UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2009

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 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 x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

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

Large accelerated filer o		Accelerated filer o

Non-accelerated filer o		Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o No x

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 13, 2009, the registrant had outstanding 645,988 shares of common stock, $1.00 par value per share.

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FIRST OTTAWA BANCSHARES, INC.

Form 10-Q Quarterly Report

Table of Contents

PART I

Item 1.	Condensed Consolidated Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	28
Item 4.	Controls and Procedures	29

PART II

Item 1.	Legal Proceedings	30
Item 1.A.	Risk Factors	30
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	30
Item 3.	Defaults Upon Senior Securities	30
Item 4.	Submission of Matters to a Vote of Security Holders	30
Item 5.	Other Information	30
Item 6.	Exhibits	30
	Signatures	31

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

	(Unaudited)
	September 30,			December 31,
	2009			2008
ASSETS
Cash and cash equivalents	$	31,093		$	26,474
Certificates of deposit	41,162			14,854
Securities available-for-sale	68,967			57,825
Loans held for sale	62			229
Loans, less allowance for loan losses of $1,893 and $1,612	142,519			157,751
Premises and equipment, net	7,448			7,198
Goodwill	2,446			2,446
Core deposit intangible	544			653
Interest receivable and other assets	10,027			7,751

Total assets	$	304,268		$	275,181

LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Demand — non-interest-bearing	$	30,756		$	31,374
NOW accounts	105,855			72,624
Money market accounts	34,903			28,959
Savings	24,098			22,235
Time, $100,000 and over	27,644			30,868
Other time	48,203			54,670
Total deposits	271,459			240,730

Other borrowings	4,000			6,000
Interest payable and other liabilities	2,566			3,782
Total liabilities	278,025			250,512

Commitments and contingent liabilities

Shareholders’ equity
Preferred stock - $1 par value, 20,000 shares authorized; none issued	—			—
Common stock - $1 par value, 1,000,000 shares authorized and 753,734 issued	754			753
Additional paid-in capital	4,575			4,408
Retained earnings	26,956			26,031
Treasury stock, at cost, 107,746 shares	(6,299		)	(6,299		)
Accumulated other comprehensive loss	257			(224		)
Total shareholders’ equity	26,243			24,669

Total liabilities and shareholders’ equity	$	304,268		$	275,181

See accompanying notes to condensed consolidated financial statements.

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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,
	2009		2008			2009			2008
Interest income
Loans (including fee income)	$	2,332	$	2,659		$	7,082		$	8,289
Securities
Taxable	280		302			772			1,054
Exempt from federal income tax	254		263			861			774
Certificates of deposit	273		151			679			368
Federal funds sold	14		70			28			185
Total interest income	3,153		3,445			9,422			10,670

Interest expense
NOW account deposits	73		134			221			428
Money market deposit accounts	22		134			98			394
Savings deposits	19		29			65			89
Time deposits	617		784			2,080			2,728
Other borrowings	32		46			98			126
Repurchase agreements	—		1			—			1
Total interest expense	763		1,128			2,562			3,766

NET INTEREST INCOME	2,390		2,317			6,860			6,904
Provision for loan losses	120		30			510			90

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES	2,270		2,287			6,350			6,814

Non-interest income
Service charges on deposit accounts	220		227			621			646
Trust and farm management fee income	138		135			410			405
Gain on loan sales	46		9			364			54
Securities gains (losses)	3		(8		)	238			20
Market value adjustment on derivatives	5		(80		)	(3		)	(256		)
Other income	166		140			500			489
Total non-interest income	578		423			2,130			1,358

Non-interest expense
Salaries and employee benefits	1,121		1,079			3,357			3,262
Occupancy and equipment expense	309		339			920			984
Data processing expense	127		111			393			350
Insurance expense	197		48			460			141
Professional fees expense	101		95			368			333
Amortization of core deposit intangible	37		40			110			122
Other expenses	302		237			908			793
Total non-interest expense	2,194		1,949			6,516			5,985

INCOME BEFORE INCOME TAXES	654		761			1,964			2,187

Provision for income taxes	163		188			445			530

NET INCOME	$	491	$	573		$	1,519		$	1,657

Earnings per share-basic	$	0.76	$	0.89		$	2.35		$	2.57
Earnings per share-diluted	$	0.76	$	0.89		$	2.35		$	2.56
Dividends per share	$	0.92	$	1.00		$	0.92		$	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, 2009 and 2008

(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, 2009	$	753	$	4,408	$	26,031		$	(6,299	)	$	(224	)	$	24,669

Net income	—		—		1,519			—			—			1,519
Unrealized net gain on securities available-for-sale, net of reclassi-fications and tax effects	—		—		—			—			588			588
Net loss relating to benefit obligation	—		—		—			—			(107		)	(107		)

Comprehensive income	—		—		—			—			—			951

Cash dividends declared ($.92 per share)	—		—		(594		)	—			—			(594		)

Stock options vested	—		89		—			—			—			89

Shares granted	—		9		—			—			—			9

Stock options exercised	1		69		—			—			—			70

Balance at September 30, 2009	$	754	$	4,575	$	26,956		$	(6,299	)	$	257		$	26,243

Balance at January 1, 2008	$	753	$	4,300	$	26,113		$	(6,102	)	$	(458	)	$	24,606

Net income	—		—		1,657			—			—			1,657
Unrealized net loss on securities available-for-sale, net of reclassi-fications and tax effects	—		—		—			—			(106		)	(106		)
Net gain relating to benefit obligation	—		—		—			—			25			25

Comprehensive income														1,576

Cash dividends declared ($1 per share)	—		—		(644		)	—			—			(644		)

Stock options vested	—		79		—			—			—			79

Stock options exercised	—		3		—			—			—			3

Purchased 2,526 treasury shares	—		—		—			(197		)	—			(197		)

Balance at September 30, 2008	$	753	$	4,382	$	27,126		$	(6,299	)	$	(539	)	$	25,423

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, 2009 and 2008

(In thousands)

(Unaudited)

	2009			2008
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	1,519		$	1,657
Adjustments to reconcile net income to net cash from operating activities
Provision for loan losses	510			90
Depreciation and amortization	394			494
Premium amortization on securities, net	287			187
Derivative valuation adjustment	87			609
Loans originated for sale	(17,701		)	(2,596		)
Proceeds from the sale of loans	18,232			2,650
Gain on loan sales	(364		)	(54		)
Gain on sales of securities	(238		)	(20		)
Grant of Incentive shares	9			—
Vested stock options	89			79
Change in interest receivable and other assets	(741		)	(78		)
Change in interest payable and other liabilities	83			(617		)
Net cash from operating activities	2,166			2,401

CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of securities available-for-sale	14,492			4,333
Proceeds from maturities of securities	12,152			15,783
Purchases of securities available-for-sale	(36,945		)	(13,842		)
Proceeds from maturities of certificates of deposit	14,334			6,064
Purchases of certificates of deposit	(40,729		)	(16,779		)
Net change in loans receivable	12,694			5,017
Proceeds from sale of other real estate owned	80			200
Net property and equipment expenditures	(531		)	(127		)
Net cash from investing activities	(24,453		)	649

CASH FLOWS FROM FINANCING ACTIVITIES
Change in deposits	30,729			2,597
Repayment of other borrowings	(2,000		)	(214		)
Proceeds from other borrowings	—			6,214
Change in securities sold under agreements To repurchase	—			2,000
Purchase of treasury shares	—			(197		)
Proceeds from exercised options	70			3
Dividends paid	(1,893		)	(1,942		)
Net cash from financing activities	(26,906		)	8,461

Change in cash and cash equivalents	4,619			11,511

Cash and cash equivalents at beginning of period	26,474			16,499

CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	31,093		$	28,010

See accompanying notes to condensed consolidated financial statements.

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2009 and 2008

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, 2009 are not necessarily indicative of the results that may be expected for the year ended December 31, 2009.

The accompanying unaudited condensed consolidated financial statements of First Ottawa Bancshares, Inc. (the “Company”) 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 2008 filed with the U.S. Securities and Exchange Commission. The condensed consolidated balance sheet of the Company as of December 31, 2008 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

Earnings per share were computed as follows:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2009		2008		2009		2008

Net income (in thousands)	$	491	$	573	$	1,519	$	1,657
Weighted average shares outstanding	645,985		644,849		645,500		645,418
Effect of dilutive securities:
Stock options	2,987		1,611		1,705		1,636
Shares used to compute diluted earnings per share	648,972		646,460		647,205		647,064

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2009 and 2008

(Unaudited)

NOTE 2 — EARNINGS PER SHARE (Continued)

Earnings per share:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2009		2008		2009		2008

Basic	$	0.76	$	0.89	$	2.35	$	2.57
Diluted	0.76		0.89		2.35		2.56

A total of 32,200 and 39,014 options for the three month periods ended September, 2009 and 2008 are not included in the above calculations as they are non-dilutive. A total of 50,788 and 32,700 options for the nine month periods ended September, 2009 and 2008 are not included in the above calculations as they are non-dilutive.

NOTE 3 — CAPITAL RATIOS

At the dates indicated, the Company’s and Bank’s capital ratios were materially the same and were:

	September 30, 2009				December 31, 2008
	Amount		Ratio		Amount		Ratio

Total capital (to risk-weighted assets)	$	24,849	13.8	%	$	23,354	13.2	%
Tier I capital (to risk-weighted assets)	22,956		12.5	%	21,742		12.3	%
Tier I capital (to average assets)	22,956		7.8	%	21,742		8.1	%

At September 30, 2009, 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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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2009 and 2008

NOTE 4 - DERIVATIVES

Fair value hedges are intended to reduce the interest rate risk associated with the underlying hedged item. Fair value hedges are considered to be highly effective and any hedge ineffectiveness was deemed not material. The Company uses this fair value hedge 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 Broker Dealer Financial Services Corporation (BDFS) to fix the interest rate on a specific certificate of deposit product. At September 30, 2009, the Company had $3.6 million of certificates of deposit, which mature in 2009 through 2014, on which it has prepaid BDFS for an interest rate swap and will receive an interest rate from BDFS based on the appreciation of the S&P 500 Index. This interest received from BDFS will be paid to the customer. The certificates of deposit have an embedded derivative which is a written call option. The assets and liabilities in this transaction are being netted in time deposits and the fair value adjustment recorded in other income.

The table below presents certain information regarding the Company’s interest rate swap agreement designated as a fair value hedge.

	September 30, 2009		December 31, 2008
	(unaudited)

Fair value of interest rate swap agreement	$	813	$	594
Balance sheet location of fair value amount	Other Liabilities		Other Liabilities

	Three Months Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
Gain (loss) on interest rate swap	247		(90	)	219		(221	)
Gain (loss) on call option	(246	)	93		(216	)	233
Net gain (loss) recognized in income	1		3		3		12
Location of gain (loss) recognized in income	Other Income		Other Income		Other Income		Other Income

In addition to the above, the Company also purchased $1.1 million of certificates of deposit which are included in the certificates of deposit caption on the consolidated balance sheet. These certificates of deposit were purchased as investments to generate a return and have a five year term from date of purchase. The investments do not individually exceed $100,000 and are insured 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, which is a purchased call option, is recorded in certificates of deposit and the fair value adjustment is included in other income. At September 30, 2009, the Company had allocated $15,000 to this asset and recorded a valuation loss of $3,000.

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2009 and 2008

(Unaudited)

NOTE 4 — DERIVATIVE FINANCIAL INSTRUMENTS (Continued)

The table below presents certain information regarding the Company’s purchased and written call options which are embedded derivatives that are not designated as hedging instruments:

	September 30, 2009		December 31, 2008
	(unaudited)		(unaudited)

Purchased call options- Investment cds	$	15	$	135
Balance sheet location of fair value amount	Certificates of Deposit		Certificates of Deposit
Written call options — Customer cds	813		597
Balance sheet location of fair value amount	Other Liabilities		Other Liabilities

	Three Months Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
Purchased call options- Investment cds
Net gain (loss) recognized in income	5		(80	)	(3	)	(256	)
Location of gain (loss) recognized in income – Market value adjustment on derivatives
Written call options — Customer cds
Net gain (loss) recognized in income	(246	)	93		(216	)	233
Location of gain (loss) recognized in income	Other Income		Other Income		Other Income		Other Income

NOTE 5 — SECURITIES AVAILABLE FOR SALE

			Gross		Gross
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
September 30, 2009
U. S. Treasury	$	5,215	$	10	$	—		$	5,225
Federal agencies	19,207		162		(15		)	19,354
State and municipal	27,070		492		(47		)	27,515
Corporate obligations	10,850		311		(3		)	11,158
Mortgage—backed securities and collateralized mortgage obligations	3,690		119		—			3,809
Marketable equity securities	1,512		394		—			1,906

Total investment securities	$	67,544	$	1,488	$	(65	)	$	68,967

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2009 and 2008

(Unaudited)

NOTE 5 — SECURITIES AVAILABLE FOR SALE (Continued)

			Gross		Gross
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
December 31, 2008
U. S. Treasury	$	1,033	$	51	$	—		$	1,084
Federal agencies	11,556		234		—			11,790
State and municipal	38,926		268		(106		)	39,088
Mortgage—backed securities and collateralized mortgage obligations	4,885		91		(6		)	4,970
Marketable equity securities	893		—		—			893

Total investment securities	$	57,293	$	644	$	(112	)	$	57,825

As of September 30, 2009 and December 31, 2008, the Company had approximately $13,935,000 and $14,498,000 invested in bonds issued by municipalities located within LaSalle County, Illinois.

Securities with an approximate carrying value of $53,827,000 and $35,927,000 were pledged at September 30, 2009 and December 31, 2008 to secure trust and public deposits, and for other purposes as required or permitted by law.

The amortized cost and fair value of contractual maturities of securities available for sale at September 30, 2009 were as follows. Securities not due at a single maturity date, primarily mortgage—backed and equity securities, are shown separately.

	Amortized Cost		Fair Value
Within one year	$	16,209	$	16,236
One to five years	40,070		40,756
Five to ten years	6,063		6,260
After ten years	—		—
	62,341		63,252
Mortgage—backed securities and collateralized mortgage obligations	3,690		3,809
Marketable equity securities	1,512		1,906

Totals	$	67,544	$	68,967

Information regarding realized gains and losses on sales of securities available for sale as of September 30, 2009 and 2008 follows:

	2009			2008
Gross gains	$	239		$	28
Gross losses	(1		)	—
Tax expense	81			9

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2009 and 2008

NOTE 5 — SECURITIES AVAILABLE FOR SALE (Continued)

Certain investments in debt and marketable equity securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at September 30, 2009 and December 31, 2008 was $11.2 million and $9.7 million, respectively, which was approximately 16.3% and 16.7% of the Company’s available—for—sale investment portfolio at those dates. These declines primarily resulted from market interest rates being greater than the coupon rates on the individual bonds.

Based on evaluation of available evidence, including recent changes in market interest rates, management believes the declines in fair value for these securities are temporary. Should the impairment of any of these securities become other-than-temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other—than—temporary impairment is identified.

The following table shows our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses

September 30, 2009

Federal Agencies	$	3,567	$	(15	)	$	—	$	—		$	3,567	$	(15	)
State and municipal	7,205		(46		)	130		(1		)	7,335		(47		)
Corporate obligations	304		(3		)	—		—			304		(3		)
Total temporarily impaired securities	$	11,076	$	(64	)	$	130	$	(1	)	$	11,206	$	(65	)

December 31, 2008

State and Municipal	$	8,241	$	(104	)	$	400	$	(2	)	$	8,641	$	(106	)
Mortgage—backed securities and collateralized mortgage obligations	655		(4		)	381		(2		)	1,036		(6		)

Total temporarily impaired securities	$	8,896	$	(108	)	$	781	$	(4	)	$	9,677	$	(112	)

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2009 and 2008

NOTE 6 — DISCLOSURES ABOUT FAIR VALUE OF ASSETS AND LIABILITIES

FASB Accounting Standards Codification (ASC) Topic 820-10-20 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Topic 820-10-20 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

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

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

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

Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Available-for-sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include certain collateralized mortgage and debt obligations, government agency bonds and certain municipal securities, and corporate obligations. Third party vendors compile prices from various sources and may apply such techniques as matrix pricing to determine the value of identical or similar investment securities (level 2). Matrix pricing is a mathematical technique widely used in the banking industry to value investment securities without relying exclusively on quoted prices for specific investment securities but rather relying on the investment securities’ relationship to other benchmark quoted investment securities. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. The Company currently holds no Level 3 securities.

Interest Rate Swap Agreements

The fair value is estimated by a third party using inputs that are observable or that can be corroborated by observable market data (such as the S&P 500 index) and, therefore, are classified within Level 2 of the valuation hierarchy.

Impaired Loans and Other Real Estate Owned

Loan impairment is reported when scheduled payments under contractual terms are deemed uncollectible. Impaired loans are carried at the fair value of collateral if the loan is collateral dependent. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. If these allocations cause the allowance for loan losses to increase, such increase is reported as a component of the provision for loan losses. Loan losses are charged against the allowance when management believes the uncollectability of the loan is confirmed. The valuation would be considered Level 3, consisting of appraisals of underlying collateral and discounted cash flow analysis.

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2009 and 2008

NOTE 6 — DISCLOSURES ABOUT FAIR VALUE OF ASSETS AND LIABILITIES (Continued)

The fair value for impaired loans and other real estate owned is measured based on the value of the collateral securing those loans/real estate and is determined using several methods. The fair value of real estate is generally determined based on appraisals by qualified licensed appraisers. The appraisers typically determine the value of the real estate by utilizing an income or market valuation approach. If an appraisal is not available, the fair value may be determined by using a cash flow analysis. Fair value on other collateral such as business assets is typically calculated by using the financial information such as financial statements and aging reports provided by the borrower and is discounted as considered appropriate.

The following table presents the fair value measurements of assets and liabilities recognized in the accompanying balance sheet measured at fair value on a recurring and non-recurring basis and the level within the FASB ASC fair value hierarchy in which the fair value measurements fall at September 30, 2009:

				Fair Value Measurements Using
	Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Recurring basis:
Assets:
Available-for-sale securities:
U.S. Treasuries	$	5,225		$	—	$	5,225		$	—
Federal Agencies	19,354			—		19,354			—
State and Municipals	27,515			—		27,515			—
Corporate obligations	11,158			—		11,158			—
Mortgage—backed securities and collateralized mortgage obligations	3,809			—		3,809			—
Equities	1,906			1,906		—			—
Purchased call options-investment cds	15			—		15			—
Interest rate swap agreements — customer cds	813			—		813			—
Total assets	69,795			1,906		67,889			—

Liabilities:
Written call options-customer cds	(813		)	—		(813		)	—

Non-recurring basis:
Impaired loans	4,069			—		—			4,069
Other real estate owned	2,243			—		—			2,243
Total assets	6,312			—		—			6,312

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2009 and 2008

(Unaudited)

NOTE 6 — DISCLOSURES ABOUT FAIR VALUE OF ASSETS AND LIABILITIES (Continued)

The following table presents the fair value measurements of assets and liabilities recognized in the accompanying balance sheet measured at fair value on a recurring basis and the level within the FASB ASC fair value hierarchy in which the fair value measurements fall at December 31, 2008:

				Fair Value Measurements Using
	Fair Value			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets:
Available-for-sale securities:
U.S. Treasuries	$	1,084		$	—	$	1,084		$	—
Federal Agencies	11,790			—		11,790			—
State and Municipals	39,088			—		39,088			—
Mortgage—backed securities and collateralized mortgage obligations	4,970			—		4,970			—
Equities	893			893		—			—
Purchased call options — investment cds	135			—		135			—
Interest rate swap agreements — customer cds	594			—		594			—
Total assets	58,554			893		57,661			—

Liabilities:
Written call options — customer cds	(597		)	—		(597		)	—

The following methods and assumptions were used to estimate fair values for financial instruments carried on the balance sheet at other than fair value. The carrying amount is considered to estimate fair value for cash and due from banks, demand, NOW, money market and savings deposits, accrued interest receivable and payable, and variable rate loans or deposits. The fair value of loans held for sale are based on quoted market prices. For fixed rate loans, deposits, or other borrowings, the fair value is estimated by discounted cash flow analysis using current market rates for the estimated life and credit risk. The fair value of off—balance—sheet items is based on the fees or cost that would currently be charged to enter into or terminate such agreements and is not material.

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2009 and 2008

(Unaudited)

NOTE 6 — DISCLOSURES ABOUT FAIR VALUE OF ASSETS AND LIABILITIES (Continued)

The carrying values and estimated fair values of the Company’s financial instruments as of September 30, 2009 and December 31, 2008 were as follows:

	September 30,				December 31,
	2009				2008
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Assets
Cash and cash equivalents	$	31,093	$	31,093	$	26,474	$	26,474
Certificates of deposit and related derivative	41,162		41,162		14,854		15,071
Securities available for sale	68,967		68,967		57,825		57,825
Loans held for sale	62		62		229		229
Loans	142,519		141,463		157,751		156,826
Interest receivable	1,889		1,889		1,603		1,603

Liabilities
Deposits with no stated maturities	195,612		195,612		155,192		155,192
Time deposits	75,847		77,264		85,538		86,498
Other Borrowings	4,000		4,073		6,000		6,081
Interest Payable	544		544		684		684

NOTE 7 — RECLASSIFICATIONS

Certain reclassifications have been made to the December 31, 2008 consolidated financial statements in order to conform to the September 30, 2009 condensed consolidated financial statement presentation. These reclassifications had no effect on net income.

NOTE 8 — SUBSEQUENT EVENTS

Subsequent events have been evaluated through November 16, 2009, which is the date the financial statements were available to be issued.

NOTE 9 — FUTURE ACCOUNTING PRONOUNCEMENTS

Statement of Financial Accounting Standard No. 166, Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140 (“SFAS 166’).

On June 12, 2009, the FASB issued SFAS 166 which removes the concept of a qualifying special-purpose entity (“QSPE”) from Statement 140, and eliminates the exception for QSPEs from the consolidation guidance of FASB Interpretation No. 46 (R), Consolidation of Variable Interest Entities (“FIN 46 (R)”). Concurrent with the issuance of SFAS 166, the FASB issued SFAS 167, Amendment to FASB Interpretation No. 46(R) (“SFAS 167”). SFAS 167 addresses the effect of eliminating the QSPE concept from Statement 140 and enhances the transparency of an entity’s involvement in a variable interest entity (“VIE”). SFAS 166 is effective as of the beginning of the Corporation’s first annual reporting period beginning after November 15, 2009. Earlier adoption is prohibited. The Corporation does not expect the adoption of the provisions of SFAS 166 to have a material effect on the Company’s financial condition and results of operations.

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2009 and 2008

NOTE 9 — FUTURE ACCOUNTING PRONOUNCEMENTS (Continued)

Statement of Financial Accounting Standards No. 167, Amendment to FASB Interpretation No. 46 (R) (“SFAS 167”).

On June 12, 2009, the FASB issued SFAS 167 to address the effects of eliminating the QSPE concept from FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Liabilities and enhance the transparency of an entity’s involvement in a variable interest entity (“VIE”). SFAS 167 is effective as of the beginning of the Corporation’s first annual reporting period beginning after November 15, 2009. Earlier adoption is prohibited. The Corporation does not expect the adoption of the provisions of SFAS 167 to have a material effect on the Company’s financial condition and results of operations.

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

OVERVIEW

The Company is the holding company for First National Bank of Ottawa (the “Bank”). 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, Illinois. The Company continues to explore expansion opportunities within its existing market area and in surrounding areas.

The Company has submitted an application with the Office of the Comptroller of Currency and received approval to relocate the branch located at 401 East Main Street in Streator, Illinois, to 409 East Bridge Street in Streator Illinois. This relocation would be considered a short distance relocation as defined in 12 CFR 5.3(i).

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.

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The Company’s net income for the nine months ended September 30, 2009, was $1.5 million, or $2.35 per common share, compared to net income of $1.7 million, or $2.57 per common share for the nine months ended September 30, 2008.

The Company’s assets at September 30, 2009 were $304.3 million compared to $275.2 million at December 31, 2008, an increase of $29.1 million, or 10.6%.

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, 2008. The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to make estimates and assumptions. The Company’s financial condition 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 of operations, and they require management to make estimates that are difficult, subjective, or complex.

Allowance for Loan Losses- The allowance for loan losses provides coverage for probable losses inherent in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for loan 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 loan 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

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regarding a customer’s financial condition or changes in a customer’s unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company’s evaluation of 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 assets in the condensed 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 in certificates of deposit and the fair value adjustment is included in other income.

Stock Compensation- Grants under the Company’s stock incentive plan are accounted for by 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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Valuation Measurements- Valuation methodologies often involve a significant degree of judgment, particularly when there are no observable active markets for the items being valued.Investment securities and derivatives are carried at fair value, as defined in FASB ASC Topic 820, which requires key judgments affecting how fair value for such assets and liabilities is determined. In addition, the outcomes of valuations have a direct bearing on the carrying amounts of goodwill, mortgage servicing rights, and pension and other postretirement benefit obligations. To determine the values of these assets and liabilities, as well as the extent to which related assets may be impaired, management makes assumptions and estimates related to discount rates, asset returns, prepayment rates and other factors. The use of different discount rates or other valuation assumptions could produce significantly different results, which could affect the Company’s results of operations.

Goodwill- Under FASB ASC Topic 350-10 the Company is required to evaluate goodwill for impairment on an annual basis or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The Company has elected to test for goodwill impairment as of December 31st of each year. The Company cannot predict the occurrence of certain future events that might adversely affect the reported value of goodwill. Such events include, but are not limited to, strategic decisions made in response to economic and competitive conditions, the effect of the economic environment on the Company’s customer base, or a material negative change in its relationship with significant customers.

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CONSOLIDATED FINANCIAL CONDITION

Total assets at September 30, 2009 were $304.3 million compared to $275.2 million at December 31, 2008, an increase of $29.1 million, or 10.6%. This increase was the result of an increases in cash and cash equivalents of $4.6 million, certificates of deposit in other financial institutions of $26.3 million, securities available-for-sale of $11.1 million, and interest receivable and other assets of $2.2 million. These increases were offset by decreases in loans of $15.2 million, and loans held for sale of $167,000. Cash and cash equivalents increased as excess balances at the Federal Reserve Bank increased as a result of real estate taxes collected on behalf of local municipalities. Loan balances outstanding decreased by $15.2 million due to decreased demand as a result of the contraction in the housing market and its impact on the economy, along with pay downs in the portfolio. Interest receivable and other assets increased by $2.2 million, primarily due to a $1.9 million increase in other real estate owned.

Total liabilities at September 30, 2009 were $278.0 million compared to $250.5 million at December 31, 2008, an increase of $27.5 million, or 11.0%. This increase was primarily the result of an increase in total deposits of $30.7 million, from $240.7 million at December 31, 2008, to $271.5 million at September 30, 2009. Total deposits increased due to short term deposits of a local municipality and county funds resulting from real estate tax payments. The increase in deposits was partially offset by a decrease in other borrowings of $2.0 million, and a $1.2 million decrease in interest payable and other liabilities. Other borrowings decreased by $2.0 million as a result of Federal Home Loan Bank advances repaid during the first quarter of 2009. Interest payable and other liabilities decreased by $1.2 million, due to the reduction of dividends payable at year end 2008.

Total shareholders’ equity increased to $26.2 million at September 30, 2009, compared to $24.7 million at December 31, 2008. This increase was due primarily to net income of $1.5 million for the period ended September 30, 2009, which was offset by dividends in the amount of $594,000, payable to shareholders in July 2009 that were declared in June 2009.

CONSOLIDATED RESULTS OF OPERATIONS

Net income for the third quarter of 2009 was $491,000, or $0.76 per share, a 14.3% decrease compared to $573,000, or $0.89 per share, in the third quarter of 2008. The decrease in net income for the quarter was primarily the result of an increase in non-interest expense of $245,000, and an increase in the provision for loan losses of $90,000. These decreases were partially offset by an increase in non-interest income of $155,000. The decrease in income before taxes also resulted in a decrease in the income tax provision of $25,000.

During the nine months ended September 30, 2009, net income was $1.5 million, or $2.35 per share, compared to $1.7 million, or $2.57 per share during the first nine months of 2008. This 8.3% decrease in net income for the nine month period was primarily due to a decrease in net-interest income of $44,000, an increase in the provision for loan losses of $420,000, and an

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increase in non-interest expense of $531,000, which were offset by an increase in non-interest income of $772,000, or 56.8%. The decrease in the Company’s pretax income also resulted in a decrease in the tax provision of $85,000.

The annualized return on average assets was 0.72% for the nine months ended September 30, 2009, compared to 0.79% in 2008. The annualized return on average equity decreased to 8.0% for the nine months ended September 30, 2009, from 9.1% in 2008.

NET INTEREST INCOME

Net interest income after the provision for loan losses decreased by 0.7% to $2.3 million for the three months ended September 30, 2009 as compared to 2008. Total interest income decreased to $3.2 million for the three months ended September 30, 2009, compared to $3.4 million for the three months ended September 30, 2008. This change was primarily the result of a decrease in interest income from loans to $2.3 million for the three months ended September 30, 2009 from $2.7 million for the same period a year earlier. This decrease was the result of a $11.7 million decrease in the average principal balance of the loan portfolio compared to the prior year and loans repricing downward as interest rates decreased during 2008 and in the first nine months of 2009. In addition, decreases in interest income from taxable investment securities of $22,000, tax exempt securities of $9,000, and federal funds sold of $56,000 were offset by increased interest income on interest bearing deposits held at other financial institutions of $122,000 for the third quarter of 2009 compared to the prior year. These fluctuations resulted in a change in total interest income of $292,000, an 8.5% decrease for the third quarter of 2009 compared to the prior year. Total interest expense decreased to $763,000 for the three months ended September 30, 2009 from $1.1 million for the same period ended September 30, 2008, a 32.4% decrease. Decreased interest expense was a result of lower rates paid on deposits. The $365,000 decrease in total interest expense offset the decrease in total interest income for the quarter resulting in a $73,000 increase in net interest income before the provision for loan losses for the third quarter in 2009 compared to the prior year. This increase was mitigated by the increase in the provision for loan losses of $90,000 for the third quarter of 2009, resulting in a $17,000 decrease in net interest income after the provision for loan losses when compared to the three month period ended September 30, 2008.

Net interest income for the nine months ended September 30, 2009 was $6.9 million compared to $6.9 million for the same period in 2008. The slight decrease in 2009 was the result of a $1.2 million decrease in total interest income, which was partially offset by a $1.2 million decrease in total interest expense compared to the prior year. The Company’s net interest margin was 3.82% for the nine months ended September 30, 2009 and 3.73% 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 $7.1 million for the nine months ending September 30, 2009 and for the same period in 2008. The tax equivalent yield on average earning assets of $247.8 million in 2009 and $254.7 million for the same period in 2008, decreased to 5.20% for the nine months ended September 30, 2009 from 5.70% for the same period ended September 30, 2008, a decrease of 50 basis points. This

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decrease was offset by a corresponding decrease in the cost of funds to 1.38% from 1.97% paid for the same period ended September 30, 2008, a 59 basis point decrease. These decreases resulted from ongoing repricing of assets and liabilities as they matured in the decreasing rate environment in late 2008 and during the first nine months of 2009.

PROVISION FOR LOAN LOSSES

The provision for loan losses was $120,000 during the third quarter of 2009 compared to $30,000 during the third quarter of 2008. Year to date provision for loan loss was $510,000 in 2009 compared to $90,000 in 2008. As of September 30, 2009, the allowance for loan losses totaled $1.9 million, or 1.31% of total loans, which increased from $1.6 million, or 1.01% of total loans, as of December 31, 2008. Nonaccrual loans increased from $1.0 million at December 31, 2008 to $3.5 million at September 30, 2009. Nonperforming loans, including nonaccrual loans, increased $5.9 million to $8.9 million over the same period. Management feels that the Bank was well collateralized on the nonperforming loans, which may significantly reduce 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 for loan losses. 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, 2009 to cover probable losses inherent in the Bank’s loan portfolio. 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 total non-interest income totaled $578,000 for the three months ended September 30, 2009 compared to $423,000 for the same period in 2008, an increase of $155,000, or 36.6%. The increase in total non-interest income was primarily due to market value adjustments associated with the derivative portion of certificates of deposits held for investment purposes which increased $85,000 compared to the same period in 2008. In addition, gains on loan sales to the secondary market, which increased $37,000 due to increased origination and refinancing volume as a result of lower interest rates contributed to the increase in third quarter 2009 non-

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interest income. Other income increased $26,000, or 18.6%, compared to the prior year due to an increase in First Ottawa Financial Services commissions and fees, and an increase in rental income from other real estate owned. These increases were partially offset by a decrease in service charges on deposit accounts of $7,000, or 3.1%, which resulted from decreased overdraft charges compared to the prior year.

For the nine months ended September 30, 2009, total non-interest income increased by 56.8% or $772,000 to $2.1 million. Market value adjustments associated with the derivative portion of certificates of deposits held for investment purposes increased $253,000, or 98.8%. Securities gains increased $218,000 to $238,000 compared to the prior year. Also, gains on loan sales to the secondary market increased $310,000 to $364,000 compared to 2008, due to increased origination and refinancing volume. Service charges on deposit accounts decreased by $25,000, or 3.9%, due to lower overdraft volume.

NON-INTEREST EXPENSE

The Company’s total non-interest expense increased by $245,000 to $2.2 million for the three months ended September 30, 2009, compared to $2.0 million for the same period in 2008. Salaries and employee benefits, the largest component of non-interest expense, increased $42,000, or 3.9%, to $1.1 million. This increase, as well as increases in insurance expense of $149,000, professional fees expense of $6,000, data processing expense of $16,000, and other expenses of $65,000, was partially offset by nominal decreases in occupancy and equipment expense of $30,000 and amortization of core deposit intangible of $3,000. Insurance expense increased by $149,000 compared to the prior year due to a significant increase in the FDIC insurance assessment rate for 2009. Other expenses increased by $65,000 over the prior year due to an increase in other real estate owned expenses and an increase in amortization of the mortgage servicing asset as our serviced portfolio refinanced during the current year.

For the nine months ended September 30, 2009, total non-interest expense increased $531,000 to $6.5 million, or 8.9%, compared to the year earlier period. Salaries and employee benefits increased $95,000, or 2.9%, to $3.4 million. Increases in professional fees expense of $35,000, other expenses of $115,000, data processing expense of $43,000, and insurance expense of $319,000 were partially offset by decreases in occupancy and equipment expenses of $64,000 and amortization of core deposit intangible of $12,000. Insurance expense increased by $319,000 compared to the prior year due to a significant increase in the FDIC insurance assessment rate for 2009. Other expenses increased by $115,000 over the prior year due to an increase in other real estate owned expenses and an increase in amortization of the mortgage servicing asset as our serviced portfolio refinanced during the current year.

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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, 2009, cash and short-term investments totaled $31.1 million. The Company has other sources of liquidity if a need for additional funds arises, including securities and certificates of deposit held at other financial institutions 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.

The following table discloses contractual obligations and commercial commitments of the Company as of September 30, 2009 (Dollars in thousands):

			Less Than						After
	Total		1 Year		1 – 3 Years		4 – 5 Years		5 Years

Lines of credit(1)	$	23,023	$	10,455	$	4,386	$	1,945	$	6,237

Federal Home Loan Bank advances	4,000		2,000		2,000		—		—

Data processing contract payable	890		223		445		222		—

Standby letters of credit(1)	728		472		256		—		—

	$	28,641	$	13,150	$	7,087	$	2,167	$	6,237

(1) Represents amounts committed to customers.

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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, 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.

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.

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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 is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information under this item.

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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 the Chief Financial Officer concluded that 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, 2009 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, 2009. 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 or disclosure controls.

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PART II

ITEM 1.	LEGAL PROCEEDINGS

	There are no material pending legal proceedings to which the Company or its subsidiaries are a party other than ordinary routine litigation incidental to their respective businesses.

ITEM 1.A.	RISK FACTORS

	The Company is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information under this item.

ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

	None

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES

	None

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

	None

ITEM 5.	OTHER INFORMATION

	None

ITEM 6.	EXHIBITS

	Exhibits

	31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d- 14(a).
	31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d- 14(a).
	32.1	Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2	Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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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)


Date: November 16, 2009	/S/ Joachim J. Brown
	Joachim J. Brown
	President and Chief Executive Officer
	(Principal Executive Officer)


Date: November 16, 2009	/S/ Vincent G. Easi
	Vincent G. Easi
	Chief Financial Officer
	(Principal Financial and Accounting Officer)

FIRST OTTAWA BANCSHARES, INC - Quarter Report: 2009 September (Form 10-Q)

Washington, D.C. 20549

FORM 10-Q

FIRST OTTAWA BANCSHARES, INC.