Jacksonville Bancorp (JAXB) 10-Q 2014 Q1 Quarterly report

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 March 31, 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 April 30, 2014, the latest practicable date, there were 3,177,574 shares of the Registrant’s common stock outstanding and 2,617,521 shares of the Registrant’s nonvoting common stock outstanding.

JACKSONVILLE BANCORP, INC.

TABLE OF CONTENTS

Description		Page
Special Cautionary Notice Regarding Forward-Looking Statements		1
PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements	2
	Consolidated Balance Sheets	2
	Consolidated Statements of Operations	3
	Consolidated Statements of Comprehensive Income (Loss)	4
	Consolidated Statements of Changes in Shareholders’ Equity	5
	Consolidated Statements of Cash Flows	6
	Notes to Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	40
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	58
Item 4.	Controls and Procedures	58
PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	59
Item 1A.	Risk Factors	59
Item 5.	Other Information	59
Item 6.	Exhibits	61
SIGNATURES		62
EXHIBIT INDEX		63

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.

1

JACKSONVILLE BANCORP, INC.

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Dollars in thousands, except per share amounts)

	March 31, 2014			December 31, 2013
ASSETS
Cash and due from financial institutions	$	16,155		$	16,799
Federal funds sold and other		7,408			23,526
Cash and cash equivalents		23,563			40,325
Securities available-for-sale		81,123			84,771
Loans, net of allowance for loan losses of $15,104 and $15,760 as of March 31, 2014 and December 31, 2013, respectively		364,180			354,592
Premises and equipment, net		6,322			6,421
Bank-owned life insurance		13,010			12,956
Federal Home Loan Bank stock, at cost		1,356			1,580
Other real estate owned, net		3,559			3,078
Accrued interest receivable		1,647			1,723
Other intangible assets, net		777			849
Other assets		1,237			994
Total assets	$	496,774		$	507,289
LIABILITIES
Deposits
Noninterest-bearing demand deposits	$	97,715		$	100,788
Money market, NOW and savings deposits		190,193			188,085
Time deposits		136,071			146,093
Total deposits		423,979			434,966
Federal Home Loan Bank advances and other borrowings		20,147			20,153
Subordinated debentures		16,170			16,154
Accrued expenses and other liabilities		1,974			2,084
Total liabilities		462,270			473,357
SHAREHOLDERS' EQUITY
Preferred stock		-			-
Common stock, $.01 par value, 3,177,574 and 3,177,090 shares issued and outstanding as of March 31, 2014 and December 31, 2013, respectively(1)		32			32
Nonvoting common stock, $.01 par value, 2,617,521 and 2,618,005 shares issued and outstanding as of March 31, 2014 and December 31, 2013, respectively(1)		26			26
Additional paid–in capital(1)		138,067			138,050
Retained earnings (deficit)		(102,662	)		(102,688	)
Accumulated other comprehensive (loss) income		(959	)		(1,488	)
Total shareholders’ equity		34,504			33,932
Total liabilities and shareholders’ equity	$	496,774		$	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 the Consolidated Financial Statements.

2

JACKSONVILLE BANCORP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(Dollars in thousands, except per share amounts)

	Three Months Ended
	March 31,
	2014		2013
Interest and dividend income:
Loans, including fees	$	4,660	$	5,879
Taxable securities		320		278
Tax-exempt securities		100		175
Federal funds sold and other		38		30
Total interest income		5,118		6,362
Interest expense:
Deposits		564		799
Federal Reserve and other borrowings		11		74
Federal Home Loan Bank advances		74		53
Subordinated debentures		203		207
Total interest expense		852		1,133
Net interest income		4,266		5,229
Provision for loan losses		-		217
Net interest income after provision for loan losses		4,266		5,012
Noninterest income:
Service charges on deposit accounts		174		207
Other income		203		217
Total noninterest income		377		424
Noninterest expense:
Salaries and employee benefits		2,159		2,047
Occupancy and equipment		649		673
Regulatory assessments		192		198
Data processing		540		440
Advertising and business development		58		94
Professional fees		238		472
Telephone expense		93		87
Other real estate owned expense		69		307
Other		619		919
Total noninterest expense		4,617		5,237
Net income before income taxes		26		199
Income tax benefit		-		-
Net income	$	26	$	199
Noncash, implied preferred stock dividend		-		(31,464	)
Net income (loss) available to common shareholders	$	26	$	(31,265	)
Weighted average common shares outstanding: (1)
Basic shares		5,795,095		2,572,322
Dilutive stock options		7,733		32
Diluted shares		5,802,828		2,572,354
Earnings (loss) per common share: (1)
Basic	$	0.00	$	(12.15	)
Diluted	$	0.00	$	(12.15	)

⁽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 the Consolidated Financial Statements.

3

JACKSONVILLE BANCORP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

(Dollars in thousands)

	Three Months Ended
	March 31,
	2014		2013
Net income	$	26	$	199
Other comprehensive income (loss):
Change in unrealized holding (losses) gains on available-for-sale securities		524		(423	)
Net unrealized derivative gains on cash flow hedge		5		97
Reclassification adjustment for net gains on investments realized in earnings		-		(37	)
Other comprehensive income (loss)		529		(363	)
Tax effect		-		-
Other comprehensive (loss) income, net of tax effect		529		(363	)
Total comprehensive income ( loss)	$	555	$	(164	)

See accompanying notes to the Consolidated Financial Statements.

4

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																			199						199
Other comprehensive loss																						(363	)		(363	)
Total comprehensive loss																									(164	)
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																	12								12
Balance as of March 31, 2013		2,676,544	$	27		2,618,000		$	26		-			-		$	133,852	$	(101,529	)	$	1,048		$	33,424
Balance as of December 31, 2013		3,177,090	$	32		2,618,005		$	26		-		$	-		$	138,050	$	(102,688	)	$	(1,488	)	$	33,932
Net income																			26						26
Other comprehensive income																						529			529
Total comprehensive income																									555
Permitted transfer of nonvoting common stock to common stock		484		0		(484	)		0																-
Share-based compensation expense																	17								17
Balance as of March 31, 2014		3,177,574	$	32		2,617,521		$	26		-		$	-		$	138,067	$	(102,662	)	$	(959	)	$	34,504

⁽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.

5

JACKSONVILLE BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 (Unaudited)

(Dollars in thousands)

	Three Months Ended
	March 31,
	2014			2013
Cash flows from operating activities:
Net income	$	26		$	199
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		177			171
Net amortization of deferred loan fees		65			3
Provision for loan losses		-			217
Premium amortization for securities, net of accretion		226			280
Net realized gain on sale of securities		-			(37	)
Net accretion of purchase accounting adjustments		(101	)		(777	)
Net gain on sale of other real estate owned		-			(67	)
Write-down of other real estate owned		23			47
Capitalized other real estate owned expenses		(12	)		-
Earnings on bank-owned life insurance		(54	)		(43	)
Share-based compensation		17			12
Net change in:
Accrued interest receivable and other assets		(170	)		1,260
Accrued expenses and other liabilities		(105	)		(135	)
Net cash from operating activities		92			1,130
Cash flows from investing activities:
Available-for-sale securities:
Sales		-			2,174
Maturities, prepayments and calls		3,946			6,177
Purchases		-			(16,330	)
Loan (originations) payments, net		(9,960	)		1,651
Proceeds from sale of other real estate owned		-			727
Additions to premises and equipment, net		(75	)		(85	)
Purchase of Federal Home Loan Bank stock, net of redemptions		224			192
Net cash used for investing activities		(5,865	)		(5,494	)
Cash flows from financing activities:
Net change in deposits		(10,989	)		(43,754	)
Net cash used for financing activities		(10,989	)		(43,754	)
Net change in cash and cash equivalents		(16,762	)		(48,118	)
Cash and cash equivalents at beginning of period		40,325			72,079
Cash and cash equivalents at end of period	$	23,563		$	23,961

See accompanying notes to Consolidated Financial Statements.

6

JACKSONVILLE BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Cont.)

(Unaudited)

(Dollars in thousands)

	Three Months Ended
	March 31,
	2014		2013
Supplemental disclosures of cash flow information:
Cash paid during the period for
Interest	$	876	$	1,504
Income taxes		-		-
Supplemental schedule of noncash investing activities:
Acquisition of other real estate owned	$	492	$	3,669
Supplemental schedule of noncash financing activities:
Implied preferred stock dividend	$	-	$	31,464

See accompanying notes to Consolidated Financial Statements.

7

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 and for the periods ended March 31, 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 dependent on 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 on the level yield 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.

8

JACKSONVILLE BANCORP, INC.

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 entity 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 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 three months ended March 31, 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.

9

JACKSONVILLE BANCORP, INC.

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 three months ended March 31, 2014 and 2013, partial charge-offs were $466 and $229, respectively, on nonperforming and impaired loans of $2,833 and $3,130, 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 March 31, 2014 and December 31, 2013, overdrawn customer checking accounts reclassified as commercial loans were $49 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.

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.

10

JACKSONVILLE BANCORP, INC.

NOTE 1 – BASIS OF PRESENTATION (Continued)

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.

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 ofour 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 broad deterioration of property values, reduced consumer and business spending as a result of continued high unemployment and reduced credit availability and lack of confidence in 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.

11

JACKSONVILLE BANCORP, INC.

NOTE 1 – BASIS OF PRESENTATION (Continued)

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.

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 1-for-20 reverse stock split.  Please refer to Note 9 – Shareholders’ Equity for additional information related to the reverse stock split.

12

JACKSONVILLE BANCORP, INC.

NOTE 1 – BASIS OF PRESENTATION (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.

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”).

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.

13

JACKSONVILLE BANCORP, INC.

NOTE 2—CAPITAL RAISE TRANSACTIONS (Continued)

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.

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.

14

JACKSONVILLE BANCORP, INC.

NOTE 2—CAPITAL RAISE TRANSACTIONS (Continued)

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.

Management believes 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.  During the three months ended March 31, 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.  Such improvements have not yet materially impacted our financial condition or results of operations; however, these changes have contributed to the recent improvements in the Company’s overall asset quality.

15

JACKSONVILLE BANCORP, INC.

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 March 31, 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
March 31, 2014
Available-for-sale:
U.S. government-sponsored entities and agencies	$	8,045	$	124	$	(48	)	$	8,121
State and political subdivisions		7,383		414		(17	)		7,780
Mortgage-backed securities - residential		31,023		793		(96	)		31,720
Collateralized mortgage obligations		30,985		132		(752	)		30,365
Corporate bonds		3,034		103		-			3,137
Total available-for-sale securities	$	80,470	$	1,566	$	(913	)	$	81,123

	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 March 31, 2014 and December 31, 2013, the Company’s investment securities portfolio did not include any held-to-maturity securities.

The following table summarizes the proceeds from sales of available-for-sale securities and the associated gains and losses for the three months ended March 31, 2014 and 2013:

	Three Months Ended
	March 31,
(Dollars in thousands)	2014		2013
Gross gains	$	-	$	37
Gross losses		-		-
Net gain	$	-	$	37
Proceeds	$	-	$	2,174

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) March 31, 2014	Amortized Cost		Fair Value
Available-for-sale:
Within one year	$	-	$	-
One to five years		2,889		3,011
Five to ten years		4,437		4,472
Beyond ten years		11,136		11,555
Mortgage-backed securities – residential		31,023		31,720
Collateralized mortgage obligations		30,985		30,365
Total	$	80,470	$	81,123

16

JACKSONVILLE BANCORP, INC.

NOTE 3 - INVESTMENT SECURITIES (Continued)

The following table summarizes the investment securities with unrealized losses as of March 31, 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) March 31, 2014	Fair Value		Unrealized losses			Fair Value		Unrealized losses			Fair Value		Unrealized losses
Available-for-sale:
U.S. government-sponsored entities and agencies	$	952	$	(48	)	$	-	$	-		$	952	$	(48	)
State and political subdivisions		845		(17	)		-		-			845		(17	)
Mortgage backed securities – residential		5,457		(96	)		-		-			5,457		(96	)
Collateralized mortgage obligations		7,575		(172	)		10,045		(580	)		17,620		(752	)
Corporate bonds		-		-			-		-			-		-
Total available-for-sale securities	$	14,829	$	(333	)	$	10,045	$	(580	)	$	24,874	$	(913	)

	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 March 31, 2014 and December 31, 2013, the Company’s security portfolio consisted of $81,123 and $84,771, respectively, in available-for-sale securities, of which $24,874 and $33,679 were in an unrealized loss position for the related periods.  The unrealized losses as of March 31, 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 March 31, 2014 and December 31, 2013, the number of U.S. Agency Securities with unrealized losses were one and two, respectively.  As of March 31, 2014 and December 31, 2013, these securities had depreciated 4.85% 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 March 31, 2014 and December 31, 2013, Municipal Bonds with unrealized losses were one and two, respectively.  As of March 31, 2014 and December 31, 2013, these securities had depreciated 1.94% 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.

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 March 31, 2014 and December 31, 2013, Mortgage-backed Securities with unrealized losses were six and eight, respectively.  As of March 31, 2014 and December 31, 2013, these securities had depreciated 1.73% 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.

17

JACKSONVILLE BANCORP, INC.

NOTE 3 - INVESTMENT SECURITIES (Continued)

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 March 31, 2014 and December 31, 2013, collateralized mortgage obligations with unrealized losses were fourteen and seventeen, respectively.  As of March 31, 2014 and December 31, 2013, these securities had depreciated 4.10% 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 March 31, 2014 and December 31, 2013, corporate bonds with unrealized losses were none and one, respectively.  As of March 31, 2014 and December 31, 2013, these securities had depreciated 0% 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 March 31, 2014 and December 31, 2013.

For the three months ended March 31, 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 March 31, 2014 and December 31, 2013 were as follows:

(Dollars in thousands)	March 31, 2014			December 31, 2013
Commercial loans	$	47,111		$	43,855
Real estate mortgage loans:
Residential		72,752			71,192
Commercial		227,451			223,182
Construction and land		30,213			30,355
Consumer and other loans		2,095			2,041
Loans, gross		379,622			370,625
Less:
Net deferred loan fees		(338	)		(273	)
Allowance for loan losses		(15,104	)		(15,760	)
Loans, net	$	364,180		$	354,592

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 March 31, 2014 and December 31, 2013.  This discount will be accreted into interest income as deemed appropriate over the remaining term of the related loans.

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JACKSONVILLE BANCORP, INC.

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

(Dollars in thousands) March 31, 2014	Gross Contractual Amount Receivable		Discount		Carrying Balance
Commercial loans	$	2,070	$	167	$	1,903
Real estate mortgage loans:
Residential		19,185		1,210		17,975
Commercial		43,388		2,931		40,457
Construction and land		4,723		400		4,323
Consumer and other loans		441		6		435
Total	$	69,807	$	4,714	$	65,093

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.

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.

19

JACKSONVILLE BANCORP, INC.

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

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.

Activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2014 and 2013 was as follows:

	Three Months Ended
	March 31,
(Dollars in thousands)	2014			2013
Allowance at beginning of period	$	15,760		$	20,198
Charge-offs:
Commercial loans		203			-
Real estate mortgage loans		664			547
Consumer and other loans		12			133
Total charge-offs		879			680
Recoveries:
Commercial loans		17			11
Real estate mortgage loans		201			68
Consumer and other loans		5			6
Total recoveries		223			85
Net charge-offs		656			595
Provision for loan losses charged to operating expenses:
Commercial loans		254			137
Real estate mortgage loans		(322	)		(66	)
Consumer and other loans		68			146
Total provision		-			217
Allowance at end of period	$	15,104		$	19,820

20

JACKSONVILLE BANCORP, INC.

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 March 31, 2014 and December 31, 2013:

(Dollars in thousands)	Commercial		Real Estate		Consumer and
March 31, 2014	Loans		Mortgage Loans		Other Loans		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	17	$	1,344	$	315	$	1,676
Collectively evaluated for impairment		1,266		11,404		372		13,042
Loans acquired with deteriorated credit quality		-		386		-		386
Total ending allowance balance	$	1,283	$	13,134	$	687	$	15,104
Loans:
Loans individually evaluated for impairment	$	208	$	22,342	$	354	$	22,904
Loans collectively evaluated for impairment		46,803		289,966		1,740		338,509
Loans acquired with deteriorated credit quality		100		18,108		1		18,209
Total ending loans balance	$	47,111	$	330,416	$	2,095	$	379,622

	Commercial		Real Estate		Consumer and
December 31, 2013	Loans		Mortgage Loans		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

21

JACKSONVILLE BANCORP, INC.

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

The following table presents loans individually evaluated for impairment, by class of loans as of March 31, 2014 and December 31, 2013:

	March 31, 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	$	192	$	191	$	-	$	43	$	43	$	-
Real estate mortgage loans:
Residential		2,674		2,624		-		2,341		2,286		-
Commercial		11,700		9,188		-		4,643		4,395		-
Construction and land		4,689		3,310		-		8,586		4,806		-
Consumer and other loans		38		38		-		40		40		-
With an allowance recorded:
Commercial loans	$	18	$	17	$	17	$	264	$	261	$	223
Real estate mortgage loans:
Residential		968		896		198		1,597		1,574		209
Commercial		4,327		4,213		754		7,910		6,062		1,001
Construction and land		4,532		2,111		392		667		660		398
Consumer and other loans		339		316		315		341		324		323
Total	$	29,477	$	22,904	$	1,676	$	26,432	$	20,451	$	2,154

The following table presents the average recorded investment in impaired loans and the related interest income recognized during impairment for the three months ended March 31, 2014 and 2013.

(Dollars in thousands) March 31, 2014	Average Impaired Loans		Interest Income		Cash-Basis
Commercial loans	$	389	$	-	$	-
Real estate mortgage loans:
Residential		4,061		20		13
Commercial		12,240		55		56
Construction and land		5,524		11		3
Consumer and other loans		358		-		-
Total	$	22,572	$	86	$	72

March 31, 2013	Average Impaired Loans		Interest Income		Cash-Basis
Commercial loans	$	125	$	-	$	-
Real estate mortgage loans:
Residential		1,382		-		-
Commercial		9,190		49		47
Construction and land		3,791		-		-
Consumer and other loans		243		-		-
Total	$	14,731	$	49	$	47

22

JACKSONVILLE BANCORP, INC.

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

The following table presents the recorded investment in nonaccrual loans by class of loans as of March 31, 2014 and December 31, 2013:

(Dollars in thousands)	March 31, 2014		December 31, 2013
Commercial loans	$	208	$	304
Real estate mortgage loans:
Residential		1,198		3,716
Commercial		9,837		7,105
Construction and land		4,981		5,517
Consumer and other loans		355		366
Total(1)	$	16,579	$	17,008

⁽¹⁾ Includes loans acquired in the merger with ABI.  As of March 31, 2014 and December 31, 2013, these amounts totaled $5,695 and $4,537, respectively.

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

	Past Due Loans
(Dollars in thousands) March 31, 2014	30-59 Days		60-89 Days		90 Days and Greater		Total		Loans Not Past Due		Total
Commercial loans	$	149	$	-	$	74	$	223	$	46,888	$	47,111
Real estate mortgage loans:
Residential		380		-		700		1,080		71,672		72,752
Commercial		3,321		768		4,749		8,838		218,613		227,451
Construction and land		55		133		4,399		4,587		25,626		30,213
Consumer and other loans		-		-		39		39		2,056		2,095
Total	$	3,905	$	901	$	9,961	$	14,767	$	364,855	$	379,622

	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 March 31, 2014 and December 31, 2013, the amounts of such loans were as follows:

(Dollars in thousands)	March 31, 2014		December 31, 2013
30-59 days past due	$	11	$	87
60-89 days past due		137		167
90 days past due and greater		2,291		2,709
Total past due	$	2,439	$	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.

23

JACKSONVILLE BANCORP, INC.

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 March 31, 2014 and December 31, 2013.

(Dollars in thousands)	March 31, 2014		December 31, 2013
Recorded investment(1)	$	14,076	$	12,535
Specific reserves allocated(2)		639		953

⁽¹⁾ Of the total recorded investment in loans modified as TDRs, $1,002 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, $369 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 months ended March 31, 2014 and 2013, respectively:

	Three Months Ended
	March 31, 2014
(Dollars in thousands)	Number of loans		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Commercial loans		-	$	-	$	-
Real estate mortgage loans:
Residential		1		24		30
Commercial		5		2,915		2,726
Construction and land		-		-		-
Consumer and other loans		1		239		239
Total		7	$	3,178	$	2,995

	Three Months Ended
	March 31, 2013
	Number of loans		Pre- Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment
Commercial loans		-	$	-		-
Real estate mortgage loans:
Residential		1		579		777
Commercial		-		-		-
Construction and land		2		3,284		3,264
Consumer and other loans		-		-		-
Total		3	$	3,863	$	4,041

24

JACKSONVILLE BANCORP, INC.

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

During the three months ended March 31, 2014, there were seven loans 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, or (vi) proposed forgiveness of principal contingent upon the satisfaction of the modified terms.  The troubled debt restructurings described above did not increase the allowance for loan losses as of March 31, 2014 and resulted in charge-offs of $195 for the three months ended March 31, 2014.   For the three months ended March 31, 2014, there were five collateral-impaired loans modified as troubled debt restructurings.

During the three months ended March 31, 2013, there were three loans modified as troubled debt restructurings.  These troubled debt restructurings include several loans modified into a multiple loan structure to accommodate the revised terms and are presented based on the number of loans pre-modification.  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) forgiveness of principal, (iv) reduced principal and interest payments through maturity with an assumption of additional debt to protect the Bank’s collateral position, or (v) 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 $42 and resulted in charge-offs of $233 for the three months ended March 31, 2013.  For the three months ended March 31, 2013, there was one collateral-impaired loan modified as troubled debt restructurings.

As of March 31, 2014 and December 31, 2013, the Company had extended additional credit of $5 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 months ended March 31, 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 months ended March 31, 2014 and 2013.  These loans had a total recorded investment of $2,787 and $5,478 as of March 31, 2014 and 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.

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.

25

JACKSONVILLE BANCORP, INC.

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 as 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 March 31, 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
March 31, 2014	Pass		Mention		Substandard		Doubtful		Total
Commercial loans	$	46,148	$	450	$	513	$	-	$	47,111
Real estate mortgage loans:
Residential		62,246		4,506		6,000		-		72,752
Commercial		202,470		9,376		15,605		-		227,451
Construction and land		22,005		350		7,858		-		30,213
Consumer and other loans		1,710		31		354		-		2,095
Total	$	334,579	$	14,713	$	30,330	$	-	$	379,622

			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

26

JACKSONVILLE BANCORP, INC.

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 March 31, 2014 and December 31, 2013, the amounts of such loans were as follows:

(Dollars in thousands)	March 31, 2014		December 31, 2013
Special mention	$	707	$	711
Substandard		10,621		9,170
Doubtful		-		-
Total	$	11,328	$	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).

27

JACKSONVILLE BANCORP, INC.

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 March 31, 2014 and December 31, 2013:

(Dollars in thousands)	March 31, 2014		December 31, 2013
Commercial loans	$	154	$	160
Real estate mortgage loans:
Residential		4,562		5,137
Commercial		14,226		14,359
Construction and land		1,391		1,398
Consumer and other loans		1		2
Unpaid principal balance	$	20,334	$	21,056
Carrying amount	$	18,209	$	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		(1,850	)
Reduction for loans sold, paid off and other		110
Loans charged off		(1,094	)
Reclassifications from nonaccretable difference		-
Disposals		-
Balance as of December 31, 2013	$	8,993
New loans purchased, including loans classified as held-for-sale		-
Accretion of income		(285	)
Reduction for loans sold, paid off and other		-
Loans charged off		-
Reclassifications from nonaccretable difference		-
Disposals		-
Balance as of March 31, 2014	$	8,708

For those purchased loans disclosed above, the Company increased the allowance for loan losses to $386 and $392 as of March 31, 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 March 31, 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.

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.  Funds remaining available under the Revolvers as of March 31, 2014 and December 31, 2013 were a direct result of this transaction.

28

JACKSONVILLE BANCORP, INC.

NOTE 5 – LOANS FROM RELATED PARTIES (Continued)

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 March 31, 2014and December 31, 2013, advances from the FHLB were as follows:

(Dollars in thousands)	March 31, 2014		December 31, 2013
Overnight advances maturing daily at a daily variable interest rate of 0.36% on March 31, 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 $28,487 as of March 31, 2014 and had borrowed $20,000, leaving $8,487 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 March 31, 2014 and December 31, 2013 was $24,318 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.

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JACKSONVILLE BANCORP, INC.

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 $759 and $765 as of March 31, 2014 and December 31, 2013, respectively.  The fair value of the hedged item was $4,723 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 March 31, 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 1^st and December 1^st, 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 March 31, 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 15^th and December 15^th, beginning February 15, 2013.

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JACKSONVILLE BANCORP, INC.

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.

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JACKSONVILLE BANCORP, INC.

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 March 31, 2014 and December 31, 2013, the carrying amount of common stock outstanding was $32.  As of March 31, 2014 and December 31, 2013, the carrying amount of 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 will continue 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

The following table presents information related to changes in accumulated other comprehensive income by component as of March 31, 2014 and March 31, 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		(423	)		97			(326	)
Amounts reclassified from accumulated other comprehensive (loss) income		(37	)		-			(37	)
Other comprehensive (loss) income, net		(460	)		97			(363	)
Balance as of March 31, 2013	$	1,758		$	(710	)	$	1,048
Balance as of December 31, 2013	$	(1,211	)	$	(277	)	$	(1,488	)
Other comprehensive (loss) income before reclassifications		524			5			529
Amounts reclassified from accumulated other comprehensive (loss) income		-			-			-
Other comprehensive (loss) income, net		524			5			529
Balance as of March 31, 2014	$	(687	)	$	(272	)	$	(959	)

Amounts reclassified from accumulated other comprehensive income during the three months ended March 31, 2013 resulted from realized gains on the sale of available-for-sale securities presented in Other income on the Consolidated Satements of Operations.

32

JACKSONVILLE BANCORP, INC.

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 March 31, 2014 and December 31, 2013, for which the Company has elected the fair value option, by level within the hierarchy:

(Dollars in thousands)
March 31, 2014	Total		Level I		Level II		Level III
Assets:
Securities available-for-sale:
U.S. government-sponsored entities and agencies	$	8,121	$	-	$	8,121	$	-
State and political subdivisions		7,780		-		7,780		-
Mortgage-backed securities - residential		31,720		-		31,720		-
Collateralized mortgage obligations		30,365		-		30,365		-
Corporate bonds		3,137		-		3,137		-
Liabilities:
Derivative liability		759		-		759		-

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 months ended March 31, 2014 and the year ended December 31, 2013.

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.

33

JACKSONVILLE BANCORP, INC.

NOTE 10 – FAIR VALUE (Continued)

The following table presents information about our assets measured at fair value on a non-recurring basis as of March 31, 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)
March 31, 2014	Total		Level I		Level II		Level III
Impaired Loans (Collateral Dependent):
Real estate mortgage loans:
Residential	$	512	$	-	$	-	$	512
Commercial		1,459		-		-		1,459
Construction and land		1,719		-		-		1,719
Other real estate owned:
Real estate mortgage loans:
Residential		-		-		-		-
Commercial		169		-		-		169
Construction and land		2,358		-		-		2,358

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

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.

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JACKSONVILLE BANCORP, INC.

NOTE 10 – FAIR VALUE (Continued)

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 March 31, 2014 and December 31, 2013, respectively.

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 March 31, 2014 and December 31, 2013. This quantitative information is the same for each class of loans.

(Dollars in thousands) March 31, 2014	Fair Value			Valuation Technique	Unobservable Inputs	Range of Inputs			Weighted Average
Impaired loans (collateral dependent)		$	3,690	Market comparable properties	Marketability discount		0% - 15.0	%		1.5	%
Other real estate owned			2,527	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 three months ended March 31, 2014 and 2013:

(Dollars in thousands) March 31, 2014	Outstanding Balance		Valuation Allowance		Net Carrying Amount		Period Expense
Impaired loans (collateral dependent)	$	5,107	$	1,417	$	3,690	$	51
Other real estate owned		3,509		982		2,527		23

March 31, 2013	Outstanding Balance		Valuation Allowance		Net Carrying Amount		Period Expense
Impaired loans (collateral dependent)	$	3,026	$	1,766	$	1,260	$	598
Other real estate owned		10,524		604		9,920		47

35

JACKSONVILLE BANCORP, INC.

NOTE 10 – FAIR VALUE (Continued)

Fair Value of Financial Instruments

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

	March 31, 2014				December 31, 2013
(Dollars in thousands)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Cash and cash equivalents	$	23,563	$	23,563	$	40,325	$	40,325
Securities available-for-sale		81,123		81,123		84,771		84,771
Loans, net		364,180		371,515		354,592		361,874
Federal Home Loan Bank stock		1,356		N/A		1,580		N/A
Accrued interest receivable		1,647		1,647		1,723		1,723
Financial Liabilities:
Deposits	$	423,979	$	413,757	$	434,966	$	422,430
Federal Home Loan Bank Advances and other borrowings		20,147		20,320		20,153		20,351
Subordinated debentures		16,170		7,729		16,154		7,275
Accrued interest payable		145		145		167		167
Interest rate swap		759		759		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 March 31, 2014 and December 31, 2013, respectively, the breakdown of cash and cash equivalents between Level I and Level II were as follows:

	March 31, 2014						December 31, 2013
(Dollars in thousands)	Level I			Level II			Level I			Level II
Cash and cash equivalents		$	17,876		$	5,687		$	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 in 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.

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.

36

JACKSONVILLE BANCORP, INC.

NOTE 10 – FAIR VALUE (Continued)

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 March 31, 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 March 31, 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.

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 March 31, 2014 and December 31, 2013, when the Bank had total risk-based capital of 14.00% and 14.11%, respectively, and Tier 1 leverage capital of 9.74% and 9.33% as of the same dates.

37

JACKSONVILLE BANCORP, INC.

NOTE 11 – CAPITAL ADEQUACY (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 capital to risk-weighted assets of at least 8.00%, at least half of which must be Tier 1 capital.  As of March 31, 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 March 31, 2014 and December 31, 2013:

(Dollars in thousands)	Actual					For Capital Adequacy Purposes					Minimum To Be Well Capitalized Under Prompt Corrective Action Provisions
March 31, 2014	Amount		Ratio			Amount		Ratio			Amount			Ratio
Total capital to risk-weighted assets:
Consolidated	$	55,728		14.68	%	$	30,367		8.00	%		N/	A		N/	A
Bank		53,082		14.00			30,338		8.00		$	37,922			10.00	%
Tier 1 (Core) capital to risk-weighted assets:
Consolidated		46,506		12.25			15,183		4.00			N/	A		N/	A
Bank		48,214		12.71			15,169		4.00			22,753			6.00
Tier 1 (Core) capital to average assets:
Consolidated		46,506		9.39			19,820		4.00			N/	A		N/	A
Bank		48,214		9.74			19,792		4.00			24,740			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

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 March 31, 2014 and December 31, 2013, remaining funds available under the Revolvers were $2,200.

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JACKSONVILLE BANCORP, INC.

NOTE 11 – CAPITAL ADEQUACY (Continued)

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.

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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 March 31, 2014 and December 31, 2013 and results of operations for the three months ended March 31, 2014 compared to the same period 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.  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 conditions.

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.

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

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

The Company received updated appraisals on a majority of its substandard assets during the second half of 2012.  As a result of having current appraisals, more modest discounts were required due to the factors noted above.  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 March 31, 2014 were 1.5% 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 March 31, 2014 and December 31, 2013, the Bank was well-capitalized with total risk based capital of 14.00% and 14.11% and Tier 1 leverage capital of 9.74% and 9.33%, respectively.  During the three months ended March 31, 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.  Such improvements have not yet materially impacted our financial condition or results of operations; however, these changes have contributed to the recent improvements in the Company’s overall asset quality.

To further supplement the Company’s business strategy, the Bank has adopted a philosophy of seeking and retaining the best available personnel for positions of responsibility, 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.  Please refer to Item 1A. Risk Factors of Part II—Other Information for additional information related to these events and the potential impact on our operating results.

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.

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JACKSONVILLE BANCORP, INC.

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

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.

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.

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JACKSONVILLE BANCORP, INC.

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

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

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.

Introduction

The Company’s performance during the periods ended March 31, 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 recent indicators of stabilization in the local real estate markets, the Company recognized no provision expense, reduced noninterest expense and a continued general reduction in nonperforming loans during the three months ended March 31, 2014.

Comparison of Financial Condition as of March 31, 2014 and December 31, 2013

Total assets decreased $10.5 million, or 2.07%, from $507.3 million as of December 31, 2013 to $496.8 million as of March 31, 2014.  The Company experienced a significant decrease in cash and cash equivalents as a result of a reduction in federal funds sold in the amount of $16.1 million and a decrease in securities available-for-sale of $3.6 million.  These amounts were offset by an increase in net loans of $9.6 million and other real estate owned of $0.5 million during the three months ended March 31, 2014.

Investment securities available-for-sale decreased $3.6 million, or 4.30%, from $84.8 million as of December 31, 2013 to $81.1 million as of March 31, 2014.  During the three months ended March 31, 2014, the Company received $3.9 million in proceeds from principal repayments, maturities and calls.  The remaining variance is due to the change in fair market value during the same year-to-date period.

Total deposits decreased by $11.0 million, or 2.53%, during the three months ended March 31, 2014, from $435.0 million as of December 31, 2013 to $424.0 million as of March 31, 2014.  The following is an explanation of the changes in each of the major deposit categories during the three months ended March 31, 2014:

· Noninterest-bearing deposits decreased $3.1 million, or 3.05%, as a result of expected seasonality, largely due to our business customer deposit base from disbursements of year-end bonuses and taxes due;

· Money market, NOW and savings deposits increased $2.1 million, or 1.12%, due to natural fluctuations in account balances; and

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JACKSONVILLE BANCORP, INC.

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

· The time deposit portfolio decreased by $10.0 million, or 6.86%, driven primarily by a $9.2 million reduction in local CDs.  The remaining variance was due to a decrease in national CDs when compared to the prior year-end.

Loans from related parties and FHLB advances and other borrowings remained substantially unchanged during the three months ended March 31, 2014, with no balance outstanding from loans from related parties as of March 31, 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.

Total shareholders’ equity increased slightly during the three months ended March 31, 2014, from $33.9 million as of December 31, 2013 to $34.5 million as of March 31, 2014.  This increase was attributable to a decrease in accumulated comprehensive loss of $0.5 million and net income during the three months ended March 31, 2014 of $26 thousand.  Accumulated comprehensive income increased based on changes in interest rates during the three months ended March 31, 2014.

Comparison of Operating Results for the Three Months Ended March 31, 2014 and 2013

Net Income

The Company had net income of $26 thousand for the three months ended March 31, 2014 compared to net income of $199 thousand for the three months ended March 31, 2013.  On a diluted per share basis, the Company had no income available to common shareholders for the three months ended March 31, 2014, compared to a net loss of $12.15 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 $4.3 million for the three months ended March 31, 2014, compared to $5.2 million for the same period in 2013.

Total interest income decreased $1.3 million for the three months ended March 31, 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 5.03% for the three months ended March 31, 2014 compared to 6.03% for the three months ended March 31, 2013.  The decrease in the loan yield was driven by a decrease in accretion recognized on acquired loans of approximately $0.7 million as well as a slight decrease in the core average yield earned on loans.

The average cost of interest-bearing liabilities decreased 16 basis points to 0.95% for the three months ended March 31, 2014 compared to 1.11% 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.

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JACKSONVILLE BANCORP, INC.

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

The net interest margin decreased by 46 basis point to 3.62% from 4.08%, when comparing the first three months of 2014 to the same period in the prior year.  The Company closely monitors its liquidity needs in conjunction with the cost of its funding sources and evaluates rates paid on its core deposits to ensure they remain competitive in the local market environment.

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.

	Three Months Ended March 31,
	2014							2013
(Dollars in thousands)	Average Balance		Interest		Average Rate			Average Balance		Interest		Average Rate
Interest-earning assets:
Loans (1)	$	375,753	$	4,660		5.03	%	$	395,589	$	5,879		6.03	%
Securities available-for-sale:
Taxable		76,996		320		1.69			74,297		278		1.52
Tax-exempt(2)		8,009		100		5.01			16,889		175		4.20
Other interest-earning assets(3)		17,566		38		0.88			32,816		30		0.37
Total interest-earning assets		478,324		5,118		4.34			519,591		6,362		4.97
Noninterest-earning assets(4)		17,656							18,464
Total assets	$	495,980						$	538,055
Interest-bearing liabilities:
Savings deposits	$	9,623	$	4		0.17	%	$	9,778	$	7		0.29	%
NOW deposits		26,162		5		0.08			21,693		5		0.09
Money market deposits		152,320		140		0.37			164,115		273		0.67
Time deposits		138,266		415		1.22			178,859		514		1.17
FHLB advances		20,000		74		1.50			20,000		74		1.50
Federal Reserve and other borrowings		11		-		0.00			11		-		0.00
Subordinated debt		16,160		203		5.09			16,097		207		5.22
Other interest-bearing liabilities(5)		-		11		0.00			2,200		53		9.77
Total interest-bearing liabilities		362,542		852		0.95			412,753		1,133		1.11
Noninterest-bearing liabilities		99,227							91,734
Shareholders' equity		34,211							33,568
Total liabilities and shareholders' equity	$	495,980						$	538,055
Net interest income			$	4,266						$	5,229
Interest rate spread(6)						3.39	%						3.86	%
Net interest margin(7)						3.62	%						4.08	%

⁽¹⁾ Average loans include nonperforming loans.  Interest on loans included loan fees (in thousands) of $17 and $70 for the three months ended March 31, 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.

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

⁽⁵⁾ Includes federal funds purchased and 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.

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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.

	Three Months Ended March 31, 2014 vs. 2013
	Increase (Decrease) Due to(1)
(Dollars in thousands)	Rate			Volume			Total
Interest-earning assets:
Loans	$	(936	)	$	(283	)	$	(1,219	)
Securities available-for-sale:
Taxable		32			10			42
Tax-exempt		29			(104	)		(75	)
Other interest-earning assets		27			(19	)		8
Total interest-earning assets	$	(848	)	$	(396	)	$	(1,244	)
Interest-bearing liabilities:
Savings deposits	$	(3	)	$	-		$	(3	)
NOW deposits		(1	)		1			-
Money market deposits		(115	)		(18	)		(133	)
Time deposits		22			(121	)		(99	)
FHLB advances		-			-			-
Federal Reserve and other borrowings		-			-			-
Subordinated debt		(5	)		1			(4	)
Other interest-bearing liabilities		(15	)		(27	)		(42	)
Total interest-bearing liabilities	$	(117	)	$	(164	)	$	(281	)
Net change in net interest income	$	(731	)	$	(232	)	$	(963	)

⁽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 $377 thousand and $424 thousand in service charges and other income for the three months ended March 31, 2014 and 2013, respectively.  Included in Other income, the Company recorded a net gain of $37 thousand from the sale of municipal securities during the three months ended March 31, 2013.

Noninterest expense decreased to $4.6 million for the three months ended March 31, 2014, compared to $5.2 million for the same period in 2013.  This decrease was due to a decrease in professional fees of $0.2 million, mainly related to audit and legal fees that were higher in the first three months of 2013 as a result of the special shareholders’ meeting held in the first quarter of 2013.  In addition, there was a decrease of $0.5 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 three months ended March 31, 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 March 31, 2014 and December 31, 2013, it was determined that the need for a full valuation allowance still existed.

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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 March 31, 2014 and December 31, 2013 were as follows:

(Dollars in thousands)	March 31, 2014			December 31, 2013
Nonperforming loans:
Commercial	$	208		$	304
Real estate mortgage loans
Residential		1,198			3,716
Commercial		9,837			7,105
Construction and land		4,981			5,517
Consumer loans and other		355			366
Total nonperforming loans(1)		16,579			17,008
Other real estate owned, net		3,559			3,078
Total nonperforming assets		20,138			20,086
Performing loans classified as troubled debt restructurings		8,863			6,542
Nonperforming loans classified as troubled debt restructurings(1)		5,213			5,993
Total loans classified as troubled debt restructuring	$	14,076		$	12,535
Nonperforming loans as a percent of gross loans		4.37	%		4.59	%
Nonperforming loans and other real estate owned as a percent of total assets		4.05	%		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 remained relatively flat with a slight increase of $52 thousand as of March 31, 2014 from December 31, 2013, respectively.  Nonperforming loans decreased $0.4 million as of the same dates.  The general reduction of nonperforming loans was primarily due to charge-off’s (both partial and full) on impaired loans that were specifically reserved for as of December 31, 2013 as well as several impaired loans that were paid off in the first quarter of 2014.  This was slightly offset by one large commercial real estate relationship that went on nonaccrual in the first quarter 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 March 31, 2014, impaired loans increased by $2.4 million to $22.9 million, compared to $20.5 million as of December 31, 2013.  Of the $22.9 million impaired loans as of March 31, 2014, $3.5 million were loans acquired from the merger with ABI.  Nonperforming impaired loans were $14.0 million as of March 31, 2014.  Specific reserves in the amount of $1.7 million were allocated to impaired loans as of March 31, 2014.

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 March 31, 2014, the Company had loan balances of $14.1 million for customers whose loans were classified as troubled debt restructurings, of which $13.6 million were included in the impaired loans balance as of the same date.  Of the total loans classified as troubled debt restructurings, $1.0 million were classified as troubled debt restructurings with collateral shortfalls.  The Company has allocated $0.4 million to customers whose loan terms have been modified as troubled debt restructurings with collateral shortfalls and $43 thousand to the remaining troubled debt restructurings included in the impaired loans balance as of March 31, 2014.   An additional allocation in the amount of $9 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.

47

JACKSONVILLE BANCORP, INC.

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

The troubled debt restructurings that occurred during the three months ended March 31, 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.  As of March 31, 2014, the Company had extended additional credit of $5 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 three months ended March 31, 2014.  These loans had a total recorded investment of $2.8 million and $5.5 million as of March 31, 2014 and 2013, respectively.  Modifications during the three months ended March 31, 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, or (iii) extension of interest-only payments for a limited period of time.

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.

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

(Dollars in thousands) March 31, 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	$	74	$	-	$	-	$	74
Real estate mortgage loans:
Residential		185		-		-		185
Commercial		1,839		768		-		2,607
Construction and land		56		-		-		56
Consumer and other loans		-		-		-		-
Total	$	2,154	$	768	$	-	$	2,922

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

The decrease in total loans past due 30-89 days still accruing interest to $2.9 million as of March 31, 2014 from $5.9 million as of December 31, 2013 was driven primarily by general improvements in asset quality during the three months ended March 31, 2014.

48

JACKSONVILLE BANCORP, INC.

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

Adversely classified loans increased slightly to $30.3 million as of March 31, 2014 compared to $30.1 million as of December 31, 2013.  Of the total adversely classified loans as of March 31, 2014, $16.6 million were nonperforming and $10.6 million were from the merger with ABI.  The $10.6 million of adversely classified loans from ABI are net of a fair value adjustment of $1.0 million, or 8.8% of the gross contractual amount receivable as of March 31, 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.

(Dollars in thousands) March 31, 2014	Total Loans		Loans Acquired from ABI		Loans Acquired from ABI with Deteriorated Credit Quality		% of Total
Nonaccrual	$	16,579	$	5,695	$	2,538		15.3	%
Past Due		14,767		2,439		2,290		15.5
Special Mention		14,713		707		685		4.7
Substandard		30,330		10,621		3,858		12.7
Doubtful		-		-		-		-
	$	45,043	$	11,328	$	4,543		10.1

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 three months ended March 31, 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 10.1% as of March 31, 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 March 31, 2014, we had loans acquired with deteriorated credit quality on nonaccrual in the amount of $2.5 million.

49

JACKSONVILLE BANCORP, INC.

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

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.  However, the Company’s ratio of nonaccrual loans to total loans has improved from December 31, 2013 to March 31, 2014 as the Company has shown improvements in our overall asset quality during the three months ended March 31, 2014.  In addition, the Company has historically maintained a higher allowance for loan loss reserves as a percentage of total loans when compared to our peers.

Allowance and Provision for Loan Losses

The allowance for loan losses decreased by $0.7 million during the three months ended March 31, 2014, amounting to $15.1 million as of March 31, 2014 as compared to $15.8 million as of December 31, 2013.  The allowance represented approximately 3.98% and 4.25% of total loans as of March 31, 2014 and December 31, 2013, respectively.

Activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2014 and 2013 was as follows:

	Three Months Ended
	March 31,
(Dollars in thousands)	2014			2013
Allowance at beginning of period	$	15,760		$	20,198
Charge-offs:
Commercial loans		203			-
Real estate mortgage loans		664			547
Consumer and other loans		12			133
Total charge-offs		879			680
Recoveries:
Commercial loans		17			11
Real estate mortgage loans		201			68
Consumer and other loans		5			6
Total recoveries		223			85
Net charge-offs		656			595
Provision for loan losses charged to operating expenses:
Commercial loans		254			137
Real estate mortgage loans		(322	)		(66	)
Consumer and other loans		68			146
Total provision		-			217
Allowance at end of period	$	15,104		$	19,820

The decrease in the allowance for loan losses as of March 31, 2014 compared to December 31, 2013 was driven primarily by charge-offs taken in the first quarter of 2014 that were specifically reserved as part of loans individually evaluated for impairment as of December 31, 2013. In addition, there was an overall slight decrease in the historical loss component used in 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.

50

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 March 31, 2014.

As of March 31, 2014, of the $13.0 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 1.17%, or $2.9 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 1.60%, or $21 thousand.  Impaired loans were $22.9 million as of March 31, 2014, of which $1.7 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 March 31, 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 March 31, 2014, there was one acquired loan with deteriorated credit quality that was deemed a troubled debt restructuring in the amount of $511 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 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.

51

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 March 31, 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 $92 thousand and $1.1 million for the three months ended March 31, 2014 and 2013, respectively.  Net cash from operating activities for the three months ended March 31, 2014 was primarily impacted by net income of $26 thousand, as adjusted for (i) net accretion of purchase accounting adjustments, mainly purchased loans, of $101 thousand, (ii) premium amortization for securities, net of accretion, of $226 thousand, (iii) depreciation and amortization of $177 thousand, (iv) net change in accrued interest receivable and other assets of $170 thousand, and (v) net change in accrued expenses and other liabilities of $105 thousand.  Net cash from operating activities for the same period in the prior year reflected net income of $199 thousand, as adjusted for (a) the net change in accrued interest receivable and other assets of $1.3 million, (b) net accretion of purchase accounting adjustments of $0.8 million, (c) premium amortization for securities, net of accretion, of $0.3 million, and (d) provision for loan losses of $0.2 million.

Cash Flows from Investing Activities:

Net cash used for investing activities was $ 5.9 million and $5.5 million for the three months ended March 31, 2014 and 2013, respectively.  The increase in cash flows used for investing activities was primarily due to a net increase of $11.6 million in cash outflows for loan originations offset by a decrease in net cash inflows of $11.9 million for available-for-sale securities.

52

JACKSONVILLE BANCORP, INC.

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

Cash Flows from Financing Activities:

Net cash used for financing activities was $11.0 million and $43.8 million for the three months ended March 31, 2014 and 2013, respectively.  The period-over-period decrease in cash outflows was due to $11.0 million in net deposit cash flows during the three months ended March 31, 2014, compared to $43.8 million in deposit outflows during the same period in the prior year.

Capital Resources

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 March 31, 2014, the Company had $81.1 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.

The Bank has an unsecured federal funds purchased accommodation with its main correspondent bank totaling $6.0 million as of March 31, 2014, all of which was available as of that date.  In addition, the Bank has established two additional unsecured federal funds purchased accommodations with its secondary correspondent banks for $14.5 million, all of which was available as of March 31, 2014.  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 $28.5 million as of March 31, 2014 and had borrowed $20.0 million, leaving $8.5 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 March 31, 2014 was $24.3 million, all of which was available as of that date.  While these lines of credit were available to the Company as of March 31, 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 March 31, 2014, the Bank had $57.9 million in national CDs and $10.4 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.

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 March 31, 2014 and December 31, 2013, respectively.  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.

53

JACKSONVILLE BANCORP, INC.

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

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 March 31, 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 March 31, 2014 as our net income for the three months ended March 31, 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.

As of March 31, 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%.  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.

54

JACKSONVILLE BANCORP, INC.

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

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 March 31, 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 March 31, 2014 and December 31, 2013, when the Bank had total risk-based capital of 14.00% and 14.11% and Tier 1 leverage capital of 9.74% 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 March 31, 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 276.7% compared to 275.8% as of December 31, 2013.  Both our March 31, 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.

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 March 31, 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.

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations (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 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 March 31, 2014 and December 31, 2013, there were $2.2 million in remaining funds available under the Revolvers, respectively.  During the three months ended March 31, 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.

· 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.

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.

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

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.

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 March 31, 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.

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

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.

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.

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.

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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.

Item 5. Other Information

On May 6, 2014, Valerie A. Kendall, the Executive Vice President and Chief Financial Officer of Bancorp and the Bank, entered into an Amended and Restated Executive Employment Agreement with Bancorp and the Bank (the “New Kendall Agreement”), which replaced Ms. Kendall’s previous Employment Agreement dated May 13, 2009, as amended.  Other than as set forth below, the New Kendall Agreement did not materially change the compensation payable to Ms. Kendall or the terms of her employment, as previously described in Bancorp’s filings with the SEC.

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On May 8, 2014, Margaret A. Incandela, the Executive Vice President and Chief Credit Officer of Bancorp and the Bank, entered into an Amended and Restated Executive Employment Agreement with Bancorp and the Bank (the “New Incandela Agreement”), which replaced Ms. Incandela’s previous Executive Employment Agreement dated September 5, 2012.  Other than as set forth below, the New Incandela Agreement did not materially change the compensation payable to Ms. Incandela or the terms of her employment, as previously described in Bancorp’s filings with the SEC.  The New Incandela Agreement reflected a change in Ms. Incandela’s title from Executive Vice President, Chief Operating Officer and Chief Credit Officer of Bancorp and the Bank to Executive Vice President and Chief Credit Officer of Bancorp and the Bank, which change was effective on April 22, 2014. The New Kendall Agreement and the New Incandela Agreement are collectively referred to herein as the “New Employment Agreements.”

The provisions related to the compensation and benefits payable on a termination of the executive were amended in the New Employment Agreements to clarify the existing language and to expand the definition of “change in control” as a termination triggering event to include, among other things, mergers of Bancorp and the Bank with another entity having common ownership.  Under the New Employment Agreements, a “change in control” includes (i) any person or group becoming the beneficial owner of at least 50% of the combined voting power of the Bank’s or Bancorp’s outstanding voting securities, subject to certain exceptions, (ii) any reorganization, merger, consolidation, statutory share exchange or similar transaction involving Bancorp or the Bank and any person or entity other than a Controlling Person that requires approval of Bancorp’s shareholders, or any sale or other disposition of all or substantially all of Bancorp’s or the Bank’s assets to any person or entity other than a Controlling Person, and (iii) the approval of a complete liquidation or dissolution of Bancorp.  “Controlling Person” means a person or group who is the beneficial owner of at least 25% of the combined voting power of Bancorp’s or the Bank’s outstanding voting securities as of the date of the applicable New Employment Agreement.

Under each New Employment Agreement, the executive will be entitled to receive one year’s base salary after termination of her employment in the case of a termination by the Bank or Bancorp without “cause” or for a termination by the executive for “good cause” other than as a result of a change in control.  If the executive’s employment is terminated by the executive for “good cause” as a result of a change in control that results in a change in the executive’s position or duties within one year of the change in control, the executive is entitled to receive her base salary for a period of 2.9 years following termination.  In addition, Ms. Incandela is entitled to receive severance payments if she terminates her employment within 30 days of a change in control regardless of whether the change in control results in a change in her position or duties.

The foregoing description of the New Employment Agreements does not purport to be complete and is qualified in its entirety by the full text of the New Employment Agreements, copies of which are filed as Exhibits 10.3 and 10.4 to this report and incorporated by reference herein.

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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	Form of Incentive Stock Option Agreement under 2008 Amendment and Restatement of Jacksonville Bancorp, Inc. 2006 Stock Incentive Plan. †
Exhibit No. 10.2	Form of Nonstatutory Stock Option Agreement under 2008 Amendment and Restatement of Jacksonville Bancorp, Inc. 2006 Stock Incentive Plan. †
Exhibit No. 10.3	Amended and Restated Executive Employment Agreement among Jacksonville Bancorp, Inc., The Jacksonville Bank and Margaret A. Incandela. †
Exhibit No. 10.4	Amended and Restated Executive Employment Agreement among Jacksonville Bancorp, Inc., The Jacksonville Bank and Valerie A. Kendall. †
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 *
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.

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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:  May 9, 2014	By:	/S/    KENDALL L. SPENCER
		Kendall L. Spencer
		President and Chief Executive Officer
		(Principal executive officer)
Date:  May 9, 2014	By:	/S/    VALERIE A. KENDALL
		Valerie A. Kendall
		Executive Vice President and
		Chief Financial Officer
		(Principal financial officer and
		Chief accounting officer)

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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	Form of Incentive Stock Option Agreement under 2008 Amendment and Restatement of Jacksonville Bancorp, Inc. 2006 Stock Incentive Plan. †
Exhibit No. 10.2	Form of Nonstatutory Stock Option Agreement under 2008 Amendment and Restatement of Jacksonville Bancorp, Inc. 2006 Stock Incentive Plan. †
Exhibit No. 10.3	Amended and Restated Executive Employment Agreement among Jacksonville Bancorp, Inc., The Jacksonville Bank and Margaret A. Incandela. †
Exhibit No. 10.4	Amended and Restated Executive Employment Agreement among Jacksonville Bancorp, Inc., The Jacksonville Bank and Valerie A. Kendall. †
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 *
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.

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