UNITED
STATES




SECURITIES
AND EXCHANGE COMMISSION




WASHINGTON,
DC  20549




FORM
10 – Q








(Mark
one)




(X)    
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934


FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2008





(__)  
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934


FOR THE TRANSITION PERIOD:






COMMISSION
FILE NUMBER:  0-16120






SECURITY
FEDERAL CORPORATION




South
      Carolina
            57-0858504(State
      or other jurisdiction of incorporation or organization)
            (IRS
      Employer Identification No.)




1705 WHISKEY ROAD, AIKEN, SOUTH
CAROLINA                                                                            
29801


(Address of Principal Executive
Office)                                                                                       
    (Zip code)






(803)
641-3000


(Registrant’s
telephone number, including area code)






Indicate
by check mark whether the registrant:  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.








Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.  See definition of
“large accelerated filer” and “accelerated filer” in Rule 12b-2 of the Exchange
Act.




Large accelerated
      filed          [  
      ]
            
            Accelerated
      filer                    
      [     ]Non-accelerated
      filer             [ 
       ]
            
            Smaller reporting
      company   [ X ]




Indicate
by check mark whether the registrant is a shell company (defined in Rule 12b-2
of the Exchange Act).








Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practical date.




CLASS:
            
            OUTSTANDING
      SHARES AT:
            
            SHARES:Common
      Stock, par value $0.01 per share
            
            January
      31, 2009
            
            2,458,146












INDEX




PART
      I.
            FINANCIAL
      INFORMATION (UNAUDITED)
            
            PAGE
      NO.Item
      1.
            Financial
      Statements (Unaudited):Consolidated
      Balance Sheets at December 31, 2008 and March 31, 2008
            
            1Consolidated
      Statements of Income for the Three and Nine Months Ended December 31, 2008
      and 2007
            
            2Consolidated
      Statements of Shareholders’ Equity and Comprehensive Income at December
      31, 2008 and 2007
            
            5Consolidated
      Statements of Cash Flows for the Nine Months Ended December 31, 2008 and
      2007
            
            6Notes
      to Consolidated Financial Statements
            
            8Item
      2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            17Item
      3.
            Quantitative
      and Qualitative Disclosures about Market Risk
            
            33Item
      4.
            Controls
      and Procedures
            
            33PART
      II.
            OTHER
      INFORMATIONItem
      1.
            Legal
      Proceedings
            
            35Item
      1A.
            Risk
      Factors
            
            35Item
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            
            44Item
      3.
            Defaults
      Upon Senior Securities
            
            45Item
      4.
            Submission
      of Matters to a Vote of Security Holders
            
            45Item
      5
            Other
      Information
            
            45Item
      6.
            Exhibits
            
            45Signatures
            
            47











SCHEDULES
OMITTED






All
schedules other than those indicated above are omitted because of the absence of
the conditions under which they are required or because the information is
included in the consolidated financial statements and related
notes.







Part
I.  Financial Information





Item
1.  Financial Statements (Unaudited)


Security
Federal Corporation and Subsidiaries


Consolidated
Balance Sheets


December
      31, 2008
            
            March
      31, 2008Assets:
            
            (Unaudited)
            
            (Audited)Cash
      And Cash Equivalents
            $
            9,706,023
            $
            10,539,054Investment
      And Mortgage-Backed Securities:Available
      For Sale:(Amortizedcost of $237,491,676
      atDecember 31, 2008and $240,295,683 atMarch 31, 2008)
            
            240,773,404
            
            244,157,872Held
      To Maturity:(Fair value of$36,467,089atDecember 31, 2008and  $20,506,250 atMarch 31,
      2008)
            
            35,662,305
            
            20,154,618Total
      Investment And Mortgage-Backed Securities
            
            276,435,709
            
            264,312,490Loans
      Receivable, Net:Held
      For Sale
            
            2,910,051
            
            2,295,721Held
      For Investment:(Net of
      allowanceof $8,673,527atDecember 31, 2008and $8,066,762 atMarch 31, 2008)
            
            594,411,779
            
            515,635,984Total
      Loans Receivable, Net
            
            597,321,830
            
            517,931,705Accrued
      Interest Receivable:Loans
            
            1,903,092
            
            1,952,866Mortgage-Backed
      Securities
            
            942,201
            
            822,379Investments
            
            585,284
            
            764,746Premises
      And Equipment, Net
            
            21,887,402
            
            21,544,380Federal
      Home Loan Bank Stock, At Cost
            
            11,544,100
            
            9,497,100Bank
      Owned Life Insurance
            
            9,551,305
            
            8,310,813Repossessed
      Assets Acquired In Settlement Of Loans
            
            661,640
            
            767,096Intangible
      Assets, Net
            
            375,000
            
            442,500Goodwill
            
            1,197,954
            
            1,197,954Other
      Assets
            
            2,842,096
            
            1,947,403Total
      Assets
            $
            934,953,636
            $
            840,030,486Liabilities
      And Shareholders’ EquityLiabilities:Deposit
      Accounts
            $
            620,642,981
            $
            590,850,208Advances
      From Federal Home Loan Bank
            
            223,722,356
            
            178,234,007Other
      Borrowed Money
            
            14,416,481
            
            12,784,094Advance
      Payments By Borrowers For Taxes And Insurance
            
            317,524
            
            620,467Mandatorily
      Redeemable Financial Instrument
            
            1,522,312
            
            1,417,312Junior
      Subordinated Debentures
            
            5,155,000
            
            5,155,000Other
      Liabilities
            
            3,928,552
            
            3,472,985Total
      Liabilities
            $
            869,705,206
            $
            792,534,073Shareholders'
      Equity:Serial
      Preferred Stock, $.01 Par Value; Authorized Shares – 200,000; Issued And
      Outstanding Shares – 18,000
            $
            17,600,000
            $
            -Warrants
      Issued In Conjunction With Serial Preferred Stock
            
            400,000
            
            -Common
      Stock, $.01 Par Value; Authorized Shares – 5,000,000; Issued - 2,659,079 And
      Outstanding Shares – 2,458,146 At December 31, 2008 And 2,649,027 And
      2,532,192 At March 31, 2008
            
            26,025
            
            25,925Additional
      Paid-In Capital
            
            5,271,566
            
            5,072,086Treasury
      Stock, (At Cost, 200,933 and 116,835 Shares, At December 31, 2008 and
      March 31, 2008 Respectively)
            
            (4,330,712)
            
            (2,769,446)Accumulated
      Other Comprehensive Income
            
            2,033,988
            
            2,395,537Retained
      Earnings, Substantially Restricted
            
            44,247,563
            
            42,772,311Total
      Shareholders' Equity
            $
            65,248,430
            $
            47,496,413Total
      Liabilities And Shareholders' Equity
            $
            934,953,636
            $
            840,030,486


See
accompanying notes to consolidated financial statements.





Security
Federal Corporation and Subsidiaries


Consolidated
Statements of Income (Unaudited)





Three
      Months Ended December 31,2008
            
            2007Interest
      Income:Loans
            $
            8,999,835
            $
            9,416,982Mortgage-Backed
      Securities
            
            2,558,840
            
            1,937,244Investment
      Securities
            
            694,633
            
            1,365,705Other
            
            729
            
            17,277Total
      Interest Income
            
            12,254,037
            
            12,737,208Interest
      Expense:NOW
      And Money Market Accounts
            
            1,115,271
            
            1,603,372Passbook
      Accounts
            
            27,033
            
            38,586Certificate
      Accounts
            
            3,520,046
            
            3,927,298Federal
      Home Loan Bank Advances And Other Borrowed Money
            
            2,025,915
            
            2,096,187Junior
      Subordinated Debentures
            
            74,140
            
            93,267Total
      Interest Expense
            
            6,762,405
            
            7,758,710Net
      Interest Income
            
            5,491,632
            
            4,978,498Provision
      For Loan Losses
            
            525,000
            
            150,000Net
      Interest Income After Provision For Loan Losses
            
            4,966,632
            
            4,828,498Non-Interest
      Income:Gain
      On Sale Of Loans
            
            107,726
            
            134,732Service
      Fees On Deposit Accounts
            
            293,327
            
            307,045Income
      From Cash Value Of Life Insurance
            
            90,000
            
            92,246Commissions
      From Insurance Agency
            
            141,771
            
            145,148Other
      Agency Income
            
            85,633
            
            19,670Trust
      Income
            
            105,000
            
            102,000Other
            
            196,893
            
            227,250Total
      Non- Interest  Income
            
            1,020,350
            
            1,028,091General
      And Administrative Expenses:Salaries
      And Employee Benefits
            
            2,949,973
            
            2,660,655Occupancy
            
            500,193
            
            425,489Advertising
            
            155,088
            
            80,857Depreciation
      And Maintenance Of Equipment
            
            380,470
            
            333,985FDIC
      Insurance Premiums
            
            201,882
            
            15,402Amortization
      of Intangibles
            
            22,500
            
            22,500Mandatorily
      Redeemable Financial Instrument Valuation Expense
            
            45,000
            
            -Other
            
            989,397
            
            789,044Total
      General And Administrative Expenses
            
            5,244,503
            
            4,327,932Income
      Before Income Taxes
            
            742,479
            
            1,528,657Provision
      For Income Taxes
            
            252,855
            
            488,046Net
      Income
            
            489,624
            
            1,040,611Preferred
      Stock Dividends
            
            27,500
            
            -Net
      Income Available to Common Shareholders
            $
            462,124
            $
            1,040,611Basic
      Net Income Per Common Share
            $
            0.19
            $
            0.40Diluted
      Net Income Per Common Share
            $
            0.18
            $
            0.40Cash
      Dividend Per Share On Common Stock
            $
            0.08
            $
            0.07Basic
      Weighted Average Common Shares Outstanding
            
            2,490,630
            
            2,585,234Diluted
      Weighted Average Common Shares Outstanding
            
            2,511,910
            
            2,588,318


See
accompanying notes to consolidated financial statements.


2


Security
Federal Corporation and Subsidiaries


Consolidated
Statements of Income (Unaudited)





Nine
      Months Ended December 31,2008
            
            2007Interest
      Income:Loans
            $
            26,483,081
            $
            27,625,147Mortgage-Backed
      Securities
            
            7,575,321
            
            5,036,650Investment
      Securities
            
            2,361,362
            
            4,583,201Other
            
            9,806
            
            45,179Total
      Interest Income
            
            36,429,570
            
            37,290,177Interest
      Expense:NOW
      And Money Market Accounts
            
            3,006,058
            
            4,931,098Passbook
      Accounts
            
            90,595
            
            121,535Certificate
      Accounts
            
            10,752,681
            
            10,797,386Federal
      Home Loan Bank Advances And Other Borrowed Money
            
            6,278,073
            
            6,047,885Junior
      Subordinated Debentures
            
            223,112
            
            276,345Total
      Interest Expense
            
            20,350,519
            
            22,174,249Net
      Interest Income
            
            16,079,051
            
            15,115,928Provision
      For Loan Losses
            
            1,025,000
            
            450,000Net
      Interest Income After Provision For Loan Losses
            
            15,054,051
            
            14,665,928Non-Interest
      Income:Gain
      On Sale Of Investments
            
            126,440
            
            -Gain
      On Sale Of Loans
            
            335,444
            
            416,303Service
      Fees On Deposit Accounts
            
            850,720
            
            957,790Income
      From Cash Value Of Life Insurance
            
            268,492
            
            241,447Commissions
      From  Insurance Agency
            
            474,901
            
            464,309Other
      Agency Income
            
            208,651
            
            75,838Trust
      Income
            
            315,000
            
            340,625Other
            
            622,512
            
            641,747Total
      Non-Interest Income
            
            3,202,160
            
            3,138,059General
      And Administrative Expenses:Salaries
      And Employee Benefits
            
            8,565,480
            
            7,858,206Occupancy
            
            1,490,879
            
            1,293,602Advertising
            
            402,765
            
            270,278Depreciation
      And Maintenance Of Equipment
            
            1,222,304
            
            990,601FDIC
      Insurance Premiums
            
            549,227
            
            45,599Amortization
      of Intangibles
            
            67,500
            
            67,500Mandatorily
      Redeemable Financial Instrument Valuation Expense
            
            105,000
            
            -Other
            
            2,738,726
            
            2,434,592Total
      General And Administrative Expenses
            
            15,141,881
            
            12,960,378Income
      Before Income Taxes
            
            3,114,330
            
            4,843,609Provision
      For Income Taxes
            
            1,037,963
            
            1,579,392Net
      Income
            
            2,076,367
            
            3,264,217Preferred
      Stock Dividends
            
            27,500
            
            -Net
      Income Available to Common Shareholders
            $
            2,048,867
            $
            3,264,217





(Continued)


3


Security
Federal Corporation and Subsidiaries


Consolidated
Statements of Income (Unaudited)





Nine
      Months Ended December 31,2008
            
            2007Basic
      Net Income Per Common Share
            $
            0.81
            $
            1.26Diluted
      Net Income Per Common Share
            $
            0.81
            $
            1.25Cash
      Dividend Per Share On Common Stock
            $
            0.24
            $
            0.21Basic
      Weighted Average Common Shares Outstanding
            
            2,515,579
            
            2,599,352Diluted
      Weighted Average Common Shares Outstanding
            
            2,529,702
            
            2,605,686


See
accompanying notes to consolidated financial statements.


4


Security
Federal Corporation and Subsidiaries


Consolidated
Statements of Shareholders’ Equity and Comprehensive Income
(Unaudited)





Common
      Stock
            
            
            Additional
              Paid
      – In
              Capital
            
            
            Treasury
              Stock
            
            
            Accumulated
      Other Comprehensive
              Income
      (Loss)
            
            
            Retained
              Earnings
            
            
            TotalBalance
      At March 31, 2007
            
            $
            25,814
            
            
            $
            4,850,029
            
            
            $
            (651,220
            )
            
            $
            (747,316
            )
            
            $
            39,215,901
            
            
            $
            42,693,208Net
      Income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3,264,217
            
            
            
            3,264,217Other
      Comprehensive Income,
              Net
      Of Tax:Unrealized
      Holding Gains
              On
      Securities Available
              For
      Sale
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,585,599
            
            
            
            -
            
            
            
            1,585,599Comprehensive
      Income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            4,849,816Purchase
      Of Treasury Stock
              At
      Cost, 82,313 shares
            
            
            -
            
            
            
            -
            
            
            
            (1,986,691
            )
            
            
            -
            
            
            
            -
            
            
            
            (1,986,691
            )Employee
      Stock Purchase Plan Purchases
            
            
            36
            
            
            
            74,145
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            74,181Exercise
      Of Stock Options
            
            
            63
            
            
            
            104,958
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            105,021Stock
      Compensation Expense
            
            
            -
            
            
            
            10,007
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            10,007Cash
      Dividends
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (545,635
            )
            
            
            (545,635
            )Balance
      At December 31, 2007
            
            $
            25,913
            
            
            $
            5,039,139
            
            
            $
            (2,637,911
            )
            
            $
            838,283
            
            
            $
            41,934,483
            
            
            $
            45,199,907









Preferred
              Stock
            
            
            Warrants
            
            
            Common
      Stock
            
            
            Additional
              Paid
      – In
              Capital
            
            
            Treasury
              Stock
            
            
            Accumulated
      Other Comprehensive Income (Loss)
            
            
            Retained
      Earnings
            
            
            TotalBalance
      At March 31, 2008
            
            $
            -
            
            
            $
            -
            
            
            $
            25,925
            
            
            $
            5,072,086
            
            
            $
            (2,769,446
            )
            
            $
            2,395,537
            
            
            $
            42,772,311
            
            
            $
            47,496,413Net
      Income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            2,076,367
            
            
            
            2,076,367Other
      Comprehensive Income,
              Net
      Of Tax:Unrealized
      Holding Losses
              On
      Securities Available
              For
      Sale, Net Of Taxes
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (283,156
            )
            
            
            -
            
            
            
            (283,156
            )Reclassification
      Adjustment
              For
      Gains Included In Net
              Income,
      Net Of Taxes
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (78,393
            )
            
            
            -
            
            
            
            (78,393
            )Comprehensive
      Income
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1,714,818Purchase
      Of Treasury Stock
              At
      Cost, 84,098 shares
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (1,561,266
            )
            
            
            -
            
            
            
            -
            
            
            
            (1,561,266
            )Issuance
      Of Preferred Stock
              And
      Related Warrants
            
            
            17,600,000
            
            
            
            400,000
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            18,000,000Employee
      Stock Purchase Plan
              Purchases
            
            
            -
            
            
            
            -
            
            
            
            40
            
            
            
            75,110
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            75,150Exercise
      Of Stock Options
            
            
            -
            
            
            
            -
            
            
            
            60
            
            
            
            99,960
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            100,020Stock
      Compensation Expense
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            24,410
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            24,410Cash
      Dividends- Common
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (601,115
            )
            
            
            (601,115
            )Balance
      At December 31, 2008
            
            $
            17,600,000
            
            
            $
            400,000
            
            
            $
            26,025
            
            
            $
            5,271,566
            
            
            $
            (4,330,712
            )
            
            $
            2,033,988
            
            
            $
            44,247,563
            
            
            $
            65,248,430





See
accompanying notes to consolidated financial statements.










5





Security
Federal Corporation and Subsidiaries


Consolidated
Statements of Cash Flows (Unaudited)







Nine
      Months Ended December 31,2008
            
            
            2007Cash
      Flows From Operating Activities:Net
      Income
            
            $
            2,076,367
            
            
            $
            3,264,217Adjustments
      To Reconcile Net Income To Net Cash Provided By Operating
      Activities:Depreciation
      Expense
            
            
            1,116,801
            
            
            
            789,116Amortization
      Of Intangible Assets
            
            
            67,500
            
            
            
            67,500Stock
      Option Compensation Expense
            
            
            24,410
            
            
            
            10,007Discount
      Accretion And Premium Amortization
            
            
            273,331
            
            
            
            161,021Mandatorily
      Redeemable Financial Instrument Valuation Expense
            
            
            105,000
            
            
            
            -Provisions
      For Losses On Loans And Real Estate
            
            
            1,025,000
            
            
            
            450,000Gain
      On Sale Of Loans
            
            
            (335,444
            )
            
            
            (416,303
            )Gain
      On Sale Of Investments
            
            
            (126,440
            )
            
            
            -Loss
      (Gain) On Sale Of Real Estate
            
            
            5,906
            
            
            
            (27,293
            )Amortization
      Of Deferred Fees On Loans
            
            
            (81,819
            )
            
            
            (87,601
            )Loss
      on Disposition of Premises and Equipment
            
            
            61
            
            
            
            356Proceeds
      From Sale Of Loans Held For Sale
            
            
            26,912,369
            
            
            
            25,998,343Origination
      Of Loans For Sale
            
            
            (27,191,255
            )
            
            
            (26,822,970
            )(Increase)
      Decrease In Accrued Interest Receivable:Loans
            
            
            49,774
            
            
            
            (387,120
            )Mortgage-Backed
      Securities
            
            
            (119,822
            )
            
            
            (121,500
            )Investments
            
            
            179,462
            
            
            
            27,718Decrease
      In Advance Payments By Borrowers
            
            
            (302,943
            )
            
            
            (22,151
            )Other,
      Net
            
            
            (240,214
            )
            
            
            99,559Net
      Cash Provided By Operating Activities
            
            
            3,438,044
            
            
            
            2,982,899Cash
      Flows From Investing Activities:Principal
      Repayments On Mortgage-Backed Securities Available For
Sale
            
            
            32,064,937
            
            
            
            27,258,442Principal
      Repayments On Mortgage-Backed Securities Held To Maturity
            
            
            126,754
            
            
            
            -Purchase
      Of Investment Securities Available For Sale
            
            
            (8,184,620
            )
            
            
            (29,542,601
            )Purchase
      Of Mortgage-Backed Securities Available For Sale
            
            
            (48,075,466
            )
            
            
            (47,317,221
            )Purchase
      Of Mortgage-Backed Securities Held To Maturity
            
            
            (26,588,294
            )
            
            
            -Purchase
      Of Investment Securities Held To Maturity
            
            
            (1,000,000
            )
            
            
            -Maturities
      Of Investment Securities Available For Sale
            
            
            16,677,263
            
            
            
            22,371,400Maturities
      of Investment Securities Held To Maturity
            
            
            12,000,000
            
            
            
            19,000,000Proceeds
      From Sale Of Mortgage-Backed Securities Available For Sale
            
            
            2,993,520
            
            
            
            -Proceeds
      From Sale Of Investment Securities Available For Sale
            
            
            7,135,335
            
            
            
            -Purchase
      Of Federal Home Loan Bank Stock
            
            
            (8,284,200
            )
            
            
            (8,272,900
            )Redemption
      Of Federal Home Loan Bank Stock
            
            
            6,237,200
            
            
            
            7,197,900Increase
      In Loans To Customers
            
            
            (79,966,426
            )
            
            
            (63,895,411
            )Proceeds
      From Sale Of Repossessed Assets
            
            
            367,000
            
            
            
            295,279Purchase
      And Improvement Of Premises And Equipment
            
            
            (1,461,534
            )
            
            
            (5,395,783
            )Proceeds
      From Sale of Premises And Equipment
            
            
            1,650
            
            
            
            500Purchase
      Of Bank Owned Life Insurance
            
            
            (1,240,492
            )
            
            
            (2,441,447
            )Net
      Cash Used By Investing Activities
            
            
            (97,197,373
            )
            
            
            (80,741,842
            )


(Continued











6







Security
Federal Corporation and Subsidiaries


Consolidated
Statements of Cash Flows (Unaudited)





Nine
      Months Ended December 31,2008
            
            
            2007Cash
      Flows From Financing Activities:Increase
      In Deposit Accounts
            
            
            29,792,773
            
            
            
            50,177,687Proceeds
      From Federal Home Loan Bank Advances
            
            
            247,900,000
            
            
            
            296,700,000Repayment
      Of Federal Home Loan Bank Advances
            
            
            (202,411,651
            )
            
            
            (272,011,420
            )Net
      Proceeds Of Other Borrowings
            
            
            1,632,387
            
            
            
            4,607,358Proceeds
      From Issuance Of Preferred Stock
            
            
            18,000,000
            
            
            
            -Dividends
      Paid To Shareholders- Common Stock
            
            
            (601,115
            )
            
            
            (545,635
            )Purchase
      Of Treasury Stock
            
            
            (1,561,266
            )
            
            
            (1,986,691
            )Proceeds
      From Employee Stock Purchases
            
            
            75,150
            
            
            
            74,181Proceeds
      From Exercise of Stock Options
            
            
            100,020
            
            
            
            105,021Net
      Cash Provided By Financing Activities
            
            
            92,926,298
            
            
            
            77,120,501





Net
      Decrease In Cash And Cash Equivalents
            
            
            (833,031
            )
            
            
            (638,442
            )Cash
      And Cash Equivalents At Beginning Of Period
            
            
            10,539,054
            
            
            
            13,438,129Cash
      And Cash Equivalents At End Of Period
            
            $
            9,706,023
            
            
            $
            12,799,687Supplemental
      Disclosure Of Cash Flows Information:Cash
      Paid During The Period For Interest
            
            $
            20,635,914
            
            
            $
            22,011,826Cash
      Paid During The Period For Income Taxes
            
            $
            1,549,900
            
            
            $
            1,304,290Additions
      To Repossessed Acquired Through Foreclosure
            
            $
            247,450
            
            
            $
            720,873Decrease (Increase) In Unrealized Net Loss On Securities Available For
      Sale,  Net Of Taxes
            
            $
            (283,156
            )
            
            $
            1,585,599





See
accompanying notes to consolidated financial statements.











7


Security
Federal Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Unaudited)





1.
            Basis
      of Presentation





The
accompanying unaudited consolidated financial statements were prepared in
accordance with instructions for Form 10-Q and accounting principles generally
accepted in the United States of America; therefore, they do not include all
disclosures necessary for a complete presentation of financial condition,
results of operations, and cash flows.  Such statements are unaudited
but, in the opinion of management, reflect all adjustments, which are of a
normal recurring nature and necessary for a fair presentation of results for the
selected interim periods.  Users of financial information produced for
interim periods are encouraged to refer to the footnotes contained in the
audited financial statements appearing in Security Federal Corporation’s (the
“Company”) 2008 Annual Report to Shareholders when reviewing interim financial
statements.  The results of operations for the nine month period ended
December 31, 2008 are not necessarily indicative of the results that may be
expected for the entire fiscal year.  This Quarterly Report on Form
10-Q contains certain forward-looking statements with respect to the financial
condition, results of operations, and business of the Company.  These
forward-looking statements involve certain risks and
uncertainties.  Factors that may cause actual results to differ
materially from those anticipated by such forward-looking statements include,
but are not limited to, changes in interest rates, the demand for loans, the
regulatory environment, general economic conditions and inflation, and the
securities markets.  Management cautions readers of this Form 10-Q not
to place undue reliance on the forward-looking statements contained
herein.





2.
            Principles
      of Consolidation





The
accompanying unaudited consolidated financial statements include the accounts of
the Company and its wholly owned subsidiary, Security Federal Bank (the “Bank”),
and the Bank’s wholly owned subsidiaries, Security Federal Insurance, Inc.
(“SFINS”), Security Federal Investments, Inc. (“SFINV”), Security Federal Trust,
Inc. (“SFT”), and Security Financial Services Corporation (“SFSC”). Security
Federal Corporation has a wholly owned subsidiary, Security Federal Statutory
Trust (the “Trust”), which issued and sold fixed and floating rate capital
securities of the Trust.  However, under current accounting guidance,
the Trust is not consolidated in the Company’s financial statements. The Bank is
primarily engaged in the business of accepting savings and demand deposits and
originating mortgage and other loans to individuals and small businesses for
various personal and commercial purposes.  SFINS, SFINV, and SFT were
formed during the year ended March 31, 2002 and began operation during the
December 2001 quarter.  SFINS is an insurance agency offering auto,
business, health, and home insurance.  SFINV engages primarily in
investment brokerage services.  SFT offers trust, financial planning
and financial management services.  SFSC is currently
inactive.





3.  Critical
Accounting Policies





The
Company has adopted various accounting policies, which govern the application of
accounting principles generally accepted in the United States in the preparation
of our financial statements.  The Company’s significant accounting
policies are described in the footnotes to the audited consolidated financial
statements at March 31, 2008 included in its 2008 Annual Report to Stockholders,
which was filed as an exhibit to the Annual Report on Form 10-K for the year
ended March 31, 2008.  Certain accounting policies involve significant
judgments and assumptions by management, which have a material impact on the
carrying value of certain assets and liabilities.  The Company
considers these accounting policies to be critical accounting
policies.  The judgments and assumptions the Company uses are based on
historical experience and other factors, which the Company believes to be
reasonable under the circumstances.  Because of the nature of the
judgments and assumptions we make, actual results could differ from these
judgments and estimates which could have a material impact on the carrying
values of assets and liabilities and the results of operations.





The
Company believes the allowance for loan losses is a critical accounting policy
that requires the most significant judgments and estimates used in preparation
of the consolidated financial statements.  The Company provides for
loan losses using the allowance method.  Accordingly, all loan losses
are charged to the related allowance and all recoveries are credited to the
allowance for loan losses.  Additions to the allowance for loan losses
are provided by charges to operations based on various factors, which, in
management’s judgment, deserve current recognition in estimating possible
losses.  Such factors considered by management include the fair value
of the underlying collateral; stated guarantees by the borrower, if applicable,
the borrower’s ability to repay from other economic resources, growth and
composition of the loan portfolios, the relationship of the allowance for loan
losses to the outstanding loans, loss experience, delinquency trends, and
general economic conditions.  Management evaluates the carrying value
of the loans periodically and the allowance is adjusted
accordingly.  While management uses the best information available to
make evaluations, future adjustments may be necessary if economic conditions
differ substantially from the assumptions used in making these
evaluations.  Allowance for loan losses are subject to periodic
evaluations by various authorities and may be subject to adjustments based upon
the information that is available at the time of their examination.








8







Security
Federal Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Unaudited), Continued





3.
            Critical
      Accounting Policies, Continued





The
Company values impaired loans at the loan’s fair value if it is probable that
the Company will be unable to collect all amounts due according to the terms of
the loan agreement at the present value of expected cash flows, the market price
of the loan, if available, or the value of the underlying
collateral.  Expected cash flows are required to be discounted at the
loan’s effective interest rate.  When the ultimate collectibility of
an impaired loan’s principal is in doubt, wholly or partially, all cash receipts
are applied to principal.  When this doubt does not exist, cash
receipts are applied under the contractual terms of the loan agreement first to
interest and then to principal.  Once the recorded principal balance
has been reduced to zero, future cash receipts are applied to interest income to
the extent that any interest has been foregone.  Further cash receipts
are recorded as recoveries of any amounts previously charged off.





4.
            Earnings
      Per Common Share





The
Company calculates earnings per common share (“EPS”) in accordance with
Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per
Share.”  SFAS No. 128 specifies the computation, presentation and
disclosure requirements for EPS for entities with publicly held common stock or
potential common stock such as options, warrants, convertible securities or
contingent stock agreements if those securities trade in a public
market.





This
standard specifies computation and presentation requirements for both basic EPS
and, for entities with complex capital structures, diluted EPS.  Basic
EPS is computed by dividing net income by the weighted average number of common
shares outstanding.  Diluted EPS is similar to the computation of
basic EPS except that the denominator is increased to include the number of
additional common shares that would have been outstanding if the dilutive
potential common shares had been issued.  The dilutive effect of
options outstanding under the Company’s stock option plan is reflected in
diluted earnings per common share by application of the treasury stock
method.





The
following table provides a reconciliation of the numerators and denominators of
the basic and diluted EPS computations:





For
      the Quarter EndedDecember
      31, 2008Income
      (Numerator) Amount
            
            
            Shares
      (Denominator)
            
            
            Per
      ShareBasic
      EPS
            
            $
            462,124
            
            
            
            2,490,630
            
            
            $
            0.19Effect
      of Diluted Securities:Mandatorily
      Redeemable
              Shares
            
            
            -
            
            
            
            21,280
            
            
            
            (0.01
            )Stock Options
            
            
            -
            
            
            
            -
            
            
            
            -Diluted
      EPS
            
            $
            462,124
            
            
            
            2,511,910
            
            
            $
            0.18





For
      the Quarter EndedDecember
      31, 2007Income
      (Numerator) Amount
            
            
            Shares
      (Denominator)
            
            
            Per
      ShareBasic
      EPS
            
            $
            1,040,611
            
            
            
            2,585,234
            
            
            $
            0.40Effect
      of Diluted Securities:Stock Options
            
            
            -
            
            
            
            3,084
            
            
            
            -Diluted
      EPS
            
            $
            1,040,611
            
            
            
            2,588,318
            
            
            $
            0.40

















9











Security
Federal Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Unaudited), Continued





4.   Earnings
Per Common Share, Continued





For
      the Nine Months EndedDecember
      31, 2008Income
      (Numerator) Amount
            
            
            Shares
      (Denominator)
            
            
            Per
      ShareBasic
      EPS
            
            
            2,048,867
            
            
            
            2,515,579
            
            
            $
            0.81Effect
      of Diluted Securities:Mandatorily
      Redeemable
              Shares
            
            
            -
            
            
            
            14,123
            
            
            
            -Stock Options
            
            
            -
            
            
            
            -
            
            
            
            -Diluted
      EPS
            
            
            2,048,867
            
            
            
            2,529,702
            
            
            $
            0.81





For
      the Nine Months EndedDecember
      31, 2007Income
      (Numerator) Amount
            
            
            Shares
      (Denominator)
            
            
            Per
      ShareBasic
      EPS
            
            $
            3,264,217
            
            
            
            2,599,352
            
            
            $
            1.26Effect
      of Diluted Securities:Stock Options
            
            
            -
            
            
            
            6,334
            
            
            
            (0.01
            )Diluted
      EPS
            
            $
            3,264,217
            
            
            
            2,605,686
            
            
            $
            1.25





5.      Stock-Based
Compensation





Certain
officers and directors of the Company participate in an incentive and non-
qualified stock option plan. Options are granted at exercise prices not less
than the fair value of the Company’s common stock on the date of the grant. The
following is a summary of the activity under the Company’s stock option plan for
the three and nine months ended December 31, 2008:





Three
      Months Ended
              December
      31, 2008
            
            Nine
      Months Ended
              December
      31, 2008Shares
            Weighted
              Average
              Exercise
      Price
            
            Shares
            Weighted
              Average
              Exercise
      PriceBalance,
      Beginning of Period/Year
            100,500
            $22.01
            
            111,100
            $21.55Options
      granted
            -
            -
            
            4,500
            22.91Options
      exercised
            -
            -
            
            6,000
            16.67Options
      forfeited
            -
            -
            
            9,100
            20.32Balance,
      December 31, 2008
            100,500
            $22.01
            
            100,500
            $22.01Options
      Exercisable
            60,000
            $21.09Range
      of Exercise Prices For
              Exercisable
      Options
            $16.67-$24.22Options
      Available For Grant
            50,000





The
weighted average remaining contractual life of all outstanding options at
December 31, 2008 was 6.33 years. All non-vested awards are expected to be
recognized over a weighted average period of 7.83 years.








10











Security
Federal Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Unaudited), Continued





5.
            Stock-Based
      Compensation, Continued





The
following table summarizes the stock-based awards granted by the Company, the
fair market value of each award granted as estimated on the date of grant using
the Black-Scholes option-pricing model, and the weighted average assumptions
used for such grants for the periods indicated:





For
      Awards Granted During The Three Month Period Ended December
      31,
            
            
            For
      Awards Granted During The Nine Month Period Ended December
    31,2008
            
            
            2007
            
            
            2008
            
            
            2007Awards
      granted
            
            
            -
            
            
            
            2,000
            
            
            
            4,500
            
            
            
            5,000Dividend
      Yield
            
            
            -
            
            
            
            1.60
            %
            
            
            1.76-1.79
            %
            
            
            1.52-1.60
            %Weighted
      Average Expected
              Volatility
            
            
            -
            
            
            
            20.92
            %
            
            
            17.62-18.10
            %
            
            
            22.71
            %Risk-free
      interest rate
            
            
            -
            
            
            
            4.50
            %
            
            
            3.69-3.88
            %
            
            
            4.76
            %Expected
      life
            
            
            -
            
            
            
            9.00
            
            
            
            9.00
            
            
            
            9.00








At
December 31, 2008, the Company had the following options
outstanding:





Grant
      Date
            
            Outstanding
      Options
            
            Option
      Price
            
            Expiration
      Date10/19/99
            
            9,600
            
            $16.67
            
            09/30/05
      to 09/30/0909/01/03
            
            2,400
            
            $24.00
            
            08/31/1312/01/03
            
            3,000
            
            $23.65
            
            11/30/1301/01/04
            
            5,500
            
            $24.22
            
            12/31/1303/8/04
            
            13,000
            
            $21.43
            
            03/08/1406/07/04
            
            2,000
            
            $24.00
            
            06/07/1401/01/05
            
            20,500
            
            $20.55
            
            12/31/1401/01/06
            
            4,000
            
            $23.91
            
            01/01/1608/24/06
            
            14,000
            
            $23.03
            
            08/24/1605/24/07
            
            2,000
            
            $24.34
            
            05/24/1707/09/07
            
            1,000
            
            $24.61
            
            07/09/17100/1/07
            
            2,000
            
            $24.28
            
            10/01/1701/01/08
            
            17,000
            
            $23.49
            
            01/01/1805/19/08
            
            2,500
            
            $22.91
            
            05/19/1807/01/08
            
            2,000
            
            $22.91
            
            07/01/18














11











Security
Federal Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Unaudited), Continued





6.
            Fair
      Value Measurements





Effective
April 1, 2008, the Company adopted SFAS No. 157, “Fair Value Measurements”
(“SFAS 157”) which provides a framework for measuring and disclosing fair value
under generally accepted accounting principles. SFAS 157 requires disclosures
about the fair value of assets and liabilities recognized in the balance sheet
in periods subsequent to initial recognition, whether the measurements are made
on a recurring basis (for example, available-for-sale investment securities) or
on a nonrecurring basis (for example, impaired loans).





SFAS 157
defines fair value as the exchange price that would be received for an asset or
paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date. SFAS 157 also establishes a fair
value hierarchy which requires an entity to maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring fair value.
The standard describes three levels of inputs that may be used to measure fair
value:





Level
      1
            Quoted
      prices in active markets for identical assets or liabilities. Level 1
      assets and liabilities include debt and equity securities and derivative
      contracts that are traded in an active exchange market, as well as U.S.
      Treasuries and money market funds.Level
      2
            Observable
      inputs other than Level 1 prices such as quoted prices for similar assets
      or liabilities; quoted prices in markets that are not active; or other
      inputs that are observable or can be corroborated by observable market
      data for substantially the full term of the assets or liabilities. Level 2
      assets and liabilities include debt securities with quoted prices that are
      traded less frequently than exchange-traded instruments, mortgage-backed
      securities, municipal bonds, corporate debt securities and derivative
      contracts whose value is determined using a pricing model with inputs that
      are observable in the market or can be derived principally from or
      corroborated by observable market data. This category generally includes
      certain derivative contracts and impaired loans.Level
      3
            Unobservable
      inputs that are supported by little or no market activity and that are
      significant to the fair value of the assets or liabilities. Level 3 assets
      and liabilities include financial instruments whose value is determined
      using pricing models, discounted cash flow methodologies, or similar
      techniques, as well as instruments for which the determination of fair
      value requires significant management judgment or estimation. For example,
      this category generally includes certain private equity investments,
      retained residual interests in securitizations, residential mortgage
      servicing rights, and highly-structured or long-term derivative
      contracts.





Assets
and liabilities measured at fair value on a recurring basis are as follows as of
December 31, 2008:





Assets:
            Quoted
      Market Price
              In
      Active Markets
              (Level
      1)
            Significant
      Other
              Observable
      Inputs
              (Level
      2)
            Significant
              Unobservable
      Inputs
              (Level
      3)Available-For-SaleInvestment
      And
              Mortgage-
      BackedSecurities
            $-
            $                     240,773,404
            $-Mortgage
      Loans HeldFor
      Sale
            -
            2,910,051
            -Total
            $-
            $                     243,683,455
            $-Liabilities:MandatorilyRedeemable
      Financial
              Instrument
            $-
            $                         1,522,312
            $                             -Total
            $                                    -
            $                         1,522,312
            $-












12




Security
Federal Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Unaudited), Continued





6.    Fair
Value Measurements, Continued





The
Company is predominantly an asset based lender with real estate serving as
collateral on a substantial majority of loans. Loans which are deemed to be
impaired are primarily valued on a nonrecurring basis at the fair values of the
underlying real estate collateral. Such fair values are obtained using
independent appraisals, which the Company considers to be level 2 inputs. As of
December 31, 2008 and March 31, 2008, the recorded investment in impaired loans
was $11.8 million and $4.3 million, respectively. The average recorded
investment in impaired loans was $10.8 million and $7.4 million, respectively,
for the three and nine months ended December 31, 2008, and $1.0 million and $1.2
million, respectively for the same periods last year.





Financial
Accounting Standards Board (“FASB”) Staff Position No. FAS 157-2 delays the
implementation of SFAS 157 until the first quarter of 2009 with respect to
goodwill, other intangible assets, real estate and other assets acquired through
foreclosure and other non-financial assets measured at fair value on a
nonrecurring basis.





The
Company has no assets or liabilities whose fair values are measured using level
3 inputs that require disclosure as of December 31, 2008.





7.      Accounting
and Reporting Changes





The
following is a summary of recent authoritative pronouncements that could impact
the accounting, reporting, and / or disclosure of financial information by the
Company.





In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” (“SFAS
141(R)”) which replaces SFAS 141. SFAS 141(R) establishes principles and
requirements for how an acquirer in a business combination recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any controlling interest; recognizes and measures
goodwill acquired in the business combination or a gain from a bargain purchase;
and determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business
combination. SFAS 141(R) is effective for acquisitions by the Company taking
place on or after April 1, 2009. Early adoption is prohibited. Accordingly, the
Company is required to record and disclose business combinations following
existing accounting guidance until April 1, 2009. The Company will assess the
impact of SFAS 141(R) if and when a future acquisition occurs.





Also in
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS 160”).
SFAS 160 establishes new accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. Before this statement, limited guidance existed for reporting
noncontrolling interests (minority interest). Specifically, SFAS 160 requires
the recognition of a noncontrolling interest (minority interest) as equity in
the consolidated financials statements and separate from the parent’s equity.
The amount of net income attributable to the noncontrolling interest will be
included in consolidated net income on the face of the income statement. SFAS
160 clarifies that changes in a parent’s ownership interest in a subsidiary that
do not result in deconsolidation are equity transactions if the parent retains
its controlling financial interest. In addition, this statement requires that a
parent recognize gain or loss in net income when a subsidiary is deconsolidated.
Such gain or loss will be measured using the fair value of the noncontrolling
equity investment on the deconsolidation date. SFAS 160 also includes expanded
disclosure requirements regarding the interests of the parent and its
noncontrolling interests. SFAS 160 is effective for the Company on April 1,
2009.   Earlier adoption is prohibited. The Company is currently
evaluating the impact, if any, the adoption of SFAS 160 will have on its
financial position, results of operations and cash flows.





In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities” (“SFAS 161”).  SFAS 161 requires enhanced
disclosures about an entity’s derivative and hedging activities and thereby
improving the transparency of financial reporting.  It is intended to
enhance the current disclosure framework in SFAS No. 133 by requiring that
objectives for using derivative instruments be disclosed in terms of underlying
risk and accounting designation. This disclosure better conveys the purpose of
derivative use in terms of the risks that the entity is intending to manage.
SFAS 161 is effective for the Company on April 1, 2009. This pronouncement does
not impact accounting measurements but will result in additional disclosures if
the Company is involved in material derivative and hedging activities at that
time.





In
February 2008, the FASB issued FASB Staff Position No. 140-3, “Accounting for
Transfers of Financial Assets and Repurchase Financing Transactions” (“FSP
140-3”).  FSP 140-3 provides guidance on accounting for a transfer of a
financial asset and the transferor’s repurchase financing of the asset.
 This FSP presumes that an initial transfer of a financial asset and a
repurchase financing are considered part of the same arrangement (linked
transaction) under SFAS No. 140.






13






Security Federal
Corporation and Subsidiaries


Notes to
Consolidated Financial Statements (Unaudited), Continued




7.      Accounting
and Reporting Changes, Continued





However,
if certain criteria are met, the initial transfer and repurchase financing are
not evaluated as a linked transaction and are evaluated separately under
Statement 140.  FSP 140-3 will be effective for financial statements issued
for fiscal years beginning after November 15, 2008, and interim periods within
those fiscal years and earlier application is not permitted. Accordingly, this
FSP is effective for the Company on April 1, 2009.  The Company is
currently evaluating the impact, if any, the adoption of FSP 140-3 will have on
its financial position, results of operations and cash flows.





In April
2008, the FASB issued FASB Staff Position No. 142-3, “Determination of the
Useful Life of Intangible Assets” (“FSP 142-3”).  This FSP amends the
factors that should be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible asset under SFAS
No. 142, “Goodwill and Other Intangible Assets”.  The intent of this
FSP is to improve the consistency between the useful life of a recognized
intangible asset under SFAS No. 142 and the period of expected cash flows used
to measure the fair value of the asset under SFAS 141(R), “Business
Combinations,”and
other U.S. generally accepted accounting principles.  This FSP is
effective for financial statements issued for fiscal years beginning after
December 15, 2008, and interim periods within those fiscal years and early
adoption is prohibited.  Accordingly, this FSP is effective for the
Company on April 1, 2009.  The Company does not believe the adoption
of FSP 142-3 will have a material impact on its financial position, results of
operations or cash flows.





In May,
2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles,” (“SFAS 162”).  SFAS 162 identifies the sources
of accounting principles and the framework for selecting the principles used in
the preparation of financial statements of nongovernmental entities that are
presented in conformity with generally accepted accounting principles (GAAP) in
the United States (the GAAP hierarchy).  SFAS 162 is effective
November 15, 2008. The FASB has stated that it does not expect SFAS 162 will
result in a change in current practice. The application of SFAS 162 had no
effect on the Company’s financial position, results of operations or cash
flows.





The FASB
issued FASB Staff Position No. APB 14-1, “Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement),” (“FSP APB 14-1”). The Staff Position specifies that issuers of
convertible debt instruments that may be settled in cash upon conversion should
separately account for the liability and equity components in a manner that will
reflect the entity’s nonconvertible debt borrowing rate when interest cost is
recognized in subsequent periods.  FSP APB 14-1 provides guidance for
initial and subsequent measurement as well as derecognition
provisions.  The Staff Position is effective for financial statements
issued for fiscal years beginning after December 15, 2008, and interim periods
within those fiscal years. Early adoption is not permitted.  The
Company is currently analyzing the effect, if any, the adoption of this Staff
Position will have on the Company’s financial position, results of operations or
cash flows.




FSP SFAS
133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain
Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No.
45; and Clarification of the Effective Date of FASB Statement No. 161,” (“FSP
SFAS 133-1 and FIN 45-4”) was issued September 2008, effective for reporting
periods (annual or interim) ending after November 15, 2008.  FSP SFAS
133-1 and FIN 45-4 amends SFAS No. 133 to require the seller of credit
derivatives to disclose the nature of the credit derivative, the maximum
potential amount of future payments, fair value of the derivative, and the
nature of any recourse provisions.  Disclosures must be made for
entire hybrid instruments that have embedded credit derivatives.





The staff
position also amends FIN 45 to require disclosure of the current status of the
payment/performance risk of the credit derivative guarantee.  If an
entity utilizes internal groupings as a basis for the risk, how the groupings
are determined must be disclosed as well as how the risk is
managed.





The staff
position encourages that the amendments be applied in periods earlier than the
effective date to facilitate comparisons at initial adoption.  After
initial adoption, comparative disclosures are required only for subsequent
periods.





FSP SFAS
133-1 and FIN 45-4 clarifies the effective date of SFAS 161 such that required
disclosures should be provided for any reporting period (annual or quarterly
interim) beginning after November 15, 2008.  The adoption of this
Staff Position had no material effect on the Company’s financial position,
results of operations or cash flows.





The SEC’s
Office of the Chief Accountant and the staff of the FASB issued 2008-234 on
September 30, 2008 (“Press Release”) to provide clarifications on fair value
accounting.  The press release includes guidance on the use of
management’s internal assumptions and the use of “market” quotes.







14






Security
Federal Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Unaudited), Continued





7.      Accounting
and Reporting Changes, Continued





It also
reiterates the factors in SEC Staff Accounting Bulletin (“SAB”) Topic 5M which
should be considered when determining other-than-temporary impairment: the
length of time and extent to which the market value has been less than cost;
financial condition and near-term prospects of the issuer; and the intent and
ability of the holder to retain its investment for a period of time sufficient
to allow for any anticipated recovery in market value.





On
October 10, 2008, the FASB issued FSP SFAS 157-3, “Determining the Fair Value of
a Financial Asset When the Market for That Asset Is Not Active” (“FSP SFAS
157-3”). This FSP clarifies the application of SFAS No. 157, “Fair Value
Measurements” (see Note 6) in a market that is not active and provides an
example to illustrate key considerations in determining the fair value of a
financial asset when the market for that asset is not active.  The FSP
is effective upon issuance, including prior periods for which financial
statements have not been issued. For the Company, this FSP is effective for the
quarter ended September 30, 2008.





The
Company considered the guidance in the Press Release and in FSP SFAS 157-3 when
conducting its review for other-than-temporary impairment as of December 31,
2008 and determined that it did not result in a change to its impairment
estimation techniques.





FSP SFAS
140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about
Transfers of Financial Assets and Interests in Variable Interest Entities,”
(“FSP SFAS 140-4 and FIN 46(R)-8”) was issued in December 2008 to require public
entities to disclose additional information about transfers of financial assets
and to require public enterprises to provide additional disclosures about their
involvement with variable interest entities.  The FSP also requires
certain disclosures for public enterprises that are sponsors and servicers of
qualifying special purpose entities.  The FSP is effective for the
first reporting period ending after December 15, 2008.  This FSP had
no material impact on the financial position of the Company.





Other
accounting standards that have been issued or proposed by the FASB or other
standards-setting bodies are not expected to have a material impact on the
Company’s financial position, results of operations and cash flows.





8.      Securities





Investment And
Mortgage-Backed Securities, Available For Sale




The
amortized cost, gross unrealized gains, gross unrealized losses, and fair values
of investment and mortgage-backed securities available for sale are as
follows:




December 31, 2008
            
            Amortized
              Cost
            
            
            Gross
              Unrealized
              Gains
            
            
            Gross
              Unrealized
              Losses
            
            
            Fair
      ValueFHLB
      Securities
            
            $
            20,787,450
            
            
            $
            350,230
            
            
            $
            12,521
            
            
            $
            21,125,159Federal
      Farm Credit Securities
            
            
            11,485,414
            
            
            
            179,178
            
            
            
            -
            
            
            
            11,664,592Federal
      National Mortgage
              Association
      (“FNMA”) Bonds
            
            
            2,000,000
            
            
            
            9,070
            
            
            
            -
            
            
            
            2,009,070Mortgage-Backed
      Securities
            
            
            203,115,874
            
            
            
            3,699,645
            
            
            
            894,036
            
            
            
            205,921,483Equity
      Securities
            
            
            102,938
            
            
            
            -
            
            
            
            49,838
            
            
            
            53,100Total
            
            $
            237,491,676
            
            
            $
            4,238,123
            
            
            $
            956,395
            
            
            $
            240,773,404March 31, 2008
            
            Amortized
              Cost
            
            
            Gross
              Unrealized
              Gains
            
            
            Gross
              Unrealized
              Losses
            
            
            Fair
      ValueFHLB
      Securities
            
            $
            31,891,456
            
            
            $
            625,583
            
            
            $
            -
            
            
            $
            32,517,039Federal
      Farm Credit Securities
            
            
            14,849,646
            
            
            
            323,594
            
            
            
            -
            
            
            
            15,173,240FNMA
      Bonds
            
            
            2,997,470
            
            
            
            7,840
            
            
            
            -
            
            
            
            3,005,310Mortgage-Backed
      Securities
            
            
            190,454,173
            
            
            
            3,023,143
            
            
            
            104,283
            
            
            
            193,373,033Equity
      Securities
            
            
            102,938
            
            
            
            -
            
            
            
            13,688
            
            
            
            89,250Total
            
            $
            240,295,683
            
            
            $
            3,980,160
            
            
            $
            117,971
            
            
            $
            244,157,872










15





Security
Federal Corporation and Subsidiaries


Notes
to Consolidated Financial Statements (Unaudited), Continued





8.      Securities,
Continued





FHLB
securities, Federal Farm Credit securities, FNMA bonds and FNMA and FHLMC
mortgage- backed securities are issued by government-sponsored enterprises
(“GSEs”). GSEs are not backed by the full faith and credit of the United States
government. Included in the tables above in mortgage-backed securities are GNMA
mortgage-backed securities, which are backed by the full faith and credit of the
United States government. At December 31, 2008, the Bank held an amortized cost
and fair value of $97.3 million and $98.7 million, respectively in GNMA
mortgage-backed securities included in mortgage-backed securities listed
above.





Investment and
Mortgage-Backed Securities, Held to Maturity




The
amortized cost, gross unrealized gains, gross unrealized losses, and fair values
of investment and mortgage-backed securities held to maturity are as
follows:




December 31, 2008
            
            Amortized
      Cost
            
            
            Gross
              Unrealized
              Gains
            
            
            Gross
              Unrealized
              Losses
            
            
            Fair
      ValueFHLB
      Securities
            
            $
            9,995,612
            
            
            $
            409,088
            
            
            $
            14,690
            
            
            $
            10,390,010Federal
      Farm Credit Securities
            
            
            1,000,000
            
            
            
            28,750
            
            
            
            -
            
            
            
            1,028,750Mortgage-Backed
      Securities
            
            
            24,511,693
            
            
            
            381,636
            
            
            
            -
            
            
            
            24,893,329Equity
      Securities
            
            
            155,000
            
            
            
            -
            
            
            
            -
            
            
            
            155,000Total
            
            $
            35,662,305
            
            
            $
            819,474
            
            
            $
            14,690
            
            
            $
            36,467,089March 31, 2008
            
            Amortized
      Cost
            
            
            Gross
              Unrealized
              Gains
            
            
            Gross
              Unrealized
              Losses
            
            
            Fair
      ValueFHLB
      Securities
            
            
            17,999,618
            
            
            $
            320,072
            
            
            $
            -
            
            
            $
            18,319,690Federal
      Farm Credit Securities
            
            
            2,000,000
            
            
            
            31,560
            
            
            
            -
            
            
            
            2,031,560Equity
      Securities
            
            
            155,000
            
            
            
            -
            
            
            
            -
            
            
            
            155,000Total
            
            $
            20,154,618
            
            
            $
            351,632
            
            
            $
            -
            
            
            $
            20,506,250





FHLB
securities, Federal Farm Credit securities and FNMA and FHLMC mortgage- backed
securities are issued by GSEs. These enterprises are not backed by the full
faith and credit of the United States government. Included in the tables above
in mortgage-backed securities are GNMA and Small Business Administration (“SBA”)
mortgage-backed securities, which are backed by the full faith and credit of the
United States government. At December 31, 2008, the Bank held an amortized cost
and fair value of $11.6 million and $11.7 million, respectively in GNMA
mortgage-backed securities and $5.6 million and $5.7 million, respectively, in
SBA mortgage-backed securities included in mortgage-backed securities held to
maturity listed above.





9.      Loans
Receivable, Net





Loans
receivable, net, at December 31, 2008 and March 31, 2008 consisted of the
following:





December
      31, 2008
            
            
            March
      31,
              2008Residential
      Real Estate
            
            $
            133,544,316
            
            
            $
            131,863,466Consumer
            
            
            69,343,229
            
            
            
            66,832,377Commercial
      Business And Real Estate
            
            
            408,475,146
            
            
            
            333,386,661Loans
      Held For Sale
            
            
            2,910,051
            
            
            
            2,295,721614,272,742
            
            
            
            534,378,225Less:Allowance
      For Possible Loan Loss
            
            
            8,673,527
            
            
            
            8,066,762Loans
      In Process
            
            
            7,976,767
            
            
            
            8,064,728Deferred
      Loan Fees
            
            
            300,618
            
            
            
            315,03016,950,912
            
            
            
            16,446,520$
            597,321,830
            
            
            $
            517,931,705







16








Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations





Safe
Harbor Statement





Certain
matters in this Quarterly Report on Form 10-Q for the quarter ended December 31,
2008 constitute forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995.  These forward-looking
statements relate to, among others, expectations of the business environment in
which the Company operates, projections of future performance, perceived
opportunities in the market, potential future credit experience, and statements
regarding the Company’s mission and vision.  These forward-looking
statements are based upon current management expectations, and may, therefore,
involve risks and uncertainties.  The Company’s actual results,
performance, or achievements may differ materially from those suggested,
expressed, or implied by forward-looking statements as a result of a wide range
of factors including, but not limited to the credit risks of lending activities,
including changes in the level and trend of loan delinquencies and write offs;
changes in general economic conditions, either nationally or in our market area,
that are worse than expected; changes in the levels of general interest rates,
deposit interest rates, our net interest margin and funding sources;
fluctuations in the demand for loans, the number of unsold homes and other
properties and fluctuations in real estate values in our market areas; an
adverse change in the residential or commercial real estate market; our ability
to manage loan delinquency rates; results of examinations by the bank regulatory
authorities; our ability to control operating costs and expenses; our ability to
retain key members of our senior management team; costs and effects of any
litigation; increased competitive pressures among  financial services
companies; changes in consumer spending, borrowing, and savings habits;
legislative or regulatory changes that adversely affect our business; the
availability of resources to address changes in laws, rules, or regulations or
to respond to regulatory actions; adverse changes in the securities markets; the
inability of key third-party providers to perform their obligations to us;
changes in accounting policies and principles; war or terrorist activities;
other economic, competitive, governmental, regulatory, and technological factors
affecting our operations, pricing, products, and services and other risks
detailed in the Company’s reports filed with the Securities and Exchange
Commission, including the Annual Report on Form 10-K for the fiscal year ended
March 31, 2008.  Forward-looking statements are effective only as of
the date that they are made and the Company assumes no obligation to update this
information.





Comparison
of Financial Condition At December 31, 2008 and March 31, 2008





General– Total assets
increased $94.9 million or 11.3% to $935.0 million at December 31, 2008 from
$840.0 million at March 31, 2008.  The primary reason for the growth
in total assets was a $79.4 million or 15.3% increase in net loans receivable,
net to $597.3 million.  Almost all of this increase was in our
commercial business and real estate loan portfolio. For the nine months ended
December 31, 2008, the demand for loans was funded with increased deposits of
$29.8 million or 5.0%, increased advances from the FHLB of $45.5 million or
25.5% and increased other borrowed money of $1.6 million or 12.8%. In addition,
the Company received $18.0 million through the issuance of preferred stock in
conjunction with the Treasury’s Capital Purchase Program. See the section below
entitled “Recent Developments” for additional information.





Assets –The increases and
decreases in total assets were primarily concentrated in the following asset
categories:





Increase
      (Decrease)December
      31,
              2008
            
            
            March
      31,
              2008
            
            
            Amount
            
            
            PercentCash
      And Cash Equivalents
            
            $
            9,706,023
            
            
            $
            10,539,054
            
            
            $
            (833,031
            )
            
            
            (7.90
            )%Investment
      And Mortgage-
              Backed
      Securities –
              Available
      For Sale
            
            
            240,773,404
            
            
            
            244,157,872
            
            
            
            (3,384,468
            )
            
            
            (1.39
            )Investment
      And Mortgage-
              Backed
      Securities – Held
              To
      Maturity
            
            
            35,662,305
            
            
            
            20,154,618
            
            
            
            15,507,687
            
            
            
            76.94Loan
      Receivable, Net
            
            
            597,321,830
            
            
            
            517,931,705
            
            
            
            79,390,125
            
            
            
            15.33Premises
      And Equipment,
              Net
            
            
            21,887,402
            
            
            
            21,544,380
            
            
            
            343,022
            
            
            
            1.59FHLB
      Stock, At Cost
            
            
            11,544,100
            
            
            
            9,497,100
            
            
            
            2,047,000
            
            
            
            21.55Bank
      Owned Life Insurance
            
            
            9,551,305
            
            
            
            8,310,813
            
            
            
            1,240,492
            
            
            
            14.93Repossessed
      Assets
              Acquired
      in Settlement of
              Loans
            
            
            661,640
            
            
            
            767,096
            
            
            
            (105,456
            )
            
            
            (13.75
            )









17





Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





Cash and
cash equivalents decreased $833,000 to $9.7 million at December 31, 2008 from
$10.5 million at March 31, 2008.  The reason for the decrease was the
Company used cash and cash equivalents to fund loans and purchase investment and
mortgage- backed securities.





Investment
and mortgage-backed securities available for sale decreased $3.4 million or 1.4%
to $240.8 million at December 31, 2008 from $244.2 million at March 31,
2008.  The decrease in investments and mortgage-backed securities
available for sale can be attributed to principal paydowns on mortgage-backed
securities and calls and maturities on mortgage-backed securities and
investments that occurred during the period.  Investment and
mortgage-backed securities held to maturity increased $15.5 million to $35.7
million at December 31, 2008 from $20.2 million at March 31, 2008 as a result of
additional purchases during the period offset slightly by principal paydowns on
mortgage-backed securities and calls and maturities on investment
securities.





Loans
receivable, net, increased $79.4 million or 15.3% to $597.3 million at December
31, 2008 from $517.9 million at March 31, 2008.  Residential real
estate loans increased $1.7 million or 1.3% to $133.5 million at December 31,
2008 from $131.9 million at March 31, 2008. Consumer loans increased $2.5
million or 3.8% to $69.3 million at December 31, 2008 from $66.8 million at
March 31, 2008. The increase in residential real estate and consumer loans can
be attributed to normal growth of the Company.  Commercial business
and real estate loans increased $75.1 million or 22.5% to $408.5 million at
December 31, 2008 from $333.4 million at March 31, 2008. The increase in
commercial loans was attributable to the Company’s recent expansion into the new
market areas of Richland County, South Carolina and Columbia County, Georgia. In
connection with its expansion into these areas, the Company hired additional
loan originators. Loans held for sale increased $614,000 or 26.7% to $2.9
million at December 31, 2008 from $2.3 million at March 31, 2008.





Premises
and equipment, net increased $343,000 or 1.6% to $21.9 million at December 31,
2008 from $21.5 million at March 31, 2008.  The majority of this
increase was attributable to the relocation of the Company’s Clearwater branch
office and for renovations to the Operations Center in Aiken, South
Carolina.





FHLB
stock, at cost, increased $2.0 million to $11.5 million at December 31, 2008
from $9.5 million at March 31, 2008.  The increase was attributable to
a FHLB requirement that the Company maintain stock in the FHLB equal to 0.20% of
total assets at December 31, 2008 plus a transaction component, which equals
4.5% of outstanding advances (borrowings) from the FHLB of Atlanta.





Bank
owned life insurance increased $1.2 million to $9.6 million at December 31, 2008
from $8.3 million at March 31, 2008.  The Company purchased additional
life insurance to provide key man life insurance for additional
officers.





Repossessed
assets acquired in the settlement of loans decreased $105,000 to $662,000 at
December 31, 2008 from $767,000 at March 31, 2008. The Company sold two
properties and foreclosed on five additional properties during the nine month
period. At December 31, 2008 the balance in repossessed assets consisted of nine
properties: two lots within one subdivision of Aiken, South Carolina; one lot
within a subdivision of Columbia, South Carolina; a commercial building located
in Augusta, Georgia; a commercial lot of land located in Augusta Georgia; and
four single-family residences located in Langley and North Augusta, South
Carolina and Augusta, Georgia.





Other
assets increased $895,000 to $2.8 million at December 31, 2008 from $1.9 million
at March 31, 2008.  The majority of the increase resulted from an
increase in the deferred tax asset related to a decrease in the market value of
available for sale securities.









































18





Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





Liabilities





Deposit
Accounts





BalanceDecember
      31, 2008
            
            March
      31, 2008
            
            Increase
      (Decrease)Balance
            
            Weighted
              Rate
            
            Balance
            
            Weighted
              Rate
            
            Amount
            
            PercentDemand
      Accounts:Checking
            $
            96,371,802
            
            0.21%
            $
            100,585,610
            
            0.47%
            $
            (4,213,808)
            
            (4.19)%Money
      Market
            
            147,789,473
            
            2.21
            
            143,225,218
            
            2.84
            
            4,564,255
            
            3.19Regular
      Savings
            
            15,318,984
            
            0.64
            
            15,966,557
            
            0.97
            
            (647,573)
            
            (4.06)Total
            
            259,480,259
            
            1.38
            
            259,777,385
            
            1.87
            
            (297,126)
            
            (0.11)Certificate
      Accounts0.00
      – 1.99%
            
            1,064,832
            
            
            
            -
            
            
            
            1,064,832
            
            100.002.00
      – 2.99%
            
            65,445,842
            
            
            
            14,047,109
            
            
            
            51,398,733
            
            365.903.00
      – 3.99%
            
            105,758,841
            
            
            
            59,526,823
            
            
            
            46,232,018
            
            77.674.00
      – 4.99%
            
            181,776,079
            
            
            
            68,149,323
            
            
            
            113,626,756
            
            166.735.00
      – 5.99%
            
            7,117,128
            
            
            
            189,349,568
            
            
            
            (182,232,440)
            
            (96.24)Total
            
            361,162,722
            
            3.78
            
            331,072,823
            
            4.75
            
            30,089,899
            
            9.09Total
      Deposits
            $
            620,642,981
            
            2.78%
            $
            590,850,208
            
            3.46%
            $
            29,792,773
            
            5.04%





Included
in the certificate accounts above at December 31, 2008 were $10.4 million in
brokered deposits with a weighted average interest rate of.
2.95%.  These deposits have a term of seven months or
less.  There were no brokered deposits at March 31, 2008.





Advances From FHLB– FHLB
advances are summarized by year of maturity and weighted average interest rate
in the table below:





BalanceDecember
      31, 2008
            
            March
      31, 2008
            
            
            Increase
      (Decrease)Fiscal
      Year Due:
            
            Balance
            Rate
            
            Balance
            Rate
            
            
            Balance
            
            Percent2009
            $
            5,000,000
            4.05%
            $
            42,300,000
            3.28%
            
            $
            (37,300,000)
            
            (88.18)%2010
            
            90,800,000
            1.17
            
            10,000,000
            4.88
            
            
            80,800,000
            
            808.002011
            
            15,000,000
            4.87
            
            15,000,000
            4.87
            
            
            -
            
            -2012
            
            24,700,000
            4.56
            
            24,700,000
            4.56
            
            
            -
            
            -2013
            
            10,000,000
            4.76
            
            10,000,000
            4.76
            
            
            -
            
            -Thereafter
            
            78,222,356
            4.18
            
            76,234,007
            4.25
            
            
            1,988,349
            
            2.61Total
      Advances
            $
            223,722,356
            3.07%
            $
            178,234,007
            4.18%
            
            $
            45,488,349
            
            25.52%





These
advances are secured by a blanket collateral agreement with the FHLB by pledging
the Bank’s portfolio of residential first mortgage loans and investment
securities with an approximate amortized cost and fair value of $173.3 million
and $176.9 million, respectively, at December 31, 2008.  Advances are
subject to prepayment penalties.











19







Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





The
following table shows callable FHLB advances as of the dates
indicated.  These advances are also included in the above
table.  All callable advances are callable at the option of the
FHLB.  If an advance is called, the Bank has the option to payoff the
advance without penalty, re-borrow funds on different terms, or convert the
advance to a three-month floating rate advance tied to LIBOR.





As
      of December 31, 2008Borrow
      Date
            
            Maturity
      Date
            
            Amount
            
            Int.
      Rate
            
            Type
            
            Call
      Dates02/20/04
            
            02/20/14
            $
            5,000,000
            
            3.225%
            
            1
      Time Call
            
            02/20/0906/24/05
            
            06/24/15
            
            5,000,000
            
            3.710%
            
            1
      Time Call
            
            06/24/1011/10/05
            
            11/10/15
            
            5,000,000
            
            4.400%
            
            1
      Time Call
            
            11/10/0911/23/05
            
            11/23/15
            
            5,000,000
            
            3.933%
            
            Multi-Call
            
            05/25/08
      and quarterly thereafter11/29/05
            
            11/29/13
            
            5,000,000
            
            4.320%
            
            1
      Time Call
            
            05/29/0912/14/05
            
            12/14/11
            
            5,000,000
            
            4.640%
            
            1
      Time Call
            
            09/14/0901/12/06
            
            01/12/16
            
            5,000,000
            
            4.450%
            
            1
      Time Call
            
            01/12/1103/01/06
            
            03/03/14
            
            5,000,000
            
            4.720%
            
            1
      Time Call
            
            03/03/1006/02/06
            
            06/02/16
            
            5,000,000
            
            5.160%
            
            1
      Time Call
            
            06/02/1107/11/06
            
            07/11/16
            
            5,000,000
            
            4.800%
            
            Multi-Call
            
            07/11/08
      and quarterly thereafter11/29/06
            
            11/29/16
            
            5,000,000
            
            4.025%
            
            Multi-Call
            
            05/29/08
      and quarterly thereafter01/19/07
            
            07/21/14
            
            5,000,000
            
            4.885%
            
            1
      Time Call
            
            07/21/1103/09/07
            
            03/09/12
            
            4,700,000
            
            4.286%
            
            Multi-Call
            
            06/09/08
      and quarterly thereafter05/24/07
            
            05/24/17
            
            7,900,000
            
            4.375%
            
            Multi-Call
            
            05/27/08
      and quarterly thereafter06/29/07
            
            06/29/12
            
            5,000,000
            
            4.945%
            
            1
      Time Call
            
            06/29/0907/25/07
            
            07/25/17
            
            5,000,000
            
            4.396%
            
            Multi-Call
            
            07/25/08
      and quarterly thereafter11/16/07
            
            11/16/11
            
            5,000,000
            
            3.745%
            
            Multi-Call
            
            11/17/08
      and quarterly thereafter08/28/08
            
            08/28/13
            
            5,000,000
            
            3.113%
            
            Multi-Call
            
            08/30/10
      and quarterly thereafter08/28/08
            
            08/28/18
            
            5,000,000
            
            3.385%
            
            1
      Time Call
            
            08/28/11








As
      of March 31, 2008Borrow
      Date
            
            Maturity
      Date
            
            Amount
            
            Int.
      Rate
            
            Type
            
            Call
      Dates02/20/04
            
            02/20/14
            $
            5,000,000
            
            3.225%
            
            1
      Time Call
            
            02/20/0904/16/04
            
            04/16/14
            
            3,000,000
            
            3.330
            
            1
      Time Call
            
            04/16/0806/24/05
            
            06/24/15
            
            5,000,000
            
            3.710
            
            1
      Time Call
            
            06/24/1007/22/05
            
            07/22/15
            
            5,000,000
            
            3.790
            
            1
      Time Call
            
            07/22/0811/10/05
            
            11/10/15
            
            5,000,000
            
            4.400
            
            1
      Time Call
            
            11/10/0911/23/05
            
            11/23/15
            
            5,000,000
            
            3.933
            
            Multi-Call
            
            05/25/08
      and quarterly thereafter11/29/05
            
            11/29/13
            
            5,000,000
            
            4.320
            
            1
      Time Call
            
            05/29/0912/14/05
            
            12/14/11
            
            5,000,000
            
            4.640
            
            1
      Time Call
            
            09/14/0901/12/06
            
            01/12/16
            
            5,000,000
            
            4.450
            
            1
      Time Call
            
            01/12/1103/01/06
            
            03/03/14
            
            5,000,000
            
            4.720
            
            1
      Time Call
            
            03/03/1006/02/06
            
            06/02/16
            
            5,000,000
            
            5.160
            
            1
      Time Call
            
            06/02/1107/11/06
            
            07/11/16
            
            5,000,000
            
            4.800
            
            Multi-Call
            
            07/11/08
      and quarterly thereafter10/25/06
            
            10/25/11
            
            5,000,000
            
            4.830
            
            1
      Time Call
            
            10/27/0811/29/06
            
            11/29/16
            
            5,000,000
            
            4.025
            
            Multi-Call
            
            05/29/08
      and quarterly thereafter01/19/07
            
            07/21/14
            
            5,000,000
            
            4.885
            
            1
      Time Call
            
            07/21/1103/09/07
            
            03/09/12
            
            4,700,000
            
            4.286
            
            Multi-Call
            
            06/09/08
      and quarterly thereafter05/24/07
            
            05/24/17
            
            7,900,000
            
            4.375
            
            Multi-Call
            
            05/27/08
      and quarterly thereafter06/29/07
            
            06/29/12
            
            5,000,000
            
            4.945
            
            1
      Time Call
            
            06/29/0907/25/07
            
            07/25/17
            
            5,000,000
            
            4.396
            
            Multi-Call
            
            07/25/08
      and quarterly thereafter11/16/07
            
            11/16/11
            
            5,000,000
            
            3.745
            
            Multi-Call
            
            11/17/08
      and quarterly thereafter























20


Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





Other Borrowed Money–The
Company had $14.4 million and $12.8 million in other borrowings (non-FHLB
advances) at December 31, 2008 and March 31, 2008,
respectively.  These borrowings consist of short-term repurchase
agreements with certain commercial demand deposit customers for sweep accounts
and the current balance on a revolving line of credit with another financial
institution.





At
December 31, 2008 and March 31, 2008, short-term repurchase agreements were $9.6
million and $9.8 million, respectively. The repurchase agreements typically
mature within one to three days and the interest rate paid on these borrowings
floats monthly with money market type rates. At December 31, 2008 and March 31,
2008, the interest rate paid on the repurchase agreements was 1.34% and 3.01%,
respectively.  The Bank had pledged as collateral for these repurchase
agreements investment and mortgage-backed securities with amortized costs and
fair values of $24.9 million and $25.1 million, respectively at December 31,
2008.





At
December 31, 2008 and March 31, 2008, the balance on the line of credit was $4.8
million and $3.0 million, respectively. This $10.0 million unsecured line of
credit has an interest rate equal to one month LIBOR plus 2.0% and matures on
April 1, 2009.





Mandatorily Redeemable Financial
Instrument – On June 30, 2006, the Company recorded a $1.4 million
mandatorily redeemable financial instrument as a result of the acquisition of
the Collier-Jennings Companies. The shareholder of Collier-Jennings Companies
received cash and was issued stock in the Company to settle the
acquisition.  The Company will release the shares to the shareholder
of Collier-Jennings Companies over a three-year period.  The stock is
mandatorily redeemable at the option of the shareholder of Collier-Jennings
Companies in cumulative increments of 20% per year for a five-year period at the
greater of $26 per share or one and one-half times the book value per common
share of the Company’s stock.  As of December 31, 2008 the shareholder
had not elected to redeem any of the shares.





Junior Subordinated Debentures
– On September 21, 2006, Security Federal Statutory Trust (the “Trust”), a
wholly-owned subsidiary of the Company, issued and sold fixed and floating rate
capital securities of the Trust (the “Capital Securities”), which are reported
on the consolidated balance sheet as junior subordinated debentures, generating
proceeds of $5.0 million. The Trust loaned these proceeds to the Company to use
for general corporate purposes, primarily to provide capital to the
Bank.





The
Capital Securities accrue and pay distributions annually at a rate per annum
equal to a blended rate of 5.29% at December 31, 2008.  One-half of
the Capital Securities issued in the transaction have a fixed rate of 6.88% and
the remaining half has a floating rate of three-month LIBOR plus 170 basis
points, which was 3.70% at December 31, 2008. The distribution rate payable on
the Capital Securities is cumulative and payable quarterly in arrears. The
Company has the right, subject to events of default, to defer payments of
interest on the Capital Securities for a period not to exceed 20 consecutive
quarterly periods, provided that no extension period may extend beyond the
maturity date of December 15, 2036. The Company has no current intention to
exercise its right to defer payments of interest on the Capital
Securities.





The
Capital Securities mature or are mandatorily redeemable upon maturity on
December 15, 2036, and or upon earlier optional redemption as provided in the
indenture. The Company has the right to redeem the Capital Securities in whole
or in part, on or after


September
15, 2011. The Company may also redeem the capital securities prior to such dates
upon occurrence of specified conditions and the payment of a redemption
premium





Equity – Shareholders’ equity
increased $17.8 million or 37.4% to $65.2 million at December 31, 2008 from
$47.5 million at March 31, 2008 primarily as a result of the issuance of $18.0
million in senior preferred stock and warrants in conjunction with the
Treasury’s Capital Purchase Program. See the section below entitled “Recent
Developments” for more information concerning this transaction. Accumulated
other comprehensive income, net of tax, decreased $362,000 to $2.0 million at
December 31, 2008 from $2.4 million at March 31, 2008.  The Company’s
net income available to common shareholders for the nine-month period was $2.0
million.  During this nine month period, the Board of Directors of the
Company declared the 70th, 71st, and 72nd consecutive quarterly dividend, which
was $.08 per share, in April, August, and October 2008, which totaled
$601,000.  Book value per common share was $19.22 at December 31,
2008 compared to $18.76 at March 31, 2008.













21







Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





Non-performing
Assets.  The following table sets forth detailed information
concerning our non-performing assets for the periods indicated:





At
      December 31, 2008
            
            
            At
      March 31, 2008
            
            
            $
      Increase
            
            
            %
      IncreaseAmount
            
            
            Percent
      (1)
            
            
            Amount
            
            
            Percent
      (1)
            
            
            (Decrease)
            
            
            (Decrease)Loans
      90 days or more past due or non-accrual loans:1-4  family real
      estate
            
            $
            1,541,548
            
            
            
            0.3
            %
            
            $
            609,336
            
            
            
            0.1
            %
            
            $
            932,212
            
            
            
            153.0
            %Real estate
      construction
            
            
            2,774,781
            
            
            
            0.5
            
            
            
            −
            
            
            
            0.0
            
            
            
            2,774,781
            
            
            
            100.0Consumer
            
            
            940,167
            
            
            
            0.2
            
            
            
            415,796
            
            
            
            0.1
            
            
            
            524,371
            
            
            
            126.1Commercial business & real
      estate
            
            
            5,813,627
            
            
            
            1.0
            
            
            
            4,994,249
            
            
            
            0.9
            
            
            
            819,378
            
            
            
            16.4Total non-performing
      loans
            
            
            11,070,123
            
            
            
            1.8
            
            
            
            6,019,381
            
            
            
            1.1
            
            
            
            5,050,742
            
            
            
            83.9Other
      non-performing assetsRepossessed
    assets
            
            
            −
            
            
            
            −
            
            
            
            6,000
            
            
            
            0.0
            
            
            
            (6,000
            )
            
            
            (100.0
            )Real estate
    owned
            
            
            661,640
            
            
            
            0.1
            
            
            
            761,096
            
            
            
            0.1
            
            
            
            (99,456
            )
            
            
            (13.1
            )Total other non-performing
      assets
            
            
            661,640
            
            
            
            0.1
            
            
            
            767,096
            
            
            
            0.1
            
            
            
            (105,456
            )
            
            
            (13.7
            )Total
      non-performing assets
            
            $
            11,731,763
            
            
            
            1.9
            %
            
            $
            6,786,477
            
            
            
            1.3
            %
            
            $
            4,945,286
            
            
            
            72.9
            %Total
      non-performing assets as a percentage of total assets
            
            
            1.3
            %
            
            
            
            
            
            
            0.8
            %





(1)
Percent of gross loans receivable, net of deferred fees and loans in process and
loans held for sale





The
Company’s non-performing assets increased $4.9 million to $11.7 million at
December 31, 2008 from $6.8 million at March 31, 2008.  The increase
was primarily the result of cash flow problems experienced by six local
residential builders resulting in their inability to meet the debt service
requirements of their loans.  The Company also experienced a slight
increase in non-performing one- to four- family real estate loans as a result of
the general deteriorating conditions in the local economy including rising
unemployment rates and declining housing markets.





The
Company classified $2.8 million in real estate construction loans and $861,000
in commercial business and real estate loans associated with six local builders
as non-performing during the period. This amount was comprised of the
following:  $719,000 relates to a commercial building and related
equipment in Chapin, South Carolina along with $318,000 related to two developed
one- to four -family homes occupied by renters also in the Midlands area of
South Carolina,  $183,000 is a developed one-to four-family
residential lot in North Augusta, South Carolina, and the remaining $2.4 million
relates to seven one- to four-family residential houses in varying stages of
completion (i.e., developed lots to completed homes) located in North Augusta,
Columbia and Lexington, South Carolina and Evans, Georgia.





The
cumulative interest not accrued during the quarter relating to all
non-performing loans totaled $184,000, while the total for the nine months ended
December 31, 2008 was $437,000. We intend to work with our builders and other
borrowers to reach acceptable payment plans while protecting our interests in
the existing collateral.  In the event an acceptable arrangement
cannot be reached, we may have to acquire these properties through foreclosure
or other means and subsequently sell, develop, or liquidate them.




























Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





Recent
Developments





On
December 19, 2008, as part of the Troubled Asset Relief Capital Purchase Program
of the U.S. Department of the Treasury (“Treasury”), the Company sold to
Treasury 18,000 shares of Cumulative Perpetual Preferred Stock, Series A and a
warrant to purchase 137,966 shares of the Company’s common stock, par value
$0.01 per share, for an aggregate purchase price of $18.0 million in cash to the
Treasury.  The Company allocated $17.6 million of the total purchase
price to preferred stock and the remaining $400,000 to the warrant based on the
relative fair values of each.





The
preferred stock requires cumulative dividends at a rate of 5% per annum for the
first five years, and 9% per annum thereafter. The Company has the option to
redeem the preferred stock after three years. Prior to the end of three years,
the preferred stock may be redeemed only with proceeds from a qualifying equity
offering. The warrant has a 10-year term and is currently exercisable with an
exercise price equal to $19.57 per share of common stock. The Treasury has
agreed not to exercise voting power with respect to any shares of common stock
issued upon exercise of the warrant that it holds.





The
agreement also subjects the Company to certain executive compensation
limitations included in the EESA and restricts the Company from increasing
dividends from the last quarterly cash dividend per share ($0.08) declared on
its common stock prior to December 19, 2008. These restrictions will terminate
on the earlier of December 19, 2011 or the date on which the preferred stock is
redeemed in whole or transferred fully by the Treasury to a third
party.
















23


Security
Federal Corporation and Subsidiaries




Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





COMPARISON OF THE RESULTS OF
OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2008 AND
2007





Net Income -Net income
available to common shareholders decreased $578,000 or 55.6% to $462,000 for the
three months ended December 31, 2008 compared to $1.0 million for the three
months ended December 31, 2007. The decrease in net income was primarily the
result of a decrease in net interest margin, the Company’s decision to increase
the provision for loan losses as a result of the weakening economy and increases
in its nonperforming loans and an increase in general and administrative
expenses attributable to costs associated with the Company’s recent expansion
into two new market areas.





Net Interest Income -The
precipitous decline in interest rates in recent quarters in conjunction with the
Federal Reserve’s decision to lower interest rates during the current quarter,
continued to negatively impact the Bank’s net interest margin during the quarter
ended December 31, 2008. This significant decrease in addition to the Bank’s
efforts to maintain competitive deposit rates within its primary market area
resulted in a nine basis point decrease in net interest margin to 2.52% for the
quarter ended December 31, 2008 compared to 2.61% for the comparable period in
the previous year.





Despite
the compression in the Company’s margin, net interest income increased $513,000
or 10.3% to $5.5 million during the three months ended December 31, 2008,
compared to $5.0 million for the same period in 2007, as a result of a decrease
in interest expense offset in part by a decrease in interest income. During the
three months ended December 31, 2008, average interest earning assets increased
$107.6 million to $870.4 million while average interest-bearing liabilities
increased $108.6 million to $826.4 million.  The interest rate spread
remained constant at 2.36% during the three months ended December 31, 2008 and
2007, respectively.





Interest Income -Total
interest income decreased $483,000 or 3.8% to $12.3 million during the three
months ended December 31, 2008 from $12.7 million for the same period in
2007.  Total interest income on loans decreased $417,000 or 4.4% to
$9.0 million during the three months ended December 31, 2008 compared to $9.4
million for the same period in 2007 as a result of the yield on the loan
portfolio decreasing 150 basis points offset in part by the average loan
portfolio balance increasing $94.8 million.  Interest income from
mortgage-backed securities increased $622,000 or 32.1% to $2.6 million as a
result of an increase in the average balance of the portfolio offset slightly by
a decrease in the yield.  Interest income from investment securities
decreased $671,000 or 49.1% to $695,000 as a result of a decrease in the average
balance and yield of the investments portfolio.





The
following table compares detailed average balances, associated yields, and the
resulting changes in interest income for the three months ended December 31,
2008 and 2007:





Three
      Months Ended December 31,2008
            
            
            2007Average
      Balance
            
            
            Yield
            
            
            Average
      Balance
            
            
            Yield
            
            
            Increase
      (Decrease) In Interest And Dividend Income From 2007Loans
      Receivable, Net
            
            $
            590,171,933
            
            
            
            6.10
            %
            
            $
            495,376,936
            
            
            
            7.60
            %
            
            $
            (417,147
            )Mortgage-Backed
      Securities
            
            
            212,464,776
            
            
            
            4.82
            
            
            
            140,981,296
            
            
            
            5.50
            
            
            
            621,596Investments
            
            
            64,393,513
            
            
            
            4.31
            
            
            
            124,623,250
            
            
            
            4.38
            
            
            
            (671,072
            )Overnight
      Time
            
            
            3,352,759
            
            
            
            0.09
            
            
            
            1,845,087
            
            
            
            3.75
            
            
            
            (16,548
            )Total
      Interest-Earning Assets
            
            $
            870,382,981
            
            
            
            5.63
            %
            
            $
            762,826,569
            
            
            
            6.68
            %
            
            $
            (483,171
            )





Interest Expense - Total
interest expense decreased $996,000 or 12.8% to $6.8 million during the three
months ended December 31, 2008 compared to $7.8 million for the same period
one-year earlier. The decrease in total interest expense was attributable to
decreases in interest rates paid offset partially by an increase in the average
balances of interest-bearing liabilities.





Interest
expense on deposits decreased $907,000 or 16.3% to $4.7 million during the three
months ended December 31, 2008 compared to $5.6 million for the same period
one-year earlier. The decrease was attributable to a 99 basis point decrease in
the cost of deposits offset by an increase in the average interest bearing
deposits of $49.7 million when compared to the cost and average balance in the
three months ended December 31, 2007. Interest expense on advances and other
borrowings decreased $70,000 or 3.4% as a result of the cost of borrowings
decreasing 122 basis points and average total borrowings outstanding increasing
$58.9 million to $243.7 million during the 2008 period compared to $184.8
million during 2007.








24




Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





Interest
expense on junior subordinated debentures was $74,000 for the three months ended
December 31, 2008 compared to $93,000 for the same period one year ago.





The
following table compares detailed average balances, cost of funds, and the
resulting changes in interest expense for the three months ended December 31,
2008 and 2007:





Three
      Months Ended December 31,2008
            
            
            2007Average
              Balance
            
            
            Yield
            
            
            Average
              Balance
            
            
            Yield
            
            
            Decrease
      In Interest Expense From 2007Now
      And Money MarketAccounts
            
            $
            202,314,408
            
            
            
            2.21
            %
            
            $
            203,523,577
            
            
            
            3.15
            %
            
            $
            (488,101
            )Passbook
      Accounts
            
            
            15,660,153
            
            
            
            0.69
            
            
            
            15,671,523
            
            
            
            0.98
            
            
            
            (11,553
            )Certificate
      Accounts
            
            
            359,534,279
            
            
            
            3.92
            
            
            
            308,615,496
            
            
            
            5.09
            
            
            
            (407,252
            )FHLB
      Advances And OtherBorrowed
      Money
            
            
            243,724,712
            
            
            
            3.32
            
            
            
            184,848,789
            
            
            
            4.54
            
            
            
            (70,272
            )Junior
      SubordinatedDebentures
            
            
            5,155,000
            
            
            
            5.75
            
            
            
            5,155,000
            
            
            
            7.24
            
            
            
            (19,127
            )Total
      Interest-BearingLiabilities
            
            $
            826,388,552
            
            
            
            3.27
            %
            
            $
            717,814,385
            
            
            
            4.32
            %
            
            $
            (996,305
            )





Provision for Loan Losses -The amount of the provision is determined by management’s on-going
monthly analysis of the loan portfolio.  Management uses multiple
methods to measure the estimate of the adequacy of the allowance for loan
losses.  These methods incorporate percentage of classified loans,
five-year averages of historical loan losses in each loan category and current
economic trends, and the assignment of percentage targets of reserves in each
loan category.  The Company also considers subjective factors such as
changes in local and national economic conditions, industry trends, the
composition and volume of the loan portfolio, credit concentrations, lending
policies, and the experience and ability of the staff and Board of
Directors.





Conditions
in the local and national economy continued to deteriorate during the quarter
ended December 31, 2008 as a result of the recession. Rising unemployment rates
and further decline in the housing market negatively impacted borrowers’ ability
to repay their loan obligations. The Bank’s provision for loan losses was
$525,000 and $150,000 during the three months ended December 31, 2008 and 2007,
respectively. The $375,000 increase reflects the Company’s concern for
deteriorating economic conditions in the local economy coupled with an increase
in non-performing assets within its loan portfolio.





The
following table details selected activity associated with the allowance for loan
losses for the three months ended December 31, 2008 and 2007:





December
      31, 2008
            
            December
      31, 2007Beginning
      Balance
            $
            8,263,335
            $
            7,564,211Provision
            
            525,000
            
            150,000Charge-offs
            
            (132,819)
            
            (144,482)Recoveries
            
            18,011
            
            78,647Ending
      Balance
            $
            8,673,527
            $
            7,648,376Allowance
      For Loan Losses As A Percentage Of Gross Loans Receivable
              And
      Loans Held For Sale At The End Of The Period
            
            1.43%
            
            1.51%Allowance
      For Loan Losses As A Percentage Of Impaired Loans At
              The
      End Of The Period
            
            73.20%
            
            557.82%Impaired
      Loans
            
            11,849,874
            
            1,371,125Non-accrual
      Loans And 90 Days Or More Past Due Loans As A
              Percentage
      Of Gross Loans Receivable And Loans Held For Sale At The
              End
      Of The Period
            
            1.83%
            
            0.73%Loans
      Receivable, Net
            $
            597,321,830
            $
            500,091,429








25






Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





Non-performing
assets, which consisted of 70 non-accrual loans and nine repossessed properties,
increased $4.9 million to $11.7 million at December 31, 2008 from $6.8 million
at March 31, 2008. Despite this increase, non-performing assets comprised less
than 2% of gross loans at December 31, 2008 and March 31, 2008, respectively.
The Bank also maintained relatively low and stable trends related to net
charge-offs. Annualized net charge-offs as a percent of gross loans were 0.08%
for the three months ended December 31, 2008 compared to 0.02% for the year
ended March 31, 2008 and 0.05% for the three months ended December 31, 2007.
Management of the Bank continues to be concerned about current market conditions
and closely monitors the loan portfolio on an ongoing basis to proactively
identify any potential issues.





Non-accrual
loans and loans 90 days or more past due increased $5.1 million to $11.1 million
at December 31, 2008 when compared to $6.0 million at March 31, 2008. The
increase was primarily attributable to a slowing down of the residential real
estate market and the overall deterioration of economic conditions in the
Company’s market area. The Company does not have a sub-prime lending program
therefore this increase was not a direct result of the sub-prime lending
crisis.





Non-Interest Income -Non-interest income remained relatively stable at $1.0 million for the
three months ended December 31, 2008 and 2007.  The following table
provides a detailed analysis of the changes in the components of non-interest
income:





Three
      Months Ended December 31,
            
            
            Increase
      (Decrease)2008
            
            
            2007
            
            
            Amounts
            
            
            PercentGain
      On Sale Of Loans
            
            $
            107,726
            
            
            $
            134,732
            
            
            $
            (27,005
            )
            
            
            (20.04
            )%Service
      Fees On Deposit Accounts
            
            
            293,327
            
            
            
            307,045
            
            
            
            (13,719
            )
            
            
            (4.47
            )Income
      From Cash Value OfLife
      Insurance
            
            
            90,000
            
            
            
            92,246
            
            
            
            (2,246
            )
            
            
            (2.43
            )Commissions
      On Insurance
            
            
            141,771
            
            
            
            145,148
            
            
            
            (3,378
            )
            
            
            (2.33
            )Other
      Agency Income
            
            
            85,633
            
            
            
            19,670
            
            
            
            65,963
            
            
            
            335.34Trust
      Income
            
            
            105,000
            
            
            
            102,000
            
            
            
            3,000
            
            
            
            2.94Other
            
            
            196,893
            
            
            
            227,250
            
            
            
            (30,356
            )
            
            
            (13.36
            )Total
      Non-Interest Income
            
            $
            1,020,350
            
            
            $
            1,028,091
            
            
            $
            (7,741
            )
            
            
            (0.75
            )%





Gain on
sale of loans decreased $27,000 or 20.0% to $108,000 for the three months ended
December 31, 2008 when compared to the same period one year ago. Service fees on
deposit accounts decreased $14,000 or 4.5% to $293,000 for the three months
ended December 31, 2008 compared to $307,000 for the same three month period
one-year earlier. This decrease can be attributable to decreases in the average
balance in now and money market accounts and passbook accounts during the period
offset slightly by an increase in the number of accounts.





Income
from the cash value of life insurance was $90,000 for the three months ended
December 31, 2008 compared to $92,000 during the same period one year ago. This
decrease was the result of a decrease in the cash surrender value offset by an
increase in the balance of bank owned life insurance as a result of the
Company’s purchase of additional insurance for certain officers of the Company
during the period.





Commissions
from insurance and other agency income increased $63,000 to $227,000 during the
quarter ended December 31, 2008 when compared to the same quarter one year ago.
The increase can be attributed primarily to the growth and expansion of the
Bank’s insurance subsidiary. Trust income increased $3,000 to $105,000 during
the period compared to $102,000 for the same period one year ago.





Other
miscellaneous income including credit life insurance commissions, safe deposit
rental income, annuity and stock brokerage commissions, and other miscellaneous
fees, decreased $30,000 to $197,000 during the three months ended December 31,
2008 compared to $227,000 during the same period one year ago.











26










Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





General And Administrative
Expenses – General and administrative expenses increased $917,000 or
21.2% to $5.2 million for the three months ended December 31, 2008 from $4.3
million for the same period one year ago.  The following table
provides a detailed analysis of the changes in the components of general and
administrative expenses:





Three
      Months Ended December 31,
            
            
            Increase2008
            
            
            2007
            
            
            Amounts
            
            
            PercentSalaries
      And Employee Benefits
            
            $
            2,949,973
            
            
            $
            2,660,655
            
            
            $
            289,319
            
            
            
            10.87
            %Occupancy
            
            
            500,193
            
            
            
            425,489
            
            
            
            74,703
            
            
            
            17.56Advertising
            
            
            155,088
            
            
            
            80,857
            
            
            
            74,231
            
            
            
            91.80Depreciation
      And MaintenanceOf
      Equipment
            
            
            380,470
            
            
            
            333,985
            
            
            
            46,485
            
            
            
            13.92FDIC
      Insurance Premiums
            
            
            201,882
            
            
            
            15,402
            
            
            
            186,480
            
            
            
            1,210.78Amortization
      of Intangibles
            
            
            22,500
            
            
            
            22,500
            
            
            
            −
            
            
            
            −Mandatorily
      Redeemable FinancialInstrument
      Valuation Expense
            
            
            45,000
            
            
            
            −
            
            
            
            45,000
            
            
            
            100.00Other
            
            
            989,397
            
            
            
            789,044
            
            
            
            200,353
            
            
            
            25.39Total
      General And AdministrativeExpenses
            
            $
            5,244,503
            
            
            $
            4,327,932
            
            
            $
            916,571
            
            
            
            21.18
            %





Salary
and employee benefits increased $289,000 to $2.9 million for the three months
ended December 31, 2008 from $2.7 million for the same period one year
ago.  Occupancy increased $75,000 or 17.6% to $500,000 for the three
months ended December 31, 2008 when compared to $425,000 for the same period a
year ago. The majority of the increases in salary and employee benefits and
occupancy are the result of hiring additional staff to handle the Company’s
growth including expansion into the two new market areas of Richland County,
South Carolina and Columbia County, Georgia.





Advertising
expense increased $74,000 to $155,000 for the three months ended December 31,
2008 from $81,000 for the same period one year ago. The increase was
attributable to the Company using more print media advertising to attract
deposits within its new market areas and to promote the insurance
subsidiary.  Depreciation and maintenance of equipment increased to
$380,000 for the three months ended December 31, 2008 from $334,000 for the same
period one-year prior.





FDIC
insurance premiums increased $186,000 or 1,210.8% to $202,000 for the three
month period ended December 31, 2008 when compared to the same period a year
ago. Previously, the Bank was benefiting from a one-time credit assessment made
available by the Federal Deposit Insurance Reform Act of 2005. The credit
assessment amount was applied to reduce the Bank’s quarterly deposit insurance
assessments, which was exhausted during the quarter ended June 30,
2008.





Mandatorily
redeemable financial instrument valuation expense was $45,000 for the three
months ended December 31, 2008 compared to no expense for the same period one
year earlier. Based on its terms, the mandatorily redeemable financial
instrument is redeemable at the greater of $26 per share or one and a half times
the book value per common share of the Company which equaled $28.83 at December
31, 2008. The Company recorded a valuation expense to properly reflect the fair
value of the instrument at December 31, 2008 based on the book
value.





Other
general and administrative expenses increased $200,000 or 25.4% to $989,000 when
compared to $789,000 for the same period one year ago.





Provision For Income Taxes –Provision for income taxes decreased $235,000 or 48.2% to $253,000 for
the three months ended December 31, 2008 from $488,000 for the same period one
year ago as a result of reduced taxable income.  Income before income
taxes was $742,000 and $1.5 million, respectively for the three months ended
December 31, 2008 and 2007. The Company’s combined federal and state effective
income tax rate for the current quarter was 34.1% compared to 31.9% for the same
quarter one year ago.














27







Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





COMPARISON OF THE RESULTS OF
OPERATIONS FOR THE NINE MONTHS ENDED DECEMBER 31, 2008 AND
2007





Net Income -Net income
available to common shareholders decreased $1.2 million or 37.2% to $2.0 million
for the nine months ended December 31, 2008 compared to $3.3 million for the
nine months ended December 31, 2007.  The decrease in net income was
primarily the result of compression of the net interest margin in conjunction
with the Company’s decision to increase the provision for loan losses as a
result of the weakening economy and increases in non-performing assets and an
increase in general and administrative expenses attributable to costs associated
with the Company’s recent expansion into two new market areas.  These
factors were offset slightly by an increase in non-interest income.





Net Interest Income -The
Federal Reserve’s precipitous decline in interest rates in recent quarters
continued to negatively impact the Bank’s interest rate margin during the period
ended December 31, 2008. This significant decrease in addition to the Bank’s
efforts to maintain competitive deposit rates within its primary market area
resulted in a 17 basis point decrease in net interest margin to 2.56% for the
nine months ended December 31, 2008 compared to 2.73% for the comparable period
in the previous year.




Despite
the compression in the Company’s margin, net interest income increased $963,000
or 6.4% to $16.1 million during the nine months ended December 31, 2008,
compared to $15.1 million for the same period in 2007. The increase was a result
of a decrease in interest expense offset in part by a decrease in interest
income.  Average interest earning assets increased $99.2 million to
$836.6 million while average interest-bearing liabilities increased $102.6
million to $794.1 million.  The interest rate spread was 2.39% and
2.47% during the nine months ended December 31, 2008 and 2007,
respectively.




Interest Income -Total
interest income decreased $861,000 or 2.3% to $36.4 million during the nine
months ended December 31, 2008 from $37.3 million for the same period in
2007.  Total interest income on loans decreased $1.1 million or 4.1%
to $26.5 million during the nine months ended December 31, 2008, compared to
$27.6 million for the same period in 2007. The decrease was a result of the
yield in the loan portfolio decreasing 147 basis points offset in part by the
average loan portfolio balance increasing $85.7 million.





Interest
income from mortgage-backed securities increased $2.5 million or 50.4% to $7.6
million as a result of an increase in the average balance of the portfolio of
$73.0 million, despite a decrease in the yield of the mortgage-backed securities
portfolio.  Interest income from investment securities decreased $2.2
million or 48.5% to $2.4 million as a result of a decrease in the yield and
average balance of the investment securities portfolio.





The
following table compares detailed average balances, associated yields, and the
resulting changes in interest income for the nine months ended December 31, 2008
and 2007:





Nine
      Months Ended December 31,2008
            
            
            2007Average
              Balance
            
            
            Yield
            
            
            Average
              Balance
            
            
            Yield
            
            
            Increase
      (Decrease) In Interest And Dividend Income From 2007Loans
      Receivable, Net
            
            $
            558,021,225
            
            
            
            6.33
            %
            
            $
            472,350,077
            
            
            
            7.80
            %
            
            $
            (1,142,066
            )Mortgage-Backed
      Securities
            
            
            209,265,802
            
            
            
            4.83
            
            
            
            136,239,152
            
            
            
            4.93
            
            
            
            2,538,671Investments
            
            
            67,408,412
            
            
            
            4.67
            
            
            
            127,408,732
            
            
            
            4.80
            
            
            
            (2,221,839
            )Overnight
      Time
            
            
            1,931,124
            
            
            
            0.68
            
            
            
            1,435,612
            
            
            
            4.20
            
            
            
            (35,173
            )Total
      Interest-Earning Assets
            
            $
            836,626,563
            
            
            
            5.81
            %
            
            $
            737,433,573
            
            
            
            6.74
            %
            
            $
            (860,607
            )





Interest Expense - Total
interest expense decreased $1.8 million or 8.2% to $20.4 million during the nine
months ended December 31, 2008 compared to $22.2 million for the same period one
year earlier.  The decrease in total interest expense was attributable
to the decreases in short-term interest rates paid despite an increase in the
total amount of interest-bearing deposits and borrowings. Interest expense on
deposits decreased $2.0 million or 12.6% during the period as average interest
bearing deposits grew $51.5 million compared to the average balance in the nine
months ended December 31, 2007 while the cost of interest bearing deposits
decreased 86 basis points.








28





Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





Interest
expense on advances and other borrowings increased $230,000 or 3.8% despite the
cost of borrowings decreasing 86 basis points because average total borrowings
outstanding increased approximately $51.1 million to $230.6 million during the
nine months ended December 31, 2008 compared to the same period in
2007.





Interest
expense on junior subordinated debentures was $223,000 for the nine months ended
December 31, 2008 compared to $276,000 for the same period one year
ago.





The
following table compares detailed average balances, cost of funds, and the
resulting changes in interest expense for the nine months ended December 31,
2008 and 2007:


Nine
      Months Ended December 31,2008
            
            
            2007Average
      Balance
            
            
            Yield
            
            
            Average
      Balance
            
            
            Yield
            
            
            Increase
      (Decrease) In Interest Expense From 2007Now
      And Money MarketAccounts
            
            $
            202,900,887
            
            
            
            1.98
            %
            
            $
            205,550,000
            
            
            
            3.20
            %
            
            $
            (1,925,040
            )Passbook
      Accounts
            
            
            16,106,786
            
            
            
            0.75
            
            
            
            16,479,117
            
            
            
            0.98
            
            
            
            (30,940
            )Certificate
      Accounts
            
            
            339,425,711
            
            
            
            4.22
            
            
            
            284,859,916
            
            
            
            5.05
            
            
            
            (44,705
            )FHLB
      Advances And OtherBorrowed
      Money
            
            
            230,557,226
            
            
            
            3.63
            
            
            
            179,454,602
            
            
            
            4.49
            
            
            
            230,188Junior
      SubordinatedDebentures
            
            
            5,155,000
            
            
            
            5.77
            
            
            
            5,155,000
            
            
            
            7.15
            
            
            
            (53,233
            )Total
      Interest-BearingLiabilities
            
            $
            794,145,610
            
            
            
            3.42
            %
            
            $
            691,498,635
            
            
            
            4.28
            %
            
            $
            (1,823,730
            )





Provision for Loan Losses -Problems associated with deteriorating asset quality, the sub prime
lending and credit crisis, and the overall volatility in the financial markets
continued to plague the banking industry during the period. Although the Company
did not participate in sub prime lending, it was indirectly impacted by these
events and the general condition of the national and local
economies.  The provision for loan losses was $1.0 million for the
nine months ended December 31, 2008 compared to $450,000 for the same period in
the prior year. This increase reflects the Company’s concern for deteriorating
economic conditions in the local economy coupled with an increase in
non-performing assets within its loan portfolio.





The
following table details selected activity associated with the allowance for loan
losses for the nine months ended December 31, 2008 and 2007.





December
      31, 2008
            
            December
      31, 2007Beginning
      Balance
            $
            8,066,762
            $
            7,296,791Provision
            
            1,025,000
            
            450,000Charge-offs
            
            (444,409)
            
            (212,893)Recoveries
            
            26,174
            
            114,478Ending
      Balance
            $
            8,673,527
            $
            7,648,376Allowance
      For Loan Losses As A Percentage Of Gross Loans Receivable
              And
      Loans Held For Sale At The End Of The Period
            
            1.43%
            
            1.51%Allowance
      For Loan Losses As A Percentage Of Impaired Loans At The
              End
      Of The Period
            
            73.20%
            
            557.82%Impaired
      Loans
            
            11,849,874
            
            1,371,125Nonaccrual
      Loans And 90 Days Or More Past Due Loans As A
              Percentage
      Of  Gross Loans Receivable And Loans Held For Sale At The End Of
      The Period
            
            1.83%
            
            0.73%Loans
      Receivable, Net
            $
            597,321,830
            $
            500,091,429









29








Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





Non-Interest Income -Non-interest income increased $64,000 or 2.0% to $3.2 million for the
nine months ended December 31, 2008 from $3.1 million for the same period one
year ago.  The following table provides a detailed analysis of the
changes in the components of non-interest income:





Nine
      Months Ended December 31,
            
            
            Increase
      (Decrease)2008
            
            
            2007
            
            
            Amounts
            
            
            PercentGain
      On Sale Of Investments
            
            $
            126,440
            
            
            $
            −
            
            
            $
            126,440
            
            
            
            100.00
            %Gain
      On Sale Of Loans
            
            
            335,444
            
            
            
            416,303
            
            
            
            (80,858
            )
            
            
            (19.42
            )Service
      Fees On Deposit Accounts
            
            
            850,720
            
            
            
            957,790
            
            
            
            (107,071
            )
            
            
            (11.18
            )Income
      From Cash Value OfLife
      Insurance
            
            
            268,492
            
            
            
            241,447
            
            
            
            27,045
            
            
            
            11.20Commissions
      From Insurance Agency
            
            
            474,901
            
            
            
            464,309
            
            
            
            10,591
            
            
            
            2.28Other
      Agency Income
            
            
            208,651
            
            
            
            75,838
            
            
            
            132,813
            
            
            
            175.13Trust
      Income
            
            
            315,000
            
            
            
            340,625
            
            
            
            (25,625
            )
            
            
            (7.52
            )Other
            
            
            622,512
            
            
            
            641,747
            
            
            
            (19,234
            )
            
            
            (3.00
            )Total
      Non-Interest Income
            
            $
            3,202,160
            
            
            $
            3,138,059
            
            
            $
            64,101
            
            
            
            2.04
            %





Gain on
sale of investments was $126,000 for the nine months ended December 31, 2008
compared to no gain in the comparable period in the prior year as a result of
the sale of 11 securities. Gain on sale of loans decreased $81,000 or 19.4% to
$335,000 for the nine month period ended December 31, 2008 compared to $416,000
for the same period one year ago.





Service
fees on deposit accounts decreased $107,000 to $851,000 for the nine months
ended December 31, 2008 from $958,000 for the comparable period in the prior
year. This decrease can be attributable to a decrease in the average balance in
now and money market accounts and passbook accounts of $3.0 million during the
nine month period when compared to the same period in the prior year offset
slightly by an increase in the number of accounts for the same
period.





Income
from cash value of life insurance increased $27,000 to $268,000 for the nine
months ended December 31, 2008 from $241,000 during the same period one year
ago.  This increase was the result of the Company purchasing bank
owned life insurance for certain officers of the Company offset slightly by
decreases in the cash surrender value.





Trust
income decreased $26,000 to $315,000 during the nine months ended December 31,
2008 compared to $341,000 for the same period in the prior year as a result of a
decrease in market values of the underlying trust accounts. The Bank earns trust
fees as a percentage of the market value of each trust account.





Commissions
from insurance and other agency income increased $143,000 to $684,000 during the
nine months ended December 31, 2008 compared to $540,000 during the same period
one year ago.  This increase was attributable to growth and expansion
of the Bank’s insurance subsidiary. Other miscellaneous income including credit
life insurance commissions, safe deposit rental income, annuity and stock
brokerage commissions, and other miscellaneous fees, decreased $19,000 to
$623,000 during the nine months ended December 31, 2008 compared to $642,000
during the same period one year ago.









































30











Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





General And Administrative
Expenses – General and administrative expenses increased $2.2 million or
16.8% to $15.1 million for the nine months ended December 31, 2008 from $13.0
million for the same period one year ago.  The following table
provides a detailed analysis of the changes in the components of general and
administrative expenses:





Nine
      Months Ended December 31,
            
            
            Increase2008
            
            
            2007
            
            
            Amounts
            
            
            PercentSalaries
      And Employee Benefits
            
            $
            8,565,480
            
            
            $
            7,858,206
            
            
            $
            707,275
            
            
            
            9.00
            %Occupancy
            
            
            1,490,879
            
            
            
            1,293,602
            
            
            
            197,276
            
            
            
            15.25Advertising
            
            
            402,765
            
            
            
            270,278
            
            
            
            132,487
            
            
            
            49.02Depreciation
      And MaintenanceOf
      Equipment
            
            
            1,222,304
            
            
            
            990,601
            
            
            
            231,703
            
            
            
            23.39FDIC
      Insurance Premiums
            
            
            549,227
            
            
            
            45,599
            
            
            
            503,628
            
            
            
            1,104.48Amortization
      of Intangibles
            
            
            67,500
            
            
            
            67,500
            
            
            
            −
            
            
            
            −Mandatorily
      Redeemable FinancialInstrument
      Valuation Expense
            
            
            105,000
            
            
            
            −
            
            
            
            105,000
            
            
            
            100.00Other
            
            
            2,738,726
            
            
            
            2,434,592
            
            
            
            304,134
            
            
            
            12.49Total
      General And AdministrativeExpenses
            
            $
            15,141,881
            
            
            $
            12,960,378
            
            
            $
            2,181,503
            
            
            
            16.83
            %





Salary
and employee benefits increased $707,000 to $8.6 million for the nine months
ended December 31, 2008 from $7.9 million for the same period one year
ago.  Occupancy increased $197,000 or 15.3% to $1.5 million for the
nine month period ended December 31, 2008 when compared to $1.3 million for the
same period one year ago. The majority of the increases in salary and employee
benefits and occupancy are the result of hiring additional staff in connection
with the Company’s expansion into the two new market areas of Richland County,
South Carolina and Columbia County, Georgia. Depreciation and maintenance
expense increased $232,000 or 23.4% to $1.2 million for the nine months ended
December 31, 2008 from $991,000 for the same period one year ago primarily as a
result of the Company’s recent expansion and additional locations.





Advertising
expense increased $132,000 to $403,000 for the nine months ended December 31,
2008 from $270,000 for the same period one year ago.  The increase was
attributable to the Company using more print media advertising to attract
deposits specifically in its new market areas and to promote the Bank’s
insurance subsidiary. FDIC insurance premiums increased $504,000 or 1,104.5% to
$549,000 for the nine month period ended December 31, 2008 when compared to the
same period a year ago. Previously, the Bank was benefiting from a one-time
credit assessment made available by the Federal Deposit Insurance Reform Act of
2005. The credit assessment amount was applied to reduce the Bank’s quarterly
deposit insurance assessments, which was exhausted during the quarter ended June
30, 2008.





Mandatorily
redeemable financial instrument valuation expense was $105,000 for the nine
months ended December 31, 2008 compared to no expense for the same period one
year earlier. Based on its terms, the mandatorily redeemable financial
instrument is redeemable at the greater of $26 per share or one and a half times
the book value per common share of the Company which equated to $28.83 at
December 31, 2008. The Company recorded a valuation expense to properly reflect
the fair value of the instrument at December 31, 2008 based on the book
value.





Provision For Income Taxes –Provision for income taxes decreased $541,000 or 34.3% to $1.0 million
for the nine months ended December 31, 2008 compared to $1.6 million for the
nine months ended December 31, 2007 as a result of reduced taxable
income.





Income
before income taxes was $3.1 million for the nine months ended December 31, 2008
compared to $4.8 million for the nine months ended December 31,
2007.  The Company’s combined federal and state effective income tax
rate for the nine months ended December 31, 2008 was 33.3% compared to 32.6% for
the same period one year ago.
































Security
Federal Corporation and Subsidiaries


Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations, Continued





Liquidity
Commitments, Capital Resources, and Impact of Inflation and Changing
Prices





Liquidity –The Company
actively analyzes and manages the Bank’s liquidity with the objective of
maintaining an adequate level of liquidity and to ensure the availability of
sufficient cash flows to support loan growth, fund deposit withdrawals, fund
operations, and satisfy other financial commitments.  See the
“Consolidated Statements of Cash Flows” contained in Item 1 – Financial
Statements, herein.





The
primary sources of funds are customer deposits, loan repayments, loan sales,
maturing investment securities, and advances from the FHLB.  The
sources of funds, together with retained earnings and equity, are used to make
loans, acquire investment securities and other assets, and fund continuing
operations.  While maturities and the scheduled amortization of loans
are a predictable source of funds, deposit flows and mortgage repayments are
greatly influenced by the level of interest rates, economic conditions, and
competition.  Management believes that the Company’s current liquidity
position and its forecasted operating results are sufficient to fund all of its
existing commitments.





During
the nine months ended December 31, 2008 loan disbursements exceeded loan
repayments resulting in a $79.4 million or 15.3% increase in total net loans
receivable.  During the nine months ended December 31, 2008, deposits
increased $29.8 million, the Company drew $1.8 million on a line of credit with
another financial institution and FHLB advances increased $45.5 million. The
Company also received $18.0 million through the issuance of preferred stock
through the Treasury’s Capital Purchase Program. The Bank had $44.4 million in
additional borrowing capacity at the FHLB and $5.2 million remaining on the line
of credit at the end of the period.  At December 31, 2008, the Bank
had $321.9 million of certificates of deposit maturing within one
year.  Based on previous experience, the Bank anticipates a
significant portion of these certificates will be renewed.





Off-Balance Sheet Commitments
– The Company is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
customers.  These financial instruments generally include commitments
to originate mortgage, commercial and consumer loans, and involve to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized in the balance sheet.  The Company’s maximum exposure to
credit loss in the event of nonperformance by the borrower is represented by the
contractual amount of those instruments.  Since some commitments may
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.  The Company uses the same credit
policies in making commitments as it does for on-balance sheet
instruments.  Collateral is not required to support
commitments.





The
following table sets forth the length of time until maturity for unused
commitments to extend credit and standby letters of credit at December 31,
2008.





(Dollars
      in thousands)
            
            Within
              One
              Month
            
            
            After
      One
              Through
              Three
              Months
            
            
            After
              Three
              Through
              Twelve
              Months
            
            
            Within
              One
      Year
            
            
            Greater
              Than
              One
              Year
            
            
            TotalUnused
      lines of credit
            
            $
            1,502
            
            
            $
            3,483
            
            
            $
            35,505
            
            
            $
            40,490
            
            
            $
            38,222
            
            
            $
            78,712Standby
      letters of credit
            
            
            41
            
            
            
            122
            
            
            
            643
            
            
            
            806
            
            
            
            −
            
            
            
            806Total
            
            $
            1,543
            
            
            $
            3,605
            
            
            $
            36,148
            
            
            $
            41,296
            
            
            $
            38,222
            
            
            $
            79,518

















32










Security
Federal Corporation and Subsidiaries





Item
3. Quantitative and Qualitative Disclosures about Market Risk





Market
risk is the risk of loss from adverse changes in market prices and
rates.  The Company’s market risk arises principally from interest
rate risk inherent in its lending, investment, deposit and borrowing
activities.  Management actively monitors and manages its interest
rate risk exposure.  Although the Company manages other risks such as
credit quality and liquidity risk in the normal course of business, management
considers interest rate risk to be its most significant market risk that could
potentially have the largest material effect on the Company’s financial
condition and results of operations.  Other types of market risks such
as foreign currency exchange rate risk and commodity price do not arise in the
normal course of the Company’s business activities.





The
Company’sprofitability is
affected by fluctuations in the market interest rate.  Management’s
goal is to maintain a reasonable balance between exposure to interest rate
fluctuations and earnings.  A sudden and substantial increase or
decrease in interest rates may adversely impact the Company’s earnings to the
extent that the interest rates on interest-earning assets and interest-bearing
liabilities do not change at the same rate, to the same extent or on the same
basis.  The Company monitors the impact of changes in interest rates
on its net interest income using a test that measures the impact on net interest
income and net portfolio value of an immediate change in interest rates in 100
basis point increments and by measuring the Bank’s interest sensitivity gap
(“Gap”).  Net portfolio value is defined as the net present value of
assets, liabilities, and off-balance sheet contracts.  Gap is the
amount of interest sensitive assets repricing or maturing over the next twelve
months compared to the amount of interest sensitive liabilities maturing or
repricing in the same time period.  Recent net portfolio value reports
furnished by the OTS indicate that the Bank’s interest rate risk sensitivity has
increased slightly over the past year.  When interest rates rise 100,
200, or 300 basis points, our net interest income and net portfolio value
decreases because the rate we earn on our interest-earning assets does not
increase as rapidly as the rates we would pay on our interest-bearing
liabilities.





For the
nine months ended December 31, 2008, the Bank's interest rate spread, defined as
the average yield on interest bearing assets less the average rate paid on
interest bearing liabilities was 2.39%.  For the year ended March 31,
2008, the interest rate spread was 2.44%.  The Federal Reserve’s
recent interest rate decreases resulted in lower yields on adjustable rate
assets while intense competition in the marketplace continued to affect the
interest rates paid on deposits. In addition, the Bank’s liabilities tend to
re-price at a more gradual rate than its assets.





Item
4. Controls and Procedures





(a)
Evaluation of Disclosure Controls and Procedures: An evaluation of the Company’s
disclosure controls and procedures (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934 (the “Act”)) was carried out as of December 31,
2008 under the supervision and with the participation of the Company’s Chief
Executive Officer, Chief Financial Officer and several other members of the
Company’s senior management.  In designing and evaluating our
disclosure controls and procedures, management recognized that disclosure
controls and procedures, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the disclosure
controls and procedures are met.  Our disclosure controls and procedures
have been designed to meet, and management believes that they meet, reasonable
assurance standards.  Additionally, in designing disclosure controls and
procedures, our management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible disclosure controls and
procedures. The design of any disclosure controls and procedures also is based
in part upon certain assumptions about the likelihood of future events, and
there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions.  Based on their
evaluation, the Company’s Chief Executive Officer and Chief Financial Officer
concluded that, as of December 31, 2008, the Company’s disclosure controls and
procedures were effective at the reasonable assurance level in ensuring that the
information required to be disclosed by the Company in the reports it files or
submits under the Act is (i) accumulated and communicated to the Company’s
management (including the Chief Executive Officer and Chief Financial Officer)
to allow timely decisions regarding required disclosure, and (ii) recorded,
processed, summarized and reported within the time periods specified in the
SEC’s rules and forms.





(b)
Changes in Internal Controls: During the quarter ended December 31, 2008, no
change occurred in the Company’s internal controls over financial reporting that
has materially affected, or is reasonably likely to materially affect, the
Company’s internal control over financial reporting.





The
Company does not expect that its internal control over financial reporting will
prevent all error and all fraud.  A control procedure, no matter how
well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control procedure are
met.  Because of the inherent limitations in all control procedures,
no evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the Company have been
detected.  These inherent limitations include the realities that
judgments in decision-making can be faulty, and that breakdowns can occur
because of simple error or mistake.








33






Security
Federal Corporation and Subsidiaries


Item
4. Controls and Procedures, Continued





Additionally,
controls can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the
control.  The design of any control procedure also is based in part
upon certain assumptions about the likelihood of future events, and there can be
no assurance that any design will succeed in achieving its stated goals under
all potential future conditions; over time, controls may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate.  Because of the inherent limitations in
a cost-effective control procedure, misstatements due to error or fraud may
occur and not be detected.




















34




Security
Federal Corporation and Subsidiaries






Part
II:   Other Information




Item
1      Legal
Proceedings


The
Company is not engaged in any legal proceedings of a material nature at the
present time.  From time to time, the Company is a party to legal
proceedings in the ordinary course of business wherein it enforces its security
interest in mortgage loans it has made.





Item
1A   Risk
Factors


There
have been no material changes in the risk factors previously disclosed in the
Company’s Annual Report on Form 10-K for the year ended March 31, 2008 except
that the following risk factors are added to those previously contained in the
Form 10-K:





Risks
Related to the United States Financial Industry





Difficult
market conditions have adversely affected our industry.





We are
particularly exposed to downturns in the U.S. housing market. Dramatic declines
in the housing market over the past year, with falling home prices and
increasing foreclosures, unemployment and under-employment, have negatively
impacted the credit performance of mortgage loans and resulted in significant
write-downs of asset values by financial institutions, including
government-sponsored entities, major commercial and investment banks, and
regional financial institutions such as our Company.  Reflecting
concern about the stability of the financial markets generally and the strength
of counterparties, many lenders and institutional investors have reduced or
ceased providing funding to borrowers, including to other financial
institutions. This market turmoil and tightening of credit have led to an
increased level of commercial and consumer delinquencies, lack of consumer
confidence, increased market volatility and widespread reduction of business
activity generally. The resulting economic pressure on consumers and lack of
confidence in the financial markets have adversely affected our business,
financial condition and results of operations. We do not expect that the
difficult conditions in the financial markets are likely to improve in the near
future. A worsening of these conditions would likely exacerbate the adverse
effects of these difficult market conditions on us and others in the financial
institutions industry.  In particular, we may face the following risks
in connection with these events:





$
            We
      potentially face increased regulation of our industry. Compliance with
      such regulation may increase our costs and limit our ability to pursue
      business opportunities.





$
            Our
      ability to assess the creditworthiness of our customers may be impaired if
      the models and approaches we use to select, manage and underwrite our
      customers become less predictive of future
  behaviors.





$
            The
      process we use to estimate losses inherent in our credit exposure requires
      difficult, subjective and complex judgments, including forecasts of
      economic conditions and how these economic conditions might impair the
      ability of our borrowers to repay their loans.  The level of
      uncertainty concerning economic conditions may adversely affect the
      accuracy of our estimates which may, in turn, impact the reliability of
      the process.





$
            Competition
      in our industry could intensify as a result of the increasing
      consolidation of financial services companies in connection with current
      market conditions.





$
            We
      may be required to pay significantly higher Federal Deposit Insurance
      Corporation premiums because market developments have significantly
      depleted the insurance fund of the Federal Deposit Insurance Corporation
      and reduced the ratio of reserves to insured
  deposits.





Recently
enacted legislation and other measures undertaken by the Treasury, the Federal
Reserve and other governmental agencies may not help stabilize the U.S.
financial system or improve the housing market.





On
October 3, 2008, President Bush signed into law the Emergency Economic
Stabilization Act of 2008, or the EESA, which, among other measures, authorized
the Treasury Secretary to establish the Troubled Asset Relief Program, or
TARP.










35







Security
Federal Corporation and Subsidiaries






Part
II: Other Information, Continued







The EESA
gives broad authority to the Treasury to purchase, manage, modify, sell and
insure the troubled mortgage related assets that triggered the current economic
crisis as well as other Atroubled
assets.@  The
EESA includes additional provisions directed at bolstering the economy,
including:





$
            authority
      for the Federal Reserve to pay interest on depository institution
      balances;





$
            mortgage
      loss mitigation and homeowner
protection;





$
            temporary
      increase in Federal Deposit Insurance Corporation insurance coverage from
      $100,000 to $250,000 through December 31, 2009;
  and





$
            authority
      to the SEC to suspend mark-to-market accounting requirements for any
      issuer or class of category of
transactions.





Pursuant
to the TARP, the Treasury has the authority to, among other things, purchase up
to $700 billion (of which $250 billion is currently available) of mortgages,
mortgage-backed securities and certain other financial instruments from
financial institutions for the purpose of stabilizing and providing liquidity to
the U.S. financial markets.  On November 12, 2008, the Treasury
Secretary announced that the Treasury was no longer pursuing a broad plan to
purchase illiquid mortgage-related assets, but would continue to examine whether
targeted forms of asset purchase can play a useful role.





Shortly
following the enactment of the EESA, the Treasury announced the creation of a
capital purchase program, or CPP, pursuant to which it proposes to provide
access to capital to financial institutions through a standardized program to
acquire preferred stock from eligible financial institutions that will serve as
Tier I capital.  On December 19, 2008, Security Federal Corporation
received a direct equity investment of $18.0 million from the Treasury pursuant
to the CPP and is subject to certain restrictions as a result.  See
A
–Risks Related to Our Common Stock—The securities purchase agreement between us
and Treasury limits our ability to pay dividends on and repurchase our common
stock.”





The EESA
also contains a number of significant employee benefit and executive
compensation provisions, some of which apply to employee benefit plans
generally, and others of which impose on financial institutions that participate
in the TARP program restrictions on executive compensation.





The EESA
followed, and has been followed by, numerous actions by the Federal Reserve,
Congress, Treasury, the SEC and others to address the currently liquidity and
credit crisis that has followed the sub-prime meltdown that commenced in
2007.  These measures include homeowner relief that encourages loan
restructuring and modification; the establishment of significant liquidity and
credit facilities for financial institutions and investment banks; the repeated
lowering of the federal funds rate; emergency action against short selling
practices; a temporary guaranty program for money market funds; the
establishment of a commercial paper funding facility to provide back-stop
liquidity to commercial paper issuers; coordinated international efforts to
address illiquidity and other weaknesses in the banking sector.





In
addition, the Internal Revenue Service, or the IRS, has issued an unprecedented
wave of guidance in response to the credit crisis, including a relaxation of
limits on the ability of financial institutions that undergo an Aownership
change@
to utilize their pre-change net operating losses and net unrealized built-in
losses.  The relaxation of these limits may make significantly more
attractive the acquisition of financial institutions whose tax basis in their
loan portfolios significantly exceeds the fair market value of those
portfolios.





Moreover,
on October 14, 2008, the Federal Deposit Insurance Corporation announced the
establishment of a Temporary Liquidity Guarantee Program, or TLGP, to provide
full deposit insurance for all non-interest bearing transaction accounts and
guarantees of certain newly issued senior unsecured debt issued by Federal
Deposit Insurance Corporation-insured institutions and their holding
companies.  Insured institutions are automatically covered by this
program for the period commencing October 14, 2008 and will continue to be
covered as long as they did not opt out of the program by December 5,
2008.










36






Security
Federal Corporation and Subsidiaries






Part
II: Other Information, Continued




Security
Federal Bank did not opt out of the program.  Under the program, the
Federal Deposit Insurance Corporation will guarantee timely payment of newly
issued senior unsecured debt issued on or before June 30, 2009.  The
debt includes all newly issued unsecured senior debt (e.g., promissory notes,
commercial paper and inter-bank funding). The aggregate coverage for an
institution may not exceed 125% of its debt outstanding on September 30, 2008
that was scheduled to mature before June 30, 2009, or, for certain insured
institutions, 2% of liabilities as of September 30, 2008.  The
guarantee will extend to June 30, 2012 even if the maturity of the debt is after
that date.





The
actual impact that the EESA and such related measures undertaken to alleviate
the credit crisis will have generally on the financial markets, including the
extreme levels of volatility and limited credit availability currently being
experienced is unknown.  The failure of such measures to help
stabilize the financial markets and a continuation or worsening of current
financial market conditions could materially and adversely affect our business,
financial condition, results of operations, access to credit or the trading
price of our common stock.





Current
levels of market volatility are unprecedented.





The
capital and credit markets have been experiencing volatility and disruption for
more than a year.  In recent months, the volatility and disruption has
reached unprecedented levels.  In some cases, the markets have
produced downward pressure on stock prices and credit availability for certain
issuers without regard to those issuers= underlying
financial strength.  If current levels of market disruption and
volatility continue or worsen, there can be no assurance that we will not
experience an adverse effect, which may be material, on our ability to access
capital and on our business, financial condition and results of
operations.




Risks
Related to Our Business







Our business is subject to general
economic risks that could adversely impact our results of operations and
financial condition.




·
            Changes
      in economic conditions, particularly a further economic slowdown in Aiken,Richland, andLexingtonCountiesinSouth
      CarolinaandColumbiaCountyinGeorgia,
      could hurt our business.




Our
business is directly affected by market conditions, trends in industry and
finance, legislative and regulatory changes, and changes in governmental
monetary and fiscal policies and inflation, all of which are beyond our
control.  In 2007, the housing and real estate sectors experienced an
economic slowdown that has continued into 2009.  Further deterioration
in economic conditions, in particular within our primary market area real estate
markets, could result in the following consequences, among others, any of which
could hurt our business materially:





o
            loan
      delinquencies may increase;


o
            problem
      assets and foreclosures may
increase;


o
            demand
      for our products and services may decline;
and


o
            collateral
      for loans made by us, especially real estate, may decline in value, in
      turn reducing a customer’s borrowing power and reducing the value of
      assets and collateral securing our
loans.





·
            Further
      downturns in the real estate markets in our primary market area could hurt
      our business.




Our
business activities and credit exposure are primarily concentrated in Aiken,
Richland, and Lexington Counties in South Carolina and Columbia County
in Georgia.  While we do not have any sub-prime loans, our
construction and land loan portfolios, our commercial and multifamily loan
portfolios and certain of our other loans have been affected by the downturn in
the residential real estate market.  We anticipate that further
declines in the estate markets in our primary market area will hurt our
business.  As of December 31, 2008, substantially all of our loan
portfolio consisted of loans secured by real estate located in Aiken, Richland,
and Lexington Counties in South Carolina and Columbia County in
Georgia.  If real estate values continue to decline the collateral for
our loans will provide less security.  As a result, our ability to
recover on defaulted loans by selling the underlying real estate will be
diminished, and we would be more likely to suffer losses on defaulted
loans.







37




Security
Federal Corporation and Subsidiaries






Part
II: Other Information, Continued




The
events and conditions described in this risk factor could therefore have a
material adverse effect on our business, results of operations and financial
condition.





·
            We
      may suffer losses in our loan portfolio despite our underwriting
      practices.




We seek to mitigate the
risks inherent in our loan portfolio by adhering to specific underwriting
practices.   Although we believe that our underwriting criteria
are appropriate for the various kinds of loans we make, we may incur losses on
loans that meet our underwriting criteria, and these losses may exceed the
amounts set aside as reserves in our allowance for loan losses.







Recent
negative developments in the financial industry and credit markets may continue
to adversely impact our financial condition and results of
operations.




Negative
developments beginning in the latter half of 2007 in the sub-prime mortgage
market and the securitization markets for such loans, together with other
factors, have resulted in uncertainty in the financial markets in general and a
related general economic downturn, which have continued in 2008.


Many
lending institutions, including us, have experienced substantial declines in the
performance of their loans, including construction and land loans, multifamily
loans, commercial loans and consumer loans.  Moreover, competition
among depository institutions for deposits and quality loans has increased
significantly. In addition, the values of real estate collateral supporting many
construction and land, commercial and multifamily and other commercial loans and
home mortgages have declined and may continue to decline. Bank and holding
company stock prices have been negatively affected, as has the ability of banks
and holding companies to raise capital or borrow in the debt markets compared to
recent years. These conditions may have a material adverse effect on our
financial condition and results of operations.  In addition, as a
result of the foregoing factors, there is a potential for new federal or state
laws and regulations regarding lending and funding practices and liquidity
standards, and bank regulatory agencies are expected to be very aggressive in
responding to concerns and trends identified in examinations, including the
expected issuance of formal enforcement orders.  Negative developments
in the financial industry and the impact of new legislation in response to those
developments could restrict our business operations, including our ability to
originate or sell loans, and adversely impact our results of operations and
financial condition.







·
            We
      may be required to make further increases in our provisions for loan
      losses and to charge off additional loans in the future, which could
      adversely affect our results of
operations.




For
      the quarter ended December 31, 2008 we recorded a provision for loan
      losses of $525,000 compared to $150,000 for the quarter ended December 31,
      2007, an increase of $375,000. We are experiencing increasing loan
      delinquencies and credit losses.  Generally, our non-performing
      loans and assets reflect operating difficulties of individual borrowers
      resulting from weakness in the local economy.  In addition,
      slowing housing sales have been a contributing factor to the increase in
      non-performing loans as well as the increase in
      delinquencies.  At December 31, 2008 our total non-performing
      loans had increased to $11.7 million compared to $3.7 million at December
      31, 2007.  If current trends in the housing and real estate
      markets continue, we expect that we will continue to experience increased
      delinquencies and credit losses.  Moreover, if a recession
      occurs we expect that it would negatively impact economic conditions in
      our market areas and that we could experience significantly higher
      delinquencies and credit losses.  An increase in our credit
      losses or our provision for loan losses would adversely affect our
      financial condition and results of
operations.




Liquidity
risk could impair our ability to fund operations and jeopardize our financial
condition.




Liquidity
is essential to our business. An inability to raise funds through deposits,
borrowings, the sale of loans and other sources could have a substantial
negative effect on our liquidity. Our access to funding sources in amounts
adequate to finance our activities or the terms of which are acceptable to us
could be impaired by factors that affect us specifically or the financial
services industry or economy in general. Factors that could detrimentally impact
our access to liquidity sources include a decrease in the level of our business
activity as a result of a downturn in the markets in which our loans are
concentrated or adverse regulatory action against us. Our ability to borrow
could also be impaired by factors that are not specific to us, such as a
disruption in the financial markets or negative views and expectations about the
prospects for the financial services industry in light of the recent turmoil
faced by banking organizations and the continued deterioration in credit
markets.









38


Security
Federal Corporation and Subsidiaries





Part
II: Other Information, Continued





In
addition, if we are unable to redeem the Series A Preferred Stock prior to
December 19, 2014, the cost of this capital to us will increase substantially on
that date, from 5.0% per annum (approximately $900,000 annually) to 9.0% per
annum (approximately $1.6 million annually).  Depending on our
financial condition at the time, this increase in the annual dividend rate on
the Series A Preferred Stock could have a material negative effect on our
liquidity.





·
            If
      external funds were not available, this could adversely impact our growth
      and prospects.




We rely
on retail deposits, brokered deposits, and advances from the Federal Home Loan
Bank (“FHLB”) of Atlanta and other borrowings to fund our
operations.  At December 31, 2008, we had $223.7 million in FHLB
advances. Although we have historically been able to replace maturing deposits
and advances as necessary, we might not be able to replace such funds in the
future if, among other things, our results of operations or financial condition
or the results of operations or financial condition of the FHLB of Atlanta or
market conditions were to change. In addition, if we fall below the FDIC’s
thresholds to be considered “well capitalized” we will be unable to continue
with uninterrupted access to the brokered funds markets.




Although
we consider these sources of funds adequate for our liquidity needs, there can
be no assurance in this regard and we may be compelled or elect to seek
additional sources of financing in the future.  Likewise, we may seek
additional debt in the future to achieve our long-term business objectives, in
connection with future acquisitions or for other reasons.  There can
be no assurance additional borrowings, if sought, would be available to us or,
if available, would be on favorable terms.  If additional financing
sources are unavailable or not available on reasonable terms, our financial
condition, results of operations and future prospects could be materially
adversely affected.




The
securities purchase agreement between us and Treasury limits our ability to pay
dividends on and repurchase our common stock.




The
securities purchase agreement between us and Treasury provides that prior to the
earlier of (i) December 19, 2011 and (ii) the date on which all of the shares of
the Series A Preferred Stock have been redeemed by us or transferred by Treasury
to third parties, we may not, without the consent of Treasury, (a) increase the
cash dividend on our common stock or (b) subject to limited exceptions, redeem,
repurchase or otherwise acquire shares of our common stock or preferred stock
(other than the Series A Preferred Stock) or trust preferred
securities.  In addition, we are unable to pay any dividends on our
common stock unless we are current in our dividend payments on the Series A
Preferred Stock.  These restrictions, together with the potentially
dilutive impact of the warrant described in the next risk factor, could have a
negative effect on the value of our common stock.   Moreover,
holders of our common stock are entitled to receive dividends only when, as and
if declared by our Board of Directors. Although we have historically paid cash
dividends on our common stock, we are not required to do so and our Board of
Directors could reduce or eliminate our common stock dividend in the
future.




The
Series A Preferred Stock impacts net income available to our common shareholders
and earnings per common share, and the warrant we issued to Treasury may be
dilutive to holders of our common stock.




The
dividends declared on the Series A Preferred Stock will reduce the net income
available to common shareholders and our earnings per common
share.  The Series A Preferred Stock will also receive preferential
treatment in the event of liquidation, dissolution or winding up of Security
Federal Corporation.  Additionally, the ownership interest of the
existing holders of our common stock will be diluted to the extent the warrant
we issued to Treasury in conjunction with the sale to Treasury of the Series A
Preferred Stock is exercised.  The shares of common stock underlying
the warrant represent approximately 5.3% of the shares of our common stock
outstanding as of January 31, 2009 (including the shares issuable upon exercise
of the warrant in total shares outstanding).  Although Treasury has
agreed not to vote any of the shares of common stock it receives upon exercise
of the warrant, a transferee of any portion of the warrant or of any shares of
common stock acquired upon exercise of the warrant is not bound by this
restriction.





Fluctuations
in interest rates could reduce our profitability and affect the value of our
assets.





Our
profitability depends substantially upon our net interest income.  Net
interest income is the difference between the interest earned on loans and
investments and interest paid on deposits and borrowings.  Market
interest rates for loans and deposits are highly sensitive to competition for
these products.  We expect that we will periodically experience
imbalances in the interest rate sensitivities of our assets and liabilities and
the relationships of various interest rates to each other.








39


Security
Federal Corporation and Subsidiaries




Part
II: Other Information, Continued





Over any
period of time, our interest-earning assets may be more sensitive to changes in
market interest rates than our interest-bearing liabilities, or vice
versa.  In addition, the individual market interest rates underlying
our loan and deposit products may not change to the same degree over a given
time period.  In any event, if market interest rates should move
contrary to our position, our earnings may be negatively affected.  In
addition, loan volume and quality and deposit volume and mix can be affected by
market interest rates.  Changes in levels of market interest rates
could materially adversely affect our net interest spread, asset quality,
origination volume and overall profitability.




Recently,
interest rates dropped quickly and significantly.  Since September 18,
2007, the U.S. Federal Reserve decreased its target for federal funds rate, from
5.25% to 0.25% for a total decrease of 500 basis points.  Sudden
significant decreases in these short-term market interest rates negatively
impact margins as our assets tend to reprice faster than our liabilities in the
short-term.  However, sudden and significant increases in short-term
market rates can also adversely affect our net interest margins and the value of
our assets.  We principally manage interest rate risk by managing our
volume and mix of our earning assets and funding liabilities.  In a
changing interest rate environment, we may not be able to manage this risk
effectively.  If we are unable to manage interest rate risk
effectively, our business, financial condition and results of operations could
be materially harmed.




An
inadequate allowance for loan losses would reduce our earnings.







We are
exposed to the risk that our borrowers will be unable to repay their loans
according to their terms and that any collateral securing the payment of their
loans will not be sufficient to assure full repayment.  Credit losses
are inherent in the lending business and could have a material adverse effect on
our operating results.  Volatility and deterioration in the economy
may also increase our risk for credit losses.  We evaluate the
collectibility of our loan portfolio and provide an allowance for loan losses
that we believe is adequate based upon such factors as:




·  cash flow
of the borrower and/or the project being financed;




·  in the
case of a collateralized loan, the changes and uncertainties as to the future
value of the collateral;




·  the
credit history of a particular borrower;




·  changes
in economic and industry conditions; and




·  the
duration of the loan.




If our
evaluation is incorrect and borrower defaults cause losses exceeding our
allowance for loan losses, our earnings may be materially, adversely
affected.  Our allowance may not be adequate to cover loan losses
inherent in our portfolio.  We may experience losses in our loan
portfolio or perceive adverse trends that require us to significantly increase
our allowance for loan losses in the future, which would also reduce our
earnings.  In addition, our banking regulators, as an integral part of
their examination process, may require us to make additional provisions for loan
losses.




Our
deposit insurance premiums are expected to increase substantially, which will
adversely affect our profits.





Our
deposit insurance premiums during calendar year 2008 totaled $565,000. These
premiums are expected to increase in calendar year 2009 due to recent strains on
the FDIC deposit insurance fund due to the cost of large bank failures and
increase in the number of troubled banks.  The current rates for FDIC
assessments have ranged from 5 to 43 basis points, depending on the health of
the insured institution.  The FDIC has proposed increasing that
assessment range to 12 to 50 basis points for the first quarter of
2009.  For the remainder of 2009, it has proposed a range of 10 to 45
basis points for institutions that do not trigger risk factors for brokered
deposits and unsecured debt and higher rates for those that do trigger those
risk factors. The FDIC also proposed that it could increase assessment rates in
the future without formal rulemaking.





The
level of our commercial real estate loan portfolio may subject us to additional
regulatory scrutiny.





The FDIC,
the Federal Reserve, the Office of Thrift Supervision and the Office of the
Comptroller of the Currency, have promulgated joint guidance on sound risk
management practices for financial institutions with concentrations in
commercial real estate lending.  Under the guidance, a financial
institution that, like us, is actively involved in commercial real estate
lending should perform a risk assessment to identify
concentrations.







40





Security
Federal Corporation and Subsidiaries





Part
II: Other Information, Continued





A
financial institution may have a concentration in commercial real estate lending
if, among other factors,  (i) total reported loans for construction,
land acquisition and development, and other land represent 100% or more of total
capital or (ii) total reported loans secured by multi-family and non-farm
residential properties, loans for construction, land acquisition and development
and other land and loans otherwise sensitive to the general commercial real
estate market, including loans to commercial  real estate related
entities, represent 300% or more of total capital. In addition, the guidance
requires in this event that management employ heightened risk management
practices including board and management oversight and strategic planning,
development of underwriting standards, risk assessment and monitoring
through market analysis and stress testing.  We have concluded that we
have a concentration in commercial real estate lending under the foregoing
standards.While we
believe we have implemented policies and procedures with respect to our
commercial real estate loan portfolio consistent with this guidance, bank
regulators could require us to implement additional policies and procedures
consistent with their interpretation of the guidance which could result in
additional costs to us.





We
are subject to extensive regulation from numerous governmental agencies, which
could restrict our activities and impose financial requirements or limitations
on the conduct of our business.





We are
subject to extensive federal and state regulation and supervision, primarily
through Security Federal Bank.  Banking regulations are primarily
intended to protect depositors’ funds, the federal deposit insurance fund and
the banking system as a whole, not shareholders.  These regulations
affect our lending practices, capital structure, investment practices, dividend
policy and growth, among other things.  Congress and federal
regulatory agencies continually review banking laws, regulations and policies
for possible changes.  Changes to statutes, regulations or regulatory
policies, including changes in interpretation or implementation of statutes,
regulations or policies, could affect us in substantial and unpredictable
ways.  These changes could subject us to additional costs, limit the
types of financial services and products we may offer and/or increase the
ability of non-banks to offer competing financial services and products, among
other things.  Failure to comply with laws, regulations or policies
could result in sanctions by regulatory agencies, civil money penalties and/or
reputation damage, which could have a material adverse effect on our business,
financial condition and results of operations.  While we have policies
and procedures designed to prevent any such violations, violations may still
occur.




·
            We
      may elect or be compelled to seek additional capital in the future, but
      that capital may not be available when it is
  needed.




We are
required by federal and state regulatory authorities to maintain adequate levels
of capital to support our operations.  In addition, we may elect to
raise additional capital to support our business or to finance acquisitions, if
any, or we may otherwise elect to raise additional capital.  In that
regard, a number of financial institutions have recently raised considerable
amounts of capital as a result of a deterioration in their results of operations
and financial condition arising from the turmoil in the mortgage loan market,
deteriorating economic conditions, declines in real estate values and other
factors. Should we be required by regulatory authorities or otherwise elect to
raise additional capital, we may seek to do so through the issuance of, among
other things, our common stock or securities convertible into our common stock,
which could dilute your ownership interest in the Corporation.




Our
ability to raise additional capital, if needed, will depend on conditions in the
capital markets, economic conditions and a number of other factors, many of
which are outside our control, and on our financial performance. Accordingly, we
cannot assure you of our ability to raise additional capital if needed or on
terms acceptable to us. If we cannot raise additional capital when needed, it
may have a material adverse effect on our financial condition, results of
operations and prospects.




Difficult
market conditions have adversely affected our industry.




We are
particularly exposed to downturns in the U.S. housing market. Dramatic declines
in the housing market over the past year, with falling home prices and
increasing foreclosures, unemployment and under-employment, have negatively
impacted the credit performance of mortgage loans and resulted in significant
write-downs of asset values by financial institutions, including
government-sponsored entities, major commercial and investment banks, and
regional financial institutions such as our Company.  Reflecting
concern about the stability of the financial markets generally and the strength
of counterparties, many lenders and institutional investors have reduced or
ceased providing funding to borrowers, including to other financial
institutions.








41


Security
Federal Corporation and Subsidiaries





Part
II: Other Information, Continued





This
market turmoil and tightening of credit have led to an increased level of
commercial and consumer delinquencies, lack of consumer confidence, increased
market volatility and widespread reduction of business activity generally. The
resulting economic pressure on consumers and lack of confidence in the financial
markets have adversely affected our business, financial condition and results of
operations. We do not expect that the difficult conditions in the financial
markets are likely to improve in the near future. A worsening of these
conditions would likely exacerbate the adverse effects of these difficult market
conditions on us and others in the financial institutions industry.In particular, we may
face the following risks in connection with these events:




·
            We
      potentially face increased regulation of our industry. Compliance with
      such regulation may increase our costs and limit our ability to pursue
      business opportunities.




·
            The
      process we use to estimate losses inherent in our credit exposure requires
      difficult, subjective and complex judgments, including forecasts of
      economic conditions and how these economic conditions might impair the
      ability of our borrowers to repay their loans.  The level of
      uncertainty concerning economic conditions may adversely affect the
      accuracy of our estimates which may, in turn, impact the reliability of
      the process.




·
            Competition
      in our industry could intensify as a result of the increasing
      consolidation of financial services companies in connection with current
      market conditions.




·
            We
      may be required to pay significantly higher FDIC premiums because market
      developments have significantly depleted the insurance fund of the FDIC
      and reduced the ratio of reserves to insured
  deposits.




There
can be no assurance that recently enacted legislation and other measures
undertaken by the Treasury, the Federal Reserve and other governmental agencies
will help stabilize the U.S. financial system or improve the housing
market.




On
October 3, 2008, President Bush signed into law the Emergency Economic
Stabilization Act of 2008 (the “EESA”), which, among other measures, authorized
the Treasury Secretary to establish the Troubled Asset Relief Program
(“TARP”).  EESA gives broad authority to Treasury to purchase, manage,
modify, sell and insure the troubled mortgage related assts that triggered the
current economic crisis as well as other “troubled assets.”  EESA
includes additional provisions directed at bolstering the economy,
including:




·
              Authority
      for the Federal Reserve to pay interest on depository institution
      balances;
  ·
                Mortgage
      loss mitigation and homeowner
protection;


·
            Temporary
      increase in Federal Deposit Insurance Corporation (“FDIC”) insurance
      coverage from $100,000 to $250,000 through December 31, 2009;
      and




·
            Authority
      to the Securities and Exchange Commission (the “SEC”) to suspend
      mark-to-market accounting requirements for any issuer or class of category
      of transactions.




Pursuant
to the TARP, the Treasury has the authority to, among other things, purchase up
to $700 billion (of which $250 billion is currently available) of mortgages,
mortgage-backed securities and certain other financial instruments from
financial institutions for the purpose of stabilizing and providing liquidity to
the U.S. financial markets.  Shortly following the enactment of EESA,
the Treasury announced the creation of specific TARP programs to purchase
mortgage-backed securities and whole mortgage loans.  In addition,
under the TARP, the Treasury created a capital purchase program, pursuant to
which it proposes to provide access to capital to financial institutions through
a standardized program to acquire preferred stock (accompanied by warrants) from
eligible financial institutions that will serve as Tier 1 capital. Security
Federal Corporation is participating in this program.







42




Security
Federal Corporation and Subsidiaries





Part
II: Other Information, Continued





EESA also
contains a number of significant employee benefit and executive compensation
provisions, some of which apply to employee benefit plans generally, and others
which impose on financial institutions that participate in the TARP program
restrictions on executive compensation.




EESA
followed, and has been followed by, numerous actions by the Federal Reserve,
Congress, Treasury, the SEC and others to address the currently liquidity and
credit crisis that has followed the sub-prime meltdown that commenced in
2007.  These measures include homeowner relief that encourage loan
restructuring and modification; the establishment of significant liquidity and
credit facilities for financial institutions and investment banks; the lowering
of the federal funds rate, including a 50 basis point decrease on October 8,
2008; emergency action against short selling practices; a temporary guaranty
program for money market funds; the establishment of a commercial paper funding
facility to provide back-stop liquidity to commercial paper issuers; coordinated
international efforts to address illiquidity and other weaknesses in the banking
sector.




In
addition, the Internal Revenue Service has issued an unprecedented wave of
guidance in response to the credit crisis, including a relaxation of limits on
the ability of financial institutions that undergo an “ownership change” to
utilize their pre-change net operating losses and net unrealized built-in
losses.  The relaxation of these limits may make significantly more
attractive the acquisition of financial institutions whose tax basis in their
loan portfolios significantly exceeds the fair market value of those
portfolios.




On
October 14, 2008, the FDIC announced the establishment of a temporary liquidity
guarantee program to provide insurance for all non-interest bearing transaction
accounts and guarantees of certain newly issued senior unsecured
debt  issued by financial institutions (such as Security Federal
Bank), bank holding companies and savings and loan holding companies (such as
Security Federal Corporation).  Financial institutions were
automatically covered by this program for the 30-day period commencing October
14, 2008 and will continue to be covered as long as they do not affirmatively
opt out of the program.  Security Federal Corporation did not opt out
of the program.




Under the
program, newly issued senior unsecured debt issued on or before June 30, 2009
will be insured in the event the issuing institution subsequently fails, or its
holding company files for bankruptcy.  The debt includes all newly
issued unsecured senior debt (e.g., promissory notes,
commercial paper and inter-bank funding). The aggregate coverage for an
institution may not exceed 125% of its debt outstanding on September 30, 2008
that was scheduled to mature before June 30, 2009.  The guarantee will
extend to June 30, 2012 even if the maturity of the debt is after that
date.  Many details of the program still remain to be worked
out.




There can
be no assurance as to the actual impact that EESA and such related measures
undertaken to alleviate the credit crisis will have generally on the financial
markets, including the extreme levels of volatility and limited credit
availability currently being experienced.   The failure of such
measures to help stabilize the financial markets and a continuation or worsening
of current financial market conditions could materially and adversely affect our
business, financial condition, results of operations, access to credit or the
trading price of our common stock.




Current
levels of market volatility are unprecedented.




The
capital and credit markets have been experiencing volatility and disruption for
more than a year. In recent months, the volatility and disruption has reached
unprecedented levels. In some cases, the markets have produced downward pressure
on stock prices and credit availability for certain issuers without regard to
those issuers’ underlying financial strength. If current levels of market
disruption and volatility continue or worsen, there can be no assurance that we
will not experience an adverse effect, which may be material, on our ability to
access capital and on our business, financial condition and results of
operations.

















43







Security
Federal Corporation and Subsidiaries





Part
II: Other Information, Continued





Item
2    Unregistered Sales of Equity
Securities and Use Of Proceeds





Period
            (a)
      Total Number of Shares Purchased
            (b)
      Average Price Paid per Share
            (c)
      Total Number of Shares Purchased as Part of Publicly Announced
      Program
            (d)
      Maximum Number of Shares that May Yet Be Purchased Under the
      ProgramOctober
      1 – October 31, 2008
            2,449
            $20.06
            2,449
            118,666November
      1 – November 30, 2008
            68,399
            18.00
            68,399
            50,267December
      1 – December 31, 2008
            200
            18.21
            200
            50,067Total
            71,048
            $18.07
            71,048
            50,067





In August
2008, the Company’s Board of Directors authorized a plan to continue
repurchasing shares of the Company’s outstanding common stock. This plan
authorized the repurchase of 125,000 shares or 5% of the Company’s outstanding
common stock. As of December 31, 2008, 74,933 shares have been repurchased under
this program. The Company repurchased 71,048 shares of its outstanding Common
Stock under this program during the three months ended December 31,
2008.





TARP Capital Purchase Program:
On October 14, 2008, the Treasury announced a voluntary Capital Purchase
Program (the “CPP”) under which the Treasury will purchase senior preferred
shares from qualifying financial institutions. The plan is part of the
$700 billion Emergency Economic Stabilization Act signed into law in
October 2008.





On
December 19, 2008, pursuant to the CPP established by the Treasury the
Company entered into a Letter Agreement, which incorporates by reference the
Securities Purchase Agreement — Standard Terms, with the Treasury (the
“Agreement”), pursuant to which the Company issued and sold to the Treasury for
an aggregate purchase price of $18.0 million in cash, 18,000 shares of its Fixed
Rate Cumulative Perpetual Preferred Stock, Series A, par value $0.01 per
share, having a liquidation preference of $1,000 per share (the “Series A
Preferred Stock”), and (ii) a ten-year warrant to purchase up to 137,966
shares of common stock, par value $.01 per share, of the Company (“Common
Stock”), at an initial exercise price of $19.57 per share, subject to certain
anti-dilution and other adjustments (the “Warrant”).





The
Series A Preferred Stock will pay cumulative dividends at a rate of 5% per
annum on the liquidation preference for the first five years, and thereafter at
a rate of 9% per annum. The Series A Preferred Stock has no maturity date
and ranks senior to the Common Stock with respect to the payment of dividends
and distributions and amounts payable in the unlikely event of any future
liquidation or dissolution of the Company. The Company may redeem the Series A
Preferred Stock after three years at a price of $1,000 per share plus accrued
and unpaid dividends. The Series A Preferred Stock may not be redeemed
during the first three years except with the proceeds from a “qualified equity
offering” (as defined in the Agreement). Prior to December 19, 2011, unless
the Company has redeemed the Series A Preferred Stock or the Treasury has
transferred the Series A Preferred Stock to a third party, the consent of
the Treasury will be required for the Company to increase its Common Stock
dividend above the amount of the last quarterly cash dividend per share declared
on the Common Stock prior to October 14, 2008, or repurchase its Common Stock or
other equity or capital securities, other than in certain circumstances
specified in the Agreement.





The
Warrant is immediately exercisable. The Warrant provides for the adjustment of
the exercise price and the number of shares of Common Stock issuable upon
exercise pursuant to customary anti-dilution provisions, such as upon stock
splits or distributions of securities or other assets to holders of Common
Stock, and upon certain issuances of Common Stock at or below a specified price
relative to the then-current market price of Common Stock. The Warrant expires
ten years from the issuance date. If, on or prior to December 31, 2009, the
Company receives aggregate gross cash proceeds of not less than the purchase
price of the Series A Preferred Stock from one or more “qualified equity
offerings” announced after October 13, 2008, the number of shares of Common
Stock issuable pursuant to the Treasury’s exercise of the Warrant will be
reduced by one-half of the original number of shares, taking into account all
adjustments, underlying the Warrant. Pursuant to the Agreement, the Treasury has
agreed not to exercise voting power with respect to any shares of Common Stock
issued upon exercise of the Warrant.










44





Security
Federal Corporation and Subsidiaries





Part
II: Other Information, Continued





Item
3     Defaults Upon Senior
Securities


None





Item
4     Submission Of Matters To A
Vote Of Security Holders


None





Item
5     Other
Information


None




Exhibits


3.1
              Articles Of
      Incorporation, as amended (1)3.2
              Articles of
      Amendment, including Certificate of Designation relating to the Company’s
      Fixed Rate Cumulative Perpetual Preferred Stock Series A (2)3.3
              Bylaws (3)4.1
              Instruments
      defining the rights of security holders, including indentures (4)4.2
              Warrant to
      purchase shares of the Company’s common stock dated December 19, 2008
      (2)4.3
              Letter
      Agreement (including Securities Purchase Agreement – Standard Terms,
      attached as Exhibit A) dated December 19, 2008 between the Company and the

                United 
      States Department of the Treasury (2)10.1
              1993 Salary
      Continuation Agreements (5)10.2
              Amendment One
      to 1993 Salary Continuation Agreement (6)10.3
              Form of 2006
      Salary Continuation Agreement(7)10.4
              1999 Stock
      Option Plan (3)10.5
              1987 Stock
      Option Plan (5)10.6
              2002 Stock
      Option Plan (8)10.7
              2004 Employee
      Stock Purchase Plan (9)10.8
              Incentive
      Compensation Plan (5)10.9
              Form of
      Security Federal Bank Salary Continuation Agreement (10)10.10
              Form of
      Security Federal Split Dollar Agreement (10)10.11
              Form of
      Compensation Modification Agreement (2)14
              Code of Ethics
      (11)31.1
              Certification
      of the Chief Executive Officer Pursuant to Section 302 of the
      Sarbanes-Oxley Act.31.2
              Certification
      of the Chief Financial Officer Pursuant to Section 302 of the
      Sarbanes-Oxley Act.32
              Certifications
      Pursuant to Section 906 of the Sarbanes-Oxley
Act.





(1)
            Filed
      on June 26, 1998, as an exhibit to the Company’s Proxy Statement and
      incorporated herein by reference.


(2)
            Incorporated
      by reference to the Registrant’s Current Report on Form 8-K on December
      23, 2008.


(3)
            Filed
      on March 2, 2000, as an exhibit to the Company’s Registration Statement on
      Form S-8 and incorporated herein by
reference.




(4)
            Filed
      on August 12, 1987, as an exhibit to the Company’s Registration Statement
      on Form 8-A and incorporated herein by
  reference.




(5)
            Filed
      on June 28, 1993, as an exhibit to the Company’s Annual Report on Form
      10-KSB and incorporated herein by
reference.


(6)
            Filed
      as an exhibit to the Company’s Quarterly Report on Form 10-QSB for the
      quarter ended September 30, 1993 and incorporated herein by
      reference.


(7)
            Filed
      on May 24, 2006 as an exhibit to the Company’s Current Report on Form 8-K
      dated May 18, 2006 and incorporated herein by
  reference.


(8)
            Filed
      on June 19, 2002, as an exhibit to the Company’s Proxy Statement and
      incorporated herein by reference.




(9)
            Filed
      on June 18, 2004, as an exhibit to the Company’s Proxy Statement and
      incorporated herein by reference.




(10)
              Filed
      on May 24, 2006 as an exhibit to the Current Report on Form 8-K and
      incorporated herein by reference.









45




Security
Federal Corporation and Subsidiaries





Part
II: Other Information, Continued




(11)
            Filed
      on June 27, 2007 as an exhibit to the Company’s Annual Report on Form 10-K
      and incorporated herein by
reference.













46


Security
Federal Corporation and Subsidiaries





Signatures





Pursuant
to the requirement of the Securities Exchange Act of 1934, the registrant has
duly caused this report to the signed on its behalf by the undersigned thereunto
duly authorized.




SECURITY FEDERAL CORPORATION




Date:
            February
      13, 2009
            
            By:
            /s/
      Timothy W. SimmonsTimothy
      W. SimmonsPresidentDuly
      Authorized Representative









Date:
            February
      13, 2009
            
            By:
            /s/
      Roy G. LindburgRoy
      G. LindburgChief
      Financial OfficerDuly
      Authorized Representative


























47