SECURITY FEDERAL CORPORATION Forward-Looking Statements and "Safe Harbor" statement under the Private Securities Litigation Reform Act of 1995
Certain matters discussed in this Quarterly Report on Form 10-Q may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to our financial condition, results of operations, plans, objectives, future performance or business. Forward-looking statements are not statements of historical fact, are based on certain assumptions and are generally identified by use of the words "believes," "expects," "anticipates," "estimates," "forecasts," "intends," "plans," "targets," "potentially," "probably," "projects," "outlook" or similar expressions or future or conditional verbs such as "may," "will," "should," "would" and "could." Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, assumptions and statements about, among other things, expectations of the business environment in which we operate, projections of future performance or financial items, perceived opportunities in the market, potential future credit experience, and statements regarding our mission and vision. These forward-looking statements are based upon current management expectations and may, therefore, involve risk and uncertainties. Our actual results, performance, or achievements may differ materially from those suggested, expressed, or implied by forward-looking statements as a result of a wide variety or range of factors, including, but not limited to: •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, including, without limitation, as a result of employment levels, labor shortages and the effects of inflation, a potential recession or slowed economic growth caused by increasing political instability from acts of war includingRussia's invasion ofUkraine , as well as increasing oil prices and supply chain disruptions, and any governmental or societal responses to the novel coronavirus disease 2019 ("COVID-19") pandemic, including the possibility of new COVID-19 variants; •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 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 future of the London Interbank Offered Rate ("LIBOR"), and the transition away from LIBOR toward new interest rate benchmarks;
•fluctuations in the demand for loans, the number of unsold homes, land and other properties and fluctuations in real estate values in our market areas;
•secondary market conditions for loans and our ability to originate loans for sale and sell loans in the secondary market;
•results of examinations of the Company by theBoard of Governors of theFederal Reserve System ("Federal Reserve") and the Bank by theFederal Deposit Insurance Corporation ("FDIC") and theSouth 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 other governmental initiatives affecting the financial services industry;
•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;
30
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIESManagement's Discussion and Analysis of Financial Condition and Results of
Operations•our ability to retain key members of our senior management team;
•costs and effects of litigation, including settlements and judgments;
•our ability to manage loan delinquency rates;
•increased competitive pressures among financial services companies;
•changes in consumer spending, borrowing and savings habits;
•the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions;
•our ability to pay dividends on our common stock;
•the quality and composition of our securities portfolio and the impact of any adverse changes in the securities markets;
•inability of key third-party providers to perform their obligations to us;
•changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the FASB, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods;
•the effects of climate change, severe weather events, natural disasters, pandemics, epidemics and other public health crises, acts of war or terrorism, and other external events on our business;
•other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; and
•other risks described elsewhere in this document and in the Company's other filings with theSecurities and Exchange Commission , including our Annual Report on Form 10-K for the year endedDecember 31, 2021 ("2021 10-K"). Some of these forward-looking statements are discussed in the Company's 2021 Form 10-K as well as other risk factors under Item 1A, "Risk Factors." Such developments could have an adverse impact on our consolidated financial position and results of operations. Any of the forward-looking statements that we make in this quarterly report on Form 10-Q and in other public reports and statements we make may turn out to be inaccurate as a result of our beliefs and assumptions we make in connection with the factors set forth above or because of other unidentified and unpredictable factors. Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements and you should not rely on such statements. The Company undertakes no obligation to publish revised forward-looking statements to reflect the occurrence of unanticipated events or circumstances after the date hereof. These risks could cause our actual results for 2022 and beyond to differ materially from those expressed in any forward-looking statements by or on behalf of us, and could negatively affect the Company's consolidated financial condition, consolidated results of operations, liquidity and stock price performance.
Response to COVID-19
The Company maintains its commitment to supporting its community and clients during the COVID-19 pandemic and remains focused on keeping its employees safe and the Bank running effectively to serve its clients. As ofSeptember 30, 2022 , all Bank branches were open with normal hours. The Bank will continue to monitor branch access and occupancy levels in relation to cases and close contact scenarios and follow governmental restrictions and public health authority guidelines. 31
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIESManagement's Discussion and Analysis of Financial Condition and Results of
Operations
Financial Condition at
Assets - Total assets increased$56.8 million to$1.4 billion atSeptember 30, 2022 from$1.3 billion atDecember 31, 2021 . This increase was primarily due to increases in investments held to maturity ("HTM") and cash and cash equivalents, which were partially offset by a decline investments available for sale ("AFS"). Changes in total assets are shown below. Increase (Decrease) (Dollars in thousands) September 30, 2022 December 31, 2021 $ % Cash and Cash Equivalents $ 20,068 $ 27,623$ (7,555) (27.4) % Certificates of Deposits with Other Banks 1,100 1,100 - - Investments AFS 591,550 682,849 (91,299) (13.4) Investments HTM 137,969 23,507 114,462 486.9 Loans Receivable, Net 523,094 499,497 23,597 4.7 Accrued Interest Receivable 4,493 3,752 741 19.7 OREO 120 130 (10) (7.7) Operating Lease ROU Assets 1,974 2,252 (278) (12.3) Land Held for Sale 1,097 1,530 (433) (28.3) Premises and Equipment, Net 27,424 25,237 2,187 8.7 FHLB Stock 651 586 65 11.1 BOLI 27,167 26,710 457 1.7 Goodwill 1,200 1,200 - - Other Assets 20,074 5,241 14,833 283.0 Total Assets $ 1,357,981$ 1,301,214 $ 56,767 4.4% Cash and cash equivalents decreased$7.6 million or 27.4% to$20.1 million atSeptember 30, 2022 compared to$27.6 million atDecember 31, 2021 , as a result of the purchase of investments HTM and funding of loans. Investments AFS decreased$91.3 million or 13.4% to$591.6 million atSeptember 30, 2022 from$682.8 million atDecember 31, 2021 as maturities and principal paydowns of investments AFS exceeded purchases during the nine months endedSeptember 30, 2022 . Additionally, investments AFS experienced a$46.7 million decrease in fair value during the nine months endedSeptember 30, 2022 . Investments HTM increased$114.5 million to$138.0 million atSeptember 30, 2022 from$23.5 million atDecember 31, 2021 . The increase is primarily the result of the Company's investment of Emergency Capital Investment Program ("ECIP") proceeds. For additional details on the ECIP, see "Note 17 - Preferred Stock" of the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report. Loans receivable, net, including loans held for sale, increased$23.6 million or 4.7% to$523.1 million atSeptember 30, 2022 from$499.5 million atDecember 31, 2021 , primarily due to residential real estate, commercial real estate and construction real estate loans originated during the period. Loan balances in all loan categories increased during the nine months endedSeptember 30, 2022 with the exception of the commercial and agricultural loan category, which decreased$13.2 million or 29.5% to$31.5 million atSeptember 30, 2022 from$44.7 million atDecember 31, 2021 . Commercial real estate loans increased$19.0 million or 8.4% to$246.8 million atSeptember 30, 2022 from$227.8 million atDecember 31, 2021 . Residential mortgage loans increased$12.4 million or 14.6% to$97.4 million atSeptember 30, 2022 from$85.0 million atDecember 31, 2021 . Construction real estate loans increased$4.1 million or 4.1% to$104.3 million atSeptember 30, 2022 from$100.2 million atDecember 31, 2021 . Consumer HELOC increased$1.3 million or 4.7% to$30.0 million atSeptember 30, 2022 from$28.6 million atDecember 31, 2021 . Other consumer loans increased$1.6 million or 7.7% to$23.1 million atSeptember 30, 2022 from$21.4 million atDecember 31, 2021 . Loans held for sale, decreased$1.9 million or 47.0% to$2.1 million atSeptember 30, 2022 from$4.0 million atDecember 31, 2021 . Land held for sale decreased$433,000 during 2022 due to a write down in the value of the land based on a recent appraisal. Other assets increased$14.8 million or 283.0% to$20.1 million atSeptember 30, 2022 from$5.2 million atDecember 31, 2021 . The increase was primarily the result of a$14.9 million increase in net deferred taxes, which was related to increased unrealized losses in the investment portfolio atSeptember 30, 2022 . 32 -------------------------------------------------------------------------------- SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Liabilities
Deposit Accounts
Total deposits increased $2.9 million or 0.3% to $1.12 billion at September 30,
2022 from $1.12 billion at December 31, 2021 . This growth was primarily due to
increases in checking and savings accounts partially offset by a decline in
higher cost certificates of deposits. The majority of the Bank's deposits are
originated within the Bank's immediate market area. The Bank had $6.0 million
and $10.0 million in brokered time deposits at September 30, 2022 and
December 31, 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 both September 30, 2022 and December 31, 2021 . For
additional details of deposits, see "Note 9 - Deposits" of the Notes to
Consolidated Financial Statements included in Part I. Item 1 of this report.
Shareholders' Equity
Shareholders' equity increased$41.1 million or 35.6% to$156.6 million atSeptember 30, 2022 from$115.5 million atDecember 31, 2021 . The increase was primarily attributable to a$82.9 million issuance of the Company's Senior Non-Cumulative Perpetual Preferred Stock, Series ECIP (the "Preferred Stock") during the second quarter of 2022 and year to date net income of$6.9 million . The increase was partially offset by a$46.7 million decrease in accumulated other comprehensive (loss) income, net of tax, combined with$2.1 million in dividends paid to common shareholders during the nine months endedSeptember 30, 2022 . The decrease in net accumulated other comprehensive income, net of tax, was related to the unrecognized loss in fair value of investments AFS during the nine months endedSeptember 30, 2022 reflecting the increase in market interest rates during the year. For additional details on the issuance of the Preferred Stock pursuant to the ECIP, see "Note 17 - Preferred Stock" of the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report. 33
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIESManagement's Discussion and Analysis of Financial Condition and Results of
Operations
Results of Operations for the Quarters Ended
Net Income
Net income decreased$1.4 million , or 30.5%, to$3.2 million or$0.99 per basic common share for the quarter endedSeptember 30, 2022 compared to$4.6 million or$1.43 per basic common share for the quarter endedSeptember 30, 2021 . The decrease in net income was primarily due to no grant income received during the third quarter of 2022 compared to a$1.8 million grant received in the third quarter of 2021 combined with the$665,000 reversal of provision for loan losses in the quarter endedSeptember 30, 2021 compared to no provision or reversal for loan losses for the quarter endedSeptember 30, 2022 . In addition, non-interest expense increased$229,000 , partially offsetting a$1.3 million increase in net interest income for the quarter endedSeptember 30, 2022 compared to the same quarter in 2021. Net Interest Income Net interest income increased$1.3 million , or 14.8%, to$10.1 million during the quarter endedSeptember 30, 2022 , compared to$8.8 million for the same quarter in 2021. During the quarter endedSeptember 30, 2022 , average interest-earning assets increased$194.0 million or 17.2% to$1.3 billion from$1.1 billion for the same quarter in 2021, while average interest-bearing liabilities increased$47.5 million or 5.5% to$914.1 million for the quarter endedSeptember 30, 2022 from$866.6 million for the comparable quarter in 2021. The Company's net interest margin was 3.09% for the quarter endedSeptember 30, 2022 compared to 3.16% for the comparable quarter in 2021. The Company's net interest spread on a tax equivalent basis was 2.93% for the quarter endedSeptember 30, 2022 compared to 3.07% for the quarter endedSeptember 30, 2021 . Loan yields in 2021 were impacted favorably as a result of recognition of unamortized deferred fee income on PPP loans forgiven and repaid by the SBA. Loan yields in 2022 were impacted favorably as a result of the rising interest rate environment. SinceMarch 2022 , in response to inflation, theFederal Open Market Committee ("FOMC") of theBoard of Governors of theFederal Reserve System ("Federal Reserve") has increased the target range for the federal funds rate by 300 basis points, including 150 basis points during the third quarter of 2022, to a range of 3.00% to 3.25% as ofSeptember 30, 2022 . InNovember 2022 , theFOMC increased the target range for the federal funds rate another 75 basis points to a range of 3.75% to 4.00%. We believe our net interest margin during the current year will continue to increase to reflect the lagging benefit of variable rate interest-earnings assets beginning to reprice higher and if theFOMC continues to raise the targeted federal funds rate in an effort to curb inflation, which appears likely based on recentFederal Reserve communications and interest rate forecasts. Interest Income The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the three months endedSeptember 30, 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 table. Loan yields have been reduced to reflect the negative impact on our earnings of loans on nonaccrual status. Quarter Ended September 30, 2022 2021 Change in Increase Interest Interest Average (Decrease) in (Dollars in thousands) Average Balance Income Yield(1) Average Balance Income Yield(1) Balance Interest Income Loans Receivable, Net$ 521,143 $ 6,306 4.84 %$ 505,191 $ 7,262 5.75 %$ 15,952 $ (956) Taxable Investments 741,358 4,550 2.45 570,578 2,191 1.54 170,780 2,359 Non-taxable Investments (2) 44,685 417 3.73 43,814 281 2.56 871 136 Deposits with other Banks 13,569 94 2.78 7,148 3 0.19 6,421 91
Total Interest-Earning Assets
3.44 %$ 1,126,731 $ 9,737 3.46 %$ 194,024 $ 1,630 (1) Annualized (2) Tax equivalent basis recognizes the income tax savings when comparing taxable and tax-exempt assets and was calculated using the effective tax rate for the quarters endedSeptember 30, 2022 and 2021. The tax equivalent adjustment relates to the tax exempt municipal bonds and was approximately$74,000 and$68,000 for the quarters endedSeptember 30, 2022 and 2021, respectively. 34 -------------------------------------------------------------------------------- SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Total tax equivalent interest income on average interest-earning assets
increased
Interest income on loans decreased$956,000 or 13.2% to$6.3 million for the quarter endedSeptember 30, 2022 from$7.3 million for the third quarter of 2021. The decrease in loan interest income was the result of a 91 basis point decrease in the average yield on loans receivable, primarily due to a decrease in deferred interest income on PPP loans recognized during the period. This decrease was partially offset by a$16.0 million increase in the average loan portfolio balance. Interest income from taxable investments increased$2.4 million to$4.5 million during the quarter endedSeptember 30, 2022 due to a$170.8 million increase in the average balance of these assets combined with a 91 basis point increase in the average yield. Tax equivalent interest income from non-taxable investments increased$136,000 to$417,000 during the quarter endedSeptember 30, 2022 due to an increase in the average yield on non-taxable investments. Interest income from deposits with other banks increased$91,000 during the quarter endedSeptember 30, 2022 due to a$6.4 million increase in the average balance of these assets combined with a significant increase in the average yield earned on these assets. The increase in the average balance of these assets was primarily related to the$82.9 million in cash received during the second quarter of 2022 from the sale of the Preferred Stock mentioned above.
Interest Expense
The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the three months endedSeptember 30, 2022 and 2021. Quarter Ended September 30, Increase 2022 2021 Change in (Decrease) in Average Interest Average Interest Average
Interest
(Dollars in thousands) Balance Expense Cost(1) Balance Expense Cost(1) Balance
Expense
Checking,Savings & Money Market Accounts$ 700,322 $ 540 0.31 %$ 627,678 $ 191 0.12 %$ 72,644 $ 349 Certificates Accounts 139,841 136 0.39 165,084 185 0.45 (25,243) (49) FHLB Advances & Other Borrowed Money (2) 39,099 44 0.45 38,676 51 0.52 423
(6)
Junior Subordinated Debentures 5,155 50 3.87 5,155 24 1.86 - 26 Subordinated Debentures 29,652 389 5.25 30,000 394 5.25 (348) (5)
Total Interest-Bearing Liabilities
$ 866,593 $ 845 0.39 %$ 47,476 $ 315 (1) Annualized (2) Includes FHLB Advances, FRB Borrowings and Repurchase Agreements
Total interest expense increased
Interest expense on deposits increased$300,000 to$676,000 for the quarter endedSeptember 30, 2022 due to a$47.4 million increase in the average balance of interest bearing deposit accounts combined with a 13 basis point increase in the average cost of interest-bearing deposits during the third quarter of 2022 when compared to the same quarter in 2021. Interest expense on certificate accounts decreased$49,000 due to a decrease of$25.2 million in the average balance combined with a six basis point decrease in the average cost of certificate deposits during the third quarter of 2022, as management elected to utilize liquidity gained from lower cost deposits to reduce its balances of higher cost certificates of deposit in a managed reduction of these funds. Interest expense on all other interest-bearing deposits increased$349,000 during the quarter due to a$72.6 million increase in the average balance combined with a 19 basis point increase in the average cost. Interest expense on the junior subordinated debentures increased due to increased floating interest rates reflecting higher market interest rates. 35 -------------------------------------------------------------------------------- SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
OperationsProvision for Loan Losses
The amount of the provision is determined by management's on-going monthly analysis of the loan portfolio and the adequacy of the allowance for loan losses. The Company has policies and procedures in place for evaluating and monitoring the overall credit quality of the loan portfolio and for timely identification of potential problem loans including internal and external loan reviews. The adequacy of the allowance for loan losses is reviewed monthly by the Asset Classification Committee and quarterly by the Board of Directors. Management's review of the adequacy of the allowance includes three main components. The first component is an analysis of loss potential in various homogeneous segments of the loan portfolio based on historical trends and the risk inherent in each loan category. Currently, management applies a ten year historical loss ratio to each loan category to estimate the inherent loss in these pooled loans. The second component of management's monthly analysis is the specific review and evaluation of significant problem credits identified through the Company's internal monitoring system. These loans are evaluated for impairment and recorded in accordance with accounting guidance. For each loan deemed impaired, management calculates a specific reserve for the amount in which the recorded investment in the loan exceeds the fair value. This estimate is based on a thorough analysis of the most probable source of repayment, which is typically liquidation of the collateral underlying the loan. The third component is an analysis of changes in qualitative factors that may affect the portfolio, including but not limited to: relevant economic trends that could impact borrowers' ability to repay, industry trends, changes in the volume and composition of the portfolio, credit concentrations, or lending policies and the experience and ability of the staff and Board of Directors. 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. Because the SBA guarantees 100% of the PPP loans made to eligible borrowers, these loans do not have a corresponding allowance for loan loss.
The table below shows the changes in the allowance for loan losses for the
quarters ended
Quarter Ended September 30,
(Dollars in thousands) 2022 2021
Beginning Balance $ 11,198 $ 11,424
(Reversal of) Provision for Loan Losses - (665)
Charge-offs (54) (46)
Recoveries 155 459
Net Recoveries $ 101 $ 413
Ending Allowance for Loan Losses Balance $ 11,299 $ 11,172
At Period End: 9/30/2022 9/30/2021
Impaired Loans $ 2,047 $ 2,484
Gross Loans Receivable, Held For Investment (1) $ 532,252 $ 508,184
Total Loans Receivable, Net $ 523,094 $ 500,601
Allowance For Loan Losses as a % of Impaired Loans 551.9 % 449.8 %
Allowance For Loan Losses as a % of Gross Loans Receivable (1) 2.1 % 2.2 %
(1) TOTAL LOANS HELD FOR INVESTMENT, NET OF DEFERRED FEES
The Company had net recoveries of$101,000 for the quarter endedSeptember 30, 2022 compared to net recoveries of$413,000 for the third quarter of 2021. There was no provision for loan losses for the quarter endedSeptember 30, 2022 compared to a negative provision of$665,000 for the third quarter of 2021 following significantly higher loan loss provisions during 2020 in response to the ongoing COVID-19 pandemic. The reversal of loan loss provisions during the three months endedSeptember 30, 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 ofSeptember 30, 2021 . Non-performing assets improved to$2.8 million , or 0.21% of total assets, atSeptember 30, 2022 from$3.1 million , or 0.25% of total assets, atSeptember 30, 2021 . 36 -------------------------------------------------------------------------------- SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Our strategy is to work with our borrowers to reach acceptable payment plans
while protecting our interests in the existing collateral. In the event an
acceptable arrangement cannot be reached, we may need to acquire these
properties through foreclosure or other means and subsequently sell, develop or
liquidate them. Management believes the allowance for loan losses is adequate
based on its best estimates of the probable losses inherent in the loan
portfolio, although there can be no guarantee these estimates will not be proven
incorrect in the future. In addition, bank regulatory agencies may require
additional provisions to the allowance for loan losses based on their judgments
and estimates as part of their examination process. Because the allowance for
loan losses is an estimate, there is no guarantee that actual loan losses will
not exceed the allowance for loan losses, or that additional increases in the
allowance for loan losses will not be required in the future. A further decline
in national and local economic conditions, as a result of the effects of
inflation, a potential recession or slowed economic growth and any governmental
or societal responses to the COVID-19 pandemic among 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.
Non-Interest Income
Non-interest income decreased$2.3 million , or 50.9%, to$2.2 million for the quarter endedSeptember 30, 2022 compared to$4.5 million for the quarter endedSeptember 30, 2021 . The decrease was primarily due to a$645,000 decrease in gain on sale of loans reflecting the decline in originations of loans held for sale following recent market interest rate increases combined with a$1.8 million decrease in grant income. These decreases were partially offset by increases in all other non-interest income line items with the exception of BOLI income, which decreased$4,000 during the quarter endedSeptember 30, 2022 when compared to the quarter endedSeptember 30, 2021 . For additional details of the changes in non-interest income, see "Note 15 - Non-Interest Income" of the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report. Non-Interest Expense Non-interest expense increased$229,000 or 2.8% to$8.3 million for the quarter endedSeptember 30, 2022 compared to$8.0 million for the quarter endedSeptember 30, 2021 . The following table summarizes the changes in non-interest expense: Quarter Ended September 30, Increase (Decrease) 2022 2021 $ % Compensation and Employee Benefits$ 5,019,920 $ 4,757,937 $ 261,983 5.5 % Occupancy 703,310 641,555 61,755 9.6 Advertising 153,460 275,947 (122,487) (44.4) Depreciation and Maintenance of Equipment 751,739 781,217 (29,478) (3.8) FDIC Insurance Premiums 87,858 73,845 14,013 19.0 Net Cost of Operation of OREO 10,000 55,000 (45,000) (81.8) Consulting 179,318 182,684 (3,366) (1.8) Debit Card Expense 307,092 284,434 22,658 8.0 Telephone 97,204 100,113 (2,909) (2.9) Postage 59,654 16,469 43,185 262.2 General Insurance 76,566 77,731 (1,165) (1.5) Other 831,564 801,964 29,600 3.7 Total Non-Interest Expense$ 8,277,685 $ 8,048,896 $ 228,789 2.8 %
The increase in non-interest expense was primarily due to increases in compensation and employee benefits and occupancy expense during the third quarter of 2022, which were partially offset by a decrease in advertising expense.
Compensation and employee benefits increased$262,000 or 5.5% to$5.0 million for the quarter endedSeptember 30, 2022 when compared to the quarter endedSeptember 30, 2021 due to general 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 and the overall growth of the Company. Occupancy expense and other non-interest expense also increased during the third quarter of 2022 due to increased operations and the addition of our newest branch located inColumbia, South Carolina . 37 -------------------------------------------------------------------------------- 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 $472,000 or 35.6% to $855,000 for the
quarter ended September 30, 2022 from $1.3 million for the same period in 2021
due to lower net income before taxes in 2022. Pre-tax net income was $4.1
million for the quarter ended September 30, 2022 compared to $6.0 million for
the third quarter of 2021. The Company's combined federal and state effective
income tax rate was 20.9% and 22.2% for the quarters ended September 30, 2022
and 2021, respectively.
38
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIESManagement's Discussion and Analysis of Financial Condition and Results of
Operations
Results of Operations for the Nine Months Ended
Net Income
Net income decreased$3.8 million or 35.4% to$6.9 million or$2.13 per common share for the nine months endedSeptember 30, 2022 compared to$10.7 million or$3.30 per common share for the nine months endedSeptember 30, 2021 . The decrease in net income was primarily due to the reversal of$2.3 million in loan loss reserves during the nine months endedSeptember 30, 2021 compared to no provision or reversal for loan losses recorded during the nine months endedSeptember 30, 2022 . A decrease in non-interest income and increase in non-interest expenses also contributed to lower net income during the nine months endedSeptember 30, 2022 when compared to the same period last year.
Net Interest Income
Net interest income increased$2.0 million or 8.1% to$26.6 million for the nine months endedSeptember 30, 2022 compared to$24.6 million for the same period last year. During the nine months endedSeptember 30, 2022 , average interest earning assets increased$164.5 million or 14.8% to$1.3 billion from$1.1 billion for the nine months endedSeptember 30, 2021 . Average interest-bearing liabilities also increased by$58.0 million or 6.7% to$927.7 million for the nine months endedSeptember 30, 2022 from$869.7 million for the same period in 2021. The Company's net interest margin fell 18 basis points to 2.79% for the nine months endedSeptember 30, 2022 compared to 2.97% for the nine months endedSeptember 30, 2021 . The net interest spread on a tax equivalent basis fell 20 basis points to 2.68% for the nine months endedSeptember 30, 2022 from 2.88% for the comparable period in 2021.
Interest Income
The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the nine months endedSeptember 30, 2022 and 2021:
Nine Months Ended
2022 2021 Change in Increase
Interest Interest Average (Decrease) in
(Dollars in Thousands) Average Balance Income Yield(1) Average Balance Income Yield(1) Balance Interest Income
Loans Receivable, Net $ 518,436 $ 18,608 4.79 % $ 508,693 $ 20,039 5.25 % $ 9,743 $ (1,431)
Taxable Investments 696,283 9,720 1.86 556,001 6,409 1.54 140,282 3,310
Non-taxable Investments(2) 44,633 1,086 3.25 44,014 1,230 3.73 619 (144)
Deposits with other Banks 18,545 151 1.08 4,672 6 0.18 13,873 144
Total Interest-Earning Assets $ 1,277,897 $ 29,565 3.08 % $ 1,113,380 $ 27,684 3.32 % $ 164,517 $ 1,879
(1) Annualized
(2) Tax equivalent basis recognizes the income tax savings when comparing
taxable and tax-exempt assets and was calculated using an effective tax rate of
21% for the nine months ended September 30, 2022 and 2021. The tax equivalent
adjustment relates to the tax exempt municipal bonds and was approximately
$184,000 and $202,000 for the nine months ended September 30, 2022 and 2021,
respectively.
Total tax equivalent interest income increased $1.9 million to $29.6 million
during the nine months ended September 30, 2022 compared to $27.7 million during
the nine months ended September 30, 2021 , primarily due to an increase in
interest income from taxable investments, which was partially offset by a
decrease in interest income from loans. Total interest income on loans decreased
$1.4 million or 7.1% to $18.6 million during the nine months ended September 30,
2022 from $20.0 million for the same period in 2021. The decrease was a result
of a 46 basis point decrease in the average yield on loans receivable, which was
primarily driven by the recognition of $3.3 million in fee income related to PPP
loans during the nine months ended September 30, 2021 . The decrease was
partially offset by a $9.7 million or 1.9% increase in the average loan balance.
Interest income from taxable investment securities increased $3.3 million or
51.6% to $9.7 million for the nine months ended September 30, 2022 from $6.4
million for the same period in 2021. The increase was the result of a $140.3
million increase in the average balance of taxable investments, primarily HTM,
combined with an increase of 32 basis points in the average yield earned on
taxable investment securities. Tax equivalent interest income from non-taxable
investment securities decreased $144,000 or 11.7% to $1.1 million for the nine
months ended September 30, 2022 when compared to the nine months ended September
30, 2021 .
39
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIESManagement's Discussion and Analysis of Financial Condition and Results of
Operations
Interest income from deposits with other banks increased $144,000 for the nine
months ended September 30, 2022 due to a $13.9 million increase in the average
balance of these assets, primarily due to the cash received for the sale of the
Company's Preferred Stock, combined with an increase of 90 basis points in the
average yield.
Interest Expense
The following table compares detailed average balances, cost of funds on an
annualized basis, and the resulting changes in interest expense for the nine
months ended
Nine Months Ended September 30,
2022 2021 Change in Change in
Average Interest Cost of Average Interest Cost of Average Interest
(Dollars in Thousands) Balance Expense Funds Balance Expense Funds Balance Expense
Checking, Savings & Money Market
Accounts $ 700,580 $ 998 0.19 % $ 598,496 $ 542 0.12 % $ 102,084 $ 456
Certificates Accounts 150,670 420 0.37 176,589 716 0.54 (25,919) (296)
FHLB Advances & Other Borrowed
Money (1) 41,374 91 0.29 59,429 389 0.87 (18,055) (298)
Junior Subordinated Debentures 5,155 111 2.87
5,155 73 1.89 - 38
Subordinated Debentures 29,883 1,177 5.25 30,000 1,181 5.25 (117) (4)
Total Interest-Bearing Liabilities
$ 869,669 $ 2,901 0.44 %$ 57,993 $ (104)
(1) Includes FHLB Advances, FRB Borrowings and Repurchase Agreements
Interest expense decreased$104,000 or 3.5% to$2.8 million during the nine months endedSeptember 30, 2022 compared to$2.9 million for the same period in 2021. The decrease in total interest expense was attributable to a decrease of four basis points in the average cost of interest-bearing liabilities, which was partially offset by a$58.0 million or 6.7% increase in the average balance of these liabilities. Interest expense on deposits increased$161,000 to$1.4 million for the nine months endedSeptember 30, 2022 due to a$76.2 million increase in the average balance of interest bearing deposit accounts. Interest expense on certificate accounts decreased$296,000 due to a$25.9 million decrease in the average balance combined with a 17 basis point decrease in the average cost of certificate deposits during the first nine months of 2022, as management elected to utilize liquidity gained from lower cost deposits to reduce its balances of higher cost certificates of deposit in a managed reduction of these funds. Interest expense on all other interest-bearing deposits increased$457,000 during the nine months endedSeptember 30, 2022 due to a$102.1 million increase in the average balance combined with a seven basis point increase in the average cost. Interest expense on FHLB advances and other borrowed money decreased$298,000 or 76.5% to$91,000 from$389,000 due to a$18.1 million or 30.4% decrease in the average balance combined with a decline of 58 basis points in the average cost of these liabilities during the nine months endedSeptember 30, 2022 when compared to the same period last year.
Provision for Loan Losses
There was no provision for loan losses recorded during the nine months endedSeptember 30, 2022 compared to a reversal of provision expense of$2.3 million for the same period in 2021. The negative provision during 2021 resulted from a reduction in qualitative adjustment factors due to the improvement in the economic and business conditions at both the national and regional levels as ofSeptember 30, 2021 following significantly higher loan loss provisions during 2020 in response to the potential and unknown economic impact of the ongoing COVID-19 pandemic. For additional details related to the provision for loan losses and changes in the allowance for loan losses, see "Note 8 - Loans Receivable, Net" of the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report. 40 -------------------------------------------------------------------------------- SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Non-Interest Income
Non-interest income decreased $2.5 million or 25.3% to $7.5 million for the nine
months ended September 30, 2022 , compared to $10.0 million for the nine months
ended September 30, 2021 . The following table summarizes the changes in the
components of non-interest income:
Nine Months Ended September 30, Increase (Decrease)
2022 2021 $ %
Gain on Sale of Loans $ 1,511,905 $ 3,022,755 $ (1,510,850) (50.0) %
Service Fees on Deposit Accounts 809,287 702,548 106,739 15.2
Commissions From Insurance Agency 620,779 468,083 152,696 32.6
Trust Income 1,084,249 1,005,517 78,732 7.8
BOLI Income 457,202 485,000 (27,798) (5.7)
ATM & Check Card Fee Income 2,109,173 1,811,216 297,957 16.5
Grant Income 170,699 1,826,265 (1,655,566) 100.0
Other 702,135 669,379 32,756 4.9
Total Non-Interest Income $ 7,465,429 $ 9,990,763 $ (2,525,334) (25.3) %
The decrease in non-interest income was primarily attributable to a decreases in
gain on sale of loans and grant income, which was partially offset by increases
in every other non-interest income line item with the exception of BOLI income,
which decreased $28,000 during the nine months ended September 30, 2022 . Gain on
sale of loans decreased $1.5 million or 50.0% to $1.5 million for the nine
months ended September 30, 2022 compared to $3.0 million during the same period
in 2021 as the dollar volume of loans sold decreased. Commissions from insurance
subsidiary increased $153,000 to $621,000 during the nine months ended September
30, 2022 due to an increase in the number of insurance policies sold. ATM &
Check Card Fee income increased $298,000 primarily due to an increase in debit
card usage.
Non-Interest Expense
For the nine months ended September 30, 2022 , non-interest expense increased
$2.2 million or 9.5% to $25.3 million compared to $23.1 million for the same
period in 2021. The table below summarizes the changes in the components of
non-interest expense.
Nine Months Ended September 30, Increase (Decrease)
2022 2021 $ %
Compensation and Employee Benefits
$ 835,783 5.9 % Occupancy 2,110,746 1,922,369 188,377 9.8 Advertising 693,389 671,186 22,203 3.3 Depreciation and Maintenance of Equipment 2,278,890 2,354,958 (76,068) (3.2) FDIC Insurance Premiums 284,083 215,181 68,902 32.0 Net Cost (Recovery) of Operation of OREO 10,000 (115,840) 125,840 (108.6) Change in Value of Land HFS 433,077 - 433,077 100.0 Consulting 513,299 512,998 301 0.1 Debit Card Expense 917,225 859,357 57,868 6.7 Telephone 291,069 313,229 (22,160) (7.1) Postage 182,202 147,600 34,602 23.4 General Insurance 257,577 248,691 8,886 3.6 Other 2,348,375 1,829,544 518,831 28.4 Total Non-Interest Expense$ 25,301,078 $ 23,104,636 $ 2,196,442 9.5 % 41
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIESManagement's Discussion and Analysis of Financial Condition and Results of
Operations
Compensation and employee benefits expenses increased $836,000 or 5.9% to $15.0
million for the nine months ended September 30, 2022 compared to $14.1 million
during the same period last year 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 and the
overall growth of the Company. Occupancy expense and advertising also increased
due to the addition of our newest branch located in Columbia, South Carolina .
The Company had $10,000 in write-down expenses on OREO properties during the
nine months ended September 30, 2022 compared to a net recovery of $116,000
during the nine months ended September 30, 2021 . This line item includes all
income and expenses associated with OREO, including gain or loss on sales and
write-downs in value during each period.
Land held for sale decreased $433,000 during 2022 due to a write down in the
value of the land based on a recent appraisal. Other non-interest expense
increased $519,000 or 28.4% to $2.3 million for the nine months ended September
30, 2022 compared to $1.8 million during the nine months ended September 30,
2021 due to increased operations and the opening of our newest branch in 2022.
Provision For Income Taxes
The provision for income taxes decreased$1.2 million or 39.6% to$1.8 million for the nine months endedSeptember 30, 2022 from$3.0 million for the same period in 2021 primarily due to higher pre-tax income in 2021. Income before taxes was$8.7 million and$13.7 million for the nine months endedSeptember 30, 2022 and 2021, respectively. The Company's combined federal and state effective income tax rate was 20.7% for the nine months endedSeptember 30, 2022 compared to 21.8% for the same period in 2021. 42 -------------------------------------------------------------------------------- SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
OperationsLiquidity Commitments, Capital Resources, and Impact of Inflation and Changing Prices
The Company actively analyzes and manages the Bank's liquidity with the objective of maintaining an adequate level of liquidity and to ensure the availability of sufficient cash flows to support loan growth, fund deposit withdrawals, fund operations, and satisfy other financial commitments. See the "Consolidated Statements of Cash Flows" contained in Item 1 - Financial Statements, herein.
The Bank's primary sources of funds include deposits, scheduled loan and investment securities repayments, including interest payments, maturities and sales of loans and investment securities, advances from the FHLB and FRB, and cash flow generated from operations. The sources of funds, together with retained earnings and equity, are used to make loans, acquire investment securities and other assets, and fund continuing operations. While maturities and the scheduled amortization of loans are a predictable source of funds, deposit flows and mortgage repayments are greatly influenced by the level of interest rates, economic conditions, and competition. Management believes that the Company's current liquidity position and its forecasted operating results are sufficient to fund all of its existing commitments. The Bank had$173.0 million in unused commitments to extend credit and standby letters of credit atSeptember 30, 2022 . During the nine months endedSeptember 30, 2022 , loan disbursements exceeded loan repayments resulting in a$23.6 million or 4.7% increase in total net loans receivable. Also during the nine months endedSeptember 30, 2022 , deposits increased$2.9 million or 0.3%. The Bank had no outstanding FHLB advances atSeptember 30, 2022 with$401.7 million in additional borrowing capacity at the FHLB at that date. The Bank had$1.0 million of outstanding borrowings from the discount window facility at the FRB atSeptember 30, 2022 , which was collateralized by investments AFS with a fair market value of$70.4 million at that date. The Bank also had a$50.0 million unused Fed Funds facility withPacific Coast Bankers Bank atSeptember 30, 2022 . Subject to market conditions, we expect to utilize these borrowing facilities from time to time in the future to fund loan originations and deposit withdrawals, to satisfy other financial commitments, repay maturing debt and to take advantage of investment opportunities to the extent feasible. As discussed above, onMay 24, 2022 , the Company sold$89.4 million of Preferred Stock to theU.S. Department of Treasury pursuant to the ECIP. The Company is a separate legal entity from the Bank and must provide for its own liquidity. AtSeptember 30, 2022 , the Company, on an unconsolidated basis, had liquid assets of$94.5 million . In addition to its operating expenses, the Company is responsible for paying any dividends declared, if any, to its shareholders, funds paid for Company stock repurchases, and payments on trust-preferred securities and subordinated debentures held at the Company level. The Company has the ability to receive dividends or capital distributions from the Bank, although there are regulatory restrictions on the ability of the Bank to pay dividends. We currently expect to continue our current practice of paying quarterly cash dividends on our common stock subject to our 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$0.12 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. Assuming continued payment during 2022 at this rate of$0.12 per share, our average total dividend paid each quarter would be approximately$390,000 based on the number of outstanding shares atSeptember 30, 2022 . AtSeptember 30, 2022 , the Bank exceeded all regulatory capital requirements with Common Equity Tier 1 Capital (CET1), Tier 1 leverage-based capital, Tier 1 risk-based capital, and total risk-based capital ratios of 17.86%, 10.32%, 17.86%, and 19.11%, respectively. To be categorized as "well capitalized" under the prompt corrective action provisions the Bank must maintain minimum CET1, total risk based capital, Tier 1 risk-based capital and Tier 1 leverage capital ratios of 6.5%, 10.0%, 8.0% and 5.0%, respectively. In addition to the minimum capital requirements, the Bank must maintain a capital conservation buffer, which consists of additional CET1 capital greater than 2.5% of risk weighted assets above the required minimum levels in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses. AtSeptember 30, 2022 the Bank's conservation buffer was 11.1%. For additional details, see "Note 12 - Regulatory Matters" of the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report. 43 -------------------------------------------------------------------------------- SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
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