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JAXB > SEC Filings for JAXB > Form 10-K on 26-Mar-2013All Recent SEC Filings

Show all filings for JACKSONVILLE BANCORP INC /FL/ | Request a Trial to NEW EDGAR Online Pro

Form 10-K for JACKSONVILLE BANCORP INC /FL/


26-Mar-2013

Annual Report


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

Management's discussion and analysis of the financial condition and results of operations represents an overview of the consolidated financial condition and results of operations of the Company as of, and for the years ended, December 31, 2012 and 2011. This discussion is designed to provide a more comprehensive review of the financial condition and operating results than could be obtained from an examination of the financial statements alone. This analysis should be read in conjunction with the Consolidated Financial Statements and accompanying notes contained in this Annual Report on Form 10-K.

General

Jacksonville Bancorp, Inc. ("Bancorp") was incorporated on October 24, 1997 and was organized to conduct the operations of The Jacksonville Bank (the "Bank"). The Bank is a Florida state-chartered commercial bank that opened for business on May 28, 1999, and its deposits are insured by the FDIC. During 2000, the Bank formed Fountain Financial, Inc., a wholly owned subsidiary. The primary business activities of Fountain Financial, Inc. consist of the referral of the Bank's customers to third parties for the sale of insurance and investment products. On November 16, 2010, Bancorp acquired Atlantic BancGroup, Inc. ("ABI") by merger, and on the same date, ABI's wholly owned subsidiary, Oceanside Bank, merged with and into the Bank. The Bank provides a variety of community banking services to businesses and individuals in Duval County, Florida and surrounding communities within St. Johns, Clay and Nassau counties.

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 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 new overall strategy to accelerate the disposition of substandard assets on an individual customer basis. Certain then-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 new strategy has materially impacted the Company's earnings for the year ended December 31, 2012 through the increased provision for loan losses. Looking forward, the Company intends to continue reducing problem assets in conjunction with the fine tuning of the current credit processes. In addition, the Company is working to reposition its loan and deposit portfolio mix to better align with our targeted


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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)

market segment of professional services, wholesalers, distributors and other service industries. Our balance sheet mix will be diversified as a result of the capital received late in 2012. This excess capital will be deployed into short-term investments to maximize earnings while the desired loan growth is achieved.

On December 28, 2012, the Bank entered into an Asset Purchase Agreement (the "Asset Purchase Agreement") with a real estate investment firm (the "Asset Purchaser") for the purchase by the Asset Purchaser of approximately $25.1 million of certain of the Bank's loans and other assets for approximately $11.7 million (the "Asset Sale"). The assets underlying the Asset Sale included OREO, non-accrual loans and other loans with a history of being past due. 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, immediately prior to the closing of the Stock Purchase, and involved the immediate transfer of servicing from the Bank, as permitted by federal law. The Asset Sale was in line with the Company's strategy to accelerate the disposition of substandard assets in 2012.

To further supplement the Company's business strategy, the Bank has adopted a philosophy of seeking and retaining the best available personnel for positions of responsibility, whom we believe will provide us with a competitive edge in the local banking market. Since the retirement of Mr. Price Schwenck, the Company's former Chief Executive Officer, the Company has appointed Stephen C. Green as President and Chief Executive Officer and Margaret A. Incandela as Chief Operating Officer and Chief Credit Officer as a means of adding critical management expertise.

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 Series A Preferred Stock, at a purchase price of $1,000 per share, in the Private Placement. Included in the 50,000 shares 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 the Company's Series B Preferred Stock purchased by CapGen (for an aggregate of $5.0 million) in September 2012 as part of a bridge financing. Also included in shares sold in the Private Placement were 2,265 shares of Series A Preferred Stock sold to certain of the Company's directors, executive officers and other related parties (the "Subscribers") through individual subscription agreements. Consideration for the shares of Series A Preferred Stock sold under the subscription agreements consisted of an aggregate of $0.5 million in cash and $1.8 million in the cancellation of outstanding debt under the Company's revolving loan agreements held by certain of the Subscribers and/or their related interests.

For the year ended December 31, 2012, gross proceeds from the issuance of preferred stock were $50.0 million, including gross proceeds from the sale of Series A Preferred Stock of $45.0 million, $40.2 million net of offering expenses and the conversion of loans from related parties to equity, and gross proceeds from the sale of the Series B Preferred Stock of $5.0 million, or $4.8 million net of offering expenses. Net proceeds from the issuance of preferred stock in the amount of $45.1 million were used for general operating expenses, mainly for the subsidiary bank, to improve capital adequacy ratios, and will be used to supplement the Company's business strategy going forward.

Executive Overview

The Company's performance during the years ended December 31, 2012 and 2011 is reflective of the current low interest rate environment which has placed significant pressure on our margin, largely on the repricing of our assets. It also demonstrates the continued depressed real estate market that has been ongoing in the market in which the Bank operates.


Table of Contents
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)

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

Total assets increased $3.6 million, or 0.7%, from $561.4 million as of December 31, 2011 to $565.1 million as of December 31, 2012. This increase was influenced by a significant year-over-year increase in cash and cash equivalents of $62.1 million, or 624.0%, and securities available-for-sale of $20.8 million, or 33.0%. This increase was primarily offset by a reduction in net loans of $71.8 million, or 16.0%, other real estate owned of $1.0 million, or 12.5%, and a full impairment of the remaining balance of goodwill in the amount of $3.1 million during the year ended December 31, 2012.

The increase in cash and cash equivalents from $10.0 million as of December 31, 2011 to $72.1 million as of December 31, 2012 was primarily due to federal funds sold in the amount of $57.5 million. The large federal funds sold position was driven by the proceeds received from the 2012 capital raise activities and the Asset Sale completed late in the fourth quarter of 2012. During the year ended December 31, 2012, the Company purchased $23.1 million in GNMA and FNMA securities, $6.0 million in SBA bonds, $2.0 million in U.S. agency securities and $2.0 million in corporate bonds. These purchases contributed to the increase in securities available-for-sale from $63.1 million as of December 31, 2011 to $84.0 million as of December 31, 2012. During 2012, the Company utilized additional cash balances from increased deposits and run-off in the loan portfolio to fund additional purchasing activities for securities available-for-sale to maximize the yield on our interest-earning assets in the current interest rate environment.

The year-over-year reduction in net loans and other real estate owned was the direct result of the accelerated disposition of substandard assets, including the Asset Sale completed on December 31, 2012, whereby the Company sold $25.1 million of other real estate own nonaccrual loans, and other loans with a history of being past due for $11.7 million. The assets underlying the Asset Sale included OREO of $0.5 million and loans, including non-accrual loans and other loans with a history of being past due, of $24.6 million. Of the $24.6 million in loans sold, $5.6 million were acquired in the merger with ABI.

The allowance for loan loss as a percentage of total loans outstanding was 5.1% as of December 31, 2012, compared to 2.8% as of December 31, 2011. During 2012, the Company had charge-offs of $31.7 million, recoveries of $0.9 million and provision for loan loss of $38.0 million, compared to charge-offs of $12.8 million, recoveries of $0.4 million and provision for loan losses of $12.4 million in 2011. The increased allowance for loan losses as of December 31, 2012, compared to December 31, 2011, was driven primarily by the increase in the amount of allowance needed on loans collectively evaluated for impairment, an increase in individually evaluated for impairment as a percentage of total loans, and an increase in historical loss factors as a result of current year charge-offs, which increased the amount of allowance needed on loans collectively evaluated for impairment. The high level of charge-offs during 2012 and the increase in the amount of allowance needed on loans collectively evaluated for impairment was primarily due to the timing of recorded charge-offs related to the Company's disposition of distressed assets on an individual basis and includes the impact of the Asset Sale.

Total deposits increased by $16.1 million, or 3.4%, during the year ended December 31, 2012, from $473.9 million as of December 31, 2011 to $490.0 million as of December 31, 2012. The following are changes in each of the major deposit categories during 2012:

Noninterest-bearing deposits increased $11.7 million, or 14.1%, as a result of the Bank's strategy to focus its sales efforts on gaining low cost deposits.

Money market, NOW and savings deposits remained relatively consistent year over year with a decrease of $0.7 million, or 0.3%.

The time deposit portfolio increased by $5.1 million, or 2.6%, driven primarily by a $36.6 million increase in national CDs that occurred during the first quarter of 2012. The Company is not currently offering or renewing national or brokered CDs.


Table of Contents
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)

Borrowed funds, primarily consisting of Federal Home Loan Bank (FHLB) advances, subordinated debentures and loans from related parties, totaled $38.5 million as of December 31, 2012, compared to $55.8 million as of December 31, 2011. FHLB advances and other borrowings decreased $16.6 million, or 45.1%, during 2012, from $36.8 million as of December 31, 2011 to $20.2 million as of December 31, 2012. The elevated prior year balance of FHLB advances was the result of increased overnight borrowings by the Bank of $18.6 million during late 2011. Also during the year ended December 31, 2012, loans from related parties decreased $0.8 million, or 26.7%, while subordinated debentures remained relatively consistent year over year. Loans from related parties decreased as a result of the Company's 2012 capital raise transactions, whereby certain of the Company's directors, executive officers and other related parties (the "Subscribers") received shares of Series A Preferred Stock through individual subscription agreements in exchange for consideration in the amount of $0.5 million in cash and $1.8 million in the cancellation of outstanding debt under the Company's revolving loan agreements held by such Subscribers and/or their related interests offset by additional borrowings of $1.0 million during 2012.

Total shareholders' equity increased $4.2 million, or 14.4%, during 2012, from $29.3 million as of December 31, 2011 to $35.8 million as of December 31, 2012. This increase was primarily the result of net proceeds from the issuance of preferred stock in the amount of $46.9 million. These amounts were offset by a net loss for the year ended December 31, 2012 of $43.0 million. Management remains committed to retaining sufficient equity to protect shareholders and depositors, provide for reasonable growth and fully comply with regulatory requirements.

Comparison of Operating Results for the years ended December 31, 2012 and 2011

For the year ended December 31, 2012, the Company had a net loss of $43.0 million as compared to net loss of $24.1 million for the year ended December 31, 2011. On a basic and diluted share basis, the net loss was $7.31 for 2012, compared to net loss of $4.09 in 2011. Return on average assets and return on average equity were (7.55)% and (188.47)%, respectively, in 2012 compared to
(3.93)% and (44.53)%, respectively, in 2011. The net loss for the year ended December 31, 2012 was driven primarily by (i) an increase in the provision for loan losses, noncash goodwill impairment expense and OREO expenses, (ii) an increase in loan related expenses, (iii) a decrease in interest income on loans, and (iv) additional expenses related to 2012 capital raise activities and the Asset Sale completed late in the fourth quarter of 2012. In comparison, the net loss for the year ended December 31, 2011 was driven primarily by the provision for loan losses, noncash goodwill impairment expense and noncash income tax expense (i.e., full valuation allowance) during the period. The level of the provision for loan losses and OREO and loan related expenses continued to be impacted by the depressed real estate market in which the Company operates. The prior year income tax expense was mostly the result of recording a full valuation allowance on the Company's deferred tax asset offset by additional interest income recognized as a result of the acquisition of ABI in the fourth quarter of 2010 and the consistent decline in interest expense in recent years.

Net interest income, the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities, was $21.0 million for the year ended December 31, 2012, compared to $23.7 million for the year ended December 31, 2011. Interest earned on interest-earning assets decreased $4.5 million, or 14.6%, with interest income of $26.3 million in 2012, compared to $30.7 million in 2011. This decrease was driven primarily by (i) a decrease in average earning assets, in particular average loan balances which declined by $45.2 million when compared to the prior year, (ii) a decrease in the average yield on loans to 5.41% in 2012 as compared to 5.84% in 2011, and (iii) a decrease in interest income as a result of accretion recognized on acquired loans of $1.0 million, from $3.1 million in 2011 to $2.1 million in 2012. The decrease in the average yield on loans was mainly due to a decrease in the accretion on acquired loans and a decrease in the weighted-average loan yield as well as continued modifications to reduce existing loan rates to be competitive in the


Table of Contents
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)

current low-rate market environment. The decrease in accretion on acquired loans was a direct result of the Company's strategy to accelerate the disposition of substandard assets and the natural maturity of the loans acquired. Interest paid on interest-bearing liabilities decreased 32 basis points from 1.47% in 2011 to 1.15% in 2012. The average cost of interest-bearing deposits and all interest-bearing liabilities reflect the ongoing reduction in interest rates paid on deposits as a result of the re-pricing of deposits in the current market environment.

Noninterest income was $1.5 million for both of the years ended December 31, 2012 and 2011, while noninterest expense decreased $2.5 million, from $30.2 million in 2011 to $27.7 million in 2012. The decrease in noninterest expense was driven primarily by a decrease in goodwill impairment charges from $11.2 million in 2011 to $3.1 million in 2012, offset by an increase in other expenses, including loan related expenses and nonrecurring expenses related to the 2012 capital raise and Asset Sale activities.

Basic weighted average common shares outstanding remained relatively consistent year over year, with 5,890,432 weighted average common shares outstanding for the year ended December 31, 2012, as compared to 5,889,439 for the year ended December 31, 2011. Basic and diluted weighted average common shares outstanding are the same for 2012 and 2011, respectively, as the Company was in a loss position for each year. As a result, all potential common shares for 2012 and 2011 were excluded from the calculation of diluted earnings per share as the shares would have had an anti-dilutive effect.

Critical Accounting Policies

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

Allowance for Loan Loss

The allowance for loan 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


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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)

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, 2011. The Company performed an analysis as of December 31, 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 for the same amount of the impairment which contributed to our net loss for the year ended December 31, 2012.

Recent Accounting Pronouncements

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


Table of Contents
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)

FDIC Insurance Assessments

The FDIC is an independent federal agency established originally to insure the deposits, up to prescribed statutory limits, of federally insured banks and to preserve the safety and soundness of the banking industry. The FDIC has adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities.

The Bank's deposit accounts are insured by the FDIC to the maximum extent permitted by law. The Bank pays deposit insurance premiums to the FDIC based on a risk-based assessment system established by the FDIC for all insured institutions. Institutions considered well-capitalized and financially sound pay the lowest premiums, while those institutions that are less than adequately capitalized and of substantial supervisory concern pay the highest premiums. Total base assessment rates currently range from 0.03% of deposits for an institution in the highest sub-category of the high category to 0.45% of deposits for an institution in the lowest category.

In February 2006, the Federal Deposit Insurance Reform Act of 2005 and the . . .

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