Executive Summary / Key Takeaways

• Security Federal Corporation ($SFDL) demonstrated robust financial performance in Q1 2025, with net income available to common shareholders increasing significantly year-over-year, primarily driven by strong net interest income growth and improved net interest margin.
• The company maintains a well-capitalized status, exceeding all regulatory requirements, providing a solid foundation for operations and potential strategic actions, including managing its investment portfolio and pursuing growth opportunities.
• Strategic initiatives, such as the pursuit of CDFI recertification and the potential repurchase of ECIP preferred stock at a significant discount, offer potential avenues for enhanced funding, tax benefits, and capital management, though uncertainties remain regarding outcomes and timing.
• While leveraging its local branch network and community focus as key competitive advantages, SFDL faces challenges from larger, more technologically advanced regional banks and fintechs, which exhibit greater operational efficiency and faster processing capabilities.
• Key factors for investors to monitor include the trajectory of interest rates and their impact on net interest margin and investment portfolio valuation, the success of CDFI recertification, progress towards meeting ECIP repurchase conditions, and the company's ability to manage operating costs and enhance technological capabilities relative to peers.

Setting the Scene: A Community Bank's Foundation and Evolving Strategy

Security Federal Corporation, through its wholly-owned subsidiary, Security Federal Bank, operates as a state-chartered, federally insured savings bank deeply rooted in its local communities. Its core business revolves around the fundamental pillars of banking: accepting savings and demand deposits and originating a diverse portfolio of loans, including mortgage, commercial, and consumer credit, catering primarily to individuals and small businesses. Complementing these core activities, the company extends its reach through wholly-owned subsidiaries dedicated to managing investment securities and operating an insurance agency, offering a broader suite of financial services to its customer base.

The company's history reflects a journey of measured growth and strategic capital management. Significant financing activities, such as the issuance of junior subordinated debentures in 2006 and the sale of subordinated notes in 2019, have been instrumental in shaping its capital structure and funding growth initiatives. A notable event in recent history was the $82.9 million preferred stock investment from the U.S. Department of Treasury under the Emergency Capital Investment Program (ECIP) in 2022, bolstering its Tier 1 capital and underscoring a commitment to serving low- and moderate-income communities. More recently, the redemption of subordinated notes in late 2024 and the initiation and expansion of a share repurchase program signal a proactive approach to optimizing its capital structure and returning value to shareholders. Physical expansion is also on the agenda, evidenced by the recent purchase of a property intended for a future full-service branch.

In the regional banking landscape, SFDL positions itself as a community-focused institution. Its strategy heavily relies on the strength of its local branch network, which fosters deep customer relationships and loyalty. This localized approach provides a distinct competitive advantage, particularly against larger regional players and digital-only entrants, by offering personalized service and tailored financial solutions. This is particularly evident in niche areas like construction loans and personalized financial planning through its insurance and trust services. This community-centric model contributes to higher recurring revenue from deposits and loans and can yield better gross margins in its specific rural markets compared to competitors with a less localized presence.

However, this strategy comes with inherent competitive disadvantages. Maintaining a physical branch network contributes to higher operating costs compared to leaner, digitally-focused models employed by some competitors. Furthermore, while SFDL utilizes standard banking technology, including data processing, cloud services, and debit card systems, the company appears to lack proprietary or significantly differentiated technological moats that provide a distinct operational or cost advantage over more technologically advanced peers. Competitors like First Citizens BancShares (FCNCA) and SouthState Corporation (SSB), for instance, leverage advanced digital platforms that enable faster loan processing and account onboarding, leading to greater operational efficiency and potentially lower costs per unit. This technological gap represents a vulnerability for SFDL, potentially impacting its ability to compete on speed and efficiency in certain service areas. The company's investment in standard IT infrastructure, reflected in data processing and cloud services expenses, is necessary for modern banking operations but does not appear to provide a unique edge in the competitive landscape.

The competitive environment is dynamic. SFDL competes directly with regional banks like First Citizens BancShares, SouthState Corporation, Regions Financial Corporation (RF), and Truist Financial Corporation (TFC), all vying for market share in deposits and lending within the Southeast. These larger institutions benefit from economies of scale, potentially offering more competitive pricing on loans and deposits and operating with lower costs per loan due to their extensive networks and technological investments. Indirect competition from fintech firms and national banks offering digital alternatives further pressures traditional banking models. SFDL's strategic response appears to be a focus on leveraging its community ties and personalized service to retain and attract customers, while managing costs and selectively investing in infrastructure like new branches.

Financial Performance: Riding the Rate Wave

Security Federal Corporation delivered a strong financial performance in the first quarter of 2025. Net income available to common shareholders surged by $838,000, or 47.8%, reaching $2.60 million, or $0.81 per basic common share, compared to $1.80 million, or $0.54 per basic common share, in the same period of 2024. This significant increase was primarily attributable to a substantial rise in net interest income and non-interest income, coupled with a decrease in the provision for credit losses. These positive factors were partially offset by higher non-interest expenses, an increased provision for income taxes, and the introduction of preferred stock dividends in the first quarter of 2025.

Net interest income, the lifeblood of a bank's profitability, grew by a robust $1.2 million, or 12.5%, totaling $11.2 million for the quarter ended March 31, 2025, up from $10.0 million in the prior year period. This expansion was fueled by a combination of factors: an increase in average interest-earning assets and a notable improvement in the net interest margin, which climbed to 3.05% in Q1 2025 from 2.75% in Q1 2024. The net interest spread also widened to 2.35% from 2.03% on a tax-equivalent basis.

Breaking down the interest income components, interest earned on the loan portfolio saw a significant jump of $1.6 million, or 16.6%, reaching $11.1 million. This was a direct result of a higher average loan balance ($58.2 million increase) and a 41 basis point increase in the average yield on loans, reflecting the impact of adjustable-rate loans repricing in the current higher interest rate environment and new loans being originated at more favorable market rates. Conversely, interest income from taxable investments decreased by $585,000, or 7.8%, due to a lower average balance and a decrease in the average yield. Interest from deposits with other banks also declined, reflecting both a lower average balance and a decrease in yields in line with market rates.

On the expense side, total interest expense decreased by $733,000, or 8.4%, to $8.0 million. This decrease occurred despite an increase in the average balance of interest-bearing liabilities, primarily due to a significant reduction in the average balance of borrowings from the Federal Reserve Bank and a decrease in the average cost of these liabilities. Interest expense on deposits, however, increased by $748,000, driven by a substantial $111.2 million increase in the average balance of interest-bearing deposit accounts. This growth was concentrated in higher-cost certificates of deposit and money market accounts, though the average cost of deposits saw a slight decrease. The strategic repayment of FRB borrowings, facilitated by excess liquidity, significantly reduced borrowing costs, contributing positively to the net interest margin expansion.

Credit quality indicators remained stable, with no provision for credit losses recorded in the first quarter of 2025, a favorable comparison to the $335,000 provision in the same period of 2024. The company also reported net recoveries totaling $111,000 in Q1 2025, compared to $15,000 in Q1 2024. This suggests a stable credit environment and effective management of the loan portfolio during the period.

Non-interest income saw a modest increase of $122,000, or 5.3%, reaching $2.4 million. This growth was primarily fueled by an increase in "other non-interest income," which benefited from a $60,000 increase in rental income from a recently purchased multi-tenant property and a $62,000 gain on the sale of land held for sale. Other components like service fees on deposits and trust income saw slight decreases, while insurance commissions and ATM/check card fees increased.

Operating expenses, or non-interest expense, increased by $205,000, or 2.1%, totaling $9.8 million. The largest contributor to this increase was compensation and employee benefits expense, which rose by $255,000. This was attributed to higher staffing levels and associated costs necessary to support the company's growth and operational requirements. Other expense categories saw mixed changes, with some increases (occupancy, debit card, data processing, cloud services) and some decreases (advertising, depreciation, other).

The provision for income taxes increased by 42.4% due to the higher pre-tax net income, although the effective tax rate decreased slightly to 21.6% in Q1 2025 from 24.9% in Q1 2024.

Balance Sheet, Liquidity, and Capital Strength

The balance sheet saw a slight contraction, with total assets decreasing by $26.3 million, or 1.6%, to $1.59 billion at March 31, 2025, from $1.61 billion at December 31, 2024. This decrease was primarily driven by a significant reduction in cash and cash equivalents ($45.2 million decrease), largely due to the repayment of borrowings from the Federal Reserve Bank. This decrease was partially offset by increases in available-for-sale (AFS) securities ($15.1 million increase), loans receivable, net ($2.8 million increase), and premises and equipment ($4.2 million increase). The increase in AFS securities resulted from purchases exceeding sales and maturities, while loan growth was concentrated in real estate loans and HELOCs, partially offset by a decrease in commercial and agricultural loans.

On the liabilities side, total deposits increased by $21.5 million, or 1.6%, reaching $1.35 billion. This growth was primarily in higher-cost certificates of deposit and money market accounts, partially offset by a decrease in checking accounts. The company continues to utilize brokered deposits, holding $25.8 million in brokered time deposits and $5.4 million in non-certificate brokered deposits. An estimated 25.4% of the deposit portfolio ($341.3 million) was uninsured at quarter-end. Borrowings from the Federal Reserve Bank were fully repaid, resulting in zero outstanding FRB borrowings at March 31, 2025, compared to $50.0 million at the end of 2024. Other borrowings, consisting of short-term repurchase agreements, also decreased slightly. The company had no outstanding FHLB advances.

Liquidity remains a key focus. SFDL actively manages its liquidity position to ensure sufficient cash flows to support loan growth, deposit withdrawals, operations, and other commitments. The decrease in cash and cash equivalents was a direct result of utilizing excess liquidity to repay higher-cost borrowings.

The company maintains significant borrowing capacity, including $463.9 million available at the FHLB (subject to collateral) and a $50.0 million unused Fed Funds facility. These facilities provide substantial flexibility to meet future funding needs. Liquid assets, including cash, certificates of deposit with other banks, and AFS securities, totaled $643.9 million at March 31, 2025.

Capital strength is a cornerstone of SFDL's profile. The Bank continues to exceed all regulatory capital requirements and is categorized as well-capitalized under prompt corrective action provisions. At March 31, 2025, the Bank's Common Equity Tier 1 (CET1), Tier 1 leverage, Tier 1 risk-based, and total risk-based capital ratios were 18.90%, 10.60%, 18.90%, and 20.20%, respectively, all comfortably above the minimum requirements for a well-capitalized institution (6.50%, 5.00%, 8.00%, and 10.00%, respectively). The Bank also maintained a robust capital conservation buffer of 12.20%.

Shareholders' equity increased by $5.8 million, or 3.2%, to $188.2 million. This increase was driven by the net income available to common shareholders and a $3.7 million reduction in accumulated other comprehensive loss (AOCL). The improvement in AOCL was primarily due to favorable changes in market interest rates positively impacting the fair value of AFS securities. These gains were partially offset by cash dividends paid on both common ($0.15 per share) and preferred stock. The company also continued its share repurchase program, repurchasing a small number of shares in Q1 2025, with 127,041 shares remaining available under the authorization.

Strategic Outlook and Key Considerations

Looking ahead, Security Federal Corporation's strategy appears centered on leveraging its community banking model while navigating the current interest rate environment and pursuing capital management opportunities. The strong Q1 2025 performance, particularly the expansion of net interest income and margin, provides positive momentum. The ability to repay FRB borrowings using excess liquidity demonstrates effective balance sheet management in response to market conditions.

A significant strategic initiative is the pursuit of recertification as a Community Development Financial Institution (CDFI). While the process involves navigating revised application requirements and is subject to approval, successful recertification could unlock access to various funding opportunities, tax incentives (like the New Markets Tax Credit), technical assistance, and potential regulatory benefits. These benefits could enhance the company's ability to serve its target markets and support future growth. However, the outcome of the recertification process is not assured, and the company is also monitoring potential impacts from a recent Executive Order related to the CDFI Fund's operations.

Another notable capital management opportunity lies in the option to repurchase the ECIP Preferred Stock held by the U.S. Department of Treasury. The company anticipates the repurchase price could be significantly discounted from the face value based on current market conditions. While this presents a potential avenue for enhancing shareholder value and optimizing the capital structure, the option cannot be exercised until specific conditions related to lending growth or the preferred stock dividend rate are met. The earliest this could potentially occur is June 30, 2026.

While the company did not provide explicit quantitative forward guidance in recent reports, the Q1 2025 results offer insights into potential trends. The continued benefit from higher loan yields as adjustable-rate loans reprice and new loans are originated should support net interest income, although competition for deposits in the higher-rate environment could pressure funding costs. The absence of a provision for credit losses in Q1 is positive, but credit risk remains a factor to monitor, particularly given the concentration in real estate loans. The investment in a new branch location signals an intent for continued physical expansion, aligning with the community-focused strategy, but also contributing to operational expenses.

Key risks and challenges include the sensitivity of net interest income to future changes in market interest rates, which could impact both asset yields and funding costs. The presence of unrealized losses in the AFS and HTM investment portfolios, while currently not deemed credit-related and not expected to result in realized losses before maturity, highlights the exposure to interest rate fluctuations. Credit risk, inherent in lending activities, requires ongoing monitoring, particularly concerning loan delinquencies and potential write-offs, although recent trends have been favorable. Regulatory changes and the uncertainty surrounding CDFI recertification also pose potential risks. Competition from larger, more efficient banks and disruptive fintechs could pressure margins and market share over time, particularly if SFDL does not continue to invest in technology to enhance efficiency and customer experience.

Conclusion

Security Federal Corporation's first quarter 2025 results paint a picture of a community bank effectively leveraging the current interest rate environment to drive significant growth in net interest income and overall profitability. The company's strong capital position provides a solid foundation, enabling it to manage its balance sheet, pursue strategic initiatives, and return capital to shareholders through dividends and share repurchases. The potential to repurchase the ECIP preferred stock at a discount represents a compelling future opportunity for capital optimization, contingent on meeting specific performance thresholds.

However, SFDL operates in a competitive landscape where scale and technological prowess are increasingly important. While its deep community ties and local presence offer a valuable competitive moat, the company faces ongoing pressure from larger, more efficient regional banks and innovative fintechs. Successfully navigating this environment will require continued focus on managing operating costs, maintaining credit quality, and strategically investing in technology to enhance efficiency and customer service, even if it lacks a unique technological differentiator compared to some peers. The outcome of the CDFI recertification process and the trajectory of interest rates will be critical factors influencing the company's performance and strategic flexibility in the periods ahead. For investors, SFDL represents a well-capitalized community bank with recent strong performance, but one that must continue to adapt and execute effectively to sustain growth and enhance value in a challenging market.