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, 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, including as a result of employment levels and labor shortages, and the
effects of inflation, a potential recession or slowed economic growth caused by
increasing oil prices and supply chain disruptions;;
•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 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;
30
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIESManagement's Discussion and Analysis of Financial Condition and Results of
Operations•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;
•inability of key third-party providers to perform their obligations to us;
•changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies or the FASB, including additional guidance and interpretation on accounting issues and details of the implementation of new accounting methods;
•other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; and
•the 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 ofJune 30, 2022 , all Bank branches were open with normal hours and substantially all employees had returned to their normal working environments. 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$100.9 million to$1.4 billion atJune 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) June 30, 2022 December 31, 2021 $ % Cash and Cash Equivalents$ 78,873 $ 27,623$ 51,250 185.5 % Certificates of Deposits with Other Banks 1,100 1,100 - - Investments AFS 634,540 682,849 (48,309) (7.1) Investments HTM 105,036 23,507 81,529 346.8 Loans Receivable, Net 502,979 499,497 3,482 0.7 Accrued Interest Receivable 3,906 3,752 154 4.1 OREO 130 130 - - Operating Lease ROU Assets 2,038 2,252 (214) (9.5) Land Held for Sale 1,097 1,530 (433) (28.3) Premises and Equipment, Net 26,965 25,237 1,728 6.8 FHLB Stock 651 586 65 11.1 BOLI 27,016 26,710 306 1.1 Goodwill 1,200 1,200 - - Other Assets 16,619 5,241 11,378 217.1 Cash and cash equivalents increased$51.3 million or 185.5% to$78.9 million atJune 30, 2022 compared to$27.6 million atDecember 31, 2021 . The increase was primarily a result of the sale of preferred stock to theU.S. Treasury pursuant to the Emergency Capital Investment Program ("ECIP"), loan repayments and an increase in total deposits, which exceeded the funds required for loan originations and used for purchases of investment securities. For additional details on the ECIP, see the discussion in Shareholders' Equity below and within "Note 17 - Preferred Stock" of the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report.. Investments AFS decreased$48.3 million or 7.1% to$634.5 million atJune 30, 2022 from$682.8 million atDecember 31, 2021 as maturities and principal paydowns of investments AFS exceeded purchases during the six months endedJune 30, 2022 . Additionally, investments AFS experienced a$33.6 million decrease in fair value during the six months endedJune 30, 2022 . Investments HTM increased$81.5 million or 346% to$105.0 million atJune 30, 2022 from$23.5 million atDecember 31, 2021 . The increase is primarily the result of the Company's investment of ECIP proceeds. Loans receivable, net, including loans held for sale, increased$3.5 million or 0.7% to$503.0 million atJune 30, 2022 from$499.5 million atDecember 31, 2021 , primarily due to residential real estate loans and commercial real estate loans originated during the period. Loan balances in the residential real estate, and other consumer categories all increased during the period endedJune 30, 2022 while real estate construction, commercial and agricultural loans, and consumer HELOCs all decreased since the prior year end. Commercial real estate loans increased$13.3 million or 5.8% to$241.1 million atJune 30, 2022 from$227.8 million atDecember 31, 2021 . Construction real estate loans decreased$2.5 million or 2.5% to$97.6 million atJune 30, 2022 from$100.2 million atDecember 31, 2021 . Consumer HELOC decreased$15,000 or 0.1% to$28.6 million atJune 30, 2022 from$28.6 million atDecember 31, 2021 . Commercial and agricultural loans decreased$16.2 million or 36.2% to$28.5 million atJune 30, 2022 from$44.7 million atDecember 31, 2021 . Residential mortgage loans increased$11.0 million or 13.0% to$96.0 million atJune 30, 2022 from$85.0 million atDecember 31, 2021 . Other consumer loans decreased$1.1 million or 5.0% to$22.5 million million atJune 30, 2022 from$21.4 million atDecember 31, 2021 . Loans held for sale, decreased$3.4 million or 85.4% to$590,000 atJune 30, 2022 from$4.0 million atDecember 31, 2021 .
Land held for sale decreased
32
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIESManagement's Discussion and Analysis of Financial Condition and Results of
Operations
Other assets increased $11.4 million or 217.1% to $16.6 million at June 30, 2022
from $5.2 million at December 31, 2021 . The increase was primarily the result of
a $7.2 million increase in net deferred taxes, which was related to increased
unrealized losses in the investment portfolio at June 30, 2022 .
Liabilities
Deposit Accounts
Total deposits increased $33.7 million or 3.0% to $1.15 billion at June 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 Company had $10.0
million in brokered time deposits at both June 30, 2022 and December 31, 2021 .
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 June 30,
2022 . 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$51.4 million or 44.5% to$166.9 million atJune 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. The increase was offset by a$33.6 million decrease in accumulated other comprehensive income, net of tax, combined with$1.7 million in dividends paid to common shareholders during the six months endedJune 30, 2022 , which was partially offset by net income of$3.7 million . The decrease in net accumulated other comprehensive income was related to the unrecognized loss in value of investments AFS during the six months endedJune 30, 2022 . OnMay 24, 2022 , Company entered into a Letter Agreement with theU.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 the Company's Preferred Stock as Senior Non-Cumulative Perpetual Preferred Stock, Series ECIP (the "Preferred Stock") for an aggregate purchase price of$82.9 million in cash. 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$760,000 or 26.0% to$2.2 million or$0.67 per basic common share for the quarter endedJune 30, 2022 compared to$2.9 million or$0.90 per basic common share for the quarter endedJune 30, 2021 . The decrease in net income was primarily due to the$735,000 reversal of provision for loan losses in the quarter endedJune 30, 2021 following significantly higher loan loss provisions during 2020 in response to the ongoing COVID-19 pandemic. In addition, non-interest expense increased$982,000 , offsetting an$805,000 increase in net interest income for the quarter endedJune 30, 2022 compared to the same quarter in 2021. Net Interest Income Net interest income increased$805,000 or 10.4% to$8.5 million during the quarter endedJune 30, 2022 , compared to$7.7 million for the same quarter in 2021. During the quarter endedJune 30, 2022 , average interest-earning assets increased$165.2 million or 14.8% to$1.3 billion from$1.1 billion for the same quarter in 2021, while average interest-bearing liabilities increased$54.7 million or 6.2% to$929.5 million for the quarter endedJune 30, 2022 from$874.8 million for the comparable quarter in 2021. The Company's net interest margin was 2.68% for the quarter endedJune 30, 2022 compared to 2.78% for the comparable quarter in 2021. The Company's net interest spread on a tax equivalent basis was 2.58% for the quarter endedJune 30, 2022 compared to 2.68% for the quarter endedJune 30, 2021 . Loan yields in 2021 were impacted favorably as a result of recognition of unamortized deferred fee income on PPP loans forgiven and repaid by the SBA.
Interest Income
The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the three months endedJune 30, 2022 and 2021. The average balances were derived from the daily balances throughout the periods indicated. The average yields or costs were calculated by dividing the income or expense by the average balance of the corresponding assets or liabilities. Nonaccrual loans are included in earning assets in the following table. Loan yields have been reduced to reflect the negative impact on our earnings of loans on nonaccrual status. Quarter Ended June 30, Increase Change in (Decrease) in 2022 2021 Average Interest (Dollars in thousands) Average Balance Yield(1) Average Balance Yield(1) Balance Income Loans Receivable, Net$ 517,732 4.79 %$ 516,277 4.88 %$ 1,455 $ (88) Taxable Investments 685,032 1.67 553,592 1.45 131,440 845 Non-taxable Investments (2) 44,702 2.98 44,445 4.32 257
(147)
Deposits with other Banks 36,014 0.60 3,966 0.16 32,048
52
Total Interest-Earning Assets$ 1,283,480 2.94 %$ 1,118,280 3.15 %$ 165,200 $ 662 (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 endedJune 30, 2022 and 2021. The tax equivalent adjustment relates to the tax exempt municipal bonds and was approximately$60,000 and$68,000 for the quarters endedJune 30, 2022 and 2021, respectively.
Total tax equivalent interest income on average interest-earning assets
increased
Interest income on loans decreased$88,000 or 1.4% to$6.2 million for the quarter endedJune 30, 2022 from$6.3 million for the second quarter of 2021. The decrease in loan interest income was the result of a nine 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$1.5 million increase in the average loan portfolio balance. Interest income from taxable investments increased$845,000 to$2.9 million during the quarter endedJune 30, 2022 due to a$131.4 million increase in the average balance of these assets combined with a 22 basis point increase in the average yield. Tax equivalent interest income from non-taxable investments decreased$147,000 to$333,000 during the quarter endedJune 30, 2022 due to a decrease in the average yield on non-taxable investments. 34 -------------------------------------------------------------------------------- SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Interest income from deposits with other banks increased $52,000 during the
quarter ended June 30, 2022 due to a $32.0 million increase in the average
balance of these assets combined with a 44 basis point increase in the average
yield. The increase in the average balance of these assets was primarily related
to the $82.9 million in cash received during the second quarter of 2022 for the
sale of preferred stock mentioned above.
Interest Expense
The following table compares detailed average balances, cost of funds, and the resulting changes in interest expense for the three months endedJune 30, 2022 and 2021. Quarter Ended June 30, 2022 2021 Change in Average Average Increase (Decrease) (Dollars in thousands) Average Balance Cost(1) Balance Cost(1) Balance in Interest Expense Checking,Savings & Money Market Accounts$ 706,739 0.14 %$ 601,498 0.12 %$ 105,241 $ 70 Certificates Accounts 151,820 0.39 179,415 0.51 (27,595) (83) FHLB Advances & Other Borrowed Money (2) 35,780 0.19 58,770 1.02 (22,990) (132) Junior Subordinated Debentures 5,155 2.73 5,155 1.89 - 11 Subordinated Debentures 30,000 5.25 30,000 5.25 - -
Total Interest-Bearing Liabilities
$ 874,838 0.45 %$ 54,656 $ (135) (1) Annualized (2) Includes FHLB Advances, FRB Borrowings and Repurchase Agreements Total interest expense decreased$135,000 or 13.8% to$844,000 for the quarter endedJune 30, 2022 compared to$978,000 for the same quarter in 2021 due to a decline of nine basis points in the average cost of interest bearing liabilities, which was partially offset by a$54.7 million or 6.2% increase in the average balance of these liabilities. Despite a$77.6 million increase in the average balance of deposit accounts, the average cost of interest-bearing deposits decreased three basis points, resulting in a$13,000 decrease in interest expense on deposit accounts during the second quarter of 2022 when compared to the same quarter in 2021. Interest expense on certificate accounts decreased$83,000 due to a decrease of$27.6 million in the average balance combined with a 12 basis point decrease in the average cost of certificate deposits during the second 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 other borrowings decreased$132,000 for the second quarter of 2022 due to a$23.0 million decrease in the average balance of these interest-bearing liabilities, combined with a decrease of 83 basis points in the average cost.
Provision for Loan Losses
The amount of the provision is determined by management's on-going monthly
analysis of the loan portfolio and the adequacy of the allowance for loan
losses. The Company has policies and procedures in place for evaluating and
monitoring the overall credit quality of the loan portfolio and for timely
identification of potential problem loans including internal and external loan
reviews. The adequacy of the allowance for loan losses is reviewed monthly by
the Asset Classification Committee and quarterly by the Board of Directors.
Management's 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.
35
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIESManagement's Discussion and Analysis of Financial Condition and Results of
Operations
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 June 30,
(Dollars in thousands) 2022 2021
Beginning Balance $ 11,129 $ 11,947
(Reversal of) Provision for Loan Losses - (735)
Charge-offs (12) (19)
Recoveries 81 231
Net Recoveries $ 69 $ 212
Ending Allowance for Loan Losses Balance $ 11,198 $ 11,424
At Period End: 6/30/2022 6/30/2021
Impaired Loans $ 2,082 $ 2,435
Gross Loans Receivable, Held For Investment (1) $ 513,587 $ 509,932
Total Loans Receivable, Net $ 502,979 $ 503,287
Allowance For Loan Losses as a % of Impaired Loans 538.0 % 469.2 %
Allowance For Loan Losses as a % of Gross Loans Receivable (1) 2.2 % 2.2 %
(1) TOTAL LOANS HELD FOR INVESTMENT, NET OF DEFERRED FEES
The Company had net recoveries of$69,000 for the quarter endedJune 30, 2022 compared to net recoveries of$212,000 for the second quarter of 2021. There was no provision for loan losses for the quarter endedJune 30, 2022 compared to a negative provision of$735,000 for the second quarter of 2021. The reversal of loan loss provisions during the three months endedJune 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 ofJune 30, 2021 . Non-performing assets improved to$2.6 million atJune 30, 2022 from$2.8 million atDecember 31, 2021 . Non-performing assets represented 0.2% of total assets at bothJune 30, 2022 andDecember 31, 2021 . 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 decline in national and local economic conditions, as a result of the COVID-19 pandemic or other factors, could result in a material increase in the allowance for loan losses and may adversely affect the Company's financial condition and results of operations. 36
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIESManagement's Discussion and Analysis of Financial Condition and Results of
Operations
Non-Interest Income
Non-interest income decreased $50,000 or 1.9% to $2.64 million for the quarter
ended June 30, 2022 compared to $2.69 million for the quarter ended June 30,
2021 . A $508,000 decrease in gain on sale of loans reflecting the decline in
originations of loans held for sale following recent interest rate increases was
offset by increases in all other non-interest income line items with the
exception of BOLI income, which decreased $16,000 during the quarter ended
June 30, 2022 when compared to the quarter ended June 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
Quarter Ended June 30, Increase (Decrease)
2022 2021 $ %
Compensation and Employee Benefits
$ 386,426 8.6 % Occupancy 694,650 659,532 35,118 5.3 Advertising 279,596 195,837 83,759 42.8 Depreciation and Maintenance of Equipment 806,490 770,894 35,596 4.6 FDIC Insurance Premiums 84,183 72,720 11,463 15.8Net Cost (Recovery) of Operation of OREO - (67,173) 67,173 (100.0) Write down of Land Held for Sale 93,733 - 93,733 100.0 Consulting 169,231 161,404 7,827 4.8 Debit Card Expense 326,344 316,260 10,084 3.2 Other 1,069,716 818,402 251,314 30.7 Total Non-Interest Expense$ 8,428,549 $ 7,446,056 $ 982,493 13.2 % The increase in non-interest expense was primarily due to increases in compensation and employee benefits expense and all other line items of non-interest expense during the second quarter of 2022 as well as a write down of land held for sale combined with a net recovery on operation of OREO during the second quarter of 2021. Compensation and employee benefits increased$386,000 or 8.6% to$4.9 million for the quarter endedJune 30, 2022 when compared to the quarter endedJune 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 overall growth of the Company. Occupancy expense and depreciation and maintenance of equipment also increased during the second quarter of 2022 due to the addition of our newest branch located inColumbia, South Carolina . The net gain on OREO sales exceeded write-downs and other costs, resulting in a net recovery of$67,000 from the operation of OREO properties, which decreased non-interest expense during the quarter endedJune 30, 2021 . Other non-interest expense increased$251,000 or 30.7% to$1.1 million for the quarter endedJune 30, 2022 compared to$818,000 during the second quarter of 2021 due to increased operations and the opening of our newest branch in 2022. Provision For Income Taxes The provision for income taxes decreased$202,000 or 25.6% to$589,000 for the quarter endedJune 30, 2022 from$791,000 for the same period in 2021 due to lower net income before taxes in 2022. Pre-tax net income was$2.8 million for the quarter endedJune 30, 2022 compared to$3.7 million for the second quarter of 2021. The Company's combined federal and state effective income tax rate was 21.4% and 21.3% for the quarters endedJune 30, 2022 and 2021, respectively. 37 -------------------------------------------------------------------------------- SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Results of Operations for the Six Months Ended
Net Income
Net income decreased$2.4 million or 39.2% to$3.7 million or$1.14 per common share for the six months endedJune 30, 2022 compared to$6.1 million or$1.88 per common share for the six months endedJune 30, 2021 . The decrease in net income was primarily due to the reversal of$1.6 million in loan loss reserves during the first six months of 2021 following significantly higher loan loss provisions during 2020 in response to the potential and unknown economic impact of the ongoing COVID-19 pandemic. A decrease in gain on sale of loans and increase in non-interest expenses also contributed to lower net income during the six months endedJune 30, 2022 when compared to the same period last year.
Net Interest Income
Net interest income increased$690,000 or 4.4% to$16.4 million for the six months endedJune 30, 2022 compared to$15.8 million for the same period last year. During the six months endedJune 30, 2022 , average interest earning assets increased$149.6 million or 13.5% to$1.3 billion from$1.1 billion for the six months endedJune 30, 2021 . Average interest-bearing liabilities also increased by$63.1 million or 7.2% to$935.0 million for the six months endedJune 30, 2022 from$871.9 million for the same period in 2021. The Company's net interest margin fell 24 basis points to 2.64% for the six months endedJune 30, 2022 compared to 2.88% for the six months endedJune 30, 2021 . The net interest spread on a tax equivalent basis fell 23 basis points to 2.55% for the six months endedJune 30, 2022 from 2.78% for the comparable period in 2021.
Interest Income
The following table compares detailed average balances, associated yields, and the resulting changes in interest income for the six months endedJune 30, 2022 and 2021: Six Months Ended June 30, Change in 2022 2021 Average Increase (Decrease) (Dollars in Thousands) Average Balance Yield(1) Average Balance Yield(1) Balance in Interest Income Loans Receivable, Net$ 517,061 4.76 %$ 510,413 5.01 %$ 6,648 $ (475) Taxable Investment Securities 673,236 1.50 549,015 1.54 124,221 841 Non-taxable Investment Securities(2) 44,705 3.49 43,614 4.35 1,091 (169) Deposits with other Banks 20,919 0.54 3,278 0.19 17,641 53 Total Interest-Earning Assets$ 1,255,921 2.90 %$ 1,106,320 3.25 %$ 149,601 $ 250 (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 six months endedJune 30, 2022 and 2021. The tax equivalent adjustment relates to the tax exempt municipal bonds and was approximately$111,000 and$134,000 for the six months endedJune 30, 2022 and 2021, respectively. Total tax equivalent interest income increased$250,000 to$18.2 million during the six months endedJune 30, 2022 compared to$17.9 million during the first six months of 2021, primarily due to an increase in interest income from taxable investments, which was partially offset by decreases in interest income from loans and non-taxable investments. Total interest income on loans decreased$475,000 or 3.7% to$12.3 million during the six months endedJune 30, 2022 from$12.8 million for the same period in 2021. The decrease was a result of a 25 basis point decrease in the average yield on loans receivable, which was primarily driven by the recognition of$1.8 million in fee income related to PPP loans during the six months endedJune 30, 2021 . The decrease was partially offset by a$6.6 million or 1.3% increase in the average loan balance. Interest income from taxable investment securities increased$841,000 or 19.9% to$5.1 million for the six months endedJune 30, 2022 from$4.2 million for the same period in 2021. The increase was the result of a$124.2 million increase in the average balance of taxable investments, primarily HTM, which was partially offset by a slight decrease of four basis points in the average yield earned on taxable investment securities. Tax equivalent interest income from investment securities decreased$169,000 or 17.8% to$781,000 for the six months endedJune 30, 2022 when compared to the first six months of 2021. Interest income from deposits with other banks increased$53,000 for the six months endedJune 30, 2022 due to a$17.6 million increase in the average balance of these assets, primarily due to the cash received for the sale of the Companies preferred stock. 38 -------------------------------------------------------------------------------- SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Interest Expense
The following table compares detailed average balances, cost of funds on an
annualized basis, and the resulting changes in interest expense for the six
months ended
Six Months Ended June 30,
2022 2021 Change in Change in
Average Average Interest
(Dollars in Thousands) Average Balance Cost of Funds Balance Cost of Funds Balance Expense Checking, Savings & Money Market Accounts
$ 701,395 0.14 %
155,886 0.35 182,437 0.58 (26,551) (262)
FHLB Advances & Other Borrowed Money
(1) 42,530 0.22 70,640 0.96 (28,110) (291)
Junior Subordinated Debentures 5,155 2.38 5,155 1.90 - 12
Subordinated Debentures 30,000 5.25 30,000 5.25 - -
Total Interest-Bearing Liabilities $ 934,966 0.35 % (1) Includes FHLB Advances, FRB Borrowings and Repurchase Agreements
Interest expense decreased$418,000 or 20.3% to$1.6 million during the six months endedJune 30, 2022 compared to$2.1 million for the same period in 2021. The decrease in total interest expense was attributable to a decrease of 12 basis points in the cost of interest-bearing liabilities, which was partially offset by a$63.1 million or 7.2% increase in the average balance of these liabilities. Interest expense on FHLB advances and other borrowings decreased$291,000 or 86.1% to$47,000 from$338,000 due to a$28.1 million or 39.8% decrease in the average balance combined with a decline of 74 basis points in the average cost of these liabilities during the six months endedJune 30, 2022 when compared to the same period last year. Provision for Loan Losses There was no provision for loan losses recorded during the six months endedJune 30, 2022 compared to a reversal of provision expense of$1.6 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 ofJune 30, 2021 . 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. Non-Interest Income Non-interest income decreased$220,000 or 4.0% to$5.2 million for the six months endedJune 30, 2022 , compared to$5.5 million for the six months endedJune 30, 2021 . The following table summarizes the changes in the components of non-interest income: Six Months Ended June 30, Increase (Decrease) 2022 2021 $ % Gain on Sale of Loans$ 1,224,824 $ 2,090,415 $ (865,591) (41.4) % Service Fees on Deposit Accounts 529,378 451,108 78,270 17.4 Commissions From Insurance Agency 385,273 280,426 104,847 37.4 Trust Income 720,419 646,482 73,937 11.4 BOLI Income 306,203 330,000 (23,797) (7.2) ATM & Check Card Fee Income 1,421,400 1,195,648 225,752 18.9 Grant Income 170,699 - 170,699 100.0 Other 482,846 467,065 15,781 3.4 Total Non-Interest Income$ 5,241,042 $ 5,461,144
39
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SECURITY FEDERAL CORPORATION AND SUBSIDIARIESManagement's Discussion and Analysis of Financial Condition and Results of
Operations
The decrease in non-interest income was primarily attributable to a decrease in
gain on sale of loans, which was partially offset by increases in every
non-interest income line item with the exception of BOLI income, which decreased
$24,000 during the six months ended June 30, 2022 . Gain on sale of loans
decreased $866,000 or 41.4% to $1.2 million for the six months ended June 30,
2022 compared to $2.1 million during the same period in 2021 as the dollar
volume of loans sold decreased. ATM & Check Card Fee income increased $226,000
primarily due to an increase in debit card usage.
Non-Interest Expense
For the six months ended
Six Months Ended June 30, Increase (Decrease)
2022 2021 $ %
Compensation and Employee Benefits
$ 573,800 6.1 % Occupancy 1,407,436 1,280,814 126,622 9.9 Advertising 539,929 395,239 144,690 36.6 Depreciation and Maintenance of Equipment 1,527,151 1,573,741 (46,590) (3.0) FDIC Insurance Premiums 196,225 141,336 54,889 38.8 Net Recovery of Operation of OREO - (170,840) 170,840 (100.0) Change in Value of Land HFS 433,077 - 433,077 100.0 Consulting 333,981 330,314 3,667 1.1 Debit Card Expense 610,133 574,923 35,210 6.1 Other 2,014,235 1,542,787 471,448 30.6 Total Non-Interest Expense$ 17,023,393 $ 15,055,740 $ 1,967,653 13.1 % Compensation and employee benefits expenses increased$574,000 or 6.1% to$10.0 million for the six months endedJune 30, 2022 compared to$9.4 million during the same period last year. The increase was primarily due to the decrease in loan origination cost deferrals. Loan origination cost deferrals decreased$348,000 to$463,000 for the six months endedJune 30, 2022 compared to$811,000 during the same period last year which was largely a result of the Company's PPP loan originations during the six months endedJune 30, 2021 . Additionally, the increase in compensation and benefits was affected by the 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 overall growth of the Company.
Occupancy expense and depreciation and maintenance of equipment increased due to
the addition of our newest branch located in
The Company had no expenses or recoveries related to the operation of OREO properties during the six months endedJune 30, 2022 compared to a net recovery of$171,000 during the six months endedJune 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. Other non-interest expense increased$471,000 or 30.6% to$2.0 million for the six months endedJune 30, 2022 compared to$1.5 million during the six months endedJune 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$713,000 or 42.8% to$954,000 for the six months endedJune 30, 2022 from$1.7 million for the same period in 2021 primarily due to higher pre-tax income in 2021. Income before taxes was$4.7 million and$7.8 million for the six months endedJune 30, 2022 and 2021, respectively. The Company's combined federal and state effective income tax rate was 20.4% for the six months endedJune 30, 2022 compared to 21.4% for the same period in 2021. 40 -------------------------------------------------------------------------------- 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 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$157.0 million in unused commitments to extend credit and standby letters of credit atJune 30, 2022 . During the six months endedJune 30, 2022 , loan disbursements exceeded loan repayments resulting in a$3.5 million or 0.7% increase in total net loans receivable. Also during the six months endedJune 30, 2022 , deposits increased$33.7 million or 3.0%. The Bank had no outstanding FLHB advances atJune 30, 2022 with$389.8 million in additional borrowing capacity at the FHLB at that date. The Bank also had no outstanding borrowings from the discount window facility at the FRB atJune 30, 2022 , which was collateralized by investments AFS with a fair market value of$73.4 million . AtJune 30, 2022 , the Bank had no outstanding borrowings at the FRB. The Bank also had a$5.0 million unused Fed Funds facility withPacific Coast Bankers Bank atJune 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. AtJune 30, 2022 , the Company, on an unconsolidated basis, had liquid assets of$93.9 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 atJune 30, 2022 . AtJune 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 18.15%, 10.01%, 18.15%, and 19.41%, 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. AtJune 30, 2022 the Bank's conservation buffer was 11.4%. For additional details, see "Note 12 - Regulatory Matters" of the Notes to Consolidated Financial Statements included in Part I. Item 1 of this report. 41 -------------------------------------------------------------------------------- SECURITY FEDERAL CORPORATION AND SUBSIDIARIES
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