SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

FIRST OTTAWA BANCSHARES, INC.

(Exact name of Registrant as specified in its charter)

 

 

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.

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  o

Accelerated filer  o

Non-accelerated filer  x

 

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

 

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 7, 2007, the Registrant had outstanding 649,273 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 1.A.	Risk Factors
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,
		2007			2006
ASSETS
Cash and cash equivalents		$	22,422		$	10,644
Certificates of deposit		7,182			6,135
Securities available-for-sale		73,127			83,085
Loans, less allowance for loan losses of $1,506 and $1,463		159,171			159,475
Bank premises and equipment, net		7,554			7,753
Interest receivable and other assets		10,424			10,961
Total assets		$	279,880		$	278,053
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Demand – non-interest-bearing		$	31,836		$	29,964
NOW accounts		59,514			53,864
Money market accounts		44,879			38,266
Savings		21,869			24,062
Time, $100,000 and over		36,480			38,484
Other time		57,643			65,711
Total deposits		252,221			250,341
Interest payable and other liabilities		2,568			4,203
Total liabilities		254,789			254,544
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		752			750
Additional paid-in capital		4,242			4,103
Retained earnings		26,751			25,644
Treasury stock, at cost, 102,659 and 100,951 shares		(5,898		)	(5,767		)
Accumulated other comprehensive loss		(756		)	(1,221		)
Total shareholders’ equity		25,091			23,509
Total liabilities and shareholders’ equity		$	279,880		$	278,053

 

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,
		2007			2006			2007			2006
Interest income
Loans (including fee income)		$	3,060		$	2,909		$	8,942		$	8,546
Securities
Taxable		466			547			1,493			1,683
Exempt from federal income tax		208			220			632			688
Certificates of deposit		56			43			132			198
Federal funds sold		213			199			243			207
Total interest income		4,003			3,918			11,442			11,322
Interest expense
NOW account deposits		259			205			745			577
Money market deposit accounts		340			424			1,014			808
Savings deposits		30			33			93			98
Time deposits		981			1,012			2,817			2,950
Federal funds purchased		—			1			100			122
Total interest expense		1,610			1,675			4,769			4,555
NET INTEREST INCOME		2,393			2,243			6,673			6,767
Provision for loan losses		45			45			135			135
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		2,348			2,198			6,538			6,632
Noninterest income
Service charges on deposit accounts		273			252			765			719
Trust and farm management fee income		135			135			405			405
Gain on loan sales		4			10			26			18
Securities gains (losses), net		—			—			—			(13		)
Other income		162			311			624			552
Total noninterest income		574			708			1,820			1,681
Noninterest expenses
Salaries and employee benefits		1,131			1,159			3,449			3,489
Occupancy and equipment expense		311			321			941			947
Data processing expense		105			92			293			284
Supplies		23			31			89			119
Amortization of core deposit intangible		51			64			153			192
Professional fees		151			82			396			294
Other expenses		238			260			744			849
Total noninterest expenses		2,010			2,009			6,065			6,174
INCOME BEFORE INCOME TAXES		912			897			2,293			2,139
Provision for income taxes		239			242			537			528
NET INCOME		$	673		$	655		$	1,756		$	1,611
Earnings per share-basic		$	1.04		$	1.01		$	2.71		$	2.48
Earnings per share-diluted		$	1.04		$	1.01		$	2.70		$	2.48
Dividends per share		$	1.00		$	1.00		$	1.00		$	1.00

 

See accompanying notes to condensed consolidated financial statements.

 

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

Nine Months ended September 30, 2007 and 2006

(In thousands, except per share data)

(Unaudited)

 

														Accumulated			Total
					Additional									Other			Share-
		Common			Paid-In			Retained			Treasury			Comprehensive			holders’
		Stock			Capital			Earnings			Stock			Income (Loss		)	Equity
Balance at January 1, 2007		$	750		$	4,103		$	25,644		$	(5,767	)	$	(1,221	)	$	23,509
Net income		—			—			1,756			—			—			1,756
Unrealized net gain on securities available-for-sale, net of reclassi- fications and tax effects		—			—			—			—			465			465
Comprehensive income																	2,221
Cash dividends declared ($1 per share)		—			—			(649		)	—			—			(649		)
Vested options		—			47			—			—			—			47
Stock options exercised		2			92			—			—			—			94
Purchased 1,708 treasury shares		—						—			(131		)	—			(131		)
Balance at September 30, 2007		$	752		$	4,242		$	26,751		$	(5,898	)	$	(756	)	$	25,091
Balance at January 1, 2006		$	750		$	4,039		$	25,258		$	(5,745	)	$	(1,444	)	$	22,858
Net income		—			—			1,611			—			—			1,611
Unrealized net gain on securities available-for-sale, net of reclassi- fications and tax effects		—			—			—			—			134			134
Comprehensive income																	1,745
Cash dividends declared ($1 per share)		—			—			(650		)	—			—			(650		)
Vested options		—			26			—			—			—			26
Stock options exercised		—			26			—			—			—			26
Balance at September 30, 2006		$	750		$	4,091		$	26,219		$	(5,745	)	$	(1,310	)	$	24,005

 

See accompanying notes to condensed consolidated financial statements.

 

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months ended September 30, 2007 and 2006

(In thousands)

(Unaudited)

 

		2007			2006
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$	1,756		$	1,611
Adjustments to reconcile net income to net cash from operating activities
Provision for loan losses		135			135
Depreciation and amortization		525			567
Premium amortization on securities, net		286			295
Derivative valuation adjustment		385			(103		)
Loans originated for sale		(1,009		)	(1,436		)
Proceeds from the sale of loans		1,035			838
Gain on loan sales		(26		)	(18		)
Loss on sale/call of securities available-for-sale		—			13
Vested Stock Options		47			26
Change in interest receivable and other assets		397			(775		)
Change in interest payable and other liabilities		(335		)	725
Net cash from operating activities		3,196			1,878
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of securities available-for-sale		—			4,247
Proceeds from maturities of securities		10,598			4,321
Purchases of securities available-for-sale		(221		)	(1,770		)
Proceeds from maturities of certificates of deposit		1,650			5,584
Purchases of certificates of deposit		(3,082		)	—
Net change in loans receivable		(113		)	(9,345		)
Proceeds from sale of other real estate owned		16			90
Property and equipment expenditures		(160		)	(123		)
Net cash from investing activities		8,688			3,004
CASH FLOWS FROM FINANCING ACTIVITIES
Change in deposits		1,880			19,931
Change in federal funds purchased		—			(12,700		)
Purchase of treasury shares		(131		)	—
Proceeds from exercised options		94			26
Dividends paid		(1,949		)	(1,949		)
Net cash from financing activities		(106		)	5,308
Change in cash and cash equivalents		11,778			10,190
Cash and cash equivalents at beginning of period		10,644			6,857
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	22,422		$	17,047

 

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, 2007 and 2006

 

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 and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ended December 31, 2007.

 

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 2006 filed with the U.S. Securities and Exchange Commission. The condensed consolidated balance sheet of the Company as of December 31, 2006 has been derived from the audited consolidated balance sheet as of that date.

 

First National Bank of Ottawa (the Bank), a national banking association headquartered in Ottawa, Illinois, is a wholly – owned subsidiary of the Company. The Bank’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,
		2007			2006			2007			2006
Net income (in thousands)		$	673		$	655		$	1,756		$	1,611
Weighted Average Shares outstanding		648,898			649,783			649,137			649,557
Effect of dilutive securities: Stock options		979			1,303			933			1,303
Shares used to compute diluted earnings per share		649,877			651,086			650,070			650,860

 

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Earnings per share:

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2007			2006			2007			2006
Basic		$	1.04		$	1.01		$	2.71		$	2.48
Diluted		1.04			1.01			2.70			2.48

 

NOTE 3 – CAPITAL RATIOS

 

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

 

		September 30, 2007					December 31, 2006
		Amount			Ratio		Amount			Ratio
Total capital (to risk-weighted assets)		$	23,966		12.8	%	$	22,668		12.0	%
Tier I capital (to risk-weighted assets)		22,460			12.0	%	21,205			11.2	%
Tier I capital (to average assets)		22,460			8.1	%	21,205			7.5	%

 

At September 30, 2007, 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.

 

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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, 2007, the Company had $901,000 of certificates of deposit, which mature in 2007 through 2012, in which it pays the Federal Home Loan Bank a weighted average interest rate of 3.03% 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 $3.2 million of certificates of deposit, which are included in the certificates of deposit caption on the consolidated balance sheet. These investments mature in 2007 through 2011. The investments individually do not exceed $100,000 and are secured by the FDIC. 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, 2007, the Bank had allocated $1.0 million to this asset and recorded valuation income of $146,000 for the current year.

 

NOTE 5 – FUTURE ACCOUNTING PRONOUNCEMENTS

 

On September 6, 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements.  SFAS 157 clarifies the fair value measurement objective, its application in GAAP and establishes a framework that builds on current practice and requirements.  The framework simplifies and, where appropriate, codifies the similar guidance in existing pronouncements and applies broadly to financial and non-financial assets and liabilities.  The Statement clarifies the definition of fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, known as an exit-price definition of fair value.  It also provides further guidance on the valuation techniques to be used in estimating fair value.  Current disclosures about the use of fair value to measure assets and liabilities are expanded in this Statement.  The disclosures focus on the methods used for fair value measurements and apply whether the assets and liabilities are measured at fair value in all periods, such as trading securities, or in only some periods, such as impaired assets.   The Statement is effective for all financial statements issued for fiscal years beginning after November 15^th, 2007 as well as for interim periods within such fiscal years.  The Company is currently evaluating the impact of this Statement on its financial statements.

 

9

 

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115.  SFAS 159 allows companies to report selected financial assets and liabilities at fair value. The changes in fair value are recognized in earnings and the assets and liabilities measured under this methodology are required to be displayed separately in the balance sheet.  The main intent of the Statement is to mitigate the difficulty in determining reported earnings caused by a “mixed-attribute model” (or reporting some assets at fair value and others using a different valuation attribute such as amortized cost). The project is separated into two phases.  This first phase addresses the creation of a fair value option for financial assets and liabilities.  A second phase will address creating a fair value option for selected non-financial items. SFAS 159 is effective for all financial statements issued for fiscal years beginning after November 15^th, 2007.  The Company is currently evaluating the impact of this Statement on its financial statements.

 

NOTE 6 – CHANGE IN ACCOUNTING PRINCIPLE

 

The Company or one of its subsidiaries files income tax returns in the U.S. federal and Illinois jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local examinations by tax authorities for years before 2004.

 

The Company adopted the provisions of the Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109, on January 1, 2007. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As a result of the implementation of FIN 48, the Company did not identify any uncertain tax positions that it believes should be recognized in the financial statements.

 

NOTE 7 – RECLASSIFICATIONS

 

Certain reclassifications have been made to the September 30, 2006 third quarter condensed consolidated financial statements in order to conform to the September 30, 2007 condensed consolidated financial statement presentation.  These reclassification had no effect on net income.

 

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARY

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, two branches in Streator, a branch in Yorkville, a branch in Morris, and a loan production office in Minooka. 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 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 nine months ended September 30, 2007, was $1.8 million, or $2.71 per common share, compared to net income of $1.6 million, or $2.48 per common share for the nine months ended September 30, 2006. The increase in net income was due primarily to an increase in non interest income and a decrease in non interest expenses, which was partially offset by a decrease in net interest income.

 

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The Company’s assets at September 30, 2007 were $279.9 million contrasted to $278.1 million at December 31, 2006, an increase of $1.8 million, or 0.7%.

 

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, 2005. 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

 

12

 

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 Accounting Standards (SFAS) No. 123(R), 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, relating to the stock options is measured and recorded based on the estimated value of the options.

 

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CONSOLIDATED FINANCIAL CONDITION

 

Total assets at September 30, 2007 were $279.9 million contrasted to $278.1 million at December 31, 2006, an increase of $1.8 million, or 0.7%. This increase was the result of an increase in cash and cash equivalents, federal funds sold, and certificates of deposits at other financial institutions . These increases were partially offset by decreases securities available for sale and nominal fluctuations in loans, premises, and other assets. Cash and cash equivalents increased as a result of a $14.1 million increase in federal funds sold. This increase was primarily funded through securities available for sale maturities. Other assets decreased by $537,000, due primarily to the decrease in the deferred tax asset associated with the market value fluctuations in the investment portfolio.

 

Total liabilities at September 30, 2007 were $254.7 million compared to $254.5 million at December 31, 2006, an increase of $245,000, or 0.1%. This increase was primarily the result of an increase in money market accounts holding public funds. Deposits increased by $1.8 million, from $250.3 million at December 31, 2006, to $252.2 million at September 30, 2007, primarily due to increases in short term deposits of a local municipality and county funds resulting from real estate tax payments. Other liabilities decreased $1.6 million, or 38.9%, to $2.6 million at September 30, 2007, compared to $4.2 million at December 31, 2006, due primarily to decreased dividends payable.

 

Total equity increased to $25.1 million at September 30, 2007 compared to $23.5 million at December 31, 2006. This increase was due primarily to a decrease in accumulated other comprehensive loss of $465,000, net of tax, relating to the Company’s investment portfolio coupled with dividends in the amount of $650,000, payable to shareholders in July 2007 that were declared in June 2007, all of which were netted against net income of $1.8 million for the period ended September 30, 2007.

 

CONSOLIDATED RESULTS OF OPERATIONS

 

Net income for the third quarter of 2007 was $673,000, or $1.04 per share, a 2.7% increase compared to $655,000, or $1.01 per share, in the third quarter of 2006. The increase in net income for the quarter was primarily the result of an increase in net interest income of $150,000. This change was offset by a decrease in other income of $134,000 compared to the third quarter of 2006. The decrease in other income was the result of a $139,000, decrease in income related to the market value adjustment associated with the derivative portion of certificates of deposit held for investment purposes.

 

During the nine months ended September 30, 2007, net income was $1.76 million, or $2.71 per share, compared to $1.61 million, or $2.48 per share during the first nine months of 2006. This 9.0% increase in net income for the nine month period was primarily due to a $139,000 increase in non interest income or 8.3%. Net interest income decreased by $94,000, but was offset by decreases in non interest expense of $109,000. The increase in the Company’s pretax income also resulted in an increase in the tax provision of $9,000.

 

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The annualized return on average assets was 0.84% for the nine months ended September 30, 2007, compared to 0.75% in 2006. The annualized return on average equity increased to 9.3% for the nine months ended September 30, 2007, from 8.7% in 2006.

 

NET INTEREST INCOME

 

Net interest income increased by 6.8% to $2.3 million for the three months ended September 30, 2007 as compared to 2006. Total interest income increased to $4.0 million for the three months ended September 30, 2007, compared to $3.9 million for the three months ended September 30, 2006. This change was primarily the result of an increase in interest income from loans to $3.1 million for the three months ended September 30, 2007 from $2.9 million for the same period a year earlier. This increase was the result of loan repricing and new loans added at current market rates during the first three quarters of 2007. In addition, an increase in interest income from investment certificates of deposits of $13,000 and a decline in interest income from securities of $93,000 compared to prior year resulted in a change of $131,000 in total interest income. Interest expense decreased to $1.6 million for the three months ended September 30, 2007 from $1.7 million for the same period ended September 30, 2006, a 3.9% decrease. This decrease in interest expense contributed to the increase in net interest income for the three month period.

 

Net interest income for the nine months ended September 30, 2007 and 2006 was $6.7 and $6.8 million, respectively. This decrease was primarily the result of a $214,000 increase in interest expense which was partially offset by a $120,000 increase in interest income compared to prior year. The Company’s net interest margin was 3.59% for the nine months ended September 30, 2007 and 3.53% a year earlier. Loan and securities income is reflected on a fully tax equivalent basis utilizing a 34% rate for municipal securities and tax exempt loans. Net interest income on a fully taxable equivalent basis was $6.7 million for the nine months ending September 30, 2007 and $6.8 million for the same period in 2006. The tax equivalent yield on average earning assets of $250.5 million in 2007 and $258.4 million for the same period in 2006, increased to 6.13% for the nine months ended September 30, 2007 from 5.89% for the same period ended September 30, 2006, an increase of 24 basis points. This increase was offset by a corresponding increase in the cost of funds to 2.95% from 2.69% for the same period ended September 30, 2006, a 26 basis point increase. These increases were a result of ongoing repricing of assets and liabilities as they matured in a stable rate environment in late 2006 and during the first nine months of 2007.

 

PROVISION FOR LOAN LOSSES

 

The provision for loan losses has remained unchanged at $45,000 for the third quarter of 2007 and 2006, as well as $135,000 for the nine month periods in 2007 and 2006. As of September 30, 2007, the allowance for loan losses totaled $1.5 million, or .94% of total loans, which increased from .91% as of December 31, 2006. Nonaccrual loans increased from $362,000 at December 31, 2006 to $439,000 at September 30, 2007. This increase was primarily due to one real estate loan, which made up 98% of the nonaccrual loan balance. Nonperforming loans, including nonaccrual loans, increased $1.1 million to $1.8 million over the same period. Management feels that the Bank is well collateralized on the nonperforming loans, which significantly reduces the Company’s exposure to losses on the credits.

 

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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 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, 2007. 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 $574,000 for the three months ended September 30, 2007 compared to $708,000 for the same period in 2006, a decrease of $134,000, or 18.9%. The decrease in non interest income was primarily due to decreased other income of $149,000, due to market value adjustments associated with the derivative portion of certificates of deposit held for investment purposes. This decrease was partially offset by increases in deposit service charges of $21,000.

 

For the nine months ended September 30, 2007, non interest income increased by 8.3%, or $139,000, to $1.8 million. Service charges on deposit accounts increased by $46,000, or 6.4%, due to higher overdraft volume. Losses on the sale of investment securities decreased $13,000 compared to prior year. Gains on loan sales to the secondary market decreased $8,000 due to decreased origination and refinancing volume. Other income increased $72,000 due to increases in market value adjustments associated with the derivative portion of certificates of deposit held for investment purposes of $38,000, ATM network fees of $24,000, and increased cash surrender values of bank owned life insurance of $20,000 compared to the same period in 2006.

 

NON INTEREST EXPENSE

 

The Company’s non interest expense was $2.0 million for the three months ended September 30, 2007 and $2.0 million for the same period in 2006. Non interest expense decreased by $1,000 for the three months ended September 30, 2007, compared to 2006. Salaries and benefits, the largest component of non interest expense, decreased $28,000, or 2.4%, to $1.1 million. Decreases in occupancy expense of $10,000, amortization of core deposit intangible of $13,000, other expense of $22,000, and supplies expense of $8,000 were offset by increases in professional fees of $69,000,due primarily to litigation settlement, and data processing expense of $13,000.

 

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For the nine months ended September 30, 2007, non interest expense decreased $109,000 to $6.1 million, or 1.8%, compared to the year earlier period. Salaries and benefits increased $40,000, or 1.1%, to $3.4 million. Decreases in occupancy expense of $6,000, amortization of the core deposit intangible of $39,000, supplies expense of $30,000, and other expense of $105,000 were partially offset by increased data processing expense of $9,000, and increased professional fees of $102,000. The decrease in other expenses was the result of reductions in postage expense, repossessed auto expense, and insurance expense while the increase in professional fees was the result of increased collections expenses and a litigation settlement in the current year.

 

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, 2007, cash and short-term investments totaled $25.7 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 M&I Marshall & Ilsley Bank.

 

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The following table discloses material contractual obligations and commercial commitments of the Company as of September 30, 2007:

 

					Less Than									After
		Total			1 Year			1 – 3 Years			4 – 5 Years			5 Years
Lines of credit(1)		$	17,492		$	8,350		$	7,162		$	197		$	1,783
Data processing contract payable		1,335			223			445			445			222
Standby letters of credit(1)		875			875			—			—			—
		$	19,702		$	9,448		$	7,607		$	642		$	2,005

 

(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. The factors which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries are detailed in the “Risk Factors” section included under Item 1a. of Part I of our Form 10-K. In addition to the risk factors described in that section, there are other factors that may impact any public company, including ours, which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.

 

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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, 2007 and September 30, 2006.

 

		2007 Net Income
		Amount			Change			Change
		(Dollars in Thousands )
+200 bp		$	3,106		$	284		10.0	%
Base		2,822			—			—
–200 bp		2,540			(282		)	(10.0	)%

 

		2006 Net Income
		Amount			Change			Change
		(Dollars in Thousands )
+200 bp		$	2,516		$	(23	)	(0.9	)%
Base		2,539			—			—
–200 bp		2,555			16			0.6	%

 

As shown above, at September 30, 2007, the effect of an immediate 200 basis point increase in interest rates would increase the Company’s net income by 10.0% or approximately $284,000. The effect of an immediate 200 basis point decrease in rates would decrease the Company’s net income by 10.0% or approximately $282,000. The Company’s exposure to a volatile rate environment has increased but remains within tolerable limits.

 

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONTROLS AND PROCEDURES

 

ITEM 4:  CONTROLS AND PROCEDURES

 

As required by Rules 13a-15(b) and 15d-15(b) under the Securities Exchange Act of 1934, management has evaluated, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded the Company’s disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e)) were effective as of September 30, 2007 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and were effective as of September 30, 2007.  These disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

 

There have been no changes in the Company’s internal controls or disclosure controls or in other factors that have materially affected, or are reasonably likely to materially affect internal controls over financial reporting.

 

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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 1.A.                RISK FACTORS

 

There have been no material changes in the risk factors applicable to the Company from those disclosed in Part I, Item 1.A. “Risk Factors,” in the Company’s 2006 Annual Report on Form 10-K. Please refer to that section of the Company’s Form 10-K for disclosures regarding the risks and uncertainties related to the Company’s business.

 

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, 2007 through July 31, 2007		0		0			0		0
August 1 2007 through August 31, 2007		123		$	78.79		0		0
September 1, 2007 through September 30, 2007		64		$	78.59		0		0
Total		187		$	78.72		0		0

 

ITEM 3.                       DEFAULTS UPON SENIOR SECURITIES

 

None

 

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

 

None

 

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ITEM 5.                           OTHER INFORMATION

 

None

 

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

 

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