JACKSONVILLE BANCORP INC /FL/ - FORM 10-Q - August 8, 2014

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

FORM 10-Q

(Mark One)
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended 
June 30, 2014

or

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

For the transition period from __________ to ____________.

Commission file number  000-30248

JACKSONVILLE BANCORP, INC.
(Exact name of registrant as specified in its charter)
 
Florida
 
59-3472981
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
100 North Laura Street, Suite 1000 Jacksonville, Florida
 
32202
(Address of principal executive offices)
 
(Zip Code)
 
 
(904) 421-3040
 
 
(Registrant’s telephone number,
including area code)
 

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

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 x              No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
o
 
Accelerated filer
o
 
Non-accelerated filer
o
 
Smaller reporting company
x
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o             No x

As of July 31, 2014, the latest practicable date, there were 3,180,300 shares of the Registrant’s common stock outstanding and 2,614,821 shares of the Registrant’s nonvoting common stock outstanding.
 
JACKSONVILLE BANCORP, INC.

TABLE OF CONTENTS

Description
Page
1
 
 
PART I – FINANCIAL INFORMATION
 
 
 
 
Item 1.
2
 
 
 
 
2
 
 
 
 
3
 
 
 
 
4
 
 
 
 
5
 
 
 
 
6
 
 
 
 
8
 
 
 
Item 2.
44
 
 
 
Item 3.
66
 
 
 
Item 4.
66
 
 
PART II – OTHER INFORMATION
 
 
 
 
Item 1.
67
 
 
 
Item 1A.
67
 
 
 
Item 6.
68
 
 
 
70
 
 
 
71
JACKSONVILLE BANCORP, INC.

SPECIAL CAUTIONARY NOTICE REGARDING
FORWARD-LOOKING STATEMENTS
 
Various of the statements contained in this Quarterly Report on Form 10-Q, the Annual Report on Form 10-K for the year ended December 31, 2013, Current Reports on Form 8-K, and reports to shareholders are “forward-looking statements” within the meaning and protections of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.

Forward-looking statements include statements with respect to management’s beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions and future performance, and involve known and unknown risks, uncertainties and other factors, including economic and market conditions, which may be beyond our control, and which may cause the actual results, performance or achievements of the Company to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements.  Management cautions readers not to place undue reliance on any of the Company’s forward-looking statements, which speak only as of the date made.  The Company has no obligation to and does not undertake to update, revise, or correct any of these forward-looking statements after the date of this report.

All statements other than statements of historical fact are statements that could be forward-looking statements. Words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “evaluate,” “continue,” “further,” “plan,” “point to,” “project,” “could,” “intend,” “target” and other similar words and expressions of the future identify forward-looking statements.  These forward-looking statements may not be realized due to a variety of factors, including, without limitation:

• the effects of future economic, business and market conditions and changes, domestic and foreign, including seasonality;
 
• governmental monetary and fiscal policies;
 
• legislative and regulatory changes, including changes in banking, securities and tax laws, regulations and policies and their application by our regulators;
 
• changes in accounting rules, practices and interpretations;
 
• the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest-sensitive assets and liabilities;
 
• changes in borrower credit risks and payment behaviors;
 
• changes in the availability and cost of credit and capital in the financial markets;
 
• changes in the prices, values and sales volumes of residential and commercial real estate;
 
• the effects of concentrations in our loan portfolio;
 
• our ability to resolve nonperforming assets;
 
• the failure of assumptions and estimates underlying the establishment of reserves for possible loan losses and other estimates and valuations;
 
• the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;
 
• the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and possible failures to achieve expected gains, revenue growth, expense savings and/or other results from such transactions;
 
• changes in technology or products that may be more difficult, costly, or less effective than anticipated;
 
• the effects of war or other conflicts, acts of terrorism, hurricanes, floods, tornados or other catastrophic events that may affect economic conditions; or
 
• management’s expectation that the Company’s recapitalization plan and strategic initiatives will have a sustained positive impact on results of operations and compliance with all regulatory agreements and associated requirements.
 
All forward-looking statements that are made by or attributable to the Company are qualified in their entirety by and should be read in conjunction with this cautionary notice and the risks described or referred to in Item 1A – Risk Factors of the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 14, 2014 and in the Company’s other filings with the SEC.
JACKSONVILLE BANCORP, INC.
 
PART I—FINANCIAL INFORMATION

Item 1.
Financial Statements
 
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands, except per share amounts)
           
 
  
June 30,
2014
    
December 31,
2013
  
ASSETS
  
   
 
Cash and due from financial institutions
  
$
23,585
    
$
16,799
  
Federal funds sold and other
    
6,545
      
23,526
  
Cash and cash equivalents
    
30,130
      
40,325
  
Securities available-for-sale
    
82,168
      
84,771
  
Loans, net of allowance for loan losses of $14,616 and $15,760 as of June 30, 2014 and December 31, 2013, respectively
    
353,944
      
354,592
  
Premises and equipment, net
    
5,326
      
6,421
  
Assets held for sale
    
944
      
-
  
Bank-owned life insurance
    
13,053
      
12,956
  
Federal Home Loan Bank stock, at cost
    
1,356
      
1,580
  
Other real estate owned, net
    
4,000
      
3,078
  
Accrued interest receivable
    
1,576
      
1,723
  
Other intangible assets, net
    
706
      
849
  
Other assets
    
1,436
      
994
  
Total assets
  
$
494,639
    
$
507,289
  
 
                
LIABILITIES
                
Deposits
                
Noninterest-bearing demand deposits
  
$
103,743
    
$
100,788
  
Money market, NOW and savings deposits
    
183,746
      
188,085
  
Time deposits
    
133,381
      
146,093
  
Total deposits
    
420,870
      
434,966
  
Federal Home Loan Bank advances and other borrowings
    
20,141
      
20,153
  
Subordinated debentures
    
16,186
      
16,154
  
Accrued expenses and other liabilities
    
1,922
      
2,084
  
Total liabilities
    
459,119
      
473,357
  
 
                
SHAREHOLDERS' EQUITY
                
Preferred stock
    
-
      
-
  
Common stock, $.01 par value, 3,180,274 and 3,177,090 shares issued and outstanding as of June 30, 2014 and December 31, 2013, respectively(1)
    
32
      
32
  
Nonvoting common stock, $.01 par value, 2,614,821 and 2,618,005 shares issued and outstanding as of June 30, 2014 and December 31, 2013, respectively(1)
    
26
      
26
  
Additional paid–in capital(1)
    
138,084
      
138,050
  
Retained earnings (deficit)
    
(102,155
)
    
(102,688
)
Accumulated other comprehensive loss
    
(467
)
    
(1,488
)
Total shareholders’ equity
    
35,520
      
33,932
  
Total liabilities and shareholders’ equity
  
$
494,639
    
$
507,289
  
 
  (1) Reflects the 1-for-20 reverse stock split completed in October 2013.  Please refer to Note 9 – Shareholders’ Equity for additional information related to the reverse stock split.
 
See accompanying notes to Consolidated Financial Statements.
JACKSONVILLE BANCORP, INC.
 
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share amounts)
           
 
  
Three Months Ended
    
Six Months Ended
  
 
  
June 30,
    
June 30,
  
 
  
2014
    
2013
    
2014
    
2013
  
Interest and dividend income:
  
   
   
   
 
Loans, including fees
  
$
5,099
    
$
5,317
    
$
9,759
    
$
11,196
  
Taxable securities
    
302
      
301
      
622
      
579
  
Tax-exempt securities
    
91
      
157
      
191
      
332
  
Federal funds sold and other
    
41
      
22
      
79
      
52
  
Total interest income
    
5,533
      
5,797
      
10,651
      
12,159
  
 
                                
Interest expense:
                                
Deposits
    
541
      
754
      
1,105
      
1,553
  
Federal Reserve and other borrowings
    
11
      
54
      
22
      
107
  
Federal Home Loan Bank advances
    
75
      
75
      
149
      
149
  
Subordinated debentures
    
205
      
206
      
408
      
413
  
Total interest expense
    
832
      
1,089
      
1,684
      
2,222
  
Net interest income
    
4,701
      
4,708
      
8,967
      
9,937
  
Provision for loan losses
    
287
      
(484
)
    
287
      
(267
)
Net interest income after provision for loan losses
    
4,414
      
5,192
      
8,680
      
10,204
  
 
                                
Noninterest income:
                                
Service charges on deposit accounts
    
190
      
188
      
364
      
395
  
Other income
    
189
      
189
      
392
      
406
  
Total noninterest income
    
379
      
377
      
756
      
801
  
 
                                
Noninterest expense:
                                
Salaries and employee benefits
    
2,177
      
2,006
      
4,336
      
4,053
  
Occupancy and equipment
    
616
      
634
      
1,265
      
1,307
  
Regulatory assessments
    
169
      
205
      
361
      
403
  
Data processing
    
490
      
459
      
1,030
      
899
  
Advertising and business development
    
83
      
80
      
141
      
174
  
Professional fees
    
256
      
452
      
494
      
924
  
Telephone expense
    
96
      
90
      
189
      
177
  
Other real estate owned expense
    
41
      
808
      
110
      
1,115
  
Other
    
358
      
806
      
977
      
1,725
  
Total noninterest expense
    
4,286
      
5,540
      
8,903
      
10,777
  
Net income before income taxes
    
507
      
29
      
533
      
228
  
Income tax benefit
    
-
      
-
      
-
      
-
  
Net income
  
$
507
    
$
29
    
$
533
    
$
228
  
 
                                
Noncash, implied preferred stock dividend
    
-
      
-
      
-
      
(31,464
)
Net income (loss) available to common shareholders
  
$
507
    
$
29
    
$
533
    
$
(31,236
)
 
                                
Weighted average common shares outstanding: (1)
                                
Basic shares
    
5,795,095
      
5,294,547
      
5,795,095
      
3,940,955
  
Dilutive stock options
    
544
      
1,388
      
3,923
      
-
  
Diluted shares
    
5,795,639
      
5,295,935
      
5,799,018
      
3,940,955
  
 
                                
Earnings (loss) per common share: (1)
          
Basic
  
$
0.09
    
$
0.01
    
$
0.09
    
$
(7.93
)
Diluted
  
$
0.09
    
$
0.01
    
$
0.09
    
$
(7.93
)

                                                                    
  (1) Reflects the 1-for-20 reverse stock split completed in October 2013.  Please refer to Note 9 – Shareholders’ Equity for additional information related to the reverse stock split.
 
See accompanying notes to Consolidated Financial Statements.
JACKSONVILLE BANCORP, INC.
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(Dollars in thousands)
           
 
  
Three Months Ended
    
Six Months Ended
  
 
  
June 30,
    
June 30,
  
 
  
2014
    
2013
    
2014
    
2013
  
 
  
   
   
   
 
Net income
  
$
507
    
$
29
    
$
533
    
$
228
  
Other comprehensive income (loss):
                                
Change in unrealized holding (losses) gains on available-for-sale securities
    
531
      
(1,759
)
    
1,054
      
(2,182
)
Net unrealized derivative gains (losses) on cash flow hedge
    
(39
)
    
326
      
(33
)
    
423
  
Reclassification adjustment for net gains on investments realized in earnings
    
-
      
(9
)
    
-
      
(46
)
Other comprehensive income (loss)
    
492
      
(1,442
)
    
1,021
      
(1,805
)
Tax effect
    
-
      
-
      
-
      
-
  
Other comprehensive (loss) income, net of tax effect
    
492
      
(1,442
)
    
1,021
      
(1,805
)
Total comprehensive income ( loss)
  
$
999
    
$
(1,413
)
  
$
1,554
    
$
(1,577
)
 
See accompanying notes to Consolidated Financial Statements.

JACKSONVILLE BANCORP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Unaudited)
(Dollars in thousands)
                                               
 
  
   
Nonvoting
    
   
   
Additional
    
Retained
    
Accumulated Other
    
 
 
  
Common Stock (1)
    
Common Stock (1)
    
Preferred Stock
    
Paid-In
    
Earnings
    
Comprehensive
    
 
 
  
Shares
    
Amount
    
Shares
    
Amount
    
Shares
    
Amount
    
Capital (1)
    
(Deficit)
    
Income (Loss)
    
Total
  
Balance as of December 31, 2012
    
294,544
    
$
3
      
-
    
$
-
      
50,000
    
$
18,536
    
$
83,890
    
$
(70,264
)
  
$
1,411
    
$
33,576
  
Net income
                                                            
228
              
228
  
Other comprehensive loss
                                                                    
(1,805
)
    
(1,805
)
Total comprehensive loss
                                                                            
(1,577
)
Vesting of restricted stock
    
38
      
0
                                              
0
              
0
  
Accretion of discount on preferred stock, Series A
                                            
31,464
              
(31,464
)
            
-
  
Conversion of preferred stock, Series A, to common stock and nonvoting common stock (1)
    
2,382,000
      
24
      
2,618,000
      
26
      
(50,000
)
    
(50,000
)
    
49,950
                      
-
  
Share-based compensation expense
                                                    
34
                      
34
  
Balance as of June 30, 2013
    
2,676,582
    
$
27
      
2,618,000
    
$
26
      
-
      
-
    
$
133,874
    
$
(101,500
)
  
$
(394
)
  
$
32,033
  
 
                                                                                
Balance as of December 31, 2013
    
3,177,090
    
$
32
      
2,618,005
    
$
26
      
-
    
$
-
    
$
138,050
    
$
(102,688
)
  
$
(1,488
)
  
$
33,932
  
Net income
                                                            
533
              
533
  
Other comprehensive income
                                                                    
1,021
      
1,021
  
Total comprehensive income
                                                                            
1,554
  
Permitted transfer of nonvoting common stock to common stock
    
3,184
              
(3,184
)
                                                    
-
  
Share-based compensation expense
                                                    
34
                      
34
  
Balance as of June 30, 2014
    
3,180,274
    
$
32
      
2,614,821
    
$
26
      
-
    
$
-
    
$
138,084
    
$
(102,155
)
  
$
(467
)
  
$
35,520
  
                                                                      
(1) Reflects the 1-for-20 reverse stock split completed in October 2013.  Please refer to Note 9 – Shareholders Equity for additional information related to the reverse stock split.
 
See accompanying notes to Consolidated Financial Statements.
JACKSONVILLE BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
(Dollars in thousands)
     
 
  
Six Months Ended
  
 
  
June 30,
  
 
  
2014
    
2013
  
Cash flows from operating activities:
  
   
 
Net income
  
$
533
    
$
228
  
Adjustments to reconcile net income to net cash from operating activities:
                
Depreciation and amortization
    
353
      
348
  
Net amortization of deferred loan fees
    
81
      
6
  
Provision for loan losses
    
287
      
(267
)
Premium amortization for securities, net of accretion
    
441
      
533
  
Net realized gain on sale of securities
    
-
      
(46
)
Net accretion of purchase accounting adjustments
    
(572
)
    
(1,068
)
Net loss (gain) on sale of other real estate owned
    
1
      
(84
)
Write-down of other real estate owned
    
36
      
472
  
Capitalized other real estate owned expense
    
(14
)
    
-
  
Earnings on bank-owned life insurance
    
(97
)
    
(65
)
Loss on disposal of premises and equipment
    
7
      
1
  
Share-based compensation
    
34
      
34
  
Net change in:
                
Accrued interest receivable and other assets
    
(301
)
    
993
  
Accrued expenses and other liabilities
    
(196
)
    
88
  
Net cash from operating activities
    
593
      
1,173
  
 
                
Cash flows from investing activities:
                
Available-for-sale securities:
                
Sales
    
-
      
4,167
  
Maturities, prepayments and calls
    
8,344
      
13,218
  
Purchases
    
(5,127
)
    
(19,349
)
Loan (originations) payments, net
    
46
      
11,178
  
Proceeds from sale of other real estate owned
    
21
      
969
  
Additions to premises and equipment, net
    
(203
)
    
(103
)
Redemptions of Federal Home Loan Bank stock, net of purchases
    
224
      
192
  
Net cash from investing activities
    
3,305
      
10,272
  
 
                
Cash flows from financing activities:
                
Net change in deposits
    
(14,093
)
    
(40,725
)
Net cash used for financing activities
    
(14,093
)
    
(40,725
)
 
                
Net change in cash and cash equivalents
    
(10,195
)
    
(29,280
)
Cash and cash equivalents at beginning of period
    
40,325
      
72,079
  
Cash and cash equivalents at end of period
  
$
30,130
    
$
42,799
  
 
See accompanying notes to Consolidated Financial Statements.

JACKSONVILLE BANCORP, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS (Cont.)
(Unaudited)
(Dollars in thousands)
     
 
  
Six Months Ended
  
 
  
June 30,
  
 
  
2014
    
2013
  
 
  
   
 
Supplemental disclosures of cash flow information:
  
   
 
Cash paid during the period for
  
   
 
Interest
  
$
1,699
    
$
2,615
  
Income taxes
    
-
      
-
  
 
                
Supplemental schedule of noncash investing activities:
                
Acquisition of other real estate owned
  
$
965
    
$
3,690
  
Transfer of assets to held for sale
  
$
944
    
$
-
  
 
                
Supplemental schedule of noncash financing activities:
                
Implied preferred stock dividend
  
$
-
    
$
31,464
  
 
See accompanying notes to Consolidated Financial Statements.

JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 1 – BASIS OF PRESENTATION
 
Principles of Consolidation

The accounting and reporting policies of the Company reflect banking industry practice and conform to U.S. generally accepted accounting principles (“U.S. GAAP”).  The Consolidated Financial Statements include the accounts of Jacksonville Bancorp, Inc. (“Bancorp”), its wholly owned, primary operating subsidiary The Jacksonville Bank, and The Jacksonville Bank’s wholly owned subsidiary, Fountain Financial, Inc.  The consolidated entity is referred to as the “Company” and The Jacksonville Bank and Fountain Financial, Inc. are collectively referred to as the “Bank.”  The Company’s financial condition and operating results principally reflect those of the Bank.  All intercompany transactions and balances have been eliminated in consolidation.  In preparing the Consolidated Financial Statements, management makes estimates and assumptions that affect the reported asset and liability balances and revenue and expense amounts, and the disclosure of contingent assets and liabilities.  Actual results could differ significantly from those estimates and assumptions.

The consolidated financial information included herein as of June 30, 2014 and December 31, 2013 and for the periods ended June 30, 2014 and 2013 is unaudited.  Accordingly, it does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.  However, such information reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the financial condition and results of operations for the interim periods.  The December 31, 2013 consolidated balance sheet was derived from the Company’s December 31, 2013 audited Consolidated Financial Statements.

Nature of Operations

Bancorp is a financial holding company headquartered in Jacksonville, Florida, that currently provides financial services through eight full-service branches in Jacksonville and Jacksonville Beach, Duval County, Florida, as well as its virtual branch.  The Company’s 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.  Substantially all loans are secured by specific items of collateral, including business assets, consumer assets, and commercial and residential real estate.  Commercial loans are expected to be repaid from cash flow from operations of businesses.  There are no significant concentrations of loans to any one industry or customer.  However, the customers’ ability to repay their loans is impacted by the real estate and general economic conditions in the area.  For further information, please refer to the Consolidated Financial Statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 14, 2014.

Investment Securities
 
Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity.  Debt securities are classified as available-for-sale when they might be sold before maturity. Equity securities with readily determinable fair values are classified as available-for-sale.  Available-for-sale securities are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.  Other securities, such as Federal Home Loan Bank (“FHLB”) stock, are carried at cost.

Interest income includes amortization of purchase premiums and accretion of purchase discounts. Premiums and discounts on securities are amortized using the level yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated.

Gains and losses are recorded on the trade date and determined using the specific identification method.  Declines in the fair value of securities below their cost that are other-than-temporary are reflected as realized losses.
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 1 – BASIS OF PRESENTATION (Continued)

Other-Than-Temporary Impairment

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis and more frequently when economic or market conditions warrant such an evaluation.  In determining OTTI for debt securities, management considers many factors, including:  (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial conditions and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more-likely-than-not will be required to sell the debt security before its anticipated recovery.  The assessment of whether an OTTI decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

In order to determine OTTI for purchased beneficial interests that, on the purchase date, were rated below AA, the Company compares the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows.  OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.  It is not the Bank’s policy to purchase securities rated below AA.

When OTTI occurs for either debt securities or purchased beneficial interests that, on the purchase date, were rated below AA, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more-likely-than-not that it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss.  If an entity intends to sell or it is more-likely-than-not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date.  If an entity does not intend to sell the security and it is not more-likely-than-not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors.  The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings.  The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes.  The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

For the six months ended June 30, 2014 and 2013, there were no credit losses recognized in earnings related to investment securities.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs, and allowance for loan losses.  Interest income is accrued on the unpaid principal balance of the loans.  Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level‑yield method without anticipating prepayments.

Interest income on a loan in any of our portfolio segments is discontinued at the time the loan is 90 days delinquent unless the loan is well secured and in process of collection.  Past due status is based on the contractual terms of the loan.  In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.  All unsecured loans in our consumer and other portfolio segment are charged off once they reach 90 days delinquent.  This is the only portfolio segment that the Company charges off loans solely based on the number of days of delinquency.  For real estate mortgage, commercial loan, secured consumer and other portfolio segments, the charge-off policy is that a loan is fully or partially charged off when, based on management’s assessment, it has been determined that it is highly probable that the Company would not collect all principal and interest payments according to the contractual terms of the loan agreement.  This assessment is determined based on a detailed review of all substandard and doubtful loans each month.  This review considers such criteria as the value of the underlying collateral, financial condition and reputation of the borrower and guarantors and the amount of the borrower’s equity in the loan.  The Company’s charge-off policy has remained materially unchanged for all periods presented.

JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 1 – BASIS OF PRESENTATION (Continued)

At times, the Company will charge off a portion of a nonperforming or impaired loan versus recording a specific reserve. The decision to charge off a portion of the loan is based on specific facts and circumstances unique to each loan.  General criteria considered are: the probability that the Company will foreclose on the property, the value of the underlying collateral compared to the principal amount outstanding on the loan and the personal guarantees associated with the loan.  For the six months ended June 30, 2014 and 2013, partial charge-offs were $1,273 and $1,918, respectively, on nonperforming and impaired loans of $5,915 and $5,480, respectively.  For the year ended December 31, 2013, partial charge-offs were $4,994 on nonperforming and impaired loans of $7,578.

Partial charge-offs impact the Company’s credit loss metrics and trends, in particular a reduction in the coverage ratio, by decreasing substandard loan balances, decreasing capital and increasing the historical loss factor used in the calculation of the allowance for loan losses.  However, the impact of the historical loss factor on the allowance for loan losses would be slightly offset by the fact that the charge-off reduces the overall loan balance.

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Overdrawn customer checking accounts are reclassified as commercial loans and are evaluated on an individual basis for collectability.  These balances are included in the estimate of allowance for loan losses and are charged off when collectability is considered doubtful.  As of June 30, 2014 and December 31, 2013, overdrawn customer checking accounts reclassified as commercial loans were $77 and $37, respectively.

Certain Purchased Loans

As part of our merger with Atlantic BancGroup, Inc. (“ABI”) in November 2010, the Company purchased individual loans and groups of loans, some of which have shown evidence of credit deterioration since origination.  These purchased loans were recorded at fair value, such that there is no carryover of the seller’s allowance for loan losses.  Fair values were preliminary and subject to refinement for up to one year after the closing date of the merger as new information relative to the closing date fair value became available.  After acquisition, losses are recognized by an increase in the allowance for loan losses if the reason for the loss was due to events and circumstances that did not exist as of the acquisition date.  If the reason for the loss was due to events and circumstances that existed as of the acquisition date due to new information obtained during the measurement period (i.e., 12 months from date of acquisition), that, if known, would have resulted in the recognition of additional deterioration, the additional deterioration was recorded as additional carrying discount with a corresponding increase to goodwill.

The Company has purchased loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected.  Such purchased loans are accounted for individually.  The Company estimates the amount and timing of expected cash flows for each purchased loan, and the expected cash flows in excess of the amount paid are recorded as interest income over the remaining life of the loan (accretable yield).  The excess of the loan’s contractual principal and interest over expected cash flows is not recorded (non-accretable difference).

Over the life of the loan, expected cash flows continue to be estimated.  If the present value of expected cash flows is less than the carrying amount, a loss is recorded.  If the present value of expected cash flows is greater than the carrying amount, it is recognized as part of future interest income as earned.
 
Allowance for Loan Losses

The allowance for loan losses is a valuation allowance for probable incurred credit losses.  Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors.  Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.  Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is likely.  Subsequent recoveries, if any, are credited to the allowance.
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 1 – BASIS OF PRESENTATION (Continued)

The allowance consists of specific and general components.  The specific components relate to loans that are individually classified as impaired.  The general components relate to all loans not specifically identified as impaired and are modeled on loss by portfolio, weighted by recent historic data and economic factors.

The Company’s policy for assessing loans for impairment is the same for all classes of loans and is included in our allowance for loan losses policy.  The Company classifies a loan as impaired when it is probable that the Company will be unable to collect all amounts due, including both principal and interest, according to the contractual terms of the loan agreement.  An impairment determination is performed utilizing the following general factors:  (i) a risk rating of substandard or doubtful, (ii) a loan amount greater than $100, and/or (iii) a past due aging of 90 days or more.  In addition, the Company also considers the following: the financial condition of the borrower, the Company’s best estimate of the direction and magnitude of any future changes in the borrower’s financial condition, the fair value of collateral if the loan is collateral dependent, the loan’s observable market price, expected future cash flow and, if a purchased loan, the amount of the remaining unaccreted carrying discount.  For loans acquired in the acquisition of ABI, if the loss was attributed to events and circumstances that existed as of the acquisition date as a result of new information obtained during the measurement period (i.e., 12 months from date of acquisition) that, if known, would have resulted in the recognition of additional deterioration, the additional deterioration was recorded as additional carrying discount with a corresponding increase to goodwill.  If not, the additional deterioration was recorded as additional provision expense with a corresponding increase in the allowance for loan losses.  After the measurement period, any additional impairment above the current carrying discount is recorded as additional provision expense with a corresponding increase in the allowance for loan losses.

If a loan is deemed to be impaired, a portion of the allowance for loan losses may be allocated so that the loan is reported, net, at the present value of estimated expected 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.  If an impaired loan is on nonaccrual, then recognition of interest income would follow our nonaccrual policy, which is to no longer accrue interest and account for any interest received on the cash-basis or cost-recovery method until qualifying again for interest accrual.  If an impaired loan is not on nonaccrual, then recognition of interest income would accrue on the unpaid principal balance based on the contractual terms of the loan.  All impaired loans are reviewed on at least a quarterly basis for changes in the measurement of impairment.  For impaired loans measured using the present-value-of-expected-cash-flows method, any change to the previously-recognized impairment loss is recognized as a change in the allowance for loan loss account and recorded in the Consolidated Statement of Operations as a component of the provision for loan losses.

Loans, for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.  Troubled debt restructurings are measured at the present value of estimated expected future cash flows using the loan’s effective rate at inception.  Key factors that the Company considers at the time a loan is restructured to determine whether the loan should accrue interest include if the loan is less than 90 days past due and if the loan is in compliance with the modified terms of the loan.  The Company determines that the loan has been restructured to be reasonably assured of repayment and of performance according to the modified terms by performing an analysis that documents exactly how the loan is expected to perform under the modified terms.  Once loans become troubled debt restructurings, they remain troubled debt restructurings until they mature or are paid off in the normal course of business.
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 1 – BASIS OF PRESENTATION (Continued)

The general component covers all other loans not identified as impaired and is based on historical losses with consideration given to current environmental factors.  The historical loss component of the allowance is determined by losses recognized by each portfolio segment over the preceding five years with the most recent years carrying more weight.  This is supplemented by the risks for each portfolio segment.  In calculating the historical component of our allowance, we aggregate the portfolio segments by class of loans as follows:  commercial loans, residential real estate mortgage loans, commercial real estate mortgage loans (which includes construction and land loans), and consumer and other loans.  Risk factors impacting loans in each of the portfolio segments include changes in property values, consumer and business spending, and consumer confidence regarding a sustainable recovery.  Actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment.  These economic factors include consideration of the following:  the concentration of watch and substandard loans as a percentage of total loans, levels of loan concentration within a portfolio segment or division of a portfolio segment and broad economic conditions.

Assets Held for Sale

The Company reclassifies long-lived assets to assets held for sale when all required criteria for such reclassification are met.  The assets held for sale are recorded at the lower of the carrying value or fair value less costs to sell.  An asset held for sale must meet the following conditions: (1) management, having authority to approve the action, commits to a plan to sell the asset, (2) the asset is available for immediate sale in its present condition, (3) an active program to locate a buyer and other actions required to complete the plan to sell the asset have been initiated, (4) the sale of the asset is probable, and transfer of the asset is expected to qualify for recognition as a completed sale, within one year, (5) the asset is being actively marketed for sale at a price that is reasonable in relation to its current fair value, and (6) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.

In the second quarter of 2014, a determination was made that certain assets met the criteria to be classified as held for sale.  The fair value for the related assets approximated their carrying value.  Therefore, no gain or loss has been recorded to noninterest expense. Please refer to Note 12 – Assets Held for Sale for additional information.

Convertible Securities

On December 31, 2012, the Company completed a $50,000 private placement capital raise (the “Private Placement”) whereby Bancorp sold a total of 50,000 shares of Mandatorily Convertible, Noncumulative, Nonvoting Perpetual Preferred Stock, Series A, par value $0.01 per share (the “Series A Preferred Stock”) at a purchase price of $1,000 per share.  Please refer to Note 2—Capital Raise Transactions for additional information regarding the Private Placement and Note 9—Shareholders’ Equity for additional information pertaining to the Series A Preferred Stock.

Pursuant to the Series A Preferred Stock designation, the Series A Preferred Stock was mandatorily convertible into shares of the Company’s common stock, par value $0.01 per share, and a new class of nonvoting common stock, par value $0.01 per share, upon receipt of requisite approval by the Company’s shareholders.  As of the date of issuance, the effective conversion price of $9.71 per share was less than the fair value of $16.00 per share of the Company’s common stock.  In accordance with U.S. GAAP, the Series A Preferred Stock was deemed to include a beneficial conversion feature with an intrinsic value of $6.29 per share for a total discount of $31,464.  On the date of conversion, the discount due to the beneficial conversion feature was recognized as an implied preferred stock dividend.  This noncash, implied dividend decreased retained earnings and net income available to common shareholders in the earnings per share calculation.

Fair Value of Financial Instruments

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 10—Fair Value.  Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items.  Changes in assumptions or in market conditions could significantly affect these estimates.
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 1 – BASIS OF PRESENTATION (Continued)

Reclassifications

Certain amounts in the prior year’s financial statements were reclassified to conform to the current year’s presentation.  These reclassifications had no impact on the prior periods’ net income or shareholders’ equity.

Bancorp’s Board of Directors implemented a 1-for-20 reverse stock split of Bancorp’s outstanding shares of common stock and nonvoting common stock effective October 24, 2013.  As a result of the reverse stock split, each 20 shares of issued and outstanding common stock and nonvoting common stock, par value $0.01 per share, respectively, were automatically and without any action on the part of the respective holders combined and reconstituted as one share of the respective class of common equity as of the effective date.  Consequently, the aggregate par value of common stock and nonvoting common stock eliminated in the reverse stock split was reclassed on the Company’s consolidated balance sheets from the respective class of common equity to additional paid-in capital.  Additional adjustments were made to the aforementioned accounts as a result of rounding to avoid the existence of fractional shares.  All share and per share information in the Consolidated Financial Statements and the accompanying notes have been retrospectively adjusted to reflect the common equity 1-for-20 reverse stock split.  Please refer to Note 9 – Shareholders’ Equity for additional information related to the reverse stock split.

Recently Issued Accounting and Reporting Standards

In July 2013, the FASB issued an accounting standards update that requires that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, be presented in the financial statements as a reduction of a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, with specified exceptions.  To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available as of the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets.  The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist as of the reporting date and should be made presuming disallowance of the tax position at the reporting date. The amendments in this update were effective for fiscal years, and interim periods within those years, beginning after December 15, 2013.  No new recurring disclosures are required by this update.  The Company has evaluated this standard and determined that it will not have a material effect on the Company’s Consolidated Financial Statements.
 
In May 2014, the FASB issued ASU No. 2014-09 Revenue from Contracts with Customers (Topic 606) (ASU 2014-09).  This update to the Accounting Standards Codification is the culmination of efforts by the FASB and the International Accounting Standards Board to develop a common revenue standard for U.S. GAAP and International Financial Reporting Standards and creates a new Topic 606 – Revenue from Contracts with Customers.  ASU 2014-09 supersedes Topic 605 – Revenue Recognition and most industry-specific guidance.  The core principal of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The guidance in ASU 2014-09 describes a 5-step process entities can apply to achieve the core principle of revenue recognition and requires disclosures sufficient to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers and the significant judgments used in determining that information.  The amendments in ASU 2014-9 are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period and early application is not allowed.  The Company is currently evaluating the effects of ASU 2014-04 on its Consolidated Financial Statements and disclosures, if any.

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

NOTE 2 – CAPITAL RAISE TRANSACTIONS

2012 Capital Raise Activities

During the year ended December 31, 2012, the Company executed a financial advisory agreement with an investment banking firm to assist in raising capital.  On August 22, 2012, Bancorp executed a stock purchase agreement (the “Original Stock Purchase Agreement”) with its largest shareholder, CapGen Capital Group IV LP (“CapGen”), for the sale to CapGen of up to 25,000 shares of Bancorp’s Series A Preferred Stock, at a purchase price of $1,000 per share, subject to the terms and conditions contained in the Original Stock Purchase Agreement.  The Original Stock Purchase Agreement was executed in connection with Bancorp’s private offering to accredited investors of an aggregate of 50,000 shares of Series A Preferred Stock at a purchase price of $1,000 per share (the “Private Placement”).
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 2—CAPITAL RAISE TRANSACTIONS (Continued)

On September 27, 2012, as a part of a bridge financing, Bancorp and CapGen entered into a subscription agreement under which Bancorp sold to CapGen 5,000 shares of Bancorp’s newly designated Noncumulative, Nonvoting, Perpetual Preferred Stock, Series B, par value $0.01 per share (“Series B Preferred Stock”), at a purchase price of $1,000 per share for an aggregate of $5,000 (the “Series B Sale”).  In connection with the Series B Sale and also on September 27, 2012, Bancorp and CapGen entered into an exchange agreement whereby Bancorp agreed to exchange shares of Series B Preferred Stock for shares of Series A Preferred Stock concurrently with the issuance of shares of Series A Preferred Stock in the Private Placement, unless such shares of Series B Preferred Stock were first redeemed by Bancorp.

On December 31, 2012, Bancorp entered into an amended and restated stock purchase agreement (the “Restated Stock Purchase Agreement”) with CapGen and 29 other accredited investors for the sale of 50,000 shares of Series A Preferred Stock at a price of $1,000 per share, subject to the terms and conditions contained in the Restated Stock Purchase Agreement.  The Private Placement closed on the same date for an aggregate of $50,000.  Included in the 50,000 shares of Series A Preferred Stock sold in the Private Placement were 5,000 shares of Series A Preferred Stock issued to CapGen in exchange for the 5,000 shares of Series B Preferred Stock purchased by CapGen in the Series B Sale, pursuant to an amended and restated exchange agreement between Bancorp and CapGen dated December 31, 2012.  Also included in the shares sold in the Private Placement was an aggregate of 2,265 shares of Series A Preferred Stock sold through individual subscription agreements to certain of Bancorp’s directors, executive officers and other related parties (the “Subscribers”) for consideration of an aggregate of $465 in cash and $1,800 in the cancellation of outstanding debt under the Company’s revolving loan agreements held by certain of the Subscribers and/or their related interests.  As a result of this transaction, no one entity owns more than 50% of Bancorp’s voting equity.

Pursuant to the Series A Preferred Stock designation, the Series A Preferred Stock was mandatorily convertible into shares of Bancorp’s common stock and a new class of nonvoting common stock upon receipt of requisite approvals by Bancorp’s shareholders.  On February 18, 2013, the Company received shareholder approvals to amend its Amended and Restated Articles of Incorporation to (i) increase the number of authorized shares of the Company’s common stock to 20,000,000, and (ii) authorize 5,000,000 shares of a new class of nonvoting common stock, par value $0.01 per share (the “Capital Amendment”).  On the same date, the Company also received shareholder approval to issue an aggregate of 5,000,000 shares of its common stock and nonvoting common stock in the conversion of the 50,000 outstanding shares of the Company’s Series A Preferred Stock.

On February 19, 2013, the Company filed the Capital Amendment with the Florida Secretary of State, and on the same date, all of the outstanding shares of the Company’s Series A Preferred Stock automatically converted into an aggregate of 2,382,000 shares of common stock and 2,618,000 shares of nonvoting common stock (the “Conversion”).  The Conversion was based on a conversion price of $10.00 per share and a conversion rate of 100 shares of common stock and/or nonvoting common stock for each share of Series A Preferred Stock outstanding.  As a result of the Conversion, no shares of the Series A Preferred Stock remained outstanding and an aggregate of 2,676,544 shares of common stock and 2,618,000 shares of nonvoting common stock were outstanding immediately following the Conversion.

Net proceeds from the issuance of preferred stock in the amount of $45,140 were used for general operating expenses, mainly for the subsidiary bank, to improve capital ratios, and will be used to support the Company’s business strategy going forward.  Please refer Note 9—Shareholders’ Equity for additional information pertaining to the Company’s equity securities issued in conjunction with the previously described capital raise transactions.

Immediately prior to the closing of the Private Placement, the Bank sold $25,134 of other real estate owned, nonaccrual loans, loans with a history of being past due, and other loans that were part of an overall customer relationship to a real estate investment firm, who was also an investor in the Private Placement, for a purchase price of $11,705 (the “Asset Sale”).  Total assets sold in the Asset Sale included loans of $24,601 and other real estate owned of $533.  Total proceeds of $11,705 included proceeds from the sale of loans of $11,313 and proceeds from the sale of other real estate owned of $392.

JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 2—CAPITAL RAISE TRANSACTIONS (Continued)

2013 Capital Raise Activities

On August 21, 2013, the Company distributed to its eligible existing shareholders nontransferable subscription rights to purchase shares of the Company’s common stock at a subscription price of $10.00 per share.  The subscription rights entitled the holders of our common stock as of August 20, 2013 (excluding participants in the Private Placement) to purchase an aggregate of approximately 500,000 shares of the Company’s common stock.  The subscription period for the rights offering expired on September 20, 2013 and resulted in the sale of 104,131 shares of the Company’s common stock for an aggregate of $1,041, or $937 net of offering expenses.

Concurrently with the rights offering, the Company initiated a public offering of shares of the Company’s common stock not subscribed for in the rights offering at an equal subscription price of $10.00 per share.  At the completion of the rights offering, 395,869 shares of common stock remained available for sale in the public offering.

The public offering expired on October 4, 2013 whereby the Company sold all remaining shares of common stock available for sale for an aggregate of $3,959, or $3,226 net of offering expenses.  As a result of the concurrent offerings, the Company sold a total of 500,000 shares of common stock for aggregate proceeds of $5,000.  Total net proceeds in the amount of $4,163 will be used to support management’s business strategy going forward.

Management’s Plans

The Company’s strategic initiatives address the actions necessary to restore profitability and achieve full compliance with all outstanding regulatory agreements.  In addition to the capital raise transactions described in the preceding paragraphs, management has also pursued, and will continue to pursue, various options to aid in the steady improvement of the Company’s results of operations.

During the second quarter of 2012, the Company adopted a new overall strategy to accelerate the disposition of substandard assets on an individual customer basis.  Certain current appraised values were discounted to estimated fair market value based on current market data such as recent sales of similar properties, discussions with potential buyers and negotiations with existing customers.  This strategy materially impacted the Company’s earnings for the year ended December 31, 2012 as a result of the increased provision for loan losses, expenses related to protecting our collateral position, and aggressively pursuing foreclosure actions when necessary.  Additionally, the aggressive pursuit of foreclosure actions resulted in an increase in other real estate owned expenses during the same period.

In the fourth quarter of 2013, Bancorp’s Board of Directors implemented a 1-for-20 reverse stock split of the Company’s issued and outstanding shares of common stock and nonvoting common stock in an effort to increase the market price of the Company’s common stock and thereby enhance the overall liquidity of issued and outstanding shares of common stock and nonvoting common stock and regain compliance with NASDAQ continued listing standards.  As of the effective date of the reverse stock split, the Company’s per share market price increased from $0.51 to $10.20.  On November 7, 2013, the Company received notification that it had regained compliance with the Minimum Bid Price Rule and therefore, was no longer subject to delisting from the NASDAQ Stock Market.  However, there can be no assurance that the reverse stock split, or any other measures taken by Bancorp’s Board of Directors to increase the market price of the Company’s common stock, will result in the intended benefits or have a sustainable impact going forward.  Please refer to Note 9 – Shareholders’ Equity for additional information related to the reverse stock split.
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 2—CAPITAL RAISE TRANSACTIONS (Continued)

The Company’s recapitalization plan that was executed in 2012 and completed in 2013, combined with the strategic initiative to accelerate the disposal of substandard assets has enabled the Company to restore capital to prescribed regulatory levels.  During the six months ended June 30, 2014 and looking forward, the Company intends to maintain the quality of its loan portfolio through the continued reduction of problem assets in a prudent and reasonable manner and to continue to improve the overall credit process including, but not limited to, loan origination disciplines, stricter underwriting criteria, and succinct funding and onboarding processes.  In addition, the Company will carry on with the repositioning of its loan and deposit portfolio mix to better align with our targeted market segment of professional services, wholesalers, distributors, and other service industries.  In addition, during the second quarter of 2014, the Company announced a reduction in workforce of approximately 16%.  Affected employees were provided comprehensive severance packages that will be paid out in the third quarter of 2014.  Severance package related expenses of $48 were accrued for as of June 30, 2014.  This action occurred to better align the Company’s processes and procedures with the best industry practices and standards.  These changes have not yet materially impacted our financial condition or results of operations.

NOTE 3 - INVESTMENT SECURITIES

The following table summarizes the amortized cost and fair value of the available-for-sale and held-to-maturity investment securities portfolio as of June 30, 2014 and December 31, 2013 and the corresponding amounts of unrealized gains and losses recognized in accumulated other comprehensive income (loss):

(Dollars in thousands)
Amortized
Cost
  
Unrealized
Gains
  
Unrealized
Losses
  
Fair Value
  
June 30, 2014
  
   
   
   
 
Available-for-sale:
  
   
   
   
 
U.S. government-sponsored entities and agencies
  
$
7,753
    
$
134
    
$
(37
)
  
$
7,850
  
State and political subdivisions
    
7,011
      
480
      
-
      
7,491
  
Mortgage-backed securities - residential
    
32,256
      
937
      
(50
)
    
33,143
  
Collateralized mortgage obligations
    
30,935
      
152
      
(531
)
    
30,556
  
Corporate bonds
    
3,031
      
98
      
(1
)
    
3,128
  
Total available-for-sale securities
  
$
80,986
    
$
1,801
    
$
(619
)
  
$
82,168
  
 
 
Amortized
Cost
  
Unrealized
Gains
  
Unrealized
Losses
  
Fair Value
  
December 31, 2013
                              
Available-for-sale:
                              
U.S. government-sponsored entities and agencies
$
8,343
    
$
123
    
$
(70
)
  
$
8,396
  
State and political subdivisions
  
7,762
      
342
      
(67
)
    
8,037
  
Mortgage-backed securities - residential
  
32,709
      
686
      
(170
)
    
33,225
  
Collateralized mortgage obligations
  
32,791
      
143
      
(956
)
    
31,978
  
Corporate bonds
  
3,037
      
104
      
(6
)
    
3,135
  
Total available-for-sale securities
$
84,642
    
$
1,398
    
$
(1,269
)
  
$
84,771
  
 
As of June 30, 2014 and December 31, 2013, the Company’s investment securities portfolio did not include any held-to-maturity securities.
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 3 - INVESTMENT SECURITIES (Continued)
 
The following table summarizes the proceeds from sales of available-for-sale securities and the associated gains and losses for the three and six months ended June 30, 2014 and 2013:
 
 
  
Three Months Ended
    
Six Months Ended
  
 
  
June 30,
    
June 30,
  
(Dollars in thousands)
  
2014
    
2013
    
2014
    
2013
  
Gross gains
  
$
-
    
$
42
    
$
-
    
$
79
  
Gross losses
    
-
      
(33
)
    
-
      
(33
)
Net gain
  
$
-
    
$
9
    
$
-
    
$
46
  
Proceeds
  
$
-
    
$
1,993
    
$
-
    
$
4,167
  

The amortized cost and fair value of the investment securities portfolio are presented below in order of contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.  Securities not due at a single maturity date, primarily mortgage-backed securities – residential and collateralized mortgage obligations, are shown separately.
 
(Dollars in thousands)
June 30, 2014
  
Amortized
Cost
    
Fair
Value
  
Available-for-sale:
  
   
 
Within one year
  
$
500
    
$
512
  
One to five years
    
2,386
      
2,487
  
Five to ten years
    
3,978
      
4,026
  
Beyond ten years
    
10,931
      
11,444
  
Mortgage-backed securities – residential
    
32,256
      
33,143
  
Collateralized mortgage obligations
    
30,935
      
30,556
  
Total
  
$
80,986
    
$
82,168
  

JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 3 - INVESTMENT SECURITIES (Continued)
 
The following table summarizes the investment securities with unrealized losses as of June 30, 2014 and December 31, 2013 listed by aggregated major security type and length of time in a continuous unrealized loss position:
 
 
  
Less Than 12 Months
    
12 Months or Longer
    
Total
  
(Dollars in thousands)
June 30, 2014
  
Fair
Value
    
Unrealized losses
    
Fair
Value
    
Unrealized losses
    
Fair
Value
    
Unrealized losses
  
Available-for-sale:
  
   
   
   
   
   
 
U.S. government-sponsored entities and agencies
  
$
-
    
$
-
    
$
963
    
$
(37
)
  
$
963
    
$
(37
)
State and political subdivisions
    
-
      
-
      
-
      
-
      
-
      
-
  
Mortgage backed securities – residential
    
2,070
      
(3
)
    
2,533
      
(47
)
    
4,603
      
(50
)
Collateralized mortgage obligations
    
2,800
      
(19
)
    
12,249
      
(512
)
    
15,049
      
(531
)
Corporate bonds
    
999
      
(1
)
    
-
      
-
      
999
      
(1
)
Total available-for-sale securities
  
$
5,869
    
$
(23
)
  
$
15,745
    
$
(596
)
  
$
21,614
    
$
(619
)
 
 
  
Less Than 12 Months
    
12 Months or Longer
    
Total
  
December 31, 2013
  
Fair
Value
    
Unrealized losses
    
Fair
Value
    
Unrealized losses
    
Fair
Value
    
Unrealized losses
  
Available-for-sale:
  
   
   
   
   
   
 
U.S. government-sponsored entities and agencies
  
$
1,828
    
$
(70
)
  
$
-
    
$
-
    
$
1,828
    
$
(70
)
State and political subdivisions
    
1,015
      
(67
)
    
-
      
-
      
1,015
      
(67
)
Mortgage backed securities – residential
    
7,025
      
(170
)
    
-
      
-
      
7,025
      
(170
)
Collateralized mortgage obligations
    
17,686
      
(674
)
    
5,131
      
(282
)
    
22,817
      
(956
)
Corporate bonds
    
994
      
(6
)
    
-
      
-
      
994
      
(6
)
Total available-for-sale securities
  
$
28,548
    
$
(987
)
  
$
5,131
    
$
(282
)
  
$
33,679
    
$
(1,269
)
 
As of June 30, 2014 and December 31, 2013, the Company’s security portfolio consisted of $82,168 and $84,771, respectively, in available-for-sale securities, of which $21,614 and $33,679 were in an unrealized loss position for the related periods.  The unrealized losses as of June 30, 2014 and December 31, 2013 were related to all securities types held by the Company, as discussed below.

U.S. Government-Sponsored Entities and Agency Securities (“U.S. Agency Securities”):
All of the U.S. Agency Securities held by the Company were issued by U.S. government-sponsored entities and agencies. As of June 30, 2014 and December 31, 2013, the number of U.S. Agency Securities with unrealized losses were one and two, respectively.  As of June 30, 2014 and December 31, 2013, these securities had depreciated 3.71% and 3.67%, respectively, from the Company’s amortized cost basis.  The decline in fair value was attributable to changes in interest rates, not credit quality.

State and Political Securities (“Municipal Bonds”):
All of the Municipal Bonds held by the Company were issued by a state, city or other local government and represent general obligations of the issuer that are secured by specified revenues.  As of June 30, 2014 and December 31, 2013, Municipal Bonds with unrealized losses were zero and two, respectively.  As of June 30, 2014 and December 31, 2013, these securities had depreciated 0.00% and 6.16%, respectively, from the Company’s amortized cost basis. The decline in fair value was primarily attributable to changes in interest rates rather than the ability or willingness of the municipality to repay.
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 3 - INVESTMENT SECURITIES (Continued)

Mortgage-backed Securities – Residential (“Mortgage-backed Securities”):
All of the Mortgage-backed Securities held by the Company were issued by U.S. government-sponsored entities and agencies, primarily Ginnie Mae and Fannie Mae, institutions which have the full faith and credit of the U.S. government.  As of June 30, 2014 and December 31, 2013, Mortgage-backed Securities with unrealized losses were six and eight, respectively.  As of June 30, 2014 and December 31, 2013, these securities had depreciated 1.07% and 2.37%, respectively, from the Company’s amortized cost basis.  The decline in fair value was attributable to changes in interest rates, not credit quality.

Collateralized Mortgage Obligations:
All of the collateralized mortgage obligation securities held by the Company were issued by U.S. government-sponsored entities and agencies, primarily Ginnie Mae, an institution which has the full faith and credit of the U.S. government.  As of June 30, 2014 and December 31, 2013, collateralized mortgage obligations with unrealized losses were thirteen and seventeen, respectively.  As of June 30, 2014 and December 31, 2013, these securities had depreciated 3.41% and 4.02%, respectively, from the Company’s amortized cost basis.  The decline in fair value was attributable to changes in interest rates, not credit quality.

Corporate Bonds:
All of the corporate bonds held by the Company were debt obligations issued by corporations, with no inherent claim to ownership.  As of June 30, 2014 and December 31, 2013, corporate bonds with unrealized losses were one and one, respectively.  As of June 30, 2014 and December 31, 2013, these securities had depreciated 0.08% and 0.61%, respectively, from the Company’s amortized cost basis.  The decline in fair value was attributable to changes in interest rates, not the credit quality of the issuer.

Other-Than-Temporary Impairment
 
Because the Company does not have the intent to sell these securities, and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these to be other-than-temporarily impaired as of June 30, 2014 and December 31, 2013.

For the six months ended June 30, 2014 and 2013, there were no credit losses recognized in earnings related to investment securities.

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES
 
Loans as of June 30, 2014 and December 31, 2013 were as follows:
 
(Dollars in thousands)
  
June 30,
2014
    
December 31,
2013
  
Commercial loans
  
$
48,919
    
$
43,855
  
Real estate mortgage loans:
                
Residential
    
71,306
      
71,192
  
Commercial
    
218,602
      
223,182
  
Construction and land
    
28,107
      
30,355
  
Consumer and other loans
    
1,981
      
2,041
  
Loans, gross
    
368,915
      
370,625
  
Less:
                
Net deferred loan fees
    
(355
)
    
(273
)
Allowance for loan losses
    
(14,616
)
    
(15,760
)
Loans, net
  
$
353,944
    
$
354,592
  
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Loans acquired as a result of the merger with ABI were recorded at fair value on the date of acquisition.  The amounts reported in the table above are net of the fair value adjustments.  The table below reflects the contractual amount of purchased loans less the discount to principal balances remaining from these fair value adjustments by class of loan as of June 30, 2014 and December 31, 2013.  This discount will be accreted into interest income as deemed appropriate over the remaining term of the related loans.
 
(Dollars in thousands)
June 30, 2014
  
Gross Contractual
Amount Receivable
    
Discount
    
Carrying Balance
  
Commercial loans
  
$
1,876
    
$
164
    
$
1,712
  
Real estate mortgage loans:
                        
Residential
    
18,103
      
1,121
      
16,982
  
Commercial
    
40,248
      
2,416
      
37,832
  
Construction and land
    
3,871
      
379
      
3,492
  
Consumer and other loans
    
426
      
5
      
421
  
Total
  
$
64,524
    
$
4,085
    
$
60,439
  
 
December 31, 2013
  
Gross Contractual
Amount Receivable
    
Discount
    
Carrying Balance
  
Commercial loans
  
$
2,165
    
$
175
    
$
1,990
  
Real estate mortgage loans:
                        
Residential
    
20,614
      
1,282
      
19,332
  
Commercial
    
44,249
      
3,026
      
41,223
  
Construction and land
    
4,763
      
412
      
4,351
  
Consumer and other loans
    
468
      
6
      
462
  
Total
  
$
72,259
    
$
4,901
    
$
67,358
  
 
The Company has divided the loan portfolio into three portfolio segments, each with different risk characteristics and methodologies for assessing risk.  The three portfolio segments identified by the Company are described below.

Commercial Loans:
Commercial loans are primarily underwritten on the basis of the borrowers’ ability to service such debt from income.  The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value.  As a general practice, we take as collateral a security interest in any available real estate, equipment, or other chattel, although loans may also be made on an unsecured basis.  Collateralized working capital loans typically are secured by short-term assets whereas long-term loans are primarily secured by long-term assets.  Risk is mitigated by the diversity and number of borrowers.
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Real Estate Mortgage Loans:
Real estate mortgage loans are typically segmented into three classes:  commercial real estate, residential real estate and construction and land development.  Commercial real estate loans are secured by the subject property and are underwritten based upon standards set forth in the policies approved by the Bank’s Board.  Such standards include, among other factors, loan-to-value limits, cash flow coverage and general credit worthiness of the obligors.  Residential real estate loans are underwritten in accordance with policies set forth and approved by the Bank’s Board, including repayment capacity and source, value of the underlying property, credit history, stability and purchaser guidelines.  Construction loans to borrowers are to finance the construction of owner occupied and lease properties.  These loans are categorized as construction loans during the construction period, later converting to commercial or residential real estate loans after the construction is complete and amortization of the loan begins.  Real estate development and construction loans are approved based on an analysis of the borrower and guarantor, the viability of the project and on an acceptable percentage of the appraised value of the property securing the loan.   Real estate development and construction loan funds are disbursed periodically based on the percentage of construction completed.  The Bank carefully monitors these loans with on-site inspections and requires the receipt of lien waivers prior to advancing funds.  Development and construction loans are typically secured by the properties under development or construction, and personal guarantees are typically obtained.  Further, to assure that reliance is not placed solely on the value of the underlying property, the Bank considers the market conditions and feasibility of proposed projects, the financial condition and reputation of the borrower and guarantors, the amount of the borrower’s equity in the project, independent appraisals, cost estimates and pre-construction sale information.  The Bank also makes loans on occasion for the purchase of land for future development by the borrower.  Land loans are extended for the future development of either commercial or residential use by the borrower.  The Bank carefully analyzes the intended use of the property and the viability thereof.

Repayment of real estate loans is primarily dependent upon the personal income or business income generated by the secured property of the borrowers, which can be impacted by the economic conditions in their market area.  Risk is mitigated by the fact that the properties securing the Company’s real estate loan portfolio are diverse in type and spread over a large number of borrowers.

Consumer and Other Loans:
Consumer and other loans are extended for various purposes, including purchases of automobiles, recreational vehicles, and boats.  We also offer home improvement loans, lines of credit, personal loans, and deposit account collateralized loans.  Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas, such as unemployment levels. Loans to consumers are extended after a credit evaluation, including the credit worthiness of the borrower(s), the purpose of the credit, and the secondary source of repayment. Consumer loans are made at fixed and variable interest rates and may be made on terms of up to ten years. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Activity in the allowance for loan losses by portfolio segment for the three and six months ended June 30, 2014 and 2013 was as follows:

 
  
Three Months Ended
    
Six Months Ended
  
 
  
June 30,
    
June 30,
  
(Dollars in thousands)
  
2014
    
2013
    
2014
    
2013
  
Allowance at beginning of period
  
$
15,104
    
$
19,820
    
$
15,760
    
$
20,198
  
 
                                
Charge-offs:
                                
Commercial loans
    
-
      
64
      
203
      
64
  
Real estate mortgage loans
    
825
      
2,042
      
1,489
      
2,589
  
Consumer and other loans
    
3
      
40
      
15
      
173
  
Total charge-offs
    
828
      
2,146
      
1,707
      
2,826
  
 
                                
Recoveries:
                                
Commercial loans
    
11
      
59
      
28
      
70
  
Real estate mortgage loans
    
37
      
29
      
237
      
97
  
Consumer and other loans
    
5
      
25
      
11
      
31
  
Total recoveries
    
53
      
113
      
276
      
198
  
Net charge-offs
    
775
      
2,033
      
1,431
      
2,628
  
 
                                
Provision for loan losses charged to operating expenses:
                                
Commercial loans
    
(126
)
    
78
      
128
      
215
  
Real estate mortgage loans
    
563
      
(563
)
    
241
      
(629
)
Consumer and other loans
    
(150
)
    
1
      
(82
)
    
147
  
Total provision
    
287
      
(484
)
    
287
      
(267
)
Allowance at end of period
  
$
14,616
    
$
17,303
    
$
14,616
    
$
17,303
  

JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
 
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of June 30, 2014 and December 31, 2013:
 
(Dollars in thousands)
June 30, 2014
  
Commercial
Loans
    
Real Estate
Mortgage Loans
    
Consumer and
Other Loans
    
Total
  
Allowance for loan losses:
  
   
   
   
 
Ending allowance balance attributable to loans:
  
   
   
   
 
Individually evaluated for impairment
  
$
86
    
$
2,310
    
$
311
    
$
2,707
  
Collectively evaluated for impairment
    
1,082
      
10,438
      
229
      
11,749
  
Loans acquired with deteriorated credit quality
    
-
      
160
      
-
      
160
  
Total ending allowance balance
  
$
1,168
    
$
12,908
    
$
540
    
$
14,616
  
Loans:
                                
Loans individually evaluated for impairment
  
$
128
    
$
24,783
    
$
344
    
$
25,255
  
Loans collectively evaluated for impairment
    
48,687
      
277,487
      
1,637
      
327,811
  
Loans acquired with deteriorated credit quality
    
104
      
15,745
      
-
      
15,849
  
Total ending loans balance
  
$
48,919
    
$
318,015
    
$
1,981
    
$
368,915
  

December 31, 2013
  
Commercial
Loans
    
Real Estate
Mortgage Loans
    
Consumer and
Other Loans
    
Total
  
Allowance for loan losses:
  
   
   
   
 
Ending allowance balance attributable to loans:
  
   
   
   
 
Individually evaluated for impairment
  
$
223
    
$
1,608
    
$
323
    
$
2,154
  
Collectively evaluated for impairment
    
992
      
11,919
      
303
      
13,214
  
Loans acquired with deteriorated credit quality
    
-
      
392
      
-
      
392
  
Total ending allowance balance
  
$
1,215
    
$
13,919
    
$
626
    
$
15,760
  
Loans:
                                
Loans individually evaluated for impairment
  
$
304
    
$
19,783
    
$
364
    
$
20,451
  
Loans collectively evaluated for impairment
    
43,449
      
286,188
      
1,676
      
331,313
  
Loans acquired with deteriorated credit quality
    
102
      
18,758
      
1
      
18,861
  
Total ending loans balance
  
$
43,855
    
$
324,729
    
$
2,041
    
$
370,625
  
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
 
The following table presents loans individually evaluated for impairment, by class of loans as of June 30, 2014 and December 31, 2013:
 
 
  
June 30, 2014
    
December 31, 2013
  
(Dollars in thousands)
  
Unpaid
Principal
Balance
    
Recorded
Investment
    
Allowance for
Loan Losses
Allocated
    
Unpaid
Principal
Balance
    
Recorded
Investment
    
Allowance for
Loan Losses
Allocated
  
With no related allowance recorded:
  
   
   
   
   
   
 
Commercial loans
  
$
43
    
$
42
    
$
-
    
$
43
    
$
43
    
$
-
  
Real estate mortgage loans:
                                                
Residential
    
2,018
      
1,964
      
-
      
2,341
      
2,286
      
-
  
Commercial
    
13,289
      
10,381
      
-
      
4,643
      
4,395
      
-
  
Construction and land
    
8,517
      
4,515
      
-
      
8,586
      
4,806
      
-
  
Consumer and other loans
    
34
      
33
      
-
      
40
      
40
      
-
  
With an allowance recorded:
                                                
Commercial loans
  
$
91
    
$
86
    
$
86
    
$
264
    
$
261
    
$
223
  
Real estate mortgage loans:
                                                
Residential
    
1,091
      
1,009
      
216
      
1,597
      
1,574
      
209
  
Commercial
    
6,478
      
6,322
      
1,802
      
7,910
      
6,062
      
1,001
  
Construction and land
    
601
      
592
      
292
      
667
      
660
      
398
  
Consumer and other loans
    
336
      
311
      
311
      
341
      
324
      
323
  
 
                                                
Total
  
$
32,498
    
$
25,255
    
$
2,707
    
$
26,432
    
$
20,451
    
$
2,154
  

JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

The following tables present the average recorded investment in impaired loans and the related interest income recognized during impairment for the three and six months ended June 30, 2014 and 2013.

 
  
Three Months Ended
June 30, 2014
    
Six Months Ended
June 30, 2014
  
(Dollars in thousands)
  
Average
Impaired
Loans
    
Interest
Income
    
Cash-Basis
    
Average
Impaired
Loans
    
Interest
 Income
    
Cash-Basis
  
Commercial loans
  
$
155
    
$
-
    
$
-
    
$
272
    
$
-
    
$
-
  
Real estate mortgage loans:
                                                
Residential
    
2,948
      
15
      
29
      
3,504
      
34
      
42
  
Commercial
    
16,473
      
54
      
57
      
14,357
      
109
      
113
  
Construction and land
    
5,372
      
10
      
11
      
5,448
      
21
      
14
  
Consumer and other loans
    
348
      
-
      
-
      
353
      
-
      
-
  
Total
  
$
25,296
    
$
79
    
$
97
    
$
23,934
    
$
164
    
$
169
  

 
  
Three Months Ended
June 30, 2013
    
Six Months Ended
June 30, 2013
  
(Dollars in thousands)
  
Average
Impaired
Loans
    
Interest
Income
    
Cash-Basis
    
Average
Impaired
Loans
    
Interest
Income
    
Cash-Basis
  
Commercial loans
  
$
262
    
$
-
    
$
-
    
$
172
    
$
-
    
$
-
  
Real estate mortgage loans:
                                                
Residential
    
2,090
      
-
      
-
      
1,736
      
-
      
-
  
Commercial
    
9,230
      
49
      
52
      
9,210
      
99
      
100
  
Construction and land
    
4,735
      
9
      
8
      
4,263
      
9
      
8
  
Consumer and other loans
    
245
      
-
      
-
      
244
      
-
      
-
  
Total
  
$
16,562
    
$
58
    
$
60
    
$
15,625
    
$
108
    
$
108
  

The following table presents the recorded investment in nonaccrual loans by class of loans as of June 30, 2014 and December 31, 2013:
 
(Dollars in thousands)
  
June 30,
2014
    
December 31,
2013
  
Commercial loans
  
$
128
    
$
304
  
Real estate mortgage loans:
                
Residential
    
1,437
      
3,716
  
Commercial
    
12,652
      
7,105
  
Construction and land
    
4,072
      
5,517
  
Consumer and other loans
    
344
      
366
  
Total(1)
  
$
18,633
    
$
17,008
  
            
(1) Includes loans acquired in the merger with ABI.  As of June 30, 2014 and December 31, 2013, these amounts totaled $4,642 and $4,537, respectively.
 
The number of loans past due over 90 days still on accrual was one and none as of June 30, 2014 and December 31, 2013, respectively.  As of June 30, 2014, the recorded investment of the loan past due over 90 days still on accrual was $99.
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

The following table presents the aging of the recorded investment in past due loans by class of loans as of June 30, 2014 and December 31, 2013:

 
  
Past Due Loans
    
   
 
(Dollars in thousands)
June 30, 2014
  
30-59
Days
    
60-89
Days
    
90 Days and
Greater
    
Total
    
Loans Not
Past Due
    
Total
  
Commercial loans
  
$
12
    
$
8
    
$
-
    
$
20
    
$
48,899
    
$
48,919
  
Real estate mortgage loans:
                                                
Residential
    
191
      
14
      
938
      
1,143
      
70,163
      
71,306
  
Commercial
    
211
      
2,921
      
5,465
      
8,597
      
210,005
      
218,602
  
Construction and land
    
-
      
181
      
3,673
      
3,854
      
24,253
      
28,107
  
Consumer and other loans
    
-
      
221
      
-
      
221
      
1,760
      
1,981
  
Total
  
$
414
    
$
3,345
    
$
10,076
    
$
13,835
    
$
355,080
    
$
368,915
  
 
 
  
Past Due Loans
    
   
 
December 31, 2013
  
30-59
Days
    
60-89
Days
    
90 Days and
Greater
    
Total
    
Loans Not
Past Due
    
Total
  
Commercial loans
  
$
-
    
$
138
    
$
86
    
$
224
    
$
43,631
    
$
43,855
  
Real estate mortgage loans:
                                                
Residential
    
359
      
134
      
1,648
      
2,141
      
69,051
      
71,192
  
Commercial
    
2,558
      
3,103
      
6,475
      
12,136
      
211,046
      
223,182
  
Construction and land
    
-
      
119
      
4,470
      
4,589
      
25,766
      
30,355
  
Consumer and other loans
    
321
      
10
      
39
      
370
      
1,671
      
2,041
  
Total
  
$
3,238
    
$
3,504
    
$
12,718
    
$
19,460
    
$
351,165
    
$
370,625
  

Included in the past due loan table above are loans acquired in the merger with ABI.  As of June 30, 2014 and December 31, 2013, the amounts of such loans were as follows:

(Dollars in thousands)
  
June 30,
2014
    
December 31,
2013
  
30-59 days past due
  
$
39
    
$
87
  
60-89 days past due
    
1,128
      
167
  
90 days past due and greater
    
1,089
      
2,709
  
Total past due
  
$
2,256
    
$
2,963
  
 
The delinquency status of purchased credit impaired loans that resulted from our acquisition of ABI is based on the contractual terms of the loan.  In effect, past due status of an acquired loan is determined in the same manner as loans originated by the Bank.
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
 
Troubled Debt Restructurings

During the normal course of business, the Company may restructure or modify the terms of a loan for various reasons.  The restructuring of a loan is considered a troubled debt restructuring if both (i) the borrower is experiencing financial difficulties and (ii) a concession is granted that otherwise would not have occurred under normal circumstances.

The following table presents the recorded investment and specific reserves allocated to loans modified as troubled debt restructurings (“TDRs”) as of June 30, 2014 and December 31, 2013.

(Dollars in thousands)
  
June 30,
2014
    
December 31,
2013
  
Recorded investment(1)
  
$
13,929
    
$
12,535
  
Specific reserves allocated(2)
    
689
      
953
  
            
(1) Of the total recorded investment in loans modified as TDRs, $2,186 and $1,256, respectively, were for customers whose loans were collateral dependent with collateral shortfalls.
(2) Of the specific reserves allocated to customers whose loan terms were modified as TDRs, $415 and $622, respectively, were allocated to customers whose loans were collateral dependent with collateral shortfalls.
 
The following table represents loans by class modified as troubled debt restructurings that occurred during the three and six months ended June 30, 2014 and 2013, respectively:

 
  
Three Months Ended
    
Six Months Ended
  
 
  
June 30, 2014
    
June 30, 2014
  
(Dollars in thousands)
  
Number
of Loans
    
Pre-
Modification
Outstanding
Recorded
Investment
    
Post-
Modification
Outstanding
Recorded
Investment
    
Number
of Loans
    
Pre-
Modification
Outstanding
Recorded
Investment
    
Post-
Modification
Outstanding
Recorded
Investment
  
Commercial loans
    
1
    
$
62
    
$
62
      
1
    
$
62
      
62
  
Real estate mortgage loans:
                                                
Residential
    
1
      
147
      
121
      
2
      
171
      
151
  
Commercial
    
1
      
664
      
904
      
6
      
3,579
      
3,629
  
Construction and land
    
2
      
281
      
219
      
2
      
281
      
219
  
Consumer and other loans
    
-
      
-
      
-
      
1
      
239
      
239
  
Total
    
5
    
$
1,154
    
$
1,306
      
12
    
$
4,332
      
4,300
  

 
  
Three Months Ended
    
Six Months Ended
  
 
  
June 30, 2013
    
June 30, 2013
  
 
  
Number
of Loans
    
Pre-
Modification
Outstanding
Recorded
Investment
    
Post-
Modification
Outstanding
Recorded
Investment
    
Number
of Loans
    
Pre-
Modification
Outstanding
Recorded
Investment
    
Post-
Modification
Outstanding
Recorded
Investment
  
Commercial loans
    
1
    
$
66
    
$
66
      
1
    
$
66
      
66
  
Real estate mortgage loans:
                                                
Residential
    
2
      
697
      
697
      
3
      
1,277
      
1,344
  
Commercial
    
-
      
-
      
-
      
-
      
-
      
-
  
Construction and land
    
-
      
-
      
-
      
3
      
3,284
      
3,264
  
Consumer and other loans
    
-
      
-
      
-
      
1
      
-
      
130
  
Total
    
3
    
$
763
    
$
763
      
8
    
$
4,627
      
4,804
  

JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

During the three and six months ended June 30, 2014, there were five and twelve loans, respectively, modified as troubled debt restructurings.  The terms of these loans were modified as a troubled debt restructuring because the borrowers were experiencing financial difficulties. The loan modifications allowed the borrowers to make reduced payments, such as (i) reduced fixed interest rate through maturity and an advance to cover a deficiency from sale of a separate foreclosed property, (ii) change from principal and interest payments to interest only payments for a limited period of time, (iii) reduced principal and interest payments through maturity, (iv) change from variable rate interest only payments through maturity to fixed rate interest only payments for a limited period of time and reduced principal and interest payments through maturity,  (v) change from variable rate interest only payments through maturity to fixed rate and reduced principal and interest payments through maturity, (vi) proposed forgiveness of principal contingent upon the satisfaction of the modified terms, (vii) extension of maturity date with an amortization amount beyond market terms, (viii) forgiveness of principal, or (ix) modification of terms as a result of Chapter 11 bankruptcy court approved plan.  The troubled debt restructurings described above did not increase the allowance for loan losses as of June 30, 2014 and resulted in charge-offs of $61 and $256 for the three and six months ended June 30, 2014, respectively.  For the three and six months ended June 30, 2014, there were three and eight collateral-impaired loans modified as troubled debt restructurings, respectively.

During the three and six months ended June 30, 2013, the number of loans modified as troubled debt restructurings were three and eight, respectively.  The terms of these loans were modified as a troubled debt restructuring because the borrowers were experiencing financial difficulties. The loan modifications allowed the borrowers to make reduced payments, such as (i) forbearance of payments for a limited period of time with revised payment schedules to coordinate with periods of forbearance, (ii) change from principal and interest payments to interest only payments through maturity, (iii) reduced principal and interest payments through maturity, (iv) forgiveness of principal, (v) reduced principal and interest payments through maturity with an assumption of additional debt to protect the Bank’s collateral position, or (vi) proposed forgiveness of principal contingent upon the satisfaction of the modified terms.  Principal forgiven in the amount of $565 was offset by existing reserves from purchase accounting adjustments in the amount of $545 which resulted in a net charge-off of $20.  The troubled debt restructurings described above increased the allowance for loan losses by $87 and $129, respectively, and resulted in no charge-offs for the three months ended June 30, 2013 and charge-offs of $233 for the six months ended June 30, 2013.  For the three and six months ended June 30, 2013, the number of collateral-impaired loans modified as troubled debt restructurings were one and two, respectively.

As of June 30, 2014 and December 31, 2013, the Company had extended additional credit of $245 and $483, respectively, to customers with outstanding loans whose terms have been modified as TDRs.

There were no TDRs for which there was a payment default within twelve months following the modification during the three and six months ended June 30, 2014 and 2013, respectively.  A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms.

The terms of certain other loans that did not meet the definition of a troubled debt restructuring were modified during the three and six months ended June 30, 2014 and 2013.  These loans had a total recorded investment of $6,853 and $10,141 for the three and six months ended June 30, 2014, respectively, and $677 and $6,116 for the three and six months ended June 30, 2013, respectively.  These modifications involved loans to borrowers who were not experiencing financial difficulties and included (i) allowing the borrowers to make interest-only payments for a limited period of time, (ii) adjusting the interest rate to a market interest rate through maturity, (iii) extension of interest-only payments for a limited period of time, or (iv) extension of maturity date.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Company’s internal underwriting policy.
 
Credit Quality Indicators
 
The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors.
JACKSONVILLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
 
The Company analyzes loans individually by classifying the loans as to credit risk.  All loans are graded upon initial issuance.  Loans classified as substandard or special mention are reviewed at least quarterly by the Company for further deterioration or improvement to determine if they are appropriately classified and whether there is any impairment.  Further, commercial loans are typically reviewed at least annually to determine the appropriate loan grading.  In addition, during the renewal process of any loan, as well as if a loan becomes past due, the Company determines the appropriate loan grade.

Loans excluded from the review process above are generally classified as pass credits until:  (i) they become past due; (ii) management becomes aware of a deterioration in the credit worthiness of the borrower; or (iii) the customer contacts the Company for a modification.  In these circumstances, the loan is specifically evaluated for potential classification to special mention, substandard or doubtful.  The Company uses the following definitions for risk ratings:

Special Mention:
Loans classified as special mention have a potential weakness that deserves management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.
 
Substandard:
Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful:
Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above-described process are considered to be pass-rated loans.  As of June 30, 2014 and December 31, 2013, and based on the most recent analysis performed, the risk category of loans by class of loans was as follows:

(Dollars in thousands)
  
   
Special
    
   
   
 
June 30, 2014
  
Pass
    
Mention
    
Substandard
    
Doubtful
    
Total
  
Commercial loans
  
$
48,511
    
$
55
    
$
353
    
$
-
    
$
48,919
  
Real estate mortgage loans:
                                        
Residential
    
61,249
      
4,620
      
5,437
      
-
      
71,306
  
Commercial
    
195,138
      
4,069
      
19,395
      
-
      
218,602
  
Construction and land
    
21,024
      
166
      
6,917
      
-
      
28,107
  
Consumer and other loans
    
1,607
      
30
      
344
      
-
      
1,981
  
Total
  
$
327,529
    
$
8,940
    
$
32,446
    
$
-
    
$
368,915
  
 
                                        

 
  
   
Special
    
   
   
 
December 31, 2013
  
Pass
    
Mention
    
Substandard
    
Doubtful
    
Total
  
Commercial loans
  
$
42,945
    
$
295
    
$
615
    
$
-
    
$
43,855
  
Real estate mortgage loans:
                                        
Residential
    
59,003
      
5,301
      
6,888
      
-
      
71,192
  
Commercial
    
198,447
      
10,836
      
13,899
      
-
      
223,182
  
Construction and land
    
21,652
      
350
      
8,353
      
-
      
30,355
  
Consumer and other loans
    
1,633
      
32
      
376
      
-
      
2,041
  
Total
  
$
323,680
    
$
16,814
    
$
30,131
    
$
-
    
$
370,625
  

JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)

Included in the risk category of loans by class of loans table above are loans acquired in the merger with ABI.  As of June 30, 2014 and December 31, 2013, the amounts of such loans were as follows:

(Dollars in thousands)
  
June 30,
2014
    
December 31,
2013
  
Special mention
  
$
521
    
$
711
  
Substandard
    
10,022
      
9,170
  
Doubtful
    
-
      
-
  
Total
  
$
10,543
    
$
9,881
  

Loans Sold
 
On December 28, 2012, the Bank entered into an Asset Purchase Agreement with a real estate investment firm for the sale of $25,134 in assets, including non-accrual loans, loans with a history of being past due, and other loans that were part of an overall customer relationship for a total of $24,601 and other real estate owned (“OREO”) of $533, for a purchase price of $11,705.  The Asset Sale was completed on December 31, 2012, immediately prior to the closing of the Private Placement.  The carrying amount and composition of loans sold in the Asset Sale, as well as total net charge-offs that occurred on the date of sale, were as follows:
 
(Dollars in thousands)
  
Recorded Investment
    
Total Net Charge-Offs(1)
  
 
  
   
 
Loans originated by the Company:
  
   
 
Commercial loans
  
$
113
    
$
(53
)
Real estate mortgage loans:
                
Residential
    
2,584
      
1,435
  
Commercial
    
13,159
      
7,394
  
Construction and land
    
3,162
      
2,042
  
Consumer and other loans
    
-
      
-
  
 
                
Loans acquired:
                
Commercial loans
  
$
111
    
$
46
  
Real estate mortgage loans:
                
Residential
    
546
      
185
  
Commercial
    
4,926
      
2,157
  
Construction and land
    
-
      
-
  
Consumer and other loans
    
-
      
-
  
 
                
Total loans:
                
Commercial loans
  
$
224
    
$
(7
)
Real estate mortgage loans:
                
Residential
    
3,130
      
1,620
  
Commercial
    
18,085
      
9,551
  
Construction and land
    
3,162
      
2,042
  
Consumer and other loans
    
-
      
-
  
 
                
Total loans sold
  
$
24,601
    
$
13,206
  
 
(1) Includes any specific reserve that existed prior to the date of sale (if applicable).
JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 4 – LOANS AND ALLOWANCE FOR LOAN LOSSES (Continued)
 
Purchased Loans

The Company has purchased loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected.  The carrying amounts of these loans were as follows as of June 30, 2014 and December 31, 2013:

(Dollars in thousands)
  
June 30,
2014
    
December 31,
2013
  
Commercial loans
  
$
160
    
$
160
  
Real estate mortgage loans:
                
Residential
    
4,403
      
5,137
  
Commercial
    
12,433
      
14,359
  
Construction and land
    
578
      
1,398
  
Consumer and other loans
    
1
      
2
  
Unpaid principal balance
  
$
17,575
    
$
21,056
  
Carrying amount
  
$
15,849
    
$
18,861
  

Accretable yield, or income collected, from these loans was as follows:

(Dollars in thousands)
  
 
Balance as of December 31, 2012
  
$
11,827
  
New loans purchased, including loans classified as held-for-sale
    
-
  
Accretion of income
    
(1,163
)
Reduction for loans sold, paid off and other
    
(609
)
Loans charged off
    
(935
)
Reclassifications from nonaccretable difference
    
-
  
Disposals
    
-
  
Balance as of June 30, 2013
  
$
9,120
  
Balance as of December 31, 2013
  
$
8,993
  
New loans purchased, including loans classified as held-for-sale
    
-
  
Accretion of income
    
(548
)
Reduction for loans sold, paid off and other
    
(1,619
)
Loans charged off
    
(28
)
Reclassifications from nonaccretable difference
    
-
  
Disposals
    
-
  
Balance as of June 30, 2014
  
$
6,798
  

For those purchased loans disclosed above, the Company increased the allowance for loan losses to $160 and $392 as of June 30, 2014 and December 31, 2013, respectively.

NOTE 5 – LOANS FROM RELATED PARTIES
 
During the year ended December 31, 2011, the Company entered into revolving loan agreements (collectively, the “Revolvers”) with several of its directors and other related parties.  There were no amounts outstanding under the Revolvers as of June 30, 2014 and December 31, 2013 with $2,200 remaining funds available as of the same dates.  Each Revolver pays an annual rate of interest equal to 8% on a quarterly basis of the Revolver amount outstanding.  To the extent that any Revolver is not fully drawn, an unused revolver fee is calculated and paid quarterly at an annual rate of 2% on the revolving loan commitment less the daily average principal amount outstanding.  The Revolvers mature on January 1, 2015.
JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 5 – LOANS FROM RELATED PARTIES (Continued)
 
In connection with the Private Placement, certain of the Company’s directors, executive officers and other related parties (the “Subscribers”) purchased shares of Series A Preferred Stock through individual subscription agreements.  Consideration for the shares of Series A Preferred Stock sold under the Subscription Agreements included $1,800 in the cancellation of outstanding debt under the Company’s Revolvers held by such Subscribers and/or their related interests.

During the second quarter of 2013, participants in the Private Placement were granted the option to reduce their loan commitments under the Revolvers based on the amount previously utilized to purchase shares of Series A Preferred Stock.  If elected by June 15, 2013, this option would reduce the amount of the loan commitment, as applied to each lender, to zero as of July 1, 2013 and correspondingly reduce the calculation of the unused revolver fee in future periods.  As of June 15, 2013, all such participants in the Private Placement elected to reduce the amount of their loan commitments under the Revolvers resulting in a reduction of the maximum borrowings available to the Company from $4,000 as of December 31, 2012 to $2,200 as of July 1, 2013.  The reduction of loan commitments on these revolving loan agreements impacted only related parties that participated in the Private Placement and did not result in any modifications to the remaining loan agreements.

NOTE 6 – SHORT-TERM BORROWINGS AND FEDERAL HOME LOAN BANK ADVANCES

As of June 30, 2014 and December 31, 2013, advances from the FHLB were as follows:

(Dollars in thousands)
  
June 30,
2014
    
December 31,
2013
  
Overnight advances maturing daily at a daily variable interest rate of 0.36% on June 30, 2014
  
$
-
    
$
-
  
Advances maturing July 15, 2014 at a fixed rate of 2.42%
    
2,500
      
2,500
  
Advance maturing January 9, 2015 at a fixed rate of 0.88%
    
4,000
      
4,000
  
Advances maturing March 2, 2015 at a fixed rate of 0.76%
    
2,000
      
2,000
  
Advances maturing July 15, 2016 at a fixed rate of 2.81%
    
2,500
      
2,500
  
Advances maturing January 9, 2017 at a fixed rate of 1.40%
    
4,000
      
4,000
  
Advances maturing May 30, 2017 at a fixed  rate of 1.23%
    
5,000
      
5,000
  
Total advances from the FHLB
  
$
20,000
    
$
20,000
  

Each advance is payable at its maturity date, with a prepayment penalty for early termination.  The advances are collateralized by a blanket lien arrangement on the Company’s first mortgage loans, second mortgage loans and commercial real estate loans.  Based upon this collateral and the Company’s holdings of FHLB stock, the Company was eligible to borrow up to a total of $29,834 as of June 30, 2014 and had borrowed $20,000, leaving $9,834 available.  As of December 31, 2013, the Company was eligible to borrow up to a total of $26,716 and had borrowed $20,000, leaving $6,716 available as of the same date.

The Company also has a “Borrower in Custody” line of credit with the Federal Reserve by pledging collateral.  The amount of this line as of June 30, 2014 and December 31, 2013 was $23,495 and $24,875, respectively, all of which was available as of the respective dates.

NOTE 7 – SUBORDINATED DEBENTURES
 
The Company and ABI, which the Company acquired by merger, have participated in four offerings related to debt securities and trust preferred securities, each with 30-year lives.  Interest on all subordinated debentures related to trust preferred securities is payable quarterly.  Under these arrangements, the Company has the right to defer dividend payments to the trust preferred security holders for up to five years.  During the year ended December 31, 2012, the Company exercised its contractual right to defer interest payments with respect to all of the outstanding trust preferred securities.  Under the terms of the related indentures, the Company may defer interest payments for up to 20 consecutive quarters without default or penalty.  Subsequent to their deferral, these payments were periodically evaluated and were reinstated as of March 15, 2013.  Previously deferred payments were paid in full as of the same date.
JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 8 – DERIVATIVE FINANCIAL INSTRUMENTS

On July 7, 2009, the Company entered into an interest rate swap transaction with SunTrust Bank to mitigate interest rate risk exposure.  Under the terms of the agreement, which relates to the subordinated debt issued to Jacksonville Bancorp, Inc. Statutory Trust III in the amount of $7,550, the Company agreed to pay a fixed rate of 7.53% for a period of ten years in exchange for the original floating-rate contract (90-day LIBOR plus 375 basis points).  The fair value of this derivative instrument was $799 and $765 as of June 30, 2014 and December 31, 2013, respectively.  The fair value of the hedged item was $4,859 and $4,636 as of the same dates.

The hedge was designated as a cash flow hedge and was determined to be fully effective during all periods presented.  As such, no amount of ineffectiveness has been included in net income and the aggregate fair value of the swap was recorded in Accrued expenses and other assets on the consolidated balance sheets with changes in fair value recorded in other comprehensive income (“OCI”).  The amount included in accumulated other comprehensive income would be reclassified to current earnings should the hedge no longer be considered effective.  The Company expects the hedge to remain fully effective during the remaining term of the swap.

Credit risk may result from the inability of the counterparties to meet the terms of their contracts.  The Company’s exposure is limited to the replacement value of the contracts rather than the notional amount.

NOTE 9 – SHAREHOLDERS’ EQUITY

Preferred Equity

As of June 30, 2014 and December 31, 2013, Bancorp was authorized to issue up to 10,000,000 shares of preferred stock, par value $0.01 per share.  During the year ended December 31, 2012, Bancorp designated and issued two series of preferred stock in connection with the Company’s capital raise efforts.  The voting and other powers, preferences and relative participating, optional or other rights, and the qualifications, limitations and restrictions of each series of Bancorp’s preferred stock are set forth in the corresponding amendment to Bancorp’s Amended and Restated Articles of Incorporation designating such series of preferred stock.  Material features of each series of preferred stock are discussed below.

If declared by Bancorp’s Board of Directors, dividends on any outstanding shares of Bancorp’s preferred stock would reduce earnings available to common shareholders.  In addition, both new series of preferred stock qualified as Tier 1 capital for regulatory purposes.

Series B Preferred Stock:
The Series B Preferred Stock, designated as “Noncumulative, Nonvoting, Perpetual Preferred Stock, Series B,” was issued and sold by Bancorp on September 27, 2012 in connection with a bridge financing transaction. The Series B Preferred Stock has a liquidation preference of $1,000 per share and ranks senior to Bancorp’s common stock and equally with the Series A Preferred Stock (described below).  Holders of the outstanding shares of Series B Preferred Stock (if any) are entitled to receive, when and if declared by Bancorp’s Board of Directors, dividends at a rate equal to 10% per share per annum of the Series B liquidation amount of $1,000 (equivalent to $100 per share per annum).  Dividends are payable biannually on June 1st and December 1st, beginning June 1, 2013.

In connection with the Private Placement, all of the issued and outstanding shares of Series B Preferred Stock were exchanged, on a one-for-one basis, for shares of Series A Preferred Stock.  As a result, no shares of Series B Preferred Stock were issued or outstanding as of June 30, 2014 and December 31, 2013, respectively.

Series A Preferred Stock:
The Series A Preferred Stock, designated as “Mandatorily Convertible, Noncumulative, Nonvoting, Perpetual Preferred Stock, Series A,” was issued and sold by Bancorp on December 31, 2012 in the Private Placement.   The Series A Preferred Stock has a liquidation preference of $1,000 per share and ranks senior to Bancorp’s common stock and equally with the Series B Preferred Stock.  Holders of the outstanding shares of Series A Preferred Stock are entitled to receive, when and if declared by Bancorp’s Board of Directors, dividends at a rate equal to 5% per share per annum of the liquidation amount of $1,000 (equivalent to $50 per share per annum).  Dividends are payable biannually on June 15th and December 15th, beginning February 15, 2013.
JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 9 – SHAREHOLDERS’ EQUITY (Continued)

The Series A Preferred Stock was mandatorily convertible into shares of common stock and/or a new class of nonvoting common stock upon receipt of requisite shareholder approvals, including (i) approval of an increase in authorized shares of common stock, (ii) authorization of the new class of nonvoting common stock, and (iii) approval of the issuance of shares of common stock and nonvoting common stock upon conversion of the Series A Preferred Stock.  The initial conversion price was $10.00 per share, with each share of Series A Preferred Stock expected to convert into an aggregate of approximately 100 shares of common stock and/or nonvoting common stock, subject to adjustment as provided in the designation for the Series A Preferred Stock.  The conversion price of the Series A Preferred Stock was subject to certain adjustments, including (i) a 10% decrease if the requisite shareholder approvals were not received within 50 days following the Private Placement, or by February 19, 2013 and (ii) customary anti-dilution adjustments, including in connection with stock dividends or distributions in shares of the common stock or subdivisions, splits and combinations of the common stock.

As of the date of issuance of the Series A Preferred Stock, the effective conversion price of $9.71 per share was less than the fair value of Bancorp’s common stock of $16.00 per share.  In accordance with U.S. GAAP, the Series A Preferred Stock was deemed to include a beneficial conversion feature with an intrinsic value of $6.29 per share for a total discount of $31,464.  This discount was recognized by allocating a portion of the proceeds from the Series A Preferred Stock to additional paid-in capital attributable to common stock on the Company’s consolidated balance sheets as of December 31, 2012.

On February 18, 2013, the Company received shareholder approvals to amend its Amended and Restated Articles of Incorporation to (i) increase the number of authorized shares of the Company’s common stock to 20,000,000, (ii) authorize 5,000,000 shares of a new class of nonvoting common stock, par value $0.01 per share (the “Capital Amendment”).  On the same date, the Company also received shareholder approval to issue an aggregate of 5,000,000 shares of its common stock and nonvoting common stock in the conversion of the 50,000 outstanding shares of the Company’s Series A Preferred Stock.

On February 19, 2013, the Company filed the Capital Amendment with the Florida Secretary of State, and on the same date, all of the outstanding shares of the Company’s Series A Preferred Stock automatically converted into an aggregate of 2,382,000 shares of common stock and 2,618,000 shares of nonvoting common stock (the “Conversion”).  The Conversion was based on a conversion price of $10 per share and a conversion rate of 100 shares of common stock and/or nonvoting common stock for each share of Series A Preferred Stock outstanding.  In addition, the full balance of the discount due to the beneficial conversion feature was transferred from common stock to preferred stock and recognized as an implied preferred stock dividend, which decreased retained earnings and net income available to common shareholders in the earnings per share calculation.  As a result of the Conversion, no shares of the Series A Preferred Stock remained outstanding and an aggregate of 2,676,544 shares of common stock and 2,618,000 shares of nonvoting common stock were outstanding immediately following the Conversion.

Common Equity

As a result of the Capital Amendment (described above), the number of authorized shares of the Company’s common stock increased from 2,000,000 to 20,000,000.  In addition, a new class of nonvoting common stock, par value $0.01 per share, was authorized in the amount of up to 5,000,000 shares.  Other than voting rights, the common stock and nonvoting common stock have the same rights and privileges, share ratably in all assets of the Company upon its liquidation, dissolution or winding-up, will be entitled to receive dividends in the same amount per share and at the same time when, as and if declared by Bancorp’s Board of Directors, and are identical in all other respects as to all other matters (other than voting).  Holders of the nonvoting common stock are not entitled to vote except as required by the Florida Business Corporation Act.  In addition, holders of the nonvoting common stock have no cumulative voting rights or preemptive rights (other than the limited contractual preemptive rights of certain shareholders) to purchase or subscribe for any additional shares of common stock or nonvoting common stock or other securities, and there are no redemption or sinking fund provisions with respect to the nonvoting common stock.
JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 9 – SHAREHOLDERS’ EQUITY (Continued)

As provided in the Capital Amendment, each share of nonvoting common stock will automatically convert into one share of common stock in the event of a “permitted transfer” to a transferee.  A “permitted transfer” is a transfer of nonvoting common stock (i) in a widespread public distribution, (ii) in which no transferee (or group of associated transferees) would receive 2% or more of any class of voting securities of the Company, or (iii) to a transferee that would control more than 50% of the voting securities of the Company without any transfer from such holder of nonvoting common stock.

As of June 30, 2014 and December 31, 2013, the carrying amount of the par value of the common stock outstanding was $32.  As of June 30, 2014 and December 31, 2013, the carrying amount of the par value of the nonvoting common stock outstanding was $26.

Reverse Stock Split

On October 8, 2013, Bancorp’s Board of Directors approved a one-for-twenty (1-for-20) reverse stock split of the Company’s common stock and nonvoting common stock, effective at 12:01 a.m. on October 24, 2013.  As a result of the reverse stock split, the stated capital attributable to common stock and nonvoting common stock was reduced by dividing the amount of the stated capital prior to the reverse stock split by 20 (including retrospective adjustment of prior periods) and an equivalent increase to additional paid-in capital.  Additional adjustments were made to the aforementioned accounts as a result of rounding to avoid the existence of fractional shares.  The reverse stock split reduced the number of authorized shares of common stock and nonvoting common stock; however, the par value per share of each class of common stock remained unchanged.

The reverse stock split was implemented primarily to regain compliance with NASDAQ continued listing standards.  The Company’s common stock continues to trade on a post-split basis on the NASDAQ Stock Market under the symbol “JAXB.”  All share and per share amounts disclosed in the Consolidated Financial Statements and the accompanying notes have been retrospectively adjusted to reflect the common equity 1-for-20 reverse stock split, including common shares outstanding, earnings per share and share-based compensation.

Accumulated Other Comprehensive Income (Loss)

The following table presents information related to changes in accumulated other comprehensive income (loss) by component as of June 30, 2014 and June 30, 2013:

(Dollars in thousands)
  
Change in
Unrealized Gains
(Losses) on
Available-for-Sale
Securities
    
Change in
Unrealized
Derivative Gains
(Losses) on Cash
Flow Hedge
    
Total
  
Balance as of December 31, 2012
  
$
2,218
    
$
(807
)
  
$
1,411
  
Other comprehensive (loss) income before reclassifications
    
(2,182
)
    
423
      
(1,759
)
Amounts reclassified from accumulated other comprehensive (loss) income
    
(46
)
    
-
      
(46
)
Other comprehensive (loss) income, net
    
(2,228
)
    
423
      
(1,805
)
Balance as of June 30, 2013
  
$
(10
)
  
$
(384
)
  
$
(394
)
Balance as of December 31, 2013
  
$
(1,211
)
  
$
(277
)
  
$
(1,488
)
Other comprehensive (loss) income before reclassifications
    
1,054
      
(33
)
    
1,021
  
Amounts reclassified from accumulated other comprehensive (loss) income
    
-
      
-
      
-
  
Other comprehensive (loss) income, net
    
1,054
      
(33
)
    
1,021
  
Balance as of June 30, 2014
  
$
(157
)
  
$
(310
)
    
(467
)

JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 9 – SHAREHOLDERS’ EQUITY (Continued)

Amounts reclassified from accumulated other comprehensive income (loss) during the six months ended June 30, 2013 resulted from realized gains on the sale of available-for-sale securities presented in Other income on the Consolidated Statements of Operations.

NOTE 10 – FAIR VALUE

Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures defines fair value as the exchange price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Assets and liabilities are measured using valuation techniques specific to the following three-tier hierarchy, which prioritizes the inputs used in measuring fair value.

Level I, II and III Valuation Techniques

Level I: Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.
Level II: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
Level III: Unobservable inputs for the asset or liability.

The following table presents information about the Company’s assets and liabilities measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013, for which the Company has elected the fair value option, by level within the hierarchy:

(Dollars in thousands)
 
 
 
 
June 30, 2014
Total
  
Level I
  
Level II
  
Level III
  
Assets:
 
 
 
 
Securities available-for-sale:
 
 
 
 
U.S. government-sponsored entities and agencies
  
$
7,850
    
$
-
    
$
7,850
    
$
-
  
State and political subdivisions
    
7,491
      
-
      
7,491
      
-
  
Mortgage-backed securities - residential
    
33,143
      
-
      
33,143
      
-
  
Collateralized mortgage obligations
    
30,556
      
-
      
30,556
      
-
  
Corporate bonds
    
3,128
      
-
      
3,128
      
-
  
Liabilities:
                                
Derivative liability
    
799
      
-
      
799
      
-
  

December 31, 2013
  
Total
    
Level I
    
Level II
    
Level III
  
Assets:
  
   
   
   
 
Securities available-for-sale:
  
   
   
   
 
U.S. government-sponsored entities and agencies
  
$
8,396
    
$
-
    
$
8,396
    
$
-
  
State and political subdivisions
    
8,037
      
-
      
8,037
      
-
  
Mortgage-backed securities - residential
    
33,225
      
-
      
33,225
      
-
  
Collateralized mortgage obligations
    
31,978
      
-
      
31,978
      
-
  
Corporate bonds
    
3,135
      
-
      
3,135
      
-
  
Liabilities:
                                
Derivative liability
    
765
      
-
      
765
      
-
  
 
There were no transfers between Level 1 and Level 2 during the three and six months ended June 30, 2014 and the year ended December 31, 2013.
JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 10 – FAIR VALUE (Continued)
 
The Company used the following methods and significant assumptions to estimate the fair value of each type of recurring financial instrument:

Securities Available-for-Sale:
The fair values of securities available for sale are determined by obtaining quoted prices on nationally-recognized securities exchanges (Level I inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted securities (Level II inputs).

Derivatives:
The fair value of derivatives is based on valuation models using observable market data as of the measurement date resulting in a Level II classification.

The following table presents information about our assets measured at fair value on a non-recurring basis as of June 30, 2014 and December 31, 2013, by level within the fair value hierarchy.  The amounts in the tables represent only assets for which the carrying amount has been adjusted for impairment during the period; therefore, these amounts will differ from the total amounts outstanding.

(Dollars in thousands)
 
 
 
 
June 30, 2014
Total
  
Level I
  
Level II
  
Level III
  
Impaired Loans (Collateral Dependent):
  
   
   
   
 
Real estate mortgage loans:
  
   
   
   
 
Residential
  
$
513
    
$
-
    
$
-
    
$
513
  
Commercial
    
2,798
      
-
      
-
      
2,798
  
Construction and land
    
300
      
-
      
-
      
300
  
Other real estate owned:
                                
Real estate mortgage loans:
                                
Residential
    
-
      
-
      
-
      
-
  
Commercial
    
169
      
-
      
-
      
169
  
Construction and land
    
2,717
      
-
      
-
      
2,717
  
 
                                
December 31, 2013
Total
  
Level I
  
Level II
  
Level III
  
Impaired Loans (Collateral Dependent):
                                
Real estate mortgage loans:
                                
Residential
  
$
568
    
$
-
    
$
-
    
$
568
  
Commercial
    
2,981
      
-
      
-
      
2,981
  
Construction and land
    
262
      
-
      
-
      
262
  
Other real estate owned:
                                
Real estate mortgage loans:
                                
Residential
    
155
      
-
      
-
      
155
  
Commercial
    
169
      
-
      
-
      
169
  
Construction and land
    
2,754
      
-
      
-
      
2,754
  
JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 10 – FAIR VALUE (Continued)
 
The Company used the following methods and significant assumptions to estimate the fair value of each type of non-recurring financial instrument:
 
Impaired Loans (Collateral Dependent):
Management determined fair value measurements on impaired loans primarily through evaluations of appraisals performed.  The Company considered the appraisal as the starting point for determining fair value and then considered other factors and events in the environment that affected the fair value.  Appraisals for impaired loans are obtained by the Chief Credit Officer and performed by certified general appraisers whose qualifications and licenses have been reviewed and verified by the Company.  Once reviewed, a third-party specialist reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison to independent data sources such as recent market data or industry-wide statistics.  On an annual basis, the Company compares the actual selling price of collateral that has been sold to the most recent appraised value to determine what additional adjustments, if any, should be made to the appraised value of existing collateral to arrive at fair value.  Adjustments may be made to reflect the age of the appraisal and the type of underlying property.  Certain current appraised values were discounted to estimated fair value based on current market data such as recent sales of similar properties, discussions with potential buyers and negotiations with existing customers.  The Company’s overall strategy is to accelerate the disposition of substandard assets through such arrangements.

Other Real Estate Owned (“OREO”):
Assets acquired as a result of, or in lieu of, loan foreclosure are initially recorded at fair value (based on the lower of the current appraised value or listing price) at the date of foreclosure, establishing a new cost basis.  Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell.  Management has determined fair value measurements on OREO primarily through evaluations of appraisals performed and current and past offers for the OREO under evaluation.  Appraisals of OREO are obtained subsequent to acquisition as deemed necessary by the Chief Credit Officer.  Appraisals are reviewed for accuracy and consistency by a third-party specialist, supervised by the Chief Credit Officer, and are selected from the list of approved appraisers maintained by management. Certain current appraised values were discounted to estimated fair value based on factors such as sales prices for comparable properties in similar geographic areas and/or assessment through observation of such properties.

Transfers of assets and liabilities between levels within the fair value hierarchy are recognized when an event or change in circumstances occurs.  There were no transfers between fair value levels for June 30, 2014 and December 31, 2013, respectively.
JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 10 – FAIR VALUE (Continued)

Quantitative Information about Level III Fair Value Measurements

The following table presents quantitative information about unobservable inputs for assets measured on a non-recurring basis using Level III measurements as of June 30, 2014 and December 31, 2013.  This quantitative information is the same for each class of loans.

(Dollars in thousands)
June 30, 2014
Fair Value
  
Valuation Technique
Unobservable Inputs
  
Range of
Inputs
    
Weighted
Average
  
Impaired loans (collateral dependent)
  
$
3,611
  
Market comparable properties
Marketability discount
    
0% - 0.4
%
    
0.4
%
Other real estate owned
    
2,886
  
Market comparable properties
Comparability adjustments
    
0% - 0.5
%
    
0.5
  
 
        
 
 
                
December 31, 2013
Fair Value
  
Valuation Technique
Unobservable Inputs
  
Range of
Inputs
    
Weighted
Average
  
Impaired loans (collateral dependent)
  
$
3,811
  
Market comparable properties
Marketability discount
    
0% – 23.5
%
    
1.6
%
Other real estate owned
    
3,078
  
Market comparable properties
Comparability adjustments
    
0% – 20.0
%
    
1.8
  

The table below summarizes the outstanding balance, valuation allowance, net carrying amount and period expense related to Level III non-recurring instruments for the six months ended June 30, 2014 and 2013:

(Dollars in thousands)
June 30, 2014
  
Outstanding
Balance
    
Valuation
Allowance
    
Net Carrying
Amount
    
Period Expense
  
Impaired loans (collateral dependent)
  
$
6,259
    
$
2,648
    
$
3,611
    
$
1,660
  
Other real estate owned
    
3,880
      
994
      
2,886
      
36
  

June 30, 2013
  
Outstanding
Balance
    
Valuation
Allowance
    
Net Carrying
Amount
    
Period Expense
  
Impaired loans (collateral dependent)
  
$
2,966
    
$
1,178
    
$
1,788
    
$
1,698
  
Other real estate owned
    
10,317
      
1,175
      
9,142
      
472
  

JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 10 – FAIR VALUE (Continued)

Fair Value of Financial Instruments

The carrying amount and estimated fair values of financial instruments as of June 30, 2014 and December 31, 2013 were as follows:

 
  
June 30, 2014
    
December 31, 2013
  
(Dollars in thousands)
  
Carrying
Amount
    
Fair
Value
    
Carrying Amount
    
Fair
Value
  
Financial assets:
  
   
   
   
 
Cash and cash equivalents
  
$
30,130
    
$
30,130
    
$
40,325
    
$
40,325
  
Securities available-for-sale
    
82,168
      
82,168
      
84,771
      
84,771
  
Loans, net
    
353,944
      
361,178
      
354,592
      
361,874
  
Federal Home Loan Bank stock
    
1,356
      
N/A
 
    
1,580
      
N/A
 
Accrued interest receivable
    
1,576
      
1,576
      
1,723
      
1,723
  
 
                                
Financial Liabilities:
                                
Deposits
  
$
420,870
    
$
413,491
    
$
434,966
    
$
422,430
  
Federal Home Loan Bank
                                
Advances and other borrowings
    
20,141
      
20,316
      
20,153
      
20,351
  
Subordinated debentures
    
16,186
      
7,932
      
16,154
      
7,275
  
Accrued interest payable
    
137
      
137
      
167
      
167
  
Interest rate swap
    
799
      
799
      
765
      
765
  

The methods and assumptions not previously presented, used to estimate fair value are described as follows:

Cash and cash equivalents:
The carrying amounts of cash and cash equivalents approximate the fair value and are classified as either Level I or Level II in the fair value hierarchy.  As of June 30, 2014 and December 31, 2013, respectively, the breakdown of cash and cash equivalents between Level I and Level II were as follows:

 
  
June 30, 2014
    
December 31, 2013
  
(Dollars in thousands)
  
Level I
    
Level II
    
Level I
    
Level II
  
Cash and cash equivalents
  
$
24,693
    
$
5,437
    
$
34,139
    
$
6,186
  
 
Loans, net:
The fair value of variable-rate loans that re-price frequently and with no significant change in credit risk is based on the carrying value and results in a classification of Level III within the fair value hierarchy.  Fair value for other loans is estimated using discounted cash flow analysis using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level III classification in the fair value hierarchy. The methods used to estimate the fair value of loans do not necessarily represent an exit price.

Nonmarketable equity securities:
Nonmarketable equity securities include FHLB stock and other nonmarketable equity securities. It is not practicable to determine the fair value of nonmarketable equity securities due to restrictions placed on their transferability.

Deposits:
The fair value of demand deposits (e.g., interest and noninterest-bearing, savings and certain types of money market accounts) is, by definition, equal to the amount payable on demand at the reporting date (i.e., carrying value) resulting in a Level II classification in the fair value hierarchy.  The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair value at the reporting date resulting in a Level II classification in the fair value hierarchy. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level II classification.
JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 10 – FAIR VALUE (Continued)
 
Federal Home Loan advances:
The fair value of FHLB advances is estimated using a discounted cash flow analysis based on the current borrowing rates for similar types of borrowings and is classified as a Level II in the fair value hierarchy.

Accrued interest receivable/payable:
The carrying amounts of accrued interest receivable approximate fair value resulting in a Level III classification. The carrying amounts of accrued interest payable approximate fair value resulting in a Level II classification.

Subordinated debt:
The fair value of subordinated debt, where a market quote is not available, is based on discounted cash flows, using a rate appropriate to the instrument and the term of the issue resulting in a Level II classification.

Off-balance sheet instruments:
The fair value of off-balance sheet instruments is based on the current fees that would be charged to enter into or terminate such arrangements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.  The fair value of these commitments as of June 30, 2014 was not material.

NOTE 11 – CAPITAL ADEQUACY
 
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies.  Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices.  Capital amounts and classifications are also subject to qualitative judgments by regulators.  Failure to meet capital requirements can initiate regulatory action.

Bank

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), among other things, requires the federal banking agencies to take “prompt corrective action” regarding depository institutions that do not meet minimum capital requirements.  FDICIA establishes five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare to various relevant capital measures and certain other factors, as established by regulation.

The “prompt corrective action” rules provide that a bank will be: (i) “well capitalized” if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, a leverage capital ratio of 5% or greater and is not subject to certain written agreements, orders, capital directives or prompt corrective action directives by a federal bank regulatory agency to maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater, and generally has a leverage capital ratio of 4% or greater; (iii) “undercapitalized” if it has a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 4% or generally has a leverage capital ratio of less than 4%; (iv) “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3% or a leverage capital ratio of less than 3%; or (v) “critically undercapitalized” if its tangible equity is equal to or less than 2% to total assets.  The federal bank regulatory agencies have authority to require additional capital.

The Bank was well capitalized as of June 30, 2014 and December 31, 2013, respectively.  Depository institutions that are no longer “well capitalized” for bank regulatory purposes must receive a waiver from the Federal Deposit Insurance Corporation (“FDIC”) prior to accepting or renewing brokered deposits.  FDICIA generally prohibits a depository institution from making any capital distribution (including paying dividends) or paying any management fee to its holding company, if the depository institution would thereafter be undercapitalized.
JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)

NOTE 11 – CAPITAL ADEQUACY (Continued)

The Bank had a Memorandum of Understanding (“MoU”) with the FDIC and the Florida Office of Financial Regulation (“OFR”) that was entered into in 2008 (the “2008 MoU”), which required the Bank to have a total risk-based capital of at least 10% and a Tier 1 leverage capital ratio of at least 8%.  On July 13, 2012, the 2008 MoU was replaced by a new MoU  (the “2012 MoU”), which, among other things, requires the Bank to have a total risk-based capital of at least 12% and a Tier 1 leverage capital ratio of at least 8%.   The Bank met the minimum capital requirements of the 2012 MoU as of June 30, 2014 and December 31, 2013, when the Bank had total risk-based capital of 14.54% and 14.11%, respectively, and Tier 1 leverage capital of 9.92% and 9.33% as of the same dates.

Bancorp

The Federal Reserve requires bank holding companies, including Bancorp, to act as a source of financial strength for their depository institution subsidiaries.

The Federal Reserve has a minimum guideline for bank holding companies of Tier 1 capital to adjusted average quarterly assets (“leverage ratio”) equal to at least 4.00%, and total capital to risk-weighted assets of at least 8.00%, at least half of which must be Tier 1 capital.  As of June 30, 2014 and December 31, 2013, the Company met these requirements.

The following table presents the capital ratios and related information for the Company and the Bank as of June 30, 2014 and December 31, 2013:

(Dollars in thousands)
  
Actual
    
For Capital
Adequacy Purposes
    
Minimum To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
  
June 30, 2014
  
Amount
    
Ratio
    
Amount
    
Ratio
    
Amount
    
Ratio
  
Total capital to risk-weighted assets:
  
   
   
   
   
   
 
Consolidated
  
$
56,237
      
15.13
%
  
$
29,741
      
8.00
%
    
N/A
    
N/A
 
Bank
    
53,996
      
14.54
      
29,714
      
8.00
    
$
37,143
      
10.00
%
Tier 1 (Core) capital to risk-weighted assets:
                                                
Consolidated
    
47,276
      
12.72
      
14,870
      
4.00
      
N/A
 
    
N/A
 
Bank
    
49,230
      
13.25
      
14,857
      
4.00
      
22,286
      
6.00
  
Tier 1 (Core) capital to average assets:
                                                
Consolidated
    
47,276
      
9.51
      
19,887
      
4.00
      
N/A
 
    
N/A
 
Bank
    
49,230
      
9.92
      
19,859
      
4.00
      
24,824
      
5.00
  

 
  
Actual
    
For Capital
Adequacy Purposes
    
Minimum To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
  
December 31, 2013
  
Amount
    
Ratio
    
Amount
    
Ratio
    
Amount
    
Ratio
  
Total capital to risk-weighted assets:
  
   
   
   
   
   
 
Consolidated
  
$
55,515
      
14.91
%
  
$
29,779
      
8.00
%
    
N/A
 
    
N/A
 
Bank
    
52,488
      
14.11
      
29,754
      
8.00
    
$
37,192
      
10.00
%
Tier 1 (Core) capital to risk-weighted assets:
                                                
Consolidated
    
46,378
      
12.46
      
14,889
      
4.00
      
N/A
 
    
N/A
 
Bank
    
47,702
      
12.83
      
14,887
      
4.00
      
22,315
      
6.00
  
Tier 1 (Core) capital to average assets:
                                                
Consolidated
    
46,378
      
9.05
      
20,491
      
4.00
      
N/A
 
    
N/A
 
Bank
    
47,702
      
9.33
      
20,443
      
4.00
      
25,553
      
5.00
  

JACKSONVILLE BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share and per share amounts)
 
NOTE 11 – CAPITAL ADEQUACY (Continued)

Dividends and Distributions

Prior to October 2009, dividends received from the Bank were Bancorp’s principal source of funds to pay its expenses and interest on and principal of Bancorp’s debt.  Banking regulations and enforcement actions require the maintenance of certain capital levels and restrict the payment of dividends by the Bank to Bancorp or by Bancorp to its shareholders.  Commercial banks generally may only pay dividends without prior regulatory approval out of the total of current net profits plus retained net profits of the preceding two years, and banks and bank holding companies are generally expected to pay dividends from current earnings.  Banks may not pay a dividend if the dividend would result in the bank being “undercapitalized” for prompt corrective action purposes, or would violate any minimum capital requirement specified by law or the Bank’s regulators.  The Bank has not paid dividends since October 2009 and cannot currently pay dividends.  Bancorp cannot currently pay dividends on its capital stock under applicable Federal Reserve policies and enforcement actions.  Bancorp has relied upon revolving loan agreements with certain of its directors and other related parties to pay its expenses during such time.  As of June 30, 2014 and December 31, 2013, remaining funds available under the Revolvers were $2,200.

During the second quarter of 2013, participants in the Private Placement who purchased shares of Series A Preferred Stock through the cancellation of debt under their Revolvers, were given the option and thereby elected to reduce the amount of their loan commitments under the Revolvers resulting in a reduction of the maximum borrowings available to the Company from $4,000 as of December 31, 2012 to $2,200 effective July 1, 2013.  Please refer to Note 5 – Loans from Related Parties for additional information related to the Revolvers.

NOTE 12 – ASSETS HELD FOR SALE

The Company periodically reviews long-lived assets against its plans to retain or ultimately dispose of these assets.  If the Company decides to dispose of an asset and commits to a plan to actively market and sell the asset, it will be moved to assets held for sale.  The Company analyzes market conditions each reporting period and records additional impairments due to declines in market values of like assets.  The fair value of the asset is determined by observable inputs such as appraisals and prices of comparable assets in active markets for assets like the Company’s.  Gains are not recognized until the assets are sold.

On June 30, 2014, the Company ceased activities at one of its banking properties and moved the activities and customers to another existing property.  The Company is actively marketing the facility for sale.  At June 30, 2014 and December 31, 2013, existing assets held for sale were $944 and $0, respectively and no gain or loss has been recognized as fair value approximates carrying value.

JACKSONVILLE BANCORP, INC.

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

Management’s discussion and analysis of the financial condition and results of operations represents an overview of the consolidated financial condition as of June 30, 2014 and December 31, 2013 and results of operations for the three and six months ended June 30, 2014 compared to the same periods in 2013.  This discussion is designed to provide a more comprehensive review of the financial condition and operating results than could be obtained from an examination of the financial statements alone.  This analysis should be read in conjunction with the interim financial statements and related footnotes included herein, and the Company’s audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC on March 14, 2014.

General

Jacksonville Bancorp, Inc. (“Bancorp”) was incorporated on October 24, 1997 and was organized to conduct the operations of The Jacksonville Bank (the “Bank”).  The Bank is a Florida state-chartered commercial bank that opened for business on May 28, 1999, and its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”).  The Bank provides a variety of community banking services to businesses and individuals in the greater Jacksonville area of Northeast Florida.  During 2000, the Bank formed Fountain Financial, Inc., a wholly owned subsidiary.  Through Fountain Financial, Inc., and our marketing agreement with New England Financial (an affiliate of MetLife), we are able to meet the investment and insurance needs of our customers.  On November 16, 2010, Bancorp acquired Atlantic BancGroup, Inc. (“ABI”) by merger, and on the same date, Oceanside Bank, a wholly owned subsidiary of ABI, merged with and into the Bank.  Bancorp, the Bank, and Fountain Financial, Inc. are collectively referred to herein as the “Company.”

Business Strategy

Our primary business segment is community banking and consists of attracting deposits from the general public and using such deposits and other sources of funds to originate commercial business loans, commercial real estate loans, residential mortgage loans and a variety of consumer loans.  We also invest in mortgage-backed securities and securities backed by the United States government, and agencies thereof, as well as other securities.  Our profitability depends primarily on our net interest income, which is the difference between the income we receive from our loan and securities investment portfolios and costs incurred on our deposits, the Federal Home Loan Bank (“FHLB”) advances, Federal Reserve borrowings and other sources of funding.  Net interest income is also affected by the relative amounts of interest-earning assets and interest-bearing liabilities. Net interest income is generated as the relative amounts of interest-earning assets grow in relation to the relative amounts of interest-bearing liabilities.  In addition, the levels of noninterest income earned and noninterest expenses incurred affect profitability.  Included in noninterest income are service charges earned on deposit accounts and increases in cash surrender value of Bank-Owned Life Insurance (“BOLI”).  Included in noninterest expense are costs incurred for salaries and employee benefits, occupancy and equipment expenses, data processing expenses, marketing and advertising expenses, federal deposit insurance premiums, legal and professional fees, loan related expenses, and other real estate owned (“OREO”) expenses.

Our operations are influenced by local economic conditions and by policies of financial institution regulatory authorities.  Fluctuations in interest rates due to factors such as competing financial institutions as well as fiscal policy and the Federal Reserve’s decisions on monetary policies, including interest rate targets, impact interest-earning assets and our cost of funds and, thus, our net interest margin.  In addition, the local economy and real estate market of Northeast Florida, and the demand for our products and loans, impact our margin.  The local economy and viability of local businesses can also impact the ability of our customers to make payments on loans, thus impacting our loan portfolio.  The Company evaluates these factors when valuing its allowance for loan losses. The Company also believes its underwriting procedures are relatively conservative and, as a result, the Company is not being any more affected than the overall market in the current economic downturn.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Our goal is to sustain profitable, controlled growth by focusing on increasing our loan and deposit market share in the Northeast Florida market by developing new financial products, services and delivery channels; closely managing yields on earning assets and rates on interest-bearing liabilities; focusing on noninterest income opportunities; controlling the growth of noninterest expenses; and maintaining strong asset quality.  During the second quarter of 2012, the Company adopted a strategy to accelerate the disposition of substandard assets on an individual customer basis.  This strategy materially impacted the Company’s earnings for the year ended December 31, 2012 as a result of the increased provision for loan losses, expenses related to protecting our collateral position, and aggressively pursuing foreclosure actions when necessary.  Additionally, the aggressive pursuit of foreclosure actions resulted in an increase in other real estate owned expenses during the same period.

The collateral for substandard assets that are deemed impaired is evaluated quarterly and an estimate of fair value of the collateral is determined based on appraised values, current market data such as recent sales of similar properties, discussions with potential buyers and negotiations with existing borrowers.  Appraisals are obtained during the regular course of business in accordance with the required appraisal cycle set forth by Bank policy.  Based on specific facts and circumstances surrounding a specific loan, off-cycle appraisals may be obtained when new information becomes available to management.  Additionally, in certain cases, discounts have been applied to appraised values based on the age of the appraisal, type of loan, general market factors and/or market data regarding sales of similar properties.

The Company received updated appraisals on a majority of its substandard assets during the second half of 2012.  As a result of having current appraisals, more modest discounts were required due to the factors noted above.  Appraisals were discounted an average of 9% as of December 31, 2012 compared to 28% as of June 30, 2012.  Likewise, the average discount on OREO appraisals decreased to 10% from 23% as of the same dates.  The weighted average discounts applied to impaired loans and OREO as of June 30, 2014 were 0.4% and 0.5%, respectively.  Discounts are anticipated to remain at these lower levels for the foreseeable future due to indicators of stabilization in the local real estate market; however, discounts applied to appraisals may fluctuate on a short-term basis due to changes in the property/discount mix going forward.

We believe that the Company’s recapitalization plan that was executed in 2012 and completed in 2013, combined with the strategic initiative to accelerate the disposal of substandard assets, has enabled the Company to restore capital to prescribed regulatory levels.  As of June 30, 2014 and December 31, 2013, the Bank was well-capitalized with total risk based capital of 14.54% and 14.11% and Tier 1 leverage capital of 9.92% and 9.33%, respectively.  During the six months ended June 30, 2014 and looking forward, the Company intends to maintain the quality of its loan portfolio through the continued reduction of problem assets in a prudent and reasonable manner and to continue to improve the overall credit process including, but not limited to, loan origination disciplines, strict underwriting criteria, and succinct funding and onboarding processes.  In addition, the Company will carry on with the repositioning of its loan and deposit portfolio mix to better align with our targeted market segment of professional services, wholesalers, distributors, and other service industries.  During the second quarter of 2014, the Company announced a reduction in workforce of approximately 16%.  Affected employees were provided comprehensive severance packages that will be paid out in the third quarter of 2014.  Accrued severance package related expenses were $48 thousand as of June 30, 2014.  This action occurred to better align the Company’s processes and procedures with the best industry practices and standards.  These changes have not yet materially impacted our financial condition or results of operations.
JACKSONVILLE BANCORP, INC.

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

To further supplement the Company’s business strategy, the Bank has adopted a philosophy of seeking and retaining the best available personnel for positions of responsibility, who we believe will provide us with a competitive edge in the local banking market.  Upon the retirement of Mr. Price Schwenck, the Company’s former Chief Executive Officer, the Company appointed Stephen C. Green as President and Chief Executive Officer and Margaret A. Incandela as Chief Operating Officer and Chief Credit Officer during 2012 as a means of adding critical management expertise.  In June of 2013, Mr. Green resigned as President and Chief Executive Officer of the Company, and as Chief Executive Officer of the Bank.  Following his resignation, the Company’s Board of Directors appointed Donald F. Glisson, Jr., Chairman of the Board of the Company, to serve as the Company’s principal executive officer on an interim basis until a new President and Chief Executive Officer was elected.  On December 4, 2013, the Company appointed Kendall L. Spencer as President and Chief Executive Officer to provide advanced leadership and commercial banking expertise as well as additional proficiencies in strategic financial planning and execution of operational initiatives.  On June 2, 2014, Margaret A. Incandela, resigned as Executive Vice President and Chief Credit Officer of the Company and the Bank effective August 29, 2014.  The Company is currently conducting a search for a replacement.

Capital Raise Transactions

During 2012, the Company executed a financial advisory agreement with an investment banking firm to assist in raising capital.  Efforts to secure additional equity capital were realized on December 31, 2012 with the sale of an aggregate of 50,000 shares of the Company’s Mandatorily Convertible, Noncumulative, Nonvoting Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), at a purchase price of $1,000 per share, in the Private Placement.  For the year ended December 31, 2012, gross proceeds from the issuance of preferred stock in the amount of $50.0 million, or $45.1 million net of offering expenses, were used for general operating expenses, mainly for the subsidiary bank, to improve capital ratios, and will be used to support the Company’s business strategy going forward.

On February 19, 2013, all of the outstanding shares of the Company’s Series A Preferred Stock automatically converted into an aggregate of 2,382,000 shares of common stock and 2,618,000 shares of nonvoting common stock (the “Conversion”).  The Conversion was based on a conversion price of $10.00 per share and a conversion rate of 100 shares of common stock and/or nonvoting common stock for each share of Series A Preferred Stock outstanding.  As a result of the Conversion, no shares of the Series A Preferred Stock remained outstanding and an aggregate of 2,676,544 shares of common stock and 2,618,000 shares of nonvoting common stock were outstanding immediately following the Conversion.

During the third quarter of 2013, the Company initiated concurrent offerings: (i) a rights offering to eligible existing shareholders of nontransferable subscription rights to purchase shares of the Company’s common stock at a subscription price of $10.00 per share and (ii) a public offering of shares not subscribed for in the rights offering at an equal subscription price of $10.00 per share.  The subscription period for the rights offering expired on September 20, 2013 and resulted in the sale of 104,131 shares of the Company’s common stock for aggregate proceeds of $1.0 million, or $0.9 million net of offering expenses.  The public offering expired on October 4, 2013, whereby the Company sold 395,869 shares for an aggregate of $4.0 million, or $3.2 million net of offering expenses.  Total net proceeds from the concurrent offerings will be used to support the Company’s business strategy going forward.

Please refer to Note 2 – Capital Raise Transactions and Note 9 – Shareholders’ Equity in the accompanying notes to the Consolidated Financial Statements for additional information related to the Company’s recent capital raise activities.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Asset Sale

On December 28, 2012, the Bank entered into an Asset Purchase Agreement with a real estate investment firm (the “Asset Purchaser”) for the purchase by the Asset Purchaser of approximately $25.1 million of the Bank’s loans and other assets for approximately $11.7 million (the “Asset Sale”).  The Asset Sale was consistent with the Company’s strategy to accelerate the disposition of substandard assets. Assets underlying the Asset Sale included OREO, non-accrual loans, loans with a history of being past due, and other loans that were part of an overall customer relationship.  Proceeds from the Asset Sale included $11.3 million from the sale of loans and $0.4 million from the sale of OREO.  The Asset Sale was completed on December 31, 2012 including the immediate transfer of servicing from the Bank.

All assets disposed of in conjunction with the Asset Sale were sold exclusively to the Asset Purchaser due to the relatively small size and composition of the assets being sold, particularly with respect to the current market demand for such loans.  The overall pricing methodology employed by management during the Asset Sale was influenced by several factors including, but not limited to, (i) the engagement of a third-party financial advisor, (ii) management’s experience in loan sale activities and knowledge of the local markets in which the Company operates, and (iii) the pricing expectations of prospective buyers.

Additional discounts (i.e., charge-offs) applied in excess of those assessed in the normal course of business represented a combination of the bulk sale value of the loans and the Asset Purchaser’s assumption of risk and expected rate of return.  Management reviewed information provided by our third-party financial advisor to evaluate the additional discounts applied to the Asset Sale in comparison to similar transactions and to ensure reasonableness.
 
Of the $13.3 million in charge-offs related to the Asset Sale, $4.5 million was determined to be due to one or a combination of the following factors:  (i) the most recent appraisal (discounted if appropriate), (ii) settlement discussions with the borrower, or (iii) underlying cash flows of the borrower/guarantor as compared to the borrower’s recorded investment.  This amount was included in the historical loss component in determining the appropriateness of the Company’s allowance for loan losses as of December 31, 2012 as it was determined to be indicative of historical loss experience (under the historically determined allowance for loan loss methodology) and, therefore, determined to be part of management’s estimate of the probable incurred losses on the remainder of the portfolio.

The additional $8.8 million of charge-offs required to expedite the disposition through the Asset Sale were not considered indicative of our historical loss experience and, therefore, were excluded in the determination of the appropriateness of our allowance for loan losses for the remaining portfolio as of December 31, 2012.  Asset sales and the respective discounts are not a traditional element of the Company’s normal business activities and, therefore, were excluded in order to properly estimate incurred losses associated with the remainder of the loan portfolio.  Further, management does not anticipate another asset sale in the foreseeable future.

For additional information related to the Asset Sale, please refer to Note 4 – Loans and Allowance for Loan Losses in the accompanying notes to the Consolidated Financial Statements.

JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Reverse Stock Split

Bancorp’s Board of Directors implemented a 1-for-20 reverse stock split of Bancorp’s outstanding shares of common stock and nonvoting common stock effective October 24, 2013.  As a result of the reverse stock split, each 20 shares of issued and outstanding common stock and nonvoting common stock, par value $0.01 per share, respectively, were automatically and without any action on the part of the respective holders, combined and reconstituted as one share of the respective class of common equity as of the effective date.  Consequently, the aggregate par value of common stock and nonvoting common stock eliminated in the reverse stock split was reclassed on the Company’s consolidated balance sheets from the respective class of common equity to additional paid-in capital.  Additional adjustments were made to the aforementioned accounts as a result of rounding to avoid the existence of fractional shares.  All share and per share information in this report, has been retrospectively adjusted to reflect the 1-for-20 reverse stock split.  Please refer to Note 9 – Shareholders’ Equity for additional information related to the reverse stock split.

Financial Condition and Results of Operations

The Company’s performance during the periods ended June 30, 2014 and December 31, 2013 is reflective of the Company’s ongoing strategy to accelerate the disposition of substandard assets on an individual customer basis as well as re-pricing activities in the current low interest rate environment.  As a result of these efforts, as well as continually focusing on our processes and procedures to identify cost savings opportunities, the Company had net income for the six months ended June 30, 2014.

Comparison of Financial Condition as of June 30, 2014 and December 31, 2013

Total assets decreased $12.7 million, or 2.49%, from $507.3 million as of December 31, 2013 to $494.6 million as of June 30, 2014.  The Company experienced a decrease in cash and cash equivalents in the amount of $10.2 million, a decrease in securities available-for-sale of $2.6 million and a decrease in net loans of $648 thousand.  These amounts were offset by an increase in other real estate owned of $922 million during the six months ended June 30, 2014.

Investment securities available-for-sale decreased $2.6 million, or 3.07%, from $84.8 million as of December 31, 2013 to $82.1 million as of June 30, 2014.  During the six months ended June 30, 2014, the Company received $8.3 million in proceeds from principal repayments, maturities and calls and purchased $5.1 million.  The remaining variance is due to the change in fair market value as well as premium amortization, net of accretion during the same year-to-date period.

Total deposits decreased by $14.1 million, or 3.24%, during the six months ended June 30, 2014, from $435.0 million as of December 31, 2013 to $420.9 million as of June 30, 2014.  The following is an explanation of the changes in each of the major deposit categories during the six months ended June 30, 2014:

· Noninterest-bearing deposits increased $3.0 million, or 2.93%, to 103.7 million.  This represents 24.65% of total deposits as of June 30, 2014;
· Money market, NOW and savings deposits decreased $4.3 million, or 2.31%, due to the strategic decision to not aggressively price this product in our local market; and
· The time deposit portfolio decreased by $12.7 million, or 8.7%, driven primarily by a $16.4 million reduction in local CDs and $1.1 million in brokered CDs.  This was offset by an increase in national CDs of $4.8 million.

Loans from related parties and FHLB advances and other borrowings remained substantially unchanged during the six months ended June 30, 2014, with no balance outstanding from loans from related parties as of June 30, 2014 and December 31, 2013, respectively, and FHLB advances and other borrowings of $20.1 million and $20.2 million, respectively, as of the same dates.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Total shareholders’ equity increased slightly during the six months ended June 30, 2014, from $33.9 million as of December 31, 2013 to $35.5 million as of June 30, 2014.  This increase was attributable to a decrease in accumulated comprehensive loss of $1.0 million and net income during the six months ended June 30, 2014 of $533 thousand.  Accumulated comprehensive income increased based on changes in interest rates during the six months ended June 30, 2014.

Comparison of Operating Results for the Six Months Ended June 30, 2014 and 2013

Net Income
The Company had net income of $533 thousand for the six months ended June 30, 2014 compared to net income of $228 thousand for the six months ended June 30, 2013.  On a diluted per share basis, the Company had income of $0.09 available to common shareholders for the six months ended June 30, 2014, compared to a net loss of $7.93 for the same period in the prior year.  The Company experienced a net loss per diluted common share in 2013 due to the noncash, implied preferred stock dividend.  Please refer to Note 9 – Shareholders’ Equity for additional information.

Net Interest Income
Net interest income, the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities, was $9.0 million for the six months ended June 30, 2014, compared to $9.9 million for the same period in 2013.

Total interest income decreased $1.5 million for the six months ended June 30, 2014 when compared to the same period in 2013.  This decrease was primarily driven by the decrease in average loan balances and a decrease in the average yield on loans to 5.25% for the six months ended June 30, 2014 compared to 5.75% for the six months ended June 30, 2013.  The decrease in the loan yield was driven by a decrease in accretion recognized on acquired loans of approximately $529 thousand as well as a slight decrease in the core average yield earned on loans.

The average cost of interest-bearing liabilities decreased 18 basis points to 0.94% for the six months ended June 30, 2014 compared to 1.12% for the same period in 2013.  The overall decrease in the average cost of interest-bearing deposits reflects an ongoing reduction in interest rates paid on deposits as a result of the re-pricing activities in the current low interest rate environment.

The net interest margin decreased by 15 basis points to 3.78% from 3.93%, when comparing the first six months of 2014 to the same period in the prior year.  This decrease was mainly due to the decrease in accretion recognized on acquired loans as discussed above, offset by a decrease in the average cost of interest-bearing liabilities.  The Company closely monitors its liquidity needs in conjunction with the cost of its funding sources and evaluates rates paid on its core deposits to ensure they remain competitive in the local market environment.

JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Average Balance Sheet; Interest Rates and Interest Differential:
The following table sets forth, for the 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.

 
  
Six Months Ended June 30,
  
 
  
2014
    
2013
  
(Dollars in thousands)
  
Average Balance
    
Interest
    
Average Rate
    
Average Balance
    
Interest
    
Average Rate
  
Interest-earning assets:
  
   
   
   
   
   
 
Loans (1)
  
$
375,169
    
$
9,759
      
5.25
%
  
$
392,912
    
$
11,196
      
5.75
%
Securities available-for-sale:
                                                
Taxable
    
75,434
      
622
      
1.66
      
75,925
      
579
      
1.54
  
Tax-exempt(2)
    
7,800
      
191
      
4.94
      
15,750
      
332
      
4.25
  
Other interest-earning assets(3)
    
19,719
      
79
      
0.81
      
25,154
      
52
      
0.42
  
Total interest-earning assets
    
478,122
      
10,651
      
4.49
      
509,741
      
12,159
      
4.81
  
Noninterest-earning assets(4)
    
18,675
                      
19,051
                  
Total assets
  
$
496,797
                    
$
528,792
                  
Interest-bearing liabilities:
                                                
Savings deposits
  
$
9,674
    
$
8
      
0.17
%
  
$
9,783
    
$
14
      
0.29
%
NOW deposits
    
27,451
      
12
      
0.09
      
21,903
      
11
      
0.10
  
Money market deposits
    
149,877
      
280
      
0.38
      
160,647
      
528
      
0.66
  
Time deposits
    
136,990
      
805
      
1.19
      
169,170
      
1,000
      
1.19
  
FHLB advances
    
20,000
      
149
      
1.50
      
20,000
      
149
      
1.50
  
Federal Reserve and other borrowings
    
6
      
-
      
0.00
      
6
      
-
      
0.00
  
Subordinated debt
    
16,169
      
408
      
5.09
      
16,105
      
413
      
5.17
  
Federal Funds purchased
    
-
      
-
      
0.00
      
6
      
-
      
0.00
  
Other interest-bearing liabilities(5)
    
-
      
22
      
N/A
    
2,200
      
107
      
9.81
  
Total interest-bearing liabilities
    
360,167
      
1,684
      
0.94
      
399,820
      
2,222
      
1.12
  
Noninterest-bearing liabilities
    
102,180
                      
95,604
                  
Shareholders' equity
    
34,450
                      
33,368
                  
Total liabilities and shareholders' equity
  
$
496,797
                    
$
528,792
                  
Net interest income
          
$
8,967
                    
$
9,937
          
Interest rate spread(6)
                    
3.55
%
                    
3.69
%
Net interest margin(7)
                    
3.78
%
                    
3.93
%
 
                             
(1) Average loans include nonperforming loans.  Interest on loans included loan fees (in thousands) of $78 and $123 for the six months ended June 30, 2014 and 2013, respectively.
(2) Interest income and rates do not include the effects of a tax equivalent adjustment using a federal tax rate of 34% in adjusting tax-exempt interest on tax-exempt investment securities to a fully taxable basis.
(3) Includes federal funds sold and investment CD’s.
(4) For presentation purposes, the BOLI acquired by the Bank has been included in noninterest-earning assets.
(5) Includes loans from related parties that pay an annual rate of interest equal to 8% on a quarterly basis of the amount outstanding or an unused revolver fee calculated and paid quarterly at an annual rate of 2% on the revolving loan commitment less the daily average principal amount outstanding.
(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.

JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Rate/Volume Analysis:
The following table sets forth the effect of changes in volumes, changes in rates, and changes in rate/volume on tax-equivalent interest income, interest expense and net interest income.

 
  
Six Months Ended June 30, 2014 vs. 2013
  
 
  
Increase (Decrease) Due to(1)
  
(Dollars in thousands)
  
Rate
    
Volume
    
Total
  
Interest-earning assets:
  
   
   
 
Loans
  
$
(946
)
  
$
(491
)
  
$
(1,437
)
Securities available-for-sale:
                        
Taxable
    
47
      
(4
)
    
43
  
Tax-exempt
    
47
      
(188
)
    
(141
)
Other interest-earning assets
    
40
      
(13
)
    
27
  
Total interest-earning assets
  
$
(812
)
  
$
(696
)
  
$
(1,508
)
 
                        
Interest-bearing liabilities:
                        
Savings deposits
  
$
(6
)
  
$
-
    
$
(6
)
NOW deposits
    
(2
)
    
3
      
1
  
Money market deposits
    
(215
)
    
(33
)
    
(248
)
Time deposits
    
(6
)
    
(189
)
    
(195
)
FHLB advances
    
-
      
-
      
-
  
Federal Reserve and other borrowings
    
-
      
-
      
-
  
Federal Funds purchased
    
-
      
-
      
-
  
Subordinated debt
    
(7
)
    
2
      
(5
)
Other interest-bearing liabilities
    
(31
)
    
(54
)
    
(85
)
Total interest-bearing liabilities
  
$
(267
)
  
$
(271
)
  
$
(538
)
Net change in net interest income
  
$
(545
)
  
$
(425
)
  
$
(970
)
                                        
(1) The change in interest due to both rate and volume has been allocated to the volume and rate components in proportion to the relationship of the dollar amounts of the absolute change in each component.

Noninterest Income, Noninterest Expense and Income Taxes
 
Noninterest income decreased period-over-period, with $756 thousand and $801 thousand in service charges and other income for the six months ended June 30, 2014 and 2013, respectively.  Included in Other income for the six months ended June 30, 2013, the Company recorded a net gain of $46 thousand from the sale of municipal securities. No securities were sold during the six months ended June 30, 2014.

Noninterest expense decreased to $8.9 million for the six months ended June 30, 2014, compared to $10.8 million for the same period in 2013.  This decrease was due to a decrease in professional fees of $0.4 million, mainly related to audit and legal fees that were higher in the first half of 2013 as a result of the special shareholders’ meeting held in the first quarter of 2013.  In addition, there was a decrease of $1.6 million for OREO and loan expenses as a result of the Company’s execution of its strategy to reduce problem assets. The remainder of the components of noninterest expense remained relatively flat period-over-period.

There was no income tax expense/benefit recorded for the six months ended June 30, 2014 and 2013. The Company recorded a full valuation allowance against its deferred taxes as of December 31, 2011.  This was substantially due to the fact that it was more-likely-than-not that the benefit would not be realized in future periods due to the uncertainty of future taxable income and Section 382 of the Internal Revenue Code.  Based on an analysis performed as of June 30, 2014 and December 31, 2013, it was determined that the need for a full valuation allowance still existed.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Comparison of Operating Results for the Three Months Ended June 30, 2014 and 2013

Net Income
The Company had net income of $507 thousand for the three months ended June 30, 2014, compared to $29 thousand of net income for the three months ended June 30, 2013.  On a diluted per share basis, the Company had net income of $0.09 for the three months ended June 30, 2014, compared to net income of $0.01 for the same period in the prior year. 

Net Interest Income
Net interest income was $4.7 million for the three months ended June 30, 2014, compared to $4.7 million for the same period in 2013.

Total interest income decreased $264 thousand for the three months ended June 30, 2014 when compared to the same period in 2013.  This decrease was primarily driven by a decrease in average earning assets, in particular, average loan balances which declined by $15.7 million when compared to the same period in the prior year.  The average yield on loans remained flat for the three months ended June 30, 2014 and 2013 at 5.46% for both periods.

The average cost of interest-bearing liabilities decreased 20 basis points to 0.93% for the three months ended June 30, 2014, compared to 1.13% for the same period in 2013.  The overall decrease in the average cost of interest-bearing deposits reflects an ongoing reduction in interest rates paid on deposits as a result of the re-pricing activities in the current low interest rate environment.

The net interest margin increased by 17 basis points to 3.95% from 3.78%, when comparing the second quarter of 2014 to the same period in the prior year.  This was driven by the decrease in the average cost of interest-bearing liabilities while the yield on interest-bearing assets remained relatively flat as a result of accretion recognized on a large acquired loan that was paid off in the second quarter of 2014.  The Company closely monitors its liquidity needs in conjunction with the cost of its funding sources and evaluates rates paid on its core deposits to ensure they remain competitive in the local market environment.

Noninterest Income, Noninterest Expense and Income Taxes
 
Noninterest income remained relatively consistent quarter-over-quarter, with $379 thousand and $377 thousand in service charges and other income for the three months ended June 30, 2014 and 2013, respectively.

Noninterest expense decreased to $4.3 million for the three months ended June 30, 2014, compared to $5.5 million for the same period in 2013.  This decrease was mainly due  to a reduction in other real estate owned expense of $0.8 million, loan expenses of $346 thousand and professional fees of $196 thousand.  The remainder of the components of noninterest expense remained relatively flat when compared to the same period in the prior year.

There was no income tax expense/benefit recorded for the three months ended June 30, 2014, and June 30, 2013, respectively.  As previously discussed, the Company has recorded a full valuation allowance against its deferred taxes.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Asset Quality

The Company has identified certain assets as risk elements.  These assets include nonperforming loans, loans that are contractually past due 90 days or more as to principal or interest payments and still accruing, troubled debt restructurings, and other real estate owned (i.e., foreclosed assets).  Loans are placed on nonaccrual status when management has concerns regarding the Company’s ability to collect the outstanding loan principal and interest amounts and typically when such loans are more than 90 days past due.  These loans present more than the normal risk that the Company will be unable to eventually collect or realize their full carrying value. The Company’s nonperforming loans, foreclosed assets and troubled debt restructurings as of June 30, 2014 and December 31, 2013 were as follows:

(Dollars in thousands)
  
June 30,
2014
    
December 31,
2013
  
Nonperforming loans:
  
   
 
Commercial
  
$
128
    
$
304
  
Real estate mortgage loans
                
Residential
    
1,437
      
3,716
  
Commercial
    
12,652
      
7,105
  
Construction and land
    
4,072
      
5,517
  
Consumer loans and other
    
344
      
366
  
Loans past due over 90 days still on accrual
    
99
      
-
  
Total nonperforming loans(1)
    
18,732
      
17,008
  
Other real estate owned, net
    
4,000
      
3,078
  
Total nonperforming assets
    
22,732
      
20,086
  
Performing loans classified as troubled debt restructurings
    
9,074
      
6,542
  
Nonperforming loans classified as troubled debt restructurings(1)
    
4,855
      
5,993
  
Total loans classified as troubled debt restructuring
  
$
13,929
    
$
12,535
  
Nonperforming loans as a percent of gross loans
    
5.08
%
    
4.59
%
Nonperforming loans and other real estate owned as a percent of total assets
    
4.60
%
    
3.95
%
                                    
(1) Nonperforming loans classified as troubled debt restructurings are also included in the total nonperforming loans above.

As shown in the table above, nonperforming assets increased by $2.6 million as of June 30, 2014 from December 31, 2013, respectively.  Nonperforming loans increased $1.7 million as of the same dates.  The increase in nonperforming loans was primarily due to a few large commercial real estate relationships that went on nonaccrual in the first half of 2014.  This was slightly offset by one large loan’s return to accrual, charge-offs (both partial and full) on impaired loans that were largely specifically reserved for as of December 31, 2013 as well as several impaired loans that were paid off in the first half of 2014.

Loans are deemed impaired when it is considered probable that the Company will not collect the outstanding loan principal and interest amounts according to the loan’s contractual terms.  As of June 30, 2014, impaired loans increased by $4.8 million to $25.3 million, compared to $20.5 million as of December 31, 2013.  Of the $25.3 million impaired loans as of June 30, 2014, $3.3 million were loans acquired from the merger with ABI.  Nonperforming impaired loans were $17.1 million as of June 30, 2014.  Specific reserves in the amount of $2.7 million were allocated to impaired loans as of June 30, 2014.

JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

During the normal course of business, the Company may restructure or modify the terms of a loan for various reasons.  The restructuring of a loan is considered a troubled debt restructuring if both (i) the borrower is experiencing financial difficulties and (ii) a concession was granted that otherwise would not have occurred under normal circumstances.  As of June 30, 2014, the Company had loan balances of $13.9 million for customers whose loans were classified as troubled debt restructurings, of which $13.0 million were included in the impaired loans balance as of the same date.  Of the total loans classified as troubled debt restructurings, $2.2 million were classified as troubled debt restructurings with collateral shortfalls.  The Company has allocated $0.4 million of the allowance for loan losses to customers whose loan terms have been modified as troubled debt restructurings with collateral shortfalls and $0.3 million to the remaining troubled debt restructurings included in the impaired loans balance as of June 30, 2014.   An additional allocation in the amount of $63 thousand represented one loan classified as a troubled debt restructuring that was acquired with deteriorated credit quality, and therefore, was excluded from the impaired loans balance as of the same date.

The troubled debt restructurings that occurred during the six months ended June 30, 2014 allowed the borrowers to make reduced payments, such as (i) reduced fixed interest rate through maturity and an advance to cover a deficiency from sale of a separate foreclosed property, (ii) change from principal and interest payments to interest only payments for a limited period of time, (iii) reduced principal and interest payments through maturity, (iv) change from variable rate interest only payments through maturity to fixed rate interest only payments for a limited period of time and reduced principal and interest payments through maturity, (v) change from variable rate interest only payments through maturity to fixed rate and reduced principal and interest payments through maturity, or (vi) proposed forgiveness of principal contingent upon the satisfaction of the modified terms, (vii) extension of maturity date with an amortization amount beyond market terms, (viii) forgiveness of principal, or (ix) modification of terms as a result of Chapter 11 bankruptcy court approved plan.  As of June 30, 2014, the Company had extended additional credit of $245 thousand to customers whose loans were classified as troubled debt restructurings.

The terms of certain other loans that did not meet the definition of a troubled debt restructuring were modified during the six months ended June 30, 2014.  These loans had a total recorded investment of $10.1 million and $6.1 million as of June 30, 2014 and 2013, respectively.  Modifications during the six months ended June 30, 2014 involved loans to borrowers who were not experiencing financial difficulties and included (i) allowing the borrowers to make interest-only payments for a limited period of time, (ii) adjusting the interest rate to a market interest rate through maturity, (iii) extension of interest-only payments for a limited period of time, or (iv) extension of maturity date.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification.  This evaluation is performed under the Company’s internal underwriting policy.

JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Loans past due still accruing interest as of June 30, 2014 and December 31, 2013 were categorized as follows:

 
(Dollars in thousands)
June 30, 2014
  
30-59 Days Past
Due
    
60-89 Days
Past Due
    
Greater than 90
Days Past Due
    
Total Past Due
Still Accruing
Interest
  
Commercial loans
  
$
12
    
$
-
    
$
-
    
$
12
  
Real estate mortgage loans:
                                
Residential
    
182
      
1
      
99
      
282
  
Commercial
    
88
      
907
      
-
      
995
  
Construction and land
    
-
      
-
      
-
      
-
  
Consumer and other loans
    
-
      
5
      
-
      
5
  
Total
  
$
282
    
$
913
    
$
99
    
$
1,294
  

December 31, 2013
  
30-59 Days Past
Due
    
60-89 Days
Past Due
    
Greater than 90
Days Past Due
    
Total Past Due
Still Accruing
Interest
  
Commercial loans
  
$
-
    
$
-
    
$
-
    
$
-
  
Real estate mortgage loans:
                                
Residential
    
287
      
13
      
-
      
300
  
Commercial
    
2,558
      
2,775
      
-
      
5,333
  
Construction and land
    
-
      
118
      
-
      
118
  
Consumer and other loans
    
95
      
11
      
-
      
106
  
Total
  
$
2,940
    
$
2,917
    
$
-
    
$
5,857
  

Total past due loans were $13.8 million as of June 30, 2014, compared to $19.5 million as of December 31, 2013.  The decrease is indicative of improvements in our customer’s ability to repay.  Although a loan may no longer be considered past due, it may remain a nonperforming loan until such time as future payments are reasonably assured.  The decrease in total loans past due 30-89 days still accruing interest to $1.3 million as of June 30, 2014 from $5.9 million as of December 31, 2013 was due to a few large commercial real estate relationships that moved from performing to nonperforming loan status in the first half of 2014.

Adversely classified loans increased to $32.4 million as of June 30, 2014 compared to $30.1 million as of December 31, 2013.  Of the total adversely classified loans as of June 30, 2014, $18.6 million were nonperforming and $10.0 million were from the merger with ABI.  The $10.0 million of adversely classified loans from ABI are net of a fair value adjustment of $941 thousand, or 8.8% of the gross contractual amount receivable as of June 30, 2014.

All adversely classified loans are monitored closely and the majority of these loans are collateralized by real estate.  In addition, the Company critically evaluates all requests for additional funding on classified loans to determine whether the borrower has the capacity and willingness to repay.  Any requests of this nature require concurrence by the Director’s Loan Committee of the Bank’s Board of Directors.

The Company purchased loans in its acquisition of ABI, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually-required payments would not be collected.  Loans acquired with deteriorated credit quality are included in our various disclosures of credit quality, including:  loans on nonaccrual; loans past due; special mention loans; substandard loans; and doubtful loans.  The tables below disclose the total loans for the Company, total loans acquired in the acquisition of ABI, the loans acquired with deteriorated credit quality and the percent of loans acquired with deteriorated credit quality to total loans for the Company for each credit metric.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)
 
(Dollars in thousands)
June 30, 2014
  
Total Loans
    
Loans Acquired
from ABI
    
Loans Acquired from
ABI with Deteriorated
Credit Quality
    
% of Total
  
 
  
   
   
   
 
Nonaccrual
  
$
18,732
    
$
4,642
    
$
1,549
      
8.3
%
Past Due
    
13,835
      
2,256
      
2,212
      
16.0
  
Special Mention
    
8,940
      
521
      
500
      
5.6
  
Substandard
    
32,446
      
10,022
      
3,334
      
10.3
  
Doubtful
    
-
      
-
      
-
      
-
  
 
  
$
41,386
    
$
10,543
    
$
3,834
      
9.3
  

December 31, 2013
  
Total Loans
    
Loans Acquired
from ABI
    
Loans Acquired from
ABI with Deteriorated
Credit Quality
    
% of Total
  
 
  
   
   
   
 
Nonaccrual
  
$
17,008
    
$
4,537
    
$
3,099
      
18.2
%
Past Due
    
19,460
      
2,963
      
2,709
      
13.9
  
Special Mention
    
16,814
      
711
      
687
      
4.1
  
Substandard
    
30,131
      
9,170
      
4,434
      
14.7
  
Doubtful
    
-
      
-
      
-
      
-
  
 
  
$
46,945
    
$
9,881
    
$
5,121
      
10.9
  

During the six months ended June 30, 2014, the Company experienced an overall reduction in loans acquired from ABI with deteriorated credit quality in terms of the recorded investment in such loans and as a percentage of total loans.  When comparing the total percentage of loans acquired from ABI with deteriorated credit quality for special mention and substandard loans to the total special mention and substandard loans of the Company, the percentages reflect an overall reduction to 9.3% as of June 30, 2014, compared to 10.9% as of December 31, 2013.  A similar reduction was experienced for loans on nonaccrual.

The same criteria used for all Company loans greater than 90 days past due and still accruing interest applies to loans acquired with deteriorated credit quality.  Loans acquired with deteriorated credit quality will be placed on nonaccrual status if the amount and timing of future cash flows cannot be reasonably estimated or if repayment of the loan is expected to be from collateral that has become deficient.  As of June 30, 2014, we had loans acquired with deteriorated credit quality on nonaccrual in the amount of $1.5 million.

In comparison to our internally defined peer group, the ratio of nonaccrual loans to total loans remained unfavorable throughout the current year-to-date period.  The Company has historically maintained a higher allowance for loan loss reserves as a percentage of total loans when compared to our peers.

JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Allowance and Provision for Loan Losses

The allowance for loan losses decreased by $1.1 million during the six months ended June 30, 2014, amounting to $14.6 million as of June 30, 2014 as compared to $15.8 million as of December 31, 2013.  The allowance represented approximately 3.96% and 4.25% of total loans as of June 30, 2014 and December 31, 2013, respectively.

Activity in the allowance for loan losses by portfolio segment for the six months ended June 30, 2014 and 2013 was as follows:

 
  
Six Months Ended
  
 
  
June 30,
  
(Dollars in thousands)
  
2014
    
2013
  
Allowance at beginning of period
  
$
15,760
    
$
20,198
  
 
                
Charge-offs:
                
Commercial loans
    
203
      
64
  
Real estate mortgage loans
    
1,489
      
2,589
  
Consumer and other loans
    
15
      
173
  
Total charge-offs
    
1,707
      
2,826
  
 
                
Recoveries:
                
Commercial loans
    
28
      
70
  
Real estate mortgage loans
    
237
      
97
  
Consumer and other loans
    
11
      
31
  
Total recoveries
    
276
      
198
  
Net charge-offs
    
1,431
      
2,628
  
 
                
Provision for loan losses charged to operating expenses:
                
Commercial loans
    
128
      
215
  
Real estate mortgage loans
    
241
      
(629
)
Consumer and other loans
    
(82
)
    
147
  
Total provision
    
287
      
(267
)
Allowance at end of period
  
$
14,616
    
$
17,303
  
 
The decrease in the allowance for loan losses as of June 30, 2014 compared to December 31, 2013 was driven primarily by an overall decrease in the historical loss component used in loans collectively evaluated for impairment coupled with an overall decrease in the total loans collectively evaluated for impairment.  The historical loss component of the allowance is determined by losses recognized over the preceding five years with the most recent years carrying more weight.  As the Company’s credit quality has improved, the more recent years that are more heavily weighted carry fewer losses.  This was offset slightly by specific reserves required for a few commercial real estate loans that became impaired in the first half of 2014.
JACKSONVILLE BANCORP, INC.

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

The Bank’s identification efforts of potential losses in the portfolio are based on a variety of specific factors, including the Company’s own historical experience as well as industry and economic trends.  In calculating the Company’s allowance for loan losses, the Company’s historical loss experience is supplemented with various current and economic trends.  These current qualitative factors can include any of the following: changes in volume and severity of past due status, special mention, substandard and nonaccrual loans; levels of any trends in charge-offs and recoveries; changes in nature, volume and terms of loans; changes in lending policies and procedures; changes in lending management and quality of loan review; changes in economic and business conditions; and changes in underlying collateral values and effects of concentrations. There were no changes in the current qualitative factors from December 31, 2013 to June 30, 2014.

As of June 30, 2014, of the $11.7 million of the allowance for loan losses from loans collectively evaluated for impairment, the real estate mortgage loans portfolio segment had total weighted average qualitative factors of 1.16%, or $2.8 million; the commercial loans portfolio segment had total weighted average qualitative factors of 1.30%, or $0.6 million; and the consumer and other loans portfolio segment had total qualitative factors of 1.57%, or $19 thousand.  Impaired loans were $25.3 million as of June 30, 2014, of which $2.7 million was specifically allocated to the allowance for loan losses which was deemed appropriate to absorb probable incurred credit losses.

As part of the Company’s allowance for loan losses policy, loans acquired from ABI with evidence of deteriorated credit quality were included in our evaluation of the allowance for loan losses for each period.  For loans acquired with deteriorated credit quality, if the loss was attributed to events and circumstances that existed as of the acquisition date as a result of new information obtained during the measurement period (i.e., 12 months from date of acquisition) that, if known, would have resulted in the recognition of additional deterioration, the additional deterioration was recorded as additional carrying discount with a corresponding increase to goodwill.  If not, the additional deterioration was recorded as additional provision expense with a corresponding increase to the allowance for loan losses.  After the measurement period, any additional impairment above the current carrying discount was recorded as additional provision for loan loss expense with a corresponding increase to the allowance for loan losses.  As of June 30, 2014, there were $2.5 million in loans acquired with deteriorated credit quality that were included in the evaluation of the allowance for loan losses.

For loans acquired with deteriorated credit quality that were deemed troubled debt restructurings prior to the Company’s acquisition of them, these loans were not considered troubled debt restructurings as they were accounted for under ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality.  Subsequent to the acquisition, the same criteria used for all other loans applied to loans acquired with deteriorated credit quality and their treatment as troubled debt restructurings.  As of June 30, 2014, there was one acquired loan with deteriorated credit quality that was deemed a troubled debt restructuring in the amount of $904 thousand.

The allowance for loan losses is a valuation allowance for credit losses in the loan portfolio.  Management 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 probable incurred credit losses in the Company’s loan and lease portfolio.  Due to their similarities, the Company has grouped the loan portfolio as follows: commercial loans, residential real estate loans, commercial real estate loans, and consumer and other loans.  The Company has created a loan classification system to calculate the allowance for loan losses.  Loans are periodically evaluated for impairment.  If a loan is deemed to be 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.

It is the Bank’s policy to obtain updated third-party appraisals on all OREO and real estate collateral on substandard loans on, at least, an annual basis.  Value adjustments are often made to appraised values on properties for which the existing appraisal is approximately one year old or greater at period-end.  Occasionally, at period-end, an updated appraisal has been ordered, but not yet received, on a property for which the existing appraisal is approaching one year old.  In this circumstance, an adjustment is typically made to the existing appraised value to reflect the Bank’s best estimate of the change in the value of the property, based on evidence of changes in real estate market values derived by the review of current appraisals received by the Bank on similar properties.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Real estate values in the Bank’s market area have experienced deterioration over the last several years.  The expectation for further deterioration for all property types appears to be leveling off with recent indicators of stabilization in the market.  On at least a quarterly basis, management reviews several factors, including underlying collateral, and writes down impaired loans to their net realizable value.

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.  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 periods, loan portfolio concentrations and trends in the loan portfolio.

Based on the results of the analysis performed by management as of June 30, 2014, the allowance for loan losses was considered adequate to absorb probable incurred credit losses in the portfolio as of that date.  As more fully discussed in the “Critical Accounting Policies and Estimates” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations, the process for estimating credit losses and determining the allowance for loan losses as of any balance sheet date is subjective in nature and requires material estimates and judgments.  Actual results may differ significantly from these estimates and judgments.

The amount of future charge-offs and provisions for loan losses could be affected by several factors including, but not limited to, economic conditions in Jacksonville and Jacksonville Beach, Florida, and the surrounding communities.  Such conditions could affect the financial strength of the Company’s borrowers and the value of real estate collateral securing the Company’s mortgage loans.  Future charge-offs and provisions could also be affected by environmental impairment of properties securing the Company’s mortgage loans.  Under the Company’s current policy, an environmental risk assessment is required on the majority of all commercial-type properties that are considered for a mortgage loan.  At the present time, the Company is not aware of any existing loans in the portfolio where there is environmental pollution existing on the mortgaged properties that would materially affect the value of the portfolio.

Liquidity and Capital Resources

Cash Flows
 
The Company’s primary sources of cash are deposit growth, maturities and amortization of investment securities, FHLB advances, Federal Reserve Bank borrowings and federal funds purchased.  The Company uses cash from these and other sources to fund loans.  Any remaining cash is used primarily to reduce borrowings and to purchase investment securities.

Cash Flows from Operating Activities:
Net cash from operating activities was $0.6 million and $1.2 million for the six months ended June 30, 2014 and 2013, respectively.  Net cash from operating activities for the six months ended June 30, 2014 was primarily impacted by net income of $0.5 million, as adjusted for (i) net accretion of purchase accounting adjustments, mainly purchased loans, of $0.6 million, (ii) premium amortization for securities, net of accretion, of $0.4 million, (iii) depreciation and amortization of $0.4 million, (iv) net change in accrued interest receivable and other assets of $0.3 million, (v)  provision for loan losses of $0.3 million, and (vi) net change in accrued expenses and other liabilities of $0.2 million.  Net cash from operating activities for the same period in the prior year reflected net income of $0.2 million, as adjusted for (a) net accretion of purchase accounting adjustments, mainly purchased loans, of $1.1 million, (b) net change in accrued interest receivable and other assets of $1.0 million, (c) premium amortization for securities, net of accretion, of $0.5 million, (d) write-downs of other real estate owned of $0.5 million, and (e) a negative provision for loan losses of $0.3 million.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Cash Flows from Investing Activities:
Net cash from investing activities was $3.3 million and $10.3 million for the six months ended June 30, 2014 and 2013, respectively.  The decrease in cash flows from investing activities was primarily driven by a decrease of $11.1 million in net loan payments and a decrease of $0.9 million in proceeds from sales of other real estate owned that  occurred in the first six months of 2014 as compared to the same period in 2013.  This was offset slightly by a net cash inflow in available-for-sale securities of $3.2 million for the six months ended June 30, 2014 compared to a net cash outflow of $2.0 million for the six months ended June 30, 2013.

Cash Flows from Financing Activities:
Net cash used for financing activities was $14.1 million and $40.7 million for the six months ended June 30, 2014 and 2013, respectively.  The period-over-period decrease in cash outflows was due solely to $14.1 million in net deposit outflows during the six months ended June 30, 2014, compared to $40.7 million in deposit outflows during the same period in the prior year.

Liquidity
 
The Company has both internal and external sources of near-term liquidity that can be used to fund loan growth and accommodate deposit outflows.  The primary internal sources of liquidity include principal and interest payments on loans, proceeds from maturities and monthly payments on the balance of the investment securities portfolio, and its overnight position with federal funds sold.  As of June 30, 2014, the Company had $82.2 million in available-for-sale securities, $5.4 million of which was pledged to the Federal Reserve Bank for the Borrower-in-Custody Program as well as the State of Florida.  Scheduled maturities and paydowns of the Company’s investment securities are an additional source of liquidity.  The Company also has the ability to convert marketable securities into cash or access new or existing sources of incremental funds if the need should arise.

The Company’s primary external sources of liquidity are customer deposits and borrowings from other commercial banks. The Company’s deposit base consists of both deposits from businesses and consumers in its local market as well as national market deposits.

In the second quarter of 2014, the Bank moved the majority of its correspondent bank activity to the Federal Reserve Bank.  As of June 30, 2014, the Bank has unsecured federal funds purchased accommodations with its correspondent banks totaling $19.5 million, all of which was available as of that date.  Availability of funds under the unsecured federal funds purchased accommodations are based on the Company’s capital adequacy as of that date; therefore, total funds available under these accommodations could fluctuate period-over-period.

In addition, the Bank has invested in FHLB stock for the purpose of establishing a line of credit 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 upon this collateral and the Company’s holdings of FHLB stock, the Company is eligible to borrow up to a total of $29.8 million as of June 30, 2014 and had borrowed $20.0 million, leaving $9.8 million available as of the same date.  The Bank also has a “Borrower in Custody” line of credit with the Federal Reserve Bank that utilizes excess loan collateral and pledged municipal securities.  The amount of this line as of June 30, 2014 was $23.5 million, all of which was available as of that date.  While these lines of credit were available to the Company as of June 30, 2014, they do not represent legal commitments to extend credit.

The Bank also has access to the non-brokered national and brokered deposit markets to supplement liquidity needs.  As of June 30, 2014, the Bank had $63.5 million in national CDs and $9.3 million in brokered CDs.  The Bank has historically utilized brokered deposits, but absent a waiver from the FDIC, could not offer brokered CDs during 2012 as it was not well capitalized until December 31, 2012.  Our ability to utilize brokered CDs and the rates we can pay on deposits will be limited if the Bank fails to remain well capitalized for regulatory purposes.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

During the year ended December 31, 2011, the Company entered into revolving loan agreements (collectively, the “Revolvers”) with several of its directors and other related parties.  Each Revolver pays an annual rate of interest equal to 8% on a quarterly basis of the Revolver amount outstanding.  To the extent that any Revolver is not fully drawn, an unused revolver fee is calculated and paid quarterly at an annual rate of 2% on the revolving loan commitment less the daily average principal amount outstanding.  The Revolvers mature on January 1, 2015.  There were no amounts outstanding under the Revolvers with $2.2 million remaining available as of June 30, 2014 and December 31, 2013.  During the second quarter of 2013, participants in the Private Placement who purchased Series A Preferred Stock through the cancellation of debt under their Revolvers, were given the option and thereby elected to reduce their loan commitments under the Revolvers based on the amount previously utilized to purchase shares of Series A Preferred Stock in the Private Placement.  This resulted in a reduction of the maximum borrowings available to the Company from $4.0 million as of December 31, 2012 to $2.2 million effective July 1, 2013.  Please refer to Note 5 – Loans from Related Parties in the accompanying notes to the Consolidated Financial Statements for additional information related to the reduced availability under the Revolvers.

In recent years, Bancorp has depended on the Revolvers, in addition to cash on hand and net proceeds from capital raise activities, to pay its operating and interest expenses.  Management believes the maximum borrowings available under the Revolvers as of June 30, 2014 and other sources of liquidity are sufficient through December 31, 2014.

Historically, the primary source of Bancorp’s income was 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 as of June 30, 2014 as our net income for the six months ended June 30, 2014 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.

Bancorp cannot currently pay dividends on its capital stock under applicable Federal Reserve policies and enforcement actions.  Under Federal Reserve policy, the board of directors of a bank holding company must consider different factors to ensure that its dividend level is prudent relative to maintaining a strong financial position, and is not based on overly optimistic earnings scenarios, such as potential events that could affect its ability to pay dividends, while still maintaining a strong financial position.  As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should consult with the Federal Reserve and eliminate, defer or significantly reduce the bank holding company’s dividends if:
 
• its net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends;
• its prospective rate of earnings retention is not consistent with its capital needs and overall current and prospective financial condition; or
• it will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios.

Capital
 
Banks and bank holding companies are subject to extensive regulatory capital requirements administered by federal banking agencies.  Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices.  Capital amounts and classifications are also subject to qualitative judgments by regulators.  Failure to meet capital requirements can initiate regulatory action.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

As of June 30, 2014 and December 31, 2013, Bancorp, the Bank, and the Company met all capital adequacy requirements to which they were subject.  Further, management and the Bank’s Board of Directors have committed to the FDIC to maintain Total Risk-Based Capital of 12% and Tier 1 Capital to Average Assets of 8%.  As of June 30, 2014 and December 31, 2013, the Bank met these thresholds.  For additional information related to the Company’s capital adequacy information, please refer to Note 11 – Capital Adequacy in the accompanying notes to the Consolidated Financial Statements.

Bank
 
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), among other things, requires the federal banking agencies to take “prompt corrective action” regarding depository institutions that do not meet minimum capital requirements.  FDICIA establishes five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.”  A depository institution’s capital tier will depend upon how its capital levels compare to various relevant capital measures and certain other factors, as established by regulation.
 
The “prompt corrective action” rules provide that a bank will be: (i) “well capitalized” if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, a leverage capital ratio of 5% or greater and is not subject to certain written agreements, orders, capital directives or prompt corrective action directives by a federal bank regulatory agency to maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater, and generally has a leverage capital ratio of 4% or greater; (iii) “undercapitalized” if it has a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 4% or generally has a leverage capital ratio of less than 4%; (iv) “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3% or a leverage capital ratio of less than 3%; or (v) “critically undercapitalized” if its tangible equity is equal to or less than 2% to total assets.  The federal bank regulatory agencies have authority to require additional capital.
 
The Bank was well capitalized as of June 30, 2014 and December 31, 2013, respectively.  Depository institutions that are no longer “well capitalized” for bank regulatory purposes must receive a waiver from the FDIC prior to accepting or renewing brokered deposits.  FDICIA generally prohibits a depository institution from making any capital distribution (including paying dividends) or paying any management fee to its holding company, if the depository institution would thereafter be undercapitalized.
 
The Bank had an MoU with the FDIC and the Florida Office of Financial Regulation that was entered into in 2008 (the “2008 MoU”), which required the Bank to have a total risk-based capital of at least 10% and a Tier 1 leverage capital ratio of at least 8%.  On July 13, 2012, the 2008 MoU was replaced by a new MoU (the “2012 MoU”), which, among other things, requires the Bank to have a total risk-based capital of at least 12% and a Tier 1 leverage capital ratio of at least 8%.   The Bank met the minimum capital requirements of these memoranda as of June 30, 2014 and December 31, 2013, when the Bank had total risk-based capital of 14.54% and 14.11% and Tier 1 leverage capital of 9.92% and 9.33%, respectively.

In December 2006, bank regulators issued “Joint Guidance on Concentrations in Commercial Real Estate Lending.”  This document outlines regulators’ concerns regarding the high level of growth in commercial real estate loans on banks’ balance sheets.  Many banks, especially those in Florida, have substantial exposure to commercial real estate loans.  The concentration in this category is considered when analyzing the adequacy of the loan loss allowance based on sound, reliable and well-documented information.  The Bank’s 2012 MoU with the FDIC also requires us to monitor and reduce our commercial real estate (“CRE”) loan concentrations.  As of June 30, 2014, the ratio of total loans secured by non-owner occupied multi-family, nonfarm, and nonresidential properties, as well as construction, land development and other land loans as a percentage of total risk-based capital was 264.78% compared to 275.8% as of December 31, 2013.  Both our June 30, 2014 and December 31, 2013 ratios did not exceed applicable regulatory guidance of 300% of total loans secured by non-owner occupied multi-family, nonfarm, and nonresidential properties, as well as construction, land development and other land loans.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Bancorp
 
The Federal Reserve requires bank holding companies, including Bancorp, to act as a source of financial strength for their depository institution subsidiaries.  The Federal Reserve has a minimum guideline for bank holding companies of Tier 1 capital to adjusted average quarterly assets (“leverage ratio”) equal to at least 4.00%, and total risk-based capital of at least 8.00%, at least half of which must be Tier 1 capital.  As of June 30, 2014 and December 31, 2013, Bancorp met these requirements.

Higher capital may be required in individual cases and depending upon a bank holding company’s risk profile.  All bank holding companies and banks are expected to hold capital commensurate with the level and nature of their risks including the volume and severity of their problem loans. The Federal Reserve will continue to consider a “tangible Tier 1 leverage ratio” (deducting all intangibles) in evaluating proposals for expansion or new activity.  The level of Tier 1 capital to risk-adjusted assets is becoming more widely used by bank regulators to measure capital adequacy.  The Federal Reserve has not advised the Company of any specific minimum capital ratios applicable to it.  Under Federal Reserve policies, bank holding companies are generally expected to operate with capital positions well above the minimum ratios.  The Federal Reserve believes the risk-based ratios do not take into account the quality of capital and interest rate, liquidity, market and operational risks.  Accordingly, supervisory assessments of capital adequacy may differ significantly from conclusions based solely on an organization’s risk-based capital ratios.

Dividends and Distributions
 
Prior to October 2009, dividends received from the Bank were Bancorp’s principal source of funds to pay its expenses and interest on and principal of Bancorp’s debt.  Banking regulations and enforcement actions require the maintenance of certain capital levels and restrict the payment of dividends by the Bank to Bancorp or by Bancorp to shareholders.  Commercial banks generally may only pay dividends without prior regulatory approval out of the total of current net profits plus retained net profits of the preceding two years, and banks and bank holding companies are generally expected to pay dividends from current earnings.  Banks may not pay a dividend if the dividend would result in the bank being “undercapitalized” for prompt corrective action purposes, or would violate any minimum capital requirement specified by law or the bank’s regulators.  The Bank has not paid dividends to Bancorp since October 2009 and cannot currently pay dividends, and Bancorp cannot currently pay dividends on its capital stock under applicable Federal Reserve policies and enforcement actions.  Bancorp has relied upon revolving loan agreements with certain of its directors and other related parties to pay its expenses during such time.  As of June 30, 2014 and December 31, 2013, there were $2.2 million in remaining funds available under the Revolvers.  During the six months ended June 30, 2014 and the year ended December 31, 2013, Bancorp used cash on hand and net proceeds from capital raise activities to fund operations.

Recent Updates in Capital Regulation and Supervision
 
The Dodd–Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) significantly modified the capital rules applicable to the Company and calls for increased capital, generally, as described below.

· The generally applicable prompt corrective action leverage and risk-based capital standards (the “generally applicable standards”), including the types of instruments that may be counted as Tier 1 capital, will be applied on a consolidated basis to depository institution holding companies, as well as their bank and thrift subsidiaries.
· The generally applicable standards in effect prior to the Dodd-Frank Act will be “floors” for the standards to be set by the regulators.
· Bank and thrift holding companies with assets of less than $15 billion as of December 31, 2009, will be permitted to include trust preferred securities that were issued before May 19, 2010, as Tier 1 capital, but trust preferred securities issued by a bank holding company (other than those with assets of less than $500 million) after May 19, 2010, will no longer count as Tier 1 capital.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Under the Basel III capital rules proposed by the Federal Reserve and the FDIC in June 2012, the risk weights of assets, the definitions of capital and the amounts and types of capital will be changed.  Among other things, these proposed rules included the implementation of new capital requirements and the elimination of Tier 1 treatment of trust preferred securities following a phase-in period beginning in 2013.  On November 9, 2012, the Federal Reserve and U.S. bank regulatory agencies announced via press release that the implementation of the proposed Basel III rules would be delayed and, therefore, would not go into effect on January 1, 2013.

On July 2, 2013, the Federal Reserve approved the final rules to implement the Basel III rules in the U.S.  The final rules implemented changes to the regulatory capital framework including, but not limited to, (i) a revised definition of regulatory capital, (ii) a new common equity Tier 1 minimum capital requirement, (iii) a higher minimum Tier 1 capital requirement, (iv) limitations on capital distributions and certain discretionary bonus payments based on various capital requirements, (v) amended methodologies for determining risk-weighted assets, and (vi) new disclosure requirements for top-tier banking organizations with $50.0 billion or more in total assets.  Further, the final rules incorporated these new requirements into the prompt corrective action framework.  Various provisions have been included in the final rules to provide relief to banking organizations under $50.0 billion in assets, such as community banks like ours.  Such provisions include the opportunity for a one-time opt-out from the requirement to include fluctuations in available-for-sale securities as part of regulatory capital and grandfather treatment of trust preferred securities as an element of Tier 1 capital for banking organizations under $15.0 billion.  These new rules took effect beginning January 1, 2014 and have a mandatory compliance deadline of January 1, 2015 for banking organizations with total assets less than $250.0 billion.  The Company is currently evaluating the impact of adoption.

Contractual Obligations, Commitments and Contingent Liabilities

The Company has various financial obligations, including contractual obligations and commitments that are expected to require future cash payments.  Management believes that there have been no material changes in the Company’s overall level of these financial obligations since December 31, 2013 and that any changes in the Company’s obligations which have occurred are routine for the industry.  Further discussion of the nature of each type of obligation is included in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC on March 14, 2014.

Off-Balance Sheet Arrangements

Management believes that there have been no material changes in off-balance sheet arrangements and related risks since the Company’s disclosure in its Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC on March 14, 2014.

Critical Accounting Policies and Estimates

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.  The following is a brief description of the Company’s critical accounting estimates involving significant valuation judgments.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Allowance for Loan Losses
 
The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses 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 allowance for loan losses 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 provision for loan losses, and related allowance can, and will, fluctuate.

Other Real Estate Owned (“OREO”)
 
OREO includes real estate acquired through foreclosure or deed taken in lieu of foreclosure. These amounts are recorded at estimated fair value (based on the lower of current appraised value or listing price), 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. Those subsequent changes, as well as any gains or losses recognized on the sale of these properties, are included in noninterest expense.  Fair values are preliminary and subject to refinement after the acquisition date as new information relative to the acquisition date fair value becomes available.  Valuation adjustments and gains or losses recognized on the sale of these properties occurring within 90 days of acquisition are charged against, or credited to, the allowance for loan losses.

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.  Based on these criteria, the Company determined that it was necessary to establish a full valuation allowance against our deferred tax asset as of December 31, 2013 and December 31, 2012.  The Company performed an analysis as of June 30, 2014 and determined the need for a valuation allowance still existed.  To the extent that we generate taxable income in a given quarter, the valuation allowance may be reduced to fully or partially offset the corresponding income tax expense.  Any remaining deferred tax asset valuation allowance may be reversed through income tax expense once the Company can demonstrate a sustainable return to profitability and conclude that it is more-likely-than-not that the deferred tax asset will be utilized prior to expiration.

Additional information with regard to the Company’s methodology and reporting of its critical accounting policies and associated estimates is included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC on March 14, 2014.
JACKSONVILLE BANCORP, INC.
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (Continued)

Recently Issued Accounting and Reporting Standards

In July 2013, the FASB issued an accounting standards update that requires that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, be presented in the financial statements as a reduction of a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryingforward, with specified exceptions.  To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available as of the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets.  The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist as of the reporting date and should be made presuming disallowance of the tax position at the reporting date. The amendments in this update were effective for fiscal years, and interim periods within those years, beginning after December 15, 2013.  No new recurring disclosures are required by this update.  The Company has evaluated this standard and determined that it will not have a material effect on the Company’s Consolidated Financial Statements.
 
In May 2014, the FASB issued ASU No. 2014-09 Revenue from Contracts with Customers (Topic 606) (ASU 2014-09).  This update to the Accounting Standards Codification is the culmination of efforts by the FASB and the International Accounting Standards Board to develop a common revenue standard for U.S. GAAP and International Financial Reporting Standards and creates a new Topic 606 – Revenue from Contracts with Customers.  ASU 2014-09 supersedes Topic 605 – Revenue Recognition and most industry-specific guidance.  The core principal of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  The guidance in ASU 2014-09 describes a 5-step process entities can apply to achieve the core principle of revenue recognition and requires disclosures sufficient to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers and the significant judgments used in determining that information.  The amendments in ASU 2014-9 are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period and early application is not allowed.  The Company is currently evaluating the effects of ASU 2014-04 on its Consolidated Financial Statements and disclosures, if any.

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

Item 3.
Quantitative and Qualitative Disclosures about Market Risk

Management believes that there have been no material changes in quantitative and qualitative disclosures about market risk since the Company’s disclosure in its Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC on March 14, 2014.

Item 4.
Controls and Procedures

(a)  Evaluation of Disclosure Controls and Procedures
The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (the “SEC”).  Based upon management’s evaluation of those controls and procedures as of the end of the fiscal quarter covered by this quarterly report on Form 10-Q, the Chief Executive Officer and Chief Financial Officer of the Company concluded that, subject to the limitations noted below, the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) are effective to ensure that the information required to be disclosed by Bancorp in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

(b)  Changes in Internal Control over Financial Reporting
In the ordinary course of business, the Company may routinely modify, upgrade and enhance its internal controls and procedures for financial reporting.  In an effort to improve internal control over financial reporting, Bancorp continues to emphasize the importance of identifying areas for improvement and to create and implement new policies and procedures where deficiencies exist.  There have been no changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
JACKSONVILLE BANCORP, INC.
 
Item 4.
Controls and Procedures (Continued)

(c)   Limitations on the Effectiveness of Controls
Bancorp’s management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and internal controls will prevent all error and all fraud.  A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management’s override of the control.

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
 
PART II - OTHER INFORMATION

Item 1.
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 1A.
Risk Factors

Management believes that there have been no material changes from the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the SEC on March 14, 2014.
JACKSONVILLE BANCORP, INC.
 
Item 6.
Exhibits

Exhibit No.
 
Description of Exhibit
 
 
 
Exhibit No. 3.1
 
Amended and Restated Articles of Incorporation of Jacksonville Bancorp, Inc., as amended through September 27, 2012 (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 10-Q filed on November 14, 2012, File No. 000-30248).
 
 
 
Exhibit No. 3.1a
 
Articles of Amendment to the Amended and Restated Articles of Incorporation Designating Series B Preferred Stock, effective as of December 27, 2012 (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on January 3, 2013, File No. 000-30248).
 
 
 
Exhibit No. 3.1b
 
Articles of Amendment to the Amended and Restated Articles of Incorporation Designating Series A Preferred Stock, effective as of December 27, 2012 (incorporated herein by reference to Exhibit 3.2 of the Registrant’s Form 8-K filed on January 3, 2013, File No. 000-30248).
 
 
 
Exhibit No. 3.1c
 
Articles of Amendment to the Amended and Restated Articles of Incorporation, effective as of February 19, 2013 (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on February 20, 2013, File No. 000-30248).
 
 
 
Exhibit No. 3.1d
 
Articles of Amendment to the Amended and Restated Articles of Incorporation, effective as of April 23, 2013 (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on April 24, 2013, File No. 000-30248).
 
 
 
Exhibit No. 3.1e
 
Articles of Amendment to the Amended and Restated Articles of Incorporation, effective as of October 24, 2013 (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on October 23, 2013, File No. 000-30248).
 
 
 
Exhibit No. 3.2
 
Amended and Restated Bylaws of Jacksonville Bancorp, Inc. (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on March 3, 2014, File No. 000-30248).
 
 
 
Exhibit No. 10.1
 
Amended and Restated Executive Employment Agreement among Jacksonville Bancorp, Inc., The Jacksonville Bank and Scott M. Hall (incorporated by reference to Exhibit 10.1 of the Registrant’s Form 8-K filed on May 21, 2014, File No. 000-30248. †
 
Exhibit No. 31.1
 
Certification of Chief Executive Officer (principal executive officer) required by Rule 13a-14(a)/15d-14(a) of the Exchange Act.*
 
 
 
Exhibit No. 31.2
 
Certification of Chief Financial Officer (principal financial officer) required by Rule 13a-14(a)/15d-14(a) of the Exchange Act.*
 
 
 
Exhibit No. 32.1
 
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes–Oxley Act of 2002 *
JACKSONVILLE BANCORP, INC.
 
Item 6.
Exhibits (Continued)
 
Exhibit No.
 
Description of Exhibit
 
 
 
Exhibit No. 101.INS
 
XBRL Instance Document*
 
 
 
Exhibit No. 101.SCH
 
XBRL Schema Document*
 
 
 
Exhibit No. 101.CAL
 
XBRL Calculation Linkbase Document*
 
 
 
Exhibit No. 101.DEF
 
XBRL Definition Linkbase Document*
 
 
 
Exhibit No. 101.LAB
 
XBRL Label Linkbase Document*
 
 
 
Exhibit No. 101.PRE
 
XBRL Presentation Linkbase Document*
                                                                                              
 
*
Included herewith.
 
†
Identifies management contracts or compensatory plans or arrangements.
JACKSONVILLE BANCORP, INC.
 
SIGNATURES
 
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

JACKSONVILLE BANCORP, INC.
 
 
 
Date:  August 8, 2014
By:
/S/    KENDALL L. SPENCER
 
 
Kendall L. Spencer
 
 
President and Chief Executive Officer
 
 
(Principal executive officer)
 
 
 
Date:  August 8, 2014
By:
/S/    VALERIE A. KENDALL
 
 
Valerie A. Kendall
 
 
Executive Vice President and
 
 
Chief Financial Officer
 
 
(Principal financial officer and
 
 
Chief accounting officer)

JACKSONVILLE BANCORP, INC.
 
EXHIBIT INDEX
 
Exhibit No.
 
Description of Exhibit
 
 
 
Exhibit No. 3.1
 
Amended and Restated Articles of Incorporation of Jacksonville Bancorp, Inc., as amended through September 27, 2012 (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 10-Q filed on November 14, 2012, File No. 000-30248).
 
 
 
Exhibit No. 3.1a
 
Articles of Amendment to the Amended and Restated Articles of Incorporation Designating Series B Preferred Stock, effective as of December 27, 2012 (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on January 3, 2013, File No. 000-30248).
 
 
 
Exhibit No. 3.1b
 
Articles of Amendment to the Amended and Restated Articles of Incorporation Designating Series A Preferred Stock, effective as of December 27, 2012 (incorporated herein by reference to Exhibit 3.2 of the Registrant’s Form 8-K filed on January 3, 2013, File No. 000-30248).
 
 
 
Exhibit No. 3.1c
 
Articles of Amendment to the Amended and Restated Articles of Incorporation, effective as of February 19, 2013 (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on February 20, 2013, File No. 000-30248).
 
 
 
Exhibit No. 3.1d
 
Articles of Amendment to the Amended and Restated Articles of Incorporation, effective as of April 23, 2013 (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on April 24, 2013, File No. 000-30248).
 
 
 
Exhibit No. 3.1e
 
Articles of Amendment to the Amended and Restated Articles of Incorporation, effective as of October 24, 2013 (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on October 23, 2013, File No. 000-30248).
 
 
 
Exhibit No. 3.2
 
Amended and Restated Bylaws of Jacksonville Bancorp, Inc. (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Form 8-K filed on March 3, 2014, File No. 000-30248).
 
 
 
Exhibit No. 10.1
 
Amended and Restated Executive Employment Agreement among Jacksonville Bancorp, Inc., The Jacksonville Bank and Scott M. Hall (incorporated by reference to Exhibit 10.1 of the Registrant’s Form 8-K filed on May 21, 2014, File No. 000-30248. †
 
 
 
 
Certification of Chief Executive Officer (principal executive officer) required by Rule 13a-14(a)/15d-14(a) of the Exchange Act.*
 
 
 
 
Certification of Chief Financial Officer (principal financial officer) required by Rule 13a-14(a)/15d-14(a) of the Exchange Act.*
 
 
 
 
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes–Oxley Act of 2002 *
JACKSONVILLE BANCORP, INC.

EXHIBIT INDEX (Continued)

Exhibit No.
 
Description of Exhibit
 
 
 
Exhibit No. 101.INS
 
XBRL Instance Document*
 
 
 
Exhibit No. 101.SCH
 
XBRL Schema Document*
 
 
 
Exhibit No. 101.CAL
 
XBRL Calculation Linkbase Document*
 
 
 
Exhibit No. 101.DEF
 
XBRL Definition Linkbase Document*
 
 
 
Exhibit No. 101.LAB
 
XBRL Label Linkbase Document*
 
 
 
Exhibit No. 101.PRE
 
XBRL Presentation Linkbase Document*
                                                                                              
 
*
Included herewith.
 
†
Identifies management contracts or compensatory plans or arrangements.
 
 
72

JACKSONVILLE BANCORP INC /FL/ Reports