News Column

JACKSONVILLE BANCORP, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

August 7, 2014

Management's discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of the Company. The information contained in this section should be read in conjunction with the unaudited consolidated financial statements and accompanying notes thereto.



Forward Looking Statements

This Form 10-Q contains certain "forward-looking statements" which may be identified by the use of words such as "believe," "expect," "anticipate," "should," "planned," "estimated," and "potential." Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operations and business that are subject to various factors that could cause actual results to differ materially from these estimates and most other statements that are not historical in nature. These factors include, but are not limited to, the effect of disruptions in the financial markets, changes in interest rates, general economic conditions and the current weak state of the United States economy, deposit flows, demand for mortgage and other loans, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation, including the Dodd-Frank Act and the elimination of the Office of Thrift Supervision; and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing of products and services.



Critical Accounting Policies and Use of Significant Estimates

In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in preparing our financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. Management believes the following discussion addresses our most critical accounting policies and significant estimates, which are those that are most important to the portrayal of our financial condition and results and require management's most difficult, subjective and complex judgements, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Allowance for Loan Losses - The Company believes the allowance for loan losses is the critical accounting policy that requires the most significant judgments and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is a material estimate that is particularly susceptible to significant changes in the near term and is established through a provision for loan losses. The allowance is based upon past loan experience and other factors which, in management's judgement, deserve current recognition in estimating loan losses. The evaluation includes a review of all loans on which full collectibility may not be reasonably assured. Other factors considered by management include the size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, existing economic conditions and historical losses on each portfolio category. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for significant properties, which collateralize loans. Management uses the available information to make such determinations. If circumstances differ substantially from the assumptions used in making determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be affected. While we believe we have established our existing allowance for loan losses in conformity with accounting principles generally accepted in the United States of America, there can be no assurance that regulators, in reviewing the Company's loan portfolio, will not request an increase in the allowance for loan losses. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that increases to the allowance will not be necessary if loan quality deteriorates. 38 Foreclosed Assets - Foreclosed assets primarily consist of real estate owned. Real estate owned acquired through loan foreclosures are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. The adjustment at the time of foreclosure is recorded through the allowance for loan losses. Due to the subjective nature of establishing fair value when the asset is acquired, the actual fair value of the other real estate owned could differ from the original estimate. If it is determined that fair value of an asset declines subsequent to foreclosure, the asset is written down through a charge to non-interest expense. Operating costs associated with the assets after acquisition are also recorded as non-interest expense. Gains and losses on the disposition of other real estate owned are netted and posted to non-interest expense. Deferred Income Tax Assets/Liabilities - Our net deferred income tax asset arises from differences in the dates that items of income and expense enter into our reported income and taxable income. Deferred tax assets and liabilities are established for these items as they arise. From an accounting standpoint, deferred tax assets are reviewed to determine that they are realizable based upon the historical level of our taxable income, estimates of our future taxable income and the reversals of deferred tax liabilities. In most cases, the realization of the deferred tax asset is based on our future profitability. If we were to experience net operating losses for tax purposes in a future period, the realization of our deferred tax assets would be evaluated for a potential valuation reserve. Impairment of Goodwill - Goodwill, an intangible asset with an indefinite life, was recorded on our balance sheet in prior periods as a result of acquisition activity. Goodwill is evaluated for impairment annually, unless there are factors present that indicate a potential impairment, in which case, the goodwill impairment test is performed more frequently. Mortgage Servicing Rights - Mortgage servicing rights are very sensitive to movements in interest rates as expected future net servicing income depends on the projected outstanding principal balances of the underlying loans, which can be greatly reduced by prepayments. Prepayments usually increase when mortgage interest rates decline and decrease when mortgage interest rates rise. Fair Value Measurements - The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Company estimates the fair value of financial instruments using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. When the financial instruments are not actively traded, other observable market inputs, such as quoted prices of securities with similar characteristics, may be used, if available, to determine fair value. When observable market prices do not exist, the Company estimates fair value. Other factors such as model assumptions and market dislocations can affect estimates of fair value. The above listing is not intended to be a comprehensive list of all our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States of America, with no need for management's judgement in their application. There are also areas in which management's judgement in selecting any available alternative would not produce a materially different result. Basel III On July 2, 2013, the Board of Governors of the Federal Reserve System announced its approval of the final rule to implement the Basel III regulatory capital reforms, among other changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Federal Deposit Insurance Corporation adopted the new rule on July 9, 2013. The approved rule includes a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5%, as well as a common equity Tier 1 capital conservation buffer of 2.5 of risk-weighted assets. The rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking institutions. The phase-in for banking institutions such as Jacksonville Savings Bank will not begin until January 2015, while the phase-in for larger banks began in January 2014. We are currently evaluating the impact of the implementation of the new capital standards. 39 Financial Condition



June 30, 2014 Compared to December 31, 2013

Total assets decreased by $9.6 million, or 3.0%, to $308.8 million at June 30, 2014 from $318.4 million at December 31, 2013. Net loans (excluding loans held for sale) decreased $6.7 million, or 3.7%, to $173.9 million at June 30, 2014 from $180.6 million at December 31, 2013. The decrease in loans is primarily due to decreases of $2.8 million in commercial business loans reflecting payments on lines of credit and $1.9 million in commercial real estate loans reflecting loan payoffs. The loan portfolio continues to be affected by low loan demand. At June 30, 2014 and December 31, 2013, goodwill totaled $2.7 million. At these dates, our goodwill was not impaired. Total deposits increased $348,000, or 0.1%, to $252.1 million at June 30, 2014 from $251.7 million at December 31, 2013. The increase reflects a $5.5 million increase in lower-cost transaction accounts, partially offset by a $5.2 million decrease in time deposits. Transaction accounts continue to grow as customers prefer to maintain short-term, liquid deposits in the current low-rate environment. Other borrowings, which consisted of overnight repurchase agreements and overnight advances from the FHLB, decreased $14.3 million, or 72.9%, to $5.3 million at June 30, 2014. The repurchase agreements are a cash management service provided to our commercial deposit customers. The decrease reflects the seasonal nature of our commercial cash management customers and loan payoffs. Stockholders' equity increased $3.0 million, or 7.2%, to $44.1 million at June 30, 2014. The increase in stockholders' equity was the result of $1.5 million in net income and a $1.9 million increase in accumulated other comprehensive income, partially offset by the payment of $286,000 in dividends and $371,000 in stock repurchases. Accumulated other comprehensive income (loss) consisted of an increase in unrealized gains, net of tax, on available-for-sale securities reflecting changes in market prices for securities in our portfolio. Accumulated other comprehensive income (loss) does not include changes in the fair value of other financial instruments included in the condensed consolidated balance sheet.



Results of Operations

Comparison of Operating Results for the Three Months Ended June 30, 2014 and 2013

General: Net income for the three months ended June 30, 2014 was $625,000, or $0.35 per common share, basic and diluted, compared to net income of $760,000, or $0.41 per common share, basic and diluted, for the three months ended June 30, 2013. The $135,000 decrease in net income reflects increases of $256,000 in non-interest expense and $30,000 in the provision for loan losses and a decrease of $80,000 in non-interest income, partially offset by an increase of $137,000 in net interest income and a decrease of $94,000 in income taxes. Interest Income: Total interest income for the three months ended June 30, 2014 increased $54,000, or 1.8%, to $3.0 million from $2.9 million during the same period of 2013. The increase in interest income reflected increases of $74,000 in interest income on mortgage-backed securities and $2,000 in interest income on investment securities, partially offset by decreases of $11,000 in interest income on loans and $11,000 in interest income on other interest-earning assets. Interest income on loans decreased $11,000 to $2.3 million during the second quarter of 2014 primarily due to a decrease in the average yield of loans. The average yield decreased 26 basis points to 5.11% during the second quarter of 2014, compared to 5.37% during the second quarter of 2013. The decrease in the average yield reflected lower market rates of interest and the competitive lending environment. The average balance of the loan portfolio increased $7.9 million to $179.3 million during the second quarter of 2014. The increase in the average balance of the loan portfolio reflected increases in the average balance of residential real estate loans and commercial business loans. 40 Interest income on investment securities increased $2,000 to $444,000 during the second quarter of 2014 compared to the second quarter of 2013. The increase reflected an increase in the average yield of investment securities to 3.00% during the second quarter of 2014 from 2.95% during the second quarter of 2013. The majority of our investment portfolio consists of municipal bonds which are exempt from federal taxation, resulting in a higher tax-equivalent yield. The increase in the average yield was partially offset by a decrease of $713,000 in the average balance of the investment securities portfolio to $59.2 million during the second quarter of 2014, compared to $59.9 million for the second quarter of 2013. Interest income on mortgage-backed securities increased $74,000 to $246,000 during the second quarter of 2014, compared to $172,000 during the second quarter of 2013. The increase reflected a 63 basis point increase in the average yield of mortgage-backed securities to 2.00% for the second quarter of 2014, compared to 1.37% for the second quarter of 2013. The average yield benefitted from lower premium amortization resulting from slower prepayment speeds on mortgage-backed securities. The amortization of premiums on mortgage-backed securities, which reduces the average yield, decreased $83,000 to $142,000 during the second quarter of 2014, compared to $225,000 during the second quarter of 2013. The increase in the average yield was partially offset by a $1.0 million decrease in the average balance of mortgage-backed securities to $49.1 million during the second quarter of 2014. Interest income on other interest-earning assets, consisting of interest-earning demand and time deposit accounts and federal funds sold, decreased $11,000 to $1,000 during the second quarter of 2014, compared to the second quarter of 2013. The average balance of these accounts decreased $8.0 million to $2.5 million for the three months ended June 30, 2014 compared to $10.5 million for the three months ended June 30, 2013. The decrease in the average balance reflected a decrease in the average balance of federal funds sold and time deposit accounts. The average yield on other interest-earning assets decreased to 0.10% during the second quarter of 2014 from 0.46% during the second quarter of 2013, reflecting the decrease in the higher-yielding time deposit accounts during this same time frame. Interest Expense: Total interest expense decreased $83,000, or 18.3%, to $371,000 during the three months ended June 30, 2014 compared to $454,000 during the three months ended June 30, 2013. The lower interest expense reflected an $83,000 decrease in the cost of deposits. Interest expense on deposits decreased $83,000 to $369,000 during the second quarter of 2014 compared to $452,000 during the second quarter of 2013. The decrease in interest expense on deposits was primarily due to a 12 basis point decrease in the average rate paid on deposits to 0.65% during the second quarter of 2014 from 0.77% during the second quarter of 2013. The decrease reflected lower average deposit balances in 2014 as compared to 2013, as well as a change in the composition of our deposits. The average balance of deposits decreased $7.6 million to $226.0 million for the second quarter of 2014. The decrease reflected a $12.7 million decrease in the average balance of time deposit accounts, partially offset by a $5.1 million increase in the average balance of lower cost transaction accounts. Interest paid on borrowed funds, which consisted of overnight repurchase agreements and FHLB advances, decreased slightly to $2,000 during the second quarter of 2014. The average rate paid on borrowed funds decreased to 0.13% during the second quarter of 2014 compared to 0.17% during the second quarter of 2013. The average balance of borrowed funds was $6.8 million for the second quarter of 2014 compared to $6.0 million for the second quarter of 2013, reflecting the use of overnight FHLB advances during 2014. Net Interest Income. As a result of the changes in interest income and interest expense noted above, net interest income increased by $137,000, or 5.6%, to $2.6 million for the three months ended June 30, 2014 from $2.5 million for the three months ended June 30, 2013. Our net interest margin increased 21 basis points to 3.60% during the second quarter of 2014 from 3.39% during the second quarter of 2013. Our interest rate spread increased by 22 basis points to 3.47% during the second quarter of 2014 from 3.25% during the second quarter of 2013. Our ratio of interest earning assets to interest bearing liabilities was 1.25x and 1.22x at June 30, 2014 and June 30, 2013, respectively. 41



Provision for Loan Losses: The provision for loan losses is determined by management as the amount needed to replenish the allowance for loan losses, after net charge-offs have been deducted, to a level considered adequate to absorb inherent losses in the loan portfolio, in accordance with accounting principles generally accepted in the United States of America.

The provision for loan losses equaled $30,000 during the second quarter of 2014, compared to $0 during the second quarter of 2013. The increase in the provision for loan losses reflected an increase in net charge-offs to $57,000 during the second quarter of 2014, compared to net recoveries of $27,000 during the second quarter of 2013. The allowance for loan losses decreased $131,000 to $3.3 million at June 30, 2014 from $3.5 million at June 30, 2013. Loans delinquent 30 days or more increased to $3.1 million, or 1.73% of total loans, as of June 30, 2014, from $1.8 million, or 0.99% of total loans, as of December 31, 2013. Loans delinquent 30 days or more totaled $2.0 million, or 1.19% of total loans at June 30, 2013. The $1.3 million increase in delinquent loans during 2014 primarily reflected the delinquency of a commercial real estate borrower totaling $889,000 and a commercial business borrower totaling $286,000, both of which are in the process of collection. Provisions for loan losses have been made to bring the allowance for loan losses to a level deemed adequate following management's evaluation of the repayment capacity and collateral protection afforded by each problem credit. This review also considered the local economy and the level of bankruptcies and foreclosures in our market area. The following table sets forth information regarding nonperforming assets at the dates indicated. June 30, 2014 December



31, 2013

Non-accruing loans:

One-to-four family residential $ 1,219,580 $ 1,339,487

Commercial real estate 173,629



208,297

Agricultural real estate 126,323 - Commercial business 315,234 37,939 Home equity 138,764 133,823 Consumer 179,529 62,617 Total $ 2,153,059 $ 1,782,163

Accruing loans delinquent more than 90 days: Total $ - $ - Foreclosed assets: One-to-four family residential 39,478



132,725

Commercial real estate 144,193 149,193 Consumer - 1,689 Total $ 183,671 $ 283,607

Total nonperforming assets $ 2,336,730 $



2,065,770

Total as a percentage of total assets 0.76 % 0.65 %

Nonperforming assets increased $271,000 to $2.3 million, or 0.76% of total assets, as of June 30, 2014, compared to $2.1 million, or 0.65% of total assets, as of December 31, 2013. The increase in nonperforming assets was due to an increase of $371,000 in nonperforming loans, partially offset by a $100,000 decrease in foreclosed assets. The increase in nonperforming loans primarily reflected the delinquency of the $286,000 commercial business customer noted above. 42 The following table shows the aggregate principal amount of potential problem credits on the Company's watch list at June 30, 2014 and December 31, 2013. All non-accruing loans are automatically placed on the watch list. The decrease in Substandard credits reflected significant payments of $394,000 and charge-offs of $123,000. June 30, 2014December 31, 2013



Special Mention credits $ 956,819 $ 1,057,028

Substandard credits 5,539,229



6,131,950

Total watch list credits $ 6,496,048 $ 7,188,978

Non-Interest Income: Non-interest income decreased $80,000, or 7.8%, to $948,000 for the three months ended June 30, 2014 from $1.0 million for the same period in 2013. The decrease in non-interest income resulted primarily from decreases of $43,000 in gains on the sale of available-for-sale securities, $26,000 in net income from mortgage banking operations and $23,000 in service charges on deposits, partially offset by an increase of $22,000 in ATM and bank card interchange income. The decrease in gains on the sale of securities reflected changing market conditions as sales increased to $6.7 million during the second quarter of 2014 compared to $3.6 million during the same period of 2013. The decrease in mortgage banking income was due to a lower volume of loan sales, reflecting an increase in mortgage rates. We sold $4.3 million of loans to the secondary market during the second quarter of 2014, compared to $7.4 million during the same period of 2013. The decrease in service charges on deposits reflects a decrease in fees related to nonsufficient funds. The increase in ATM and bank card interchange income reflects a higher transaction volume. Non-Interest Expense: Total non-interest expense increased $256,000, or 10.4%, to $2.7 million for the three months ended June 30, 2014. The increase was primarily due to increases of $241,000 in professional fees and $14,000 in ATM and bank card expense. The increase in professional fees reflects non-recurring legal and consulting expenses. The increase in ATM and bank card expense reflect processing fees related to the higher transaction volume. Income Taxes: The provision for income taxes decreased $94,000 to $176,000 during the second quarter of 2014 compared to the same period of 2013. The decrease in the income tax provision reflected a decrease in taxable income. The effective tax rate was 22.00% and 26.25% during the three months ended June 30, 2014 and 2013, respectively.



Comparison of Operating Results for the Six Months Ended June 30, 2014 and 2013

General: Net income for the six months ended June 30, 2014 was $1,465,000, or $0.82 per common share, basic, and $0.81 per common share, diluted, compared to net income of $1,773,000, or $0.95 per common share, basic and diluted, for the six months ended June 30, 2013. The $308,000 decrease in net income reflects a decrease of $569,000 in non-interest income and increases of $242,000 in non-interest expense and $30,000 in the provision for loan losses, partially offset by an increase of $313,000 in net interest income and a decrease of $220,000 in income taxes. Interest Income: Total interest income during the six months ended June 30, 2014 increased $147,000, or 2.5%, to $6.0 million from $5.9 million during the same period of 2013. The increase in interest income reflected increases of $233,000 in interest income on mortgage-backed securities and $17,000 in interest income on investment securities, partially offset by decreases of $80,000 in interest income on loans and $23,000 in interest on other interest-earnings assets. Interest income on loans decreased $80,000 to $4.6 million during the six months ended June 30, 2014, compared to the same period of 2013. The decrease in interest income on loans was primarily due to a decrease in the average yield of loans. The average yield on loans decreased 31 basis points to 5.09% during the first six months of 2014 from 5.40% during the first six months of 2013. The decrease in the average yield reflected lower market rates of interest and the competitive lending environment. The average balance of the loan portfolio increased $7.6 million to $179.6 million for the first six months of 2014 from $172.0 million for the first six months of 2013. The increase in the average balance of the loan portfolio reflected increases in the average balance of residential real estate loans and commercial business loans. 43 Interest income on investment securities increased $17,000 to $894,000 during the six months ended June 30, 2014 from the same period of 2013. The increase in interest income reflects a $2.0 million increase in the average balance of the investment portfolio to $60.0 million during 2014. The increase in the average balance was partially offset by a decrease in the average yield of investment securities. The average yield of investment securities decreased to 2.97% during the first six months of 2014 from 3.02% for the first six months of 2013 due to purchases of newer securities at lower interest rates. The majority of our investment portfolio consists of municipal bonds which are exempt from federal taxation, resulting in a higher tax-equivalent yield. Interest income on mortgage-backed securities increased $233,000 to $565,000 during the six months ended June 30, 2014, compared to $332,000 during the same period of 2013. The increase reflected a 98 basis point increase in the average yield of mortgage-backed securities to 2.30% for the first half of 2014, compared to 1.32% for the first half of 2013. The average yield benefitted from lower premium amortization resulting from slower national prepayment speeds on mortgage-backed securities. The amortization of premiums on mortgage-backed securities, which reduces the average yield, decreased $259,000 to $211,000 during the first six months of 2014, compared to $470,000 during the first six months of 2013. The increase in interest income on mortgage-backed securities was partially offset by a decrease of $1.3 million in the average balance of mortgage-backed securities to $49.2 million during the first half of 2014. Interest income on other interest-earning assets, consisting of interest-earning demand and time deposit accounts and federal funds sold, decreased $23,000 to $1,000 during the first half of 2014, compared to the first half of 2013. The average balance of these accounts decreased $8.5 million to $2.6 million for the six months ended June 30, 2014 compared to $11.1 million for the six months ended June 30, 2013. The decrease in the average balance reflected a decrease in the average balance of federal funds sold and time deposit accounts. The average yield on other interest-earning assets decreased to 0.05% during the first half of 2014 from 0.43% during the first half of 2013, reflecting the decrease in higher-yielding time deposit accounts during this same time frame.



Interest Expense: Total interest expense decreased $166,000, or 17.9%, to $761,000 during the six months ended June 30, 2014 compared to $927,000 during the six months ended June 30, 2013. The lower interest expense reflected a $166,000 decrease in the cost of deposits.

Interest expense on deposits decreased $166,000 to $755,000 for the six months ended June 30, 2014 compared to $921,000 for the six months ended June 30, 2013. The decrease in interest expense on deposits was primarily due to a 12 basis point decrease in the average rate paid to 0.67% during the first half of 2014 from 0.79% during the first half of 2013. The decrease reflected a decrease in the average balance of deposits, as well as a change in the composition of our deposits. The average balance of deposits decreased $8.6 million to $225.5 million for the first half of 2014 compared to $234.1 million for the first half of 2013. The decrease reflected a $13.0 million decrease in the average balance of time deposit accounts, partially offset by a $4.4 million increase in the average balance of lower cost transaction accounts. Interest paid on borrowed funds, which consisted of overnight repurchase agreements and FHLB advances, totaled $5,000 during the first six months of 2014 and 2013. The average rate paid on borrowed funds decreased to 0.12% during the first half of 2014 compared to 0.21% during the first half of 2013. The average balance of borrowed funds increased $3.7 million to $8.7 million during the first half of 2014, reflecting the use of overnight advances from the FHLB during 2014. Net Interest Income. As a result of the changes in interest income and interest expense noted above, net interest income increased by $313,000, or 6.3%, to $5.3 million for the six months ended June 30, 2014 from $5.0 million for the six months ended June 30, 2013. Our net interest margin increased 21 basis points to 3.61% for the first half of 2014 from 3.40% for the first half of 2013. Our interest rate spread increased by 23 basis points to 3.49% during the first half of 2014 from 3.26% during the first half of 2013. 44 Provision for Loan Losses: The provision for loan losses is determined by management as the amount needed to replenish the allowance for loan losses, after net charge-offs have been deducted, to a level considered adequate to absorb inherent losses in the loan portfolio, in accordance with accounting principles generally accepted in the United States of America. The following table shows the activity in the allowance for loan losses for the six months ended June 30, 2014 and 2013. Six Months Ended June 30, 2014June 30,



2013

Balance at beginning of period $ 3,406,434$ 3,339,464

Charge-offs: One-to-four family residential 30,000 - Commercial real estate 93,474 - Consumer 5,503 52,186 Total 128,977 52,186



Recoveries:

One-to-four family residential 960



15,471

Commercial real estate 168 111,569 Commercial business 32 7,341 Home equity 1,050 13,550 Consumer 1,600 7,327 Total 3,810 155,258

Net loan charge-offs (recoveries) 125,167



(103,072 )

Additions charged to operations 60,000



30,000

Balance at end of period $ 3,341,267 $



3,472,536

The allowance for loan losses decreased $131,000 to $3.3 million at June 30, 2014, from $3.5 million at June 30, 2013. The provision increased $30,000 to $60,000 during the first six months of 2014, compared to $30,000 during the first six months of 2013, reflecting the increase in net charge-offs during 2014. Net charge-offs equaled $125,000 during the first half of 2014, compared to net recoveries of $103,000 during the first half of 2013. Non-Interest Income: Non-interest income decreased $569,000, or 22.6%, to $1.9 million for the six months ended June 30, 2014. The decrease in non-interest income resulted primarily from decreases of $527,000 in gains on the sale of available-for-sale securities, $84,000 in net income from mortgage banking operations, and $65,000 in service charges on deposits, partially offset by increases of $57,000 in commission income and $47,000 in ATM and bank card interchange income. The decrease in gains on the sale of securities reflected changing market conditions and a lower volume of securities sales totaling $13.0 million during the first half of 2014 compared to $18.0 million during the same period of 2013. Securities sales during 2013 and 2014 were primarily made to reduce the volatility to interest rate changes in municipal bonds and to eliminate faster paying mortgage-backed securities. The decrease in mortgage banking operations income was due to a lower volume of loan sales in 2014, as we sold $5.9 million of loans to the secondary market during the first half of 2014, compared to $15.0 million during the same period of 2013. The lower volume of sales reflected a reduced volume of mortgage originations, which are affected by changes in market interest rates. The decrease in service charges on deposits reflects a decrease in fees related to nonsufficient funds. The increase in commission income reflected improved market conditions and increased account activity during 2014. The increase in ATM and bank card interchange income reflects a higher transaction volume. 45 Non-Interest Expense: Total non-interest expense increased $242,000, or 4.9%, to $5.2 million for the six months ended June 30, 2014 compared to the same period of 2013. The increase in non-interest expense consisted primarily of increases of $212,000 in professional fees and $42,000 in ATM and bank card expense. The increase in professional fees reflects non-recurring legal and consulting expenses. The increase in ATM and bank card expense reflects processing fees related to the higher transaction volume. Income Taxes: The provision for income taxes decreased $220,000 to $490,000 during the first six months of 2014 compared to the same period of 2013. The decrease in the income tax provision reflected a decrease in taxable income, as well as an increase in tax-exempt income. The effective tax rate was 25.06% and 28.58% during the six months ended June 30, 2014 and 2013, respectively.



Liquidity and Capital Resources

The Company's most liquid assets are cash and cash equivalents. The levels of these assets are dependent on the Company's operating, financing, and investing activities. At June 30, 2014 and December 31, 2013, cash and cash equivalents totaled $5.3 million and $6.1 million, respectively. The Company's primary sources of funds include principal and interest repayments on loans (both scheduled payments and prepayments), maturities of investment securities and principal repayments from mortgage-backed securities (both scheduled payments and prepayments). During the past six months, the most significant sources of funds have been calls and sales of investment securities, and principal repayments on loans and mortgage-backed securities, and growth in deposits. These funds have been used primarily for purchases of U.S. Agency, municipal and mortgage-backed securities and the reduction of other borrowings.



While scheduled loan repayments and proceeds from maturing investment securities and principal repayments on mortgage-backed securities are relatively predictable, deposit flows and prepayments are more influenced by interest rates, general and local economic conditions, and competition. The Company attempts to price its deposits to meet asset-liability objectives and stay competitive with local market conditions.

Liquidity management is both a short- and long-term responsibility of management. The Company adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected purchases of investment and mortgage-backed securities, (iii) expected deposit flows, (iv) yields available on interest-bearing deposits, and (v) liquidity of its asset/liability management program. Excess liquidity is generally invested in interest-earning overnight deposits and other short-term U.S. agency obligations. If the Company requires funds beyond its ability to generate them internally, it has the ability to borrow funds from the FHLB. The Company may borrow from the FHLB under a blanket agreement which assigns all investments in FHLB stock as well as qualifying first mortgage loans equal to 150% of the outstanding balance as collateral to secure the amounts borrowed. This borrowing arrangement is limited to a maximum of 30% of the Company's total assets or twenty times the balance of FHLB stock held by the Company. At June 30, 2014, the Company had $1.1 million in outstanding FHLB advances and approximately $25.6 million available to it under the above-mentioned borrowing arrangement. The Company maintains minimum levels of liquid assets as established by the Board of Directors. The Company's liquidity ratios at June 30, 2014 and December 31, 2013 were 40.2% and 39.0%, respectively. This ratio represents the volume of short-term liquid assets as a percentage of net deposits and borrowings due

within one year. 46 The Company must also maintain adequate levels of liquidity to ensure the availability of funds to satisfy loan commitments. The Company anticipates that it will have sufficient funds available to meet its current commitments principally through the use of current liquid assets and through its borrowing capacity discussed above. The following table summarizes these commitments at June 30, 2014 and December 31, 2013. June 30, 2014December 31, 2013



Commitments to fund loans $ 40,020,516$ 41,694,350

Standby letters of credit 650,880 360,000 Quantitative measures established by applicable regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and Tier 1 capital (as defined) to average assets (as defined). Management believes that at June 30, 2014, the Company met all its capital adequacy requirements. Under Illinois law, Illinois-chartered savings banks are required to maintain a minimum core capital to total assets ratio of 3%. The Illinois Commissioner of Savings and Residential Finance (the "Commissioner") is authorized to require a savings bank to maintain a higher minimum capital level if the Commissioner determines that the savings bank's financial condition or history, management or earnings prospects are not adequate. If a savings bank's core capital ratio falls below the required level, the Commissioner may direct the savings bank to adhere to a specific written plan established by the Commissioner to correct the savings bank's capital deficiency, as well as a number of other restrictions on the savings bank's operations, including a prohibition on the declaration of dividends by the savings bank's board of directors. At June 30, 2014, the Bank's core capital ratio was 12.29% of total average assets, which substantially exceeded the required amount. The Bank is also required to maintain regulatory capital requirements imposed by the Federal Deposit Insurance Corporation. The Bank must have: (i) Tier 1 Capital to Average Assets of 4.0%, (ii) Tier 1 Capital to Risk-Weighted Assets of 4.0%, and (iii) Total Capital to Risk-Weighted Assets of 8.0%. At June 30, 2014 and December 31, 2013, minimum requirements and the Bank's actual ratios are as follows: June 30, 2014 December 31, 2013 Minimum Actual Actual Required

Tier 1 Capital to Average Assets 12.29 % 11.51 % 4.00 % Tier 1 Capital to Risk-Weighted Assets 18.49 % 16.89 % 4.00 % Total Capital to Risk-Weighted Assets 19.74 %



18.15 % 8.00 %

Effect of Inflation and Changing Prices

The condensed consolidated financial statements and related financial data presented herein have been prepared in accordance with GAAP which require the measurement of financial position and operating results in terms of historical dollars, without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the Company's operations. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. 47



The following table sets forth the average balances and interest rates (costs) on the Company's assets and liabilities during the periods presented.

Consolidated Average Balance Sheet and Interest Rates (Dollars in thousands) Three Months Ended June 30, 2014 2013 Average Average Balance Interest Yield/Cost Balance Interest Yield/Cost



Interest-earnings assets:

Loans $ 179,260$ 2,288 5.11 % $ 171,318$ 2,299 5.37 % Investment securities 59,207 443 3.00 %

59,920 442 2.95 % Mortgage-backed securities 49,132 246 2.00 % 50,150 172 1.37 % Other 2,496 1 0.10 % 10,473 12 0.46 % Total interest-earning assets 290,095 2,978 4.11 % 291,861 2,925 4.01 % Non-interest earnings assets 20,820 21,548 Total assets $ 310,915$ 313,409 Interest-bearing liabilities: Deposits $ 225,966$ 369 0.65 % $ 233,594$ 452 0.77 % Other borrowings 6,773 2 0.13 % 5,952 3 0.17 % Total interest-bearing liabilities 232,739 371 0.64 % 239,546 455 0.76 % Non-interest bearing liabilities 34,774 29,652 Stockholders' equity 43,402 44,211 Total



liabilities/stockholders'

equity $ 310,915



$ 313,409

Net interest income $ 2,607$ 2,470 Interest rate spread (average yield earned minus average rate paid) 3.47 % 3.25 % Net interest margin (net interest income divided by average interest-earning assets) 3.60 % 3.39 % 48 The following table sets forth the changes in rate and changes in volume of the Company's interest earning assets and liabilities for the comparative three month periods. Analysis of Volume and Rate Changes (In thousands) Three Months Ended June 30, 2014 Compared to 2013 Increase(Decrease) Due to Rate Volume Net



Interest-earnings assets:

Loans $ (115 )$ 104



$ (11 )

Investment securities 7 (5 )



2

Mortgage-backed securities 78 (4 )



74

Other (6 ) (5 ) (11 ) Total net change in income on interest-earning assets (36 ) 90 54



Interest-bearing liabilities:

Deposits (69 ) (14 )



(83 )

Other borrowings - - - Total net change in expense on interest-bearing liabilities (69 ) (14 ) (83 )



Net change in net interest income $ 33$ 104$ 137

49



The following table sets forth the average balances and interest rates (costs) on the Company's assets and liabilities during the periods presented.

Consolidated Average Balance Sheet and Interest Rates (Dollars in thousands) Six Months Ended June 30, 2014 2013 Average Average Balance Interest Yield/Cost Balance Interest Yield/Cost



Interest-earnings assets:

Loans $ 179,554$ 4,565 5.09 % $ 171,957$ 4,645 5.40 % Investment securities 60,088 893 2.97 %

58,078 876 3.02 % Mortgage-backed securities 49,164 565 2.30 % 50,466 332 1.32 % Other 2,563 1 0.05 % 11,060 24 0.43 % Total interest-earning assets 291,369 6,024 4.14 % 291,561 5,877 4.03 % Non-interest earnings assets 20,730 21,638 Total assets $ 312,099$ 313,199 Interest-bearing liabilities: Deposits $ 225,548$ 755 0.67 % $ 234,159$ 921 0.79 % Other borrowings 8,699 5 0.12 % 5,026 5 0.21 % Total interest-bearing liabilities 234,247 760 0.65 % 239,185 926 0.77 % Non-interest bearing liabilities 35,179 29,852 Stockholders' equity 42,673 44,162 Total



liabilities/stockholders'

equity $ 312,099



$ 313,199

Net interest income $ 5,264$ 4,951 Interest rate spread (average yield earned minus average rate paid) 3.49 % 3.26 % Net interest margin (net interest income divided by average interest-earning assets) 3.61 % 3.40 % 50

The following table sets forth the changes in rate and changes in volume of the Company's interest earning assets and liabilities for the comparative six month periods. Analysis of Volume and Rate Changes (In thousands) Six Months Ended June 30, 2014 Compared to 2013 Increase(Decrease) Due to Rate Volume Net Interest-earnings assets: Loans $ (280 )$ 200



$ (80 )

Investment securities (13 ) 30



17

Mortgage-backed securities 242 (9 )



233

Other (12 ) (11 ) (23 ) Total net change in income on interest-earning assets (63 ) 210 147



Interest-bearing liabilities:

Deposits (133 ) (33 )



(166 )

Other borrowings (3 ) 3 - Total net change in expense on interest-bearing liabilities (136 ) (30 ) (166 )



Net change in net interest income $ 73$ 240$ 313

51



JACKSONVILLE BANCORP, INC.


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