ITEM 1. BUSINESS.
GENERAL
Jacksonville Bancorp, Inc.'s (the "Company") primary asset is Jacksonville Savings Bank, SSB ("Jacksonville" or the "Bank"). The business of Jacksonville consists primarily of attracting deposits from the general public and using those and other available sources of funds to originate loans secured by single-family residences located in Cherokee County and surrounding counties in East Texas. To a lesser extent, Jacksonville also originates construction loans, land loans, consumer loans, home equity loans, and a limited number of commercial real estate loans. After approval of equity lending beginning January 1, 1998, Jacksonville established an equity loan department. In addition, Jacksonville invests in United States government and federal agency securities and mortgage-backed securities, including collateralized mortgage obligations ("C.M.O."). Jacksonville also has a small portfolio of private-label C.M.O's.
On July 2, 1997, Jacksonville Savings and Loan Association converted from a Texas chartered savings and loan association to a Texas chartered savings bank, changing its name to Jacksonville Savings Bank, SSB. The change did not affect operations of the Bank but did provide the Bank with additional flexibility. In addition, the change of charter reduced governmental supervision costs, because the Office of Thrift Supervision ("OTS")would no longer regulate the institution along with the Texas Savings and Loan Department and the Federal Deposit Insurance Corporation. The Bank is now regulated by the Federal Deposit Insurance Corporation and the Texas Savings and Loan Department. The Company continues to be regulated by the OTS as a savings and loan holding company.
On July 16, 1997, after receiving appropriate regulatory approvals, Jacksonville IHC, a Delaware chartered company ("IHC") acquired all the issued and outstanding stock of Jacksonville Savings Bank, SSB previously held by the Company. IHC is, and was at the time of the acquisition, a wholly-owned subsidiary of the Company. The purpose of the transaction was to minimize certain Texas state taxation expenses imposed on holding companies with Texas source income. In addition to holding all the issued and outstanding shares of Jacksonville, IHC's only other business activity was to loan funds to Jacksonville's Employee Stock Ownership Plan.
MARKET AREA
Jacksonville's market area consists of Cherokee County and surrounding counties in East Texas. The labor force of Cherokee County has evolved from agriculture to manufacturing and service industries. The components of the area's economic base have consisted of manufacturing, mining, agriculture, retail and tourism. Jacksonville is the largest city in Cherokee County and the principal business activity in the city is manufacturing. There are 90 manufacturing concerns in Jacksonville according to numbers supplied by the Jacksonville Chamber of Commerce. Industries represented are plastic manufacturing and plastic injected molding, oil (reflecting the heritage of East Texas as the center of the Texas oil country), timber, cattle and bedding plant. Slowdowns in the petroleum industry had a material negative impact on the area's economy in the early 1980s which was compounded by defense-related cutbacks. However, the area's economy has improved in recent years due to further entrance of business in the market area and especially in Tyler and Longview. In addition, the area's economic base has diversified into such fields as health services, research and technology.
Major companies in Jacksonville's market area include Alligence HealthCare, Inc., Astro Air, Zimmerman & Sons, Trane Corporation, Kelly-Springfield, Carrier Air Conditioning, Tyler Pipe Industries, Marathon Le Tourneau, Eastman Kodak, Powell Plant Farm, Texas Department of Corrections, Western Lithotech and Wal-Mart (a distribution center). The market area is also served by the University of Texas Hospital, Mother Frances Hospital, and Medical Center Hospital. These hospitals are also a major source of employment for the market area. Colleges and universities include the University of Texas at Tyler, Stephen F. Austin University, Tyler Junior College, Texas
College, Lon Morris College, Jacksonville College, LeTourneau University and Trinity Valley Junior College. According to reports from the Bureau of Labor Statistics, as of September 30, 2002, the unemployment rate in Cherokee County and surrounding counties in East Texas was estimated to be 5.4% as compared to 4.8% in 2001 and the estimated unemployment rates for the United States during these periods were 5.9% and 5.4% respectively.
LENDING ACTIVITIES
At September 30, 2002, Jacksonville's net loan portfolio totaled $265.1 million representing approximately 62.3% of Jacksonville's $425.3 million of total assets at that date. The principal lending activity of Jacksonville is the origination of single-family residential loans. At September 30, 2002, approximately 99% of Jacksonville's single-family residential loan portfolio consisted of conventional loans with the remaining single-family residential loans either insured by the Federal Housing Administration ("FHA") or partially guaranteed by the Department of Veterans Affairs ("VA"). At September 30, 2002, Jacksonville's single-family residential loan portfolio totaled $189.5 million, representing approximately 67.8% of Jacksonville's total loans, before net items, at that date. Jacksonville held $22.9 million in commercial real estate loans at that date, representing 8.2% of total loans, before net items. Of the commercial real estate loans, $782,000, or 3.4%, were secured by real estate acquired in satisfaction of debts previously contracted or by improvements on such properties. In addition to these loans secured by real estate acquired in satisfaction of debts previously contracted, Jacksonville originated $10.8 million in new commercial real estate loans during fiscal 2002. Other significant areas of lending activity by Jacksonville are construction loans, consumer loans and land loans, which, as of September 30, 2002, represented $40.8 million, or 14.6%, $21.5 million, or 7.7% and $3.4 million, or 1.2% of net loans. Home equity loans in the amount of $27.2 million are included in the single family portfolio.
As a Texas-chartered savings bank, Jacksonville has general authority to originate and purchase loans secured by real estate located throughout the United States. Notwithstanding this nationwide lending authority, approximately 99% of all of the mortgage loans in Jacksonville's portfolio are secured by properties located in Cherokee County and surrounding counties in East Texas, reflecting Jacksonville's emphasis on local lending.
At September 30, 2002, Jacksonville's limit on loans-to-one borrower was $5.0 million, and its five largest loans or groups of loans-to-one borrower, including related entities, aggregated $4.7 million, $3.6 million, $2.7 million, $2.2 million, and $2.2 million. The first group of loans totaling $4.7 million consists of ten loans secured by 1-4 family units, six loans for the construction of a single family residences, two loans secured by commercial buildings, and two loans for the development of single family subdivisions. The second group of loans for $3.6 million consists of two loans secured by residential subdivisions, three loans for the construction of single family residences, and one loan for the construction of a shopping center. The third group is made up of one loan for the development of a single family subdivision, five loans for the construction of single family residences and one loan secured by land for future development. The fourth largest group of loans consist of a loan for the development of a residential subdivision, one loan for the construction of a single family residence, and for loans secured by 1-4 family units. The fifth largest loan totaling $1.4 million consisted of one loan secured by a church.
LOAN PORTFOLIO COMPOSITION. The following table sets forth the composition of Jacksonville's loan portfolio by type of loan at the dates indicated.
- --------------------- (1) Includes first and second liens on single-family residences.
CONTRACTUAL PRINCIPAL REPAYMENTS. The following table sets forth certain information at September 30, 2002, regarding the dollar amount of loans maturing in Jacksonville's portfolio, based on the contractual terms to maturity, before giving effect to net items. Demand loans, loans having no stated schedule of repayments and no stated maturity and overdrafts are reported as due in one year.
- --------------------------------- (1) Includes first and second liens on single-family residences.
The following table sets forth the dollar amount of all loans, before net items, due after one year from September 30, 2002 which have fixed interest rates or which have floating or adjustable interest rates.
- ----------------------------------- (1) Includes first and second liens on single-family residences.
Scheduled contractual amortization of loans does not reflect the actual term of Jacksonville's loan portfolio. The average life of loans is substantially less than their contractual terms because of prepayments and due-on-sale
clauses, which give Jacksonville the right to declare a conventional loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage and the loan is not repaid.
ORIGINATIONS, PURCHASES AND SALES OF LOANS. The lending activities of Jacksonville are subject to the written, non-discriminatory, loan underwriting and administration guidelines established by Jacksonville's Board of Directors and management. Loan originations are obtained from a variety of sources, including referrals from real estate brokers, developers, builders, existing customers, newspaper, radio, periodical advertising and walk-in customers. Loan applications are taken by lending personnel, and the loan department supervises the obtaining of credit reports, appraisals and other documentation involved with a loan. Property valuations are generally performed by independent outside appraisers approved by Jacksonville's Board of Directors. Jacksonville requires title insurance on most all mortgage loans except for certain small second mortgages of a minimal amount. Jacksonville obtains a letter certificate from title companies on some personal real estate loans and most home equity loans.
Jacksonville's loan approval process is intended to assess the borrower's ability to repay the loan, the viability of the loan and the adequacy of the value of the property that will secure the loan. After a loan application is first reviewed by Jacksonville's loan department, the loan can receive approval with at least two officers' authorization. All loan approvals by officers are then reviewed and ratified by the Loan and Executive Committee. Any loan not approved by at least two officers must be submitted to the Loan and Executive Committee for review and disposition.
Certain loans, because of their amount or because they do not meet one or more specified guidelines, must receive direct approval of the Board of Directors.
Jacksonville originates both fixed- and adjustable-rate residential real estate loans as market conditions dictate. Prior to fiscal 1999 Jacksonville followed a policy of selling approximately 95% of its loans secured by first mortgage liens on single-family residences ("residential first mortgage loans") with fixed rates and terms greater than 15 years to third parties while retaining all of its variable-rate loans. However, during 2000 management elected to portfolio a greater percentage of its fixed rate mortgage product because of increased interest rates. During 2001 and 2002 Jacksonville continued a policy to sell a portion of the loans originated to the secondary market and portfolio the balance. When loans are sold to others, except to the Federal Home Loan Mortgage Corporation ("FHLMC"), servicing of the loans is usually released to the buyers. At September 30, 2002, $91.9 million in loans were being serviced for others, primarily the FHLMC. See Note 5 to the Consolidated Financial Statements. While Jacksonville has utilized various indices to adjust its adjustable-rate mortgages ("ARMs") portfolio, most would qualify such loans for securitization under FHLMC guidelines. Adjustable-rate loans are currently indexed to an index of U.S. Treasury obligations whose maturity matches the interest adjustment period for the corresponding loan and have their interest rates readjusted every one to five years. At September 30, 2002, $153.0 million or 54.7% of Jacksonville's total loans, before net items, were fixed-rate single-family residential loans, and $36.5 million or 13.1% of such total loans were adjustable-rate single-family residential mortgage loans. Of these adjustable mortgages, $14.8 million, or 40.5%, have interest rates adjustable in one year, and the remainder adjust at periods greater than one year up to five years.
The following table shows total loans originated, purchased, sold and repaid during the periods indicated.
- --------------------------- (1) Consists of loan foreclosures, extensions and changes in net items.
SINGLE-FAMILY RESIDENTIAL LOANS. The primary lending activity of Jacksonville is the origination of loans secured by first mortgage liens on single-family residences. Jacksonville also offers second mortgage loans on such properties including home improvement and home equity loans. At September 30, 2002, $189.5 million or 67.8% of Jacksonville's total loan portfolio, before net items, consisted of single-family residential loans.
The loan-to-value ratio, maturity and other provisions of the residential first mortgage loans made by Jacksonville generally have reflected the policy of making less than the maximum loan permissible under applicable regulations, in accordance with sound lending practices, market conditions and underwriting standards established by Jacksonville. All residential first mortgage loans, except those made to facilitate the sale of such dwellings held as real estate owned, are generally underwritten in conformance with current guidelines of the FHLMC. Jacksonville's lending policies on residential first mortgage loans generally limit the maximum loan-to-value ratio to 97% of the lesser of the appraised value or purchase price of the property and generally all residential first mortgage loans in excess of an 80% loan-to-value ratio require private mortgage insurance. Jacksonville makes a limited number of 100% loan to value loans to those customers whose credit scores exceeded 700 with the requirement of 30% private mortgage insurance coverage.
Jacksonville offers fixed-rate residential first mortgage loans with terms up to 30 years. Such loans are amortized on a monthly basis with principal and interest due each month and customarily include "due-on-sale" clauses, which are provisions giving Jacksonville the right to declare a loan immediately due and payable in the event the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not repaid. Jacksonville enforces due-on-sale clauses to the extent permitted under applicable laws. Approximately 99% of Jacksonville's residential first mortgage loan portfolio consists of conventional loans, with the remaining loans either insured by the FHA or partially guaranteed by the VA.
Jacksonville is aware that there are inherent risks in originating fixed-rate residential first mortgage loans for its portfolio, especially during periods of historically low interest rates, but recognizes the need to respond to market demand for fixed-rate loans and to generate income from any origination fees, where applicable, for such loans. To address these concerns, in October 1987 Jacksonville began a policy of selling substantially all of the fixed-rate residential first mortgage loans that it originates to a large mortgage banking company with operations throughout the United States. While Jacksonville continues to maintain its loan sales relationship with the mortgage banking company, a substantial majority of its loan sales since July 1993 have been to FHLMC with servicing retained by Jacksonville. Since July 1993, Jacksonville has sold $179.2 million of loans to FHLMC and has retained the servicing on all of these loans. Since that same date, Jacksonville has sold $59.2 million of loans to the mortgage banking company. During fiscal 2002, Jacksonville sold $29.0 million of loans to FHLMC and $10.2 million to the mortgage banking company as compared to $11.7 million of loans to FHLMC and $9.2 million to the mortgage banking company during fiscal 2001. Loan sales were up primarily as a result of the increase in originations during fiscal 2002.
During the year ended September 30, 2002, Jacksonville originated $85.3 million of single-family residential loans of which $79.2 million, or 92.8%, were fixed rate and $6.1 million, or 7.2%, were adjustable rate. Of the fixed-rate single-family residential loans originated during the period, Jacksonville sold $29.0 million, or 36.6%, to FHLMC. The volume of single-family residential loans originated increased by 20.3% from $70.9 million during fiscal 2001 as compared to $85.3 million during fiscal 2002 and the percentage of sales of such originations increased from 29.5% in fiscal 2001 to 46.0% in fiscal 2002. Single family loan originations increased in fiscal 2002 primarily due to an increase in refinancing caused by lower interest rates. During the year Jacksonville elected to portfolio a number of its 15 and 30 year mortgage loan product. Jacksonville will reevaluate this policy if there is a material and prolonged change in interest rates and may elect to again sell most of its loan originations with terms of more than 15 years.
Since November 1980, Jacksonville has been offering adjustable-rate loans in order to decrease the vulnerability of its operations to changes in interest rates. Interest rate adjustment periods range from one to five years. The demand for adjustable-rate loans in Jacksonville's primary market area has been a function of several factors, including the level of interest rates, the expectations of changes in the level of interest rates and the difference between the interest rates offered for fixed-rate loans and adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate residential loans that can be originated at any time is largely determined by the demand for each in a competitive environment. As interest rates have fluctuated since November 1981, the demand for fixed- and adjustable-rate loans has changed as Jacksonville's customers have preferred adjustable rates in a high interest rate environment and fixed-rate loans as interest rates lowered. In an effort to originate and maintain a percentage of adjustable-rate residential first mortgage loans, Jacksonville has offered various forms of adjustable-rate loans combined with a policy of selling a portion of its 15 and 30 year fixed-rate loans from its portfolio. As a result, at September 30, 2002, $36.5 million, or 19.3%, of the single-family residential loans in Jacksonville's loan portfolio, before net items, consisted of adjustable-rate loans.
Jacksonville's residential first mortgage adjustable-rate loans are fully amortizing loans with contractual maturities of up to 30 years. These loans have interest rates which are scheduled to adjust every one, three or five years in accordance with designated published indices based upon U.S. Government securities. Jacksonville currently offers a one, three and five-year adjustable mortgage with a 2% cap on the rate adjustment per period and a 4% to 6% cap rate adjustment over the life of the loan, depending on its term. Jacksonville's adjustable-rate residential first mortgage loans are not convertible by their terms into fixed-rate loans, are not assumable, do not contain prepayment penalties and do not produce negative amortization.
Due to the generally lower rates of interest prevailing in prior periods, Jacksonville's ability to originate adjustable-rate residential first mortgage loans has decreased as consumer preference for fixed-rate loans has increased. As a result, even as interest rates have fluctuated in recent years, adjustable rate loans represented 7.2%, 3.7%, and 17.8% of Jacksonville's total originations of single-family residential loans during the years ended September 30, 2002, 2001, and 2000, respectively.
Adjustable-rate loans decrease the risks to Jacksonville associated with changes in interest rates but involve other risks, primarily because as interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, thereby increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates. Jacksonville believes that these risks, which have not had a material adverse effect on Jacksonville to date, generally are less than the risks associated with holding fixed-rate loans in an increasing interest rate environment.
Jacksonville also makes home improvement loans which amounted to $2.0 million as of September 30, 2002. These loans are secured by either first or second liens on single-family residences. Second mortgage loans on single-family residences made by Jacksonville are generally secured by properties on which Jacksonville holds the first mortgage lien.
HOME EQUITY LOANS. In recent years, Jacksonville has increased its emphasis on the origination of home equity loans. Loans are secured by the homestead property, and may not exceed 80% of the appraised value of the property based on either the current market value as set forth by the County Appraisal District or by a new appraisal prepared by a qualified person. These loans are usually in a second lien position, but can be a first lien either through paying off the existing first lien or by having no existing liens on the property at the time the home equity loan is made. These loans are typically made for a term of 20 years or less. These loans are usually at a slightly higher rate of interest than most first lien loans and have lower closing cost, making them very attractive for both the consumer and Jacksonville. At September 30, 2002 Jacksonville had $27.2 million or 9.7 % of the total loan portfolio, before net items, in home equity loans.
COMMERCIAL MORTGAGE LOANS. At September 30, 2002, $22.9 million, or 8.2%, of Jacksonville's total loan portfolio, before net items, consisted of loans secured by existing commercial real estate. Of these commercial mortgage loans, $782,000, or 3.4%, represented loans secured by real estate acquired in satisfaction of debts previously contracted or by improvements on such properties. Jacksonville currently originates a limited number of commercial mortgage loans. Commercial mortgage loan originations for the years ended September 30, 2002, 2001 and 2000 were, respectively, $10.8 million, $4.5 million, and $3.0 million.
As of September 30, 2002, the commercial mortgage loans in Jacksonville's portfolio not secured by real estate acquired in satisfaction of debts previously contracted or improvements thereon totaled $22.1 million. These loans have terms up to 30 years and have both fixed and adjustable rates. At September 30, 2002, $15.0 million, or 67.9%, of the commercial mortgage loan portfolio not secured by real estate acquired in satisfaction of debts previously contracted consisted of adjustable-rate loans.
The majority of Jacksonville's commercial real estate loans are secured by office buildings, churches, retail shops, and manufacturing facilities, and are secured by property located in Jacksonville's lending area.
Appraisals are required on all properties securing commercial real estate loans. They generally are performed by an independent appraiser designated by Jacksonville and are reviewed by management and members of the loan and executive committee.
In originating commercial mortgage loans, Jacksonville considers the quality of the property, the credit of the borrower, cash flow of the project, location of the real estate and the quality of management involved with the property.
Commercial mortgage lending is generally considered to involve a higher degree of risk than single-family residential lending. Such lending typically involves large loan balances concentrated in a single borrower or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties is typically dependent on the successful operation of the related real estate project and thus may be subject to a greater extent to adverse conditions in the real estate market or in the economy generally.
CONSTRUCTION LOANS. At September 30, 2002, construction loans totaled $40.8 million or 14.6% of the total loan portfolio, before net items.
Jacksonville makes construction loans to individuals for the construction of their residences. During recent years, it expanded its construction lending activities to include lending to developers for the construction of single-family subdivisions and residences. Because Jacksonville views construction loans as involving greater risk than permanent single-family residential loans, it applies stricter underwriting standards to them. Construction loan originations increased during the year ended September 30, 2002 to $45.7 million from $45.5 million during fiscal 2001.
Construction lending is generally limited to Jacksonville's primary lending area, within 100 miles of Jacksonville's home office or within 25 miles of each branch office. Construction loans are only made to individuals and to developers who have a sound financial and operational reputation in the market area. The loans to individuals are structured to be converted to permanent loans at the end of the construction phase, which typically is six months but may be extended for 30- or 60-day periods for good reason. Construction loans have rates and terms which generally exceed the non-construction loans then offered by Jacksonville except that during the construction phase the borrower normally only pays interest on the loan. Funds are released periodically pursuant to a construction-completion schedule and only after an on-site inspection by an employee or agent of Jacksonville. Jacksonville generally attempts to mitigate the risks associated with construction lending by, among other things, lending primarily in its market area and using low loan-to-value ratios in the underwriting process. The maximum loan to value ratio is 80% except for a small amount of loans that have private mortgage insurance. Construction financing also is generally considered to involve a higher degree of risk of loss than long-term financing on improved, owner-occupied real estate because of the uncertainties of construction, including the possibility of costs exceeding the initial estimates.
LAND LOANS. As of September 30, 2002, land loans totaled $3.3 million or 1.2% of the total loan portfolio, before net items. As of that date, Jacksonville had 74 land loans in its loan portfolio, over 90% of which were utilized for ranching, agricultural or residential purposes. With limited exceptions, Jacksonville's underwriting guidelines require land loans to have a loan-to-land value ratio of 80% and a term of 20 years or less. The average balance of Jacksonville's land loans, as of September 30, 2002, was approximately $46,000.
CONSUMER LOANS. At September 30, 2002, consumer loans totaled $21.5 million or 7.7% of the total loan portfolio, before net items, and consisted primarily of loans secured by deposits, loans secured by vehicles, personal real estate loans and loans to purchase personal property. Loans secured by deposits total $2.7 million at September 30, 2002. A loan secured by a deposit at Jacksonville is structured to have a term that ends on the same date as the maturity date of the certificate securing it or if secured by a statement savings account has a one-year term with a hold on withdrawals that would result in the balance being lower than the loan balance. Typically these loans require quarterly payments of interest only. Jacksonville also makes loans to individuals for future home sites and for additional property adjacent to their existing residence, and for small 1 to 4 family residences. Although under Texas law such loans may have a term of up to 20 years, the average term of Jacksonville's personal real estate loans was substantially less than 20 years as of September 30, 2002. All of these loans are secured by the purchased land, but because these loans are typically for $40,000 or less they are not underwritten in the same manner as the Bank's other mortgage loans. Jacksonville relies on the general creditworthiness of the borrower and uses tax valuations or limited appraisals to determine the value of the property. In some cases a title search is obtained from a title insurance company rather than a title policy. At September 30, 2002, the bank had 264 personal real estate loans with an average balance of $16,000. Jacksonville's vehicle loan portfolio totaled $10.5 million at September 30, 2002. Jacksonville makes both new and used vehicle loans. Most all used vehicle loans are originated at higher interest rates than those rates on new vehicle loans. The Bank does not purchase vehicle loans from dealers. The term for vehicle loans is typically six months to five years with monthly payments of principal and interest.
MULTI-FAMILY AND COMMERCIAL BUSINESS LOANS. At September 30, 2002, $1.0 million or 0.4%, and $411,000, or 0.1%, of Jacksonville's total loan portfolio, before net items, consisted of multi-family loans and commercial business loans, respectively. While Jacksonville has the authority, up to applicable limitations, to engage in the business of making both multi-family and commercial business loans, its policy has been to confine its primary lending activities to other types of lending. Of the eight multi-family loans in Jacksonville's loan portfolio as of September 30, 2002, the largest loan had a principal amount of $419,000 which represented 40.2% of the multi-family loan portfolio. As of September 30, 2002, Jacksonville had 30 commercial business loans, the largest having a balance of $61,000 which is secured by commercial vehicles.
LOAN ORIGINATION AND OTHER FEES. In some cases, in addition to interest earned on loans, Jacksonville receives loan origination fees or "points" for originating loans. Loan points are a percentage of the principal amount of the mortgage loan and are charged to the borrower in connection with the origination of the loan.
The charging of points, in most cases, was limited during fiscal 2002 because of market conditions and strong competition in the one-to-four family residential loans in the East Texas market. Most financial institutions charged no points on these loan products; however, primarily on low principal amount residential mortgages and commercial loans, Jacksonville continued to charge a loan fee.
Loan fees received are accounted for substantially in accordance with FASB Statement No. 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases." Loan fees and certain direct loan origination costs are deferred, and the net fee is recognized as an adjustment to interest income over the contractual life of the loans. Jacksonville has not deferred direct costs related to short-term loans for which no origination fees are charged. Management considers this departure to be immaterial considering the short-term nature of these loans. Commitment fees and costs relating to commitments whose likelihood of exercise is remote are recognized over the commitment period on a straight-line basis. If the commitment is subsequently exercised during the commitment period, the remaining unamortized commitment fee at the time of exercise is recognized over the life of the loan as an adjustment of yield. At September 30, 2002, Jacksonville had $443,000 of loan fees which had been deferred and are being recognized as income over the life of the related loans. See Note 2 to the Consolidated Financial Statements.
ASSET QUALITY
DELINQUENT LOANS. The following table sets forth information concerning delinquent loans at September 30, 2002, in dollar amount and as a percentage of Jacksonville's total loan portfolio, before net items. The amounts presented represent the total outstanding principal balances of the related loans, rather than the actual payment amounts which are past due.
NON-PERFORMING ASSETS. All loans are reviewed on a regular basis and are placed on a non-accrual status when, in the opinion of management, the collection of additional interest is deemed insufficient to warrant further accrual. Jacksonville does not accrue interest on loans past due 90 days or more except when the estimated value of the collateral and collection efforts were deemed sufficient to ensure full recovery. Uncollectible interest on loans that are contractually past due is charged off or an allowance is established based on management's periodic evaluation. The allowance is established by a charge to interest income equal to all interest previously accrued, and income is subsequently recognized only to the extent cash payments are received until, in management's judgment, the borrower's ability to make periodic interest and principal payments is restored or until management accepts a payment that results in a cure of the 90-day delinquency. In such cases, the loan is returned to accrual status.
FORECLOSED REAL ESTATE. Foreclosed real estate (REO) is real property acquired by Jacksonville through foreclosure, deed in lieu of foreclosure, or through an exchange of foreclosed real estate. It is typically a poor or nonearning asset, and its acquisition in limited amounts is generally regarded as an unavoidable result of normal business operations. However, the holding of abnormally large amounts of REO for extensive periods of time can adversely affect earnings. As a result of adverse economic conditions that existed in Jacksonville's market area during the 1980s, Jacksonville, like most financial institutions in its market area, acquired an inordinately large amount of REO consisting primarily of commercial real estate and, to a lesser degree, single-family residential property.
As the economy has improved in its market area in recent years, Jacksonville has reduced its outstanding REO each year by following a policy of prudent management and market monitoring. The details of this policy are embodied in Jacksonville's Real Estate Owned Policy adopted by the Board of Directors. The primary objectives of the REO Policy are to: (1) establish procedures for the handling and disposition of REO; (2) ensure that REO has been properly accounted for on the institution's books; (3) set forth Jacksonville's philosophy for the management of repossessed property; (4) provide for the periodic revaluation of real estate owned; and (5) provide guidelines for the accounting of the sale of REO. These objectives are monitored by the Board of Directors.
REO is recorded at the lower of unpaid principal balance of the loan plus acquisition costs or fair value, as determined by an appraisal of the property obtained at acquisition. Costs relating to development and improvement of property are capitalized, whereas costs relating to holding the property are expensed. Valuations are periodically performed by management and an allowance for losses is established by a charge to operations if the carrying value of a property exceeds its estimated net realizable value. Jacksonville develops an asset plan for each parcel of REO that it holds for more than six months. The plan includes specific marketing strategies, a consideration of necessary
improvements and an estimate of the expected holding period and asking price. As a result of the general improvement in economic conditions in Jacksonville's market area and through the implementation of the REO Policy, Jacksonville's REO amounted to $87,000, $63,000, and $124,000 as of September 30, 2002, 2001, and 2000 respectively.
Generally, a transfer of REO is recognized by Jacksonville as a sale for accounting purposes upon consummation of the transaction unless Jacksonville retains some type of continuing involvement in the property without a transfer of the risks and rewards of ownership to the buyer or, under some circumstances, if it has financed the sale of the REO. In the latter case, in order for a sale to be recognized, a buyer must, among other things, demonstrate his commitment to the property by making adequate initial and continuing investments. The percentage of sales price viewed as an adequate initial investment level varies with the type of loan, but a generally acceptable percentage of the sales price is between 10% to 25% for commercial real estate and 5% for a single-family primary residence. REO sales financed by Jacksonville in which a buyer's initial investment is less than what is considered an adequate initial investment level under the REO Policy are carried on Jacksonville's books as REO sold by the deposit method until the buyer has an adequate level of equity. As of September 30, 2002, Jacksonville had no REO sold and accounted for by the deposit method.
The following table sets forth the amounts and categories of Jacksonville's non-performing assets at the dates indicated.
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(1) Includes first and second liens on single-family residences.
(2) Includes real estate acquired by foreclosure, by deed in lieu of foreclosure and deemed in-substance foreclosure net of specified reserves.
At September 30, 2002, management was not aware of any additional loans with possible credit problems which caused it to have doubts as to the ability of the borrowers to comply with present loan repayment terms and which in management's view may result in the future inclusion of such items in the non-performing asset categories.
The interest income that would have been recorded during fiscal 2002, 2001, and 2000 if Jacksonville's non-accruing loans at the end of such periods had been current in accordance with their terms during such periods were approximately $41,000, $63,000, and $25,000, respectively. Jacksonville has not committed to lend additional funds to debtors whose loans have been modified. See Note 5 to the Consolidated Financial Statements. During the year ended September 30, 2002, no interest income was actually recorded on any loans after they were placed on non-accrual status.
CLASSIFIED ASSETS. Federal regulations require that each insured depository institution classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, federal examiners have authority to identify problem assets and, if appropriate, classify them. There are three classifications for problem assets: "substandard," "doubtful" and "loss." Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. Another category designated "special mention" also must be established and maintained for assets which do not currently expose an insured institution to a sufficient degree of risk to warrant classification as substandard, doubtful or loss. Assets classified as substandard or doubtful require the institution to establish general allowances for loan losses. If an asset or portion thereof is classified loss, the insured institution must either establish specific allowances for loan losses in the amount of 100% of the portion of the asset classified loss, or charge-off such amount. General loss allowances established to cover possible losses related to assets classified substandard or doubtful may be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses do not qualify as regulatory capital. Federal examiners may disagree with an insured institution's classifications and amounts reserved.
Jacksonville's classified assets at September 30, 2002 consisted of $4,000 of assets classified as special mention, $2,420,000 of assets classified as substandard, and none classified as doubtful or loss. All of the assets classified special mention were single-family residential loans. Of assets classified substandard, $87,000, or 3.6%, were residential real estate parcels acquired as real estate owned, $1,670,000, or 69.0%, were single-family residential loans, $55,000, or 2.3%, were land loans and $342,000, or 14.1%, were commercial loans. The remaining balance of $221,000, or 9.1%, was in consumer loans and $45,000, or 1.9%, in repossessed autos.
The following table sets forth the Bank's classified assets at the dates indicated.
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ALLOWANCE FOR LOAN LOSSES. It is management's policy to maintain an allowance for estimated losses on loans based upon an assessment of past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay and current economic conditions. For fiscal 2002 non-performing loans increased to $694,000 while net charge-offs for the period totaled $67,000. The Company's level of net loans outstanding increased $18.7 million. Overall economic conditions remained stable for the market area and credit quality for the applicants showed no material change. Upon consideration of such factors, Jacksonville determined that $102,000 in provisions for loan losses were appropriate primarily because of the
increase in the loan portfolio. Although management believes that it uses the best information available to make such determinations, future adjustments to allowances may be necessary, and net earnings could be significantly affected, if circumstances differ substantially from the assumptions used in making the initial determinations. Currently, the allowance for loan losses is formally reevaluated on a quarterly basis.
At September 30, 2002, Jacksonville's allowance for loan losses amounted to $ 1.3 million, an increase of $35,000 from September 30, 2001.
The following table sets forth an analysis of Jacksonville's allowance for loan losses during the periods indicated.
The following table presents the allocation of the allowance for loan losses to the total amount of loans in each category listed at the dates indicated.
MORTGAGE-BACKED SECURITIES
Jacksonville has invested in a portfolio of mortgage-backed securities which are insured or guaranteed by the FHLMC, FNMA or the GNMA. Jacksonville also has in its mortgage-backed securities portfolio two private label C.M.O.'s. Mortgage-backed securities increase the quality of Jacksonville's assets by virtue of the guarantees that back them, are more liquid than individual mortgage loans and may be used to collateralize borrowings or other obligations of Jacksonville. In addition, at September 30, 2002, $35.3 million of Jacksonville's mortgage-backed securities consist of pools of adjustable-rate mortgages. Mortgage-backed securities of this type serve to reduce the interest rate risk associated with rising interest rates.
The following table sets forth the activity in Jacksonville's mortgage-backed securities portfolio during the periods indicated.
At September 30, 2002, Jacksonville's mortgage-backed securities had an amortized cost value and estimated market value of $89.4 million and $89.8 million, respectively. Of the $89.4 million portfolio, $34.4 million was scheduled to mature in five years or less; $14.6 million was scheduled to mature in over five years but less than ten years; and $40.4 million was scheduled to mature after ten years. Due to prepayments of the underlying loans, the actual maturities of mortgage-backed securities generally are substantially less than the scheduled maturities.
All mortgage-backed securities in the portfolio qualify for regulatory liquidity under Texas state savings bank regulations. Of the $89.4 million of mortgage backed securities on September 30, 2002, $54.1 million consisted of fixed rate and $35.3 million were adjustable rate securities. Of Jacksonville's total investment in mortgage-backed securities at September 30, 2002, $39.9 million consisted of FNMA certificates, $2.0 million consisted of GNMA certificates and $14.2 million consisted of FHLMC certificates and $33.3 million in C.M.O. certificates. See Note 4 to the Consolidated Financial Statements for additional information.
The actual maturity of a mortgage-backed security may be less than its stated maturity due to prepayments of the underlying mortgages. Prepayments that are faster than anticipated may shorten the life of the security and adversely affect its yield to maturity. The yield is based upon the interest income and the amortization of any premium or discount related to the mortgage-backed security. In accordance with generally accepted accounting principles, premiums and discounts are amortized over the estimated lives of the loans, which decrease and increase interest income, respectively. The prepayment assumptions used to determine the amortization period for premiums and discounts can significantly affect the yield of the mortgage-backed security, and these assumptions are reviewed periodically to reflect actual prepayments. Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the geographical location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of falling mortgage interest rates, if the coupon rate of the underlying mortgages exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgages and the related security. Under such circumstances, Jacksonville may be subject to reinvestment risk because to the extent that Jacksonville's
mortgage-backed securities amortize or prepay faster than anticipated, Jacksonville may not be able to reinvest the proceeds of such repayments and prepayments at a comparable rate.
Interest rates declined during 2002. Should they continue to decline or remain the same, the Company's interest income will be adversely impacted since the Company will be unable to replace maturing securities with new securities of comparable yields.
INVESTMENT ACTIVITIES
Jacksonville's investment securities portfolio is managed in accordance with a written Investment Policy adopted by the Board of Directors and administered by the Investment Committee which consists of one outside Director, the President, the Executive Vice President, the Senior Vice President and the First Vice President. The members of the Investment Committee are: Robert Brown, Jerry Chancellor and Bill W. Taylor, Jerry Hammons and Chan Campsey. There is no investment limit for investments in U.S. Treasury obligations and FHLB obligations having maturities of ten years or less and in other U.S. federal agency or federally sponsored agency obligations, including, but not limited to FHLMC, FNMA, GNMA and the Student Loan Marketing Association, municipal obligations rated AAA, AA, A or BBB or issued by a public housing agency and backed by the full faith and credit of the U.S. government having maturities of 30 years or less. In addition, there are no investment limits on bankers acceptances of 12 months or less and federal funds of 360 days or less. Up to $100,000 per bank may be invested in commercial bank certificates of deposit with maturities up to one year. Other investments must be approved by the Board of Directors. At September 30, 2002, Jacksonville had U.S. Government agency held-to-maturity securities with an amortized cost of $8.0 million and an estimated market value of $8.1 million. See Note 3 to the Consolidated Financial Statement for further information. At September 30, 2002, Jacksonville held U.S. Government Agency securities as available-for-sale with an amortized cost of $29.0 million and an estimated market value of $29.2 million.
The following table sets forth Jacksonville's investment and mortgage-backed securities at the dates indicated.
(1) Securities classified as available for sale were carried at fair value at September 30, 2002, 2001, and 2000. Securities classified as held-to-maturity were carried at historical cost at all respective dates.
At September 30, 2002, $10.5 million or 28.2% of total investment securities excluding mortgage backed securities, held by Jacksonville were scheduled to mature in one year or less and had a weighted average yield of 3.30%. Included in the amount is $10.0 million invested in an adjustable rate mortgage fund with a yield of 3.15%. Of the remaining investment securities, $8.0 million was scheduled to mature after one year through five years, $16.7 million was scheduled to mature six years through ten years, and $2.0 million scheduled to mature in over ten years.
The following table sets forth certain information regarding the maturities of Jacksonville's investment securities at September 30, 2002.
INTEREST-BEARING DEPOSITS
As of September 30, 2002, Jacksonville also had demand deposit accounts in the FHLB of Dallas of $10.3 million. In order to comply with a policy adopted by its Board of Directors, Jacksonville's deposits in FDIC-insured institutions are limited to $100,000 per bank in certificates of deposit with a maximum maturity of five years. As of September 30, 2002 Jacksonville had 11 certificates of deposits totaling $1.1 million.
SOURCES OF FUNDS
GENERAL. Deposits are the primary source of Jacksonville's funds for lending and other investment purposes. In addition to deposits, Jacksonville derives funds from loan principal repayments. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. They may also be used on a longer term basis for general business purposes.
DEPOSITS. Jacksonville's deposits are attracted principally from within Jacksonville's primary market area through the offering of a broad selection of deposit instruments, including demand and NOW accounts, money market accounts, passbook savings accounts, and term certificate accounts. Included among these deposit products are individual retirement account certificates of approximately $26.0 million at September 30, 2002.
Deposit account terms vary, with the principal differences being the minimum balance required, the time periods the funds must remain on deposit and the interest rate.
Interest rates paid, maturity terms, service fees and withdrawal penalties are established by Jacksonville on a periodic basis. Determination of rates and terms are predicated on funds acquisition and liquidity requirements, rates paid by competitors, growth goals and federal regulations.
Jacksonville does not advertise for deposits outside its local market area or utilize the services of deposit brokers.
The following table sets forth the dollar amount of deposits in the various types of deposit programs offered by Jacksonville at the dates indicated.
The following table sets forth the savings activities of Jacksonville during the periods indicated.
The following table shows the interest rate and maturity information for Jacksonville's certificates of deposit at September 30, 2002.
The following table sets forth the maturities of Jacksonville's certificates of deposit having principal amounts of $100,000 or more at September 30, 2002.
The following table sets forth the maximum month-end balance and average balance of Jacksonville's FHLB advances during the periods indicated. Also see Note 10 to the Consolidated Financial Statements.
The following table sets forth certain information as to Jacksonville's long-term (terms to maturity in excess of 90 days) and short-term (terms to maturity of 90 days or less) FHLB advances at the dates indicated.
BORROWINGS. Until fiscal 1998 wherein management elected to implement a wholesale growth strategy using FHLB advances, Jacksonville had not frequently borrowed from the FHLB of Dallas. It obtains advances from the FHLB of Dallas upon the security of the common stock it owns in that bank and certain of its residential mortgage loans, provided certain standards related to creditworthiness have been met. Such advances are made
pursuant to several credit programs, each of which has its own interest rate and range of maturities. Such advances are generally available to meet seasonal and other withdrawals of deposit accounts and to permit increased lending. At September 30, 2002, Jacksonville had $25.1 million in advances from the FHLB of Dallas, as compared to $48.1 million at September 30, 2001.
Borrowings from the Federal Home Loan Bank of Dallas are an important source of funding for Jacksonville and are subject to limitations imposed by the FHLB of Dallas. In general, the FHLB of Dallas limits borrowing to 50% of a member's total assets, subject to collateral availability. At September 30, 2002, Jacksonville's borrowing limit was $204.5 million, of which $25.1 million was due to the FHLB of Dallas at that date, leaving a total remaining line of credit with the FHLB of Dallas of $179.3 million at that date. The Company had sufficient mortgage assets to collateralize the remaining line on September 30, 2002.
The Company's ESOP also borrowed funds from Jacksonville IHC for the purchase of shares of the Company's Common Stock issued in connection with the Conversion. As of September 30, 2002, the outstanding balance of that loan was $918,000.
COMPETITION. The Company faces significant competition for real estate loans, principally from mortgage banking companies, other savings institutions, commercial banks and credit unions. Factors which affect competition generally include the general and local economic conditions, current interest rate levels and volatility in the mortgage markets. The Company also faces significant competition in attracting deposits. Its most direct competition for deposits has historically come from commercial banks and other savings institutions located in its market area. The Company faces additional significant competition for investors' funds from other financial intermediaries. The Company competes for deposits principally by offering depositors a variety of deposit programs, convenient branch locations, hours and other services. The Company does not rely upon any individual group or entity for a material portion of its deposits.
Federal legislation in recent years has eliminated many of the distinctions between commercial banks and savings institutions and holding companies and allowed bank holding companies to acquire savings institutions. Such legislation has generally resulted in an increase in the competition encountered by savings institutions and has resulted in a decrease in both the number of savings institutions and the aggregate size of the savings industry.
SUBSIDIARIES. Jacksonville currently owns 100% of the capital stock of JS&L Corporation ("JS&L") which was established in December 1979. JS&L is self sufficient due to income from investments, interest from residential notes receivable and lease income. Since its original charter, JS&L's main activity has been the servicing of purchased residential first and second lien notes. The portfolio includes 12 loans ranging in size from $2,000 to $52,000, some of which were purchased at a discount. For most of the second lien notes purchased, Jacksonville holds the first lien note. For the years ended September 30, 2002 and September 30, 2001, JS&L had a loss of $14,000 and a net profit of $42,000, respectively. JS&L now invests in investments permissible for Jacksonville, leases computer equipment, and originates and buys first and second liens. JS&L purchases first and second lien notes pursuant to a written mortgage loan underwriting policy adopted by JS&L's board of directors. In addition to these activities, during 1999 the Federal Deposit Insurance Corporation gave approval for the Company through its subsidiary, JS&L, to enter into a proposed residential real estate development in Hallsville, Texas, a community near Longview, Texas. The project involved acquisition and development of a 66 acre tract of land for single-family homes. JS&L executed a development loan through its parent, Jacksonville on February 25, 1999 in the amount of $1,500,000. At September 30, 2002, the interim loan balance totaled $906,000. There are currently twelve houses completed or under construction in the subdivision.
Total investment in JS&L at September 30, 2002 was $1.0 million. Total capital of JS&L at September 30, 2002 was $1.0 million.
Jacksonville IHC, Inc. holds all the issued and outstanding stock of Jacksonville Savings Bank, SSB, a wholly owned subsidiary of the Company. In addition to holding all the issued and outstanding shares of Jacksonville, IHC's only other business activity was to loan funds to Jacksonville's Employee Stock Ownership Plan.
EMPLOYEES. Jacksonville and its subsidiary had 112 full-time employees at September 30, 2002. None of these employees is represented by a collective bargaining agent, and Jacksonville believes that it enjoys good relations with its personnel.
REGULATION
Set forth below is a brief description of certain laws and regulations which relate to the regulation of the Company, IHC and the Bank. The description does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations.
THE COMPANY
SARBANES-OXLEY ACT OF 2002. On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002 implementing legislative reforms intended to address corporate and accounting fraud. In addition to the establishment of a new accounting oversight board which will enforce auditing, quality control and independence standards and will be funded by fees from all publicly traded companies, the bill restricts provision of both auditing and consulting services by accounting firms. To ensure auditor independence, any non-audit services being provided to an audit client will require preapproval by the company's audit committee members. In addition, the audit partners must be rotated. The bill requires chief executive officers and chief financial officers, or their equivalent, to certify to the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement. In addition, under the Act, counsel will be required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to its chief executive officer or its chief legal officer, and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the board of directors or the board itself.
Longer prison terms will also be applied to corporate executives who violate Federal securities laws, the period during which certain types of suits can be brought against a company or its officers has been extended, and bonuses issued to top executives prior to restatement of a company's financial statements are now subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from insider trading during retirement plan "blackout" periods, and loans to company executives are restricted. In addition, a provision directs that civil penalties levied by the SEC as a result of any judicial or administrative action under the Act be deposited to a fund for the benefit of harmed investors. The Federal Accounts for Investor Restitution ("FAIR") provision also requires the SEC to develop methods of improving collection rates. The legislation accelerates the time frame for disclosures by public companies as they must immediately disclose any material changes in their financial condition or operations. Directors and executive officers must also provide information for most changes in ownership in a company's securities within two business days of the change.
The Act also increases the oversight of, and codifies certain requirements relating to audit committees of public companies and how they interact with the company's "registered public accounting firm" ("RPAF"). Audit committee members must be independent and are barred from accepting consulting, advisory or other compensatory fees from the issuer. In addition, companies must disclose whether at least one member of the committee is a "financial expert" (as such term will be defined by the SEC) and if not, why not. Under the Act, a RPAF is prohibited from performing statutorily mandated audit services for a company if such company's chief executive officer, chief financial officer, comptroller, chief accounting officer or any person serving in equivalent positions has been employed by such firm and participated in the audit of such company during the one-year period preceding
the audit initiation date. The Act also prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the audit of the company's financial statements for the purpose of rendering the financial statement's materially misleading. The Act also requires the SEC to prescribe rules requiring inclusion of an internal control report and assessment by management in the annual report to shareholders. The Act requires the RPAF that issues the audit report to attest to and report on management's assessment of the company's internal controls. In addition, the Act requires that each financial report required to be prepared in accordance with (or reconciled to) generally accepted accounting principles and filed with the SEC reflect all material correcting adjustments that are identified by a RPAF in accordance with generally accepted accounting principles and the rules and regulations of the SEC.
THE COMPANY AND IHC
REGULATIONS. After Jacksonville converted to a Texas-chartered savings bank, the Company continued to be subject to regulation as a savings and loan holding company under the Home Owners' Loan Act, as amended ("HOLA"), instead of being subject to regulation as a bank holding company under the Bank Holding Company Act of 1956 because the Bank made an election under Section 10(l) of HOLA to be treated as a "savings association" for purposes of Section 10(e) of HOLA. As a result, the Company and IHC are registered unitary savings and loan holding companies and are subject to OTS, Federal Deposit Insurance Corporation ("FDIC") and the Texas Savings and Loan Department (the "Department") regulation, examination, supervision and reporting requirements. In addition, because the capital stock of the Company is registered under Section 12(g) of the Securities Exchange Act of 1934, the Company is also subject to various reporting and other requirements of the SEC. As a subsidiary of a savings and loan holding company, the Bank is also subject to certain Federal and state restrictions in its dealings with the Company and affiliates thereof.
FEDERAL ACTIVITIES RESTRICTIONS. Generally, there are only limited restrictions on the activities of a unitary savings and loan holding company, such as the Company, which applied to become or was a unitary savings and loan holding company prior to May 4, 1999 and its non-savings institution subsidiaries. Under the recently enacted Gramm-Leach-Bliley Act of 1999 (the "GLBA"), however, companies which applied to the OTS after May 4, 1999 to become unitary savings and loan holding companies will be restricted to engaging in those activities traditionally permitted to multiple savings and loan holding companies. If the Director of the OTS determines that there is reasonable cause to believe that the continuation by a savings and loan holding company of an activity constitutes a serious risk to the financial safety, soundness or stability of its subsidiary savings institution (i.e., a savings association or savings bank), the Director may impose such restrictions as are deemed necessary to address such risk, including limiting (i) payment of dividends by the savings institution; (ii) transactions between the savings institution and its affiliates; and (iii) any activities of the savings institution that might create a serious risk that the liabilities of the holding company and its affiliates may be imposed on the savings institution. Notwithstanding the above rules as to permissible business activities of grandfathered unitary savings and loan holding companies under the GLBA, if the savings institution subsidiary of such a holding company fails to meet the Qualified Thrift Lender ("QTL") test, then such unitary holding company also becomes subject to the activities restrictions applicable to multiple savings and loan holding companies and, unless the savings institution requalifies as a QTL within one year thereafter, must register as, and become subject to the restrictions applicable to, a bank holding company.
If the Company or IHC were to acquire control of another savings institution, other than through merger or other business combination with the Bank, the Company and IHC would thereupon become a multiple savings and loan holding company. Except where such acquisition is pursuant to the authority to approve emergency thrift acquisitions and where each subsidiary savings institution meets the QTL test, as set forth below, the activities of the Company and any of its subsidiaries (other than the Bank or other subsidiary savings institutions) would thereafter be subject to further restrictions. No multiple savings and loan holding company or subsidiary thereof which is not a savings institution may commence or continue beyond a limited period of time after becoming a
multiple savings and loan holding company or subsidiary thereof any business activity, other than: (i) furnishing or performing management services for a subsidiary savings institution; (ii) conducting an insurance agency or escrow business; (iii) holding, managing, or liquidating assets owned by or acquired from a subsidiary savings institution; (iv) holding or managing properties used or occupied by a subsidiary savings institution; (v) acting as trustee under deeds of trust; (vi) those activities authorized by regulation as of March 5, 1987 to be engaged in by multiple savings and loan holding companies; or (vii) unless the Director of the OTS by regulation prohibits or limits such activities for savings and loan holding companies, those activities authorized by the Federal Reserve Board as permissible for bank holding companies. The activities described in (i) through (vi) above may be engaged in only after giving the OTS prior notice and being informed that the OTS does not object to such activities. In addition, the activities described in (vii) above also must be approved by the Director of the OTS prior to being engaged in by a multiple savings and loan holding company.
RESTRICTIONS ON ACQUISITIONS. Except under limited circumstances, savings and loan holding companies are prohibited from acquiring, without prior approval of the Director of the OTS, (i) control of any other savings institution or savings and loan holding company or substantially all the assets thereof or (ii) more than 5% of the voting shares of a savings institution or holding company thereof which is not a subsidiary. Except with the prior approval of the Director of the OTS, no director or officer of a savings and loan holding company or person owning or controlling by proxy or otherwise more than 25% of such company's stock, may acquire control of any savings institution, other than a subsidiary savings institution, or of any other savings and loan holding company.
The Director of the OTS may approve acquisitions resulting in the formation of a multiple savings and loan holding company which controls savings institutions in more than one state only if (i) the multiple savings and loan holding company involved controls a savings institution which operated a home or branch office located in the state of the association to be acquired as of March 5, 1987; (ii) the acquirer is authorized to acquire control of the savings institution pursuant to the emergency acquisition provisions of the FDIA, or (iii) the statutes of the state in which the institution to be acquired is located specifically permit institutions to be acquired by the state-chartered institutions or savings and loan holding companies located in the state where the acquiring entity is located (or by a holding company that controls such state-chartered savings institutions).
LIMITATIONS ON DIVIDENDS. The Company is a legal entity separate and distinct from Jacksonville. The Company's principal source of revenue consists of dividends from Jacksonville. The payment of dividends by Jacksonville is subject to various regulatory requirements including a requirement, as a result of the Company's savings and loan holding company status, that Jacksonville notify the Director of the Office of Thrift Supervision not less than 30 days in advance of any proposed declaration by its directors of a dividend.
TEXAS REGULATIONS. Under the Texas Savings Bank Act ("TSBA"), each registered holding company, such as the Company and IHC, is required to file reports with the Department as required by the Texas Savings and Loan Commissioner ("Commissioner") and is subject to such examination as the Commissioner may prescribe.
REGULATION OF THE BANK
The Bank is required to file reports with the Department and the FDIC concerning its activities and financial condition, in addition to obtaining regulatory approvals prior to entering into certain transactions, such as any merger or acquisition with another institution. The regulatory system to which the Bank is subject is intended primarily for the protection of the deposit insurance fund and depositors, not stockholders. The regulatory structure also provides the Department and the FDIC with substantial discretion in connection with their supervisory and enforcement functions. The Department and the FDIC conduct periodic examinations of the Bank in order to assess its compliance with federal and state regulatory requirements. As a result of such examinations, the Department and the FDIC may require various corrective actions.
Virtually every aspect of the Bank's business is subject to numerous federal and/or state regulatory requirements and restrictions with respect to such matters as, for example, the nature and amounts of loans and investments that may be made, the issuance of securities, the amount of reserves that must be established against deposits, the establishment of branches, mergers, non-banking activities and other operations. Numerous laws and regulations also set forth special restrictions and procedural requirements with respect to the extension of credit, credit practices, the disclosure of credit terms and discrimination in credit transactions.
The description of statutory provisions and regulations applicable to savings banks set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Bank. Furthermore, the Bank cannot predict what other new regulatory requirements might be imposed in the future.
LIMITATIONS ON TRANSACTIONS WITH AFFILIATES. Transactions between savings institutions and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a savings institution is any company or entity which controls, is controlled by or is under common control with the savings institution. In a holding company context, the parent holding company of a savings institution (such as the Company and IHC) and any companies which are controlled by such parent holding company are affiliates of the savings institution. Generally, Sections 23A and 23B (i) limit the extent to which the savings institution or its subsidiaries may engage in covered transactions with any one affiliate to an amount equal to 10% of such institution's capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus and (ii) require that all such transactions be on terms substantially the same, or at least as favorable to the institution or subsidiary, as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and similar transactions. In addition to the restrictions imposed by Sections 23A and 23B, no savings institution may (i) loan or otherwise extend credit to an affiliate, except for any affiliate which engages only in activities which are permissible for bank holding companies, or (ii) purchase or invest in any stocks, bonds, debentures, notes or similar obligations of any affiliate, except for affiliates which are subsidiaries of the savings institution.
In addition, Sections 22(h) and (g) of the Federal Reserve Act place restrictions on loans to executive officers, directors and principal stockholders. Under Section 22(h), loans to a director, an executive officer and to a greater than 10% stockholder of a savings institution (a "principal stockholder"), and certain affiliated interests of each of them, may not exceed, together with all other outstanding loans to such person and affiliated interests, the savings institution's loans to one borrower limit (generally equal to 15% of the institution's unimpaired capital and surplus). Section 22(h) also requires that loans to directors, executive officers and principal stockholders be made on terms substantially the same as offered in comparable transactions to other persons and also requires prior board approval for certain loans. In addition, the aggregate amount of extensions of credit by a savings institution to all insiders cannot exceed the institution's unimpaired capital and surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers. At September 30, 2002, the Bank was in compliance with the above restrictions.
REGULATORY CAPITAL REQUIREMENTS. Federally-insured state-chartered banks are required to maintain minimum levels of regulatory capital. These standards generally must be as stringent as the comparable capital requirements imposed on national banks. The FDIC also is authorized to impose capital requirements in excess of these standards on individual banks on a case-by-case basis.
Under current FDIC regulations, the Bank is required to comply with three separate minimum capital requirements: a "Tier 1 capital ratio" and two "risk-based" capital requirements. "Tier 1 capital" generally includes common stockholders' equity (including retained earnings), qualifying noncumulative perpetual preferred stock and any related surplus, and minority interests in the equity accounts of fully consolidated subsidiaries, minus intangible assets, other than properly valued PMSRs up to certain specified limits and minus net deferred tax assets in excess of certain specified limits.
TIER 1 LEVERAGE CAPITAL RATIO. FDIC regulations establish a minimum 3.0% ratio of Tier 1 capital to total assets for the most highly-rated state-chartered, FDIC-supervised banks, with an additional cushion of at least 100 to 200 basis points for all other state-chartered, FDIC-supervised banks, which effectively imposes a minimum Tier 1 capital ratio for such other banks of between 4.0% to 5.0%. Under FDIC regulations, highly-rated banks are those that the FDIC determines are not anticipating or experiencing significant growth and have well diversified risk, including no undue interest rate risk exposure, excellent asset quality, high liquidity and good earnings. At September 30, 2002, the required Tier 1 leverage capital ratio requirement for the Bank was 4.00% and its actual Tier 1 leverage capital ratio was 7.61%.
RISK-BASED CAPITAL REQUIREMENTS. The risk-based capital requirements contained in FDIC regulations generally require the Bank to maintain a ratio of Tier 1 capital to risk-weighted assets of at least 4.00% and a ratio of total risk-based capital to risk-weighted assets of at least 8.00%. To calculate the amount of capital required, assets are placed in one of four categories and given a percentage weight (0%, 20%, 50% or 100%) based on the relative risk of the category. For example, U.S. Treasury Bills and GNMA securities are placed in the 0% risk category. FNMA and FHLMC securities are placed in the 20% risk category, loans secured by one-to-four family residential properties and certain privately-issued mortgage-backed securities are generally placed in the 50% risk category and commercial and consumer loans and other assets are generally placed in the 100% risk category. In addition, certain off-balance sheet items are converted to balance sheet credit equivalent amounts and each amount is then assigned to one of the four categories.
For purposes of the risk-based capital requirements, "total capital" means Tier 1 capital plus supplementary or Tier 2 capital, so long as the amount of supplementary or Tier 2 capital that is used to satisfy the requirement does not exceed the amount of Tier 1 capital. Supplementary or Tier 2 capital includes, among other things, so-called permanent capital instruments (cumulative or other perpetual preferred stock, mandatory convertible subordinated debt and perpetual subordinated debt), so-called maturing capital instruments (mandatorily redeemable preferred stock, intermediate-term preferred stock, mandatory convertible subordinated debt and subordinated debt), and a certain portion of the allowance for loan losses up to a maximum of 1.25% of risk-weighted assets.
At September 30, 2002, the Bank's Tier 1 capital to risk-weighted assets ratio was 13.23%. On the same date, the Bank's total risked-based capital percentage was 13.77%.
The following table sets forth information with respect to each of the Bank's capital requirements as of the dates shown.
The following table sets forth a reconciliation between the Bank's stockholders' equity and each of its three regulatory capital requirements at September 30, 2002.
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(1) Tier 1 capital is computed as a percentage of total adjusted assets of $418.9 million. Risk-based capital is computed as a percentage of adjusted risk-weighted assets of $240.9 million.
FDIC INSURANCE PREMIUMS. The deposits of the Bank are insured to the maximum extent permitted by the SAIF administered by the FDIC, and a resolution of the Congress states that they are backed by the full faith and credit of the U.S. Government. As the insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings institutions.
The Bank currently pays deposit insurance premiums to the FDIC based on a risk-based assessment system established by the FDIC for all SAIF-member institutions. Under applicable regulations, institutions are assigned to one of three capital groups based solely on the level of an institution's capital - "well capitalized," "adequately capitalized" and "undercapitalized" - which are defined in the same manner as the regulations establishing the prompt corrective action system under Section 38 of the FDIA. These three groups are then divided into three subgroups which reflect varying levels of supervisory concern, from those which are considered to be healthy to those which are considered to be of substantial supervisory concern. The matrix so created results in nine assessment risk classifications with effective assessments between .04% for well capitalized, healthy SAIF-member institutions to .27% for undercapitalized SAIF-member institutions with substantial supervisory concerns. At September 30, 2002, the Bank was categorized as well capitalized.
The FDIA provides for FICO debt sharing by banks and thrifts with proration sharing in the year 2000. Prior to the year 2000, SAIF insured institutions will pay approximately 6.5 basis points for FICO, while BIF insured institutions, such as commercial banks, will pay approximately 1.3 basis points. The FICO provisions of the FDIA also prohibit deposit migration strategies to avoid SAIF premiums.
Under Section 593 of the Internal Revenue Code, thrift institutions such as the Bank, which meet certain definitional tests primarily relating to their assets and the nature of their business, are permitted to establish a tax reserve for bad debts and to make annual additions thereto, which additions may, within specified limitations, be deducted in arriving at their taxable income. The Bank's deduction with respect to "qualifying loans" which are generally loans secured by certain interests in real property, prior to 1996, could be computed using an amount
based on the Bank's actual loss experience (the "experience method") or a percentage of taxable income, computed without regard to this deduction, and with additional modifications and reduced by the amount of any permitted addition to the non-qualifying reserve.
Effective January 1, 1996, the Bank is unable to make additions under the "percentage" method to its tax bad debt reserve, and is only permitted to deduct bad debts using the experience method and is additionally be required to recapture (i.e. take into taxable income) over a six year period, the excess of the balance of its bad debt reserve as of December 31, 1995 over the balance of such reserve as of December 31, 1987 (if any). Such recapture requirements can be suspended for each of two successive taxable years beginning January 1, 1996, in which the Bank originates a minimum amount of certain residential loans based upon the average of the principal amounts of such loans made by the Bank during its six taxable years preceding 1996.
REGULATORY CAPITAL REQUIREMENTS. The FDIA requires the Federal banking agencies to revise their risk-based capital guidelines to, among other things, take adequate account of interest rate risk. The Federal banking agencies continue to consider modification of the capital requirements applicable to banking organizations. In August 1995, the Federal banking agencies amended their risk-based capital guidelines to provide that the banking agencies will include in their evaluations of a bank's capital adequacy an assessment of the bank's exposure to declines in the economic value of the bank's capital due to changes in interest rates. The agencies also issued a proposed policy statement that describes the process that the agencies will use to measure and assess the exposure of a bank's capital to changes in interest rates. The agencies stated that after they and the banking industry gain sufficient experience with the measurement process, the agencies would issue proposed regulations for establishing explicit charges against capital to account for interest rate risk.
The FDIA also requires the FDIC and the other Federal banking agencies to revise their risk-based capital standards, with appropriate transition rules, to ensure that they take into account concentration of credit risk and the risks of nontraditional activities and to ensure that such standards reflect the actual performance and expected risk of loss of multifamily mortgages, of which the Bank had $1.0 million at September 30, 2002. In December 1995, the FDIC and the other Federal banking agencies promulgated final amendments to their respective risk-based capital requirements which would explicitly identify concentration of credit risk and certain risks arising from nontraditional activities, and the management of such risks as important factors to consider in assessing an institution's overall capital adequacy.
The Federal banking agencies have agreed to adopt, for regulatory purposes, SFSA Statement 115, which, among other things, generally adds a new element to stockholders' equity under generally accepted accounting principles by including net unrealized gains and losses on certain securities. In December 1994, the FDIC issued final amendments to its regulatory capital requirements which would require that the net amount of unrealized losses from available-for-sale equity securities with readily determinable fair values be deducted for purposes of calculating the Tier 1 capital ratio. All other net unrealized holding gains (losses) on available-for-sale securities are excluded from the definition of Tier 1 capital. At September 30, 2002, the Bank had $81.2 million of securities, available-for-sale, with $377,000 of aggregate net unrealized gain thereon, net of taxes.
SAFETY AND SOUNDNESS STANDARDS. Each Federal banking agency is required to prescribe, for all insured depository institutions and their holding companies, standards relating to internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits and such other operational and managerial standards as the agency deems appropriate. The compensation standards would prohibit employment contracts or other compensatory arrangements that provide excess compensation, fees or benefits or could lead to material financial loss to the institution. In addition, each Federal banking agency also is required to adopt for all insured depository institutions and their holding companies standards that specify (i) a maximum ratio of classified assets to capital, (ii) minimum earnings sufficient to absorb losses without impairing capital, (iii) to the extent feasible, a minimum ratio of market value to book value for publicly-traded shares of the institution or holding company, and (iv) such other standards relating to
asset quality, earnings and valuation as the agency deems appropriate. On July 10, 1995, the Federal banking agencies, including the FDIC, adopted final rules and proposed guidelines concerning safety and soundness required to be prescribed by regulations pursuant to Section 39 of the FDIA. In general, the standards relate to operational and managerial matters, asset quality and earnings and compensation. The operational and managerial standards cover internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. Under the asset quality and earnings standards, which were adopted by the Federal Banking agencies in October 1996, the Bank would be required to establish and maintain systems to identify problem assets and prevent deterioration in those assets and evaluate and monitor earnings to ensure that earnings are sufficient to maintain adequate capital reserves. If an insured institution fails to meet any of the standards promulgated by the regulators, then such institution will be required to submit a plan within 30 days to the FDIC specifying the steps that it will take to correct the deficiency. In the event that an insured institution fails to submit or fails in any material respect to implement a compliance plan within the time allowed by the FDIC, Section 39 of the FDIA provides that the FDIC must order the institution to correct the deficiency and may restrict asset growth, require the savings institution to increase its ratio of tangible equity to assets, restrict the rates of interest that the institution may pay or take any other action that would better carry out the purpose of prompt corrective action. The Bank believes that it has been and will continue to be in compliance with each of the standards as they have been adopted by the FDIC.
Finally, each Federal banking agency is required to prescribe standards for the employment contracts and other compensation arrangements of executive officers, employees, directors and principal stockholders of insured depository institutions that would prohibit compensation and benefits and arrangements that are excessive or that could lead to a material financial loss for the institution. In February 1996, the FDIC adopted final regulations regarding the payment of severance and indemnification to management officials and other affiliates of insured institutions ("institution affiliated parties" or "IAPs"). The limitations on severance or "golden parachute" payments apply to "troubled" institutions which seek to enter into contracts with IAPs. A golden parachute payment is generally considered to be any payment to an IAP which is contingent on the termination of that person's employment and is received when the insured institution is in a troubled condition. The definition of golden parachute payment does not include payment pursuant to qualified retirement plans, non-qualified bona fide deferred compensation plans, nondiscriminatory severance pay plans, other types of common benefit plans, state statutes and death benefits. Certain limited exceptions to the golden parachute payment prohibition are provided for in cases involving the hiring of an outside executive, unassisted changes of control and where the FDIC provides written permission to make such payment. The limitations on indemnification payments apply to all insured institutions, their subsidiaries and affiliated holding companies. Generally, this provision prohibits such entities from indemnifying an IAP for that portion of the costs sustained with regard to a civil or administrative enforcement action commenced by any Federal banking agency which results in a final order or settlement pursuant to which the IAP is assessed a civil monetary penalty, removed from office, prohibited from participating in the affairs of an insured institution or required to cease and desist from taking certain affirmative actions. Nevertheless, institutions or holding companies may purchase commercial insurance to cover such expenses (except for judgments or penalties) and the institutions or holding company may advance legal expenses to the IAP if its board of directors makes certain specific findings and the IAP agrees in writing to reimburse the institution if it is ultimately determined that the IAP violated a law, regulation or other fiduciary duty.
ACTIVITIES AND INVESTMENTS OF INSURED STATE-CHARTERED BANKS. The activities and equity investments of FDIC-insured, state-chartered banks are limited by Federal law to those that are permissible for national banks. An insured state bank generally may not acquire or retain any equity investment of a type, or in an amount, that is not permissible for a national bank. An insured state bank is not prohibited from, among other things, (i) acquiring or retaining a majority interest in a subsidiary, (ii) investing as a limited partner in a partnership the sole purpose of which is direct or indirect investment in the acquisition, rehabilitation or new construction of a qualified housing project, provided that such limited partnership investments may not exceed 2% of the bank's assets, (iii) acquiring up to 10% of the voting stock of a company that solely provides or reinsures directors' and
officers' liability insurance, and (iv) acquiring or retaining the voting shares of a depository institution if certain requirements are met.
COMMUNITY REINVESTMENT ACT. Under the Community Reinvestment Act ("CRA"), as implemented by FDIC regulations, a savings institution has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the FDIC, in connection with its examination of a savings institution, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution.
Under current CRA regulations issued by the FDIC and other Federal banking agencies, institutions are rated based on their actual performance in meeting community credit needs. In particular, the agencies will evaluate the degree to which an institution is performing under tests and standards judged in the context of information about the institution, its community, its competitors and its peers with respect to (i) lending, (ii) service delivery systems and (iii) community development. The regulations also specify that an institution's CRA performance will be considered in an institution's expansion (e.g., branching) proposals and may be the basis for approving, denying or conditioning the approval of an application. As of the date of its most recent regulatory examination, the bank was rated "satisfactory" with respect to its CRA compliance.
QUALIFIED THRIFT LENDER TEST. For the Company to qualify as a savings and loan holding company, the Bank is required to meet a QTL test set forth under Section 10(m) of the Home Owners Loan Act, as amended, ("HOLA"). Under Section 2303 of the Economic Growth and Regulatory Paperwork Reduction Act of 1996, a savings institution can comply with the QTL test set forth in the HOLA and implementing regulations or by qualifying as a domestic building and loan association as defined in Section 7701(a)(19) of the Internal Revenue Code. The QTL test set forth in HOLA requires that a depository institution must have at least 65% of its portfolio assets (which consist of total assets less intangibles, properties used to conduct the savings institution's business and liquid assets not exceeding 20% of total assets) in qualified thrift investments on a monthly average basis in nine of every 12 months. Loans and mortgage-backed securities secured by domestic residential housing, as well as certain obligations of the FDIC and certain other related entities may be included in qualifying thrift investments without limit. Certain other housing-related and non-residential real estate loans and investments, including loans to develop churches, nursing homes, hospitals and schools, and consumer loans and investments in subsidiaries engaged in housing-related activities may also be included. Qualifying assets for the QTL test include investments related to domestic residential real estate or manufactured housing, the book value of property used by an institution or its subsidiaries for the conduct of its business, an amount of residential mortgage loans that the institution or its subsidiaries sold within 90 days of origination, shares of stock issued by any FHLB and shares of stock issued by the FHLMC or the FNMA. The Bank was in compliance with the QTL test as of September 30, 2002, with in excess of 94% of its assets invested in qualified thrift investments.
LEGISLATIVE AND REGULATORY PROPOSALS. Proposals to change the laws and regulations governing the operations and taxation of, and federal insurance premiums paid by, savings banks and other financial institutions and companies that control such institutions are frequently raised in Congress, state legislatures and before the OTS, FDIC and other bank regulatory authorities. The likelihood of any major changes in the future and the impact such changes might have on the Bank are impossible to determine. Similarly, proposals to change the accounting treatment applicable to savings banks and other depository institutions are frequently raised by the SEC, the FDIC, the IRS and other appropriate authorities, including, among others, proposals relating to fair market value accounting for certain classes of assets and liabilities. The likelihood and impact of any additional future accounting rule changes and the impact such changes might have on the Bank are impossible to determine.
FEDERAL HOME LOAN BANK SYSTEM. The Bank is a member of the FHLB of Dallas, which is one of 12 regional FHLBs that administers the home financing credit function of savings institutions and commercial banks. Each FHLB serves as a source of liquidity for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by its Board of Directors. As of September 30, 2002, the Bank's advances from the FHLB of Dallas amounted to $25.1 million or 6.5% of its total liabilities.
As a member, the Bank is required to purchase and maintain stock in the FHLB of Dallas in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of total advances. At September 30, 2002, the Bank had $3.2 million in FHLB stock, which was in compliance with this requirement.
The FHLBs are required to provide funds for the resolution of troubled savings associations and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have adversely affected the level of FHLB dividends paid and could continue to do so in the future. These contributions also could have an adverse effect on the value of FHLB stock in the future. For the year ended September 30, 2002, dividends paid by the FHLB of Dallas to the Bank totaled $88,000.
FEDERAL RESERVE SYSTEM. The Federal Reserve Board requires all depository institutions to maintain reserves against their transaction accounts (primarily NOW and Super NOW checking accounts) and non-personal time deposits. At September 30, 2002, the Bank was in compliance with such requirements.
The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy applicable liquidity requirements. Because required reserves must be maintained in the form of vault cash or a noninterest-bearing account at a Federal Reserve Bank, the effect of this reserve requirement is to reduce a bank's interest-earning assets. The amount of funds necessary to satisfy this requirement has not had a material affect on the Bank's operations.
TEXAS SAVINGS BANK LAW. To qualify as a Texas Savings Bank, Jacksonville must qualify under and continue to meet the asset test of Section 7701(a)(19), Internal Revenue Code of 1986, relating to domestic savings and loan associations. A Texas savings bank may make a loan or investment or engage in an activity permitted under state law for a bank or savings and loan association or under federal law for a federal savings and loan association, savings bank, or national bank if the financial institution's principal office is located in this state. A savings bank may make commercial loans up to 50% of the savings bank's total assets. A savings bank must maintain in its portfolio not less than 15 percent of the savings bank's deposits from its local service area in: (1) first and second lien residential mortgage loans or foreclosed residential mortgage loans originated in the savings bank's local service area; (2) home improvement loans; (3) interim residential construction loans; (4) mortgage-backed securities secured by loans in the savings bank's local service area; and (5) loans for community reinvestment. The loans to one borrower rules for a Texas savings bank may not be less restrictive than those applicable to savings associations under the Federal Home Owners' Loan Act ("HOLA"). Under the HOLA, unless more stringent conditions are imposed by the Director of the OTS, savings associations are subject to the lending limits applicable to national banks, which include a limitation on loans to any one borrower of 15% of capital. Notwithstanding that limitation, savings associations generally may make loans to one borrower not to exceed $500,000, to develop domestic residential housing units, not to exceed the lesser of $30,000,000 or 30 percent of the savings association's unimpaired capital and unimpaired surplus. For loans to finance the sale of real property acquired in satisfaction of debts previously contracted, loans to any one borrower may not exceed 50 percent of unimpaired capital and surplus. A Texas savings bank or subsidiary may not invest in an equity security unless the security qualifies as an investment grade security under rules adopted by the Texas Commissioner and Finance Commission or the security is an eligible investment for a federal savings and loan association. Investments in subsidiaries are generally limited to 10 percent of the savings bank's total assets. Unless approved in advance by the Commissioner, a Texas savings
bank must maintain an amount equal to at least 10 percent of its average daily deposits for the most recently completed calendar quarter in liquid investments specified by statute, including cash, reserve balances, and readily marketable investments.
FEDERAL TAXATION
GENERAL. The Bank is subject to Federal income taxation in the same general manner as other corporations with some exceptions, including particularly the reserve for bad debts discussed below. The following discussion of Federal taxation is intended only to summarize certain pertinent Federal income tax matters and is not a comprehensive description of the tax rules applicable to the Bank.
METHOD OF ACCOUNTING. For Federal income tax purposes, the Bank currently reports its income and expenses on the accrual method of accounting, uses a tax year ending September 30, and files a consolidated Federal income tax return with the Company and affiliated entities.
BAD DEBT RESERVES. The Company uses the experience method of computing reserves for bad debts for Federal income tax purposes. The bad debt deduction allowable under this method is available to small banks with assets less than $500 million.
The Bank has been audited by the IRS or the statute of limitations has expired with respect to consolidated Federal income tax returns through the year ended September 30, 1998. With respect to years examined by the IRS, either all deficiencies have been satisfied or sufficient reserves have been established to satisfy asserted deficiencies. In the opinion of management, any examination of still open returns would not result in a deficiency which could have a material adverse effect on the financial condition of the Bank.
TEXAS TAXATION. The Bank is subject to a state franchise tax which is based on the greater of .25 percent of its capital or 4 1/2 percent of its earned surplus for the year.
ITEM 2.
ITEM 2. PROPERTIES.
At September 30, 2002, the Company conducted its business from its main office at Commerce & Neches Streets, Jacksonville, Texas, and eight full-service branches in Cherokee County and surrounding counties.
Set forth below is certain information with respect to the office and other properties of Jacksonville at September 30, 2002.
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In addition, the Company through its J S&L subsidiary has an investment of $1.0 million at September 30, 2002, in developed residential housing lots.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in routine legal proceedings occurring in the ordinary course of business which, in the aggregate, are believed by management to be immaterial to the financial condition of the Company.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The information required herein is incorporated by reference from the inside back cover of the Company's 2002 Annual Report to Stockholders, which is included herein as Exhibit 13 ("2002 Annual Report") and from Part III, Item 12 hereof.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The information required herein is incorporated by reference from pages 1 and 2 of the Company's 2002 Annual Report.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The information required herein is incorporated by reference from pages 3 to 17 of the Company's 2002 Annual Report.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required herein is incorporated by reference from pages 4 to 5 of the Company's 2002 Annual Report.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required herein is incorporated by reference from pages to of Company's 2002 Annual Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable.
PART III.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required herein is incorporated by reference from pages 2 to 8 of the Company's definitive proxy statement, dated January 21, 2003, ("Proxy Statement").
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information required herein is incorporated by reference from pages 9 to 14 of the Company's Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required herein is incorporated by reference from pages 3 to 5 of the Company's Proxy Statement.
EQUITY COMPENSATION PLAN INFORMATION. The following table sets forth certain information for all equity compensation plans and individual compensation arrangements (whether with employees or non-employees, such as directors), in effect as of September 30, 2002.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required herein is incorporated by reference from page 13 of the Company's Proxy Statement.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES.
Within 90 days prior to the date of this annual report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective. There were no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
Disclosure controls and procedures are the controls and other procedures of the Company that are designed to ensure that the information required to be disclosed by the Company in its reports filed or submitted under the Securities Exchange Act of 1934, as amended ("Exchange Act") is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in its reports filed under the Exchange Act is accumulated and communicated to the Company's management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
PART IV.
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this Report
(1) The following financial statements are incorporated by reference from Item 8 hereof (see Exhibit 13 attached hereto):
Independent Auditor's Report
Consolidated Statements of Financial Condition at September 30, 2002 and 2001
Consolidated Statements of Earnings for the Years Ended September 30, 2002, 2001, and 2000
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended September 30, 2002, 2001, and 2000
Consolidated Statements of Cash Flows for the Years Ended September 30, 2002, 2001, and 2000
Notes to Consolidated Financial Statements
(2) All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are omitted because of the absence of conditions under which they are required or because the required information is included in the financial statements and related notes thereto.
(3) The following exhibits are filed as part of this Form 10-K and this list includes the Exhibit Index.
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* Incorporated herein by reference to the Registrant's Form 10-K filed as of December 29, 1997.
** Incorporated herein by reference to the Registrant's Registration Statement No. 33-81015 on Form S-1.
*** Incorporated herein by reference to the Registrant's Registration Statement No. 333-18031 on Form S-8.
**** Incorporated herein by reference to the Registrant's Form 10-K filed as of December 30, 1996. ***** Incorporated herein by reference to the Registrant's proxy statement on Schedule 14A filed December 21, 2001.
(b) Reports on Form 8-K during the quarter ended September 30, 2002:
1. On July 19, 2002, the Company filed a current report on Form 8-K reporting earnings for the quarter ended June 30, 2002.
2. On September 10, 2002, the Company filed a current report on Form 8-K reporting the declaration of a $0.125 per share dividend.
(c) See (a)(3) above for all exhibits filed herewith and the Exhibit Index.
(d) There are no other financial statements and financial statement schedules which were excluded from Item 8 which are required to be included herein.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
December 18, 2002 By: /s/ Jerry M. Chancellor ------------------------------- Jerry M. Chancellor Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
CERTIFICATIONS
I, Jerry M. Chancellor, certify that:
1. I have reviewed this annual report on Form 10-K of Jacksonville Bancorp, Inc. (the "Registrant");
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this annual report;
4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and
6. The Registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: December 18, 2002 /s/ Jerry M. Chancellor -------------------------------------- Jerry M. Chancellor President and Chief Executive Officer
I, Bill W. Taylor, certify that:
1. I have reviewed this annual report on Form 10-K of Jacksonville Bancorp, Inc. (the "Registrant");
2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this annual report;
4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and
6. The Registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: December 18, 2002 /s/ Bill W. Taylor ------------------------------------ Bill W. Taylor Executive Vice President and Chief Financial Officer