Unassociated Document
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 September 30, 2008   

¨
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
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)

100 North Laura Street, Suite 1000, Jacksonville, Florida 32202
(Address of principal executive offices)

(904) 421-3040
(Registrant’s telephone number)

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 ¨

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
¨
Accelerated filer
¨
Non-accelerated filer
¨
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 ¨ No x

As of November 6, 2008, the latest practicable date, 1,748,799 of the Registrant’s common shares, $.01 par value, were issued and outstanding.



JACKSONVILLE BANCORP, INC.

TABLE OF CONTENTS
 
   
Page
     
PART I—FINANCIAL INFORMATION
 
     
Item 1.
Financial Statements
 
     
 
Consolidated Balance Sheets
3
     
 
Consolidated Statements of Income
4
     
 
Consolidated Statements of Changes in Shareholders’ Equity
5
     
 
Consolidated Statements of Cash Flows
6
     
 
Notes to Consolidated Financial Statements
7
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
14
   
 
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
24
     
Item 4.
Controls and Procedures
24
     
PART II—OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
26
     
Item 1A.
Risk Factors
26
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
26
     
Item 3.
Defaults Upon Senior Securities
26
     
Item 4.
Submission of Matters to a Vote of Security Holders
26
     
Item 5.
Other Information
26
     
Item 6.
Exhibits
26
     
SIGNATURES
27
   
EXHIBIT INDEX
28
   
CERTIFICATIONS
 
Certification of Gilbert J. Pomar, III under Section 302 of the Sarbanes-Oxley Act of 2002
29
Certification of Valerie A. Kendall under Section 302 of the Sarbanes-Oxley Act of 2002
30
Certification under Section 906 of the Sarbanes-Oxley Act of 2002
31
 
2


JACKSONVILLE BANCORP, INC.
PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)

   
September 30,
 
December 31,
 
   
2008
 
2007
 
   
(Unaudited)
     
ASSETS
             
Cash and due from banks
 
$
6,744
 
$
5,584
 
Federal funds sold
   
1,002
   
451
 
Total cash and cash equivalents
   
7,746
   
6,035
 
Securities available for sale
   
28,924
   
29,727
 
Securities held to maturity
   
50
   
50
 
Loans, net of allowance for loan losses of $4,337 at 2008 and $3,116 at 2007
   
376,344
   
339,265
 
Premises and equipment, net
   
4,046
   
4,342
 
Bank-owned life insurance (BOLI)
   
8,696
   
5,010
 
Federal Home Loan Bank (FHLB) stock
   
2,591
   
3,638
 
Accrued interest receivable
   
2,091
   
2,275
 
Other assets
   
2,684
   
1,620
 
               
Total assets
 
$
433,172
 
$
391,962
 
               
LIABILITIES
             
Deposits
             
Noninterest bearing
 
$
44,656
 
$
35,382
 
Money market, NOW and savings deposits
   
86,035
   
116,181
 
Time deposits
   
220,125
   
137,330
 
Total deposits
   
350,816
   
288,893
 
FHLB advances
   
40,300
   
67,830
 
Subordinated debt
   
14,550
   
7,000
 
Accrued expenses and other liabilities
   
1,055
   
1,610
 
Total liabilities
   
406,721
   
365,333
 
               
SHAREHOLDERS’ EQUITY
             
Common stock, $.01 par value, 8,000,000 shares authorized, 1,748,799 and 1,747,981 shares issued
   
17
   
17
 
Additional paid–in capital
   
18,537
   
18,459
 
Retained earnings
   
8,145
   
8,186
 
Treasury stock, 168 and 1,650 shares
   
(2
)
 
(40
)
Accumulated other comprehensive income
   
(246
)
 
7
 
Total shareholders’ equity
   
26,451
   
26,629
 
               
Total liabilities and shareholders’ equity
 
$
433,172
 
$
391,962
 

See accompanying notes to unaudited consolidated financial statements.

3


JACKSONVILLE BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Dollars in thousands, except per share amounts)


   
Three Months Ended
 
Nine Months Ended
 
   
September 30,
 
September 30,
 
   
2008
 
2007
 
2008
 
2007
 
Interest and dividend income
                         
Loans, including fees
 
$
6,096
 
$
6,747
 
$
18,331
 
$
18,733
 
Securities
   
366
   
369
   
1,100
   
1,009
 
Other
   
(5
)
 
18
   
28
   
47
 
Total interest income
   
6,457
   
7,134
   
19,459
   
19,789
 
                           
Interest expense
                         
Deposits
 
$
2,778
 
$
3,285
 
$
8,560
 
$
9,109
 
FHLB advances
   
405
   
504
   
1,237
   
1,132
 
Subordinated debt
   
223
   
140
   
456
   
414
 
Other
   
3
   
2
   
6
   
10
 
Total interest expense
   
3,409
   
3,931
   
10,259
   
10,665
 
                           
Net interest income
   
3,048
   
3,203
   
9,200
   
9,124
 
Provision for loan losses
   
665
   
32
   
2,783
   
480
 
                           
Net interest income after provision for loan losses
   
2,383
   
3,171
   
6,417
   
8,644
 
                           
Noninterest income
                         
Service charges on deposit accounts
   
170
   
169
   
496
   
470
 
Other income
   
130
   
115
   
316
   
391
 
Total noninterest income
   
300
   
284
   
812
   
861
 
                           
Noninterest expense
                         
Salaries and employee benefits
   
1,141
   
1,122
   
3,428
   
3,197
 
Merger costs
   
   
   
430
   
 
Occupancy and equipment
   
449
   
437
   
1,338
   
1,343
 
Other
   
749
   
729
   
2,281
   
1,804
 
Total noninterest expense
   
2,339
   
2,288
   
7,477
   
6,344
 
                           
Income (loss) before income taxes
   
344
   
1,167
   
(248
)
 
3,161
 
Income tax expense (benefit)
   
77
   
386
   
(212
)
 
1,143
 
Net income (loss)
 
$
267
 
$
781
 
$
(36
)
$
2,018
 
                           
Weighted average:
                         
Common shares
   
1,748,567
   
1,745,143
   
1,748,183
   
1,743,585
 
Dilutive stock options and warrants
   
28,725
   
70,441
   
   
76,052
 
Dilutive shares
   
1,777,292
   
1,815,584
   
1,748,183
   
1,819,637
 
                           
Basic earnings (loss) per common share
 
$
.15
 
$
.45
 
$
(.02
)
$
1.16
 
Diluted earnings (loss) per common share
 
$
.15
 
$
.43
 
$
(.02
)
$
1.11
 
 
See accompanying notes to unaudited consolidated financial statements.

4


JACKSONVILLE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Unaudited)
(Dollars in thousands)

   
Common Stock
 
Additional
         
Accumulated Other
     
   
Outstanding
 
Paid-In
 
Retained
 
Treasury Stock
 
Comprehensive
     
   
Shares
 
Amount
 
Capital
 
Earnings
 
Amount
 
Income (Loss)
 
Total
 
                               
                               
Balance at January 1, 2007
   
1,741,688
 
 
$17
 
 
$18,230
 
 
$5,241
 
 
$(57
)
 
$(293
)
 
$23,138
 
                                             
Comprehensive income:
                                           
Net income (loss)
                     
2,018
               
2,018
 
Change in unrealized gain (loss) on securities available for sale, net of tax effects
                                 
75
   
75
 
Total comprehensive income
                                       
2,093
 
                                             
Purchase of treasury stock
   
(4,716
)
                   
(148
)
       
(148
)
                                             
Issuance of treasury stock
   
4,950
         
1
   
(6
)
 
165
         
160
 
                                             
Share-based compensation expense
               
137
                     
137
 
                                             
Exercise of common stock options
   
4,643
         
77
                     
77
 
                                             
Balance at September 30, 2007
   
1,746,565
 
 
$17
 
 
$18,445
 
 
$7,253
 
 
$(40
)
 
$(218
)
 
$25,457
 
                                             
Balance at January 1, 2008
   
1,746,331
 
 
$17
 
 
$18,459
 
 
$8,186
 
 
$(40
)
 
$7
 
 
$26,629
 
                                             
Comprehensive income:
                                           
Net income (loss)
                     
(36
)
             
(36
)
Change in unrealized gain (loss) on securities available for sale, net of tax effects
                                 
(253
)
 
(253
)
Total comprehensive income
                                       
(289
)
                                             
Purchase of treasury stock
   
(3,018
)
                   
(62
)
       
(62
)
                                             
Issuance of treasury stock
   
4,500
         
(7
)
 
(5
)
 
100
         
88
 
                                             
Share-based compensation expense
               
82
                     
82
 
                                             
Common stock issued
   
618
                                 
 
                                             
Exercise of common stock options
   
200
            
3
                            
3
 
                                             
Balance at September 30, 2008
   
1,748,631
 
 
$17
 
 
$18,537
 
 
$8,145
 
 
$(2
)
 
$(246
)
 
$26,451
 
 
See accompanying notes to unaudited consolidated financial statements.
5


JACKSONVILLE BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)

   
Nine Months Ended
 
   
September 30,
 
   
2008
 
2007
 
Cash flows from operating activities
             
Net income (loss)
 
$
(36
)
$
2,018
 
Adjustments to reconcile net income to net cash from operating activities:
             
Depreciation and amortization
   
387
   
416
 
Net amortization of deferred loan fees
   
54
   
95
 
Provision for loan losses
   
2,783
   
480
 
Premium amortization, net of accretion
   
(18
)
 
14
 
Earnings on Bank Owned Life Insurance
   
(186
)
 
(130
)
Share-based compensation
   
170
   
297
 
Loss on disposal of assets
   
38
   
 
Net change in accrued interest receivable and other assets
   
(766
)
 
333
 
Net change in accrued expenses and other liabilities
   
(555
)
 
(10
)
Net cash from operating activities
   
1,871
   
3,513
 
               
Cash flows from investing activities
             
Purchases of securities available for sale
   
(5,107
)
 
(6,244
)
Proceeds from maturities, calls and paydown of securities available for sale
   
5,521
   
2,495
 
Loan (originations) payments, net
   
(39,916
)
 
(53,246
)
Investment in Bank Owned Life Insurance
   
(3,500
)
 
 
Additions to premises and equipment, net
   
(89
)
 
(167
)
Net change in Federal Home Loan Bank stock
   
1,047
   
(1,812
)
Net cash from investing activities
   
(42,044
)
 
(58,974
)
               
Cash flows from financing activities
             
Net change in deposits
   
61,923
   
16,880
 
Net change in overnight FHLB advances
   
(8,530
)
 
18,400
 
Net change in Fed funds purchased
   
   
(134
)
Proceeds from issuance of subordinated debt
   
7,550
   
 
Proceeds from fixed rate FHLB advances
   
   
21,000
 
Proceeds from exercise of stock options
   
3
   
46
 
Excess tax benefits from stock-based payment arrangements
   
     31  
Repayment of fixed rate FHLB advance
   
(19,000
)
 
 
Purchase of treasury stock
   
(62
)
 
(148
)
Net cash from financing activities
   
41,884
   
56,075
 
               
Net change in cash and cash equivalents
   
1,711
   
614
 
Cash and cash equivalents at beginning of period
   
6,035
   
4,478
 
Cash and cash equivalents at end of period
 
$
7,746
 
$
5,092
 
               
Supplemental disclosures of cash flow information
             
Cash paid during the period for
             
Interest
 
$
10,338
 
$
10,355
 
Income taxes
   
795
   
1,155
 

See accompanying notes to unaudited consolidated financial statements.
6


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


NOTE 1  BASIS OF PRESENTATION
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, 2007, as filed with the U.S. Securities and Exchange Commission (the “SEC”) on March 27, 2008.

The accounting and reporting policies of the Company reflect banking industry practice and conform to U.S. generally accepted accounting principles. 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 September 30, 2008 and 2007 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, 2007 consolidated balance sheet was derived from the Company's December 31, 2007 audited consolidated financial statements.

Adoption of New Accounting Standards

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements.  This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset.  The standard is effective for fiscal years beginning after November 15, 2007.  In February 2008, the FASB issued Staff Position (FSP) 157-2, Effective Date of FASB Statement No. 157.  This FSP delays the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. In October 2008, the FASB issued Staff Position (FSP) 157-3 Determining the Fair Value of a Financial Asset when the Market for that Asset is Not Active. This FSP clarifies the application of FASB Statement No. 157, Fair Value Measurements and provides key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. The impact of adoption was not material.

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities.  The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities.  The Company did not elect the fair value option for any financial assets or financial liabilities as of January 1, 2008, the effective date of the standard.

7


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

 
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. The adoption of EITF 06-4 had no material impact on the financial statements.


NOTE 2  LOAN PORTFOLIO COMPOSITION
The composition of the Bank’s loan portfolio at September 30, 2008 and December 31, 2007 is indicated below along with the growth from December 31, 2007 to September 30, 2008.

   
 
 
 
 
% Increase (Decrease)
 
 
 
Total Loans
 
Total Loans
 
from December 31, 2007
 
 
 
September 30, 2008
 
December 31, 2007
 
to September 30, 2008
 
Real estate mortgage loans:
                   
Commercial
 
$
225,508
 
$
210,614
   
7.1
%
Residential
   
84,779
   
75,141
   
12.8
%
Construction(1)
   
35,187
   
29,737
   
18.3
%
Farmland
   
2,582
   
2,325
   
11.1
%
Commercial loans
   
28,650
   
20,291
   
41.2
%
Consumer loans
   
4,387
   
4,631
   
(5.3
%)
Subtotal
   
381,093
   
342,739
   
11.2
%
Less: Net deferred loan fees
   
(412
)
 
(358
)
 
15.1
%
Total
 
$
380,681
 
$
342,381
   
11.2
%

(1)  Includes construction, land development and other land loans.

8


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

NOTE 3  ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses for the nine months ended September 30, 2008 and 2007 follows:

   
Nine Months Ended September 30,
 
   
2008
 
2007
 
           
Balance, January 1
 
$
3,116
 
$
2,621
 
Provisions for loan losses charged to expense
   
2,783
   
480
 
Loans charged off
   
(1,675
)
 
(51
)
Recoveries of loans previously charged off
   
113
   
10
 
Balance, September 30
 
$
4,337
 
$
3,060
 

Impaired loans were as follows:

   
September 30,
 
December 31,
 
   
2008
 
2007
 
Loans with no allocated allowance for loan losses
 
$
3,946
 
$
590
 
               
Loans with allocated allowance for loan losses
   
4,741
   
100
 
               
Total
 
$
8,687
 
$
690
 
               
Amount of the allowance for loan losses allocated
 
$
650
 
$
50
 

9


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

NOTE 4  CAPITAL ADEQUACY
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 September 30, 2008 and December 31, 2007:

   
Actual
 
For Capital
 Adequacy 
Purposes
 
To Be Well 
Capitalized Under 
Prompt Corrective 
Action Provisions
 
   
 Amount 
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
 
September 30, 2008
                                     
Total Capital to risk
                                     
weighted assets
                                     
Consolidated
 
 
$45,584
   
11.79
%
 
$30,942
   
8.00
%
 
N/A
   
N/A
 
Bank
   
40,493
   
10.49
%
 
30,872
   
8.00
%
 
$38,590
   
10.00
%
                                       
Tier 1 (Core) Capital to Risk
                                     
weighted assets
                                     
Consolidated
   
35,507
   
9.18
%
 
15,471
   
4.00
%
 
N/A
   
N/A
 
Bank
   
36,156
   
9.37
%
 
15,436
   
4.00
%
 
23,154
   
6.00
%
                                       
Tier 1 (Core) Capital to
                                     
average assets
                                     
Consolidated
   
35,507
   
8.24
%
 
17,231
   
4.00
%
 
N/A
   
N/A
 
Bank
   
36,156
   
8.41
%
 
17,202
   
4.00
%
 
21,503
   
5.00
%
                                       
December 31, 2007
                                     
Total Capital to risk
                                     
weighted assets
                                     
Consolidated
 
 
$36,739
   
10.60
%
 
$27,715
   
8.00
%
 
N/A
   
N/A
 
Bank
   
35,313
   
10.16
%
 
27,819
   
8.00
%
 
$34,774
   
10.00
%
                                       
Tier 1 (Core) Capital to Risk
                                     
weighted assets
                                     
Consolidated
   
33,623
   
9.70
%
 
13,858
   
4.00
%
 
N/A
   
N/A
 
Bank
   
32,197
   
9.26
%
 
13,910
   
4.00
%
 
20,864
   
6.00
%
                                       
Tier 1 (Core) Capital to
                                     
average assets
                                     
Consolidated
   
33,623
   
8.68
%
 
15,487
   
4.00
%
 
N/A
   
N/A
 
Bank
   
32,197
   
8.31
%
 
15,496
   
4.00
%
 
19,370
   
5.00
%

In addition, 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%. Management believes, as of September 30, 2008, that the Bank is well capitalized for prompt corrective action purposes. The Company has included in Tier 1 Capital and Total Capital the trust preferred securities that were issued in June 2004, December 2006 and June 2008.

10


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

NOTE 5  FEDERAL HOME LOAN BANK ADVANCES
At September 30, 2008 and December 31, 2007, advances from the Federal Home Loan Bank (FHLB) were as follows:

   
2008
 
2007
 
Overnight advance maturing daily at a daily variable rate of 3.25% and 4.40% at September 30, 2008 and December 31, 2007, respectively
 
$
20,300
 
$
28,830
 
               
Advances maturing January 11, 2008 at a fixed rate of 5.26%
   
   
6,000
 
               
Advances maturing January 26, 2008 at a fixed rate of 4.65%
   
   
5,000
 
               
Advances maturing April 11, 2008 at a fixed rate of 4.36%
   
   
3,000
 
               
Advances maturing July 28, 2008 at a fixed rate of 4.59%
   
   
5,000
 
               
Convertible advances maturing June 8, 2010 with a quarterly call option beginning June 9, 2008 at a fixed rate of 4.99%
   
5,000
   
5,000
 
               
Convertible advances maturing June 8, 2012 with a quarterly call option beginning September 10, 2007 at a fixed rate of 4.68%
   
5,000
   
5,000
 
               
Convertible advances maturing August 13, 2010 with a quarterly call option beginning August 13, 2008 at a fixed rate of 4.51%
   
5,000
   
5,000
 
               
Convertible advances maturing October 4, 2010 with a quarterly call option beginning October 6, 2008 at a fixed rate of 4.15%
   
5,000
   
5,000
 
               
   
$
40,300
 
$
67,830
 

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.

11


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

NOTE 6  FAIR VALUE
Statement 157 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) or identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Assets measured at fair value on a recurring basis are summarized below:

       
 Fair Value Measurements at September 30, 2008 Using  
 
   
September 30,
2008 
 
Quoted Prices in 
Active Markets for
Identical Assets 
 
Significant Other 
Observable 
Inputs 
 
Significant 
Unobservable
Inputs
 
Assets:
                         
Securities available for sale
 
$
28,924
   
 
$
28,924
   
 

Security fair values are based on market prices or dealer quotes on securities with similar characteristics.

Assets measured at fair value on a non-recurring basis are summarized below:

       
 Fair Value Measurements at September 30, 2008 Using
 
   
September 30,
2008 
 
Quoted Prices in 
Active Markets for
Identical Assets 
 
Significant Other 
Observable 
Inputs 
 
Significant 
Unobservable
Inputs
 
Assets:
                         
Impaired Loans
 
$
4,021
   
 
$
4,021
   
 

The following represent impairment charges recognized during the period:

Impaired loans, which are measured for impairment using discounted cash flows or the fair value of the collateral for collateral dependent loans, had a carrying amount of $4,741, with a valuation allowance of $650, resulting in an additional provision for loan loss of $610 for the period. Additional impaired loans, not measured using levels of inputs to measure fair value, had a carrying amount of $3,946. Collateral dependent impaired loans, valued under Level 2, were measured using current appraised values along with information on recent market transactions.

12


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

NOTE 7  PARTICIPATION IN THE TREASURY CAPITAL PURCHASE PROGRAM
On October 3, 2008, Congress passed the Emergency Economic Stabilization Act of 2008 (EESA), which provides the U. S. Secretary of the Treasury with broad authority to implement certain actions to help restore stability and liquidity to U.S. markets. One of the provisions resulting from the Act is the Treasury Capital Purchase Program (CPP), which provides direct equity investment of perpetual preferred stock by the Treasury in qualified financial institutions. The program is voluntary and requires an institution to comply with a number of restrictions and provisions, including limits on executive compensation, stock redemptions and declaration of dividends. Applications must be submitted by November 14, 2008 and are subject to approval by the Treasury. The CPP provides for a minimum investment of 1% of Risk-Weighted Assets, with a maximum investment equal to the lesser of 3 percent of Total Risk-Weighted Assets or $25 billion. The perpetual preferred stock investment will have a dividend rate of 5% per year until the fifth anniversary of the Treasury investment, and a dividend of 9% thereafter. The CPP also requires the Treasury to receive warrants for common stock equal to 15% of the capital invested by the Treasury. The Company is evaluating whether to apply for participation in the CPP. Participation in the program is not automatic and is subject to approval by the Treasury.

13


JACKSONVILLE BANCORP, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

General

Jacksonville Bancorp, Inc. (“Bancorp”) was incorporated on October 24, 1997 and was organized to conduct the operations of The Jacksonville Bank (the “Bank”). The Bank is a Florida state-chartered commercial bank that opened for business on May 28, 1999, and its deposits are insured by the Federal Deposit Insurance Corporation. 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. Bancorp, the Bank and Fountain Financial, Inc. are collectively referred to herein as the “Company.”

Forward Looking Statements

All statements, other than statements of historical facts, included in this Quarterly Report on Form 10-Q regarding our estimates, expectations, beliefs, intentions, projections or strategies for the future, results of operations, financial position, prospects and plans and objectives of management for future operations may be “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995, as amended. We have based these forward-looking statements on our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives and financial needs. These forward-looking statements can be identified by the use of terms and phrases such as “believe,” “plan,” “intend,” “anticipate,” “target,” “estimate,” “expect,” and the like, and/or future-tense or conditional constructions (“will,” “may,” “could,” “should,” etc.). Items contemplating or making assumptions about actual or potential future operating results also constitute forward-looking statements. The Company cautions that these forward-looking statements are subject to numerous assumptions, risks and uncertainties, including 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 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 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 and legal and professional fees.

14


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, that have resulted in additional loan and deposit opportunities.

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-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 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. However, the Company believes that the local real estate market has softened somewhat in the residential real estate area. The Company also believes its underwriting procedures are relatively conservative and, as a result, the Company is not being any more affected than the overall market in the current economic downturn.

In 2008, the Federal Reserve reduced the federal funds rate five times. At December 31, 2007, the federal funds rate was 4.25%. The Federal Reserve reduced the federal funds rate to 3.50% on January 22, 2008, to 3.0% on January 30, 2008, to 2.25% on March 18, 2008, to 2.0% on April 30, 2008 and to 1.5% on October 8, 2008. In anticipation, the Company positioned itself to be in a slightly liability sensitive position, which means the pricing on our earning assets will reset to the lower short-term rates at a slower pace than our interest bearing liabilities. This position would typically have a positive impact on the net interest margin. However, other variables, such as liquidity needs, competition and the need to pursue alternative funding sources, have offset the benefits of the pricing resets.

On January 28, 2008, Bancorp entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Heritage Bancshares, Inc. (“Heritage”) pursuant to which, subject to the satisfaction or waiver of the conditions contained therein, Heritage would merge with and into Bancorp (the “Merger”), with Bancorp remaining as the surviving entity.

On June 24, 2008, Bancorp announced that, through mutual agreement, the Merger Agreement with Heritage had been terminated. Both companies attributed the amicable termination of the deal to the current economic climate in the banking industry which changed the benefits of the merger for their respective stockholders.

Introduction

In the following pages, management presents an analysis of the financial condition of the Company as of September 30, 2008 compared to December 31, 2007, and the results of operations for the nine months ended September 30, 2008 compared with the same period in 2007. 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.

15


Comparison of Financial Condition at September 30, 2008 and December 31, 2007

Total assets increased $41.2 million, or 10.5%, from $392 million at December 31, 2007 to $433.2 million at September 30, 2008. During the nine months ended September 30, 2008, the Company experienced net loan growth of $37.1 million, or 10.9%. The increase in net loans was driven by increases in commercial real estate loans of $14.9 million, or 7.1%, residential real estate loans of $9.6 million, or 12.8%, construction real estate loans of $5.5 million, or 18.3%, and commercial loans of $8.4 million, or 41.2%. The Company funded the increase in earning assets through an increase in deposits of $61.9 million and an increase of subordinated debt of $7.6 million offset by a decrease in FHLB advances by $27.5 million.

Total deposits increased $61.9 million, or 21.4%, from $288.9 million at December 31, 2007 to $350.8 million at September 30, 2008. During the nine months ended September 30, 2008, noninterest-bearing deposits increased $9.3 million to $44.7 million. Also during the nine months ended September 30, 2008, money market, NOW and savings deposits decreased $30.1 million to $86.0 million, and time deposits increased $82.8 million to $220.1 million.

Investment securities available for sale decreased $803,000 to $28.9 million at September 30, 2008. During the nine months ended September 30, 2008, we purchased $5.1 million of securities and received $5.5 million in proceeds from maturities, calls and principal repayments. Of the $5.1 million purchased in the current year, approximately $2.4 million was invested in mortgage-backed securities and $2.7 million was invested in U.S. government agency securities.

During the nine months ended September 30, 2008, Bank-owned life insurance increased $3.7 million primarily due to the purchase of an additional $3.5 million BOLI contract entered into by the Bank during the second quarter.

Subordinated debt increased by $7.6 million as a result of a private placement offering of trust preferred securities. The securities were issued at a rate 3.75% over 90-day LIBOR rates. The Company has treated the trust preferred securities as Tier 1 capital up to the maximum amount allowed and the remainder as Tier 2 capital for federal regulatory purposes.

Total shareholders' equity decreased by $178,000, or .7%, from $26.6 million at December 31, 2007 to $26.5 million at September 30, 2008. The decrease is mainly attributable to a net loss of $36,000 and a decrease in the value of the securities available for sale. At September 30, 2008, the Company had 8,000,000 authorized shares of $.01 par value common stock, of which 1,748,799 shares were issued and 1,748,631 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 September 30, 2008.

Comparison of Operating Results for the Nine Months Ended September 30, 2008 and 2007

Net Income

There was a net loss for the first nine months of 2008 of $36,000, compared to a $2.0 million net income in the first nine months of 2007. On a diluted per share basis, the net loss was $.02 for the nine months ended September 30, 2008 compared to net income of $1.11 for the nine months ended September 30, 2007. The net loss was driven primarily by additional provisions for loan losses, lower net interest margin, and expenses related to the termination of the merger agreement with Heritage.

16


Net Interest Income

Net interest income, the difference between interest earned on interest-earning assets and interest paid on interest-bearing liabilities, was flat at $9.1 million for the nine months ended September 30, 2008 and 2007. Interest income declined $330,000 when compared to the first nine months of the prior year as a result of the ongoing reduction in short-term rates by the Federal Reserve as well as $7.8 million in nonperforming assets; this was offset by average earning asset growth of $60.3 million. Interest expense declined by $406,000 as a result of the reduction in short-term rates offset by a transition from core deposits into more expensive time deposits.

When comparing the first nine months of 2008 to the same period last year, the Company experienced growth in its loan portfolio of 11.2%, compared to 18.7% for the same period in the previous year, with the most significant impact occurring in commercial loans. 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 lower level of the prime rate in the first nine months of 2008 compared to the comparative period in 2007 is reflected in the lower average yield of the loan portfolio due to lower rates earned on variable rate loans and new loan production. The average yield on interest-earning assets for the first nine months of 2008 was 6.49%, which was a decrease of 129 basis points, compared to the 7.78% yield earned during the first nine months of 2007.

The average cost of interest-bearing liabilities decreased 91 basis points from 4.85% in the first nine months of 2007 to 3.94% in the comparable period in 2008. The average cost of interest-bearing deposits and all interest-bearing liabilities reflect, in part, the change in the funding mix for the first nine months of 2008 as compared to the same period in 2007.

The net interest margin decreased by 52 basis points from 3.59% to 3.07% when comparing the first nine months of 2008 to the same period last year. This decrease is mainly the result of the rapid reduction in short-term rates by the Federal Reserve which immediately affected our variable priced loans offset by a lag in deposit repricing due to maturities of time deposits and the competitive nature of the funding markets. Additionally, $7.8 million in loans were placed on non-accrual status during the second quarter. Furthermore, proceeds from maturity, amortization and prepayment of loans and securities continue to be invested at current market rates. 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. In the current interest rate environment, the margin may contract further; however, as stated above, management has implemented various strategies to reduce the rising cost of funding.

17


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

   
Nine Months Ended September 30,
 
   
2008
 
2007
 
   
Average
     
Average
 
Average
     
Average
 
   
Balance
 
Interest
 
Rate
 
Balance
 
Interest
 
Rate
 
   
(Dollars in thousands)
 
Interest-earning assets:
                                     
Loans (1)
 
 
$367,001
 
 
$18,331
   
6.67
%
 
$310,169
 
 
$18,733
   
8.07
%
Securities (2)
   
31,798
   
1,100
   
4.62
   
29,177
   
1,009
   
4.62
 
Other interest-earning assets (3)
   
1,775
   
28
   
2.11
   
885
   
47
   
7.10
 
Total interest-earning assets
   
400,574
   
19,459
   
6.49
   
340,231
   
19,789
   
7.78
 
Noninterest-earning assets (4)
   
16,442
               
13,716
             
Total assets
 
 
$417,016
             
 
$353,947
             
                                       
Interest-bearing liabilities:
                                     
Savings deposits
 
 
$14,687
 
 
$333
   
3.03
 
 
$10,058
 
 
$236
   
3.14
 
NOW deposits
   
6,826
   
10
   
.20
   
7,048
   
9
   
.17
 
Money market deposits
   
85,641
   
1,639
   
2.56
   
123,059
   
4,208
   
4.57
 
Time deposits
   
188,092
   
6,578
   
4.67
   
118,167
   
4,656
   
5.27
 
FHLB advances
   
42,531
   
1,237
   
3.89
   
28,499
   
1,132
   
5.31
 
Subordinated debt
   
9,838
   
456
   
6.19
   
7,000
   
414
   
7.91
 
Other interest-bearing liabilities (5)
   
272
   
6
   
2.95
   
242
   
10
   
5.52
 
Total interest-bearing liabilities
   
347,887
   
10,259
   
3.94
   
294,073
   
10,665
   
4.85
 
Noninterest-bearing liabilities
   
42,133
               
35,867
             
Shareholders' equity
   
26,996
               
24,007
             
Total liabilities and shareholders' equity
 
 
$417,016
             
 
$353,947
             
Net interest income
       
 
$9,200
             
 
$9,124
       
Interest rate spread (6)
               
2.55
%
             
2.93
%
Net interest margin (7)
               
3.07
%
             
3.59
%
 
(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.

18


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.

   
Nine Months Ended September 30,
 
   
2008 Versus 2007 (1)
 
   
Increase (decrease) due to changes in:
 
           
Net
 
   
Volume
 
Rate
 
Change
 
   
(Dollars in thousands)
 
Interest income:
                   
Loans
 
$
3,127
 
$
(3,529
)
$
(402
)
Securities
   
91
   
   
91
 
Other interest-earning assets
   
28
   
(47
)
 
(19
)
Total interest income
   
3,246
   
(3,576
)
 
(330
)
                     
Interest expense:
                   
Savings deposits
   
105
   
(8
)
 
97
 
NOW deposits
   
   
1
   
1
 
Money market deposits
   
(1,049
)
 
(1,520
)
 
(2,569
)
Time deposits
   
2,495
   
(573
)
 
1,922
 
FHLB advances
   
461
   
(356
)
 
105
 
Subordinated debt
   
144
   
(102
)
 
42
 
Other interest-bearing liabilities
   
1
   
(5
)
 
(4
)
Total interest expense
   
2,157
   
(2,563
)
 
(406
)
                     
Increase in net interest income
 
$
1,089
 
$
(1,013
)
$
76
 
 

(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 probable and estimable incurred 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.

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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, 2007, as filed with the SEC on March 27, 2008.

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 according to the loan’s contractual terms or realize the full carrying value of the loan. During the first nine months in 2008, the Company experienced an increase in impaired loans from $690,000 to $8.7 million driven by an increase in nonperforming loans of $7.7 million and $947,000 for two additional loans that were identified as a result of the expanded efforts of management as discussed under the Allowance and Provision for Loan Losses section below. The Company’s nonperforming assets at September 30, 2008 and December 31, 2007 are as follows:

   
September 30,
 
December 31,
 
   
2008
 
2007
 
   
(Dollars in thousands)
 
           
Nonaccruing loans
 
$
7,740
 
$
690
 
Loans past due over 90 days still on accrual
   
   
 
Total nonperforming loans
   
7,740
   
690
 
Foreclosed assets, net
   
89
   
 
Total nonperforming assets
 
$
7,829
 
$
690
 
               
Allowance for loan losses
 
$
4,337
 
$
3,116
 
               
Nonperforming loans and foreclosed assets as a percent of total assets
   
1.81
%
 
.18
%
Nonperforming loans as a percent of gross loans
   
2.03
%
 
.20
%
Allowance for loan losses as a percent of nonperforming loans
   
56.03
%
 
451.59
%

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 Loan Committee of the Board of Directors.

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Allowance and Provision for Loan Losses

The allowance for loan losses grew by $1.2 million during the first nine months of 2008, amounting to $4.3 million at September 30, 2008, as compared to $3.1 million at December 31, 2007. The allowance represented approximately 1.14% of total loans at September 30, 2008 and .91% at December 31, 2007. During the first nine months of 2008, the Company had charge-offs of $1.7 million, recoveries of $113,000 and recorded a $2.8 million provision for loan losses compared to charge-offs of $51,000, recoveries of $10,000 and a provision for loan losses of $480,000 for the first nine months of 2007. The larger provision for loan losses in 2008 was driven primarily from continued loan growth and the Bank’s expanded efforts to identify potential losses inherent in the portfolio. The Bank’s increased identification efforts of potential losses in the portfolio are based on a variety of specific factors, including the Company’s and peer banks’ experiences as well as industry and economic trends. The Bank had net charge-offs of $1.6 million during the first nine months of 2008. During the third quarter, the Bank had net charge-offs of $541,000, of which $466,000 was identified and reserved during the second quarter. As a result of the expanded efforts, management does not believe that the same level of charge-offs experienced during the nine-month period of 2008 will be experienced in future periods. Impaired loans increased to $8.7 million as of September 30, 2008; of this amount, $650,000 was specifically allocated to the allowance for loan losses which is deemed sufficient to absorb any future potential losses.

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

Bank regulators have 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 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 September 30, 2008, 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.

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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 91% of the Company’s total loans outstanding at September 30, 2008. 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 relatively stable in this market and real estate values have experienced some softening. Residential real estate values have experienced greater volatility and have declined in most areas. 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. The Company is unable to determine at this time the effect of such an occurrence on the Company’s financial condition and results of operations; however, management believes that 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 $812,000 for the nine months ended September 30, 2008, compared to $861,000 for the comparable 2007 period. The decrease in total noninterest income was primarily the result of a reduction in mortgage origination referral income due to the slowing real estate market, partially offset by income earned on an additional $3.5 million BOLI contract entered into by the Bank during the second quarter.

Noninterest expense increased to $7.5 million for the nine months ended September 30, 2008, from $6.3 million for the nine months ended September 30, 2007. Compensation expenses, professional fees, data processing fees, FDIC assessments, a one-time charge of $38,000 for the disposal of fixed assets no longer in use and a one-time charge of $430,000 for expenses related to the termination of the merger agreement with Heritage Bancshares, Inc. accounted for the majority of noninterest expense increasing $1.1 million over the same period in 2007.

Income taxes for the nine months ended September 30, 2008 was a tax benefit of $212,000 (an effective tax rate of 85.48%) compared to income taxes of $1.1 million for the nine months ended September 30, 2007 (an effective tax rate of 36.16%). The increase in the effective tax rate compared to one year earlier is the result of the benefits derived from tax-free municipal bonds and tax-free income earned on the bank-owned life insurance policies resulting in a lower percentage of income, or greater percentage of loss, being taxed at the statutory rates.

Comparison of Operating Results for the Three Months Ended September 30, 2008 and 2007

Net income for the third quarter of 2008 was $267,000, or $.15 per diluted share, as compared to a net income of $781,000, or $.43 per diluted share, earned for the same quarter last year. The largest component of the decrease in net income is an increase in provision for loan loss of $633,000. During the third quarter, the Company had net loan charge-offs of $541,000, compared to $20,000 during the same period in the prior year. Of the charge-offs recorded during the third quarter, $466,000 had been identified and were reserved during the prior quarter.

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Net interest income for the third quarter of 2008 decreased $155,000 from $3.2 million in the third quarter of 2007, compared to $3.0 million in the third quarter of 2008. Interest income for the quarter declined $677,000 when compared to the prior year as a result of the ongoing reduction in short-term rates by the Federal Reserve; this was offset by average earning asset growth of $49.6 million. Interest expense declined by $522,000 as a result of the reduction in short-term rates offset by a transition from core deposits into more expensive time deposits and wholesale funding required to support the Company’s earning asset growth. The net interest margin was 2.94% for the third quarter of 2008, compared to 3.54% for the comparable period in 2007.

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 Bank’s total risk-based capital, Tier 1 risk-based capital and Tier 1 leverage capital ratios were 10.49%, 9.37% and 8.41%, respectively, at September 30, 2008. The Company also maintains capital levels that meet the same regulatory standards. If the capital ratios of the Company and Bank were to fall below levels required under regulatory standards, it is the Company’s and Bank’s policy to increase capital in an amount sufficient to meet regulatory requirements within 30 days.

During the second quarter, the Company issued $7.6 million in a private placement offering of trust preferred securities. The trust preferred securities are treated as Tier 1 capital up to the maximum amount allowed and the remainder as Tier 2 capital for federal regulatory purposes.

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 nine months of 2008, the Company’s cash and cash equivalent position increased by $1.7 million. The increase in cash mainly resulted from an increase in deposit accounts of approximately $61.9 million from $288.9 million at December 31, 2007 to $350.8 million at September 30, 2008, offset by net loan originations of $37.1 million as well as a decrease in FHLB advances of $27.5 million from $67.8 million at December 31, 2007 to $40.3 million at September 30, 2008.

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 September 30, 2008, the Company had $29.9 million in federal funds sold and available-for-sale securities not subject to pledge agreements.

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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 and brokered certificates of deposit. The Company can also borrow overnight federal funds and fixed-rate term products under credit facilities established with the FHLB, Federal Reserve Discount Window and other commercial banks. These lines, in the aggregate amount of approximately $141.2 million, do not represent legal commitments to extend credit on the part of the other banks.

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, 2007 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, 2007, as filed with the SEC on March 27, 2008, 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, 2007.

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 of Directors 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. There have been no significant changes in the Bank’s primary market risk exposure or how those risks are managed since our disclosures in our Annual Report on Form 10-K for the year ended December 31, 2007.

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, 2007. 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.

24

 
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. 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 Rules 13a-15(e) under the Exchange Act) are effective to ensure that the information required to be disclosed by the Company 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 Controls
 
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, the Company continues to emphasize the importance of identifying areas for improvement and to create and implement new policies and procedures where deficiencies exist. The Company has improved controls relating to credit policies, loan grading and the allowance for loan loss. However, there have not been any changes in the Company’s internal controls 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.
 
(c) Limitations on the Effectiveness of Controls
 
Our 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.

25

 
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 and its subsidiary are 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 the Company or the Bank 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
 
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, 2007, as filed with the SEC on March 27, 2008.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
None

Item 3.
Defaults Upon Senior Securities
 
None

Item 4.
Submission of Matters to a Vote of Security Holders
None

Item 5.
Other Information
None

Item 6. Exhibits

Exhibit No. 3.1: Articles of Incorporation of the Company (1)

Exhibit No. 3.2:  Amended and Restated Bylaws of the Company, as amended to date (2)

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 Appendix A to Form SB-2, filed September 30, 1998, Registration No. 333-64815.
 
(2)
Incorporated herein by reference to Exhibit No. 3.2 to Form 10-K for year ended December 31, 2007, filed March 27, 2008, File No. 000-30248.

26


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: November 6, 2008
/s/ Gilbert J. Pomar, III
 
Gilbert J. Pomar, III
 
President and Chief Executive Officer
   
   
Date: November 6, 2008
/s/ Valerie A. Kendall
 
Valerie A. Kendall
 
Executive Vice President
 
and Chief Financial Officer
 
27


JACKSONVILLE BANCORP, INC.

EXHIBIT INDEX

Exhibit No. 3.1: Articles of Incorporation of the Company (1)

Exhibit No. 3.2:  Amended and Restated Bylaws of the Company, as amended to date (2)

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 Appendix A to Form SB-2, filed September 30, 1998, Registration No. 333-64815.
 
(2)
Incorporated herein by reference to Exhibit No. 3.2 to Form 10-K for year ended December 31, 2007, filed March 27, 2008, File No. 000-30248.

28