|• SECURITY FEDERAL CORPORATION FORM 10-K • EXHIBIT 13 • EXHIBIT 21 • EXHIBIT 23 • EXHIBIT 31.1 • EXHIBIT 31.2 • EXHIBIT 32 • EXHIBIT 99.1 • EXHIBIT 99.2 • EXHIBIT 101-INS • EXHIBIT 101-PRE • EXHIBIT 101-LAB • EXHIBIT 101-DEF • EXHIBIT 101-CAL • EXHIBIT 101-SCH|
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES NO X
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES NO X
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T ('232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act (Check one):
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES NO X
As of June 21, 2012, there were issued and outstanding 3,144,934 shares of the registrant's Common Stock, which are traded on the over-the-counter market through the OTC "Electronic Bulletin Board" under the symbol "SFDL." The aggregate market value of the voting stock held by non-affiliates of the registrant, computed by reference to the average of the bid and asked price of such stock as of September 30, 2011, was $18.3 million. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.)
DOCUMENTS INCORPORATED BY REFERENCE
This Form 10-K, including information included or incorporated by reference, contents, and future filings by Security Federal Corporation ("Company") on Form 10-Q, and Form 8-K, and future oral and written statements by the Company and its management may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements often include 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." These forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from the results anticipated, including, but not limited to:
These developments could have an adverse impact on our financial position and our results of operations.
Any forward-looking statements are based upon management's beliefs and assumptions at the time they are made. We undertake no obligation to publicly update or revise any forward-looking statements included or incorporated by reference in this document or to update the reasons why actual results could differ from those contained in such statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this document might not occur, and you should not put undue reliance on any forward-looking statements.
As used throughout this report, the terms "we," "our " or "us" refer to Security Federal Corporation and our consolidated subsidiary, Security Federal Bank.
The Company provides a link on its investor information page at www.securityfederalbank.com to the Securities and Exchange Commission's ("SEC") website (www.sec.gov) for purposes of providing copies of its annual report to shareholders, annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and press releases. These filings are available free of charge and also can be obtained by calling the SEC at 1-800-SEC-0330.
Item 1. Business
Security Federal Corporation
Security Federal Corporation (the "Company") was incorporated under the laws of the State of Delaware in July 1987 for the purpose of becoming the savings and loan holding company for Security Federal Bank ("Security Federal" or the "Bank") upon the Bank's conversion from mutual to the stock form (the "Conversion"). Effective August 17, 1998, the Company changed its state of incorporation from Delaware to South Carolina. On December 28, 2011, the Company reorganized into a bank holding company in connection with the Bank's conversion from a federally chartered stock savings bank to a South Carolina chartered commercial bank. As a result of the reorganization, the Board of Governors of the Federal Reserve System ("Federal Reserve") is now the Company's primary federal regulator.
As a South Carolina corporation, the Company is authorized to engage in any activity permitted by South Carolina General Corporation Law. The Company is a one bank holding company. Through the bank holding company structure, it is possible to expand the size and scope of the financial services offered beyond those currently offered by the Bank. The holding company structure also provides the Company with greater flexibility than the Bank would have to diversify its business activities, through existing or newly formed subsidiaries, or through acquisitions or mergers of financial institutions as well as other companies. There are no current arrangements, understandings or agreements regarding any such acquisition. Future activities of the Company, other than the continuing operations of Security Federal, will be funded through dividends from Security Federal and through borrowings from third parties. See "Regulation B Regulation of the Company B Dividends" and "Taxation." Activities of the Company may also be funded through sales of additional securities or income generated by other activities of the Company. At this time, there are no plans regarding sales of additional securities or other activities.
At March 31, 2012, the Company had assets of $924.6 million, deposits of $696.2 million and shareholders' equity of $80.8 million.
The executive office of the Company is located at 238 Richland Avenue West, Aiken, South Carolina 29801, and its telephone number is (803) 641-3000.
Security Federal Bank
General. Security Federal is a South Carolina chartered commercial bank headquartered in Aiken, South Carolina. Security Federal, with 13 branch offices in Aiken, Richland and Lexington counties, South Carolina and Columbia County, Georgia, was originally chartered under the name Aiken Building and Loan Association on March 27, 1922. It received its federal charter and changed its name to Security Federal Savings and Loan Association of Aiken on March 7, 1962, and later changed its name to Security Federal Savings Bank of South Carolina, on November 11, 1986. Effective April 8, 1996, the Bank changed its name to Security Federal Bank. The Bank converted from the mutual to the stock form of organization on October 30, 1987. As mentioned above, effective December 28, 2011, Security Federal converted from a federally chartered stock savings bank to a South Carolina chartered commercial bank. As a result of the conversion to a South Carolina commercial bank, the Bank is regulated by the South Carolina State Board of Financial Institutions ("State Board") and the Federal Deposit Insurance Corporation ("FDIC").
The principal business of Security Federal is accepting deposits from the general public and originating commercial real estate loans, commercial business loans, consumer loans, as well as mortgage loans to buy or refinance one-to-four family residential real estate. The Bank also originates construction loans on single-family residences, multi-family dwellings and projects, and commercial real estate, as well as loans for the acquisition, development and construction of residential subdivisions and commercial projects.
Security Federal's income is derived primarily from interest and fees earned in connection with its lending activities, and its principal expenses are interest paid on savings deposits and borrowings and operating expenses.
Issuance of Convertible Senior Debentures. On December 1, 2009, the Company issued $6.1 million in convertible senior debentures. The debentures mature on December 1, 2029 and accrue interest at the rate of 8.0% per annum until maturity or earlier redemption or repayment. Interest on the debentures is payable on June 1 and December 1 of each year, commencing June 1, 2010. The debentures are convertible into the Company's common stock at a conversion price of $20 per share at the option of the holder at any time prior to maturity.
The debentures are redeemable, in whole or in part, at the option of the Company at any time on or after December 1, 2019, at a price equal to 100% of the principal amount of the debentures to be purchased plus any accrued and unpaid interest to, but excluding, the date of redemption. The debentures are unsecured general obligations of the Company ranking equal in right of payment to all of its present and future unsecured indebtedness that is not expressly subordinated.
Community Development Capital Initiative ("CDCI"). On September 29, 2010, the Company entered into a Letter Agreement with the U.S. Department of the Treasury ("Treasury") in connection with its participation in the CDCI which was established by the Treasury pursuant to the Troubled Asset Relief Program ("TARP"). The CDCI was established by the Treasury to invest lower cost capital in Community Development Financial Institutions ("CDFI"), supporting their efforts to provide credit to small businesses and other qualified customers.
Pursuant to the CDCI, the Company entered into an Exchange Agreement with the Treasury and exchanged the 18,000 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A ("Series A Preferred Stock"), previously sold to the Treasury on December 19, 2008 pursuant to the TARP Capital Purchase Program ("CPP"), for 18,000 shares of newly designated Fixed Rate Cumulative Perpetual Preferred Stock, Series B ("Series B Preferred Stock").
In addition and in connection with the Company's participation in the CDCI, on September 29, 2010, the Company entered into a Letter Agreement with the Treasury (including the Securities Purchase Agreement - Standard Terms, the "Purchase Agreement"), pursuant to which the Company sold an additional 4,000 shares of Series B Preferred Stock to the Treasury at a price of $4.0 million. As a result of its participation in the CDCI and the transactions under the Exchange Agreement and the Purchase Agreement, the Treasury now holds 22,000 shares of the Company's Series B Preferred Stock, with an aggregate liquidation preference amount of $22.0 million.
The additional capital received by the Company from Treasury pursuant to the Purchase Agreement was contingent upon the Company's completion of a separate stock offering of the same amount, as required by the Company's prior federal regulator, the Office of Thrift Supervision ("OTS"). In satisfaction of this requirement, on September 29, 2010, the Company sold 400,000 shares of its common stock to certain accredited investors in a private placement at a price of $10.00 per share, for gross proceeds of $4.0 million.
The warrant issued to Treasury for the purchase of 137,966 shares of the Company's common stock in connection with the TARP CPP on December 19, 2008 remains outstanding. For additional information regarding the CDCI transaction and the TARP CPP transaction, see Note 21 of the Notes to Consolidated Financial Statements contained in the 2012 Annual Report to Stockholders ("Annual Report").
Elimination of Mandatorily Redeemable Shares. On April 11, 2011, the Company eliminated the mandatorily redeemable shares of its common stock as a result of an investor's purchase of these shares in a private transaction. In connection with the purchase of these shares, the redemption feature was eliminated. As a result, the Company no longer has the liability related to these shares on its balance sheet and the Company's capital increased by $1.5 million.
Selected Consolidated Financial Information. This information is incorporated by reference to page seven of the Annual Report.
Yields Earned and Rates Paid. This information is incorporated by reference to page 18 of the Annual Report.
Rate/Volume Analysis. This information is incorporated by reference to page 17 of the Annual Report.
General. The primary source of revenue for the Bank is interest and fee income from lending activities. The principal lending activities are making loans on commercial real estate and one-to-four family residential real estate. The Bank originates fixed rate residential real estate loans for sale in the secondary market and adjustable rate mortgage loans to be held in its portfolio. The Bank also originates construction loans on single family residences, multi-family dwellings and commercial real estate, and loans for the acquisition, development and construction of residential subdivisions and commercial projects. To a lesser extent, the Bank originates consumer loans and commercial business loans.
The loan-to-value ratio, maturity and other provisions of loans made by the Bank reflect its policy of making the maximum loan permissible consistent with applicable regulations, established lending policies and market conditions. The Bank requires title insurance (or acceptable legal opinions on smaller loans secured by real estate) and fire insurance, and flood insurance where applicable, on loans secured by improved real estate.
Loan Portfolio Composition. The following table sets forth information concerning the composition of the Bank's loan portfolio, including loans held for sale, in dollar amounts and in percentages by type of loan, and presents a reconciliation of total loans receivable before net items.
The following table sets forth information concerning the composition of the Bank's loan portfolio, including loans held for sale, in dollar amounts and in percentages by type of loan, and presents a reconciliation of total loans receivable before net items.
The total amount of loans due after March 31, 2013, which have predetermined or fixed interest rates is $164.9 million, while the total amount of loans due after that date which have floating or adjustable interest rates is $146.4 million.
The following schedule illustrates the maturities of Security Federal's loan portfolio, including loans held for sale, at March 31, 2012. Mortgages which have adjustable or renegotiable interest rates are shown as maturing in the period when the contract is due. This schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
(2) Loan amounts are net of undisbursed funds for loans in process of $1.9 million.
Loan Originations, Purchases and Sales. The following table shows the loan origination, purchase, sale and repayment activities of the Bank for the years indicated.
In addition to interest earned on loans, the Bank receives loan origination fees or "points" for originating loans. Loan points are a percentage of the principal amount of the mortgage loan which are charged to the borrower for the
creation of the loan. The Bank's loan origination fees are generally 1% on conventional residential mortgages, and 0.25% to 1% on commercial real estate loans and commercial business loans. The total fee income (including amounts amortized to income as yield adjustments) for the fiscal year ended March 31, 2012 was $503,000.
Loan origination and commitment fees are volatile sources of income. These fees vary with the volume and type of loans and commitments made and purchased and with competitive conditions in mortgage markets, which in turn are governed by the demand for and availability of money.
The following table shows deferred mortgage loan origination fees recognized as income by the Bank expressed as a percentage of the dollar amount of total mortgage loans originated (and retained in the Bank's portfolio) and purchased during the periods indicated and the dollar amount of deferred loan origination fees at the end of each respective period.
The Bank also receives other fees and charges related to existing loans, conversion fees, assumption fees, late charges and other fees collected in connection with a change in borrower or other loan modifications.
Security Federal currently sells substantially all conforming fixed rate loans with terms of 15 years or greater in the secondary mortgage market. These loans are sold in order to provide a source of funds and as one of the strategies available to close the gap between the maturities of the Bank's interest-earning assets and interest-bearing liabilities. Currently, most fixed rate, long-term mortgage loans are being originated based on Federal National Mortgage Association ("Fannie Mae") and Federal Home Loan Mortgage Corporation ("Freddie Mac") underwriting standards.
Secondary market sales have been made primarily to Freddie Mac, or other banks or investors. Freddie Mac is a quasi-governmental agency that purchases residential mortgage loans from federally insured financial institutions and certain other lenders. All loans sold to Freddie Mac are without recourse to Security Federal and generally all other loans sold to other investors are without recourse. For the past few years, substantially all loans have been sold on a servicing released basis.
In fiscal 2012, Security Federal sold $40.4 million in fixed rate residential loans on a servicing released basis in the secondary market. Loans closed but not yet settled with Freddie Mac or other investors, are carried in the Bank's "loans held for sale" portfolio. At March 31, 2012, the Bank had $2.7 million of loans held for sale. These loans are fixed rate residential loans that have been originated in the Bank's name and have closed. Virtually all of these loans have commitments to be purchased by investors and the majority of these loans were locked in by price with the investors on the same day or shortly thereafter that the loan was locked in with the Bank's customers. Therefore, these loans present very little market risk for the Bank. The Bank usually delivers to, and receives funding from, the investor within 30 days. Security Federal originates all of its loans held for sale on a "best efforts" basis. Best efforts means that the Bank suffers no penalty if it is unable to deliver a loan to a potential investor.
The Bank also originates and holds adjustable and fixed rate construction loans. The construction loans are for one year terms. At March 31, 2012, the Bank held $9.5 million, or 2.1% of the total loan portfolio, in construction loans
to individuals in its residential portfolio. Construction loans to individuals, also known as construction/permanent loans, generally have a construction period of one year or less where the borrower pays interest only during that period. At the end of construction, the loan converts to a one year ARM or a three year/one year ARM. At that time, the borrower also has a one time option to convert the loan to a fixed rate loan, which is then sold immediately to the secondary market. At March 31, 2012, the Bank also held approximately $9.8 million in longer term fixed rate residential mortgage loans. These loans, which were 2.2% of the entire loan portfolio at March 31, 2012, had converted from ARM loans to fixed rate loans during the previous 60 months, and had remaining maturities of 10 to 29 years. The Bank no longer originates ARM loans with conversion features that are not sold on the secondary market upon conversion.
Loan Solicitation and Processing. The Bank actively solicits mortgage loan applications from existing customers, real estate agents, builders, real estate developers and others. The Bank also receives mortgage loan applications as a result of customer referrals and from walk-in customers.
Detailed loan applications are obtained to determine the borrower's creditworthiness and ability to repay. The more significant items on loan applications are verified through the use of credit reports, financial statements and confirmations. After analysis of the loan application and property or collateral involved, including an appraisal of the property (residential appraisals are obtained through independent fee appraisers), the lending decision is made in accordance with the underwriting guidelines of the Bank. These guidelines are generally consistent with Freddie Mac and Fannie Mae guidelines for residential real estate loans. With respect to commercial real estate loans, the Bank also reviews the capital adequacy of the business, the income potential of the property, the ability of the borrower to repay the loan and honor its other obligations, and general economic and industry conditions.
Upon receipt of a loan application and all required related information from a prospective borrower, the loan application is submitted for approval or rejection. The residential mortgage loan underwriters approve loans which meet Freddie Mac and Fannie Mae underwriting requirements. The Chairman of the Company, the Chief Executive Officer of the Company and the Bank, or the President of the Bank individually have the authority to approve loans of $500,000 or less, except as set forth above for conforming conventionally underwritten, single family mortgage loans, which are approved by the underwriters. The Executive Vice President/Commercial Loans and the Executive Vice President/Chief Lending Officer have the authority to approve loans up to $500,000. Loans in excess of $500,000 and up to $1.0 million require the approval of any three of the following: Chairman of the Company, the Chief Executive Officer of the Company and the Bank, the President of the Bank, the Executive Vice President/Chief Financial Officer, the Executive Vice President/Commercial Loans, the Executive Vice President/Chief Lending Officer, the Vice Chairman of the Executive Committee or the Secretary of the Executive Committee. Any loan in excess of $1.0 million must be approved by the Bank's Executive Committee, which operates as the Bank's Loan Committee. The loan approval limits shown are the aggregate of all loans to any one borrower or entity, not including loans that are the borrower's primary residence, and are conventionally underwritten.
The general policy of Security Federal is to issue loan commitments to qualified borrowers for a specified time period. These commitments are generally for a period of 45 days or less. With management approval, commitments may be extended for up to 45 days. As of March 31, 2012, Security Federal had no residential mortgage loan commitments for portfolio loans issued (excluding undisbursed portions of construction loans in process). Security Federal had outstanding commitments available on retail lines of credit (including home equity and other consumer loans) totaling $27.7 million as of March 31, 2012. See Note 19 of the Notes to Consolidated Financial Statements contained in the Annual Report.
Permanent Residential Mortgage Lending. Permanent residential real estate mortgage loans constituted approximately 20.4% of the Bank's total outstanding loan portfolio at March 31, 2012.
Security Federal offers a variety of ARMs which offer adjustable rates of interest, payments, loan balances or terms to maturity which vary according to specified indices. The Bank's ARMs generally have a loan term of 15 to 30 years with initial rate adjustments every one, three, five or seven years during the term of the loan. After the initial rate adjustment, the loan rate then adjusts annually. Most of the Bank's ARMs contain a 200 basis point limit as to the maximum amount of change in the interest rate at any adjustment period and a 500 or 600 basis point limit over the life of the loan. The Bank generally originates ARMs to retain in its portfolio. These loans are generally made consistent
with Freddie Mac and Fannie Mae guidelines. At March 31, 2012, residential ARMs totaled $87.0 million, or 19.5% of the Bank's loan portfolio. For the year ended March 31, 2012, the Bank originated $54.9 million in residential real estate loans, 31.1% of which had adjustable rates of interest.
There are unquantifiable risks resulting from possible increased costs to the borrower as a result of periodic repricing. Despite the benefits of ARMs to the Bank's asset/liability management program, these loans also pose potential additional risks, primarily because as interest rates rise, the underlying payment by the borrower rises, increasing the potential for default. At the same time, marketability of the underlying property may be adversely affected by higher interest rates.
When making a one- to four-family residential mortgage loan, the Bank evaluates both the borrower's creditworthiness and his or her general ability to make principal and interest payments, and the value of the property that will secure the loan. The Bank generally makes loans on one- to four-family residential properties in amounts of 95% or less of the appraised value of the collateral. Where loans are made in amounts which exceed 80% of the appraised value of the underlying real estate, the Bank's general policy is to require private mortgage insurance on the portion of the loan in excess of 80% of the appraised value. In general, the Bank restricts its residential lending to South Carolina and the nearby Augusta, Georgia market.
The Bank also provides construction financing for single family dwellings to owner-occupants. Construction loans are generally made for periods of six months to one year with either adjustable or fixed rates. At March 31, 2012, residential construction loans on one- to four-family dwellings to owner-occupants totaled $9.5 million, or 2.1%, of the Bank's loan portfolio. On loans of this type, the Bank seeks to evaluate the financial condition and prior performance of the builder, as well as the borrower's creditworthiness and his or her general ability to make principal and interest payments, and the value of the property that will secure the loan. On construction loans offered to individuals (non-builders), the Bank offers a construction/permanent loan. The construction portion of the loan has an adjustable rate (typically prime) or a fixed rate (typically prime plus 0.25%) during the construction period. The borrower typically pays interest on the loan during the construction phase. During the current year, because the prime rate was so low, the Bank added a floor of 5% or 6% to these construction loans. After construction, the loan then automatically converts to a one year ARM or a three year/one year ARM loan. The borrower also has the option, after the construction period only, to convert the loan to a fixed rate loan which the Bank then sells on the secondary market immediately on a servicing released basis.
Commercial Real Estate, Commercial Business and Multi-Family Loans. The commercial business loans originated by the Bank are primarily secured by business equipment, furniture and fixtures, inventory and receivables or are unsecured. At March 31, 2012, the Bank had $9.6 million, or 2.1%, of the Bank's total loan portfolio, in commercial business loans. A total of $2.3 million, or 23.7% of these loans were unsecured at March 31, 2012.
The commercial real estate loans originated by the Bank are primarily secured by non-residential commercial properties, churches, hotels, residential developments, single family construction loans to builders for speculative or pre-sold homes, lot loans to builders, income property developments, and undeveloped land. At March 31, 2012, the Bank had $263.9 million, or 59.3%, of the Bank's total loan portfolio, in commercial real estate loans. Included in these loans at March 31, 2012 was $13.0 million in acquisition and development loans with terms of typically two to three years. Also included in commercial real estate loans was $15.0 million in loans for the construction of single family dwellings to builders with a term of typically one year.
The multi-family loans originated by the Bank are primarily secured by commercial residential properties including apartment complexes, condominiums or townhouses, and loans for acquisition and development of, or improvements to multi-family residential properties. At March 31, 2012, the Bank had $12.4 million, or 2.8%, of the Bank's total loan portfolio, in multi-family loans.
The following table summarizes the Bank's commercial real estate, commercial business, and multi-family loans by geographic market area at March 31, 2012.
Loans secured by commercial real estate are typically written for amortization terms of 10 to 20 years. Commercial loans not secured by real estate are typically based on terms of three to 60 months. Both commercial real estate loans and commercial business loans not secured by real estate can be originated on adjustable or fixed rate terms. Adjustable rates are tied to the prime rate as quoted in The Wall Street Journal and typically adjust on a daily basis. Since 2009, the Bank instituted floors of typically 6% on newly originated adjustable rate commercial business and real estate loans. If ceilings are used, the loan will typically balloon in 60 months or less. Fixed rate loans on commercial real estate usually balloon in 36 to 60 months. Fixed rate loans on non-real estate collateral are generally amortizing in five years or less.
Commercial real estate lending entails significant additional credit risk when compared to residential lending. Commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers. Because payments on loans secured by commercial properties often depend upon the successful operation and management of the properties, repayment of these loans may be affected by adverse conditions in the real estate market or the economy. The Bank previously had a maximum loan-to-value ratio limit of 75% to 85% for commercial real estate loans. However, due to economic conditions, the Bank recently changed this maximum loan-to-value ratio to 65% to 75%. In order to minimize the risks associated with this type of loan, the Bank generally limits the maximum loan-to-value ratio to 65% to 75%, appraises the property at the time of the loan by appraisers designated by the Bank, and strictly scrutinizes the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. Although the creditworthiness of the business and its principals is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.
Commercial business lending generally involves greater risk than residential mortgage lending and involves risks that are different from those associated with lending that is secured by real estate. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan-to-collateral values, and liquidation of the underlying real estate collateral is viewed as the primary source of repayment in the event of borrower default. Although commercial business loans often have equipment, inventory, accounts receivable or other business assets as collateral, the liquidation of collateral in the event of a borrower default is often not a sufficient source of repayment because accounts receivable may be uncollectible and inventories and equipment may be obsolete or of limited use, among other conditions. Accordingly, the repayment of a commercial business loan depends primarily on the creditworthiness of the borrower (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment. The Bank seeks to minimize these risks by strictly scrutinizing the borrower's current financial condition, ability to pay, past earnings and payment history. In addition, the current financial condition and payment history of all principals are reviewed. Typically, the Bank requires the principal or owners of a business to guarantee all loans made to their business by the Bank. Although the creditworthiness of the business and its principals is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.
Federal law restricts the Bank's permissible lending limits to one borrower to the greater of $500,000 or 15% of unimpaired capital and surplus. At March 31, 2012, the Bank's legal lending limit under this restriction was $14.0 million. At that date, the Bank's largest loan relationship to a single borrower was $12.4 million. South Carolina law restricts the Bank's permissible lending limits to one borrower to 10% of unimpaired capital unless prior approval is
granted by a two-thirds vote of the Board of Directors, in which case the limit is increased to 15% of unimpaired capital. The Bank's lending limit at 10% of unimpaired capital was $9.3 million at March 31, 2012.
Consumer Loans. The Bank originates consumer loans for any personal, family or household purpose, including the financing of home improvements, loans to individuals for residential lots for a future home, automobiles, boats, mobile homes, recreational vehicles and education. The Bank also makes consumer first and second mortgage loans secured by residences. These loans typically do not qualify for sale in the secondary market, but are generally not considered sub-prime lending. In addition, the Bank offers home equity lines of credit. Home equity loans are secured by mortgage liens on the borrower's principal or second residence. Home equity lines are open end lines of credit where the borrowers pay a minimum of interest only monthly on drawn lines. The terms are for a maximum period of 20 years and the rate is a variable rate tied to prime and floats monthly. Margins range from zero to one percent. The Bank recently instituted a floor of 6% on new originations and a maximum loan-to-value ratio of 80% for first mortgages originated by Security Federal and 60% for first mortgages originated by other lenders. Previously, the maximum loan- to-value ratio was 90%, but was decreased because of the current economic environment. At March 31, 2012, the Bank had $27.0 million of home equity lines of credit outstanding and $20.6 million of additional commitments of home equity lines of credit. The Bank also makes secured and unsecured lines of credit available. Although consumer loans involve a higher level of risk than one- to four-family residential mortgage loans, they generally provide higher yields and have shorter terms to maturity than one- to four-family residential mortgage loans. At March 31, 2012, the Bank had total consumer loans of $58.7 million, or 13.2% of the Bank's loan portfolio.
The Bank's underwriting standards for consumer loans include a determination of the applicant's payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant's monthly income is determined by verification of gross monthly income from primary employment, and from any verifiable secondary income. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.
The Bank also has a credit card program. As of March 31, 2012, the Bank had issued 2,247 Visa credit cards with total approved credit lines of $6.7 million, of which $2.2 million was outstanding on that date.
Loan Delinquencies and Defaults
General. The Bank's collection procedures provide that when a real estate loan is approximately 20 days past due, the borrower is contacted by mail and payment is requested. If the delinquency continues for another 10 days, subsequent efforts are made to contact the delinquent borrower and establish a program to bring the loan current. In certain instances, the Bank may modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his financial affairs. If the loan continues in a delinquent status for 60 days or more, the Bank generally initiates foreclosure proceedings after the customer has been notified by certified mail. The Bank institutes the same collection procedure for its commercial real estate loans. At March 31, 2012, the Bank had property acquired as the result of foreclosures and other property repossessed classified as repossessed assets valued at $14.2 million.
Delinquent Loans. The following table sets forth information concerning delinquent loans at March 31, 2012. The amounts presented represent the total remaining principal balances of the delinquent loans (before specific reserves for losses), rather than the actual payment amounts which are overdue.
Classified Assets. Federal regulations provide for the classification of loans and other assets such as debt and equity securities considered to be of lesser quality as "substandard," "doubtful" or "loss" assets. The regulations require commercial banks to classify their own assets and to establish prudent general allowances for loan losses for assets classified "substandard" or "doubtful." For the portion of assets classified as "loss," an institution is required to either establish specific allowances of 100% of the amount classified or charge off such amount. In addition, the State Board and/or FDIC may require the establishment of a general allowance for losses based on assets classified as "substandard" and "doubtful" or based on the general quality of the asset portfolio of an association. See "Regulation - Regulation of the Bank." Assets which do not currently expose the insitution to sufficient risk to warrant classification in one of the aforementioned categories but possess potential weaknesses are designated "special mention" by management.
At March 31, 2012, $55.0 million, or 12.4%, of the Bank's loans were classified "substandard" compared to $45.9 million, or 9.2%, at March 31, 2011. At March 31, 2012, $20.4 million were classified as "special mention" compared to $30.9 million at March 31, 2011. At March 31, 2012, $22.5 million were classified as "caution" compared to $11.3 million at March 31, 2011. The Bank had no loans classified as "doubtful" or "loss" at March 31, 2012 and 2011. As of March 31, 2012, there were loans totaling $18.0 million which were troubled debt restructurings. The Bank's policy is to classify all troubled debt restructurings as substandard. The Bank's classification of assets is consistent with FDIC regulatory classifications.
Non-performing Assets. Loans are placed on non-accrual status when the collection of principal and/or interest becomes doubtful. In addition, all loans are placed on non-accrual status when the loan becomes 90 days or more contractually delinquent. All consumer loans more than 90 days delinquent are charged against the consumer loan allowance for loan losses unless there is adequate collateral which is in the process of being repossessed or foreclosed on. At March 31, 2012, the Bank had $18.0 million in troubled debt restructurings which involve forgiving a portion of interest or principal on any loans or making loans at a rate materially less than market rate. Other loans of concern are those loans (not delinquent more than 60 days) that management has determined need to be closely monitored as the potential exists for increased risk on these loans in the future. Non-performing loans are reviewed monthly on a loan by loan basis. Charge-offs, whether partial or in full, associated with these loans will vary based on estimates of recovery for each loan.
The following table sets forth the amounts and categories of risk elements in the Bank's loan portfolio.
At March 31, 2012, there were no accruing loans equal to or more than 90 days delinquent. Of the commercial real estate category, $8.1 million was concentrated in hotel loans. Of this balance, $5.9 million consisted of three loans to one borrower secured by three different hotels all located in Georgia. The remaining $2.2 million related to one loan to another borrower secured by a hotel located on the coast of South Carolina.
Of the remaining non-performing commercial real estate category, $7.0 million consisted of 12 loans secured by commercial buildings to nine separate borrowers and $876,000 consisted of four loans secured by raw land to three separate borrowers. The majority of the remaining loans in the commercial real estate category were secured by first mortgages on principal residences.
For the fiscal year ended March 31, 2012, the interest income that was not recognized and would have been recognized with respect to non-accruing loans, had such loans been current in accordance with their original terms and with respect to troubled debt restructurings, had such loans been current in accordance with their original terms, totaled $964,000 compared to $887,000 for the year ended March 31, 2011. For the fiscal year ended March 31, 2012 actual interest recorded on these loans amounted to $739,000 compared to $229,000 for the previous year.
Also included in non-accruing loans at March 31, 2012 were 15 residential real estate loans totaling $3.6 million, two commercial loan relationships totaling $21,000 and 17 consumer loans totaling $620,000. Of the 17 consumer loans on non-accrual status at March 31, 2012, no loan or total relationship exceeded $172,000. Of the two commercial loan relationships on non-accrual status at fiscal year end, no loan or total loan relationship exceeded $14,000.
Troubled Debt Restructurings. The Bank identifies and reviews all loans to be restructured based on an assessment of the borrower's credit status. This assessment is a continuous process that involves a review of the financial statements and prospects for repayment, payment delinquency, non-accrual status, and risk rating.
Not all loan modifications are troubled debt restructurings ("TDR"). The Bank designates a loan modification as a TDR when the following two conditions are present: the borrower is experiencing financial difficulty, and because of this difficulty, the Bank grants a concession it would not otherwise consider. Typically these concessions involve a change in the interest rate, maturity date or payment amount or some combination of each. These concessions rarely result in the forgiveness of principal or interest.
TDRs are considered impaired and generally reported as non-performing loans on non-accrual status. Non-performing TDRs may be returned to accrual status when payment in full of all amounts due under the restructured terms is anticipated and the borrower has demonstrated a sustained payment history which is typically six months.
During the year ended March 31, 2012, the Bank modified 15 loans that were considered to be TDRs. TDRs have increased as a result of the Bank's efforts to work with customers to keep their properties. The Bank had 28 loans totaling $18.0 million at March 31, 2012 which were TDRs compared to 33 loans totaling $12.2 million at March 31, 2011. The 28 troubled debt restructurings consisted of one consumer loan secured by a first mortgage on a residential dwelling totaling $73,000, one consumer auto loan totaling $15,000 and one jumbo mortgage loan totaling $710,000. The remaining 25 restructurings consisted of 24 commercial real estate loans to eight separate borrowers and one unsecured commercial loan. The commercial real estate loans were secured primarily by first mortgages on six single family residences and one lot, 11 commercial buildings, two parcels of land and three hotels.
Six of the TDRs to three borrowers totaling $3.5 million were subsequently in default at March 31, 2012. The Bank considers any loan 30 days or more past due to be in default.
Potential Problem Loans. Potential problem loans include loans not included as non-accrual loans or TDRs where management has become aware of information regarding possible credit issues for borrowers that could potentially cause doubt about their ability to comply with current repayment terms. At March 31, 2012 and 2011, the Bank had identified $23.7 million and $22.6 million, respectively, of potential problem loans through its internal loan review procedures.
Repossessed Assets. Repossessed assets acquired in settlement of loans were $14.2 million at March 31, 2012 and consisted of the following 50 real estate properties: 17 single-family residences and 17 lots within residential subdivisions located throughout our market area in South Carolina and Georgia; five parcels of land in South Carolina and one in Georgia; four commercial buildings in the Midlands area of South Carolina and one commercial building in Augusta, Georgia; a 40 lot subdivision development and adjacent 17 acres of land in Columbia, South Carolina; a 233 acre subdivision in Blythewood, South Carolina; a 43 lot subdivision in Elgin, South Carolina; a two rental complex in Columbia, South Carolina; and 34.8 acres of land in Bluffton, South Carolina which was originally acquired as a participation loan from another financial institution.
Provision for Losses on Loans. Security Federal recognizes that it will experience credit losses during the course of making loans and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a secured loan, the quality of the underlying security for the loan. The Bank seeks to establish and maintain sufficient reserves for estimated losses on specifically identified loans and real estate where such losses can be estimated. Additionally, general reserves for estimated possible losses are established on specified portions of the Bank's portfolio such as consumer loans and higher risk residential construction mortgage loans based on management's estimate of the potential loss for loans which normally can be classified as higher risk. Specific and general reserves are based on, among other criteria: (1) the risk characteristics of the loan portfolio, (2) current economic conditions on a local as well as a statewide basis, (3) actual losses experienced historically and (4) the level of reserves for possible losses in the future. Additionally, the Bank maintains a reserve for uncollected interest on loans 90 days or more past due.
At March 31, 2012, the allowance for loan losses or reserve was $14.6 million. In determining the adequacy of the reserve for loan losses, management reviews past experience of loan charge-offs, the level of past due and non-accrual loans, the size and mix of the portfolio, general economic conditions in the market area, and individual loans to identify potential credit problems. Commercial business, commercial real estate and consumer loans have increased to $344.6 million, or 77.4% of the Bank's total loan portfolio at March 31, 2012. Although commercial and consumer loans carry a higher level of credit risk than conventional residential mortgage loans, the level of reserves reflects management's continuing evaluation of this risk based on the Bank's past loss experience. At March 31, 2012, the Bank's ratio of loans delinquent more than 60 days to total assets was 3.10%. Management uses four methods or calculations to estimate the adequacy of the reserve using the factors mentioned above. The reserve is management's best estimate for the reserve. There can be no guarantee that the estimate is adequate or accurate. Management believes that reserves for loan losses are at a level adequate to provide for inherent loan losses. Although management believes that it has considered all relevant factors in its estimation of future losses, future adjustments to reserves may be necessary if conditions change substantially from the assumptions used in making the original estimations. Regulators will from time to time evaluate the allowance for loan losses which is subject to adjustment based upon the information available to the regulators at the time of their examinations.
At March 31, 2012, the Bank had no allowance for losses on real estate owned because at the time a property is transferred to real estate owned, the Bank writes the property down to the appraised value less estimated costs to sell the property. Because of this practice, an allowance is not necessary.
The following table sets forth an analysis of the Bank's allowance for loan losses.
The distribution of the Bank's allowance for loan losses at the dates indicated is summarized in the following table. The entire allowance is available to absorb losses from all loan categories.
At March 31, 2012, Security Federal's net investment in its service corporations (including loans to service corporations) totaled $4.1 million. In addition to investments in service corporations, federal institutions are permitted to invest an unlimited amount in operating subsidiaries engaged solely in activities which a commercial bank may engage in directly.
Security Federal Insurance, Inc. ("SFINS"). SFINS, a wholly owned subsidiary of the Bank, was formed during fiscal 2002 and began operating during the December 2001 quarter. SFINS is an insurance agency offering auto, business, health and home insurance, and premium finance. The operations of SFINS are included in the Company's Consolidated Financial Statements.
Collier Jennings Financial Corporation. Collier Jennings Financial Corporation is a subsidiary of SFINS, a subsidiary of the Bank, which is described above. The Company acquired the insurance and premium finance businesses of Collier Jennings Financial Corporation and its subsidiaries, Collier-Jennings, Inc., The Auto Insurance Store, Inc., and Collier-Jennings Premium Pay Plans, Inc. (the "Collier-Jennings Companies"), effective June 30, 2006.
Investment securities. The Bank has authority to invest in various types of liquid assets, including U.S. Treasury obligations and securities of various federal agencies, certificates of deposit at insured institutions, mutual funds, bankers' acceptances and federal funds. The Bank may also invest a portion of its assets in certain commercial paper and corporate debt securities. See "Regulation - Regulation of the Bank."
As a member of the Federal Home Loan Bank ("FHLB") System, Security Federal must maintain minimum levels of investments that are liquid assets as defined in Federal regulations. See "Regulation - Regulation of the Bank - Federal Home Loan Bank System." Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans.
Historically, the Bank has maintained its liquid assets at a level believed adequate to meet requirements of normal daily activities, repayment of maturing debt and potential deposit outflows. Management regularly reviews and updates cash flow projections to assure that adequate liquidity is provided.
The following table sets forth the composition of the Company's portfolio of securities and other investments, not including mortgage-backed securities.
(1) Does not include mortgage-backed securities.
At March 31, 2012, the Company did not have any investment securities (exclusive of obligations of the U.S. Government and federal agencies) issued by any one entity with a total book value in excess of 10% of its shareholders' equity. SBA bonds are backed by the full faith and credit of the U.S. government and carry a zero percent risk base when calculating risk based assets for regulatory capital purposes.
FHLB securities, Federal Farm Credit Bank securities, Fannie Mae bonds and Freddie Mac bonds are all securities that are issued by government sponsored enterprises ("GSEs"). GSE securities are not backed by the full faith and credit of the United States government.
The following table sets forth the maturities or repricing of investment securities, not including mortgage-backed securities, and FHLB stock at March 31, 2012, and the weighted average yields of such securities and FHLB stock (calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security). Tax equivalent yields on tax exempt municipal bonds are calculated using a 34% tax rate. Callable securities are shown at their likely call dates based on current interest rates. The table was prepared using amortized cost. Small Business Administration securities are based on maturity dates without the effect of scheduled payments or anticipated prepayments.
(1) FHLB stock has no stated maturity date.
(2) Excludes mortgage-backed securities totaling $273.2 million with a yield of 3.31%.
For information regarding the market value of the Bank's securities portfolios, see Notes 2 and 3 of the Notes to Consolidated Financial Statements contained in the Annual Report.
Mortgage-backed Securities. Security Federal has a portfolio of mortgage-backed securities which it holds in both an available for sale and a held to maturity portfolio. Mortgage-backed securities can serve as collateral for borrowings and, through repayments, as a source of liquidity. Under the Bank's risk-based capital requirement, mortgage-backed securities have a risk weight of 20% (or 0% in the case of Government National Mortgage Association ("Ginnie Mae") securities) in contrast to the 50% risk weight carried by residential loans. See "Regulation."
The following table sets forth the composition of the mortgage-backed securities available for sale portfolio at fair value and the held to maturity portfolio at amortized cost at the dates indicated.