FIRST OTTAWA BANCSHARES, INC - Quarter Report: 2010 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2010

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

For transition period from to

Commission file number 005-57237

FIRST OTTAWA BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

Delaware		36-4331185
(State or other jurisdiction		(I.R.S. Employer Identification No.)
of incorporation or organization)

701 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 12, 2010, 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	17
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27
Item 4.	Controls and Procedures	28

	PART II

Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors	29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	29
Item 3.	Defaults Upon Senior Securities	29
Item 4.	Removed and Reserved	29
Item 5.	Other Information	29
Item 6.	Exhibits	29
	Signatures	30

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ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

(Unaudited)

	September 30,			December 31,
	2010			2009
ASSETS
Cash and cash equivalents	$	58,587		$	17,921
Certificates of deposit	58,505			41,011
Securities available-for-sale	43,607			56,373
Loans held for sale	675			46
Loans, less allowance for loan losses of $2,355 and $2,334	136,256			147,105
Premises and equipment, net	7,846			7,484
Goodwill	2,446			2,446
Core deposit intangible	397			507
Other real estate owned	3,942			1,898
Interest receivable and other assets	9,017			8,910

Total assets	$	321,278		$	283,701

LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Demand — non-interest-bearing	$	32,745		$	34,851
NOW accounts	135,945			93,322
Money market accounts	18,915			20,912
Savings	27,512			25,787
Time, $100,000 and over	28,042			28,553
Other time	47,440			47,804
Total deposits	290,599			251,229

Other borrowings	2,000			4,000
Interest payable and other liabilities	2,147			2,494
Total liabilities	294,746			257,723

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; 753,734 shares issued	754			754
Additional paid-in capital	4,700			4,603
Retained earnings	27,365			26,871
Treasury stock, at cost, 107,746 shares	(6,299		)	(6,299		)
Accumulated other comprehensive income (loss)	12			49
Total shareholders’ equity	26,532			25,978

Total liabilities and shareholders’ equity	$	321,278		$	283,701

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,
	2010		2009		2010		2009
Interest income
Loans (including fee income)	$	2,217	$	2,332	$	6,599	$	7,082
Securities
Taxable	163		280		541		772
Exempt from federal income tax	156		254		537		861
Certificates of deposit	280		273		771		679
Federal funds sold	20		14		35		28
Total interest income	2,836		3,153		8,483		9,422

Interest expense
NOW deposits	50		73		148		221
Money market deposits	11		22		39		98
Savings deposits	12		19		41		65
Time deposits	469		617		1,471		2,080
Other borrowings	16		32		53		98
Total interest expense	558		763		1,752		2,562

NET INTEREST INCOME	2,278		2,390		6,731		6,860
Provision for loan losses	270		120		810		510

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES	2,008		2,270		5,921		6,350

Non-interest income
Service charges on deposit accounts	181		220		558		621
Trust and farm management fees	135		138		405		410
Gain on loan sales	255		46		427		364
Securities gains	263		3		341		238
Other	185		171		581		497
Total non-interest income	1,019		578		2,312		2,130

Non-interest expense
Salaries and employee benefits	1,188		1,121		3,508		3,357
Occupancy and equipment	400		309		1,010		920
Data processing	121		127		373		393
Insurance	176		197		524		460
Professional fees	123		101		399		368
Amortization of core deposit intangible	37		37		110		110
Other real estate owned	145		46		382		111
Other	304		256		938		797
Total non-interest expense	2,494		2,194		7,244		6,516

INCOME BEFORE INCOME TAXES	533		654		989		1,964

Provision for (benefit from) income taxes	136		163		146		445

NET INCOME	$	397	$	491	$	843	$	1,519

Earnings per share-basic	$	0.62	$	0.76	$	1.30	$	2.35
Earnings per share-diluted	$	0.61	$	0.76	$	1.30	$	2.35
Dividends per share	$	0.54	$	0.92	$	0.54	$	0.92

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, 2010 and 2009

(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, 2010	$	754	$	4,603	$	26,871		$	(6,299	)	$	49		$	25,978

Net income	—		—		843			—			—			843
Unrealized net loss on securities available-for-sale, net of reclassifications and tax effects	—		—		—			—			(37		)	(37		)

Comprehensive income														806

Cash dividends declared ($.54 per share)	—		—		(349		)	—			—			(349		)

Stock options vested	—		97		—			—			—			97

Balance at September 30, 2010	$	754	$	4,700	$	27,365		$	(6,299	)	$	12		$	26,532

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 reclassifications and tax effects	—		—		—			—			588			588
Net loss relating to benefit obligation	—		—		—			—			(107		)	(107		)

Comprehensive income														2,000

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

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, 2010 and 2009

(In thousands)

(Unaudited)

	2010			2009
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	843		$	1,519
Adjustments to reconcile net income to net cash from operating activities
Provision for loan losses	810			510
Depreciation and amortization	495			394
Premium amortization on securities, net	276			287
Derivative valuation adjustment	3			87
Loans originated for sale	(17,425		)	(17,701		)
Proceeds from the sale of loans	17,223			18,232
Gain on loan sales	(427		)	(364		)
Gain on sales of securities	(341		)	(238		)
Grant of incentive shares	—			9
Vested stock options	97			89
Change in interest receivable and other assets	34			(741		)
Change in interest payable and other liabilities	54			83
Net cash from operating activities	1,642			2,166

CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from sales of securities available-for-sale	15,107			14,492
Proceeds from maturities of securities	25,463			12,152
Purchases of securities available-for-sale	(27,796		)	(36,945		)
Proceeds from maturities of certificates of deposit	12,652			14,334
Purchases of certificates of deposit	(30,149		)	(40,729		)
Net change in loans receivable	6,626			12,694
Proceeds from sale of other real estate owned	1,240			80
Net property and equipment expenditures	(739		)	(531		)
Net cash from investing activities	2,404			(24,453		)

CASH FLOWS FROM FINANCING ACTIVITIES
Change in deposits	39,370			30,729
Repayment of other borrowings	(2,000		)	(2,000		)
Proceeds from exercised options	—			70
Cash dividends paid	(750		)	(1,893		)
Net cash from financing activities	36,620			26,906

Change in cash and cash equivalents	40,666			4,619

Cash and cash equivalents at beginning of period	17,921			26,474

CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	58,587		$	31,093

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, 2010 and 2009

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, 2010 are not necessarily indicative of the results that may be expected for the year ended December 31, 2010.

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 2009 filed with the U.S. Securities and Exchange Commission. The condensed consolidated balance sheet of the Company as of December 31, 2009 has been derived from the audited consolidated balance sheet as of that date.

The Company’s wholly-owned subsidiary, The First National Bank of Ottawa (the “Bank”), operates as a full service community bank. First Ottawa Financial Corporation, a wholly owned subsidiary of the Bank, 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,
	2010		2009		2010		2009

Net income (in thousands)	$	397	$	491	$	843	$	1,519
Weighted average shares outstanding	645,988		645,985		645,988		645,500
Effect of dilutive securities:
Stock options	13		2,987		1,162		1,705
Shares used to compute diluted earnings per share	646,001		648,972		647,150		647,205

Earnings per share:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2010		2009		2010		2009

Basic	$	0.62	$	0.76	$	1.30	$	2.35
Diluted	0.61		0.76		1.30		2.35

A total of 70,874 and 32,200 options for the three month periods ended September 30, 2010 and 2009 are not included in the above calculations as they are non-dilutive. A total of 67,579 and 50,788 options for the nine month periods ended September, 2010 and 2009 are not included in the above calculations as they are non-dilutive.

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2010 and 2009

NOTE 3 — CAPITAL RATIOS

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

	September 30, 2010				December 31, 2009
	Amount		Ratio		Amount		Ratio

Total capital (to risk-weighted assets)	$	25,805	14.9	%	$	25,133	14.3	%
Tier I capital (to risk-weighted assets)	23,642		13.6	%	21,939		13.1	%
Tier I capital (to average assets)	23,642		7.9	%	21,939		8.1	%

At September 30, 2010, the Company and the Bank met the requirements to be categorized as well capitalized under general minimum regulatory requirements, and management is not aware of any conditions or events that would change the Company’s or Bank’s categories.

NOTE 4 — DERIVATIVE FINANCIAL INSTRUMENTS

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 a 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, 2010, the Company had $3.6 million of certificates of deposit, which mature in 2010 through 2015, 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.

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2010 and 2009

NOTE 5 — SECURITIES AVAILABLE-FOR-SALE

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
September 30, 2010
U. S. Treasury	$	3,584	$	21	$	—		$	3,605
Federal agencies	16,337		266		—			16,603
State and municipal	19,001		435		(139		)	19,297
Corporate	1,822		36		—			1,858
Mortgage—backed securities and collateralized mortgage obligations	2,117		105		—			2,222
Equity securities	25		1		(4		)	22

Total investment securities	$	42,886	$	864	$	(143	)	$	43,607

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
December 31, 2009
U. S. Treasury	$	5,182	$	16	$	—		$	5,198
Federal agencies	23,732		183		(38		)	23,877
State and municipal	23,332		526		(27		)	23,831
Mortgage—backed securities and collateralized mortgage obligations	3,325		115		—			3,440
Equity securities	25		4		(2		)	27

Total investment securities	$	55,596	$	844	$	(67	)	$	56,373

As of September 30, 2010 and December 31, 2009, the Company had approximately $16,089,000 and $10,884,000, respectively, invested in bonds issued by municipalities located within LaSalle County, Illinois.

Securities with an approximate carrying value of $40,998,000 and $47,793,000, were pledged at September 30, 2010 and December 31, 2009, respectively, to secure trust and public deposits, and for other purposes as required or permitted by law.

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2010 and 2009

NOTE 5 — SECURITIES AVAILABLE-FOR-SALE (Continued)

The amortized cost and fair value of contractual maturities of securities available-for-sale at September 30, 2010 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	$	12,476	$	12,463
One to five years	21,215		21,648
Five to ten years	5,678		5,952
After ten years	1,375		1,300
	40,744		41,363
Mortgage—backed securities and collateralized mortgage obligations	2,117		2,222
Equity securities	25		22

Totals	$	42,886	$	43,607

Information regarding realized gains and losses on sales of securities available-for-sale as of September 30, 2010 and 2009 follows:

	2010		2009
Gross gains	$	341	$	239
Gross losses	—		(1		)
Tax expense	116		81

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, 2010 and December 31, 2009 was $8.8 million and $14.7 million, respectively, which was approximately 20.3% and 26.1% 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 believed 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.

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2010 and 2009

NOTE 5 — SECURITIES AVAILABLE—FOR-SALE (Continued)

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, 2010
State and municipal	$	8,115	$	(133	)	$	724	$	(6	)	$	8,839	$	(139	)
Equity securities	2		(4		)	—		—			2		(4		)

Total temporarily impaired securities	$	8,117	$	(137	)	$	724	$	(6	)	$	8,841	$	(143	)

December 31, 2009
Federal agencies	$	9,814	$	(38	)	$	—	$	—		$	9,814	$	(38	)
State and municipal	4,867		(26		)	52		(1		)	4,919		(27		)
Equity securities	8		(2		)	—		—			8		(2		)

Total temporarily impaired securities	$	14,689	$	(66	)	$	52	$	(1	)	$	14,741	$	(67	)

NOTE 6 — DISCLOSURES ABOUT FAIR VALUE OF ASSETS AND LIABILITIES

FASB Accounting Standards Codification (ASC) Topic 820 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 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.

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2010 and 2009

NOTE 6 — DISCLOSURES ABOUT FAIR VALUE OF ASSETS AND LIABILITIES

(Continued)

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. There were no transfers between Level 1 and 2 classifications in the third quarter of 2010. The Company’s policy is to recognize transfers in and transfers out as of the actual date of the event or change in circumstances that caused the transfer.

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 present value of estimated future cash flows using the loan’s existing rate, or 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.

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.

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2010 and 2009

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 and non-recurring basis and the level within the FASB ASC fair value hierarchy in which the fair value measurements fall at September 30, 2010:

				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	$	3,605		$	—	$	3,605		$	—
Federal agencies	16,603			—		16,603			—
State and municipals	19,297			—		19,297			—
Corporate	1,858			—		1,858			—
Mortgage—backed securities and collateralized mortgage obligations	2,222			—		2,222			—
Equities	22			22		—			—
Interest rate swap agreements — customer CDs	885			—		885			—
Total assets	44,492			22		44,470			—

Liabilities:
Written call options-customer CDs	(885		)	—		(885		)	—

Non-recurring basis:
Impaired loans	4,719			—		—			4,719
Other real estate owned	3,942			—		—			3,942
Total assets	8,661			—		—			8,661

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2010 and 2009

NOTE 6 — DISCLOSURES ABOUT FAIR VALUE OF ASSETS AND LIABILITIES

(Continued)

				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	$	5,198		$	—	$	5,198		$	—
Federal agencies	23,877			—		23,877			—
State and municipals	23,831			—		23,831			—
Mortgage—backed securities and collateralized mortgage obligations	3,440			—		3,440			—
Equities	27			27		—			—
Interest rate swap agreements — customer CDs	835			—		835			—
Total assets	57,208			27		57,181			—

Liabilities:
Written call options — customer CDs	(835		)	—		(835		)	—

Non-recurring basis:
Impaired loans	8,914			—		—			8,914
Other real estate owned	1,898			—		—			1,898
Total assets	10,812			—		—			10,812

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 costs 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, 2010 and 2009

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, 2010 and December 31, 2009 were as follows:

	September 30,				December 31,
	2010				2009
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Assets
Cash and due from banks	$	58,587	$	58,587	$	17,921	$	17,921
Certificates of deposit (and related derivative)	58,505		59,714		41,011		41,781
Securities available-for-sale	43,607		43,607		56,373		56,373
Loans held for sale	675		675		46		46
Loans	136,256		134,599		147,105		145,690
Interest receivable	1,637		1,637		1,361		1,361

Liabilities
Deposits with no stated maturities	215,117		215,117		174,872		174,872
Time deposits	75,482		77,453		76,357		77,705
Other borrowings	2,000		2,035		4,000		4,061
Interest payable	417		417		427		427

NOTE 7 — RECLASSIFICATIONS

Certain reclassifications have been made to the December 31, 2009 condensed consolidated financial statements in order to conform to the September 30, 2010 condensed consolidated financial statement presentation. These reclassifications had no effect on net income.

NOTE 8 — SUBSEQUENT EVENTS

Subsequent to September 30, 2010, the Company was informed by a lead bank that two participation loans, the first of which is recorded at a value of $2.3 million and the second at a value of $1.5 million, may be subject to impairment or reclassification to “doubtful” or “loss” categories. The Company has ordered its own appraisals of the real estate securing the loans and may, depending on that analysis, incur impairment or other charges in the fourth quarter.

Subsequent events have been evaluated through November 12, 2010, which is the date the financial statements were issued.

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Table dollars in thousands)

September 30, 2010 and 2009

NOTE 9 — NEW ACCOUNTING PRONOUNCEMENTS

In July 2010, the FASB issued Accounting Standards Update 2010-20, Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The new guidance will increase disclosures made about the credit quality of loans and the allowance for loan losses. The disclosures will provide additional information about the nature of credit risk inherent in the Company’s loan portfolio, how credit risk is analyzed and assessed, and the reasons for the change in the allowance for loan losses. The requirements will be effective for the Company’s year ended December 31, 2010. The Company has not yet determined the impact the requirements will have on its consolidated financial statements.

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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’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, non-interest income, and non-interest 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. Non-interest 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. Non-interest expenses include salaries and employee benefits, as well as occupancy and equipment expenses and other 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, 2010, was $843,000, or $1.30 per common share, compared to net income of $1.5 million, or $2.35 per common share for the nine months ended September 30, 2009.

The Company’s assets at September 30, 2010 were $321.3 million compared to $283.7 million at December 31, 2009, an increase of $37.6 million, or 13.2%.

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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, 2009. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. The Company’s 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 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 regarding a customer’s financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company’s evaluation of imprecision risk

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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 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.

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

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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, 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 31 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.

RECENT REGULATORY DEVELOPMENTS

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), which is perhaps the most significant financial reform since the Great Depression. Among other things, the law:

· Creates a Financial Services Oversight Council to identify emerging systemic risks and improve interagency cooperation;

· Creates a Consumer Financial Protection Agency authorized to promulgate and enforce consumer protection regulations relating to financial products, which would affect both banks and non-bank finance companies;

· Establishes strengthened capital standards for banks and bank holding companies, and disallows trust preferred securities from being included in the Tier 1 capital determination for certain financial institutions;

· Enhances regulation of financial markets, including derivatives and securitization markets;

· Contains a series of provisions covering mortgage loan origination standards affecting, among other things, originator compensation, minimum repayment standards and pre-payments;

· Grants the Board of Governors of the Federal Reserve System the power to regulate debit card interchange fees;

· Prohibits certain trading activities by banks;

· Permanently increases the maximum standard FDIC deposit insurance amount to $250,000; and

· Creates an Office of National Insurance with the U.S. Department of Treasury.

While the provisions of the Act receiving the most public attention have generally been those more likely to affect larger institutions, the Act also contains many provisions which will affect smaller institutions such as the Company in substantial and unpredictable ways. Consequently, compliance with the Act’s provisions may curtail the Company’s revenue opportunities, increase its operating costs, require it to hold higher levels of regulatory capital and/or liquidity or otherwise adversely affect the Company’s business or financial results in the future. The Company’s management continues to review the provisions of the Act and assessing its

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probable impact on the Company’s business, financial condition, and result of operations. However, because many aspects of the Act are subject to future rulemaking, it is difficult to precisely anticipate its overall financial impact on the Company and the Bank at this time.

CONSOLIDATED FINANCIAL CONDITION

Total assets at September 30, 2010 were $321.3 million compared to $283.7 million at December 31, 2009, an increase of $37.6 million, or 13.2%. This increase was the result of an increase in cash and cash equivalents of $40.7 million, and increased certificates of deposits held for investments of $17.5 million. The increases were partially offset by decreases in loans of $10.8 million and securities of $12.8 million. Cash and cash equivalents increased as excess balances at the Federal Reserve Bank grew due to an increase in local municipal money collected for real estate taxes. Certificates of deposits held for investment increased as a result of the decline in the investment securities portfolio. Loan balances outstanding decreased by $10.8 million due to decreased demand primarily as a result of the contraction in the housing market and its impact on the economy, along with pay downs in the portfolio, and foreclosures and transfers to other real estate owned. Other real estate owned increased by $2.0 million.

Total liabilities at September 30, 2010 were $294.7 million compared to $257.7 million at December 31, 2009, an increase of $37.0 million, or 14.4%. This increase in total liabilities was primarily the result of a $40.6 million increase in interest-bearing demand accounts, a $1.0 million decrease in time deposit accounts, a $2.1 million decrease in non-interest bearing demand accounts, a $2.0 million decrease in other borrowings, and a $347,000 decrease in other liabilities. Increases in interest-bearing demand accounts were attributable to local municipalities receiving real estate tax payments and other seasonal payments. The decrease in other liabilities was primarily due to the payment of dividends in the first quarter. Other borrowings decreased by $2.0 million as a result of the repayment of Federal Home Loan Bank advances during the first quarter of 2010.

Total shareholders’ equity increased to $26.5 million at September 30, 2010, compared to $26.0 million at December 31, 2009. This increase was due primarily to an increase in retained earnings resulting from net income of $843,000 for the period ended September 30, 2010, which was offset by dividends in the amount of $349,000, payable to shareholders in July 2010 that were declared in June 2010.

CONSOLIDATED RESULTS OF OPERATIONS

Net income for the third quarter of 2010 was $397,000, or $0.62 per basic common share, a 19.1% decrease compared to $491,000, or $0.76 per share, in the third quarter of 2009. The decrease in net income for the quarter was primarily the result of a decrease in net interest income of $112,000, and an increase in the provision for loan losses of $150,000. Non-interest expense also increased due to an increase in other real estate owned expenses of $99,000, and an impairment charge of $81,000 taken during the third quarter of 2010, regarding the value of a former branch. Decreases in net interest income and increases in non-interest expense were partially offset by increases of $209,000 in gains on loan sales and $260,000 on gains on security sales. The decrease in income before taxes also resulted in a decrease in the income tax provision of $27,000 for the third quarter.

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During the nine months ended September 30, 2010, net income was $843,000, or $1.30 per share, compared to $1.5 million, or $2.35 per share, during the first nine months of 2009. This 44.5% decrease in net income for the nine month period was due in part to a decrease in net interest income of $129,000, and an increase in the provision for loan losses of $300,000. In addition non-interest income increased by $182,000, or 8.5%, and non-interest expense increased by $728,000 or 11.2%, compared to the nine months ended September 30, 2009. Increases in non-interest income were primarily due to gains on loan sales and also gains on the sale of securities. Increases in non-interest expense resulted from an aggregation of impairment charges regarding an investment security and also a former branch facility, increased expenses related to other real estate owned and increased insurance expenses. The decrease in the Company’s pretax income also resulted in a decrease in the income tax provision of $299,000.

The annualized return on average assets was 0.38% for the nine months ended September 30, 2010, compared to 0.72% in 2009. The annualized return on average equity decreased to 4.3% for the nine months ended September 30, 2010, from 8.0% in 2009.

NET INTEREST INCOME

Net interest income before the provision for loan losses decreased by 4.7% to $2.3 million for the three months ended September 30, 2010 as compared to 2009. Total interest income decreased to $2.8 million for the three months ended September 30, 2010, compared to $3.2 million for the three months ended September 30, 2009. This change was primarily the result of a decrease in interest income from loans to $2.2 million for the three months ended September 30, 2010 from $2.3 million for the same period a year earlier. This decrease was the result of a $6.9 million decrease in the average principal balance of the loan portfolio compared to the prior year and loans repricing downward as mortgage interest rates decreased during 2009 and 2010. In addition, a decrease in interest income from taxable investment securities of $117,000, and a decrease of interest income from tax exempt securities of $98,000, for the third quarter of 2010 compared to the prior year resulted in a change in total interest income of $317,000 for the third quarter of 2010 compared to the prior year. Total interest expense decreased to $558,000 for the three months ended September 30, 2010 from $763,000 for the same period ended September 30, 2009, which represents a 26.9% decrease. Decreased interest expense was a result of lower rates paid on deposits. The $205,000 decrease in total interest expense partially offset the decrease in total interest income for the quarter resulting in a $112,000 decrease in net interest income for the third quarter in 2010 compared to the prior year.

Net interest income before the provision for loan losses decreased by 1.9% to $6.7 million for the nine months ended September 30, 2010 as compared to 2009. There was a decrease in net interest income of $129,000 in 2010 which was the result of a $939,000 decrease in total interest income, that was partially offset by an $810,000 decrease in total interest expense compared to the prior year. Total interest income decreased to $8.5 million for the nine months ended September 30, 2010, compared to $9.4 million for the nine months ended September 30, 2009. The Company’s net interest margin was 3.82% for the nine months ended September 30, 2010 and 2009. 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 $6.8 million for the nine months ending September 30, 2010 and $7.1 million for the same period in 2009. The tax equivalent yield on average earning assets of $236.8 million in 2010 and $247.8 million for the same period in 2009, decreased to 4.81% for the nine months ended September 30, 2010 from 5.20% for the same period ended September 30, 2009, a decrease of 39 basis points. This decrease was offset by a corresponding decrease in the cost of funds to .99% from 1.38% paid

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for the same period ended September 30, 2009, a 39 basis point decrease. These decreases resulted from ongoing repricing of assets and liabilities as they matured in the decreasing rate environment in late 2009 and during the first nine months of 2010.

PROVISION FOR LOAN LOSSES

The provision for loan losses was $270,000 during the third quarter of 2010 compared to $120,000 during the third quarter of 2009. Year to date provision for loan loss was $810,000 in 2010 compared to $510,000 in 2009. This provision level, which is high compared to historical periods, is a result of ongoing national and local economic issues, including uncertainties regarding the economic downturn and recovery that could have a negative impact on the ability of borrowers to repay loans during 2010. As of September 30, 2010, the allowance for loan losses totaled $2.4 million, or 1.69% of total loans, which increased from $2.3 million, or 1.56% of total loans, as of December 31, 2009. Nonaccrual loans decreased from $6.8 million at December 31, 2009 to $4.7 million at September 30, 2010. Nonperforming loans, including nonaccrual loans, decreased $3.9 million to $5.5 million over the same period. Management believes that these nonperforming loans are well collateralized, 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 difficulties, and the level of nonperforming 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, 2010 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 was $1.0 million for the three months ended September 30, 2010 compared to $578,000 for the same period in 2009, an increase of $441,000, or 76.3%. The increase in total non-interest income was due to an increase in gains on loan sales to the secondary market of $209,000 due to increased origination and refinancing volume as interest rates have been at historical low levels for residential mortgages. The Bank sells most of the mortgage loans it originates. In addition, gains as a result of security sales increased by $260,000 in the third quarter of 2010 compared to the same period in 2009 due to increased sales activity in the current year. Service charges on deposit accounts decreased $39,000, or 17.7%, compared to the same period last year, which resulted from decreased overdraft charges

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compared to the prior year. Other income increased $14,000, or 8.2%, compared to the prior year due to an increase in rental income from other real estate owned compared to the same period in 2009.

For the nine months ended September 30, 2010, total non-interest income increased by 8.5% or $182,000 to $2.3 million. Other income increased $84,000, or 16.9%, primarily due to an increase in rental income from other real estate owned, and gains on the sale of other real estate owned. Securities gains increased $103,000 to $341,000 compared to the prior year. Also, gains on loan sales to the secondary market increased $63,000 to $427,000 compared to 2009, due to increased origination and refinancing volume. Service charges on deposit accounts decreased by $63,000, or 10.1%, due to lower overdraft volume.

NON-INTEREST EXPENSE

The Company’s total non-interest expense increased by $300,000 to $2.5 million for the three months ended September 30, 2010, compared to $2.2 million for the same period in 2009. Salaries and employee benefits, the largest component of non-interest expense, increased by $67,000, or 6.0%, to $1.2 million. In addition, professional fees expense increased by $22,000, occupancy expense increased by $91,000, other real estate owned expenses increased by $99,000, and other expenses increased by $48,000, compared to the same period in the prior year. Other real estate owned expenses increased due to an increase in repossessed properties in the current year. Occupancy expense increased by $91,000 over the prior year, primarily due to an impairment charge of $81,000 that was recorded for a former branch facility during the third quarter of 2010. Other expenses increased by $48,000 in the current year, partially due to a $20,000 increase in amortization of mortgage servicing assets as the serviced portfolio refinanced in the low rate environment during the third quarter. In addition, income tax expense decreased $27,000 to $136,000 in the third quarter of 2010 compared to the same period in 2009.

For the nine months ended September 30, 2010, total non-interest expense increased $728,000 to $7.2 million, or 11.2%, compared to the prior year period. Salaries and employee benefits increased $151,000, or 4.5%, to $3.5 million. Increases in professional fees expense of $31,000, other real estate owned expenses of $271,000, other expenses of $141,000, insurance expense of $64,000 and occupancy and equipment expenses of $90,000 were partially offset by a decrease in data processing expense of $20,000. Insurance expense increased by $64,000 compared to the prior year due to an expected increase in the FDIC insurance assessment rate for 2010. Other real estate owned expenses increased due to an increase in repossessed properties in the current year. Other expenses increased by $141,000 over the prior year due to an impairment charge of $129,000 regarding an investment security that was taken during the second quarter of 2010. Occupancy expense increased by $90,000 over the prior year due to an impairment charge of $81,000 that was recorded for a former branch facility during the third quarter of 2010. In addition, income tax expense decreased $299,000 to $146,000 in 2010 compared to the same period in 2009.

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

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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, 2010, cash and cash equivalents totaled $58.6 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.

The following table discloses contractual obligations and commercial commitments of the Company as of September 30, 2010 (dollars in thousands):

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

Lines of credit(1)	$	24,155	$	10,966	$	2,040	$	2,459	$	8,690
Federal Home Loan Bank advances	2,000		2,000		—		—		—
Data processing contract payable	668		223		445		—		—
Standby letters of credit(1)	337		337		—		—		—

	$	27,160	$	13,526	$	2,485	$	2,459	$	8,690

(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 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, 2010 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. 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.

During the third quarter of 2010, 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 1A. 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. REMOVED AND RESERVED

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 12, 2010	/S/ Joachim J. Brown
	Joachim J. Brown
	President and Chief Executive Officer
	(Principal Executive Officer)


Date: November 12, 2010	/S/ Vincent G. Easi
	Vincent G. Easi
	Chief Financial Officer
	(Principal Financial Officer)