Washington, D.C. 20549
For the transition period from __________ to ____________.
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.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of The Exchange Act).
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of The Exchange Act).
As of August 10, 2007, the latest practicable date, 1,743,338 of the Registrant’s common shares, $.01 par value, were issued and outstanding.
JACKSONVILLE BANCORP, INC.
See accompanying notes to financial statements.
JACKSONVILLE BANCORP, INC.
See accompanying notes to financial statements.
See accompanying notes to financial statements.
JACKSONVILLE BANCORP, INC.
See accompanying notes to financial statements.
JACKSONVILLE BANCORP, INC.
Jacksonville Bancorp, Inc. is a bank holding company headquartered in Jacksonville, Florida. Jacksonville Bancorp, Inc. owns and operates The Jacksonville Bank, which has a total of five operating branches in Jacksonville, Florida.
The consolidated financial statements include the accounts of Jacksonville Bancorp, Inc. and its wholly owned 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 its subsidiary are collectively referred to as the “Bank.” The Company’s financial condition and operating results principally reflect those of the Bank. All intercompany balances and amounts have been eliminated. For further information 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, 2006.
The accounting and reporting policies of the Company reflect banking industry practice and conform to generally accepted accounting principles in the United States of America. In preparing the consolidated financial statements, management is required to make 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.
The consolidated financial information included herein as of and for the periods ended June 30, 2007 and 2006 is unaudited; however, such information reflects all adjustments which are, in the opinion of management, necessary for a fair statement of results for the interim periods. The December 31, 2006 consolidated balance sheet was derived from the Company's December 31, 2006 audited consolidated financial statements.
In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-5, Accounting for Purchases of Life Insurance - Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 (Accounting for Purchases of Life Insurance). This issue requires that a policyholder consider contractual terms of a life insurance policy in determining the amount that could be realized under the insurance contract. It also requires that if the contract provides for a greater surrender value if all individual policies in a group are surrendered at the same time, that the surrender value be determined based on the assumption that policies will be surrendered on an individual basis. Lastly, the issue discusses whether the cash surrender value should be discounted when the policyholder is contractually limited in its ability to surrender a policy. This issue is effective for fiscal years beginning after December 15, 2006. The adoption of this issue on January 1, 2007 did not have an impact on the financial statements of the Company.
JACKSONVILLE BANCORP, INC.
The composition of the Bank’s loan portfolio at June 30, 2007 and December 31, 2006 is indicated below along with the growth from the prior year end.
Activity in the allowance for loan losses for the six months ended June 30, 2007 and 2006 follows:
Federal banking regulators have established certain capital adequacy standards required to be maintained by banks and bank holding companies. The minimum requirements established in the regulations are set forth in the table below, along with the actual ratios at June 30, 2007 and December 31, 2006:
At June 30, 2007 and December 31, 2006, advances from the Federal Home Loan Bank (FHLB) were as follows:
Each advance is payable at its maturity date, with a prepayment penalty for the fixed rate advances. The advances are collateralized by a blanket lien arrangement of the Company’s first mortgage loans, second mortgage loans and commercial real estate loans.
JACKSONVILLE BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation
General
Jacksonville Bancorp, Inc. (“Bancorp”) was incorporated on October 24, 1997 and was organized to conduct the operations of The Jacksonville Bank (the “Bank”), collectively (the “Company”). 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. The Bank provides a variety of community banking services to businesses and individuals in the greater Jacksonville area of Northeast Florida. During 2000, the Bank formed Fountain Financial, Inc., a wholly owned subsidiary. The primary business activities of Fountain Financial, Inc. consist of referral of our customers to third parties for the sale of insurance products.
Forward Looking Statements
“Management's Discussion and Analysis of Financial Condition and Results of Operations” and “Quantitative and Qualitative Disclosures About Market Risk” contain various forward-looking statements with respect to financial performance and business matters. Such statements are generally contained in sentences including the words or phrases “will likely result,” “are expected to,” “is anticipated,” or “estimate,” “project” or “believe.” The Company cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, including changes in local economic conditions, changes in regulatory requirements, fluctuations in interest rates, demand for products, and competition, and, therefore, actual results could differ materially from those contemplated by the forward-looking statements. In addition, the Company assumes no duty to update forward-looking statements to reflect events or circumstances after the date of such statements.
Business Strategy
Our primary business segment is community banking and consists of attracting deposits from the general public and using such deposits and other sources of funds to originate commercial business loans, commercial real estate loans, residential mortgage loans and a variety of consumer loans. We also invest in securities backed by the United States Government, and agencies thereof, as well as municipal tax-exempt bonds. Our profitability depends primarily on our net interest income, which is the difference between the income we receive from our loan and securities investment portfolios and our costs incurred on our deposits, the Federal Home Loan Bank (“FHLB”) advances, and other sources of funding. Net interest income is also affected by the relative amounts of interest-earning assets and interest-bearing liabilities. Net interest income is generated as the relative amounts of interest-earning assets grow in relation to the relative amounts of interest-bearing liabilities. In addition, the level of noninterest income earned and noninterest expenses incurred also affects profitability. Included in noninterest income are service charges earned on deposit accounts, increases in cash surrender value of Bank Owned Life Insurance (“BOLI”) and mortgage origination fees. Included in noninterest expense are costs incurred for salaries and employee benefits, occupancy and equipment expenses, marketing and advertising expenses, federal deposit insurance premiums and legal and professional fees.
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 interest-earning assets and rates on interest-bearing liabilities; focusing on noninterest income opportunities; controlling the growth of noninterest expenses; and maintaining strong asset quality. We have initiated programs to expand our scope of services and achieve these goals. The Bank has adopted a philosophy of seeking out and retaining the best available personnel for positions of responsibility which we believe will provide us with a competitive edge in the local banking industry. The Bank opened its fourth and fifth locations in 2006 in key areas of Jacksonville, which provide additional visibility and access to businesses and individuals and will likely result in additional loan and deposit growth.
Our operations are influenced by the 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 the Federal Reserve’s decisions on changes in interest rates, impact interest-earnings 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 impacts 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 and believes that the local economy is stable. Additionally, the Company believes that the local real estate market is relatively stable, albeit soft in the residential real estate area. The Company also believes its underwriting procedures are relatively conservative and, as a result, the Company should not be any more affected than the overall market in the event of economic downturn.
As stated above, fluctuations in interest rates impact our yield on interest-earning assets and our cost of funds, and thus our net interest margin. After 17 interest rate increases beginning in June 2004 and ending in June 2006, the Federal Reserve has left the federal funds rate unchanged at 5.25%. The recent flattening of rates has resulted in a stabilization in our yield on earning assets. Conversely, a change in our deposit mix to more costly time deposits, coupled with rates charged on FHLB advances and other borrowings, has resulted in an increase in our cost of funds.
Introduction
In the following pages, management presents an analysis of the financial condition of the Company, as of June 30, 2007 compared to December 31, 2006, and the results of operations for the three months ended June 30, 2007 compared with the same period in 2006. This discussion is designed to provide a more comprehensive review of the operating results and financial position than could be obtained from an examination of the financial statements alone. This analysis should be read in conjunction with the interim financial statements and related footnotes included herein.
Comparison of Financial Condition at June 30, 2007 and December 31, 2006
Total assets increased $42.6 million, or 13.1%, from $325.6 million at December 31, 2006 to $368.1 million at June 30, 2007. During the six months ended June 30, 2007, the Company experienced net loan growth of $38.5 million, or 13.7%. The increase in net loans was driven by increases in commercial real estate loans of $26.0 million, or 15.2%, and residential real estate loans of $7.3 million, or 11.7%. The Company funded the increase in earning assets through an increase in deposits of $18.6 million and an increase in Federal Home Loan Bank advances of $23 million.
Total deposits increased $18.6 million, or 6.6%, from $282.6 million at December 31, 2006 to $301.2 million at June 30, 2007. During the six months ended June 30, 2007, noninterest-bearing deposits increased $2.6 million to $35.6 million. Money market, NOW and savings deposits decreased $12.3 million to $138.2 million. Time deposits increased $28.3 million to $127.4 million.
Investment securities available for sale increased $527,000 to $26.6 million at June 30, 2007. During the six months ended June 30, 2007, we purchased $2.6 million of securities and received $1.8 million in proceeds from maturities and principal repayments. Of the $2.6 million purchased in the current year, approximately $1.0 million was invested in tax-exempt municipal securities and $1.6 million was invested in mortgage-backed securities. $1.0 million of the mortgage-backed security purchase in the current year qualified for CRA (Community Reinvestment Act) credit.
Total shareholders' equity increased by $1.1 million, or 4.9%, from $23.1 million at December 31, 2006 to $24.2 million at June 30, 2007. The increase is mainly attributable to net income of $1.2 million. At June 30, 2007, the Company had 8,000,000 authorized shares of $.01 par value common stock, of which 1,743,338 shares were issued and 1,741,668 shares were outstanding. In addition, the Company had 2,000,000 authorized shares of $.01 par value preferred stock, none of which were issued or outstanding at June 30, 2007.
Comparison of Operating Results for the Six Months Ended June 30, 2007 and 2006
Net Income
Net income increased $40,000, or 3.3%, from $1,197,000 for the six months ended June 30, 2006 to $1,237,000 for the six months ended June 30, 2007. Diluted earnings per share increased $.02 from $.66 for the six months ended June 30, 2006 to $.68 for the six months ended June 30, 2007. This increase in net income and diluted earnings per share was due to an increase in net interest income and noninterest income, offset by an increase in noninterest expense and income tax expense. Net interest income increased as a result of an increase in interest-earning assets. The increase in noninterest income was primarily due to an increase in deposit service charges and mortgage fees. Mortgage fees increased as a result of the implementation of a mortgage initiative during 2006. Salaries and employee benefits, which accounted for the largest portion of the increase in noninterest expenses, increased primarily due to the costs associated with the opening of two additional branches during 2006. The increase in income tax expense was directly related to the increase in net income.
Net Interest Income
Net interest income, the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities, increased $640,000, or 12% from $5.3 million for the six months ended June 30, 2006 to $5.9 million for the six months ended June 30, 2007. This increase resulted from an increase in interest income of $2.4 million, offset by an increase in interest expense of $1.8 million, driven primarily by an increase in time deposits, our highest cost deposit category. Additional funding from short-term borrowings and FHLB advances also increased interest expense by $336,000. The primary driver in the increase in net interest income will continue to be the growth in our earning assets.
When comparing the first six months of 2007 to the same period last year, the Company experienced substantial growth in its loan portfolio, with the most significant impact occurring in commercial real estate. The Company also experienced growth in deposit products, with the largest increase occurring in time deposit accounts.
Many of the Bank’s loans are indexed to the prime rate. The higher level of the prime rate in the first half of 2007 compared to the comparative period in 2006 is reflected in the higher average yield of the loan portfolio due to higher rates earned on variable rate loans and new loan production. The average yield on interest-earning assets for the first half of 2007 was 7.76%, which was an increase of 41 basis points, compared to the 7.35% yield earned during the first half of 2006.
The average cost of interest-bearing liabilities increased 58 basis points from 4.21% in the first half of 2006 to 4.79% in the comparable period in 2007. The average cost of interest-bearing deposits and all interest-bearing liabilities reflect, in part, the increase in short-term interest rates and the change in the funding mix for the first half of 2007 as compared to the same period in 2006.
The net interest margin decreased by 17 basis points from 3.80% to 3.63% when comparing the first six months of 2007 to the same period last year. This decrease is mainly the result of the stabilization on yields earned on interest-earning assets while the funding costs continued to increase. The Company closely monitors its cost of funds and has taken action to reduce such costs through deposit gathering initiatives focused on generating lower cost demand, money market and savings accounts. Furthermore, proceeds from maturity, amortization and prepayment of loans and securities continue to be invested at stable rates for the most part and are no longer increasing since short-term interest rates have not changed since June 2006. In the current interest rate environment, the margin may contract further; however, as stated above, management is currently implementing various strategies to impact the rising cost of funding.
Average Balance Sheet; Interest Rates and Interest Differential. The following table sets forth the average daily balances for each major category of assets, liabilities and shareholders’ equity as well as the amounts and average rates earned or paid on each major category of interest-earning assets and interest-bearing liabilities.
| | | Six Months Ended June 30, | |
| | | 2007 | | 2006 | |
| | | Average | | | | Average | | Average | | | | Average | |
| | | Balance | | Interest | | Rate | | Balance | | Interest | | Rate | |
| | | (Dollars in thousands) | |
| Interest-earning assets: | | | | | | | | | | | | | |
Loans (1) | | $ | 299,608 | | $ | 11,986 | | | 8.07% | | $ | 247,804 | | $ | 9,503 | | | 7.73% | |
Securities (2) | | | 28,348 | | | 647 | | | 4.60 | | | 26,926 | | | 574 | | | 4.30 | |
Other interest-earning assets (3) | | | 772 | | | 22 | | | 5.75 | | | 5,541 | | | 133 | | | 4.84 | |
| Total interest-earning assets | | | 328,728 | | | 12,655 | | | 7.76 | | | 280,271 | | | 10,210 | | | 7.35 | |
Noninterest-earning assets (4) | | | 14,058 | | | | | | | | | 13,311 | | | | | | | |
| Total assets | | $ | 342,786 | | | | | | | | $ | 293,582 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | |
| Savings and NOW deposits | | $ | 17,414 | | $ | 164 | | | 1.90 | | $ | 18,376 | | $ | 166 | | | 1.82 | |
| Money market deposits | | | 126,679 | | | 2,846 | | | 4.53 | | | 136,120 | | | 2,931 | | | 4.34 | |
| Time deposits | | | 108,232 | | | 2,814 | | | 5.24 | | | 65,757 | | | 1,381 | | | 4.24 | |
| FHLB advances | | | 23,811 | | | 628 | | | 5.32 | | | 11,865 | | | 292 | | | 4.96 | |
| Subordinated debt | | | 7,000 | | | 274 | | | 7.89 | | | 4,000 | | | 153 | | | 7.71 | |
Other interest-bearing liabilities (5) | | | 246 | | | 8 | | | 6.56 | | | 214 | | | 6 | | | 5.65 | |
| Total interest-bearing liabilities | | | 283,382 | | | 6,734 | | | 4.79 | | | 236,332 | | | 4,929 | | | 4.21 | |
| Noninterest-bearing liabilities | | | 35,728 | | | | | | | | | 36,901 | | | | | | | |
| Shareholders' equity | | | 23,676 | | | | | | | | | 20,349 | | | | | | | |
| Total liabilities and shareholders' equity | | $ | 342,786 | | | | | | | | | | | | | | | | |
| Net interest income | | | | | $ | 5,921 | | | | | | | | $ | 5,281 | | | | |
Interest rate spread (6) | | | | | | | | | 2.97% | | | | | | | | | 3.14% | |
Net interest margin (7) | | | | | | | | | 3.63% | | | | | | | | | 3.80% | |
(1) | Includes nonaccrual loans. |
(2) | Due to immateriality, the interest income and yields related to certain tax exempt assets have not been adjusted to reflect a fully taxable equivalent yield. |
(3) | Includes federal funds sold. |
(4) | For presentation purposes, the BOLI acquired by the Bank has been included in noninterest-earning assets. |
(5) | Includes federal funds purchased. |
(6) | Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. |
(7) | Net interest margin is net interest income divided by average interest-earning assets. |
Rate/Volume Analysis. The following table sets forth the effect of changes in volumes, changes in rates, and changes in rate/volume on tax-equivalent interest income, interest expense and net interest income.
| | | Six Months Ended June 30, | |
| | | 2007 Versus 2006 (1) | |
| | | Increase (decrease) due to changes in: | |
| | | | | | | Net | |
| | | Volume | | Rate | | Change | |
| | | (Dollars in thousands) | |
| Interest income: | | | | | | | |
| Loans | | $ | 2,058 | | $ | 425 | | $ | 2,483 | |
| Securities | | | 31 | | | 42 | | | 73 | |
| Other interest-earning assets | | | (132 | ) | | 21 | | | (111 | ) |
| Total interest income | | | 1,957 | | | 488 | | | 2,445 | |
| | | | | | | | | | | |
| Interest expense: | | | | | | | | | | |
| Savings and NOW deposits | | | (9 | ) | | 7 | | | (2 | ) |
| Money market deposits | | | (209 | ) | | 124 | | | (85 | ) |
| Time deposits | | | 1,047 | | | 386 | | | 1,433 | |
| FHLB advances | | | 314 | | | 22 | | | 336 | |
| Subordinated debt | | | 117 | | | 4 | | | 121 | |
| Other interest-bearing liabilities | | | 1 | | | 1 | | | 2 | |
| Total interest expense | | | 1,261 | | | 544 | | | 1,805 | |
| | | | | | | | | | | |
| Increase in net interest income | | $ | 696 | | $ | (56 | ) | $ | 640 | |
| (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. |
Critical Accounting Policies
A critical accounting policy is one that is both very important to the portrayal of the Company’s financial condition and requires management’s most difficult, subjective or complex judgments. The circumstances that make these judgments difficult, subjective or complex have to do with the need to make estimates about the effect of matters that are inherently uncertain. Based on this definition, the Company’s primary critical accounting policy is the establishment and maintenance of an allowance for loan losses.
The allowance for loan loss is established through a provision for loan loss charged to expense. Loans are charged against the allowance for loan loss when management believes that the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb inherent losses on existing loans that may become uncollectible based on evaluations of the collectibility 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 loss is also impacted by increases and decreases in loans outstanding because either more or less allowance is required as the amount of the Company’s credit exposure changes. To the extent actual loan losses differ materially from management’s estimate of these subjective factors, loan growth/run-off accelerates, or the mix of loan types changes, the level of provision for loan loss, and related allowance can, and will, fluctuate.
Additional information with regard to the Company’s methodology and reporting of the allowance for loan losses is included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.
Asset Quality
The Company has identified certain assets as nonperforming. These assets include nonaccruing loans, loans that are contractually past due 90 days or more as to principal or interest payments and still accruing, and foreclosed real estate. Loans are placed on nonaccrual status when management has concerns regarding its 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. Loans are impaired when it is considered probable that management will not collect the outstanding loan principal and interest amounts or realize the full carrying value of the loan. The Company’s nonperforming assets at June 30, 2007 and December 31, 2006 are as follows:
| | | June 30, | | December 31, | |
| | | 2007 | | 2006 | |
| | | (Dollars in thousands) | |
| | | | | | |
| Nonaccruing loans | | $ | 511 | | $ | 420 | |
| Loans past due over 90 days still on accrual | | | — | | | 809 | |
| Total nonperforming loans | | | 511 | | | 1,229 | |
| Foreclosed assets, net | | | — | | | — | |
| Total nonperforming assets | | $ | 511 | | $ | 1,229 | |
| | | | | | | | |
| Allowance for loan losses | | $ | 3,048 | | $ | 2,621 | |
| Nonperforming loans and foreclosed assets as a percent of total assets | | | .14 | % | | .38 | % |
| Nonperforming loans as a percent of gross loans | | | .16 | % | | .43 | % |
| Allowance for loan losses as a percent of nonperforming loans | | | 596.48 | % | | 213.26 | % |
The allowance for loan losses grew by $427,000 during the first six months of 2007, amounting to $3.0 million at June 30, 2007, as compared to $2.6 million at December 31, 2006. The allowance represented approximately .94% and .92% of total loans at both dates, respectively. During the first six months of 2007, the Company had charge-offs of $23,900, recoveries of $3,600 and recorded a $448,000 provision for loan losses compared to charge-offs of $99,000, recoveries of $2,000 and a provision for loan losses of $268,000 for the first six months of 2006. The larger provision for loan losses in 2007 resulted primarily from continued loan growth and management’s assessment of local and national economic conditions.
The allowance for loan losses is a valuation allowance for credit losses in the loan portfolio. Management has adopted a methodology to properly analyze and determine an adequate loan loss allowance. The analysis is based on sound, reliable and well documented information and is designed to support an allowance that is adequate to absorb all estimated incurred losses in the Company’s loan and lease portfolio. Due to their similarities, the Company has grouped the loan portfolio into three components. The components are residential real estate, consumer loans and commercial loans. The Company has created a loan classification system to properly calculate the allowance for loan losses. Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the sale of the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment and, accordingly, they are not separately identified for impairment disclosures.
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 period, loan portfolio concentrations and trends in the loan portfolio.
Bank regulators recently issued a “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 seen a substantial increase in exposure to commercial real estate loans. The Company has and will continue to pursue fundamentally sound commercial real estate lending opportunities that fit within its lending parameters. The ongoing growth and concentration in this category is considered when analyzing the adequacy of the loan loss allowance based on sound, reliable and well documented information.
Based on the results of the analysis performed by management at June 30, 2007, the allowance for loan loss is considered to be adequate to absorb estimated loan losses in the portfolio as of that date. As more fully discussed in the “Critical Accounting Policies” section of this 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. Actual results could differ significantly from these estimates.
The amount of future charge-offs and provisions for loan losses could be affected by, among other things, economic conditions in Jacksonville, Florida, and the surrounding communities. Such conditions could affect the financial strength of the Company’s borrowers and do affect the value of real estate collateral securing the Company’s mortgage loans. Loans secured by real estate represent approximately 92% of the Company’s total loans outstanding at June 30, 2007. In recent years, economic conditions in Jacksonville and the surrounding communities have been strong and real estate values have appreciated in a healthy manner. Presently, economic conditions remain healthy in this market and real estate values appear to have stabilized. Conditions and values could deteriorate in the future, and such deterioration could be substantial. If this were to occur, some of the Company’s borrowers may be unable to make the required contractual payments on their loans, and the Company may be unable to realize the full carrying value of such loans through foreclosure. However, management believes that the Company’s underwriting policies are relatively conservative and, as a result, the Company should not be any more affected than the overall market.
Future provisions and charge-offs could also be affected by environmental impairment of properties securing the Company’s mortgage loans. Under the Company’s current policy, an environmental audit is required on practically 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.
Noninterest Income, Noninterest Expense and Income Taxes
Noninterest income was $577,000 for the six months ended June 30, 2007, compared to $487,000 for the 2006 period. The increase in total noninterest income was primarily due to the increase in mortgage origination fees and service charges on deposit accounts.
Noninterest expense increased to $4.1 million for the six months ended June 30, 2007, from $3.6 million for the six months ended June 30, 2006. Salaries and employee benefits and occupancy and equipment accounted for the majority of noninterest expense increasing $451,000 over the same period of 2006. This increase is a result of the absorption of additional staffing, rent and equipment expense related to the Company’s two newest locations. The Company opened its fourth location in February 2006 and its fifth location in June 2006.
Income taxes for the six months ended June 30, 2007 were $757,000 (an effective rate of 37.96%) compared to income taxes of $678,000 for the six months ended June 30, 2006 (an effective tax rate of 36.16%). Income tax expense increased due to the increase in net income.
Comparison of Operating Results for the Three Months Ended June 30, 2007 and 2006
Net income for the second quarter of 2007 was $694,000, or $.38 per diluted share, as compared to $689,000, or $.38 per diluted share, earned for the same quarter last year. The largest components of the increase in net income are an increase in net interest income of $199,000, offset by an $84,000 increase in the allowance for loan loss due to an increase in the loan portfolio, and a $76,000 increase in noninterest expense due to the increase in salaries, occupancy and equipment expense, and other operating expenses discussed above with respect to the six-month periods.
Net interest income increased by $199,000, or 7.3%, from $2.8 million for the second quarter of 2006 to $3.0 million for the current quarter. The increase is primarily comprised of a positive volume variance of $392,000 and a negative rate variance of $193,000. The reasons for the positive volume variance and negative rate variance are the same as those discussed above with respect to the six-month periods.
Capital
The Company’s capital management policy is designed to build and maintain capital levels that meet regulatory standards. Under current regulatory capital standards, banks are classified as well-capitalized, adequately-capitalized or undercapitalized. Under such standards, a well-capitalized bank is one that has a total risk-based capital ratio equal to or greater than 10%, a Tier 1 risk-based capital ratio equal to or greater than 6%, and a Tier 1 leverage capital ratio equal to or greater than 5%. The Company’s total risk-based capital, Tier 1 risk-based capital and Tier 1 leverage capital ratios were 10.66%, 9.73% and 8.94%, respectively, at June 30, 2007.
Cash Flows and Liquidity
Cash Flows. The Company’s primary sources of cash are deposit growth, maturities and amortization of investment securities, FHLB advances and federal funds purchased. The Company uses cash from these and other sources to fund loan growth. Any remaining cash is used primarily to reduce borrowings and to purchase investment securities. During the first six months of 2007, the Company’s cash and cash equivalent position increased by $2.4 million. The increase in cash mainly resulted from an increase in deposit accounts of approximately $18.6 million from $282.6 million at December 31, 2006 to $301.2 million at June 30, 2007 as well as an increase in FHLB advances of $23.0 million from $11.7 million at December 31, 2006 to $34.7 million at June 30, 2007. These increases were offset by net loan originations of $38.5 million.
Liquidity. The Company has both internal and external sources of near-term liquidity that can be used to fund loan growth and accommodate deposit outflows. The primary internal sources of liquidity are 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. At June 30, 2007, the Company had $29.2 million in federal funds sold and available-for-sale securities not subject to pledge agreements.
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 core deposits from businesses and consumers in its local and national market. The Company can also borrow overnight federal funds and fixed-rate term products under credit facilities established with the Federal Home Loan Bank and other commercial banks. These lines, in the aggregate amount of approximately $83.9 million, do not represent legal commitments to extend credit on the part of the other banks.
Recent Accounting Pronouncements
In September 2006, FASB issued Statement No. 157, Fair Value Measurements. This new standard provides guidance for using fair value to measure assets and liabilities. Under Statement 157, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, Statement 157 establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. The provisions of Statement 157 are effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years, with earlier application encouraged. The Company has not yet determined the effect of adopting this Statement.
On February 15, 2007, FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This new standard permits entities to measure many financial instruments at fair value. The provisions of Statement 159 provide entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. Statement 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007; however, the early adoption must occur within 120 days of the start of the fiscal year and before any quarterly financial statements are issued. An entity electing to adopt Statement 159 early must also elect to apply the provisions of Statement 157 (discussed above). The Company has not elected to early adopt this Statement and has not yet determined the effect of adopting this Statement.
In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This issue is effective for fiscal years beginning after December 15, 2007. Management does not expect the adoption of EITF 06-4 to have a material impact on the financial statements.
Contractual Obligations, Commitments and Contingent Liabilities. The Company has various financial obligations, including contractual obligations and commitments that may 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, 2006 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 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, 2006 and is incorporated herein by reference.
Off-Balance Sheet Arrangements. There have been no material changes in the risks related to off-balance sheet arrangements since the Company’s disclosure in its Annual Report on Form 10-K for the year ended December 31, 2006.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Market risk is the risk that a financial institution will be adversely impacted by unfavorable changes in market prices. These unfavorable changes could result in a reduction in net interest income, which is the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities.
Interest rate risk is the sensitivity of income to variations in interest rates over both short-term and long-term horizons. The primary goal of interest rate risk management is to control this risk within limits approved by the Board and narrower guidelines approved by the Asset Liability Committee. These limits and guidelines reflect the Bank’s tolerance for interest rate risk. The Bank attempts to control interest rate risk by identifying and quantifying exposures. The Bank quantifies its interest rate risk exposures using sophisticated simulation and valuation models as well as simpler gap analyses performed by a third-party vendor specializing in this activity.
The Bank’s internal policy on interest rate risk specifies that if interest rates were to shift immediately up or down 200 basis points, estimated net interest income for the next 12 months should change by less than 15%. The most current simulation projects the Bank’s net interest income to be within the parameters of its internal policy and has not changed significantly from our disclosures in our Annual Report on Form 10-K for the year ended December 31, 2006. Such simulation involves numerous assumptions and estimates, which are inherently subjective and are subject to substantial business and economic uncertainties. Accordingly, the actual effects of an interest rate shift under actual future conditions may be expected to vary significantly from those derived from the simulation to the extent that the assumptions used in the simulation differ from actual conditions.
Item 4. Controls and Procedures
Not applicable.
Item 4T. 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, is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based upon their evaluation of those controls and procedures performed as of the end of the period covered by this report, the chief executive officer and principal financial officer of the Company concluded that the Company’s disclosure controls and procedures were adequate. |
| b. | | Changes in internal controls. The Company made no significant changes in its internal control over financial reporting during its most recent quarter that has materially affected the Company’s internal control over financial reporting. |
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
There are no material pending legal proceedings to which we are a party or to which any of our properties are subject; nor are there material proceedings known to be contemplated by any governmental authority; nor are there any material proceedings known to us, pending or contemplated, in which any of our directors, officers, affiliates or any principal security holders, or any associate of any of the foregoing, is a party or has an interest adverse to us, except as set forth below.
On April 11, 2006, The Jacksonville Bank was served with a Summons and a copy of the Complaint filed by Wells Fargo Financial Leasing, Inc. in the Circuit Court of the Fourth Judicial Circuit in and for Duval County, Florida. The basis of the Complaint stems from an erroneous wire transfer that was made by Wells Fargo on February 16, 2005 to one of our customers, offsetting an overdraft in our customer’s account in the amount of $33,143.95. The Bank retained the amount and Wells Fargo is pursuing the refund plus interest and costs. The Bank does not expect to incur any material loss with regard to this matter.
On September 13, 2006, The Jacksonville Bank was served with a Summons and a copy of a Complaint filed by Harrell & Harrell, P.A. in the Circuit Court of the Fourth Judicial Circuit in and for Duval County, Florida. The Complaint states that the Bank “cashed or otherwise converted instruments of Harrell & Harrell, P.A. for the benefit of parties who were not entitled to enforce the instruments or receive payment.” The “parties” referred to are Daniel J. Glary and Jonathan B. Israel, local attorneys who are indebted to The Jacksonville Bank. The action calls for damages that exceed the sum of $15,000, exclusive of costs, interest and attorneys’ fees. Mediations did not result in any agreement. The lawsuit was dismissed on February 6, 2007. Harrell & Harrell re-filed the lawsuit and the Bank’s counsel has filed motions to have the suit dismissed again. The Bank received an offer of settlement from Glary & Israel, P.A., Jonathan Israel and Harrell & Harrell, P.A. in June 2007. The Bank made a counter offer and is awaiting reply from the parties. Daniel Glary will not be party to the settlement; the Bank will pursue legal action against him individually.
On January 17, 2007, a Counterclaim to the aforementioned suit was filed by Daniel J. Glary against Jonathan B. Israel, Angela C. McDonald, Scott M. Hall and The Jacksonville Bank asserting that Scott Hall and the Bank facilitated the wrongful taking of funds that belonged to others by Israel and McDonald. The suit against the Bank and Hall was dismissed. Glary was given ten days to amend his claim, but failed to do so. Glary then filed a new suit against The Jacksonville Bank and several of its officers. A motion to dismiss has been filed and is pending before the court. Damages in excess of $15,000, attorneys’ fees and costs of this action, and pre-judgment interest are being sought.
| | 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, 2006. |
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
| Item 3. | Defaults Upon Senior Securities |
| Item 4. | Submission of Matters to a Vote of Security Holders |
| | On April 24, 2007, the company held an annual meeting of the shareholders of its common stock to vote on the election of four persons to the Company’s Board of Directors. |
| | All of the directors up for election at the annual meeting were elected to serve a term of office of three years, expiring at the annual meeting in the year 2010. The following table sets forth the votes for, votes against and votes withheld with respect to the election of the directors: |
| Director Nominee | | Votes For | | Votes Against | | Votes Withheld | |
| | | | | | | | |
| John W. Rose | | | 1,565,451 | | | -0- | | | 4,600 | |
| | | | | | | | | | | |
| John R. Schultz | | | 1,566,251 | | | -0- | | | 3,800 | |
| | | | | | | | | | | |
| Price W. Schwenck | | | 1,566,251 | | | -0- | | | 3,800 | |
| | | | | | | | | | | |
| Gary L. Winfield, M.D. | | | 1,565,451 | | | -0- | | | 4,600 | |
| | The following directors’ term of office continued after the 2007 annual meeting: D. Michael Carter, CPA, Melvin Gottlieb, James M. Healey, John C. Kowkabany, Bennett A. Tavar, R.C. Mills, Gilbert J. Pomar, III, Donald E. Roller and Charles F. Spencer. |
None
EXHIBIT INDEX
Exhibit No. 3.1: Articles of Incorporation of the Company (1)
Exhibit No. 3.2: Amended and Restated Bylaws of the Company (2)
Exhibit No. 3.3: Amendment No. 1 to Amended and Restated Bylaws of the Company (3)
Exhibit No. 3.4: Amendment No. 2 to Amended and Restated Bylaws of the Company (4)
Exhibit No. 31.1: Certification of principal executive officer required by Rule 13a-14(a)/15d-14(a) of the Exchange Act
Exhibit No. 31.2: Certification of principal financial officer required by Rule 13a-14(a)/15d-14(a) of the Exchange Act
Exhibit No. 32: Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
| (1) | Incorporated herein by reference to Exhibit No. 3.1 to Form SB-2, Registration Statement and amendments thereto, effective as of September 30, 1998, Registration No. 333-64815. |
| (2) | Incorporated herein by reference to Exhibit No. 3.2 to Form 10-QSB for the quarter ended June 30, 2002, filed August 14, 2002. |
| (3) | Incorporated herein by reference to Exhibit No. 3.3 to Form 10-QSB for the quarter ended June 30, 2005, filed August 10, 2005. |
| (4) | Incorporated herein by reference to Exhibit 99.1 to Form 8-K, filed May 29, 2007. |
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.
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| Date: August 13, 2007 | | /s/ Gilbert J. Pomar, III |
| |
Gilbert J. Pomar, III |
| | President and Chief Executive Officer |
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| Date: August 13, 2007 | | /s/ Valerie A. Kendall |
| |
Valerie A. Kendall |
| | Executive Vice President
and Chief Financial Officer |
