SECURITY FEDERAL CORP

Security Federal Corporation (SFC) 10-K Filing Analysis and Investment Outlook

Introduction

Warren.AI 💰 6.0 / 10

Security Federal Corporation is a regional bank holding company that primarily serves communities in South Carolina and parts of Georgia. Its primary operating subsidiary, Security Federal Bank, has been serving the local market for decades. The 2024 Form 10-K provides an extensive overview of its business operations, financial performance, risk management practices, and regulatory environment. In this blog post, we dive deep into the key elements of the filing to assess the company’s investment potential.

Business and Operations Overview

Security Federal was originally incorporated in 1987 and has evolved into a community-focused financial institution. Its core operations include accepting deposits from the public and originating a diverse range of loans—spanning residential mortgages, commercial and agricultural loans, construction loans, and other consumer lending products. The bank’s footprint is limited largely to South Carolina and parts of Georgia, which suggests that its business is highly reliant on local economic conditions.

The holding company structure allows Security Federal Corporation some flexibility in expanding its service offerings beyond the traditional banking activities of its subsidiary. However, it also means that almost all material operations, including lending, are conducted through Security Federal Bank. This concentrated exposure can be both an advantage and a limitation. On one hand, the bank has deep local relationships; on the other, its performance is susceptible to local economic downturns.

Financial Performance

Balance Sheet Highlights

• Total Assets: The company reported total assets of approximately $1.61 billion, reflecting a moderate scale typical of community banks.
• Deposits: With deposit balances exceeding $1.3 billion, the bank has a robust funding base that supports its lending activities. However, a significant portion of these deposits is uninsured, which underscores the institution’s dependence on savvy deposit management and competitive interest rates.
• Loans Receivable: The net loans receivable, after accounting for provisions, are about $687 million. This portfolio includes various segments with a strong focus on real estate: construction, residential, and commercial loans. The low level of non-performing loans (roughly 0.47% of total assets) is a positive sign of asset quality.
• Shareholders’ Equity and Regulatory Capital: The equity stood at around $182 million. Capital ratios, including the common equity Tier 1 ratio, are well above the regulatory minimums, reflecting a sound financial basis and robust oversight by regulatory authorities.

Income Statement Insights

• Net Interest Income (NII): The bank’s NII increased to nearly $41.8 million in 2024. This growth was driven largely by higher loan volumes and increased yields. However, a rising cost of funds—mainly due to higher deposit rates—added upward pressure on interest expense. The net effect is a modest increase in NII despite the challenges of a shifting rate environment.
• Credit Loss Provisions and Net Income: One of the most notable changes in 2024 was a marked increase in the provision for credit losses. Although the overall quality of the loan portfolio remains good, there has been pressure on margins as some loans moved into lower credit quality categories. Consequently, net income available to common shareholders decreased to $8.9 million, compared to $10.2 million in the previous year. This decline in profitability is a cause for caution for potential investors.

Expense and Profitability Dynamics

Rising non-interest expenses further compressed the bottom line. Operating costs have increased, particularly in the areas of compensation, data processing, and cloud services. Combined with higher provisions for credit losses and tax expenses, these factors contributed to a lower net income despite a healthy growth in net interest income. The earnings per share (EPS) also declined, reflecting the overall contraction in profitability.

Risk Factors

The 10-K report provides an extensive list of risk factors that potential investors should carefully evaluate:

1. Economic and Local Market Risks: The bank’s geographic concentration means that its fortunes are closely tied to the economic conditions in South Carolina and the immediate Georgia market. Any significant downturn in these areas could lead to increased loan defaults and falling collateral values.
2. Interest Rate Volatility: The bank’s earnings heavily depend on the spread between interest income (from loans and securities) and interest expense (on deposits and borrowings). With a mismatched re-pricing structure—shorter-term liabilities versus longer-term loans—a sudden rise or fall in interest rates can compress margins substantially. Although management employs NII and EVE simulation models to stress test the balance sheet, these tools rely on assumptions that may not fully capture future volatility.
3. Credit Risk: Despite a low percentage of non-performing loans, the increase in the allowance for credit losses is a red flag. The adoption of the CECL model means that future losses will be recognized earlier, which could lead to further declines in reported net income if adverse economic conditions persist.
4. Regulatory Environment: Like all banks, Security Federal is subject to heavy regulation. Changes in federal or state regulatory requirements, more stringent capital or liquidity guidelines, or shifts in supervisory practices can all have material effects on operations and profitability.
5. Cybersecurity and Technology Risks: As the bank relies heavily on electronic systems for transactions, any breach or failure in cybersecurity measures could disrupt operations, lead to financial losses, or damage its reputation. While management has taken steps to mitigate these risks, the dynamic nature of the threat landscape remains a concern.
6. Competitive Pressure: Operating primarily in a traditional community banking space, Security Federal faces direct competition from other local banks as well as non-traditional financial service providers like FinTech companies. Competition could constrain growth in both deposit accumulation and loan origination.

Management's Discussion and Strategic Initiatives

Management acknowledges both the strengths and the challenges in the current operating environment. While the bank continues to expand its loan portfolio and shows growth in net interest income, it is also grappling with higher operating costs and more conservative loan loss estimates in light of the new CECL model. The move to adopt CECL is significant, as it forces the bank to be more forward-looking in its assessment of credit risks, and may present earnings volatility in the near term.

Another positive note in the filing is the sustained commitment to returning value to shareholders. The bank has maintained a robust dividend policy with consistent quarterly payouts over 129 consecutive quarters and has an active share repurchase program. However, the fact that the company’s common stock trades on the OTC Pink market might raise concerns about liquidity and transparency.

**Investment Potential **

When assessing the investment potential of Security Federal Corporation, there are strong elements such as:

• Stable Capital Position: The bank is well capitalized relative to its asset base and consistently meets or exceeds regulatory capital requirements.
• Healthy Deposit Base: With deposits forming the majority of its funding, the bank shows strong local customer relationships, which are a bedrock for its lending activities.
• Asset Quality: The overall asset quality remains solid with very low non-performing loans despite the increased provisions for credit losses.
• Dividend and Buyback Policy: A consistent dividend history and share repurchase program are attractive signals for income-focused investors.

However, some factors limit its upside:

• Declining Profitability: The drop in net income and earnings per share is a cautionary sign. Higher provisions and operating expenses could persist, straining future profits.
• Geographic Concentration: Limited geographic reach means the bank is more prone to localized economic headwinds.
• Interest Rate Sensitivity: The reliance on net interest margin makes the bank vulnerable to market interest rate fluctuations.

Final Thoughts

For investors, Security Federal Corporation represents a moderate-risk opportunity. It offers a stable banking platform with strong regulatory capital, a conservative loan portfolio, and the appeal of consistent dividend payments. However, its local market focus, sensitivity to rising credit loss provisions, and relatively modest earnings growth may limit significant upside. Accordingly, while the bank is a viable income-oriented investment, it does not offer the explosive growth potential of larger, diversified institutions.

Conclusion

In summary, after reviewing the 10-K filing, the investment potential of Security Federal Corporation is rated at 6.0 out of 10. The company demonstrates solid fundamentals and has implemented prudent risk management strategies, yet its performance is moderated by regional exposure and increasing pressures from credit and interest rate risks. Net profit for 2024 was approximately $8.9 million—a modest figure that investors should consider in the context of both the company’s stable dividend history and the broader risks inherent in the community banking sector.

Investors should weigh the benefits of steady dividends and strong capital adequacy against the limited growth potential and the risks discussed above. If you have a moderate risk tolerance and are looking for a stable income investment in a community bank, Security Federal Corporation might be an appropriate addition to your portfolio.