Security Federal Corp 10-K for FY2022
Security Federal Corp (SFDL)
10-K
2023-03-24
For: 2022-12-31
View Original
Added on
April 11, 2026
About this 10-K
Security Federal Corp filed this 10-K on March 24, 2023, covering the fiscal year ended December 31, 2022 (FY2022).
Headline figures
Fiscal year ended December 31, 2022, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Net income
- $10.23M
- down 19.9% from net income of $12.77M a year earlier
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||||||||||||
For the fiscal year ended | ||||||||||||||
OR | ||||||||||||||
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||||||||||||
| For the transition period _________ to _________ | ||||||||||||||
| Commission File Number: | | |||||||||||||
| (Exact Name of Registrant as Specified in its Charter) | ||||||||||||||
| (State of incorporation) | (I.R.S. Employer Identification No.) | |||||||||||||
| (Address of principal executive offices) | (Zip Code) | |||||||||||||
(Registrants telephone number)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock , par value $0.01 per share
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
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 ☒ 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 ☒ No ☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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 ☐ | 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. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ☐ NO ☒
As of March 24, 2023, there were issued and outstanding 3,253,210 shares of the registrant's Common Stock, which is traded on the OTC Pink Open Market under the symbol “SFDL ." The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the average of the bid and asked price of such stock as of June 30, 2022, was $50,198,148 . (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)
DOCUMENTS INCORPORATED BY REFERENCE
1.Portions of the Registrant's Annual Report to Stockholders for the Year Ended December 31, 2022 (the "Annual Report") are incorporated by reference into Parts I and II of this Annual Report on Form 10-K for the Year Ended December 31, 2022 ("Form 10-K") where indicated.
2.Portions of the Registrant's Proxy Statement for the 2023 Annual Meeting of Stockholders (the "2023 Proxy Statement") are incorporated by reference into Part III of this Annual Report on Form 10-K where indicated. The 2023 Proxy Statement will be filed with the U.S. Securities and Exchange Commission within 120 days after the end of the fiscal year to which this report relates.
Forward-Looking Statements
This Form 10-K, including information incorporated by reference herein, contains, and future filings by Security Federal Corporation ("Company") on Form 10-Q, and Form 8-K, and future oral and written statements by the Company and its management may contain, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words "believes," "expects," "anticipates," "estimates," "forecasts," "intends," "plans," "targets," "potentially," "probably," "projects," "outlook" or similar expressions or future or conditional verbs such as "may," "will," "should," "would" and "could." Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance and operations or financial condition, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management's expectations and may, therefore, involve risk and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors, including, but not limited to:
•potential adverse impacts to economic conditions in our local market areas, other markets where the Company has lending relationships, or other aspects of the Company’s business operations or financial markets, generally, resulting from the ongoing novel coronavirus 2019 (“COVID-19”) and any governmental or societal responses thereto;
•the credit risks of lending activities, including changes in the level and trend of loan delinquencies and write-offs and changes in our allowance for loan losses and provision for loan losses that may be affected by deterioration in the housing and commercial real estate markets which may lead to increased losses and non-performing assets in our loan portfolio, and may result in our allowance for loan losses not being adequate to cover actual losses, and require us to materially increase our reserves;
•changes in general economic conditions, either nationally or in our market areas;
•changes in the levels of general interest rates, and the relative differences between short and long term interest rates, deposit interest rates, our net interest margin and funding sources;
•the transition away from London Interbank Offered Rate (“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 sell loans in the secondary market;
•results of examinations of the Company by the Board of Governors of the Federal Reserve System ("Federal Reserve") and the Bank by the Federal Deposit Insurance Corporation ("FDIC") and the South Carolina State Board of Financial Institutions ("State Board"), 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 changes in banking, securities and tax laws, and in regulatory policies and principles, or the interpretation of regulatory capital or other rules, and including changes as a result of COVID-19;
•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 risk associated with the loans on our balance sheet;
•staffing fluctuations in response to product demand or the implementation of corporate strategies that affect our workforce and potential associated charges;
•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;
•costs and effects of litigation, including settlements and judgments;
i
•our ability to manage loan delinquency rates;
•increased competitive pressures among financial services companies;
•changes in consumer spending, borrowing and savings habits;
•the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
•our ability to pay dividends on our common stock;
•adverse changes in the securities markets;
•inability of key third-party providers to perform their obligations to us;
•changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board ("FASB"), including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods;
•other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; and
•the other risks described elsewhere in this Form 10-K.
These developments could have an adverse impact on our financial condition and results of operations.
Any of the forward-looking statements that we make may turn out to be inaccurate as a result of our beliefs and assumptions we make in connection with the factors set forth above or because of other unidentified and unpredictable factors. Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements and you should not rely on such statements. The Company undertakes no obligation to publish revised forward- looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. These risks could cause our actual results for 2023 and beyond to differ materially from those expressed in any forward-looking statements by or on behalf of us, and could negatively affect the Company’s consolidated financial condition and consolidated results of operations, liquidity and stock price performance.
As used throughout this report, the terms "we," "our," or "us" refer to Security Federal Corporation and our consolidated subsidiary, Security Federal Bank.
Available Information
The Company provides a link on its investor information page at www.securityfederalbank.com to the Securities and Exchange Commission's ("SEC") website (www.sec.gov) for purposes of providing copies of its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports, as soon as reasonably practicable after we have electronically filed such material with, or furnished such material to, the SEC. Other than an investor’s own internet access charges, these filings are available free of charge at the SEC’s website at www.sec.gov. The information contained on the Company’s website is not included as part of, or incorporated by reference into, this Form 10-K.
ii
PART I
Item 1. Business
Security Federal Corporation
Security Federal Corporation (the "Company") was incorporated under the laws of the State of Delaware in July 1987 for the purpose of becoming the savings and loan holding company for Security Federal Bank ("Security Federal" or the "Bank") upon the Bank's conversion from mutual to stock form (the "Conversion"). Effective August 17, 1998, the Company changed its state of incorporation from Delaware to South Carolina. On December 28, 2011, the Company reorganized into a bank holding company in connection with the Bank's conversion from a federally chartered stock savings bank to a South Carolina chartered commercial bank. As a result of the reorganization, the Federal Reserve became the Company's primary federal regulator.
As a South Carolina corporation, the Company is authorized to engage in any activity permitted by South Carolina General Corporation Law. The Company is a one bank holding company. Through the bank holding company structure, it is possible to expand the size and scope of the financial services offered beyond those currently offered by the Bank. The holding company structure also provides the Company with greater flexibility than the Bank would have to diversify its business activities, through existing or newly formed subsidiaries, or through acquisitions or mergers of financial institutions as well as other companies. There are no current arrangements, understandings or agreements regarding any such acquisition. Future activities of the Company will be funded through the continuing operations of Security Federal and through borrowings from third parties. Activities of the Company may also be funded through sales of additional securities or income generated by other activities of the Company. At this time, there are no plans regarding sales of additional securities or other activities.
At December 31, 2022, the Company had assets of $1.4 billion, deposits of $1.1 billion and shareholders' equity of $160.2 million. The executive office of the Company is located at 238 Richland Avenue Northwest, Aiken, South Carolina 29801, and its telephone number is (803) 641-3000.
Security Federal Bank
Security Federal is a South Carolina chartered commercial bank headquartered in Aiken, South Carolina. Security Federal, with 18 branch offices in Aiken, Lexington, Richland and Saluda counties in South Carolina and Columbia and Richmond counties in Georgia, was originally chartered under the name Aiken Building and Loan Association on March 27, 1922. It received its federal charter and changed its name to Security Federal Savings and Loan Association of Aiken on March 7, 1962, and later changed its name to Security Federal Savings Bank of South Carolina, on November 11, 1986. Effective April 8, 1996, the Bank changed its name to Security Federal Bank. The Bank converted from the mutual to the stock form of organization on October 30, 1987. As mentioned above, effective December 28, 2011, Security Federal converted from a federally chartered stock savings bank to a South Carolina chartered commercial bank. As a result of the conversion to a South Carolina commercial bank, the Bank is regulated by the State Board and the FDIC. The Bank will open its 19th branch office, in Augusta, Georgia in 2023.
In 2010, the Bank and the Company applied for and became a Certified Community Development Financial Institution ("CDFI"). The designation enables the Bank to be eligible for certain grants from United States Treasury ("Treasury"). The Treasury administers CDFIs and the Bank and Company must re-certify as a CDFI every year. Re-certification currently depends on the Bank making 60% of its loans by dollar and number of loans in its Target Market, which consists primarily of low to moderate income census tracts in the Bank’s market area. The criteria to remain a CDFI can change from year to year.
On May 24, 2022, the Company entered into a Letter Agreement (“Agreement”) with the Treasury under the Emergency Capital Investment Program (“ECIP”). Established by the Consolidated Appropriations Act, 2021, the ECIP was created to encourage CDFIs and minority depository institutions to provide loans, grants, and forbearance for small businesses, minority-owned businesses, and consumers, especially low-income and underserved communities, by providing direct and indirect capital investments in CDFIs. Pursuant to the Agreement, the Company agreed to issue and sell 82,949 shares of Preferred Stock for an aggregate purchase price of $82.9 million in cash. This ECIP investment is treated as tier 1 capital. The Preferred Stock bears no dividend for the first 24 months following the investment date. Thereafter, the dividend rate will be adjusted, not higher than 2%, based on the lending growth criteria listed in the Agreement. After the tenth anniversary of the investment date, the dividend rate will be fixed based on the average annual amount of lending in years 2 through 10. Dividends will be payable quarterly in arrears on March 15, June 15, September 15, and December 15. The Preferred Stock may be redeemed at the option of the Company on or after the fifth anniversary of issuance (or earlier in the event of loss of regulatory capital treatment), subject to the approval of the appropriate federal banking regulator and in accordance with the federal banking agencies’ regulatory capital regulations.
1
The principal business of Security Federal is accepting deposits from the general public and originating commercial real estate loans, commercial business loans, consumer loans, as well as mortgage loans to buy or refinance one-to-four family residential real estate. The Bank also originates construction loans on single-family residences, multi-family dwellings and projects, and commercial real estate, as well as loans for the acquisition, development and construction of residential subdivisions and commercial projects. Security Federal's income is derived primarily from interest and fees earned in connection with its lending activities, and its principal expenses are interest paid on savings deposits and borrowings and operating expenses. In addition, the Bank operates Security Federal Trust and Investments, a division of the Bank that offers trust, financial planning and financial management services.
Security Federal has two active wholly owned subsidiaries: Security Federal Investments, Inc. ("SFINV") and Security Federal Insurance, Inc. (“SFINS”). SFINV was formed to hold investment securities and allow for better management of the securities portfolio. SFINS is an insurance agency offering auto, business, and home insurance. Effective April 30, 2022, Collier Jennings Financial Corporation, a wholly owned subsidiary of SFINS, and its subsidiaries, Security Federal Auto Insurance, The Auto Insurance Store Inc., and Security Federal Premium Pay Plans Inc. ("SFPPP") and its wholly owned premium finance subsidiary were dissolved. SFPPP’s ownership interests in four other premium finance subsidiaries were disposed of at an immaterial gain. Additionally, effective April 30, 2022, previously inactive SFSC was dissolved.
Lending Activities
Security Federal's principal lending activities are making loans on commercial real estate and one-to-four family residential real estate. The Bank originates fixed rate residential real estate loans for sale in the secondary market and adjustable rate mortgage loans ("ARMS") to be held in its portfolio. The Bank also originates construction loans on single family residences, multi-family dwellings and commercial real estate, and loans for the acquisition, development and construction of residential subdivisions and commercial projects. To a lesser extent, the Bank originates consumer loans and commercial business loans.
The loan-to-value ratio, maturity and other provisions of loans made by the Bank reflect its policy of making the maximum loan permissible consistent with applicable regulations, established lending policies and market conditions. The Bank requires title insurance (or acceptable legal opinions on smaller loans secured by real estate), fire insurance, and flood insurance where applicable, on loans secured by improved real estate.
Loan Portfolio Composition
Loans receivable, net, including loans held for sale, increased to $549.9 million at December 31, 2022 from $499.5 million at December 31, 2021 primarily due to increases in real estate and consumer loans. For a detailed breakdown of the composition of our loan portfolio, see "Note 4 - Loans Receivable, Net" of the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
The following schedule illustrates the maturities of Security Federal's loan portfolio, excluding loans held for sale, at December 31, 2022. Mortgages which have adjustable or renegotiable interest rates are shown as maturing in the period when the contract is due. This schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
| Within One Year | After One Year Through Five Years | After Five Years Through Fifteen Years | After Fifteen Years | Total | |||||||||||||||||||||||||
| (In Thousands) | |||||||||||||||||||||||||||||
| Construction Real Estate | $ | 47,918 | $ | 57,275 | $ | 6,808 | $ | 793 | $ | 112,794 | |||||||||||||||||||
| Residential Real Estate | 5,931 | 45,564 | 13,364 | 45,198 | 110,057 | ||||||||||||||||||||||||
| Commercial Real Estate | 26,168 | 160,470 | 55,815 | 9,701 | 252,154 | ||||||||||||||||||||||||
| Commercial and Agricultural | 7,670 | 12,131 | 10,846 | — | 30,647 | ||||||||||||||||||||||||
| Consumer HELOC | 2,465 | 2,670 | 7,535 | 19,067 | 31,737 | ||||||||||||||||||||||||
| Other Consumer | 5,444 | 13,241 | 4,913 | — | 23,598 | ||||||||||||||||||||||||
| Total | $ | 95,596 | $ | 291,351 | $ | 99,281 | $ | 74,759 | $ | 560,987 | |||||||||||||||||||
2
The following table sets forth the amount of total loans due after December 31, 2023, with fixed or adjustable interest rates.
Fixed-Rate | Adjustable-Rate | Total | |||||||||||||||
(In thousands) | |||||||||||||||||
| Construction Real Estate | $ | 16,037 | $ | 48,838 | $ | 64,875 | |||||||||||
| Residential Real Estate | 43,923 | 60,203 | 104,126 | ||||||||||||||
| Commercial Real Estate | 187,615 | 38,371 | 225,986 | ||||||||||||||
| Commercial and Agricultural | 21,038 | 1,940 | 22,978 | ||||||||||||||
| Consumer HELOC | 145 | 29,127 | 29,272 | ||||||||||||||
| Other Consumer | 18,154 | 1 | 18,155 | ||||||||||||||
Total | $ | 286,912 | $ | 178,480 | $ | 465,392 | |||||||||||
Loan Originations/ Renewals, Purchases and Sales
In addition to interest earned on loans, the Bank receives loan origination fees or "points" for originating loans. Loan origination points are a percentage of the principal amount of the loan which are charged to the borrower for the creation of the loan. The Bank's loan origination fees are generally 1% on conventional residential mortgages, and 0.25% to 1% on commercial real estate loans and commercial and agricultural loans.
Loan origination and commitment fees are volatile sources of income. These fees vary with the volume and type of loans and commitments made and purchased and with competitive conditions in mortgage markets, which in turn are governed by the demand for and availability of money. The Bank also receives other fees and charges related to existing loans, conversion fees, assumption fees, late charges and other fees collected in connection with a change in borrower or other loan modifications.
Security Federal currently sells substantially all conforming fixed rate loans with terms of 15 years or greater in the secondary mortgage market. These loans are sold in order to provide a source of funds and as one of the strategies available to close the gap between the maturities of the Bank's interest-earning assets and interest-bearing liabilities. Currently, most fixed rate, long-term mortgage loans are being originated based on Federal National Mortgage Association ("Fannie Mae") and Federal Home Loan Mortgage Corporation ("Freddie Mac") underwriting standards.
Secondary market sales are made to other banks or institutional investors. Generally, all loans sold to investors are without recourse. For the past several years, substantially all loans have been sold on a servicing released basis. During the year ended December 31, 2022, Security Federal sold $48.5 million in fixed rate residential loans on a servicing released basis in the secondary market. Loans closed but not yet settled with banks or other investors, are carried in the Bank's "loans held for sale" portfolio. At December 31, 2022, the Bank had $913,000 of loans held for sale. These loans are fixed rate residential loans that have been originated in the Bank's name and have closed. Virtually all of these loans have commitments to be purchased by investors and the majority of these loans were price locked with the investors on the same day or shortly after the loan was price locked with the Bank's customers. Therefore, these loans present very little market risk for the Bank. The Bank usually delivers loans to, and receives funding from, the investor within 30 days. Security Federal originates all of its loans held for sale on a "best efforts" basis which means that the Bank suffers no penalty if it is unable to deliver a loan to a potential investor.
Federal law restricts the Bank's permissible lending limits to one borrower to the greater of $500,000 or 15% of unimpaired capital and surplus. At December 31, 2022, the Bank's legal lending limit under this restriction was $22.9 million. At that date, the Bank's largest loan relationship to a single borrower was $15.6 million, comprised of three loans for commercial real estate properties and one construction loan. These loans were performing in accordance with their repayment terms at December 31, 2022.
South Carolina law restricts the Bank's permissible lending limits to one borrower to 10% of unimpaired capital, or $15.3 million at December 31, 2022, unless prior approval is granted by a two-thirds vote of the Board of Directors, in which case the limit is increased to 15% of unimpaired capital. During 2022, the Board approved the increased loan limits mentioned above.
Loan Solicitation and Processing
The Bank actively solicits mortgage loan applications from existing customers, real estate agents, builders, real estate developers and others. The Bank also receives mortgage loan applications as a result of customer referrals and from walk-in customers. Detailed loan applications are obtained to determine the borrower's creditworthiness and ability to repay. The more significant items on loan applications are verified through the use of credit reports, financial statements and
3
confirmations. After analysis of the loan application and property or collateral involved, including an appraisal of the property (residential appraisals are obtained through independent fee appraisers), a lending decision is made in accordance with the underwriting guidelines of the Bank. These guidelines are generally consistent with Freddie Mac and Fannie Mae guidelines for residential real estate loans. With respect to commercial real estate loans, the Bank also reviews the capital adequacy of the business, the income potential of the property, the ability of the borrower to repay the loan and honor its other obligations, and general economic and industry conditions.
Upon receipt of a loan application and all required related information from a prospective borrower, the loan application is submitted for approval or rejection. The residential mortgage loan underwriters approve loans which meet Freddie Mac and Fannie Mae underwriting requirements. The Chairman of the Company, the Chief Executive Officer of the Company and the Bank, the President of the Bank, the President of the Company, the Chief Financial Officer, the Executive Vice President/Business Development, the Senior Vice President/Chief Lending Officer and Senior Vice President/Mortgage Lending individually have the authority to approve loans of $500,000 or less, except as set forth above for conforming conventionally underwritten, single family mortgage loans, which are approved by the underwriters. Loans in excess of $500,000 and up to $1.0 million require the approval of any three of the following: Chairman of the Company, the Chief Executive Officer of the Company and the Bank, the President of the Bank, the President of the Company, the Chief Financial Officer, the Executive Vice President/Financial Services, the Chief Lending Officer, or the Secretary of the Executive Committee. Any loan in excess of $1.0 million must be approved by the Bank's Executive Committee, which operates as the Bank's Loan Committee. The loan approval limits discussed above are the aggregate of all loans to any one borrower or entity, not including loans that are secured by the borrower's primary residence, and are conventionally underwritten.
The general policy of Security Federal is to issue loan commitments to qualified borrowers for a specified term, generally for a period of 45 days or less. With management approval, commitments may be extended for up to an additional 45 days. At December 31, 2022, the Bank had $1.0 million in outstanding commitments on mortgage loans not yet closed compared to $3.3 million at December 31, 2021. Security Federal had outstanding commitments available on all lines of credit (including letters of credit, commercial, undisbursed loans in process, home equity, credit cards and other consumer loans) totaling $173.3 million at December 31, 2022. For a more detailed discussion, see "Note 19 - Commitments and Contingencies" in the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
Residential and Construction Real Estate Lending
At December 31, 2022 the Bank had $110.1 million or 19.6% of the Bank's total outstanding loan portfolio in residential real estate loans. These loans have adjustable or fixed rates and include permanent one- to four-family and multi-family residential mortgage loans.
Security Federal offers a variety of ARMs with adjustable rates of interest which vary according to specified indices. The Bank's ARMs generally have a loan term of 15 to 30 years with initial rate adjustments every one, three, five or seven years during the term of the loan. After the initial rate adjustment, the loan rate then adjusts annually. Most of the Bank's ARMs contain a 200 basis point limit as to the maximum amount of change in the interest rate at any adjustment period and a 500 or 600 basis point limit over the life of the loan. The Bank generally originates ARMs to retain in its portfolio. These loans are generally made consistent with Freddie Mac and Fannie Mae guidelines. The Bank sells the majority of its longer term fixed rate mortgage loans at origination.
Despite the benefits of ARMs to the Bank's asset/liability management program, these loans also pose potential additional risks, primarily because as interest rates rise, the underlying payment by the borrower rises, increasing the potential for default. At the same time, marketability of the underlying property may be adversely affected by higher interest rates.
When making a one- to four-family residential mortgage loan, the Bank evaluates both the borrower's creditworthiness and his or her general ability to make principal and interest payments, and the value of the property that will secure the loan. The Bank generally makes loans on one- to four-family residential properties in amounts of 95% or less of the appraised value of the collateral. When loans are made for amounts which exceed 80% of the appraised value of the underlying real estate, the Bank's general policy is to require private mortgage insurance on the portion of the loan in excess of 80% of the appraised value. In general, the Bank restricts its residential lending to South Carolina and the nearby Evans and Augusta, Georgia market.
Many of the one- to four-family residential mortgage loans we retain in our portfolio consist of loans that do not satisfy acreage limits, income, credit, conforming loan limits (i.e., jumbo mortgages) or various other requirements imposed by Freddie Mac or Fannie Mae. Some of these loans are also originated to meet the needs of borrowers who cannot otherwise satisfy Freddie Mac or Fannie Mae credit requirements because of personal and financial reasons (i.e., bankruptcy, length of time employed, etc.), and other aspects, which do not conform to their underwriting guidelines. Such borrowers may have higher debt-to-income
4
ratios, or the loans are secured by unique properties in rural markets for which there are no sales of comparable properties to support the value according to secondary market requirements. We may require additional collateral or lower loan-to-value ratios to reduce the risk of these loans. We believe that these loans satisfy the needs of borrowers in our market area. As a result, subject to market conditions, we intend to continue to originate these types of loans. We also retain jumbo loans which exceed the conforming loan limits and therefore, are not eligible to be purchased by Freddie Mac or Fannie Mae.
Construction real estate loans include commercial lots and one- to four-family construction loans, which are generally made for periods of six months to one year with either adjustable or fixed rates. At December 31, 2022, construction real estate loans totaled $112.8 million, or 20.1%, of the Bank's loan portfolio. On loans of this type, the Bank seeks to evaluate the financial condition and prior performance of the builder, as well as the borrower's creditworthiness and his or her general ability to make principal and interest payments, and the value of the property that will secure the loan. On construction loans offered to individuals (non-builders), the Bank offers a construction/permanent loan. The borrower pays interest on the loan during the one year construction phase. After construction, the loan then automatically converts, depending on the borrower's upfront selection, to a one year ARM, a three year/one year ARM, or a five year/one year ARM loan in which the borrower will pay principal and interest. The borrower also has the option, after the construction period only, to convert the loan to a fixed rate residential mortgage loan which the Bank immediately sells on the secondary market on a servicing released basis.
Commercial Real Estate
The commercial real estate loans originated by the Bank are primarily secured by non-residential commercial properties, churches, hotels, residential developments, and single family speculative dwellings. At December 31, 2022, the Bank had $252.2 million, or 44.9% of its total loan portfolio, in commercial real estate loans.
Loans secured by commercial real estate are typically written for amortization terms of 10 to 20 years and are originated on adjustable or fixed rate terms. Adjustable rates are tied to the prime rate as quoted in The Wall Street Journal and typically adjust on a daily basis. Since 2009, the Bank has instituted floors of typically 4% to 6% on newly originated adjustable rate commercial real estate loans. If ceilings are used, the loan will typically require a balloon payment in 60 months or less. Fixed rate loans on commercial real estate usually require a balloon payment in 36 to 60 months.
Commercial real estate lending entails significant additional credit risk when compared to residential lending. Commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers. Because payments on loans secured by commercial properties often depend upon the successful operation and management of the properties, repayment of these loans may be affected by adverse conditions in the real estate market or the economy. In order to minimize the risks associated with this type of loan, the Bank generally limits the maximum loan-to-value ratio for commercial real estate to a range of 65% to 80%, based on appraisals of the property at the time of the loan by appraisers designated by the Bank, and strictly scrutinizes the credit history, financial condition and cash flow of the borrower, the quality of the collateral and the expertise of management of the property securing the loan. Although the creditworthiness of the business and its principals is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.
Commercial and Agricultural Business Loans (Non Real Estate)
The commercial and agricultural business loans originated by the Bank are primarily secured by business equipment, furniture and fixtures, inventory and receivables, or are unsecured. At December 31, 2022, the Bank had $30.6 million, or 5.5% of its total loan portfolio, in commercial and agricultural business loans.
Commercial and agricultural business loans are typically originated on terms of three to 60 months and with adjustable or fixed interest rate terms. Adjustable rates are tied to the prime rate as quoted in The Wall Street Journal and typically adjust on a daily basis. Since 2009, the Bank has instituted floors of typically 4% to 6% on newly originated adjustable rate commercial and agricultural business loans. If ceilings are used, the loan will typically require a balloon payment in 60 months or less. Fixed rate commercial and agricultural business loans are generally amortizing in five years or less.
Commercial and agricultural business lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with lending that is secured by real estate. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan-to-collateral values, and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial and agricultural business loans often have equipment, inventory, accounts receivable or other business assets as collateral, the liquidation of collateral in the event of a borrower default is often not a sufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other conditions. Accordingly, the repayment of a commercial and agricultural business loan depends primarily on the
5
creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment. The Bank seeks to minimize these risks by strictly scrutinizing the borrower's current financial condition, ability to pay, past earnings and payment history. In addition, the current financial condition and payment history of all principals are reviewed. Typically, the Bank requires the principal or owners of a business to guarantee all loans made to their business by the Bank. Although the creditworthiness of the business and its principals is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.
HELOC and Consumer Loans
The Bank originates consumer loans for any personal, family or household purpose, including the financing of home improvements, loans to individuals for residential lots for a future home, automobiles, boats, mobile homes, recreational vehicles and education. The Bank also offers home equity lines of credit (HELOC). HELOCs are open end lines of credit, secured by mortgage liens on the borrower's principal or second residence, where the borrowers pay a minimum of interest only monthly on drawn lines. The terms are for a maximum period of 20 years and the rate is a variable rate tied to prime and floats monthly.
In 2012, the Bank instituted interest rate floors, which currently range from 3.00% to 6.00%, on new home equity line originations and a maximum loan-to-value ratio of 80%. The Bank also makes secured and unsecured lines of credit available. Although consumer loans involve a higher level of risk than one- to four-family residential mortgage loans, they generally provide higher yields and have shorter terms to maturity than one- to four-family residential mortgage loans. At December 31, 2022, the Bank had $31.7 million, or 5.7% of its loan portfolio, in outstanding HELOC loans.
The Bank's underwriting standards for consumer loans include a determination of the applicant's payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant's monthly income is determined by verification of gross monthly income from primary employment, and from any verifiable secondary income. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount. At December 31, 2022, the Bank had $23.6 million, or 4.2% of its loan portfolio, in consumer loans.
Credit cards and personal lines of credit are also included in consumer loans. As of December 31, 2022, the Bank had issued approved credit card lines of $13.8 million, of which $3.2 million was outstanding on that date.
Loan Delinquencies and Defaults
The Bank's collection procedures provide that when a real estate loan is approximately 20 days past due, the borrower is contacted by mail and payment is requested. If the delinquency continues for another 10 days, subsequent efforts are made to contact the delinquent borrower and establish a program to bring the loan current. In certain instances, the Bank may modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his financial affairs. If the loan continues in a delinquent status for 60 days or more, the Bank generally initiates foreclosure proceedings after the customer has been notified by certified mail. The Bank institutes the same collection procedure for its commercial real estate loans. The Bank’s non-accrual loans were $6.3 million at December 31, 2022 compared to $2.7 million at December 31, 2021. For a more detailed discussion of our non-accrual loans, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Note 4 - Loans Receivable, Net" in the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8. Financial Statements and Supplementary Data,” respectively, of this Form 10-K.
Classified Assets
Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered to be of lesser quality as "substandard," "doubtful" or "loss" assets. The regulations require commercial banks to classify their own assets and to establish prudent general allowances for loan losses for assets classified "substandard" or "doubtful." For the portion of assets classified as "loss," an institution is required to either establish specific allowances of 100% of the amount classified or charge off such amount. In addition, the State Board and/or FDIC may require the establishment of a general allowance for losses based on assets classified as "substandard" and "doubtful" or based on the general quality of the asset portfolio of a Bank. See "Regulation - Regulation of the Bank."
The Company uses a risk-based approach based on the following credit quality measures consistent with regulatory guidelines when analyzing the loan portfolio: pass, caution, special mention, and substandard. For a more detailed discussion of our credit quality measures, see "Note 4- Loans Receivable, Net - Credit Quality Indicators" in the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
6
At December 31, 2022, $9.2 million of the total loan balance was classified "substandard" compared to $6.9 million at December 31, 2021. At December 31, 2022, $7.1 million of the total loan balance was designated as "special mention" compared to $15.1 million at December 31, 2021. At December 31, 2022, $105.4 million of the total loan balance was designated as “caution” compared to $89.2 million at December 31, 2021. The Bank had no loans classified as "doubtful" or "loss" at December 31, 2022 and 2021.
Troubled Debt Restructurings ("TDRs")
The Bank identifies and reviews all loans to be restructured based on an assessment of the borrower's credit status. This assessment is a continuous process that involves a review of the financial statements and prospects for repayment, payment delinquency, non-accrual status, and risk rating. Not all loan modifications are TDRs. The Bank designates a loan modification as a TDR when the following two conditions are present: the borrower is experiencing financial difficulty, and because of this difficulty, the Bank grants a concession it would not otherwise consider. For a more detailed discussion of our TDRs, see "Management's Discussion and Analysis of Financial Condition and Results of Operations- Financial Condition - Non-Performing Assets" and "Note 4- Loans Receivable, Net -Troubled Debt Restructurings and Loan Modifications" in the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8. Financial Statements and Supplementary Data,” respectively, of this Form 10-K.
Provision for Losses on Loans
Security Federal recognizes that it will experience credit losses during the course of making loans and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a secured loan, the quality of the underlying security for the loan. The Bank seeks to establish and maintain sufficient reserves for estimated losses on specifically identified loans and real estate where such losses can be estimated. Additionally, general reserves for estimated possible losses are established on specified portions of the Bank's portfolio such as consumer loans and higher risk residential construction mortgage loans based on management's estimate of the potential loss for loans which normally can be classified as higher risk. Specific and general reserves are based on, among other criteria: (1) the risk characteristics of the loan portfolio, (2) current economic conditions on a local as well as a statewide basis, (3) actual losses experienced historically and (4) the level of reserves for possible losses in the future.
In determining the adequacy of the reserve for loan losses, management reviews past experience of loan charge-offs, the level of past due and non-accrual loans, the size and mix of the portfolio, general economic conditions in the market area, and individual loans to identify potential credit problems. The level of reserves reflects management's continuing evaluation of this risk based on the Bank's past loss experience. The reserve is management's best estimate for offsetting risk for our estimated possible losses. There can be no guarantee that the estimate is adequate or accurate.
Management believes that reserves for loan losses are at a level adequate to provide for inherent loan losses. Although management believes that it has considered all relevant factors in its estimation of future losses, future adjustments to reserves may be necessary if conditions change substantially from the assumptions used in making the original estimations. Regulators will from time to time evaluate the allowance for loan losses which is subject to adjustment based upon the information available to the regulators at the time of their examinations.
For a breakdown of the activity within the allowance for loan losses by loan category for the years ended December 31, 2022 and 2021, see "Note 4- Loans Receivable, Net - Allowance for Loan Losses" in the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
7
The following table summarizes annual net (recoveries) charge-offs as a percentage of average loans outstanding in each loan category for the years indicated.
| Year Ended December 31, | |||||||||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | Net Charge-offs (Recoveries) | Average Loans | Ratio | Net Charge-offs (Recoveries) | Average Loans | Ratio | |||||||||||||||||||||||||||||||||||
| Construction | $ | (35) | $ | 104,516 | (0.03) | % | $ | (188) | $ | 82,816 | (0.23) | % | |||||||||||||||||||||||||||||
| Residential Mortgage | (46) | 94,075 | (0.05) | (65) | 85,008 | (0.08) | |||||||||||||||||||||||||||||||||||
| Commercial Real Estate: | (132) | 243,104 | (0.05) | (420) | 219,548 | (0.19) | |||||||||||||||||||||||||||||||||||
| Other Commercial and Agricultural Loans | 62 | 31,338 | 0.20 | 4 | 67,883 | 0.01 | |||||||||||||||||||||||||||||||||||
| HELOC | (52) | 29,652 | (0.18) | (15) | 28,059 | (0.05) | |||||||||||||||||||||||||||||||||||
| Other Consumer | 112 | 23,563 | 0.48 | 36 | 22,588 | 0.16 | |||||||||||||||||||||||||||||||||||
| Total | $ | (91) | $ | 526,248 | (0.02) | % | $ | (648) | $ | 505,902 | (0.13) | % | |||||||||||||||||||||||||||||
8
Subsidiaries
At December 31, 2022, the Company had two subsidiaries, Security Federal, its wholly owned operating bank subsidiary, and Security Federal Statutory Trust (the “Trust”), which issued and sold fixed and floating rate capital securities of the Trust. Under current accounting guidance, the Trust is not consolidated in the Company’s financial statements.
At December 31, 2022, Security Federal had two subsidiaries, SFINV and SFINS. SFINV was formed to hold investment securities and allow for better management of the securities portfolio. SFINS is an insurance agency offering auto, business and home insurance. Security Federal's net investment in its subsidiaries totaled $17.1 million at December 31, 2022.
Investment Activities
The Bank has authority to invest in various types of liquid assets, including U.S. Treasury obligations and securities of various federal agencies, certificates of deposit at insured institutions, mutual funds, bankers' acceptances and federal funds. The Bank may also invest a portion of its assets in certain commercial paper and corporate debt securities. See "Regulation - Regulation of the Bank."
As a member of the Federal Home Loan Bank ("FHLB") System, Security Federal must maintain minimum levels of investments that are liquid assets as defined in Federal regulations. See "Regulation - Regulation of the Bank - Federal Home Loan Bank System." Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Historically, the Bank has maintained its liquid assets at a level believed adequate to meet requirements of normal daily activities, repayment of maturing debt and potential deposit outflows. Management regularly reviews and updates cash flow projections to assure that adequate liquidity is provided.
At December 31, 2022, our investment portfolio totaled $717.6 million. Security Federal has a portfolio of available for sale ("AFS") and held to maturity ("HTM") investments, the majority of which are mortgage-backed securities ("MBS"). MBS can serve as collateral for borrowings and, through repayments, as a source of liquidity. MBS investments do not have a fixed maturity date. Under the Bank's risk-based capital requirement, MBS have a risk weight of 20% (or 0% in the case of Government National Mortgage Association ("Ginnie Mae") securities) compared to the 50% risk weight carried by residential loans. SBA bonds are backed by the full faith and credit of the U.S. government and carry a zero percent risk base when calculating risk-based assets for regulatory capital purposes. Student Loan Pools are typically 97% guaranteed by the U.S. government. The FHLB, Fannie Mae and Freddie Mac are government sponsored enterprises ("GSEs") and the securities and bonds issued by GSEs are not backed by the full faith and credit of the U.S. government. AFS investments are carried at fair value.
HTM investments are carried at amortized cost, adjusted for the amortization of any related premiums or the accretion of any related discounts into interest income. At December 31, 2022, these securities had a combined book value of $167.4 million and an average book yield of 4.22%, which was calculated by multiplying the carrying value of each HTM investment by its yield and dividing the sum of these results by the total carrying value. The following table includes a summary of the amortized cost and average book yield of HTM investment securities by contractual maturity at December 31, 2022. Since MBS investments do not have fixed maturity dates, they are disclosed separately.
| Carrying Value | Average Book Yield | ||||||||||
| HTM Investments: | |||||||||||
| Due in less than one year | — | — | % | ||||||||
| Due in one year to five years | 36,463,713 | 3.21 | |||||||||
| Due in five to ten years | 3,521,293 | 4.39 | |||||||||
| Due in ten years or more | 16,387,997 | 6.04 | |||||||||
| MBS | 111,064,613 | 4.28 | |||||||||
| Total HTM Investments | 167,437,616 | 4.22 | % | ||||||||
For more detailed information regarding the Bank's securities portfolios, see "Note 2 - Investments, Available for Sale" and "Note 3 - Investments, Held to Maturity" in the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
9
Sources of Funds
Deposit accounts have traditionally been a principal source of the Bank's funds for use in lending and for other general business purposes. The Bank attracts both short-term and long-term deposits from the general public by offering a wide assortment of account types and rates. The Bank offers regular savings accounts, checking accounts, various money market accounts, fixed interest rate certificates with varying maturities, and individual retirement accounts. In addition to deposits, the Bank derives funds from loan repayments, cash flows generated from operations (including interest credited to deposit accounts), FHLB of Atlanta advances, borrowings from the Federal Reserve Bank of Atlanta, sales of investment securities, sales of securities under agreements to repurchase, and loan sales. See "Borrowings" below. Scheduled loan payments are a relatively stable source of funds while deposit inflows and outflows and the related cost of such funds have varied widely. FHLB of Atlanta advances, borrowings from the Federal Reserve Bank and the sale of securities under agreements to repurchase, referred to as retail repurchase agreements, may be used on a short-term basis to compensate for seasonal reductions in deposits or deposit inflows at less than projected levels and may be used on a longer-term basis in support of expanded lending activities. The availability of funds from loan and investment sales is influenced by general interest rates. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" contained in the Annual Report and incorporated by reference into “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K.
Deposits
The Bank attracts both short-term and long-term deposits from the general public by offering a wide assortment of account types and rates. The Bank offers regular savings accounts, checking accounts, various money market accounts, fixed interest rate certificates with varying maturities, negotiated rate $100,000 or above jumbo certificates of deposit ("Jumbo CDs") and individual retirement accounts. The Bank believes that, based on its experience over the past several years, its savings and transaction accounts are stable sources of deposits. The Bank relies upon locally obtained Jumbo CDs to maintain its deposit levels. At December 31, 2022 deposits totaled $1.1 billion. At that date, approximately $30.3 million of our deposit portfolio was uninsured. The uninsured amounts are estimates based on the methodologies and assumptions used for the Bank’s regulatory reporting requirements.
The following table includes deposit accounts and associated weighted average interest rates for each category of deposit at the dates indicated.
| Year Ended December 31, | |||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| Average Balance | % of Total | Weighted Avg Rate | Average Balance | % of Total | Weighted Avg Rate | ||||||||||||||||||||||||||||||
| (Dollars in thousands) | |||||||||||||||||||||||||||||||||||
| Interest bearing checking | $ | 114,065 | 10 | % | 0.60 | % | $ | 97,466 | 10 | % | 0.23 | % | |||||||||||||||||||||||
| Savings and money market | 589,849 | 53 | % | 0.27 | % | 518,632 | 52 | % | 0.11 | % | |||||||||||||||||||||||||
| Certificates of deposit | 143,619 | 13 | % | 0.42 | % | 172,995 | 17 | % | 0.51 | % | |||||||||||||||||||||||||
| Total interest bearing deposits | 847,533 | 76 | % | 0.34 | % | 789,093 | 79 | % | 0.21 | % | |||||||||||||||||||||||||
| Non-interest checking | 267,246 | 24 | % | 208,822 | 21 | % | |||||||||||||||||||||||||||||
| Total Deposits | $ | 1,114,779 | 100 | % | $ | 997,915 | 100 | % | |||||||||||||||||||||||||||
For additional information regarding our deposits, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Note 9 - Deposits" in the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8. Financial Statements and Supplementary Data,” respectively, of this Form 10-K.
Borrowings
At December 31, 2022, the Bank had $44.1 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. At December 31, 2022, the borrowing rate was 4.50%.
As a member of the FHLB of Atlanta, the Bank is required to own capital stock in the FHLB of Atlanta and is authorized to apply for advances from the FHLB of Atlanta. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB of Atlanta may prescribe the acceptable uses to which these advances may be
10
utilized as well as limitations on the size of the advances and repayment provisions. At December 31, 2022, the Bank had no outstanding advances from the FHLB of Atlanta.
At December 31, 2022, the Bank had $27.6 million in other borrowings consisting of retail repurchase agreements with an average rate of 0.75%.
For additional information regarding our borrowings, see "Note 10 - FHLB Advances and FRB Borrowings" and “Note 11 - Other Borrowings” in the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K. See also, "Regulation - Regulation of the Bank - Federal Home Loan Bank System" in this Form 10-K.
At December 31, 2022, the Company had $5.2 million in junior subordinated debentures. The debentures accrue and pay distributions quarterly at a floating rate of three-month LIBOR plus 170 points which was equal to 6.47% at December 31, 2022. The debentures were callable by the Company in September 2011, and quarterly thereafter, with a final maturity date of December 15, 2036. See "Note 12 - Junior Subordinated Debentures" of the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
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 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 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. See "Note 14 – Subordinated Debentures" in the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
Competition
The Bank serves the counties of Aiken, Lexington, Richland and Saluda, South Carolina, and the counties of Columbia and Richmond, Georgia through its 18 full service branch offices located in Aiken, Ballentine, Clearwater, Columbia, Graniteville, Langley, Lexington, North Augusta, Ridge Spring, Wagener, and West Columbia, South Carolina, and Augusta and Evans, Georgia.
Security Federal faces strong competition both in originating loans and in attracting deposits. Competition in originating loans comes primarily from other commercial banks, federal savings institutions, mortgage bankers and credit unions who also make loans in the Bank's market area, and more recently, financial technology (or “FinTech”) companies.
The Bank competes for loans principally on the basis of the interest rates and loan fees it charges, the types of loans it makes and the quality of services it provides to borrowers. The Bank faces substantial competition in attracting deposits from federal savings institutions, commercial banks, money market and mutual funds, credit unions and other investment vehicles.
The ability of the Bank to attract and retain deposits depends on its ability to provide an investment opportunity that satisfies the requirements of investors as to rate of return, liquidity, risk and other factors. The Bank attracts a significant amount of deposits through its branch offices primarily from the communities in which those branch offices are located. Therefore, competition for those deposits is principally from federal savings institutions, credit unions and commercial banks located in the same communities. FinTech companies also compete for consumer deposit relationships. The Bank competes for these deposits by offering a variety of deposit accounts at competitive rates, convenient business hours, online/mobile services, and convenient branch locations with interbranch deposit and withdrawal privileges at each.
11
Human Capital
We continually strive to recruit the most talented, motivated employees in their respective fields. By providing opportunities for personal and professional growth coupled with an environment that values teamwork and work-life balance, we are able to attract and retain outstanding individuals. We pride ourselves on providing excellent benefits, competitive salaries and the opportunity for participation in the company's long-term success.
At December 31, 2022, the Company employed 258 (247 full-time and 11 part-time) employees. The Bank's employees are not represented by any collective bargaining agreement. Management of the Bank is committed to providing equality of opportunity in all aspects of employment through a comprehensive affirmative action plan that is updated annually. As of December 31, 2022, our workforce was 72% female and 28% male, and women held 64% of the Bank’s management roles. The ethnicity of our workforce was 76% White, 17% Black, 3% Asian, 3% Hispanic or Latino, 1% Indian and less than 1% Two or More Races.
The following chart depicts the percentage of self-identified females and minorities in our workforce at December 31, 2022, by job classification as defined by the Equal Employment Opportunity Commission (“EEOC”):
| Job Classification | Female | Minority (1) | Distribution by EEOC Job Classification | ||||||||
| Executive / Senior level officers | 3.8 | % | 3.2 | % | 8.1 | % | |||||
| Mid-level officers and managers | 22.7 | % | 15.9 | % | 21.3 | % | |||||
| Professionals | 19.5 | % | 22.2 | % | 24.0 | % | |||||
| Sales | 1.6 | % | — | % | 1.6 | % | |||||
| Administrative support | 52.4 | % | 58.7 | % | 45.0 | % | |||||
| Total | 100.0 | % | 100.0 | % | 100.0 | % | |||||
(1) Includes employees self-disclosed as Asian, Black, Hispanic or Latino, Indian, or Two or More Races. | |||||||||||
Benefits - The Company provides competitive comprehensive benefits to employees. The Company values the health and well-being of its employees and strives to provide programs to support this. Benefit programs available to eligible employees may include 401(k) savings plan, employee stock ownership plan, health and life insurance, employee assistance program, paid holidays, paid time off, and other leave as applicable.
Board of Directors - The Company’s board of directors is comprised of the Company’s Chief Executive Officer, President and nine non-employee directors. The non-employee directors are represented by 11% female and 11% minority.
Training and Education - The Company recognizes that the skills and knowledge of its employees are critical to the success of the organization, and promotes training and continuing education as an ongoing function for employees. The Bank’s compliance training program provides annual training courses to assure that all employees and officers know the rules applicable to their jobs.
12
Executive Officers
The following table sets forth information regarding the executive officers of the Company and the Bank at December 31, 2022.
| Age at December 31, | Position | |||||||||||||||||||
| Name | 2022 | Company | Bank | |||||||||||||||||
| J. Chris Verenes | 66 | Chief Executive Officer | Chief Executive Officer Chairman of the Board | |||||||||||||||||
| Roy G. Lindburg | 62 | President | — | |||||||||||||||||
| Philip R. Wahl | 59 | — | President | |||||||||||||||||
| Darrell Rains | 66 | Chief Financial Officer | Chief Financial Officer | |||||||||||||||||
The following is a description of the principal occupation and employment of the executive officers of the Company and the Bank during at least the past five years:
J. Chris Verenes is Chief Executive Officer of the Company and Chairman of the Board and Chief Executive Officer of the Bank, positions he has held since January 1, 2012 and January 1, 2011, respectively. Prior to that, he served as President of the Bank since 2004. Before joining the Bank, Mr. Verenes held a variety of management positions with Washington Group International, from 1996 to 2004. Prior to his employment by Washington Group International, Mr. Verenes served as Controller for Riegel Textile Corporation, as Director of Control Data and Business and Technology Center, and as Executive Director of the South Carolina Democratic Party.
Roy G. Lindburg was appointed President of the Company in June 2014. Prior to that, he served as the Chief Financial Officer of the Company and the Bank since January 1995. Mr. Lindburg was named Executive Vice President and appointed to the Company's and the Bank's Boards of Directors in 2005. Prior to joining Security Federal, Mr. Lindburg was employed by Keokuk Bancshares/First Community Bank in Keokuk, Iowa from 1986 to 1994. Mr. Lindburg is a Certified Public Accountant.
Philip R. Wahl was appointed President of the Bank effective August 2019. Prior to that, he served as the Bank's Augusta Market President since 2017. Prior to joining the Bank, Mr. Wahl held a variety of management positions with local and national banks in the Augusta area during his 35 year banking career. Most recently, he was employed by First Community Bank from 2012 to 2016. He currently serves on the Georgia Health Sciences Foundation Board of Trustees and is Chairman of the Board of the Augusta Convention & Visitors Bureau.
Darrell Rains was appointed Chief Financial Officer of the Company and the Bank effective July 2020. Prior to that, he served as the Bank's Executive Vice President of Insurance, Mortgage and Trust Services since June 2019. Before joining the Bank, he was the Chief Financial Officer at Woodside Communities from 2017 to 2019 and the Chief Financial Officer of Southeastern Bank Financial Corporation and successors from 2005 to 2017. Mr. Rains has over 30 years of experience in the banking industry. He is a Certified Public Accountant.
13
REGULATION
The following is a brief description of certain laws and regulations which are applicable to the Company and the Bank. Descriptions of laws and regulations here and elsewhere in this Form 10-K do not purport to be complete and are qualified in their entirety by reference to the actual laws and regulations. Legislation is introduced from time to time in the United States Congress or in the South Carolina State Legislature that may affect the operations of the Company and the Bank. In addition, the regulations governing the Company and the Bank may be amended from time to time by the State Board, the FDIC, the Federal Reserve, the SEC and the Consumer Protection Financial Bureau (“CFPB”). Any such legislation or regulatory changes in the future could have an adverse effect on our operations and financial condition. We cannot predict whether any such changes may occur.
As a bank holding company, the Company is subject to examination and supervision by, and is required to file certain reports with, the Federal Reserve. The Company also is subject to the rules and regulations of the SEC under the federal securities laws. The Bank, as a state-chartered commercial bank, is subject to regulation and oversight by the State Board, the applicable provisions of South Carolina law and by the regulations of the State Board adopted thereunder. In some circumstances, the law and regulations of other states can apply. The Bank also is subject to regulation and examination by the FDIC, which insures its deposits to the maximum extent permitted by law.
Regulation of the Company
The Bank is an FDIC-insured, state-chartered commercial bank and is subject to various statutory requirements and rules and regulations promulgated and enforced primarily by the FDIC and the State Board. These statutes, rules, and regulations relate to insurance of deposits, required reserves, allowable investments, loans, mergers, consolidations, issuance of securities, payment of dividends, establishment of branches and other aspects of the business of the Bank. The FDIC has broad authority to prohibit the Bank from engaging in what it determines to be unsafe or unsound banking practices. In addition, federal law imposes a number of restrictions on state-chartered, FDIC-insured banks, and their subsidiaries. These restrictions cover many matters, examples of which include prohibitions against engaging as a principal in certain activities and the requirement of prior notification of branch closings. The Bank is not a member of the Federal Reserve System.
The Bank is required to file periodic reports with the FDIC and the State Board and is subject to periodic examinations and evaluations by those regulatory authorities. Based on these evaluations, the regulators may revalue the assets of an institution and require that it establish specific reserves to compensate for the differences between the determined value and the book value of these assets. The FDIC and the State Board may each accept the results of an examination by the other in lieu of conducting an independent examination.
Federal Deposit Insurance Corporation
The Deposit Insurance Fund ("DIF") of the FDIC insures deposits in the Bank up to $250,000 per separately insured deposit ownership right or category and such insurance is backed by the full faith and credit of the United States Government. As insurer, the FDIC imposes deposit insurance premiums (assessments) and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. For the year ended December 31, 2022, the Bank paid $375,000 in FDIC premiums.
The FDIC assesses deposit insurance premiums quarterly on each FDIC-insured institution applied to its deposit base, which is its average consolidated total assets minus its Tier 1 capital. No institution may pay a dividend if it is in default on its federal deposit insurance assessment. At December 31, 2022, total base assessment rates ranged from 3 to 30 basis points subject to certain adjustments.
Extraordinary growth in insured deposits during the first and second quarters of 2020 caused the DIF reserve ratio to decline below the statutory minimum of 1.35% as of June 30, 2020. In September 2020, the FDIC Board of Directors adopted a Restoration Plan to restore the reserve ratio to at least 1.35% within eight years, absent extraordinary circumstances, as required by the Federal Deposit Insurance Act. The Restoration Plan maintained the assessment rate schedules in place at the time and required the FDIC to update its analysis and projections for the deposit insurance fund balance and reserve ratio at least semiannually. In the semiannual update for the Restoration Plan in June 2022, the FDIC projected that the reserve ratio was at risk of not reaching the statutory minimum of 1.35% by September 30, 2028, the statutory deadline to restore the reserve ratio. Based on this update, the FDIC Board approved an Amended Restoration Plan, and concurrently proposed an increase in initial base deposit insurance assessment rate schedules uniformly by 2 basis points, applicable to all insured depository institutions.
In October 2022, the FDIC Board finalized the increase with an effective date of January 1, 2023, applicable to the first quarterly assessment period of 2023. The revised assessment rate schedules are intended to increase the likelihood that the reserve ratio of the DIF reaches the statutory minimum level of 1.35% by September 30, 2028. Revised assessment rate
14
schedules will remain in effect unless and until the reserve ratio meets or exceeds 2%, absent further action by the FDIC Board. A significant increase in insurance premiums or a special assessment levied by the FDIC could likely have an adverse effect on the operating expenses and results of operations of the Bank. There can be no prediction as to what changes in insurance assessment rates may be made in the future.
The FDIC may terminate the deposit insurance of any insured depository institution if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is not aware of any existing circumstances which would result in termination of the Bank's deposit insurance. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. There can be no prediction as to what changes in insurance assessment rates may be made in the future.
Prompt Corrective Action
Federal statutes establish a supervisory framework based on five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. An institution's category depends upon where its capital levels are in relation to relevant capital measures, which include risk-based capital measures, a common equity Tier 1 ("CET1") measure, a leverage ratio measure and certain other factors. The well-capitalized category is described below in "Capital Requirements". An institution that is not well capitalized is subject to certain restrictions on brokered deposits, including restrictions on the rates it can offer on its deposits, generally. Any institution which is neither well capitalized nor adequately capitalized is considered undercapitalized.
Undercapitalized institutions are subject to certain prompt corrective action requirements, regulatory controls and restrictions that become more extensive as an institution becomes more severely undercapitalized. Failure by institutions to comply with applicable capital requirements would, if unremedied, result in progressively more severe restrictions on their activities and lead to enforcement actions, including, but not limited to, the issuance of a capital directive to ensure the maintenance of required capital levels and, ultimately, the appointment of the FDIC as receiver or conservator. Banking regulators will take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. Additionally, approval of any regulatory application filed for review by the banking agencies may be dependent on compliance with capital requirements.
At December 31, 2022, the Bank was categorized as "well capitalized" under the prompt corrective action regulations of the FDIC. For additional information, see "Capital Requirements" below and "Note 16 - Regulatory Matters" in the Notes to Consolidated Financial Statements included in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
Capital Requirements
In September 2019, the regulatory agencies, including the FDIC and Federal Reserve adopted a final rule, effective January 1, 2020, creating a community bank leverage ratio ("CBLR") for institutions with total consolidated assets of less than $10 billion, and that meet other qualifying criteria related to off-balance sheet exposures and trading assets and liabilities. The CBLR provides for a simple measure of capital adequacy for qualifying institutions. Management has elected to use the CBLR framework for the Bank. Consolidated regulatory capital requirements identical to those applicable to subsidiary banks generally apply to bank holding companies. However, the Federal Reserve Board has provided a “Small Bank Holding Company” exception to its consolidated capital requirements, and bank holding companies with less than $3.0 billion of consolidated assets are not subject to the consolidated holding company capital requirements unless otherwise directed by the Federal Reserve Board.
The CBLR is calculated as Tier 1 Capital to average consolidated assets as reported on an institution's regulatory reports. Tier 1 Capital, for the Company and the Bank, generally consists of common stock plus related surplus and retained earnings, adjusted for goodwill and other intangible assets. For some financial institutions it also includes accumulated and other comprehensive amounts (“AOCI”); however, the Company and the Bank made a one-time election to exclude AOCI as permitted by the regulators. Qualifying institutions that elect to use the CBLR framework and that maintain a leverage ratio of greater than 9% will be considered to have satisfied the generally applicable risk-based and leverage capital requirements in the regulatory agencies' capital rules, and to have met the well-capitalized ratio requirements. A qualifying institution utilizing the CBLR framework whose leverage ratio does not fall more than one percent below the required percentage is allowed a two-quarter grace period in which to increase its leverage ratio back above the required percentage. During the grace period, a qualifying
15
institution will still be considered well capitalized so long as its leverage ratio does not fall more than one percent below the required percentage. If an institution either fails to meet all the qualifying criteria within the grace period or has a leverage ratio that falls more than one percent below the required percentage, it becomes ineligible to use the CBLR framework and must instead comply with generally applicable capital rules, sometimes referred to as Basel III rules. A bank may also opt out of the framework at any time, without restriction, by reverting to the generally applicable capital rules.
The FASB has adopted a new accounting standard, referred to as Current Expected Credit Loss, or CECL. Upon adoption of CECL, a banking organization must record a one-time adjustment to its credit loss allowances as of the beginning of the fiscal year of adoption equal to the difference, if any, between the amount of credit loss allowances under the current methodology and the amount required under CECL. The federal banking regulators (the Federal Reserve, the Office of the Comptroller of the Currency and the FDIC) have adopted a rule that gives a banking organization the option to phase in over a three-year period the day-one adverse effects of CECL on its regulatory capital. For more on this new accounting standard, see "Note 1- Significant Accounting Policies-Recently Issued or Adopted Accounting Standards" in the Notes to Consolidated Financial Statements included in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
Federal Home Loan Bank System
The Bank is a member of the FHLB of Atlanta, which is one of 11 regional FHLBs that administer the home financing credit function of financial institutions. The FHLBs are subject to the oversight of the Federal Housing Finance Agency and each FHLB serves as a reserve or central bank for its members within its assigned region. The FHLBs are funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System and make loans or advances to members in accordance with policies and procedures established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Finance Board. All advances from the FHLB of Atlanta are required to be fully secured by sufficient collateral as determined by the FHLB of Atlanta. In addition, all long-term advances are required to provide funds for residential home financing. At December 31, 2022, the Bank had no outstanding advances from the FHLB of Atlanta under an available credit facility of $388.3 million, which is limited to available collateral. See "Business - Sources of Funds - Borrowings."
As a member, the Bank is required to purchase and maintain stock in the FHLB of Atlanta. At December 31, 2022, the Bank had $650,600 in FHLB of Atlanta stock, which was in compliance with this requirement. In past years, the Bank has received substantial dividends on its FHLB of Atlanta stock. These dividend yields have averaged 4.88% for the year ended December 31, 2022; 3.69% for the year ended December 31, 2021 and 4.40% for the year ended December 31, 2020.
The FHLBs continue to contribute to low- and moderately-priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have in the past affected adversely the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB of Atlanta stock in the future. A reduction in value of the Bank's FHLB of Atlanta stock may result in a decrease in net income and possibly the Bank's capital.
Affiliate Transactions
The Company and the Bank are separate and distinct legal entities. Federal laws strictly limit the ability of banks to engage in certain transactions with their affiliates, including their bank holding companies. Transactions deemed to be "covered transactions" under Section 23A of the Federal Reserve Act and between a subsidiary bank and its parent company or the nonbank subsidiaries of the bank holding company are limited to 10% of the bank subsidiary's capital and surplus and, with respect to the parent company and all such nonbank subsidiaries, to an aggregate of 20% of the bank subsidiary's capital and surplus. Further, covered transactions that are loans and extensions of credit generally are required to be secured by eligible collateral in specified amounts. Federal law also requires that covered transactions and certain other transactions listed in Section 23B of the Federal Reserve Act between a bank and its affiliates be on terms as favorable to the bank as transactions with non-affiliates.
Community Reinvestment Act
The Bank is also subject to the provisions of the Community Reinvestment Act of 1977 ("CRA"), which requires the appropriate federal bank regulatory agency to assess a bank’s performance under the CRA in meeting the credit needs of the community serviced by the Bank, including low and moderate income neighborhoods. The regulatory agency's assessment of a bank's record is made available to the public. Further, a bank’s CRA performance rating must be considered in connection with a bank’s application to, among other things, establish a new branch office that will accept deposits, relocate an existing office or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution, and in connection with certain applications by a bank holding company, such as bank acquisitions. The Bank received an "outstanding" rating during its most recent CRA examination.
16
Dividends
Dividends from the Bank constitute the major source of funds for dividends which may be paid by the Company to shareholders. The amount of dividends payable by the Bank to the Company depends upon the Bank's earnings and capital position, and is limited by federal and state laws, regulations and policies, including the capital conservation buffer requirement discussed above. South Carolina banking regulations restrict the amount of dividends that the Bank can pay to the Company, and may require prior approval before declaration and payment of any excess dividend.
The amount of dividends actually paid during any one period will be strongly affected by the Bank's management policy of maintaining a strong capital position. Federal law further provides that no insured depository institution may pay a cash dividend if it would cause the institution to be "undercapitalized," as defined in the prompt corrective action regulations. Moreover, the federal bank regulatory agencies also have the general authority to limit the dividends paid by insured banks if such payments should be deemed to constitute an unsafe and unsound practice.
Activities and Investments of Insured State-Chartered Financial Institutions
Federal law generally limits the activities and equity investments of FDIC-insured, state-chartered banks to those that are permissible for national banks. An insured state bank is not prohibited from, among other things, (i) acquiring or retaining a majority interest in a subsidiary, (ii) investing as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank's total assets, (iii) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors', trustees' and officers' liability insurance coverage or bankers' blanket bond group insurance coverage for insured depository institutions, (iv) acting as agent for a customer in many capacities, and (v) acquiring or retaining the voting shares of a depository institution if certain requirements are met.
Federal Reserve System
The Federal Reserve requires that all depository institutions maintain reserves on transaction accounts, primarily checking accounts. In response to the COVID-19 pandemic, the Federal Reserve reduced reserve requirement ratios to zero percent effective on March 26, 2020, to support lending to households and businesses. At December 31, 2022, the Bank was in compliance with the reserve requirements in place at that time.
Standards for Safety and Soundness
The federal banking regulatory agencies have prescribed, by regulation, guidelines for all insured depository institutions relating to internal controls, information systems and internal audit systems; loan documentation; credit underwriting; interest rate risk exposure; asset growth; asset quality; earnings; and compensation, fees and benefits. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. Each insured depository institution must implement a comprehensive written information security program that includes administrative, technical, and physical safeguards appropriate to the institution’s size and complexity and the nature and scope of its activities. The information security program must be designed to ensure the security and confidentiality of customer information, protect against any unanticipated threats or hazards to the security or integrity of such information, protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer, and ensure the proper disposal of customer and consumer information. Each insured depository institution must also develop and implement a risk-based response program to address incidents of unauthorized access to customer information in customer information systems. If the FDIC determines that an institution fails to meet any of these guidelines, it may require an institution to submit to the FDIC an acceptable plan to achieve compliance. Management of the Bank is not aware of any conditions relating to these safety and soundness standards which would require submission of a plan of compliance.
Environmental Issues Associated with Real Estate Lending
The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), a federal statute, generally imposes strict liability on all prior and present "owners and operators" of sites containing hazardous waste. However, Congress acted to protect secured creditors by providing that the term "owner and operator" excludes a person whose ownership is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this "secured creditor exemption" has been the subject of judicial interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan. To the extent that legal uncertainty exists in this area, all creditors, including the Bank, that have made loans secured by properties with potentially hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs, which costs often substantially exceed the value of the collateral property.
17
Privacy Standards
The Bank is subject to FDIC regulations implementing the privacy protection provisions of the Gramm-Leach-Bliley Financial Services Modernization Act of 1999. These regulations require the Bank to disclose its privacy policy, including informing consumers of its information sharing practices and informing consumers of their rights to opt out of certain practices.
Bank Secrecy Act / Anti-Money Laundering Laws
The Bank is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA PATRIOT Act of 2001. These laws and regulations require the Bank to implement policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing and to verify the identity of their customers. Violations of these requirements can result in substantial civil and criminal sanctions. In addition, provisions of the USA PATRIOT Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing mergers and acquisitions.
Other Consumer Protection Laws and Regulations
The Dodd-Frank Act established the CFPB and empowered it to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws. The Bank is subject to consumer protection regulations issued by the CFPB, but as a financial institution with assets of less than $10 billion, the Bank is generally subject to supervision and enforcement by the FDIC and the State Board with respect to our compliance with federal and state consumer financial protection laws and regulations.
The Bank is subject to a broad array of federal and state consumer protection laws and regulations that govern almost every aspect of its business relationships with consumers. While the list set forth below is not exhaustive, these include the Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Right to Financial Privacy Act, the Home Ownership and Equity Protection Act, the Consumer Leasing Act, the Fair Credit Billing Act, the Homeowners Protection Act, the Check Clearing for the 21st Century Act, laws governing flood insurance, laws governing consumer protections in connection with the sale of insurance, federal and state laws prohibiting unfair and deceptive business practices, and various regulations that implement some or all of the foregoing. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans, and providing other services. Failure to comply with these laws and regulations can subject the Bank to various penalties, including but not limited to, enforcement actions, injunctions, fines, civil liability, criminal penalties, punitive damages, and the loss of certain contractual rights.
Regulation of the Company
The Company, as the sole shareholder of the Bank, is a registered bank holding company with the Federal Reserve. Bank holding companies are subject to comprehensive regulation by the Federal Reserve under the Bank Holding Company Act of 1956, as amended ("BHCA"), and the regulations promulgated thereunder. This regulation and oversight is generally intended to ensure that the Company limits its activities to those allowed by law and that it operates in a safe and sound manner without endangering the financial health of the Bank.
As a bank holding company, the Company is required to file with the Federal Reserve semi-annual and periodic reports and such additional information as the Federal Reserve may require and is subject to regular examinations by the Federal Reserve. The Federal Reserve may examine the Company, and any of its subsidiaries, and charge the Company for the cost of the examination. The Federal Reserve also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices.
The Bank Holding Company Act
Under the BHCA, the Company is supervised by the Federal Reserve. The Federal Reserve has a policy that a bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, the Dodd-Frank Act and earlier Federal Reserve policy provide that a bank holding company should serve as a source of strength to its subsidiary bank by having the ability to provide financial assistance to its subsidiary bank during periods of financial distress to the bank, and should maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting its subsidiary bank. A bank holding company's failure to meet its obligation to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve to be an unsafe and unsound banking practice or a violation of the Federal Reserve's regulations or both. No regulations have yet been proposed by the Federal Reserve to implement the source of strength provisions of the Dodd-Frank Act. The Company
18
and any subsidiaries that it may control are considered "affiliates" within the meaning of the Federal Reserve Act, and transactions between the Bank and affiliates (except subsidiaries of the Bank) are subject to numerous restrictions. With some exceptions, the Company and its subsidiaries, are prohibited from tying the provision of various services, such as extensions of credit, to other services offered by the Company, or by its affiliates.
Acquisitions
The BHCA prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. Under the BHCA, the Federal Reserve is authorized to approve the ownership of shares by a bank holding company in any company, the activities of which the Federal Reserve has determined to be so closely related to the business of banking or managing or controlling banks as to be a proper incident thereto. The list of activities determined by regulation to be closely related to banking within the meaning of the BHCA includes, among other things: operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; selling money orders, travelers' checks and U.S. Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers. The Federal Reserve must approve the acquisition (or acquisition of control) of a bank or other FDIC-insured depository institution by a bank holding company, and the appropriate federal banking regulator must approve a bank’s acquisition (or acquisition of control) of another bank or other FDIC-insured institution.
Capital Requirements
As discussed above, pursuant to the Act, effective August 30, 2018, bank holding companies with less than $3.0 billion in consolidated assets are generally no longer subject to the Federal Reserve’s capital regulations, which are essentially the same as the capital regulations applicable to the Bank described under the caption “Capital Requirements” above. If the Company were subject to regulatory guidelines for bank holding companies with $3.0 billion or more in assets at December 31, 2022, the Company would have exceeded all regulatory requirements. The Federal Reserve expects a holding company's subsidiary banks to be well capitalized under the prompt corrective action regulations. For additional information, see "Note 16 - Regulatory Matters" of the Notes to Consolidated Financial Statements included in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
Dividends
As a South Carolina corporation, the Company is subject to restrictions on the payment of dividends under South Carolina law. In addition, the Company is an entity separate and distinct from its principal subsidiary, Security Federal Bank, and derives substantially all of its revenue in the form of dividends from this subsidiary. Accordingly, the Company is, and will be, dependent upon dividends from the Bank to pay the principal of and interest on its indebtedness, to satisfy its other cash needs and to pay dividends on its common stock. The Company is also subject to certain federal regulatory considerations. The Federal Reserve has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve's view that a bank holding company should pay cash dividends only to the extent that the company's net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the company's capital needs, asset quality and overall financial condition, and that it is inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Dividends are also subject to restriction if the capital conservation buffer requirement is not met.
Stock Repurchases
Bank holding companies, except for certain "well-capitalized" and highly rated bank holding companies, are required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of their consolidated net worth. The Federal Reserve may disapprove a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order, or any condition imposed by, or written agreement with, the Federal Reserve.
Federal Securities Laws
The Company’s common stock is registered with the SEC under Section 12(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We are subject to information, proxy solicitation, insider trading restrictions and other requirements under the Exchange Act.
19
Sarbanes-Oxley Act of 2002
As a public company that files periodic reports with the SEC under the Exchange Act, the Company is subject to the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”), which addresses, among other issues, corporate governance, auditing and accounting, executive compensation and enhanced and timely disclosure of corporate information. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. Our policies and procedures have been updated to comply with the requirements of the Sarbanes-Oxley Act.
Jumpstart Our Business Startups ("JOBS") Act
The JOBS Act was signed into law on April 5, 2012 and allows banks and bank holding companies to terminate the registration of a class of securities under Section 12(g) and Section 12(b) of the Exchange Act if such class is held of record by less than 1,200 persons. The Company's Board continues to evaluate the costs and advantages and disadvantages of being an SEC registered company and the effects of deregistering its shares of common stock, including among other things, the resulting decrease in the liquidity of its shares.
TAXATION
Federal Taxation
The Company and the Bank report their income on a calendar year basis using the accrual method of accounting and are subject to federal income taxation in the same manner as other corporations with some exceptions, including particularly the Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to the Bank or the Company.
To the extent that the Bank makes "nondividend distributions" to the Company, these distributions will be considered to result in distributions from the balance of its bad debt reserve as of December 31, 1987 (or a lesser amount if the Bank's loan portfolio decreased since December 31, 1987) and then from the supplemental reserve for losses on loans ("Excess Distributions"), and an amount based on the Excess Distributions will be included in the Bank's taxable income. Nondividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. However, dividends paid out of the Bank's current or accumulated earnings and profits, as calculated for federal income tax purposes, will not be considered to result in a distribution from the Bank's bad debt reserve. The amount of additional taxable income created from an Excess Distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, if the Bank makes a "nondividend distribution," then approximately one and one-half times the Excess Distribution would be includable in gross income for federal income tax purposes, assuming a 21% corporate income tax rate (exclusive of state and local taxes). See "Regulation - Regulation of the Bank - Dividends” for limits on the payment of dividends by the Bank. The Bank does not intend to pay dividends that would result in a recapture of any portion of its tax bad debt reserve.
The Company may carryforward net operating losses indefinitely. As of December 31, 2022, management determined it is more likely than not that the total deferred tax asset will be realized except for the deferred tax asset associated with state net operating loss carryforwards, and, accordingly, has established a valuation allowance only for this item. The change in the valuation allowance was $4,084.
The Company may exclude from its income dividends received from the Bank as a wholly-owned subsidiary of the Company that files a consolidated return with the Bank. The corporate dividends-received deduction is 100%, or 80%, in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, depending on the level of stock ownership of the payer of the dividend. Corporations that own less than 20% of the stock of a corporation distributing a dividend may deduct 70% of dividends received or accrued on their behalf.
The Company, the Bank and its consolidated subsidiaries have been audited or their books closed without audit by the IRS with respect to consolidated federal income tax returns through December 31, 2021. For additional information regarding income taxes, see "Note 15 - Income Taxes" in the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
State Taxation
South Carolina has adopted the Internal Revenue Code as it relates to commercial banks, effective for taxable years beginning after December 31, 1986. The Bank is subject to South Carolina income tax at the rate of 4.5%. The Bank has not been audited by the State of South Carolina during the past five years. The Company's income tax returns have not been audited by federal or state authorities within the last five years. For additional information regarding income taxes, see "Note 15 - Income Taxes" in the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
20
Item 1A. Risk Factors.
An investment in our common stock involves various risks which are particular to Security Federal Corporation, our industry, and our market area. Before making an investment decision, you should carefully consider the risks and uncertainties described below, together with all of the other information included in this report and out filings with the SEC. In addition to the risks and uncertainties described below, other risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition, capital levels, liquidity, cash flows, results of operations and prospects. The market price of our common stock could decline significantly due to any of these identified or other risks, and you could lose some or all of your investment.
Risks Related to Macroeconomic Conditions
Our business may be adversely affected by downturns in the national economy and in the economies in our market areas.
Our operations are significantly affected by the general economic conditions of the states of South Carolina and Georgia and the specific local markets in which we operate. Our entire real estate portfolio consists primarily of loans secured by properties located in Aiken, Richland, and Lexington Counties in South Carolina and Columbia and Richmond Counties in Georgia. Weakness in the global economy and global supply chain issues have adversely affected many businesses operating in our markets that are dependent upon international trade. Changes in agreements or relationships between the United States and other countries may also affect these businesses.
A deterioration in economic conditions in the market areas we serve, as a result of inflation, a recession, the effects of COVID-19 variants or other factors could result in loan losses beyond that which is provided for in our allowance for loan losses and could result in the following consequences, any of which could have a materially adverse effect on our business, financial condition, or results of operations:
•loan delinquencies, problem assets and foreclosures may increase;
•we may increase our allowance for loan losses;
•demand for our products and services may decline, possibly resulting in a decrease in our total loans or assets;
•collateral for our loans, especially real estate, may decline in value, exposing us to increased risk of loss on existing loans, reducing customers’ borrowing power, and reducing the value of assets and collateral associated with existing loans;
•the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us; and
•the amount of our low-cost or noninterest-bearing deposits may decrease
A decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse. Many of the loans in our portfolio are secured by real estate. Deterioration in the real estate markets where collateral for a mortgage loan is located could negatively affect the borrower’s ability to repay the loan and the value of the collateral securing the loan. Real estate values are affected by various other factors, including changes in general or regional economic conditions, governmental rules or policies and natural disasters such as earthquakes. If we are required to liquidate a significant amount of collateral during a period of reduced real estate values, our financial condition and profitability could be adversely affected. Adverse changes in the regional and general economy could reduce our growth rate, impair our ability to collect loans and generally have a negative effect on our financial condition and results of operations.
External economic factors, such as changes in monetary policy and inflation, may have an adverse effect on our business, financial condition and results of operations.
Our financial condition and results of operations are affected by credit policies of monetary authorities, particularly the Federal Reserve. Actions by monetary and fiscal authorities, including the Federal Reserve, could lead to inflation, deflation, or other economic phenomena that could adversely affect our financial performance. Inflation has risen sharply since the end of 2021 and throughout 2022 at levels not seen for over 40 years. Inflationary pressures are currently expected to remain elevated throughout 2023. Small to medium-sized businesses may be impacted more during periods of high inflation as they are not able to leverage economics of scale to mitigate cost pressures compared to larger businesses. Consequently, the ability of our business customers to repay their loans may deteriorate, and in some cases this deterioration may occur quickly, which would adversely impact our results of operations and financial condition. Furthermore, a prolonged period of inflation could cause wages and other costs to the Company to increase, which could adversely affect our results of operations and financial condition. Virtually all of our assets and liabilities are monetary in nature. As a result, interest rates tend to have a more significant impact on our performance than general levels of inflation or deflation. Interest rates do not necessarily move in the same direction or by the same magnitude as the prices of goods and services.
21
Risks Related to Our Lending Activities
Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
Lending money is a substantial part of our business and each loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
•cash flow of the borrower and/or the project being financed;
•the changes and uncertainties as to the future value of the collateral, in the case of a collateralized loan;
•the duration of the loan;
•the character and creditworthiness of a particular borrower; and
•changes in economic and industry conditions.
We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by our management through periodic reviews and consideration of several factors, including, but not limited to:
•our general reserve, based on our historical default and loss experience and certain macroeconomic factors based on management's expectations of future events;
•our specific reserve, based on our evaluation of impaired loans and their underlying collateral; and
•an unallocated reserve to provide for other credit losses inherent in our portfolio that may not have been contemplated in the other loss factors.
The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. If our estimates are incorrect, the allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in the need for additions to our allowance through an increase in the provision for loan losses. Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may increase our loan charge-offs and/or may otherwise require an increase in the allowance for loan losses. Our allowance for loan losses was 2.09% of total loans outstanding (excluding loans held for sale) at December 31, 2022.
For additional information concerning our allowance for loan losses, see “Management’s Discussion and Analysis of Financial Condition - Comparison of Results of Operations for the Years Ended December 31, 2022 and 2021 - Provision for Loan Losses” contained in the Annual Report and incorporated by reference into “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation” of this Form 10-K.
Effective January 1, 2023, the Bank adopted Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, also known as CECL. CECL replaces the incurred loss impairment framework in current GAAP. Adoption of this guidance resulted in a $2.0 million increase in the allowance for credit losses, comprised of increases in the allowance for loan losses of $800,000 and the reserve for unfunded commitments of $1.2 million. The cumulative effect adjustment to retained earnings was $1.6 million, net of tax. For additional information on CECL, see “Note 1 - Basis of Presentation and Summary of Significant Accounting Policies – Recently Issued or Adopted Accounting Standards” of the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
In addition, bank regulatory agencies periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize additional loan charge-offs. Any increases in the provision for loan losses may result in a decrease in net income and may have a material adverse effect on our financial condition, results of operations and capital.
If our non-performing assets increase, our earnings will be adversely affected.
At December 31, 2022, our non-performing assets (which consist of non-accrual loans and OREO) were $6.4 million, or 0.46% of total assets. Our non-performing assets adversely affect our net income in various ways:
•we record interest income only on a cash basis for nonaccrual loans and any non-performing investment securities;
•we do not record interest income for OREO;
•we provide for probable loan losses through a current period charge to the provision for loan losses;
22
•non-interest expense increases when we write down the value of properties in our OREO portfolio to reflect changing market values or recognize other-than-temporary impairment on non-performing investment securities;
•there are legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance, and maintenance fees related to our OREO; and
•the resolution of non-performing assets requires the active involvement of management, which can distract them from more profitable activity.
If additional borrowers become delinquent and do not pay their loans and we are unable to successfully manage our non-performing assets, our losses and troubled assets could increase significantly, which could have a material adverse effect on our financial condition and results of operations.
Our level of commercial real estate loans may expose us to increased lending risks.
While commercial real estate lending may potentially be more profitable than single-family residential lending, it is generally more sensitive to regional and local economic conditions, making loss levels more difficult to predict. Collateral evaluation and financial statement analysis in these types of loans requires a more detailed analysis at the time of loan underwriting and on an ongoing basis. At December 31, 2022, we had $252.2 million of commercial real estate loans, representing 44.9% of our total loan portfolio. Commercial real estate loans typically involve higher principal amounts than other types of loans and some of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one‑to‑four family residential loan. Repayment on these loans is dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service that may be adversely affected by changes in the economy or local market conditions. For example, if the cash flow from the borrower’s project is reduced as a result of leases not being obtained or renewed, the borrower’s ability to repay the loan may be impaired. Commercial real estate loans also expose a lender to greater credit risk than loans secured by one-to-four family residential real estate because the collateral securing these loans typically cannot be sold as easily as residential real estate. In addition, many of our commercial real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to either sell or refinance the underlying property in order to make the payment that may increase the risk of default or non-payment.
A secondary market for most types of commercial real estate loans is not readily available, so we have less opportunity to mitigate credit risk by selling part or all of our interest in these loans. As a result of these characteristics, if we foreclose on a commercial real estate loan, our holding period for the collateral typically is longer than for one‑to‑four family residential loans because there are fewer potential purchasers of the collateral. Accordingly, charge-offs on commercial real estate loans may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.
Our construction real estate loans are based upon estimates of costs and the value of the completed project.
We originate construction loans on single-family residences, multi-family dwellings and projects, and commercial real estate, as well as loans for the acquisition and development and construction of residential subdivisions and commercial projects. We originate these loans whether or not the collateral property underlying the loan is under contract for sale.
Construction lending involves additional risks when compared with permanent residential lending because funds are advanced upon the collateral for the project based on an estimate of costs that will produce a future value at completion. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the completed project loan-to-value ratio. Changes in the demand, such as for new housing and higher than anticipated building costs, may cause actual results to vary significantly from those estimated. For these reasons, this type of lending also typically involves higher loan principal amounts and is often concentrated with a small number of builders. A downturn in housing, or the real estate market, could increase loan delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. Some of our builders have more than one loan outstanding with us and also have residential mortgage loans for rental properties with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss.
These loans often involve the disbursement of funds with repayment substantially dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or guarantor to repay principal and interest. If our appraisal of the value of a completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss. Because construction loans require active monitoring of the building process, including cost comparisons and
23
on-site inspections, these loans are more difficult and costly to monitor. Increases in market rates of interest may have a more pronounced effect on construction loans by rapidly increasing the end-purchasers’ borrowing costs, thereby reducing the overall demand for the project. Properties under construction are often difficult to sell and typically must be completed in order to be successfully sold which also complicates the process of working out problem construction loans. This may require us to advance additional funds and/or contract with another builder to complete construction. Furthermore, in the case of speculative construction loans, there is the added risk associated with identifying an end-purchaser for the finished project. Land loans also pose additional risk because of the lack of income being produced by the property and the potential illiquid nature of the collateral. These risks can also be significantly impacted by supply and demand conditions.
Construction acquisition and development (A&D) loans pose additional risk because of the lack of income being produced by the property and the potential illiquid nature of the collateral. These risks can be significantly impacted by supply and demand conditions. As a result, this type of lending often involves the disbursement of substantial funds with repayment dependent on the success of the ultimate project and the ability of the borrower to develop, sell or lease the property, rather than the ability of the borrower or guarantor to independently repay principal and interest. There were no non-performing A&D loans at December 31, 2022. A material increase in our non-performing construction and development loans could have a material adverse effect on our financial condition and results of operation.
Repayment of our commercial and agricultural business loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value.
At December 31, 2022, $30.6 million or 5.5% of our total loans were commercial and agricultural business loans. These loans involve risks that are different from those associated with residential and commercial real estate lending. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral being viewed as the primary source of repayment in the event of borrower default. Our commercial and agricultural business loans are primarily made based on the cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. The borrowers' cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. Although commercial and agricultural business loans are often collateralized by equipment, inventory, accounts receivable, or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use, among other things. Accordingly, the repayment of commercial and agricultural business loans depends primarily on the cash flow and credit worthiness of the borrower and secondarily on the underlying collateral provided by the borrower.
Our real estate lending also exposes us to the risk of environmental liabilities.
In the course of our business, we may foreclose and take title to real estate, and we could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third persons for property damage, personal injury, investigation, and clean-up costs incurred by these parties in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. If we ever become subject to significant environmental liabilities, our business, financial condition and results of operations could be materially and adversely affected.
If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to increase our valuation reserves, our earnings could be reduced.
We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed upon and the property taken in as OREO, and at certain other times during the assets holding period. Our net book value in the loan at the time of foreclosure and thereafter is compared to the updated market value of the foreclosed property less estimated selling costs (fair value). A charge-off is recorded for any excess in the asset's net book value over its fair value. If our valuation process is incorrect, or if the property declines in value after foreclosure, the fair value of our investments in OREO may not be sufficient to recover our net book value in such assets, resulting in the need for additional charge-offs. Additional material charge-offs to our investments in OREO could have a material adverse effect on our financial condition and results of operations. In addition, bank regulators periodically review our OREO and may require us to recognize further charge-offs. Significant charge-offs, as required by such regulators, may have a material adverse effect on our financial condition and results of operations.
24
We may incur losses on our securities portfolio as a result of changes in interest rates.
Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency actions in respect of the securities, defaults by, or other adverse events affecting, the issuer or with respect to the underlying securities, and changes in market interest rates and continued instability in the capital markets. Any of these factors, among others, could cause other-than-temporary impairments and realized and/or unrealized losses in future periods and declines in other comprehensive income, which could have a material effect on our business, financial condition and results of operations. The process for determining whether impairment of a security is other-than-temporary usually requires complex, subjective judgments about the future financial performance and liquidity of the issuer and any collateral underlying the security to assess the probability of receiving all contractual principal and interest payments on the security. There can be no assurance that the declines in market value will not result in other-than-temporary impairments of these assets, and would lead to accounting charges that could have a material adverse effect on our net income and capital levels. For the year ended December 31, 2022, we did not incur any other-than-temporary impairments on our securities portfolio.
Risk Related to Changes in Market Interest Rates
Changes in interest rates may reduce our net interest income, and may result in higher defaults in a rising rate environment.
As with most financial institutions, our earnings and cash flows are largely dependent upon our net interest income. Interest rates are sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies, and in particular, the Federal Reserve. Since March 2022, in response to inflation, the Federal Open Market Committee (“FOMC”) of the Federal Reserve has increased the target range for the federal funds rate by 425 basis points, including 125 basis points during the fourth calendar quarter of 2022, to a range of 4.25% to 4.50% as of December 31, 2022. As it seeks to control inflation without creating a recession, the FOMC has indicated further increases are to be expected during 2023. If the FOMC further increases the targeted federal funds rate, interest rates will likely continue to rise, which will positively impact our net interest income but may negatively impact both the housing market, by reducing refinancing activity and new home purchases, and the U.S. economy.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially affected.
Changes in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers to repay their current loan obligations or by reducing our margins and profitability. Our net interest margin is the difference between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding. Changes in interest rates-up or down-could adversely affect our net interest margin and, as a result, our net interest income. Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract. Our liabilities tend to be shorter in duration than our assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest margin to contract until the yields on interest-earning assets catch up.
Changes in the slope of the “yield curve”, or the spread between short-term and long-term interest rates-could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets. Also, interest rate decreases can lead to increased prepayments of loans and mortgage-backed securities as borrowers refinance their loans to reduce borrowing costs. Under these circumstances, we are subject to reinvestment risk as we may have to redeploy such repayment proceeds into lower yielding investments, which would likely hurt our income.
A sustained increase in market interest rates could adversely affect our earnings. As is the case with many banks and savings institutions, our emphasis on increasing the development of core deposits, those deposits bearing no or a relatively low rate of interest with no stated maturity date, has resulted in an increasing percentage of our deposits being comprised of deposits bearing no or a relatively low rate of interest and having a shorter duration than our assets. We would incur a higher cost of funds to retain these deposits in a rising interest rate environment. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected.
25
Changes in interest rates also affect the value of our investment securities portfolio. Generally, the fair value of fixed-rate securities fluctuates inversely with changes in interest rates. Unrealized gains and losses on securities available for sale are reported as a separate component of equity, net of tax. Decreases in the fair value of securities available for sale resulting from increases in interest rates could have an adverse effect on stockholders’ equity. At December 31, 2022, we had an accumulated other comprehensive loss of $40.8 million, which is reflected as a reduction to stockholders’ equity.
Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management and Market Risk” included in the Annual Report and incorporated by reference into “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K.
An increase in interest rates, change in the programs offered by governmental sponsored entities ("GSE"), or our ability to qualify for such programs may reduce our mortgage revenues, which would negatively impact our non-interest income.
Our mortgage banking operations provide a portion of our non-interest income. We generate mortgage revenues primarily from gains on the sale of single-family mortgage loans underwritten pursuant to programs currently offered by Freddie Mac and Fannie Mae. These entities account for a substantial portion of the secondary market in residential mortgage loans. Any future changes in these programs, our eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly affect the activity of such entities could, in turn, materially adversely affect the success of our mortgage banking program and, consequently, our results of operations.
Mortgage loan production levels are sensitive to changes in economic conditions and can suffer from decreased economic activity, a slowdown in the housing market or higher interest rates. Generally, any sustained period of decreased economic activity or higher interest rates could adversely affect mortgage originations and, consequently, adversely affect income from mortgage lending activities.
Our results of operations will also be affected by the amount of non-interest expense associated with mortgage banking activities, such as salaries and employee benefits, occupancy, equipment and data processing expense and other operating costs. If we cannot generate a sufficient volume of loans for sale, our results of operations may be adversely affected. In addition, during periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in loan originations. Finally, deteriorating economic conditions may also increase the potential for home buyers to default on their mortgages. In certain of these cases where we have originated loans and sold them to investors, we may be required to repurchase loans or provide a financial settlement to investors if it is proven that the borrower failed to provide full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor. If repurchase and indemnity demands increase on loans that we sell from our portfolios, our liquidity, results of operations and financial condition could be adversely affected.
Risk Related to Regulatory and Compliance Matters
New or changing tax, accounting, and regulatory rules and interpretations could significantly impact strategic initiatives, results of operations, cash flows, and financial condition.
The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit our shareholders. These regulations may sometimes impose significant limitations on operations. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on an institution's operations, the classification of assets by the institution and the adequacy of an institution's allowance for loan losses. These bank regulators also have the ability to impose conditions in the approval of merger and acquisition transactions.
The significant federal and state banking regulations that affect us are described in this report under “Business - Regulation” in Item 1 of this Form 10-K. These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time. Any new regulations or legislation, change in existing regulations or oversight, whether a change in regulatory policy or a change in a regulator’s interpretation of a law or regulation, could have a material impact on our operations, increase our costs
26
of regulatory compliance and of doing business and/or otherwise adversely affect us and our profitability. Additionally, actions by regulatory agencies or significant litigation against us and may lead to penalties that materially affect us. Further, changes in accounting standards can be both difficult to predict and involve judgment and discretion in their interpretation by us and our independent registered public accounting firm. These changes could materially impact, potentially even retroactively, how we report our financial condition and results of our operations as could our interpretation of those changes. We cannot predict what restrictions may be imposed upon us with future legislation.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions.
The USA PATRIOT Act and Bank Secrecy Acts and related regulations require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts and beneficial owners of accounts. Failure to comply with these regulations could result in fines or sanctions. During the last few years, several banking institutions have received large fines for non-compliance with these laws and regulations. While we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations. If our policies and procedures are deemed deficient, we would be subject to liability, including fines and regulatory actions, which may include restrictions on our ability to pay dividends and the denial of regulatory approvals to proceed with certain aspects of our business plan, including acquisitions.
Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us. Any of these results could have a material adverse effect on our business, financial condition, results of operations and growth prospects.
The Company’s reported financial results depend on management’s selection of accounting methods and certain assumptions and estimates, which, if incorrect, could cause unexpected losses in the future.
The Company’s accounting policies and methods are fundamental to how the Company records and reports its financial condition and results of operations. The Company’s management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment regarding the most appropriate manner to report the Company’s financial condition and results of operations. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which might be reasonable under the circumstances, yet might result in the Company’s reporting materially different results than would have been reported under a different alternative.
Certain accounting policies are critical to presenting the Company’s financial condition and results of operations. They require management to make difficult, subjective or complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or estimates. These critical accounting policies include, but are not limited to the allowance for credit losses on loans, securities and unfunded commitments; the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans; income taxes, including tax provisions and realization of deferred tax assets; and the fair value of assets and liabilities. Because of the uncertainty of estimates involved in these matters, the Company may be required, among other things, to significantly increase the allowance for credit losses and/or sustain credit losses that are significantly higher than the reserve provided. For more information, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Estimates” contained in the Annual Report and incorporated by reference into “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed, or the cost of that capital may be very high.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that our capital resources will satisfy our capital requirements for the foreseeable future. Nonetheless, we may at some point need to raise additional capital to support continued growth or be required by our regulators to increase our capital resources. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. Accordingly, we may not be able to raise additional capital, if needed, on terms that are acceptable to us. If we cannot raise additional capital when needed, our operations could be materially impaired and our financial condition and liquidity could be materially and adversely affected. In addition, if we are unable to raise additional capital when required by our banking regulators, we may be subject to additional adverse regulatory action.
27
Risks Related to Cybersecurity, Third Parties and Technology
We are subject to certain risks in connection with our use of technology.
Our security measures may not be sufficient to mitigate the risk of a cyber-attack. Communications and information systems are essential to the conduct of our business, as we use such systems to manage our customer relationships, our general ledger and virtually all other aspects of our business. Our operations rely on the secure processing, storage, and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our computer systems, software, and networks may be vulnerable to breaches, unauthorized access, misuse, computer viruses, or other malicious code and cyber-attacks that could have a security impact. If one or more of these events occur, this could jeopardize our or our customers' confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our customers or counterparties. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us. We could also suffer significant reputational damage.
Security breaches in our internet banking activities could further expose us to possible liability and damage our reputation.
Increases in criminal activity levels and sophistication, advances in computer capabilities, new discoveries, vulnerabilities in third party technologies (including browsers and operating systems) or other developments could result in a compromise or breach of the technology, processes and controls that we use to prevent fraudulent transactions and to protect data about us, our customers and underlying transactions. Any compromise of our security could deter customers from using our internet banking services that involve the transmission of confidential information. We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. Although we have developed and continue to invest in systems and processes that are designed to detect and prevent security breaches and cyber-attacks and periodically test our security, these precautions may not protect our systems from compromises or breaches of our security measures, and could result in losses to us or our customers, our loss of business and/or customers, damage to our reputation, the incurrence of additional expenses, disruption to our business, our inability to grow our online services or other businesses, additional regulatory scrutiny or penalties, or our exposure to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations.
Our security measures may not protect us from system failures or interruptions.
While we have established policies and procedures to prevent or limit the impact of systems failures and interruptions, there can be no assurance that such events will not occur or that they will be adequately addressed if they do. In addition, we outsource certain aspects of our data processing and other operational functions to certain third-party providers. While we select third-party vendors carefully, we do not control their actions. If our third-party providers encounter difficulties including those resulting from breakdowns or other disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher transaction volumes, cyber-attacks and security breaches or if we otherwise have difficulty in communicating with them, our ability to adequately process and account for transactions could be affected, and our ability to deliver products and services to our customers and otherwise conduct business operations could be adversely impacted. Replacing these third-party vendors could also entail significant delay and expense. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
We cannot assure you that such breaches, failures or interruptions will not occur or, if they do occur, that they will be adequately addressed by us or the third parties on which we rely. We may not be insured against all types of losses as a result of third party failures and insurance coverage may be inadequate to cover all losses resulting from breaches, system failures or other disruptions. If any of our third-party service providers experience financial, operational or technological difficulties, or if there is any other disruption in our relationships with them, we may be required to identify alternative sources of such services, and we cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all. Further, the occurrence of any systems failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to additional regulatory scrutiny, or could expose us to legal liability. Any of these occurrences could have a material adverse effect on our financial condition and results of operations. The board of directors oversees the risk management process, including the risk of cybersecurity, and engages with management on cybersecurity issues.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
As a bank, we are susceptible to fraudulent activity that may be committed against us or our customers which may result in financial losses or increased costs to us or our customers, disclosure or misuse of our information or our customer’s
28
information, misappropriation of assets, privacy breaches against our customers, litigation or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, social engineering and other dishonest acts. Nationally, reported incidents of fraud and other financial crimes have increased. We have also experienced losses due to apparent fraud and other financial crimes. While we have policies and procedures designed to prevent such losses, there can be no assurance that such losses will not occur.
We are subject to certain risks in connection with our data management or aggregation.
We are reliant on our ability to manage data and our ability to aggregate data in an accurate and timely manner to ensure effective risk reporting and management. Our ability to manage data and aggregate data may be limited by the effectiveness of our policies, programs, processes and practices that govern how data is acquired, validated, stored, protected and processed. While we continuously update our policies, programs, processes and practices, many of our data management and aggregation processes are manual and subject to human error or system failure. Failure to manage data effectively and to aggregate data in an accurate and timely manner may limit our ability to manage current and emerging risks, as well as to manage changing business needs.
Risks Related to Our Business and Industry Generally
We will be required to transition from the use of LIBOR in the future.
We have certain loans, investment securities, subordinated debentures and trust preferred securities indexed to LIBOR to calculate the interest rate. ICE Benchmark Administration, the authorized and regulated administrator of LIBOR, ended publication of the one-week and two-month U. S. Dollar (“USD”) LIBOR tenors on December 31, 2021 and the remaining USD LIBOR tenors will end publication in June 2023. Financial services regulators and industry groups have collaborated to develop alternate reference rate indices or reference rates. The transition to a new reference rate requires changes to contracts, risk and pricing models, valuation tools, systems, product design and hedging strategies. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR (with the exception of overnight repurchase agreements, which are expected to be based on the Secured Overnight Financing Rate, or SOFR). Uncertainty as to the nature of such potential changes, alternative reference rates, the elimination or replacement of LIBOR, or other reforms may adversely affect the value of and the return on our loans and our investment securities, and may impact the availability and cost of hedging instruments and borrowings, including the rates we pay on our subordinated debentures and trust preferred securities. The language in our LIBOR-based contracts and financial instruments has developed over time and may have various events that trigger when a successor rate to the designated rate would be selected. If a trigger is satisfied, contracts and financial instruments may give the calculation agent discretion over the substitute index or indices for the calculation of interest rates to be selected. The implementation of a substitute index or indices for the calculation of interest rates under our loan agreements with our borrowers or our existing borrowings may result in our incurring significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the substitute index or indices, and may result in disputes or litigation with clients and creditors over the appropriateness or comparability to LIBOR of the substitute index or indices, which could have an adverse effect on our results of operations.
We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect our prospects.
Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge of, and experience in, the community banking industry where Security Federal conducts its business. The process of recruiting personnel with the combination of skills and attributes required to carry out our strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing and technical personnel and upon the continued contributions of our management and personnel. In particular, our success has been and continues to be highly dependent upon the abilities of key executives, including our Chief Executive Officer, J. Chris Verenes, and certain other employees. In addition, our success has been and continues to be highly dependent upon the services of our directors, many of whom are at or nearing retirement age, and we may not be able to identify and attract suitable candidates to replace such directors.
Ineffective liquidity management could impair our ability to fund operations and jeopardize our financial condition, growth and prospects.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and investments or other sources could have a substantial negative effect on our liquidity. Our primary sources of liquidity are increases in deposits, advances, as needed, from the FHLB, borrowings, as needed, from the Federal Reserve Bank of Richmond ("FRB") and other borrowings to fund our operations. Historically, we have been able to replace maturing deposits and advances if desired; however, we may not be able to replace such funds in the future if, among other things, our financial condition, the
29
financial condition of the FHLB or FRB, or market conditions change. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the South Carolina or Georgia markets where our loans are concentrated, negative operating results, or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations or deterioration in credit markets. Deposit flows, calls of investment securities and wholesale borrowings, and the prepayment of loans and mortgage-related securities are also strongly influenced by such external factors as the direction of interest rates, whether actual or perceived, and competition for deposits and loans in the markets we serve. Furthermore, changes to the FHLB's underwriting guidelines for wholesale borrowings or lending policies may limit or restrict our ability to borrow, and could therefore have a significant adverse impact on our liquidity. In addition, the need to replace funds in the event of large-scale withdrawals of brokered deposits could require us to pay significantly higher interest rates on retail deposits or other wholesale funding sources, which would have an adverse impact on our net interest income and net income. A decline in available funding could adversely impact our ability to originate loans, invest in securities, meet our expenses, or to fulfill such obligations as repaying our borrowings or meeting deposit withdrawal demands.
Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Although we consider our sources of funds adequate for our liquidity needs, we may seek additional debt in the future to achieve our long-term business objectives. Additional borrowings, if sought, may not be available to us or, if available, may not be available on reasonable terms. If additional financing sources are unavailable, or are not available on reasonable terms, our financial condition, results of operations, growth and future prospects could be materially adversely affected. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. Additionally, collateralized public funds are bank deposits of state and local municipalities. These deposits are required to be secured by certain investment grade securities to ensure repayment, which on the one hand, tends to reduce our contingent liquidity risk by making these funds somewhat less credit sensitive, but on the other hand, reduces standby liquidity by restricting the potential liquidity of the pledged collateral. Although these have historically been a relatively stable source of funds for us, availability depends on the individual municipality's fiscal policies and cash flow needs. At December 31, 2022, $120.4 million of our deposits were public funds.
If we fail to meet the expectations of our stakeholders with respect to our environmental, social and governance (“ESG”) practices, including those relating to sustainability, it may have an adverse effect on our reputation and results of operation.
Our reputation may also be negatively impacted by our diversity, equity and inclusion (“DEI”) efforts if they fall short of expectations. In addition, various private third-party organizations have developed ratings processes for evaluating companies on their approach to ESG and DEI matters. These ratings may be used by some investors to assist with their investment and voting decisions. Any unfavorable ratings may lead to reputational damage and negative sentiment among our investors and other stakeholders. Furthermore, increased ESG related compliance costs could result in increases to our overall operational costs. Failure to adapt to or comply with regulatory requirements or investor or stakeholder expectations and standards could negatively impact our reputation, ability to do business with certain partners, and our stock price. New government regulations could also result in new or more stringent forms of ESG oversight and expanding mandatory and voluntary reporting, diligence, and disclosure.
The Company’s ability to pay dividends and make subordinated debt payments is subject to the ability of the Bank to make capital distributions to the Company.
The Company is a separate legal entity from its subsidiary and does not have significant operations of its own. The long-term ability of the Company to pay dividends to its stockholders and debt payments is based primarily upon the ability of the Bank to make capital distributions to the Company, and also on the availability of cash at the holding company level. The availability of dividends from the Bank is limited by the Bank’s earnings and capital, as well as various statutes and regulations. In the event, the Bank is unable to pay dividends to the Company, the Company may not be able to pay dividends on its common stock or make payments on its outstanding debt. Consequently, the inability to receive dividends from the Bank could adversely affect the Company’s financial condition, results of operations, and future prospects. At December 31, 2022, the Company had $28.8 million in unrestricted cash to support dividend and debt payments.
Item 1B. Unresolved Staff Comments
None.
30
Item 2. Properties
At December 31, 2022, the Company owned the buildings and land for 11 of its branch offices and the operations center; leased the land and owned the improvements thereon for one of its offices; and leased five of the remaining six offices, including its main office. The remaining branch, located in Ridge Spring, is owned by the Town of Ridge Spring; however, Security Federal has made some capital improvements to the building. In addition to the properties related to current Company offices, Security Federal owned five other properties at December 31, 2022. The five properties consist of (i) two lots originally purchased for future branch sites located in Aiken County and Richland County, South Carolina, which are currently for sale and recorded as land held for sale at December 31, 2022, (ii) another lot in Aiken County, South Carolina that was originally purchased to be used for a new Operations Center, which is also currently for sale and included in land held for sale at December 31, 2022, (iii) a property consisting of land and a building that is located adjacent to our 1705 Whiskey Road office that is currently leased at December 31, 2022, and (iv) a property consisting of land and a building located in Augusta, Georgia, which will be a future branch opening in 2023. The Company also rents the building located at 234 Richland Avenue, which is adjacent to our main office, and then subleases it to another business. See "Note 5 - Premises and Equipment, Net and Leases" of the Notes to Consolidated Financial Statements contained in the Annual Report and incorporated by reference into “Item 8. Financial Statements and Supplementary Data” of this Form 10-K.
Item 3. Legal Proceedings
The Company is involved as plaintiff or defendant in various legal actions arising in the course of its business. It is the opinion of management, after consultation with counsel, that the resolution of these legal actions will not have a material adverse effect on the Company's financial condition and results of operations.
Item 4. Mine Safety Disclosures
Not applicable.
31
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
General. The Company’s stock is traded on the OTC Pink Open Market under the symbol “SFDL.OB.” As of March 24, 2023, the Company had approximately 291 shareholders of record, not including shares held in street name, and 3,253,210 outstanding shares of common stock.
Our Board of Directors has declared quarterly cash dividends on our common stock for 125 consecutive quarters. Our cash dividend payout policy is reviewed regularly by management and the Board of Directors. Any dividends declared and paid in the future would depend upon a number of factors, including capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations, and general economic conditions. No assurances can be given that any dividends will be paid or that, if paid, will not be reduced or eliminated in future periods. Our future payment of dividends may depend, in part, upon receipt of dividends from the Bank, which are restricted by federal regulations.
Stock Repurchases. The Company had no stock repurchases of its outstanding common stock during the quarter ended December 31, 2022, and did not have an authorized stock repurchase program in place as of or during the year ended December 31, 2022.
Equity Compensation Plan Information. The equity compensation plan information presented under subparagraph (d) in Part III, Item 12 of this report is incorporated herein by reference.
Performance Graph. The following graph compares the cumulative total shareholder return on the Company's Common Stock with the cumulative total return on the NASDAQ Composite Index and a peer group of the S&P Regional Bank Index. Total return assumes the reinvestment of all dividends and that the value of Common Stock and each index was $100 on December 31, 2017.
| Period Ending | ||||||||||||||||||||||||||||||||||||||
| Index | 12/31/2017 | 12/31/2018 | 12/31/2019 | 12/31/2020 | 12/31/2021 | 12/31/2022 | ||||||||||||||||||||||||||||||||
| Security Federal Corporation | $ | 100.00 | $ | 91.23 | $ | 114.13 | $ | 85.24 | $ | 107.36 | $ | 87.51 | ||||||||||||||||||||||||||
| NASDAQ Composite | $ | 100.00 | $ | 97.16 | $ | 132.81 | $ | 192.47 | $ | 235.15 | $ | 158.65 | ||||||||||||||||||||||||||
| S&P 600 Regional Banks | $ | 100.00 | $ | 90.15 | $ | 108.69 | $ | 95.59 | $ | 129.76 | $ | 119.53 | ||||||||||||||||||||||||||
Source: S&P Global Market Intelligence
32
Item 6. Selected Financial Data
[Reserved]
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report is incorporated herein by reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises principally from interest rate risk inherent in our lending, investing, deposit and borrowings activities. Management actively monitors and manages its interest rate risk exposure. In addition to other risks that we manage in the normal course of business, such as credit quality and liquidity, management considers interest rate risk to be a significant market risk that could potentially have a material effect on our financial condition and result of operations. The information contained in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management" in the Annual Report is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm*
Consolidated Balance Sheets at December 31, 2022 and 2021*
Consolidated Statements of Income for the Years Ended December 31, 2022 and 2021*
Consolidated Statements of Comprehensive (Loss) Income for the Years Ended December 31, 2022 and 2021*
Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 2022 and 2021*
Consolidated Statements of Cash Flows for the Years Ended December 31, 2022 and 2021*
Notes to Consolidated Financial Statements*
* Contained in the Annual Report filed as an exhibit to this Form 10-K and incorporated herein by reference.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of the Company's disclosure controls and procedures (as defined in Section 13a-15(e) of the Securities Exchange Act of 1934 (the "Act")) was carried out as of December 31, 2022 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 report. The Company's Chief Executive Officer and Chief Financial Officer concluded that based on their evaluation at December 31, 2022, 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 to allow timely decisions regarding required disclosure, specified in the SEC’s rules and forms, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms.
(b) Report of Management on Internal Control over Financial Reporting: The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control process has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company's financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.
Management conducted an assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2022, utilizing the framework established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company's internal control over financial reporting as of December 31, 2022 is effective.
33
Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that accurately and fairly reflect, in reasonable detail, transactions and dispositions of assets; and provide reasonable assurances that: (1) transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States; (2) receipts and expenditures are being made only in accordance with authorizations of management and the directors of the Company; and (3) unauthorized acquisition, use, or disposition of the Company's assets that could have a material effect on the Company's financial statements are prevented or timely detected.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
This Form 10-K does not include an attestation report of the Company's independent registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's independent registered public accounting firm pursuant to rules of the SEC that permit the Company to provide only management's report in this Form 10-K.
(c) Changes in Internal Controls: There have been no changes in the Company's internal control over financial reporting during the quarter ended December 31, 2022 that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting.
Item 9B. Other Information
None.
Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections
Not applicable.
PART III
Item 10. Directors, Executive Officers and Corporate Governance
Directors. The information contained under the section captioned "Proposal 1 - Election of Directors" in the 2023 Proxy Statement is incorporated herein by reference.
Executive Officers. For information regarding the executive officers of the Company and the Bank, see the information contained herein under the section captioned "Item 1. Business - Executive Officers."
Nominating Procedures. There have been no material changes to the procedures by which stockholders may recommend nominees to our Board of Directors since last disclosed to stockholders.
Audit Committee and Audit Committee Financial Expert. The Company has a separately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act. The Audit Committee of the Company is composed of Directors Moore (Chairperson), Alexander, Clyburn, Thomas, Simmons and Cummins. Directors Moore, Alexander, Clyburn and Thomas are independent, as independence is defined for audit committee members in the listing standards of The Nasdaq Stock Market, LLC. Although Security Federal’s common stock is not listed on Nasdaq, it has chosen to apply Nasdaq’s definition of independence, as permitted by the SEC. The Board of Directors has determined there is no "audit committee financial expert" as defined by the SEC; however, the Board believes that the current members of the Audit Committee are qualified to serve based on their collective experience and background.
Code of Ethics. The Board of Directors has adopted a Code of Ethics for the Company's officers (including its senior financial officers), directors and employees. The Code is applicable to the Company's principal executive officer and senior financial officers. The Company has posted its Code of Ethics on its website www.securityfederalbank.com.
Item 11. Executive Compensation
The information contained in the section captioned "Executive Compensation" in the 2023 Proxy Statement is incorporated herein by reference.
34
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
(a)Security Ownership of Certain Beneficial Owners. The information contained in the section captioned "Security Ownership of Certain Beneficial Owners and Management" in the 2023 Proxy Statement is incorporated herein by reference.
(b)Security Ownership of Management. The information contained in the section captioned "Security Ownership of Certain Beneficial Owners and Management" in the 2023 Proxy Statement is incorporated herein by reference.
(c) Changes in Control. The Company is not aware of any arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the Company.
(d) Equity Compensation Plan Information. There were no securities remaining to be granted or issued upon exercise of outstanding options, warrants and rights under the Company's equity compensation plans as of December 31, 2022.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Related Transactions. The information contained in the section captioned "Meetings and Committees of the Board of Directors and Corporate Governance Matters - Corporate Governance - Related Party Transactions" in the 2023 Proxy Statement is incorporated herein by reference.
Director Independence. The information contained in the section captioned "Meetings and Committees of the Board of Directors and Corporate Governance Matters - Corporate Governance - Director Independence" in the 2023 Proxy Statement is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
The information contained under the section captioned "Independent Registered Public Accounting Firm" in the 2023 Proxy Statement is incorporated herein by reference.
35
PART IV
Item 15. Exhibits and Financial Statement Schedules
1. Financial Statements. For a list of the financial statements filed as part of this report see Part II - Item 8.
2. Financial Statement Schedules. All schedules have been omitted as the required information is either inapplicable or contained in the Consolidated Financial Statements or related Notes contained in the Annual Report filed as an exhibit hereto.
3. Exhibit Index:
| 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) | ||||
| 4.2 | |||||
| 10.1 | |||||
| 10.2 | |||||
| 10.3 | |||||
| 10.4 | |||||
| 13 | |||||
| 14 | |||||
| 21 | |||||
| 23 | |||||
| 31.1 | |||||
| 31.2 | |||||
| 32 | |||||
| 101 | The following materials from Security Federal Corporation's Annual Report on Form 10-K for the year ended December 31, 2022, formatted in Extensible Business Reporting Language (XBRL): (1) Consolidated Balance Sheets; (2) Consolidated Statements of Income; (3) Consolidated Statements of Comprehensive (Loss) Income; (4) Consolidated Statements of Changes in Shareholders' Equity; (5) Consolidated Statements of Cash Flows; and (6) Notes to Consolidated Financial Statements | ||||
| 104 | Cover Page Interactive Date File (formatted as inline XBRL and contained in Exhibit 101) | ||||
(1)Filed on June 26, 1998, as an exhibit to the Company's Proxy Statement and incorporated herein by reference.
(2)Incorporated herein by reference to the Registrant's Current Report on Form 8-K filed on January 16, 2015.
(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 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.
(5)Filed on March 28, 2018, as an exhibit to the Company’s Proxy Statement and incorporated herein by reference.
(6)Filed on June 8, 2022, as an exhibit to the Company's Current Report on Form 8-K dated May 24, 2022 and incorporated herein by reference.
(7)The Company elects to satisfy Regulation S-K §229.406(c) by posting its Code of Ethics on its website at www.securityfederalbank.com.
Item 16. Form 10-K Summary
None.
36
SIGNATURES
Pursuant to the requirements of section 13 or 15(d) 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: March 24, 2023 | /s/ J. Chris Verenes | |||||||
| J. Chris Verenes | ||||||||
| Chief Executive Officer and Director | ||||||||
| (Duly Authorized Representative) | ||||||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| By: | /s/ J. Chris Verenes | March 24, 2023 | ||||||
| J. Chris Verenes | ||||||||
| Chief Executive Officer and Director | ||||||||
| (Principal Executive Officer) | ||||||||
| By: | /s/Darrell Rains | March 24, 2023 | ||||||
| Darrell Rains | ||||||||
| Chief Financial Officer | ||||||||
| (Principal Financial and Accounting Officer) | ||||||||
| By: | /s/Roy G. Lindburg | March 24, 2023 | ||||||
| Roy G. Lindburg | ||||||||
| President and Director | ||||||||
| By: | /s/Timothy W. Simmons | March 24, 2023 | ||||||
| Timothy W. Simmons | ||||||||
| Chairman of the Board and Director | ||||||||
| By: | /s/Frank M. Thomas, Jr. | March 24, 2023 | ||||||
| Frank M. Thomas, Jr. | ||||||||
| Director | ||||||||
| By: | /s/Frampton W. Toole III | March 24, 2023 | ||||||
| Frampton W. Toole III | ||||||||
| Director | ||||||||
37
| By: | /s/Richard T. Harmon | March 24, 2023 | ||||||
| Richard T. Harmon | ||||||||
| Director | ||||||||
| By: | /s/Robert E. Alexander | March 24, 2023 | ||||||
| Robert E. Alexander | ||||||||
| Director | ||||||||
| By: | /s/Jessica T. Cummins | March 24, 2023 | ||||||
| Jessica T. Cummins | ||||||||
| Director | ||||||||
| By: | /s/Thomas L. Moore | March 24, 2023 | ||||||
| Thomas L. Moore | ||||||||
| Director | ||||||||
| By: | /s/William Clyburn | March 24, 2023 | ||||||
| William Clyburn | ||||||||
| Director | ||||||||
| By: | ______ __, 2023 | |||||||
| Harry O. Weeks, Jr. | ||||||||
| Director | ||||||||
38
Exhibit 4.2
DESCRIPTION OF THE CAPITAL STOCK
The 5,200,000 shares of capital stock authorized by Security Federal Corporation's articles of incorporation are divided into two classes, consisting of 5,000,000 shares of common stock (par value $.01 per share) and 200,000 shares of serial preferred stock (par value $.01 per share). As of March 24, 2023, there were 3,253,210 shares of our common stock issued and outstanding and no shares of our preferred stock issued and outstanding.
Common Stock
General. Each share of common stock has the same relative rights and is identical in all respects with each other share of the common stock. Each holder of common stock is entitled to one vote for each share held on all matters voted upon by stockholders, subject to certain limitations.
Liquidation or Dissolution. In the unlikely event of the liquidation or dissolution of Security Federal Corporation, the holders of the common stock will be entitled to receive - after payment or provision for payment of all debts and liabilities of Security Federal Corporation (including all deposits in the Bank and accrued interest thereon) and after distribution of the liquidation account established in the mutual to stock conversion of Security Federal Bank - all assets of Security Federal Corporation available for distribution, in cash or in kind. If preferred stock is outstanding, the holders thereof may have a priority over the holders of common stock in the event of liquidation or dissolution.
No Preemptive Rights. Holders of the common stock are not entitled to preemptive rights with respect to any shares which may be issued.
Preferred Stock
Our articles of incorporation permit our Board of Directors to authorize the issuance of up to 200,000 shares of preferred stock, par value $0.01, in one or more series, without shareholder action.
Exhibit 13
Annual Report to Stockholders
1
2
3
4
5
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Selected Consolidated Financial and Other Data
6
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Selected Consolidated Financial and Other Data
7
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Selected Consolidated Financial and Other Data
8
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Selected Consolidated Financial and Other Data
9
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Selected Consolidated Financial and Other Data
10
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Selected Consolidated Financial and Other Data
11
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Selected Consolidated Financial and Other Data
The following tables provide selected consolidated financial and operating data of Security Federal Corporation at and for the years indicated. In conjunction with the data provided in the following tables and in order to more fully understand our historical consolidated financial and operating data, you should also read our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and the accompanying notes included in this report.
| At and For the Year Ended December 31, | |||||||||||||||||||||||||||||
| 2022 | 2021 | 2020 | 2019 | 2018 | |||||||||||||||||||||||||
| Balance Sheet Data at End of Period | (Dollars in Thousands, Except Per Share Data) | ||||||||||||||||||||||||||||
| Total Assets | $ | 1,381,366 | $ | 1,301,214 | $ | 1,171,710 | $ | 963,228 | $ | 912,614 | |||||||||||||||||||
| Cash and Cash Equivalents | 28,502 | 27,623 | 18,025 | 12,536 | 12,706 | ||||||||||||||||||||||||
| Certificates of Deposit with Other Banks | 1,100 | 1,100 | 350 | 950 | 1,200 | ||||||||||||||||||||||||
| Investment Securities | 717,586 | 706,356 | 607,579 | 433,892 | 409,894 | ||||||||||||||||||||||||
Total Loans Receivable, Net (1) | 549,917 | 499,497 | 479,167 | 452,859 | 430,054 | ||||||||||||||||||||||||
| Deposits | 1,110,085 | 1,115,963 | 918,096 | 771,407 | 767,497 | ||||||||||||||||||||||||
| Advances From Federal Home Loan Bank ("FHLB") | — | — | 35,000 | 38,138 | 34,030 | ||||||||||||||||||||||||
| Borrowings from Federal Reserve Bank ("FRB") | 44,080 | — | 48,700 | — | — | ||||||||||||||||||||||||
| Total Shareholders' Equity | 160,233 | 115,523 | 111,906 | 91,758 | 80,518 | ||||||||||||||||||||||||
| Common Shareholders' Equity | 77,284 | 115,523 | 111,906 | 91,758 | 80,518 | ||||||||||||||||||||||||
| Income Data | |||||||||||||||||||||||||||||
| Total Interest Income | $ | 42,578 | $ | 37,117 | $ | 37,096 | $ | 36,934 | $ | 33,072 | |||||||||||||||||||
| Total Interest Expense | 5,028 | 3,824 | 6,581 | 8,311 | 5,449 | ||||||||||||||||||||||||
| Net Interest Income | 37,550 | 33,293 | 30,515 | 28,623 | 27,623 | ||||||||||||||||||||||||
| (Reversal of) Provision for Loan Losses | — | (2,404) | 3,600 | 375 | 925 | ||||||||||||||||||||||||
| Net Interest Income After (Reversal of) Provision for Loan Losses | 37,550 | 35,697 | 26,915 | 28,248 | 26,698 | ||||||||||||||||||||||||
| Non-Interest Income | 9,612 | 12,633 | 11,421 | 9,097 | 7,669 | ||||||||||||||||||||||||
| Non-Interest Expense | 34,225 | 32,047 | 29,708 | 27,871 | 25,590 | ||||||||||||||||||||||||
| Income Taxes | 2,709 | 3,509 | 1,577 | 1,680 | 1,570 | ||||||||||||||||||||||||
| Net Income | $ | 10,228 | $ | 12,774 | $ | 7,051 | $ | 7,794 | $ | 7,207 | |||||||||||||||||||
| Per Common Share Data | |||||||||||||||||||||||||||||
| Net Income Per Common Share (Basic) | $ | 3.14 | $ | 3.93 | $ | 2.19 | $ | 2.64 | $ | 2.44 | |||||||||||||||||||
| Cash Dividends Per Share | $ | 0.76 | $ | 0.44 | $ | 0.40 | $ | 0.40 | $ | 0.36 | |||||||||||||||||||
12
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Selected Consolidated Financial and Other Data
| Year Ended December 31, | |||||||||||||||||||||||||||||
| 2022 | 2021 | 2020 | 2019 | 2018 | |||||||||||||||||||||||||
| Other Data | |||||||||||||||||||||||||||||
| Average Interest Rate Spread | 2.89 | % | 2.87 | % | 2.91 | % | 3.10 | % | 3.27 | % | |||||||||||||||||||
| Net Interest Margin (Net Interest Income / Average Earning Assets) | 3.03 | % | 2.97 | % | 3.04 | % | 3.26 | % | 3.38 | % | |||||||||||||||||||
| Average Interest-Earning Assets to Average Interest-Bearing Liabilities | 134.63 | % | 128.62 | % | 120.99 | % | 116.83 | % | 116.01 | % | |||||||||||||||||||
| Common Equity to Total Assets | 5.59 | % | 8.88 | % | 9.55 | % | 9.53 | % | 8.82 | % | |||||||||||||||||||
Non-Performing Assets to Total Assets (2) | 0.46 | % | 0.22 | % | 0.31 | % | 0.43 | % | 0.85 | % | |||||||||||||||||||
| Return on Assets | 0.75 | % | 1.04 | % | 0.63 | % | 0.80 | % | 0.81 | % | |||||||||||||||||||
| Return on Common Equity | 11.39 | % | 11.20 | % | 6.81 | % | 8.90 | % | 9.30 | % | |||||||||||||||||||
| Average Common Equity to Average Assets Ratio | 6.63 | % | 9.27 | % | 9.32 | % | 9.05 | % | 8.69 | % | |||||||||||||||||||
Dividend Payout Ratio on Common Shares(3) | 24.17 | % | 11.20 | % | 18.46 | % | 14.41 | % | 14.76 | % | |||||||||||||||||||
| Number of Full-Service Offices | 18 | 17 | 17 | 17 | 16 | ||||||||||||||||||||||||
(1) INCLUDES LOANS HELD FOR SALE
(2) NON-PERFORMING ASSETS CONSIST OF NON-ACCRUAL LOANS AND OTHER REAL ESTATE OWNED ("OREO")
(3) RATIO OF DIVIDENDS PAID ON COMMON SHARES TO NET INCOME AVAILABLE TO COMMON SHAREHOLDERS
13
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
General
The following discussion and analysis is presented to provide the reader with an understanding of the financial condition and the results of operations of Security Federal Corporation and its subsidiaries. The investment and other activities of the parent company, Security Federal Corporation (the “Company”), have had no significant impact on the results of operations for the periods presented in the Consolidated Financial Statements included herein. Because we conduct all of our material business operations through Security Federal Bank (the "Bank"), a wholly owned subsidiary of the Company, the following discussion of financial results are primarily indicative of the activities of the Bank. The Bank was founded in 1922 as a mutual building and loan association. In 1987, the Bank converted to a federally chartered stock savings bank. On December 28, 2011, the Bank completed a charter conversion from a federally chartered stock savings bank to a South Carolina chartered commercial bank. In connection with this transaction, the Company reorganized from a savings and loan holding company into a bank holding company.
The Bank has three wholly owned subsidiaries: Security Federal Investments, Inc. ("SFINV"), Security Federal Insurance, Inc. (“SFINS”) and Security Financial Services Corporation (“SFSC”). SFINV was formed to hold investment securities and allow for better management of the securities portfolio. SFINS is an insurance agency offering auto, business, and home insurance. Effective April 30, 2022, Collier Jennings Financial Corporation, a wholly owned subsidiary of SFINS, and its subsidiaries, Security Federal Auto Insurance, The Auto Insurance Store Inc., and Security Federal Premium Pay Plans Inc. ("SFPPP") and its wholly owned premium finance subsidiary were dissolved. SFPPP’s ownership interests in four other premium finance subsidiaries were disposed of at an immaterial gain. Additionally, effective April 30, 2022, previously inactive SFSC was dissolved.
In addition to the Bank, the Company has another wholly owned subsidiary, Security Federal Statutory Trust (the “Trust”), which issued and sold fixed and floating rate capital securities of the Trust. Under current accounting guidance, however, the Trust is not consolidated in the Company’s financial statements. Unless the context indicates otherwise, references to the "Company," "we," "us," and "our" shall include Security Federal Corporation, the Bank and the Bank's subsidiaries.
The principal business of the Bank is accepting deposits from the general public and originating consumer and commercial business loans as well as mortgage loans that enable borrowers to purchase or refinance one-to-four family residential real estate. The Bank also originates construction loans on single-family residences, multi-family dwellings, and commercial real estate, as well as loans for the acquisition, development and construction of residential subdivisions, and commercial projects. The Bank also provides trust services and it offers property and casualty insurance products through its subsidiary, SFINS.
The Bank's net income depends primarily on its interest rate spread which is the difference between the average yield earned on its loan and investment portfolios and the average rate paid on its deposits and borrowings. When the rate earned on interest-earning assets equals or exceeds the rate paid on interest-bearing liabilities, this positive interest rate spread will generate net interest income. The Bank’s interest spread is influenced by interest rates, deposit flows, and loan demands. Levels of non-interest income and operating expense are also significant factors in earnings.
Forward-Looking Statements
This document, including information incorporated by reference herein, may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words "believes," "expects," "anticipates," "estimates," "forecasts," "intends," "plans," "targets," "potentially," "probably," "projects," "outlook" or similar expressions or future or conditional verbs such as "may," "will," "should," "would" and "could." Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risk and uncertainties.
14
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
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:
•potential adverse impacts to economic conditions in our local market areas, other markets where the Company has lending relationships, or other aspects of the Company's business operations or financial markets, generally, resulting from the ongoing novel coronavirus of 2019 (“COVID-19”) and any governmental or societal responses thereto;
•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;
•the transition away from London Interbank Offered Rate ("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 and sell loans in the secondary market;
•results of examinations of the Company by the Board of Governors of the Federal Reserve System ("Federal Reserve") and the Bank by the Federal Deposit Insurance Corporation ("FDIC") and the South Carolina State Board of Financial Institutions, or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, or impose additional requirements or restrictions on us, any of which could adversely affect our liquidity and earnings;
•legislative or regulatory changes that adversely affect our business, including changes in banking, securities and tax law, and in regulatory policies and principles, or the interpretation of regulatory capital or other rules, and including changes as a result of COVID-19;
•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;
•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;
15
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
•inability of key third-party providers to perform their obligations to us;
•changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the Financial Accounting Standards Board ("FASB"), including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods;
•other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; and
•the other risks described elsewhere in this annual report to shareholders and in the Company's other filings with the Securities and Exchange Commission, including its Annual Report on Form 10-K for the year ended December 31, 2022 ("2022 Form 10-K").
Some of these and other factors are discussed in the 2022 Form 10-K under Item 1A, “Risk Factors.” Such developments could have an adverse impact on our financial condition and results of operations.
Any of the forward-looking statements that we make may turn out to be inaccurate as a result of our beliefs and assumptions we make in connection with the factors set forth above or because of other unidentified and unpredictable factors. Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements and you should not rely on such statements. The Company undertakes no obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. These risks could cause our actual results for 2023 and beyond to differ materially from those expressed in any forward-looking statements by or on behalf of us, and could negatively affect the Company’s consolidated financial condition and consolidated results of operations, liquidity and stock price performance.
Critical Accounting Estimates
We prepare our consolidated financial statements in accordance with GAAP. In doing so, we have to make estimates and assumptions. Our critical accounting estimates are those estimates that involve a significant level of uncertainty at the time the estimate was made, and changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used in the current period, would have a material impact on our financial condition or results of operations. Accordingly, actual results could differ materially from our estimates. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We have reviewed our critical accounting estimates with the audit committee of our Board of Directors.
The significant accounting policies of the Company are described in Note 1 of the Notes to the Consolidated Financial Statements included herein.
The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments, estimates and assumptions used in preparation of the Consolidated Financial Statements. The impact of an unexpected large loss could deplete the allowance and potentially require increased provisions to replenish the allowance, which would negatively affect earnings. The Company provides for loan losses using the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to the allowance for loan losses. Additions to the allowance for loan losses are provided by charges to operations based on various factors, which, in management’s judgment, deserve current recognition in estimating possible losses. Such factors considered by management include the fair value of the underlying collateral, stated guarantees by the borrower (if applicable), the borrower’s ability to repay from other economic resources, growth and composition of the loan portfolio, the relationship of the allowance for loan losses to the outstanding loans, loss experience, delinquency trends, and general economic conditions. Management evaluates the carrying value of the loan portfolio monthly and adjusts the allowance accordingly. While management uses the best information available to make evaluations, future adjustments may be necessary if economic conditions differ substantially from the assumptions used in making these evaluations. The allowance for loan losses is subject to periodic evaluations by bank regulatory agencies that may require adjustments to the allowance based upon the information that is available at the time of their examination. For a further discussion of the Company’s estimation process and methodology related to the allowance for loan losses, see the discussion under the section entitled “Financial Condition” and “Comparison of the Years Ended December 31, 2022 and 2021-Provision for Loan Losses” included herein.
16
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
The Company values an impaired loan at the loan’s fair value if it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the original loan agreement. Impaired loans are measured 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 collectability of an impaired loan’s principal is in doubt, wholly or partially, all payments received are applied to principal. Once the recorded principal balance has been reduced to zero, any additional payments received are applied to interest income to the extent that any interest has been foregone. Any additional payments received are recorded as recoveries of any amounts previously charged off. When the repayment of the loan is not in doubt, payments are applied under the contractual terms of the loan agreement first to interest and then to principal.
The Company uses assumptions and estimates in determining income taxes payable or refundable for the current year, deferred income tax liabilities and assets for events recognized differently in its financial statements and income tax returns, and income tax expense. Determining these amounts requires analysis of certain transactions and interpretation of tax laws and regulations.
The Company exercises considerable judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments and estimates are reevaluated on a continual basis as regulatory and business factors change.
No assurance can be given that either the tax returns submitted by the Company or the income tax reported on the Consolidated Financial Statements will not be adjusted by either adverse rulings by the United States Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service.
Asset and Liability Management
The objective of the Bank’s program of asset and liability management is to limit the Bank’s vulnerability to material and prolonged increases or decreases in interest rates, or "interest rate risk." As a financial institution, interest rate risk is the Bank's most significant market risk. The earnings and economic value of our shareholders’ equity varies in relation to changes in interest rates and the corresponding impact on the market values of our assets and liabilities. The Bank has an Asset Liability Management Committee (“ALCO”) who monitors the Bank’s asset liability strategy.
The asset/liability management process is designed to achieve relatively stable net interest margins and assure liquidity by coordinating the volumes, maturities or re-pricing opportunities of interest-earning assets, deposits and borrowed funds. It is the responsibility of the ALCO to determine and achieve the most appropriate volume and mix of interest-earning assets and interest-bearing liabilities, as well as ensure an adequate level of liquidity and capital, within the context of corporate performance goals. The ALCO meets regularly to review interest rate risk and liquidity in relation to present and potential market conditions and evaluate funding and balance sheet management strategies to ensure the level of risk is consistent with our asset/liability objectives.
Simulation is the principal tool used by the Bank in its ongoing effort to measure interest rate risk. Simulation involves the use of a financial modeling system that provides reports showing the current and future impact of changes in interest rates and our strategies and tactics. The Bank uses two dynamic methods: net interest income (“NII”) simulation and economic value of equity (“EVE”) analysis. The NII simulation models the impact that changes in interest rates will have on our earnings while EVE analysis models the impact those changes will have on the net present value of our asset and liability portfolios. These models take into account our contractual agreements with regard to investments, loans, deposits and borrowings, and also include assumptions surrounding market and customer behavior under different rate scenarios. The assumptions we use are based upon a combination of proprietary and market data that reflect historical results and current market conditions. These assumptions relate to interest rates, prepayments, deposit decay rates and the market value of certain assets and liabilities under the various interest rate scenarios. We use market data to determine prepayments and maturities of loans, investments and borrowings and use our own assumptions on deposit decay rates except for time deposits. Time deposits are modeled to reprice to market rates upon their stated maturities. We also assume that non-maturity deposits can be maintained with rate adjustments not directly proportionate to the change in market interest rates, based upon our historical deposit rates. We have demonstrated in the past that the tiering structure of our deposit accounts during changing rate environments results in relatively lower volatility and less than market rate changes in our interest expense for deposits. These assumptions are based upon our analysis of our customer base, competitive factors and historical experience.
17
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
While these models are dependent on the accuracy of the assumptions that underlie the process, we believe that such modeling provides a better illustration of our sensitivity to interest rate risk than does a traditional static gap analysis. These tools provide our ALCO with the capability to estimate and manage the amount of earnings at risk in future periods and in selected interest rate risk environments.
NII Simulation- The Bank’s primary focus is on NII simulation. Using NII simulation, the Bank measures earnings exposure over both a 12 and 24 month period under multiple instantaneous rate shock scenarios. The Bank’s policy provides the maximum acceptable negative impact on net interest income and return on assets ("ROA") over each time horizon associated with each respective change in interest rates. Our ALCO monitors compliance with these policy limits and reports them to the Board of Directors quarterly.
The following table indicates the NII simulation scenarios modeled and the applicable policy parameters.
| Change in Market Rates | Maximum Allowable Change in NII Over | Maximum Allowable Change in ROA Over | ||||||||||||||||||
| (in Basis Points) | 12 Months | 24 Months | 12 Months | 24 Months | ||||||||||||||||
| 400 | (20)% | (20)% | (40)% | (40)% | ||||||||||||||||
| 300 | (15)% | (15)% | (30)% | (30)% | ||||||||||||||||
| 200 | (10)% | (10)% | (20)% | (20)% | ||||||||||||||||
| 100 | (7.5)% | (7.5)% | (10)% | (10)% | ||||||||||||||||
| — | —% | —% | —% | —% | ||||||||||||||||
| (100) | (7.5)% | (7.5)% | (10)% | (10)% | ||||||||||||||||
| (200) | (10)% | (10)% | (20)% | (20)% | ||||||||||||||||
| (300) | (15)% | (15)% | (30)% | (30)% | ||||||||||||||||
| (400) | (20)% | (20)% | (40)% | (40)% | ||||||||||||||||
The Bank performs a liquidity analysis, a component of managing liquidity risk and monitoring the Bank's asset liability strategy. This analysis compares outstanding sources of liquidity to applicable policy parameters. The Bank was in compliance with policy parameters as of December 31, 2022 and 2021. In addition, the Bank performs a Contingency Funding plan analysis which incorporates various simulations in order to evaluate Bank's funding resources under stressed conditions. Both the liquidity and Contingency Funding plan analysis are performed by the Bank's ALCO and presented to the Board of Directors quarterly.
18
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
EVE simulation- The EVE analysis serves as an indicator of the extent to which the present value of our capital could change, given potential changes in interest rates. The difference represented by the present value of assets minus the present value of liabilities is defined as the economic value of equity. This measure assumes a static balance sheet and does not incorporate any growth assumptions, but does assume loan prepayments and certain other cash flows occur. It provides a measure of rate risk extending beyond the 12 or 24 month time horizon contained in the NII simulation analyses.
While an instantaneous and severe shift in interest rates is used in this analysis to provide an estimate of exposure under an extremely adverse scenario, a gradual shift in interest rates would have a much more modest impact. Since EVE measures the discounted present value of cash flows over the estimated lives of instruments, the change in EVE does not directly correlate to the degree that earnings would be impacted over a shorter time horizon, i.e., the next fiscal year. Further, EVE does not take into account factors such as future balance sheet growth, changes in product mix, change in yield curve relationships, and changing product spreads that could mitigate the adverse impact of changes in interest rates.
The following table indicates the EVE simulation scenarios modeled and the applicable policy parameters.
| Change in Market Rates (In Basis Points) | Maximum Change in Economic Value of Equity | |||||||
| 400 | (40)% | |||||||
| 300 | (30)% | |||||||
| 200 | (20)% | |||||||
| 100 | (10)% | |||||||
| — | —% | |||||||
| (100) | (10)% | |||||||
| (200) | (20)% | |||||||
| (300) | (30)% | |||||||
| (400) | (40)% | |||||||
In evaluating the Bank's exposure to interest rate risk, certain shortcomings inherent in the method of analysis described above are considered. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual occurrences to differ from underlying assumptions. For example, loan repayment rates and withdrawals of deposits will likely differ substantially from the assumptions used in the simulation models in the event of significant changes in interest rates due to the option of borrowers to prepay their loans and the ability of depositors to withdraw funds prior to maturity. In addition, this analysis does not consider any strategic changes to our balance sheet which management may consider as a result of changes in market conditions.
19
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Financial Condition - Assets
Total assets increased $80.2 million or 6.2% to $1.4 billion at December 31, 2022 from $1.3 billion at December 31, 2021. This increase was primarily due to increases in held to maturity ("HTM") investment securities, net loans receivable and, to a lesser extent other assets, partially offset by a decrease in available for sale ("AFS") investment securities.
Cash and cash equivalents increased $879,000 or 3.2% to $28.5 million at December 31, 2022 compared to $27.6 million at December 31, 2021. Total investment securities increased $11.2 million or 1.6% to $717.6 million at December 31, 2022 from $706.4 million at December 31, 2021 as purchases of investments exceeded maturities, sales and principal paydowns during the year. The Company purchased $210.3 million of investment securities during the year ended December 31, 2022 compared to $217.6 million during the prior year and sold $22.4 million of AFS investment securities during the year ended December 31, 2022 compared to no sales during 2021.
Loans receivable, net, including loans held for sale, increased $50.4 million or 10.1% to $549.9 million at December 31, 2022 from $499.5 million at December 31, 2021 primarily due to increases in construction, residential mortgage and commercial real estate loans. In addition, home equity lines of credit ("HELOCs") and other consumer loans also increased while commercial and agricultural loans decreased during 2022 compared to 2021.
Construction loans increased $12.6 million or 12.6% to $112.8 million at December 31, 2022 from $100.2 million at December 31, 2021. Residential mortgage loans held for investment increased $25.1 million or 29.5% to $110.1 million at December 31, 2022 from $85.0 million at December 31, 2021. Commercial real estate loans increased $24.4 million or 10.7% to $252.2 million at December 31, 2022 from $227.8 million at December 31, 2021.
Commercial and agricultural loans decreased $14.1 million or 31.4% to $30.6 million at December 31, 2022 from $44.7 million at December 31, 2021.
HELOCs increased $3.1 million or 10.9% to $31.7 million at December 31, 2022 from $28.6 million at December 31, 2021. Other consumer loans increased $2.2 million or 10.0% to $23.6 million at December 31, 2022 from $21.4 million at December 31, 2021.
Loans held for sale, comprised of fixed rate residential loans, decreased $3.1 million or 77.4% to $913,000 at December 31, 2022 from $4.0 million at December 31, 2021. Typically, long term, newly originated fixed rate residential real estate loans are not retained in the portfolio but are sold immediately in contrast to adjustable rate mortgage ("ARM") loans, which are generally retained in the portfolio. The Bank sells all its fixed rate residential loans on a service-released basis. Fixed rate residential loans sold to institutional investors, on a service-released basis totaled $48.5 million during the year ended December 31, 2022, $112.9 million during the year ended December 31, 2021 and $111.1 million during the year ended December 31, 2020.
Property and equipment, net increased $2.8 million or 10.8% to $28.0 million at December 31, 2022 from $25.2 million at December 31, 2021 due to capital costs related to branch improvements and construction of the Bank's newest branch.
Other assets increased $14.0 million or 267.2% to $19.2 million at December 31, 2022 from $5.2 million at December 31, 2021. The increase was primarily the result of a $14.6 million increase in net deferred taxes, which was related to increased unrealized losses in the AFS investment securities.
20
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Financial Condition - Non-Performing Assets
The Bank’s non-performing assets, which consist of non-accrual loans and OREO, increased $3.6 million or 127.3% to $6.4 million at December 31, 2022 from $2.8 million at December 31, 2021. Non-performing assets represented 0.5% and 0.2% of total assets at December 31, 2022 and 2021, respectively.
| At December 31, 2022 | At December 31, 2021 | $ | % | ||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Amount | Percent (1) | Amount | Percent (1) | Change | Change | |||||||||||||||||||||||||||||
| Non-Performing Loans: | |||||||||||||||||||||||||||||||||||
| Construction | $ | 115 | 0.02 | % | $ | 21 | — | % | $ | 94 | 447.6 | % | |||||||||||||||||||||||
| Residential Mortgage | 1,545 | 0.28 | 1,389 | 0.28 | 156 | 11.2 | |||||||||||||||||||||||||||||
| Commercial Real Estate | 4,282 | 0.76 | 1,057 | 0.21 | 3,225 | 305.1 | |||||||||||||||||||||||||||||
| Commercial and Agricultural | 113 | 0.02 | 64 | 0.01 | 49 | 76.6 | |||||||||||||||||||||||||||||
| HELOC | 189 | 0.03 | 142 | 0.03 | 47 | 33.1 | |||||||||||||||||||||||||||||
| Other Consumer | 29 | 0.01 | 9 | — | 20 | 222.2 | |||||||||||||||||||||||||||||
| Total Non-Performing Loans | 6,273 | 1.12 | % | 2,682 | 0.53 | % | 3,591 | 133.9 | % | ||||||||||||||||||||||||||
| Other Non-Performing Assets: | |||||||||||||||||||||||||||||||||||
| OREO | 120 | 0.02 | % | 130 | 0.03 | % | (10) | (7.7) | % | ||||||||||||||||||||||||||
| Total Non-Performing Assets | $ | 6,393 | 1.14 | % | $ | 2,812 | 0.56 | % | $ | 3,581 | 127.3 | % | |||||||||||||||||||||||
| Total Non-Performing Assets as a Percentage of Total Assets | 0.46 | % | 0.22 | % | |||||||||||||||||||||||||||||||
(1) PERCENT OF GROSS LOANS RECEIVABLE HELD FOR INVESTMENT, NET OF DEFERRED FEES AND LOANS IN PROCESS.
Non-performing loans increased in all loan categories during 2022 compared to 2021. The largest increase in non-performing loans was in the commercial real estate loan category, which increased $3.2 million or 305.1% to $4.3 million at December 31, 2022 from $1.1 million at December 31, 2021. The balance in non-performing commercial real estate loans consisted of three loans to three borrowers with an average loan balance of $1.1 million at December 31, 2022 compared to eight loans to six borrowers with an average loan balance of $151,000 at December 31, 2021.
Non-performing residential loans, which represented the second largest category of non-performing loans, increased $156,000 or 11.2% to $1.5 million at December 31, 2022 from $1.4 million at December 31, 2021. Non-performing residential mortgage loans at December 31, 2022 consisted of 16 loans to 16 borrowers with an average loan balance of $97,000, the largest of which was $250,000, compared to 12 loans to 12 borrowers with an average loan balance of $116,000, the largest of which was $274,000, at December 31, 2021.
Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the underlying collateral. In the event an acceptable arrangement cannot be reached, we may have to acquire these properties through foreclosure or other means and subsequently sell, develop, or liquidate them.
The balance of loans classified as troubled debt restructurings ("TDRs") decreased $309,000 or 44.5% during the year ended December 31, 2022. The Bank had two TDRs totaling $385,000 at December 31, 2022 compared to three TDRs totaling $694,000 at December 31, 2021. At both December 31, 2022 and 2021, all TDRs were non-accruing. All TDRs are reviewed for impairment loss and included in impaired loans until paid off. TDR loans can be classified as either accrual or non-accrual. TDR loans are classified as non-accrual loans unless they have been performing in accordance with their modified terms for a period of at least six months in which case they are placed on accrual status. At December 31, 2022, the Bank had $5.6 million of impaired loans, including $385,000 in TDRs, compared to $2.3 million impaired loans, including $694,000 in TDRs, at December 31, 2021.
OREO decreased $10,000 or 7.7% to $120,000 at December 31, 2022 from $130,000 at December 31, 2021. At December 31, 2022, the balance of OREO consisted of five acres of commercial land in Aiken, South Carolina.
21
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
The Bank reviews its loan portfolio and allowance for loan losses on a monthly basis. When determining the appropriate allowance for loan losses during the years ended December 31, 2022 and 2021, management took into consideration such factors as the national and state unemployment rates and related trends, national and state unemployment benefit claim levels and related trends, the amount of and timing of financial assistance provided by the government, inflation, consumer spending levels and trends, industries significantly impacted by the COVID-19 pandemic and a review of the Bank's largest commercial loan relationships.
Effective January 1, 2023, the Bank adopted Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, also known as CECL. CECL replaces the incurred loss impairment framework in current GAAP. Adoption of this guidance resulted in a $2.0 million increase in the allowance for credit losses, comprised of increases in the allowance for loan losses of $800,000 and the reserve for unfunded commitments of $1.2 million. The cumulative effect adjustment to retained earnings was $1.6 million, net of tax. For additional information, refer to “Recently Issued or Adopted Accounting Standards” in Note 1 of the Notes to Consolidated Financial Statements included herein.
Management will continue to closely monitor economic conditions and will work with borrowers as necessary to assist them through this challenging economic climate. Future additions to the Bank's allowance for loan losses are dependent on, among other things, the performance of the Bank's loan portfolio, the economy, changes in real estate values, and interest rates. There can be no assurance that additions to the allowance will not be required in future periods. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes.
Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses. The ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. If charge-offs in future periods exceed the allowance for loan losses, we will need additional provisions to increase the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations. Management continually monitors its loan portfolio for the impact of local economic changes. The ratio of the allowance for loan losses to total loans was 2.09% and 2.19% at December 31, 2022 and 2021, respectively.
22
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Financial Condition - Liabilities and Shareholders' Equity
Total deposits decreased $5.9 million or 0.5% to $1.11 billion at December 31, 2022 from $1.12 billion at December 31, 2021. The majority of the Bank’s deposits are originated within the Bank’s immediate market area. The Bank had brokered time deposits of $6.0 million and $10.0 million at December 31, 2022 and 2021, respectively. The Bank uses brokered time deposits to manage interest rate risk because they are accessible in bulk at rates typically only slightly higher than those in our market areas. A portion of these brokered time deposits give the Bank a call option that allows the Bank the choice to redeem them early should rates change. In addition, the Bank had $5.0 million in other brokered deposits at December 31, 2022. Total deposits at December 31, 2022, excluding brokered deposits, decreased $1.9 million or 0.2%. Brokered deposits were 1.0% and 1.3% of total deposits at December 31, 2022 and 2021, respectively.
Certificate of deposits that met or exceeded the FDIC insurance limit of $250,000 totaled $30.3 million and $39.4 million at December 31, 2022 and 2021, respectively. The following table summarizes the maturity schedule of certificates of deposit with a balance of $250,000 or more at December 31, 2022:
| (In Thousands) | |||||
| Within 3 Months | $ | 4,036 | |||
| After 3 Months, Within 6 Months | 3,741 | ||||
| After 6 Months, Within 12 Months | 14,010 | ||||
| After 12 Months | 8,485 | ||||
| $ | 30,272 | ||||
Total certificates of deposit scheduled to mature in one year or less totaled $96.2 million at December 31, 2022 compared to $118.1 million at December 31, 2021.
Management’s policy is to maintain deposit rates at levels that are competitive with other local financial institutions. Based on historical experience, we believe that a significant portion of maturing certificates of deposit will remain with the Bank.
The Bank had outstanding FHLB advances and borrowings from the "discount window" of the FRB of Atlanta totaling $0 and $44.1 million at December 31, 2022, respectively, compared to no such advances or borrowings at December 31, 2021. 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.
Other borrowings increased $803,000 or 3.0% to $27.6 million at December 31, 2022 from $26.8 million at December 31, 2021. 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 0.75% and 0.15% at December 31, 2022 and 2021, respectively. The Bank had pledged as collateral for these repurchase agreements AFS investment securities and HTM investment securities with amortized costs and fair values of $52.3 million and $49.8 million, at December 31, 2022, and $45.3 million and $45.2 million, at December 31, 2021, respectively.
At both December 31, 2022 and 2021, the Company had $5.2 million in junior subordinated debentures outstanding. In addition, the Company had $26.5 million and $30.0 million in subordinated debentures (“Notes”) outstanding at December 31, 2022 and 2021, respectively. During the year ended December 31, 2022, the Company repurchased $3.5 million in principal amount of the Notes. For additional information, refer to Note 12 and Note 14 of the Notes to Consolidated Financial Statements included herein.
Total shareholders' equity increased $44.7 million or 38.7% to $160.2 million at December 31, 2022 from $115.5 million at December 31, 2021. The increase was primarily attributable to an $82.9 million issuance of Senior Non-Cumulative Perpetual Preferred Stock, Series ECIP (the “Preferred Stock”) by the Company and net income of $10.2 million during 2022. These increases were partially offset by $2.5 million in dividends paid to common shareholders and a $46.0 million decrease in accumulated other comprehensive income, net of tax, related to the unrecognized loss in value of AFS investment securities during the year ended December 31, 2022. Book value per common share was $23.76 at December 31, 2022 compared to $35.51 at December 31, 2021.
23
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The table also distinguishes between the changes related to higher or lower outstanding balances and the changes related to the volatility of interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (1) changes in rate (multiplied by prior year volume); (2) changes in volume (multiplied by prior year rate); and (3) net change (the sum of the prior columns). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change attributable to volume and the change attributable to rate. Changes in income are calculated on a tax equivalent basis using the effective tax rate for the period.
| Years Ended December 31, | |||||||||||||||||||||||||||||||||||
| 2022 vs. 2021 | 2021 vs. 2020 | ||||||||||||||||||||||||||||||||||
| (Decrease) Increase Due to Change in | (Decrease) Increase Due to Change in | ||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | Volume | Rate | Net | Volume | Rate | Net | |||||||||||||||||||||||||||||
| Interest-Earning Assets: | |||||||||||||||||||||||||||||||||||
Loans: (1) | $ | 591 | $ | (2,150) | $ | (1,559) | $ | (2) | $ | 924 | $ | 922 | |||||||||||||||||||||||
| Taxable Investment Securities | 1,784 | 5,410 | 7,194 | 2,176 | (2,948) | (772) | |||||||||||||||||||||||||||||
Non-taxable Investment Securities (2) | 16 | (395) | (379) | 283 | (327) | (44) | |||||||||||||||||||||||||||||
| Deposits in Other Banks | 34 | 154 | 188 | (38) | (31) | (69) | |||||||||||||||||||||||||||||
| Total Interest-Earning Assets | $ | 2,425 | $ | 3,019 | $ | 5,444 | $ | 2,419 | $ | (2,382) | $ | 37 | |||||||||||||||||||||||
| Interest-Bearing Liabilities: | |||||||||||||||||||||||||||||||||||
| Deposits: | |||||||||||||||||||||||||||||||||||
| Certificate Accounts | $ | (133) | $ | (139) | $ | (272) | $ | (474) | $ | (1,414) | $ | (1,888) | |||||||||||||||||||||||
| Other Interest Bearing Deposits | 103 | 1,449 | 1,552 | 209 | (616) | (407) | |||||||||||||||||||||||||||||
| Total Deposits | (30) | 1,310 | 1,280 | (265) | (2,030) | (2,295) | |||||||||||||||||||||||||||||
| Borrowings | (252) | 176 | (76) | (125) | (337) | (462) | |||||||||||||||||||||||||||||
| Total Interest-Bearing Liabilities | (282) | 1,486 | 1,204 | (390) | (2,367) | (2,757) | |||||||||||||||||||||||||||||
Effect on Net Tax Equivalent Interest Income (2) | $ | 2,707 | $ | 1,533 | $ | 4,240 | $ | 2,809 | $ | (15) | $ | 2,794 | |||||||||||||||||||||||
(1) INTEREST ON NON-ACCRUAL LOANS IS NOT INCLUDED IN INCOME, ALTHOUGH THEIR LOAN BALANCES ARE INCLUDED IN AVERAGE LOANS OUTSTANDING.
(2)THE TAX-EQUIVALENT INTEREST INCOME ADJUSTMENT RELATES TO THE TAX EXEMPT MUNICIPAL BONDS
24
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Average Balances, Interest Income and Expenses, and Average Yields and Rates
The following table compares detailed average balances, average yields on interest earning assets, and average costs of interest bearing liabilities at December 31, 2022 and 2021. The average balances were derived from the daily balances throughout the periods indicated. The average yields or costs were calculated by dividing the income or expense by the average balance of the corresponding assets or liabilities. Nonaccrual loans are included in earning assets in the following tables. Loan yields have been reduced to reflect the negative impact on our earnings of loans on nonaccrual status.
| For the Year Ended December 31, | ||||||||||||||||||||||||||||||||||||||
| 2022 | 2021 | |||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Average Balance | Interest | Yield/Rate | Average Balance | Interest | Yield/Rate | ||||||||||||||||||||||||||||||||
| Interest-Earning Assets: | ||||||||||||||||||||||||||||||||||||||
Loans (1) | $ | 525,396 | $ | 25,637 | 4.88 | % | $ | 513,987 | $ | 27,196 | 5.29 | % | ||||||||||||||||||||||||||
Taxable Investment Securities | 695,960 | 16,145 | 2.32 | % | 591,387 | 8,952 | 1.51 | % | ||||||||||||||||||||||||||||||
Non-taxable Investments (2) | 23,651 | 846 | 3.58 | % | 23,351 | 1,225 | 5.25 | % | ||||||||||||||||||||||||||||||
| Deposits in Other Banks | 3,649 | 203 | 5.56 | % | 1,639 | 14 | 0.85 | % | ||||||||||||||||||||||||||||||
| Total Interest-Earning Assets | $ | 1,248,656 | $ | 42,831 | 3.43 | % | $ | 1,130,364 | $ | 37,387 | 3.31 | % | ||||||||||||||||||||||||||
| Interest-Bearing Liabilities: | ||||||||||||||||||||||||||||||||||||||
| Checking, Savings and Money Market Accounts | $ | 703,914 | $ | 2,304 | 0.33 | % | $ | 616,098 | $ | 752 | 0.12 | % | ||||||||||||||||||||||||||
| Certificate Accounts | 143,619 | 607 | 0.42 | % | 172,995 | 879 | 0.51 | % | ||||||||||||||||||||||||||||||
| Total Interest-Bearing Deposits | 847,533 | 2,911 | 0.34 | % | 789,093 | 1,631 | 0.21 | % | ||||||||||||||||||||||||||||||
| Junior Subordinated Debt | 5,155 | 180 | 3.49 | % | 5,155 | 97 | 1.88 | % | ||||||||||||||||||||||||||||||
| Subordinated Debt | 29,332 | 1,548 | 5.28 | % | 30,000 | 1,575 | 5.25 | % | ||||||||||||||||||||||||||||||
FHLB Advances and Other Borrowings (3) | 45,477 | 389 | 0.86 | % | 54,593 | 521 | 0.95 | % | ||||||||||||||||||||||||||||||
| Total Interest-Bearing Liabilities | $ | 927,497 | $ | 5,028 | 0.54 | % | $ | 878,841 | $ | 3,824 | 0.44 | % | ||||||||||||||||||||||||||
| Net Interest Rate Spread | 2.89 | % | 2.87 | % | ||||||||||||||||||||||||||||||||||
Tax Equivalent Net Interest Income/Margin (2) | $ | 37,803 | 3.03 | % | $ | 33,563 | 2.97 | % | ||||||||||||||||||||||||||||||
Less: tax equivalent adjustment (2) | 253 | 270 | ||||||||||||||||||||||||||||||||||||
| Net Interest Income | $ | 37,550 | $ | 33,293 | ||||||||||||||||||||||||||||||||||
(1) INTEREST INCOME FROM OTHER LOANS INCLUDED IN THE TABLES ABOVE AND BELOW INCLUDES DEFERRED PPP LOAN FEES OF $441,000 AND $4.7 MILLION RECOGNIZED DURING THE YEARS ENDED DECEMBER 31, 2022 AND 2021, RESPECTIVELY.
(2)TAX EQUIVALENT BASIS RECOGNIZES THE INCOME TAX SAVINGS WHEN COMPARING TAXABLE AND TAX-EXEMPT ASSETS AND WAS CALCULATED USING THE EFFECTIVE TAX RATE IN PLACE FOR THE YEARS ENDED DECEMBER 31, 2022 AND 2021. THE TAX-EQUIVALENT INTEREST INCOME ADJUSTMENT RELATES TO THE TAX EXEMPT MUNICIPAL BONDS INCLUDED IN OUR INVESTMENT PORTFOLIO DURING THE PERIODS INDICATED.
(3)INCLUDES FHLB ADVANCES, BORROWINGS FROM THE FRB AND REPURCHASE AGREEMENTS.
.
.
25
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Comparison of the Years Ended December 31, 2022 and 2021
Net Income
Net income decreased $2.6 million or 19.9% to $10.2 million or $3.14 per basic and diluted common share for the year ended December 31, 2022, compared to $12.8 million or $3.93 per basic and diluted common share for the year ended December 31, 2021. The decrease in net income during 2022 compared to the prior year was due to a decline in non-interest income and an increase in non-interest expense, partially offset by an increase in net interest income. Also contributing to the decrease in net income was a $2.4 million reversal of loan loss reserves during 2021 following significantly higher loan loss provisions recorded in 2020 in response to the potential and unknown economic impact of the ongoing COVID-19 pandemic compared to no provision for loan losses in 2022.
Net Interest Income
Net interest income increased $4.3 million or 12.8% to $37.6 million for the year ended December 31, 2022, compared to $33.3 million in 2021. The increase in net interest income was primarily due to higher interest income from investments, which was partially offset by an increase in interest expense. The net interest margin on a tax-equivalent basis increased six basis points to 3.03% for the year ended December 31, 2022 from 2.97% for the year ended December 31, 2021.
Total average interest-earning assets increased $118.3 million or 10.5% to $1.25 billion for the year ended December 31, 2022 from $1.13 billion for the year ended December 31, 2021 with a 12 basis point increase in the average yield earned on these assets. Average interest-bearing liabilities increased $48.7 million or 5.5% to $927.5 million for the year ended December 31, 2022 from $878.8 million for the year ended December 31, 2021 with an increase of 10 basis points in the average cost. The interest rate spread on a tax-equivalent basis increased two basis points to 2.89% for the year ended December 31, 2022 from 2.87% in 2021.
Total interest income increased $5.5 million or 14.7% to $42.6 million for the year ended December 31, 2022, compared to $37.1 million for the year ended December 31, 2021 as a result of increased interest income from taxable investments which was partially offset by lower interest income from loans and tax-exempt investments.
Total tax-equivalent interest income on investments increased $6.8 million, or 67.0%, due to a $104.9 million, or 17.1%, increase in the aggregate average balance of these interest-earning assets combined with an increase of 70 basis points in the average yield earned on these assets during 2022 when compared to 2021.
Interest income from loans decreased $1.6 million or 5.7% to $25.6 million for the year ended December 31, 2022 compared to $27.2 million for the year ended December 31, 2021. The decrease was primarily attributable to a decrease in deferred loan fees on PPP loans recognized in 2022. The Bank recognized $441,000 and $4.7 million in deferred loan fees on PPP loans during the years ended December 31, 2022 and 2021, respectively. There was no unamortized net deferred fees on PPP loans remaining at December 31, 2022. This decrease was partially offset by an increase of $11.4 million in the average balance of loans outstanding during the year ended December 31, 2022.
Total interest expense increased $1.2 million or 31.5% to $5.0 million for the year ended December 31, 2022, compared to $3.8 million for the year ended December 31, 2021 due to a 10 basis point increase in the average cost of interest-bearing liabilities combined with an increase of $48.7 million, or 5.5%, in the average balance of these liabilities.
The largest increase was in interest expense on deposits, which increased $1.3 million or 78.4% to $2.9 million in 2022 compared to $1.6 million in 2021. Average interest-bearing deposits increased $58.4 million or 7.4% to $847.5 million during the year ended December 31, 2022 compared to $789.1 million during 2021, while the average cost of those deposits increased 13 basis points to 0.34% during 2022 from 0.21% in 2021.
Interest expense on borrowings from the FRB and other borrowings decreased $132,000 or 25.3% to $389,000 during the year ended December 31, 2022 from $521,000 during the prior year. The decrease was attributable to a $9.1 million, or 16.7% decrease in the average balance of these liabilities combined with a decrease of nine basis points in the average cost to 0.86% in 2022 from 0.95% during 2021.
26
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Provision for Loan Losses
The Company recorded no provision for loan losses for the year ended December 31, 2022 compared to a $2.4 million reversal of the provision for loan losses for the year ended December 31, 2021. The reversal of loan loss provision during 2021 was the result of a reduction in historical loss and qualitative adjustment factors related to improvement in the economic and business conditions at both the national and regional levels as of December 31, 2021. Non-performing assets increased $3.6 million, or 127.3%, to $6.4 million at December 31, 2022 from $2.8 million at December 31, 2021. Non-performing assets represented 0.46% and 0.22% of total assets at December 31, 2022 and 2021, respectively.
The amount of the provision is determined by management’s on-going monthly analysis of the loan portfolio and the adequacy of the allowance for loan losses. The Company has established policies and procedures for evaluating and monitoring the credit quality of the loan portfolio and for the timely identification of potential problem loans including internal and external loan reviews. The adequacy of the allowance for loan losses is reviewed monthly by the Asset Classification Committee and quarterly by the Board of Directors.
Management’s monthly review of the adequacy of the allowance includes three main components. The first component is an analysis of loss potential in various homogeneous segments of the portfolio based on historical trends and the risk inherent in each category. The historical loss periods used to calculate these ratios can range from one to ten years depending on which period is deemed a more relevant indicator of future losses. 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, including but not limited to classified loans, non-accrual loans and TDRs. These loans are evaluated for impairment and recorded in accordance with accounting guidance. All TDRs and substantially all non-accrual loans are individually evaluated for impairment. In accordance with our policy, non-accrual commercial loans with a balance less than $200,000 and non-accrual non-commercial (consumer, HELOC, residential mortgage) loans with a balance less than $100,000 are deemed immaterial and therefore excluded from the individual impairment review. For each loan deemed impaired, management calculates a specific reserve for the amount in which the recorded investment in the loan exceeds the fair value. This estimate is based on a thorough analysis of the most probable source of repayment, which is typically liquidation of the collateral.
The third component is an analysis of changes in qualitative factors that may affect the portfolio, including but not limited to: relevant economic trends that could impact borrowers’ ability to repay, industry trends, changes in the volume and composition of the portfolio, credit concentrations, or lending policies and the experience and ability of the staff and Board of Directors. Management also reviews and incorporates certain ratios such as percentage of classified loans, average historical loan losses by loan category, delinquency percentages, and the assignment of percentage targets of reserves in each loan category when evaluating the allowance. Once the analysis is completed, the three components are combined and compared to the allowance amount. Based on this, charges are made to the provision as needed.
Management believes the allowance for loan losses at December 31, 2022 is adequate based on its best estimates of the losses inherent in the loan portfolio, although there can be no guarantee as to these estimates. In addition, bank regulatory agencies may require additional provisions to the allowance for loan losses based on their judgments and estimates as part of their examination process. Because the allowance for loan losses is an estimate, there can be no guarantee that actual loan losses will not exceed the allowance for loan losses, or that additional increases in the allowance for loan losses will not be required in the future. A further decline in national and local economic conditions as a result of inflation, a recession, unemployment, money supply fluctuations 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.
27
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Non-Interest Income
Non-interest income decreased $3.0 million or 23.9% to $9.6 million for the year ended December 31, 2022 from $12.6 million for the year ended December 31, 2021. The decrease in non-interest income was primarily attributable to decreases in gain on sales of loans and grant income. These decreases in non-interest income were partially offset by increases in service fees on deposit accounts, insurance commissions, trust income, and ATM and check card fee income.
Gain on sales of loans decreased $2.1 million or 55.6% to $1.7 million for the year ended December 31, 2022 compared to $3.8 million in 2021 as the dollar volume of loans sold to investors decreased. The Bank sold $48.5 million of loans in 2022 compared to $112.9 million during 2021.
Insurance commissions increased $174,000 or 28.5% to $784,000 for the year ended December 31, 2022 compared to $610,000 in 2021 due to an increase in the number of insurance policies sold. Trust income increased $110,000 or 7.6% to $1.5 million during the year ended December 31, 2022 compared to $1.4 million in 2021 due to an increase in assets under management. ATM and check card fee income increased $346,000 or 14.0% to $2.8 million for the year ended December 31, 2022 compared to $2.5 million in 2021 reflecting higher transaction volume.
The Bank received $171,000 and $1.8 million in grant income during the years ended December 31, 2022 and 2021, respectively. During 2022, the Bank was awarded a $171,000 grant by the Community Development Financial Institutions ("CDFI") Fund Bank Enterprise Award ("BEA") program for the Bank's continued community development financing and service activities in the most economically distressed communities. During 2021, the Bank was awarded a $1.8 million grant by the CDFI Fund Rapid Response Program ("RRP") created to provide certified CDFIs with resources to help counter the economic impact of COVID-19 in distressed and underserved communities. The grant proceeds were used to fund qualified loans within the Bank’s target market areas, which satisfied the performance obligation of the grant.
Non-Interest Expense
Non-interest expense increased $2.2 million or 6.8% to $34.2 million during the year ended December 31, 2022 compared to $32.0 million during 2021. The increase in non-interest expense was primarily due to increases in compensation and employee benefits, a write-down of the value of land held for sale and other non-interest expenses, partially offset by a decrease in consulting expenses.
Compensation and employee benefits increased $890,000 or 4.6% to $20.1 million during the year ended December 31, 2022 from $19.2 million for the year ended December 31, 2021 primarily due to annual cost of living increases and an increase in the number of full time equivalent employees as a result of our newest branch added during the first quarter of 2022. Occupancy expense also increased by $190,000 primarily due to the addition of our newest branch located in Columbia, South Carolina.
A write-down of the fair value of land held for sale during the year ended December 31, 2022 based on an updated appraisal resulted in a $433,000 increase in non-interest expense.
Consulting expense decreased $497,000 or 41.4% to $705,000 for the year ended December 31, 2022 compared to $1.2 million during the prior year. The decrease was primarily due to a one-time expense of $605,000 for IT related consulting expenses incurred in 2021.
The Company incurred costs of $10,000 from the operation of OREO properties during the year ended December 31, 2022, compared to a net recovery of $116,000 during the prior year during which OREO sales exceeded write-downs and other costs. There were no sales of OREO properties during 2022 and therefore, no gain on OREO sales during 2022 compared to $105,000 in 2021.
Other non-interest expense increased $1.3 million or 35.8% to $4.7 million for the year ended December 31, 2022 compared to $3.4 million during 2021 due to increased operations and the addition of our newest branch added in 2022. As a result of the COVID-19 pandemic, some branch locations were not open during all twelve months of 2021. As of May 2021, all branches had reopened and resumed normal business hours.
28
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 $800,000 or 22.8% to $2.7 million during the year ended December 31, 2022 compared to $3.5 million for the year ended December 31, 2021 due to higher pre-tax income in 2021. The Company's combined federal and state effective tax rate was 20.9% for 2022 compared to 21.6% for 2021.
Comparison of the Years Ended December 31, 2021 and 2020
A comparison of our operating results for the 2021 and 2020 fiscal years may be found under the heading “Comparison of Operating Results for the Years Ended December 31, 2021 and 2020” in our Annual Report to Shareholders which was filed as Exhibit 13 to our Annual Report on Form 10-K for the year ended December 31, 2021.
Net cost of operation of OREO includes all expenses associated with OREO properties, including write-downs in value and
29
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Regulatory Capital
The following table reconciles the Bank's shareholders' equity to its various regulatory capital positions.
| December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| (In Thousands) | |||||||||||
Bank’s Shareholders’ Equity (1) | $ | 142,652 | $ | 124,983 | |||||||
| Reduction for Goodwill | 1,200 | 1,200 | |||||||||
| Tangible Capital | 141,452 | 123,783 | |||||||||
| Core Capital | 141,452 | 123,783 | |||||||||
| Supplemental Capital | 9,956 | 8,923 | |||||||||
| Total Risk-Based Capital | $ | 151,408 | $ | 132,706 | |||||||
(1)EXCLUDES UNREALIZED (LOSSES) GAINS ON INVESTMENT SECURITIES OF $(40.8) MILLION and $5.2 MILLION AT DECEMBER 31, 2022 AND 2021, RESPECTIVELY.
The Bank is subject to minimum capital requirements imposed by the FDIC. Based on capital levels at December 31, 2022, the Bank was considered to be well capitalized. At December 31, 2022, the Bank exceeded all regulatory capital requirements with Tier 1 leverage-based capital, Tier 1 risk-based capital, total risk-based capital, and common equity Tier 1 (CET1) capital ratios of 10.4%, 17.8%, 19.0%, and 17.8%, respectively.
CET1 consists of Tier 1 capital less all capital components that are not considered common equity. In addition to the FDIC’s minimum capital ratios, the Bank is required to maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses. At December 31, 2022, the Bank’s capital conservation buffer was 11.0%.
For additional information regarding the Bank's and Company's regulatory capital compliance, see the discussion included in Note 16 of the Notes to Consolidated Financial Statements included herein.
30
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Liquidity and Capital Resources
Liquidity refers to the ability to generate sufficient cash flows to fund current loan demand, repay maturing borrowings, fund maturing deposit withdrawals, and meet operating expenses. The Bank's primary sources of funds include deposits, scheduled loan and investment security repayments, including interest payments, maturities and sales of loans and investment securities, borrowings from the FRB, advances from the FHLB and cash flow generated from operations. The need for funds varies among periods depending on funding needs as well as the rate of amortization and prepayment on loans. The use of borrowings from the FRB, FHLB advances and other borrowings varies depending on loan demand, deposit inflows, and the use of investment leverage strategies that we might employee to increase net interest income.
The principal use of the Bank's funds is the origination of mortgages and other loans and the purchase of investment securities. Originations of new loans and renewals of previously funded loans on loans held for investment were $557.1 million during the year ended December 31, 2022 compared to $438.4 million during the year ended December 31, 2021. Purchases of investment securities totaled $210.3 million during 2022 compared to $217.6 million during 2021. Other uses of the Bank's funds during the year ended December 31, 2022 included repurchases of subordinated debentures and dividend payments to shareholders.
In the normal course of business, the Company makes off-balance sheet arrangements, including credit commitments to its customers to meet their financial needs. These arrangements involve, to varying degrees, elements of credit and interest rate risk not recognized in the consolidated statement of financial condition. The Bank makes personal, commercial, and real estate lines of credit available to customers and does issue standby letters of credit.
Commitments to extend credit to customers are subject to the Bank’s normal credit policies and are essentially the same as those involved in extending loans to customers. Unused lines of credit on HELOCs, credit cards, and commercial loans amounted to $173.3 million at December 31, 2022. HELOCs are made on a floating rate basis with final maturities of 15 to 20 years. The Bank issues fixed rate credit cards, currently at 9.99%, and variable rate rewards credit cards with a floating rate equal to prime plus 9.99%. Credit cards are renewed every three years. The Bank had undisbursed loans-in-process of $22.7 million at December 31, 2022, which will be disbursed over an average of 90 days, and are included in the total unused commitments above. These commitments to originate loans and future advances of lines of credit are expected to be funded from loan amortizations and prepayments, deposit inflows, maturing investments, and short-term borrowing capacity. See Note 19 of the Notes to the Consolidated Financial Statements included herein for additional information regarding our commitments and off-balance sheet arrangements.
We incur capital expenditures on an ongoing basis to expand and improve our product offerings, enhance and modernize our technology infrastructure, and to introduce new technology-based products to compete effectively in our markets. We evaluate capital expenditure projects based on a variety of factors, including expected strategic impacts (such as forecasted impact on revenue growth, productivity, expenses, service levels and customer retention) and our expected return on investment. The amount of capital investment is influenced by, among other things, current and projected demand for our services and products, cash flow generated by operating activities, cash required for other purposes and regulatory considerations. Based on current capital allocation objectives, there are no projects scheduled for capital investments in premises and equipment during 2023 that would materially impact liquidity. We also have purchase obligations, generally with remaining terms of less than three years and contracts with various vendors to provide services, including information processing, for periods generally ranging from one to five years, for which our financial obligations are dependent upon acceptable performance by the vendor. For the year ending December 31, 2023, we project that fixed commitments will include $518,000 of operating lease payments. See Note 5 of the Notes to the Consolidated Financial Statements included herein for additional information regarding our operating leases.
The Bank’s liquidity has been positively impacted by increases in deposit levels in recent years. During the year ended December 31, 2022, deposits decreased by $5.9 million after increasing by $197.9 million during the year ended December 31, 2021. Our liquid assets in the form of cash and cash equivalents, certificates of deposit at other banks and investments increased to $747.2 million at December 31, 2022 from $735.1 million at December 31, 2021. Total certificates of deposit scheduled to mature in one year or less totaled $96.2 million at December 31, 2022 compared to $118.1 million at December 31, 2021. Management’s policy is to maintain deposit rates at levels that are competitive with other local financial institutions. Based on historical experience, we believe that a significant portion of maturing certificates of deposit will remain with the Bank.
31
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of Operations
Primary sources of short-term liquidity for the Bank include the Federal Reserve Bank discount window and a $50.0 million line of credit with the Pacific Coast Bankers Bank. In addition, at December 31, 2022, the Bank had $388.3 million in unused borrowing capacity at the FHLB. Management believes that future liquidity can be met through the Bank's deposit base, which had a balance of $1.11 billion at December 31, 2022, sales and maturities of investment securities, and loans sold to investors. During the years ended December 31, 2022 and 2021, the Bank sold $53.3 million and $118.4 million in loans, respectively.
Historically the Bank’s cash flow from operating activities has been relatively stable. The cash flows from investing activities vary with sales of investment securities and with the need to invest excess funds or utilize leverage strategies with the purchase of investment securities. The cash flows from financing activities vary depending on the need for borrowings from the FRB, FHLB advances and other borrowings. The Bank's management believes that the liquid assets combined with the available lines of credit provide adequate liquidity to meet current financial obligations for at least the next 12 months.
Security Federal Corporation is a separate legal entity from the Bank and must provide for its own liquidity and pay its own operating expenses. Sources of capital and liquidity for Security Federal Corporation include distributions from the Bank and the issuance of debt or equity securities, although there are regulatory restrictions on the ability of the Bank to pay dividends. At December 31, 2022, Security Federal Corporation (on an unconsolidated basis) had liquid assets of $28.8 million. The Company currently expects to continue the current practice of paying quarterly cash dividends on common stock subject to the Board of Directors' discretion to modify or terminate this practice at any time and for any reason without prior notice. Our current quarterly common stock dividend rate is $0.13 per share, as approved by our Board of Directors, which we believe is a dividend rate per share which enables us to balance our multiple objectives of managing and investing in the Bank, and returning a substantial portion of our cash to our shareholders. In addition to the quarterly dividends paid in 2022, the Company also paid a special cash dividend of $0.28 per share in 2022 to all shareholders of record as of March 31, 2022. Assuming continued payment during 2023 at this rate of $0.13 per share, our average total dividends paid each quarter would be approximately $422,875 based on the number of our current outstanding shares at December 31, 2022.
32
[Letterhead of Elliot Davis, LLP]
Report of Independent Registered Public Accounting Firm (PCAOB ID 149 )
To the Shareholders and the Board of Directors of Security Federal Corporation:
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Security Federal Corporation and its Subsidiaries (the Company) as of December 31, 2022 and 2021, the related consolidated statements of income, comprehensive income (loss), shareholders' equity and cash flows for each of the three years in the period ended December 31, 2022, and the related notes to the consolidated financial statements (collectively, the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2022 and 2021 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2022, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
33
Allowance for Loan Losses
As described in Note 4 to the Company’s financial statements, the Company has a gross loan portfolio of approximately $561.0 million and related allowance for loan losses of approximately $11.2 million as of December 31, 2022. As described by the Company in Note 1, the evaluation of the allowance for loan losses is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance for loan losses is evaluated on a regular basis and is based upon the Company’s review of the fair value of the underlying collateral, stated guarantees by the borrower (if applicable), the borrower’s ability to repay from other economic resources, growth and composition of the loan portfolio, the relationship of the allowance for loan losses to the outstanding loans, loss experience, delinquency trends, and general economic conditions.
We identified the Company’s estimate of the allowance for loan losses as a critical audit matter. The principal considerations for our determination of the allowance for loan losses as a critical audit matter related to the high degree of subjectivity in the Company’s judgments in determining the qualitative factors for collectively evaluated loans. Auditing these complex judgments and assumptions by the Company involves especially challenging auditor judgment due to the nature and extent of audit evidence and effort required to address these matters, including the extent of specialized skill or knowledge needed.
The primary procedures we performed to address this critical audit matter included the following:
•We evaluated the relevance and the reasonableness of assumptions related to evaluation of the loan portfolio, current economic conditions, and other risk factors used in development of the qualitative factors for collectively evaluated loans.
•We evaluated the reasonableness of assumptions and data used by the Company in developing the qualitative factors by comparing these data points to internally developed and third-party sources, and other audit evidence gathered.
•We performed analytical procedures to evaluate the directional consistency of changes that occurred in the qualitative factors for collectively evaluated loans.
•We validated the mathematical accuracy of the calculation.
We have served as the Company's auditor since 1998.
/s/ Elliott Davis, LLC
March 24, 2023
34
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
| December 31, | |||||||||||
| (Dollars in thousands) | 2022 | 2021 | |||||||||
| Assets: | |||||||||||
| Cash and Cash Equivalents | $ | $ | |||||||||
| Certificates of Deposit with Other Banks | |||||||||||
| Investment Securities: | |||||||||||
| Available For Sale ("AFS") | |||||||||||
Held To Maturity ("HTM") (Fair Value of $ | |||||||||||
| Total Investments | |||||||||||
| Loans Receivable, Net: | |||||||||||
| Held For Sale | |||||||||||
Held For Investment (Net of Allowance of $ | |||||||||||
| Total Loans Receivable, Net | |||||||||||
| Accrued Interest Receivable | |||||||||||
| Operating Lease Right-of-Use Assets | |||||||||||
| Land Held for Sale | |||||||||||
| 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: | |||||||||||
| Deposit Accounts | $ | $ | |||||||||
| Borrowings from Federal Reserve Bank ("FRB") | |||||||||||
| Other Borrowings | |||||||||||
| Junior Subordinated Debentures | |||||||||||
| Subordinated Debentures | |||||||||||
| Operating Lease Liabilities | |||||||||||
| Other Liabilities | |||||||||||
| Total Liabilities | |||||||||||
| Commitments (Note 19) | |||||||||||
| Shareholders' Equity: | |||||||||||
Senior Non-Cumulative Perpetual Preferred Stock, Series ECIP, $ | $ | $ | |||||||||
Common Stock, $ | |||||||||||
| Additional Paid-In Capital ("APIC") | |||||||||||
Treasury Stock, at Cost ( | ( | ( | |||||||||
| Accumulated Other Comprehensive (Loss) Income ("AOCI") | ( | ||||||||||
| Retained Earnings | |||||||||||
| Total Shareholders' Equity | |||||||||||
| Total Liabilities and Shareholders' Equity | $ | $ | |||||||||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
35
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
| Years Ended December 31, | |||||||||||
| (Dollars in thousands, except per share amounts) | 2022 | 2021 | |||||||||
| Interest Income: | |||||||||||
| Loans | $ | $ | |||||||||
| Investment Securities | |||||||||||
| Other | |||||||||||
| Total Interest Income | |||||||||||
| Interest Expense: | |||||||||||
| Deposits | |||||||||||
| FHLB Advances and Other Borrowings | |||||||||||
| Subordinated Debentures | |||||||||||
| Junior Subordinated Debentures | |||||||||||
| Total Interest Expense | |||||||||||
| Net Interest Income | |||||||||||
| (Reversal of) Provision for Loan Losses | ( | ||||||||||
| Net Interest Income after Provision for Loan Losses | |||||||||||
| Non-Interest Income: | |||||||||||
| (Loss) Gain on Sales of Investment Securities | ( | ||||||||||
| Gain on Sale of Loans | |||||||||||
| Service Fees on Deposit Accounts | |||||||||||
| Commissions From Insurance Agency | |||||||||||
| Trust Income | |||||||||||
| BOLI Income | |||||||||||
| ATM and Check Card Fee Income | |||||||||||
| Grant Income | |||||||||||
| Other | |||||||||||
| Total Non-Interest Income | |||||||||||
| Non-Interest Expense: | |||||||||||
| Compensation and Employee Benefits | |||||||||||
| Occupancy | |||||||||||
| Advertising | |||||||||||
| Depreciation and Maintenance of Equipment | |||||||||||
| FDIC Insurance Premiums | |||||||||||
| Net (Recovery) Expense from Operation of OREO | ( | ||||||||||
| Write Down of Land Held for Sale | |||||||||||
| Consulting | |||||||||||
| Debit Card Expenses | |||||||||||
| Other | |||||||||||
| Total Non-Interest Expense | |||||||||||
| Income Before Income Taxes | |||||||||||
| Provision For Income Taxes | |||||||||||
| Net Income | $ | $ | |||||||||
| Net Income Per Common Share (Basic) | $ | $ | |||||||||
| Cash Dividend Per Share On Common Stock | $ | $ | |||||||||
| Weighted Average Shares Outstanding (Basic) | |||||||||||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
36
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
| Years Ended December 31, | |||||||||||
| (Dollars in thousands) | 2022 | 2021 | |||||||||
| Net Income | $ | $ | |||||||||
| Other Comprehensive Loss | |||||||||||
| Unrealized Losses on Securities: | |||||||||||
Unrealized Holding Losses on AFS Securities, Net of Taxes of $( | ( | ( | |||||||||
Reclassification Adjustment for Losses (Gains) Included in Net Income, Net of Taxes of $( | |||||||||||
Amortization of Unrealized Gains (Losses) on AFS Securities Transferred to HTM, Net of Taxes of $ | |||||||||||
| Other Comprehensive Loss | ( | ( | |||||||||
| Comprehensive (Loss) Income | $ | ( | $ | ||||||||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
37
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
| Preferred Stock | Common Stock | Treasury Stock | ||||||||||||||||||||||||||||||||||||||||||||||||
| (Shares and Dollars in thousands) | Shares | Amount | Shares | Amount | Shares | Amount | APIC | AOCI (Loss) | Retained Earnings | Total | ||||||||||||||||||||||||||||||||||||||||
| December 31, 2020 | — | $ | — | $ | $ | ( | $ | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||||
| Net Income | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||
| Other Comprehensive Loss, Net of Tax | — | — | — | — | — | — | — | ( | — | ( | ||||||||||||||||||||||||||||||||||||||||
| Cash Dividends on Common Stock | — | — | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||
| December 31, 2021 | $ | — | $ | $ | ( | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||||
| Net Income | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||
| Other Comprehensive Loss, Net of Tax | — | — | — | — | — | — | — | ( | — | ( | ||||||||||||||||||||||||||||||||||||||||
| Preferred Stock Issuance | 83 | 82,949 | — | — | — | — | — | — | — | 82,949 | ||||||||||||||||||||||||||||||||||||||||
| Cash Dividends on Common Stock | — | — | — | — | — | — | — | — | ( | ( | ||||||||||||||||||||||||||||||||||||||||
| December 31, 2022 | $ | 82,949 | $ | $ | ( | $ | $ | ( | $ | $ | ||||||||||||||||||||||||||||||||||||||||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
38
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
| For the Years Ended December 31, | |||||||||||
| (Dollars in thousands) | 2022 | 2021 | |||||||||
| 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, Net | |||||||||||
| (Reversal of) Provisions for Loan Losses | ( | ||||||||||
Earnings on BOLI | ( | ( | |||||||||
Gain on Sales of Loans | ( | ( | |||||||||
| Loss (Gain) on Sales of Investments AFS | |||||||||||
Gain on Sales of OREO | ( | ||||||||||
Write Down on OREO | |||||||||||
| Write Down of Land Held For Sale ("HFS") | |||||||||||
| Proceeds From Sale of Loans HFS | |||||||||||
| Origination of Loans HFS | ( | ( | |||||||||
| Increase in Accrued Interest Receivable | ( | ( | |||||||||
Amortization of Operating Lease Right-of-Use ("ROU") Assets | |||||||||||
Other, Net | ( | ||||||||||
| Net Cash Provided By Operating Activities | |||||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||||||
| Purchase of Investments AFS | ( | ( | |||||||||
| Proceeds from Payments and Maturities of Investments AFS | |||||||||||
| Proceeds from Sale of Investments AFS | |||||||||||
| Purchase of Investments HTM | ( | ( | |||||||||
| Proceeds from Payments and Maturities of Investments HTM | |||||||||||
| Investment in Certificates of Deposits with Other Banks | ( | ||||||||||
| Purchase of FHLB Stock | ( | ( | |||||||||
| Redemption of FHLB Stock | |||||||||||
| Net 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: | |||||||||||
| (Decrease) Increase in Deposit Accounts | ( | ||||||||||
| Repayment of FHLB Advances | ( | ||||||||||
| Proceeds from Other Borrowings, Net | |||||||||||
| Repurchase of Subordinated Debentures | ( | ||||||||||
| Proceeds from Issuance of Preferred Stock | |||||||||||
| Proceeds from FRB Borrowings | |||||||||||
| Repayment of FRB Borrowings | ( | ( | |||||||||
| 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 Year | |||||||||||
| Cash and Cash Equivalents at End of Year | $ | $ | |||||||||
39
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
| For the Years Ended December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: | |||||||||||
| Cash Paid During the Period For: | |||||||||||
| Interest | $ | $ | |||||||||
| Income Taxes | $ | $ | |||||||||
| Supplemental Schedule of Non Cash Transactions: | |||||||||||
| Transfers From Premises and Equipment, Net to Land HFS | $ | $ | |||||||||
| Decrease in Unrealized Gains on Securities AFS, Net of Taxes | $ | ( | $ | ( | |||||||
| Initial Recognition of Lease ROU Assets | $ | — | $ | ||||||||
| Initial Recognition of Lease Liability | $ | — | $ | 282 | |||||||
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
40
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
The following is a description of the more significant accounting and reporting policies used in the preparation and presentation of the accompanying consolidated financial statements. All significant intercompany transactions have been eliminated in consolidation.
Basis of Consolidation and Nature of Operations
The accompanying consolidated financial statements include the accounts of Security Federal Corporation (the “Company”) and its wholly owned subsidiary, Security Federal Bank (the “Bank”) and the Bank’s wholly owned subsidiaries, Security Federal Investments, Inc. ("SFINV"), Security Federal Insurance, Inc. (“SFINS”), and Security Financial Services Corporation (“SFSC”). SFINV was formed to hold investment securities and allow for better management of the securities portfolio. SFINS is an insurance agency offering auto, business, and home insurance. Effective April 30, 2022, Collier Jennings Financial Corporation, a wholly owned subsidiary of SFINS, and its subsidiaries, Security Federal Auto Insurance, The Auto Insurance Store Inc., and Security Federal Premium Pay Plans Inc. ("SFPPP") and its wholly owned premium finance subsidiary were dissolved. SFPPP’s ownership interests in four other premium finance subsidiaries were disposed of at an immaterial gain. Additionally, effective April 30, 2022, previously inactive SFSC was dissolved. All significant intercompany transactions and balances have been eliminated in consolidation.
Investment Securities
Investment securities are classified in one of three categories: HTM, AFS, or trading. Management determines the appropriate classification of debt securities at the time of purchase. Investment securities are classified as HTM when the Company has the positive intent and ability to hold the securities to maturity. These securities are recorded at cost and adjusted for amortization of premiums and accretion of discounts over a level yield basis. Callable debt securities held at a premium are amortized until the earliest call date. Prepayment assumptions on mortgage-backed securities are anticipated.
Loans Receivable Held for Investment
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal balance adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest is recognized over the term of the loan based on the outstanding loan balance. Fees charged for originating loans, if any, are deferred and offset by the deferral of certain direct expenses associated with loans originated. The net deferred fees are recognized as yield adjustments by applying the interest method.
Allowance for Loan Losses
The Company provides for loan losses using the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to the allowance for loan losses. Additions to the allowance for loan losses are provided by charges to operations based on various factors, which, in management’s judgment, deserve current recognition in estimating possible losses. Such factors considered by management include the fair value of the underlying collateral, stated guarantees by the borrower (if applicable), the borrower’s ability to repay from other economic resources, growth and composition of the loan portfolio, the relationship of the allowance for loan losses to the outstanding loans, loss experience, delinquency trends, and general economic conditions. Management evaluates the carrying value of the loans periodically and the allowance is adjusted accordingly.
41
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The Company regularly re-evaluates its practices in determining the allowance for loan losses. During the year ended December 31, 2020, the Company increased its look-back period to incorporate the effects of at least one economic downturn in its loss history. The Company believes the extension of its look-back period is appropriate due to the risks inherent in the loan portfolio. Absent this extension, the early cycle periods in which the Company experienced significant losses would be excluded from the determination of the allowance for loan losses and its balance would decrease. For the year ended December 31, 2020, the Company increased its look-back period to 10 years to continue to include losses incurred by the Company beginning with the first quarter of 2011. The Company continued to use a look-back period of 10 years for the year ended December 31, 2022.
While management uses the best information available to make evaluations, future adjustments may be necessary if economic conditions differ substantially from the assumptions used in making these evaluations. The allowance for loan losses is subject to periodic evaluations by bank regulatory agencies that may require adjustments to be made to the allowance based upon the information that is available at the time of their examination.
The Company values impaired loans at the loan’s fair value if it is probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement at the present value of expected cash flows, the market price of the loan, if available, or the value of the underlying collateral less estimated selling costs. In accordance with our policy, non-accrual loans for commercial purposes which have a balance less than $200,000 and non-accrual non-commercial loans (HELOCs, consumer residential mortgage and other consumer loans) with a balance less than $100,000 are deemed immaterial and therefore excluded from the individual impairment review. Expected cash flows are required to be discounted at the loan’s effective interest rate. When the ultimate collectability of an impaired loan’s principal is in doubt, wholly or partially, all cash receipts are applied to principal. When this doubt does not exist, cash receipts are applied under the contractual terms of the loan agreement first to interest and then to principal. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries of any amounts previously charged off.
The Company did not designate loans with payment deferrals granted due to the novel coronavirus of 2019 (“COVID-19’) pandemic as delinquent or impaired in accordance with provisions of The Coronavirus Aid, Relief, and Economic Security Act of 2020 (the “CARES Act”) and the Consolidated Appropriations Act, 2021 (the “CAA, 2021”) and related regulatory guidance. Additional analysis was also completed on the allowance for loan losses during 2021 and 2020 based on the significance of loan modifications in accordance with the CARES Act and regulatory guidance and loan risk rating downgrades as well as additional risk factors related to COVID-19.
Loans Receivable Held for Sale
The Company originates fixed rate residential loans on a servicing released basis in the secondary market. Loans closed but not yet settled with institutional investors are carried in the Company’s loans held for sale portfolio. These loans are fixed rate residential loans that have been originated in the Company’s name and have closed. Virtually all of these loans have commitments to be purchased by investors and the majority of these loans were locked in by price with the investors on the same day or shortly thereafter that the loan was locked in with the Company’s customers. Therefore, these loans present very little market risk for the Company.
The Company usually delivers to, and receives funding from, the investor within 30 days. Commitments to sell these loans to the investor are considered derivative contracts and are sold to investors on a “best efforts" basis. The Company is not obligated to deliver a loan or pay a penalty if a loan is not delivered to the investor. As a result of the short-term nature of these derivative contracts, the fair value of the mortgage loans held for sale in most cases is the same as the value of the loan amount at its origination.
Other Real Estate Owned
Other real estate owned represents real estate and other assets acquired through foreclosure or repossession and are initially recorded at the estimated fair value less costs to sell. Subsequent improvements are capitalized. Costs of holding real estate, such as property taxes, insurance, general maintenance and interest expense, are expensed as a period cost. Fair values are reviewed regularly and allowances for possible losses are established when the carrying value of the asset owned exceeds the fair value less estimated costs to sell. Fair values are generally determined by reference to an outside appraisal.
42
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Premises and Equipment
Premises and equipment are carried at cost, net of accumulated depreciation. Depreciation of premises and equipment is amortized on a straight-line method over the estimated useful life of the related asset. Estimated lives are 7 to 40 years for buildings and improvements and generally 3 to 10 years for furniture, fixtures and equipment. Maintenance and repairs are charged to current expense. The cost of major renewals and improvements are capitalized.
Land Held for Sale
During the year ended December 31, 2021, the Company transferred three parcels of land with a combined book balance of $1.5 million from premises and equipment to land held for sale. Land held for sale is reported at the lower of the carrying amount and fair value less costs to sell. During the year ended December 31, 2022, the Company recorded a write down on land for sale totaling $433 thousand due to a reduction in fair value less costs to sell. No write down was recorded during 2021.
Income Taxes
Income tax expense or benefit is recognized for the net change in the deferred tax liability or asset during the year. That amount together with income taxes currently payable is the total amount of income tax expense or benefit for the year. Deferred taxes are provided for by the differences in financial reporting bases for assets and liabilities compared with their tax bases. Generally, a current tax liability or asset is established for taxes presently payable or refundable and a deferred tax liability or asset is established for future tax items. A valuation allowance, if applicable, is established for deferred tax assets that may not be realized. Deferred income taxes are provided for differences between the provision for loan losses for financial statement purposes and those allowed for income tax purposes.
Loan Fees and Costs Associated with Originating Loans
Loan fees received, net of direct incremental costs of originating loans, are deferred and amortized over the contractual life of the related loan. The net fees are recognized as yield adjustments by applying the interest method. Prepayments are not anticipated.
Interest Income
Interest on loans is accrued and credited to income monthly based on the principal balance outstanding and the contractual rate on the loan. The Company places loans on non-accrual status when they become greater than 90 days delinquent or when, in the opinion of management, full collection of principal or interest is unlikely. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received first to principal and then to interest income. The loans are returned to an accrual status when full collection of principal and interest appears likely.
Advertising Expense
Advertising and public relations costs are generally expensed as incurred. External costs relating to direct mailing are expensed in the period in which the direct mailings are sent. Advertising and public relations costs of $1.0 million and $1.1 million were included in the Company’s results of operations for the years ended December 31, 2022 and 2021, respectively.
43
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Stock-Based Compensation
The Company accounts for compensation costs under its stock option plans using the fair value method. This method requires the measurement of the cost of employee services received in exchange for an award of equity instruments based upon the fair value of the award on the grant date. The cost of the award is recognized in the income statement over the vesting period of the award.
Net Income Per Common Share
Accounting guidance specifies 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 as of December 31, 2022 and 2021; and therefore, no dilutive options in the calculation of diluted EPS for those periods. The following tables show the Company’s net income per common share for the years indicated.
| Year Ended December 31, | |||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||
| (Dollars in thousands, except EPS) | Income | Shares | EPS | Income | Shares | EPS | |||||||||||||||||
| Basic EPS | $ | $ | $ | 3,252,884 | $ | ||||||||||||||||||
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of income and expenses during the reporting periods. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes include:
• Determination of the allowance for loan losses and provision for credit losses
• Valuation of real estate acquired in conjunction with foreclosures or in satisfaction of loans
• Income taxes, including tax provisions and realization of deferred tax assets
• Fair value of assets and liabilities
Operating Segments
Accounting standards require that information be reported about a company’s operating segments using a “management approach.” Reportable segments are identified in these standards as those revenue producing components for which separate financial information is produced internally and which are subject to evaluation by the chief operating decision maker. While the chief operating decision maker monitors the revenue streams of the various products and services, operations are managed, and financial performance is evaluated on a Company-wide basis. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable segment.
44
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Recently Issued or Adopted Accounting Standards
The following is a summary of recent authoritative pronouncements that could affect accounting, reporting, and disclosure of financial information by the Company:
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The new guidance, which was further modified by subsequent related updates, replaces the incurred loss impairment framework in current GAAP with a current expected credit loss (“CECL”) framework, which requires an estimate of credit losses for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts and generally applies to financial assets measured at amortized cost and some off-balance sheet credit exposures. Financial assets measured at amortized cost will be presented at the net amount expected to be collected by using an allowance for credit losses. Credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses prospectively, with such allowance limited to the amount by which fair value is below amortized cost.
The Company adopted Accounting Standards Codification (“ASC”) 326 as of January 1, 2023 using the modified retrospective method for loans, leases and off-balance sheet credit exposures. Adoption of this guidance resulted in a $2.0 million increase in the allowance for credit losses, comprised of increases in the allowance for loan losses of $800,000 and the reserve for unfunded commitments of $1.2 million. The cumulative effect adjustment to retained earnings was $1.6 million, net of tax. Calculated credit losses on held-to-maturity debt securities were not material and there was no impact to the available-for-sale portfolio or other financial instruments. The allowance for loan losses for the majority of loans was calculated using a remaining life loss methodology applied to fourteen portfolios with a two quarter reasonable and supportable forecast period and an immediate reversion period. In connection with the adoption, management has implemented changes to relevant systems, processes and controls where necessary. Model validation was completed during the fourth quarter of 2022. In addition, management is in the final stages of implementing the accounting, reporting and governance processes to comply with the new guidance. The Company's expected credit loss will fluctuate over time due to macroeconomic conditions and forecasts as well as the size and composition of the loan portfolios.
In March 2022, the FASB amended the Receivables–Troubled Debt Restructuring by Creditors subtopic and Financial Instruments–Credit Losses subtopic to the Accounting Standards Codification. The amendments eliminate the accounting guidance for TDRs by creditors while enhancing disclosure requirements for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. In addition, for public business entities, the amendments require disclosure of current-period gross write-offs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20. The amendments are effective as of January 1, 2023 and will not have a material effect on the Company’s financial statements.
In December 2022, the FASB issued amendments to extend the period of time preparers can use the reference rate reform relief guidance under ASC Topic 848 from December 31, 2022, to December 31, 2024, to address the fact that all London Interbank Offered Rate ("LIBOR") tenors were not discontinued as of December 31, 2021, and some tenors will be published until June 2023. The amendments are effective immediately for all entities and are applied prospectively. The Company does not expect these amendments to have a material effect on its financial statements.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting authorities are not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.
45
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 2 - INVESTMENTS, AVAILABLE FOR SALE
AFS securities are recorded at fair market value. The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of AFS securities at the dates indicated were as follows:
| December 31, 2022 | |||||||||||||||||||||||
| (Dollars in thousands) | 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 ("MBS") | |||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||
| (Dollars in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair value | |||||||||||||||||||
| Student Loan Pools | $ | $ | $ | $ | |||||||||||||||||||
| SBA Bonds | |||||||||||||||||||||||
| Tax Exempt Municipal Bonds | |||||||||||||||||||||||
| Taxable Municipal Bonds | |||||||||||||||||||||||
| MBS | |||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||
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. The majority of the Bank's MBS are issued or guaranteed by an agency of the United States government such as Ginnie Mae, or by Government Sponsored Entities ("GSEs"), including Fannie Mae and Freddie Mac. Ginnie Mae MBS are backed by the full faith and credit of the United States government, while those issued by GSEs are not. Also included in MBS are private label collateralized mortgage obligation ("CMO") securities, which are issued by non-governmental real estate mortgage investment conduits and are not backed by the full faith and credit of the United States government. At December 31, 2022 the Bank held an amortized cost and fair value of $60.1 million and $53.8 million in private label CMO securities, compared to an amortized cost and fair value of $41.8 million and $41.7 million at December 31, 2021, respectively.
The amortized cost and fair value of investments AFS at December 31, 2022 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 MBS are not due at a single maturity date, they are disclosed separately, rather than allocated over the maturity groupings below.
| (Dollars in thousands) | Amortized Cost | Fair Value | |||||||||
| Due in less than one year | $ | $ | |||||||||
| Due in one year to five years | |||||||||||
| Due in five to ten years | |||||||||||
| Due in ten years or more | |||||||||||
| MBS | |||||||||||
| $ | $ | ||||||||||
46
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The amortized cost and fair value of AFS investments pledged as collateral for certain deposit accounts, FHLB advances and other borrowings were $318.0 million and $297.0 million at December 31, 2022, and $335.6 million and $342.6 million at December 31, 2021, respectively.
The Bank received $22.4 million in gross proceeds from sales of AFS securities and recognized gross gains of $159,000 and gross losses of $161,000 during the year ended December 31, 2022. There were no sales of AFS securities during the year ended December 31, 2021, and therefore, no proceeds from sales, gross gains or gross losses were recorded during that year.
The following tables summarize gross unrealized losses and the related fair value, aggregated by investment category and length of time that individual AFS securities have been in a continuous unrealized loss position at the dates indicated.
| December 31, 2022 | |||||||||||||||||||||||||||||||||||
| Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||||||||||||
| Student Loan Pools | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| SBA Bonds | |||||||||||||||||||||||||||||||||||
| Tax Exempt Municipal Bonds | |||||||||||||||||||||||||||||||||||
| Taxable Municipal Bonds | |||||||||||||||||||||||||||||||||||
| MBS | |||||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||||||||
| Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||||||||||||
| Student Loan Pools | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| SBA Bonds | |||||||||||||||||||||||||||||||||||
| Taxable Municipal Bonds | |||||||||||||||||||||||||||||||||||
| MBS | |||||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
At December 31, 2022 and 2021, there were 416 and 199 individual AFS securities in a loss position, including 211 and 83 securities that were in a loss position for greater than 12 months, respectively. The Company has the ability and intent to hold these securities until such time as the value recovers or the securities mature. The Company believes, based on industry analyst reports and credit ratings, that the deterioration in value is attributable to changes in market interest rates and is not in the credit quality of the issuer and therefore, these losses are not considered other-than-temporary. The Company reviews its investment securities portfolio at least quarterly and more frequently when economic conditions warrant, assessing whether there is any indication of other-than-temporary impairment (“OTTI”).
Factors considered in the Company's review of its investment securities portfolio include estimated future cash flows, length of time and extent to which market value has been less than cost, the financial condition and near term prospects of the issuer, and our intent and ability to retain the security to allow for an anticipated recovery in market value. If the review determines that there is OTTI, then an impairment loss is recognized in earnings equal to the entire difference between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made, or the Company may recognize a portion of the impairment in other comprehensive income. The fair value of investments on which OTTI is recognized then becomes the new cost basis of the investment. There was no OTTI recognized during the years ended December 31, 2022 and 2021.
47
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 3 - INVESTMENTS, HELD TO MATURITY
HTM securities are recorded at amortized cost. The amortized cost, gross unrealized gains, gross unrealized losses, and fair values of HTM securities at the dates indicated were as follows:
| December 31, 2022 | |||||||||||||||||||||||
| (Dollars in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||||||||
| US Treasury Bonds | $ | $ | $ | $ | |||||||||||||||||||
| FHLB Bond | |||||||||||||||||||||||
| Student Loan Pools | |||||||||||||||||||||||
| SBA Bonds | |||||||||||||||||||||||
| Taxable Municipal Bonds | |||||||||||||||||||||||
| MBS | |||||||||||||||||||||||
| Total HTM | $ | $ | $ | $ | |||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||
| (Dollars in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||||||||
| MBS | $ | $ | $ | $ | |||||||||||||||||||
| Total HTM | $ | $ | $ | $ | |||||||||||||||||||
At December 31, 2022, the amortized cost and fair value of HTM securities that were pledged as collateral for certain deposit accounts, FHLB advances and other borrowings were $25.3 million and $24.5 million compared to an amortized cost and fair value of $9.0 million and $9.5 million at December 31, 2021, respectively.
The following tables summarize gross unrealized losses and the related fair value, aggregated by investment category and length of time that individual HTM securities have been in a continuous unrealized loss position at the dates indicated.
| December 31, 2022 | |||||||||||||||||||||||||||||||||||
| Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||||||||||||
| US Treasury Bonds | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| FHLB Bond | |||||||||||||||||||||||||||||||||||
| Student Loan Pools | |||||||||||||||||||||||||||||||||||
| Taxable Municipal Bonds | |||||||||||||||||||||||||||||||||||
| MBS | |||||||||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||||||||
| Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | |||||||||||||||||||||||||||||
| MBS | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||||||||
At December 31, 2022 and 2021, 54 and six individual HTM securities were in a loss position, including six and two securities that were in a loss position for greater than 12 months, respectively. The Company believes, based on industry analyst reports and credit ratings, that the deterioration in value was attributable to changes in market interest rates and was not in the credit quality of the issuer and therefore, the loss was not considered other-than-temporary. The Company has the ability and intent to hold these securities to maturity.
48
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 4 - LOANS RECEIVABLE, NET
Loans receivable, net, at the dates indicated are summarized as follows:
| December 31, | |||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||
| (Dollars in thousands) | Balance | % of Total Gross Loans | Balance | % of Total Gross Loans | |||||||||||||||||||
| Real Estate Loans: | |||||||||||||||||||||||
| Construction | $ | 20.1 | % | $ | 19.7 | % | |||||||||||||||||
| Residential Mortgage | 19.6 | % | 16.8 | % | |||||||||||||||||||
| Commercial | 44.9 | % | 44.9 | % | |||||||||||||||||||
| Other Commercial and Agricultural Loans | 5.5 | % | 8.8 | % | |||||||||||||||||||
| Consumer Loans: | |||||||||||||||||||||||
| Home Equity Lines of Credit ("HELOC") | 5.7 | % | 5.6 | % | |||||||||||||||||||
| Other Consumer Loans | 4.2 | % | 4.2 | % | |||||||||||||||||||
| Total Loans Held For Investment, Gross | 100.0 | % | 100.0 | % | |||||||||||||||||||
| Less: | |||||||||||||||||||||||
| Allowance For Loan Losses | |||||||||||||||||||||||
| Deferred Loan Fees | |||||||||||||||||||||||
| Loans Receivable Held For Investment, Net | $ | $ | |||||||||||||||||||||
During 2022, the Bank continued its participation in the SBA's Paycheck Protection Program (“PPP”) by processing applications for PPP loan forgiveness. PPP loans are included in Commercial and Agricultural loans in the tables above and below and had a total balance of $12,000 at December 31, 2022 compared to $9.8 million at December 31, 2021. There were no remaining unamortized net deferred fees on PPP loans at December 31, 2022 compared to $441,000 at December 31, 2021.
Credit Quality Indicators
The Bank categorizes loans into risk categories based on relevant information regarding the borrowers' ability to payoff their loan in accordance with its terms. This information includes; but is not limited to, current financial and credit documentation, payment history, public information and current economic trends, among other factors. Risk ratings are used to rate the credit quality of loans for the purposes of determining the Bank’s allowance for loan losses. The following definitions are used for credit quality risk ratings:
Pass - 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.
Caution - loans that do not currently expose the Bank to sufficient risk to warrant adverse classification but possess weaknesses.
Special Mention - loans that do not currently expose the Bank to sufficient risk to warrant adverse classification but possess more weaknesses than Caution loans.
Substandard - 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.
49
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following tables summarize the loan grades used by the Bank to measure the credit quality of gross loans receivable, excluding those held for sale, by loan segment at the dates indicated.
| December 31, 2022 | |||||||||||||||||||||||||||||
| (Dollars in thousands) | Pass | Caution | Special Mention | Substandard | Total Loans | ||||||||||||||||||||||||
| Construction Real Estate | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Residential Real Estate | |||||||||||||||||||||||||||||
| Commercial Real Estate | |||||||||||||||||||||||||||||
| Commercial and Agricultural | |||||||||||||||||||||||||||||
| Consumer HELOC | |||||||||||||||||||||||||||||
| Other Consumer | |||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||
| (Dollars in thousands) | Pass | Caution | Special Mention | Substandard | Total Loans | ||||||||||||||||||||||||
| Construction Real Estate | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Residential Real Estate | |||||||||||||||||||||||||||||
| Commercial Real Estate | |||||||||||||||||||||||||||||
| Commercial and Agricultural | |||||||||||||||||||||||||||||
| Consumer HELOC | |||||||||||||||||||||||||||||
| Other Consumer | |||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Past Due and Non-accrual Loans
The following tables present an age analysis of past due balances by category at the dates indicated.
| December 31, 2022 | |||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | 30-59 Days Past Due | 60-89 Days Past Due | 90 Days or More Past Due | Total Past Due | Current | Total Loans Receivable | |||||||||||||||||||||||||||||
| Construction Real Estate | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Residential Real Estate | |||||||||||||||||||||||||||||||||||
| Commercial Real Estate | |||||||||||||||||||||||||||||||||||
| Commercial and Agricultural | |||||||||||||||||||||||||||||||||||
| Consumer HELOC | |||||||||||||||||||||||||||||||||||
| Other Consumer | |||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | 30-59 Days Past Due | 60-89 Days Past Due | 90 Days or More Past Due | Total Past Due | Current | Total Loans Receivable | |||||||||||||||||||||||||||||
| Construction Real Estate | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Residential Real Estate | |||||||||||||||||||||||||||||||||||
| Commercial Real Estate | |||||||||||||||||||||||||||||||||||
| Commercial and Agricultural | |||||||||||||||||||||||||||||||||||
| Consumer HELOC | |||||||||||||||||||||||||||||||||||
| Other Consumer | |||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
50
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
At December 31, 2022 and 2021, the Bank did not have any loans that were 90 days or more past due and still accruing interest. Our strategy is to work with our borrowers to reach acceptable payment plans while protecting our interests in the existing collateral. In the event an acceptable arrangement cannot be reached, we may have to acquire these properties through foreclosure or other means and subsequently sell, develop, or liquidate them.
The following table shows non-accrual loans by category at the dates indicated.
| December 31, 2022 | December 31, 2021 | Increase (Decrease) | |||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Amount | Percent (1) | Amount | Percent (1) | $ | % | |||||||||||||||||||||||||||||
| Non-accrual Loans: | |||||||||||||||||||||||||||||||||||
| Construction Real Estate | $ | % | $ | % | $ | % | |||||||||||||||||||||||||||||
| Residential Real Estate | |||||||||||||||||||||||||||||||||||
| Commercial Real Estate | |||||||||||||||||||||||||||||||||||
| Commercial and Agricultural | |||||||||||||||||||||||||||||||||||
| Consumer HELOC | |||||||||||||||||||||||||||||||||||
| Other Consumer | |||||||||||||||||||||||||||||||||||
| Total Non-accrual Loans | $ | % | $ | % | $ | % | |||||||||||||||||||||||||||||
(1) PERCENT OF GROSS LOANS RECEIVABLE HELD FOR INVESTMENT, NET OF DEFERRED FEES
Allowance for Loan Losses
The tables below show the allowance for loan losses by loan category for the years indicated.
| For the Year Ended December 31, 2022 | ||||||||||||||||||||||||||||||||||||||||||||
| Real Estate | Consumer | |||||||||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Construction | Residential | Commercial | Commercial and Agricultural | HELOC | Other | Total | |||||||||||||||||||||||||||||||||||||
| Beginning Balance | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||
| (Provision for) Reversal of loan losses | ( | ( | ( | |||||||||||||||||||||||||||||||||||||||||
| Charge-Offs | ( | ( | ( | |||||||||||||||||||||||||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||||||||||||||||||
| Ending Balance | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||
| For the Year Ended December 31, 2021 | ||||||||||||||||||||||||||||||||||||||||||||
| Real Estate | Consumer | |||||||||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Construction | Residential | Commercial | Commercial and Agricultural | HELOC | Other | Total | |||||||||||||||||||||||||||||||||||||
| Beginning Balance | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||
| (Provision for) Reversal of loan losses | ( | ( | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||
| Charge-Offs | ( | ( | ( | ( | ||||||||||||||||||||||||||||||||||||||||
| Recoveries | ||||||||||||||||||||||||||||||||||||||||||||
| Ending Balance | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||
51
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Allowance for Loan Losses and Loans Receivable Evaluated for Impairment
The following tables summarize the impaired loans evaluated individually and collectively for impairment within the allowance for loan losses and loans receivable balances at the dates indicated.
| December 31, 2022 | |||||||||||||||||||||||||||||||||||
| Allowance For Loan Losses | Loans Receivable | ||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Individually Evaluated For Impairment | Collectively Evaluated For Impairment | Total | Individually Evaluated For Impairment | Collectively Evaluated For Impairment | Total | |||||||||||||||||||||||||||||
| Construction Real Estate | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Residential Real Estate | |||||||||||||||||||||||||||||||||||
| Commercial Real Estate | |||||||||||||||||||||||||||||||||||
| Commercial and Agricultural | |||||||||||||||||||||||||||||||||||
| Consumer HELOC | |||||||||||||||||||||||||||||||||||
| Other Consumer | |||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||||||||
| Allowance For Loan Losses | Loans Receivable | ||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Individually Evaluated For Impairment | Collectively Evaluated For Impairment | Total | Individually Evaluated For Impairment | Collectively Evaluated For Impairment | Total | |||||||||||||||||||||||||||||
| Construction Real Estate | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| Residential Real Estate | |||||||||||||||||||||||||||||||||||
| Commercial Real Estate | |||||||||||||||||||||||||||||||||||
| Commercial and Agricultural | |||||||||||||||||||||||||||||||||||
| Consumer HELOC | |||||||||||||||||||||||||||||||||||
| Other Consumer | |||||||||||||||||||||||||||||||||||
| 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 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.
52
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following tables present information related to impaired loans by loan category as of and for the years indicated.
| December 31, 2022 | |||||||||||||||||||||||||||||
Impaired Loans (Dollars in thousands) | Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | Interest Income Recognized | ||||||||||||||||||||||||
| Construction Real Estate | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Residential Real Estate | |||||||||||||||||||||||||||||
| Commercial Real Estate | |||||||||||||||||||||||||||||
| Commercial and Agricultural | |||||||||||||||||||||||||||||
| Consumer HELOC | |||||||||||||||||||||||||||||
| Other Consumer | |||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | 5,715 | $ | |||||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||
Impaired Loans (Dollars in thousands) | Recorded Investment | Unpaid Principal Balance | Related Allowance | Average Recorded Investment | Interest Income Recognized | ||||||||||||||||||||||||
| Construction Real Estate | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
| Residential Real Estate | |||||||||||||||||||||||||||||
| Commercial Real Estate | |||||||||||||||||||||||||||||
| Commercial and Agricultural | |||||||||||||||||||||||||||||
| Consumer HELOC | |||||||||||||||||||||||||||||
| Other Consumer | — | ||||||||||||||||||||||||||||
| Total | $ | $ | 3,736 | $ | $ | 2,426 | $ | ||||||||||||||||||||||
Troubled Debt Restructurings and Loan Modifications
In the course of resolving delinquent loans, the Bank may choose to restructure the contractual terms of certain loans. A troubled debt restructuring ("TDR") is a restructuring in which the Bank, for economic or legal reasons related to a borrower’s financial difficulties, grants a concession to a borrower that it would not otherwise consider (ASC Topic 310-40). The concessions granted on TDRs generally include terms to reduce the interest rate, extend the term of the debt obligation, or modify the payment structure on the debt obligation. The Bank grants such concessions to reassess the borrower’s financial status and develop a plan for repayment.
At the date of modification, TDRs are initially classified as nonaccrual TDRs. They are returned to accruing status when there is economic substance to the restructuring, there is documented credit evaluation of the borrower's financial condition, the remaining balance is reasonably assured of repayment in accordance with its modified terms, and the borrower has demonstrated sustained repayment performance in accordance with the modified terms for a reasonable period of time (generally a minimum of six months).
The Bank had two TDRs with a total balance of $385,000 included in impaired loans at December 31, 2022 compared to three TDRs totaling $694,000 at December 31, 2021. There were no loans restructured as TDRs during 2022 compared to one commercial real estate loan restructured as a TDR during 2021 with a balance of $412,000 at the time of restructure and immediately thereafter. At December 31, 2022 and 2021, there were no TDRs in default. The Bank considers any loan 30 days or more past due to be in default. At December 31, 2022 and 2021, the Bank had no commitments to extend additional credit to borrowers whose loan terms have been modified in a TDR. All TDRs are also classified as impaired loans and are included in the loans individually evaluated for impairment.
53
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Our policy with respect to accrual of interest on loans restructured as a TDR follows relevant supervisory guidance. That is, if a borrower has demonstrated performance under the previous loan terms and shows capacity to perform under the restructured loan terms, continued accrual of interest at the restructured interest rate is probable. If a borrower was materially delinquent on payments prior to the restructuring but shows capacity to meet the restructured loan terms, the loan will likely continue as nonaccrual going forward. Lastly, if the borrower does not perform under the restructured terms, the loan is placed on nonaccrual status.
The Bank will continue to closely monitor these loans and will cease accruing interest on them if management believes that the borrowers may not continue performing based on the restructured note terms. If, after previously being classified as a TDR, a loan is restructured a second time, then that loan is automatically placed on nonaccrual status. The Bank's policy with respect to nonperforming loans requires the borrower to become current and then make a minimum of six consecutive payments in accordance with the loan terms before that loan can be placed back on accrual status. Further, the borrower must show capacity to continue performing into the future prior to restoration of accrual status.
NOTE 5 - PREMISES AND EQUIPMENT, NET AND LEASES
Premises and equipment, net, at the dates indicated are summarized as follows:
| December 31, | |||||||||||
| (Dollars in thousands) | 2022 | 2021 | |||||||||
| Land | $ | $ | |||||||||
| Buildings and Improvements | |||||||||||
| Furniture and Equipment | |||||||||||
| Construction in Progress | |||||||||||
| Total Premises and Equipment | |||||||||||
| Less: Accumulated Depreciation | ( | ( | |||||||||
| Total Premises and Equipment, Net | $ | $ | |||||||||
Construction in progress of $3.0 million at December 31, 2022 primarily included building and construction costs associated with our newest branch, which is scheduled for opening in 2023. At December 31, 2022 the estimated additional costs to complete and equip the branch was approximately $1.9 million. Depreciation expense on premises and equipment was $2.0 million and $2.0 million for the years ended December 31, 2022 and 2021, respectively.
The Bank has operating leases on six of its branches. During the year ended December 31, 2022, the Company made cash payments in the amount of $499,000 for operating leases. The lease expense recognized during this period was $512,000 recorded in occupancy expense within the Consolidated Statements of Income. The lease liability had a net decrease of $389,000. At December 31, 2022, the Bank had ROU assets of $1.9 million and a lease liability of $1.9 million recorded on its consolidated balance sheet compared to ROU assets of $2.3 million and a lease liability of $2.3 million at December 31, 2021. The lease agreements have maturity dates ranging from 2023 through 2027, some of which include options for multiple five or ten year extensions. At December 31, 2022, the remaining weighted average lease term was 4.17 years and the weighted average discount rate used was 3.3%.
54
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
At December 31, 2022, future undiscounted lease payments for operating leases with initial terms of one year or more were as follows:
| Year ended December 31, | (Dollars in thousands) | ||||
| 2023 | $ | 518 | |||
| 2024 | 522 | ||||
| 2025 | 475 | ||||
| 2026 | 364 | ||||
| 2027 | 147 | ||||
| Thereafter | 9 | ||||
| Total undiscounted lease payments | 2,035 | ||||
| Less: effect of discounting | 131 | ||||
| Present value of estimated lease payments (lease liability) | $ | 1,904 | |||
NOTE 6 - GOODWILL
NOTE 7 - FHLB STOCK
NOTE 8 - OTHER REAL ESTATE OWNED
The Bank owned $120,000 and $130,000 in OREO at December 31, 2022 and 2021, respectively. Transactions in OREO for the years indicated are summarized as follows:
| (Dollars in thousands) | 2022 | 2021 | |||||||||||||||
| Balance, beginning of year | $ | $ | |||||||||||||||
| Additions | |||||||||||||||||
| Sales | ( | ||||||||||||||||
| Write-downs | ( | ( | |||||||||||||||
| Balance, end of year | $ | $ | |||||||||||||||
There were no sales of OREO properties during the year ended December 31, 2022 compared to two OREO properties sold during the year ended December 31, 2021 for gross proceeds of $454,000, which resulted in a related gain on sale of OREO in the amount of $105,000.
55
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 9 - DEPOSITS
Deposits outstanding at the dates indicated are summarized below by account type as follows:
Deposit Type (Dollars in thousands) | December 31, 2022 | December 31, 2021 | ||||||||||||
| Checking | $ | $ | ||||||||||||
| Money Market | ||||||||||||||
| Savings | ||||||||||||||
| Certificates of Deposit | ||||||||||||||
| Total Deposits | $ | $ | ||||||||||||
The Bank had $5.0 million in brokered deposits which are included in checking and money market deposits above at December 31, 2022 and 2021. In addition, the Bank had $6.0 million and $10.0 million in brokered time deposits at December 31, 2022 and 2021, with a weighted average interest rate of 0.30 % and 0.26 %, respectively. Brokered time deposits are included in certificates of deposit above and below. The $6.0 million balance at December 31, 2022 will mature within one year. At December 31, 2022 and 2021, the Bank had $98,000 and $68,000 , respectively, in overdrafts that were reclassified to loans.
Certificate of deposits that met or exceeded the FDIC insurance limit of $250,000 were $30.3 million and $39.4 million at December 31, 2022 and 2021, respectively.
The amounts and scheduled maturities of all certificates of deposit at the dates indicated were as follows:
| December 31, | |||||||||||
| (Dollars in thousands) | 2022 | 2021 | |||||||||
| Within 1 Year | $ | $ | |||||||||
| After 1 Year, Within 2 Years | |||||||||||
| After 2 Years, Within 3 Years | |||||||||||
| After 3 Years, Within 4 Years | |||||||||||
| After 4 Years, Within 5 Years | |||||||||||
| Total Certificates of Deposits | $ | $ | |||||||||
56
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 10 - FHLB ADVANCES AND FRB BORROWINGS
There were no outstanding FHLB advances at December 31, 2022 and 2021. FHLB advances are secured by a blanket collateral agreement with the FHLB by pledging the Bank’s portfolio of residential first mortgage loans and investment securities. The Bank's pledged collateral for FHLB advances had an amortized cost and fair value of $70.1 million and $61.1 million at December 31, 2022 and $94.3 million and $94.3 million at December 31, 2021, respectively.
FHLB advances are subject to prepayment penalties. During the year ended December 31, 2022, the Bank prepaid no FHLB advances. During the year ended December 31, 2021, the Bank prepaid one FHLB advance in the amount of $10.0 million, which resulted in a prepayment fee of approximately $90,000, which is included in FHLB interest expense. The Bank did not prepay any FHLB advances during the year ended December 31, 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. The Bank did not have any callable FHLB advances at December 31, 2022. At December 31, 2022 and 2021, the Bank had $388.3 million and $369.0 million, respectively, in additional borrowing capacity at the FHLB.
NOTE 11 - OTHER BORROWINGS
NOTE 12 - JUNIOR SUBORDINATED DEBENTURES
On September 21, 2006, Security Federal Statutory Trust (the “Trust”), a wholly-owned subsidiary of the Company, issued and sold fixed and floating rate capital securities of the Trust (the “Capital Securities”), which are reported on the consolidated balance sheet as junior subordinated debentures, generating proceeds of $5.2 million. The Trust loaned these proceeds to the Company to use for general corporate purposes, primarily to provide capital to the Bank. The Capital Securities accrue and pay distributions quarterly at a floating rate of three month LIBOR plus 170 basis points which was a rate per annum equal to 6.47 % and 1.90 % at December 31, 2022 and 2021, respectively. The distribution rate payable on the Capital Securities is cumulative and payable quarterly in arrears. The Company has the right, subject to events of default, to defer payments of interest on the Capital Securities for a period not to exceed 20 consecutive quarterly periods, provided that no extension period may extend beyond the maturity date of December 15, 2036. The Company has no current intention to exercise its right to defer payments of interest on the Capital Securities. The Capital Securities mature or are mandatorily redeemable upon maturity on December 15, 2036, or upon earlier optional redemption as provided in the indenture. The Company has had the right to redeem the Capital Securities in whole or in part since September 15, 2011.
As of a result of the discontinuation of LIBOR, effective June 30, 2023, the Capital Securities will transition from its floating rate of three month LIBOR plus 170 basis points to a replacement rate which is expected to be the floating rate of three month Secured Overnight Financing Rate ("SOFR") as adjusted by the relevant spread adjustment of 0.26161 plus 170 basis points.
57
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 13 - SENIOR CONVERTIBLE DEBENTURES
In December 2009, the Company issued $6.1 million of 8.0 % Senior Convertible Debentures with a maturity date of December 1, 2029. The debentures were 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.
NOTE 14 - SUBORDINATED DEBENTURES
In November 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.
Both the 10-Year and 15-Note Year subordinated notes include remedies in the event that LIBOR is discontinued. The Company is currently determining an appropriate benchmark replacement for LIBOR. The Company expects the replacement benchmark to be materially consistent with the three-month LIBOR.
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 Notes have been structured to qualify as Tier 2 capital for the Company under applicable regulatory guidelines. The Company used the net proceeds from the sale of the Notes to fund the redemption of the convertible senior debentures and for general corporate purposes to support future growth.
During the year ended December 31, 2022 the Company repurchased $1.0 million in principal of the 10-Year Notes and $2.5 million in principal of the 15-Year Notes, leaving an aggregate remaining principal balance of $16.5 million and $10.0 million, respectively.
58
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 15 - INCOME TAXES
Income tax expense was comprised of the following for the years indicated below:
| Year Ended December 31, | |||||||||||
| (Dollars in thousands) | 2022 | 2021 | |||||||||
| Current: | |||||||||||
| Federal | $ | $ | |||||||||
| State | |||||||||||
| Total Current Tax Expense | |||||||||||
| Deferred: | |||||||||||
| Federal | ( | ||||||||||
| State | |||||||||||
| Total Deferred Tax (Benefit) Expense | ( | ||||||||||
| Total Income Tax Expense | $ | $ | |||||||||
The Company's income taxes differ from those computed at the statutory federal income tax rate for the years indicated, as follows:
| Year Ended December 31, | |||||||||||
| (Dollars in thousands) | 2022 | 2021 | |||||||||
| Tax at Statutory Income Tax Rate | $ | $ | |||||||||
| State Tax and Other | |||||||||||
| Tax Exempt Interest | ( | ( | |||||||||
| Life Insurance | ( | ( | |||||||||
| Valuation Allowance | ( | ||||||||||
| Total Income Tax Expense | $ | $ | |||||||||
59
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2022 and 2021 are presented below. Net deferred tax assets or liabilities were included in other assets or other liabilities at December 31, 2022 and 2021.
| December 31, | |||||||||||
| (Dollars in thousands) | 2022 | 2021 | |||||||||
| Deferred Tax Assets: | |||||||||||
| Deferred Compensation | $ | $ | |||||||||
| Provision for Loan Losses | |||||||||||
| Other Real Estate Owned | |||||||||||
| Net Fees Deferred for Financial Reporting | |||||||||||
| Net Operating Losses | |||||||||||
| PPP Loan Fees | — | 96 | |||||||||
| Unrealized Loss on Securities AFS | 13,230 | — | |||||||||
| Other | |||||||||||
| Total Gross Deferred Tax Assets | |||||||||||
| Less: Valuation Allowance | ( | ( | |||||||||
| Net Deferred Tax Assets | |||||||||||
| Deferred Tax Liabilities: | |||||||||||
| FHLB Stock Basis Over Tax Basis | |||||||||||
| Depreciation | |||||||||||
| Prepaid Expenses | |||||||||||
| Unrealized Gain on Securities AFS | |||||||||||
| Total Gross Deferred Tax Liability | |||||||||||
| Net Deferred Tax Asset | $ | $ | |||||||||
The Company measures deferred tax assets and liabilities using enacted tax rates that will apply in the years in which the temporary differences are expected to be recovered or paid. Deferred tax assets represent the future tax benefit of deductible differences and, if it is more likely than not that a tax asset will not be realized, a valuation allowance is required to reduce the recorded deferred tax assets to net realizable value. As of December 31, 2022, management has determined that it is more likely than not that the total deferred tax asset will be realized except for the deferred tax asset associated with state net operating loss carryforwards, and, accordingly, has established a valuation allowance only for this item. The change in the valuation allowance was approximately $(4,000 ). The Company had state net operating losses attributable to the non-bank entities of $11.7 million and $11.8 million for the years ended December 31, 2022 and 2021, respectively.
Retained earnings at December 31, 2022 included tax bad debt reserves of $2.1 million, for which no provision for federal income tax has been made. If, in the future, these amounts are used for any purpose other than to absorb bad debt losses, including dividends, stock redemptions, or distributions in liquidation, or the Company ceases to be qualified as a bank holding company, they may be subject to federal income tax at the prevailing corporate tax rate. At December 31, 2022, the Company had no material unrecognized tax benefits or accrued interest and penalties. It is the Company's policy to account for interest and penalties accrued relative to unrecognized tax benefits as a component of income tax expense. Tax returns for 2019 and subsequent years are subject to examination by taxing authorities.
60
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 16 - REGULATORY MATTERS
The Bank, as a state-chartered, federally insured savings bank, is subject to the capital requirements established by the FDIC. Under the FDIC's capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors.
The Company is a bank holding company registered with the Board of Governors of the Federal Reserve System (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.
Based on its capital levels at December 31, 2022, the Bank exceeded all regulatory capital requirements as of that date. Consistent with the Bank's goals to operate a sound and profitable organization, it is the Bank's policy to maintain a "well-capitalized" status under the regulatory capital categories of the FDIC. Based on capital levels at December 31, 2022, the Bank was considered to be "well-capitalized" under applicable regulatory requirements. Management monitors the capital levels to provide for current and future business opportunities and to maintain the Bank's "well-capitalized" status.
The tables below provide the Bank’s regulatory capital requirements and actual results at December 31, 2022 and 2021.
| Actual | For Capital Adequacy | To Be Well Capitalized | |||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||||||||||||
| December 31, 2022 | |||||||||||||||||||||||||||||||||||
| Tier 1 Risk-Based Core Capital (To Risk Weighted Assets) | $ | 141,452 | 17.8 | % | $ | 47,714 | 6.0 | % | $ | 63,619 | 8.0 | % | |||||||||||||||||||||||
| Total Risk-Based Capital (To Risk Weighted Assets) | 151,408 | 19.0 | % | 63,619 | 8.0 | % | 79,523 | 10.0 | % | ||||||||||||||||||||||||||
| Common Equity Tier 1 Capital (To Risk Weighted Assets) | 141,452 | 17.8 | % | 35,785 | 4.5 | % | 51,690 | 6.5 | % | ||||||||||||||||||||||||||
| Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets) | 141,452 | 10.4 | % | 54,372 | 4.0 | % | 67,965 | 5.0 | % | ||||||||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||||||||
| Tier 1 Risk-Based Core Capital (To Risk Weighted Assets) | $ | 123,783 | 17.4 | % | $ | 42,701 | % | $ | 56,934 | % | |||||||||||||||||||||||||
| Total Risk-Based Capital (To Risk Weighted Assets) | 132,706 | 18.6 | % | 56,934 | % | 71,168 | % | ||||||||||||||||||||||||||||
| Common Equity Tier 1 Capital (To Risk Weighted Assets) | 123,783 | 17.4 | % | 32,025 | 4.5 | % | 46,259 | 6.5 | % | ||||||||||||||||||||||||||
| Tier 1 Leverage (Core) Capital (To Adjusted Tangible Assets) | 123,783 | 9.9 | % | 50,169 | % | 62,711 | % | ||||||||||||||||||||||||||||
In addition to the minimum capital requirements, the Bank must maintain a capital conservation buffer, which consists of additional Common Equity Tier 1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses. At December 31, 2022 the Bank’s conservation buffer was 11.0%.
61
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 17 - EMPLOYEE BENEFIT PLANS
The Company participates in a multiple employer defined contribution employee benefit plan covering substantially all employees with six months or more of service. The Company matches a portion of the employees’ contributions and the plan has a discretionary profit sharing provision. Total employer contributions were $357,000 and $328,000 for the years ended December 31, 2022 and 2021, respectively, which are included within Compensation and Employee Benefits within the Company's Consolidated Statements of Income.
The Company has an Employee Stock Purchase Plan (“ESPP”). The ESPP allows employees of the Company to purchase stock quarterly through a payroll deduction at a discount calculated as 15 % of the market value with a floor equal to the Company’s book value. The ESPP, which was approved by stockholders in April 2018, became effective July 1, 2018. Participation in the ESPP is voluntary. Employees are limited to investing $25,000 or 5 % of their annual salary, whichever is lower, during the year. There were no employee stock purchases during the year ended December 31, 2022.
In 2014, the Company implemented an Incentive Compensation Plan (the "Plan"). Incentive awards are based on the financial and operating performance of the Company as well as other participant specific objectives. The Plan allows employees of the Company to earn up to 7.5 days of their annual salary for successfully completing specific goals established by the participants and their respective supervisors plus an additional 2.5 days of their annual salary if the Company meets an annual predetermined net operating income amount determined by the Board of Directors.
In 2016, the Company implemented a Quarterly Branch Incentive Compensation Plan (the "Branch Incentive Plan"), and all branch employees were moved from the Plan to the Branch Incentive Plan. This plan is for retail branch employees only and pays incentive on a quarterly basis based on specific performance goals established for each branch location.
The Company also implemented an Incentive Compensation Plan for executive level officers (the "Executive Plan"). Under this plan, incentive awards are based on contributions to performance as measured by critical operating and financial ratios, and other participant specific objectives. The Company has to meet the annual predetermined net operating income amount determined by the Board of Directors for any incentive awards to be paid under the Executive Plan. If the Company does not meet the required net income amount, no incentives are paid regardless of the executive's performance on individual objectives or entity wide objectives.
Participation in the ESPP, the Plan, the Branch Incentive Plan and the Executive Plan is voluntary. During the years ended December 31, 2022 and 2021, the Company incurred expenses of $501,000 and $597,000 , respectively, related to these incentive plans, which are included in Compensation and Employee Benefits within the Company's Consolidated Statements of Income.
Certain officers of the Company participate in a supplemental retirement plan. These benefits are not qualified under the Internal Revenue Code and they are not funded. During the years ended December 31, 2022 and 2021, the Company incurred expenses of $490,000 and $551,000 , respectively, for this plan, which are included in Compensation and Employee Benefits within the Company's Consolidated Statements of Income.
NOTE 18 - BANK OWNED LIFE INSURANCE
62
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 19 - COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Bank has various outstanding commitments and contingent liabilities that are not reflected in the accompanying consolidated financial statements. In addition, the Bank is a defendant in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial condition of the Company.
In conjunction with its lending activities, the Bank enters into various commitments to extend credit. The Bank also issues letters of credit. Loan commitments (unfunded loans and unused lines of credit) and letters of credit are issued to accommodate the financing needs of the Bank's customers. Loan commitments are agreements by the Bank to lend at a future date, so long as there are no violations of any conditions established in the agreement. Letters of credit commit the Bank to make payments on behalf of customers when certain specified events occur.
Financial instruments where the contract amount represents the Bank's credit risk include commitments under pre-approved but unused lines of credit of $173.3 million and $163.8 million and letters of credit of $4.5 million and $3.0 million at December 31, 2022 and 2021, respectively. These loan and letter of credit commitments are subject to the same credit policies and reviews as loans on the balance sheet. Collateral, both the amount and nature, is obtained based upon management's assessment of the credit risk. Since many of the extensions of credit are expected to expire without being drawn, the total commitment amounts do not necessarily represent future cash requirements.
Included in the loan commitments noted above were unused credit card loan commitments of $10.7 million and $8.0 million and undisbursed loans in process of $22.7 million and $21.4 million at December 31, 2022 and 2021, respectively. The Bank also had $970,000 in outstanding commitments on mortgage loans approved but not yet closed at December 31, 2022 compared to $3.3 million at December 31, 2021. These commitments, which are funded subject to certain limitations, extend over varying periods of time with the majority being funded within 45 days.
At December 31, 2022 and 2021, the Bank had outstanding commitments to sell approximately $913,000 and $4.0 million of loans, respectively, which encompassed the Bank’s held for sale loans. The Bank also has commitments to sell mortgage loans not yet closed, on a best efforts basis. Best efforts means the Bank suffers no penalty if they are unable to deliver the loans to the potential buyers. The fair value of the Bank’s commitment to originate mortgage loans at committed interest rates and to sell such loans to permanent investors is insignificant.
63
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 20 - RELATED PARTY TRANSACTIONS
Certain directors, executive officers and companies with which they are affiliated are customers of, and have banking transactions with, the Bank in the ordinary course of business. Loans to directors, executive officers and their affiliates are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable arms-length transactions. A summary of loan transactions with directors, executive officers and their affiliates for the years indicated, is as follows:
| Years Ended December 31, | |||||||||||||||||
| (Dollars in thousands) | 2022 | 2021 | |||||||||||||||
| Balance, Beginning of Period | $ | $ | |||||||||||||||
| New Loans | |||||||||||||||||
| Less Loan Payments | ( | ( | |||||||||||||||
| Balance, End of Period | $ | $ | |||||||||||||||
Loans to all employees, officers, and directors of the Company constituted approximately 2.10 % and 2.13 % of the Company’s total shareholders' equity at December 31, 2022 and 2021, respectively. Deposits from executive officers and directors of the Company and their related interests were approximately $19.6 million and $18.3 million at December 31, 2022 and 2021 and have substantially the same terms, including interest rates, as those prevailing at the time with other non-related depositors.
The Company leased office space from a related party during the years ended December 31, 2022 and 2021. The lease is with a company in which the related party, who is a director of the Company, has an ownership interest. The Company incurred rent expense of $96,500 and $89,800 for the years ended December 31, 2022 and 2021, respectively, related to this lease. Management is of the opinion that the transactions with respect to office rent were made on terms that are comparable to those which would be made with unaffiliated persons.
64
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 21 - PARENT COMPANY ONLY CONDENSED FINANCIAL STATEMENTS
The following is condensed financial information of Security Federal Corporation (Parent Company only). The primary asset is its investment in the Bank subsidiary and the principal source of income for the Company is equity in undistributed earnings from the Bank.
Condensed Balance Sheet Data
| December 31, | |||||||||||
| (In Thousands) | 2022 | 2021 | |||||||||
| Assets: | |||||||||||
| Cash | $ | $ | |||||||||
| Investments, HTM | |||||||||||
| Investment in Security Federal Statutory Trust | |||||||||||
| Investment in Security Federal Bank | |||||||||||
| Accrued Interest Receivable | |||||||||||
| Accounts Receivable and Other Assets | |||||||||||
| Total Assets | $ | $ | |||||||||
| Liabilities and Shareholders’ Equity: | |||||||||||
| Accounts Payable and Other Liabilities | $ | $ | |||||||||
| Long-term Debt | |||||||||||
| Shareholders’ Equity | |||||||||||
| Total Liabilities and Shareholders’ Equity | $ | $ | |||||||||
Condensed Statements of Income Data
| Years Ended December 31, | |||||||||||||||||
| (In Thousands) | 2022 | 2021 | |||||||||||||||
| Income: | |||||||||||||||||
| Equity in Earnings of Security Federal Bank | $ | $ | |||||||||||||||
| Investment Securities Interest Income | |||||||||||||||||
| Miscellaneous Income | |||||||||||||||||
| Total Income | |||||||||||||||||
| Expenses: | |||||||||||||||||
| Interest Expense | |||||||||||||||||
| Other Expenses | |||||||||||||||||
| Total Expenses | |||||||||||||||||
| Income Before Income Taxes | |||||||||||||||||
| Income Tax Benefit | ( | ( | |||||||||||||||
| Net Income | $ | $ | |||||||||||||||
65
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Condensed Statements of Cash Flow Data
| Years Ended December 31, | |||||||||||
| (In Thousands) | 2022 | 2021 | |||||||||
| Operating Activities: | |||||||||||
| Net Income | $ | $ | |||||||||
| Adjustments to Reconcile Net Income to Net Cash Used in Operating Activities: | |||||||||||
| Equity in Earnings of Security Federal Bank | ( | ( | |||||||||
| Discount Accretion and Premium Amortization, Net | ( | — | |||||||||
| Increase in Accrued Interest Receivable | (190) | — | |||||||||
| Decrease in Accounts Receivable and Other Assets | |||||||||||
| Increase (Decrease) in Accounts Payable and Other Liabilities | |||||||||||
| Net Cash Used By Operating Activities | ( | ( | |||||||||
| Investing Activities: | |||||||||||
| Purchase of Investment Securities HTM | ( | ||||||||||
| Proceeds from Principal Paydowns of HTM Securities | |||||||||||
| Investment in Subsidiary | ( | ||||||||||
| Net Cash Used By Investing Activities | ( | ||||||||||
| Financing Activities: | |||||||||||
| Repurchase of Subordinated Debentures | ( | ||||||||||
| Proceeds from Issuance of Preferred Stock | |||||||||||
| Dividends Paid to Shareholders-Common Stock | ( | ( | |||||||||
| Net Cash Provided (Used) By Financing Activities | ( | ||||||||||
| Net Increase (Decrease) in Cash | ( | ||||||||||
| Cash at Beginning of Period | |||||||||||
| Cash at End of Period | $ | $ | |||||||||
66
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 22 - CARRYING AMOUNTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS
GAAP requires the Company to disclose fair value of financial instruments measured at amortized cost on the balance sheet and to measure that fair value using an exit price notion, the price that would be received for an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date under current market conditions.
Accounting guidance emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, the guidance establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).
The following three levels of inputs may be used to measure fair value:
Level 1
Valuation is based upon quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 1 assets and liabilities include debt and equity securities and derivative contracts that are traded in an active exchange market, as well as U.S. Treasuries and money market funds.
Level 2
Valuation is based upon quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 2 assets and liabilities include debt securities with quoted prices that are traded less frequently than exchange-traded instruments, mortgage-backed securities, municipal bonds, corporate debt securities and derivative contracts whose value is determined using a pricing model with inputs that are observable in the market or can be derived principally from or corroborated by observable market data. This category generally includes certain derivative contracts.
Level 3
Valuation is generated from model-based techniques that use at least one significant assumption based on unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
The following is a description of the valuation methodologies used for assets and liabilities recorded at fair value.
Investment Securities AFS
Investment securities AFS are recorded at fair value on a recurring basis. At December 31, 2022, the Company’s investment portfolio was comprised of student loan pools, government and agency bonds, MBS issued by government sponsored agencies or GSEs, private label CMO securities and municipal securities. Fair value measurement is based upon prices obtained from third party pricing services that use independent pricing models which rely on a variety of factors including reported trades, broker/dealer quotes, benchmark yields, economic and industry events and other relevant market information. As such, these securities are classified as Level 2.
67
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Mortgage Loans Held for Sale
The Company originates fixed rate residential loans on a servicing released basis in the secondary market. Loans closed but not yet settled with institutional investors are carried in the Company’s loans held for sale portfolio. These loans are fixed rate residential loans that have been originated in the Company’s name and have closed. Virtually all of these loans have commitments to be purchased by investors and the majority of these loans were locked in by price with the investors on the same day or shortly thereafter that the loan was locked in with the Company’s customers. Therefore, these loans present very little market risk for the Company.
The Company usually delivers to, and receives funding from, the investor within 30 days. Commitments to sell these loans to the investor are considered derivative contracts and are sold to investors on a “best efforts" basis. The Company is not obligated to deliver a loan or pay a penalty if a loan is not delivered to the investor. As a result of the short-term nature of these derivative contracts, the fair value of the mortgage loans held for sale in most cases is the same as the value of the loan amount at its origination. These loans are classified as Level 2.
Land Held for Sale
Land held for sale is reported at the lower of the carrying amount or fair value less costs to sell. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral less estimated selling costs. The Company records land held for sale as nonrecurring level 3.
Impaired Loans
The Company does not record loans held for investment at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established as necessary. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment.
Fair value is estimated using one of the following methods: fair value of the collateral less estimated costs to sell, discounted cash flows, or market value of the loan based on similar debt. The fair value of the collateral less estimated costs to sell is the most frequently used method. Typically, the Company reviews the most recent appraisal and if it is over 24 months old will request a new third party appraisal. Depending on the particular circumstances surrounding the loan, including the location of the collateral, the date of the most recent appraisal and the value of the collateral relative to the recorded investment in the loan, management may order an independent appraisal immediately or, in some instances, may elect to perform an internal analysis. Specifically as an example, in situations where the collateral on a nonperforming commercial real estate loan is out of the Company’s primary market area, management would typically order an independent appraisal immediately, at the earlier of the date the loan becomes nonperforming or immediately following the determination that the loan is impaired. However, as a second example, on a nonperforming commercial real estate loan where management is familiar with the property and surrounding areas and where the original appraisal value far exceeds the recorded investment in the loan, management may perform an internal analysis whereby the previous appraisal value would be reviewed and adjusted for current conditions including recent sales of similar properties in the area and any other relevant economic trends. These valuations are reviewed at a minimum on a quarterly basis.
Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2022, all impaired loans were evaluated based on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. The Company records impaired loans as nonrecurring Level 3.
Foreclosed Assets
Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, they are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral less estimated selling costs. The Company records all foreclosed assets as nonrecurring level 3.
68
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The tables below present the balances of assets measured at fair value on a recurring basis at the dates indicated.
| December 31, 2022 | December 31, 2021 | ||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | 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 | |||||||||||||||||||||||||||||||||||
| Total | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. The table below presents assets measured at fair value on a nonrecurring basis at the dates indicated, aggregated by the level in the fair value hierarchy within which those measurements fall. There were no liabilities measured at fair value on a nonrecurring basis as of December 31, 2022 and 2021.
| December 31, 2022 | |||||||||||||||||||||||
| Assets (in thousands): | Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||
| Mortgage Loans Held For Sale | $ | $ | $ | $ | |||||||||||||||||||
| Land Held For Sale | — | — | |||||||||||||||||||||
Collateral Dependent Impaired Loans (1) | |||||||||||||||||||||||
| Foreclosed Assets | |||||||||||||||||||||||
| Total | $ | $ | $ | $ | |||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||
| Assets (in thousands): | Level 1 | Level 2 | Level 3 | Total | |||||||||||||||||||
| Mortgage Loans Held For Sale | $ | $ | $ | $ | |||||||||||||||||||
| Land Held For Sale | — | — | |||||||||||||||||||||
Collateral Dependent Impaired Loans (1) | |||||||||||||||||||||||
| Foreclosed Assets | |||||||||||||||||||||||
| Total | $ | $ | $ | $ | |||||||||||||||||||
(1) Reported net of specific reserves. There were no specific reserves at December 31, 2022 and 2021.
For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis, the significant unobservable inputs used in the fair value measurements at the dates indicated were as follows:
| Valuation | Significant | 2022 | 2021 | ||||||||||||||||||||||||||
| Level 3 Assets | Technique | Unobservable Inputs | Range | Range | |||||||||||||||||||||||||
| Land Held for Sale | Appraised Value/Comparable Sales | 10% | 10% | ||||||||||||||||||||||||||
| Collateral Dependent Impaired Loans | Appraised Value | ||||||||||||||||||||||||||||
| Foreclosed Assets | Appraised Value/Comparable Sales | ||||||||||||||||||||||||||||
69
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
For assets and liabilities not presented on the balance sheet at fair value, the following methods are used to determine fair value:
Cash and cash equivalents—The carrying amount of these financial instruments approximates fair value. All mature within 90 days and do not present unanticipated credit concerns.
Certificates of deposits with other banks—Fair value is based on market prices for similar assets.
Investment securities held to maturity—Securities held to maturity are valued at quoted market prices or dealer quotes.
Loans Receivable, Net—The fair value of loans are estimated using an exit price notion. The exit price notion uses a discounted cash flows technique to calculate the present value of expected future cash flows for a financial instrument and also incorporates other factors, such as enhanced credit risk, illiquidity risk and market factors that sometimes exist in exit prices in dislocated markets. The credit risk assumption is intended to approximate the fair value that a market participant would realize in a hypothetical orderly transaction. The Company’s loan portfolio is initially fair valued using a segmented approach. The Company divides its loan portfolio into the following categories: commercial real estate, other commercial, residential real estate, consumer and all other loans. The results are then adjusted to account for credit risk as described above. A further credit risk discount must be applied through the use of a discounted cash flow model to compensate for illiquidity risk, based on certain assumptions included within the discounted cash flow model, primarily the use of discount rates that better capture inherent credit risk over the lifetime of a loan. This consideration of enhanced credit risk provides an estimated exit price for the Company’s loan portfolio. For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values approximate carrying values.
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.
Note Payable—The carrying value of the note payable approximates fair value.
Senior Convertible Debentures— The fair value is estimated by discounting the future cash flows using the current rates at which similar debenture offerings with similar terms and maturities would be issued by similar institutions. As discount rates are based on current debenture rates as well as management estimates, the fair values presented may not be indicative of the value negotiated in an actual sale.
Subordinated Debentures—The fair value is estimated by discounting the future cash flows using the current rates at which similar debenture offerings with similar terms and maturities would be issued by similar institutions. As discount rates are based on current debenture rates as well as management estimates, the fair values presented may not be indicative of the value negotiated in an actual sale.
Junior Subordinated Debentures—The carrying value of junior subordinated debentures approximates fair value.
70
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following tables summarize the carrying value and estimated fair value of the Company’s financial instruments at the dates indicated, presented in accordance with the applicable accounting guidance.
| December 31, 2022 | |||||||||||||||||||||||||||||
| Carrying | Fair Value | ||||||||||||||||||||||||||||
| (In Thousands) | Amount | Total | Level 1 | Level 2 | Level 3 | ||||||||||||||||||||||||
| Financial Assets: | |||||||||||||||||||||||||||||
| Cash and Cash Equivalents | $ | 28,502 | $ | $ | $ | $ | |||||||||||||||||||||||
| Certificates of Deposits with Other Banks | 1,100 | ||||||||||||||||||||||||||||
| Investment Securities | 717,586 | ||||||||||||||||||||||||||||
| Loans Receivable, Net | 549,917 | ||||||||||||||||||||||||||||
| FHLB Stock | 651 | ||||||||||||||||||||||||||||
| Land Held for Sale | 1,097 | — | — | 1,097 | |||||||||||||||||||||||||
| Financial Liabilities: | |||||||||||||||||||||||||||||
| Deposits: | |||||||||||||||||||||||||||||
| Checking, Savings and Money Market Accounts | $ | 968,054 | $ | $ | $ | $ | |||||||||||||||||||||||
| Certificate Accounts | 142,031 | ||||||||||||||||||||||||||||
| Borrowings from FRB | 44,071 | 44,071 | — | — | |||||||||||||||||||||||||
| Other Borrowed Money | |||||||||||||||||||||||||||||
| Subordinated Debentures | 24,435 | — | 24,435 | — | |||||||||||||||||||||||||
| Junior Subordinated Debentures | |||||||||||||||||||||||||||||
| December 31, 2021 | |||||||||||||||||||||||||||||
| Carrying | Fair Value | ||||||||||||||||||||||||||||
| (In Thousands) | Amount | Total | Level 1 | Level 2 | Level 3 | ||||||||||||||||||||||||
| Financial Assets: | |||||||||||||||||||||||||||||
| Cash and Cash Equivalents | $ | 27,623 | $ | $ | $ | $ | |||||||||||||||||||||||
| Certificates of Deposits with Other Banks | 1,100 | ||||||||||||||||||||||||||||
| Investment Securities | 706,356 | ||||||||||||||||||||||||||||
| Loans Receivable, Net | 499,497 | ||||||||||||||||||||||||||||
| FHLB Stock | 586 | ||||||||||||||||||||||||||||
| Land Held for Sale | 1,530 | 1,530 | — | — | 1,530 | ||||||||||||||||||||||||
| Financial Liabilities: | |||||||||||||||||||||||||||||
| Deposits: | |||||||||||||||||||||||||||||
| Checking, Savings and Money Market Accounts | $ | 958,601 | $ | $ | $ | $ | |||||||||||||||||||||||
| Certificate Accounts | 157,362 | ||||||||||||||||||||||||||||
| Other Borrowed Money | |||||||||||||||||||||||||||||
| Subordinated Debentures | 30,000 | 30,154 | — | 30,154 | — | ||||||||||||||||||||||||
| Junior Subordinated Debentures | |||||||||||||||||||||||||||||
At December 31, 2022, the Company had $177.8 million of off-balance sheet financial commitments. These commitments are to originate loans and unused consumer lines of credit and credit card lines. Because these obligations are based on current market rates, if funded, the original principal is considered to be a reasonable estimate of fair value.
Fair value estimates are made on a specific date, based on relevant market data and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the Bank’s entire holdings of a particular financial instrument.
71
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Because no active market exists for a significant portion of the Company'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.
72
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 23 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Unaudited condensed financial data by quarter for the years ended December 31, 2022 and 2021 is as follows (dollars, except per share data, in thousands):
Quarter ended | |||||||||||||||||||||||
| 3/31/2022 | 6/30/2022 | 9/30/2022 | 12/31/2022 | ||||||||||||||||||||
| Interest Income | $ | $ | $ | $ | |||||||||||||||||||
| Interest Expense | |||||||||||||||||||||||
| Net Interest Income | |||||||||||||||||||||||
| Provision for Loan Losses | |||||||||||||||||||||||
Net Interest Income After Provision for Loan Losses | |||||||||||||||||||||||
| Non-interest Income | |||||||||||||||||||||||
| Non-interest Expense | |||||||||||||||||||||||
| Income Before Income Tax | |||||||||||||||||||||||
| Provision for Income Taxes | |||||||||||||||||||||||
| Net Income | $ | $ | $ | $ | |||||||||||||||||||
| Basic Net Income Per Common Share | $ | $ | $ | $ | |||||||||||||||||||
| Basic Weighted Average Shares Outstanding | |||||||||||||||||||||||
| Quarter ended | |||||||||||||||||||||||
| 3/31/2021 | 6/30/2021 | 9/30/2021 | 12/31/2021 | ||||||||||||||||||||
| Interest Income | $ | $ | $ | $ | |||||||||||||||||||
| Interest Expense | |||||||||||||||||||||||
| Net Interest Income | |||||||||||||||||||||||
| Reversal of Provision For Loan Losses | ( | ( | ( | ( | |||||||||||||||||||
Net Interest Income After Provision for Loan Losses | |||||||||||||||||||||||
| Non-interest Income | |||||||||||||||||||||||
| Non-interest Expense | |||||||||||||||||||||||
| Income Before Income Tax | |||||||||||||||||||||||
| Provision for Income Taxes | |||||||||||||||||||||||
| Net Income | $ | $ | $ | $ | |||||||||||||||||||
| Basic Net Income Per Common Share | $ | $ | $ | $ | |||||||||||||||||||
| Basic Weighted Average Shares Outstanding | |||||||||||||||||||||||
73
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
NOTE 24 - NON-INTEREST INCOME
The following table presents non-interest income for the years indicated. All revenue from contracts with customers within the scope of ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) is recognized in non-interest income, with the exception of gains on the sale of OREO, which are included in non-interest expense when applicable.
| Year Ended December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Non-interest income (in thousands): | |||||||||||
(Loss) Gain on Sale of Investments, net (1) | $ | (2) | $ | — | |||||||
Gain on Sale of Loans (1) | 1,705 | 3,836 | |||||||||
| Service Fees on Deposit Accounts | 1,071 | 957 | |||||||||
Commissions From Insurance Agency (1) | 784 | 610 | |||||||||
| Trust Income | 1,548 | 1,439 | |||||||||
BOLI Income (1) | 608 | 635 | |||||||||
| ATM and Check Card Fee Income | 2,816 | 2,470 | |||||||||
Grant Income (1) | 171 | 1,826 | |||||||||
Other (1) | 911 | 860 | |||||||||
| Total non-interest income | $ | 9,612 | $ | 12,633 | |||||||
(1) Not within the scope of ASC 606 | |||||||||||
Revenue Recognition
The following is a discussion of key revenues within the scope of the current revenue guidance.
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 Bank 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, management 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 performance obligation is satisfied.
The five-step model is only applied 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 Bank 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 amount of the transaction price that is allocated to the respective performance obligation is recognized as revenue when (or as) the performance obligation is satisfied.
Service Fees on Deposit Accounts
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.
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 Topic 606, based on the fees charged by the Bank, we do not anticipate any changes in the accounting for trust income at this time.
74
SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
ATM and 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.
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.
NOTE 25 - PREFERRED STOCK
On May 24, 2022, the Company entered into a Letter Agreement (“Agreement”) with the U.S. Department of Treasury under the Emergency Capital Investment Program (“ECIP”). Established by the Consolidated Appropriations Act, 2021, the ECIP was created to encourage low- and moderate-income community financial institutions and minority depository institutions to provide loans, grants, and forbearance for small businesses, minority-owned businesses, and consumers, especially low-income and underserved communities, including counties with persistent poverty, that may be disproportionately impacted by the economic effect of the COVID-19 pandemic by providing direct and indirect capital investments in low- and moderate-income community financial institutions.
Pursuant to the Agreement, the Company agreed to issue and sell 82,949 shares of Preferred Stock for an aggregate purchase price of $82.9 million in cash. This ECIP investment is treated as tier 1 capital. The Preferred Stock bears no dividend for the first 24 months following the investment date. Thereafter, the dividend rate will be adjusted, not higher than 2%, based on the lending growth criteria listed in the Agreement. After the tenth anniversary of the investment date, the dividend rate will be fixed based on the average annual amount of lending in years 2 through 10. Dividends will be payable quarterly in arrears on March 15, June 15, September 15, and December 15.
The Preferred Stock may be redeemed at the option of the Company on or after the fifth anniversary of issuance (or earlier in the event of loss of regulatory capital treatment), subject to the approval of the appropriate federal banking regulator and in accordance with the federal banking agencies’ regulatory capital regulations. The Preferred Stock is reported on the Consolidated Balance Sheets as Senior Non-Cumulative Perpetual Preferred Stock, Series ECIP.
NOTE 26 - SUBSEQUENT EVENTS
Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Non-recognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.
The Company has disclosed deposit concentrations in Note 9 of the Notes to Consolidated Financial Statements included herein. In relation to current economic conditions, management has monitored deposit concentrations through the date the financial statements were issued noting no significant changes to concentrations. In addition, there has been no significant deposit deterioration through the date the financial statements were issued.
The Company has disclosed its investment portfolio position in Notes 2 and 3 of the Notes to Consolidated Financial Statements included herein. There has been no significant deterioration in the investment portfolio through the date the consolidated financial statements were issued.
Management has reviewed the events occurring through the date the financial statements were issued and no additional subsequent events occurred requiring accrual or disclosure.
75
SHAREHOLDERS INFORMATION
ANNUAL MEETING
The annual meeting of shareholders will be held at 11:00 a.m. on Thursday, May 11, 2023.
STOCK LISTING
The Company’s stock is traded on the Pink Open Market under the symbol “SFDL.” The stock began trading in October 2003.
PRICE RANGE OF COMMON STOCK
The table below shows the range of high and low bid prices. These prices represent actual transactions and do not include retail markups, markdowns or commissions.
| High | Low | |||||||||||||
| Year Ended December 31, 2022 | ||||||||||||||
| 03/31/2022 | $35.00 | $31.36 | ||||||||||||
| 06/30/2022 | $34.87 | $27.10 | ||||||||||||
| 09/30/2022 | $29.00 | $26.00 | ||||||||||||
| 12/31/2022 | $37.75 | $25.30 | ||||||||||||
| Year Ended December 31, 2021 | ||||||||||||||
| 03/31/2021 | $34.52 | $25.31 | ||||||||||||
| 06/30/2021 | $36.49 | $31.56 | ||||||||||||
| 09/30/2021 | $34.63 | $30.98 | ||||||||||||
| 12/31/2021 | $32.96 | $30.98 | ||||||||||||
As of December 31, 2022, the Company had approximately 279 shareholders of record, not including shares held in street name, and 3,252,884 outstanding shares of common stock.
DIVIDENDS
The first quarterly dividend on the stock was paid to shareholders on March 15, 1991. Dividends will be paid upon the determination of the Board of Directors that such payment is consistent with the long-term interest of the Company. The factors affecting this determination include the Company’s current and projected earnings, operating results, financial condition, regulatory restrictions, future growth plans, and other relevant factors. During 2021 and 2022, the Company paid quarterly cash dividends per share of $0.11 and $0.12, respectively. In addition to the quarterly dividends paid in 2022, the Company also paid a special cash dividend of $0.28 per share in 2022 to all shareholders of record as of March 31, 2022. During 2023, the Company expects to pay a quarterly cash dividend of $0.13 per share.
The ability of the Company to pay dividends depends primarily on the ability of the Bank to pay dividends to the Company. The Bank may not declare or pay a cash dividend on its stock or repurchase shares of its stock if the offset thereof would be to cause its regulatory capital to be reduced below the amount required to meet applicable regulatory capital requirements. South Carolina banking regulations restrict the amount of dividends that the Bank can pay to the Company, and may require prior approval before declaration and payment of any excess dividend. Unlike the Bank, there is no regulatory restriction on the payment of dividends by the Company; however, it is subject to the requirements of South Carolina law. South Carolina law generally prohibits the Company from paying dividends if, after giving effect to a proposed dividend: (1) the Company would be unable to pay its debts as they become due in the normal course of business, or (2) the Company’s total assets would be less than its total liabilities plus the sum that would be needed to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the dividend. The Federal Reserve also has the authority to prohibit the Company from paying a dividend on its common stock.
CODE OF ETHICS
A copy of the Company’s Code of Ethics may be obtained at the Company’s Internet website at www.securityfederalbank.com.
76
Exhibit 21
Subsidiaries of the Registrant
| Parent | Subsidiary | State of Incorporation | Percentage of Ownership | ||||||||
| Security Federal Corporation | Security Federal Bank | United States | 100% | ||||||||
| Security Federal Statutory Trust | South Carolina | 100% | |||||||||
| Security Federal Bank | Security Federal Insurance, Inc. | South Carolina | 100% | ||||||||
| Security Federal Investments, Inc. | South Carolina | 100% | |||||||||
[Letterhead of Elliot Davis, LLC]
Exhibit 23
Consent of Elliott Davis, LLC
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to incorporation by reference in Registration Statement No. 333-225297 on Form S-8 of Security Federal Corporation of our report dated March 24, 2023, relating to the consolidated financial statements of Security Federal Corporation and Subsidiaries, appearing in the Annual Report to Shareholders, which is incorporated in this Annual Report on Form 10-K of Security Federal Corporation for the year ended December 31, 2022.
/s/ Elliott Davis, LLC
Columbia, South Carolina
March 24, 2023
Exhibit 31.1
Certification Required
by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934
I, J. Chris Verenes, certify that:
1.I have reviewed this annual report on Form 10-K of Security Federal Corporation;
2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5.The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: March 24, 2023
| /s/J. Chris Verenes | |||||
| J. Chris Verenes | |||||
| Chief Executive Officer | |||||
Exhibit 31.2
Certification Required
by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934
I, Darrell Rains, certify that:
1.I have reviewed this annual report on Form 10-K of Security Federal Corporation;
2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c)Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d)Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
5.The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions):
(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
Date: March 24, 2023
| /s/Darrell Rains | |||||
| Darrell Rains | |||||
| Chief Financial Officer | |||||
Exhibit 32
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
OF SECURITY FEDERAL CORPORATION
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned hereby certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and in connection with this Annual Report on Form 10-K, that:
1.the report fully complies with the requirements of Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, and
2.the information contained in the report fairly presents, in all material respects, the company's financial condition and results of operations.
| /s/J. Chris Verenes | /s/Darrell Rains | |||||||
| J. Chris Verenes | Darrell Rains | |||||||
| Chief Executive Officer | Chief Financial Officer | |||||||
Dated: March 24, 2023