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 September 30, 2005

 

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		(I.R.S. Employer Identification No.)
of incorporation or organization)
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  ý  No  o

 

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

 

Indicate by check mark whether the Registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act)

                                                                                                                                                                                Yes  o  No  ý

 

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock as of the latest practicable date:  As of November 9, 2005, the Registrant had outstanding 649,349 shares of common stock, $1.00 par value per share.

 

 

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.	Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits
Item 7.	Signatures

 

2

 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

		(Unaudited)
		September 30,			December 31,
		2005			2004
ASSETS
Cash and cash equivalents		$	7,058		$	7,930
Federal funds sold		8,800			—
Cash and cash equivalents		15,858			7,930
Certificates of deposit		14,547			24,647
Securities available-for-sale		98,817			104,652
Loans held for sale		—			1,701
Loans, less allowance for loan losses of $1,336 and $1,174		146,216			131,618
Bank premises and equipment, net		8,089			7,624
Interest receivable and other assets		10,326			10,487
Total assets		$	293,853		$	288,659
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Demand – non-interest-bearing		$	30,519		$	31,582
NOW accounts		69,486			61,613
Money market accounts		30,508			38,252
Savings		24,964			28,235
Time, $100,000 and over		43,727			22,462
Other time		68,845			71,820
Total deposits		268,049			253,964
Federal funds purchased		—			5,600
Securities sold under agreements to repurchase		—			750
Borrowings		27			559
Interest payable and other liabilities		1,977			3,934
Total liabilities		270,053			264,807
Commitments and contingent liabiliies
Shareholders’ equity
Preferred stock - $1 par value, 20,000 shares authorized; none issued		—			—
Common stock - $1 par value, 750,000 shares authorized and issued		750			750
Additional paid-in capital		4,033			4,018
Retained earnings		25,738			24,662
Treasury stock, at cost, 100,651 and 99,391 shares		(5,745		)	(5,656		)
Accumulated other comprehensive income (loss)		(976		)	78
Total shareholders’ equity		23,800			23,852
Total liabilities and shareholders’ equity		$	293,853		$	288,659

 

See accompanying notes to condensed consolidated financial statements.

 

3

 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except share and per share data)

(Unaudited)

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2005			2004			2005			2004
Interest income
Loans (including fee income)		$	2,440		$	2,092		$	6,857		$	6,201
Securities
Taxable		656			875			2,066			2,818
Exempt from federal income tax		265			263			753			695
Certificates of deposit		133			155			450			387
Federal funds sold		141			13			162			39
Total interest income		3,635			3,398			10,288			10,140
Interest expense
NOW account deposits		172			101			454			301
Money market deposit accounts		200			247			537			624
Savings deposits		34			41			108			134
Time deposits		818			637			2,195			2,098
Repurchase agreements		—			—			4			—
Borrowings		—			4			7			9
Federal funds purchased		—			5			33			7
Total interest expense		1,224			1,035			3,338			3,173
NET INTEREST INCOME		2,411			2,363			6,950			6,967
Provision for loan losses		75			75			225			225
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		2,336			2,288			6,725			6,742
Noninterest income
Service charges on deposit accounts		278			290			835			798
Trust and farm management fee income		114			114			342			342
Gain on loan sales		13			98			69			303
Securities gains, net		—			159			54			342
Other income		302			61			610			357
Total noninterest income		707			722			1,910			2,142
Noninterest expenses
Salaries and employee benefits		1,161			1,140			3,484			3,507
Occupancy and equipment expense		326			311			961			895
Data processing expense		95			76			274			259
Supplies		67			34			157			120
Amortization of core deposit intangible		80			100			239			299
Professional fees		119			102			338			342
Other expenses		312			368			912			1,207
Total noninterest expenses		2,160			2,131			6,365			6,629
INCOME BEFORE INCOME TAXES		883			879			2,270			2,255
Provision for income taxes		223			202			544			521
NET INCOME		$	660		$	677		$	1,726		$	1,734
Dividends per share		$	1.00		$	1.00		$	1.00		$	1.00

 

See accompanying notes to condensed consolidated financial statements.

 

4

 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

Nine Months ended September 30, 2005 and 2004

(In thousands, except per share data)

(Unaudited)

 

														Accumulated
					Additional									Other			Total
		Common			Paid-In			Retained			Treasury			Comprehensive			Shareholders’
		Stock			Capital			Earnings			Stock			Income (Loss)			Equity
Balance at January 1, 2005		$	750		$	4,018		$	24,662		$	(5,656	)	$	78		$	23,852
Net income		—			—			1,726			—			—			1,726
Unrealized net gain on securities available-for-sale, net of reclassifications and tax effects		—			—			—			—			(1,054		)	(1,054		)
Comprehensive income																	672
Cash dividends declared ($1 per share)		—			—			(650		)	—			—			(650		)
Vested options		—			15			—			—			—			15
Purchased 1,260 treasury shares		—			—			—			(89		)	—			(89		)
Balance at September 30, 2005		$	750		$	4,033		$	25,738		$	(5,745	)	$	(976	)	$	23,800
Balance at January 1, 2004		$	750		$	4,008		$	23,988		$	(5,585	)	$	1,494		$	25,183
Net income		—			—			1,734			—			—			1,734
Unrealized net gain on securities available-for-sale, net of reclassifications and tax effects		—			—			—			—			(888		)	(888		)
Comprehensive income																	846
Cash dividends declared ($1 per share)		—			—			(651		)	—			—			(651		)
Vested options		—			6			—			—			—			6
Balance at September 30, 2004		$	750		$	4,014		$	25,071		$	(5,585	)	$	606		$	24,856

 

See accompanying notes to condensed consolidated financial statements.

 

5

 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months ended September 30, 2005 and 2004

(In thousands)

(Unaudited)

 

		2005			2004
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$	1,726		$	1,734
Adjustments to reconcile net income to net cash from operating activities
Change in deferred loan fees		—			(16		)
Provision for loan losses		225			225
Depreciation and amortization		583			588
Premium amortization on securities, net		320			385
Derivative valuation adjustment		(162		)	(9		)
Net real estate loans originated for sale		496			266
Gain on loan sales		(69		)	(303		)
Gain on sale/call of securities available-for-sale		(54		)	(342		)
(Gain) /Loss on sale of other real estate owned		(14		)	(23		)
Change in interest receivable and other assets		25			598
Change in interest payable and other liabilities		(111		)	255
Net cash from operating activities		2,965			3,358
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of securities available-for-sale		5,083			11,256
Proceeds from maturities of securities		3,618			17,689
Purchases of securities available-for-sale		(4,729		)	(32,247		)
Proceeds from maturities of certificates of deposit		13,522			2,589
Purchases of certificates of deposit		(3,260		)	(14,322		)
Net change in loans receivable		(14,017		)	(944		)
Proceeds from sale of other real estate owned		394			89
Property and equipment expenditures		(824		)	(448		)
Net cash from investing activities		(213		)	(16,338		)
CASH FLOWS FROM FINANCING ACTIVITIES
Change in deposits		14,085			2,207
Change in federal funds purchased		(5,600		)	4,500
Change in other borrowings		(532		)	(1		)
Change in securities sold under agreements to repurchase		(750		)	—
Vested stock options		15			6
Purchase of treasury shares		(89		)	—
Dividends paid		(1,953		)	(1,956		)
Net cash from financing activities		5,176			4,756
Change in cash and cash equivalents		7,928			(8,224		)
Cash and cash equivalents at beginning of period		7,930			17,877
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	15,858		$	9,653

 

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)

September 30, 2005 and 2004

 

NOTE 1 – BASIS OF PRESENTATION

 

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, two branches in Streator, a branch in Morris and a recently opened branch in Yorkville.

 

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 and nine months ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ended December 31, 2005.

 

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 the Company’s annual report on Form 10-K for 2004 filed with the U.S. Securities and Exchange Commission.  The condensed consolidated balance sheet of the Company as of December 31, 2004 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						Nine Months Ended
		September 30,						September 30,
		2005			2004			2005			2004
Net income (in thousands)		$	660		$	677		$	1,726		$	1,734
Weighted Average Shares outstanding		649,599			651,627			649,992			651,627
Effect of dilutive securities:
Stock options		2,107			—			2,107			—
Shares used to compute diluted earnings per share		651,706			651,627			652,099			651,627
Earnings per share:
Basic		$	1.02		$	1.04		$	2.66		$	2.66
Diluted		1.01			1.04			2.65			2.66

 

7

 

NOTE 3 – CAPITAL RATIOS

 

At the end of the period, the Company’s and Bank’s capital ratios were materially the same and were:

 

 

At September 30, 2005, 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.

 

8

 

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 September 30, 2005, the Company had $2.8 million of certificates of deposit, which mature in 2006 through 2010, in which it pays the Federal Home Loan Bank a weighted average interest rate of 3.64% 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 interest expense on deposits.

 

In addition to the above, the Company also purchased $7.7 million of certificates of deposit, which are included in the certificates of deposit caption on the consolidated balance sheet.  These investments mature in 2006 through 2010.  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 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 September 30, 2005, the Bank had allocated $1.0 million to this asset and recorded a valuation expense of $28,000 for the current year.

 

9

 

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, two branches in Streator, a branch in Morris and a recently opened branch in Yorkville.

 

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 non-interest 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 September 30, 2005, of $660,000, or $1.02 basic earnings per common share, decreased compared to net income of $677,000, or $1.04 basic earnings per common share, for the three months ended September 30, 2004.

 

The Company’s net income for the nine months ended September 30, 2005 and 2004, was $1.7 million, or $2.66 per basic common share.

 

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, 2004. 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

 

11

 

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 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.

 

Stock Compensation- Grants under the Company’s stock incentive plan are accounted for under the provisions of Statement of Financial Accounting Standards (SFAS) No. 123, as revised, applying the fair value method and the use of an option pricing model to estimate the value of the options granted. The stock options are granted with an exercise price equal to the market price at the date of grant. Resulting compensation expense under the stock options is measured and recorded based on the estimated value of the options.

 

12

 

CONSOLIDATED FINANCIAL CONDITION

 

Total assets at September 30, 2005 were $293.9 million contrasted to $288.7 million at December 31, 2004, an increase of $5.2 million, or 1.8%.  This increase was the result of an increase in cash and cash equivalents, loans, and premises and equipment. These increases were partially offset by decreases in certificates of deposits at other financial institutions, loans held for sale and securities available for sale. Proceeds from maturing certificates of deposits at other financial institutions and available for sale securities were used to fund loan growth of $14.6 million. Cash and cash equivalents increased as a result of an $8.8 million increase in federal funds sold. This increase was funded through deposit growth. Bank premises and equipment increased due to the construction and opening of a full service Yorkville branch during 2005. Other assets decreased by $161,000, primarily due to a decrease in core deposit intangible due to amortization, and also a reduction of prepaid automobile dealer reserves, which are being payed down as the installment loan portfolio pays down.

 

Total liabilities at September 30, 2005 were $270.1 million compared to $264.8 million at December 31, 2004, an increase of $5.3 million, or 2.0%. This increase was primarily the result of an increase in time deposits over $100,000.  Deposits increased by $14.1 million, from $254.0 million at December 31, 2004, to $268.1 million at September 30, 2005, primarily due to increases in short term time deposits of a local municipality and county funds resulting from real estate tax payments. In addition, resulting decreases in federal funds purchased, other borrowings, and repurchase agreements were funded through increased deposits. Other liabilities decreased by $2.0 million, due to the $543,000 reduction in the deferred tax liability associated with the market value of the available for sale investment portfolio. In addition, dividends payable were $1.3 million as of December 31, 2004.

 

Total equity was $23.8 million at September 30, 2005 compared to $23.9 million at December 31, 2004. This decrease was the result of $1.7 million of additional retained earnings from net income for the first nine months of 2005 and a decrease of $1.1 million, net of tax, in the market value of the Company’s investment portfolio due to increasing interest rates.  In addition, cash dividends of $650,000, were paid in July 2005.

 

CONSOLIDATED RESULTS OF OPERATIONS

 

Net income for the third quarter of 2005 was $660,000, or $1.02 per basic common share, a 2.5% decrease compared to $677,000, or $1.04 per share, in the third quarter of 2004.  The decrease in net income for the quarter was primarily the result of increases in non-interest expense of $29,000 and the provision for income taxes of $21,000. In addition, non-interest income decreased by $15,000. These changes were partially offset by an increase in net interest income of $48,000.

 

During the nine months ended both September 30, 2005 and 2004, net income was $1.7 million, or $2.66 per share. Decreases in net interest income of $17,000, and non-interest income of $232,000, during 2005 were offset by a decrease in non-interest expense of $264,000.

 

The annualized return on average assets was .78% for the nine months ended September 30, 2005, compared to .77% for the same period in 2004.   The annualized return on average equity

 

13

 

decreased to 9.5% for the nine months ended September 30, 2005, from 9.8% for the same period in 2004.

 

NET INTEREST INCOME

 

Net interest income was $2.4 million for both the three months ended September 30, 2005 and 2004.  Total interest income increased to $3.6 million for the three months ended September 30, 2005 from $3.4 million for the same period ended in 2004, a 7.0% increase.  The components of interest income changed for 2005. This change was primarily the result of an increase in interest income from loans to $2.4 million for the three months ended September 30, 2005 from $2.1 million in 2004, and an increase in interest income from federal funds sold of $128,000 compared to the same period a year earlier. In addition, decreases in interest income from investment certificates of deposits of $22,000 and a decline in interest income from securities of $219,000 compared to prior year resulted in an increase of $237,000 in total interest income. This increase was mitigated by an increase in interest expense of $189,000 for the three months ended September 30, 2005 compared to September 30, 2004.

 

Net interest income for both the nine months ended September 30, 2005 and 2004 was $7.0 million. Total interest income increased to $10.3 million for the nine months ended September 30, 2005 from $10.1 million for the same period in 2004, a 1.5% increase.  The Company’s tax equivalent net interest margin was 3.58% for the nine months ended September 30, 2005 and 3.45% a year earlier.  The yield on average earning assets increased to 5.31% for the nine months ended September 30, 2005 from 5.04% for the first nine months of 2004, an increase of 27 basis points.  This increase was partially offset by a corresponding increase in the cost of funds to 1.96% from 1.78% paid for the same period in 2004, an 18 basis point increase. These increases were a result of ongoing repricing of assets and liabilities as they matured in the rising rate environment in late 2004 and during the first nine months of 2005.

 

PROVISION FOR LOAN LOSSES

 

The provision for loan losses was $75,000 during the third quarters of 2005 and 2004. Year to date provision for loan loss was $225,000 in 2005 and 2004. As of September 30, 2005, the allowance for loan losses totaled $1.3 million, or .91% of total loans, which increased from .88% as of December 31, 2004.  This increase in the allowance was attributable to risk associated with continued expansion into new markets. Nonaccrual loans decreased from $161,000 at December 31, 2004 to $91,000 at September 30, 2005. Nonperforming loans, including nonaccrual loans, decreased $4,000 to $884,000 over the same period. Management feels that loans are generally well collateralized, which significantly reduces the Company’s exposure to losses on the credits.

 

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. While the general economy has showed signs of improvement, borrowers may continue to 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

 

14

 

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 was adequate at September 30, 2005. However, there can be no assurance that the allowance for loan losses will be adequate to cover all losses.

 

NON-INTEREST INCOME

 

The Company’s non-interest income totaled $707,000 for the three months ended September 30, 2005 compared to $722,000 for the same period in 2004, a decrease of $15,000 or 2.1%. The decrease in non-interest income was primarily due to decreases in gains on loan sales to the secondary market of $85,000 and gains on the sale of investment securities of $159,000.   This decrease in gains on loan sales was due to decreasing mortgage refinancing demand compared to the prior year as a result of the rising interest rate environment. Other income increased $241,000 to $302,000, largely due to increases in income related to the valuation of the derivatives imbedded in the Company’s index powered certificates of deposit held as investments, as well as to increases in ATM and merchant income fees.

 

For the nine months ended September 30, 2005, non-interest income decreased by 10.8% or $232,000 to $1.9 million.  Service charges on deposit accounts increased by $37,000, or 4.6%. Gains on the sale of investment securities decreased $288,000 compared to prior year. Gains on loan sales to the secondary market decreased $234,000 due to decreased origination and refinancing volume. Other income increased $253,000, compared to prior year.  This increase was due primarily to market value adjustments to index powered certificates of deposits held for investment which increased $133,000, ATM surcharge fees which increased $48,000, and merchant income fees which increased $28,000, compared to the prior year.

 

NON-INTEREST EXPENSE

 

The Company’s non-interest expense was $2.2 million and $2.1 million for the three months ended September 30, 2005 and 2004.  Salaries and benefits, which is the largest component of non-interest expense, increased $21,000, or 1.8%, to $1.2 million.  Increases in occupancy and equipment expense of $15,000, data expense of $19,000, supplies expense of $33,000 and professional fees of $17,000, were offset by decreases in amortization of core deposit intangible expense of $20,000 and other expense of $56,000, compared to the prior year period. Income tax expense increased by $21,000 compared to the same period in 2004. The Company had been using a state tax carry forward credit in prior years, which was unavailable in 2005.

 

For the nine months ended September 30, 2005, non-interest expense decreased $264,000 to $6.4 million, or 4.0%, compared to the year earlier period.  Salaries and benefits decreased $23,000, or 0.7%, to $3.5 million.  Decreases in professional fees of $4,000, amortization of the core deposit intangible of $60,000, and other expense of $295,000 were partially offset by increased occupancy and equipment expense of $66,000, and increased supplies expense of $37,000 as a result of an additional facility. Other expense was reduced due to decreased collection expenses,

 

15

 

decreased secondary mortgage market expenses, decreased directors’ life insurance expense and decreased miscellaneous loan expenses. Income tax expense increased by $23,000 compared to the prior year. The Company’s effective tax rate increased slightly due to an increase in state income tax expense.

 

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.

 

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 September 30, 2005, cash and short-term investments totaled $38.6 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.

 

16

 

The following table discloses material contractual obligations and commercial commitments of the Company as of September 30, 2005:

 

 

(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.

 

17

 

SAFE HARBOR STATEMENT

 

This document 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.

 

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

 

18

 

•              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.

 

19

 

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

QUANTITATIVE 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 September 30, 2005 and September 30, 2004.

 

 

As shown above, at September 30, 2005, the effect of an immediate 200 basis point increase in interest rates would decrease the Company’s net income by 1.0% or approximately $25,000.  The effect of an immediate 200 basis point decrease in rates would increase the Company’s net income by 0.1% or approximately $3,000.  The Company’s exposure to an increasing rate environment has decreased compared to prior year.

 

20

 

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 September 30, 2005. 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.

 

21

 

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.          UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Issuer Purchases of Equity Securities
Period		Total Number of Shares Purchased		Average Price Paid per Share			Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
July 1, 2005 through July 31, 2005		0		0			0		0
August 1 2005 through August 31, 2005		640		$	72.00		0		0
September 1, 2005 through September 30, 2005		0		0			0		0
Total		640		$	72.00		0		0

 

ITEM 3.          DEFAULTS UPON SENIOR SECURITIES

 

None

 

ITEM 4.          SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None

 

ITEM 5.          OTHER INFORMATION

 

None

 

22

 

ITEM 6.          EXHIBITS

 

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.

 

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 (Chief Executive Officer)
	/S/ VINCENT G. EASI
	Vincent G. Easi
	Chief Financial Officer

 

23