	$	1,069,470	$	1,060,159	$	1,048,345
Check card fee income	1,449,416		1,284,954		1,138,501
Trust income	1,061,200		974,000		796,000
Insurance commissions ⁽¹⁾	674,991		682,367		584,020
Gain on sale of investment securities, net ⁽¹⁾	819,053		573,266		494,146
Gain on sale of loans, net⁽¹⁾	1,728,741		1,250,530		1,179,837
BOLI income ⁽¹⁾	678,609		540,000		1,160,133
Grant income ⁽¹⁾	478,049		343,078		227,282
Other non-interest income ⁽¹⁾	1,137,614		960,792		716,019
Total non-interest income	$	9,097,143	$	7,669,146	$	7,344,283
⁽¹⁾ Not within the scope of ASC 606

The Company recognizes revenue as it is earned and noted no impact to its revenue recognition policies as a result of the adoption of ASU 2014-09. The following is a discussion of key revenues within the scope of the new revenue guidance.

Revenue Recognition

In accordance with Topic 606, revenues are recognized when control of promised goods or services is transferred to customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of Topic 606, the Company performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the Company satisfies a performance obligation.

The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of Topic 606, the Company assesses the goods or services that are promised within each contract and identifies those that contain performance obligations, and assesses whether each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

Deposit Fees

The Bank earns fees from its deposit customers for account maintenance, transaction-based and overdraft services. Account maintenance fees consist primarily of account fees and analyzed account fees charged on deposit accounts on a monthly basis. The performance obligation is satisfied and the fees are recognized on a monthly basis as the service period is completed. Transaction-based fees on deposits accounts are charged to deposit customers for specific services provided to the customer, such as non-sufficient funds fees, overdraft fees, and wire fees. The performance obligation is completed as the transaction occurs and the fees are recognized at the time each specific service is provided to the customer.

SECURITY FEDERAL CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(24) Non-Interest Income, Continued

Check Card Fee Income

Check card fee income represents fees earned when a debit card issued by the Bank is used. The Bank earns interchange fees from debit cardholder transactions through the Mastercard payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. The performance obligation is satisfied and the fees are earned when the cost of the transaction is charged to the card. Certain expenses directly associated with the debit card are recorded on a net basis with the fee income.

Trust Income

Trust income includes monthly advisory fees that are based on assets under management and certain transaction fees that are assessed and earned monthly, concurrently with the investment management services provided to the customer. The Bank does not charge performance based fees for its trust services and does not currently have any institutional clients, hedge funds or mutual funds. Although trust income is included within the scope of ASC 606, based on the fees charged by the Bank, the Company does not anticipate any changes in the accounting for trust income at this time.

Gains/Losses on OREO Sales

Gains/losses on the sale of OREO are included in non-interest expense and are generally recognized when the performance obligation is complete. This is typically at delivery of control over the property to the buyer at the time of each real estate closing.

(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 determined the following subsequent events required disclosure:

The 2019 novel coronavirus (or “COVID-19”) has adversely affected, and may continue to adversely affect economic activity globally, nationally and locally. Following the COVID-19 outbreak in December 2019 and January 2020, market interest rates have declined significantly, with the 10-year Treasury bond falling below 1.00% on March 3, 2020 for the first time. Such events also may adversely affect business and consumer confidence, generally, and the Company and its customers, and their respective suppliers, vendors and processors may be adversely affected. On March 3, 2020, the Federal Open Market Committee reduced the target federal funds rate by 50 basis points to 1.00% to 1.25%. This rate was further reduced to 0% to 0.25% on March 16, 2020. These reductions in interest rates and other effects of the COVID-19 outbreak may adversely affect the Company’s financial condition and results of operations.

SHAREHOLDERS INFORMATION

ANNUAL MEETING

The annual meeting of shareholders will be held at 11:00 a.m. on Thursday, May 21, 2020 at Newberry Hall, 117 Newberry Street SW, Aiken, South Carolina.

STOCK LISTING

The Company’s stock is traded on the Over-The-Counter-Bulletin Board under the symbol “SFDL.” 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.



	High	Low
Year Ended December 31, 2019
03/31/2019	$31.34	$27.43
06/30/2019	$34.34	$30.78
09/30/2019	$34.80	$32.06
12/31/2019	$35.00	$33.00

Year Ended December 31, 2018
03/31/2018	$32.31	$30.53
06/30/2018	$30.72	$29.96
09/30/2018	$31.81	$29.87
12/31/2018	$31.40	$28.30

As of December 31, 2019, the Company had approximately 280 shareholders of record, not including shares held in street name, and 2,956,854 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 $0.08 per share cash dividends each quarter since the first quarter of fiscal 2009 through the last quarter in 2016. During 2017 and 2018, the Company paid $0.09 per share. Since 2019, the Company has paid $0.10 per share cash dividends each quarter.

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 law. South Carolina law 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. The Federal Reserve also has the authority to prohibit the Company from paying a dividend on its common stock.

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.

Attached files

Stock widget

Investing forum

SECURITY FEDERAL CORP Reports