FIRST OTTAWA BANCSHARES, INC - Quarter Report: 2001 June (Form 10-Q)

NET INTEREST INCOME
Net interest income was $1,807,000 and $1,909,000 during the three months ended June 30, 2001 and 2000.  Total interest income declined to $3,785,000 for the three months ended June 30, 2001 from $3,995,000 for the same period ended June 30, 2000.  This decrease was primarily the result of a decrease in interest income from loans to $2,405,000 for the three months ended June 30, 2001 from $2,623,000 for the same period a year earlier, an 8.3% decrease.   This decrease was partially mitigated by a similar decline in interest expense, $1,978,000 for the three months ended June 30, 2001 from $2,086,000 for the same period ended June 30, 2000, a 5.2% decrease.

Net interest income for the six months ended June 30, 2001 and 2000 was $3,583,000 and $3,874,000, respectively.  The Company’s net interest margin was 3.86% for the six months ended June 30, 2001 and 3.99% a year earlier.  The yield on average earning assets decreased to 7.74% for the six months ended June 30, 2001 from 7.80% for the same period ended June 30, 2000, a .06% decline.  This decrease was offset by a corresponding decrease in the interest paid as a ratio of average earning assets to 3.86% from 3.99% for the six months ended June 30, 2000, a .13% decrease.

PROVISION FOR LOAN LOSSES
The provision for loan losses remained unchanged at $90,000 in the second quarter of 2001 and 2000.  As of June 30, 2001, the allowance for loan losses totaled $1.2 million, or 1.06% of total loans which is an increase from .95% as of December 31, 2000.  Nonaccrual loans increased from $467,000 at December 31, 2000 to $801,000 at June 30, 2001.  Nonperforming loans, including nonaccrual loans, also increased $406,000 to $3,050,000 over the same period.  The amounts of the provision and allowance for loan losses are influenced by current economic conditions, actual loss experience, industry trends and other factors, including real estate values in the Company’s market area and management’s assessment of current collection risks within the loan portfolio.

NONINTEREST INCOME
The Company’s non-interest income totaled $519,000 for the three months ended June 30, 2001 compared to $417,000 for the same period in 2000, an increase of $102,000.  Service charges on deposit accounts increased $46,000, or 25.6%, to $226,000. Trust and farm management fee income increased $18,000 due to modest growth in trust relationships and estates under administration.  Other fees and commissions increased $24,000 to $175,000 largely due to an increase in mortgage banking income.

For the six months ended June 30, 2001, non-interest income increased $214,000 to $985,000.  Service charges on deposit accounts increased $77,000, or 22.1%, trust and farm management fee increased $36,000, or 20%, and other fees and commissions increased $87,000 for the reasons previously discussed.

NONINTEREST EXPENSE
The Company’s non-interest expenses increased to $1,737,000 for the three months ended June 30, 2001 from $1,643,000 for the same period in 2000.  Salaries and benefits increased $66,000, or 7.3%, to $970,000.  Increases in occupancy and equipment expense of $13,000, supplies expense of $9,000, data processing expense of $4,000, and $44,000 in professional fees were offset to some extent by declines in advertising and promotional expense of $17,000 and other expenses of $25,000.

For the six months ended June 30, 2001, non-interest expenses increased $155,000 to $3,379,000, or 4.8%, compared to the year earlier period.  Salaries and benefits increased $127,000, or 7.3%, to $1,866,000.  Occupancy and equipment expense, supplies expense, data processing, advertising and promotion expense, and other expense declined $14,000 in total due to a disciplined approach to cost controls.   Professional fees increased by $43,000.  The increase in professional fees is primarily due to more extensive outsourcing of formerly in-house functions. LIQUIDITY AND CAPITAL RESOURCES
The Company’s primary sources of funds are deposits and proceeds from principal and interest payments on loans and securities.  While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions, and competition.  The Company generally manages the pricing of its deposits to be competitive and to increase core deposit relationships.

Liquidity management is both a daily and long-term responsibility of management.  The Company adjusts its investments in liquid assets based upon management’s assessment of (i) expected loan demand, (ii) expected deposit flows, (iii) yields available on interest-earning deposits and securities, and (iv) the objectives of its asset/liability management program.  Excess liquid assets are invested generally in interest-earning overnight deposits and short- and intermediate-term U.S. government and agency obligations.

The Company’s most liquid assets are cash and short-term investments.  The levels of these assets are dependent on the Company’s operating, financing, lending, and investing activities during any given year.  At June 30, 2001, cash and short-term investments totaled $6.2 million.  The Company has other sources of liquidity if a need for additional funds arises, including securities maturing within one year and the repayment of loans.  The Company may also utilize the sale of securities available-for-sale, federal funds lines of credit from correspondent banks and advances from the Federal Home Loan Bank.

IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation.  The primary impact of inflation on the operations of the Company is reflected in increased operating costs.  Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature.  As a result, interest rates, generally, have a more significant impact on a financial institution’s performance than does inflation.  Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.