SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

ý                                 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2004

 

OR

 

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

 

For transition period from                to               

 

Commission file number 005-57237

 

FIRST OTTAWA BANCSHARES, INC.

(Exact name of Registrant as specified in its charter)

 

Delaware		36-4331185
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
701-705 LaSalle Street Ottawa, Illinois		61350
(Address of principal executive offices)		(ZIP Code)
(815) 434-0044
(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the Registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes o   No ý

 

Indicate by check mark whether the Registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act)

 

Yes o   No ý

 

 

 

FIRST OTTAWA BANCSHARES, INC.

 

Form 10-Q Quarterly Report

 

Table of Contents

 

PART I
Item 1.	Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures about Market Risk
Item 4.	Controls and Procedures
PART II
Item 1.	Legal Proceedings
Item 2.	Changes in Securities, Use of Proceeds and Issue Purchases of Equity Securities
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits and Reports on Form 8-K
Item 7.	Signatures

 

2

 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

		March 31, 2004			December 31, 2003
		(Unaudited)
ASSETS
Cash and due from banks		$	11,814		$	11,477
Federal funds sold		—			6,400
Cash and cash equivalents		11,814			17,877
Certificates of deposit		17,935			13,190
Securities available-for-sale		126,167			113,433
Loans held for sale		1,300			1,644
Loans, less allowance for loan losses of $1,059 and $1,049		126,282			129,255
Premises and equipment, net		7,695			7,537
Interest receivable and other assets		9,986			11,554
Total assets		$	301,179		$	294,490
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Demand – non-interest-bearing		$	28,559		$	29,933
NOW accounts		65,379			64,050
Money market accounts		32,595			28,828
Savings		29,359			27,826
Time, $100,000 and over		28,846			26,425
Other time		81,152			87,859
Total deposits		265,890			264,921
Federal funds purchased		5,900			—
Borrowings		490			490
Interest payable and other liabilities		3,186			4,424
Total liabilities		275,466			269,835
Commitments and contingent liabilities
Shareholders’ equity
Preferred stock - $1 par value, 20,000 shares Authorized; none issued		—			—
Common stock - $1 par value, 1,000,000 shares authorized and 750,000 issued		750			750
Additional paid-in capital		4,010			4,008
Retained earnings		24,467			23,988
Treasury stock, at cost, 98,373 shares		(5,585		)	(5,585		)
Accumulated other comprehensive income		2,071			1,494
Total shareholders’ equity		25,713			24,655
Total liabilities and shareholders’ equity		$	301,179		$	294,490

 

See accompanying notes to condensed consolidated financial statements.

 

3

 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

Three Months ended March 31, 2004 and 2003

(In thousands, except share and per share data)

(Unaudited)

 

		2004			2003
Interest income
Loans		$	2,064		$	1,965
Securities
Taxable		1,003			909
Exempt from federal income tax		183			196
Certificates of deposit		105			105
Federal funds sold		14			—
Total interest income		3,369			3,175
Interest expense
NOW account deposits		103			123
Money market deposit accounts		172			29
Savings deposits		49			62
Time deposits		768			906
Repurchase agreements		—			7
Federal funds purchased		1			57
Borrowings		4			3
Total interest expense		1,097			1,187
NET INTEREST INCOME		2,272			1,988
Provision for loan losses		75			30
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSS		2,197			1,958
Noninterest income
Service charges on deposit accounts		233			189
Trust and farm management fee income		114			114
Gain on loan sales		73			220
Securities gains		111			—
Other income		107			103
Total noninterest income		638			626
Noninterest expense
Salaries and employee benefits		1,184			967
Occupancy and equipment expense		285			226
Data processing expense		86			114
Supplies		41			31
Advertising and promotions		12			17
Professional fees		106			65
Other expenses		500			334
Total noninterest expenses		2,214			1,754
INCOME BEFORE INCOME TAXES		621			830
Provision for income taxes		142			216
NET INCOME		$	479		$	614
Earnings per share – basic and diluted		$	0.74		$	0.94
Average shares outstanding – basic and diluted		651,627			656,956

 

See accompanying notes to condensed consolidated financial statements.

 

4

 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

 

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

Three Months ended March 31, 2004 and 2003

(In thousands, except per share data)

(Unaudited)

 

		Common Stock				Additional Paid-In Capital			Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Total Share- holders’ Equity
Balance at January 1, 2004		$		750		$	4,008		$	23,988		$	(5,585	)	$	1,494		$	24,655
Net income		—				—			479			—			—			479
Unrealized net gain on securities available-for-sale, net of reclassi- fications and tax effects		—				—			—			—			577			577
Comprehensive income		—				—			—			—			—			1,056
Options vested		—				2			—			—			—			2
Balance at March 31, 2004		$	750			$	4,010		$	24,467		$	(5,585	)	$	2,071		$	25,713
Balance at January 1, 2003		$	750			$	4,000		$	23,491		$	(5,270	)	$	2,212		$	25,183
Net income		—				—			614			—			—			614
Unrealized net loss on securities available-for-sale, net of reclassi- fications and tax effects		—				—			—			—			(319		)	(319		)
Comprehensive income		—				—			—			—			—			295
Balance at March 31, 2003		$	750			$	4,000		$	24,105		$	(5,270	)	$	1,898		$	25,478

 

See accompanying notes to condensed consolidated financial statements.

 

5

 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Three Months ended March 31, 2004 and 2003

(In thousands)

(Unaudited)

 

		2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$	479		$	614
Adjustments to reconcile net income to net cash from operating activities
Change in deferred loan fees		—			(2		)
Provision for loan losses		75			30
Depreciation and amortization		211			55
Premium amortization on securities, net		124			46
Derivative valuation adjustment		79			—
Net change in loans held for sale		417			(77		)
Gain on loan sales		(73		)	(220		)
Gain on sales of securities		(111		)	—
Loss on sale of other real estate owned		—			13
Change in interest receivable and other assets		1,530			(116		)
Change in interest payable and other liabilities		(230		)	(72		)
Net cash from operating activities		2,501			271
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of securities available-for-sale		3,763			—
Proceeds from maturities and calls of securities		7,711			4,862
Purchases of securities available-for-sale		(23,347		)	—
Proceeds from maturities of certificates of deposit		—			99
Purchases of certificates of deposit		(4,824		)	(200		)
Net change in loans receivable		2,832			(2,036		)
Proceeds from sale of other real estate owned		—			166
Property and equipment expenditures		(265		)	(353		)
Net cash from investing activities		(14,130		)	2,538
CASH FLOWS FROM FINANCING ACTIVITIES
Change in deposits		969			(5,239		)
Change in federal funds purchased		5,900			4,200
Change in securities sold under agreements to repurchase		—			(551		)
Change in borrowings		—			(475		)
Vested stock options		2			—
Dividends paid		(1,305		)	(1,316		)
Net cash used in financing activities		5,566			(3,381		)
Change in cash and cash equivalents		(6,063		)	(572		)
Cash and cash equivalents at beginning of period		17,877			8,606
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	11,814		$	8,034

 

See accompanying notes to condensed consolidated financial statements.

 

6

 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINACIAL STATEMENTS

(Table dollars in thousands)

March 31, 2004 and 2003

 

NOTE 1 – BASIS OF PRESENTATION

 

The accounting policies followed in the preparation of the interim condensed consolidated financial statements are consistent with those used in the preparation of annual consolidated financial statements.  The interim condensed consolidated financial statements reflect all normal and recurring adjustments, which are necessary, in the opinion of management, for a fair statement of results for the interim periods presented.  Results for the three months ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ended December 31, 2004.

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for the interim financial period and with the instructions to Form 10-Q.  Accordingly, they do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements.  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in First Ottawa Bancshares, Inc.’s (the Company) annual report on Form 10-K for 2003 filed with the U.S. Securities and Exchange Commission.  The condensed consolidated balance sheet of the Company as of December 31, 2003 has been derived from the audited consolidated balance sheet as of that date.

 

The Company’s wholly-owned subsidiary, First Ottawa Financial Corporation, sells insurance and investment products.

 

NOTE 2 – EARNINGS PER SHARE

 

The number of shares used to compute basic and diluted earnings per share were as follows:

 

		Three Months Ended March 31,
		2004			2003
Net income (in thousands)		$	479		$	614
Weighted Average Shares outstanding		651,627			656,956
Effect of dilutive securities:
Stock options		—			—
Shares used to compute diluted earnings per share		651,627			656,956

 

7

 

Earnings per share:
Basic		$	0.74		$	0.94
Diluted		0.74			0.94

 

Options to purchase 6,750 shares at March 31, 2004 were not included in the earnings per share calculation as they were anti-dilutive.

 

NOTE 3 – CAPITAL RATIOS

 

At the dates indicated, the Company’s capital ratios were:

 

		March 31, 2004					December 31, 2003
		Amount			Ratio		Amount			Ratio
Total capital (to risk-weighted  assets)		$	20,194		12.0	%	$	19,661		11.9	%
Tier I capital (to risk-weighted assets)		19,135			11.4	%	18,612			11.3	%
Tier I capital (to average assets)		19,135			6.6	%	18,612			7.2	%

 

At the dates indicated, the Company and the Bank were categorized as well capitalized and management is not aware of any conditions or events since the most recent notification that would change the Company’s or Bank’s categories.

 

NOTE 4 - DERIVATIVES

 

The Company uses derivatives to fix future cash flows for interest payments on some of its floating rate certificates of deposit.  In this regard, the Company has entered into an interest rate swap with the Federal Home Loan Bank of Chicago to fix the interest rate on a specific certificate of deposit product.  At March 31, 2004, the Company had $2.6 million of certificates of deposit, which mature in 2006, 2007, 2008, and 2009 in which it pays the Federal Home Loan Bank a weighted average interest rate of 2.92% and will receive an interest rate from the Federal Home Loan Bank based on the appreciation of the S&P 500 Index.  This interest received from the Federal Home Loan Bank will be paid to the customer.  The assets and liabilities in this transaction are being netted and the expense recorded in other expense.

 

In addition to the above, the Company also purchased $6.3 million of certificates of deposit, which are included in the certificates of deposit caption on the consolidated balance sheet.  These investments mature throughout 2006, 2007, 2008, and 2009.  The investments that individually do not exceed $100,000 are secured by the FDIC.  Investments that do individually exceed $100,000 are guaranteed by a standby letter of credit issued by the Federal Home Loan

 

8

 

Bank of Pittsburgh with an interest rate of 0%.  The initial investment is not at risk, but the return on the investment is based on a calculation of the appreciation in the S&P 500 Index.  The fair value of this embedded derivative is recorded in investment certificates of deposit and the fair value adjustment is included in other income.  At March 31, 2004, the  Bank had allocated $498,000 to this asset, and recorded a valuation expense of $79,000 for the current year.

 

9

 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis is intended as a review of significant factors affecting the financial condition and results of operations of the Company for the periods indicated.  The discussion should be read in conjunction with the Condensed Consolidated Financial Statements and Notes.  In addition to historical information, the following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties.  The Company’s actual results could differ significantly from those anticipated in these forward-looking statements as a result of certain factors discussed elsewhere in this report.

 

Overview

 

First Ottawa Bancshares, Inc. is the holding company for First National Bank of Ottawa. The Company is headquartered in Ottawa, Illinois and operates four offices in Ottawa, a new branch in Morris and purchased two branches in Streator during the fourth quarter of 2003. The Company has purchased real estate in Yorkville, Illinois with the intention of establishing a full service branch facility in that community in early 2005.  The Company continues to explore expansion opportunities within its existing market area and in surrounding areas.

 

The Company’s principal business is conducted by the Bank and consists of a full range of community-based financial services, including commercial and retail banking.  The profitability of the Company’s operations depends primarily on its net interest income, provision for loan losses, other income, and other expenses.  Net interest income is the difference between the income the Company receives on its loan and securities portfolios and its cost of funds, which consists of interest paid on deposits and borrowings.  The provision for loan losses reflects the cost of credit risk in the Company’s loan portfolio.  Other income consists of service charges on deposit accounts, trust and farm management fee income, securities gains (losses), gains (losses) on sales of loans, and other income.  Other expenses include salaries and employee benefits, as well as occupancy and equipment expenses and other noninterest expenses.

 

Net interest income is dependent on the amounts and yields of interest-earning assets as compared to the amounts of and rates on interest-bearing liabilities.  Net interest income is sensitive to changes in market rates of interest and the Company’s asset/liability management procedures in coping with such changes.  The provision for loan losses is dependent upon management’s assessment of the collectibility of the loan portfolio under current economic conditions.

 

The Company’s net income for the three months ended March 31, 2004, was $479,000, or $.74 per common share, compared to net income of $614,000, or $.94 per common share for the three months ended March 31, 2003.  The decrease in net income was due primarily to increases in noninterest expenses related to the opening of an additional branch in Morris and the acquisition of two branches in Streator after March 31, 2003.

 

10

 

CRITICAL ACCOUNTING POLICIES

 

The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry.  The Company’s significant accounting policies are described in detail in the notes to the Company’s consolidated financial statements for the year ended December 31, 2003. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective, or complex.

 

Allowance for Credit Losses- The allowance for credit losses provides coverage for probable losses inherent in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for credit losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer-specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management’s estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic and political conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge-offs.

 

The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for homogeneous consumer loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences, and historical losses, adjusted for current trends, for each homogeneous category or group of loans. The allowance for credit losses relating to impaired loans is based on the loan’s observable market price, the collateral for certain collateral-dependent loans, or the discounted cash flows using the loan’s effective interest rate.

 

Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures.  The estimates are based upon the Company’s evaluation of imprecision risk

 

11

 

associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment.

 

Mortgage Servicing Rights- Mortgage servicing rights (“MSRs”) associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. For purposes of measuring impairment, the servicing rights are compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates. Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets.

 

Derivatives- As a part of the Company’s funding strategy, derivative financial instruments, all of which are interest rate swap arrangements, are used to reduce exposure to changes in interest rates for certain financial instruments.  These derivatives are accounted for by recognizing the fair value of the contracts on the balance sheet.  The valuation of these derivatives is considered critical because carrying assets and liabilities at fair value inherently results in more financial statement volatility.  The fair values and the information used to record valuation adjustments for the interest rate swaps and related deposit products are provided by third parties.

 

Additionally, the Company has purchased certificate of deposits which contain an equity related embedded derivative component.  The initial investment in the certificate of deposit is not at risk but the return on the investment is based on appreciation in the S&P 500 Index.  Accordingly, the fair value of the embedded derivative is recorded at fair value as an adjustment to the certificate of deposit and other income.

 

12

 

CONSOLIDATED FINANCIAL CONDITION

 

Total assets at March 31, 2004 were $301.2 million contrasted to $294.5 million at December 31, 2003, an increase of $6.7 million, or 2.2%.  This increase in total assets was the result of an increase in securities available for sale and certificates of deposits at other financial institutions and modest increases in bank premises and equipment. These increases were partially offset by decreases in federal funds sold, loans, loans held for sale and other assets. The $12.7 million increase in securities and the $4.7 million increase in certificates of deposits at other financial institutions was funded by a decrease in federal funds sold of $6.4 million, decreases in loans and loans held for sale of $3.3 million, and an increase in federal funds purchased of $5.9 million.  Premises and equipment increased by $158,000 due to capital expenditures on existing buildings and capitalization of expenses associated with the conversion to a new core data processor. The Company has purchased real estate in Yorkville, Illinois and is in the process of establishing a full service branch facility in that community.  Construction of the facility is to begin in late 2004 and the branch is expected to open in early 2005.  The Bank anticipates additional 2004 capital expenditures of approximately $700,000 to complete this branch facility.

 

Total liabilities at March 31, 2004 were $275.5 million compared to $269.8 million at December 31, 2003, an increase of $5.7 million, or 2.1%. This increase in total liabilities was a result of increases in deposits of $970,000, and a $5.9 million increase in federal funds purchased. Other liabilities decreased by $1.2 million due to the payment of declared dividends in the first quarter.

 

Total equity was $25.7 million at March 31, 2004 compared to $24.6 million at December 31, 2003.  This increase was the result of $479,000 of additional retained earnings from net income for the quarter ended March 31, 2004 and an increase of $577,000, net of tax, in the Company’s investment portfolio.

 

CONSOLIDATED RESULTS OF OPERATIONS

 

Net income for the first quarter of 2004 was $479,000, or $.74 per share, a 21.9% decrease compared to $614,000, or $.94 per share, in the first quarter of 2003.  The decrease in net income for the quarter was primarily the result of an increase in non interest expense of $460,000, and an increase in the provision for loan loss. These changes were partially offset by an increase in net interest income of $284,000, and a $74,000 decrease in the provision for income taxes.

 

The annualized return on average assets was .65% in the first quarter of 2004 compared to 1.04% in the first quarter of 2003.   The annualized return on average equity decreased to 8.19% in the first quarter of 2004 from 10.58% in the first quarter of 2003.

 

NET INTEREST INCOME

 

Net interest income was $2.2 million and $2.0 million for the three months ended March 31, 2004 and 2003.  Total interest income increased to $3.4 million for the three months ended March 31, 2004 from $3.2 million in 2003.  This increase was primarily the result of modest

 

13

 

increases in interest income from loans to $ 2.1 million and securities to $1.2 million for the three months ended March 31, 2004, from $ 2.0 million on loans and $1.1 million on securities for the same period a year earlier. Increases in interest income are attributable to increases in principal balances as yields on earning assets fell compared to the prior year. Similarly, a decline in interest expense to $1.1 million for the three months ended March 31, 2004 from $1.2 million in 2003 occurred as a result of declining interest rates on deposits.

 

The Company’s net interest margin was 3.42% for the three months ended March 31, 2004 and 3.71% a year earlier.  The yield on average earning assets decreased to 5.10% for the three months ended March 31, 2004 from 5.87% for the same period ended March 31, 2003, a 77 basis point decline.  This decrease was offset by a corresponding decrease in the cost of funds to 1.89% from 2.52% paid for the same period ended March 31, 2003, a 63 basis point decline. These decreases were reflective of the low rate environment throughout 2003, with the low rates continuing into 2004.

 

PROVISION FOR LOAN LOSSES

 

The provision for loan losses was $75,000 in the first quarter of 2004 compared to $30,000 for the same period in 2003. As of March 31, 2004, the allowance for loan losses totaled $1.1 million, or .83% of total loans, which is a slight increase from .80% as of December 31, 2003.  Nonaccrual loans increased modestly from $137,000 at December 31, 2003 to $153,000 at March 31, 2004. Nonperforming loans, including nonaccrual loans, increased $702,000 to $1.1 million over the same period due primarily to one large commercial credit which is in process of foreclosure. Management feels that the bank is well collateralized and expects no loss on the credit.

 

The amounts of the provision and allowance for loan losses are influenced by a number of factors, including 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. Along with other financial institutions, management shares a concern for the possible continued weak economy for the remainder of 2004. Even though there have been various signs of emerging strength in the economy, it is not certain that this strength will be sustainable. Should the economic climate continue to deteriorate, borrowers may experience difficulty, and the level of non-performing loans, charge- offs, and delinquencies could rise and require increases in the provision. The allowance for loan losses represents management’s estimate of probable incurred losses based on information available as of the date of the financial statements.  The allowance for loan losses is based on management’s evaluation of the collectibility of the loan portfolio, including past loan loss experience, known and inherent risks in the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, and economic conditions.

 

Management has concluded that the allowance for loan losses is adequate at March  31, 2004.  However, there can be no assurance that the allowance for loan losses will be adequate to cover all losses.

 

14

 

NONINTEREST INCOME

 

The Company’s noninterest income totaled $638,000 for the three months ended March 31, 2004 compared to $626,000 for the same period in 2003, an increase of $12,000 or 1.9%. The increase in non-interest income was primarily due to security gains of $111,000 and an increase in deposit service charges of $44,000.  These increases were mitigated by gains on loan sales to the secondary market which decreased $191,000 to $73,000 in 2004 compared to 2003. This decrease was due primarily to decreased mortgage refinance demand compared to prior year. Trust and farm management fee income remained constant at $114,000 in 2004 compared to the same period in 2003.  Other income increased $44,000 to $107,000.

 

NONINTEREST EXPENSE

 

The Company’s noninterest expense was $2.2 and $1.8 million for the three months ended March 31, 2004 and 2003.  Salaries and benefits, the largest component of noninterest expense, increased $217,000, or 22.4%, to $1.2 million.  Increases in occupancy and equipment expense of $59,000, professional fees of $41,000, supplies expense of $10,000, and other expenses of $166,000 were offset to some extent by decreases in data processing expense of $28,000, and advertising expense of $5,000. The increase in salaries, supplies and occupancy and equipment expenses was due primarily to increased personnel, supplies and depreciation on capital expenditures related to additional facilities in Morris and Streator which were opened after March 31, 2003. The increase in professional fees was a result of anticipated increases in general legal expenses and audit expenses for the additional facilities, as well as an increase in one time consulting fees related to strategic planning and the Streator acquisition paid in 2004.  Increases in other expenses resulted from increased insurance and other costs related to the operation of additional facilities. In addition, amortization expense of $100,000 related to the core deposit intangible resulting from the purchase of the Streator branches was recorded in the first quarter of 2004.

 

LIQUIDITY AND CAPITAL RESOURCES

 

The Company’s primary sources of funds are deposits, repurchase agreements, and proceeds from principal and interest payments on loans and securities.  While maturities and scheduled amortization of loans and securities and calls of 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.

 

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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 March 31, 2004, cash and short-term investments totaled $35.4 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 borrowings from the Federal Home Loan Bank of Chicago and Bank One.

 

The following table discloses contractual obligations and commercial commitments of the Company as of March 31, 2004:

 

		Total				Less Than 1 Year			1 – 3 Years			4 – 5 Years			After 5 Years
Federal funds purchased		$	5,900			$	5,900		$	—		$	—		$	—
Data processing contract payable		1,043				145			387			511			—
Note payable		490				490			—			—			—
Lines of credit(1)		18,266				12,675			3,557			1,260			774
Standby letters of credit(1)		240				240			—			—			—
		$		25,939		$	19,450		$	3,944		$	1,771		$	774

 

(1)  Represents amounts committed to customers.

 

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.

 

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SAFE HARBOR STATEMENT

 

This document (including information incorporated by reference) contains, and future oral and written statements of the Company and its management may contain, forward-looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company.  Forward-looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions.  Additionally, all statements in this document, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.

 

The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain.  Factors which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, the following:

 

•                                          The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company’s assets.

 

•                                          The economic impact of past and any future terrorist attacks, acts of war or threats thereof and the response of the United States to any such threats and attacks.

 

•                                          The effects of, and changes in, federal, state and local laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters.

 

•                                          The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company’s assets) and the policies of the Board of Governors of the Federal Reserve System.

 

•                                          The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector.

 

•                                          The inability of the Company to obtain new customers and to retain existing customers.

 

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•                                          The timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet.

 

•                                          Technological changes implemented by the Company and by other parties, including third party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to the Company and its customers.

 

•                                          The ability of the Company to develop and maintain secure and reliable electronic systems.

 

•                                          The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner.

 

•                                          Consumer spending and saving habits which may change in a manner that affects the Company’s business adversely.

 

•                                          Business combinations and the integration of acquired businesses which may be more difficult or expensive than expected.

 

•                                          The costs, effects and outcomes of existing or future litigation.

 

•                                          Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board.

 

•                                          The ability of the Company to manage the risks associated with the foregoing as well as anticipated.

 

These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.  Additional information concerning the Company and its business, including other factors that could materially affect the Company’s financial results, is included in the Company’s filings with the Securities and Exchange Commission.

 

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

QUANITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

ITEM 3:   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company’s overall interest rate sensitivity is demonstrated by net income analysis and “Gap” analysis.  Net income analysis measures the change in net income in the event of hypothetical changes in interest rates.  This analysis assesses the risk of change in net income in the event of sudden and sustained 2.0% increases and decreases in market interest rates.  The tables below present the Company’s projected changes in annualized net income for the various rate shock levels at March 31, 2004 and March 31, 2003.

 

			2004 Net Income
			Amount			Change			Change
			(Dollars in Thousands)
+200 bp			$	1,897		$	(202	)	(9.6	)%
Base			2,099			—			—
–200 bp			2,185			86			4.1	%

 

			2003 Net Income
			Amount			Change			Change
			(Dollars in Thousands)
+200 bp			$	2,243		$	(138	)	(5.8	)%
Base			2,381			—			—
–200 bp			2,195			(186		)	(7.8	)%

 

As shown above, at March 31, 2004, the effect of an immediate 200 basis point increase in interest rates would decrease the Company’s net income by 9.6% or approximately $202,000.  The effect of an immediate 200 basis point decrease in rates would increase the Company’s net interest income by 4.1% or approximately $86,000. However, the Company does not anticipate market interest rates decreasing an additional 200 basis points, so these results may not be achievable.  Net income sensitivity has increased since March 31, 2003.

 

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ITEM 4:   CONTROLS AND PROCEDURES

 

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of March 31, 2004. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls.

 

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PART II

 

ITEM 1.		LEGAL PROCEEDINGS
		There are no material pending legal proceedings to which the Company or its subsidiaries are a party other than ordinary routine litigation incidental to their respective businesses.
ITEM 2.		CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES
		None
ITEM 3.		DEFAULTS UPON SENIOR SECURITIES
		None
ITEM 4.		SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
		None
ITEM 5.		OTHER INFORMATION
		None
ITEM 6.		EXHIBITS AND REPORTS ON FORM 8-K
		Exhibits
		31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)
		31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)
		32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
		32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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		Reports on Form 8-K
		A report on Form 8-K was filed on April 13, 2004 , as an Amendment to the Form 8-K filed with the Securities and Exchange Commission on November 19, 2003, to disclose that the Company will not file financial statements pursuant to Item 7(a) of Form 8-K or pro forma financial information pursuant to Item 7(b) of Form 8-K for the previously announced branch acquisitions in Streator, Illinois.
		A report on Form 8-K was filed on April 23, 2004 pursuant to Item 12, which reported, in the form of a press release, the Corporation’s financial results for the quarter ended March 31, 2004.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

	FIRST OTTAWA BANCSHARES, INC.
	(Registrant)
	/s/ Joachim J. Brown
	Joachim J. Brown
	President (Principal Executive Officer)
	/s/ Vincent G. Easi
	Vincent G. Easi
	Chief Financial Officer
	(Principal Financial Officer)

 

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