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JAXB > SEC Filings for JAXB > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for JACKSONVILLE BANCORP INC /FL/

Form 10-Q for JACKSONVILLE BANCORP INC /FL/


14-Nov-2012

Quarterly Report


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

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. The primary business activities of Fountain Financial, Inc. consist of referral of the Bank's customers to third parties for the sale of insurance products. Bancorp, the Bank, and Fountain Financial, Inc. are collectively referred to herein as the "Company."

Forward-Looking Statements

All statements, other than statements of historical facts, included in this Quarterly Report on Form 10-Q regarding our estimates, expectations, beliefs, intentions, projections or strategies for the future, results of operations, financial position, prospects and plans and objectives of management for future operations may be "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995, as amended. We have based these forward-looking statements on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short- and long-term business operations and objectives and financial needs. These forward-looking statements can be identified by the use of terms and phrases such as "believe," "plan," "intend," "anticipate," "target," "estimate," "expect," and the like, and/or future-tense or conditional constructions ("will," "may," "could," "should," etc.). Statements contemplating or making assumptions about actual or potential future operating results also constitute forward-looking statements. The Company cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, including our ability to raise additional capital, the future economic, business and market conditions, legislative and regulatory changes, fluctuations in interest rates, our ability to minimize credit risk and nonperforming assets, demand for products, and competition, and, therefore, actual results could differ materially from those contemplated by the forward-looking statements. In addition, the Company assumes no duty to update forward-looking statements to reflect events or circumstances after the date of such statements.

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 securities backed by the United States government, and agencies thereof, as well as municipal tax-exempt and corporate bonds. 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 level of noninterest income earned and noninterest expenses incurred also affects 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, and other real estate owned ("OREO") expenses.

Our goal is to focus 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 interest-earning assets and rates on interest-bearing liabilities; focusing on noninterest income opportunities; controlling the growth of noninterest expenses; and strengthening asset quality. 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 has materially impacted the Company's earnings for the three and nine months ended September 30, 2012 through the increased provision for loan losses. The Company expects to continue this new strategy for the foreseeable future.

In addition, the Company has executed a financial advisory agreement with an investment banking firm (the "Firm") to assist in raising capital. During the third quarter of 2012, Bancorp executed a Stock Purchase Agreement (the "Stock Purchase Agreement") with its largest shareholder, CapGen Capital Group IV LP ("CapGen"), for the sale of up to 25,000 shares of the Company's preferred stock, to-be-designated as Mandatorily Convertible, Noncumulative, Nonvoting Perpetual Preferred Stock, Series A ("Series A Preferred Stock") with a liquidation preference of $1,000 per share.


Table of Contents

JACKSONVILLE BANCORP, INC.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Cont.)

The Stock Purchase Agreement was approved unanimously by Bancorp's Board of Directors in contemplation of the private placement of 50,000 shares of Series A Preferred Stock at a purchase price of $1,000 per share for an aggregate of $50.0 million (the "Private Placement"). The closing of the Private Placement is conditioned upon certain factors, among other customary closing conditions, including: (i) the aggregate sale of $50.0 million in Series A Preferred Stock to investors, (ii) the determination of the conversion price and conversion rate of the Series A Preferred Stock issuance, (iii) the receipt of Federal Reserve approval of CapGen's additional investment in Bancorp, (iv) the receipt of an opinion from the Company's independent auditors that the Private Placement should not be an "ownership change" for purposes of Section 382 of the Internal Revenue Code, and (v) the receipt of a fairness opinion from a third-party investment banker.

Also in the third quarter of 2012, Bancorp completed a $5.0 million capital raise through the sale of 5,000 shares of the Company's Noncumulative, Nonvoting, Perpetual Preferred Stock, Series B, $0.01 par value ("Series B Preferred Stock"), at a purchase price of $1,000 per share. Proceeds from the sale of Series B Preferred Stock were $4.9 million, net of offering expenses, and were used for general operating expenses mainly for the subsidiary bank. In connection with the $5.0 million capital raise, Bancorp and CapGen entered into an Exchange Agreement whereby Bancorp agreed to exchange shares of Series B Preferred Stock for the Series A Preferred Stock simultaneously with the issuance of shares of Series A Preferred Stock in the Private Placement (the "Exchange"), unless such shares of Series B Preferred Stock are first redeemed by the Company. In the Exchange, all issued and outstanding shares of Series B Preferred Stock would be exchanged for the number of shares of Series A Preferred Stock having an aggregate liquidation preference equal to the aggregate Series B liquidation preference, unless otherwise specified under the closing terms of the Private Placement.

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. The Bank has adopted a philosophy of seeking and retaining the best available personnel for positions of responsibility, whom we believe will provide us with a competitive edge in the local banking industry.

Critical Accounting Policies

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

Allowance for Loan 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.


Table of Contents

JACKSONVILLE BANCORP, INC.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Cont.)

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, 2011. The Company performed an analysis as of September 30, 2012 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.

Goodwill and Other Intangible Assets:

Goodwill resulting from business combinations is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any non-controlling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Impairment exists when the carrying value of goodwill exceeds its fair value, which is determined through a two-step impairment test. Step 1 includes the determination of the carrying value of the reporting unit, including the existing goodwill and intangible assets, and estimating the fair value. If the carrying amount exceeds its fair value, we are required to perform a second step to the impairment test. Step 2 of the impairment test is performed to measure the potential impairment loss, which requires that the implied fair value of goodwill be compared with the carrying amount. The amount of excess carrying amount over the implied fair value is recognized as an impairment loss.

An impairment analysis as of December 31, 2011 determined that as a result of our net loss as of December 31, 2011, largely due to the recording of an additional provision for loan losses and a full valuation allowance on our deferred tax asset, there was a goodwill impairment of $11.2 million, leaving a balance of $3.1 million. The annual impairment analysis as of September 30, 2012 determined that there had been a goodwill impairment of $3.1 million, which reduced the carrying value of the remaining goodwill balance to zero. This impairment was due to several factors, including the financial performance of the Company during 2012 and the increased provision for loan losses. The Company recorded a charge to earnings in the third quarter for the same amount of the impairment which contributed to our net loss for the nine months ended September 30, 2012.

Additional information with regard to the Company's methodology and reporting of its critical accounting policies is included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC on March 30, 2012.

Introduction

On the following pages, management presents an analysis of the financial condition of the Company as of September 30, 2012 compared to December 31, 2011, and the results of operations for the three and nine months ended September 30, 2012 compared with the same periods in 2011. This discussion is designed to provide a more comprehensive review of the operating results and financial position 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, 2011, as filed with the SEC on March 30, 2012.

Comparison of Financial Condition as of September 30, 2012 and December 31, 2011

Total assets decreased $9.9 million, or 1.8%, from $561.4 million as of December 31, 2011 to $551.6 million as of September 30, 2012. The Company experienced a significant increase in securities available-for-sale of $25.7 million, or 40.7%, and cash and cash equivalents of $3.7 million, or 37.2%, during the nine months ended September 30, 2012. This increase was primarily offset by a reduction in net loans of $30.9 million, or 6.9%, other real estate owned of $3.4 million, or 42.3%, and a full impairment of the remaining balance of goodwill in the amount of $3.1 million during the same period.

Total cash and cash equivalents increased by $3.7 million, from $10.0 million as of December 31, 2011 to $13.7 million as of September 30, 2012. Investment securities available-for-sale increased $25.7 million to $88.8 million as of September 30, 2012. During the nine months ended September 30, 2012, the Company purchased $23.1 million in GNMA and FNMA securities, $6.0 million in SBA bonds, $2.0 million in agency securities and $2.0 million in corporate bonds. In addition, we received $9.4 million in proceeds from principal repayments, maturities and calls.


Table of Contents

JACKSONVILLE BANCORP, INC.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Cont.)

Total deposits increased $19.3 million, or 4.1%, from $473.9 million as of December 31, 2011 to $493.2 million as of September 30, 2012. During the nine months ended September 30, 2012, noninterest-bearing demand deposits increased $5.0 million, or 6.0%, from $82.9 million as of December 31, 2011 to $87.8 million as of September 30, 2012; money market, NOW and savings deposits decreased $2.4 million, or 1.2%, from $199.1 million as of December 31, 2011 to $196.7 million as of September 30, 2012; and time deposits increased $16.7 million, or 8.7%, from $192.0 million as of December 31, 2011 to $208.7 million as of September 30, 2012. The overall increase in time deposits was driven primarily by the $37.1 million increase in National CDs. The Company is not currently offering or renewing our brokered CDs.

FHLB advances and other borrowings decreased by $16.6 million as of September 30, 2012 from December 31, 2011. Loans from related parties increased to $4.0 million as of September 30, 2012 from $3.0 million as of December 31, 2011. On August 21, 2012, the Company exercised its contractual rights to defer interest payments with respect to all of its 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. The Company believes it prudent capital stewardship to refrain from making further payments until the completion of the Private Placement. These payments are periodically evaluated and will be reinstated when appropriate.

Total shareholders' equity decreased by $15.8 million from $29.3 million as of December 31, 2011 to $13.6 million as of September 30, 2012. The decrease is mainly attributable to a net loss of $21.2 million. This loss was slightly offset by $4.9 million in additional paid-in capital from the issuance of the Series B Preferred Stock combined with a net increase of $463 thousand for net unrealized gains on securities and cash flow hedge. The Company had 40,000,000 authorized shares of $.01 par value common stock, of which 5,890,880 shares were issued and outstanding as of September 30, 2012. In addition, the company had 10,000,000 authorized shares of preferred stock, 10,000 of which were designated as $.01 par value preferred stock, Series B, with 5,000 shares issued and outstanding as of September 30, 2012.

Comparison of Operating Results for the Nine Months Ended September 30, 2012 and 2011

Net Income

The Company had a net loss for the nine months ended September 30, 2012 of $21.2 million, compared to $2.8 million of net income for the nine months ended September 30, 2011. On a diluted per share basis, the net loss was $3.60 for the nine months ended September 30, 2012, compared to net income of $0.47 per diluted share for the same period in the prior year. The net loss for the nine months ended September 30, 2012 was driven primarily by (i) an increase in the provision for loan losses, noncash goodwill impairment expense and OREO expenses, (ii) an increase in loan related expenses, and (iii) a decrease in interest income on loans.

Net Interest Income

Net interest income, the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities, was $15.8 million for the nine months ended September 30, 2012, compared to $18.2 million for the same period in 2011. The average yield on interest-earning assets for the nine months ended September 30, 2012 was 4.82%, a decrease of 69 basis points, compared to the 5.51% yield earned during the same period in the prior year.

Total interest income decreased $3.8 million for the nine months ended September 30, 2012 when compared to the same period in 2011. This decrease was primarily driven by a decrease in average earning assets, in particular, average loan balances which declined by $44.0 million when compared to the same period in the prior year. This decrease was also the result of a decrease in the average yield on loans from the 5.93% recognized during the nine months ended September 30, 2011 to 5.36% for the nine months ended September 30, 2012. The decrease in the loan yield was driven by the following factors when compared to the same period in the prior year:

Decrease in accretion recognized on acquired loans of approximately $1.4 million;

Decrease in the weighted-average loan yield for new loans of 74 basis points; and

Modifications to reduce existing loan rates to be competitive in the current low-rate market environment.

The average cost of interest-bearing liabilities decreased 34 basis points from 1.49% for the nine months ended September 30, 2011 to 1.15% for the same period in 2012. The decrease in the average cost of interest-bearing deposits and all interest-bearing liabilities reflect an ongoing reduction in interest rates paid on deposits as a result of the re-pricing of


Table of Contents

JACKSONVILLE BANCORP, INC.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (Cont.)

deposits in the current market environment. Additionally, average noninterest-bearing demand deposits increased $9.8 million with average interest-bearing deposits decreasing $28.6 million over the previous year's nine-month period, which further reduced our overall funding costs.

The net interest margin decreased by 39 basis points, from 4.24% for the nine months ended September 30, 2011 to 3.85% for the same period in 2012. The Company closely monitors its liquidity needs in conjunction with the cost of its funding sources and has reduced the rates paid on its core deposits.

Average Balance Sheet; Interest Rates and Interest Differential. The following table sets forth the average daily balances for each major category of assets, liabilities and shareholders' equity as well as the amounts and average rates earned or paid on each major category of interest-earning assets and interest-bearing liabilities.

                                                                     Nine Months Ended September 30,
                                                             2012                                       2011
                                              Average                     Average        Average                     Average
(Dollars in thousands)                        Balance      Interest        Rate          Balance      Interest        Rate
Interest-earning assets:
Loans (1)                                    $ 454,195     $  18,233          5.36 %    $ 498,154     $  22,086          5.93 %
Securities (2)                                  81,691         1,500          2.45         66,080         1,450          2.93
Other interest-earning assets (3)               12,681            52          0.55          8,371            63          1.01

Total interest-earning assets                  548,567        19,785          4.82        572,605        23,599          5.51

Noninterest-earning assets (4)                  26,905                                     46,669

Total assets                                 $ 575,472                                  $ 619,274

Interest-bearing liabilities:
Savings deposits                             $  10,679     $      31          0.39 %    $  12,419     $      74          0.80 %
NOW deposits                                    21,746            12          0.07         19,021            20          0.14
Money market deposits                          172,416           981          0.76        172,327         1,244          0.97
Time deposits                                  212,994         1,848          1.16        242,715         3,024          1.67
FHLB advances                                   22,333           248          1.48         20,645           285          1.85
Federal Reserve and other borrowings(8)          3,333           213          8.54          1,745           111          8.50
Subordinated debt                               16,050           637          5.30         15,985           667          5.58
Other interest-bearing liabilities(5)              256            -             -           1,085            -             -

Total interest-bearing liabilities             459,807         3,970          1.15        485,942         5,425          1.49

Noninterest-bearing liabilities                 89,391                                     79,894
Shareholders' equity                            26,274                                     53,438

Total liabilities and shareholders' equity   $ 575,472                                  $ 619,274

Net interest income                                        $  15,815                                  $  18,174

Interest rate spread(6)                                                       3.67 %                                     4.02 %

Net interest margin(7)                                                        3.85 %                                     4.24 %

(1) Average loans include nonperforming loans. Interest on loans includes deferred loan fees.

(2) Interest income and rates do not include the effects of a tax equivalent adjustment using a federal tax rate of 34% in adjusting tax-exempt interest on tax-exempt investment securities to a fully taxable basis.

(3) Includes federal funds sold.

(4) For presentation purposes, the BOLI acquired by the Bank has been included in noninterest-earning assets.

(5) Includes federal funds purchased.

(6) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(7) Net interest margin is net interest income divided by average interest-earning assets.

(8) Federal Reserve and other borrowings include loans from related parties that . . .

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