Exhibit 13

Jacksonville Bancorp, Inc.

2012 Annual Report

To Our Shareholders:

It is always a pleasure to begin our annual shareholders’ letter discussing the highlights of a record year.  You may remember 2011 was a very good year for Jacksonville Bancorp, Inc. and we are happy to report 2012 was even better.

Net income for 2012 was $3.6 million, a 9% increase over the 2011 record earnings.  At year-end, our total assets stood at $ 321.4 million, we had $ 44.1 million in capital and our deposits totaled $258.5 million – all new record highs.  As a result of the outstanding year, we were pleased to pay you a special one-time dividend of $0.10 per share in addition to our regular quarterly dividend.

One of the keys to achieving our results during the past two years has been maintaining the quality of our loan portfolio.  Our level of nonperforming assets decreased in 2012 and remains below peer group averages.  In addition, the financial strength of our agricultural customers enabled them to weather the recent drought conditions.

Our trust department and our brokerage subsidiary, Financial Resources Group, continued to build and expand relationships during the year.  Both are strong contributors to our non-interest revenues.  At year-end we had $80 million of trust assets under management and approximately $220 million in brokerage assets under management.

Keeping up with technology and the ever expanding outlets through which customers communicate is always a challenge.  In 2012, we introduced an iPad app to complement our existing mobile banking options.  We also established a social media presence and implemented a social media strategy.

Technology is just one of the external influences that affects the business of community banking.  Compliance changes along with additional rules and regulations increases our cost of doing business and creates the need to retain industry consultants to assist with the interpretation and implementation of new regulatory requirements.

A factor that cannot be controlled at the local level is the low interest rate environment in which we have been operating.  Low interest rates were initially beneficial because they resulted in reducing our cost of funds.  However, the prolonged period of low rates will eventually start to squeeze the net interest margins of many banks including ours.  At some point the Federal Reserve will end its accommodative monetary policy, but there is little to suggest that compliance and regulatory requirements will become less burdensome.

Each year brings new challenges and opportunities and 2013 promises to have plenty of both.  On behalf of the every member of the Jacksonville Savings Bank team, we thank you for your support, trust and confidence.  Our goal continues to be to provide the very best in financial services in all the markets we serve.

Sincerely,

Andrew F. Applebee	Richard A. Foss
Chairman of the Board	President and CEO

Table of Contents

	Page
Business of the Company	1
Selected Consolidated Financial Information	2
Management’s Discussion and Analysis of Financial Condition and Results of Operations	4
Report of Independent Registered Public Accounting Firm	20
Consolidated Financial Statements	21
Notes to Consolidated Financial Statements	30
Common Stock Information	84
Directors and Executive Officers	85
Corporate Information	86
Annual Meeting	86

Business of the Company

Jacksonville Bancorp, Inc. (the “Company”) is a Maryland corporation.  On July 14, 2010, Jacksonville Bancorp, Inc. completed its conversion from the mutual holding company structure and the related public offering and is now a stock holding company that is fully owned by the public.  The Company owns 100% of Jacksonville Savings Bank.

Jacksonville Savings Bank is an Illinois-chartered savings bank headquartered in Jacksonville, Illinois.  We conduct our business from our main office and six branches, two of which are located in Jacksonville and one of which is located in each of the following Illinois communities: Virden, Litchfield, Chapin, and Concord.  We were originally chartered in 1916 as an Illinois-chartered mutual savings and loan association and converted to a mutual savings bank in 1992.  In 1995, Jacksonville Savings Bank converted to an Illinois-chartered stock savings bank and reorganized to the mutual holding company form of organization.  We have been a member of the Federal Home Loan Bank System since 1932.  Our deposits are insured by the Federal Deposit Insurance Corporation.

We are a community-oriented savings bank engaged primarily in the business of attracting retail deposits from the general public in our market area and using such funds, together with borrowings and funds from other sources, to originate mortgage loans secured by one-to-four family residential real estate, commercial and agricultural real estate and home equity loans. We also originate commercial and agricultural business loans and consumer loans.  Additionally, we invest in United States Government agency securities, bank-qualified, general obligation municipal issues, and mortgage-backed securities issued or guaranteed by the United States Government or agencies thereof.  We maintain a portion of our assets in liquid investments, such as overnight funds at the Federal Home Loan Bank.

Our principal sources of funds are customer deposits, proceeds from the sale of loans, funds received from the repayment and prepayment of loans and mortgage-backed securities, and the sale, call, or maturity of investment securities.  Principal sources of income are interest income on loans and investments, sales of loans and securities, service charges, commissions, loan servicing fees and other fees.  Our principal expenses are interest paid on deposits, employee compensation and benefits, occupancy and equipment expense, data processing and telecommunications expense, and Federal Deposit Insurance Corporation insurance premiums.

We operate a full service trust department and an investment center.  The investment center is operated through Financial Resources Group, Inc., Jacksonville Savings Bank’s wholly-owned subsidiary.

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Selected Consolidated Financial Information

The following tables set forth certain information concerning the consolidated financial position, consolidated data from operations and performance ratios of the Company at the dates and for the years indicated.  Selected quarterly financial data for each of the last two years is set forth at Note 19 to the Consolidated Financial Statements.

	At December 31,
	2012		2011		2010		2009		2008
	(In thousands)
Selected Financial Condition Data:
Total assets	$	321,446	$	307,289	$	301,481	$	288,846	$	288,275
Cash and cash equivalents		7,294		11,388		8,943		15,696		7,145
Investment securities		63,431		62,258		52,872		37,196		50,988
Mortgage-backed securities		51,956		40,364		41,995		40,984		27,795
Loans, net(1)		174,465		171,312		176,722		174,497		184,337
Federal Home Loan Bank of Chicago stock, at cost		1,114		1,114		1,114		1,109		1,109
Foreclosed assets, net		137		435		460		383		769
Bank owned life insurance		6,613		4,403		4,239		4,095		3,907
Deposits		258,521		254,240		256,424		254,700		238,151
Federal Home Loan Bank of Chicago advances		700		—		—		—		13,500
Short-term borrowings		12,041		6,518		4,018		3,789		7,633
Stockholders’ equity		44,120		41,165		35,678		25,263		24,259

	For the Years Ended December 31,
	2012		2011		2010		2009		2008
	(In thousands, except per share amounts)
Selected Operating Data:
Interest income	$	12,791	$	13,867	$	13,529	$	14,420	$	15,908
Interest expense		2,303		2,879		3,953		5,432		7,716
Net interest income		10,488		10,988		9,576		8,988		8,192
Provision for loan losses		490		625		1,725		2,575		310
Net interest income after provision for loan losses		9,998		10,363		7,851		6,413		7,882
Noninterest income		4,882		3,996		4,197		4,209		3,161
Noninterest expense		9,976		9,814		9,576		9,126		9,221
Income before income tax		4,904		4,545		2,472		1,497		1,822
Provision for income taxes		1,337		1,259		406		101		304
Net income	$	3,567	$	3,286	$	2,066	$	1,396	$	1,518
Earnings per share:
Basic	$	1.89	$	1.74	$	1.09	$	0.72	$	0.76
Diluted	$	1.89	$	1.74	$	1.08	$	0.72	$	0.76
Dividends per share	$	0.40	$	0.30	$	0.30	$	0.30	$	0.30

(1)      Includes loans held for sale of $712,000, $447,000, $280,000, $814,000, and $1.4 million at December 31, 2012, 2011, 2010, 2009, and 2008, respectively.

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	At or For the Years Ended December 31,
	2012			2011			2010			2009			2008
Selected Financial Ratios and Other Data:
Performance Ratios:
Return on average assets (ratio of net income to average total assets)		1.14	%		1.08	%		0.70	%		0.47	%		0.52	%
Return on average equity (ratio of net income to average equity)		8.25	%		8.57	%		6.77	%		5.69	%		6.59	%
Interest rate spread(1)		3.46	%		3.68	%		3.30	%		3.08	%		2.70	%
Net interest margin(2)		3.62	%		3.87	%		3.51	%		3.30	%		3.01	%
Efficiency ratio(3)		64.90	%		65.50	%		69.53	%		69.15	%		81.22	%
Dividend pay-out ratio		21.00	%		17.14	%		20.37	%		18.96	%		18.75	%
Non-interest expense to average total assets		3.20	%		3.23	%		3.25	%		3.10	%		3.14	%
Average interest-earning assets to average interest-bearing liabilities		119.76	%		118.84	%		114.78	%		111.14	%		110.66	%
Average equity to average total assets		13.86	%		12.60	%		10.37	%		8.33	%		7.85	%
Asset Quality Ratios:
Nonperforming assets to total assets		0.73	%		0.92	%		1.19	%		0.81	%		0.68	%
Nonperforming loans to total loans		1.25	%		1.38	%		1.75	%		1.11	%		0.64	%
Allowance for loan losses to non-performing loans		150.85	%		137.33	%		94.56	%		117.20	%		162.47	%
Allowance for loan losses to gross loans(4)		1.88	%		1.89	%		1.65	%		1.29	%		1.04	%
Capital Ratios (Bank):
Total capital (to risk-weighted assets)		17.72	%		16.67	%		14.77	%		11.83	%		10.94	%
Tier I capital (to risk-weighted assets)		16.46	%		15.42	%		13.52	%		10.70	%		10.02	%
Tier I capital (to total assets)		10.89	%		10.35	%		9.25	%		7.44	%		7.30	%
Other Data:
Number of offices		7			7			7			7			7
Full time equivalent employees		104			104			104			106			106

(1) The interest rate spread represents the difference between the weighted-average yield on interest-earning assets and the weighted- average cost of interest-bearing liabilities for the period.

(2) The net interest margin represents net interest income as a percent of average interest-earning assets for the period.

(3) The efficiency ratio represents non-interest expense divided by the sum of net interest income and non-interest income.

(4) Gross loans include loans held for sale.

3

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

General

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

Certain statements in this annual report and throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations are “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and involve known and unknown risk, uncertainties and other factors that may cause the Company’s actual results, performance or achievements to be materially different from the results, performance or achievements expressed or implied by the forward looking statement.  Factors that impact such forward looking statements include, among others, changes in general economic conditions, changes in interest rates and competition.  We decline any obligation to publicly announce future events or developments that may affect the forward-looking statements herein.

Operating Strategy – Overview

Our business consists principally of attracting deposits from the general public and using deposits and borrowings to originate mortgage loans secured by one-to-four family residences, commercial real estate and agricultural real estate. In addition, we originate commercial and agricultural business loans and consumer loans.  Our net income, like other financial institutions, is primarily dependent on our net interest income, which is the difference between the income earned on our interest-earning assets, such as loans and investments, and the cost of our interest-bearing liabilities, primarily deposits and borrowings.  Our net income is also affected by provisions for loan losses and other non-interest income and expenses.  General economic conditions, particularly changes in market interest rates, government legislation, monetary policies, and attendant actions of the regulatory authorities are the external influences affecting many of the factors of our net income.

Management has implemented various strategies designed to enhance our profitability.  These strategies include reducing our exposure to interest rate risk by selling fixed-rate loans and offering other fee-based services to our customers.  We recognize the need to establish and adhere to strict loan underwriting criteria and guidelines.  We generally limit our investment portfolio to securities issued by the United States Government and Government sponsored entities, mortgage-backed securities collateralized by United States Government sponsored entities, and bank-qualified general obligation municipal issues.

The recession which began in 2008 had a severe impact on the entire banking industry resulting in increased bank failures nationwide and a decline in market interest rates.  The ongoing low interest rate environment has resulted in higher levels of originations of fixed-rate residential loans for sale to the secondary market during 2012 and 2011.  During the years ended December 31, 2012 and 2011, we sold $52.7 million and $32.2 million, respectively, of fixed-rate residential mortgage loans.  Market conditions and higher prepayment speeds resulted in a decline in the value of our mortgage servicing rights during 2011, but during 2012 the value of our mortgage servicing rights remained stable.  We do not have subprime mortgage or Alt-A loan products.  Our investment portfolio has not been affected by the recession and financial crisis, since all of our mortgage-backed securities are issued by United States Government or United States Government sponsored entities.  However, the higher prepayment speeds on residential loans did have an adverse effect on our income from mortgage-backed securities due to accelerated premium amortization.  Since the real estate values in our market area did not increase as dramatically as they did in other parts of the nation prior to 2008, we have not experienced dramatic decreases in home values during the current recession.

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We continue to service our existing borrowers and originate new loans to credit-worthy borrowers in an effort to meet the credit needs of our community.  We intend to remain a community-oriented financial institution dedicated to meeting the credit and financial services needs of our customers in our market area.

Critical Accounting Policies and Use of Significant Estimates

In the ordinary course of business, we have made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in preparing our financial statements in conformity with accounting principles generally accepted in the United States of America.  Actual results could differ significantly from those estimates under different assumptions and conditions.  Management believes the following discussion addresses our most critical accounting policies and significant estimates, which are those that are most important to the portrayal of our financial condition and results and require management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

Allowance for Loan Losses. We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgments and assumptions used in the preparation of the consolidated financial statements.  The allowance for loan losses is a material estimate that is particularly susceptible to significant changes in the near term and is established through a provision for loan losses.  The allowance is based upon past loan experience and other factors which, in management’s judgment, deserve current recognition in estimating loan losses.  The evaluation includes a review of all loans on which full collectability may not be reasonably assured.  Other factors considered by management include the size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, existing economic conditions and historical losses on each portfolio category.  In connection with the determination of the allowance for loan losses, management uses independent appraisals for significant properties, which collateralize loans.  Management uses the available information to make such determinations.  If circumstances differ substantially from the assumptions used in making determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be affected.  While we believe we have established our existing allowance for loan losses in conformity with accounting principles generally accepted in the United States of America, there can be no assurance that regulators, in reviewing our loan portfolio, will not request an increase in the allowance for loan losses.  Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that increases to the allowance will not be necessary if loan quality deteriorates.

Foreclosed Assets. Foreclosed assets, consisting of real estate owned acquired through loan foreclosures, are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis.  The adjustment at the time of foreclosure is recorded through the allowance for loan losses.  Due to the subjective nature of establishing fair value when the asset is acquired, the actual fair value of the foreclosed asset could differ from the original estimate.  If it is determined that the fair value has declined subsequent to foreclosure, the asset is written down through a charge to non-interest expense.  Operating costs associated with the assets after acquisition are also recorded as non-interest expense.  Gains and losses on the disposition of foreclosed assets are netted and posted to non-interest expense.

Deferred Income Tax Assets/Liabilities. Our net deferred income tax asset arises from differences in the dates that items of income and expense enter into our reported income and taxable income.  Deferred tax assets and liabilities are established for these items as they arise.  From an accounting standpoint, deferred tax assets are reviewed to determine that they are realizable based upon the historical level of our taxable income, estimates of our future taxable income and the reversals of deferred tax liabilities.  In most cases, the realization of the deferred tax asset is based on our future profitability.  If we were to experience net operating losses for tax purposes in a future period, the realization of our deferred tax assets would be evaluated for a potential valuation reserve.

5

Impairment of Goodwill.Goodwill, an intangible asset with an indefinite life, was recorded on our balance sheet in prior periods as a result of acquisition activity.  Goodwill is evaluated for impairment annually, unless there are factors present that indicate a potential impairment, in which case, the goodwill impairment test is performed more frequently.  During 2012, goodwill was evaluated quarterly due to market conditions.

Mortgage Servicing Rights.Mortgage servicing rights are very sensitive to movements in interest rates as expected future net servicing income depends on the projected outstanding principal balances of the underlying loans, which can be greatly reduced by prepayments.  Prepayments usually increase when mortgage interest rates decline and decrease when mortgage interest rates rise.

Fair Value Measurements. The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale.  We estimate the fair value of financial instruments using a variety of valuation methods.  Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value.  When the financial instruments are not actively traded, other observable market inputs, such as quoted prices of securities with similar characteristics, may be used, if available, to determine fair value.  When observable market prices do not exist, we estimate fair value.  Other factors such as model assumptions and market dislocations can affect estimates of fair value.

Recent Accounting Pronouncements

In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements by U.S. GAAP and IFRSs.  The amendments in this ASU generally represent clarifications of FASB ASC Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed.  This ASU results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRSs.  The amendments in this ASU are to be applied prospectively.  For public entities, the amendments became effective for interim and annual periods beginning after December 15, 2011.  The adoption of this ASU is reflected in Note 16 – Disclosures about Fair Value of Assets and Liabilities.

In June 2011, the FASB issued ASU No. 2011-05, Amendments to Topic 220, Comprehensive Income.  Under the amendments in this ASU, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income.  This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity.  The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  The amendments in this ASU should be applied retrospectively.  For public entities, the amendments became effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  Early adoption was permitted.  The Company retroactively adopted the ASU during the first quarter of 2012 with separate condensed consolidated statements of comprehensive income.

6

In September 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment.  The update provides entities with the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary.  However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit.  If the carrying amount of a reporting unit exceeds its fair value, then the entity is required to perform the second step of the goodwill impairment test to measure the amount of the impairment loss, if any.  Under the amendments in ASU No. 2011-08, an entity has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test.  An entity may resume performing the qualitative assessment in any subsequent period.  The amendments enacted by ASU No. 2011-08 became effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  Early adoption was permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for the nonpublic entities, have not yet been made available for issuance.  The adoption of this update did not have any impact on the Company’s consolidated financial position or results of operations.

In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.  ASU 2011-11 requires an entity to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement.  ASU 2011-11 was effective for annual reporting periods beginning on or after January 1, 2012, and interim periods within those annual periods.  Retroactive disclosure is required for all comparative periods presented.  The adoption of this update did not have any impact on the Company’s consolidated financial position or results of operations.

Federal Deposit Insurance Corporation Insurance Coverage

The Company’s depositors are protected against the loss of their insured deposits by the FDIC.  Currently, basic FDIC insurance coverage is $250,000 per depositor.

Recent Developments

Midwest drought conditions during 2012 reduced crop yields. As further discussed in Note 4 to the condensed consolidated financial statements included herein, the Company originates agricultural operating lines of credit, which generally have terms of one year and are secured by growing crops, livestock and equipment, and mortgages on farmland.  The repayment of agricultural business loans generally is dependent on the successful operation of a farm and can be adversely affected by fluctuations in crop prices, increase in interest rates, and changes in weather conditions.  These developments can result in smaller harvests and less income for farmers which can adversely affect such borrower’s ability to repay a loan, and potentially result in an increase in the level of problem loans and loan losses in our agricultural portfolio.  While not required, the majority of our agricultural business loans are covered by crop insurance, which provides protection against loss due to lower crop yields as a result of drought conditions.  The Company experienced minimal impact on its agricultural borrowers and continues to evaluate the impact these conditions may have on the local economy.

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Financial Condition

Total assets increased by $14.1 million, or 4.6%, to $321.4 million at December 31, 2012 from $307.3 million at December 31, 2011.  Net loans increased $2.9 million, or 1.7%, to $173.8 million at December 31, 2012 from $170.9 million at December 31, 2011.  Available-for-sale investment securities increased $1.2 million, or 1.9%, to $63.4 million at December 31, 2012 from $62.3 million at December 31, 2011.  Mortgage-backed securities increased $11.6 million, or 28.7%, to $52.0 million at December 31, 2012 from $40.4 million at December 31, 2011. The growth in investment and mortgage-backed securities was primarily due to the investment of funds in more liquid alternatives during a period of low loan demand and low interest rates.  Cash and cash equivalents decreased $4.1 million to $7.3 million at December 31, 2012 from $11.4 million at December 31, 2011.

At December 31, 2012, we have $2.7 million recorded in goodwill associated with a prior acquisition.  In 2012, management reviewed goodwill for impairment on a quarterly basis.  Management’s analysis concluded that our goodwill was not impaired as of December 31, 2012.  At December 31, 2012, we also had $664,000 in mortgage servicing rights, net of the valuation allowance.  Our mortgage servicing rights asset represented approximately 45 basis points of the $148.3 million in loans that we serviced.  We obtain an independent valuation of the mortgage servicing rights at least annually.  Our most recent valuation was obtained as of December 31, 2012.  We did not record any impairment of mortgage servicing rights during 2012.

Total deposits increased $4.3 million to $258.5 million at December 31, 2012.  The mix of our deposits has changed during 2012 with an increase of $12.8 million in low-cost transaction accounts, partially offset by a decrease of $8.5 million in higher-cost time deposits.  Transaction accounts have continued to grow, and time deposits have declined, as customers have preferred to maintain short-term, liquid deposits in the current low interest rate environment.  In addition, the increase in total deposits reflects customers choosing the safety of insured deposits versus alternative investments.  Other borrowings increased $6.2 million during the year to $12.7 million as of December 31, 2012, primarily due to the seasonal deposits of our agricultural business customers.  Other borrowings consisted primarily of overnight repurchase agreements, which are provided as a service to our commercial deposit customers.

Stockholders’ equity increased $3.0 million, or 7.2%, to $44.1 million at December 31, 2012.  The increase in stockholders’ equity was primarily the result of $3.6 million in net income and $224,000 in other comprehensive income, which was partially offset by the payment of $749,000 in cash dividends and $231,000 in stock repurchases.  Other comprehensive income consisted of the increase in net unrealized gains, net of tax, on available-for-sale securities reflecting changes in market prices for securities in our portfolio. Other comprehensive income does not include changes in the fair value of other financial instruments included on the balance sheet.  Our tangible book value per share increased to $21.69 as of December 31, 2012 from $20.01 at December 31, 2011.

COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2012 AND 2011

General

Net income for the year ended December 31, 2012 totaled $3.6 million, or $1.89 per common share, basic and diluted, compared to net income for the year ended December 31, 2011 of $3.3 million, or $1.74 per common share, basic and diluted.  The increase of $281,000 in net income reflected an increase of $886,000 in non-interest income and a decrease of $135,000 in the provision for loan losses, partially offset by a decrease of $500,000 in net interest income and increases of $162,000 in non-interest expense and $78,000 in income taxes.

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Interest Income

Interest income decreased to $12.8 million for the year ended December 31, 2012 from $13.9 million for the year ended December 31, 2011.  The $1.1 million decrease in interest income resulted from decreased income of $721,000 on loans, $63,000 on investment securities, and $328,000 on mortgage-backed securities, partially offset by an increase of $37,000 on other interest-earning assets.  As noted below, the changes in the composition of our interest-earning assets reflects the investment in investment securities and mortgage-backed securities during a time period where satisfactory loan origination opportunities were lacking.

Interest income on loans decreased $721,000 to $10.0 million for the year ended December 31, 2012 from $10.7 million for the year ended December 31, 2011 due to decreases in both the average yield and average balance of loans.  The average yield of the loan portfolio decreased 27 basis points to 5.75% for 2012 from 6.02% for 2011. The decrease in the average yield reflected lower market rates of interest and the competitive lending environment.  The average balance of loans decreased $4.0 million to $173.6 million during 2012.  The decrease in the average balance of loans was primarily due to a decrease in the average balance of commercial real estate and home equity loans, partially offset by growth in residential real estate and agricultural real estate loans.  The decrease in the average balance of commercial real estate loans was primarily due to the payoff of several large loans as the borrowers sold the securing property.  The decrease in the average balance of home equity loans reflected the volume of loans refinanced and subsequently sold into the secondary market.

Interest income on investment securities decreased $63,000 to $2.0 million for the year ended December 31, 2012, reflecting a decrease of 22 basis points in the average yield of the investment securities portfolio. The average yield of investment securities decreased to 3.36% during 2012 from 3.58% during 2011.  The average yield does not reflect the benefit of the higher tax-equivalent yield of our municipal bonds, which was reflected as a reduction in income tax expense.  Adjusting for this benefit, the tax equivalent yield of the investment portfolio equaled 4.77% for 2012 compared to 4.89% for 2011. The decrease in interest income was partially offset by an increase of $1.8 million in the average balance of the investment securities portfolio to $58.5 million during 2012 from $56.7 million during 2011.  The increase in the average balance of investment securities was primarily due to the investment of funds from deposit growth and the lack of corresponding loan demand.

Interest income on mortgage-backed securities decreased $328,000 to $801,000 for the year ended December 31, 2012 from $1.1 million for the year ended December 31, 2011, reflecting a decrease of 87 basis points in the average yield on mortgage-backed securities.  The average yield on mortgage-backed securities decreased to 1.77% during 2012 from 2.64% during 2011.  The average yield was impacted by higher premium amortization resulting from faster prepayments on mortgage-backed securities.  The amortization of premiums on mortgage-backed securities, which reduces the average yield, increased $325,000 to $804,000 during 2012, compared to $479,000 during 2011.  The decrease in interest income due to a lower average yield was partially offset by a $2.3 million increase in the average balance of mortgage-backed securities to $45.1 million during 2012 from $42.8 million during 2011.

Interest income from other interest-earning assets, which consisted of interest-earning demand and time deposits and federal funds sold, increased to $47,000 during the year ended December 31, 2012, from $10,000 for the year ended December 31, 2011.  The $37,000 increase is primarily due to a 23 basis point increase in the average yield to 0.38% during 2012 from 0.15% during 2011, reflecting the investment in higher-yielding time deposit accounts during the fourth quarter of 2011.  The average balance of these accounts also increased $5.7 million to $12.4 million during 2012 from $6.7 million during 2011.

9

Interest Expense

Total interest expense decreased $576,000 to $2.3 million during the year ended December 31, 2012 from $2.9 million during the year ended December 31, 2011.  The decrease in interest expense was due to a decrease of $575,000 in the cost of deposits.

Interest expense on deposits decreased $575,000 to $2.3 million during the year ended December 31, 2012 from $2.9 million during the year ended December 31, 2011.  The decrease in interest expense on deposits was primarily due to a 25 basis point decrease in the average rate paid on deposits to 0.97% during 2012 from 1.22% during 2011.  The decrease reflected low short-term market interest rates which continued during 2012 and the change in the composition of our deposits to a higher percentage of low-cost transaction accounts.  The decrease in the average rate paid was partially offset by a $1.3 million increase in the average balance of deposits to $235.6 million during 2012 from $234.3 million during 2011.  The increase in the average balance of deposits was primarily due to a $6.1 million increase in the average balance of lower-cost transaction accounts, partially offset by a $4.8 million decrease in the average balance of time deposit accounts.

Interest paid on borrowed funds decreased $1,000 to $15,000 in 2012 due to a decrease in the average cost of borrowings, partially offset by an increase in the average balance of borrowings.  Borrowed funds consist primarily of overnight repurchase agreements.  The average rate paid on borrowed funds decreased to 0.23% during 2012 compared to 0.37% during 2011.  The average balance of borrowed funds increased to $6.4 million during 2012 compared to $4.6 million during 2011.

Net Interest Income

As a result of the changes in interest income and interest expense noted above, net interest income decreased by $500,000, or 4.6%, to $10.5 million in 2012 from $11.0 million in 2011.  Our interest rate spread decreased by 22 basis points to 3.46% during 2012 from 3.68% during 2011.  Our net interest margin decreased 25 basis points to 3.62% during 2012 from 3.87% during 2011.  Our net interest income was affected by lower asset yields, partially offset by our lower cost of funds.

Provision for Loan Losses

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

The allowance for loan losses increased $43,000, or 1.3%, during 2012 to $3.3 million as of December 31, 2012.  The increase was the result of the provision for loan losses exceeding net charge-offs.  We recorded a provision for loan losses of $490,000 for the year ended December 31, 2012, compared to $625,000 during 2011.  The decrease in the provision reflects the lower level of nonperforming loans.  Net charge-offs increased $154,000 to $447,000 during 2012 from $293,000 during 2011.  The increase in charge-offs was concentrated in the charge-off of $340,000 on one loan secured by commercial real estate, which is in the process of foreclosure.

10

The provisions in 2012 and 2011 were made to bring the allowance for loan losses to a level deemed adequate following management’s evaluation of the repayment capacity and collateral protection afforded by each problem loan identified by management.  The review also considered the local economy and the level of bankruptcies and foreclosures in our market area.

The following table sets forth the composition of our non-performing assets at December 31, 2012 and 2011, respectively.

December 31,
2012 December 31,
2011

	(Dollars in thousands)
Non-accrual loans:
Real estate loans:
One- to four-family residential	$	1,203		$	1,298
Commercial		560			362
Agricultural		—			—
Home equity		277			423
Commercial business loans		52			67
Agricultural business loans		—			—
Consumer loans		122			251
Total non-accrual loans		2,214			2,401
Loans delinquent 90 days or greater and still accruing:
Real estate loans:
One- to four-family residential		—			—
Commercial		—			—
Agricultural		—			—
Home equity		—			—
Commercial business loans		—			—
Agricultural business loans		—			—
Consumer loans		—			—
Total loans delinquent 90 days or greater and still accruing		—			—
Total nonperforming loans		2,214			2,401
Other real estate owned and foreclosed assets:
Real estate loans:
One- to four-family residential		—			19
Commercial		137			416
Agricultural		—			—
Home equity		—			—
Commercial business loans		—			—
Agricultural business loans		—			—
Consumer loans		—			—
Total  other real estate owned and foreclosed assets		137			435
Total nonperforming assets	$	2,351		$	2,836
Ratios:
Nonperforming loans to total loans		1.25	%		1.38	%
Nonperforming assets to total assets		0.73			0.92

Management monitors all past due loans and nonperforming assets.  Such loans are placed under close supervision with consideration given to the need for additions to the allowance for loan losses and (if appropriate) partial or full charge-off.  At December 31, 2012, we had no loans 90 days or more delinquent which were still accruing interest. Nonperforming assets decreased by $485,000 to $2.3 million at December 31, 2012 as compared to $2.8 million at December 31, 2011.  The decrease in the level of nonperforming assets reflects a decrease of $187,000 in nonperforming loans and $298,000 in foreclosed assets.  The decrease in nonperforming loans primarily reflected decreases in one-to-four family residential, home equity, and consumer loans, partially offset by an increase in commercial real estate loans.  The $198,000 increase in non-accrual commercial real estate is due to the delinquency of a $201,000 loan secured by commercial real estate, which is in the process of foreclosure.

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The allowance for loan losses as a percentage of nonperforming loans increased to 150.85% at December 31, 2012, as compared to 137.33% at December 31, 2011.  This increase was due to both an increase in the allowance for loan losses and a decrease in nonperforming loans during 2012.  The decision to increase the allowance for loan losses reflects the growth of the loan portfolio and the changes in the composition of our loan portfolio to reflect higher percentages of commercial business and agricultural loans.  We have an experienced chief lending officer and collections and loan review departments which monitor the loan portfolio and seek to prevent any deterioration of asset quality.

The following table shows the principal amount of special mention and classified loans at December 31, 2012 and December 31, 2011.

	December 31, 2012		December 31, 2011
	(In thousands)
Special Mention loans	$	1,847	$	3,311
Substandard loans		5,945		6,599
Total Special Mention and Substandard loans	$	7,792	$	9,910

The total amount of classified and special mention loans decreased $2.1 million, or 21.4%, to $7.8 million at December 31, 2012 from $9.9 million at December 31, 2011.  The decrease in classified and special mention loans during 2012 was due to decreases of $1.5 million in special mention loans and $654,000 in substandard loans.  The decrease in special mention loans reflects $903,000 in loans that were upgraded to a pass rating, $592,000 in loans that were downgraded to a substandard rating, and $120,000 in principal reductions on the special mention loans, partially offset by $386,000 in additional loans rated as special mention during 2012.  The decrease in substandard loans was primarily related to $1.2 million in principal reductions on these loans, $406,000 in write-offs, and $236,000 in loans upgraded to a pass rating, partially offset by $592,000 in loans downgraded from special mention and $710,000 of additional loans rated as substandard during 2012.

Non-interest Income

Non-interest income increased $886,000, or 22.2%, to $4.9 million for the year ended December 31, 2012, compared to $4.0 million for the year ended December 31, 2011.  The increase in non-interest income resulted primarily from increases of $877,000 in gains on the sale of available-for-sale securities, $274,000 in net income from mortgage banking operations, and $53,000 in income from fiduciary activities, partially offset by a decrease of $360,000 in commission income.  The increase in gains on the sale of securities reflected changing market conditions and a higher volume of securities sold totaling $40.7 million during the 2012 compared to $28.4 million during 2011.  The sales were made in order to realize gains on the securities while restructuring a portion of the portfolio to reduce our interest rate risk position and improve the quality.  During 2012, we sold mortgage-backed securities whose yields were affected by faster prepayment speeds and premium amortization, as well as longer-term, taxable municipal bonds.  The increase in mortgage banking income was due to a higher volume of loan sales, as we sold $52.7 million of loans in the secondary market during 2012, compared to $32.2 million during 2011.  The increase in income from fiduciary activities reflected growth in trust accounts and improved market conditions.  The decrease in commission income reflected reduced account rollover activity during 2012.

12

Non-interest Expense

Total non-interest expense increased $162,000, or 1.7%, to $10.0 million for the year ended December 31, 2012, compared to the year ended December 31, 2011.  The increase in non-interest expense was primarily due to increases of $222,000 in compensation and benefits expense and $64,000 in professional fees, partially offset by decreases of $71,000 in FDIC insurance premiums and $59,000 in the impairment of mortgage servicing rights.  The increase in compensation and benefits expense resulted primarily from higher expenses related to the effect of lower discount rates and the funding of benefit plans, as well as normal salary and benefit cost increases.  The increase in professional fees is due to increased legal expenses.  FDIC insurance premiums reflect reduced premium rates effective in the second quarter of 2011.  The decrease in the impairment of mortgage servicing rights was due to a $59,000 impairment charge recognized during 2011.

Income Taxes

The provision for income taxes increased $78,000 to $1.3 million during 2012 compared to 2011. The increase in the income tax provision reflected an increase in taxable income.  Our effective tax rate was 27.3% for 2012 and 27.7% for 2011, reflecting the impact of tax-exempt income.

13

Average Balances and Yields

The following table sets forth, for the years indicated, information regarding average balances of assets and liabilities as well as the total dollar amounts of interest income from average interest-earning assets and interest expense on average interest-bearing liabilities, resultant yields, interest rate spread, net interest margin, and ratio of average interest-earning assets to average interest-bearing liabilities.

	For the Years Ended December 31,
	2012							2011
	Average Outstanding Balance		Interest		Yield/ Rate			Average Outstanding Balance		Interest		Yield/ Rate
	(Dollars in thousands)
Interest-earning assets:
Loans (1)	$	173,600	$	9,975		5.75	%	$	177,597	$	10,697		6.02	%
Investment securities (2)		58,554		1,968		3.36			56,733		2,031		3.58
Mortgage-backed securities		45,173		801		1.77			42,832		1,129		2.64
Cash and cash equivalents		12,390		47		0.38			6,658		10		0.15
Total interest-earning assets		289,717		12,791		4.42	%		283,820		13,867		4.89	%
Non-interest-earning assets		22,271							20,241
Total assets	$	311,988						$	304,061
Interest-bearing liabilities:
Interest bearing checking	$	34,810	$	68		0.19	%	$	35,150	$	87		0.25	%
Savings accounts		31,791		119		0.38			29,057		134		0.46
Certificates of deposit		131,527		1,950		1.48			136,353		2,439		1.79
Money market savings		29,848		129		0.43			27,508		173		0.63
Money market deposits		7,582		22		0.29			6,182		29		0.47
Total interest-bearing deposits		235,558		2,288		0.97			234,250		2,862		1.22
Federal Home Loan Bank advances		2		—		1.00			159		1		0.30
Short-term borrowings		6,359		15		0.23			4,408		16		0.37
Total borrowings		6,361		15		0.23			4,567		17		0.37
Total interest-bearing liabilities		241,919		2,303		0.95	%		238,817		2,879		1.21	%
Non-interest-bearing liabilities		26,822							26,926
Total liabilities		268,741							265,743
Stockholders’ equity		43,247							38,318
Total liabilities and stockholders’ equity	$	311,988						$	304,061
Net interest income			$	10,488						$	10,988
Net interest rate spread (3)						3.46	%						3.68	%
Net interest-earning assets (4)			$	47,798						$	45,003
Net interest margin (5)						3.62	%						3.87	%
Average interest-earning assets to average interest-bearing liabilities						119.76	%						118.84	%

(1) Includes non-accrual loans and loans held for sale and fees of $103,000 for 2012 and $109,000 for 2011.

(2) Includes Federal Home Loan Bank stock and U.S. Agency securities.

(3) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.

(4) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.

(5) Net interest margin represents net interest income divided by average total interest-earning assets.

14

Rate/Volume Analysis

The following table presents the effects of changing rates and volumes on our net interest income for the fiscal years indicated.  The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume).  The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate).  The net column represents the sum of the prior columns.  For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume.

	Years Ended December 31,
	2012 vs. 2011
	Increase (Decrease) Due to						Total Increase (Decrease)
	Rate			Volume
	(In thousands)
Interest-earning assets:
Loans	$	(485	)	$	(237	)	$	(722	)
Investment securities		(127	)		64			(63	)
Mortgage-backed securities		(387	)		59			(328	)
Cash and cash equivalents		24			13			37
Total interest-earning assets	$	(975	)	$	(101	)	$	(1,076	)
Interest-bearing liabilities:
Interest bearing checking	$	(19	)	$	(1	)	$	(20	)
Savings accounts		(26	)		12			(14	)
Certificates of deposit		(405	)		(84	)		(489	)
Money market savings		(59	)		14			(45	)
Money market deposits		(12	)		5			(7	)
Total interest-bearing deposits		(521	)		(54	)		(575	)
Federal Home Loan Bank advances		—			—			—
Short-term borrowings		(7	)		6			(1	)
Total interest-bearing liabilities		(528	)		(48	)		(576	)
Change in net interest income	$	(447	)	$	(53	)	$	(500	)

15

Asset and Liability Management

As a financial institution, we face risk from interest rate volatility.  Fluctuations in interest rates affect both our level of income and expense on a large portion of our assets and liabilities.  Fluctuations in interest rates also affect the market value of all interest-earning assets.

The primary goal of our interest rate risk management strategy is to maximize net interest income while maintaining an acceptable interest rate risk profile.  We seek to coordinate asset and liability decisions so that, under changing interest rate scenarios, portfolio equity and net interest income remain within an acceptable range.

Our policy in recent years has been to reduce our interest rate risk by better matching the maturities of our interest rate sensitive assets and liabilities, selling our long-term fixed-rate residential mortgage loans with terms of 15 years or more to the secondary market, originating adjustable rate loans, balloon loans with terms ranging from three to five years, and originating consumer and commercial business loans, which typically are for a shorter duration and at higher rates of interest than one- to four-family residential mortgage loans.  Our portfolio of mortgage-backed securities, including both fixed and variable rates, also provides monthly cash flow.  The remaining investment portfolio has been structured to better match the maturities and rates of our interest-bearing liabilities.  With respect to liabilities, we have attempted to increase our savings and transaction deposit accounts, which management believes are more resistant to changes in interest rates than certificate accounts.  The board of directors appoints the Asset-Liability Management Committee (“ALCO”), which is responsible for reviewing our asset and liability management policies.  The ALCO meets quarterly to review interest rate risk and trends, as well as liquidity and capital requirements.

We use comprehensive asset/liability software provided by a third-party vendor to perform interest rate sensitivity analysis for all product categories.  The primary focus of our analysis is the effect of interest rate increases and decreases on net interest income.  Management believes that this analysis reflects the potential effects on current earnings of interest rate changes.  Call criteria and prepayment assumptions are taken into consideration for investment securities and loans.  All of our interest sensitive assets and liabilities are analyzed by product type and repriced based upon current offering rates.  The software performs interest rate sensitivity analysis by performing rate shocks of plus or minus 300 basis points in 100 basis point increments.  As a result of the historically low interest rate environment, the table below only shows the change in our assets and liabilities based upon a 100 basis point decrease in interest rates.

The following table shows projected results at December 31, 2012 and 2011, of the impact on net interest income from an immediate change in interest rates, as well as the benchmarks established by the ALCO.  The results are shown as a dollar and percentage change in net interest income over the next twelve months.

	Change in Net Interest Income
	December 31, 2012						December 31, 2011						ALCO Benchmark
Rate Shock	$ Change			% Change			$ Change			% Change
	(Dollars in thousands)
+300 basis points		(193	)		(1.64	)%		(160	)		(1.36	)%	>(20.00)%
+200 basis points		(95	)		(0.81	)		(84	)		(0.71	)	>(20.00)%
+100 basis points		(34	)		(0.29	)		(21	)		(0.18	)	>(12.50)%
(100) basis points		(503	)		(4.26	)		(200	)		(1.70	)	>(12.50)%

The table above indicates that at December 31, 2012, in the event of a 200 basis point increase in interest rates, we would experience a 0.81% decrease in net interest income.  In the event of a 100 basis point decrease in interest rates, we would experience a 4.26% decrease in net interest income.

16

The effects of interest rates on net interest income are not predictable. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, prepayments, and deposit run-offs, and should not be relied upon as indicative of actual results. Certain shortcomings are inherent in these computations. Although some assets and liabilities may have similar maturity or periods of repricing, they may react at different times and in different degrees to changes in market interest rates. Rates on other types of assets and liabilities may lag behind changes in market interest rates. Assets, such as adjustable rate mortgage loans, generally have features that restrict changes in interest rates on a short-term basis and over the life of the asset. After a change in interest rates, prepayments and early withdrawal levels could deviate significantly from those assumed in making the calculations set forth above. Additionally, increased credit risk may result if our borrowers are unable to meet their repayment obligations as interest rates increase.

Liquidity and Capital Resources

Liquidity is the ability to meet current and future short-term financial obligations.  Our ALCO Committee is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs of our customers as well as unanticipated contingencies.  At December 31, 2012, we had access to immediately available funds of approximately $22.3 million from the Federal Home Loan Bank of Chicago and $62.1 million in overnight federal funds purchased.

We regularly adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program.  Excess liquid assets are invested generally in interest-earning deposits and short- and intermediate-term securities.

Our most liquid assets are cash and cash equivalents.  The levels of these assets are dependent on our operating, financing, and investing activities.  At December 31, 2012 and 2011, cash and cash equivalents totaled $7.3 million and $11.4 million, respectively.  Our primary sources of funds include customer deposits, proceeds from sales of loans, maturities and sales of investments, and principal repayments from loans and mortgage-backed securities (both scheduled and prepayments).  During the years ended December 31, 2012 and 2011, the most significant sources of funds have been deposit growth, loan repayments, and investment calls, sales, and principal payments.

Our cash and cash equivalents decreased $4.1 million during the year ended December 31, 2012, compared to an increase of $2.4 million during the year ended December 31, 2011.  Net cash provided by operating activities increased to $4.3 million during 2012 from $4.1 million during 2011.  Net cash used in investing activities increased to $18.1 million during 2012 from the $1.4 million in cash used during 2011.  Cash used in purchases of investment and mortgage-backed securities, net of sales and maturities, increased to $12.1 million during 2012 from the $3.7 million net cash used during 2011.  Cash used in net loan originations and payments increased to $3.4 million during 2012 from the net cash provided of $4.6 million during 2011.  Cash provided by financing activities increased to $9.6 million during 2012 from the $241,000 in cash used during 2011.  The increase was primarily due to deposit growth during 2012.

While loan sales and principal repayments on mortgage-backed securities are relatively predictable, deposit flows and early prepayments are more influenced by interest rates, general economic conditions, and competition.  We attempt to price our deposits to meet asset/liability objectives and stay competitive with local market conditions.

17

Liquidity management is both a short- and long-term responsibility of management.  We adjust our investments in liquid assets based upon management’s assessment of expected loan demand, projected purchases of investment and mortgage-backed securities, expected deposit flows, yields available on interest-bearing deposits, and liquidity of its asset/liability management program.  Excess liquidity is generally invested in interest-earning overnight deposits, federal funds sold, and other short-term U.S. agency obligations.  We use securities sold under agreements to repurchase as an additional funding source.  The agreements represent our obligations to third parties and are secured by investments which we pledge as collateral.  At December 31, 2012, we had $12.0 million in outstanding repurchase agreements, which were utilized for overnight funding.

If we require funds beyond our ability to generate them internally, we have the ability to borrow funds from the Federal Home Loan Bank.  We may borrow from the Federal Home Loan Bank under a blanket agreement which assigns all investments in Federal Home Loan Bank stock as well as qualifying first mortgage loans equal to 150% of the outstanding balance as collateral to secure the amounts borrowed.  This borrowing arrangement is limited to the lesser of 30% of our total assets, 75% of the balance of qualifying one- to four-family residential loans, or twenty times the balance of Federal Home Loan Bank stock held by us.  At December 31, 2012, we had $700,000 in outstanding advances and a borrowing capacity of approximately $22.3 million.

We maintain levels of liquid assets as established by the board of directors.  Our liquidity ratio, adjusted for pledged assets, at December 31, 2012 and 2011 was 43.5% and 40.4%, respectively.  This ratio represents the volume of short-term liquid assets as a percentage of net deposits and borrowings due within one year.

We must also maintain adequate levels of liquidity to ensure the availability of funds to satisfy loan commitments.  We anticipate that we will have sufficient funds available to meet our current commitments principally through the use of current liquid assets and through our borrowing capacity discussed above.  The following table summarizes our outstanding loan commitments at December 31, 2012 and 2011.

	December 31, 2012		December 31, 2011
	(In thousands)
Commitments to fund loans	$	34,758	$	40,878
Standby letters of credit		368		401

Quantitative measures established by regulation to ensure capital adequacy require Jacksonville Savings Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets and Tier I capital to average assets.  At December 31, 2012, Jacksonville Savings Bank met all capital adequacy requirements to which it is subject.

The Director of the Illinois Department of Financial and Professional Regulation is authorized to require a savings bank to maintain a minimum capital level based upon the savings bank’s financial condition or history, management or earnings.  If a savings bank’s core capital ratio falls below the required level, the Director may direct the savings bank to adhere to a specific written plan established by the Director to correct the savings bank’s capital deficiency, as well as a number of other restrictions on the savings bank’s operations, including a prohibition on the declaration of dividends by the savings bank’s board of directors.  At December 31, 2012, Jacksonville Savings Bank’s core capital ratio was 10.89% of total adjusted average assets, which exceeded the required ratio of 4.00%.

18

As of December 31, 2012, the Federal Deposit Insurance Corporation categorized Jacksonville Savings Bank as well capitalized under the regulatory framework for prompt corrective action.  To be categorized as adequately capitalized, Jacksonville Savings Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table below.  There are no conditions or events since that notification that management believes have changed Jacksonville Savings Bank’s category.  Jacksonville Savings Bank’s actual capital ratios at December 31, 2012 and 2011 are presented in the table below.

	Minimum Required			December 31, 2012 Actual			December 31, 2011 Actual
Tier 1 Capital to Average Assets		4.00	%		10.89	%		10.35	%
Tier 1 Capital to Risk-Weighted Assets		4.00	%		16.46	%		15.42	%
Total Capital to Risk-Weighted Assets		8.00	%		17.72	%		16.67	%

Effect of Inflation and Changing Prices

The consolidated financial statements and related notes of Jacksonville Bancorp, Inc. have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”).  GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation.  The impact of inflation is reflected in the increased cost of our operations.  Unlike industrial companies, our assets and liabilities are primarily monetary in nature.  As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.

* * * * * *

19

Report of Independent Registered Public Accounting Firm

Audit Committee, Board of Directors, and Stockholders

Jacksonville Bancorp, Inc.

Jacksonville, Illinois

We have audited the accompanying consolidated balance sheets of Jacksonville Bancorp, Inc. (Company) as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for the years then ended.  The Company’s management is responsible for these financial statements.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing auditing procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  Our audits also include examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management and evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Jacksonville Bancorp, Inc. as of December 31, 2012 and 2011, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

/sig/ BKD, LLP

Decatur, Illinois

March 15, 2013

20

Jacksonville Bancorp, Inc.

Consolidated Balance Sheets

December 31, 2012 and 2011

Assets

	2012		2011
Cash and due from banks	$	2,696,107	$	2,805,490
Federal funds sold		—		5,000,000
Interest-earning demand deposits in banks		4,597,604		3,582,457
Cash and cash equivalents		7,293,711		11,387,947
Interest-earning time deposits in banks		2,972,000		2,476,000
Available-for-sale securities:
Investment securities		63,431,342		62,257,962
Mortgage-backed securities		51,956,481		40,364,086
Other investments		96,041		116,088
Loans held for sale		711,986		446,818
Loans, net of allowance for loan losses of $3,339,464 and $3,296,607 at December 31, 2012 and 2011		173,753,059		170,865,102
Premises and equipment, net of accumulated depreciation of $8,179,076 and $7,843,394 at December 31, 2012 and 2011		5,654,776		5,532,720
Federal Home Loan Bank stock		1,113,800		1,113,800
Foreclosed assets held for sale, net		137,193		435,480
Cash surrender value of life insurance		6,612,642		4,402,602
Interest receivable		2,053,472		2,071,534
Deferred income taxes		464,548		413,110
Income taxes receivable		—		47,433
Mortgage servicing rights, net of valuation allowance of $129,279 and $173,791 as of December 31, 2012 and 2011		664,436		697,733
Goodwill		2,726,567		2,726,567
Other assets		1,804,184		1,934,375
Total assets	$	321,446,238	$	307,289,357

See Notes to Consolidated Financial Statements

21

Jacksonville Bancorp, Inc.

Consolidated Balance Sheets

December 31, 2012 and 2011

Liabilities and Stockholders’ Equity

	2012			2011
Liabilities
Deposits
Demand	$	25,220,684		$	22,752,901
Savings, NOW and money market		110,435,383			100,170,389
Time		122,864,662			131,316,770
Total deposits		258,520,729			254,240,060
Short-term borrowings		12,740,610			6,517,750
Deferred compensation		3,707,402			3,295,827
Advances from borrowers for taxes and insurance		832,345			740,083
Interest payable		276,757			349,121
Income taxes payable		214,115			—
Other liabilities		1,033,951			981,093
Total liabilities		277,325,909			266,123,934
Stockholders’ Equity
Preferred stock, $.01 par value, authorized 10,000,000 shares; none issued and outstanding		—			—
Common stock, $.01 par value; authorized 25,000,000 shares; issued 1,908,556 – December 31, 2012 and  1,920,955 – December 31, 2011		19,086			19,210
Additional paid-in capital		15,943,273			16,066,624
Retained earnings		25,585,757			22,767,719
Accumulated other comprehensive income		2,896,593			2,672,490
Unallocated ESOP shares		(324,380	)		(360,620	)
Total stockholders’ equity		44,120,329			41,165,423
Total liabilities and stockholders’ equity	$	321,446,238		$	307,289,357

See Notes to Consolidated Financial Statements

22

Jacksonville Bancorp, Inc.

Consolidated Statements of Income

Years Ended December 31, 2012 and 2011

	2012		2011
Interest and Fee Income
Loans, including fees	$	9,975,109	$	10,696,562
Debt securities
Taxable		361,183		584,342
Tax-exempt		1,606,535		1,446,810
Mortgage-backed securities		801,400		1,129,544
Other		47,006		10,021
Total interest income		12,791,233		13,867,279
Interest Expense
Deposits		2,288,065		2,862,768
Short-term borrowings		14,916		16,187
Federal Home Loan Bank advances		19		473
Total interest expense		2,303,000		2,879,428
Net Interest Income		10,488,233		10,987,851
Provision for Loan Losses		490,000		625,000
Net Interest Income After Provision for Loan Losses		9,998,233		10,362,851
Noninterest Income
Fiduciary activities		289,947		236,838
Commission income		972,082		1,332,247
Service charges on deposit accounts		863,465		922,916
Mortgage banking operations, net		578,735		304,793
Net realized gains on sales of available-for-sale securities		1,158,535		281,810
Loan servicing fees		360,756		369,046
Increase in cash surrender value of life insurance		202,465		156,112
Other		456,243		392,121
Total noninterest income		4,882,228		3,995,883

See Notes to Consolidated Financial Statements

23

Jacksonville Bancorp, Inc.

Consolidated Statements of Income

Years Ended December 31, 2012 and 2011

	2012		2011
Noninterest Expense
Salaries and employee benefits	$	6,452,122	$	6,229,964
Occupancy and equipment		979,690		1,010,415
Data processing and telecommunications		534,549		560,396
Professional		259,382		195,870
Marketing		128,550		115,790
Postage and office supplies		265,773		281,595
Deposit insurance premium		157,491		228,925
Impairment on mortgage servicing rights asset		—		58,818
Other		1,198,393		1,132,184
Total noninterest expense		9,975,950		9,813,957
Income Before Income Taxes		4,904,511		4,544,777
Provision for Income Taxes		1,337,487		1,259,094
Net Income	$	3,567,024	$	3,285,683
Basic Earnings Per Share	$	1.89	$	1.74
Diluted Earnings Per Share	$	1.89	$	1.74
Cash Dividends Per Share	$	0.40	$	0.30

See Notes to Consolidated Financial Statements

24

Jacksonville Bancorp, Inc.

Consolidated Statements of Comprehensive Income

Years Ended December 31, 2012 and 2011

	2012		2011
Net Income	$	3,567,024	$	3,285,683
Other Comprehensive Income
Unrealized appreciation on available-for-sale securities, net of taxes of $509,349 and $1,550,239, for 2012 and 2011, respectively		988,737		3,009,287
Less:  reclassification adjustment for realized gains included in net income, net of taxes of $393,901 and $95,815, for 2012 and 2011, respectively		764,634		185,995
		224,103		2,823,292
Comprehensive Income	$	3,791,127	$	6,108,975

See Notes to Consolidated Financial Statements

25

Jacksonville Bancorp, Inc.

Consolidated Statements of Stockholders’ Equity

Years Ended December 31, 2012 and 2011

							Additional
	Issued Common Stock						Paid-in			Retained
	Shares			Amount			Capital			Earnings
Balance, January 1, 2011		1,923,689		$	19,237		$	16,159,960		$	20,045,095
Net income		—			—			—			3,285,683
Other comprehensive income		—			—			—			—
Stock repurchases		(10,000	)		(100	)		(137,900	)		—
Exercise of stock options		21,661			217			211,351			—
Less purchase/retirement of stock		(14,395	)		(144	)		(181,797	)		—
Tax benefit of nonqualified options		—			—			4,609			—
Common shares held by ESOP, committed to be released		—			—			10,401			—
Dividends on common stock, $.30 per share		—			—			—			(563,059	)
Balance, December 31, 2011		1,920,955			19,210			16,066,624			22,767,719
Net income		—			—			—			3,567,024
Other comprehensive income		—			—			—			—
Stock repurchases		(13,600	)		(136	)		(230,384	)		—
Exercise of stock options		1,201			12			15,487			—
Tax benefit of nonqualified options		—			—			1,291			—
Stock-based compensation expense		—			—			67,931			—
Common shares held by ESOP, committed to be released		—			—			22,324			—
Dividends on common stock, $.40 per share		—			—			—			(748,986	)
Balance, December 31, 2012		1,908,556		$	19,086		$	15,943,273		$	25,585,757

See Notes to Consolidated Financial Statements

26

Jacksonville Bancorp, Inc.

Consolidated Statements of Stockholders’ Equity

Years Ended December 31, 2012 and 2011

	Accumulated
	Other
	Comprehensive			Unallocated
	Income (Loss)			ESOP			Total
Balance, January 1, 2011	$	(150,802	)	$	(395,340	)	$	35,678,150
Net income		—			—			3,285,683
Other comprehensive income		2,823,292			—			2,823,292
Stock repurchases		—			—			(138,000	)
Exercise of stock options		—			—			211,568
Less purchase/retirement of stock		—			—			(181,941	)
Tax benefit of nonqualified options		—			—			4,609
Common shares held by ESOP, committed to be released		—			34,720			45,121
Dividends on common stock, $.30 per share		—			—			(563,059	)
Balance, December 31, 2011		2,672,490			(360,620	)		41,165,423
Net income		—			—			3,567,024
Other comprehensive income		224,103			—			224,103
Stock repurchases		—			—			(230,520	)
Exercise of stock options		—			—			15,499
Tax benefit of nonqualified options		—			—			1,291
Stock-based compensation expense		—			—			67,931
Common shares held by ESOP, committed to be released		—			36,240			58,564
Dividends on common stock, $.40 per share		—			—			(748,986	)
Balance, December 31, 2012	$	2,896,593		$	(324,380	)	$	44,120,329

See Notes to Consolidated Financial Statements

27

Jacksonville Bancorp, Inc.

Consolidated Statements of Cash Flows

Years Ended December 31, 2012 and 2011

	2012			2011
Operating Activities
Net income	$	3,567,024		$	3,285,683
Items not requiring (providing) cash
Depreciation and amortization		337,710			321,730
Provision for loan losses		490,000			625,000
Amortization of premiums and discounts on securities and loans		774,638			516,317
Deferred income taxes		(166,886	)		(246,539	)
Net realized gains on available-for-sale securities		(1,158,535	)		(281,810	)
Amortization of mortgage servicing rights		342,296			276,014
Impairment of mortgage servicing rights asset		—			58,818
Increase in cash surrender value of life insurance		(210,040	)		(163,687	)
Gains on sales of foreclosed assets		(45,046	)		(19,840	)
Shares held by ESOP committed to be released		58,564			45,121
Stock-based compensation expense		67,931			—
Changes in
Interest receivable		18,062			(198,755	)
Other assets		(478,201	)		(164,597	)
Interest payable		(72,364	)		(207,136	)
Other liabilities		464,433			54,711
Origination of loans held for sale		(52,330,075	)		(32,048,301	)
Proceeds from sales of loans held for sale		52,676,939			32,227,052
Net cash provided by operating activities		4,336,450			4,079,781
Investing Activities
Net change in interest-earning time deposits		(496,000	)		(2,476,000	)
Purchases of available-for-sale securities		(73,126,783	)		(48,099,957	)
Proceeds from maturities and payments  of available-for-sale securities		20,365,257			16,020,469
Proceeds from the sales of available-for-sale investments and other investments		40,704,778			28,375,527
Purchase of bank owned life insurance		(2,000,000	)		—
Net change in loans		(3,375,471	)		4,646,656
Purchase of premises and equipment		(459,766	)		(195,376	)
Proceeds from the sale of foreclosed assets		324,224			334,047
Net cash used in investing activities		(18,063,761	)		(1,394,634	)

See Notes to Consolidated Financial Statements

28

Jacksonville Bancorp, Inc.

Consolidated Statements of Cash Flows

Years Ended December 31, 2012 and 2011

	2012			2011
Financing Activities
Net increase in demand deposits, money market, NOW and savings accounts	$	12,732,777		$	11,778,838
Net decrease in certificates of deposit		(8,452,108	)		(13,962,425	)
Net increase in short-term borrowings		6,222,860			2,499,515
Net increase in advances from borrowers for taxes and insurance		92,262			110,295
Stock repurchase		(230,520	)		(138,000	)
Proceeds from stock options exercised		16,790			34,236
Dividends paid		(748,986	)		(563,059	)
Net cash provided by (used in) financing activities		9,633,075			(240,600	)
Increase (Decrease) in Cash and Cash Equivalents		(4,094,236	)		2,444,547
Cash and Cash Equivalents, Beginning of Year		11,387,947			8,943,400
Cash and Cash Equivalents, End of Year	$	7,293,711		$	11,387,947
Supplemental Cash Flows Information
Interest paid	$	2,375,364		$	3,086,564
Income taxes paid	$	1,243,000		$	1,676,000
Sale and financing of foreclosed assets	$	229,550		$	149,834
Real estate acquired in settlement of loans	$	261,532		$	460,996
Dividends declared not paid	$	—		$	144,073
Exercise and retirement of shares in stock option plan	$	15,499		$	29,627

See Notes to Consolidated Financial Statements

29

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Note 1: Nature of Operations and Summary of Significant Accounting Policies

Nature of Operations

Jacksonville Bancorp, Inc. (the “Company”) is a Maryland corporation.  The Company owns 100% of Jacksonville Savings Bank (the “Bank”).  The Bank was founded in 1916 as an Illinois-chartered savings and loan association and converted to an Illinois-chartered savings bank in 1992.  The Bank is headquartered in Jacksonville, Illinois and operates six branches in addition to its main office.  The Bank’s deposits have been federally insured since 1945 by the Federal Deposit Insurance Corporation (“FDIC”).  The Bank has been a member of the Federal Home Loan Bank (“FHLB”) System since 1932.

The Bank is a community-oriented savings bank engaged primarily in the business of attracting retail deposits from the general public in the Bank’s market area and using such funds together with borrowings and funds from other sources to originate consumer loans and mortgage loans secured by one-to-four family residential real estate.  The Bank also originates commercial real estate loans, multi-family real estate loans, commercial business loans, and agricultural loans.  When possible, the Bank emphasizes the origination of mortgage loans with adjustable interest rates (“ARM”), as well as fixed-rate balloon loans with terms ranging from three to five years, consumer loans, which are primarily home equity loans secured by second mortgages, commercial business loans, and agricultural loans.  The Bank also offers trust and investment services.  The investment center, Berthel Fisher and Company Financial Services, Inc., is operated through the Bank’s wholly-owned subsidiary, Financial Resources Group, Inc.

The Company is subject to competition from other financial institutions and nonfinancial institutions providing financial products.  Additionally, the Company is subject to the regulations of certain regulatory agencies and undergoes periodic examinations by those regulatory agencies.

The significant accounting and reporting policies of the Company and its subsidiary follow:

Principles of Consolidation and Financial Statement Presentation

The consolidated financial statements include the accounts of the Company, the Bank and the Bank’s wholly owned subsidiary, Financial Resources Group, Inc.  Significant intercompany accounts and transactions have been eliminated in consolidation.  Based on the Company’s approach to decision making, it has decided that its business is comprised of a single segment.

The consolidated financial statements of the Company have been prepared in conformity with accounting principles generally accepted in the United States of America and conform to predominate practice within the banking industry.

30

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, fair value of securities, valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, valuation of loan servicing rights, valuation of deferred tax assets and goodwill impairment.

Cash Equivalents

The Company considers all liquid investments with original maturities of three months or less to be cash equivalents.  At December 31, 2012 and 2011, cash equivalents consisted primarily of federal funds sold and interest-earning demand deposits in banks.

At December 31, 2012, the Company’s cash accounts did not exceed federally insured limits.

Pursuant to legislation enacted in 2010, the FDIC fully insured all noninterest-bearing transaction accounts beginning December 31, 2010, through December 31, 2012, at all FDIC-insured institutions.  This legislation expired on December 31, 2012.  Beginning January 1, 2013, noninterest-bearing transaction accounts are subject to the $250,000 limit on FDIC insurance per covered institution.

Interest-earning Time Deposits in Banks

Interest-earning time deposits in banks are generally short-term and are carried at cost.

Securities

Available-for-sale securities, which include any security for which the Company has no immediate plan to sell but which may be sold in the future, are carried at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income.  Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.  Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

For debt securities with fair value below amortized cost when the Company does not intend to sell a debt security, and it is more likely than not the Company will not have to sell the security before recovery of its cost basis, it recognizes the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income.

31

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Other Investments

Other investments at December 31, 2012 and 2011 include local municipal bonds and equity investments in local community development organizations.  The municipal bonds mature ratably through the year 2020.  These securities have no readily ascertainable market value and are carried at cost.

Loans Held for Sale

Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value in the aggregate.  Net unrealized losses, if any, are recognized through a valuation allowance by charges to noninterest income.  Gains and losses on loan sales are recorded in noninterest income, and direct loan origination costs and fees are deferred at origination of the loan and are recognized in noninterest income upon sale of the loan.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoffs are reported at their outstanding principal balances adjusted for unearned income, charge-offs, the allowance for loan losses, any unamortized deferred fees or costs on originated loans.

For loans amortized at cost, interest income is accrued based on the unpaid principal balance.  Loan origination fees, net of certain direct origination costs, as well as premiums and discounts, are deferred and amortized as a level yield adjustment over the respective term of the loan.

The accrual of interest on loans is generally discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection.  Past due status is based on contractual terms of the loan.  In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual or charged off are reversed against interest income.  The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income.  Loan losses are charged against the allowance when management believes collectibility of the principal is unlikely.  Subsequent recoveries, if any, are credited to the allowance.

32

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of allocated and general components.  The allocated component relates to loans that are classified as impaired.  For those loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.  The general component covers nonclassified loans and is based on historical charge-off experience and expected loss given default derived from the Company’s internal risk rating process.  Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.

Groups of loans with similar risk characteristics are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans.  Accordingly, the Company does not separately identify individual consumer and residential loans for impairment measurements, unless such loans are the subject of a restructuring agreement due to financial difficulties of the borrower.

Premises and Equipment

Depreciable assets are stated at cost less accumulated depreciation.  Depreciation is charged to expense using the straight-line method over the estimated useful lives of the assets.

The estimated useful lives for each major depreciable classification of premises and equipment are as follows:

Buildings and improvements	35-40 years
Equipment	3-5 years

33

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Federal Home Loan Bank Stock

Federal Home Loan Bank stock is a required investment for institutions that are members of the Federal Home Loan Bank system.  The required investment in the common stock is based on a predetermined formula, carried at cost and evaluated for impairment.

Foreclosed Assets Held for Sale

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis.  Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell.  Revenue and expenses from operations and changes in the valuation allowance are included in income or expense from foreclosed assets.

Bank-owned Life Insurance

Bank-owned life insurance policies are reflected on the consolidated balance sheets at the estimated cash surrender value.  Changes in the cash surrender value are reflected in noninterest income in the consolidated statements of income.

Goodwill

Goodwill is evaluated annually for impairment.  A qualitative assessment is performed to determine whether the existence of events or circumstances leads to a determination that it is more likely than not the fair value is less than the carrying amount, including goodwill.  If, based on the evaluation, it is determined to be more likely than not that the fair value is less than the carrying value, then goodwill is tested further for impairment.  If the implied fair value of goodwill is lower than its carrying amount, a goodwill impairment is indicated and goodwill is written down to its implied fair value.  Subsequent increases in goodwill value are not recognized in the financial statements.  The goodwill was not deemed impaired as of December 31, 2012 or 2011.

Mortgage Servicing Rights

Mortgage servicing assets are recognized separately when rights are acquired through purchase or through sale of financial assets.  Under the servicing assets and liabilities accounting guidance (ASC 860-50), servicing rights resulting from the sale or securitization of loans originated by the Company are initially measured at fair value at the date of transfer.  Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income.  The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses.  These variables change from quarter to quarter as market conditions and projected interest rates change.

34

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The Company subsequently measures each class of servicing asset using either the fair value or the amortization method.  The Company has elected to subsequently measure the mortgage servicing rights under the amortization method.  Under the amortization method, servicing rights are amortized in proportion to and over the period of estimated net servicing income.  The amortized assets are assessed for impairment or increased obligation based on fair value at each reporting date.  Each class of separately recognized servicing assets subsequently measured using the amortization method are evaluated and measured for impairment.  Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type.  Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the carrying amount of the servicing assets for that tranche.  The valuation allowance is adjusted to reflect changes in the measurement of impairment after the initial measurement of impairment.  Changes in valuation allowances are reported as a separate line item in noninterest expense on the income statement.  Fair value in excess of the carrying amount of servicing assets for that stratum is not recognized.

Servicing fee income is recorded for fees earned for servicing loans.  The fees are based on a contractual percentage of the outstanding principal and are recorded as income when earned in loan servicing fees in non-interest income.  The amortization of mortgage servicing rights is netted from the gains on sale of loans, both cash gains as well as the capitalized gains, and is included in mortgage banking operations, net in non-interest income.

Stock Options

At December 31, 2012 and 2011, the Company has a stock-based employee compensation plan, which is described more fully in Note 14.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered.  Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company — put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

35

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Income Taxes

The Company accounts for income taxes in accordance with income tax accounting guidance (ASC 740, Income Taxes).  The income tax accounting guidance results in two components of income tax expense:  current and deferred.  Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues.  The Company determines deferred income taxes using the liability (or balance sheet) method.  Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.

Deferred income tax expense results from changes in deferred tax assets and liabilities between periods.  Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.

Tax positions are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination.  The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any.  A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information.  The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to the management’s judgment.  With a few exceptions, the Company is no longer subject to U.S. federal and state income tax examinations by tax authorities for years before 2009.

The Company recognizes interest and penalties on income taxes as a component of income tax expense.

The Company files consolidated income tax returns with its subsidiary.

Earnings Per Share

Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during each period.  Diluted earnings per share reflects additional potential common shares that would have been outstanding if dilutive potential common shares had been issued.  Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method.

36

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Comprehensive Income

Comprehensive income consists of net income and other comprehensive income, net of applicable income taxes.  Other comprehensive income includes unrealized appreciation (depreciation) on available-for-sale securities.

Trust Assets

Assets held in fiduciary or agency capacities are not included in the consolidated balance sheets since such items are not assets of the Company.  Fees from trust activities are recorded as revenue over the period in which the service is provided.  Fees are a function of the market value of assets managed and administered, the volume of transactions, and fees for other services rendered, as set forth in the underlying client agreement with the Trust Department.  This revenue recognition involves the use of estimates and assumptions, including components that are calculated based on estimated asset valuations and transaction volumes.  Generally, the actual trust fee is charged to each account on a quarterly basis.  Any out of pocket expenses or services not typically covered by the fee schedule for trust activities are charged directly to the trust account on a gross basis as trust revenue is incurred.  The Company managed or administered approximately 110 and 100 trust accounts with assets totaling approximately $79.8 million and $70.9 million at December 31, 2012 and 2011, respectively.

Recent and Future Accounting Requirements

In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements by U.S. GAAP and IFRSs.  The amendments in this ASU generally represent clarifications of FASB ASC Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed.  This ASU results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRSs.  The amendments in this ASU are to be applied prospectively.  For public entities, the amendments are effective for interim and annual periods beginning after December 15, 2011.  Early application by public entities was not permitted.  The adoption of this ASU is reflected in the footnotes.

37

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

In June 2011, the FASB issued ASU No. 2011-05, Amendments to Topic 220, Comprehensive Income.  Under the amendments in this ASU, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income.  This ASU eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity.  The amendments in this ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  The amendments in this ASU should be applied retrospectively.  For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  Early adoption was permitted.  The Company retrospectively adopted this ASU during the first quarter of 2012 with separate condensed consolidated statements of comprehensive income.

In September 2011, the FASB issued ASU No. 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment.  The update provides entities with the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary.  However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit.  If the carrying amount of a reporting unit exceeds its fair value, then the entity is required to perform the second step of the goodwill impairment test to measure the amount of the impairment loss, if any.  Under the amendments in ASU No. 2011-08, an entity has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test.  An entity may resume performing the qualitative assessment in any subsequent period.  The amendments enacted by ASU No. 2011-08 are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011.  Early adoption was permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for the nonpublic entities, have not yet been made available for issuance.  The adoption of this update did not have any impact on the Company’s consolidated financial position or results of operations.

In December 2011, the FASB issued ASU No. 2011-11, Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.  ASU 2011-11 requires an entity to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement.  ASU 2011-11 was effective for annual reporting periods beginning on or after January 1, 2012, and interim periods within those annual periods.  Retrospective disclosure was required for all comparative periods presented.  The adoption of this update did not have any impact on the Company’s consolidated financial position or results of operations.

38

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Note 2: Restriction on Cash and Due From Banks

The Company is required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank.  The reserve required at December 31, 2012 and 2011, was $1,327,000 and $1,328,000, respectively.

Note 3: Securities

The amortized cost and approximate fair values, together with gross unrealized gains and losses, of securities are as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available-for-sale Securities
December 31, 2012:
U.S. Government and federal agencies	$	10,090,835	$	248,601	$	(10,556	)	$	10,328,880
Mortgage-backed securities (Government-sponsored enterprises - residential)		50,917,555		1,134,245		(95,319	)		51,956,481
Municipal bonds		49,990,655		3,264,169		(152,362	)		53,102,462
	$	110,999,045	$	4,647,015	$	(258,237	)	$	115,387,823
December 31, 2011:
U.S. Government and federal agencies	$	14,132,240	$	211,540	$	(8,137	)	$	14,335,643
Mortgage-backed securities (Government-sponsored enterprises - residential)		39,479,133		905,509		(20,556	)		40,364,086
Municipal bonds		44,961,448		2,995,639		(34,768	)		47,922,319
	$	98,572,821	$	4,112,688	$	(63,461	)	$	102,622,048

39

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The amortized cost and fair value of available-for-sale securities at December 31, 2012, by contractual maturity, are shown below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available-for-sale
	Amortized Cost		Fair Value
Within one year	$	101,779	$	102,867
One to five years		10,950,852		11,503,003
Five to ten years		25,391,965		26,755,049
After ten years		23,636,894		25,070,423
		60,081,490		63,431,342
Mortgage-backed securities		50,917,555		51,956,481
Totals	$	110,999,045	$	115,387,823

The carrying value of securities pledged as collateral, to secure public deposits and for other purposes, was $24,370,760 at December 31, 2012 and $25,424,309 at December 31, 2011.

The carrying value of securities sold under agreements to repurchase amounted to $13,705,583 and $6,784,967 at December 31, 2012 and 2011, respectively.

Gross gains of $1,158,693 and $281,810 and gross losses of $(158) and $0 resulting from sales of available-for-sale securities were realized for 2012 and 2011, respectively.  The tax provision applicable to these net realized gains amounted to $393,902 and $95,815, respectively.

Certain investments in debt securities are reported in the consolidated financial statements at an amount less than their historical cost.  Total fair value of these investments at December 31, 2012 and 2011, was $23,955,743 and $9,260,036, which is approximately 21% and 9%, respectively, of the Company’s available-for-sale investment portfolio.  The declines primarily resulted from recent changes in market interest rates.

Management believes the declines in fair value for these securities are temporary.

40

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The following table shows the Company’s investments’ gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2012 and 2011:

	December 31, 2012
	Less than 12 Months					12 Months or More				Total
Description of Securities	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Available-for-sale Securities
U.S. Government and agencies	$	545,291	$	(10,556	)	$	—	$	—	$	545,291	$	(10,556	)
Mortgage-backed securities (Government-sponsored enterprises - residential)		16,172,999		(95,319	)		—		—		16,172,999		(95,319	)
Municipal bonds		7,237,453		(152,362	)		—		—		7,237,453		(152,362	)
Total temporarily impaired securities	$	23,955,743	$	(258,237	)	$	—	$	—	$	23,955,743	$	(258,237	)

	December 31, 2011
	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Available-for-sale Securities
U.S. Government and agencies	$	1,491,864	$	(8,137	)	$	—	$	—		$	1,491,864	$	(8,137	)
Mortgage-backed securities (Government-sponsored enterprises - residential)		4,910,314		(18,488	)		623,455		(2,068	)		5,533,769		(20,556	)
Municipal bonds		2,234,403		(34,768	)		—		—			2,234,403		(34,768	)
Total temporarily impaired securities	$	8,636,581	$	(61,393	)	$	623,455	$	(2,068	)	$	9,260,036	$	(63,461	)

U.S. Government Agencies

The unrealized losses on the Company’s investments in direct obligations of U.S. government agencies were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2012.

41

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Residential Mortgage-backed Securities

The unrealized losses on the Company’s investment in residential mortgage-backed securities were caused by interest rate increases.  The Company expects to recover the amortized cost basis over the term of the securities.  Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2012.

Municipal Bonds

The unrealized losses on the Company’s investments in securities of municipal bonds were caused by interest rate increases.  The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments.  Because the Company does not intend to sell the investments and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2012.

Note 4: Loans and Allowance for Loan Losses

Classes of loans at December 31, include:

	2012			2011
Mortgage loans on real estate
Residential 1-4 family	$	41,386,147		$	39,472,008
Commercial		30,973,177			40,169,813
Agricultural		37,392,116			29,971,649
Home equity		12,733,963			16,042,788
Total mortgage loans on real estate		122,485,403			125,656,258
Commercial loans		29,046,437			23,198,454
Agricultural		10,982,491			9,590,745
Consumer		14,571,819			15,755,973
		177,086,150			174,201,430
Less
Net deferred loan fees		(6,373	)		39,721
Allowance for loan losses		3,339,464			3,296,607
Net loans	$	173,753,059		$	170,865,102

42

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The Company believes that sound loans are a necessary and desirable means of employing funds available for investment.  Recognizing the Company’s obligations to its depositors and to the communities it serves, authorized personnel are expected to seek to develop and make sound, profitable loans that resources permit and that opportunity affords.  The Company maintains lending policies and procedures in place designed to focus lending efforts on the types, locations, and duration of loans most appropriate for the business model and markets.  The Company’s principal lending activities include the origination of one-to four-family residential mortgage loans, multi-family loans, commercial real estate loans, agricultural loans, home equity lines of credits, commercial business loans, and consumer loans.  The primary lending market includes the Illinois counties of Morgan, Macoupin and Montgomery.  Generally, loans are collateralized by assets, primarily real estate, of the borrowers and guaranteed by individuals.  The loans are expected to be repaid from cash flows of the borrowers or from proceeds from the sale of selected assets of the borrowers.

Loan originations are derived from a number of sources such as real estate broker referrals, existing customers, builders, attorneys and walk-in customers.  Upon receipt of a loan application, a credit report is obtained to verify specific information relating to the applicant’s employment, income, and credit standing.  In the case of a real estate loan, an appraisal of the real estate intended to secure the proposed loan is undertaken by an independent appraiser approved by the Company.  A loan application file is first reviewed by a loan officer in the loan department who checks applications for accuracy and completeness, and verifies the information provided.  The financial resources of the borrower and the borrower’s credit history, as well as the collateral securing the loan, are considered an integral part of each risk evaluation prior to approval.  The board of directors has established individual lending authorities for each loan officer by loan type.  Loans over an individual officer’s lending limit must be approved by the officers’ loan committee consisting of the chairman of the board, president, chief lending officer and all lending officers, which meets three times a week, and has lending authority up to $500,000 depending on the type of loan.  Loans with a principal balance over this limit, up to $1.0 million, must be approved by the directors’ loan committee, which meets weekly and consists of the chairman of the board, president, senior vice president, chief lending officer and at least two outside directors, plus all lending officers as non-voting members.  The board of directors approves all loans with a principal balance over $1.0 million.  The board of directors ratifies all loans that are originated.  Once the loan is approved, the applicant is informed and a closing date is scheduled.  Loan commitments are typically funded within 30 days.

If the loan is approved, the borrower must provide proof of fire and casualty insurance on the property serving as collateral which insurance must be maintained during the full term of the loan; flood insurance is required in certain instances.  Title insurance or an attorney’s opinion based on a title search of the property is generally required on loans secured by real property.

One-to-Four Family Mortgage Loans - Historically, the primary lending origination activity has been one-to-four family, owner-occupied, residential mortgage loans secured by property located in the Company’s market area.  The Company generates loans through marketing efforts, existing customers and referrals, real estate brokers, builders and local businesses.  Generally, one-to-four family loan originations are limited to the financing of loans secured by properties located within the Company’s market area.  

43

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Fixed-rate one-to-four family residential mortgage loans are generally conforming loans, underwritten according to secondary market guidelines.  The Company generally originates both fixed- and adjustable-rate mortgage loans in amounts up to the maximum conforming loan limits established by the Federal Housing Finance Agency for the secondary market.

The Company originates for resale to the secondary market fixed-rate one-to-four family residential mortgage loans with terms of 15 years or more.  The fixed-rate mortgage loans amortize monthly with principal and interest due each month.  Residential real estate loans often remain outstanding for significantly shorter periods than their contractual terms because borrowers may refinance or prepay loans at their option.  The Company offers fixed-rate one-to-four family residential mortgage loans with terms of up to 30 years without prepayment penalty.

The Company currently offers adjustable-rate mortgage loans for terms ranging up to 30 years.  They generally offer adjustable-rate mortgage loans that adjust between one and five years on the anniversary date of origination.  Interest rate adjustments are up to two hundred basis points per year, with a cap of up to six hundred basis points on interest rate increases over the life of the loan.  In a rising interest rate environment, such rate limitations may prevent adjustable-rate mortgage loans from repricing to market interest rates, which would have an adverse effect on the net interest income.  In the low interest rate environment that has existed over the past two years, the adjustable-rate portfolio has repriced downward resulting in lower interest income from this portion of the loan portfolio.  The Company has used different interest indices for adjustable-rate mortgage loans in the past such as the average yield on U.S. Treasury securities, adjusted to a constant maturity of either one-year, three-years or five-years.  The origination of fixed-rate mortgage loans versus adjustable-rate mortgage loans is monitored on an ongoing basis and is affected significantly by the level of market interest rates, customer preference, interest rate risk position and competitors’ loan products.

Adjustable-rate mortgage loans make the loan portfolio more interest rate sensitive and provides an alternative for those borrowers who meet the underwriting criteria, but are unable to qualify for a fixed-rate mortgage.  However, as the interest income earned on adjustable-rate mortgage loans varies with prevailing interest rates, such loans do not offer predictable cash flows in the same manner as long-term, fixed-rate loans.  Adjustable-rate mortgage loans carry increased credit risk associated with potentially higher monthly payments by borrowers as general market interest rates increase.  It is possible that during periods of rising interest rates that the risk of delinquencies and defaults on adjustable-rate mortgage loans may increase due to the upward adjustment of interest costs to the borrower, resulting in increased loan losses.

Residential first mortgage loans customarily include due-on-sale clauses, which gives the Company the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells or otherwise disposes of the underlying real property serving as collateral for the loan.  Due-on-sale clauses are a means of imposing assumption fees and increasing the interest rate on mortgage portfolio during periods of rising interest rates.

44

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

When underwriting residential real estate loans, the Company reviews and verifies each loan applicant’s income and credit history.  Management believes that stability of income and past credit history are integral parts in the underwriting process.  Generally, the applicant’s total monthly mortgage payment, including all escrow amounts, is limited to 28% of the applicant’s total monthly income.  In addition, total monthly obligations of the applicant, including mortgage payments, should not generally exceed 38% of total monthly income.  Written appraisals are generally required on real estate property offered to secure an applicant’s loan.  For one-to-four family real estate loans with loan to value ratios of over 80%, private mortgage insurance is required.  Fire and casualty insurance is also required on all properties securing real estate loans.  Title insurance, or an attorney’s title opinion, may be required, as circumstances warrant.

The Company does not offer an “interest only” mortgage loan product on one-to-four family residential properties (where the borrower pays interest for an initial period, after which the loan converts to a fully amortizing loan).  They also do not offer loans that provide for negative amortization of principal, such as “Option ARM” loans, where the borrower can pay less than the interest owed on the loan, resulting in an increased principal balance during the life of the loan.  The Company does not offer a “subprime loan” program (loans that generally target borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios) or Alt-A loans (traditionally defined as loans having less than full documentation).

Commercial and Agricultural Real Estate Loans - The Company originates and purchases commercial and agricultural real estate loans.  Commercial and agricultural real estate loans are secured primarily by improved properties such as farms, retail facilities and office buildings, churches and other non-residential buildings.  The maximum loan-to-value ratio for commercial and agricultural real estate loans originated is generally 80%.  The commercial and agricultural real estate loans are generally written up to terms of five years with adjustable interest rates.  The rates are generally tied to the prime rate and generally have a specified floor.  Many of the adjustable-rate commercial real estate loans are not fully amortizing and therefore require a “balloon” payment at maturity.  The Company purchases from time to time commercial real estate loan participations primarily from outside the Company’s market area.  All participation loans are approved following a review to ensure that the loan satisfies the underwriting standards.

Underwriting standards for commercial and agricultural real estate loans include a determination of the applicant’s credit history and an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan.  The income approach is primarily utilized to determine whether income generated from the applicant’s business or real estate offered as collateral is adequate to repay the loan.  There is an emphasis on the ratio of the property’s projected net cash flow to the loan’s debt service requirement (generally requiring a minimum ratio of 120%).  In underwriting a loan, the value of the real estate offered as collateral in relation to the proposed loan amount is considered.  Generally, the loan amount cannot be greater than 80% of the value of the real estate.  Written appraisals are usually obtained from either licensed or certified appraisers on all commercial and agricultural real estate loans in excess of $250,000.  Creditworthiness of the applicant is assessed by reviewing a credit report, financial statements and tax returns of the applicant, as well as obtaining other public records regarding the applicant.

45

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Loans secured by commercial and agricultural real estate generally involve a greater degree of credit risk than one-to-four family residential mortgage loans and carry larger loan balances.  This increased credit risk is a result of several factors, including the effects of general economic conditions on income producing properties and the successful operation or management of the properties securing the loans.  Furthermore, the repayment of loans secured by commercial and agricultural real estate is typically dependent upon the successful operation of the related business and real estate property.  If the cash flow from the project is reduced, the borrower’s ability to repay the loan may be impaired.

Commercial and Agricultural Business Loans - The Company originates commercial and agricultural business loans to borrowers located in the Company’s market area which are secured by collateral other than real estate or which can be unsecured.  Commercial business loan participations are also purchased from other lenders, which may be made to borrowers outside the Company’s market area.  Commercial and agricultural business loans are generally secured by accounts receivable, equipment, and inventory and generally are offered with adjustable rates tied to the prime rate or the average yield on U.S. Treasury securities, adjusted to a constant maturity of either one-year, three-years or five-years and various terms of maturity generally from three years to five years.  Unsecured business loans are originated on a limited basis in those instances where the applicant’s financial strength and creditworthiness has been established.  Commercial and agricultural business loans generally bear higher interest rates than residential loans, but they also may involve a higher risk of default since their repayment is generally dependent on the successful operation of the borrower’s business.  Personal guarantees are generally obtained from the borrower or a third party as a condition to originating its business loans.

Underwriting standards for commercial and agricultural business loans include a determination of the applicant’s ability to meet existing obligations and payments on the proposed loan from normal cash flows generated in the applicant’s business.  Financial strength of each applicant is assessed through the review of financial statements and tax returns provided by the applicant.  The creditworthiness of an applicant is derived from a review of credit reports as well as a search of public records.  Business loans are periodically reviewed following origination.  Financial statements are requested at least annually and review them for substantial deviations or changes that might affect repayment of the loan.  Loan officers also visit the premises of borrowers to observe the business premises, facilities, and personnel and to inspect the pledged collateral.  Underwriting standards for business loans are different for each type of loan depending on the financial strength of the applicant and the value of collateral offered as security.

Home Equity and Consumer Loans – The Company originates home equity and other consumer loans.  Home equity loans and lines of credit are generally secured by the borrower’s principal residence.  The maximum amount of a home equity loan or line of credit is generally 95% of the appraised value of a borrower’s real estate collateral less the amount of any prior mortgages or related liabilities.  Home equity loans and lines of credit are approved with both fixed and adjustable interest rates which are determined based upon market conditions.  Such loans may be fully amortized over the life of the loan or have a balloon feature.  Generally, the maximum term for home equity loans is 10 years.

46

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The principal types of other consumer loans offered are loans secured by automobiles, deposit accounts, and mobile homes.  Unsecured consumer loans are also generated.  Consumer loans are generally offered on a fixed-rate basis.  Automobile loans with maturities of up to 60 months are offered for new automobiles.  Loans secured by used automobiles will have maximum terms which vary depending upon the age of the automobile.  Automobile loans with a loan-to-value ratio below the greater of 80% of the purchase price or 100% of NADA loan value are generally originated, although in the case of a new car loan the loan-to-value ratio may be greater or less depending on the borrower’s credit history, debt to income ratio, home ownership and other banking relationships with the Company.

Underwriting standards for consumer loans include a determination of the applicant’s credit history and an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan.  The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment, and additionally from any verifiable secondary income.  The length of employment with the borrower’s present employer is also considered, as well as the amount of time the borrower has lived in the local area.  Creditworthiness of the applicant is of primary consideration; however, the underwriting process also includes a comparison of the value of the collateral in relation to the proposed loan amount.

Consumer loans entail greater risks than one-to-four family residential mortgage loans, particularly consumer loans secured by rapidly depreciating assets such as automobiles or loans that are unsecured.  In such cases, collateral repossessed after a default may not provide an adequate source of repayment of the outstanding loan balance because of damage, loss or depreciation.  Further, consumer loan payments are dependent on the borrower’s continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.  Such events would increase the risk of loss on unsecured loans.  Finally, the application of various Federal and state laws, including Federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans in the event of a default. 

47

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The following tables present the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method as of December 31, 2012 and 2011:

December 31, 2012
	1-4 Family			Commercial Real Estate			Agricultural Real Estate		Commercial		Agricultural			Home Equity			Consumer			Unallocated		Total
Allowance for loan losses:
Balance, beginning of year	$	697,223		$	1,107,585		$	115,154	$	711,864	$	58,428		$	309,409		$	138,385		$	158,559	$	3,296,607
Provision charged to expense		99,055			(11,157	)		34,414		219,102		(14,498	)		86,076			74,224			2,784		490,000
Losses charged off		(82,192	)		(356,270	)		—		—		—			(80,126	)		(66,958	)		—		(585,546	)
Recoveries		26,943			88,715			—		3,285		—			13,637			5,823			—		138,403
Balance, end of year	$	741,029		$	828,873		$	149,568	$	934,251	$	43,930		$	328,996		$	151,474		$	161,343	$	3,339,464
Ending balance: individually evaluated for impairment	$	—		$	262,177		$	—	$	610,779	$	—		$	—		$	6,185		$	—	$	879,141
Ending balance: collectively evaluated for impairment	$	741,029		$	566,696		$	149,568	$	323,472	$	43,930		$	328,996		$	145,289		$	161,343	$	2,460,323
Loans:
Ending balance	$	41,386,147		$	30,973,177		$	37,392,116	$	29,046,437	$	10,982,491		$	12,733,963		$	14,571,819		$	—	$	177,086,150
Ending balance: individually evaluated for impairment	$	339,513		$	1,603,956		$	—	$	728,672	$	—		$	56,677		$	14,392		$	—	$	2,743,210
Ending balance: collectively evaluated for impairment	$	41,046,634		$	29,369,221		$	37,392,116	$	28,317,765	$	10,982,491		$	12,677,286		$	14,557,427		$	—	$	174,342,940

December 31, 2011
	1-4 Family			Commercial Real Estate			Agricultural Real Estate		Commercial		Agricultural		Home Equity			Consumer			Unallocated		Total
Allowance for loan losses:
Balance, beginning of year	$	561,309		$	1,193,928		$	92,988	$	472,376	$	58,250	$	300,257		$	163,690		$	121,487	$	2,964,285
Provision charged to expense		266,296			195,118			22,166		83,654		178		26,863			(6,347	)		37,072		625,000
Losses charged off		(130,382	)		(306,303	)		—		—		—		(24,904	)		(25,289	)		—		(486,878	)
Recoveries		—			24,842			—		155,834		—		7,193			6,331			—		194,200
Balance, end of year	$	697,223		$	1,107,585		$	115,154	$	711,864	$	58,428	$	309,409		$	138,385		$	158,559	$	3,296,607
Ending balance: individually evaluated for impairment	$	36,300		$	357,880		$	—	$	296,149	$	—	$	—		$	—		$	—	$	690,329
Ending balance: collectively evaluated for impairment	$	660,923		$	749,705		$	115,154	$	415,715	$	58,428	$	309,409		$	138,385		$	158,559	$	2,606,278
Loans:
Ending balance	$	39,472,008		$	40,169,813		$	29,971,649	$	23,198,454	$	9,590,745	$	16,042,788		$	15,755,973		$	—	$	174,201,430
Ending balance: individually evaluated for impairment	$	551,921		$	1,727,406		$	—	$	552,814	$	—	$	29,353		$	7,569		$	—	$	2,869,063
Ending balance: collectively evaluated for impairment	$	38,920,087		$	38,442,407		$	29,971,649	$	22,645,640	$	9,590,745	$	16,013,435		$	15,748,404		$	—	$	171,332,367

48

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

There have been no changes to the Company’s accounting policies or methodology from the prior periods.

Credit Quality Indicators

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends among other factors.  The Company analyzes loans individually by classifying the loans as to credit risk.  This analysis is performed on all loans at origination.  In addition, lending relationships over $500,000, new commercial and commercial real estate loans, and watch list credits are reviewed annually by our loan review department in order to verify risk ratings.  The Company uses the following definitions for risk ratings:

Special Mention – Loans classified as special mention have a potential weakness that deserves management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be Pass rated loans.  During the periods presented, none of our loans were classified as Doubtful.

49

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The following tables present the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of December 31, 2012 and 2011:

	1-4 Family				Commercial Real Estate				Agricultural Real Estate				Commercial
	2012		2011		2012		2011		2012		2011		2012		2011
Pass	$	38,123,451	$	36,040,795	$	28,283,081	$	36,936,906	$	37,392,116	$	29,567,057	$	28,301,663	$	22,253,904
Special Mention		1,273,558		1,642,602		187,936		574,484		—		404,592		849		3,402
Substandard		1,989,138		1,788,611		2,502,160		2,658,423		—		—		743,925		941,148
Total	$	41,386,147	$	39,472,008	$	30,973,177	$	40,169,813	$	37,392,116	$	29,971,649	$	29,046,437	$	23,198,454

	Agricultural Business				Home Equity				Consumer
	2012		2011		2012		2011		2012		2011
Pass	$	10,982,491	$	9,336,899	$	11,919,440	$	14,746,631	$	14,291,487	$	15,409,729
Special Mention		—		253,846		272,563		278,323		111,945		153,316
Substandard		—		—		541,960		1,017,834		168,387		192,928
Total	$	10,982,491	$	9,590,745	$	12,733,963	$	16,042,788	$	14,571,819	$	15,755,973

The following tables present the Company’s loan portfolio aging analysis as of December 31, 2012 and 2011:

	December 31, 2012
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 Days & Accruing
1-4 Family	$	727,315	$	213,126	$	984,996	$	1,925,437	$	39,460,710	$	41,386,147	$	—
Agricultural real estate		—		—		—		—		37,392,116		37,392,116		—
Commercial real estate		—		—		279,622		279,622		30,693,555		30,973,177		—
Agricultural business		—		—		—		—		10,982,491		10,982,491		—
Commercial		—		—		—		—		29,046,437		29,046,437		—
Home equity		158,414		70,596		136,508		365,518		12,368,445		12,733,963		—
Consumer		181,171		64,390		33,692		279,253		14,292,566		14,571,819		—
Total	$	1,066,900	$	348,112	$	1,434,818	$	2,849,830	$	174,236,320	$	177,086,150	$	—

	December 31, 2011
	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days		Total Past Due		Current		Total Loans Receivable		Total Loans > 90 Days & Accruing
1-4 Family	$	289,337	$	161,654	$	1,020,862	$	1,471,853	$	38,000,155	$	39,472,008	$	—
Agricultural real estate		—		—		—		—		29,971,649		29,971,649		—
Commercial real estate		75,924		—		48,428		124,352		40,045,461		40,169,813		—
Agricultural business		—		—		—		—		9,590,745		9,590,745		—
Commercial		—		—		—		—		23,198,454		23,198,454		—
Home equity		511,562		50,455		197,191		759,208		15,283,580		16,042,788		—
Consumer		156,404		126,077		37,337		319,818		15,436,155		15,755,973		—
Total	$	1,033,227	$	338,186	$	1,303,818	$	2,675,231	$	171,526,199	$	174,201,430	$	—

50

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan.  Impaired loans include nonperforming commercial loans but also include loans modified in troubled debt restructurings where concessions have been granted to borrowers experiencing financial difficulties.  These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

Impairment is measured on a loan-by-loan basis by either the present value of the expected future cash flows, the loan’s observable market value, or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses.  Significant restructured loans are considered impaired in determining the adequacy of the allowance for loan losses.

The Company actively seeks to reduce its investment in impaired loans.  The primary tools to work through impaired loans are settlement with the borrowers or guarantors, foreclosure of the underlying collateral, or restructuring.

The Company will restructure loans when the borrower demonstrates the inability to comply with the terms of the loan, but can demonstrate the ability to meet acceptable restructured terms.  Restructurings generally include one or more of the following restructuring options; reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance, or other actions intended to maximize collection.  Restructured loans in compliance with modified terms are classified as impaired.

51

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The following tables present impaired loans for the years ended December 31, 2012 and 2011:

	December 31, 2012
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized		Interest Income Recognized Cash Basis
Loans without a specific valuation allowance
1-4 Family	$	339,513	$	339,513	$	—	$	343,593	$	17,163	$	16,909
Commercial real estate		201,135		201,135		—		205,756		27,727		16,136
Consumer		8,207		8,207		—		9,795		495		422
Home equity		56,677		56,677		—		57,934		4,087		4,162
Loans with a specific valuation allowance
Commercial real estate		1,402,821		1,402,821		262,177		1,443,005		91,130		91,075
Commercial		728,672		728,672		610,779		780,979		44,887		52,898
Consumer		6,185		6,185		6,185		7,096		573		576
Total:
1-4 family		339,513		339,513		—		343,593		17,163		16,909
Commercial real estate		1,603,956		1,603,956		262,177		1,648,761		118,857		107,211
Commercial		728,672		728,672		610,779		780,979		44,887		52,898
Consumer		14,392		14,392		6,185		16,891		1,068		998
Home equity		56,677		56,677		—		57,934		4,087		4,162
Total	$	2,743,210	$	2,743,210	$	879,141	$	2,848,158	$	186,062	$	182,178

52

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

	December 31, 2011
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Average Investment in Impaired Loans		Interest Income Recognized		Interest Income Recognized Cash Basis
Loans without a specific valuation allowance
1-4 Family	$	235,856	$	235,856	$	—	$	249,103	$	10,446	$	11,162
Commercial real estate		69,249		69,249		—		71,972		457		254
Commercial		—		—		—		—		—		—
Consumer		—		—		—		—		—		—
Home equity		29,353		29,353		—		21,954		1,933		1,605
Loans with a specific valuation allowance
1-4 family		316,065		316,065		36,300		368,040		25,241		18,341
Commercial real estate		1,658,157		1,658,157		357,880		1,726,905		88,084		117,289
Commercial		552,814		552,814		296,149		592,796		37,192		36,628
Consumer		7,569		7,569		—		7,569		37		—
Home equity		—		—		—		—		—		—
Total:
1-4 family		551,921		551,921		36,300		617,143		35,687		29,503
Commercial real estate		1,727,406		1,727,406		357,880		1,798,877		88,541		117,543
Commercial		552,814		552,814		296,149		592,796		37,192		36,628
Consumer		7,569		7,569		—		7,569		37		—
Home equity		29,353		29,353		—		21,954		1,933		1,605
Total	$	2,869,063	$	2,869,063	$	690,329	$	3,038,339	$	163,390	$	185,279

Included in certain loan categories in the impaired loans are troubled debt restructurings (TDR’s), where economic concessions have been granted to borrowers who have experienced financial difficulties, that were classified as impaired.  These concessions typically result from our loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions.  TDR’s are considered impaired at the time of restructuring and typically are returned to accrual status after considering the borrower’s sustained repayment performance for a reasonable period of at least six months.

When loans are modified into a TDR, the Company evaluates any possible impairment similar to other impaired loans based on the present value of expected cash flows, discounted at the contractual interest rate of the original loan agreement, or based upon on the current fair value of the collateral, less selling costs for collateral dependent loans.  If the Company determined that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance.  In periods subsequent to modification, the Company evaluates all TDR’s, including those that have payment defaults, for possible impairment and recognizes impairment through the allowance.

53

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

During the quarter ended September 30, 2011, the Company adopted ASU 2011-02.  The amendments in ASU 2011-02 require prospective application of the impairment measurement guidance in ASC 310-10-35 for those receivables newly identified as impaired.  As a result of adopting ASU 2011-02, the Company reassessed all restructurings that occurred on or after January 1, 2011, the beginning of our fiscal year, for identification of TDR’s.  The Company identified no loans as troubled debt restructurings for which the allowance for loan losses had previously been measured under a general allowance for credit losses methodology.  Thereafter, there was no additional impact to the allowance for loan losses as a result of the adoption.

The following table presents the recorded balance, at original cost, of troubled debt restructurings, as of December 31, 2012 and 2011.

	2012		2011
1-4 family	$	267,916	$	213,966
Agricultural real estate		—		—
Commercial real estate		1,011,350		1,075,483
Agricultural business		—		—
Commercial		701,271		477,798
Home equity		84,123		125,588
Consumer		91,206		83,962
Total	$	2,155,866	$	1,976,797

The following table presents the recorded balance, at original cost, of troubled debt restructurings, which were performing according to the terms of the restructuring, as of December 31, 2012 and 2011.

	2012		2011
1-4 family	$	127,399	$	131,990
Agricultural real estate		—		—
Commercial real estate		983,450		1,007,723
Agricultural business		—		—
Commercial		701,271		477,798
Home equity		84,123		95,769
Consumer		89,045		83,962
Total	$	1,985,288	$	1,797,242

54

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The following table presents loans modified as troubled debt restructurings during the years ended December 31, 2012 and 2011.

	Year Ended December 31, 2012				Year Ended December 31, 2011
	Number of Modifications		Recorded Investment		Number of Modifications		Recorded Investment
1-4 family		2	$	70,739		3	$	178,046
Agricultural real estate		—		—		—		—
Commercial real estate		—		—		2		938,474
Agricultural business		—		—		—		—
Commercial		2		266,968		5		143,814
Home equity		3		21,422		2		95,769
Consumer		3		20,513		1		3,430
Total		10	$	379,642		13	$	1,359,533

2012 Modifications

The Company modified two one-to-four family residential real estate loans, with a recorded investment of $70,739, which were deemed to be TDR’s.  One of the modifications was made to change the payment schedule to interest-only for a period of time.  One of the loans was restructured with a reduced interest rate and the accrued interest capitalized to the balance of the note.  None of the modifications resulted in a write-off of the principal balance.

The Company modified two commercial loans with a total recorded balance of $266,968, which were deemed TDR’s.  Both modifications were made to lower the contractual interest.

The Company also modified three home equity loans with a total recorded investment of $21,422 and three consumer loan with a recorded investment of $20,513.  Two of the modifications were made to extend the amortization schedule and lower the monthly payment amount.  One of the modifications was made to change the payment schedule to interest-only for a period of time.  Three of the loans were restructured with the accrued interest capitalized to the note.  None of the modifications resulted in a reduction of the contractual interest rate or a write-off of the principal balance.

2011 Modifications

The Company modified three one-to-four family residential real estate loans, with a recorded investment of $178,046, which were deemed to be TDR’s.  Two of the modifications were made to change the payment schedule to interest-only for a period of time.  One of the loans was restructured with the accrued interest capitalized to the balance of the note.  None of the modifications resulted in a reduction of the contractual interest rate or a write-off of the principal balance.

55

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

In addition, the Company modified two commercial real estate loans with a total recorded investment of $938,474 to the same borrower.  The loans are participations purchased from another financial institution, which lowered the contractual interest rate and extended the amortization schedule to lower the monthly payment amount.  The modification resulted in a specific allocation to the allowance for loan losses of $133,889 based upon the fair value of the collateral.

The Company modified five commercial loans with a total recorded balance of $143,814 to the same borrower.  The modifications were made to lower the contractual interest rate and extend the amortization schedule to lower the monthly payment amount.

The Company also modified two home equity loans with a total recorded investment of $95,769 and one consumer loan with a recorded investment of $3,430.  Two of the modifications were made to extend the amortization schedule and lower the monthly payment amount.  One of the modifications was made to change the payment schedule to interest-only for a period of time.  None of the modifications resulted in a reduction of the contractual interest rate or a write-off of the principal balance.

TDRs with Defaults

Management considers the level of defaults within the various portfolios when evaluating qualitative adjustments used to determine the adequacy of the allowance for loan losses.  During the year ended December 31, 2012, two residential real estate loan of $111,754 and one commercial real estate loan of $27,900 that were considered TDR’s defaulted as they were more than 90 days past due at December 31, 2012.  In addition, two one-to-four family residential real estate loans of $91,521, two commercial business loans of $50,587, two home equity loans of $10,836, and one consumer loan of $68,538 were considered TDR’s defaulted as they were in a nonaccrual status but are performing in accordance with their modified terms.  

During the year ended December 31, 2011, one residential real estate loan of $55,521 and one home equity loan of $29,819 that were considered TDR’s defaulted as they were more than 90 days past due at December 31, 2011.  In addition, one one-to-four family residential real estate loan of $26,455, one commercial business loan of $18,252 and one consumer loan of $80,533 that were considered TDR’s defaulted as they were in a nonaccrual status but are performing in accordance with their modified terms.  Default occurs when a loan is 90 days or more past due, transferred to nonaccrual or charged-off, and is within twelve months of restructuring.

56

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The following table presents the Company’s nonaccrual loans at December 31, 2012 and 2011.  This table excludes performing troubled debt restructurings.

	2012		2011
1-4 family	$	1,203,328	$	1,297,953
Agricultural real estate		—		—
Commercial real estate		560,073		361,524
Agricultural business		—		—
Commercial		51,436		66,852
Home equity		276,877		423,113
Consumer		122,064		251,025
Total	$	2,213,778	$	2,400,467

Note 5: Premises and Equipment

Major classifications of premises and equipment, stated at cost, are as follows:

	2012			2011
Land	$	983,276		$	983,276
Buildings and improvements		7,756,293			7,573,247
Equipment		5,094,283			4,819,591
		13,833,852			13,376,114
Less accumulated depreciation		(8,179,076	)		(7,843,394	)
Net premises and equipment	$	5,654,776		$	5,532,720

Note 6: Loan Servicing

Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets.  The risks inherent in mortgage servicing assets relate primarily to changes in prepayments that result from shifts in mortgage interest rates.  The unpaid principal balance of mortgage loans serviced for others was $148,346,763 and $146,160,915 at December 31, 2012 and 2011, respectively.

57

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The following summarized the activity pertaining to mortgage servicing rights measured using the amortization method, along with the aggregate activity in related valuation allowances:

	2012			2011
Mortgage servicing rights
Balance, beginning of year	$	871,524		$	961,316
Additions		219,975			137,206
Amortization		(297,784	)		(226,998	)
Balance at end of year		793,715			871,524
Valuation allowances
Balance at beginning of year		173,791			163,989
Additions due to decreases in market value		—			58,818
Reduction due to increases in market value		—			—
Reduction due to payoff of loans		(44,512	)		(49,016	)
Balances at end of year		129,279			173,791
Mortgage servicing assets, net	$	664,436		$	697,733
Fair value disclosures
Fair value as of the beginning of the period	$	758,175		$	1,012,722
Fair value as of the end of the period	$	765,029		$	758,175

During 2008, a valuation allowance of $428,030 was necessary to adjust the aggregate cost basis of the mortgage servicing right asset to fair value.  The valuation allowance was adjusted during 2011 and 2012 due to payments received on the related loans as well as changes in the estimated market value on the mortgage servicing rights asset.

Comparable market values and a valuation model that calculates the present value of future cash flows were used to estimate fair value.  For purposes of measuring impairment, risk characteristics including product type, investor type, and interest rates, were used to stratify the originated mortgage servicing rights.

58

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Note 7: Interest-bearing Deposits

Interest-bearing deposits in denominations of $100,000 or more totaled $104,717,280 at December 31, 2012 and $95,661,871 at December 31, 2011.

The following table represents deposit interest expense by deposit type:

	December 31,
	2012		2011
Savings, NOW and Money Market	$	339,065	$	425,505
Certificates of deposit		1,949,000		2,437,263
Total deposit interest expense	$	2,288,065	$	2,862,768

At December 31, 2012, the scheduled maturities of time deposits are as follows:

2013	$	66,105,894
2014		24,582,551
2015		16,626,587
2016		7,140,684
2017		8,408,946
	$	122,864,662

Note 8: Short-term Borrowings

Short-term borrowings include securities sold under agreements to repurchase totaling $12,040,610 and $6,517,750 at December 31, 2012 and 2011, respectively.

Securities sold under agreements to repurchase consist of obligations of the Company to other parties.  The obligations are secured by investments and such collateral is held by the Company.  The maximum amount of outstanding agreements at any month end during 2012 and 2011 totaled $23,463,685 and $6,517,750, respectively, and the monthly average of such agreements totaled $6,366,508 and $4,541,552 for 2012 and 2011, respectively.  The agreements at December 31, 2012, are all for overnight borrowings.

Also included in short-term borrowings are overnight advances with the Federal Home Loan Bank (FHLB) of which $700,000 and $0 had been extended as of December 31, 2012 and 2011, respectively.  The advances mature in 2013 and are secured by mortgage loans totaling $28,758,638 at December 31, 2012.  Advances, at an interest rate of 0.30% are subject to restrictions or penalties in the event of prepayment.

59

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Note 9: Income Taxes

The Company and its subsidiary file income tax returns in the U.S. federal and state of Illinois jurisdictions.  During the years ended December 31, 2012 and 2011, the Company did not recognize expense for interest or penalties.

The provision for income taxes includes these components:

	2012			2011
Taxes currently payable
Federal	$	1,037,608		$	1,067,443
State		466,765			438,190
Deferred income taxes		(166,886	)		(246,539	)
Income tax expense	$	1,337,487		$	1,259,094

A reconciliation of income tax expense at the statutory rate to the Company’s actual income tax expense is shown below:

	2012			2011
Computed at the statutory rate (34%)	$	1,667,534		$	1,545,224
Increase (decrease) resulting from
Tax exempt interest		(546,910	)		(498,697	)
State income taxes, net		286,869			268,790
Increase in cash surrender value		(68,838	)		(53,078	)
Other		(1,168	)		(3,145	)
Actual tax expense	$	1,337,487		$	1,259,094
Tax expense as a percentage of pre-tax income		27.27	%		27.70	%

60

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The tax effects of temporary differences related to deferred taxes shown on the consolidated balance sheets were:

	2012			2011
Deferred tax assets
Allowance for loan losses	$	1,214,733		$	1,197,475
Deferred compensation		1,492,971			1,327,230
State net operating loss carryforward		196,811			196,811
Other		4,555			—
		2,909,070			2,721,516
Deferred tax liabilities
Unrealized gains on available-for-sale securities		(1,492,185	)		(1,376,737	)
Depreciation		(452,711	)		(400,541	)
Federal Home Loan Bank stock dividends		(152,224	)		(152,224	)
Prepaid expenses		(79,834	)		(65,907	)
Mortgage servicing rights		(267,568	)		(285,178	)
Other		—			(27,819	)
		(2,444,522	)		(2,308,406	)
Net deferred tax asset	$	464,548		$	413,110

At December 31, 2012 and 2011, the Company had Illinois net operating loss carryforwards totaling approximately $4,084,922, which will expire in varying amounts between 2018 and 2022.  Recent Illinois legislation has suspended the use of these loss carryovers for tax years 2011 through 2013 and the expiration dates were extended by three years.  Management believes the Company will produce taxable earnings in the future which will enable the net operating loss carryforwards to be utilized prior to expiration.

Retained earnings at December 31, 2012 and 2011, include approximately $2,600,000, for which no deferred federal income tax liability has been recognized.  These amounts represent an allocation of income to bad debt deductions for tax purposes only.  Reduction of amounts so allocated for purposes other than tax bad debt losses or adjustments arising from carryback of net operating losses would create income for tax purposes only, which would be subject to the then-current corporate income tax rate.  The deferred income tax liabilities on the preceding amounts that would have been recorded if they were expected to reverse into taxable income in the foreseeable future were approximately $1,000,000 at December 31, 2012 and 2011.

61

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Note 10: Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income, included in stockholders’ equity, are as follows:

	2012			2011
Net unrealized gain on securities available-for-sale	$	4,388,778		$	4,049,227
Tax effect		(1,492,185	)		(1,376,737	)
Net-of-tax amount	$	2,896,593		$	2,672,490

Note 11: Regulatory Matters

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements.  Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices.  The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.  Furthermore, the Bank’s regulators could require adjustments to regulatory capital not reflected in these consolidated financial statements.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital to average assets (as defined).  Management believes, as of December 31, 2012 and 2011, that the Bank meets all capital adequacy requirements to which it is subject.

As of December 31, 2012, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.  To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table.  There are no conditions or events since that notification that management believes have changed the Bank’s category.

62

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The Bank’s actual capital amounts (in thousands) and ratios are also presented in the table.

	Actual					Minimum Capital Requirement					Minimum to Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2012
Total risk-based capital (to risk-weighted assets)	$	36,620		17.72	%	$	16,535		8.0	%	$	20,668		10.0	%
Tier I capital (to risk-weighted assets)		34,027		16.46			8,267		4.0			12,401		6.0
Tier I capital (to average assets)		34,027		10.89			12,503		4.0			15,628		5.0
Tangible capital (to adjusted tangible assets)		34,027		10.89			4,689		1.5			—		N/A
As of December 31, 2011
Total risk-based capital (to risk-weighted assets)	$	33,667		16.67	%	$	16,153		8.0	%	$	20,191		10.0	%
Tier I capital (to risk-weighted assets)		31,134		15.42			8,076		4.0			12,115		6.0
Tier I capital (to average assets)		31,134		10.35			12,032		4.0			15,040		5.0
Tangible capital (to adjusted tangible assets)		31,134		10.35			4,512		1.5			—		N/A

The following is a reconciliation of the Bank equity amount included in the consolidated balance sheets to the amounts (in thousands) reflected above for regulatory capital purposes as of December 31:

	2012		2011
Bank equity	$	39,650	$	36,548
Less net unrealized gain		2,896		2,672
Less disallowed goodwill		2,727		2,727
Less disallowed servicing amounts		—		15
Tier 1 capital		34,027		31,134
Plus allowance for loan losses		2,593		2,533
Total risked-based capital	$	36,620	$	33,667

63

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval.  As of December 31, 2012, the Bank has $7,900,000 available for the payment of dividends without prior regulatory approval.

Note 12: Related Party Transactions

At December 31, 2012 and 2011, the Company had loans outstanding to executive officers, directors, significant shareholders and their affiliates (related parties) in the amount of $3,922,338 and $2,927,377, respectively.

Annual activity consisted of the following:

	2012			2011
Balance beginning of year	$	2,927,377		$	2,820,414
Additions		3,188,495			1,918,418
Repayments		(2,193,534	)		(1,811,455	)
Balance, end of year	$	3,922,338		$	2,927,377

In management’s opinion, such loans and other extensions of credit and deposits were made in the ordinary course of business and were made on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons.  Further, in management’s opinion, these loans did not involve more than normal risk of collectibility or present other unfavorable features.

Deposits from related parties held by the Company at December 31, 2012 and 2011 totaled approximately $2,788,000 and $2,614,000, respectively.

Note 13: Employee Benefits

401(k) Plan — The Company maintains a 401(k) savings plan for eligible employees.  The Company’s contributions to this plan were $213,983 and $182,833 for the years ended December 31, 2012 and 2011, respectively.  The plan invests some of its assets in deposit accounts at the Company which earned interest at a rate of 2.00% to 2.50% for the year ended December 31, 2012 and 2.50% to 2.75% for the year ended December 31, 2011.

Deferred Compensation Plan — The Company maintains a deferred compensation plan for certain key officers and employees.  Contributions are determined annually by the Company’s Board of Directors.  Effective in 2005, the Company froze this plan and no contributions to this plan were made for the years ended December 31, 2012 or 2011.  The plan accrues interest at a variable rate which fluctuates based on Moody’s Corporate Bond Average Index.  The amount recorded on the consolidated balance sheets as deferred compensation was $2,329,859 and $2,288,283 as of December 31, 2012 and 2011, respectively.  Compensation expense related to the plan was $135,730 and $153,145 for the years ended December 31, 2012 and 2011, respectively.

64

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

The Company has also entered into deferred compensation agreements with certain key officers and employees.  The agreements provide for monthly payments at retirement or death.  The charge to expense for this plan reflects the accrual using the principal and interest method over the vesting period of the present value of benefits due each participant on the full eligibility date using a 4.75% discount rate.  The amount recorded on the consolidated balance sheets as deferred compensation was $1,377,543 and $1,007,544 as of December 31, 2012 and 2011, respectively.  Compensation expense related to the plans was $398,899 and $199,662 for the years ended December 31, 2012 and 2011, respectively.

Employee Stock Ownership Plan (ESOP) — The ESOP is a noncontributory defined contribution plan which covers substantially all employees.  The Company may contribute to the Plan, at its discretion, an amount determined by the Board of Directors.

As part of the second step conversion, in July 2010 the Company acquired 41,614 additional shares of Company common stock at $10 per share in the conversion with funds provided by a loan from the Company.  Accordingly, $416,140 of common stock acquired by the ESOP was shown as a reduction of stockholders’ equity.  Shares are released to participants proportionately as the loan is repaid.  Dividends on allocated shares are recorded as dividends and charged to retained earnings.  Dividends on unallocated shares are used to repay the loan and are treated as compensation expense.  Compensation expense is recorded equal to the fair market value of the stock when contributions, which are determined annually by the Board of Directors of the Company, are made to the ESOP.

ESOP expense for the years ended December 31, 2012 and 2011 was $58,564 and $45,121, respectively.

	2012		2011
Allocated shares		49,668		52,815
Shares committed for allocation		3,624		3,471
Unearned shares		32,438		32,591
Total ESOP shares		85,730		88,877
Fair value of unearned shares at December 31	$	562,799	$	448,126

The Company is obligated at the option of each beneficiary to repurchase shares of the ESOP upon the beneficiary’s termination or after retirement.  At December 31, 2012, the fair value of the 49,668 allocated shares held by the ESOP is $861,740.  The fair value of all shares subject to the repurchase obligation is $924,616.

65

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Note 14: Stock Option Plans

The Jacksonville Savings Bank and Jacksonville Bancorp, MHC 1996 Stock Option Plan was adopted on April 23, 1996 and is administered by the Board of Directors.  A total of 83,625 shares of common stock were reserved and awarded under the Plan.  Awards expire ten years after the grant date and are exercisable at a price of $8.83 per share.  In 2004, 5,600 shares related to this plan were reissued at a price of $14.00 per share.  The Jacksonville Savings Bank 2001 Stock Option Plan was adopted on April 30, 2001 and is administered by the Stock Benefits Committee.  A total of 87,100 shares of common stock were reserved and awarded under the Plan during 2001 that expire ten years after the grant date and are exercisable at a price of $10.00 per share.

The Jacksonville Bancorp, Inc. 2012 Stock Option Plan, which is shareholder approved,  permits the grant of share options and shares to its employees for up to 104,035 shares of common stock.  The Company believes that such awards better align the interests of its employees with those of its shareholders.  All shares were awarded as of the approval date, expire ten years after the grant date, and are exercisable at a price of $15.65 per share.

The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model that uses the assumptions noted in the following table.  Expected volatility is based on historical volatility of the Company’s stock and other factors.  The Company uses historical data to estimate option exercise and employee termination within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes.  The expected term of options granted represents the period of time that options are expected to be outstanding; the range given below results from certain groups of employees exhibiting different behavior.  The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.  The discount rate for post-vesting restrictions is estimated based on the Company’s credit-adjusted risk-free rate of return.

	2012
Expected volatility		33.41	%
Expected dividend yield		2.19	%
Expected term (in years)		7
Risk-free rate		1.37	%

66

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

A summary of option activity under the Plans as of December 31, 2012 and 2011, and changes during the years then ended, is presented below:

	2012
	Shares			Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding, beginning of year		4,504		$	13.98
Granted		104,035			15.65
Exercised		(1,201	)		13.98
Forfeited or expired		—			—
Outstanding, end of year		107,338		$	15.60		9.25	$	187,991
Exercisable, end of year		3,303		$	13.98		1.50	$	11,131

	2011
	Shares			Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding, beginning of year		33,382		$	10.52
Exercised		(21,661	)		9.98
Forfeited or expired		(7,217	)		9.98
Outstanding, end of year		4,504		$	13.98		2.50	$	—
Exercisable, end of year		4,504		$	13.98		2.50	$	—

The aggregate intrinsic value of options outstanding and exercisable at the end of the year 2011 excludes 4,504 shares that are exercisable at a price of $13.98 per share and were antidilutive.

The total intrinsic value of options exercised during the years ended December 31, 2012 and 2011 was $2,630 and $63,683, respectively.

67

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

As of December 31, 2012, there was $383,129 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the 2012 Plan.  That cost is expected to be recognized over a weighted-average period of 5 years.  The total fair value of shares vested during the year ended December 31, 2012 was $67,931.  The recognized tax benefit related thereto was $27,356 for the year ended December 31, 2012.  There was no unrecognized compensation cost related to nonvested share-based compensation arrangements as of December 31, 2011.

A summary of the status of the Company’s nonvested shares as of December 31, 2012, and changes during the year then ended, is presented below:

	Shares		Weighted- Average Grant- Date Fair Value
Nonvested, beginning of year		—	$	—
Granted		104,035		15.65
Vested		—		—
Forfeited		—		—
Nonvested, end of year		104,035	$	15.65

Note 15: Earnings Per Share

Earnings per share (EPS) were computed as follows:

	Year Ended December 31, 2012
	Income		Weighted- Average Shares		Per Share Amount
Net income	$	3,567,024
Basic earnings per share
Income available to common stockholders				1,883,375	$	1.89
Effect of dilutive securities
Stock options				447
Diluted earnings per share
Income available to common stockholders	$	3,567,024		1,883,822	$	1.89

68

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Options to purchases 104,035 shares of common stock were outstanding at December 31, 2012, but were not included in the computation of diluted EPS because the shares were considered antidilutive for the year ended December 31, 2012.

	Year Ended December 31, 2011
	Income		Weighted-Average Shares		Per Share Amount
Net income	$	3,285,683
Basic earnings per share
Income available to common stockholders				1,890,449	$	1.74
Effect of dilutive securities
Stock options				—
Diluted earnings per share
Income available to common stockholders	$	3,285,683		1,890,449	$	1.74

Options to purchases 4,504 shares of common stock at $13.98 per share were outstanding at December 31, 2011, but were not included in the computation of diluted EPS because the options’ exercise price was greater than the average market price of the common shares.

Note 16: Disclosures about Fair Value of Assets and Liabilities

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs.  There is a hierarchy of three levels of inputs that may be used to measure fair value:

Level 1 Quoted prices in active markets for identical assets or liabilities

Level 2 Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

69

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Recurring Measurements

The following table presents the fair value measurements of assets  recognized in the accompanying consolidated balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2012 and 2011:

			December 31, 2012
			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Government and agencies	$	10,328,880	$	—	$	10,328,880	$	—
Mortgage-backed securities (Government-sponsored enterprises - residential)		51,956,481		—		51,956,481		—
Municipal bonds		53,102,462		—		53,102,462		—

			December 31, 2011
			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Government and agencies	$	14,335,643	$	—	$	14,335,643	$	—
Mortgage-backed securities (Government-sponsored enterprises - residential)		40,364,086		—		40,364,086		—
Municipal bonds		47,922,319		—		47,922,319		—

70

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying consolidated balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.  There have been no significant changes in the valuation techniques during the year ended December 31, 2012.

Available-for-Sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy.  The Company has no Level 1 securities.  If quoted market prices are not available, then fair values are estimated by using quoted prices of securities with similar characteristics or independent asset pricing services and pricing models.  Such securities are classified in Level 2 of the valuation hierarchy.  In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy.  The Company did not have securities considered Level 3 as of December 31, 2012 or December 31, 2011.

Nonrecurring Measurements

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2012 and 2011:

			December 31, 2012
			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans (collateral dependent)	$	1,032,580	$	—	$	—	$	1,032,580
Foreclosed assets		137,193		—		—		137,193

71

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

			December 31, 2011
			Fair Value Measurements Using
	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans (collateral dependent)	$	867,318	$	—	$	—	$	867,318
Mortgage servicing rights		697,733		—		—		697,733
Foreclosed assets		435,480		—		—		435,480

Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying consolidated balance sheets, as well as the general classification of such assets and liabilities pursuant to the valuation hierarchy.  For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.

Impaired Loans (Collateral Dependent)

The estimated fair value of collateral-dependent impaired loans is based on the appraised fair value of the collateral, less estimated cost to sell.  Collateral-dependent impaired loans are classified within Level 3 of the fair value hierarchy.

The Company considers the appraisal or evaluation as the starting point for determining fair value and then considers other factors and events in the environment that may affect the fair value.  Appraisals of the collateral underlying collateral-dependent loans are obtained when the loan is determined to be collateral-dependent and subsequently as deemed necessary.  Appraisals are reviewed for accuracy and consistency.  Appraisers are selected from the list of approved appraisers maintained by management.  The appraised values are reduced by discounts to consider lack of marketability and estimated cost to sell if repayment or satisfaction of the loan is dependent on the sale of the collateral.  Fair value adjustments on impaired loans were $(183,319) and $(393,319) at December 31, 2012 and 2011.

72

Jacksonville Bancorp, Inc.
Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Mortgage Servicing Rights

Mortgage servicing rights do not trade in an active, open market with readily observable prices.  Accordingly, fair value is estimated using discounted cash flow models having significant inputs of discount rate, prepayment speed and default rate.  Due to the nature of the valuation inputs, mortgage servicing rights are classified within Level 3 of the hierarchy.

Mortgage servicing rights are tested for impairment on at least an annual basis.  The Company uses a third-party to measure mortgage servicing rights through the completion of a proprietary model.  Inputs to the model are reviewed by the Company.  Fair value adjustments on mortgage servicing rights were $0 and $(58,818) at December 31, 2012 and 2011.

Foreclosed Assets Held for Sale

Foreclosed assets are carried at the lower of fair value at acquisition date or current estimated fair value, less estimated cost to sell when the real estate is acquired.  Estimated fair value of foreclosed assets is based on appraisals or evaluations.  Foreclosed assets are classified within Level 3 of the fair value hierarchy.

Appraisals of foreclosed assets are obtained when the real estate is acquired and subsequently as deemed necessary.  Appraisals are reviewed for accuracy and consistency.  Appraisers are selected from the list of approved appraisers maintained by management.  Fair value adjustments on real estate owned were $(56,193) and $32,352 at December 31, 2012 and 2011.

Unobservable (Level 3) Inputs

The following table presents quantitative information about unobservable inputs used in nonrecurring Level 3 fair value measurements.

	Fair Value at December 31, 2012		Valuation Technique	Unobservable Inputs	Range (Weighted Average)
Foreclosed assets	$	137,193	Market comparable properties	Comparability adjustments		(26%)
Collateral-dependent impaired loans	$	1,032,580	Market comparable properties	Marketability discount		20% – 30% (25%)

73

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Fair Value of Other Financial Instruments

The following table presents estimated fair values of the Company’s other financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at December 31, 2012 and 2011:

			December 31, 2012
			Fair Value Measurements Using
	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets
Cash and cash equivalents	$	7,293,711	$	7,293,711	$	—	$	—
Interest-earning time deposits in banks		2,972,000		—		2,972,000		—
Other investments		96,041		—		96,041		—
Loans held for sale		711,986		—		711,986		—
Loans, net of allowance for loan losses		173,753,059		—		—		172,609,490
Federal Home Loan Bank stock		1,113,800		—		1,113,800		—
Interest receivable		2,053,472		—		2,053,472		—
Financial liabilities
Deposits		258,520,729		—		135,656,067		125,864,749
Short-term borrowings		12,740,610		—		12,740,610		—
Advances from borrowers for taxes and insurance		832,345		—		832,345		—
Interest payable		276,757		—		276,757		—
Unrecognized financial instruments (net of contract amount)
Commitments to originate loans		—		—		—		—
Letters of credit		—		—		—		—
Lines of credit		—		—		—		—

74

Jacksonville Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2012 and 2011

	December 31, 2011
	Carrying Amount		Fair Value
Financial assets
Cash and cash equivalents	$	11,387,947	$	11,387,947
Interest-earning time deposits in banks		2,476,000		2,476,000
Other investments		116,088		116,088
Loans held for sale		446,818		446,818
Loans, net of allowance for loan losses		170,865,102		169,667,091
Federal Home Loan Bank stock		1,113,800		1,113,800
Interest receivable		2,071,534		2,071,534
Financial liabilities
Deposits		254,240,060		265,515,126
Short-term borrowings		6,517,750		6,517,750
Advances from borrowers for taxes and insurance		740,083		740,083
Interest payable		349,121		349,121
Unrecognized financial instruments (net of contract amount)
Commitments to originate loans		—		—
Letters of credit		—		—
Lines of credit		—		—

The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying condensed consolidated balance sheets at amounts other than fair value.

Cash and Cash Equivalents, Interest-Earning Time Deposits in Banks, Interest Receivable, Federal Home Loan Bank Stock, and Other Investments

The carrying amount approximates fair value.

Loans Held for Sale

For homogeneous categories of loans, such as mortgage loans held for sale, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics.

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Jacksonville Bancorp, Inc.
Notes to Consolidated Financial Statements
December 31, 2012 and 2011

Loans

The fair value of loans is estimated by discounting the future cash flows using the market rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  Loans with similar characteristics were aggregated for purposes of the calculations.

Deposits

Deposits include demand deposits, savings accounts, NOW accounts and certain money market deposits.  The carrying amount approximates fair value.  The fair value of fixed-maturity time deposits is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits of similar remaining maturities.

Short-term Borrowings, Interest Payable, and Advances from Borrowers for Taxes and Insurance

The carrying amount approximates fair value.

Commitments to Originate Loans, Letters of Credit, and Lines of Credit

The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties.  For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.  The fair values of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate or otherwise settle the obligations with the counterparties at the reporting date.

Note 17: Significant Estimates and Concentrations

Accounting principles generally accepted in the United States of America require disclosure of certain significant estimates and current vulnerabilities due to certain concentrations.  Estimates related to the allowance for loan losses are reflected in the note regarding loans.  Current vulnerabilities due to certain concentrations of credit risk are discussed in the note on commitments and credit risk.  Other significant estimates not discussed in those notes include:

General Litigation

The Company is subject to claims and lawsuits that arise primarily in the ordinary course of business.  It is the opinion of management that the disposition or ultimate resolution of such claims and lawsuits will not have a material adverse effect on the consolidated financial position, results of operations and cash flows of the Company.

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Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Current Economic Conditions

The current protracted economic decline continues to present financial institutions with circumstances and challenges, which in some cases have resulted in large and unanticipated declines in the fair values of investments and other assets, constraints on liquidity and capital and significant credit quality problems, including severe volatility in the valuation of real estate and other collateral supporting loans.

At December 31, 2012 and 2011, the Company held $10,982,491 and $9,590,745 in agricultural production loans and $37,392,116 and $29,971,649, respectively in agricultural real estate loans in the Company’s geographic area.  Generally, those loans are collateralized by assets of the borrower.  The loans are expected to be repaid from cash flows or from proceeds of sale of selected assets of the borrowers.  Declines in prices for corn, beans, livestock and farmland could significantly affect the repayment ability for many agricultural loan customers.

At December 31, 2012 and 2011, the Company held $30,973,177 and $40,169,813 in commercial real estate, respectively, including $4,162,724 and $7,919,284 that are outside of the Company’s normal lending area.  Due to national, state and local economic conditions, values for commercial and development real estate have declined significantly, and the market for these properties is depressed.

The accompanying consolidated financial statements have been prepared using values and information currently available to the Company.

Given the volatility of current economic conditions, the values of assets and liabilities recorded in the consolidated financial statements could change rapidly, resulting in material future adjustments in asset values, the allowance for loan losses and capital that could negatively impact the Company’s ability to meet regulatory capital requirements and maintain sufficient liquidity.  Furthermore, the Company’s regulators could require material adjustments to asset values or the allowance for loan losses for regulatory capital purposes that could affect the Company’s measurement of regulatory capital and compliance with the capital adequacy guidelines under the regulatory framework for prompt corrective action.

Goodwill

As discussed in Note 1, the Company annually tests its goodwill for impairment.  At the most recent testing date, the fair value of the banking reporting unit exceeded its carrying value.  Estimated fair value was based principally on forecasts of future income.  Management believes it has applied reasonable judgment in developing its estimates; however, unforeseen negative changes in the national, state or local economic environment may negatively impact those estimates in the near term.

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Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Note 18: Commitments and Credit Risk

The Company grants agribusiness, commercial and residential loans to customers in Cass, Morgan, Macoupin, Montgomery and surrounding counties in Illinois.  The Company’s loans are generally secured by specific items of collateral including real property, consumer assets and business assets.  Although the Company has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent upon economic conditions and the agricultural economy in these counties.  The Company also purchases participation loans from out of territory areas.

Commitments to Originate Loans

Commitments to originate loans are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since a portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  Each customer’s creditworthiness is evaluated on a case-by-case basis.  The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty.  Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate.

At December 31, 2012 and 2011, the Company had outstanding commitments to originate loans aggregating approximately $4,730,883 and $3,815,495, respectively.  The commitments extended over varying periods of time with the majority being disbursed within a one-year period.  Loan commitments at fixed rates of interest amounted to $4,186,883 and $1,352,995 at December 31, 2012 and 2011, respectively, with the remainder at floating market rates.  The range of fixed rates was 3.13% to 6.00% as of December 31, 2012.

Standby Letters of Credit

Standby letters of credit are irrevocable conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  Financial standby letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions.  Performance standby letters of credit are issued to guarantee performance of certain customers under non-financial contractual obligations.  The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loans to customers.  Should the Company be obliged to perform under the standby letters of credit, the Company may seek recourse from the customer for reimbursement of amounts paid.

The Company had total outstanding standby letters of credit amounting to $368,390 and $400,914 at December 31, 2012 and 2011, respectively, with terms of one year or less.  At December 31, 2012 and 2011, the Company’s deferred revenue under standby letters of credit agreements was nominal.

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Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Lines of Credit

Lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Lines of credit generally have fixed expiration dates.  Since a portion of the line may expire without being drawn upon, the total unused lines do not necessarily represent future cash requirements.  Each customer’s creditworthiness is evaluated on a case-by-case basis.  The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty.  Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate.  Management uses the same credit policies in granting lines of credit as it does for on-balance-sheet instruments.

At December 31, 2012, the Company had unused lines of credit to borrowers aggregating approximately $18,402,387 and $11,625,113 for commercial lines and open-ended consumer lines, respectively.  At December 31, 2011, unused lines of credit to borrowers aggregated approximately $24,618,277 for commercial lines and $12,444,370 for open-ended consumer lines.

Note 19: Quarterly Results of Operations (Unaudited)

	Year Ended December 31, 2012
	Three Months Ended
	December 31		September 30		June 30		March 31
Interest income	$	3,089,887	$	3,191,157	$	3,228,298	$	3,281,891
Interest expense		530,349		577,505		587,610		607,536
Net interest income		2,559,538		2,613,652		2,640,688		2,674,355
Provision for loan losses		120,000		120,000		170,000		80,000
Net interest income after provision for loan losses		2,439,538		2,493,652		2,470,688		2,594,355
Noninterest income		1,232,387		1,359,673		1,185,783		1,104,385
Noninterest expense		2,642,551		2,405,602		2,510,695		2,417,102
Income before income taxes		1,029,374		1,447,723		1,145,776		1,281,638
Income tax expense		254,015		417,870		298,713		366,889
Net income	$	775,359	$	1,029,853	$	847,063	$	914,749
Basic earnings per share	$	0.40	$	0.55	$	0.45	$	0.49
Diluted earnings per share	$	0.40	$	0.55	$	0.45	$	0.49

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Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

	Year Ended December 31, 2011
	Three Months Ended
	December 31		September 30		June 30		March 31
Interest income	$	3,305,598	$	3,543,418	$	3,595,496	$	3,422,767
Interest expense		637,803		684,629		752,279		804,717
Net interest income		2,667,795		2,858,789		2,843,217		2,618,050
Provision for loan losses		150,000		150,000		150,000		175,000
Net interest income after provision for loan losses		2,517,795		2,708,789		2,693,217		2,443,050
Noninterest income		1,035,151		1,001,261		974,709		984,762
Noninterest expense		2,496,863		2,492,751		2,394,685		2,429,658
Income before income taxes		1,056,083		1,217,299		1,273,241		998,154
Income tax expense		281,656		345,616		368,407		263,415
Net income	$	774,427	$	871,683	$	904,834	$	734,739
Basic earnings per share	$	0.41	$	0.46	$	0.48	$	0.39
Diluted earnings per share	$	0.41	$	0.46	$	0.48	$	0.39

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Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Note 20: Condensed Financial Information (Parent Company Only)

Presented below is condensed financial information as to financial position, results of operations and cash flows of the Company:

Condensed Balance Sheets

	December 31,
	2012		2011
Assets
Cash and due from banks	$	4,083,024	$	4,334,876
Investment in common stock of subsidiary		39,649,911		36,548,233
Loan receivable from subsidiary		326,564		360,973
Other assets		118,690		100,974
Total assets	$	44,178,189	$	41,345,056
Liabilities
Other liabilities	$	57,860	$	179,633
Stockholders’ Equity		44,120,329		41,165,423
Total liabilities and stockholders’ equity	$	44,178,189	$	41,345,056

81

Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Condensed Statements of Income and Comprehensive Income

	Year Ending December 31,
	2012			2011
Income
Dividends from subsidiary	$	1,000,000		$	300,000
Other income		21,110			26,491
Total income		1,021,110			326,491
Expenses
Other expenses		417,781			263,675
Income Before Income Tax and Equity in Undistributed Income of Subsidiary		603,329			62,816
Income Tax Benefit		(162,099	)		(95,514	)
Income Before Equity in Undistributed Income of Subsidiary		765,428			158,330
Equity in Undistributed Income of Subsidiary		2,801,596			3,127,353
Net Income	$	3,567,024		$	3,285,683
Comprehensive Income	$	3,791,127		$	6,108,975

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Jacksonville Bancorp, Inc.

Notes to Consolidated Financial Statements

December 31, 2012 and 2011

Condensed Statements of Cash Flows

	Year Ending December 31,
	2012			2011
Operating Activities
Net income	$	3,567,024		$	3,285,683
Items not providing cash, net		(2,801,596	)		(3,127,353	)
Change in other assets and liabilities, net		(156,994	)		18,389
Net cash provided by operating activities		608,434			176,719
Investing Activity
Loan payment from subsidiary		34,409			34,360
Net cash provided by investing activities		34,409			34,360
Financing Activities
Dividends paid		(748,896	)		(578,196	)
Stock repurchase		(230,520	)		(138,000	)
Stock-based compensation expense		67,931			—
Exercise of stock options		16,790			34,236
Net cash used in financing activities		(894,695	)		(681,960	)
Net Change in Cash and Cash Equivalents		(251,852	)		(470,881	)
Cash and Cash Equivalents at Beginning of Year		4,334,876			4,805,757
Cash and Cash Equivalents at End of Year	$	4,083,024		$	4,334,876

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Common Stock Information

Our common stock is traded on the Nasdaq Capital Market under the symbol “JXSB”.  As of December 31, 2012, we had approximately 771 stockholders of record, including brokers, who held 1,908,556 shares of our outstanding shares of common stock.

The following table sets forth market price and dividend information for our common stock for the two years in the period ending December 31, 2012.

	Price Per Share				Cash
	High		Low		Dividend Declared
2012
Fourth quarter	$	17.35	$	16.50	$	0.175
Third quarter		17.10		15.55		0.075
Second quarter		17.75		15.09		0.075
First quarter		15.20		13.75		0.075
2011
Fourth quarter	$	14.00	$	13.08	$	0.075
Third quarter		13.93		12.50		0.075
Second quarter		12.75		12.35		0.075
First quarter		12.90		10.78		0.075

For a discussion of the restrictions on the Company’s ability to pay dividends, see Note 11 to the Consolidated Financial Statements.

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Directors and Executive Officers

Directors	Executive Officers
Andrew F. Applebee   Chairman of the Board	Andrew F. Applebee   Chairman of the Board
Richard A. Foss   President and Chief Executive Officer	Richard A. Foss   President and Chief Executive Officer
John C. Williams   Senior Vice President and Trust Officer	John C. Williams   Senior Vice President and Trust Officer
John M. Buchanan   Certified Funeral Service Practitioner   Buchanan & Cody Funeral Home and Crematory, Inc.	John D. Eilering   Vice President – Operations / Corporate Secretary
Peggy S. Davidsmeyer   Administrator   Knollwood Retirement Village	Laura A. Marks   Senior Vice President – Retail Banking
Harmon B. Deal, III   Investment Advisor   L.A. Burton & Associates	Chris A. Royal   Senior Vice President and Chief Lending Officer
John L. Eyth   Certified Public Accountant   Zumbahlen Eyth Surratt Foote & Flynn, Ltd.	Diana S. Tone   Chief Financial Officer
Dean H. Hess   Self-employed farmer

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Corporate Information

Corporate Headquarters	Transfer Agent
1211 West Morton	Hickory Point Bank & Trust, fsb
Jacksonville, Illinois  62650	P.O. Box 2557
(217) 245-4111	Decatur, Illinois  62525-2557
Website:  www.jacksonvillesavings.com	(217) 872-6373
E-mail:  info@jacksonvillesavings.com
Special Counsel	Independent Registered Public Accounting Firm
Luse Gorman Pomerenk & Schick, P.C.	BKD, LLP
5335 Wisconsin Ave., N.W., Suite 780	225 North Water Street, Suite 400
Washington, D.C.  20015	Decatur, Illinois  62525-1580
(202) 274-2000	(217) 429-2411

Annual Meeting

The Annual Meeting of the Stockholders will be held April 23, 2013 at 1:30 p.m., central time, at our main office at 1211 West Morton, Jacksonville, Illinois.

General Inquiries

A copy of our Annual Report to the SEC on Form 10-K may be obtained without charge by written request of stockholders to Diana Tone or by calling us at (217) 245-4111.  The Form 10-K is also available on our website at www.jacksonvillesavings.com.  Our Code of Ethics, Nominating and Corporate Governance Committee Charter, and Beneficial Ownership reports of our directors and executive officers are also available on our website.

FDIC Disclaimer

This Annual Report has not been reviewed or confirmed for accuracy or relevance by the FDIC.

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