Security Federal Corp 10-Q, filed Nov 13, 2020
Security Federal Corp (SFDL)
10-Q
2020-11-13
For: 2020-09-30
View Original
Added on
April 11, 2026
About this 10-Q
Security Federal Corp filed this 10-Q on November 13, 2020, covering the quarter ended September 30, 2020.
Headline figures
Quarter ended September 30, 2020, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Net income
- $904.71K
- down 59.2% from net income of $2.22M a year earlier
- Diluted EPS
- $0.28
- down 60.6% from $0.71 a year earlier
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10 – Q
(Mark one)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2020
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD:
| FROM: | TO: | ||||||||||
COMMISSION FILE NUMBER: 000-16120
SECURITY FEDERAL CORPORATION
(Exact name of registrant as specified in its charter)
| South Carolina | 57-0858504 | |||||||||||||
| (State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | |||||||||||||
238 RICHLAND AVENUE NORTHWEST, AIKEN, SOUTH CAROLINA 29801
(Address of principal executive office and Zip Code)
(803) 641-3000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files.) Yes [ X ] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer [ ] | Smaller reporting company [ X ] | |||||||||||||
| Non-accelerated filer [ X ] | Emerging growth company [ ] | |||||||||||||
| Accelerated filer [ ] | ||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
| YES | NO | |||||||||||||||||||
Indicate by check mark whether the registrant is a shell corporation (defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Securities registered pursuant to Section 12(b) of the Act: None
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.
| CLASS: | OUTSTANDING SHARES AT: | SHARES: | ||||||||||||||||||
Common Stock, par value $0.01 per share | November 13, 2020 | 3,252,884 | ||||||||||||||||||
PART I. | FINANCIAL INFORMATION (UNAUDITED) | PAGE NO. | ||||||
Item 1. | Financial Statements (unaudited): | 3 | ||||||
Consolidated Balance Sheets at September 30, 2020 and December 31, 2019 | 3 | |||||||
Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2020 and 2019 | 4 | |||||||
Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2020 and 2019 | 5 | |||||||
Consolidated Statements of Changes in Shareholders’ Equity for the Nine Months Ended September 30, 2020 and 2019 | 6 | |||||||
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2020 and 2019 | 7 | |||||||
Notes to Consolidated Financial Statements | 9 | |||||||
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 30 | ||||||
Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 47 | ||||||
Item 4. | Controls and Procedures | 48 | ||||||
PART II. | OTHER INFORMATION | |||||||
Item 1. | Legal Proceedings | 48 | ||||||
Item 1A. | Risk Factors | 48 | ||||||
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 50 | ||||||
Item 3. | Defaults Upon Senior Securities | 50 | ||||||
Item 4. | Mine Safety Disclosures | 50 | ||||||
Item 5. | Other Information | 50 | ||||||
Item 6. | Exhibits | 50 | ||||||
Signatures | 52 | |||||||
SCHEDULES OMITTED
All schedules other than those indicated above are omitted because of the absence of the conditions under which they are required or because the information is included in the consolidated financial statements and related notes.
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Part 1. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets
| September 30, 2020 | December 31, 2019 | ||||||||||
| (Unaudited) | (Audited) | ||||||||||
| ASSETS: | |||||||||||
| Cash and Cash Equivalents | $ | $ | |||||||||
| Certificates of Deposit with Other Banks | |||||||||||
| Investment and Mortgage-Backed Securities: | |||||||||||
| Available For Sale ("AFS") | |||||||||||
Held To Maturity ("HTM") (Fair Value of $16,846,743 and $19,805,841 at September 30, 2020 and December 31, 2019, Respectively) | |||||||||||
| Total Investments and Mortgage-Backed Securities ("MBS") | |||||||||||
| Loans Receivable, Net: | |||||||||||
| Held For Sale | |||||||||||
Held For Investment (Net of Allowance of $12,845,662 and $9,225,574 at September 30, 2020 and December 31, 2019, Respectively) | |||||||||||
| Total Loans Receivable, Net | 452,858,735 | ||||||||||
| Accrued Interest Receivable: | |||||||||||
| Loans | |||||||||||
| Mortgage-Backed Securities | |||||||||||
| Investment Securities | |||||||||||
| Total Accrued Interest Receivable | |||||||||||
| Operating Lease Right-of-Use Assets | |||||||||||
| Premises and Equipment, Net | |||||||||||
| Federal Home Loan Bank ("FHLB") Stock, at Cost | |||||||||||
| Other Real Estate Owned ("OREO") | |||||||||||
| Bank Owned Life Insurance ("BOLI") | |||||||||||
| Goodwill | |||||||||||
| Other Assets | |||||||||||
| Total Assets | $ | $ | |||||||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY: | |||||||||||
| Liabilities: | |||||||||||
| Deposit Accounts | $ | $ | |||||||||
| Advance Payments By Borrowers for Taxes and Insurance | |||||||||||
| Advances from FHLB | |||||||||||
| Borrowings from Federal Reserve Bank ("FRB") | 16,025,000 | — | |||||||||
| Other Borrowings | |||||||||||
| Junior Subordinated Debentures | |||||||||||
| Senior Convertible Debentures | |||||||||||
| Subordinated Debentures | 30,000,000 | 30,000,000 | |||||||||
| Operating Lease Liabilities | |||||||||||
| Other Liabilities | |||||||||||
| Total Liabilities | $ | $ | |||||||||
| Shareholders' Equity: | |||||||||||
Common Stock, $.01 Par Value; Authorized 5,000,000 Shares; Issued and Outstanding Shares, 3,453,817 and 3,252,884, Respectively, at September 30, 2020 and 3,157,787 and 2,956,854, Respectively, at December 31, 2019 | $ | $ | |||||||||
| Additional Paid-In Capital ("APIC") | |||||||||||
| Treasury Stock, at Cost (200,933 Shares) | ( | ( | |||||||||
| Accumulated Other Comprehensive Income ("AOCI") | |||||||||||
| Retained Earnings | |||||||||||
| Total Shareholders' Equity | $ | $ | |||||||||
| Total Liabilities and Shareholders' Equity | $ | $ | |||||||||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income (Unaudited)
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| Interest Income: | |||||||||||||||||||||||
| Loans | $ | $ | $ | 19,333,257 | $ | 18,419,922 | |||||||||||||||||
| Mortgage-Backed Securities | 4,728,662 | 4,978,614 | |||||||||||||||||||||
| Investment Securities | 3,417,663 | 4,307,922 | |||||||||||||||||||||
| Other | 52,970 | 94,106 | |||||||||||||||||||||
| Total Interest Income | 27,532,552 | 27,800,564 | |||||||||||||||||||||
| Interest Expense: | |||||||||||||||||||||||
| NOW and Money Market Accounts | 912,675 | 1,597,932 | |||||||||||||||||||||
| Savings Accounts | 68,294 | 53,947 | |||||||||||||||||||||
| Certificate Accounts | 2,360,497 | 3,181,783 | |||||||||||||||||||||
| FHLB Advances and Other Borrowed Money | 700,590 | 675,985 | |||||||||||||||||||||
| Note Payable | — | 35,515 | |||||||||||||||||||||
| Senior Convertible Debentures | 81,796 | 362,640 | |||||||||||||||||||||
| Subordinated Debentures | — | 1,181,250 | — | ||||||||||||||||||||
| Junior Subordinated Debentures | 101,388 | 166,703 | |||||||||||||||||||||
| Total Interest Expense | 5,406,490 | 6,074,505 | |||||||||||||||||||||
| Net Interest Income | 22,126,062 | 21,726,059 | |||||||||||||||||||||
| Provision For Loan Losses | 3,600,000 | 175,000 | |||||||||||||||||||||
| Net Interest Income After Provision For Loan Losses | 18,526,062 | 21,551,059 | |||||||||||||||||||||
| Non-Interest Income: | |||||||||||||||||||||||
| Gain on Sale of MBS and Investment Securities | 1,332,666 | 1,056,959 | |||||||||||||||||||||
| Gain on Sale of Loans | 2,494,084 | 1,126,551 | |||||||||||||||||||||
| Service Fees on Deposit Accounts | 695,561 | 785,987 | |||||||||||||||||||||
| Commissions From Insurance Agency | 513,783 | 528,246 | |||||||||||||||||||||
| Trust Income | 782,210 | 787,200 | |||||||||||||||||||||
| BOLI Income | 408,250 | 543,609 | |||||||||||||||||||||
| Check Card Fee Income | 1,234,558 | 1,063,314 | |||||||||||||||||||||
| Grant Income | 316,814 | 332,393 | |||||||||||||||||||||
| Other | 812,202 | 872,591 | |||||||||||||||||||||
| Total Non-Interest Income | 8,590,128 | 7,096,850 | |||||||||||||||||||||
| Non-Interest Expense: | |||||||||||||||||||||||
| Compensation and Employee Benefits | 13,654,330 | 12,587,421 | |||||||||||||||||||||
| Occupancy | 1,864,202 | 1,728,732 | |||||||||||||||||||||
| Advertising | 776,605 | 539,234 | |||||||||||||||||||||
| Depreciation and Maintenance of Equipment | 2,126,683 | 1,894,997 | |||||||||||||||||||||
| Federal Deposit Insurance Corporation ("FDIC") Insurance Premiums | 67,938 | 184,022 | |||||||||||||||||||||
| Net (Recovery) Expense from Operation of OREO | ( | (27,329) | (62,680) | ||||||||||||||||||||
| Other | 3,858,305 | 4,103,020 | |||||||||||||||||||||
| Total Non-Interest Expense | 22,320,734 | 20,974,746 | |||||||||||||||||||||
| Income Before Income Taxes | 4,795,456 | 7,673,163 | |||||||||||||||||||||
| Provision For Income Taxes | 810,227 | 1,480,792 | |||||||||||||||||||||
| Net Income | 3,985,229 | 6,192,371 | |||||||||||||||||||||
| Net Income Per Common Share (Basic) | $ | $ | $ | 1.25 | $ | 2.10 | |||||||||||||||||
| Net Income Per Common Share (Diluted) | $ | $ | $ | 1.25 | $ | 1.98 | |||||||||||||||||
| Cash Dividend Per Share on Common Stock | $ | $ | $ | 0.30 | $ | 0.28 | |||||||||||||||||
| Weighted Average Shares Outstanding (Basic) | 3,199,603 | 2,955,446 | |||||||||||||||||||||
| Weighted Average Shares Outstanding (Diluted) | 3,199,603 | 3,257,646 | |||||||||||||||||||||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Unaudited)
| Three Months Ended September 30, | |||||||||||
| 2020 | 2019 | ||||||||||
| Net Income | $ | $ | |||||||||
| Other Comprehensive Income: | |||||||||||
Unrealized Holding Gains on Securities AFS, Net of Taxes of $495,302 and $421,086 at September 30, 2020 and 2019, Respectively | |||||||||||
Reclassification Adjustment for Gains Included in Net Income, Net of Taxes of $34,837 and $24,014 at September 30, 2020 and 2019, Respectively | ( | ( | |||||||||
Amortization of Unrealized Gains on AFS Securities Transferred to HTM, Net of Taxes of $(1,879) and $(1,095) at September 30, 2020 and 2019, Respectively | ( | ( | |||||||||
| Other Comprehensive Income, Net of Tax | |||||||||||
| Comprehensive Income | $ | $ | |||||||||
| Nine Months Ended September 30, | |||||||||||
| 2020 | 2019 | ||||||||||
| Net Income | $ | 3,985,229 | $ | 6,192,371 | |||||||
| Other Comprehensive Income: | |||||||||||
Unrealized Holding Gains on Securities AFS Net of Taxes of $3,051,380 and $2,341,270 at September 30, 2020 and 2019, Respectively | 9,375,250 | 7,171,440 | |||||||||
Reclassification Adjustment for Gains Included in Net Income, Net of Taxes of $333,167 and $264,240 at September 30, 2020 and 2019, Respectively | (999,499) | (792,719) | |||||||||
Amortization of Unrealized Gains on AFS Securities Transferred to HTM, Net of Taxes of $(5,733) and $(6,368) at September 30, 2020 and 2019, Respectively | (17,199) | (19,102) | |||||||||
| Other Comprehensive Income, Net of Tax | 8,358,552 | 6,359,619 | |||||||||
| Comprehensive Income | $ | 12,343,781 | $ | 12,551,990 | |||||||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders' Equity (Unaudited)
For the Nine Months Ended September 30, 2020 and 2019
| Common Stock | APIC | Treasury Stock | AOCI | Retained Earnings | Total | ||||||||||||||||||||||||||||||
| Balance at December 31, 2018 | $ | $ | $ | ( | $ | ( | $ | $ | |||||||||||||||||||||||||||
| Net Income | — | — | — | — | |||||||||||||||||||||||||||||||
| Other Comprehensive Income, Net of Tax | — | — | — | — | |||||||||||||||||||||||||||||||
| Employee Stock Purchases | — | — | — | ||||||||||||||||||||||||||||||||
| Redemption of Senior Convertible Debentures | — | — | — | ||||||||||||||||||||||||||||||||
| Cash Dividends on Common Stock | — | — | — | — | ( | ( | |||||||||||||||||||||||||||||
| Balance at March 31, 2019 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||
| Net Income | — | — | — | — | |||||||||||||||||||||||||||||||
| Other Comprehensive Income, Net of Tax | — | — | — | — | |||||||||||||||||||||||||||||||
| Employee Stock Purchases | — | — | — | ||||||||||||||||||||||||||||||||
| Cash Dividends on Common Stock | — | — | — | — | ( | ( | |||||||||||||||||||||||||||||
| Balance at June 30, 2019 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||
| Net Income | — | — | — | — | |||||||||||||||||||||||||||||||
| Other Comprehensive Income, Net of Tax | — | — | — | — | |||||||||||||||||||||||||||||||
| Employee Stock Purchases | — | — | — | ||||||||||||||||||||||||||||||||
| Cash Dividends on Common Stock | — | — | — | — | ( | ( | |||||||||||||||||||||||||||||
| Balance at September 30, 2019 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||
| Common Stock | APIC | Treasury Stock | AOCI | Retained Earnings | Total | ||||||||||||||||||||||||||||||
| Balance at December 31, 2019 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||
| Net Income | — | — | — | — | |||||||||||||||||||||||||||||||
| Other Comprehensive Loss, Net of Tax | — | — | — | ( | — | ( | |||||||||||||||||||||||||||||
| Employee Stock Purchases | — | — | — | ||||||||||||||||||||||||||||||||
| Conversion of Senior Convertible Debentures, 295,600 shares of common stock | — | — | — | ||||||||||||||||||||||||||||||||
| Cash Dividends on Common Stock | — | — | — | — | ( | ( | |||||||||||||||||||||||||||||
| Balance at March 31, 2020 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||
| Net Income | — | — | — | — | |||||||||||||||||||||||||||||||
| Other Comprehensive Income, Net of Tax | — | — | — | — | |||||||||||||||||||||||||||||||
| Cash Dividends on Common Stock | — | — | — | — | ( | ( | |||||||||||||||||||||||||||||
| Balance at June 30, 2020 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||
| Net Income | — | — | — | — | |||||||||||||||||||||||||||||||
| Other Comprehensive Income, Net of Tax | — | — | — | — | |||||||||||||||||||||||||||||||
| Cash Dividends on Common Stock | — | — | — | — | ( | ( | |||||||||||||||||||||||||||||
| Balance at September 30, 2020 | $ | $ | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
6
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows (Unaudited)
| Nine Months Ended | |||||||||||
| September 30, | |||||||||||
| 2020 | 2019 | ||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||||||
| Net Income | $ | $ | |||||||||
| Adjustments To Reconcile Net Income To Net Cash Provided By Operating Activities: | |||||||||||
| Depreciation Expense | |||||||||||
| Discount Accretion and Premium Amortization | |||||||||||
| Provision for Loan Losses | |||||||||||
| Earnings on BOLI | ( | ( | |||||||||
| Gain on Sales of Loans | ( | ( | |||||||||
| Gain on Sales of Investment Securities and MBS | ( | ( | |||||||||
| Gain on Sales of OREO | ( | ( | |||||||||
| Write Down on OREO | |||||||||||
| Amortization of Operating Lease Right-of-Use Assets | 276,664 | 279,355 | |||||||||
| Amortization of Deferred Loan Costs | |||||||||||
| Proceeds From Sale of Loans Held For Sale | |||||||||||
| Origination of Loans Held For Sale | ( | ( | |||||||||
| (Increase) Decrease in Accrued Interest Receivable: | |||||||||||
| Loans | ( | ||||||||||
| MBS | ( | ( | |||||||||
| Investment Securities | |||||||||||
| Increase in Advance Payments By Borrowers | |||||||||||
| Increase in Other, Net | ( | ( | |||||||||
| Net Cash Provided By Operating Activities | $ | $ | |||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||||||
| Purchase of MBS AFS | $ | ( | $ | ( | |||||||
| Proceeds from Paydowns, Maturities and Sales of MBS AFS | |||||||||||
| Proceeds from Payments and Maturities of MBS HTM | |||||||||||
| Purchase of Investment Securities AFS | ( | ( | |||||||||
| Proceeds from Paydowns, Maturities and Sales of Investment Securities AFS | |||||||||||
| Proceeds from Redemption of Certificates of Deposits with Other Banks | |||||||||||
| Purchase of FHLB Stock | ( | ( | |||||||||
| Redemption of FHLB Stock | |||||||||||
| Purchase of BOLI | (4,000,000) | — | |||||||||
| Proceeds From BOLI Death Benefit | — | 414,855 | |||||||||
| Increase in Loans Receivable | ( | ( | |||||||||
| Proceeds From Sale of OREO | |||||||||||
| Purchase and Improvement of Premises and Equipment | ( | ( | |||||||||
| Net Cash Used By Investing Activities | $ | ( | $ | ( | |||||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||||||
| Increase in Deposit Accounts | $ | $ | |||||||||
| Proceeds from FHLB Advances | |||||||||||
| Repayment of FHLB Advances | ( | ( | |||||||||
| Increase in Other Borrowings, Net | |||||||||||
| Repayment of Note Payable | ( | ||||||||||
| Redemption of Senior Convertible Debentures | (132,000) | — | |||||||||
| Proceeds from FRB Borrowings | 85,950,000 | — | |||||||||
| Repayment of FRB Borrowings | (69,925,000) | — | |||||||||
| Proceeds from Employee Stock Purchases | |||||||||||
| Dividends to Common Stock Shareholders | ( | ( | |||||||||
| Net Cash Provided By Financing Activities | $ | $ | |||||||||
| Net Increase in Cash and Cash Equivalents | |||||||||||
| Cash and Cash Equivalents at Beginning of Period | |||||||||||
| Cash and Cash Equivalents at End of Period | $ | $ | |||||||||
7
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
| Consolidated Statements of Cash Flows (Unaudited) (Continued) | |||||||||||
| Nine Months Ended | |||||||||||
| September 30, | |||||||||||
| 2020 | 2019 | ||||||||||
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: | |||||||||||
| Cash Paid for Interest | $ | $ | |||||||||
| Cash Paid for Income Taxes | $ | 864,401 | $ | 1,199,541 | |||||||
| Non-Cash Transactions: | |||||||||||
| Initial Recognition of Operating Lease Right-of-Use Assets | $ | — | $ | 3,090,512 | |||||||
| Initial Recognition of Operating Lease Liabilities | $ | — | $ | 3,090,512 | |||||||
| Transfers From Loans Receivable to OREO | $ | $ | |||||||||
| Conversion of Senior Convertible Debentures | $ | 5,912,000 | $ | — | |||||||
| Other Comprehensive Income | $ | 8,358,552 | $ | 6,359,619 | |||||||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
8
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
1. Basis of Presentation
2. Principles of Consolidation
The accompanying unaudited consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Security Federal Bank (the “Bank”) and the Bank’s wholly owned subsidiaries, Security Federal Insurance, Inc. (“SFINS”), 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, 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. All significant intercompany transactions and balances have been eliminated in consolidation.
The Company has a wholly owned subsidiary, Security Federal Statutory Trust (the “Trust”), which issued and sold fixed and floating rate capital securities of the Trust. However, under current accounting guidance, the Trust is not consolidated in the Company’s financial statements. The Bank is primarily engaged in the business of accepting savings and demand deposits and originating mortgage loans and other loans to individuals and small businesses for various personal and commercial purposes.
3. Critical Accounting Policies
The Company has adopted various accounting policies, which govern the application of accounting principles generally accepted in the United States in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to the audited consolidated financial statements at December 31, 2019 included in our 2019 Annual Report to Shareholders. Certain accounting policies involve significant judgments and assumptions by management, which have a material impact on the carrying value of certain assets and liabilities, and, as such, have a greater possibility of producing results that could be materially different than originally reported. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on our carrying values of assets and liabilities and our results of operations.
9
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
3. Critical Accounting Policies, Continued
While management uses the best information available to make evaluations, future adjustments may be necessary if economic conditions differ substantially from the assumptions used in making these evaluations. The allowance for loan losses is subject to periodic evaluations by our bank regulatory agencies, including the Board of Governors of the Federal Reserve System ("Federal Reserve"), the FDIC and the South Carolina Board of Financial Institutions, that may require adjustments to be made to the allowance based upon the information that is available at the time of their examination.
The Company values impaired loans at the loan’s fair value if it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement at the present value of expected cash flows, the market price of the loan, if available, or the value of the underlying collateral. Expected cash flows are required to be discounted at the loan’s effective interest rate. When the ultimate collectibility of an impaired loan’s principal is in doubt, wholly or partially, all cash receipts are applied to principal. When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to interest and then to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amounts previously charged off.
4. Earnings Per Share
Accounting guidance specifies the computation, presentation and disclosure requirements for earnings per share (“EPS”) for entities with publicly held common stock or potential common stock such as options, warrants, convertible securities or contingent stock agreements if those securities trade in a public market. Basic EPS is computed by dividing net income by the weighted average number of common shares outstanding. Diluted EPS is similar to the computation of basic EPS except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive common shares had been issued. The dilutive effect of options outstanding under the Company’s stock option plan is reflected in diluted EPS by application of the treasury stock method. There were no stock options outstanding at September 30, 2020 or September 30, 2019; and therefore, no dilutive options in the calculation of diluted EPS for those periods. Diluted EPS also assumes the Senior Convertible Debentures were converted into 302,200 shares of common stock at the beginning of the three and nine months ended September 30, 2019. The related interest expense recorded during the period, net of tax, is added back to the EPS numerator while the underlying shares are added to the denominator.
The following tables include a summary of the Company's basic and diluted EPS for the periods indicated.
| Three Months Ended September 30, | |||||||||||||||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||||||||||||||
| Income | Shares | Per Share Amounts | Income | Shares | Per Share Amounts | ||||||||||||||||||||||||||||||
| Basic EPS | $ | $ | $ | $ | |||||||||||||||||||||||||||||||
| Effect of Dilutive Securities: | |||||||||||||||||||||||||||||||||||
Senior Convertible Debentures | ( | ||||||||||||||||||||||||||||||||||
Diluted EPS | $ | $ | $ | $ | |||||||||||||||||||||||||||||||
10
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
4. Earnings Per Share, Continued
| Nine Months Ended September 30, | |||||||||||||||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||||||||||||||
| Income | Shares | Per Share Amounts | Income | Shares | Per Share Amounts | ||||||||||||||||||||||||||||||
| Basic EPS | $ | 3,985,229 | 3,199,603 | $ | 1.25 | $ | 6,192,371 | 2,955,446 | $ | 2.10 | |||||||||||||||||||||||||
| Effect of Dilutive Securities: | |||||||||||||||||||||||||||||||||||
Senior Convertible Debentures | — | — | — | 271,980 | 302,200 | (0.12) | |||||||||||||||||||||||||||||
Diluted EPS | $ | 3,985,229 | 3,199,603 | $ | 1.25 | $ | 6,464,351 | 3,257,646 | $ | 1.98 | |||||||||||||||||||||||||
5. Stock-Based Compensation
6. 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 were as follows:
| September 30, 2020 | |||||||||||||||||||||||
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||||||||||
| Student Loan Pools | $ | $ | $ | $ | |||||||||||||||||||
| Small Business Administration (“SBA”) Bonds | |||||||||||||||||||||||
| Tax Exempt Municipal Bonds | |||||||||||||||||||||||
| Taxable Municipal Bonds | |||||||||||||||||||||||
| Mortgage-Backed Securities | |||||||||||||||||||||||
| State Tax Credit | 33,034 | — | — | 33,034 | |||||||||||||||||||
| Total Available For Sale | $ | $ | $ | $ | |||||||||||||||||||
| December 31, 2019 | |||||||||||||||||||||||
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||||||||||
| Student Loan Pools | $ | $ | $ | $ | |||||||||||||||||||
| SBA Bonds | |||||||||||||||||||||||
| Tax Exempt Municipal Bonds | |||||||||||||||||||||||
| Taxable Municipal Bonds | |||||||||||||||||||||||
| Mortgage-Backed Securities | |||||||||||||||||||||||
| Total Available For Sale | $ | $ | $ | $ | |||||||||||||||||||
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.
11
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
6. Investment and Mortgage-Backed Securities, Available For Sale, Continued
At September 30, 2020, AFS GNMA mortgage-backed securities had an amortized cost and fair value of $70.0 million and $71.9 million, respectively, compared to an amortized cost and fair value of $63.2 million and $63.9 million, respectively, at December 31, 2019.
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 September 30, 2020 the Bank held AFS private label CMO mortgage-backed securities with an amortized cost and fair value of $29.1 million and $29.9 million, respectively, compared to an amortized cost and fair value of $15.8 million and $16.1 million, respectively, at December 31, 2019.
The amortized cost and fair value of investment and mortgage-backed securities available for sale at September 30, 2020 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 set forth in the table below.
| September 30, 2020 | |||||||||||
| Investment Securities: | Amortized Cost | Fair Value | |||||||||
| One Year or Less | $ | $ | |||||||||
| After One – Five Years | |||||||||||
| After Five – Ten Years | |||||||||||
| More Than Ten Years | |||||||||||
| Mortgage-Backed Securities | |||||||||||
| Total Available For Sale | $ | $ | |||||||||
At September 30, 2020 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 $226.0 million and $236.7 million, respectively, compared to an amortized cost and fair value of $171.4 million and $173.1 million, respectively, at December 31, 2019.
The Bank received $4.6 million and $8.8 million in gross proceeds from sales of available for sale securities during the three months ended September 30, 2020 and 2019, respectively. As a result, the Company recognized gross gains of $139,000 and $101,000 and gross losses of $0 and $5,000 during the three months ended September 30, 2020 and 2019, respectively.
The Bank received $25.0 million and $70.8 million in gross proceeds from sales of available for sale securities during the nine months ended September 30, 2020 and 2019, respectively. As a result, the Company recognized gross gains of $1.3 million and $1.3 million and gross losses of $0 and $288,000 for the same periods.
The following tables show gross unrealized losses and fair value, aggregated by investment category, and length of time that the individual available for sale securities were in a continuous unrealized loss position at the dates indicated.
| September 30, 2020 | ||||||||||||||||||||||||||
| Less than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||||
| Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||||
| Student Loan Pools | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||
| SBA Bonds | ||||||||||||||||||||||||||
| Taxable Municipal Bonds | ||||||||||||||||||||||||||
| Mortgage-Backed Securities | ||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
12
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
6. Investment and Mortgage-Backed Securities, Available For Sale, Continued
| 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 | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||
| SBA Bonds | ||||||||||||||||||||||||||
| Taxable Municipal Bond | ||||||||||||||||||||||||||
| Mortgage-Backed Securities | ||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
Securities classified as available for sale are recorded at fair market value. At September 30, 2020 and December 31, 2019, 56.8 % and 39.6 % of the unrealized losses, representing 90 and 69 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 majority of the securities in loss positions are adjustable rate Student Loan Pools and SBA Bonds. The secondary market on these bonds have less liquidity than other agency bonds.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”).
7. Investment and Mortgage-Backed Securities, Held to Maturity
At September 30, 2020 and 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 those dates were as follows:
| September 30, 2020 | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||||||||
Mortgage-Backed Securities (1) | $ | $ | $ | $ | |||||||||||||||||||
| Total Held To Maturity | $ | $ | $ | $ | |||||||||||||||||||
| 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 | |||||||||||||||
(1) COMPRISED OF MORTGAGE-BACKED SECURITIES OF GSEs OR GNMA
At September 30, 2020, the Bank held an amortized cost and fair value of $9.0 million and $9.6 million, respectively, in GNMA mortgage-backed securities classified as held to maturity, which are included in the table above, compared to an amortized cost and fair value of $11.3 million and $11.6 million, respectively, at December 31, 2019. The Company has not invested in any private label mortgage-backed securities classified as held to maturity.
13
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
7. Investment and Mortgage-Backed Securities, Held to Maturity, Continued
At September 30, 2020, 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 $14.6 million and $15.5 million, respectively, compared to an amortized cost and fair value of $17.5 million and $18 million, respectively, at December 31, 2019.
The following tables show gross unrealized losses, fair value, and length of time that individual held to maturity securities have been in a continuous unrealized loss position at the dates indicated below.
| September 30, 2020 | ||||||||||||||||||||||||||
| 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) | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
(1) COMPRISED OF MORTGAGE-BACKED SECURITIES OF GSEs OR GNMA
| 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 | |||||||||||||||
(1) COMPRISED OF MORTGAGE-BACKED SECURITIES OF GSEs OR GNMA
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.
8. Loans Receivable, Net
Loans receivable, net, consisted of the following as of the dates indicated below:
| September 30, 2020 | December 31, 2019 | ||||||||||
| Residential Real Estate Loans | $ | $ | |||||||||
| Consumer Loans | |||||||||||
| Commercial Business Loans | |||||||||||
| Commercial Real Estate Loans | |||||||||||
| Paycheck Protection Program ("PPP") Loans | 75,263,782 | — | |||||||||
| Total Loans Held For Investment | |||||||||||
| Loans Held For Sale | |||||||||||
| Total Loans Receivable, Gross | $ | $ | |||||||||
| Less: | |||||||||||
| Allowance For Loan Losses | |||||||||||
| Loans in Process | |||||||||||
| Deferred Loan Fees | |||||||||||
| Total Loans Receivable, Net | $ | $ | 452,858,735 | ||||||||
14
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
8. Loans Receivable, Net, Continued
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 tables below summarize the balance within each risk category by loan type, excluding loans held for sale, at September 30, 2020 and December 31, 2019.
| September 30, 2020 | Pass | Caution | Special Mention | Substandard | Total Loans | ||||||||||||||||||||||||
| Residential Real Estate | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Consumer | |||||||||||||||||||||||||||||
| Commercial Business | |||||||||||||||||||||||||||||
| Commercial Real Estate | |||||||||||||||||||||||||||||
| PPP | 75,263,782 | — | — | — | 75,263,782 | ||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| December 31, 2019 | Pass | Caution | Special Mention | Substandard | Total Loans | ||||||||||||||||||||||||
| Residential Real Estate | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Consumer | |||||||||||||||||||||||||||||
| Commercial Business | |||||||||||||||||||||||||||||
| Commercial Real Estate | |||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
The tables below present an age analysis of past due balances by loan category at September 30, 2020 and December 31, 2019:
| September 30, 2020 | |||||||||||||||||||||||||||||||||||
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 | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Consumer | |||||||||||||||||||||||||||||||||||
| Commercial Business | |||||||||||||||||||||||||||||||||||
| Commercial Real Estate | |||||||||||||||||||||||||||||||||||
| PPP | — | — | — | — | 75,263,782 | 75,263,782 | |||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| 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 | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Consumer | |||||||||||||||||||||||||||||||||||
| Commercial Business | |||||||||||||||||||||||||||||||||||
| Commercial Real Estate | |||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
15
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
8. Loans Receivable, Net, Continued
At September 30, 2020 and December 31, 2019, the Company did not have any loans that were 90 days or more past due and still accruing interest. The Company's strategy is to work with its borrowers to reach acceptable payment plans while protecting its interests in the existing collateral. In the event an acceptable arrangement cannot be reached, the Company 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 September 30, 2020 compared to December 31, 2019:
| September 30, 2020 | December 31, 2019 | Increase (Decrease) | |||||||||||||||||||||||||||||||||
| Amount | Percent (1) | Amount | Percent (1) | $ | % | ||||||||||||||||||||||||||||||
| Non-accrual Loans: | |||||||||||||||||||||||||||||||||||
| Residential Real Estate | $ | % | $ | % | $ | ||||||||||||||||||||||||||||||
| Consumer | |||||||||||||||||||||||||||||||||||
| Commercial Business | ( | ( | |||||||||||||||||||||||||||||||||
| Commercial Real Estate | ( | ( | |||||||||||||||||||||||||||||||||
| Total Non-accrual Loans | $ | % | $ | % | $ | ||||||||||||||||||||||||||||||
(1) PERCENT OF TOTAL LOANS HELD FOR INVESTMENT, NET OF DEFERRED FEES AND LOANS IN PROCESS.
The following tables show the activity in the allowance for loan losses by category for the three and nine months ended September 30, 2020 and 2019:
| Three Months Ended September 30, 2020 | |||||||||||||||||||||||||||||
| Residential Real Estate | Consumer | Commercial Business | Commercial Real Estate | Total | |||||||||||||||||||||||||
| Beginning Balance | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Provision for Loan Losses | ( | ||||||||||||||||||||||||||||
| Charge-Offs | ( | ( | ( | ||||||||||||||||||||||||||
| Recoveries | |||||||||||||||||||||||||||||
| Ending Balance | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Nine Months Ended September 30, 2020 | |||||||||||||||||||||||||||||
| Residential Real Estate | Consumer | Commercial Business | Commercial Real Estate | Total | |||||||||||||||||||||||||
| Beginning Balance | $ | 1,390,594 | $ | 1,210,849 | $ | 544,764 | $ | 6,079,367 | $ | 9,225,574 | |||||||||||||||||||
| Provision for Loan Losses | 196,497 | 168,447 | 572,745 | 2,662,311 | 3,600,000 | ||||||||||||||||||||||||
| Charge-Offs | — | (148,844) | (35,048) | (19,453) | (203,345) | ||||||||||||||||||||||||
| Recoveries | 1,800 | 54,638 | — | 166,995 | 223,433 | ||||||||||||||||||||||||
| Ending Balance | $ | 1,588,891 | $ | 1,285,090 | $ | 1,082,461 | $ | 8,889,220 | $ | 12,845,662 | |||||||||||||||||||
| Three Months Ended September 30, 2019 | |||||||||||||||||||||||||||||
| Residential Real Estate | Consumer | Commercial Business | Commercial Real Estate | Total | |||||||||||||||||||||||||
| Beginning Balance | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Provision for Loan Losses | ( | ||||||||||||||||||||||||||||
| Charge-Offs | ( | ( | |||||||||||||||||||||||||||
| Recoveries | |||||||||||||||||||||||||||||
| Ending Balance | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
16
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
8. Loans Receivable, Net, Continued
| Nine Months Ended September 30, 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 for Loan Losses | (20,899) | 82,715 | (176,443) | 289,627 | 175,000 | ||||||||||||||||||||||||
| Charge-Offs | (34,599) | (367,753) | (1,132) | (428,164) | (831,648) | ||||||||||||||||||||||||
| Recoveries | 5,526 | 104,995 | 15,113 | 117,935 | 243,569 | ||||||||||||||||||||||||
| Ending Balance | $ | 1,141,471 | $ | 1,023,550 | $ | 761,138 | $ | 5,832,479 | $ | 8,758,638 | |||||||||||||||||||
The following tables present information related to impaired loans evaluated individually and collectively for impairment in the allowance for loan losses at the dates indicated:
| Allowance For Loan Losses | |||||||||||||||||
| September 30, 2020 | Individually Evaluated For Impairment | Collectively Evaluated For Impairment | Total | ||||||||||||||
| Residential Real Estate | $ | $ | $ | ||||||||||||||
| Consumer | |||||||||||||||||
| Commercial Business | |||||||||||||||||
| Commercial Real Estate | |||||||||||||||||
| Total | $ | $ | $ | ||||||||||||||
| Allowance For Loan Losses | |||||||||||||||||
| December 31, 2019 | Individually Evaluated For Impairment | Collectively Evaluated For Impairment | Total | ||||||||||||||
| Residential Real Estate | $ | $ | $ | ||||||||||||||
| Consumer | |||||||||||||||||
| Commercial Business | |||||||||||||||||
| Commercial Real Estate | |||||||||||||||||
| Total | $ | $ | $ | ||||||||||||||
The following tables present information related to impaired loans evaluated individually and collectively for impairment in loans receivable at the dates indicated:
| Loans Receivable | |||||||||||||||||
| September 30, 2020 | Individually Evaluated For Impairment | Collectively Evaluated For Impairment | Total | ||||||||||||||
| Residential Real Estate | $ | $ | $ | ||||||||||||||
| Consumer | |||||||||||||||||
| Commercial Business | |||||||||||||||||
| Commercial Real Estate | |||||||||||||||||
| PPP | — | 75,263,782 | 75,263,782 | ||||||||||||||
| Total | $ | $ | $ | ||||||||||||||
Because the SBA guarantees 100% of the PPP loans made to eligible borrowers, and the entire principal amount of these loans, including any accrued interest, is eligible to be forgiven and repaid by the SBA, PPP loans are excluded from our allowance for loan losses calculation.
17
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
8. Loans Receivable, Net, Continued
| Loans Receivable | |||||||||||||||||
| December 31, 2019 | Individually Evaluated For Impairment | Collectively Evaluated For Impairment | Total | ||||||||||||||
| Residential Real Estate | $ | $ | $ | ||||||||||||||
| Consumer | |||||||||||||||||
| Commercial Business | |||||||||||||||||
| Commercial Real Estate | |||||||||||||||||
| Total | $ | $ | $ | ||||||||||||||
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 the 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 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. The average balance of impaired loans was $3.3 million for the three months ended September 30, 2020 compared to $4.7 million for the three months ended September 30, 2019.
The following tables present information related to impaired loans by loan category at September 30, 2020 and December 31, 2019 and for the nine months ended September 30, 2020 and 2019. There was no allowance recorded related to any impaired loans at September 30, 2020 and December 31, 2019.
| September 30, 2020 | December 31, 2019 | ||||||||||||||||||||||
| Impaired Loans | Recorded Investment | Unpaid Principal Balance | Related Allowance | Recorded Investment | Unpaid Principal Balance | Related Allowance | |||||||||||||||||
| With No Related Allowance Recorded: | |||||||||||||||||||||||
| Residential Real Estate | $ | $ | $ | — | $ | $ | $ | — | |||||||||||||||
| Consumer | — | — | |||||||||||||||||||||
| Commercial Business | — | — | |||||||||||||||||||||
| Commercial Real Estate | — | — | |||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | |||||||||||||||||
18
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
8. Loans Receivable, Net, Continued
| Three Months Ended September 30, | |||||||||||||||||
| 2020 | 2019 | ||||||||||||||||
| Impaired Loans | Average Recorded Investment | Interest Income Recognized | Average Recorded Investment | Interest Income Recognized | |||||||||||||
| With No Related Allowance Recorded: | |||||||||||||||||
| Residential Real Estate | $ | $ | $ | $ | |||||||||||||
| Consumer | |||||||||||||||||
| Commercial Business | |||||||||||||||||
| Commercial Real Estate | |||||||||||||||||
| With an Allowance Recorded: | |||||||||||||||||
| Commercial Real Estate | |||||||||||||||||
| Total | |||||||||||||||||
| Residential Real Estate | |||||||||||||||||
| Consumer | |||||||||||||||||
| Commercial Business | |||||||||||||||||
| Commercial Real Estate | |||||||||||||||||
| Total | $ | $ | $ | $ | |||||||||||||
| Nine Months Ended September 30, | |||||||||||||||||
| 2020 | 2019 | ||||||||||||||||
| Impaired Loans | Average Recorded Investment | Interest Income Recognized | Average Recorded Investment | Interest Income Recognized | |||||||||||||
| With No Related Allowance Recorded: | |||||||||||||||||
| Residential Real Estate | $ | 1,817,715 | $ | 13,030 | $ | 1,336,122 | $ | — | |||||||||
| Consumer | 178,296 | — | 1,052,347 | — | |||||||||||||
| Commercial Business | 60,262 | — | 73,526 | — | |||||||||||||
| Commercial Real Estate | 1,656,438 | 41,580 | 2,830,359 | 42,709 | |||||||||||||
| With an Allowance Recorded: | |||||||||||||||||
| Commercial Real Estate | — | — | 1,125,904 | — | |||||||||||||
| Total | |||||||||||||||||
| Residential Real Estate | 1,817,715 | 13,030 | 1,336,122 | — | |||||||||||||
| Consumer | 178,296 | — | 1,052,347 | — | |||||||||||||
| Commercial Business | 60,262 | — | 73,526 | — | |||||||||||||
| Commercial Real Estate | 1,656,438 | 41,580 | 3,956,263 | 42,709 | |||||||||||||
| Total | $ | 3,712,711 | $ | 54,610 | $ | 6,418,258 | $ | 42,709 | |||||||||
19
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
8. Loans Receivable, Net, Continued
In the course of resolving delinquent loans, the Company may choose to restructure the contractual terms of certain loans. A troubled debt restructuring ("TDR") is a restructuring in which the Company, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a borrower that it would not otherwise consider (Financial Accounting Standards Board ("FASB") 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 Company 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. TDR loans 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).
TDRs included in impaired loans at September 30, 2020 and December 31, 2019 had a combined balance of $499,000 and $825,000 , respectively, and the Company had no commitments at these dates to lend additional funds on these loans. There were no new TDRs modified during the nine months ended September 30, 2020 or 2019 and there were no 30 days or more past due to be in default.
The Company's 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.
The Company closely monitors 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. The Company's policy with respect to nonperforming loans requires the borrower to make a minimum of six consecutive payments in accordance with the modified loan terms before that loan can be placed back on accrual status. Further, the borrower must demonstrate the capacity to continue making payments on the loan prior to restoration of accrual status.
The Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act") signed into law on March 27, 2020, amended GAAP with respect to the modification of loans to borrowers affected by the COVID-19 pandemic. Among other criteria, this guidance provided that short-term loan modifications made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. To qualify as an eligible loan under the CARES Act, a loan modification must be 1) related to COVID-19; 2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and 3) executed between March 1, 2020, and the earlier of a) 60 days after the date of termination of the national emergency by the President or b) December 31, 2020. On April 7, 2020, the federal banking regulators issued a revised interagency statement on loan modifications and the reporting for financial institutions working with customers affected by the COVID-19 pandemic ("Interagency Statement"). The Interagency Statement confirmed that COVID-19 related short-term loan modifications (e.g., payment deferrals of six months or less) provided to borrowers that were current (less than 30 days past due) at the time the relief was granted are not TDR loans. Borrowers that do not meet the criteria in the CARES Act or the Interagency Statement are assessed for TDR loan classification in accordance with the Company’s accounting policies.
Since March 31, 2020 the Bank has approved over 300 loan modifications related to the COVID-19 pandemic with a combined loan balance, net of deferred fees, totaling $115.0 million. These modifications consisted of deferral of regularly scheduled principal and interest payments for three to six months. Most of these deferrals have resumed regular principal and interest payments. As of September 30, 2020, the total outstanding balance of deferred loans related to the COVID-19 pandemic was $4.3 million, including $4.0 million for commercial real estate loans. Loan modifications in accordance with the CARES Act and related banking agency regulatory guidance are still subject to an evaluation in regards to determining whether or not a loan is deemed to be impaired.
20
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
9. 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, 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 16.4%, 9.2%, 17.3% and 23.7%, respectively, at September 30, 2020.
Based on its capital levels at September 30, 2020, 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 September 30, 2020, 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 the dates indicated.
| Actual | For Capital Adequacy | To Be "Well-Capitalized" | |||||||||||||||||||||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||||||||||||||
| September 30, 2020 | Dollars in Thousands | ||||||||||||||||||||||||||||||||||
| Tier 1 Risk-Based Core Capital (To Risk Weighted Assets) | $ | $ | $ | ||||||||||||||||||||||||||||||||
| Total Risk-Based Capital (To Risk Weighted Assets) | |||||||||||||||||||||||||||||||||||
| Common Equity Tier 1 Capital (To Risk Weighted Assets) | 4.5% | 6.5% | |||||||||||||||||||||||||||||||||
| Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets) | |||||||||||||||||||||||||||||||||||
| December 31, 2019 | |||||||||||||||||||||||||||||||||||
| Tier 1 Risk-Based Core Capital (To Risk Weighted Assets) | $ | $ | $ | ||||||||||||||||||||||||||||||||
| Total Risk-Based Capital (To Risk Weighted Assets) | |||||||||||||||||||||||||||||||||||
| Common Equity Tier 1 Capital (To Risk Weighted Assets) | 4.5% | 6.5% | |||||||||||||||||||||||||||||||||
| Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets) | |||||||||||||||||||||||||||||||||||
In addition to the minimum capital requirements, the Bank must maintain a capital conservation buffer, which consists 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 September 30, 2020 the Bank’s conservation buffer was 11.6%.
21
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
10. 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 - | Quoted Market Price in Active Markets 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 - | Significant Other Observable Inputs 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 - | Significant Unobservable Inputs Valuation is generated from model-based techniques that use at least one significant assumption based on unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability. | ||||
The following is a description of the valuation methodologies used for assets and liabilities recorded at fair value.
Investment Securities Available for Sale
Investment securities available for sale are recorded at fair value on a recurring basis. At September 30, 2020, 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, municipal securities, and one state tax credit. 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 a result, 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 the FHLMC or other investors, are carried in the Company’s loans held for sale portfolio. These loans are fixed rate residential loans that have been originated in the Company’s name and have closed. Virtually all of these loans have commitments to be purchased by investors and the majority of these loans were locked in by price with the investors on the same day or shortly thereafter that the loan was locked in with the Company’s customers. Therefore, these loans present very little market risk for the Company. The Company usually delivers a commitment 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.
22
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
10. 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 impaired, management measures the impairment by determining the fair value of the collateral for the loan.
Fair value is estimated using one of the following methods: fair value of the collateral less estimated costs to sell, discounted cash flows, or market value of the loan based on similar debt. The fair value of the collateral less estimated costs to sell is the most frequently used method. Typically, the Company reviews the most recent appraisal and if it is over 24 months old will request a new third party appraisal. Depending on the particular circumstances surrounding the loan, including the location of the collateral, the date of the most recent appraisal and the value of the collateral relative to the recorded investment in the loan, management may order an independent appraisal immediately or, in some instances, may elect to perform an internal analysis. Specifically as an example, in situations where the collateral on a nonperforming commercial real estate loan is out of the Company’s primary market area, management would typically order an independent appraisal immediately, at the earlier of the date the loan becomes nonperforming or immediately following the determination that the loan is impaired. However, as a second example, on a nonperforming commercial real estate loan where management is familiar with the property and surrounding areas and where the original appraisal value far exceeds the recorded investment in the loan, management may perform an internal analysis whereby the previous appraisal value would be reviewed and adjusted for current conditions including recent sales of similar properties in the area and any other relevant economic trends. These valuations are reviewed at a minimum on a quarterly basis.
Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At September 30, 2020, our impaired loans were generally 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. At both September 30, 2020 and December 31, 2019, the recorded investment in impaired loans was $3.2 million.
Foreclosed Assets
Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. Foreclosed assets are recorded as nonrecurring Level 3.
Assets measured at fair value on a recurring basis were as follows at September 30, 2020 and December 31, 2019:
| September 30, 2020 | December 31, 2019 | ||||||||||||||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Level 1 | Level 2 | Level 3 | ||||||||||||||||||||||||||||||
| Student Loan Pools | $ | — | $ | $ | — | $ | — | $ | $ | — | |||||||||||||||||||||||||
| SBA Bonds | — | — | — | — | |||||||||||||||||||||||||||||||
| Tax Exempt Municipal Bonds | — | — | — | — | |||||||||||||||||||||||||||||||
| Taxable Municipal Bonds | — | — | — | — | |||||||||||||||||||||||||||||||
| Mortgage-Backed Securities | — | — | — | — | |||||||||||||||||||||||||||||||
| State Tax Credit | — | 33,034 | — | — | — | — | |||||||||||||||||||||||||||||
| Total | $ | — | $ | $ | — | $ | — | $ | $ | — | |||||||||||||||||||||||||
There were no liabilities measured at fair value on a recurring basis at September 30, 2020 or December 31, 2019.
23
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
10. 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 tables below present assets measured at fair value on a nonrecurring basis at September 30, 2020 and December 31, 2019, aggregated by the level in the fair value hierarchy within which those measurements fall.
| September 30, 2020 | |||||||||||||||||||||||
| Assets: | Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||
| Mortgage Loans Held For Sale | $ | $ | $ | $ | |||||||||||||||||||
Collateral Dependent Impaired Loans (1) | 3,213,891 | ||||||||||||||||||||||
| Foreclosed Assets | |||||||||||||||||||||||
| Total | $ | $ | $ | $ | |||||||||||||||||||
| December 31, 2019 | |||||||||||||||||||||||
| Assets: | Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||
| Mortgage Loans Held For Sale | $ | $ | 3,990,606 | $ | $ | ||||||||||||||||||
Collateral Dependent Impaired Loans (1) | 3,222,746 | ||||||||||||||||||||||
| Foreclosed Assets | |||||||||||||||||||||||
| Total | $ | $ | $ | $ | |||||||||||||||||||
There were no liabilities measured at fair value on a nonrecurring basis at September 30, 2020 or December 31, 2019.
For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis at September 30, 2020 and December 31, 2019, the significant unobservable inputs used in the fair value measurements were as follows:
| Valuation | Significant | September 30, 2020 | December 31, 2019 | ||||||||||||||
| Level 3 Assets | Technique | Unobservable Inputs | Range | Range | |||||||||||||
| Collateral Dependent Impaired Loans | Appraised Value | 13% - 96% | 8% - 92% | ||||||||||||||
| Foreclosed Assets | Appraised Value/Comparable Sales | 11% | 18% - 42% | ||||||||||||||
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 Deposit 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 is 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.
24
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
10. 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 and Borrowings from the FRB—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.
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 provide a summary of the carrying value and estimated fair value of the Company’s financial instruments at September 30, 2020 and December 31, 2019 presented in accordance with the applicable accounting guidance.
| September 30, 2020 | Carrying | Fair Value | |||||||||||||||||||||||||||
| Amount | Total | Level 1 | Level 2 | Level 3 | |||||||||||||||||||||||||
| Financial Assets: | Dollars in thousands | ||||||||||||||||||||||||||||
| Cash and Cash Equivalents | $ | 15,607 | $ | $ | $ | $ | |||||||||||||||||||||||
| Certificates of Deposits with Other Banks | 950 | ||||||||||||||||||||||||||||
| Investment and Mortgage-Backed Securities | 520,650 | ||||||||||||||||||||||||||||
| Loans Receivable, Net | 527,870 | ||||||||||||||||||||||||||||
| FHLB Stock | 2,354 | ||||||||||||||||||||||||||||
| Financial Liabilities: | |||||||||||||||||||||||||||||
| Deposits: | |||||||||||||||||||||||||||||
| Checking, Savings & Money Market Accounts | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Certificate Accounts | |||||||||||||||||||||||||||||
| Advances from FHLB | |||||||||||||||||||||||||||||
| Borrowings from FRB | 16,025 | 16,214 | — | 16,214 | — | ||||||||||||||||||||||||
| Other Borrowed Money | 19,768 | ||||||||||||||||||||||||||||
| Subordinated Debentures | 30,000 | 30,000 | — | 30,000 | — | ||||||||||||||||||||||||
| Junior Subordinated Debentures | |||||||||||||||||||||||||||||
25
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
10. Carrying Amounts and Fair Value of Financial Instruments, Continued
| December 31, 2019 | Carrying | Fair Value | |||||||||||||||||||||||||||
| Amount | Total | Level 1 | Level 2 | Level 3 | |||||||||||||||||||||||||
| Financial Assets: | Dollars in thousands | ||||||||||||||||||||||||||||
| Cash and Cash Equivalents | $ | 12,536 | $ | $ | $ | $ | |||||||||||||||||||||||
| Certificates of Deposits with Other Banks | 950 | ||||||||||||||||||||||||||||
| Investment and Mortgage-Backed Securities | 433,892 | ||||||||||||||||||||||||||||
| Loans Receivable, Net | |||||||||||||||||||||||||||||
| FHLB Stock | 2,537 | ||||||||||||||||||||||||||||
| Financial Liabilities: | |||||||||||||||||||||||||||||
| Deposits: | |||||||||||||||||||||||||||||
| Checking, Savings & Money Market Accounts | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Certificate Accounts | |||||||||||||||||||||||||||||
| Advances from FHLB | |||||||||||||||||||||||||||||
| Other Borrowed Money | 11,580 | ||||||||||||||||||||||||||||
| Senior Convertible Debentures | |||||||||||||||||||||||||||||
| Subordinated Debentures | 30,000 | 30,000 | — | 30,000 | — | ||||||||||||||||||||||||
| Junior Subordinated Debentures | |||||||||||||||||||||||||||||
At September 30, 2020, the Bank had $125.9 million in 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 amount 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.
11. Accounting and Reporting Changes
The following is a summary of recent authoritative pronouncements that could affect accounting, reporting, and disclosure of financial information by the Company:
In February 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 13 - Leases."
26
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
11. Accounting and Reporting Changes, Continued
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. The new standard 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.
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 became effective for reporting periods beginning after December 15, 2019. The adoption of these amendments did not have a material effect on the Company's 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 became effective for reporting periods beginning after December 15, 2019. The adoption of these amendments did not have a material effect on the Company's 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 the adoption of this guidance 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 reporting periods beginning after December 15, 2020. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.
In March 2020, the FASB issued guidance that applies to contracts, hedging relationships and other transactions that reference LIBOR or other rate references expected to be discontinued because of reference rate reform. The ASU permits an entity to make necessary modifications to eligible contracts or transactions without requiring contract remeasurement or reassessment of a previous accounting determination. This ASU is effective for all entities as of March 12, 2020 through December 31, 2022. The Company does not expect adoption of this guidance to have a material impact on its consolidated financial statements.
27
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
11. Accounting and Reporting Changes, Continued
In October 2020, the FASB issued guidance which clarifies that the Company should reevaluate whether a callable debt security is within the scope of paragraph 310-20-35-33 for each reporting period. This ASU is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The Company does not expect adoption of this guidance 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.
12. Non-Interest Income
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.
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, there were no 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.
28
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
12. Non-Interest Income, Continued
The following table presents the Company's non-interest income for the three and nine months ended September 30, 2020 and 2019. 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.
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| 2020 | 2019 | 2020 | 2019 | ||||||||||||||||||||
| Non-interest income: | |||||||||||||||||||||||
| Service fees on deposit accounts | $ | $ | $ | 695,561 | $ | 785,987 | |||||||||||||||||
| Check card fee income | 1,234,558 | 1,063,314 | |||||||||||||||||||||
| Trust income | 782,210 | 787,200 | |||||||||||||||||||||
Insurance commissions (1) | 513,783 | 528,246 | |||||||||||||||||||||
Gain on sale of MBS and investment securities, net (1) | 1,332,666 | 1,056,959 | |||||||||||||||||||||
Gain on sale of loans, net (1) | 2,494,084 | 1,126,551 | |||||||||||||||||||||
BOLI income (1) | 408,250 | 543,609 | |||||||||||||||||||||
Grant income (1) | 316,814 | 332,393 | |||||||||||||||||||||
Other non-interest income (1) | 812,202 | 872,591 | |||||||||||||||||||||
| Total non-interest income | $ | $ | $ | 8,590,128 | $ | 7,096,850 | |||||||||||||||||
(1) Not within the scope of ASC 606 | |||||||||||||||||||||||
13. Leases
Effective January 1, 2019 the Company adopted ASC 842 “Leases.” Currently, the Company has operating leases on five of its branches that are accounted for under this standard. As a result of this standard, the Company recognized a right-of-use asset of $3.1 million effective January 1, 2019. During the nine months ended September 30, 2020, the Company made cash payments in the amount of $333,000 for operating leases. The lease expense recognized during this period amounted to $344,000 and the lease liability was reduced by $266,000. The weighted average lease term is seven years and the weighted average discount rate used is 3.2%.
14. Subsequent Events
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements and “Safe Harbor” statement under the Private Securities Litigation Reform Act of 1995
Certain matters discussed in this Quarterly Report on Form 10-Q may constitute 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 effect of the COVID-19 pandemic, including on the Company’s credit quality and business operations, as well as its impact on general economic and financial market conditions and other uncertainties resulting from the COVID-19 pandemic, such as the extent and duration of the impact on public health, the U.S. and global economies, and consumer and corporate clients, including economic activity, employment levels and market liquidity;
•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;
•uncertainty regarding the future of the London Interbank Offered Rate ("LIBOR"), and the potential transition away from LIBOR toward new interest rate benchmarks;
•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 loans for sale and sell loans in the secondary market;
•results of examinations of the Company by the Federal Reserve and our bank subsidiary by the FDIC and the South Carolina 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;
•our ability to retain key members of our senior management team;
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
•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 FASB, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods;
•other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services, including the CARES Act; and
•the other risks described elsewhere in this document.
Some of these and other factors are discussed in the Company's 2019 Form 10-K under Item 1A, “Risk Factors.” Such developments could have an adverse impact on our consolidated financial position and results of operations. Any of the forward-looking statements that we make in this quarterly report on Form 10-Q and in other public reports and statements we make may turn out to be inaccurate as a result of our beliefs and assumptions we make in connection with the factors set forth above or because of other unidentified and unpredictable factors. Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements and you should not rely on such statements. The Company undertakes no obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. These risks could cause our actual results for 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, consolidated results of operations, liquidity and stock price performance.
Response to COVID-19
In response to the current global situation surrounding the COVID-19 pandemic, the Company is offering a variety of relief options designed to support our customers and the communities we serve.
Paycheck Protection Program ("PPP") Participation
The Coronavirus Aid, Relief and Economic Security Act, or CARES Act, was signed into law on March 27, 2020, and authorized the U.S. Small Business Administration (“SBA”) to temporarily guarantee loans under a new loan program called the Paycheck Protection Program, or PPP. The goal of the PPP was to avoid as many layoffs as possible, and to encourage small businesses to maintain payrolls. As a qualified SBA lender, the Company was automatically authorized to originate PPP loans upon commencement of the program in April 2020. PPP loans have: (a) an interest rate of 1.0%, (b) a two-year loan term to maturity; and (c) principal and interest payments deferred for six months from the date of disbursement. The SBA guarantees 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be forgiven and repaid by the SBA so long as certain criteria are met. In addition to the 1% interest earned on these loans, the SBA paid us fees for processing PPP loans in the following amounts: (i) 5% for loans of not more than $350,000; (ii) 3% for loans of more than $350,000 and less than $2.0 million; and (iii) 1% for loans of at least $2.0 million. These fees are amortized over the life of the loan, or earlier if the loan is forgiven and repaid by the SBA. We may not collect any fees from the loan applicants. Through the conclusion of the PPP on August 8, 2020, the Company had accepted more than 1,400 applications for PPP loans, including applications from new and existing customers who are small to midsize businesses as well as independent contractors, sole proprietors and partnerships as allowed under the PPP guidance issued in April 2020. As of September 30, 2020, the Bank had $75.3 million in PPP loans. The Bank will begin processing loan forgiveness applications as allowed under the SBA's PPP during the quarter ended December 31, 2020.
In addition, through a partnership with the City of Aiken, Aiken Corporation and the Aiken Chamber of Commerce, the Company implemented a small business loan program, which provided funding totaling $464,000 to 47 local businesses as of June 30, 2020. The loans are unsecured and the maximum loan amount is $10,000. Loans up to $5,000 carry a one-year amortization, 2.0% fixed interest rate and six-month deferral on all payments. Loans of $5,001 - $10,000 carry a two-year
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
amortization, 2.0% fixed interest rate and also a six-month deferral of payments. This loan program concluded during the second quarter of 2020. The Bank is also assisting small businesses with other borrowing options as they become available, including SBA and other government sponsored lending programs, as appropriate.
Allowance for Loan Losses and Loan Modifications
The Company recorded loan loss provisions of $3.6 million during the first nine months of 2020, compared to $175,000 during the first nine months of 2019 due primarily to the increased risk of charge-offs from loan defaults reflecting the ongoing negative impact of COVID-19 on the economy. According to the CARES Act and related bank agency guidance, banks are not required to designate as TDRs the modification of loans as a result of the COVID-19 pandemic, made on a good faith basis to borrowers who were current, as defined under the CARES Act and related bank agency guidance prior to any relief. This includes short-term (e.g. six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current under the CARES Act and related bank agency guidance if they are not more than 30 days past due on their contractual payments prior to any relief.
Since March 31, 2020, the Bank has approved modifications related to the COVID-19 pandemic on over 340 customer loans with a combined balance, net of deferred fees, of $114.9 million. The primary method of relief is to allow the borrower a three to six month payment deferral. The majority of these modifications ($108.1 million) have been for commercial real estate loans. After the deferral period, normal loan payments will continue, however, payments will be applied first to interest until the deferred interest is repaid and thereafter applied to both principal and interest with any deficiency in amortized principal payments added to the balloon payment due at maturity. All loans modified due to COVID-19 will be separately monitored and any request for continuation of relief beyond the initial modification will be reassessed at that time to determine if a further modification should be granted and if a downgrade in risk rating is appropriate. Most of these deferrals have resumed regular principal and interest payments and as of September 30, 2020, the total outstanding balance of deferred loans related to the COVID-19 pandemic was $4.3 million, including $4.0 million for commercial real estate loans. We believe the steps we are taking are necessary to effectively manage our portfolio and assist our customers through the ongoing uncertainty surrounding the duration, impact and government response to the COVID-19 pandemic.
Branch Operations and Additional Client Support
The impact of COVID-19 is rapidly evolving and its future social and economic effects are uncertain at this time. The actual impact will depend on many factors beyond our Company’s control; however, the Company is taking every step to protect the health and safety of its employees and customers. Many of our non-branch personnel are working remotely or have flexible work schedules, and we have established protective measures within our offices to help ensure the safety of those employees who must work on-site. The Families First Coronavirus Response Act, which requires certain employers to provide employees with paid sick leave or expanded family and medical leave for specified reasons related to COVID-19, also provides additional flexibility to our employees to help navigate their individual challenges.
The COVID-19 pandemic has caused significant disruptions to our branch operations resulting in the implementation of various social distancing measures at the Company to address client and community needs, including branch lobby closures. To ensure the safety of our customers and employees, services are offered through our drive through facilities, ATMs, Online/Mobile Digital Platforms and/or by appointment.
32
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Financial Condition at September 30, 2020 and December 31, 2019
Assets
Total assets increased $166.0 million or 17.2% to $1.1 billion at September 30, 2020 from $963.2 million at December 31, 2019. Changes in total assets are shown below.
| Increase (Decrease) | |||||||||||||||||||||||
| (Dollars in thousands) | 9/30/2020 | 12/31/2019 | $ | % | |||||||||||||||||||
| Cash and Cash Equivalents | $ | 15,607 | $ | 12,536 | $ | 3,071 | 24.5 | % | |||||||||||||||
| Investments and MBS – AFS | 504,802 | 414,645 | 90,157 | 21.7 | |||||||||||||||||||
| Investments and MBS – HTM | 15,848 | 19,247 | (3,399) | (17.7) | |||||||||||||||||||
| Loans Receivable, Net | 527,870 | 452,859 | 75,011 | 16.6 | |||||||||||||||||||
| OREO | 165 | 678 | (513) | (75.7) | |||||||||||||||||||
| Operating Lease Right-of-Use Assets | 2,442 | 2,719 | (277) | (10.2) | |||||||||||||||||||
| Premises and Equipment, Net | 26,700 | 27,220 | (520) | (1.9) | |||||||||||||||||||
| FHLB Stock | 2,354 | 2,537 | (183) | (7.2) | |||||||||||||||||||
| BOLI | 25,910 | 21,502 | 4,408 | 20.5 | |||||||||||||||||||
| Goodwill | 1,200 | 1,200 | — | — | |||||||||||||||||||
| Other Assets | 1,563 | 3,738 | (2,175) | (58.2) | |||||||||||||||||||
Cash and cash equivalents increased $3.1 million or 24.5% to $15.6 million at September 30, 2020 from $12.5 million at December 31, 2019, primarily due to increased cash limits at several of our branches in response to COVID-19. Investment and mortgage-backed securities AFS increased $90.2 million or 21.7% to $504.8 million at September 30, 2020 from $414.6 million at December 31, 2019 as purchases of new investment and mortgage backed securities AFS exceeded maturities, principal paydowns, and investments sold during the nine months ended September 30, 2020. Investment and mortgage-backed securities HTM decreased $3.4 million or 17.7% to $15.8 million at September 30, 2020 from $19.2 million at December 31, 2019 as a result of principal paydowns.
Loans receivable, net, including loans held for sale, increased $75.0 million or 16.6% to $527.9 million at September 30, 2020 from $452.9 million at December 31, 2019, primarily due to $75.3 million in PPP loans originated during the period. Loan balances in the commercial real estate and consumer loan categories grew while loan balances in the residential real estate and commercial business categories declined. Commercial real estate loans increased $9.4 million or 3.1% to $312.9 million at September 30, 2020 from $303.6 million at December 31, 2019 and consumer loans increased $313,000 or 0.6% to $56.6 million at September 30, 2020 from $56.3 million at December 31, 2019. Residential real estate loans decreased $3.3 million or 3.9% to $83.1 million at September 30, 2020 from $86.4 million at December 31, 2019. Commercial business loans decreased $3.0 million or 13.5% to $19.2 million at September 30, 2020 from $22.2 million at December 31, 2019. Loans held for sale increased $3.5 million or 87.9% to $7.5 million at September 30, 2020 from $4.0 million at December 31, 2019.
OREO decreased $513,000 or 75.7% to $165,000 at September 30, 2020 from $678,000 at December 31, 2019 due to the sale of four OREO properties during the nine months ended September 30, 2020, with a combined book value of $533,000. At September 30, 2020, OREO consisted of one commercial land property located in Aiken, South Carolina.
FHLB stock decreased $183,000 or 7.2% to $2.4 million at September 30, 2020 from $2.5 million at December 31, 2019 as a result of a decrease in advances from the FHLB of Atlanta. The Bank, as a member of the FHLB of Atlanta, is required to acquire and hold shares of capital stock in the FHLB of Atlanta in an amount equal to a membership component, which is 0.09% of total assets, plus a transaction component, which is 4.25% of outstanding advances (borrowings) from the FHLB of Atlanta. As the Bank's total advances have decreased, so has its required investment in FHLB stock.
Other assets decreased $2.2 million or 58.2% to $1.6 million at September 30, 2020 from $3.7 million at December 31, 2019. The decrease was primarily the result of a $2.6 million decrease in net deferred taxes, which was related to increased unrealized gains in the investment portfolio at September 30, 2020. The decrease in net deferred taxes was offset partially by a $395,000 increase in prepaid expenses.
33
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Liabilities
Deposit Accounts
Total deposits increased $133.4 million or 17.3% to $904.8 million at September 30, 2020 from $771.4 million at December 31, 2019. This growth was primarily due to proceeds from PPP loans and government stimulus checks deposited directly into customer accounts, organic growth in customer relationships and reduced withdrawals from deposit accounts due to a change in spending habits as a result of the ongoing COVID-19 pandemic. The $158.9 million increase in demand accounts was partially offset by a $25.6 million decrease in certificate accounts during the first nine months of 2020. The balance, weighted average rates and increases and decreases in deposit accounts at September 30, 2020 and December 31, 2019 are shown below.
| 9/30/2020 | 12/31/2019 | Increase (Decrease) | |||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Balance | Weighted Rate | Balance | Weighted Rate | $ | % | |||||||||||||||||||||||||||||
| Demand Accounts: | |||||||||||||||||||||||||||||||||||
| Checking | $ | 369,736 | 0.05 | % | $ | 260,136 | 0.11 | % | $ | 109,600 | 42.1 | % | |||||||||||||||||||||||
| Money Market | 258,803 | 0.19 | 230,694 | 0.72 | 28,109 | 12.2 | |||||||||||||||||||||||||||||
| Savings | 72,354 | 0.14 | 51,125 | 0.16 | 21,229 | 41.5 | |||||||||||||||||||||||||||||
| Total | $ | 700,893 | 0.12 | % | $ | 541,955 | 0.36 | % | $ | 158,938 | 29.3 | % | |||||||||||||||||||||||
| Certificate Accounts | |||||||||||||||||||||||||||||||||||
| 0.00 – 0.99% | $ | 121,549 | $ | 28,599 | $ | 92,950 | 325.0 | % | |||||||||||||||||||||||||||
| 1.00 – 1.99% | 67,467 | 122,165 | (54,698) | (44.8) | |||||||||||||||||||||||||||||||
| 2.00 – 2.99% | 14,883 | 78,690 | (63,807) | (81.1) | |||||||||||||||||||||||||||||||
| Total | $ | 203,899 | 0.91 | % | $ | 229,454 | 1.71 | % | $ | (25,555) | (11.1) | % | |||||||||||||||||||||||
| Total Deposits | $ | 904,792 | 0.30 | % | $ | 771,409 | 0.76 | % | $ | 133,383 | 17.3 | % | |||||||||||||||||||||||
Included in certificate accounts were $26.0 million and $34.6 million in brokered deposits at September 30, 2020 and December 31, 2019, respectively, with a weighted average interest rate of 0.42% and 1.87%, respectively.
Advances From FHLB
FHLB advances are summarized by contractual year of maturity and weighted average interest rate in the table below:
| (Dollars in thousands) | 9/30/2020 | 12/31/2019 | (Decrease) Increase | |||||||||||||||||||||||
| Year Due: | Balance | Rate | Balance | Rate | $ | % | ||||||||||||||||||||
| 2020 | $ | — | — | % | $ | 13,138 | 1.88 | % | $ | (13,138) | (100.0)% | |||||||||||||||
| 2021 | 25,000 | 1.97 | 25,000 | 1.97 | — | — | ||||||||||||||||||||
| Thereafter | 10,000 | 1.45 | — | — | 10,000 | 100.0 | ||||||||||||||||||||
| Total Advances | $ | 35,000 | 1.83 | % | $ | 38,138 | 1.94 | % | $ | (3,138) | (8.2)% | |||||||||||||||
Advances are secured by a blanket collateral agreement with the FHLB pledging the Bank’s portfolio of residential first mortgage loans and investment securities with an amortized cost and fair value of $109.9 million and $110.5 million, respectively, at September 30, 2020 and $100.5 million and $96.7 million, respectively, at December 31, 2019.
There were no callable FHLB advances at September 30, 2020. 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.
34
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Borrowings From the Federal Reserve Bank
At September 30, 2020, the Bank had $16.0 million in borrowings from the "discount window" of the Federal Reserve Bank of Atlanta. Depository institutions may borrow from the discount window for periods as long as 90 days, and borrowings are prepayable and renewable by the borrower on a daily basis. Effective March 16, 2020 the borrowing rate was set at the top of the targeted Federal Funds Rate, or 0.25%.
At September 30, 2020, the collateral pledged by the Bank for these borrowings consisted of investment and mortgage-backed securities with an amortized cost and fair value of $17 million and $19.8 million, respectively.
Other Borrowings (Repurchase Agreements)
The Bank had $19.8 million in other borrowings at September 30, 2020, an increase of $8.2 million or 70.7% from $11.6 million at December 31, 2019. 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 0.20% at September 30, 2020 compared to 0.50% at December 31, 2019.
Collateral pledged by the Bank for these repurchase agreements consisted of investment and mortgage-backed securities with amortized costs and fair values of $24.9 million and $25.1 million, respectively, at September 30, 2020 and $20.4 million and $20.5 million, respectively, at December 31, 2019.
Note Payable
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. The Company repaid the remaining balance of the term loan prior to its maturity date of October 1, 2019.
Junior Subordinated Debentures
On September 21, 2006, Security Federal Statutory Trust (the "Trust"), issued and sold fixed and floating rate capital securities of the Trust (the “Capital Securities”). The Trust used the net proceeds from the sale of the Capital Securities to purchase a like amount of junior subordinated debentures (the “Debentures”) of the Company which are reported on the Consolidated Balance Sheets as junior subordinated debentures. The Capital Securities accrue and pay distributions at a floating rate of three month LIBOR plus 170 basis points annually which was equal to 1.95% at September 30, 2020 compared 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.
Senior Convertible Debentures
In December 2009, the Company issued $6.1 million in Senior Convertible 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. Interest on the debentures is payable on June 1 and December 1 of each year and commenced on June 1, 2010. The debentures are convertible into the Company’s common stock at a conversion price of $20 per share at the option of the holder at any time prior to maturity. 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 Senior Convertible Debentures on March 2, 2020. Subsequent to the announcement, $5.9 million of Senior Convertible Debentures were converted into 295,600 common shares by holders of the debt. The Company redeemed the remaining $132,000 of outstanding debentures for cash on March 2, 2020.
35
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Subordinated Debentures
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 Debentures and for general corporate purposes.
Equity
Shareholders’ equity increased $17.3 million or 18.8% to $109.1 million at September 30, 2020 from $91.8 million at December 31, 2019. The increase was attributable to net income of $4.0 million combined with a $8.4 million increase in accumulated other comprehensive income, net of tax and a $5.9 million increase in additional paid in capital during the nine months ended September 30, 2020. The increase in net accumulated other comprehensive income was related to the unrecognized gain in value of investment and mortgage-backed securities during the nine months ended September 30, 2020. The increase in additional paid in capital was a result of the conversion of a large portion of the Company's Senior Convertible Debentures into 295,600 shares of common stock at a conversion price of $20 per share. These increases in equity were partially offset by $976,000 in dividends paid to common shareholders during the nine months ended September 30, 2020. Book value per common share was $33.52 at September 30, 2020 compared to $31.01 at December 31, 2019.
36
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations for the Three Month Periods Ended September 30, 2020 and 2019
Net Income
Net income decreased $1.3 million or 59.2% to $905,000 or $0.28 per basic common share for the quarter ended September 30, 2020 compared to $2.2 million or $0.75 per basic common share for the quarter ended September 30, 2019. The decrease in earnings was primarily the result of a significant increase in the provision for loan losses in response to the current economic impact of the ongoing COVID-19 pandemic, including increased risk of charge-offs from loan defaults.
Net Interest Income
Net interest income increased $558,000 or 7.6% to $7.9 million during the quarter ended September 30, 2020, compared to $7.3 million for the same period in 2019. During the quarter ended September 30, 2020, average interest-earning assets increased $120.0 million or 13.2% to $1.0 billion from $912.3 million for the same period in 2019, while average interest-bearing liabilities increased $55.0 million or 7.0% to $835.8 million for the quarter ended September 30, 2020 from $780.8 million for the comparable period in 2019. The Company's net interest margin was 3.09% for the quarter ended September 30, 2020 compared to 3.25% for the same quarter in 2019. The Company's net interest spread on a tax equivalent basis decreased 11 basis points to 2.96% for the quarter ended September 30, 2020 from 3.07% for the comparable period in 2019.
In response to COVID-19, the Federal Reserve reduced the targeted Federal Funds Rate by 150 basis points during March 2020 to a range of 0.00% to 0.25%, where it remains at September 30, 2020. The effect of changes in the targeted Federal Funds Rate on the cost of funding liabilities typically lags the effect on the yield earned on interest-earning assets because rates on many deposit accounts are based on local competition and not tied to a specific market-based index. Interest-earning assets adjust earlier because they are tied to a specific market-based index. Because the length of the COVID-19 pandemic and the effects of the extraordinary measures being put in place to address its economic consequences are unknown, until the pandemic subsides, the Company expects its net interest income and net interest margin will be adversely affected in 2020 and possibly longer.
Interest Income
The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the three months ended September 30, 2020 and 2019:
| Quarter Ended September 30, | Change in Average Balance | Increase (Decrease) in Interest Income | ||||||||||||||||||||||||
| 2020 | 2019 | |||||||||||||||||||||||||
| (Dollars in thousands) | Average Balance | Yield(1) | Average Balance | Yield(1) | ||||||||||||||||||||||
| Loans Receivable, Net | $ | 544,499 | 4.98 | % | $ | 451,652 | 5.64 | % | $ | 92,847 | $ | 404 | ||||||||||||||
| Mortgage-Backed Securities | 239,772 | 2.46 | 243,003 | 2.98 | (3,231) | (332) | ||||||||||||||||||||
Investment Securities(2) | 245,715 | 1.87 | 216,458 | 2.80 | 29,257 | (370) | ||||||||||||||||||||
| Overnight Time and Certificates of Deposit | 2,327 | 0.63 | 1,157 | 1.41 | 1,170 | — | ||||||||||||||||||||
| Total Interest-Earning Assets | $ | 1,032,313 | 3.64 | % | $ | 912,270 | 4.25 | % | $ | 120,043 | $ | (298) | ||||||||||||||
(1) Annualized
(2) 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 quarters ended September 30, 2020 and 2019. The tax equivalent adjustment relates to the tax exempt municipal bonds and was $61,425 and $56,561 for the quarters ended September 30, 2020 and 2019, respectively.
Despite a $120.0 million increase in average interest-earning assets, total tax equivalent interest income decreased $298,000 to $9.4 million for the quarter ended September 30, 2020 compared to 2019 due to a 61 basis point decline in the average yield on interest-earning assets. Total interest income on loans increased $404,000 or 6.3% to $6.8 million for the quarter ended September 30, 2020 from $6.4 million during the third quarter of 2019. The increase was the result of a $92.8 million or 20.6% increase in the average loan portfolio balance, largely due to the origination of PPP loans, which was partially offset by a decrease of 66 basis points in the average yield. Interest income from MBS decreased $332,000 or 18.4% to $1.5 million during the quarter ended September 30, 2020 due to a 52 basis point decrease in the yield and a $3.2 million decrease in the average balance of these assets. Tax equivalent interest income from investment securities decreased $370,000 or 24.4% to $1.1 million during the quarter ended September 30, 2020 due to a decrease of 93 basis points in the average yield on investment securities, partially offset by a $29.3 million or 13.5% increase in the average balance of the investment securities portfolio.
37
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Interest Expense
The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the three months ended September 30, 2020 and 2019.
| Quarter Ended September 30, | Change in Average Balance | Increase (Decrease) in Interest Expense | |||||||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||||||||
| (Dollars in thousands) | Average Balance | Cost(1) | Average Balance | Cost(1) | |||||||||||||||||||||||||
| Now and Money Market Accounts | $ | 447,997 | 0.17 | % | $ | 372,977 | 0.58 | % | $ | 75,020 | $ | (356) | |||||||||||||||||
| Savings Accounts | 67,940 | 0.15 | 51,035 | 0.15 | 16,905 | 7 | |||||||||||||||||||||||
| Certificate Accounts | 218,636 | 1.05 | 268,803 | 1.79 | (50,167) | (629) | |||||||||||||||||||||||
FHLB Advances and Other Borrowings (2) | 66,098 | 1.36 | 76,769 | 1.83 | (10,671) | (128) | |||||||||||||||||||||||
| Junior Subordinated Debentures | 5,155 | 2.05 | 5,155 | 4.15 | — | (27) | |||||||||||||||||||||||
| Subordinated Debentures | 30,000 | 5.25 | — | — | 30,000 | 394 | |||||||||||||||||||||||
| Senior Convertible Debentures | — | — | 6,044 | 8.00 | (6,044) | (121) | |||||||||||||||||||||||
| Total Interest-Bearing Liabilities | $ | 835,826 | 0.68 | % | $ | 780,783 | 1.17 | % | $ | 55,043 | $ | (861) | |||||||||||||||||
(1) Annualized
(2) Includes FHLB Advances, FRB Borrowings and Repurchase Agreements
Total interest expense decreased $861,000 or 37.6% to $1.4 million for the quarter ended September 30, 2020 compared to $2.3 million for the same period in 2019 due to a 49 basis point decline in the average cost of interest bearing liabilities, which was partially offset by a $55.0 million or 7.0% increase in the average balance of these liabilities.
The largest decrease in interest expense was related to deposits. Despite a $75.0 million increase in the average balance of now and money market deposit accounts, the average cost fell 41 basis points, resulting in a $356,000 decrease in interest expense during the third quarter of 2020 when compared to the third quarter in 2019. Interest expense on certificate accounts also decreased due to a lower average cost of 1.05% during the third quarter of 2020 combined with a $50.2 million decrease in the average balance. Interest expense on FHLB advances, FRB borrowings and repurchase agreements decreased $128,000 for the third quarter of 2020 due to a $10.7 million or 13.9% decrease in the average balance of these interest-bearing liabilities combined with a 47 basis point decline in the average cost.
Provision for Loan Losses
The amount of the provision is determined by management’s on-going monthly analysis of the loan portfolio and the adequacy of the allowance for loan losses. The Company has policies and procedures in place for evaluating and monitoring the overall credit quality of the loan portfolio and for timely identification of potential problem loans including internal and external loan reviews. The adequacy of the allowance for loan losses is reviewed monthly by the Asset Classification Committee and quarterly by the Board of Directors. Management’s monthly review of the adequacy of the allowance includes three main components.
The first component is an analysis of loss potential in various homogeneous segments of the loan portfolio based on historical trends and the risk inherent in each loan category. Currently, management applies a ten 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. These loans are evaluated for impairment and recorded in accordance with accounting guidance. For each loan deemed impaired, management calculates a specific reserve for the amount in which the recorded investment in the loan exceeds the fair value. This estimate is based on a thorough analysis of the most probable source of repayment, which is typically liquidation of the collateral underlying the loan.
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.
38
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
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.
The table below shows the changes in the allowance for loan losses for the quarters ended September 30, 2020 and 2019.
| Quarter Ended September 30, | |||||||||||
| (Dollars in thousands) | 2020 | 2019 | |||||||||
| Beginning Balance | $ | 10,676 | $ | 8,754 | |||||||
| Provision for Loan Losses | 2,200 | 75 | |||||||||
| Charge-offs | (65) | (102) | |||||||||
| Recoveries | 35 | 32 | |||||||||
| Net Charge-offs | $ | (30) | $ | (70) | |||||||
| Ending Balance | $ | 12,846 | $ | 8,759 | |||||||
| At Period End: | 9/30/2020 | 9/30/2019 | |||||||||
| Impaired Loans | $ | 3,217 | $ | 4,323 | |||||||
Gross Loans Receivable, Held For Investment (1) | $ | 533,221 | $ | 458,717 | |||||||
| Total Loans Receivable, Net | $ | 527,870 | $ | 453,641 | |||||||
| Allowance For Loan Losses as a % of Impaired Loans | 399.3 | % | 202.6 | % | |||||||
Allowance For Loan Losses as a % of Gross Loans Receivable (1) | 2.4 | % | 1.9 | % | |||||||
(1) TOTAL LOANS HELD FOR INVESTMENT, NET OF DEFERRED FEES AND LOANS IN PROCESS. | |||||||||||
The Company had net charge-offs of $30,000, or 0.01% of gross loans on an annualized basis, for the quarter ended September 30, 2020 compared to $70,000, or 0.02% of gross loans on an annualized basis, for the comparable period in 2019. The provision for loan losses was $2.2 million for the quarter ended September 30, 2020 compared to $75,000 during the third quarter of 2019 due primarily to the increased risk of charge-offs from loan defaults reflecting the adverse impact of COVID-19 on the economy. Because the SBA guarantees 100% of the PPP loans made to eligible borrowers, these loans do not have a corresponding allowance for loan loss. Refer to the "Response to COVID-19 - Allowance for Loan Losses and Loan Modifications" section herein for further information.
Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the existing collateral. In the event an acceptable arrangement cannot be reached, we may need to acquire these properties through foreclosure or other means and subsequently sell, develop or liquidate them. Management believes the allowance for loan losses is adequate based on its best estimates of the probable losses inherent in the loan portfolio, although there can be no guarantee these estimates will not be proven incorrect in the future. 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 is 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. A further decline in national and local economic conditions, as a result of the COVID-19 pandemic or other factors, could result in a material increase in the allowance for loan losses and may adversely affect the Company’s financial condition and results of operations.
39
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Non-Interest Income
Non-interest income increased $580,000 or 24.1% to $3.0 million for the three months ended September 30, 2020 compared to $2.4 million for the three months ended September 30, 2019. The table below summarizes the changes in non-interest income.
| Quarter Ended September 30, | Increase (Decrease) | ||||||||||||||||
| 2020 | 2019 | $ | % | ||||||||||||||
| Gain on Sale of MBS & Investment Securities | $ | 139,346 | $ | 96,057 | $ | 43,289 | 45.1 | % | |||||||||
| Gain on Sale of Loans | 1,184,818 | 580,220 | 604,598 | 104.2 | |||||||||||||
| Service Fees on Deposit Accounts | 222,085 | 279,360 | (57,275) | (20.5) | |||||||||||||
| Commissions From Insurance Agency | 202,007 | 201,253 | 754 | 0.4 | |||||||||||||
| BOLI Income | 138,250 | 273,609 | (135,359) | (49.5) | |||||||||||||
| Trust Income | 243,990 | 270,000 | (26,010) | (9.6) | |||||||||||||
| Check Card Fee Income | 433,528 | 365,659 | 67,869 | 18.6 | |||||||||||||
| Grant Income | 171,310 | 55,364 | 115,946 | 209.4 | |||||||||||||
| Other | 252,917 | 286,935 | (34,018) | (11.9) | |||||||||||||
| Total Non-Interest Income | $ | 2,988,251 | $ | 2,408,457 | $ | 579,794 | 24.1 | % | |||||||||
The increase in non-interest income was primarily attributable to an increase in gain on sale of loans, which was partially offset by a decrease in net gain on sale of MBS and investment securities. Gain on sale of loans increased $605,000 or 104.2% as the dollar volume of loans sold to investors increased reflecting increased refinance activity of residential loans. Net gain on sale of MBS and investment securities was $139,000 during the quarter ended September 30, 2020, an increase of $43,000 or 45.1% compared to $96,000 for the same period last year due to increased sales of investment securities during the third quarter of 2020 compared to the same period last year.
During the third quarter of 2019, the Bank recognized $139,000 in BOLI death benefits in addition to $135,000 in income related to accrued interest credited to the cash surrender value underlying the BOLI policies. The Company did not receive any BOLI death benefit proceeds during the third quarter of 2020. The entire portion of BOLI income recognized in 2020 was related to changes in the cash surrender value of the BOLI policies.
Non-Interest Expense
For the quarter ended September 30, 2020, non-interest expense increased $697,000 or 10.0% to $7.7 million compared to $7.0 million for the same period in 2019. The following table summarizes the changes in non-interest expense:
| Quarter Ended September 30, | Increase (Decrease) | ||||||||||||||||
| 2020 | 2019 | $ | % | ||||||||||||||
| Compensation and Employee Benefits | $ | 4,743,327 | $ | 4,270,515 | $ | 472,812 | 11.1 | % | |||||||||
| Occupancy | 669,258 | 599,512 | 69,746 | 11.6 | |||||||||||||
| Advertising | 325,584 | 190,070 | 135,514 | 71.3 | |||||||||||||
| Depreciation and Maintenance of Equipment | 689,118 | 644,800 | 44,318 | 6.9 | |||||||||||||
| FDIC Insurance Premiums | 51,858 | 41,540 | 10,318 | 24.8 | |||||||||||||
| Net (Recovery) Cost of Operation of OREO | (22,049) | 189,467 | (211,516) | (111.6) | |||||||||||||
| Other | 1,229,121 | 1,053,219 | 175,902 | 16.7 | |||||||||||||
| Total Non-Interest Expense | $ | 7,686,217 | $ | 6,989,123 | $ | 697,094 | 10.0 | % | |||||||||
Compensation and employee benefits expenses increased $473,000 or 11.1% to $4.7 million for the quarter ended September 30, 2020 compared to $4.3 million for the same period last year due to general annual cost of living increases, an increase in commissions and incentives on mortgage loan production, and an increase in the number of full time equivalent employees as a result of our growth and expansion into the Augusta, Georgia market.
The Company had a net recovery of $22,000 from the operation of OREO properties during the quarter ended September 30, 2020 compared to a net cost of $189,000 during the quarter ended September 30, 2019. This includes all expenses associated with OREO including write-down in value and gain or loss on sales incurred during each period.
40
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Provision For Income Taxes
The provision for income taxes decreased $370,000 or 77.8% to $105,000 for the quarter ended September 30, 2020 from $475,000 for the same period in 2019 primarily due to purchased state tax credits. Pre-tax net income was $1.0 million for the quarter ended September 30, 2020 compared to $2.7 million for the third quarter of 2019. The Company’s combined federal and state effective income tax rate was 10.4% and 17.6% for the quarters ended September 30, 2020 and 2019, respectively.
41
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations for the Nine Months Ended September 30, 2020 and 2019
Net Income
Net income decreased $2.2 million or 35.6% to $4.0 million for the nine months ended September 30, 2020 when compared to the same nine month period in 2019. The decrease in earnings was primarily the result of a significant increase in the provision for loan losses in response to the current economic impact of the ongoing COVID-19 pandemic.
Net Interest Income
Net interest income decreased $400,000 or 1.8% to $22.1 million for the nine months ended September 30, 2020 compared to $21.7 million for the same period last year. During the nine months ended September 30, 2020, average interest earning assets increased $114.1 million or 13.0% to $992.7 million from $878.6 million for the nine months ended September 30, 2019. Average interest-bearing liabilities also increased by $77.4 million or 10.3% to $827.9 million for the nine months ended September 30, 2020 from $750.5 million for the same period in 2019. The Company's net interest margin fell 33 basis points to 3.00% for the nine months ended September 30, 2020 compared to 3.33% for the nine months ended September 30, 2019. The net interest spread on a tax equivalent basis fell 32 basis points to 2.85% for the nine months ended September 30, 2020 from 3.17% for the comparable period in 2019.
Interest Income
The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the nine months ended September 30, 2020 and 2019:
| Nine Months Ended September 30, | Change in Average Balance | Increase (Decrease) in Interest Income | ||||||||||||||||||||||||
| 2020 | 2019 | |||||||||||||||||||||||||
| (Dollars in Thousands) | Average Balance | Yield(1) | Average Balance | Yield(1) | ||||||||||||||||||||||
| Loans Receivable, Net | $ | 511,611 | 5.04 | % | $ | 439,704 | 5.59 | % | $ | 71,907 | $ | 913 | ||||||||||||||
| Mortgage-Backed Securities | 239,693 | 2.63 | 222,326 | 2.99 | 17,367 | (250) | ||||||||||||||||||||
Investment Securities(2) | 235,905 | 2.04 | 211,909 | 2.84 | 23,996 | (900) | ||||||||||||||||||||
| Overnight Time & Certificates of Deposit | 5,504 | 1.28 | 4,661 | 2.69 | 843 | (41) | ||||||||||||||||||||
| Total Interest-Earning Assets | $ | 992,713 | 3.72 | % | $ | 878,600 | 4.25 | % | $ | 114,113 | $ | (278) | ||||||||||||||
(1) Annualized
(2) 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 nine months ended September 30, 2020 and 2019. The tax equivalent adjustment relates to the tax exempt municipal bonds and was $190,996 and $200,731 for the nine months ended September 30, 2020 and 2019, respectively.
Total tax equivalent interest income decreased $278,000 to $27.7 million during the nine months ended September 30, 2020 when compared to the first nine months of 2019, due to decreases in interest income from MBS, investment securities and other interest-earning assets, which were partially offset by an increase in interest income from loans. Total interest income on loans increased $913,000 or 5.0% to $19.3 million during the nine months ended September 30, 2020 from $18.4 million for the same period in 2019. The increase was a result of a $71.9 million or 16.4% increase in the average loan portfolio, which was partially offset by a decrease of 55 basis points in the average yield on loans. Interest income from MBS decreased $250,000 or 5.0% to $4.7 million for the nine months ended September 30, 2020 from $5.0 million for the same period in 2019. The decrease was the result of a 36 basis point decline in the average MBS portfolio yield, which was partially offset by a $17.4 million or 7.8% increase in the average balance of mortgage-backed securities. Tax equivalent interest income from investment securities decreased $900,000 or 20.0% to $3.6 million for the nine months ended September 30, 2020 from $4.5 million for the same period in 2019 due to a decrease of 80 basis points in the average yield on investment securities, partially offset by a $24.0 million increase in the average balance during the period.
42
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Interest Expense
The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the nine months ended September 30, 2020 and 2019:
| Nine Months Ended September 30, | Change in Average Balance | Increase (Decrease) in Interest Expense | ||||||||||||||||||||||||
| 2020 | 2019 | |||||||||||||||||||||||||
| (Dollars in Thousands) | Average Balance | Cost of Funds (1) | Average Balance | Cost of Funds (1) | ||||||||||||||||||||||
| Now and Money Market Accounts | $ | 428,663 | 0.28 | % | $ | 374,396 | 0.57 | % | $ | 54,267 | $ | (685) | ||||||||||||||
| Statement Savings Accounts | 60,131 | 0.15 | 50,223 | 0.14 | 9,908 | 14 | ||||||||||||||||||||
| Certificates Accounts | 223,450 | 1.41 | 257,247 | 1.65 | (33,797) | (821) | ||||||||||||||||||||
| FHLB Advances and Other Borrowed Money | 78,980 | 1.18 | 56,528 | 1.59 | 22,452 | 25 | ||||||||||||||||||||
| Note Payable | — | — | 902 | 5.25 | (902) | (36) | ||||||||||||||||||||
| Junior Subordinated Debentures | 5,155 | 2.62 | 5,155 | 4.31 | — | (65) | ||||||||||||||||||||
| Subordinated Debentures | 30,000 | 5.25 | — | — | 30,000 | 1,181 | ||||||||||||||||||||
| Senior Convertible Debentures | 1,500 | 7.27 | 6,046 | 8.00 | (4,546) | (281) | ||||||||||||||||||||
| Total Interest-Bearing Liabilities | $ | 827,879 | 0.87 | % | $ | 750,497 | 1.08 | % | $ | 77,382 | $ | (668) | ||||||||||||||
(1) Annualized
Interest expense decreased $668,000 or 11.0% to $5.4 million during the nine months ended September 30, 2020 compared to $6.1 million for the same period in 2019. The decrease in total interest expense was attributable to a decrease of 21 basis points in the cost of interest-bearing liabilities, which was partially offset by a $77.4 million or 10.3% increase in the average balance of these liabilities. Interest expense on deposits decreased $1.5 million or 30.9% to $3.3 million during the nine months ended September 30, 2020 compared to $4.8 million for the same period last year. The decrease was due to a decrease of 32 basis points in the average cost of interest-bearing deposit accounts, which was partially offset by a $30.0 million increase in average interest-bearing deposits to $712.0 million for the nine months ended September 30, 2020 compared to $682.0 million for the nine months ended September 30, 2019.
Interest expense on FHLB advances and other borrowings increased $25,000 or 3.6% to $701,000 during the nine months ended September 30, 2020 from $676,000 during the same period in 2019 due to a $22.5 million or 39.7% increase in the average balance, which was partially offset by a decline of 41 basis points in the average cost of these liabilities during the nine months ended September 30, 2020 when compared to the same period last year.
Interest expense on the subordinated debentures issued in November 2019 was $1.2 million during the nine months ended September 30, 2020 compared to none recognized for the same period last year.
Provision for Loan Losses
There was $3.6 million in provision for loan losses recorded during the nine months ended September 30, 2020 compared to $175,000 for the same period in 2019 reflecting probable loan losses due to the adverse economic impact of the COVID-19 pandemic. The table below summarizes the changes in the allowance for loan losses for the nine months ended September 30, 2020 and 2019.
| Nine Months Ended September 30, | |||||||||||
| 2020 | 2019 | ||||||||||
| Beginning Balance | $ | 9,225,574 | $ | 9,171,717 | |||||||
| Provision for Loan Losses | 3,600,000 | 175,000 | |||||||||
| Charge-offs | (203,345) | (831,648) | |||||||||
| Recoveries | 223,433 | 243,569 | |||||||||
| Net Recoveries (Charge-offs) | $ | 20,088 | $ | (588,079) | |||||||
| Ending Balance | $ | 12,845,662 | $ | 8,758,638 | |||||||
43
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Non-Interest Income
Non-interest income increased $1.5 million or 21.0% to $8.6 million for the nine months ended September 30, 2020, compared to $7.1 million for the nine months ended September 30, 2019. The following table summarizes the changes in the components of non-interest income:
| Nine Months Ended September 30, | Increase (Decrease) | ||||||||||||||||
| 2020 | 2019 | $ | % | ||||||||||||||
| Gain on Sale of MBS & Investment Securities | $ | 1,332,666 | $ | 1,056,959 | $ | 275,707 | 26.1 | % | |||||||||
| Gain on Sale of Loans | 2,494,084 | 1,126,551 | 1,367,533 | 121.4 | |||||||||||||
| Service Fees on Deposit Accounts | 695,561 | 785,987 | (90,426) | (11.5) | |||||||||||||
| BOLI Income | 408,250 | 543,609 | (135,359) | (24.9) | |||||||||||||
| Commissions From Insurance Agency | 513,783 | 528,246 | (14,463) | (2.7) | |||||||||||||
| Trust Income | 782,210 | 787,200 | (4,990) | (0.6) | |||||||||||||
| Check Card Fee Income | 1,234,558 | 1,063,314 | 171,244 | 16.1 | |||||||||||||
| Grant Income | 316,814 | 332,393 | (15,579) | (4.7) | |||||||||||||
| Other | 812,202 | 872,591 | (60,389) | (6.9) | |||||||||||||
| Total Non-Interest Income | $ | 8,590,128 | $ | 7,096,850 | $ | 1,493,278 | 21.0 | % | |||||||||
Net gain on sale of MBS and investment securities increased $276,000 or 26.1% to $1.3 million for the nine months ended September 30, 2020, compared to a net gain of $1.1 million during the same period last year.
Gain on sale of loans increased $1.4 million or 121.4% to $2.5 million for the nine months ended September 30, 2020 compared to $1.1 million during the same period in 2019 as the dollar volume of loans sold increased due to the increase in originations of loans held for sale reflecting increased refinance activity for residential loans.
Non-Interest Expense
For the nine months ended September 30, 2020, non-interest expense increased $1.3 million or 6.4% to $22.3 million compared to $21.0 million for the same period in 2019. The following table summarizes the changes in the components of non-interest expense:
| Nine Months Ended September 30, | Increase (Decrease) | ||||||||||||||||
| 2020 | 2019 | $ | % | ||||||||||||||
| Compensation and Employee Benefits | $ | 13,654,330 | $ | 12,587,421 | $ | 1,066,909 | 8.5 | % | |||||||||
| Occupancy | 1,864,202 | 1,728,732 | 135,470 | 7.8 | |||||||||||||
| Advertising | 776,605 | 539,234 | 237,371 | 44.0 | |||||||||||||
| Depreciation and Maintenance of Equipment | 2,126,683 | 1,894,997 | 231,686 | 12.2 | |||||||||||||
| FDIC Insurance Premiums | 67,938 | 184,022 | (116,084) | (63.1) | |||||||||||||
| Net Recovery of Operation of OREO | (27,329) | (62,680) | 35,351 | (56.4) | |||||||||||||
| Other | 3,858,305 | 4,103,020 | (244,715) | (6.0) | |||||||||||||
| Total Non-Interest Expense | $ | 22,320,734 | $ | 20,974,746 | $ | 1,345,988 | 6.4 | % | |||||||||
Compensation and employee benefits expenses increased $1.1 million or 8.5% to $13.7 million for the nine months ended September 30, 2020 compared to $12.6 million during the same period last year. The increase was due to general annual cost of living increases combined with an increase in the number of employees. The Company had an average of 243 full time equivalent employees during the nine months ended September 30, 2020 compared to an average of 230 full time equivalent employees during the nine months ended September 30, 2019.
The Company had a net recovery of $27,000 from the operation of OREO properties during the nine months ended September 30, 2020 compared to a net recovery of $63,000 during the nine months ended September 30, 2019. This line item includes all income and expenses associated with OREO, including gain or loss on sales and write-downs in value during each period. The Company recorded $46,000 in net gain on sales of OREO properties and no write-downs during the first nine months of 2020 compared to net gain on sales of $182,000 and write-downs of $22,000 during the same period in 2019.
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Depreciation and maintenance of equipment increased $232,000 or 12.2% primarily due to additional capital expenses related to our newest branch in Augusta, Georgia, which opened in September 2019. FDIC insurance premiums decreased $116,000 primarily due to the use of remaining FDIC small bank credits by the Bank. Other non-interest expense declined due to our reduced operations, including branch closures, as a result of the COVID-19 pandemic.
Provision For Income Taxes
The provision for income taxes decreased $671,000 or 45.3% to $810,000 for the nine months ended September 30, 2020 from $1.5 million for the same period in 2019 primarily due to lower pre-tax income and purchased state tax credits in 2020. Income before taxes was $4.8 million and $7.7 million for the nine months ended September 30, 2020 and 2019, respectively. The Company’s combined federal and state effective income tax rate was 16.9% for the nine months ended September 30, 2020 compared to 19.3% for the same period in 2019.
Liquidity Commitments, Capital Resources, and Impact of Inflation and Changing Prices
Liquidity
The Company actively analyzes and manages the Bank’s liquidity with the objective of maintaining an adequate level of liquidity and to ensure the availability of sufficient cash flows to support loan growth, fund deposit withdrawals, fund operations, and satisfy other financial commitments. See the “Consolidated Statements of Cash Flows” contained in Item 1 – Financial Statements, herein.
The 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 sources of funds, together with retained earnings and equity, are used to make loans, acquire investment securities and other assets, and fund continuing operations. While maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage repayments are greatly influenced by the level of interest rates, economic conditions, and competition. Management believes that the Company’s current liquidity position and its forecasted operating results are sufficient to fund all of its existing commitments.
During the nine months ended September 30, 2020 loan disbursements exceeded loan repayments resulting in a $75.0 million or 16.6% increase in total net loans receivable. Also during the nine months ended September 30, 2020, deposits increased $133.4 million or 17.3% and FHLB advances decreased $3.1 million or 8.2%. The Bank had $295.5 million in additional borrowing capacity at the FHLB at the end of the period. The Bank also has secured a $17.0 million discount window facility at the FRB, collateralized by investment securities with a fair market value of $19.8 million. At September 30, 2020, the Bank had $959,000 in additional borrowing capacity at the FRB. The Bank also had a $5.0 million unused Fed Funds facility with Pacific Coast Bankers Bank at September 30, 2020.
The Bank has the ability to supplement its liquidity in the fourth quarter of 2020 by its participation in the Federal Reserve’s Paycheck Protection Liquidity Facility (“PPPLF”) pursuant to which the Bank could pledge PPP loans as collateral at face value to obtain FRB non-recourse loans. While the Bank currently does not intend to use the PPPLF, as the Bank held a substantial cash and cash equivalent position as a result of PPP disbursed funds remaining unused in borrower deposit accounts and due to deposit customers increasing their balances due to the COVID-19 pandemic, the Bank will continue to evaluate its options. At September 30, 2020, the Bank had $141.3 million of certificates of deposit maturing within one year. Based on previous experience, the Bank anticipates a significant portion of these certificates will be renewed on maturity.
At September 30, 2020, the Bank exceeded all regulatory capital requirements with Common Equity Tier 1 Capital (CET1), Tier 1 leverage-based capital, Tier 1 risk-based capital, and total risk-based capital ratios of 18.3 %, 9.7 %, 18.3 %, and 19.6 %, respectively. To be categorized as “well capitalized” under the prompt corrective action provisions the Bank must maintain minimum CET1, total risk based capital, Tier 1 risk-based capital and Tier 1 leverage capital ratios of 6.5%, 10.0%, 8.0% and 5.0%, respectively. In addition to the minimum capital requirements, the Bank must maintain a capital conservation buffer, which consists 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 September 30, 2020 the Bank’s conservation buffer was 11.6%. For additional details, see “Footnote – Regulatory Matters” of the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report.
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Off-Balance Sheet Commitments
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments generally include commitments to originate mortgage, commercial and consumer loans, and involve to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The Company’s maximum exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amount of those instruments. Since some commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments. Collateral is not required to support commitments.
The following table sets forth the length of time until maturity for unused commitments to extend credit and standby letters of credit at September 30, 2020.
| (Dollars in thousands) | One Month or Less | After One Through Three Months | After Three Through Twelve Months | Total Within One Year | Greater Than One Year | Total | ||||||||||||||
Unused Lines of Credit | $ | 2,719 | $ | 5,551 | $ | 36,270 | $ | 44,540 | $ | 79,780 | $ | 124,320 | ||||||||
Standby Letters of Credit | 20 | — | 1,208 | 1,228 | 354 | 1,582 | ||||||||||||||
Total | $ | 2,739 | $ | 5,551 | $ | 37,478 | $ | 45,768 | $ | 80,134 | $ | 125,902 | ||||||||
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises principally from interest rate risk inherent in its lending, investment, deposit and borrowing activities. Management actively monitors and manages its interest rate risk exposure. Although the Company manages other risks such as credit quality and liquidity risk in the normal course of business, management considers interest rate risk to be its most significant market risk that could potentially have the largest material effect on the Company’s financial condition and results of operations. Other types of market risks such as foreign currency exchange rate risk and commodity price do not arise in the normal course of the Company’s business activities.
The Company’s profitability is affected by fluctuations in the market interest rate. Management’s goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase or decrease in interest rates may adversely impact the Company’s earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same rate, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using a test that measures the impact on net interest income and net portfolio value of an immediate change in interest rates in 100 basis point increments. Net portfolio value is defined as the net present value of assets, liabilities, and off-balance sheet contracts. There were no material changes in information concerning market risk from the information provided in the Company’s 2019 Form 10-K.
For the nine months ended September 30, 2020, the Bank's interest rate spread, defined as the average yield on interest bearing assets less the average rate paid on interest bearing liabilities was 2.85%.
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a - 15(e) of the Securities Exchange Act of 1934 (“Act”)) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer, Chief Financial Officer and several other members of the Company’s senior management as of the end of the period covered by this quarterly report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that at September 30, 2020 the Company’s disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is (i) accumulated and communicated to the Company’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time period specified in the Securities and Exchange Commission’s rules and forms. There have been no significant changes in our internal controls over financial reporting during the quarter ended September 30, 2020 that have materially affected or are reasonably likely to affect our internal controls over financial reporting.
The Company does not expect that its disclosure controls and procedures will prevent all error and or fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
Part II: Other Information
Item 1 Legal Proceedings
The Company is not engaged in any legal proceedings of a material nature at the present time. From time to time, the Company is a party to legal proceedings in the ordinary course of business wherein it enforces its security interest in mortgage loans it has made.
Item 1A Risk Factors
In light of recent developments relating to the novel coronavirus of 2019 (“COVID-19”), the Company is supplementing its risk factors contained in Item 1A of its Annual Report on Form 10-K for the year ended December 31, 2019, as filed with the Securities and Exchange Commission on March 20, 2020. The following risk factor should be read in conjunction with the risk factors described in the 2019 Annual Report.
The COVID-19 pandemic has adversely impacted our ability to conduct business and is expected to adversely impact our financial results and those of our clients. The ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.
The COVID-19 pandemic has significantly adversely affected our operations and the way we provide banking services to businesses and individuals. As an essential business, we continue to provide banking and financial services to our clients with drive-thru access available at the majority of our branch locations and in-person services available by appointment. In addition, we continue to provide access to banking and financial services through mobile and online banking, ATMs and by telephone. If the COVID-19 pandemic worsens it could limit or disrupt our ability to provide banking and financial services to our clients.
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Many of our employees are currently working remotely to enable us to continue to provide banking services to our clients. Heightened cybersecurity, information security and operational risks may result from these remote work-from-home arrangements. We also could be adversely affected if key personnel or a significant number of employees were to become unavailable due to the effects and restrictions of the COVID-19 pandemic. We also rely upon our third-party vendors to conduct business and to process, record and monitor transactions. If any of these vendors are unable to continue to provide us with these services, it could negatively impact our ability to serve our clients. Although we have business continuity plans and other safeguards in place, there is no assurance that such plans and safeguards will be effective.
There is pervasive uncertainty surrounding the future economic conditions that will emerge in the months and years following the start of the pandemic. As a result, management is confronted with a significant and unfamiliar degree of uncertainty in estimating the impact of the pandemic on credit quality, revenues and asset values. To date, the COVID-19 pandemic has resulted in declines in loan demand and loan originations, other than through government sponsored programs such as the Paycheck Protection Program ("PPP"), deposit availability, market interest rates and negatively impacted many of our business and consumer borrower’s ability to make their loan payments. Because the length of the pandemic and the efficacy of the extraordinary measures being put in place to address its economic consequences are unknown, including the continued low targeted federal funds rate, until the pandemic subsides, we expect our net interest income and net interest margin will be adversely affected. Many of our borrowers have become unemployed or may face unemployment, and certain businesses are at risk of insolvency as their revenues decline precipitously, especially in businesses related to travel, hospitality, leisure and physical personal services. Businesses may ultimately not reopen as there is a significant level of uncertainty regarding the level of economic activity that will return to our markets over time, the impact of governmental assistance, the speed of economic recovery, the resurgence of COVID-19 in subsequent seasons and changes to demographic and social norms that will take place.
The impact of the pandemic is expected to continue to adversely affect us during 2020 and possibly longer as the ability of many of our clients to make loan payments has been significantly affected. Although the Company makes estimates of loan losses related to the pandemic as part of its evaluation of the allowance for loan losses, such estimates involve significant judgment and are made in the context of significant uncertainty as to the impact the pandemic will have on the credit quality of our loan portfolio. It is likely that loan delinquencies, adversely classified loans and loan charge-offs will increase in the future as a result of the pandemic. Consistent with guidance provided by banking regulators, we have modified loans by providing various loan payment deferral options to our borrowers affected by the COVID-19 pandemic. Notwithstanding these modifications, these borrowers may not be able to resume making full payments on their loans once the COVID-19 pandemic is resolved. Any increases in the allowance for credit losses will result in a decrease in net income and, most likely, capital, and may have a material negative effect on our financial condition and results of operations.
As of September 30, 2020, we hold and service a portfolio of 1,474 PPP loans totaling $75.3 million. The PPP loans are subject to the provisions of the Coronavirus Aid, Relief, and Economic Security Act of 2020 ("CARES Act") and to complex and evolving rules and guidance issued by the U.S. Small Business Administration (“SBA”) and other government agencies. We expect that the great majority of our PPP borrowers will seek full or partial forgiveness of their loan obligations. We could face additional risks in our administrative capabilities to service our PPP loans, and risk with respect to the determination of loan forgiveness, depending on the final procedures for determining loan forgiveness.
In accordance with GAAP, we record assets acquired and liabilities assumed at their fair value with the excess of the purchase consideration over the net assets acquired resulting in the recognition of goodwill. If adverse economic conditions or the recent decrease in our stock price and market capitalization as a result of the pandemic were to be deemed sustained rather than temporary, it may significantly affect the fair value of our goodwill and may trigger impairment charges. Any impairment charge could have a material adverse effect on our results of operations and financial condition.
Even after the COVID-19 pandemic subsides, the U.S. economy will likely require some time to recover from its effects, the length of which is unknown. and during which we may experience a recession. As a result, we anticipate our business may be materially and adversely affected during this recovery. To the extent the effects of the COVID-19 pandemic adversely impact our business, financial condition, liquidity or results of operations, it may also have the effect of heightening many of the other risks described in the section entitled "Risk Factors" in our 2019 10-K and any subsequent Quarterly Reports on Form 10-Q.
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3 Defaults Upon Senior Securities
None
Item 4 Mine Safety Disclosures
Not applicable
Item 5 Other Information
None
Item 6 Exhibits
| 3.1 | |||||
| 3.2 | |||||
| 4.1 | Form of Stock Certificate of the Company and other instruments defining the rights of security holders, including indentures (3) | ||||
| 10.1 | 1993 Salary Continuation Agreements (4) | ||||
| 10.2 | Amendment One to 1993 Salary Continuation Agreements (5) | ||||
| 10.3 | |||||
| 10.4 | |||||
| 10.5 | |||||
| 10.6 | |||||
| 10.7 | |||||
| 10.8 | |||||
| 10.9 | |||||
| 10.10 | |||||
| 10.11 | Incentive Compensation Plan (4) | ||||
| 31.1 | |||||
| 31.2 | |||||
| 32 | |||||
| 101 | The following materials from Security Federal Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2020, formatted in Extensible Business Reporting Language (XBRL): (a) Consolidated Balance Sheets; (b) Consolidated Statements of Income; (c) Consolidated Statements of Comprehensive Income; (d) Consolidated Statements of Changes in Shareholders’ Equity; (e) Consolidated Statements of Cash Flows; and (f) Notes to Consolidated Financial Statements | ||||
_____________
(1) Filed on June 26, 1998, as an exhibit to the Company’s Proxy Statement and incorporated herein by reference.
(2) Filed on January 16, 2015 as an exhibit to the Company’s Current Report on Form 8-K dated January 15, 2015 and incorporated herein by reference.
(3) Filed on August 12, 1987, as an exhibit to the Company’s Registration Statement on Form 8-A and incorporated herein by reference.
(4) Filed on June 28, 1993, as an exhibit to the Company’s Annual Report on Form 10-KSB and incorporated herein by reference.
50
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
(5) Filed as an exhibit to the Company’s Quarterly Report on Form 10-QSB for the quarter ended September 30, 1993 and incorporated herein by reference.
(6) Filed on May 24, 2006 as an exhibit to the Company’s Current Report on Form 8-K dated May 18, 2006 and incorporated herein by reference.
(7) Filed on March 2, 2000, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference
(8) Filed on January 3, 2003, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference.
(9) Filed on August 22, 2006, as an exhibit to the Company's Registration Statement on Form S-8 (Registration Statement No. 333-136813) and incorporated herein by reference.
(10) Filed on November 12, 2008, as an exhibit to the Company's Registration Statement on Form S-8 and incorporated herein by reference.
(11) Filed on March 28, 2018, as an exhibit to the Company’s Proxy Statement and incorporated herein by reference.
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SECURITY FEDERAL CORPORATION
| Date: | November 13, 2020 | By: | /s/J. Chris Verenes | ||||||||||||||
| J. Chris Verenes | |||||||||||||||||
| Chief Executive Officer | |||||||||||||||||
Duly Authorized Representative | |||||||||||||||||
| Date: | November 13, 2020 | By: | /s/Darrell Rains | ||||||||||||||
| Darrell Rains | |||||||||||||||||
| Chief Financial Officer | |||||||||||||||||
Duly Authorized Representative | |||||||||||||||||
52