10-K 1 form10k.htm JACKSONVILLE BANCORP INC 10-K 12-31-2013

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549



FORM 10-K
 
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2013
 
or
 
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from             to
 
Commission file number 000-30248


 
JACKSONVILLE BANCORP, INC.
(Exact name of registrant as specified in its charter)
 
Florida
59-3472981
(State or other jurisdiction of incorporation or organization)
(IRS Employer Identification No.)
100 North Laura Street, Suite 1000, Jacksonville, Florida
32202
(Address of principal executive offices)
(Zip Code)

Registrant’s telephone number, including area code
(904) 421-3040
 
Securities registered pursuant to Section 12(b) of the Act:
 
Title of Each Class
Name of Each Exchange on which Registered
Common Stock, $.01 par value
The NASDAQ Stock Market (NASDAQ Capital Market)
 
Securities registered pursuant to Section 12(g) of the Exchange Act:
 
None.

 
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.
Yes  o      No  x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes  o      No  x
 


Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes  x     No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes  x     No  o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
o
Accelerated filer
o
 
 
 
 
Non-accelerated filer
o
Smaller reporting company
x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes  o      No  x
 
The aggregate market value of the registrant’s voting and nonvoting common equity held by non-affiliates of the registrant as of June 30, 2013 (based upon the per share closing sale price of $9.60 on June 28, 2013) was approximately $20,133,005.  The per share closing sale price as of June 28, 2013 has been retrospectively adjusted to reflect the reverse stock split effective October 24, 2013.
 
As of February 28, 2014, the latest practicable date, there were 3,177,090 shares of the registrant’s common stock outstanding and 2,618,005 shares of the registrant’s nonvoting common stock outstanding.



DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the registrant’s Definitive Proxy Statement for the 2014 Annual Meeting
of Shareholders are incorporated by reference in Part III (Items 10, 11, 12, 13 and 14) of this Annual Report on Form 10-K.

TABLE OF CONTENTS
 
Description Page
 
 
3
 
 
PART I
 
 
 
 
Item 1.
5
 
 
 
Item 1A.
19
 
 
 
Item 1B.
29
 
 
 
Item 2.
29
 
 
 
Item 3.
30
 
 
 
Item 4.
30
  
 
PART II
 
 
 
 
Item 5.
31
 
 
 
Item 6.
32
 
 
 
Item 7.
34
 
 
 
Item 7A.
64
 
 
 
Item 8.
67
 
 
 
Item 9.
123
 
 
 
Item 9A.
123
 
 
 
Item 9B.
124
  
 
PART III
 
 
 
 
Item 10.
125
 
 
 
Item 11.
125
 
 
 
Item 12.
125
 
 
 
Item 13.
125
 
 
 
Item 14.
125
  
 
PART IV
 
 
 
 
Item 15.
126
 
 
 
 
130

JACKSONVILLE BANCORP, INC.

SPECIAL CAUTIONARY NOTICE REGARDING
FORWARD-LOOKING STATEMENTS
 
Various of the statements made herein under the captions “Business,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Quantitative and Qualitative Disclosures about Market Risk,” “Risk Factors” and elsewhere are “forward-looking statements” within the meaning and protections of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
 
Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions and future performance, and involve known and unknown risks, uncertainties and other factors, including economic and market conditions, which may be beyond our control, and which may cause the actual results, performance or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. You should not expect us to update any forward-looking statements, and we have no obligation to do so.
 
All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “evaluate,” “continue,” “further,” “plan,” “point to,” “project,” “could,” “intend,” “target” and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation:
 
the effects of future economic, business and market conditions and changes, domestic and foreign, including seasonality;
 
governmental monetary and fiscal policies;
 
legislative and regulatory changes, including changes in banking, securities and tax laws, regulations and policies and their application by our regulators;
 
changes in accounting rules, practices and interpretations;
 
the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest-sensitive assets and liabilities;
 
changes in borrower credit risks and payment behaviors;
 
changes in the availability and cost of credit and capital in the financial markets;
 
changes in the prices, values and sales volumes of residential and commercial real estate;
 
the effects of concentrations in our loan portfolio;
 
our ability to resolve nonperforming assets;
 
the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;
 
the failure of assumptions and estimates underlying the establishment of reserves for possible loan losses and other estimates and valuations;
 
the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth, expense savings and/or other results from such transactions;
 
changes in technology or products that may be more difficult, costly, or less effective than anticipated;
 
the effects of war or other conflicts, acts of terrorism, hurricanes, floods, tornados or other catastrophic events that may affect economic conditions; or
 
management’s expectation that the Company’s recapitalization plan and strategic initiatives will have a sustained positive impact on results of operations and compliance with all regulatory agreements and associated requirements.
JACKSONVILLE BANCORP, INC.

Federal Deposit Insurance Corporation
 
The Jacksonville Bank is insured by the Federal Deposit Insurance Corporation (“FDIC”).  This Annual Report on Form 10-K also serves as the annual disclosure statement of the Bank pursuant to Part 350 of the FDIC’s rules and regulations.  This statement has not been reviewed or confirmed for accuracy or relevance by the FDIC.
JACKSONVILLE BANCORP, INC.

PART I
 
Unless the context requires otherwise, references in this report to the “Company,” “we,” “us,” or “our” refer to Jacksonville Bancorp, Inc., its wholly owned subsidiary, The Jacksonville Bank, and the Bank’s wholly owned subsidiary, Fountain Financial, Inc., on a consolidated basis.  References to “Bancorp” denote Jacksonville Bancorp, Inc., and The Jacksonville Bank is referred to as the “Bank.”
 
ITEM 1. BUSINESS
 
General
 
Bancorp was incorporated under the laws of the State of Florida on October 24, 1997 for the purpose of organizing the Bank.  Bancorp is a one-bank holding company owning 100% of the outstanding shares of the Bank.  Bancorp’s only business is the ownership and operation of the Bank, which opened for business on May 28, 1999.  The Bank is a Florida state-chartered commercial bank, and its deposits are insured by the FDIC.  On November 16, 2010, Bancorp acquired Atlantic BancGroup, Inc. (“ABI”) by merger, and on the same date, ABI’s wholly owned subsidiary, Oceanside Bank, merged with and into the Bank.  The Bank provides a variety of community banking services to businesses and individuals through its eight full-service branches in Jacksonville and Jacksonville Beach, Duval County, Florida, as well as “online banking” through its virtual branch.
 
We offer a variety of competitive commercial and retail banking services.  In order to compete with the financial institutions in the market, we use our independent status to the fullest extent.  This includes an emphasis on specialized services for small business owners with a particular focus on professional services, wholesalers, distributors, and other service industries.  Additionally, we rely on the professional and personal relationships of our officers, directors and employees.  Loan participations are arranged for customers whose loan demands exceed legal lending limits.  Our product lines include personal and business online banking, and sweep accounts that may be invested in Goldman Sachs mutual funds, in addition to our traditional banking products.  Furthermore, through the Bank’s subsidiary, Fountain Financial, Inc., and our marketing agreement with New England Financial (an affiliate of MetLife), we are able to meet the investment and insurance needs of our customers.
 
Substantial consolidation of the Florida banking market has occurred since the early 1980s.  We believe that the number of depository institutions headquartered and operating in Florida will continue to decline in future periods.  Our marketing programs focus on the advantages of local management, personal service and customer relationships.  Particular emphasis is placed on building personal face-to-face relationships.  Our management and business development teams have extensive experience with individuals and companies within our targeted market segments in the Jacksonville and surrounding geographic areas.  Based on our experience, we believe that we have been and will continue to be effective in gaining market share.  We are also focused on small business, professionals and commercial real estate.
 
Recent Events
 
During 2012, the Company executed a financial advisory agreement with an investment banking firm to assist in raising capital.  Efforts to secure additional equity capital were realized on December 31, 2012 with the sale of an aggregate of 50,000 shares of the Company’s Mandatorily Convertible, Noncumulative, Nonvoting Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), at a purchase price of $1,000 per share, in a private placement transaction (the “Private Placement”).  For the year ended December 31, 2012, gross proceeds from the issuance of preferred stock in the amount of $50.0 million, or $45.1 million net of offering expenses, were used for general operating expenses, mainly for the subsidiary bank to improve capital ratios, and will be used to support the Company’s business strategy going forward.
 
Immediately prior to the closing of the Private Placement, the Bank sold $25.1 million of other real estate owned, nonaccrual loans, loans with a history of being past due, and other loans that were part of an overall customer relationship to a real estate investment firm, who was also an investor in the Private Placement, for a purchase price of $11.7 million (the “Asset Sale”).  Total assets sold in the Asset Sale included loans of $24.6 million and other real estate owned of $0.5 million.  Total proceeds of $11.7 million included proceeds from the sale of loans of $11.3 million and proceeds from the sale of other real estate owned of $0.4 million.  Please refer to Note 4—Loans and Allowance for Loan Losses in the accompanying notes to the Consolidated Financial Statements for additional information related to loans sold in the Asset Sale.
 
Pursuant to the Series A Preferred Stock designation, the Series A Preferred Stock was mandatorily convertible into shares of Bancorp’s common stock and a new class of nonvoting common stock upon receipt of requisite approvals by Bancorp’s shareholders.  In the first quarter of 2013, the Company received shareholder approvals to amend its Amended and Restated Articles of Incorporation to (i) increase the number of authorized shares of the Company’s common stock to 20,000,000, and
JACKSONVILLE BANCORP, INC.

ITEM 1.
BUSINESS (CONTINUED)
 
(ii) authorize 5,000,000 shares of a new class of nonvoting common stock, par value $0.01 per share (the “Capital Amendment”).  On the same date, the Company also received shareholder approval to issue an aggregate of 5,000,000 shares of its common stock and nonvoting common stock in the conversion of the 50,000 outstanding shares of the Company’s Series A Preferred Stock.  The Company filed the Capital Amendment with the Florida Secretary of State on February 19, 2013, and on the same date, all of the outstanding shares of the Company’s Series A Preferred Stock automatically converted into an aggregate of 2,382,000 shares of common stock and 2,618,000 shares of nonvoting common stock (the “Conversion”).  The Conversion was based on a conversion price of $10.00 per share and a conversion rate of 100 shares of common stock and/or nonvoting common stock for each share of Series A Preferred Stock outstanding.  As a result of the Conversion, no shares of the Series A Preferred Stock remained outstanding and an aggregate of 2,676,544 shares of common stock and 2,618,000 shares of nonvoting common stock were outstanding immediately following the Conversion.
 
During the third quarter of 2013, the Company initiated concurrent offerings: (i) a rights offering to eligible existing shareholders of nontransferable subscription rights to purchase shares of the Company’s common stock at a subscription price of $10.00 per share and (ii) a public offering of shares not subscribed for in the rights offering at an equal subscription price of $10.00 per share.  The subscription period for the rights offering expired on September 20, 2013 and resulted in the sale of 104,131 shares of the Company’s common stock for aggregate proceeds of $1.0 million, or $0.9 million net of offering expenses.  The public offering expired during the fourth quarter of 2013, on October 4, 2013, whereby the Company sold 395,869 shares for an aggregate of $4.0 million, or $3.2 million net of offering expenses.  Total net proceeds from the concurrent offerings will be used for general operating expenses.
 
Please refer to Note 2 – Capital Raise Transactions in the accompanying notes to the Consolidated Financial Statements for additional information related to the Company’s recent capital raise activities.
 
In the fourth quarter of 2013, Bancorp’s Board of Directors (also referred to as the “Board”) implemented a 1-for-20 reverse stock split of Bancorp’s outstanding shares of common stock and nonvoting common stock effective October 24, 2013.  As a result of the reverse stock split, each 20 shares of issued and outstanding common stock and nonvoting common stock, par value $0.01 per share, respectively, were automatically and without any action on the part of the respective holders combined and reconstituted as one share of the respective class of common equity as of the effective date.  Consequently, the aggregate par value of common stock and nonvoting common stock eliminated in the reverse stock split was reclassed on the Company’s consolidated balance sheets from the respective class of common equity to additional paid-in capital.  Additional adjustments were made to the aforementioned accounts as a result of rounding to avoid the existence of fractional shares.  All share and per share information in this report has been retrospectively adjusted to reflect the common equity 1-for-20 reverse stock split.
 
Market Area and Competition
 
Our primary market area is all of Duval County (primarily the Southside, Westside, Arlington, Mandarin and Downtown areas of Jacksonville and Jacksonville Beach), Florida, in addition to surrounding communities within the St. Johns, Clay and Nassau counties.  Jacksonville is the largest city by area in the United States covering 747 square miles and is a leading financial and insurance center.  Jacksonville is home to the National Football League’s Jacksonville Jaguars and is the corporate headquarters to a number of regional and national companies.  Duval County has a strong commercial and industrial base, which has been steadily expanding in recent years.
 
Financial institutions primarily compete with one another for deposits.  In turn, a bank’s deposit base directly affects such bank’s loan activities and general growth.  Primary competitive factors include interest rates on deposits and loans, service charges on deposit accounts, the availability of unique financial services products, a high level of personal service, and personal relationships between our officers and customers.  We compete with financial institutions that have greater resources and that may be able to offer more services, unique services, or possibly better terms to their customers.  However, we believe that our long-standing reputation as a reliable and trustworthy banking services provider, as well as management’s extensive knowledge of, and relationships in, the local community, allows us to respond quickly and effectively to the individual needs of our customers.  Management believes that the Company’s competitive position will be able to continue to attract sufficient loans and deposits to effectively compete with other area financial institutions.
 
We are in competition with existing area financial institutions, including commercial banks and savings institutions, insurance companies, consumer finance companies, brokerage houses, mortgage banking companies, credit unions, and other business entities which target traditional banking markets, through offices, mail, the Internet, mobile devices and otherwise.  We anticipate that significant competition will continue from existing financial services providers as well as new entrants to the market.  According to our most recent estimates, there are approximately 27 separate financial institutions located in Duval County, Florida.
JACKSONVILLE BANCORP, INC.

ITEM 1. BUSINESS (CONTINUED)
 
Operating Segment
 
The Company’s financial condition and operating results principally reflect those of the Bank.  Revenues are primarily derived from interest received in connection with loans and other interest earning assets, such as investments.  Non-interest revenues are generated from service charges and other fee-based income.  Major expenses include interest paid on deposits and borrowings, followed by administrative and general operating expenses.  For comparative information related to the Company’s financial condition and results of operations, please refer to the Consolidated Financial Statements and the accompanying notes.
 
While the Company’s chief decision makers monitor the revenue streams of various products and services, operations are managed and financial performance is evaluated on a Company-wide basis.  Accordingly, all financial service operations are considered by management to be aggregated into one reportable operating segment.  Our primary business segment is community banking and consists of attracting deposits from the general public and using such deposits and other sources of funds to originate commercial business loans, commercial real estate loans, residential mortgage loans, and a variety of consumer loans.  In addition, the Company is working to reposition its loan and deposit portfolio mix to better align with our targeted market segment.  Substantially all of our revenues are attributed to the United States.
 
Funding Sources
 
Deposits
 
We offer a wide range of deposit accounts, including commercial and retail checking, money market, individual retirement and statement savings accounts, and certificates of deposit with fixed rates and a range of maturity options.  Our sources of deposits are primarily residents, businesses, and employees of businesses within our market areas, obtained through personal solicitation by our officers and directors, direct mail solicitation, and advertisements published in the local media.  We also have the ability to obtain deposits from the national and brokered CD markets (as long as we are well capitalized for regulatory purposes).  We pay competitive interest rates on interest-bearing deposits.  In addition, our service charge schedule is competitive with other area financial institutions, covering such matters as maintenance and per item processing fees on deposit accounts and special handling charges.  We are also part of the NYCE, Cirrus, and Plus ATM networks and a member of VISA.
 
Borrowings
 
Additional sources of funds are available to the Bank by borrowing from the Federal Home Loan Bank (“FHLB”) and the Federal Reserve Bank (“FRB”).  Our lending capacity with these institutions provides credit availability based on qualifying collateral from the investment and loan portfolios.  See Note 8 – Deposits and Note 10 – Short-term Borrowings and Federal Home Loan Bank Advances in the accompanying notes to the Consolidated Financial Statements for further information on our funding sources.
 
Lending Activities
 
Our Board has adopted certain policies and procedures to guide individual loan officers in carrying out lending functions.  The Bank’s Board of Directors (the “Bank’s Board”) has formed a Directors’ Loan Committee to provide the following oversight:
 
ensure compliance with loan policy, procedures and guidelines as well as appropriate regulatory requirements;
 
approve secured loans and unsecured loans above an aggregate amount of $2.5 million to any entity and/or related interests;
 
monitor overall loan quality through review of information relative to all new loans;
 
approve lending authority for individual officers under dual signatures;
 
monitor our loan review systems;
 
oversee strategies for workout of problem loan relationships;
 
 
review the adequacy of the loan loss reserve; and
 
approve any additional advances to any borrower whose loan or line of credit has been adversely classified substandard.
JACKSONVILLE BANCORP, INC.

ITEM 1. BUSINESS (CONTINUED)
 
The Board realizes that occasionally loans need to be made which fall outside the typical policy guidelines.  Consequently, the Chief Executive Officer, President and Chief Credit Officer have the authority to make certain policy exceptions on secured and unsecured loans within their loan authority limitations.  Policy exceptions on secured and unsecured loans greater than $2.5 million must be approved by the Directors’ Loan Committee, and the full Board reviews reports of all loans and policy exceptions at its regular meetings.  Additionally, the Bank has an independent company that also evaluates the quality of loans and determines if loans are originated in accordance with the guidelines established by the Board.
 
We recognize that credit losses will be experienced and the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the quality of the collateral, as well as general economic conditions.  We intend to maintain an adequate allowance for loan losses based on, among other things, industry standards, management’s experience, historical loan loss experience, evaluation of economic conditions, and regular reviews of delinquencies and loan portfolio quality.  We follow a conservative lending policy, but one which permits prudent risks to assist businesses and consumers primarily in our principal market areas.  Interest rates vary depending on our cost of funds, the loan maturity, the degree of risk and other loan terms.  As contractually required, some interest rates are adjustable with fluctuations in the “prime” rate.
 
The Bank’s lending activities are subject to a variety of legal lending limits which are calculated as a percentage of capital and limited by loan type (secured vs. non-secured).  While differing limits apply in certain circumstances, in general, the Bank’s lending limit to any one borrower is 15% of Bank capital for unsecured loans and 25% of Bank capital for secured loans.
 
Loan Portfolio Composition
 
The Company has divided the loan portfolio into three portfolio segments, each with different risk characteristics and methodologies for assessing risk.  The three portfolio segments identified by the Company include commercial loans, real estate mortgage loans, and consumer and other loans.
The following table presents the composition of the Bank’s core loan portfolio, including loans acquired in the merger with ABI, as of December 31, 2013, 2012 and 2011.
 
 
 
2013
   
2012
   
2011
 
 
 
   
% of
   
   
% of
   
   
% of
 
(Dollars in thousands)
 
Loans
   
Total Loans
   
Loans
   
Total Loans
   
Loans
   
Total Loans
 
Commercial loans
 
$
43,855
     
11.8
%
 
$
37,760
     
9.5
%
 
$
35,714
     
7.7
%
Real estate mortgage loans:
                                               
Residential
   
71,192
     
19.2
     
80,314
     
20.2
     
102,040
     
22.0
 
Commercial
   
223,182
     
60.2
     
239,839
     
60.2
     
275,242
     
59.5
 
Construction and land
   
30,355
     
8.2
     
37,557
     
9.4
     
45,891
     
9.9
 
Consumer and other loans
   
2,041
     
0.6
     
2,768
     
0.7
     
3,955
     
0.9
 
Total
 
$
370,625
     
100.0
%
 
$
398,238
     
100.0
%
 
$
462,842
     
100.0
%
 
The percentage decrease in total gross loans outstanding for the years ended December 31, 2013 and 2012, as compared to the prior year, was 6.9% and 14.0%, respectively.  Our nonperforming loans as a percentage of gross loans also decreased during the years ended December 31, 2013 and 2012, from 10.13% as of December 31, 2011 to 5.71% as of December 31, 2012 and 4.59% as of December 31, 2013.  Elevated balances as of December 31, 2011 were driven in part by the merger with ABI, whereas the continued reduction in loan balances, and particularly nonperforming loans, during 2012 and 2013 reflects the Company’s current business strategy to accelerate the disposition of substandard assets on an individual customer basis, including the Asset Sale completed in the fourth quarter of 2012.  The Bank continues to be aggressive with its strategy to dispose of nonperforming assets in a prudent and reasonable manner.  However, nonperforming loans continue to be negatively impacted by the longevity of the economic recession, specifically weaknesses in the local retail sector of the real estate markets despite recent indicators of stabilization.
 
A more detailed description of the three portfolio segments identified by the Company and presented in the table above is provided in the following paragraphs.
JACKSONVILLE BANCORP, INC.

ITEM 1. BUSINESS (CONTINUED)
 
Commercial Loans
 
Commercial loans are primarily underwritten on the basis of the borrowers’ ability to service such debt from income.  The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value.  As a general practice, we take as collateral a security interest in any available real estate, equipment, or other chattel, although loans may also be made on an unsecured basis.  Collateralized working capital loans typically are secured by short-term assets whereas long-term loans are primarily secured by long-term assets.  Risk is mitigated by the diversity and number of borrowers.
 
Real Estate Mortgage Loans
 
Real estate mortgage loans are typically segmented into three classes:  commercial real estate, residential real estate and construction and land development.  Commercial real estate loans are secured by the subject property and are underwritten based upon standards set forth in the policies approved by the Bank’s Board.  Such standards include, among other factors, loan-to-value limits, cash flow coverage and general credit worthiness of the obligors.  Residential real estate loans are underwritten in accordance with policies set forth and approved by the Bank’s Board, including repayment capacity and source, value of the underlying property, credit history, stability and purchaser guidelines.
 
Construction loans to borrowers are to finance the construction of owner occupied and lease properties.  These loans are categorized as construction loans during the construction period, later converting to commercial or residential real estate loans after the construction is complete and amortization of the loan begins.  Real estate development and construction loans are approved based on an analysis of the borrower and guarantor, the viability of the project and on an acceptable percentage of the appraised value of the property securing the loan.   Real estate development and construction loan funds are disbursed periodically based on the percentage of construction completed.  The Bank carefully monitors these loans with on-site inspections and requires the receipt of lien waivers prior to advancing funds.  Development and construction loans are typically secured by the properties under development or construction, and personal guarantees are typically obtained.  Further, to assure that reliance is not placed solely on the value of the underlying property, the Bank considers the market conditions and feasibility of proposed projects, the financial condition and reputation of the borrower and guarantors, the amount of the borrower’s equity in the project, independent appraisals, cost estimates and pre-construction sale information.  The Bank also makes loans on occasion for the purchase of land for future development by the borrower.  Land loans are extended for the future development of either commercial or residential use by the borrower.  The Bank carefully analyzes the intended use of the property and the viability thereof.
 
Repayment of real estate loans is primarily dependent upon the personal income or business income generated by the secured property of the borrowers, which can be impacted by the economic conditions in their market area.  Risk is mitigated by the fact that the properties securing the Company’s real estate loan portfolio are diverse in type and spread over a large number of borrowers.
 
Consumer and Other Loans
 
Consumer and other loans are extended for various purposes, including purchases of automobiles, recreational vehicles, and boats.  We also offer home improvement loans, lines of credit, personal loans, and deposit account collateralized loans.  Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas, such as unemployment levels. Loans to consumers are extended after a credit evaluation, including the credit worthiness of the borrower(s), the purpose of the credit, and the secondary source of repayment. Consumer loans are made at fixed and variable interest rates and may be made on terms of up to ten years. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.
 
Investments
 
The primary objective of the Company’s investment portfolio is to develop a mixture of investments with maturities and compositions so as to earn an acceptable rate of return while meeting liquidity requirements.  We invest primarily in obligations guaranteed by the U.S. government and government-sponsored agencies.  We also enter into federal funds transactions through our principal correspondent banks.  Investments with maturities in excess of one year are generally readily salable on the open market.
JACKSONVILLE BANCORP, INC.

ITEM 1. BUSINESS (CONTINUED)
 
Employees
 
As of February 28, 2014, the Bank had 103 employees.  Except for certain officers of the Bank who also serve as officers of Bancorp, Bancorp does not have any employees.   Management believes Company relations with its employees have been good and the Company’s long-term success is, and is expected to remain, highly dependent on key personnel including, but not limited to, our senior management team.
 
Data Processing
 
We currently have an agreement with FIS, formerly known as Metavante Corporation, to provide our core processing and to support certain customer products and delivery systems.  Management believes that FIS will continue to be able to provide state-of-the-art data processing and customer service-related processing at a competitive price to support our future growth.
 
Regulation and Supervision
 
We operate in a highly regulated environment, where statutes, regulations, and administrative policies govern our business activities.  We are supervised by, examined by, and submit reports to, a number of regulatory agencies, including the Federal Reserve Board, in the case of Bancorp, and the FDIC and the Florida Office of Financial Regulation (“OFR”), in the case of the Bank. Supervision, regulation and examination of Bancorp, the Bank, and our respective subsidiaries by the bank regulatory agencies are intended primarily for the protection of bank depositors rather than holders of our capital stock.  Any change in applicable law or regulation may have a material effect on our business.  The following discussion includes all supervisory and regulatory information material to the Company as of December 31, 2013; however, it is not intended to be an exhaustive description of the statutes or regulations applicable to the Company or its subsidiaries.
 
Fiscal and Monetary Policy
 
Banking is a business that depends on interest rate differentials.  In general, the difference between the interest paid by a bank on its deposits and its other borrowings, and the interest received by a bank on its loans and securities holdings, constitutes the major portion of a bank’s earnings.  Thus, the earnings and growth of Bancorp and the Bank are subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve.  The Federal Reserve regulates the supply of money through various means, including open market dealings in United States government securities, the discount rate at which banks may borrow from the Federal Reserve, and the reserve requirements applicable to deposits.
 
The financial crisis of 2008, including the downturn of global economic, financial and money markets, increased volatility in the soundness of financial institutions, and other recent events have led to numerous new laws and regulations that apply to the banking industry.  For example, the Federal Reserve has taken a number of actions to keep interest rates low and provide liquidity to the markets.  In addition to changing the discount rate and the terms of the discount window, the Federal Reserve has reduced the targeted federal funds rate to 0-0.25% and has announced that it expects to keep it within such range for the foreseeable future.  The Federal Reserve has also engaged in two rounds of “quantitative easing” by buying bonds in the market, and Operation Twist, where the Federal Reserve bought longer term bonds while selling shorter term holdings in an effort to reduce long-term interest rates.
 
Proposals to change the laws and regulations governing the banking industry are frequently introduced in Congress, in the state legislatures and by the various bank regulatory agencies.  Despite recent indicators of stabilization in the local markets, there can be no assurance that efforts to tighten the supervision of financial institutions will not continue, or become more or less stringent, in future periods.  Accordingly, the scope of regulation and permissible activities of Bancorp and the Bank are subject to change by future federal and state legislation or regulation.
 
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
 
On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”).  The Dodd-Frank Act has had and will continue to have a broad impact on the financial services industry, including significant regulatory and compliance changes like, among other things, (i) enhanced resolution authority of troubled and failing banks and their holding companies; (ii) increased capital and liquidity requirements; (iii) increased regulatory examination fees; (iv) changes to assessments to be paid to the FDIC for federal deposit insurance; and (v) numerous other provisions designed to improve supervision and oversight of, and strengthening safety and soundness for, the financial services sector.  Additionally, the Dodd-Frank Act established a new framework for systemic risk oversight within the financial system distributed among new and existing federal regulatory agencies, including the Financial
JACKSONVILLE BANCORP, INC.

ITEM 1. BUSINESS (CONTINUED)
 
Stability Oversight Council, the Federal Reserve, the Office of the Comptroller of the Currency, and the FDIC.  A summary of certain provisions of the Dodd-Frank Act is set forth below:
 
· Increased Capital Standards and Enhanced Supervision. The federal banking agencies are required to establish minimum leverage and risk-based capital requirements for banks and bank holding companies.  These new standards will be no lower than current regulatory capital and leverage standards applicable to insured depository institutions and may, in fact, be higher when established by the agencies.  The Dodd-Frank Act also increases regulatory oversight, supervision and examination of banks, bank holding companies and their respective subsidiaries by the appropriate regulatory agencies.  In addition, the federal bank regulators have proposed new capital and liquidity standards to implement those adopted by the Basel Committee on Banking Supervision (“Basel”), as part of its “Basel III” rules.
 
· The Consumer Financial Protection Bureau (“Bureau”). The Dodd-Frank Act established the Bureau as a separate agency within the Board of Governors of the Federal Reserve.  The Bureau is tasked with establishing and implementing rules and regulations under certain federal consumer protection laws with respect to the conduct of providers of certain consumer financial products and services.  The Bureau has rulemaking authority over many of the statutes governing products and services offered to bank consumers.  In addition, the Dodd-Frank Act permits states to adopt consumer protection laws and regulations that are more stringent than those regulations promulgated by the Bureau and state attorneys general are permitted to enforce consumer protection rules adopted by the Bureau against state-chartered institutions.  However, banks under $10.0 billion in assets, including the Bank, are not subject to examination by the Bureau but are indirectly influenced through the processes that occur at community banks.
 
· Deposit Insurance. The Dodd-Frank Act makes permanent the $250,000 deposit insurance limit for insured deposits. Amendments to the Federal Deposit Insurance Act also revise the assessment base against which an insured depository institution’s deposit insurance premiums paid to the Deposit Insurance Fund (“DIF”) will be calculated.  Under the amendments, the assessment base is no longer the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity during the assessment period.  Additionally, the Dodd-Frank Act makes changes to the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits and eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds.  In December 2010, the FDIC increased the reserve ratio to 2.0%.  The DIF is currently below statutory requirements and, as a result, the FDIC has adopted a restoration plan that includes provisions to increase deposit insurance assessments over the coming years.
 
· Transactions with Affiliates. The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and an increase in the amount of time for which collateral requirements regarding covered transactions must be maintained.  Prior to the Dodd-Frank Act, the Company had existing policies with developed guidelines for transactions with affiliates, including lending limitations, restrictions on investments in affiliate securities and the purchase of assets from affiliates.  These policies were not materially impacted by the enhanced provisions of the Dodd-Frank Act.
 
· Enhanced Lending Limits. The Dodd-Frank Act strengthens the existing limits on a depository institution’s credit exposure to one borrower.  Current banking law limits a depository institution’s ability to extend credit to one person (or group of related persons) in an amount exceeding certain thresholds.  The Dodd-Frank Act expands the scope of these restrictions to include credit exposure arising from derivative transactions, repurchase agreements, and securities lending and borrowing transactions.  The enhanced lending limits established by the Dodd-Frank Act restrict the Company’s ability to extend credit to sizable borrowers that exceed the Company’s current lending limit.  This limitation restricts the Company’s revenue and potential profitability from significant loans to any one borrower, as well as creates a competitive advantage for larger institutions with higher lending limits.  We seek to accommodate such borrowers by selling a portion of loans in excess of our lending limits to other banks; however, these activities may be restricted by general market conditions and the increase in bank failures in recent years.
 
· Compensation Practices. The Dodd-Frank Act provides that the securities and other federal regulators must establish standards prohibiting as an unsafe and unsound practice any compensation plan of a bank holding company or other “covered financial institution” that provides an insider or other employee with “excessive compensation” or could lead to a material financial loss to such firm.  In June 2010, prior to the Dodd-Frank Act, the bank regulatory agencies promulgated the Interagency Guidance on Sound Incentive Compensation Policies, which requires that financial institutions establish metrics for measuring the impact of activities to achieve incentive compensation with the related risk to the financial institution of such behavior.  As of December 31, 2013, the Dodd-Frank Act and the recent guidance on compensation, after consideration by the Bank, has not resulted in changes to the Company’s current compensation policies; however, final implementation of the legislation and associated guidance may impact these policies in future periods.
JACKSONVILLE BANCORP, INC.

ITEM 1. BUSINESS (CONTINUED)
 
· Holding Company Capital Levels. The Dodd-Frank Act requires bank regulators to establish minimum capital levels for holding companies, limited generally to the same capital instruments permissible to insured depository institutions.  Trust preferred securities (or “TRUPs”) issued prior to May 19, 2010 by bank holding companies with less than $15.0 billion in assets as of December 31, 2009, including Bancorp, are exempt from these capital deductions entirely.
 
Our senior management team, with additional oversight provided by the Bank’s Board, has designed and implemented various action plans in order to comply with the provisions of the Dodd-Frank Act.  These action plans include modifications to general business practices, lending policies and underwriting procedures.  These changes have not yet had a material impact on the Company’s financial condition or results of operations; however, we expect that many of the requirements called for in the Dodd-Frank Act will continue to be implemented over the course of several more years.  Although some regulations have been adopted under the Dodd-Frank Act, many remain to be finalized.  The nature, timing and effect of some requirements are presently unclear.  The changes resulting from the Dodd-Frank Act and regulatory actions, as well as the Basel III capital and liquidity proposals, may increase our costs and reduce our revenue and profitability, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements, or otherwise adversely affect our business.  These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.
 
Basel III Regulatory Framework
 
Under the Basel III capital rules proposed by the Federal Reserve and the FDIC in June 2012, the risk weights of assets, the definitions of capital and the amounts and types of capital will be changed.  Among other things, these proposed rules included the implementation of new capital requirements and the elimination of Tier 1 treatment of trust preferred securities following a phase-in period beginning in 2013.  On November 9, 2012, the Federal Reserve and U.S. bank regulatory agencies announced via press release that the implementation of the proposed Basel III rules would be delayed and, therefore, would not go into effect on January 1, 2013.
 
On July 2, 2013, the Federal Reserve approved the final rules to implement the Basel III rules in the U.S.  The final rules implemented changes to the regulatory capital framework including, but not limited to, (i) a revised definition of regulatory capital, (ii) a new common equity Tier 1 minimum capital requirement, (iii) a higher minimum Tier 1 capital requirement, (iv) limitations on capital distributions and certain discretionary bonus payments based on various capital requirements, (v) amended methodologies for determining risk-weighted assets, and (vi) new disclosure requirements for top-tier banking organizations with $50.0 billion or more in total assets.  Further, the final rules incorporated these new requirements into the prompt corrective action framework.  Various provisions have been included in the final rules to provide relief to banking organizations under $50.0 billion in assets, such as community banks like ours.  Such provisions include the opportunity for a one-time opt-out from the requirement to include fluctuations in available-for-sale securities as part of regulatory capital and grandfather treatment of trust preferred securities as an element of Tier 1 capital for banking organizations under $15.0 billion.  These new rules took effect January 1, 2014 with a mandatory compliance deadline of January 1, 2015 for banking organizations with total assets less than $250.0 billion.  The Company is currently evaluating the impact of adoption.
 
Concentrations of Real Estate Loans
 
During 2006, the federal bank regulatory agencies released guidance on “Concentrations in Commercial Real Estate Lending” (the “Guidance”). The Guidance defines commercial real estate (“CRE”) loans as exposures secured by raw land, land development and construction (including 1-4 family residential construction), multi-family property, and non-farm non-residential property where the primary or a significant source of repayment is derived from rental income associated with the property (i.e., loans for which 50% or more of the source of repayment comes from third party, non-affiliated, rental income) or the proceeds of the sale, refinancing, or permanent financing of the property. Loans to Real Estate Investment Trusts (“REIT”) and unsecured loans to developers that closely correlate to the inherent risks in CRE markets would also be considered CRE loans under the Guidance. Loans on owner occupied CRE are generally excluded.
JACKSONVILLE BANCORP, INC.

ITEM 1. BUSINESS (CONTINUED)
 
The Guidance requires that appropriate processes be in place to identify, monitor and control risks associated with real estate lending concentrations. This could include enhanced strategic planning, CRE underwriting policies, risk management, internal controls, portfolio stress testing and risk exposure limits, as well as appropriately designed compensation and incentive programs. Higher allowances for loan losses and capital levels may also be required. The Guidance is triggered when CRE loan concentrations exceed either:
 
· Total reported loans for construction, land development, and other land of 100% or more of a bank’s total risk-based capital; or
 
· Total reported loans secured by non-owner occupied multi-family, non-farm, and non-residential properties, as well as construction, land development and other land loans of 300% or more of a bank’s total risk-based capital.
 
The Guidance also applies when a bank has a sharp increase in CRE loans or has significant concentrations of CRE secured by a particular property type.
 
The Guidance applies to our CRE lending activities due to the concentration in construction and land development loans.  As of December 31, 2013 and 2012, respectively, we had approximately $28.4 million and $37.6 million in commercial construction and residential land development loans and $2.0 million and $0 in residential construction loans to individuals.  Commercial construction, residential land development loans and residential construction loans to individuals represented approximately 57.8% and 73.8% of the Bank’s total risk-based capital as of the same dates.  Total loans for non-owner occupied multi-family, non-farm, and non-residential properties, as well as construction, land development and other land loans, was $144.8 million and $160.5 million as of December 31, 2013 and 2012, respectively.  The ratio of these loans as a percentage of total risk-based capital was 275.8% as of December 31, 2013, compared to 315.5% as of December 31, 2012.  While our December 31, 2012 ratio exceeded applicable regulatory guidance of 300%, our December 31, 2013 ratio of total loans secured by non-owner occupied multi-family, non-farm, and non-residential properties, as well as construction, land development and other land loans, met this requirement.
 
We have always had significant exposure to loans secured by commercial real estate due to the nature of our markets and the loan needs of both retail and commercial customers.  We believe our long-term experience in CRE lending, underwriting policies, internal controls, and other policies currently in place, as well as our loan and credit monitoring and administration procedures, are appropriate to manage our concentrations as required under the Guidance.  The federal bank regulators are looking more closely at the risks of various assets and asset categories and risk management, and the need for additional rules regarding liquidity as well as capital rules that better reflect risk.
 
Anti-Money Laundering Regulation
 
The International Money Laundering Abatement and Anti-Terrorism Funding Act of 2001 specifies “know your customer” requirements that obligate financial institutions to take actions to verify the identity of the account holders in connection with opening an account at any U.S. financial institution. Banking regulators will consider compliance with this Act’s money laundering provisions in acting upon acquisition and merger proposals, and sanctions for violations of this Act can be imposed in an amount equal to twice the sum involved in the violating transaction, up to $1.0 million.
 
Under the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA PATRIOT Act”), financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers.
 
The USA PATRIOT Act requires financial institutions to establish anti-money laundering programs. The USA PATRIOT Act sets forth minimum standards for these programs, including:
 
the development of internal policies, procedures and controls;
 
the designation of a compliance officer;
 
an ongoing employee training program; and
 
an independent audit function to test the programs.
JACKSONVILLE BANCORP, INC.
 
ITEM 1. BUSINESS (CONTINUED)
 
Consumer Laws and Regulations
 
There are a number of laws and regulations that regulate bank’s consumer loan and deposit transactions.  Among these are the Community Reinvestment Act, the Truth in Lending Act, the Truth in Savings Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the Electronic Funds Transfer Act and the Fair Debt Collections Practices Act.  There are numerous disclosure and other compliance requirements associated with these rules and regulations, and the Company must comply with the applicable provisions as part of its ongoing customer relations.
 
Federal Reserve Board
 
We are regulated by the Federal Reserve Board under the Federal Bank Holding Company Act (“BHC Act”), which requires every bank holding company to obtain the prior approval of the Federal Reserve Board before acquiring more than 5% of the voting shares of any bank or all, or substantially all, of the assets of a bank, and before merging or consolidating with another bank holding company.  Federal Reserve Board policy, which has been added also to the Federal Deposit Insurance Act by the Dodd-Frank Act, provides that a bank holding company must serve as a source of financial strength to its subsidiary bank(s).  In adhering to the Federal Reserve Board policy, Bancorp may be required to provide financial support for the Bank at a time when, absent such policy, Bancorp may not otherwise deem it advisable to provide such assistance.
 
The Gramm-Leach-Bliley Act authorizes bank holding companies that qualify as “financial holding companies” to engage in securities, insurance and other activities that are financial in nature or incidental to a financial activity.  The activities of bank holding companies that are not financial holding companies continue to be limited to activities authorized under the BHC Act, such as activities that the Federal Reserve Board previously has determined to be closely related to banking and permissible for bank holding companies.  Bancorp has been determined to be non-complex and, therefore, does not qualify as a “financial holding company.”
 
With respect to expansion, we may establish branch offices anywhere within the State of Florida with regulatory approval. The Dodd-Frank Act allows commercial banks and thrifts to branch interstate anywhere in the United States with regulatory approval.  We are also subject to the Florida banking and usury laws limiting the amount of interest that can be charged when making loans or other extensions of credit.  In addition, the Bank, as a subsidiary of Bancorp, is subject to restrictions under federal law in dealing with Bancorp and other affiliates.  These restrictions apply to extensions of credit to an affiliate, investments in the securities of an affiliate, and the purchase of assets from an affiliate.
 
Dividends received from the Bank historically have been Bancorp’s principal source of funds to pay its expenses and interest on, and principal, of Bancorp’s debt.  Banking regulations and enforcement actions require the maintenance of certain capital levels and restrict the payment of dividends by the Bank to Bancorp or by Bancorp to shareholders.  Commercial banks generally may only pay dividends without prior regulatory approval out of the total of current net profits plus retained net profits of the preceding two years, and banks and bank holding companies are generally expected to pay dividends from current earnings.  Banks may not pay a dividend if the dividend would result in the bank being “undercapitalized” for prompt corrective action purposes, or would violate any minimum capital requirement specified by law or the bank’s regulators.  The Bank has not paid dividends since October 2009 and cannot currently pay dividends.  Bancorp cannot currently pay dividends on its capital stock under applicable Federal Reserve policies.  Bancorp has relied upon revolving loan agreements with its directors as well as recent capital raise activities to pay its expenses during such time.  The future ability of the Bank to pay dividends to Bancorp will also depend in part on the FDIC capital requirements in effect at such time and our ability to comply with such requirements.
 
Under Federal Reserve policy, the board of directors of a bank holding company must consider different factors to ensure that its dividend level is prudent relative to maintaining a strong financial position, and is not based on overly optimistic earnings scenarios, such as potential events that could affect its ability to pay dividends, while still maintaining a strong financial position.  As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should consult with the Federal Reserve and eliminate, defer or significantly reduce the bank holding company’s dividends if:
 
its net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends;
 
its prospective rate of earnings retention is not consistent with its capital needs and overall current and prospective financial condition; or
 
it will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios.
JACKSONVILLE BANCORP, INC.
 
ITEM 1. BUSINESS (CONTINUED)
 
Loans and extensions of credit, as well as derivatives and other transactions by all banks, are subject to legal lending limitations.  Under state law, a state bank may generally grant unsecured loans and extensions of credit in an amount up to 15% of its unimpaired capital and surplus to any person.  In addition, a state bank may grant additional loans and extensions of credit to the same person of up to 10% of its unimpaired capital and surplus, provided that the transactions are fully secured.  This 10% limitation is separate from, and in addition to, the 15% limitation for unsecured loans.  Loans and extensions of credit may exceed these general lending limits only if they qualify under one of several exceptions.  Section 611 of the Dodd-Frank Act prohibits state banks from engaging in derivative transactions unless a bank’s chartering state has adopted a law including credit exposure on derivatives in calculating loans to one borrower limits.  As of December 31, 2013, the Bank did not have any derivative transactions, although Bancorp had one interest rate swap not subject to this limitation on the Bank.
 
We are subject to regulatory capital requirements imposed by the Federal Reserve Board and the FDIC.  Both the Federal Reserve Board and the FDIC have established risk-based capital guidelines for bank holding companies and banks which make regulatory capital requirements more sensitive to differences in risk profiles of various banking organizations.  The capital adequacy guidelines issued by the Federal Reserve Board are applied to bank holding companies on a consolidated basis with the banks owned by the holding company.  The FDIC’s risk-based capital guidelines apply directly to banks regardless of whether they are a subsidiary of a bank holding company.  Both agencies’ requirements (which are substantially similar) provide that banking organizations must have minimum capital equivalent to 8% of risk-weighted assets to be considered adequately capitalized. The risk weights assigned to assets are based primarily on the perceived levels of risk to capital.  For example, securities with an unconditional guarantee by the United States government are assigned the lowest risk weighting and a risk weight of 50% is assigned to loans secured by owner occupied one-to-four family residential properties.  The aggregate amount of assets assigned to each risk category is multiplied by the risk weight assigned to that category to determine the weighted values, which are added together to determine total risk-weighted assets.
 
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) created and defined five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized), which are used to determine the nature of any corrective action the appropriate regulator may take in the event an institution reaches a given level of undercapitalization.  For example, an institution which becomes undercapitalized must submit a capital restoration plan to the appropriate regulator outlining the steps it will take to become adequately capitalized.  Upon approving the plan, the regulator will monitor the institution’s compliance.  Before a capital restoration plan will be approved, an entity controlling a bank (i.e., the holding company) must guarantee compliance with the plan until the institution has been adequately capitalized for four consecutive calendar quarters.  The liability of the holding company is limited to the lesser of 5% of the institution’s total assets at the time it became undercapitalized or the amount necessary to bring the institution into compliance with all capital standards.  Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent’s general unsecured creditors.  Also, undercapitalized institutions will be restricted from paying management fees, dividends and other capital distributions, will be subject to certain asset growth restrictions, and will be required to obtain prior approval from the appropriate regulator to open new branches or expand into new lines of business.  As an institution drops to lower capital levels, the extent of action to be taken by the appropriate regulator increases, restricting the types of transactions in which the institution may engage and ultimately providing for the appointment of a receiver for certain institutions deemed to be critically undercapitalized.
 
The FDICIA also requires each federal banking agency to prescribe, and the Federal Reserve Board and the FDIC have adopted, for all insured depository institutions and their holding companies, safety and soundness standards relating to such items as: internal controls, information and audit systems, asset quality, loan documentation, classified assets, credit underwriting, interest-rate risk exposure, asset growth, earnings, compensation, fees and benefits, valuation of publicly traded shares, and such other operational and managerial standards as the agency deems appropriate.  Finally, each federal banking agency was required to prescribe standards for employment contracts and other compensation arrangements with executive officers, employees, directors, and principal shareholders of insured depository institutions that would prohibit compensation and benefits and other arrangements that are excessive or that could lead to a material financial loss.  If an insured depository institution or its holding company fails to meet any of the standards described above, it will be required to submit to the appropriate federal banking agency a plan specifying the steps that will be taken to cure the deficiency.  If an institution fails to submit an acceptable plan or fails to implement a plan, the appropriate federal banking agency will require the institution or holding company to correct the deficiency and, until corrected, may impose further restrictions on the institution or holding company, including any of the restrictions applicable under the prompt corrective action provisions of the FDICIA.  Both the capital standards and the safety and soundness standards that the FDICIA implements were designed to bolster and protect the DIF.
JACKSONVILLE BANCORP, INC.
 
ITEM 1. BUSINESS (CONTINUED)
 
In response to the directives issued under the FDICIA, the regulators have adopted regulations that, among other things, prescribe the capital thresholds for each of five established capital categories. The following table reflects these capital thresholds:
 
 
Total Risk-Based
 
Tier 1 Risk-Based
 
Tier 1
 
Capital Ratio
 
Capital Ratio
 
Leverage Ratio
Well capitalized(1)
10%
 
6%
 
5%
Adequately capitalized(1)
8%
 
4%
 
4%(2)
Undercapitalized(3)
Less than 8%
 
Less than 4%
 
Less than 4%
Significantly undercapitalized
Less than 6%
 
Less than 3%
 
Less than 3%
Critically undercapitalized
 
 
Less than 2%
                                                      

(1) An institution must meet all three minimums.
(2) 3% for CAMELS composite 1 rated institutions, subject to appropriate federal banking agency guidelines.
(3) An institution falls into this category if it is below the adequately capitalized level for any of the three capital measures.
 
Under these capital categories, the Bank was classified as well capitalized as of December 31, 2013 and 2012, respectively.  As of December 31, 2013, the Bank’s total risk-based capital and Tier 1 risk-based capital ratios were 14.11% and 12.83%, respectively.  The Bank’s Tier 1 leverage ratio was 9.33% as of the same date.  In addition to maintaining all capital levels at or above well-capitalized levels, the Bank is committed to maintaining a Tier 1 leverage ratio above 8% and total risk-based capital above 12% at all times.  If the capital ratios of the Bank were to fall below the levels required under regulatory standards, it is the Bank’s policy to increase capital in an amount sufficient to meet regulatory requirements within 30 days.
 
Under federal law and regulations and subject to certain exceptions, the addition or replacement of any director, or the employment, dismissal, or reassignment of a senior executive officer at any time that the Bank is not in compliance with applicable minimum capital requirements, or otherwise in a troubled condition, or when the FDIC has determined that such prior notice is appropriate, is subject to prior notice to, and potential disapproval by, the FDIC.
 
Federal Deposit Insurance Corporation (“FDIC”)
 
The FDIC is an independent federal agency established originally to insure the deposits, up to prescribed statutory limits, of federally insured banks and to preserve the safety and soundness of the banking industry.  The FDIC has adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities.
 
The Bank’s deposit accounts are insured by the FDIC to the maximum extent permitted by law.  The Bank pays deposit insurance premiums to the FDIC based on a risk-based assessment system established by the FDIC for all insured institutions.  Institutions considered well capitalized and financially sound pay the lowest premiums, while those institutions that are less than adequately capitalized and of substantial supervisory concern pay the highest premiums.  Total base assessment rates currently range from 0.03% of deposits for an institution in the highest sub-category of the high category to 0.45% of deposits for an institution in the lowest category.
 
In February 2006, the Federal Deposit Insurance Reform Act of 2005 and the Federal Deposit Insurance Reform Conforming Amendments Act of 2005 (collectively, the “Reform Act”) were signed into law.  The Reform Act revised the laws concerning federal deposit insurance by making the following changes: (i) merged the Bank Insurance Fund and the Savings Association Insurance Fund into a new fund, the Deposit Insurance Fund (DIF), effective March 31, 2006; (ii) increased the deposit insurance coverage for certain retirement accounts to $250 thousand effective April 1, 2006; (iii) effective in 2010, deposit insurance coverage on individual accounts may be indexed for inflation; (iv) the FDIC has more discretion in managing deposit insurance assessments; and (v) eligible institutions received a one-time initial assessment credit.  The Dodd-Frank Act permanently increased the limits on the federal deposit insurance to $250 thousand.
 
The Reform Act authorized the FDIC to revise the risk-based assessment system.  Accordingly, insurance premiums are based on a number of factors, including the risk of loss that insured institutions pose to the DIF.  The Reform Act replaced the minimum reserve ratio of 1.25% with a range of between 1.15% and 1.50% for the DIF, depending on projected losses, economic changes and assessment rates at the end of each calendar year.  In addition, the FDIC is no longer prohibited from charging banks in the lowest risk category when the reserve ratio premium is greater than 1.25%.  As previously discussed, the Dodd-Frank Act made several revisions to the FDIC’s fund management authority.
JACKSONVILLE BANCORP, INC.
 
ITEM 1. BUSINESS (CONTINUED)
 
In November 2006, the FDIC adopted changes to its risk-based assessment system. Under the new system, the FDIC evaluates an institution’s risk based on supervisory ratings for all insured institutions, financial ratios for most institutions and long-term debt issuer ratings for certain large institutions.
 
On September 29, 2009, the FDIC adopted an Amended Restoration Plan to allow the DIF to return to a reserve ratio of 1.15% within eight years.  The FDIC amended its prior ruling on deposit assessments to require insured institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter 2009, and for all of 2010, 2011 and 2012.  This prepaid assessment was collected in December 2009, along with each institution’s regular quarterly risk-based deposit insurance assessment for the third quarter 2009.  The FDIC also increased annual assessment rates uniformly by three basis points effective January 1, 2011.  Additional special assessments may be imposed by the FDIC for future periods.
 
In order to promote financial stability in the economy, the FDIC adopted the Temporary Liquidity Guarantee Program (or “TLGP”) on October 13, 2008.  Participation in the program was voluntary; however, once participation was elected, it could not be revoked.  The Bank elected to participate in the Transaction Account Guarantee Program component of the TLGP, under which the FDIC fully insured funds held in noninterest-bearing transaction accounts.  Noninterest-bearing transaction accounts are ones that do not accrue or pay interest and for which the institution does not require an advance notice of withdrawal.  Also covered under this program were interest on lawyers’ trust accounts (“IOLTA”) and negotiable order of withdrawal (NOW) accounts with interest rates lower than 50 basis points.  These revisions were effective until June 30, 2010 and then extended until December 31, 2010, unless we elected to “opt out” of participating, which we did not do.  The Dodd-Frank Act extended full deposit coverage for noninterest-bearing transaction deposit accounts for two years beginning on December 31, 2010, and all financial institutions were required to participate in this extended program.
 
Following the expiration of the temporary “unlimited” FDIC insurance coverage for noninterest-bearing and IOLTA deposit accounts and beginning January 1, 2013, noninterest-bearing transaction accounts are no longer insured separately from depositors’ other accounts at the same depository institution and the aggregate balance is insured up to the standard FDIC insurance limit of $250 thousand.  Funds deposited in IOLTAs are no longer insured under the Dodd-Frank federal deposit insurance provision; however, these accounts may qualify for certain pass-through coverage applicable to fiduciary accounts as provided for by existing FDIC regulations.  If an IOLTA does not qualify for pass-through coverage as a fiduciary account, then such accounts may be insured up to $250 thousand on a per-client basis.  To the extent that state law requires, additional collateral must be pledged to secure uninsured deposits held by government/public depositors in excess of standard FDIC insurance limitations.
 
Enforcement Policies and Actions
 
The Federal Reserve, the FDIC and the OFR monitor compliance with laws and regulations.  Violations of laws and regulations, or other unsafe and unsound practices, may result in these agencies imposing fines or penalties, cease and desist orders, or taking other enforcement actions.  Under certain circumstances, these agencies may enforce these remedies directly against officers, directors, employees and others participating in the affairs of a bank or bank holding company.
 
In July 2012, and in connection with the FDIC’s March 2012 report of examination of The Jacksonville Bank (the “2012 Report”), the Bank’s Board entered into a memorandum of understanding (the “2012 MoU”) with the FDIC and OFR whereby the Bank agreed to comply in good faith with the requirements of the 2012 MoU.  The 2012 MoU, among other things, required the Bank to:
 
· Within 30 days, establish and reaffirm a Board Committee responsible for ensuring compliance with the provisions of the 2012 MoU;
 
· Develop, submit and implement a written analysis and assessment of the Bank’s current management and staffing needs as well as a plan to meet those needs, and notify the FDIC and OFR of the resignation or termination of any individual on the Bank’s Board or senior executive officer, or if the Bank proposes to add an individual to such positions;
 
· Maintain a Tier 1 leverage capital ratio of not less than 8% and a total risk-based capital ratio of not less than 12%, which shall be calculated as of the end of each calendar quarter;
 
· Review, on at least a quarterly basis, the adequacy of the Allowance for Loan and Lease Losses (“ALLL”) and establish or strengthen the comprehensive policy for determining the adequacy of the ALLL on a timely basis;
 
· Develop and submit written plans to reduce assets classified as “doubtful” and “substandard” in the 2012 Report in the amount of $500 thousand or more, and furnish certain required information pertaining to each asset and the projected impact on the ALLL;
JACKSONVILLE BANCORP, INC.

ITEM 1. BUSINESS (CONTINUED)
 
· Within ten days, charge off the remaining balances of all assets classified “loss” and 50% of those assets or portions of assets classified as “doubtful” in the 2012 Report; and
 
· Develop and submit a written policy for managing other real estate owned, reducing and monitoring the Bank’s concentration of credit in CRE loans, and improve liquidity and funds management consistent with all applicable laws, regulations and other regulatory guidance.
 
As of December 31, 2013 and 2012, the Bank met the minimum capital requirements of the 2012 MoU, with total risk based capital of 14.11% and 12.70% and Tier 1 leverage capital of 9.33% and 8.29%, respectively.  The Bank believes that it has complied substantially with the terms of the 2012 MoU.
 
In August 2008, and in connection with the FDIC’s February 2008 report of examination of The Jacksonville Bank (the “2008 Report”), the Bank’s Board entered into a memorandum of understanding (the “2008 MoU”) with the FDIC and the OFR whereby the Bank agreed to comply in good faith with the requirements of the 2008 MoU.  As a result of the 2008 MoU, management and the Bank’s Board took the following actions:
 
Credit Related:
 
· Charged off all remaining balances on loans deemed “loss” in the 2008 Report;
 
· Amended the loan policy to include items mentioned in the 2008 Report;
 
· Implemented a more comprehensive policy and methodology in assessing the adequacy of the ALLL and reassessed the adequacy of the first quarter 2008 analysis;
 
· Created Cited Loan Reports and began reporting them to the Bank’s Board on a monthly basis;
 
· Began monitoring CRE concentrations and developed a plan to reduce the exposure; and
 
· Strengthened the loan documentation process and corrected all exceptions identified in the 2008 Report.
 
Staffing:
 
· Performed a staffing analysis which resulted in upgrading two management positions (portfolio manager and deposit operations manager).
 
The Bank believes that it complied substantially with the terms of the 2008 MoU, with the exception of the minimum capital requirements as of December 31,
2011, when the Bank had total risk-based capital of 9.85% and Tier 1 leverage capital of 6.88%.  The 2008 MoU was replaced by the 2012 MoU.
 
For Additional Information
 
We are required to comply with the informational requirements of the Securities Exchange Act of 1934, as amended, and, accordingly, we file annual reports, quarterly reports, current reports, proxy statements and other information with the Securities and Exchange Commission (the “SEC”).  You may read or obtain a copy of these reports at the SEC’s public reference room at 100 F. Street, N.E., Washington, D.C. 20549 on official business days during the hours of 10:00 a.m. to 3:00 p.m..  You may obtain information on the operation of the public reference room and their copy charges by calling the SEC at 1-800-SEC-0330.  The SEC maintains a website that contains registration statements, reports, proxy information statements and other information regarding registrants that file electronically with the SEC.  The address of the website is http://www.sec.gov.  You may also access our filings with the SEC through our website at http://www.jaxbank.com.  Information on our website is not incorporated by reference into this report.  You may also obtain copies of our filings with the SEC, including this Annual Report on Form 10-K, free of charge, by writing to Glenna Riesterer, Corporate Secretary, Jacksonville Bancorp, Inc., 100 North Laura Street, Jacksonville, Florida 32202.
JACKSONVILLE BANCORP, INC.

ITEM  1A. RISK FACTORS
 
An investment in our capital stock involves a number of risks.  Before making an investment decision, you should carefully consider all of the risks, including those discussed below and elsewhere in this report.  The realization of events pertaining to any of these risks could have a materially adverse effect on our business, financial condition and results of operations as well as the market value of our capital stock.  Additional risks not presently known to the Company, or currently deemed immaterial, may also adversely affect our business, financial condition or results of operations.
 
RISKS RELATED TO OUR BUSINESS
 
We operate in a heavily regulated environment.
 
The Company and its subsidiaries are subject to extensive regulation and supervision by federal, state and local governmental authorities, including the Federal Reserve, the FDIC, and the OFR.  Banking regulations govern the activities in which we may engage and are primarily intended to protect depositors and the banking system as a whole, not the interests of shareholders.  These regulations impact our lending and investment practices, capital structure and dividend policy, among other things.  The financial services industry is subject to frequent legislative and regulatory changes and proposed changes, including sweeping changes resulting from the Dodd-Frank Act, the full-impact of which cannot be predicted.  Changes to such regulations may have a materially adverse effect on our operations by subjecting the Company to additional compliance costs, restrictions on our operations, and other enforcement actions in the event of noncompliance.
 
We are also required to comply with various corporate governance and financial reporting requirements under the Sarbanes-Oxley Act of 2002, as well as rules and regulations adopted by the SEC, the Public Company Accounting Oversight Board and NASDAQ.  In particular, we are required to include management reports on internal controls as part of our Annual Report on Form 10-K pursuant to Section 404 of the Sarbanes-Oxley Act. The SEC also has proposed a number of new rules or regulations requiring additional disclosure, including compensation rules under the Dodd-Frank Act.  We expect to continue to spend significant amounts of time and money on compliance with these rules.  Any failure to track and comply with the various rules may have a materially adverse effect on our reputation, our ability to obtain the necessary certifications to financial statements, and the value of our securities.
 
Recent legislation, regulatory initiatives and government actions in response to market and economic conditions may significantly affect our business, capital requirements, financial condition and results of operations.
 
The Dodd-Frank Act restructured the regulation of depository institutions and the financial services industry.  The Consumer Financial Protection Bureau was created largely to administer and enforce consumer and fair lending laws, a function that has historically been performed by the depository institution regulators.  The full impact of the Dodd-Frank Act on our business and operations will not be fully known until all regulations implementing the Act are written and adopted.  The Dodd-Frank Act may have a material impact on our operations, particularly through increased compliance costs resulting from possible changes to future consumer and fair lending regulations.  The Dodd-Frank Act also permanently increased the limits on federal deposit insurance to $250 thousand.
 
In June of 2012, the Federal Reserve and the FDIC proposed new capital rules to implement the Basel III capital guidelines.  On July 2, 2013, the Federal Reserve approved the final rules which implement changes to the regulatory capital framework including, but not limited to, revised definitions of “capital” for regulatory purposes, the types and minimum levels of capital required under the prompt corrective action rules and for other regulatory purposes, and the risk-weighting of various assets.  While various provisions have been included in the final rules to provide relief to banking organizations under $50.0 billion in assets, such as community banks like ours, the final rules could have a significant impact on our capital and the amount of capital required to support our business, especially on a risk-weighted basis.  The final Basel III rules took effect January 1, 2014 with a mandatory compliance deadline of January 1, 2015 for banking organizations with total assets less than $250.0 billion.  The Company is currently evaluating the impact of adopting these new rules; however, the cost of implementation combined with the impact on our capital requirements may adversely affect our financial condition and results of operations.
 
In addition to U.S. based regulatory initiatives, the federal government is also coordinating reform activities with other countries.  There can be no assurance that these various initiatives or any other future legislative or regulatory initiatives will be successful at improving economic conditions globally, nationally or in our markets, or that the measures adopted will not adversely affect our operations, financial condition and earnings.
JACKSONVILLE BANCORP, INC.
 
ITEM  1A. RISK FACTORS (CONTINUED)
 
We are required to maintain capital to meet regulatory requirements.  If we fail to maintain sufficient capital, our financial condition, liquidity and results of operations, as well as our regulatory requirements, could be adversely affected.
 
Both Bancorp and the Bank must meet regulatory capital requirements and maintain sufficient capital and liquidity and our regulators may modify and adjust such requirements in the future. The Bank’s Board of Directors has agreed to a Memorandum of Understanding (the “2012 MoU”) with the FDIC and the OFR for the Bank to maintain a total risk-based capital ratio of 12.00% and a Tier 1 leverage ratio of 8.00%.  As of December 31, 2013, the Bank was well capitalized for regulatory purposes and met the capital requirements of the 2012 MoU.  If noncompliance or other events cause the Bank to become subject to formal enforcement action, the FDIC could determine that the Bank is no longer “adequately capitalized” for regulatory purposes.  Failure to maintain sufficient capital, whether due to losses, an inability to raise additional capital or otherwise, could affect customer confidence, our ability to grow, our costs of funds and FDIC insurance costs, our ability to make distributions on our trust preferred securities, and our business, results of operation, liquidity and financial condition, generally.
 
The soundness of other financial institutions could adversely affect us.
 
Our ability to engage in routine funding and other transactions could be adversely affected by the actions and commercial soundness of other financial institutions.  Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships.  As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems, losses of depositor, creditor and counterparty confidence and could lead to losses or defaults by us or by other institutions.  We could also experience increases in deposits and assets as a result of other banks’ difficulties or failure, which would increase the capital we need to support such growth.
 
As a member institution of the FDIC, we are assessed a quarterly deposit insurance premium.  Bank failures have significantly depleted the FDIC’s DIF and reduced its ratio of reserves to insured deposits.  As a result, the FDIC has adopted a revised risk-based deposit insurance assessment schedule which raised deposit insurance premiums, and the FDIC has also implemented a special assessment on all depository institutions, which may be imposed in future periods if needed.  Regulatory assessments were $0.8 million, $0.9 million and $1.0 million for the years ended December 31, 2013, 2012 and 2011, respectively.  Due to our levels of problem assets and related risk-weightings, these assessments have significantly increased our noninterest expense in recent years and may continue to adversely affect our results of operations in future periods.
 
Difficult market conditions have adversely affected and may continue to affect us and the financial services industry.
 
We are exposed to downturns in the U.S. economy and, particularly, in the local markets in which we operate in Florida.  Declines in the housing markets, including falling home prices and low sales volumes, as well as foreclosures, have negatively affected the credit performance of mortgage and commercial real estate loans and resulted in significant write-downs of asset values by the Bank and financial institutions in general, including government-sponsored entities and major commercial and investment banks.  These write-downs have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.  Many lenders and institutional investors have reduced or ceased providing funding to borrowers, including other financial institutions.  This market turmoil and the tightening of credit have led to increased levels of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility, reduced real estate values and sales volumes, reduced credit availability for real estate borrowers and reductions in general business activities.  The resulting economic pressure on consumers and borrowers and reduced confidence in the financial markets has adversely affected our business, financial condition and results of operations.
 
Although the difficult conditions in the financial markets appear to be stabilizing or improving, a continuation or worsening of present conditions would likely have adverse effects on us and other financial institutions, including the following:
 
· Reduced ability to assess the creditworthiness of customers or to estimate the value of assets, especially in regards to collateral securing existing loans.  We estimate losses inherent in our credit exposure, the adequacy of our allowance for loan losses and the values of certain assets by using estimates based on difficult, subjective, and complex judgments, including estimates as to the effects of economic conditions and how these economic conditions might affect the value of assets or the ability of our borrowers to repay their loans.  If the models and approaches we use become less predictive of future behaviors, valuations, assumptions or estimates, the value of collateral, especially real estate, associated with existing loans may be reduced and consequently increase our credit risk exposure;
JACKSONVILLE BANCORP, INC.

ITEM  1A. RISK FACTORS (CONTINUED)
 
· Reduced ability to raise capital or borrow funds from other financial institutions on favorable terms, or at all.  The availability of capital or borrowed funds may also experience adverse effects from continued disruptions in the capital markets, or other events, including, among other things, changes in investor expectations; and
 
· Failures of other depository institutions in our markets and increasing consolidation of financial services companies as a result of current market conditions could increase our deposits and assets, necessitating additional capital, and may have unexpected adverse effects upon our ability to compete effectively or attract capital as needed.
 
Our results are significantly impacted by the economic conditions of our principal market areas.
 
The success of our operations depends on the general economic conditions of the State of Florida and the specific markets we serve.  Unlike larger organizations that are more geographically diverse, our operations are concentrated in Jacksonville, Duval County, Florida and the surrounding areas.  As a result of our geographic concentration, the economic conditions in our primary market areas have a significant impact on our financial results, including the demand for the Bank’s products and services, the ability of our customers to repay loans, the value of collateral securing existing loans, and the stability of our funding sources.  This is particularly true because a number of our borrowers are small businesses that may be less able to withstand competitive, economic and financial pressures than larger borrowers.  Consequently, their ability to repay loans may be especially adversely affected during economic downturns which could lead to higher rates of loss and loan payment delinquencies.  Moreover, the value of the real estate or other collateral that may secure our loans could be adversely affected if local economic conditions experience further deterioration.  If a borrower is unable to repay its loan and the value of the underlying real estate collateral declines to a point that is below the amount of the loan, then we will suffer a loss.
 
Weaknesses in the real estate markets, including the secondary market for residential mortgage loans, have adversely affected us and may continue to adversely affect us.
 
Financial institutions continue to be affected by ongoing challenges in real estate markets and secondary mortgage markets.  Increased volatility in housing markets, combined with the correction in residential real estate market prices and reduced levels of home sales, could result in further price reductions in single family home values and continue to adversely affect the liquidity and value of collateral securing our real estate-related loans.  This is especially true for collateral securing commercial loans for residential land acquisition, construction and development, as well as residential mortgage loans and residential property securing loans currently outstanding.  Additional consequences of continued deterioration of the housing markets include reduced mortgage loan originations and reduced gains on the sale of mortgage loans.
 
Declining real estate prices have caused higher delinquencies and losses on certain mortgage loans in general, and particularly with regard to second lien mortgages and home equity lines of credit.  Significant ongoing disruptions in the secondary market for residential mortgage loans have limited the market for, and liquidity of, most residential mortgage loans other than conforming Fannie Mae and Freddie Mac loans.  These trends could continue despite various government programs to boost the residential mortgage markets and stabilize the housing markets.
 
Our financial condition, including capital and liquidity, and results of operations have been, and may continue to be, adversely affected by declines in real estate values and home sales volumes, financial stress on borrowers as a result of unemployment, interest rate resets on adjustable rate mortgage loans or other factors that result in higher delinquencies and increased charge-offs related to credit losses.  Furthermore, in the event that our allowance for loan losses is insufficient to cover such losses, our earnings, capital and liquidity could be adversely affected.
 
Our concentration of real estate mortgage loans and loans secured by real estate may continue to adversely affect our financial condition and results of operations.
 
As of December 31, 2013 and 2012, approximately 87.6% and 89.8% of the Company’s loan portfolio consisted of real estate mortgage loans, respectively.  Commercial real estate (“CRE”) loans are especially cyclical and pose risks of loss to us due to concentration levels and similar risks of the asset.  CRE loans represented 68.4% and 69.6% of our loan portfolio as of December 31, 2013 and 2012, respectively.  Banking regulators continue to give CRE lending greater scrutiny and banks with higher levels of CRE loans are expected to implement improved underwriting, internal controls, risk management policies and portfolio stress testing.  In addition, an increased concentration of CRE loans requires higher levels of allowances for possible losses and capital levels as a result of CRE lending growth and exposures.  The downturn in the real estate market, the continued deterioration in the value of collateral, and the local and national economic recessions have adversely affected our customers’ ability to sell or refinance real estate and repay their loans.  If these conditions persist, or worsen, our customers’ ability to repay their loans will be further eroded.  In the event we are required to foreclose on a property securing one of our mortgage loans, or otherwise pursue remedies in order to protect our investment, we may be unable to recover enough value from the collateral to prevent a loss.
JACKSONVILLE BANCORP, INC.

ITEM  1A. RISK FACTORS (CONTINUED)
 
The amount that we, as a mortgagee, may realize after a default and foreclosure is dependent upon factors outside of our control, including, but not limited to:
 
· general or local economic conditions;
 
· environmental clean-up liability;
 
· neighborhood values;
 
· real estate tax rates;
 
· operating expenses of the foreclosed properties;
 
· ability to obtain and maintain adequate occupancy of the properties;
 
· zoning laws, governmental rules, regulations and fiscal policies; and
 
· natural disasters.
 
Certain expenditures associated with the ownership of real estate, principally real estate taxes and maintenance costs, may adversely affect the income from the real estate.  In the event that the cost of operating real property exceeds the rental income earned from such property, we may be required to advance funds in order to protect our investment or dispose of the real property at a loss.
 
Current levels of market volatility are significant, and negative conditions and new developments in the financial services industry and the credit markets have and may continue to adversely affect our operations, financial performance and stock price.
 
The capital and credit markets have been experiencing volatility and disruption for the past several years.  The markets have placed downward pressure on stock prices and the availability of capital, credit and liquidity has been adversely affected for many issuers, in some cases, without regard to those issuers’ underlying financial condition or performance.  If current levels of market disruption and volatility continue or worsen, we may experience adverse effects, which may be material, on our ability to maintain or access capital and credit, and on our business, financial condition (including liquidity) and results of operations.
 
The financial markets are experiencing adverse effects due to economic uncertainties, including its direction and growth, as well as high unemployment rates.  As a result of the weak economy and a decline in the value of collateral supporting loans, especially with respect to the State of Florida, many financial institutions have seen deterioration in loan portfolio performance.  In addition, stock prices of bank holding companies, like us, have been negatively affected by the recent and current conditions in the financial markets, as has our ability to raise capital as needed, compared to the period preceding the latest economic recession.
 
We operate in a highly competitive market.
 
We face competition for deposits, loans and other financial services from other community banks, regional banks, out-of-state and in-state national banks, savings banks, thrifts, credit unions and other financial institutions.  The Company also faces competition from other entities that provide financial services, including consumer finance companies, securities brokerage firms, mortgage brokers, insurance companies, mutual funds, and other lending sources and alternative investment providers.  Some of these financial institutions and financial services organizations are not subject to the same degree of regulation as we are and may have lower cost structures.  Many of our competitors offer products and services different from us, and have substantially greater resources, name recognition and market presence than we do, which benefit them in attracting business.  Larger competitors may be able to price loans and deposits more aggressively than we can, and have broader customer and geographic bases to draw upon.  Failure to compete effectively to attract new and retain current customers could adversely affect our growth and profitability, which could have a materially adverse effect on our financial condition and results of operations.
 
The banking industry is also subject to increased competition as a result of rapid technological changes with the frequent introduction of new technology-driven products and services.  In addition to providing better service to customers, the effective use of technology increases efficiency and may enable us to reduce costs.  Our future success depends in part upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience as well as to create additional operating efficiencies.  Many of our competitors, especially large national and regional banks, have substantially greater resources to invest in technological improvements, which may permit them to perform certain functions at a lower cost than we can.  There is no assurance that we will be able to implement new technology-driven products and services effectively or efficiently or be successful in marketing these to our customers, which may reduce our ability to compete effectively in the industry.
JACKSONVILLE BANCORP, INC.

ITEM  1A. RISK FACTORS (CONTINUED)
 
We could be negatively impacted by changes in interest rates.
 
Our results of operations and financial condition may be materially and adversely affected by changes in interest rates or the yield curve, and the monetary and fiscal policies of the federal government.  Our profitability is largely a function of the spread between the interest rates earned on investments and loans and those paid on deposits and other liabilities.  Changes in interest rates may negatively affect our earnings and the value of our assets as well as our levels of interest income, interest expense and net interest spread and margin.  If our assets reprice more slowly than our deposits and other liabilities, our earnings will be adversely affected if interest rates rise, but will benefit if the interest rates on our earning assets rise more quickly than the interest rates we pay on our deposits and other liabilities.  Most banks, including us, have experienced compression and reduced interest spreads and margins as a result of current historically low interest rates.  Our interest spreads and net interest margins are also affected by the shape of the yield curve, which is affected especially by monetary policy, including the Federal Reserve’s actions to keep interest rates low in recent years and its stated intent to maintain this stance into late 2014.  While we seek to manage our interest-rate risk, these measures are based on estimates and assumptions that may not be realized.
 
Changes in accounting and tax rules applicable to banks and bank holding companies could adversely affect our financial conditions and results of operations.
 
From time to time, the Financial Accounting Standards Board (“FASB”) and SEC change the financial accounting and reporting standards that govern the preparation of our financial statements.  These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations.  In some cases, we could be required to apply a new or revised standard retroactively, resulting in us restating prior period financial statements.
 
The Company’s exposure to operational and organizational risk may have a materially adverse effect on the business, our financial condition and results of operations.
 
Similar to other financial institutions, the Company and its subsidiaries are exposed to many types of operational risk, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, the risk that sensitive customer or Company data may be compromised, and the risk of operational errors, including clerical or record-keeping errors.  The Company seeks to mitigate operational risks through a system of internal controls; however, there can be no assurance that these efforts will be successful or result in a reduction of the intended risk exposure.  Failure to do so may result in losses incurred by the Company, including explicit charges, increased operational costs in the form of noninterest expenses, litigation costs, harm to the Company’s reputation, and forgone opportunities with regards to future growth.  Such losses may have a materially adverse effect on the business, our financial condition and results of operations.
 
Reputational risk and social factors may impact our results of operations.
 
Our ability to originate and maintain accounts is highly dependent upon customer and other external perceptions of our business practices and financial health.  Adverse perceptions regarding our business practices or financial health could damage our reputation in both the customer and funding markets, leading to difficulties in generating and maintaining accounts as well as in financing them.  Adverse developments with respect to the consumer or other external perceptions regarding the practices of our competitors, or the financial services industry as a whole, may also adversely impact our reputation.  Negative public opinion surrounding our Company or our industry may also result in greater regulatory or legislative scrutiny, which may lead to laws, regulations or regulatory actions that may change or constrain the manner in which we engage with our customers and the products we offer.  Adverse reputational impacts or events may also increase our litigation risk.
 
The loss of key personnel may adversely affect our operating results.
 
Our success is, and is expected to remain, highly dependent on our senior management team.  We rely heavily on our senior management because, as a community bank, our management’s extensive knowledge of, and relationships in, the community generates business for us.  Successful execution of our business strategies will continue to place significant demands on our management and the loss of any such person’s services may adversely affect our ability to resolve these problems, recapitalize the Company, resume our growth and return to profitability.
JACKSONVILLE BANCORP, INC.

ITEM  1A. RISK FACTORS (CONTINUED)
 
On December 4, 2013, the Company appointed Kendall L. Spencer as President and Chief Executive Officer to provide advanced leadership and commercial banking management expertise as well as additional proficiencies in strategic financial planning and execution of operational initiatives.  An employment agreement was executed with Mr. Spencer with equity awards subject to certain conditions.  We also continue to rely upon the services of Margaret A. Incandela, Executive Vice President, Chief Operating Officer and Chief Credit Officer, Scott M. Hall, Executive Vice President and the Bank’s President, and Valerie A. Kendall, Executive Vice President and Chief Financial Officer.  If the services of these individuals were to become unavailable for any reason, or if we were unable to hire highly qualified and experienced personnel to replace them, our results and financial condition and prospects could be adversely affected.
 
We are exposed to environmental liability risk with respect to other real estate owned.
 
A significant portion of our loan portfolio is secured by real property.  In the ordinary course of business, the Company may foreclose and take title to real estate, and could be subject to environmental liabilities with respect to these properties. We have been aggressively managing problem assets and, as a result, have taken title to the underlying collateral for a number of underperforming loans.  As of December 31, 2013, we had approximately $3.1 million in other real estate owned.  We may be held liable to a governmental entity or to third persons for property damage, personal injury, investigation and clean-up costs incurred in connection with environmental contamination, or may be required to investigate or clean up hazardous or toxic substances, or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial.  In addition, as the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property.  If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity, results of operations and prospects could be materially and adversely affected.
 
Our lending limit restricts our ability to compete with larger financial institutions and may limit our growth.
 
As of December 31, 2013, our per customer lending limit was approximately $11.9 million, subject to further reduction based on regulatory criteria relevant to any particular loan.  Accordingly, the size of loans which we can offer to potential customers is less than the size that many of our competitors with larger lending limits are able to offer.  This limit has affected and will continue to affect our ability to seek relationships with larger businesses in the market.  We seek to accommodate loans in excess of our lending limit through the sale of portions of such loans to other banks although this market has been disrupted from time to time in recent years, as other banks have exited the market or failed, and we may lose loans to competitors.  Our lending limit also impacts the efficiency of our lending activities because it lowers our average loan size, which means we have to generate an increased number of transactions in order to achieve the same portfolio volume as other institutions with higher lending limits.
 
The Company is exposed to credit risk as a result of reliance on the accuracy and completeness of information about clients and counterparties.
 
The Company often relies on information furnished by or on behalf of customers and counterparties when deciding whether to extend credit or enter into other transactions.  Financial statements, credit reports, and related financial information are considered in conjunction with certain representations of those customers, counterparties or other third parties for which there are limited opportunities for management to independently verify.  For example, management may assume that a customer’s audited financial statements conform to U.S. GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. Reliance on materially misleading information with regards to lending arrangements could have a materially adverse effect on the quality of our loan portfolio and may result in additional losses in the event of borrower default.  Such effects may adversely impact the Company’s overall asset quality, financial condition and results of operations.
 
The allowance for loan losses may not be adequate to cover actual losses.
 
Our success depends to a significant extent upon the quality of our assets, particularly loans.  In originating loans, there is a substantial likelihood that credit losses will be experienced.  The risk of loss will vary with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the quality of the collateral for the loan.  Management maintains an allowance for loan losses based on, among other things, anticipated experience, an evaluation of economic conditions, and regular reviews of delinquencies and loan portfolio quality.  Based upon such factors, management makes various assumptions and judgments about the ultimate collectability of the loan portfolio and provides an allowance for probable loan losses based upon a percentage of the outstanding balances and for specific loans when their ultimate collectability is considered questionable.  Our regulators may also require us to add to our provision for loan losses in the ordinary course of their review of the Bank.
JACKSONVILLE BANCORP, INC.

ITEM  1A. RISK FACTORS (CONTINUED)
 
As of December 31, 2013, our allowance for loan losses was $15.8 million which represented 4.25% of our gross loan portfolio as of the same date.  Nonperforming assets consisted of approximately $17.0 million in nonperforming loans and $3.1 million in other real estate owned.  Management monitors our asset quality and seeks to maintain an adequate loan loss allowance; however, the allowance may not prove sufficient to cover future loan losses.  Furthermore, although management uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the assumptions used or adverse developments arise with respect to our nonperforming or performing loans.  Accordingly, the allowance for loan losses may not be adequate to cover loan losses, or significant increases to the allowance may be required in the future if economic conditions should worsen.  Among other adverse consequences, significant additions to our allowance for loan losses could have a material impact on our financial performance and reduce our net income and capital.
 
Nonperforming assets take significant time to resolve and expose us to increased risk of loss.
 
As of December 31, 2013, our nonperforming loans were $17.0 million, or 4.6% of our gross loan portfolio, and our nonperforming assets (which include nonperforming loans) were $20.1 million, or 4.0% of total assets.  In addition, we had approximately $5.9 million in loans past due 30-89 days and still accruing interest as of December 31, 2013.  The Company experienced a decrease in nonperforming assets of approximately $9.6 million from the prior year ended December 31, 2012.  As of December 31, 2012, our nonperforming loans were $22.7 million, or 5.7% of our gross loan portfolio, and our nonperforming assets (which include nonperforming loans) were $29.7 million, or 5.3% of total assets. In addition, we had approximately $4.6 million in accruing loans that were 30-89 days delinquent as of December 31, 2012.
 
We do not record interest income on nonperforming loans or other real estate owned, thereby adversely affecting our income and increasing our loan administration costs.  We also incur the costs of funding problem assets and other real estate owned.  When we take collateral in foreclosures and similar proceedings, we are required to mark the collateral to our then fair value less expected selling costs, which, when compared to the principal amount of the loan, may result in a loss.  In addition, given the increased levels of mortgage foreclosures in our market areas, the foreclosure process is now taking longer than it has in recent years; this has served to increase the cost of foreclosures and the time needed to take title to the underlying property.  Once we take possession of foreclosed real estate, the costs of maintenance, taxes, security and potential environmental liability can be significant and serve to decrease the amount of recovery we may realize upon a sale of the property.
 
As described above, our nonperforming assets can adversely affect our net income in a variety of ways, which negatively affects our results of operations and financial condition. While we have used loan sales, workouts, restructurings and other activities to improve our level of problem assets, decreases in the value of these assets, or the underlying collateral, or in the related borrowers’ performance or financial condition may adversely affect our business, results of operations and financial condition, whether or not due to economic and market conditions beyond our control.  In addition, the resolution of nonperforming assets requires significant commitments of time from management and our directors, which can be detrimental to the performance of their other responsibilities. Until economic and market conditions significantly improve, there can be no assurance that we will not experience an increase in nonperforming assets in future periods.  As a result, we may continue to incur additional losses related to nonperforming assets, including losses on the potential disposition of loans and foreclosed assets.
 
We have had to adjust the valuation allowance against our deferred tax assets and reduce our deferred tax asset to zero.
 
We evaluate deferred tax assets for recoverability based on all available evidence.  This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws or variances between future projected operating performance and actual results.  As of the end of 2011, the Company established a valuation allowance for all our deferred tax assets, based on available evidence at the time, that it was more-likely-than-not that all of the deferred tax assets would not be realized.    In determining the more-likely-than-not criterion, management evaluates all positive and negative evidence as of the end of each reporting period.  As of December 31, 2013 and 2012, respectively, the Company determined that the need for a full valuation allowance still existed.  Future adjustments, either increases or decreases, to the deferred tax asset valuation allowance will be determined based upon changes in the expected realization of the net deferred tax assets.  The realization of the deferred tax assets ultimately depends on the existence of sufficient taxable income in either the carry-back or carry-forward periods under the tax law.  Due to significant estimates utilized in establishing the valuation allowance and the potential for changes in facts and circumstances, we may or may not be able to recapture these deferred tax assets in future periods.
JACKSONVILLE BANCORP, INC.

ITEM  1A. RISK FACTORS (CONTINUED)
 
Our location on the east coast of Florida makes us susceptible to disruptions in operations due to weather-related problems.
 
Our Bank branches and corporate headquarters are located in the Jacksonville and Jacksonville Beach, Duval County, Florida area and are vulnerable to tropical storms, hurricanes, tornadoes and flood and wind damage.  We cannot predict whether or to what extent damage that may be caused by future weather events will affect our operations or the economies in our current or future market areas.  Such weather events could result in a decline in loan originations, a decline in the value or destruction of properties securing our loans and an increase in payment delinquencies, foreclosures or loan losses.  Our business or results of operations may be adversely affected by these and other negative effects of future weather events.  Many of our customers have incurred significantly higher property and casualty insurance premiums on their properties located in our markets, which may adversely affect real estate sales and values in our markets.
 
System failures, interruptions or breaches of security could adversely impact our business and results of operations.
 
Technology and information systems are essential to our daily business operations, such as systems to manage accounting activities, customer deposits and loan operations.  In addition, the Bank provides its customers the ability to bank online.  While the Company has established policies and procedures to prevent or limit the impact of system failures, interruptions and security breaches, there can be no assurance that such events will not occur or that they will be adequately addressed if they do occur.  In addition, the secure transmission of confidential information over the Internet is a critical element of online banking.  The Bank’s network or those of its customers could be vulnerable to unauthorized access, computer viruses, phishing schemes and other security problems.  In order to mitigate these risks, the Bank may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses.  Any inability to prevent security breaches or computer viruses could expose the Bank to litigation or other liabilities and also cause existing customers to lose confidence in the Bank’s systems which could adversely affect our reputation and the ability to generate deposits, and, in turn, adversely affect our financial condition and results of operations.
 
We are dependent on the operating performance of the Bank to provide us with operating funds in the form of cash dividends, and the Bank is subject to regulatory limitations regarding the payment of dividends.
 
We are a bank holding company and, in the ordinary course of business, are dependent upon dividends from the Bank for funds to pay expenses and, if declared, cash dividends to shareholders.  A Florida state-chartered commercial bank may not pay cash dividends that would cause the bank’s capital to fall below the minimum amount required by federal or state law.  Accordingly, commercial banks may only pay dividends out of the total of current net profits plus retained net profits of the preceding two years to the extent it deems expedient, except no bank may pay a dividend at any time that the total of net income for the current year when combined with retained net income from the preceding two years, produces a loss.  In addition, banks may not pay a dividend if the dividend would result in the bank being “undercapitalized” for prompt corrective action purposes, or would violate any minimum capital requirement specified by law or the Bank’s regulators.  The Bank cannot currently pay dividends without prior regulatory approval.  Therefore, the Bank may not be able to provide Bancorp with adequate funds to conduct ongoing operations, which would adversely affect our liquidity, financial condition and results of operations.
 
More specifically, reduced liquidity may adversely affect Bancorp’s ability to pay interest on material company debt in the form of junior subordinated debt related to its trust preferred securities.  As of December 31, 2013, Bancorp had approximately $16.2 million of junior subordinated debentures issued incident to trust preferred securities and another $1.1 million of other liabilities.  Bancorp has depended on the revolving loan agreements with its directors, cash on hand, and most recently, net proceeds from capital raise transactions to pay its operating expenses and interest expenses related to its material debt obligations.  As of December 31, 2013, Bancorp had approximately $3.5 million of cash on hand and $2.2 million in funds available under its revolving loan agreements.  There is no assurance that these sources of liquidity will be sufficient to meet Bancorp’s expenses going forward.
 
Our business may face significant risks with respect to future expansion.
 
To supplement our current growth strategy, we may continue to acquire other financial institutions or parts of financial institutions in the future and we may engage in additional de novo branch expansion.  Acquisitions and mergers involve a number of risks, including but not limited to the following:
 
· the time and costs associated with identifying and evaluating potential acquisitions and merger partners, and negotiations and consummation of any such transactions;
JACKSONVILLE BANCORP, INC.

ITEM  1A. RISK FACTORS (CONTINUED)
 
· the estimates and judgments used to evaluate credit, operations, management and market risks with respect to the target institution may not be accurate;
 
· the time and costs of evaluating new markets, hiring experienced local management and opening new offices, and the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;
 
· our ability to finance an acquisition and possible dilution to our existing shareholders;
 
· the diversion of our management’s attention to the negotiation of a transaction, and the integration of the operations and personnel of the combining businesses;
 
· entry into new markets where we lack experience;
 
· the introduction of new products and services into our business;
 
· the incurrence and possible impairment of goodwill and other intangible assets associated with an acquisition and possible adverse effects on our results of operations; and
 
· the risk of loss of key employees and customers.
 
We may incur substantial costs to expand and can give no assurance that such expansion will result in the levels of profits we would expect. We may issue equity securities, including common stock, in connection with future acquisitions, which could cause ownership and economic dilution to our shareholders. There is no assurance that, following any future mergers or acquisitions, our integration efforts will be successful or, after giving effect to the acquisition, that we will achieve profits comparable to, or better than, our historical experience.
 
We have incurred losses in recent years and there is no assurance that current income will be sustained or that additional losses will not occur in future periods.
 
For the years ended December 31, 2012 and 2011, we incurred a net loss of $43.0 million and $24.1 million, respectively.  In response to recent losses, management raised additional capital and implemented a strategy to accelerate the disposal of substandard assets in order to strengthen the Company’s balance sheet, increase tangible common equity and improve capital adequacy ratios applicable to Bancorp and the Bank.  These initiatives have resulted in general improvements to the Company’s financial condition, asset quality and results of operations as evidenced by the continued reduction in substandard assets and a significant decrease in our net loss to $960 thousand for the year ended December 31, 2013.  When compared to the same period in 2012, the total reduction in net loss was $42.0 million.  While management believes that these strategies will continue to improve our financial condition and results of operations going forward, there is no assurance that such efforts will be successful or that additional losses will not occur in future periods.
 
Future liquidity needs may exceed our available liquidity sources.
 
Liquidity is essential to our business.  An inability to raise funds through deposits, borrowings, the sale of loans and other sources could limit our asset growth and have a materially adverse effect on our liquidity, financial condition and results of operations.  Our funding sources include federal funds purchases, non-core deposits, and short- and long-term debt.  The Bank is a member of the Federal Home Loan Bank of Atlanta, where we can obtain advances collateralized with eligible assets. The Bank can also use eligible collateral to borrow from the Federal Reserve Bank of Atlanta.  We maintain a portfolio of securities that can be used as a secondary source of liquidity.
 
There are other sources of liquidity available to us on an as-needed basis, including our ability to acquire additional non-core deposits (subject to applicable regulatory restrictions, if any), the sale of debt securities, and the issuance and sale of preferred or common securities in public or private transactions.  Our access to funding sources in amounts adequate to finance or capitalize our activities, or on terms which are acceptable to us, could be impaired by factors that affect us specifically or the financial services industry or economy in general.  Our ability to borrow could also be impaired by factors that are not specific to us, such as further disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of recent turmoil faced by banking organizations and elevated levels of volatility and disruption in the credit markets.
JACKSONVILLE BANCORP, INC.

ITEM  1A. RISK FACTORS (CONTINUED)
 
Additional capital may not be available when needed and, if available, could result in dilution of our shareholders’ ownership interests.
 
Any capital that is generated by our operations over the next several years is expected to be needed to support our operations.  Additionally, our Board may determine from time to time that we need to obtain additional capital through the issuance of additional shares of our common stock or other securities. These issuances likely would dilute the ownership interest of our then-current shareholders, including the per share book value of our common stock and nonvoting common stock and would only require shareholder approval under certain circumstances.  The terms of security issuances by us in future capital transactions may be more favorable to new investors, and may include preferences, superior voting rights and the issuance of warrants, which may have a further dilutive effect of current ownership interests. Also, we may incur substantial costs in pursuing future capital financing, including investment banking fees, legal fees, accounting fees, securities law compliance fees, printing and distribution expenses and other costs, whether or not an offering is completed successfully. We may also be required to recognize non-cash expenses in connection with certain securities we issue, such as convertible notes and warrants, which may adversely impact our financial condition.
 
RISKS RELATED TO OUR COMMON STOCK
 
Shares of capital stock are not an insured deposit.
 
Shares of our common stock and nonvoting common stock are not a bank deposit and are not insured or guaranteed by the FDIC or any other government agency. Investment in our capital stock is subject to investment risk, which could result in a loss of the entire investment.
 
Our common stock is thinly traded and, therefore, shareholders and investors may have difficulty selling shares.
 
Our common stock is thinly traded, which can be more volatile than stock trading in an active public market. We cannot predict the extent to which an active public market for our common stock will develop or be sustained. As a consequence, there may be periods of several days or more when trading activity in our shares is minimal or non-existent, and our shareholders may not be able to sell their shares at the volumes, prices, or times that they desire, or at all.
 
Sales of substantial amounts of our common stock in the open market could depress the stock price of our common stock and the value of our other securities.
 
Through multiple capital raise transactions completed during 2012 and 2013, the Company has registered an additional 5.5 million shares of its common stock and nonvoting common stock.  Each share of nonvoting common stock will automatically convert into one share of common stock in the event of a “permitted transfer” to a transferee.  Shares of the Company’s common stock are freely tradable without restrictions or further registration under the Securities Act of 1933, as amended.    Sales of substantial amounts of these shares in the public market, or the perception that such sales might occur, could adversely affect the market price of our common stock or other securities.  Also, these sales might make it more difficult for us to sell equity or equity-related securities at a time and price that we otherwise would deem appropriate.
 
We may issue additional shares of capital stock, which may dilute the interests of our shareholders, and may adversely affect the market value of our securities.
 
We are currently authorized to issue up to 20.0 million shares of common stock, 5.0 million shares of nonvoting common stock, and 10.0 million shares of preferred stock, of which 3,177,090 shares, 2,618,005 shares and no shares, respectively, were issued and outstanding as of February 28, 2014.  Our Board has the authority, and in certain circumstances without shareholder approval, to issue all or part of the authorized but unissued common stock or nonvoting common stock, and to establish the terms of any series of preferred stock.  Any authorized but unissued shares could be issued on terms or in circumstances that could dilute the interests of other shareholders, including the book value of each share of our common stock and nonvoting common stock.
 
We do not anticipate paying dividends for the foreseeable future.
 
We do not anticipate that dividends will be paid on our common stock or nonvoting common stock for the foreseeable future and intend to retain all earnings, if any, to support our business.  Future dividend payments will depend on Bancorp’s internal dividend policy, earnings, capital and regulatory requirements, financial condition, and other factors considered relevant by Bancorp’s Board.
JACKSONVILLE BANCORP, INC.

ITEM  1A. RISK FACTORS (CONTINUED)
 
A Florida state-chartered commercial bank may not pay cash dividends that would cause the bank’s capital to fall below the minimum amount required by federal or state law.  Accordingly, commercial banks may only pay dividends out of the total of current net profits plus retained net profits of the preceding two years to the extent it deems expedient, except as follows: No bank may pay a dividend at any time that the total of net income for the current year, when combined with retained net income from the preceding two years, produces a loss.  The Bank met this restriction in 2013 as our net income for the year combined with retained earnings from the preceding two years produced a loss.  The future ability of the Bank to pay dividends to Bancorp will also depend in part on the FDIC capital requirements in effect at such time and our ability to comply with such requirements.
 
ITEM 1B. UNRESOLVED STAFF COMMENTS
 
Not applicable.

ITEM 2. PROPERTIES
 
The following table presents the location and other important information pertaining to the Company’s corporate offices and branch offices as of December 31, 2013:
 
Location Type
 
Address
 
Year Location Established
 
Approximate Square Footage
 
Own/Lease
Headquarters/Branch Office(1)
 
100 North Laura Street
 
2004
 
20,547
 
Lease
 
 
Jacksonville, FL 32202
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Branch Office
 
10325 San Jose Boulevard
 
1998
 
3,222
 
Own
 
 
Jacksonville, Florida  32257
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Branch Office
 
12740-200 Atlantic Boulevard
 
2000
 
2,588
 
Own
 
 
Jacksonville, FL 32225
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Branch Office(2)
 
4343 Roosevelt Boulevard
 
2005
 
3,127
 
Lease
 
 
Jacksonville, FL 32210
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Branch Office(3)
 
7880 Gate Parkway
 
2006
 
9,372
 
Lease
 
 
Jacksonville, Florida  32256
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Branch Office
 
1315 South 3rd Street
 
2010
 
4,987
 
Own
 
 
Jacksonville Beach, Florida  32250
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Branch Office
 
560 Atlantic Boulevard
 
2010
 
2,203
 
Own
 
 
Neptune Beach, Florida  32266
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Branch Office(4)
 
14288 Beach Boulevard
 
2011
 
3,883
 
Lease
 
 
Jacksonville, FL 32250
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Administrative Office(5)
 
1790 Kernan Boulevard
 
2010
 
3,120
 
Own Building/
 
 
Jacksonville, FL 32246
 
 
 
 
 
Lease Land
                                                      

(1) The Bank amended its ten-year lease for our headquarters location effective April 25, 2011 to extend the end of the lease term from September 14, 2012 to September 30, 2016.  The lease specifies monthly rent of $20.00 per square foot which is subject to annual increases of $0.50 per square foot on October 1st of each year through October 1, 2015.  The Bank has five renewal options, each to extend the term of the lease for five years, the first option term commencing on October 1, 2016, and the last option term ending on September 30, 2041.  Effective July 3, 2012, the Bank amended this lease to expand the existing office space by approximately 5,732 square feet.  The amended lease terms specify monthly rent of $15.00 per square foot annually for the additional office space, with all other terms remaining the same.
(2) The Bank took occupancy of this branch on November 1, 2005 and opened for business on February 6, 2006.  The Bank has a ten-year lease that expires November 1, 2015 for this branch, which specifies rent of $90,000 per annum and is subject to annual increases of 3% on November 1 of each year through November 1, 2015.  The Bank has four renewal options, each to extend the term of the lease for five years, the first option term commencing on November 1, 2015, and the last option term ending on November 1, 2035.
JACKSONVILLE BANCORP, INC.
ITEM 2. PROPERTIES (CONTINUED)
 
(3) The Bank took occupancy of this branch on January 15, 2006 and opened for business on June 9, 2006.  The Bank has a ten-year lease that expires January 13, 2016 for this branch, which specifies rent of $210,870 per annum and is subject to annual increases on the anniversary date to the extent of any percentage change that occurs in the consumer price index for all urban consumers.  The Bank has two renewal options, each to extend the term of the lease for five years, the first option term commencing on January 13, 2016, and the last option term ending on January 13, 2026.
(4) The Bank took occupancy of this branch on July 31, 2011 and opened for business on November 1, 2011.  The Bank has a ten-year lease that expires on October 31, 2021 for this branch, which specifies rent of $81,543 per annum and is subject to an increase of 10% on the fifth anniversary of the rent commencement date.
(5) The Bank took occupancy of this location, originally a branch office, on November 16, 2010 as a result of the merger with ABI. The Bank has a 20-year land only lease that expires August 22, 2022 for this branch, which specifies rent of $75,000 per annum and is subject to a 12.5% increase every five lease years. The Bank has two renewal options, each to extend the term of the lease for ten years, the first option term commencing on August 22, 2022, and the last option term ending on August 22, 2042.  The Bank currently uses this office for administrative purposes only.
 
ITEM 3. LEGAL PROCEEDINGS
 
From time to time, as a normal incident of the nature and kind of business in which we are engaged, various claims or charges are asserted against us and/or our directors, officers or affiliates.  In the ordinary course of business, the Company is also subject to regulatory examinations, information gathering requests, inquiries and investigations.  Other than ordinary routine litigation incidental to our business, management believes after consultation with legal counsel that there are no pending legal proceedings against Bancorp or any of its subsidiaries that will, individually or in the aggregate, have a material adverse effect on the consolidated results of operations or financial condition of the Company.
 
ITEM 4. MINE SAFETY DISCLOSURES
 
Not applicable.
JACKSONVILLE BANCORP, INC.

PART II
 
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
The Company’s common stock is traded on the NASDAQ Stock Market under the symbol “JAXB.”  As previously disclosed in the Company’s filings with the SEC, effective on January 29, 2013, the listing of the Company’s common stock was transferred from the NASDAQ Global Market tier to the NASDAQ Capital Market tier of the NASDAQ Stock Market, in order for the Company to regain compliance with NASDAQ’s minimum Market Value of Publicly Held Shares requirement for continued listing.  The NASDAQ Capital Market is one of the three market tiers for NASDAQ-listed stock and operates in substantially the same manner as the NASDAQ Global Market.  There is no public trading market for the Company’s nonvoting common stock.
 
Bancorp’s Board of Directors implemented a 1-for-20 reverse stock split of Bancorp’s outstanding shares of common stock and nonvoting common stock effective October 24, 2013.  As a result of the reverse stock split, each 20 shares of issued and outstanding common stock and nonvoting common stock, par value $0.01 per share, respectively, were automatically and without any action on the part of the respective holders, combined and reconstituted as one share of the respective class of common equity as of the effective date.  Consequently, the aggregate par value of common stock and nonvoting common stock eliminated in the reverse stock split was reclassed on the Company’s consolidated balance sheets from the respective class of common equity to additional paid-in capital.  Additional adjustments were made to the aforementioned accounts as a result of rounding to avoid the existence of fractional shares.  All share and per share information in this report has been retrospectively adjusted to reflect the common equity 1-for-20 reverse stock split.  Please refer to Note 14 – Shareholders’ Equity for additional information related to the reverse stock split.
 
The following table shows the high and low sale prices of our common stock for each quarter of 2013 and 2012.
 
Year
Quarter
 
High
   
Low
 
2013
First
 
$
72.00
   
$
16.20
 
Second
 
$
31.80
   
$
8.60
 
 
Third
 
$
10.60
   
$
9.60
 
 
Fourth
 
$
13.25
   
$
9.80
 
 
 
               
2012
First
 
$
73.00
   
$
55.80
 
 
Second
 
$
68.40
   
$
25.20
 
 
Third
 
$
33.80
   
$
18.40
 
 
Fourth
 
$
22.00
   
$
15.00
 
 
As of February 28, 2014, Bancorp had 3,177,090 outstanding shares of common stock, par value $0.01 per share, held by approximately 379 registered shareholders and 2,618,005 outstanding shares of nonvoting common stock, par value $0.01 per share, held by 17 registered shareholders.
 
It is the policy of Bancorp’s Board to reinvest earnings for such period of time as is necessary to ensure its successful operations.  There are no current plans to initiate payment of cash dividends, and future dividend policy will depend on Bancorp’s earnings, capital and regulatory requirements, financial condition, and other factors considered relevant by the Board.  For more information regarding Bancorp’s ability to pay dividends and restrictions thereon, please refer to the “Liquidity and Capital Resources – Capital Resources” and the “Regulatory Capital Requirements – Dividends and Distributions” sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Item 7 of this Annual Report on Form 10-K and the “Dividends and Distributions” section in Note 16 – Capital Adequacy in the accompanying notes to the Consolidated Financial Statements, which information is hereby incorporated by reference.
 
COMPANY PURCHASES OF EQUITY SECURITIES
 
The Company did not repurchase any shares of its common stock during the last quarter of 2013.
JACKSONVILLE BANCORP, INC.

ITEM 6.
SELECTED FINANCIAL DATA
 
The selected consolidated financial data presented below as of and for the years ended December 31, 2013, 2012, 2011, 2010, and 2009 have been derived from our Consolidated Financial Statements.  The ratios and other data presented are unaudited and have been derived from our records.  Information presented for the years ended December 31, 2013, 2012, 2011 and 2010 reflect the merger with ABI on November 16, 2010.  All share and per share information has been retrospectively adjusted to reflect the common equity 1-for-20 reverse stock split.  The selected financial data presented below should be read in conjunction with the Consolidated Financial Statements and accompanying notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this Annual Report on Form 10-K.

(dollars in thousands, except share and per share data)
 
2013
   
2012
   
2011
   
2010
   
2009
 
Financial Condition Data:
 
   
   
   
   
 
Cash and cash equivalents(1)
 
$
40,325
   
$
72,079
   
$
9,955
   
$
20,297
   
$
5,647
 
Securities available-for-sale
   
84,771
     
83,985
     
63,140
     
62,356
     
22,171
 
Loans held for sale
   
-
     
-
     
-
     
13,910
     
-
 
Loans, net(2)
   
354,592
     
377,833
     
449,583
     
499,696
     
384,133
 
Goodwill
   
-
     
-
     
3,137
     
12,498
     
-
 
Other intangible assets, net
   
849
     
1,260
     
1,774
     
2,376
     
-
 
All other assets
   
26,752
     
29,900
     
33,836
     
40,700
     
26,860
 
Total assets
 
$
507,289
   
$
565,057
   
$
561,425
   
$
651,833
   
$
438,811
 
 
                                       
Total deposits
   
434,966
     
490,021
     
473,907
     
562,187
     
370,635
 
Total borrowings
   
36,307
     
38,466
     
55,837
     
34,886
     
39,777
 
Other liabilities
   
2,084
     
2,994
     
2,337
     
2,901
     
1,131
 
Shareholders’ equity(1)
   
33,932
     
33,576
     
29,344
     
51,859
     
27,268
 
Total liabilities and shareholders’ equity
 
$
507,289
   
$
565,057
   
$
561,425
   
$
651,833
   
$
438,811
 
 
                                       
Operations Data:
                                       
Total interest income
 
$
22,933
   
$
26,252
   
$
30,744
   
$
23,962
   
$
23,204
 
Total interest expense
   
4,202
     
5,256
     
7,016
     
8,282
     
9,729
 
 
                                       
Net interest income
   
18,731
     
20,996
     
23,728
     
15,680
     
13,475
 
Provision for loan losses
   
815
     
37,994
     
12,392
     
16,988
     
4,361
 
 
                                       
Net interest income (loss) after provision for loan losses
   
17,916
     
(16,998
)
   
11,336
     
(1,308
)
   
9,114
 
 
                                       
Noninterest income
   
1,760
     
1,503
     
1,531
     
1,174
     
841
 
Noninterest expenses
   
20,636
     
27,726
     
30,152
     
17,124
     
9,983
 
 
                                       
(Loss) income before income tax (benefit) expense
   
(960
)
   
(43,221
)
   
(17,285
)
   
(17,258
)
   
(28
)
Income tax (benefit) expense
   
-
     
(173
)
   
6,774
     
(5,816
)
   
(104
)
Net (loss) income
   
(960
)
   
(43,048
)
   
(24,059
)
   
(11,442
)
   
76
 
 
                                       
Noncash, implied preferred stock dividend
   
(31,464
)
   
-
     
-
     
-
     
-
 
Net (loss) income available to common shareholders
 
$
(32,424
)
 
$
(43,048
)
 
$
(24,059
)
 
$
(11,442
)
 
$
76
 
JACKSONVILLE BANCORP, INC.

ITEM 6.
SELECTED FINANCIAL DATA (CONTINUED)
 
(dollars in thousands, except share and per share data)
 
2013
   
2012
   
2011
   
2010
   
2009
 
Per Share Data:
 
   
   
   
   
 
Basic (loss) earnings per common share
 
$
(6.83
)
 
$
(146.16
)
 
$
(81.70
)
 
$
(101.41
)
 
$
0.87
 
Diluted (loss) earnings per common share
 
$
(6.83
)
 
$
(146.16
)
 
$
(81.70
)
 
$
(101.41
)
 
$
0.87
 
Dividends declared per common share
   
-
     
-
     
-
     
-
     
-
 
Total common shares outstanding at year-end(1)(3)
   
5,795,095
     
294,544
     
294,492
     
294,441
     
87,463
 
 
                                       
Ratios and Other Data:
                                       
Return on average assets
   
(0.18
)%
   
(7.55
)%
   
(3.93
)%
   
(2.42
)%
   
0.02
%
Return on average equity
   
(2.86
)%
   
(188.47
)%
   
(44.53
)%
   
(37.52
)%
   
0.28
%
Average equity to average assets
   
6.41
%
   
4.01
%
   
8.82
%
   
6.46
%
   
6.22
%
Interest rate spread
   
3.50
%
   
3.67
%
   
3.96
%
   
3.28
%
   
2.89
%
Net interest margin
   
3.74
%
   
3.86
%
   
4.19
%
   
3.52
%
   
3.23
%
Noninterest expenses to average assets
   
3.94
%
   
4.87
%
   
4.92
%
   
3.62
%
   
2.30
%
Average interest-earning assets to average interest-bearing liabilities
   
1.28
     
1.20
     
1.19
     
1.13
     
1.15
 
Nonperforming loans and other real estate owned as a percentage of total assets(2)
   
3.95
%
   
5.26
%
   
9.77
%
   
6.25
%
   
2.91
%
Allowance for loan losses as a percentage of total loans(2)
   
4.25
%
   
5.07
%
   
2.82
%
   
2.55
%
   
1.75
%
Total number of banking offices(4)
   
8
     
8
     
8
     
9
     
5
 
                                        

(1) Amounts presented for the years ended December 31, 2013 and 2012, respectively, were impacted by the completion of: (i) the rights offering on September 23, 2013 and the public offering on October 4, 2013 and (ii) the Private Placement on December 31, 2012.
(2) Amounts presented for the years ended December 31, 2012 and December 31, 2011 were impacted by the completion of the Asset Sale on December 31, 2012 and the bulk loan sale conducted on February 11, 2011, respectively.  Nonperforming loans and total loans exclude amounts classified as loans held-for-sale as of December 31, 2010.
(3) Shares outstanding as of December 31, 2013 and December 31, 2010, respectively, were impacted by (i) the conversion of the Series A Preferred Stock to shares of common stock and nonvoting stock on February 19, 2013 and (ii) additional shares issued in the merger with Atlantic BancGroup, Inc. and the subsequent sale of common stock in a private placement on November 16, 2010.
(4) Represents banking offices operating as of December 31st of each year, excluding the virtual branch.
JACKSONVILLE BANCORP, INC.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis of the financial condition and results of operations represents an overview of the Company’s consolidated financial condition as of December 31, 2013 and 2012 and results of operations for the years ended December 31, 2013, 2012 and 2011.  This discussion is designed to provide a more comprehensive review of the financial condition and operating results than could be obtained from an examination of the financial statements alone.  This analysis should be read in conjunction with the Company’s Consolidated Financial Statements and accompanying notes contained in this Annual Report on Form 10-K.
 
General
 
Jacksonville Bancorp, Inc. (“Bancorp”) was incorporated on October 24, 1997 and was organized to conduct the operations of The Jacksonville Bank (the “Bank”).  The Bank is a Florida state-chartered commercial bank that opened for business on May 28, 1999, and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”).  The Bank provides a variety of community banking services to businesses and individuals in Duval County, Florida and surrounding communities within St. Johns, Clay and Nassau counties.  During 2000, the Bank formed Fountain Financial, Inc., a wholly owned subsidiary.  Through Fountain Financial, Inc., and our marketing agreement with New England Financial (an affiliate of MetLife), we are able to meet the investment and insurance needs of our customers.  On November 16, 2010, Bancorp acquired Atlantic BancGroup, Inc. (“ABI”) by merger, and on the same date, ABI’s wholly owned subsidiary, Oceanside Bank, merged with and into the Bank.  Bancorp, the Bank, and Fountain Financial, Inc. are collectively referred to herein as the “Company.”
 
Business Strategy
 
Our primary business segment is community banking and consists of attracting deposits from the general public and using such deposits and other sources of funds to originate commercial business loans, commercial real estate loans, residential mortgage loans and a variety of consumer loans.  We also invest in mortgage-backed securities and securities backed by the United States government, and agencies thereof, as well as other securities.  Our profitability depends primarily on our net interest income, which is the difference between the income we receive from our loan and securities investment portfolios and costs incurred on our deposits, the Federal Home Loan Bank (“FHLB”) advances, Federal Reserve borrowings and other sources of funding.  Net interest income is also affected by the relative amounts of interest-earning assets and interest-bearing liabilities. Net interest income is generated as the relative amounts of interest-earning assets grow in relation to the relative amounts of interest-bearing liabilities.  In addition, the levels of noninterest income earned and noninterest expenses incurred affect profitability.  Included in noninterest income are service charges earned on deposit accounts and increases in cash surrender value of Bank-Owned Life Insurance (“BOLI”).  Included in noninterest expense are costs incurred for salaries and employee benefits, occupancy and equipment expenses, data processing expenses, marketing and advertising expenses, federal deposit insurance premiums, legal and professional fees, loan related expenses, and other real estate owned (“OREO”) expenses.
 
Our operations are influenced by local economic conditions and by policies of financial institution regulatory authorities.  Fluctuations in interest rates due to factors such as competing financial institutions as well as fiscal policy and the Federal Reserve’s decisions on monetary policies, including interest rate targets, impact interest-earning assets and our cost of funds and, thus, our net interest margin.  In addition, the local economy and real estate market of Northeast Florida, and the demand for our products and loans, impact our margin.  The local economy and viability of local businesses can also impact the ability of our customers to make payments on loans, thus impacting our loan portfolio.  The Company evaluates these factors when valuing its allowance for loan losses. The Company also believes its underwriting procedures are relatively conservative and, as a result, the Company is not being any more affected than the overall market in the current economic downturn.
 
Our goal is to sustain profitable, controlled growth by focusing on increasing our loan and deposit market share in the Northeast Florida market by developing new financial products, services and delivery channels; closely managing yields on earning assets and rates on interest-bearing liabilities; focusing on noninterest income opportunities; controlling the growth of noninterest expenses; and maintaining strong asset quality.  During the second quarter of 2012, the Company adopted a strategy to accelerate the disposition of substandard assets on an individual customer basis.  This strategy materially impacted the Company’s earnings for the year ended December 31, 2012 as a result of the increased provision for loan losses, expenses related to protecting our collateral position, and aggressively pursuing foreclosure actions when necessary.  Additionally, the aggressive pursuit of foreclosure actions resulted in an increase in other real estate owned expenses during the same period.
JACKSONVILLE BANCORP, INC.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
The collateral for substandard assets that are deemed impaired is evaluated quarterly and an estimate of fair value of the collateral is determined based on appraised values, current market data such as recent sales of similar properties, discussions with potential buyers and negotiations with existing borrowers.  Appraisals are obtained during the regular course of business in accordance with the required appraisal cycle set forth by Bank policy.  Based on specific facts and circumstances surrounding a specific loan, off-cycle appraisals may be obtained when new information becomes available to management.  Additionally, in certain cases, discounts have been applied to appraised values based on the age of the appraisal, type of loan, general market factors and/or market data regarding sales of similar properties.
 
The Company received updated appraisals on a majority of its substandard assets during the second half of 2012.  As a result of having current appraisals, more modest discounts were required due to the factors noted above.  Impaired loan appraisals were discounted an average of 9% as of December 31, 2012 compared to 28% as of June 30, 2012.  Likewise, the average discount on OREO appraisals decreased to 10% from 23% as of the same dates.  The weighted average discounts applied to impaired loans and OREO as of December 31, 2013 were 1.6% and 1.8%, respectively.  Discounts are anticipated to remain at these lower levels for the foreseeable future due to recent indicators of stabilization in the local real estate market; however, discounts applied to appraisals may fluctuate on a short-term basis due to changes in the property/discount mix going forward.
 
We believe that the Company’s recapitalization plan that was executed in 2012 and completed in 2013, combined with the strategic initiative to accelerate the disposal of substandard assets, has enabled the Company to restore capital to prescribed regulatory levels.  As of December 31, 2013 and 2012, the Bank was well-capitalized with total risk based capital of 14.11% and 12.70% and Tier 1 leverage capital of 9.33% and 8.29%, respectively.  During the year ended December 31, 2013 and looking forward, the Company intends to maintain the quality of its loan portfolio through the continued reduction of problem assets in a prudent and reasonable manner and to continue to improve the overall credit process including, but not limited to, loan origination disciplines, strict underwriting criteria, and succinct funding and onboarding processes.  In addition, the Company will carry on with the repositioning of its loan and deposit portfolio mix to better align with our targeted market segment of professional services, wholesalers, distributors, and other service industries.  In an effort to further diversify the balance sheet, the Company will deploy excess capital from the previously described capital raise transactions into other earning assets to maximize earnings while the desired loan growth is achieved.  Such improvements have not yet materially impacted our financial condition or results of operations; however, these changes have contributed to the current reduction of loan-related expenses and recent improvements in the Company’s overall asset quality.
 
To further supplement the Company’s business strategy, the Bank has adopted a philosophy of seeking and retaining the best available personnel for positions of responsibility, whom we believe will provide us with a competitive edge in the local banking market.  Upon the retirement of Price Schwenck, the Company’s former Chief Executive Officer, the Company appointed Stephen C. Green as President and Chief Executive Officer and Margaret A. Incandela as Chief Operating Officer and Chief Credit Officer during 2012 as a means of adding critical management expertise.  In June of 2013, Mr. Green resigned as President and Chief Executive Officer of the Company, and as Chief Executive Officer of the Bank.  Following his resignation, the Company’s Board of Directors appointed Donald F. Glisson, Jr., Chairman of the Board of the Company, to serve as the Company’s principal executive officer on an interim basis until a new President and Chief Executive Officer was elected.  On December 4, 2013, the Company appointed Kendall L. Spencer as President and Chief Executive Officer to provide advanced leadership and commercial banking management expertise as well as additional proficiencies in strategic financial planning and execution of operational initiatives.  Please refer to Item 1A. Risk Factors of this report for additional information related to these events and the potential impact on our operating results.
 
Executive Overview
 
The Company’s performance during the years ended December 31, 2013 and 2012 is reflective of the Company’s strategy to accelerate the disposition of substandard assets on an individual customer basis as well as re-pricing activities in the current low interest rate environment.  As a result of these efforts, as well as recent indicators of stabilization in the local real estate markets, the Company recognized reduced provision expense, noninterest expense and a general reduction in substandard assets during the year ended December 31, 2013.
JACKSONVILLE BANCORP, INC.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
Capital Raise Transactions
 
During 2012, the Company executed a financial advisory agreement with an investment banking firm to assist in raising capital.  Efforts to secure additional equity capital were realized on December 31, 2012 with the sale of an aggregate of 50,000 shares of the Company’s Mandatorily Convertible, Noncumulative, Nonvoting Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), at a purchase price of $1,000 per share, in the Private Placement.  For the year ended December 31, 2012, gross proceeds from the issuance of preferred stock in the amount of $50.0 million, or $45.1 million net of offering expenses, were used for general operating expenses, mainly for the subsidiary bank, to improve capital ratios, and will be used to support the Company’s business strategy going forward.
 
On February 19, 2013, all of the outstanding shares of the Company’s Series A Preferred Stock automatically converted into an aggregate of 2,382,000 shares of common stock and 2,618,000 shares of nonvoting common stock (the “Conversion”).  The Conversion was based on a conversion price of $10.00 per share and a conversion rate of 100 shares of common stock and/or nonvoting common stock for each share of Series A Preferred Stock outstanding.  As a result of the Conversion, no shares of the Series A Preferred Stock remained outstanding and an aggregate of 2,676,544 shares of common stock and 2,618,000 shares of nonvoting common stock were outstanding immediately following the Conversion.
 
During the third quarter of 2013, the Company initiated concurrent offerings: (i) a rights offering to eligible existing shareholders of nontransferable subscription rights to purchase shares of the Company’s common stock at a subscription price of $10.00 per share and (ii) a public offering of shares not subscribed for in the rights offering at an equal subscription price of $10.00 per share.  The subscription period for the rights offering expired on September 20, 2013 and resulted in the sale of 104,131 shares of the Company’s common stock for aggregate proceeds of $1.0 million, or $0.9 million net of offering expenses.  The public offering expired on October 4, 2013, whereby the Company sold 395,869 shares for an aggregate of $4.0 million, or $3.2 million net of offering expenses.  Total net proceeds from the concurrent offerings will be used for general operating expenses.
 
Please refer to Note 2 – Capital Raise Transactions in the accompanying notes to the Consolidated Financial Statements for additional information related to the Company’s recent capital raise activities.
 
Asset Sale
 
On December 28, 2012, the Bank entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”) with a real estate investment firm (the “Asset Purchaser”) for the purchase by the Asset Purchaser of approximately $25.1 million of the Bank’s loans and other assets for a price of approximately $11.7 million (the “Asset Sale”).  The Asset Sale was consistent with the Company’s strategy to accelerate the disposition of substandard assets. Assets underlying the Asset Sale included OREO, non-accrual loans, loans with a history of being past due, and other loans that were part of an overall customer relationship.  Proceeds from the Asset Sale included $11.3 million from the sale of loans and $0.4 million from the sale of OREO.  The Asset Sale was completed on December 31, 2012, including the immediate transfer of servicing from the Bank.
 
All assets disposed of in conjunction with the Asset Sale were sold exclusively to the Asset Purchaser due to the relatively small size and composition of the assets being sold, particularly with respect to the current market demand for such loans.  The overall pricing methodology employed by management during the Asset Sale was influenced by several factors including, but not limited to, (i) the engagement of a third-party financial advisor, (ii) management’s experience in loan sale activities and knowledge of the local markets in which the Company operates, and (iii) the pricing expectations of prospective buyers.
 
Additional discounts (i.e., charge-offs) applied in excess of those assessed in the normal course of business represented a combination of the bulk sale value of the loans and the Asset Purchaser’s assumption of risk and expected rate of return.  Management reviewed information provided by our third-party financial advisor to evaluate the additional discounts applied to the Asset Sale in comparison to similar transactions and to ensure reasonableness.
 
Of the $13.3 million in charge-offs related to the Asset Sale, $4.5 million was determined to be due to one or a combination of the following factors:  (i) the most recent appraisal (discounted if appropriate), (ii) settlement discussions with the borrower, or (iii) underlying cash flows of the borrower/guarantor as compared to the borrower’s recorded investment.  This amount was included in the historical loss component in determining the appropriateness of the Company’s allowance for loan losses as of December 31, 2012 as it was determined to be indicative of historical loss experience (under the historically determined allowance for loan loss methodology) and, therefore, determined to be part of management’s estimate of the probable incurred losses on the remainder of the portfolio.
JACKSONVILLE BANCORP, INC.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
The additional $8.8 million of charge-offs required to expedite the disposition through the Asset Sale were not considered indicative of our historical loss experience and, therefore, were excluded in the determination of the appropriateness of our allowance for loan losses for the remaining portfolio as of December 31, 2012.  Asset sales and the respective discounts are not a traditional element of the Company’s normal business activities and, therefore, were excluded in order to properly estimate incurred losses associated with the remainder of the loan portfolio.  Further, management does not anticipate an asset sale in the foreseeable future.
 
For additional information related to the Asset Sale, please refer to Note 4 – Loans and Allowance for Loan Losses in the accompanying notes to the Consolidated Financial Statements.
 
Reverse Stock Split
 
Bancorp’s Board of Directors implemented a 1-for-20 reverse stock split of Bancorp’s outstanding shares of common stock and nonvoting common stock effective October 24, 2013.  As a result of the reverse stock split, each 20 shares of issued and outstanding common stock and nonvoting common stock, par value $0.01 per share, respectively, were automatically and without any action on the part of the respective holders combined and reconstituted as one share of the respective class of common equity as of the effective date.  Consequently, the aggregate par value of common stock and nonvoting common stock eliminated in the reverse stock split was reclassed on the Company’s consolidated balance sheets from the respective class of common equity to additional paid-in capital.  Additional adjustments were made to the aforementioned accounts as a result of rounding to avoid the existence of fractional shares.  All share and per share information has been retrospectively adjusted to reflect the common equity 1-for-20 reverse stock split.
 
Comparison of Financial Condition and Operating Results
 
Comparison of Financial Condition as of December 31, 2013 and December 31, 2012
 
Total assets decreased $57.8 million, or 10.2%, from $565.1 million as of December 31, 2012 to $507.3 million as of December 31, 2013.  The Company experienced a significant decrease in cash and cash equivalents as a result of a reduction in federal funds sold and other cash and cash equivalents in the amount of $34.0 million, a decrease in net loans of $23.2 million, and a decrease in OREO of $3.9 million driven primarily by sales in excess of foreclosure activities and write-downs during the year.  These amounts were slightly offset by an increase in bank-owned life insurance of $3.2 million and securities available-for-sale of $0.8 million during the year ended December 31, 2013.
 
Investment securities available-for-sale increased $0.8 million, or 0.9%, from $84.0 million as of December 31, 2012 to $84.8 million as of December 31, 2013.  During the year ended December 31, 2013, the Company purchased $41.2 million in securities and received $22.0 million in proceeds from principal repayments, maturities and calls.  In addition, the Company received proceeds of $14.4 million and realized a $0.4 million net gain from the sale of securities during the year ended December 31, 2013.  The remaining variance is due to the change in fair market value during the same year-to-date period.
 
Total deposits decreased by $55.0 million, or 11.2%, during the year ended December 31, 2013, from $490.0 million as of December 31, 2012 to $435.0 million as of December 31, 2013.  The following is an explanation of the changes in each of the major deposit categories during the year ended December 31, 2013:
 
· Noninterest-bearing deposits increased $6.2 million, or 6.6%, as a result of a continued emphasis on core deposit growth, especially business relationships with a tendency towards carrying higher account balances;
 
· Money market, NOW and savings deposits decreased $10.3 million, or 5.2%, due to natural fluctuations in account balances, particularly money market accounts; and
 
· The time deposit portfolio decreased by $51.0 million, or 25.9%, driven primarily by a $28.2 million reduction in national CDs (the Company’s overall strategy in 2013 was not to offer or renew national CDs).  The remaining variance was due to a decrease in local CDs when compared to the prior year-end.
 
Loans from related parties decreased by $2.2 million during the year ended December 31, 2013 as a result of the full repayment of the previously outstanding balance during the fourth quarter of 2013.  FHLB advances and other borrowings remained substantially unchanged during the year ended December 31, 2013 with $20.2 million outstanding as of December 31, 2013 and 2012, respectively.
JACKSONVILLE BANCORP, INC.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
Total shareholders’ equity increased slightly during the year ended December 31, 2013, from $33.6 million as of December 31, 2012 to $33.9 million as of December 31, 2013.  This increase was attributable to a decrease in accumulated comprehensive income of $2.9 million and a net loss for the year ended December 31, 2013 of $1.0 million, offset by $4.2 million of net proceeds in additional equity issued in conjunction with the Company’s 2013 capital raise activities.  Accumulated comprehensive income decreased primarily based on changes in interest rates during 2013.  Total shareholders’ equity did not change as a result of the mandatory conversion of the Company’s Series A Preferred Stock into approximately 2.4 million shares of common stock and 2.6 million shares of a new class of nonvoting common stock, each class with a par value of $0.01 per share (the “Conversion”).  The Conversion resulted in (i) the full balance transfer of the discount due to the beneficial conversion feature on the Series A Preferred Stock from common stock additional paid-in capital to preferred stock in the amount of $31.5 million, (ii) the conversion of the outstanding balance of preferred equity to common equity, resulting in an increase in common stock of $24 thousand, nonvoting common stock of $26 thousand and additional paid-in capital of $49.95 million, and (iii) an increase in the retained deficit of $31.5 million due to the noncash, implied preferred stock dividend recognized in conjunction with the transfer of the discount due to the beneficial conversion feature to preferred stock.  In addition to its impact on the retained deficit balance, the noncash, implied preferred stock dividend also reduced net income available to common shareholders in the earnings per share calculation (as discussed below).
 
Comparison of Operating Results for the Years Ended December 31, 2013 and 2012
 
Net Income (Loss)
 
The Company had net loss of $960 thousand for the year ended December 31, 2013, compared to $43.0 million of net loss in 2012.  The year-over-year reduction in net loss was driven primarily by a decrease in the provision for loan losses from $38.0 million for the year ended December 31, 2012 to $0.8 million for the same period in 2013 as well as a decrease in non-interest expense of $7.1 million.
 
On a diluted per share basis, the Company had a net loss available to common shareholders of $(6.83) for the year ended December 31, 2013, compared to a net loss of $(146.16) for the same period in the prior year.  Combined with a net loss of $960 thousand, the Company experienced an additional increase in net loss available to common shareholders in the amount of $31.5 million as a result of the noncash, implied preferred stock dividend recognized in conjunction with the Company’s 2012 capital raise transactions and the previously described Conversion.  This increase resulted in a greater net loss available to common shareholders of $32.4 million for the year ended December 31, 2013 and an anti-dilutive impact of stock options as it pertained to the Company’s weighted average common shares outstanding for the same period.
 
Net Interest Income
 
Net interest income, the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities, was $18.7 million for the year ended December 31, 2013, compared to $21.0 million for the same period in 2012.
 
Total interest income decreased $3.3 million for the year ended December 31, 2013 when compared to the same period in 2012.  This decrease was primarily driven by a decrease in average earning assets, in particular, average loan balances which declined by $63.9 million when compared to the same period in the prior year.  The decrease in average loan balances was partially offset by an increase in the average yield on loans to 5.49% for the year ended December 31, 2013 compared to 5.41% for the year ended December 31, 2012.  The increase in the loan yield was driven primarily by an increase in the overall yield on accruing loans as well as a decrease in nonperforming loans.
 
Total interest expense for the years ended December 31, 2013 and 2012 was $4.2 million and $5.3 million, respectively.  The average cost of interest-bearing liabilities decreased 7 basis points to 1.08% for the year ended December 31, 2013, compared to 1.15% for the same period in 2012.  The overall decrease in the average cost of interest-bearing deposits reflects an ongoing reduction in interest rates paid on deposits as a result of the re-pricing activities in the current low interest rate environment coupled with an increase in average noninterest-bearing deposits to $95.7 million for the year ended December 31, 2013, compared to $88.6 million for the same period in the prior year.
 
The net interest margin decreased by 12 basis points to 3.74% from 3.86%, when comparing the year ended December 31, 2013 to the same period in the prior year.  The Company closely monitors its liquidity needs in conjunction with the cost of its funding sources and evaluates rates paid on its core deposits to ensure they remain competitive in the local market environment.
JACKSONVILLE BANCORP, INC.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
Average Balance Sheet; Interest Rates and Interest Differential:
 
The following table sets forth, for the years indicated, information regarding: (i) the total dollar amount of interest and dividend income from interest-earning assets and the resultant average yield; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average costs; (iii) net interest/dividend income; (iv) interest rate spread; and (v) net interest margin.  Average balances are based on average daily balances.
 
 
 
2013
   
2012
 
(Dollars in thousands)
 
Average Balance
   
Interest
   
Average Rate
   
Average Balance
   
Interest
   
Average
Rate
 
Interest-earning assets:
 
   
   
   
   
   
 
Loans (1)
 
$
383,197
   
$
21,043
     
5.49
%
 
$
447,061
   
$
24,183
     
5.41
%
Securities available-for-sale:
                                               
Taxable
   
76,554
     
1,186
     
1.55
     
65,343
     
1,236
     
1.89
 
Tax-exempt(2)
   
12,771
     
556
     
4.35
     
18,168
     
760
     
4.18
 
Other interest-earning assets(3)
   
28,743
     
148
     
0.51
     
13,604
     
73
     
0.54
 
Total interest-earning assets
   
501,265
     
22,933
     
4.58
     
544,176
     
26,252
     
4.82
 
Noninterest-earning assets(4)
   
21,213
                     
25,708
                 
Total assets
 
$
522,478
                   
$
569,884
                 
Interest-bearing liabilities:
                                               
Savings deposits
 
$
9,761
   
$
25
     
0.26
%
 
$
10,393
   
$
38
     
0.37
%
NOW deposits
   
23,019
     
22
     
0.10
     
21,772
     
17
     
0.08
 
Money market deposits
   
159,976
     
917
     
0.57
     
171,222
     
1,268
     
0.74
 
Time deposits
   
159,692
     
1,938
     
1.21
     
210,559
     
2,465
     
1.17
 
FHLB advances
   
20,000
     
300
     
1.50
     
21,746
     
324
     
1.49
 
Federal Reserve and other borrowings(8)
   
1,775
     
171
     
9.63
     
3,496
     
295
     
8.41
 
Subordinated debt
   
16,121
     
829
     
5.14
     
16,058
     
849
     
5.29
 
Other interest-bearing liabilities(5)
   
3
     
-
     
-
     
36
     
-
     
-
 
Total interest-bearing liabilities
   
390,347
     
4,202
     
1.08
     
455,282
     
5,256
     
1.15
 
Noninterest-bearing liabilities
   
98,616
                     
91,761
                 
Shareholders' equity
   
33,515
                     
22,841
                 
Total liabilities and shareholders' equity
 
$
522,478
                   
$
569,884
                 
Net interest income
         
$
18,731
                   
$
20,996
         
Interest rate spread(6)
                   
3.50
%
                   
3.67
%
Net interest margin(7)
                   
3.74
%
                   
3.86
%
Ratio of average interest-earning assets to average interest-bearing liabilities
   
1.28
                     
1.20
                 
                                        

(1) Average loans include nonperforming loans.  Interest on loans included loan fees (in thousands) of $223 and $(21) for the year ended December 31, 2013 and 2012, respectively.
(2) Interest income and rates do not include the effects of a tax equivalent adjustment using a federal tax rate of 34% in adjusting tax-exempt interest on tax-exempt investment securities to a fully taxable basis.
(3) Includes federal funds sold.
(4) For presentation purposes, the BOLI acquired by the Bank has been included in noninterest-earning assets.
(5) Includes federal funds purchased.
(6) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(7) Net interest margin is net interest income divided by average interest-earning assets.
(8) Federal Reserve and other borrowings include loans from related parties that pay an annual rate of interest equal to 8% on a quarterly basis of the amount outstanding or an unused revolver fee calculated and paid quarterly at an annual rate of 2% on the revolving loan commitment less the daily average principal amount outstanding.
JACKSONVILLE BANCORP, INC.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
Impact of Inflation and Changing Prices:
 
The Consolidated Financial Statements and related data presented herein have been prepared in accordance with generally accepted accounting standards, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, substantially all of our assets and liabilities are monetary in nature.  As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation which the Company does not consider to be material.  Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates.
 
Rate/Volume Analysis:
 
The following table sets forth certain information regarding changes in interest income and interest expense for the years ended December 31, 2013 and 2012.  For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (i) changes in rate (change in rate multiplied by prior volume), (ii) changes in volume (change in volume multiplied by prior rate), and (iii) changes in rate-volume (change in rate multiplied by change in volume).
 
 
 
Increase (Decrease) Due to(1)
 
(Dollars in thousands)
 
Rate
   
Volume
   
Total
 
Interest-earning assets:
 
   
   
 
Loans
 
$
362
   
$
(3,502
)
 
$
(3,140
)
Securities available-for-sale:
                       
Taxable
   
(243
)
   
193
     
(50
)
Tax-exempt
   
30
     
(234
)
   
(204
)
Other interest-earning assets
   
(3
)
   
78
     
75
 
Total interest-earning assets
 
$
146
   
$
(3,465
)
 
$
(3,319
)
 
                       
Interest-bearing liabilities:
                       
Savings deposits
 
$
(11
)
 
$
(2
)
 
$
(13
)
NOW deposits
   
4
     
1
     
5
 
Money market deposits
   
(272
)
   
(79
)
   
(351
)
Time deposits
   
87
     
(614
)
   
(527
)
FHLB advances
   
2
     
(26
)
   
(24
)
Federal Reserve and other borrowings
   
37
     
(161
)
   
(124
)
Subordinated debt
   
(23
)
   
3
     
(20
)
Other interest-bearing liabilities
   
-
     
-
     
-
 
Total interest-bearing liabilities
 
$
(176
)
 
$
(878
)
 
$
(1,054
)
 
                       
Net change in net interest income
 
$
322
   
$
(2,587
)
 
$
(2,265
)
                                        

(1) The change in interest due to both rate and volume has been allocated to the volume and rate components in proportion to the relationship of the dollar amounts of the absolute change in each component.
 
Provision for Loan Losses
 
The provision for loan losses is charged to earnings to bring the total allowance to a level deemed appropriate by management and is based upon, among others, the volume and type of lending conducted by the Company, the amount of nonperforming loans, and general economic conditions, particularly as they relate to the Company’s market areas, and other factors related to the collectability of the Company’s loan portfolio.  The provision for loan losses was $0.8 million and $38.0 million for the years ended December 31, 2013 and 2012, respectively.  The Company had net loan charge-offs of $5.3 million in 2013, compared to $30.8 million during 2012.  Elevated net charge-offs for the prior year were the result of continued depression in the local real estate market, increased foreclosure activities and net charge-offs of $13.3 million that resulted from the Asset Sale completed late in the fourth quarter of 2012.  For additional information related to the Asset Sale, please refer to Note 4 – Loans and Allowance for Loan Losses in the accompanying notes to the Consolidated Financial Statements and other disclosures under the heading “Asset Sale” within Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Management believes that the allowance for loan losses of $15.8 million as of December 31, 2013 is adequate to absorb probable incurred credit losses in the portfolio as of that date.
JACKSONVILLE BANCORP, INC.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
Noninterest Income and Noninterest Expense
 
Noninterest income increased to $1.8 million and $1.5 million for the years ended December 31, 2013 and 2012, respectively.  Included in Other income for the year ended December 31, 2013, the Company recorded a net gain of $0.4 million from the sale of municipal securities, mortgage-backed securities – residential and collateralized mortgage obligations.  There were no such gains recognized during the same period in the prior year.  Additionally, the Company recorded an impairment in the amount of $0.2 million for the stock it held in Independent Banker’s Bank for the year ended December 31, 2013.  There was no such impairment recognized during the same period in the prior year.
 
Noninterest expense decreased to $20.6 million for the year ended December 31, 2013, compared to $27.7 million for the same period in 2012.  This decrease was mainly due to a decrease in nonrecurring goodwill impairment expense of $3.1 million from the prior year and a decrease in OREO expenses of $1.9 million, loan related expenses of $1.7 million, and capital raise and Asset Sale-related expenses of $1.4 million.  These amounts were offset by an increase in professional fees of $0.5 million and data processing of $0.5 million, while the remainder of the components of noninterest expense remained relatively flat period-over-period.
 
Income Tax Expense (Benefit)
 
There was no income tax expense/benefit recorded for the year ended December 31, 2013, while there was an income tax benefit of $173 thousand for the year ended December 31, 2012.  The calculation for the income tax provision or benefit generally does not consider the tax effects of changes in other comprehensive income (“OCI”), which is a component of shareholders’ equity on the balance sheet.  However, an exception is provided in certain circumstances, such as when there is a full valuation allowance against the net deferred tax assets, there is a loss from continuing operations, and income in other components of the financial statements.  In such a case, income from other categories, such as changes in OCI, must be considered in determining a tax benefit to be allocated to the loss from continuing operations.  As of December 31, 2013, there was a loss in OCI versus income as of December 31, 2012.  Therefore, no tax benefit was recorded for the year ended December 31, 2013.
 
The Company recorded a full valuation allowance on the Company’s deferred tax asset as of December 31, 2011. This was substantially due to the fact that it was more-likely-than-not that the benefit would not be realized in future periods due to Section 382 of the Internal Revenue Code.  Based on an analysis performed as of December 31, 2013 and 2012, respectively, it was determined that the need for a full valuation allowance still existed.
 
Comparison of Operating Results for the Years Ended December 31, 2012 and 2011
 
Net Income (Loss)
 
The Company had net loss of $43.0 million, or $(146.16) per basic and diluted share, for the year ended December 31, 2012, compared to a net loss of $24.1 million, or $(81.70) per basic and diluted share, for the year ended December 31, 2011.  The net loss for the year ended December 31, 2012 was driven primarily by (i) an increase in the provision for loan losses, noncash goodwill impairment expense and OREO expenses, (ii) an increase in loan related expenses, (iii) a decrease in interest income on loans, and (iv) additional expenses related to 2012 capital raise activities and the Asset Sale completed late in the fourth quarter of 2012.  In comparison, the net loss for the year ended December 31, 2011 was driven primarily by the provision for loan losses, noncash goodwill impairment expense and noncash income tax expense (i.e., full valuation allowance) during the period.
 
Net Interest Income
 
Net interest income, the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities, was $21.0 million for the year ended December 31, 2012, compared to $23.7 million for the same period in 2011.  During the respective years, interest income and expense continued to be adversely impacted by the recent downturn in the real estate market in which the Company operates.
JACKSONVILLE BANCORP, INC.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
Total interest income decreased $4.5 million for the year ended December 31, 2012 when compared to the same period in 2011.  The year-over-year decrease in interest income was primarily due to a decrease in interest earned on loans.  This decrease was driven by a decline in average loan balances combined with a year-over-year decrease in the average yield on loans.  Average loan balances declined by $45.2 million in 2012 when compared to the same period in 2011 and the average yield on loans decreased to 5.41% in 2012, compared to 5.84% in 2011.  The decrease in loan yield was driven primarily by the following factors when compared to the prior year:
 
· A decrease in accretion recognized on acquired loans of approximately $1.0 million;
 
· A decrease in the weighted average loan yield for new loans of 63 basis points; and
 
· Modifications to reduce existing loan rates in order to be competitive in the current low-rate market environment.
 
The year-over-year decrease in interest income on loans was slightly offset by an increase in interest earned on investment securities.  Interest earned on taxable and tax-exempt securities increased to $2.0 million for the year ended December 31, 2012, compared to $1.9 million for the year ended December 31, 2011.  This increase was primarily driven by an increase in the average balance of investment securities to $83.5 million in 2012, compared to $65.9 million in 2011.  From 2011 to 2012, the average yield on taxable and tax-exempt securities decreased 42 and 13 basis points, respectively, with taxable securities decreasing from 2.31% in 2011 to 1.89% in 2012 and tax-exempt securities decreasing from 4.31% in 2011 to 4.18% in 2012.  The decrease in average yield was offset by the Company’s strategy to increase and diversify the securities portfolio with purchases of $34.8 million during 2012.
 
Total interest expense for the years ended December 31, 2012 and 2011 was $5.3 million and $7.0 million, respectively.  The year-over-year decrease in interest expense was primarily driven by a reduction in interest expense on deposit accounts which amounted to $3.8 million in 2012, compared to $5.6 million in 2011.  This decrease resulted from a decrease in the weighted average cost of interest-bearing deposits from 1.42% in 2011 to 1.01% in 2012.  The average cost of interest-bearing deposits, and all interest-bearing liabilities, reflects an ongoing reduction in interest rates paid on deposits as a result of re-pricing activities in the current low interest rate environment coupled with a change in the funding mix for 2012 compared to 2011.  Interest on FHLB advances, subordinated debentures, and Federal Reserve and other borrowings amounted to $1.5 million for the year ended December 31, 2012, with a weighted average cost of 5.07%, as compared to $1.4 million for the year ended December 31, 2011, with a weighted average cost of 4.97%.  The increase in the weighted average cost was primarily the result of a reduction in FHLB advances during 2012, coupled with increased liabilities related to other borrowings which typically carry interest rates significantly higher than FHLB advances.  This increase occurred despite the ongoing reduction of interest rates in the current low rate environment and a general decrease in rates on FHLB fixed rate advances.
 
The net interest margin decreased by 33 basis points to 3.86% as of December 31, 2012, as compared to 4.19% as of December 31, 2011.  This decrease is mainly the result of the reduced yield on our interest-earning assets offset by reduced costs of our interest-bearing liabilities in the current low interest rate environment.  The Company closely monitors its liquidity needs in conjunction with the cost of its funding sources and has taken action to reduce costs through reductions in the rates paid on its core deposits.
JACKSONVILLE BANCORP, INC.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
Average Balance Sheet; Interest Rates and Interest Differential:
 
The following table sets forth, for the years indicated, information regarding: (i) the total dollar amount of interest and dividend income from interest-earning assets and the resultant average yield; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average costs; (iii) net interest/dividend income; (iv) interest rate spread; and (v) net interest margin.  Average balances are based on average daily balances.
 
 
 
2012
   
2011
 
(Dollars in thousands)
 
Average Balance
   
Interest
   
Average Rate
   
Average Balance
   
Interest
   
Average
Rate
 
Interest-earning assets:
 
   
   
   
   
   
 
Loans (1)
 
$
447,061
   
$
24,183
     
5.41
%
 
$
492,220
   
$
28,758
     
5.84
%
Securities available-for-sale:
                                               
Taxable
   
65,343
     
1,236
     
1.89
     
46,463
     
1,071
     
2.31
 
Tax-exempt(2)
   
18,168
     
760
     
4.18
     
19,441
     
838
     
4.31
 
Other interest-earning assets(3)
   
13,604
     
73
     
0.54
     
7,698
     
77
     
1.00
 
Total interest-earning assets
   
544,176
     
26,252
     
4.82
     
565,822
     
30,744
     
5.43
 
Noninterest-earning assets(4)
   
25,708
                     
46,965
                 
Total assets
 
$
569,884
                   
$
612,787
                 
Interest-bearing liabilities:
                                               
Savings deposits
 
$
10,393
   
$
38
     
0.37
%
 
$
12,112
   
$
88
     
0.72
%
NOW deposits
   
21,772
     
17
     
0.08
     
19,431
     
29
     
0.15
 
Money market deposits
   
171,222
     
1,268
     
0.74
     
171,769
     
1,588
     
0.92
 
Time deposits
   
210,559
     
2,465
     
1.17
     
234,328
     
3,878
     
1.65
 
FHLB advances
   
21,746
     
324
     
1.49
     
20,877
     
367
     
1.76
 
Federal Reserve and other borrowings(8)
   
3,496
     
295
     
8.41
     
1,997
     
172
     
8.61
 
Subordinated debt
   
16,058
     
849
     
5.29
     
15,993
     
894
     
5.59
 
Other interest-bearing liabilities(5)
   
36
     
-
     
-
     
46
     
-
     
-
 
Total interest-bearing liabilities
   
455,282
     
5,256
     
1.15
     
476,553
     
7,016
     
1.47
 
Noninterest-bearing liabilities
   
91,761
                     
82,202
                 
Shareholders' equity
   
22,841
                     
54,032
                 
Total liabilities and shareholders' equity
 
$
569,884
                   
$
612,787
                 
Net interest income
         
$
20,996
                   
$
23,728
         
Interest rate spread(6)
                   
3.67
%
                   
3.96
%
Net interest margin(7)
                   
3.86
%
                   
4.19
%
Ratio of average interest-earning assets to average interest-bearing liabilities
   
1.20
                     
1.19
                 
                                        

(1) Average loans include nonperforming loans.  Interest on loans included loan fees (in thousands) of $(21) and $258 for the years ended December 31, 2012 and 2011, respectively.
(2) Interest income and rates do not include the effects of a tax equivalent adjustment using a federal tax rate of 34% in adjusting tax-exempt interest on tax-exempt investment securities to a fully taxable basis.
(3) Includes federal funds sold.
(4) For presentation purposes, the BOLI acquired by the Bank has been included in noninterest-earning assets.
(5) Includes federal funds purchased.
(6) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.
(7) Net interest margin is net interest income divided by average interest-earning assets.
(8) Federal Reserve and other borrowings include loans from related parties that pay an annual rate of interest equal to 8% on a quarterly basis of the amount outstanding or an unused revolver fee calculated and paid quarterly at an annual rate of 2% on the revolving loan commitment less the daily average principal amount outstanding.
JACKSONVILLE BANCORP, INC.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
Rate/Volume Analysis:
 
The following table sets forth certain information regarding changes in interest income and interest expense for the years ended December 31, 2012 and 2011.  For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: (i) changes in rate (change in rate multiplied by prior volume), (ii) changes in volume (change in volume multiplied by prior rate), and (iii) changes in rate-volume (change in rate multiplied by change in volume).
 
 
 
Increase (Decrease) Due to(1)
 
(Dollars in thousands)
 
Rate
   
Volume
   
Total
 
Interest-earning assets:
 
   
   
 
Loans
 
$
(2,046
)
 
$
(2,530
)
 
$
(4,576
)
Securities available-for-sale:
                       
Taxable
   
(216
)
   
381
     
165
 
Tax-exempt
   
(24
)
   
(54
)
   
(78
)
Other interest-earning assets
   
(46
)
   
42
     
(4
)
Total interest-earning assets
 
$
(2,332
)
 
$
(2,161
)
 
$
(4,493
)
 
                       
Interest-bearing liabilities:
                       
Savings deposits
 
$
(38
)
 
$
(11
)
 
$
(49
)
NOW deposits
   
(15
)
   
3
     
(12
)
Money market deposits
   
(315
)
   
(5
)
   
(320
)
Time deposits
   
(1,049
)
   
(364
)
   
(1,413
)
FHLB advances
   
(58
)
   
15
     
(43
)
Federal Reserve and other borrowings
   
(4
)
   
126
     
122
 
Subordinated debt
   
(49
)
   
4
     
(45
)
Other interest-bearing liabilities
   
-
     
-
     
-
 
Total interest-bearing liabilities
 
$
1,528
   
$
(232
)
 
$
(1,760
)
 
                       
Net change in net interest income
 
$
(804
)
 
$
(1,929
)
 
$
(2,733
)
                                        

(1) The change in interest due to both rate and volume has been allocated to the volume and rate components in proportion to the relationship of the dollar amounts of the absolute change in each component.
 
Provision for Loan Losses
 
The provision for loan losses is charged to earnings to bring the total allowance to a level deemed appropriate by management and is based upon the volume and type of lending conducted by the Company, the amount of nonperforming loans, and general economic conditions, particularly as they relate to the Company’s market areas, and other factors related to the collectability of the Company’s loan portfolio.  The provision for the year ended December 31, 2012 was $38.0 million, compared to $12.4 million in 2011.  The provision expense was necessitated primarily by the ongoing softening in real estate values in our market and the accelerated disposition of substandard assets.  The Company had net loan charge-offs of $30.8 million in 2012, compared to $12.4 million during 2011.  The increase in net charge-offs was primarily the result of the continued depressed real estate market and increased foreclosure activities in 2012.
 
Noninterest Income and  Noninterest Expense
 
Noninterest income remained relatively consistent year-over-year, with $1.5 million in service charges and other income for the each of the years ended December 31, 2012 and 2011, respectively.  Included in Other income, the Company recorded a net gain of $57 thousand from the sale of investment securities during the year ended December 31, 2011.  There were no such gains recorded during the year ended December 31, 2012.
 
Noninterest expense decreased to $27.7 million for the year ended December 31, 2012, compared to $30.2 million for the same period in 2011.  A primary driver of this decrease was a $3.1 million noncash goodwill impairment expense in 2012, compared to $11.2 million in 2011.  The annual impairment analysis as of September 30, 2012 determined that there had been a goodwill impairment of $3.1 million, which reduced the carrying value of the remaining goodwill balance to zero as of the same date.  This impairment was due to several factors, including the financial performance of the Company through
JACKSONVILLE BANCORP, INC.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
September 30, 2012 resulting from the increased provision for loan losses.  The year-over-year decrease in goodwill impairment expense was offset by an increase in other real estate owned expense to $3.7 million in 2012 from $2.1 million in 2011.  Other real estate owned expenses increased as a result of the Company’s strategy to accelerate the disposition of substandard assets during 2012.  In addition, other noninterest expense increased $3.9 million when compared to the prior year primarily due to loan-related expenses and other nonrecurring expenses incurred as a result of the extended period of time from the inception of the 2012 capital raise activities and the related Asset Sale to their completion late in the fourth quarter of 2012.
 
Income Tax Expense (Benefit)
 
Income tax benefit for the year ended December 31, 2012 was $173 thousand, as compared to an income tax expense of $6.8 million in 2011.  The decrease in income tax expense in comparison to the prior year was mostly the result of recording a full valuation allowance on the Company’s deferred tax asset as of December 31, 2011.  This was substantially due to the fact that it was more-likely-than-not that the benefit would not be realized in future periods due to Section 382 of the Internal Revenue Code.  Based on an analysis performed as of December 31, 2012, it was determined that the need for a full valuation allowance still existed.  The calculation for the income tax provision or benefit generally does not consider the tax effects of changes in other comprehensive income (“OCI”), which is a component of shareholders’ equity on the balance sheet.  However, an exception is provided in certain circumstances, such as when there is a full valuation allowance against the net deferred tax assets, there is a loss from continuing operations, and income in other components of the financial statements.  In such a case, income from other categories, such as changes in OCI, must be considered in determining a tax benefit to be allocated to the loss from continuing operations.  This resulted in $173 thousand of income tax benefit allocated to continuing operations for the year ended December 31, 2012.
 
Investment Securities
 
The Company’s investment securities portfolio is categorized as either “held-to-maturity,” “available-for-sale,” or “trading.”  Securities held-to-maturity represent those securities which the Bank has the intent and ability to hold to maturity.  Securities available-for-sale represent those investments which may be sold for various reasons, including changes in interest rates and liquidity considerations.  These securities are reported at fair market value and unrealized gains and losses are excluded from earnings and reported in accumulated other comprehensive income (loss).  Trading securities are held primarily for resale and are recorded at their fair values with gains or losses recognized immediately in earnings.
 
The following table sets forth the amortized costs and fair value of the Company’s investment securities portfolio as of December 31, 2013, 2012 and 2011:
 
 
 
2013
   
2012
   
2011
 
 
 
Amortized
   
Fair
   
Amortized
   
Fair
   
Amortized
   
Fair
 
(Dollars in thousands)
 
Cost
   
Value
   
Cost
   
Value
   
Cost
   
Value
 
Securities available for sale:
 
   
   
   
   
   
 
U.S. government-sponsored entities and agencies
 
$
8,343
   
$
8,396
   
$
10,286
   
$
10,491
   
$
3,093
   
$
3,093
 
State and political subdivisions
   
7,762
     
8,037
     
16,598
     
18,166
     
16,574
     
17,881
 
Mortgage-backed securities - residential
   
32,709
     
33,225
     
32,148
     
33,646
     
31,601
     
33,052
 
Collateralized mortgage obligations
   
32,791
     
31,978
     
19,349
     
19,527
     
8,929
     
9,114
 
Corporate Bonds
   
3,037
     
3,135
     
2,048
     
2,155
     
-
     
-
 
Total
 
$
84,642
   
$
84,771
   
$
80,429
   
$
83,985
   
$
60,197
   
$
63,140
 
 
As of December 31, 2013, 2012, and 2011, the Company’s investment securities portfolio did not include any securities classified as held-to-maturity or trading.
JACKSONVILLE BANCORP, INC.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
 
The following table sets forth, by maturity distribution, certain information pertaining to the fair value of securities as of December 31, 2013.  Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.  Securities not due at a single maturity date, primarily mortgage-backed securities – residential and collateralized mortgage obligations, are categorized by stated maturity as of December 31, 2013, which is based on the last date on which the principal from the collateral could be paid.
 
<
 
Within One Year
 
One to Five Years
   
Five to Ten Years
 
(Dollars in thousands)
Amount
   
Yield
 
Amount
   
Yield
   
Amount
   
Yield
 
Securities available for sale:
 
   
   
   
   
   
 
U.S. government-sponsored entities and agencies
 
$
-
     
-
%
 
$
-
     
-
%
 
$
2,668
     
2.13
%
State and political subdivisions
   
-
     
-
     
753
     
3.81
     
1,434
     
4.40
 
Mortgage-backed securities - residential
   
10
     
4.59
     
218
     
3.93
     
13,721
     
2.67
 
Collateralized mortgage obligations
   
-
     
-
     
19
     
4.49
     
3,331
     
2.11
 
Corporate bonds
   
-
     
-
     
2,141
     
3.27
     
994
     
1.24
 
Total