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EX-31.1 - SECTION 302 CERTIFICATION OF CEO - JACKSONVILLE BANCORP INC /FL/dex311.htm
EX-32.2 - SECTION 906 CERTIFICATION OF CFO - JACKSONVILLE BANCORP INC /FL/dex322.htm
EX-32.1 - SECTION 906 CERTIFICATION OF CEO - JACKSONVILLE BANCORP INC /FL/dex321.htm
EX-23.1 - CONSENT OF CROWE HORWATH LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - JACKSONVILLE BANCORP INC /FL/dex231.htm
EX-31.2 - SECTION 302 CERTIFICATION OF CFO - JACKSONVILLE BANCORP INC /FL/dex312.htm
EX-10.24 - FORM OF LOAN AGREEMENT - JACKSONVILLE BANCORP INC /FL/dex1024.htm
EX-10.15 - FIRST AMENDMENT TO EMPLOYMENT AGMT - JACKSONVILLE BANCORP INC /FL/dex1015.htm
EX-10.17 - FIRST AMENDMENT TO EMPLOYMENT AGMT - JACKSONVILLE BANCORP INC /FL/dex1017.htm
EX-10.25 - FORM OF REVOLVING LOAN NOTE - JACKSONVILLE BANCORP INC /FL/dex1025.htm
EX-21 - SUBSIDIARIES OF JACKSONVILLE BANCORP, INC - JACKSONVILLE BANCORP INC /FL/dex21.htm
Table of Contents

 

 

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, 2010

or

 

¨ TRANSITION REPORT UNDER 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)

(904) 421-3040

(Registrant’s telephone number, including area code)

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 Global 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  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

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   ¨   Accelerated filer   ¨
Non-accelerated filer   ¨   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  ¨    No  x

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant (based upon the per share closing sale price of $10.90 on June 30, 2010) was approximately $14,238,605.

There were 5,888,809 outstanding shares of common stock as of February 28, 2011.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Definitive Proxy Statement for the 2011 Annual Meeting

of Shareholders are incorporated by reference in Part III of this Annual Report.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

Description

   Page  
   Forward-Looking Statements      3   
PART I   

Item 1.

   Business      3   

Item 1A.

   Risk Factors      12   

Item 1B.

   Unresolved Staff Comments      19   

Item 2.

   Properties      20   

Item 3.

   Legal Proceedings      21   

Item 4.

   Reserved      21   

 

 

PART II

  

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      21   

Item 6.

   Selected Financial Data      22   

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      24   

Item 7A.

   Quantitative and Qualitative Disclosures about Market Risk      43   

Item 8.

   Financial Statements and Supplementary Data      F-i   

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      45   

Item 9A.

   Controls and Procedures      45   

Item 9B.

   Other Information      46   

 

 

PART III

  

Item 10.

   Directors, Executive Officers and Corporate Governance      46   

Item 11.

   Executive Compensation      50   

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      50   

Item 13.

   Certain Relationships and Related Transactions, and Director Independence      50   

Item 14.

   Principal Accountant Fees and Services      50   

 

 

PART IV

  

Item 15.

   Exhibits and Financial Statement Schedules      51   
   Signatures   


Table of Contents

Notice Regarding Forward-Looking Statements

This Annual Report on Form 10-K contains certain forward-looking statements. Assumptions relating to forward-looking statements involve judgments with respect to, among other things, future economic, competitive, and market conditions, and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. When used in this report, the words “estimate,” “project,” “anticipate,” “intend,” “believe,” “expect” and similar expressions are intended to identify forward-looking statements. Although we believe that assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate, and we may not realize the results contemplated by these statements. Management decisions are subjective in many respects and susceptible to interpretations and periodic revisions based on actual experience and business developments, the impact of which may cause us to alter our business strategy or capital expenditure plans and may, in turn, affect our results of operations. In light of the significant uncertainties inherent in the forward-looking information included in this report, you should not regard the inclusion of such information as our representation that we will achieve any strategy, objectives or other plans. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company does not undertake any obligation to publicly release any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

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.

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 currently provides a variety of community banking services to businesses and individuals through its eight full-service branches in Jacksonville, Duval County, Florida, as well as 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 the medical and legal sectors. 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 tied to Goldman Sachs proprietary 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 1980’s. We believe that the number of depository institutions headquartered and operating in Florida will continue to decline. 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 area. Based on our experience, we believe that we have been and will continue to be effective in gaining market share as evidenced by Bancorp’s successful merger with ABI. The Bank currently has 102 employees. We are focused on small business, professionals and commercial real estate. Over the past five years, Bancorp’s Board of Directors (also referred to herein as the “Board”) has granted every employee (excluding executive officers) of the Company restricted stock.

 

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Acquisition

On November 16, 2010, Bancorp acquired ABI pursuant to an agreement and plan of merger that provided for the merger of ABI with and into Bancorp. The merger agreement also included the consolidation of ABI’s wholly owned subsidiary, Oceanside Bank, into the Bank. Under the terms of the merger agreement, ABI shareholders received 0.2 shares of Bancorp common stock and $0.67 in cash for each share of ABI common stock. A total of 249,483 shares were issued to ABI shareholders. The ABI merger increased our branch locations from five full-service branches to eight full-service branches (and one drive-thru only branch, which we subsequently closed as of March 1, 2011) as well as expanded our geographic footprint in the Jacksonville Beach market. In addition, we acquired approximately $158.0 million in net loans, as more fully described below, $62.8 million in cash and cash equivalents and securities, $231.3 million in deposits and $9.5 million in borrowings in the ABI merger. We recorded $12.5 million in goodwill and $2.5 million in core deposit intangibles as a result of the ABI merger.

Cash and cash equivalents and securities

The carrying amount of cash and cash equivalents is a reasonable estimate of fair value based on the short-term nature of these assets. Fair value for securities was based on quoted market prices, where available. If quoted market prices were not available, fair value estimates were based on observable inputs, including quoted market prices for similar instruments, quoted market prices that are not in an active market or other inputs that are observable in the market.

Loans

Fair value for loans was based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and current discount rates. Loans were grouped together according to similar characteristics and were treated in the aggregate when applying various valuation techniques. The discount rates used for loans were based on current market rates for new originations of comparable loans and included adjustments for liquidity concerns. The discount rate does include a factor for credit losses. Management prepared the purchase price allocations and, in part, relied on a third party for the valuation of non-impaired loans at November 16, 2010.

The following are the fair value of loans recorded in the merger with ABI as of November 16, 2010 (dollars in thousands):

 

Loan Types

   As
Recorded

by ABI
     Fair Value
Adjustments
     Fair Value
of Acquired
Loans
     % of
Acquired

Loan
Portfolio
 

Commercial

   $ 11,240       $ 945       $ 10,295         6.50

Real estate mortgage loans:

           

Residential

     52,635         6,646         45,989         29.10

Commercial

     87,669         12,092         75,577         47.00

Construction and land

     29,311         5,765         23,546         14.90

Consumer

     2,736         172         2,564         1.60
                                   

Total

   $ 183,591       $ 25,620       $ 157,971         100.00
                                   

The acquired loans at November 16, 2010 included loans accounted for in accordance with FASB ASC 310-30 (“ASC 310-30”). As defined by ASC 310-30 and subject to certain exceptions contained in that statement, ASC 310-30 loans are loans with evidence of deterioration of credit quality for which it is probable that the borrower will not be able to make all contractually required payments. We acquired loans with an aggregate face value on November 16, 2010 of $77.8 million, for which there was, at acquisition, evidence of deterioration in credit quality and for which it was probable that the borrowers would not be able to make all contractually required payments. As a result, a discount of $18.5 million was recorded for these loans resulting in a net carrying amount of $59.3 million on November 16, 2010.

 

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Core Deposit Intangible

This intangible asset represents the value of the relationships that ABI had with its deposit customers. The fair value of this intangible asset was estimated based on a discounted cash flow methodology that gave appropriate consideration to expected customer attrition rates, cost of the deposit base, reserve requirements and the net maintenance cost attributable to customer deposits. A third party provided the valuation for the core deposit intangible at November 16, 2010.

Deposits

The fair value used for the demand and savings deposits that comprise the transaction accounts acquired, by definition, equal the amount payable on demand at the acquisition date. The fair values for time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered to the interest rates embedded on such time deposits. A third party provided the valuation of the deposits at November 16, 2010.

Capital Raise

Also on November 16, 2010, and immediately following the ABI merger, Bancorp completed the sale of 3,888,889 shares of its common stock to four accredited investors at a purchase price of $9.00 per share pursuant to a stock purchase agreement. This financing was led by CapGen Capital Group IV LP (“CapGen”) and resulted in total gross proceeds of $35.0 million to Bancorp. The amount of cash raised was directly tied to the amount of additional capital Bancorp needed in order to obtain regulatory approval to consummate the merger with ABI. The net proceeds from the sale after offering expenses were $34.7 million and were used to fund the merger and integration of ABI and Oceanside Bank into the Company.

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). Jacksonville is the largest city in the United States covering 841 square miles and is a leading financial and insurance center. Jacksonville is home to the 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. We believe, however, that we 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. We face increased competition due to the Gramm-Leach-Bliley Act (the “GLB Act”), discussed under Business-Regulation and Supervision, which allows insurance firms, securities firms, and other non-traditional financial companies to provide traditional banking services. We anticipate that significant competition will continue from existing financial services providers as well as new entrants to the market. There are 30 separate financial institutions located in Duval County.

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 an additional source of funding. 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 Star, Cirrus, Presto and Plus ATM networks and a member of VISA.

 

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Table of Contents

Borrowings

Additional sources of funds are available to the Bank by borrowing from the Federal Home Loan Bank (“FHLB”) and 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 9-Short-term Borrowings and Federal Home Loan Bank Advances” of the 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 Board has formed a Directors’ Loan Committee and appointed five directors to provide the following oversight:

 

   

ensure compliance with loan policy, procedures and guidelines as well as appropriate regulatory requirements;

 

   

approve secured loans above an aggregate amount of $2,000,000 and unsecured loans above an aggregate amount of $1,000,000 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;

 

   

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.

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 $2,000,000 and $1,000,000, respectively, 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 appropriate, some interest rates are adjustable with fluctuations in the “prime” rate.

Loan Portfolio Composition

The composition of the Bank’s core loan portfolio, excluding loans classified as held for sale at December 31, 2010 and 2009, is indicated below along with the growth from December 31, 2009.

 

(dollars in thousands)

   Total Loans
December 31,
2010(1)
     % of Total
Loans
    Total Loans
December 31,
2009
     % of Total
Loans
    % Increase
(Decrease) from
December 31,
2009 to 2010
 

Real estate mortgage loans:

            

Commercial

   $ 282,468         55.00   $ 233,570         59.70     20.90

Residential

     136,771         26.70     97,147         24.80     40.80

Construction and land

     52,808         10.30     32,987         8.40     60.10

Commercial loans

     35,976         7.00     23,838         6.10     50.90

Consumer loans

     5,110         1.00     3,899         1.00     31.10
                                          

Total

   $ 513,133         100.00   $ 391,441         100.00     31.10
                                          

 

(1)

Total loans include merger with ABI

The following table sets forth the composition of our loans classified as held for sale portfolio at December 31, 2010:

 

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Table of Contents
     Amount      % of Total
Loans
 

Real estate mortgage loans:

     

Commercial

   $ 11,649         83.80

Residential

     1,401         10.10

Construction and land

     840         6.00

Commercial loans

     20         0.10

Consumer loans

     —           —     
                 
   $ 13,910         100.00
                 

There were no loans classified as held for sale at December 31, 2009.

Our nonperforming loans as a percentage of gross loans, excluding loans classified as held for sale, increased from 2.24% at December 31, 2009 to 6.83% at December 31, 2010. This increase was driven in part by the merger with ABI as well as general economic conditions, including the real estate market that continues to be challenging in the Bank’s geographic market.

Commercial Real Estate

Commercial real estate loans are typically segmented into three categories: owner occupied commercial properties, properties used by non-profit organizations (i.e., churches and schools) and commercial properties leased to third parties for investment purposes. Commercial real estate loans are secured by the subject property and are underwritten based upon standards set forth in the policies approved by the Board. Such standards include, among other factors, loan to value limits, cash flow coverage and general creditworthiness of the obligors.

Residential Real Estate

Residential real estate loans include loans secured by first or second mortgages and home equity loans on one-to-four family residential properties. Loans in the residential real estate portfolio are underwritten in accordance with policies set forth and approved by the Board, including repayment capacity and source, value of the underlying property, credit history and stability.

Construction and Land Loans

The Bank provides construction permanent loans to borrowers 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 on funds advanced. 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, costs 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 for either commercial or residential use by the borrower. The Bank carefully analyzes the intended use of the property and the viability thereof.

Commercial Loans

Commercial loans are primarily underwritten on the basis of the borrowers’ ability to service such debt from income. 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.

Other

Consumer 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. Loans to consumers are extended after a credit evaluation, including the creditworthiness 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.

 

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Investments

The primary objective of the 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.

Employees

As of February 28, 2011, the Bank had 102 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.

Data Processing

We currently have an agreement with FIS, formerly known as Metavante Corporation, to provide our core processing and support certain customer products and delivery systems. We believe 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, the FDIC, and the Florida Department of Financial Services.

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 will have a broad impact on the financial services industry, including, significant regulatory and compliance changes, 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 establishes a new framework for systemic risk oversight within the financial system to be distributed among new and existing federal regulatory agencies, including the Financial 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 agency.

 

   

The Consumer Financial Protection Bureau (“Bureau”). The Dodd-Frank Act creates the Bureau within 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.

 

   

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 will no longer be 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 percent to 1.35 percent 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 percent. The Dodd-Frank Act also provides that, effective one year after the date of enactment, depository institutions may pay interest on demand deposits.

 

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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 increasing the amount of time for which collateral requirements regarding covered transactions must be maintained.

 

   

Transactions with Insiders. Insider transaction limitations are expanded through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivative transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions. Restrictions are also placed on certain asset sales to and from an insider to an institution, including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s board of directors.

 

   

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.

 

   

Compensation Practices. The Dodd-Frank Act provides that the appropriate 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. Together, the Dodd-Frank Act and the recent guidance on compensation may impact the current compensation policies at the Company.

 

   

Holding Company Capital Levels. The Dodd-Frank Act requires bank regulators to establish minimum capital levels for holding companies that are at least of the same nature as those applicable to financial institutions. All trust preferred securities, or TRUPs, issued by bank or thrift holding companies after May 19, 2010 will be counted as Tier II Capital (with an exception for certain small bank holding companies). Bank holding companies with at least $15 billion in assets as of December 31, 2009 will have five years to comply with this provision, and starting on January 1, 2013, these holding companies will phase in the requirement by deducting one-third of TRUPs per year for the following three years from Tier 1 capital. TRUPs issued prior to May 19, 2010 by bank holding companies with less than $15 billion in assets as of December 31, 2009 are exempt from these capital deductions entirely.

We expect that many of the requirements called for in the Dodd-Frank Act will be implemented over time, and most will be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies and through regulations, the full extent of the impact such requirements will have on financial institutions’ operations is unclear. The changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, 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.

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. The Federal Reserve Board policy, which has been codified by the Dodd-Frank Act, under its regulations and published policy statements, has maintained 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.

 

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At one time, a bank holding company was generally prohibited from acquiring control of any company which was not a bank and from engaging in any business other than the business of banking or managing and controlling banks. In April 1997, the Federal Reserve Board revised and expanded the list of permissible non-banking activities in which a bank holding company could engage; however, limitations continue to exist under certain laws and regulations. The GLB Act repeals certain regulations pertaining to bank holding companies and eliminates many of the previous prohibitions. Specifically, Title I of the GLB Act repeals Sections 20 and 32 of the Glass-Steagall Act and is intended to facilitate affiliations among banks, securities firms, insurance firms, and other financial companies. To further this goal, the GLB Act amends Section 4 of the BHC Act to authorize 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.

With respect to expansion, we may establish branch offices anywhere within the State of Florida 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.

The primary source of Bancorp’s income is expected to be dividends from the Bank. 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 2010 as our net loss at December 31, 2010 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.

Loans and extensions of credit 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.

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 state 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. 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.

 

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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. Further, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent’s general unsecured creditors. Undercapitalized institutions also 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.

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
Capital Ratio
  Tier 1 Risk-Based
Capital Ratio
  Tier 1
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 is classified as well capitalized. At December 31, 2010, the Bank’s total risk-based capital and Tier 1 risk-based capital ratios were 10.39% and 9.13%, respectively. The Tier 1 leverage ratio was 8.97% 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% at all times and total risk-based capital above 10% at all times.

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.

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. 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.

Substantially all of our revenues from external customers, long-lived assets, long-term customer relationships, mortgage and other servicing rights, deferred policy acquisition costs, and deferred tax assets are attributed to the United States.

 

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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., Room 1580, Washington, D.C. 20549. 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.

 

ITEM 1A. RISK FACTORS

An investment in our common stock involves a number of risks. Before making an investment decision, you should carefully consider all of the risks. If any of the events contemplated by the risk factors discussed below actually impact us, our business, financial condition and results of operations could be materially adversely affected. If this were to occur, the trading price of our common stock could decline.

RISKS RELATED TO OUR BUSINESS

We may have difficulties integrating ABI’s operations into our operations or may fail to realize the anticipated benefits of the merger.

The merger with ABI involves the integration of two companies that had previously operated independently of each other. Successful integration of ABI’s operations will depend primarily on our ability to consolidate ABI’s operations, systems and procedures into ours and to eliminate redundancies and costs. We may not be able to integrate the operations without encountering difficulties including, without limitation:

 

   

the loss of key employees and customers;

 

   

possible inconsistencies in standards, control procedures and policies; and

 

   

unexpected problems with costs, operations, personnel, technology or credit.

We have incurred significant costs, and expect to incur additional costs, in connection with integrating the operations of the two companies. We are continuing to assess the impact of these costs. Although we believe that the elimination of duplicate costs, as well as the realization of other efficiencies related to the integration of the businesses, will offset incremental transaction and merger-related costs over time, this net benefit may not be achieved in the near term, or at all.

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, it is our management’s extensive knowledge of, and relationships in, the community that generate business for us. Successful execution of our growth strategy will continue to place significant demands on our management and the loss of any such person’s services may adversely affect our growth and profitability. We are primarily dependent upon the services of Price W. Schwenck, Chief Executive Officer; Gilbert J. Pomar, III, President; Valerie A. Kendall, Executive Vice President and Chief Financial Officer; and Scott M. Hall, Executive Vice President and Chief Credit 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 operating results could be adversely affected.

We are integrating ABI’s business into our own. The integration process and our ability to successfully conduct ABI’s business going forward will require the experience and expertise of key employees of Oceanside Bank. Therefore, the ability to successfully integrate ABI’s operations with ours, as well as the future success of the combined company’s operations, will depend, in part, on our ability to retain key employees of Oceanside Bank. We may not be able to retain key employees for the time period necessary to complete the integration process or beyond. Although we do not have any reason to believe any of these employees will cease to be employed by us, the loss of such employees could adversely affect our ability to successfully conduct our business in the markets in which ABI operated, which could have an adverse effect on our financial results and the value of our common stock.

 

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Our business may face risks with respect to future expansion.

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:

 

   

the time and costs associated with identifying and evaluating potential acquisitions and merger partners, and negotiations and consummation of any such transactions;

 

   

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 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.

Customers may not repay their loans, which could have a material adverse effect on our profitability.

The risk that customers may fail to repay their loans is inherent in any bank lending relationship. If our loans are not repaid in accordance with the loan terms, it could have a material adverse effect on our earnings and overall financial condition as well as the value of our common stock. We focus our lending activity in commercial, commercial real estate, residential, home equity and consumer loans.

Our management attempts to minimize credit exposure by carefully monitoring the concentration of loans within specific industries and through loan application and approval procedures. However, we are unable to assure you that such monitoring and procedures will reduce lending risks. Credit losses can cause insolvency and failure of a financial institution and, in such event, shareholders could lose their entire investment.

Our concentration in loans secured by real estate may increase our credit losses, which would negatively affect our financial results.

Due to the nature of our market, a significant portion of our loan portfolio has historically been secured with real estate. As of December 31, 2010, approximately 55.0% of our $513.1 million loan portfolio, excluding loans classified as held for sale, was secured by commercial real estate.

The current 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 clients’ ability to repay their loans. If these conditions persist, or get worse, our clients’ 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 our remedies in order to protect our investment, we may be unable to recover funds in an amount equal to our projected return on our investment or in an amount sufficient to prevent a loss to us due to prevailing economic conditions, real estate values and other factors associated with the ownership of real property. As a result, the market value of the real estate or other collateral underlying our loans may not, at any given time, be sufficient to satisfy the outstanding principal amount of the loans, and consequently, we would sustain loan losses, which would negatively affect our financial results.

 

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Our capital may not be adequate to continue to support the current rate of growth.

Future capital requirements depend on many factors, including the ability to successfully attract new customers and provide additional services, the timing of opening new branch locations, the decision to acquire or merge with other banks or bank holding companies, changes in regulatory requirements for capital and the Bank’s profitability levels. If adequate capital is not available, we will be subject to an increased level of regulatory supervision, we may not be able to expand our operations, and our business operating results and financial condition could be adversely affected.

We may require additional capital in the future, which may not be available when needed, and if available, could result in dilution of our shareholders’ ownership interests.

Any capital that is likely to be generated by our operations over the next several years is expected to be needed to continue expanding our operations. Additionally, our Board may determine from time to time that, in order to support our strategic objectives, there is a need to obtain additional capital through the issuance of additional shares of our common stock or other securities. These issuances would dilute the ownership interest of our then-current shareholders, may dilute the per share book value of our 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 or other derivative securities, which may have a further dilutive effect.

There is no assurance that we will be able to raise additional capital when needed on terms favorable to us or at all. Our ability to raise additional capital will depend on our financial performance at that time and on conditions in the capital markets that are outside our control. If we cannot raise additional capital when needed, our ability to expand our operations through internal growth or to continue operations could be impaired. 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. 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.

Current levels of market volatility have been 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.

Uncertainty about the economy and its direction with the expectation for little or no economic growth as well as high unemployment during the next 12–18 months has adversely affected the financial markets. Loan portfolio performances have deteriorated at many financial institutions, including ours, resulting from, among other factors, a weak economy and a decline in the value of the collateral supporting loans. The competition for deposits has increased significantly due to liquidity concerns. 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, if needed, to raise capital compared to prior years.

 

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Our location on the east coast of Florida makes us susceptible to weather-related problems.

We rely on our ongoing operations to sustain profitability. Our Bank branches and corporate headquarters are located in the Jacksonville area of Florida and can be impacted by climate changes. The State of Florida has been vulnerable to physical effects on our business such as tropical storms, hurricanes and tornadoes. Although we have a disaster recovery plan in place, we cannot ensure that severe weather conditions affecting the State of Florida will not have a material adverse effect on our financial condition, results of operations, or cash flows.

Recent legislation and government actions in response to market and economic conditions may significantly affect our operations, financial condition and earnings.

In response to the financial crisis affecting the banking system and financial markets, the United States Congress enacted the Emergency Economic Stabilization Act of 2008 and the American Recovery and Reinvestment Act of 2009. Under these and other laws and government actions:

 

   

the U.S. Department of the Treasury, or “Treasury,” has provided capital to financial institutions and adopted programs to facilitate and finance the purchase of problem assets and finance asset-backed securities via the Troubled Assets Relief Program, or “TARP”;

 

   

the FDIC provided temporary liquidity guarantee of all FDIC-insured institutions and their affiliates’ debt as well as deposits in noninterest-bearing transaction deposit accounts; and

 

   

the federal government has undertaken various forms of economic stimulus, including assistance to homeowners in restructuring mortgage payments on qualifying loans.

The Small Business Lending Fund (“SBLF”) was enacted into law as part of the Small Business Jobs Act. SBLF is a $30 billion fund that encourages lending to small businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion. Through the SBLF, community banks and small businesses can work together to help create jobs and promote economic growth in their local communities.

The Dodd-Frank Act restructures the regulation of depository institutions and contains various provisions designed to enhance the regulation of depository institutions and prevent the recurrence of a financial crisis such as that which occurred in 2008–2009. Included is the creation of a new federal agency to administer and enforce consumer and fair lending laws, a function that is now performed by the depository institution regulators. The federal preemption of state laws currently accorded federally chartered depository institutions will be reduced as well. The full impact of the Dodd-Frank Act on our business and operations will not be known for years until 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 future consumer and fair lending regulations. The Dodd-Frank Act also permanently increased the limits on federal deposit insurance to $250,000.

TARP and the Temporary Liquidity Guarantee Program (“TLG”) are winding down, and the effects of this wind-down cannot be predicted. In addition, the federal government is considering various proposals for a comprehensive overhauling reform of the financial services industry and markets and coordinating reforms 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.

The costs of regulatory assessments and the TLG guarantees have increased and are expected to continue to adversely affect our results of operations.

Regulatory assessments increased substantially, from $417,000 in 2008 to $1.0 million in each of 2009 and 2010. We expect to pay higher FDIC premiums in the future. Bank failures have significantly depleted the FDIC’s DIF and reduced its ratio of reserves to insured deposits. 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. Additional special assessments may be imposed by the FDIC for future periods. We participate in the FDIC’s TLG Program (“TLGP”) for noninterest-bearing transaction deposit accounts guarantee program and debt guarantee program. Banks that participate in the TLG’s noninterest-bearing transaction account guarantee pay the FDIC a fee for such guarantee. These actions have significantly increased our noninterest expense in 2009 and 2010 and are expected to increase our costs for the foreseeable future, which will continue to adversely affect our results of operations.

 

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An inadequate allowance for loan losses would reduce our earnings.

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 collectibility 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 collectibility is considered questionable.

As of December 31, 2010, our allowance for loan losses was $13.1 million, which represented 2.55% of our total amount of loans, excluding loans classified as held for sale. We had approximately $35.0 million in nonperforming loans as of December 31, 2010, excluding loans classified as held for sale. We manage any nonperforming loans in an effort to minimize credit losses and monitor our asset quality to maintain an adequate loan loss allowance. The allowance may not prove sufficient to cover future loan losses. Further, 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. Material additions to our allowance for loan losses would result in a decrease of our net income and our capital, among other adverse consequences.

Nonperforming assets take significant time to resolve and adversely affect our results of operations and financial condition.

At December 31, 2010, our nonperforming loans were $35.0 million, or 6.8% of our gross loan portfolio, excluding loans classified as held for sale, and our nonperforming assets (which include nonperforming loans) were $40.8 million, or 6.3% of total assets. In addition, we had approximately $12.5 million in accruing loans that were 30-89 days delinquent at December 31, 2010.

Until economic and market conditions improve, we may continue to incur additional losses relating to an increase in nonperforming loans. We do not record interest income on non-accrual loans or other real estate owned, thereby adversely affecting our income, and increasing our loan administration costs. We incur the costs of funding problem assets and other real estate owned, however. 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 the recent past; this has served to increase the cost of foreclosures and the time needed to take title to the underlying property. Once we take possession to 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.

Unexpected losses in future reporting periods may require us to adjust the valuation allowance against our deferred tax assets.

We evaluate the 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 the future projected operating performance and the actual results. We are required to establish a valuation allowance for deferred tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In determining the more-likely-than-not criterion, we evaluate all positive and negative evidence as of the end of each reporting period. 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, it is reasonably possible that we will be required to record adjustments to the valuation allowance in future reporting periods. Such a change could have a material adverse effect on our results of operations, financial condition and capital position.

 

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We could be negatively impacted by changes in interest rates and economic conditions.

Our results of operations may be materially and adversely affected by changes in prevailing economic conditions, including continued declines in real estate market values, rapid changes in interest rates, and the monetary and fiscal policies of the federal government. Our profitability is partly a function of the spread between the interest rates earned on investments and loans and those paid on deposits and other liabilities. As with most banking institutions, our net interest spread is affected by general economic conditions and other factors that influence market interest rates. Changes in interest rates may negatively affect our earnings and the value of our assets. Changes in interest rates may affect our level of interest income, the primary component of our gross revenue, as well as the level of our interest expense, our largest recurring expenditure. In a period of rising interest rates, our interest expense could increase in different amounts and at different rates while the interest that we earn on our assets may not change in the same amounts or at the same rates. Accordingly, increases in interest rates could decrease our net interest income. At any given time, our assets and liabilities may be affected differently by a given change in interest rates. As a result, an increase or decrease in rates could have a material adverse effect on our net income, capital and liquidity. While we take measures to reduce interest-rate risk, these measures may not adequately minimize exposure to interest-rate risk.

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 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. The future ability of the Bank to pay dividends to us will also depend in part on the FDIC capital requirements in effect at such time and our ability to comply with such requirements. Therefore, the Bank may not be able to provide us with adequate funds to conduct our ongoing operations, which would adversely affect our results of operations and financial condition.

We face competition from a variety of competitors.

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 as well as 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. We face increased competition due to the GLB Act which allows insurance firms, securities firms, and other non-traditional financial companies to provide traditional banking services. It can be expected that significant competition will continue from existing financial services providers, as well as new entrants to the market. Many of these competitors have been in business for many years, have established customers, are larger, have substantially higher lending limits than we do, and are able to offer certain services that we do not provide, such as certain loan products and international banking services. In addition, many of these entities have greater capital resources than we have, which among other things may allow them to price their services at levels more favorable to the customer or to provide larger credit facilities. If we are unable to attract and retain customers with personal services, attractive product offerings and competitive rates, our business, results of operations, future growth and operational results will be adversely affected.

 

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Our lending limit restricts our ability to compete with larger financial institutions.

Our per customer lending limit is approximately $12.1 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 accommodate loans in excess of our lending limit through the sale of portions of such loans to other banks. However, we may not be successful in attracting or maintaining customers seeking larger loans or in selling portions of such larger loans on terms that are favorable to us.

We may need to spend significant money to keep up with technology so we can remain competitive.

The banking industry continues to undergo rapid technological changes with 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 enables 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 have substantially greater resources to invest in technological improvements. Such technology may permit competitors to perform certain functions at a lower cost than we can. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these to our customers.

RISKS RELATED TO OUR COMMON STOCK

Sales of substantial amounts of our common stock in the open market by former ABI shareholders or other significant shareholders could depress our stock price.

Other than shares held by persons who are affiliates of Bancorp after the merger with ABI, shares of our common stock that were issued to former ABI shareholders in the merger are freely tradable without restrictions or further registration under the Securities Act of 1933, as amended. We issued 249,483 shares of our common stock in the ABI merger. Also in connection with the $35.0 million financing, we registered 3,888,889 shares of our common stock for resale by the purchasers in the stock purchase, which can be freely traded by such purchasing Shareholders. If the former ABI shareholders and/or other Shareholders sell substantial amounts of our common stock in the public market, the market price of our common stock may decrease. These sales might also make it more difficult for us to sell equity or equity-related securities at a time and price that we otherwise would deem appropriate.

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.

We do not anticipate paying dividends for the foreseeable future.

We do not anticipate that dividends will be paid on our common stock for the foreseeable future. It is the policy of our Board to reinvest earnings for such period of time as is necessary to ensure our successful operations. There are no current plans to initiate payment of cash dividends, and future dividend policy will depend on our earnings, capital and regulatory requirements, financial conditions and other factors considered relevant by our Board. We are largely dependent upon dividends paid by the Bank to provide funds to pay cash dividends if and when our Board may declare such dividends. No assurance can be given that future earnings will be sufficient to satisfy regulatory requirements and permit the legal payment of dividends to shareholders at any time in the future. Even if we could legally declare dividends, the amount and timing of such dividends would be at the discretion of our Board.

 

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The market price of our common stock may be volatile.

The market price of our common stock is subject to fluctuations as a result of a variety of factors, some of which may be beyond our control. Factors affecting the volatility of the trading price of our common stock include:

 

   

quarterly variations in our operating results or those of other banking institutions;

 

   

changes in national and regional economic conditions, financial markets or the banking industry;

 

   

announcements of new products or services by us or our competitors; and

 

   

other developments affecting us or other financial institutions.

The trading volume of our common stock is limited, which may increase the volatility of the market price for our stock. In addition, the stock market has experienced significant price and volume fluctuations in recent years. This volatility has had a significant effect on the market prices of securities issued by many companies for reasons not necessarily related to the operating performance of these companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. For example, the trading price of our common stock could decline in reaction to events that negatively affect other companies in our industry even if these events do not directly affect us at all. In the past, many companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be a target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business.

Your shares of common stock will not be an insured deposit.

Shares of our common stock are not a bank deposit and are not insured or guaranteed by the FDIC or any other government agency. Your investment will be subject to investment risk, and you must be capable of affording the loss of your entire investment.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

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ITEM 2. PROPERTIES

 

Property Location in Jacksonville

   Year Location
Established
   Approximate
Square Footage
     Owned / Leased

Headquarters(1)

100 North Laura Street

   2004      14,815       Lease

Branch Office

10325 San Jose Boulevard

   1998      3,567       Own

Branch Office

12740-200 Atlantic Boulevard

   2000      3,080       Own

Branch Office(2)

4343 Roosevelt Boulevard

   2005      3,127       Lease

Branch Office(3)

7880 Gate Parkway

   2006      9,372       Lease

Branch Office

1315 South 3rd Street

   2010      4,588       Own

Branch Office

560 Atlantic Boulevard

   2010      1,968       Own

Branch Office(4)

13799 Beach Boulevard

   2010      11,200       Lease

Branch Office(5)

1790 Kernan Boulevard

   2010      3,120       Own Building/Lease
Land

 

(1)

The Bank has a 10-year lease that expires September 30, 2014 for our headquarters location which specifies rent of $20.00 per square foot and is subject to annual increases of $0.50 per square foot on October 1st of each year through September 30, 2014. 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, 2014, and the last option term ending on September 30, 2039.

(2)

The Bank took occupancy of this branch on November 1, 2005 and opened for business on February 6, 2006. The Bank has a 10-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.

(3)

The Bank took occupancy of this branch on January 13, 2006 and opened for business on June 9, 2006. The Bank has a 10-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 and operations facility on November 16, 2010 as a result of the merger with ABI. The Bank has a 10-year and 8-month lease that expires November 30, 2011 for this branch, which specifies rent of $186,890 per annum and is subject to increases by applying the greater of the change in the consumer price index or 3%.

(5)

The Bank took occupancy of this branch on November 16, 2010 as a result of the merger with ABI. The Bank has a 20-year 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.

 

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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. RESERVED

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is traded on NASDAQ under the symbol JAXB. The following table shows the high and low sale prices of our common stock for each quarter of 2009 and 2010.

 

Year

  Quarter   High     Low  
2009   First   $ 11.99      $ 6.99   
  Second   $ 11.17      $ 7.51   
  Third   $ 11.00      $ 10.41   
  Fourth   $ 10.93      $ 7.92   
2010   First   $ 11.00      $ 9.07   
  Second   $ 12.00      $ 9.27   
  Third   $ 10.90      $ 7.53   
  Fourth   $ 8.50      $ 7.15   

As of February 28, 2011, Bancorp had 5,888,809 outstanding shares of common stock, par value $.01 per share, held by approximately 694 registered shareholders of record.

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 Bancorp’s Board. For more information regarding Bancorp’s ability to pay dividends and restrictions thereon, please refer to the section captioned “Regulation and Supervision” under Item 1 of this Annual Report on Form 10-K, which information is hereby incorporated by reference.

Equity Compensation Plans Information

The following table sets forth information about the Jacksonville Bancorp, Inc. Stock Option Plan, as amended, and the 2008 Amendment and Restatement of the Jacksonville Bancorp, Inc. 2006 Stock Incentive Plan, as of December 31, 2010:

 

Plan Category

   Number of securities to be issued upon
exercise of outstanding options,
warrants and rights
     Weighted average exercise price of
outstanding options, warrants

and rights
     Number of securities
remaining available for
future issuance
 

Equity compensation plans approved by security holders

     190,000       $ 13.81         51,199 (1) 

Equity compensation plans not approved by security holders

     —           —           —     
                          

Total

     190,000       $ 13.81         51,199   
                          

 

(1)

Represents shares available for issuance pursuant to grants of awards under the 2008 Amendment and Restatement of the Jacksonville Bancorp, Inc. 2006 Stock Incentive Plan, as amended.

 

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COMPANY PURCHASES OF EQUITY SECURITIES

Following approval by the shareholders at the 2003 Annual Meeting, Bancorp established the Directors’ Stock Purchase Plan for nonemployee directors. Under this plan, directors may elect to receive shares of Bancorp’s common stock as an alternative to the equivalent of cash for directors’ fees. All transactions executed under the Directors’ Stock Purchase Plan were open-market purchases and were accounted for as treasury stock on the date of purchase. Effective July 1, 2010, nonemployee directors agreed to a cash-only compensation plan for payment of director fees. As a result, the Company did not repurchase any shares of its common stock during the last quarter of 2010.

 

ITEM 6. SELECTED FINANCIAL DATA

The selected consolidated financial data presented below as of and for the years ended December 31, 2010, 2009, 2008, 2007 and 2006 have been derived from our Consolidated Financial Statements. The ratios and other data are unaudited and have been derived from our records. The information presented below should be read in conjunction with the Consolidated Financial Statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in this Annual Report on Form 10-K.

At or for the Year Ended December 31,

(Dollars in thousands, except per share figures)

 

     2010(1)     2009     2008     2007      2006  

Financial Condition Data:

           

Cash and cash equivalents

   $ 20,297      $ 5,647      $ 10,148      $ 6,035       $ 4,478   

Securities, available for sale and held to maturity

     62,356        22,171        29,734        29,777         26,109   

Loans held for sale

     13,910        —          —          —           —     

Loans, net

     499,696        384,133        374,993        339,265         281,006   

Goodwill

     12,498        —          —          —           —     

Other intangible assets, net

     2,376        —          —          —           —     

All other assets

     40,700        26,860        19,124        16,885         13,982   
                                         

Total assets

   $ 651,833      $ 438,811      $ 433,999      $ 391,962       $ 325,575   
                                         

Deposit accounts

     562,187        370,635        345,544        288,893         282,626   

Other borrowings

     34,886        39,777        60,550        74,830         18,832   

All other liabilities

     2,901        1,131        1,060        1,610         979   

Shareholders’ equity

     51,859        27,268        26,845        26,629         23,138   
                                         

Total liabilities and shareholders’ equity

   $ 651,833      $ 438,811      $ 433,999      $ 391,962       $ 325,575   
                                         
     2010     2009     2008     2007      2006  

Operations Data:

           

Total interest income

   $ 23,962      $ 23,204      $ 25,563      $ 26,808       $ 22,017   

Total interest expense

     8,282        9,729        13,560        14,419         10,945   
                                         

Net interest income

     15,680        13,475        12,003        12,389         11,072   

Provision for loan losses

     16,988        4,361        3,570        542         546   
                                         

Net interest income (loss) after provision for loan losses

     (1,308     9,114        8,433        11,847         10,526   
                                         

Noninterest income

     1,174        841        1,178        1,184         1,047   

Noninterest expenses

     17,124        9,983        9,805        8,485         7,573   
                                         

Income (loss) before income taxes (benefit)

     (17,258     (28     (194     4,546         4,000   

Income tax expense (benefit)

     (5,816     (104     (229     1,588         1,477   
                                         

Net income (loss)

   $ (11,442   $ 76      $ 35      $ 2,958       $ 2,523   
                                         

Per Share Data:

           

Basic earnings per share

   $ (5.07   $ .04      $ .02      $ 1.70       $ 1.46   

Diluted earnings per share

     (5.07     .04        .02        1.63         1.39   

Dividends declared per share

     —          —          —          —           —     

Total shares outstanding at end of year

     5,888,809        1,749,243        1,748,599        1,746,331         1,741,688   

 

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Ratios and Other Data:

          

Book value per share at end of year

   $ 8.81      $ 15.59      $ 15.35      $ 15.25      $ 13.28   

Return on average assets

     (2.42 )%      0.02     0.01     0.82     0.83

Return on average equity

     (37.52 )%      0.28     0.13     12.08     11.92

Average equity to average assets

     6.46     6.22     6.40     6.76     6.95

Interest rate spread during the period

     3.28     2.89     2.46     2.90     3.15

Net yield on average interest-earning assets

     3.52     3.23     2.97     3.56     3.81

Noninterest expenses to average assets

     3.62     2.30     2.33     2.34     2.49

Average interest-earning assets to average interest-bearing liabilities

     1.13        1.15        1.15        1.16        1.17   

Nonperforming loans and foreclosed assets as a percentage of total assets at end of year(2)

     6.25     2.91     2.89     0.18     0.26

Allowance for loan losses as a percentage of total loans at end of
year
(2)

     2.55     1.75     1.24     0.91     0.92

Total number of banking offices(3)

     9        5        5        5        5   

 

(1)

Amounts include merger with ABI.

(2)

Nonperforming loans and total loans exclude amounts classified as loans held for sale as of December 31, 2010.

(3)

Amount represents banking offices operating at December 31 of each year. As of March 1, 2011, the Bank has eight full-service operating branches.

 

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ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Years Ended December 31, 2010, 2009 and 2008

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 FDIC. The Bank provides a variety of community banking services to businesses and individuals in Duval County, Florida. During 2000, the Bank formed Fountain Financial, Inc., a wholly owned subsidiary. The primary business activities of Fountain Financial, Inc. consist of the referral of the Bank’s customers to third parties for the sale of insurance and investment products.

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 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. Our current strategy is to grow organically and through acquisition if price, culture and market fit within our strategies. This was demonstrated through our acquisition of ABI and Oceanside Bank which increased our net loans on the date of acquisition by approximately $158.0 million and $231.3 million in deposits.

2010 Executive Overview

The following were significant factors related to 2010 results as compared to 2009. The 2010 performance is reflective of the successful execution of our strategy to focus on growth through acquisition within the Northeast Florida market as is evidenced by the successful merger with ABI. During 2010, our total gross loans, including loans classified as held for sale, increased by $135.7 million, or 34.7%. We recorded approximately $3.5 million in organic growth in residential and commercial loans with the remaining increase attributable to the ABI merger.

Total deposits increased by $191.6 million, or 51.7%, during 2010. This amount reflects an approximate $28.0 million in national and brokered CD run-off offset by an increase attributable to the merger with ABI. The following are changes in the deposit categories:

 

   

Noninterest-bearing deposits increased $28.7 million, or 65.7%. The noninterest-bearing deposits growth is a direct result of the merger with ABI.

 

   

Money market, savings and NOW deposits increased by $106.2 million, or 101.3%. This growth is a direct result of the merger with ABI.

 

   

The certificate of deposit portfolio increased by $56.6 million, or 25.5%. The time-deposit growth is a direct result of the merger with ABI.

 

   

Borrowed funds, primarily consisting of Federal Home Loan Bank (FHLB) advances and subordinated debentures, totaled $39.8 million at year end 2009 compared to $34.9 million at the end of 2010. During 2010, we increased our subordinated debt by $1.4 million due to the addition of a fourth statutory trust the Company acquired as a result of the merger with ABI. This increase was offset by a larger decrease in our FHLB advances of $6.9 million.

Total shareholders’ equity increased $24.6 million, or 90.2%, during 2010, primarily as a result of the $35.0 million capital raise offset by the Company’s net loss for 2010. Management remains committed to retaining sufficient equity to protect shareholders and depositors, provide for reasonable growth and fully comply with regulatory requirements.

 

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The allowance for loan loss as a percentage of total loans outstanding, excluding loans held for sale, was 2.55% at December 31, 2010, compared to 1.75% at December 31, 2009. During 2010, the Company had charge-offs of $10.9 million, recoveries of $134,000 and recorded a provision for loan loss of $17.0 million, compared to charge-offs of $2.2 million, recoveries of $23,000 and provision for loan losses of $4.4 million in 2009. Approximately $6.8 million of the increase in charge-offs is related to loans classified as held for sale during the fourth quarter which are recorded at the lower of cost or fair value. The remainder is the result of increased foreclosures in 2010 as compared to 2009 due to the continued softening of the real estate market.

Our net loss was $11.4 million in 2010 as compared to net income of $76,000 in 2009. Our basic and diluted loss per share was $5.07 in 2010 as compared to basic and diluted income per share of $0.04 in 2009. Return on average assets and return on average equity were (2.42%) and (37.52%), respectively, in 2010 compared to 0.02% and 0.28%, respectively, in 2009. The net loss was driven primarily by additional provisions for loan losses, ABI merger costs, write-down of OREO values, and other related expenses on foreclosed properties. This was partially offset by the earnings on the interest-earning assets the Company acquired in the merger with ABI.

Interest income was $24.0 million in 2010 compared to $23.2 million in 2009, an increase of $800,000, or 3.4%, as a result of the interest-earning assets the Company acquired in the merger with ABI. This was offset by the repricing of our assets in this low interest rate environment along with the increase in nonperforming loans of $26.3 million from 2009. Interest expense was $8.3 million in 2010 compared to $9.7 million in 2009, a decrease of $1.4 million, or 14.4%, as a result of the low interest rate environment; this was offset somewhat by a transition from low-cost wholesale funding into a more expensive time deposit as well as the interest-bearing liabilities the Company acquired in the merger with ABI.

Basic weighted average shares outstanding increased to 2,256,750 in 2010 from 1,748,683 in 2009 as a result of the capital raise and merger with ABI. The diluted weighted average shares outstanding increased to 2,256,750 from 1,791,164 in the same periods. Basic and diluted weighted average shares outstanding are the same for 2010 as the Company was in a loss position for the year. As a result, all potential common shares for 2010 were excluded from the calculation of diluted earnings per share as the shares would have had an anti-dilutive effect.

Noninterest income was $1.2 million for 2010 compared to $841,000 in 2009. This increase was due to the merger with ABI. In addition, included in noninterest income for 2009 was a $132,000 loss on a nonmarketable equity security.

Critical Accounting Policies

A critical accounting policy is one that is both very important to the portrayal of the Company’s financial condition and requires management’s most difficult, subjective or complex judgments. The circumstances that make these judgments difficult, subjective or complex have to do with the need to make estimates about the effect of matters that are inherently uncertain. Based on this definition, the Company’s primary critical accounting policies are as follows:

Allowance for Loan Loss

The allowance for loan loss is established through a provision for loan loss charged to expense. Loans are charged against the allowance for loan loss when management believes that the collectability of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb probable incurred credit losses on existing loans that may become uncollectible based on evaluations of the collectability of the loans. The evaluations take into consideration such objective factors as changes in the nature and volume of the loan portfolio and historical loss experience. The evaluation also considers certain subjective factors such as overall portfolio quality, review of specific problem loans and current economic conditions that may affect the borrowers’ ability to pay. The level of the allowance for loan loss is also impacted by increases and decreases in loans outstanding, because either more or less allowance is required as the amount of the Company’s credit exposure changes. To the extent actual loan losses differ materially from management’s estimate of these subjective factors, loan growth/run-off accelerates, or the mix of loan types changes, the level of the provision for loan loss, and related allowance can, and will, fluctuate.

 

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Other Real Estate Owned

Other real estate owned includes real estate acquired through foreclosure or deed taken in lieu of foreclosure. These amounts are recorded at estimated fair value, less costs to sell the property, with any difference between the fair value of the property and the carrying value of the loan being charged to the allowance for loan losses. Subsequent changes in fair value are reported as adjustments to the carrying amount, not to exceed the initial carrying value of the assets at the time of transfer. Those subsequent changes, as well as any gains or losses recognized on the sale of these properties, are included in noninterest expense.

Deferred Income Taxes

Our net deferred income tax asset arises from differences in the dates that items of income and expense enter into our reported income and taxable income. From an accounting standpoint, deferred tax assets are reviewed to determine if a valuation allowance is required based on both positive and negative evidence currently available. Positive evidence includes the historical levels of our taxable income, estimates of our future taxable income including tax planning strategies as applicable, the reversals of deferred tax liabilities and taxes available in carry-back years. Negative evidence primarily includes a cumulative three-year loss for financial reporting purposes. Additionally, current and future economic and business conditions are considered. Management believes the Company will generate sufficient operating income to realize the deferred tax asset.

Recent Accounting Pronouncements

Please refer to “Adoption of New Accounting Standards” contained in Note 1 to the accompanying Consolidated Financial Statements for information related to the adoption of new accounting standards and the effect of newly issued but not yet effective accounting standards.

FDIC Insurance Assessments

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. During 2010, assessment rates for all insured institutions ranged from approximately 5 cents per $100 of assessable deposits for well-capitalized institutions with minor supervisory concerns to 43 cents per $100 of assessable deposits for undercapitalized institutions with substantial supervisory concerns. In 2011, assessment rates are expected to range between 12 and 50 cents per $100 of assessable deposits for the first quarter and 8 and 77.5 cents per $100 of assessable deposits for the remainder of the year. The large premium increase is due to the Emergency Economic Stabilization Act of 2008 (EESA) and the Temporary Liquidity Guarantee Program, both of which increased the deposit insurance coverage available to the Bank’s depositors.

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) merging the Bank Insurance Fund and the Savings Association Insurance Fund into a new fund, the Deposit Insurance Fund (DIF), effective March 31, 2006; (ii) increasing the deposit insurance coverage for certain retirement accounts to $250,000 effective April 1, 2006; (iii) beginning in 2010, deposit insurance coverage on individual accounts may be indexed for inflation; (iv) the FDIC will have more discretion in managing deposit insurance assessments; and (v) eligible institutions will receive a one-time initial assessment credit. The Dodd-Frank Act permanently increased the limits on the federal deposit insurance to $250,000.

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%.

 

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In November 2006, the FDIC adopted changes to its risk-based assessment system. Under the new system, the FDIC will evaluate 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 TLGP on October 13, 2008. Participation in the program is voluntary; however, once participation is elected, it cannot be revoked. The Bank elected to participate in the Transaction Account Guarantee Program component of the TLGP. Under the Transaction Account Guarantee Program, the FDIC will fully insure 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 are 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 are required to participate in this extended program.

Securities

The 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. Gains or losses on trading securities are included immediately in earnings. During 2010, 2009 and 2008, the Bank had no trading securities.

The following table sets forth the amortized costs and fair value of our securities portfolio (dollars in thousands):

 

     At December 31, 2010      At December 31, 2009      At December 31, 2008  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 

Securities available for sale:

                 

U.S. government-sponsored entities and agencies

   $ —         $ —         $ 2,485       $ 2,504       $ 8,204       $ 8,284   

Mortgage-backed securities

     38,908         39,022         8,386         8,704         10,483         10,622   

State and municipal securities

     23,584         23,334         10,777         10,963         10,918         10,778   
                                                     

Total

   $ 62,492       $ 62,356       $ 21,648       $ 22,171       $ 29,605       $ 29,684   
                                                     

Security held to maturity:

                 

State of Israel bond

   $ —         $ —         $ —         $ —         $ 50       $ 50   
                                                     

 

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The following table sets forth, by maturity distribution, certain information pertaining to the fair value of securities (dollars in thousands):

 

     Within 1 Year     After 1 Year
Within 5 Years
    After 5 Years
Within 10 Years
    After 10 Years  
     Amount      Yield     Amount      Yield     Amount      Yield     Amount      Yield  

At December 31, 2010:

                    

Securities available for sale:

                    

U.S. government-sponsored entities and agencies

   $ —           0.00   $ —           0.00   $ —           0.00   $ —           0.00

Mortgage-backed securities

     173         2.71     38,376         3.58     280         2.91     193         3.74

State and municipal securities

     —           0.00     2,506         3.09     7,819         3.67     13,009         4.44
                                                                    

Total

   $ 173         2.71   $ 40,882         3.50   $ 8,099         3.44   $ 13,202         4.37
                                            

 

     Totals  
     Amount      Yield  

At December 31, 2010:

     

Securities available for sale:

     

U.S. government-sponsored entities and agencies

   $ —           0.00

Mortgage-backed securities

     39,022         3.42

State and municipal securities

     23,334         3.95
                 

Total

   $ 62,356         3.68
           

Loan Portfolio Composition

Commercial real estate loans comprise the largest group of loans in our portfolio amounting to $335.3 million, or 65.3% of the total loan portfolio, at December 31, 2010, compared to $266.6 million, or 68.1%, at December 31, 2009. Residential real estate loans comprise the second largest group of loans in the portfolio, amounting to $136.8 million, or 26.7% of the total loan portfolio, at December 31, 2010, as compared to $97.1 million, or 24.8%, at December 31, 2009. As of December 31, 2010, commercial loans amounted to $36.0 million, or 7.0% of total loans, which were $23.8 million, or 6.1%, at December 31, 2009. The following table sets forth the composition of our loan portfolio, excluding loans classified as held for sale, over the last five fiscal years (dollars in thousands):

 

     At December 31,  
     2010     2009     2008     2007     2006  
     Amount     % of
Total
    Amount     % of
Total
    Amount     % of
Total
    Amount     % of
Total
    Amount     % of
Total
 

Commercial real estate(1)

   $ 335,276        65.3   $ 266,557        68.1   $ 266,436        70.1   $ 242,676        70.8   $ 198,041        69.7

Commercial

     35,976        7.0        23,838        6.1        28,445        7.5        20,291        5.9        18,903        6.7   

Residential real estate

     136,771        26.7        97,147        24.8        81,152        21.3        75,141        21.9        62,270        21.9   

Consumer and other

     5,110        1.0        3,899        1.0        4,070        1.1        4,631        1.4        4,693        1.7   
                                                                                
   $ 513,133        100.0   $ 391,441        100.0   $ 380,103        100.0   $ 342,739        100.0   $ 283,907        100.0
                                                  

Add (deduct):

                    

Allowance for loan losses

     (13,069       (6,854       (4,705       (3,116       (2,621  

Net deferred (fees) costs

     (368       (454       (405       (358       (280  
                                                  

Loans, net

   $ 499,696        $ 384,133        $ 374,993        $ 339,265        $ 281,006     
                                                  

 

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The following table sets forth the composition of our loans classified as held for sale portfolio (dollars in thousands) as of December 31, 2010:

 

     Amount      % of
Total
 

Commercial real estate(1)

   $ 12,489         89.80

Commercial

     20         0.10   

Residential real estate

     1,401         10.10   

Consumer and other

     —           —     
                 
   $ 13,910         100.00
                 

 

(1)

For presentation purposes, construction and land loans have been classified as commercial real estate loans.

There were no loans classified as held for sale at December 31, 2009, 2008, 2007 or 2006.

The following table reflects the contractual principal repayments by period of our loan portfolio, including loans classified as held for sale, at December 31, 2010 (dollars in thousands):

 

     Commercial
Loans
     Commercial
Real Estate

Loans(1)
     Residential
Real  Estate

Loans
     Consumer
Loans
     Total  

Less than 1 year(2)

   $ 22,243       $ 66,992       $ 33,647       $ 2,264       $ 125,146   

1-5 years

     12,151         180,732         58,403         2,683         253,969   

Greater than 5 years

     1,607         100,035         46,122         164         147,928   
                                            

Total

   $ 36,001       $ 347,759       $ 138,172       $ 5,111       $ 527,043   
                                            

 

(1)

For presentation purposes, construction and land loans have been classified as commercial real estate loans.

(2)

Loans classified as held for sale were included in the ‘Less than 1 year’ column as they were sold in February 2011. See Note 22 of the Consolidated Financial Statements for further detail.

 

     Loans Maturing  

(in thousands)

   Within 1 Year(1)      1-5 Years      After 5 Years      Total  

Loans with:

           

Fixed interest rates

   $ 102,712       $ 216,130       $ 98,416       $ 417,258   

Variable interest rates

     22,434         37,840         49,511         109,785   
                                   

Total Loans

   $ 125,146       $ 253,970       $ 147,927       $ 527,043   
                                   

 

(1)

Loans classified as held for sale were included in the ‘Within one year’ column as they were sold in February 2011. See Note 22 of the Consolidated Financial Statements for further detail.

Scheduled contractual principal repayments of loans do not reflect the actual life of such assets. The average life of loans is substantially less than their average contractual terms due to prepayments. In addition, due-on-sale clauses on loans generally give us the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells real property subject to a mortgage and the loan is not repaid. The average life of mortgage loans tends to increase, however, when current mortgage loan rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgages are substantially higher than current mortgage loan rates.

 

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Credit Risk

Our primary business is making commercial, real estate, business and consumer loans. That activity entails potential loan losses, the magnitude of which depends on a variety of economic factors affecting borrowers which are beyond our control. While the Company has instituted underwriting guidelines and credit review procedures to protect it from avoidable credit losses, some losses will inevitably occur. At December 31, 2010, the Company had nonperforming loans of $35.0 million that were not accruing interest. This amount excludes $3.7 million of nonperforming loans that were classified as loans held for sale on the balance sheet as of December 31, 2010.

Loans are placed on nonaccrual status when management has concerns relating to the ability to collect the loan principal and interest and generally when such loans are 90 days or more past due. A loan is considered impaired when it is probable that not all principal and interest amounts will be collected according to the loan contract. The following table sets forth certain information regarding nonaccrual loans, including the ratio of such loans to total assets as of the dates indicated (dollars in thousands):

 

     At December 31,  
     2010     2009     2008     2007     2006  

Nonperforming loans:

          

Commercial real estate

   $ 20,425      $ 5,163      $ 9,011      $ —        $ 432   

Residential real estate loans

     14,215        3,563        3,013        —          —     

Commercial loans

     371        19        412        680        407   

Consumer loans and other

     6        —          —          10        12   
                                        

Total nonperforming loans

   $ 35,017      $ 8,745      $ 12,436      $ 690      $ 851   
                                        

Foreclosed assets, net

     5,733        4,011        89        —          —     

Total nonperforming assets

   $ 40,750      $ 12,756      $ 12,525      $ 690      $ 851   

Total loans classified as troubled debt restructure

   $ 7,497      $ 16,175        —          —          —     

Total nonperforming loans as a percentage to total loans(1)

     6.83     2.24     3.28     0.20     0.30
                                  

Total nonperforming loans and foreclosed assets as a percentage of total assets(1)

     6.25     2.91     2.89     0.18     0.26
                                        

 

(1)

Nonperforming loans and total loans exclude amounts classified as loans held for sale as of December 31, 2010.

From time to time the Bank may utilize an interest reserve for a borrower’s future interest payments to ensure the payments remain current through maturity. At December 31, 2010, we had $4.8 million in loans where such reserves existed. Of this total, $1.4 million was considered substandard and was included in the bulk loan sale that settled on February 8, 2011. See Note 22—Subsequent Events of the Notes to the Consolidated Financial Statements for further information.

Allowance and Provision for Loan Losses

The allowance for loan losses is a valuation allowance for credit losses in the loan portfolio. Management has adopted a methodology to properly analyze and determine an adequate loan loss allowance. The analysis is based on sound, reliable and well documented information and is designed to support an allowance that is adequate to absorb all estimated credit losses in the Company’s loan and lease portfolio.

Due to their similarities, the Company has grouped the loan portfolio into portfolio segments. The components are real estate mortgage loans, commercial loans, and consumer and other loans. The Company has created a loan classification system to properly calculate the allowance for loan losses. Loans are evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the sale of the collateral.

In estimating the overall exposure to loss on impaired loans, the Company has considered a number of factors, including the borrower’s character, overall financial condition, resources and payment record, the prospects for support from any financially responsible guarantors and the realizable value of any collateral.

 

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The Company also considers other internal and external factors when determining the allowance for loan losses. These factors include, but are not limited to, changes in national and local economic conditions, commercial lending staff limitations, impact from lengthy commercial loan workout and charge-off period, loan portfolio concentrations and trends in the loan portfolio.

Senior management reviews this calculation and the underlying assumptions on a routine basis not less frequently than quarterly.

The allowance for loan losses amounted to $13.1 million and $6.9 million at December 31, 2010 and December 31, 2009, respectively. Based on an analysis performed by management at December 31, 2010, the allowance for loan losses is considered to be appropriate to absorb estimated loan losses in the portfolio as of that date. However, management’s judgment is based upon a number of assumptions about future events, which are believed to be reasonable, but which may or may not prove valid. Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that significant additional increases in the allowance for loan losses will not be required.

The Bank has experienced an increase in adversely classified loans from $44.8 million at December 31, 2009 to $65.0 million at December 31, 2010. This amount includes $14.6 million of adversely classified loans from the merger with ABI. Of the $65.0 million at December 31, 2010, $45.5 million is listed as impaired. Nonperforming loans as a percentage of total loans were 6.83% at December 31, 2010, compared to 2.24% at December 31, 2009. All adversely classified loans are monitored closely and the majority of these loans are collateralized by real estate. Management has analyzed its collateral position and has concluded that the loan loss reserve at December 31, 2010 is adequate.

Loans past due still accruing interest, excluding loans classified as held for sale, at December 31, 2010, are categorized as follows (dollars in thousands):

 

     30-59 Days
Past Due
     60-89 Days
Past Due
     Greater than
90 Days
Past Due
     Total Past
Due Still
Accruing
 

Commercial

   $ 140       $ 36       $ —         $ 176   

Real estate:

           

Residential

     4,580         846         —           5,426   

Commercial

     655         4,087         —           4,742   

Construction and land

     295         1,659         —           1,954   

Consumer

     201         28         —           229   
                                   

Total

   $ 5,871       $ 6,656       $ —         $ 12,527   
                                   

The increase in total loans past due 30-89 days still accruing interest from $5,308 at December 31, 2009 to $12,527 at December 31, 2010 is being driven by loan absorption as a result of the merger with ABI as well as the continued softening of the economy throughout 2010. The loans acquired form ABI included in the table above are as follows: 30-59 days past due of $1,927 and 60-89 days past due of $2,113.

 

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The following table sets forth information with respect to activity in the allowance for loan losses for the periods indicated (dollars in thousands):

 

     Year Ended December 31,  
     2010     2009     2008     2007     2006  

Allowance at beginning of year

   $ 6,854      $ 4,705      $ 3,116      $ 2,621      $ 2,207   

Charge-offs:

          

Consumer and other loans

     107        22        46        59        16   

Real estate loans

     10,763        1,788        912        —          —     

Commercial loans

     37        425        1,137        12        124   
                                        

Total Charge-offs

     10,907        2,235        2,095        71        140   
                                        

Recoveries:

          

Consumer loans

     3        4        3        20        3   

Real estate loans

     46        9        —          —          —     

Commercial loans

     85        10        111        4        5   
                                        

Total Recoveries

     134        23        114        24        8   
                                        

Net charge-offs

     10,773        2,212        1,981        47        132   
                                        

Provision for loan losses charged to operating expenses

     16,988        4,361        3,570        542        546   
                                        

Allowance at end of year

   $ 13,069      $ 6,854      $ 4,705      $ 3,116      $ 2,621   
                                        

Ratio of net charge-offs to average loans outstanding(1)

     2.67     0.57     0.57     0.01     0.05
                                        

Allowance as a percent of total loans(2)

     2.55     1.75     1.24     0.91     0.92
                                        

 

(1)

Average loans outstanding include loans classified as held for sale as of December 31, 2010.

(2)

Total loans exclude amounts classified as loans held for sale as of December 31, 2010.

The following table presents information regarding the total allowance for loan losses as well as the allocation of such amounts to the various categories of loans (dollars in thousands):

 

     At December 31,  
     2010     2009     2008     2007     2006  
     Amount      % of
Loans
to Total
Loans
    Amount      % of
Loans
to Total
Loans
    Amount      % of
Loans
to Total
Loans
    Amount      % of
Loans
to Total
Loans
    Amount      % of
Loans
to Total
Loans
 

Commercial real estate(1)

   $ 9,235         65.3   $ 4,323         68.1   $ 2,885         70.1   $ 2,171         70.8   $ 1,689         69.7

Commercial

     570         7.0        661         6.1        879         7.5        232         5.9        225         6.7   

Residential real estate

     3,209         26.7        1,822         24.8        896         21.3        672         21.9        667         21.9   

Consumer and other

     55         1.0        48         1.0        45         1.1        41         1.4        40         1.7   

Total allowance for loan losses

   $ 13,069         100.0   $ 6,854         100.0   $ 4,705         100.0   $ 3,116         100.0   $ 2,621         100.0
                                                                                     

Allowance for loan losses as a percentage of total loans outstanding

        2.55        1.75        1.24        0.91        0.92
                                                       

 

(1)

Construction and land loans have been classified as commercial real estate loans. The amount of the allowance reserved at December 31, 2010 for construction and land loans was $3,313.

Deposits and Other Sources of Funds

General. In addition to deposits, the sources of funds available for lending and other business purposes include loan repayments, loan sales, Federal Home Loan Bank (FHLB) advances, Federal Reserve borrowings, federal funds purchased lines of credit, and securities sold under agreements to repurchase. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are influenced significantly by general interest rates and market conditions. Borrowings may be used to compensate for reductions in other sources, such as deposits, or due to favorable differentials in rates and other costs.

 

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Deposits. Deposits are attracted principally from our primary geographic market areas in Duval County, Florida. The Bank also enhanced its geographical diversity by offering certificates of deposits through brokered markets and nationally to other financial institutions. In August 2009, the Company launched its “Virtual Branch” to attract deposits from other geographic market areas. The Bank offers a broad selection of deposit products, including demand deposit accounts, NOW accounts, money market accounts, regular savings accounts, term certificates of deposit and retirement savings plans (such as IRAs). Certificate of deposit rates are set to encourage maturities based on current market conditions. Deposit account terms vary, with the primary differences being the minimum balance required, the time period the funds must remain on deposit, and the associated interest rates. The Company holds quarterly Asset Liability Committee (ALCO) meetings, comprised of members of the Board of Directors and management. In addition, pricing and liquidity management meetings are held by members of management on a monthly basis or more frequently if economic conditions dictate. The Bank emphasizes commercial banking and small business relationships in an effort to increase demand deposits as a percentage of total deposits.

The following table shows the distribution of, and certain other information relating to, our deposit accounts by type (dollars in thousands):

 

     At December 31,  
     2010     2009     2008  
     Average
Balance
     Average
Rate Paid
    Average
Balance
     Average
Rate Paid
    Average
Balance
     Average
Rate Paid
 

Demand deposits

   $ 45,481         0.00   $ 41,908         0.00   $ 41,580         0.00

NOW deposits

     7,316         0.18        7,662         0.23        6,513         0.18   

Money market deposits

     114,640         1.29        71,670         1.52        81,517         2.51   

Savings deposits

     10,422         1.16        12,578         1.61        14,588         2.91   

Time deposits

     222,060         2.30        201,117         3.25        194,568         4.55   
                                                   

Total deposits

   $ 399,919         1.68   $ 334,935         2.34   $ 338,766         3.35
                                                   

The following table represents maturity of our time deposits at December 31, 2010:

 

     Deposits
$100,000
and Greater
     Deposits
Less Than
$100,000
     Total  

Due three months or less

   $ 43,528       $ 35,199       $ 78,728   

Due more than three months to six months

     19,142         18,238         37,380   

Due more than six months to one year

     39,037         35,008         74,045   

Due one to five years

     40,416         48,133         88,549   

Due more than five years

     —           —           —     
                          
   $ 142,123       $ 136,578       $ 278,702   
                          

The Dodd-Frank Act permanently increased the limits on federal deposit insurance to $250,000.

Liquidity and Capital Resources

The Bank’s liquidity is its ability to maintain a steady flow of funds to support its ongoing operating, investing and financing activities. The Bank’s Board establishes policies and analyzes and manages liquidity to ensure that adequate funds are available to meet normal operating requirements in addition to unexpected customer demands for funds, such as high levels of deposit withdrawals or loan demand, in a timely and cost-effective manner. The most important factor in the preservation of liquidity is maintaining public confidence that facilitates the retention and growth of a large, stable supply of core deposits and wholesale funds. Ultimately, public confidence is generated through profitable operations, sound credit quality and a strong capital position. Liquidity management is viewed from a long-term and a short-term perspective as well as from an asset and liability management perspective. We monitor liquidity through a regular review of loan and deposit maturities and loan and deposit forecasts to minimize funding risk.

 

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As discussed above, sources of liquidity include principal paydowns of loans and investment securities, customer deposits and borrowings. The Bank has an unsecured federal funds purchased accommodation with its main correspondent bank totaling $14.5 million at December 31, 2010; all of which was available as of that date. In addition, the Bank has invested in FHLB stock for the purpose of establishing credit lines with FHLB. This line is collateralized by a lien arrangement on the Bank’s first mortgage loans, second mortgage loans and commercial real estate loans. Based on this collateral and the Bank’s holdings of FHLB stock, the Bank had a line of credit availability of $56.3 million from this credit line, of which it had borrowed $18.0 million at December 31, 2010. Additionally, the Bank has a “Borrower in Custody” line of credit with the Federal Reserve Bank utilizing excess loan collateral and pledging $7.5 million in municipal securities. The amount of this line at December 31, 2010 was $25.3 million, all of which was available at that date. In addition, the Bank had available credit lines with other correspondent banks totaling $9.7 million.

Additionally, the Bank has access to the national and brokered deposit markets to supplement liquidity needs. At December 31, 2010, the Bank had $73.9 million in national and $22.0 million in brokered CD’s.

Scheduled maturities and paydowns of the Company’s investment securities are an additional source of liquidity. During 2010, the Company had received approximately $8.9 million from maturities, paydowns and calls of investment securities. The Bank also has the ability to convert marketable securities into cash or access new or existing sources of incremental funds if the need should arise.

At December 31, 2010, the Bank had outstanding commitments to borrowers for available lines of credit and standby letters of credit totaling $31.6 million and $1.7 million, respectively. Based on the sources of liquidity discussed above, the Company believes that it has access to sufficient funds to cover such commitments, should the need arise.

On November 16, 2010, Bancorp closed on a $35.0 million financing through the sale of 3,888,889 shares of its common stock at $9.00 per share to accredited investors led by CapGen Capital Group IV LP (“CapGen”). The amount of cash raised was directly tied to the amount of additional capital Bancorp needed in order to obtain regulatory approval to consummate the merger with ABI. Net proceeds from the sale after offering expenses were $34.7 million and were used to fund the merger and integration of ABI and Oceanside Bank into the Company.

Regulatory Capital Requirements

The Bank is required to meet certain minimum regulatory capital requirements. Quantitative measures established by regulation to ensure capital adequacy require us to maintain minimum amounts and percentages of total and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). As of December 31, 2010, the Bank and Company met all capital adequacy requirements to which they were subject. The regulatory capital minimums and the Company’s and Bank’s actual data for the indicated periods are set forth in the table below (dollars in thousands). Management and the Board of Directors have committed to maintain Total Risk-Based Capital at 10% and Tier 1 Capital to Average Assets at 8% at the Bank and the Company.

 

     Actual     For Capital
Adequacy Purposes
    To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
 
     Amount      Ratio     Amount      Ratio     Amount      Ratio  

2010

               

Total Capital to risk weighted assets

               

Consolidated

   $ 55,232         10.40   $ 42,498         8.00     N/A         N/A   

Bank

     55,083         10.39        42,402         8.00      $ 53,003         10.00

Tier 1 (Core) Capital to risk weighted assets

               

Consolidated

     48,512         9.13        21,249         4.00        N/A         N/A   

Bank

     48,378         9.13        21,201         4.00        31,802         6.00   

Tier 1 (Core) Capital to average assets

               

Consolidated

     48,512         9.09        21,347         4.00        N/A         N/A   

Bank

     48,378         8.97        21,576         4.00        26,970         5.00   

 

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Table of Contents

2009

               

Total Capital to risk weighted assets

               

Consolidated

   $ 46,393         11.87   $ 31,273         8.00     N/A         N/A   

Bank

     43,307         11.08        31,255         8.00      $ 39,068         10.00

Tier 1 (Core) Capital to risk weighted assets

               

Consolidated

     35,909         9.19        15,637         4.00        N/A         N/A   

Bank

     38,399         9.83        15,627         4.00        23,441         6.00   

Tier 1 (Core) Capital to average assets

               

Consolidated

     35,909         8.18        17,570         4.00        N/A         N/A   

Bank

     38,399         8.75        17,556         4.00        21,945         5.00   

Under Federal Reserve policy, Bancorp is expected to act as a source of financial strength to, and to commit resources to support, the Bank. Management actively manages capital levels in conjunction with asset growth plans, creating a positive impact on shareholder value.

Off-Balance-Sheet Arrangements

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments are commitments to extend credit, unused lines of credit, and standby letters of credit, and may involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the consolidated balance sheet. The contract amounts of these instruments reflect the extent of involvement the Company has.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments as for on-balance-sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counterparty.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

Contractual Obligations

The following is a summary of the Company’s contractual obligations, including certain off-balance-sheet obligations, at December 31, 2010 (dollars in thousands):

 

     Payments Due by Period  
Contractual Obligations    Total      Less than
1 Year
     1-3
Years
     3-5
Years
     More than
5 Years
 

Certificates of deposit

   $ 278,702       $ 190,153       $ 77,907       $ 10,642       $ —     

FHLB advances

     18,124         —           18,124         —           —     

Discount window

     —           —           —           —           —     

Subordinated debt

     15,962         —           —           —           15,962   

Operating leases

     4,477         862         1,656         1,200         759   

Loans from related parties

     800         —           —           800         —     

Standby letters of credit

     1,726         1,701         25         —           —     

Unused line of credit loans

     31,612         31,612         —           —           —     
                                            

Total

   $ 350,603       $ 224,328       $ 97,712       $ 11,842       $ 16,721   
                                            

See Notes to Consolidated Financial Statements for further detail regarding the contractual obligations noted above.

 

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Table of Contents

Asset – Liability Structure

As part of its asset and liability management, the Bank has emphasized establishing and implementing internal asset-liability decision processes as well as communications and control procedures to aid in enhancing its earnings. It is believed that these processes and procedures provide the Bank with better capital planning, asset mix and volume controls, loan pricing guidelines, and deposit interest rate guidelines, which should result in tighter controls and less exposure to interest-rate risk.

The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are interest-rate sensitive and by monitoring an institution’s interest-rate sensitivity gap. An asset or liability is said to be interest-rate sensitive within a specific time period if it will mature or reprice within that time period. The interest-rate sensitivity gap is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. The gap ratio is computed as rate-sensitive assets less rate-sensitive liabilities as a percentage of total assets. A gap is considered positive when the total of rate-sensitive assets exceeds rate-sensitive liabilities. A gap is considered negative when the amount of rate-sensitive liabilities exceeds rate-sensitive assets. During a period of rising interest rates, a negative gap would be expected to adversely affect net interest income, while a positive gap should result in an increase in net interest income. During a period of falling interest rates, a negative gap would be expected to result in an increase in net interest income, while a positive gap should adversely affect net interest income.

In order to minimize the potential for adverse effects of material and prolonged changes in interest rates on the results of operations, the Bank continues to monitor asset and liability management policies to appropriately match the maturities and repricing terms of interest-earning assets and interest-bearing liabilities. Such policies have consisted primarily of: (1) emphasizing the origination of variable-rate loans; (2) maintaining a stable core deposit base; and (3) maintaining a sound level of liquid assets (cash and securities).

The following table sets forth certain information relating to our interest-earning assets and interest-bearing liabilities at December 31, 2010 that are estimated to mature or are scheduled to reprice within the period shown (dollars in thousands):

 

     3 Months
or Less
    Over 3
Months

to 6
Months
    Over 6
Months

to 1 Year
    Over 1
Year to

5 Years
    Over 5
Years
    Total  

Loans(1)

   $ 191,725      $ 38,725      $ 51,435      $ 221,734      $ 9,987      $ 513,606   

Securities

     3,744        3,273        5,289        28,621        21,430        62,356   

Overnight investments

     250        —          —          —          6,319        6,569   

FHLB & correspondent bank stock

     3,728        —          —          —          178        3,906   

Other

     3,827        —          —          1,349        9,307        14,483   
                                                

Total rate-sensitive assets

   $ 203,274      $ 41,998      $ 56,724      $ 251,704      $ 47,220      $ 600,920   
                                                

Deposit accounts:

            

NOW deposits

     —          —          —          —          17,070        17,070   

Money market accounts

     182,332        —          —          —          155        182,487   

Savings deposits

     —          —          —          —          11,498        11,498   

Time deposits

     78,597        37,314        73,986        88,057        750        278,704   
                                                

Total deposit accounts(2)

     260,928        37,314        73,986        88,057        29,473        489,759   

FHLB advances

     —          —          —          18,124        —          18,124   

Other borrowings

     —          —          —          800        —          800   

Subordinated debt

     —          —          —          —          15,962        15,962   
                                                

Total rate-sensitive liabilities

   $ 260,928      $ 37,314      $ 73,986      $ 106,981      $ 45,435      $ 524,645   
                                                

Gap repricing difference

   $ (57,655   $ 4,683      $ (17,262   $ 144,723      $ 1,785      $ 76,275   
                                                

Cumulative gap

   $ (57,655   $ (52,971   $ (70,233   $ 74,490      $ 76,275     
                                          

Cumulative gap to total rate-sensitive assets

     (9.6 )%      (8.8 )%      (11.7 )%      12.4     12.7  
                                          

 

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Table of Contents
(1)

Variable rate loans are included in the period in which the interest rates are next scheduled to adjust rather than in the period in which the loans mature. Fixed rate loans are scheduled, including repayments, according to their contractual maturities.

(2)

Certain liabilities such as NOW and savings accounts, while technically are subject to immediate repricing in response to changing market rates, historically have shown little volatility. Conversely, many of the money market accounts float with the prime lending rate and, therefore, are assumed to reprice within a three-month horizon. Management subjectively sets rates on all accounts.

Results of Operations

Our operating results depend primarily on our net interest income, which is the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities, consisting primarily of deposits. Net interest income is determined by the difference between yields earned on interest-earning assets and rates paid on interest-bearing liabilities (“interest rate spread”) and the relative amounts of interest-earning assets and interest-bearing liabilities. Our interest rate spread is affected by regulatory, economic and competitive factors that influence interest rates, loan demand and deposit flows. In addition, our net earnings are also affected by the level of nonperforming loans and foreclosed assets, as well as the level of noninterest income and noninterest expense, such as salaries and employee benefits, occupancy and equipment costs, and income taxes.

The following table sets forth, for the periods indicated, information regarding: (1) the total dollar amount of interest and dividend income from interest-earning assets and the resultant average yield; (2) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average costs; (3) net interest/dividend income; (4) interest rate spread; and (5) net interest margin. Average balances are based on average daily balances (dollars in thousands).

 

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Table of Contents
     Year Ended December 31,  
     2010     2009     2008  
     Average
Balance
     Interest
and
Dividends
    Average
Yield/
Rate
    Average
Balance
     Interest
and
Dividends
    Average
Yield/
Rate
    Average
Balance
     Interest
and
Dividends
     Average
Yield/
 

Rate

                      

Interest-earning assets:

                      

Loans(1)

   $ 403,453       $ 22,954        5.69   $ 389,208       $ 22,190        5.70   $ 370,320       $ 24,109         6.51

Securities(2)

     31,846         1,009        3.17        27,180         1,062        3.91        31,891         1,435         4.50   

Other interest-earning assets(3)

     9,623         (1     (0.01     712         (48     (6.74     1,607         19         1.18   
                                                          

Total interest-earning assets

   $ 444,922       $ 23,962        5.39      $ 417,100       $ 23,204        5.56      $ 403,818       $ 25,563         6.33   
                                        

Noninterest-earning assets(4)

     27,570             17,170             16,606         
                                        

Total assets

   $ 472,492           $ 434,270           $ 420,424         
                                        

Interest-bearing liabilities:

                      

Savings deposits

     10,422         121        1.16        12,578         202        1.61        14,588         425         2.91   

NOW deposits

     7,316         13        0.18        7,662         18        0.23        6,513         12         0.18   

Money market deposits

     114,640         1,481        1.29        71,670         1,090        1.52        81,517         2,049         2.51   

Time deposits

     222,060         5,105        2.30        201,117         6,534        3.25        194,568         8,851         4.55   

FHLB advances

     23,365         790        3.38        32,874         1,034        3.15        40,285         1,519         3.77   

Federal Reserve borrowing

     197         1        0.51        23,235         116        .50        2,063         23         1.11   

Subordinated debentures

     14,796         770        5.20        14,550         734        5.04        11,023         675         6.12   

Other interest-bearing liabilities(5)

     119         1        0.84        123         1        .81        243         6         2.47   
                                                          

Total interest-bearing liabilities

     392,915         8,282        2.11        363,809         9,729        2.67        350,800         13,560         3.87   
                                        

Noninterest-bearing liabilities

     49,077             43,451             42,720         

Shareholders’ equity

     30,500             27,010             26,904         
                                        

Total liabilities and shareholders’ equity

   $ 472,492           $ 434,270           $ 420,424         
                                        

Net interest/dividend income

      $ 15,680           $ 13,475           $ 12,003      
                                        

Interest rate spread(6)

          3.28          2.89           2.46
                                        

Net interest margin(7)

          3.52          3.23           2.97
                                        

Ratio of average interest-earning assets to average interest-bearing liabilities

     1.13             1.15             1.15         
                                        

 

(1)

Average loans include nonperforming and loans classified as held for sale. Interest on loans includes loan fees of $457 in 2010, $313 in 2009 and $408 in 2008.

(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.

 

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Table of Contents

Impact of Inflation and Changing Prices

The 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. 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 periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (change in rate multiplied by prior volume); (2) changes in volume (change in volume multiplied by prior rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Dollars are in thousands.

Years Ended December 31, 2010 vs. 2009:

 

     Increase (Decrease) Due to(1)  
     Rate     Volume     Total  

Interest-earning assets:

      

Loans

   $ (47   $ 811      $ 764   

Securities

     (219     166        (53

Other interest-earning assets

     92        (45     47   
                        

Total

     (174     932        758   
                        

Interest-bearing liabilities:

      

Savings deposits

     (50     (31     (81

NOW deposits

     (4     (1     (5

Money market deposits

     (184     575        391   

Time deposits

     (2,057     628        (1,429

FHLB advances

     73        (317     (244

Federal Reserve borrowing

     2        (117     (115

Subordinated debentures

     23        13        36   

Other interest-bearing liabilities

     —          —          —     
                        

Total

     (2,197     750        (1,447
                        

Net change in net interest income

   $ 2,023      $ 182      $ 2,205   
                        

 

(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.

 

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Table of Contents

Years Ended December 31, 2009 vs. 2008:

 

     Increase (Decrease) Due to(1)  
     Rate     Volume     Total  

Interest-earning assets:

      

Loans

   $ (3,104   $ 1,185      $ (1,919

Securities

     (176     (197     (373

Other interest-earning assets

     (62     (5     (67
                        

Total

     (3,342     983        (2,359
                        

Interest-bearing liabilities:

      

Savings deposits

     (171     (52     (223

NOW deposits

     4        2        6   

Money market deposits

     (734     (225     (959

Time deposits

     (2,606     289        (2,317

FHLB advances

     (230     (255     (485

Federal Reserve borrowing

     (19     112        93   

Subordinated debentures

     (132     191        59   

Other interest-bearing liabilities

     (3     (2     (5
                        

Total

     (3,891     60        (3,831
                        

Net change in net interest income

   $ 549      $ 923      $ 1,472   
                        

 

(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.

 

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Table of Contents

Year Ended December 31, 2010 Compared to Year Ended December 31, 2009

General. Net loss for the year ended December 31, 2010 was $11.4 million, or $5.07 per basic and diluted share, compared to net earnings of $76,000, or $0.04 per basic and $0.04 per diluted share in 2009. The net loss for the year ended December 31, 2010 is largely driven by the Company’s strategy to strengthen its balance sheet by lowering the amount of underperforming assets such as the sale of substandard loans.

Interest Income and Expense. Interest income increased by $800,000 from $23.2 million for the year ended December 31, 2009, compared to $24.0 million in 2010. Interest earned on loans was $23.0 million in 2010, compared to $22.2 million in 2009. This increase resulted from an increase in the average loan portfolio balance from $389.2 million for the year ended December 31, 2009 to $403.5 million for the year ended December 31, 2010, primarily due to the merger with ABI through which we acquired $158.0 million in loans. This was offset by a slight decrease in the average yield on loans from 5.70% in 2009 to 5.69% in 2010. Additionally, the level of nonperforming loans increased by $26.3 million since December 31, 2009. The increase in nonperforming loans was driven in part by the merger with ABI which accounts for $5.5 million. The remaining increase is due to continued softening of the real estate market in which the Company operates.

The average investment security balance was $31.8 million in 2010, compared to $27.2 million in 2009. The interest on securities decreased to $1.0 million in 2010 from $1.1 million in 2009. The average yield on securities decreased 74 basis points from 3.91% in 2009 to 3.17% in 2010. This decrease was offset by an increase in the securities portfolio primarily due to the merger with ABI.

Interest expense on deposit accounts amounted to $6.7 million for the year ended December 31, 2010, compared to $7.8 million in 2009. The decrease resulted from a decrease in the weighted average cost of interest-bearing deposits from 2.96% in 2009 to 2.05% in 2010. The average costs on interest bearing deposits and all interest bearing liabilities reflect the ongoing reduction in interest rates paid on deposits because of the repricing of deposits in the current environment coupled with the change in the funding mix for 2010 compared to 2009. Interest on FHLB advances, subordinated debt, Federal Reserve borrowing and other borrowings amounted to $1.6 million for the year ended December 31, 2010, with a weighted average cost of 4.28% compared to $1.9 million for the year ended December 31, 2009, with a weighted average cost of 3.72%. This increase in weighted average cost was primarily the result of an increase in the rates in effect on our subordinated debt, including the addition of a fourth statutory trust as a result of the merger with ABI. This was off-set by a decrease in FHLB advances and Federal Reserve borrowings.

The net interest margin increased by 30 basis points from 3.23% at December 31, 2009 to 3.52% at December 31, 2010. The increase is mainly the result of the Company focusing on core deposit gathering initiatives. 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.

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, 2010 was $17.0 million, compared to $4.4 million in 2009. The provision expense was necessitated primarily by an increase in net charge-offs and the ongoing softening in real estate values in our market. The Company had net loan charge-offs of $10.8 million in 2010 compared to $2.2 million during 2009. Approximately $6.8 million of the increase in charge-offs is related to loans classified as held for sale during the fourth quarter which are recorded at the lower of cost or fair value. The remainder was primarily the result of foreclosures and short-sales. Management believes that the allowance for loan losses of $13.1 million at December 31, 2010 is adequate to absorb estimated losses in the portfolio as of that date.

Noninterest Income. Noninterest income was $1.2 million for 2010 compared to $841,000 in 2009. The increase was principally the result of an increase in miscellaneous fee income as a result of the merger with ABI as well as increased earnings on the BOLI policy.

 

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Noninterest Expense. Noninterest expense totaled $17.1 million for the year ended December 31, 2010, compared to $10.0 million in 2009. A primary driver of this increase was the merger and capital raise-related expenses that resulted from the ABI merger of approximately $2.0 million. OREO was also a key driver of the noninterest expense increase from 2009 with an increase of $3.3 million as of December 31, 2010. The remaining increase was attributable to additional costs absorbed as a result of the merger with ABI.

Income Taxes (Benefit). The income tax benefit for the year ended December 31, 2010 was $5.8 million compared to an income tax benefit of $104,000 in 2009. The tax benefit is largely the result of the loan loss provision expense that drove the $11.4 million net loss for the year ended December 31, 2010.

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

General. Net earnings for the year ended December 31, 2009 were $76,000, or $0.04 per basic share and $0.04 per diluted share, compared to a net earnings of $35,000, or $0.02 per basic and $0.02 per diluted share in 2008.

Interest Income and Expense. Interest income decreased $2.4 million from $25.6 million for the year ended December 31, 2008, compared to $23.2 million in 2009. Interest earned on loans was $22.2 million in 2009, compared to $24.1 million in 2008. This decrease resulted from a decrease in the average yield on loans from 6.51% in 2008 to 5.70% in 2009, offset by an increase in the average loan portfolio balance from $370.3 million for the year ended December 31, 2008 to $389.2 million for the year ended December 31, 2009.

The average security balance was $27.2 million in 2009, compared to $31.9 million in 2008. The interest on securities decreased slightly from $1.4 million in 2008 to $1.1 million in 2009. The average yield on securities decreased 59 basis points from 4.50% in 2008 to 3.91% in 2009.

Interest expense on deposit accounts amounted to $7.8 million for the year ended December 31, 2009, compared to $11.3 million in 2008. The decrease resulted from a decrease in the weighted average cost of interest-bearing deposits from 3.81% in 2008 to 2.68% in 2008, offset by an increase in the average balance of interest-bearing deposits from $297.2 million in 2008 to $293.0 million in 2009. Interest on FHLB advances, subordinated debt, Federal Reserve borrowing and other borrowings amounted to $1.9 million for the year ended December 31, 2009, with a weighted average cost of 2.66%. In July 2008, the Company issued an additional $7.6 million of trust preferred securities priced at three-month LIBOR plus 375 basis points.

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, 2009 was $4.4 million, compared to $3.6 million in 2008. The increase in provision expense was necessitated primarily by an increase in net charge-offs and the Bank’s aggressive efforts to identify any potential losses in the portfolio. The Company had net loan charge-offs of $2.2 million in 2009 compared to $2.0 million during 2008. Management believes that the allowance for loan losses of $6.9 million at December 31, 2009 was appropriate.

Noninterest Income. Noninterest income was $841,000 in 2009 compared to $1.2 million in 2008.

Noninterest Expense. Noninterest expense totaled $10.0 million for the year ended December 31, 2009, compared to $9.8 million in 2008. Compensation expenses, professional fees, data processing fees, FDIC assessments accounted for the majority of noninterest expense increasing $200,000.

Income Taxes (Benefit). The income tax benefit for the year ended December 31, 2009 was $104,000 compared to an income tax expense of $229,000 in 2008.

 

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises primarily from interest-rate risk inherent in lending and deposit-taking activities. To that end, we actively monitor and manage interest-rate risk exposure. There are three primary committees that are responsible for monitoring and managing risk exposure: ALCO Committee of the Bank’s Board of Directors; Management ALCO Committee; and Pricing & Liquidity Management Committee.

The ALCO Committee of the Bank’s Board of Directors meets quarterly to review a summary reporting package along with strategies proposed by management.

The Management ALCO Committee, which consists of the Chairman of the ALCO Committee of the Bank’s Board of Directors, the Chief Executive Officer and President, the Chief Financial Officer and the Chief Credit Officer, meets quarterly to review the liquidity position and earnings simulation reports and to ensure there is adequate capital to meet growth strategies. Strategy development is structured to mitigate any exposure that is indicated through the modeling.

The Pricing & Liquidity Management Committee meets monthly to execute the strategies set forth by the preceding two committees. Senior management and select members from other departments comprise this committee.

Disclosures about the fair value of financial instruments, which reflect changes in market prices and rates, can be found in Note 7 to the Consolidated Financial Statements.

The Company utilizes a third party and its proprietary simulation model to assist in identifying and managing interest-rate risk. The December 31, 2010 analysis of the Company’s sensitivity to changes in net interest income under varying assumptions for changes in market interest rates is presented below. Specifically, the model derives expected interest income and interest expense resulting from an immediate and parallel shift in the yield curve in the amounts shown.

The starting balances in the Asset/Liability model reflect actual balances on the “as of” date, adjusted for material and significant transactions. Pro forma balances remain static unless otherwise noted by management. This enables interest-rate risk embedded within the existing balance sheet structure to be isolated (growth assumptions can mask interest-rate risk). Management believes, under normal economic conditions, the best indicator of risk is the +/- 200 basis point “shock” (parallel shift) scenario. However, due to the current rate environment, management believes a more reasonable shock in the down scenario is 100 basis points. To provide further exposure to the level of risk/volatility, a “ramping” (gradual increase over 12 months) of rates is modeled as well.

Rate changes are matched with known repricing intervals and assumptions about new growth and expected prepayments. Assumptions are based on the Company’s experience as well as industry standards under varying market and interest-rate environments. The measurement of market risk associated with financial instruments is meaningful only when all related and offsetting on- and off-balance-sheet transactions are aggregated and the resulting net positions are identified.

The analysis exaggerates the sensitivity to changes in key interest rates by assuming an immediate change in rates with no management intervention to change the composition of the balance sheet. The Bank’s primary objective in managing interest-rate risk is to minimize the adverse impact of changes in interest rates on net interest income and capital, while adjusting our asset-liability structure to obtain the maximum yield-cost spread on that structure. However, a sudden and substantial change in interest rates may adversely impact earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent or on the same basis. The Bank does not engage in trading activities.

 

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     Interest Rates
Decrease 100 BP
    Base      Interest Rates
Increase 200 BP
 

Hypothetical Net Interest Income

   $ 25,071      $ 24,699       $ 24,721   

Net Interest Income ($ change)

     372        —           22   

Net Interest Income (% change)

     1.51     —           0.09

Hypothetical Market Value of Equity

   $ 75,119      $ 76,702       $ 73,659   

Market Value ($ Change)

     (1,583     —           (3,043

Market Value (% Change)

     (2.10 )%      —           (4.00 )% 

The interest rate risk position of the Company is slightly liability sensitive. Under the simulation modeling, the base is projected to improve slightly over the first year as funding costs continue to decline; as rates fall, net interest income increases slightly as non-maturity deposits reprice reducing funding costs to a greater extent than the reduction in asset yields.

In a rising rate environment, higher funding costs are matched by increasing asset yields as floating rate loans reprice resulting in net interest income tracking in line with the base scenario.

While management carefully monitors the exposure to changes in interest rates and takes necessary actions as warranted to decrease any adverse impact, there can be no assurance on the actual effect on net interest income as a result of rate changes.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

JACKSONVILLE BANCORP, INC. AND SUBSIDIARY

Index to Consolidated Financial Statements

 

     Page  

Report of Independent Registered Public Accounting Firm

     F-1   

Consolidated Balance Sheets at December 31, 2010 and 2009

     F-2   

Consolidated Statements of Operations for the Years Ended December  31, 2010, 2009 and 2008

     F-3   
  

Consolidated Statements of Changes in Shareholders’ Equity for the Years Ended December 31, 2010, 2009 and 2008

     F-4   
  

Consolidated Statements of Cash Flows for the Years Ended December  31, 2010, 2009 and 2008

     F-5   
  

Notes to Consolidated Financial Statements

     F-6   

All schedules are omitted because of the absence of the conditions under which they are required or because the required information is included in the Consolidated Financial Statements and related Notes.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Jacksonville Bancorp, Inc.

Jacksonville, Florida

We have audited the accompanying consolidated balance sheets of Jacksonville Bancorp, Inc. as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2010. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting standards used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2010 and 2009, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2010, in conformity with accounting standards generally accepted in the United States of America.

Crowe Horwath LLP

Fort Lauderdale, Florida

March 31, 2011

 

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JACKSONVILLE BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

December 31,

(Dollar amounts in thousands except share data)

 

     2010     2009  

ASSETS

    

Cash and due from financial institutions

   $ 13,728      $ 5,647   

Federal funds sold

     6,569        —     
                

Cash and cash equivalents

     20,297        5,647   

Securities available for sale

     62,356        22,171   

Loans held for sale

     13,910        —     

Loans, net of allowance for loan losses of $13,069 in 2010 and $6,854 in 2009

     499,696        384,133   

Premises and equipment, net

     6,943        3,533   

Bank owned life insurance

     9,307        8,908   

Federal Home Loan Bank stock, at cost

     3,728        3,047   

Real estate owned, net

     5,733        4,011   

Deferred income taxes

     7,108        2,015   

Accrued interest receivable

     3,170        1,864   

Prepaid regulatory assessment

     1,738        2,599   

Goodwill

     12,498        —     

Other intangible assets, net

     2,376        —     

Other assets

     2,973        883   
                

Total assets

   $ 651,833      $ 438,811   
                

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Deposits

    

Noninterest-bearing

   $ 72,428      $ 43,704   

Money market, NOW and savings deposits

     211,057        104,838   

Time deposits

     278,702        222,093   
                

Total deposits

     562,187        370,635   

Loans from related parties

     800        —     

Federal funds purchased

     —          227   

Federal Home Loan Bank advances

     18,124        25,000   

Subordinated debentures

     15,962        14,550   

Other liabilities

     2,901        1,131   
                

Total liabilities

     599,974        411,543   

Commitments and contingent liabilities

    

Shareholders’ equity

    

Preferred stock, $.01 par value; 2,000,000 shares authorized; none issued or outstanding

     —          —     

Common stock, $.01 par value; 8,000,000 shares authorized; 5,888,809 and 1,749,526 shares issued in 2010 and 2009

     59        17   

Additional paid-in capital

     55,307        18,631   

Retained earnings (deficit)

     (3,157     8,287   

Treasury stock, at cost (2010—0 shares, 2009—283 shares)

     —          (3

Accumulated other comprehensive income

     (350     336   
                

Total shareholders’ equity

     51,859        27,268   
                

Total liabilities and shareholders’ equity

   $ 651,833      $ 438,811   
                

See accompanying notes to consolidated financial statements.

 

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JACKSONVILLE BANCORP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

Years ended December 31,

(Dollar amounts in thousands except share data)

 

     2010     2009     2008  

Interest and dividend income

      

Loans, including fees

   $ 22,954      $ 22,190      $ 24,109   

Taxable securities

     540        648        1,021   

Tax-exempt securities

     469        414        414   

Federal funds sold and other

     (1     (48     19   
                        

Total interest income

     23,962        23,204        25,563   

Interest expense

      

Deposits

     6,720        7,844        11,336   

Federal Reserve borrowing

     1        116        23   

Federal Home Loan Bank advances

     790        1,034        1,520   

Subordinated debentures

     770        734        675   

Federal funds purchased and repurchase agreements

     1        1