**Exhibit 13.1**

FIRST OTTAWABANCSHARES, INC.

FORM OF 2006ANNUAL REPORT TO STOCKHOLDERS

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FIRST OTTAWA BANCSHARES,INC. AND SUBSIDIARY

Ottawa, Illinois

# CONSOLIDATED FINANCIALSTATEMENTS

December 31, 2006,2005 and 2004

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FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARY

Ottawa, Illinois

CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006, 2005 and 2004

 

 

INDEX

 

 
| SELECTED CONSOLIDATED FINANCIAL INFORMATION                                                   |   | 1      |
|-----------------------------------------------------------------------------------------------|--------|--------|
|                                                                                          |   |   |
| MANAGEMENT’ S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITIONS AND RESULTS OF OPERATIONS |   | 2      |
|                                                                                          |   |   |
| REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING  FIRM                                      |   | 17     |
|                                                                                          |   |   |
| FINANCIAL STATEMENTS                                                                          |   |   |
|                                                                                          |   |   |
| CONSOLIDATED  BALANCE SHEETS                                                                  |   | 18     |
|                                                                                          |   |   |
| CONSOLIDATED  STATEMENTS OF INCOME                                                            |   | 19     |
|                                                                                          |   |   |
| CONSOLIDATED  STATEMENTS OF SHAREHOLDERS’ EQUITY                                         |   | 20     |
|                                                                                          |   |   |
| CONSOLIDATED  STATEMENTS OF CASH FLOWS                                                        |   | 21     |
|                                                                                          |   |   |
| NOTES TO  CONSOLIDATED FINANCIAL STATEMENTS                                                   |   | 22     |

** **

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**SELECTED CONSOLIDATED FINANCIAL INFORMATION**

The following table setsforth selected consolidated financial and other data of First OttawaBancshares, Inc. and its wholly owned subsidiary, the First National Bank ofOttawa (the Bank) and the Bank’s wholly owned subsidiary, First OttawaFinancial Corporation, together referred to as the Company.  This information should be read inconjunction with the Consolidated Financial Statements and Notes theretoincluded herein.  All dollar amounts arein thousands, except per share information.
| ** **                                                                  | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                  | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Statement of Income Data:**                                               | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total interest income                                                       |       | $                                          | 14,928     |   | $ | 13,908 |   | $ | 13,537 |   | $ | 12,651 |   | $ | 13,092 |   |
| Total interest expense                                                      |       | 6,361                                      |       | 4,613 |   | 4,200 |   | 4,384 |   | 5,733 |   |
| Net interest income                                                         |       | 8,567                                      |       | 9,295 |   | 9,337 |   | 8,267 |   | 7,359 |   |
| Provision for loan  losses                                                  |       | 180                                        |       | 300 |   | 300 |   | 120 |   | 120 |   |
| Noninterest income                                                          |       | 2,776                                      |       | 2,842 |   | 3,195 |   | 2,592 |   | 2,444 |   |
| Noninterest expenses                                                        |       | 8,075                                      |       | 8,501 |   | 8,807 |   | 7,413 |   | 6,718 |   |
| Income before income  taxes                                                 |       | 3,088                                      |       | 3,336 |   | 3,425 |   | 3,326 |   | 2,965 |   |
| Provision for income  taxes                                                 |       | 753                                        |       | 791 |   | 797 |   | 867 |   | 678 |   |
|                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| Net income                                                                  |       | $                                          | 2,335      |   | $ | 2,545 |   | $ | 2,628 |   | $ | 2,459 |   | $ | 2,287 |   |
|                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| **Per Share Data:**                                                         | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income — basic                                                     |       | $                                          | 3.59       |   | $ | 3.92 |   | $ | 4.03 |   | $ | 3.75 |   | $ | 3.47 |   |
| Net income — diluted                                                   |       | 3.59                                       |       | 3.90 |   | 4.03 |   | 3.75 |   | 3.47 |   |
| Cash dividends declared                                                     |       | 3.00                                       |       | 3.00 |   | 3.00 |   | 3.00 |   | 3.00 |   |
| Book value at end of  year (1)                                              |       | 38.08                                      |       | 37.43 |   | 36.54 |   | 35.54 |   | 34.97 |   |
|                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| **Selected Financial Ratios:**                                              | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Return on average assets  (1)                                               |       | .82                                        | %          | .87 | % | .88 | % | 1.00 | % | .99 | % |
| Return on average  equity (1)                                               |       | 9.43                                       |       | 10.50 |   | 11.05 |   | 10.50 |   | 9.73 |   |
| Dividend payout ratio                                                       |       | 83.57                                      |       | 76.53 |   | 74.44 |   | 79.79 |   | 86.46 |   |
| Average equity to  average assets (1)                                       |       | 8.71                                       |       | 8.30 |   | 7.96 |   | 9.56 |   | 10.20 |   |
| Net interest margin (tax  equivalent)                                       |       | 3.50                                       |       | 3.70 |   | 3.60 |   | 3.89 |   | 3.77 |   |
| Allowance for loan  losses to total loans at the end of period              |       | .91                                        |       | .88 |   | .88 |   | .80 |   | 1.06 |   |
| Nonperforming loans to  total loans at the end of period (2)                |       | .42                                        |       | .87 |   | 1.55 |   | 2.04 |   | 1.83 |   |
| Net loans charged off  to average total loans                               |       | .04                                        |       | .09 |   | .13 |   | .21 |   | .06 |   |
|                                                                        |       |                                       |       |   |   |   |   |   |   |   |   |
| **Balance Sheet Data:**                                                     | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total assets                                                                |       | $                                          | 278,053    |   | $ | 278,739 |   | $ | 288,659 |   | $ | 294,490 |   | $ | 240,662 |   |
| Total earning assets                                                        |       | 253,259                                    |       | 253,641 |   | 262,618 |   | 276,767 |   | 223,324 |   |
| Average assets                                                              |       | 282,729                                    |       | 290,765 |   | 299,665 |   | 247,961 |   | 232,335 |   |
| Gross loans, including  loans held for sale                                 |       | 160,938                                    |       | 152,860 |   | 134,493 |   | 131,948 |   | 111,454 |   |
| Allowance for loan  losses                                                  |       | 1,463                                      |       | 1,344 |   | 1,174 |   | 1,049 |   | 1,167 |   |
| Total deposits                                                              |       | 250,341                                    |       | 239,881 |   | 253,964 |   | 264,921 |   | 193,767 |   |
| Federal funds purchased  and securities sold under agreements to repurchase |       | —                                     |       | 12,700 |   | 6,350 |   | — |   | 16,322 |   |
| Shareholders’ equity                                                   |       | 23,509                                     |       | 22,858 |   | 23,852 |   | 24,655 |   | 25,183 |   |

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(1)     Excludesunrealized gain (loss) on securities available-for-sale.

(2)   Includes total nonaccrual loans, impairedloans, and all other loans 90 days past due and still accruing interest.

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**MANAGEMENT’S DISCUSSIONAND ANALYSIS**

**OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

The following discussionand analysis is intended as a review of significant factors affecting thefinancial condition and results of operations of the Company for the periodsindicated.  The discussion should be readin conjunction with the Consolidated Financial Statements and Notes thereto andthe Selected Consolidated Financial Data presented herein.  In addition to historical information, thefollowing Management’s Discussion and Analysis of Financial Condition andResults of Operations contains forward looking statements that involve risksand uncertainties.  The Company’s actualresults could differ significantly from those anticipated in these forward-lookingstatements as a result of certain factors discussed elsewhere in this report,including under “Risk Factors” in Item I.A. of our Form 10-K.

# **Overview**

The Company’s principalbusiness is conducted by the Bank and consists of a full range of community-basedfinancial services, including commercial and retail banking.  The profitability of the Company’s operationsdepends primarily on its net interest income, provision for loan losses, otherincome, and other expenses.  Net interestincome is the difference between the income the Company receives on its loanand securities portfolios and its cost of funds, which consists of interest paidon deposits and borrowings.  The provisionfor loan losses reflects the cost of credit risk in the Company’s loanportfolio.  Other income consists ofservice charges on deposit accounts, trust and farm management fee income,securities gains (losses), gains (losses) on sales of loans, and otherincome.  Other expenses include salariesand employee benefits, as well as occupancy and equipment expenses and othernoninterest expenses.

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

Net income was $2.3million for the year ended December 31, 2006 compared to $2.5 million for theyear ended December 31, 2005.  The returnon average assets was .82% in 2006 compared to .87% in 2005.  The return on average equity decreased to9.43% in 2006 from 10.50% in 2005.  Thisresulted primarily from the decrease in net income partially offset by thechange in average equity due to stock repurchases in 2006 and 2005.

Net income was $2.5million for the year ended December 31, 2005 compared to $2.6 million for theyear ended December 31, 2004.  The returnon average assets was .87% in 2005 compared to .88% in 2004.  The return on average equity decreased to10.50% in 2005 from 11.05% in 2004.  Thisresulted primarily from the decrease in net income partially offset by thechange in average equity due to stock repurchases in 2005 and 2004.

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# **Critical Accounting Policies**

The accounting andreporting policies of the Company are in accordance with accounting principlesgenerally accepted in the United States of America and conform to generalpractices within the banking industry.  The Company’s significantaccounting policies are described in detail in the notes to the Company’sconsolidated financial statements for the year ended December 31, 2006.The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions. The financial position and results of operations can be affected bythese estimates and assumptions and are integral to the understanding ofreported results. Critical accounting policies are those policies thatmanagement believes are the most important to the portrayal of the Company’sfinancial condition and results, and they require management to make estimatesthat are difficult, subjective, or complex.

**Allowance for Credit Losses–**Theallowance for credit losses provides coverage for probable losses inherent inthe Company’s loan portfolio.  Managementevaluates the adequacy of the allowance for credit losses each quarter based onchanges, if any, in underwriting activities, the loan portfolio composition(including product mix and geographic, industry or customer-specificconcentrations), trends in loan performance, regulatory guidance and economicfactors. This evaluation is inherently subjective, as it requires the use ofsignificant management estimates. Many factors can affect management’sestimates of specific and expected losses, including volatility of defaultprobabilities, rating migrations, loss severity and economic conditions.  The allowance is increased through provisionscharged to operating earnings and reduced by net charge-offs.

The Company determinesthe amount of the allowance based on relative risk characteristics of the loanportfolio.  The allowance recorded forcommercial loans is based on reviews of individual credit relationships and ananalysis of the migration of commercial loans and actual loss experience.  The allowance recorded for homogeneousconsumer loans is based on an analysis of loan mix, risk characteristics of theportfolio, fraud loss and bankruptcy experiences, and historical losses, adjustedfor current trends, for each homogeneous category or group of loans.  The allowance for credit losses relating toimpaired loans is based on the loan’s observable market price, thecollateral for certain collateral-dependent loans, or the discounted cash flowsusing the loan’s effective interest rate.

Regardless of the extentof the Company’s analysis of customer performance, portfolio trends or riskmanagement processes, certain inherent but undetected losses are probablewithin the loan portfolio.  This is dueto several factors including inherent delays in obtaining information regardinga customer’s financial condition or changes in their unique businessconditions, the judgmental nature of individual loan evaluations, collateralassessments and the interpretation of economic trends.  Volatility of economic or customer-specificconditions affecting the identification and estimation of losses for larger non-homogeneouscredits and the sensitivity of assumptions utilized to establish allowances forhomogenous groups of loans are among other factors.  The Company estimates a range of inherentlosses related to the existence of these exposures.  The estimates arebased upon the Company’s evaluation of imprecise risk

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associated with thecommercial and consumer allowance levels and the estimated impact of thecurrent 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 intangibleassets in the consolidated balance sheet. The value of the capitalized servicing rights represents the presentvalue of the future servicing fees arising from the right to service loans inthe portfolio.  Critical accountingpolicies for MSRs relate to the initial valuation and subsequent impairmenttests.  The methodology used to determinethe valuation of MSRs requires the development and use of a number ofestimates, including anticipated principal amortization and prepayments of thatprincipal balance.  Events that maysignificantly affect the estimates used are changes in interest rates, mortgageloan prepayment speeds and the payment performance of the underlyingloans.  The carrying value of the MSRs isperiodically reviewed for impairment based on a determination of fairvalue.  For purposes of measuringimpairment, the servicing rights are compared to a valuation prepared based ona discounted cash flow methodology, utilizing current prepayment speeds anddiscount rates.  Impairment, if any, isrecognized through a valuation allowance and is recorded as amortization ofintangible assets.

**Derivatives–**Asa part of the Company’s funding strategy, derivative financial instruments, allof which are interest rate swap arrangements, are used to reduce exposure tochanges in interest rates for certain financial instruments.  Thesederivatives are accounted for by recognizing the fair value of the contracts onthe balance sheet.  The valuation of these derivatives is consideredcritical because carrying assets and liabilities at fair value inherentlyresults in more financial statement volatility.  The fair values and theinformation used to record valuation adjustments for the interest rate swapsand related deposit products are provided by third parties.

Additionally, the Companyhas purchased certificate of deposits which contain an equity related embeddedderivative component.  The initial investment in the certificate ofdeposit is not at risk but the return on the investment is based on appreciationin the S&P 500 Index.  Accordingly,the fair value of the embedded derivative is recorded at fair value as anadjustment to the certificate of deposit and interest income.

**Stock Compensation–**Grants under the Company’s stock incentive plan are accounted for underthe provisions of Statement of Accounting Standards (SFAS) No. 123R, applyingthe fair value method and the use of an option pricing model to estimate thevalue of the options granted.  The stockoptions are granted with an exercise price equal to the market price at thedate of grant.  Resulting compensationexpense, under the stock options, is measured and recorded based onthe estimated value of the options.

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**Consolidated Financial Condition**

Total assets at December31, 2006 were $278.1 million compared to $278.8 million at December 31,2005, a decrease of $0.7 million, or 0.2%. Despite the decrease in our total assets, our total loans increased 5.3%in 2006 to $161 million.  Commercial andagricultural loans increased $5.9 million to $39.6 million during 2006 dueto an effort by management to increase the size of the commercial loanportfolio.  Real estate loans alsoincreased by $7.1 million to $102.5 million during 2006, again due to an effortby management to increase the size of the commercial and residential realestate portfolios.  These increases werepartially offset by the decrease in installment loans of $4.1 million to $7.4million during 2006 due to a general decline in indirect lending volume andmore stringent underwriting guidelines on consumer loans. Investment securitiesdecreased by $7.5 million to $83.1 million, and certificates of deposit held for investment purposes decreased by$5.4 million to $6.1 million during 2006. Premises and equipment decreased by $300,000 due to a reduction incapital expenditures on existing buildings. The increase in loans was funded bya decrease in securities and certificates of deposit held for investmentpurposes. Federal funds decreased $12.7 million as total deposits increased$10.1 million.  This increase wasprimarily a result of management’s decision to offer a number of special ratedeposit products which were designed to attract customers in new markets in2006.

Total equity was $23.5million at December 31, 2006 compared to $22.9 million at December 31,2005.  The increase was primarily theresult of a decrease in the unrealized gain on securities available-for-sale,net of tax, of $223,000, and $64,000 in additional paid in capital related tothe Company’s incentive stock option plan. Dividends declared of $1.9 millionand the repurchase of Company common stock for $22,000 were offset by netincome of $2.3 million.

# **Consolidated Results of Operations**

# **2006 Compared to 2005**

*Net Interest Income.*  Net interest income was $8.6 million and $9.3million in 2006 and 2005.  Interestincome on earning assets increased $1.0 million in 2006 from 2005.  This increase was primarily attributable toincreased interest income earned on the loan portfolio of $1.8 million, andfederal funds sold of $138,000. The increases were attributable to increases inaverage balances and also average yields available in the marketplace in 2006.Increases were offset by decreased interest income earned on taxable and nontaxable securities of $575,000, and certificates of deposit held for investmentof $316,000.  Interest expense oninterest-bearing liabilities increased $1.7 million as a result of an increasein the average rate paid on liabilities of 82 basis points, from 1.98% in 2005to 2.80% in 2006.  The net interestmargin on a tax equivalent basis decreased to 3.50% in 2006 from 3.70% in2005.  The primary reason for thedecrease in the net interest margin was the result of an increase in the marketrates offered on liabilities, and a more rapid upward repricing of liabilitiesduring a gradual reallocation of assets to loans which earn at higher ratesthan other types of interest-bearing assets.

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*Provision for Loan Losses.*  The provision for loan losses was $180,000 in2006 compared to $300,000 in 2005.  As ofDecember 31, 2006, the allowance for loan losses totaled $1.5 million, or .91%of total loans, compared to $1.3 million, or .88% of total loans, at December31, 2005.  The modest increase in theallowance for loan losses in 2006 was influenced by the continued growth in theloan portfolio.  Continued improvement inasset quality and a decreasing net charge off trend resulted in the decrease inthe 2006 provision for loan losses.

The amounts of theprovision and allowance for loan losses are influenced by current economicconditions, actual loss experience, industry trends and other factors,including real estate values in the Company’s market area and management’sassessment of current collection risks within the loan portfolio.  Along with other financial institutions,management shares a concern for the outlook of the economy for 2007.  Even though there are indications of emergingstrength, it is uncertain if this strength is sustainable. If it is notsustainable, borrowers may experience difficulty, and the level of non-performingloans, charge-offs, and delinquencies could rise and require increases in theprovision.  In addition, regulatoryagencies have warned of possible higher charge-offs in the industry if theeconomy continues to weaken.  Theallowance for loan losses represents management’s estimate of probable incurredlosses based on information available as of the date of the financialstatements.  The allowance for loanlosses 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 andvolume of the portfolio, information about specific borrower situations andestimated collateral values, and economic conditions.

Management hasconcluded that the allowance for loan losses was adequate at December  31,2006.  However, there can be no assurancethat the allowance for loan losses will be adequate to cover all losses.

*Noninterest Income.*  The Company’s noninterest income decreased$66,000, or 2.3%, compared to 2005. Noninterest income decreased primarily due to losses on securities soldof $13,000 in 2006, a decrease of $185,000 compared to the gains experienced in2005, as the Company sold securities for a gain in 2005.  Gains on loan sales to the secondary marketdecreased $60,000 to $31,000 in 2006 compared to 2005 as a result of feweroriginations of residential real estate loans because of the general increasein interest rates in 2006.  Servicecharges on deposit accounts decreased by $147,000, or 13.2%, to $1.0million.  Other income increased by$282,000, or 29.0%, compared to 2005. This increase was primarily due to a $371,000 increase in the marketvalue of derivatives related to index powered certificates of deposit held forinvestments and for customers of the Bank. Trust and farm management fee income increased by $44,000, to $540,000in 2006 compared to 2005.

*NoninterestExpense.*  The Company’snoninterest expense was $8.1 million in 2006 and $8.5 million for 2005.  Salariesand benefits, which is the largest component of non-interest expense, decreased $104,000, to $4.5 million in2006. Decreases inoccupancy and equipment expense of $21,000, supplies expense of $63,000,professional fees of $96,000, amortization of core deposit intangible expenseof $64,000, and other expenses of $100,000 were partially offset by an increasein data processing expense of $22,000 in 2006. Other expense was reduced due to decreased collection expenses,decreased secondary mortgage market expenses, and decreased miscellaneousoperating expenses.  Income tax expensedecreased by $38,000 compared to the

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prior year. TheCompany’s effective tax rate increased slightly due to an increase in stateincome tax expense.

*Income Taxes.*  The Company’s tax rate varied from statutoryrates principally due to interest income from tax-exempt securities andloans.  The Company’s effective tax ratewas 25.2% and 23.7% for 2006 and 2005.

# **2005 Compared to 2004**

*Net Interest Income.*  Net interest income was $9.3 million in 2005and 2004.  Interest income on earningassets increased $371,000 in 2005 from 2004. This increase was primarily attributable to increased interest incomeearned on the loan portfolio of $1.1 million, tax exempt securities of $50,000,and federal funds sold of $193,000. The increases were attributable toincreases in average balances and also average tax-equivalent yields availablein the marketplace in 2005. Increases were offset by decreased interest incomeearned on taxable securities of $904,000, and certificates of deposit held forinvestment of $78,000.  Interest expenseon interest-bearing liabilities increased $413,000 as a result of an increasein the average rate paid on liabilities of 25 basis points, from 1.72% in 2004to 1.98% in 2005.  The net interestmargin on a tax equivalent basis increased to 3.70% in 2005 from 3.60% in2004.  The primary reason for theincrease in the net interest margin was the result of a gradual reallocation toloans which earn at higher rates than other types of interest-bearing assets.

*Provision for Loan Losses.*  The provision for loan losses remainedconstant at $300,000 in 2005 and 2004. As of December 31, 2005, the allowance for loan losses totaled $1.3million, or .88% of total loans, compared to $1.2 million, or .88% of totalloans, at December 31, 2004.  Theincrease in the allowance for loan losses in 2005 was influenced by thecontinued growth in the loan portfolio.

The amounts of theprovision and allowance for loan losses are influenced by current economicconditions, actual loss experience, industry trends and other factors,including real estate values in the Company’s market area and management’sassessment of current collection risks within the loan portfolio.  Along with other financial institutions,management shared a concern for the outlook of the economy for 2006.  The allowance for loan losses representsmanagement’s estimate of probable incurred losses based on informationavailable as of the date of the financial statements.  The allowance for loan losses is based onmanagement’s evaluation of the collectibility of the loan portfolio, includingpast loan loss experience, known and inherent risks in the nature and volume ofthe portfolio, information about specific borrower situations and estimatedcollateral values, and economic conditions.

Management hasconcluded that the allowance for loan losses is adequate at December  31,2005.  However, there can be no assurancethat the allowance for loan losses will be adequate to cover all losses.

*Noninterest Income.*  The Company’s noninterest income decreased$353,000, or 11.0%, compared to 2004. Noninterest income decreased primarily due to gains on securities soldof $172,000 in 2005, a decrease of $293,000 compared to 2004, as the Companysold a large amount of securities for a gain in 2004.  Gains on loan sales to the secondary market decreased$163,000 to $91,000 in

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2005 compared to 2004 as a result of feweroriginations of residential real estate loans in 2004 because of the generalincrease in interest rates in 2005. Service charges on deposit accounts increased modestly by $23,000, or2.1%, to $1.1 million.  Other incomeincreased by $68,000, or 7.5%, compared to 2004.  This increase is primarily due to a $188,000increase in the market value of derivatives related to index poweredcertificates of deposit held for investments and for customers of theBank.  Trust and farm management feeincome increased modestly by $12,000, to $496,000 in 2005 compared to 2004.

*NoninterestExpense.*  The Company’snoninterest expense was $8.5 million in 2005 and $8.8 million for 2004.  Salaries and benefits, which is the largestcomponent of noninterest expense, remained constant at $4.7 million.  Increases in occupancy and equipment expenseof $10,000, data expense of $37,000, and supplies expense of $46,000 wereoffset by decreases in professional fees of $40,000, amortization of coredeposit intangible expense of $80,000, and other expenses of $279,000.  Other expense was reduced due to decreasedcollection expenses, decreased secondary mortgage market expenses, decreaseddirectors’ life insurance expense and decreased miscellaneous loanexpenses.  Income tax expense decreasedby $6,000 compared to the prior year. The Company’s effective tax rateincreased slightly due to an increase in state income tax expense.

*Income Taxes.*  The Company’s tax rate varied from statutoryrates principally due to interest income from tax-exempt securities andloans.  The Company’s effective tax ratewas 23.7% and 23.3% for 2006 and 2005.

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The components of thechanges in net interest income are shown below. Changes in net interest income are allocated between amounts attributedto changes in rate and changes in volume for the various categories of interest-earningassets and interest-bearing liabilities.

Analysis of Changes inInterest Income and Expense

($000s)
| ** **                                             | ** ** | **2006 — 2005** | ** ** | **2005 — 2004** | ** ** |
|--------------------------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **                                             | ** ** | **Increase (Decrease)**   | ** ** | **Increase (Decrease)**   | ** ** |
| ** **                                             | ** ** | ** **                     | ** ** | **Change**                     | ** ** | **Change** | ** ** | ** ** | ** ** | **Change** | ** ** | **Change** | ** ** |
| ** **                                             | ** ** | **Total**                      | ** ** | **Due to**                | ** ** | **Due to** | ** ** | **Total** | ** ** | **Due to** | ** ** | **Due to** | ** ** |
| ** **                                             | ** ** | **Change**                     | ** ** | **Volume**                     | ** ** | **Rate** | ** ** | **Change** | ** ** | **Volume** | ** ** | **Rate** | ** ** |
|                                                   |       |                           |       |                           |       |   |   |   |   |   |   |   |   |
| INTEREST INCOME                                   |       |                           |       |                           |       |   |   |   |   |   |   |   |   |
| Loans                                                  |       | $                              | 1,793      |                           | $          | 1,227 |   | $ | 566 |   | $ | 1,136 |   | $ | 708 |   | $ | 428 |   |
| Investment CDs                                         |       | (316                           | )          | (281                           | )          | (35 | ) | (78 | ) | (101 | ) | 23 |   |
| Securities                                             |       | (626                           | )          | (618                           | )          | (8 | ) | (828 | ) | (701 | ) | (127 | ) |
| Federal funds sold                                     |       | 138                            |       | 26                             |       | 112 |   | 193 |   | 107 |   | 86 |   |
| Total interest income                                  |       | 989                            |       | 353                            |       | 636 |   | 423 |   | 13 |   | 410 |   |
|                                                   |       |                           |       |                           |       |   |   |   |   |   |   |   |   |
| INTEREST EXPENSE                                       |       |                           |       |                           |       |   |   |   |   |   |   |   |   |
|                                                   |       |                           |       |                           |       |   |   |   |   |   |   |   |   |
| NOW and money market                                   |       | 671                            |       | (127                           | )          | 798 |   | 116 |   | (114 | ) | 230 |   |
| Savings                                                |       | (10                            | )          | (10                            | )          | — |   | (31 | ) | (11 | ) | (20 | ) |
| Time deposits                                          |       | 1,033                          |       | 55                             |       | 978 |   | 297 |   | 9 |   | 288 |   |
| Repurchase agreements                                  |       | (4                             | )          | —                         |       | (4 | ) | 2 |   | — |   | 2 |   |
| Borrowings                                             |       | (8                             | )          | —                         |       | (8 | ) | (4 | ) | (20 | ) | 16 |   |
| Federal funds purchased                                |       | 66                             |       | 38                             |       | 28 |   | 33 |   | 18 |   | 15 |   |
| Total interest expense                                 |       | 1,748                          |       | (45                            | )          | 1,793 |   | 413 |   | (118 | ) | 531 |   |
|                                                   |       |                           |       |                           |       |   |   |   |   |   |   |   |   |
| Net interest earnings                                  |       | (759                           | )          | 398                            |       | (1,157 | ) | 10 |   | 131 |   | (121 | ) |
| Tax equivalent adjustment                              |       | 31                             |       | —                         |       | 31 |   | (52 | ) | — |   | (52 | ) |
|                                                   |       |                           |       |                           |       |   |   |   |   |   |   |   |   |
| Net interest earnings  after tax equivalent adjustment |       | $                         | (728       | )                              | $     | 398 |   | $  | (1,126 | ) | $  | (42 | ) | $  | 131 |   | $  | (173 | ) |

 

Volume/rate variances areallocated to the volume variance and the rate variance on an absolutebasis.  Tax-exempt income is reflected ona fully tax-equivalent basis utilizing a 34% rate for municipal securities andtax-exempt loans.

# **Interest**-**Earning Assets and Interest**-**BearingLiabilities**

The following table setsforth the average balances, net interest income and expense, and average yieldsand rates for the Company’s interest-earning assets and interest-bearingliabilities for the indicated years on a tax-equivalent basis assuming a 34%tax rate.

9

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# Analysis of AverageBalances, Tax Equivalent Yields and Rates

Years EndedDecember 31, 2006, 2005 and 2004

(in Thousands)
| ** **                                                                | ** ** | **2006**             | ** ** | **2005**     | ** ** | **2004**    | ** ** |
|---------------------------------------------------------------------------|------------|----------------------|------------|--------------|------------|-------------|------------|
| ** **                                                                | ** ** | **Average**          | ** ** | ** **   | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                                | ** ** | **Balance (4)** | ** ** | **Interest** | ** ** | **Rate**    | ** ** | **Balance (4)** | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance (4)** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| **A**SSETS                                                                | ** ** | ** **           | ** ** | ** **   | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans (1) (3)                                                             |       | $                    | 159,145    |         | $          | 11,260      |       | 7.08 | % | $ | 141,807 |   | $ | 9,467 |   | 6.68 | % | $ | 131,191 |   | $ | 8,331 |   | 6.35 | % |
| Investment CDs                                                            |       | 8,128                |       | 239          |       | 2.94        |       | 17,685 |   | 555 |   | 3.14 |   | 20,910 |   | 633 |   | 3.03 |   |
| Securities (2) (5)                                                        |       | 85,448               |       | 3,583        |       | 4.19        |       | 100,187 |   | 4,209 |   | 4.20 |   | 116,892 |   | 5,037 |   | 4.31 |   |
| Federal funds sold                                                        |       | 7,127                |       | 371          |       | 5.21        |       | 6,635 |   | 233 |   | 3.51 |   | 3,589 |   | 40 |   | 1.11 |   |
| Interest-arning assets                                                    |       | 259,848              |       | 15,453       |       | 5.95        |       | 266,314 |   | 14,464 |   | 5.43 |   | 272,582 |   | 14,041 |   | 5.15 |   |
| Noninterest-earning  assets (6)                                           |       | 22,881               |       |         |       |        |       | 29,365 |   |   |   |   |   | 27,083 |   |   |   |   |   |
|                                                                      |       |                 |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Average  assets                                                           |       | $                    | 282,729    |         |       |        |       |   | $ | 295,679 |   |   |   |   |   | $ | 299,665 |   |   |   |   |   |
|                                                                      |       |                 |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                           |       |                 |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                      |       |                 |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| NOW and money market                                                      |       | $                    | 93,042     |         | 2,041      |        | 2.19       |   | $ | 98,826 |   | 1,370 |   | 1.39 |   | $ | 107,136 |   | 1,254 |   | 1.17 |   |
| Savings                                                                   |       | 25,067               |       | 130          |       | .52         |       | 27,083 |   | 140 |   | .52 |   | 29,121 |   | 171 |   | .59 |   |
| Time deposits                                                             |       | 106,750              |       | 4,067        |       | 3.81        |       | 105,301 |   | 3,034 |   | 2.88 |   | 105,002 |   | 2,737 |   | 2.61 |   |
| Repurchase agreements                                                     |       | —               |       | —       |       | —      |       | 232 |   | 4 |   | 1.72 |   | 215 |   | 2 |   | .93 |   |
| Federal funds purchased                                                   |       | 2,470                |       | 123          |       | 4.98        |       | 1,715 |   | 57 |   | 3.32 |   | 1,175 |   | 24 |   | 2.04 |   |
| Borrowings                                                                |       | —               |       | —       |       | —      |       | 126 |   | 8 |   | 6.35 |   | 438 |   | 12 |   | 2.74 |   |
| Interest-bearing  liabilities                                             |       | 227,329              |       | 6,361        |       | 2.80        |       | 233,283 |   | 4,613 |   | 1.98 |   | 243,087 |   | 4,200 |   | 1.73 |   |
|                                                                      |       |                 |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net  interest income (2)                                                  |       |                 |       | 9,092        |       |        |       |   |   | 9,851 |   |   |   |   |   | 9,841 |   |   |   |
| Net  yield on interest-earning assets                                     |       |                 |       |         |       | 3.50        |       |   |   |   |   | 3.70 |   |   |   |   |   | 3.61 |   |
| Interest-bearing  liabilities to earning assets ratio                     |       |                 |       |         |       | 87.49       |       |   |   |   |   | 87.60 |   |   |   |   |   | 89.18 |   |
|                                                                      |       |                 |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing  liabilities                                          |       | 32,175               |       |         |       |        |       | 38,959 |   |   |   |   |   | 32,185 |   |   |   |   |   |
|                                                                      |       |                 |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Shareholders’ equity                                                 |       | 23,225               |       |         |       |        |       | 23,487 |   |   |   |   |   | 24,393 |   |   |   |   |   |
| Average  liabilities and shareholders’ equity                        |       | $               | 282,729    |         |       |        |       |   | $  | 295,679 |   |   |   |   |   | $  | 299,665 |   |   |   |   |   |
| Tax equivalent  adjustment                                                |       |                 |       | 525          |       |        |       |   |   | 556 |   |   |   |   |   | 504 |   |   |   |
| Net interest income as reported in the consolidated statements of  income |       |                 |       | $       | 8,567      |        |       |   |   |   | $  | 9,295 |   |   |   |   |   | $  | 9,337 |   |   |   |

----

(1)          Interest income on loans includes loanorigination and other fees of $98 for 2006, $136 for 2005, and $168 for 2004.

(2)          Loan and securities income is reflected ona fully tax-equivalent basis utilizing a 34% rate for municipal securities andtax-exempt loans.

(3)          Non-accrual loans are included in averageloans.

(4)          Average balances are derived from theaverage daily balances.

(5)          Rate information is calculated based uponaverage amortized cost.

(6)          Average balance information includes an averagevaluation allowance for securities of $(2,327), $(1,228) and $909,respectively.

10

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# **Impact of Accounting Changes**

**Share Based Payment**

The Company has a stock-based employee compensationplan, which is described in Notes of Financial Statements included in theDecember 31, 2006 Annual Report to shareholders.

Effective January 1, 2006, the Company adoptedStatement of Financial Accounting Standards No. 123(R), Share-BasedPayment (“SFAS 123(R)”).  SFAS 123(R)addresses all forms of share-based payment awards, including shares underemployee stock purchase plans, stock options, restricted stock and stockappreciation rights. SFAS 123(R) requires all share-based payments to berecognized as expense, based upon their fair values, in the financial statementsover the vesting period of the awards.

Since the Company previously accounted for its stockoptions in accordance with SFAS No. 123, the adoption of SFAS No. 123(R) didnot have a significant impact on the Company’s financial condition or resultsof operation. Certain disclosures required by SFAS No. 123(R), have beenomitted due to their immaterial nature.

**Servicing Assets and Liabilities**

In March 2006, the FinancialAccounting Standards Board (FASB) issued Statement of Financial AccountingStandard (SFAS) No. 156.  This Statementamends SFAS 140, *Accounting for Transfersand Servicing of Financial Assets and Extinguishments of Liabilities,*with respect to the accounting for separately recognized servicing assets andservicing liabilities.

SFAS No. 156 requires anentity to initially recognize a servicing asset or servicing liability at fairvalue each time it undertakes an obligation to service a financial asset byentering into a servicing contract in other specific situations.

Inaddition, SFAS No. 156 permits an entity to choose either of the followingsubsequent measurement methods for each class of separately recognizedservicing assets and servicing liabilities:

·                  Amortizationmethod—Amortize servicing assets or servicing liabilities in proportion to andover the period of estimated net servicing income or net servicing loss andassess servicing assets or servicing liabilities for impairment or increasedobligation based on fair value at each reporting date.

·                  Fairvalue measurement method—Measure servicing assets or servicing liabilities atfair value at each reporting date and report changes in fair value in earningsin the period in which the changes occur.

SFAS No. 156 is effective atthe beginning of an entity’s first fiscal year that begins after September 15,2006 and should be applied prospectively for recognition and initialmeasurement of servicing assets and servicing liabilities.  Earlier adoption is permitted as of the

11

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beginning of an entity’sfiscal year, provided the entity has not yet issued financial statements,including interim financial statements, for any period of that fiscal year.

The Company did not earlyadopt SFAS No. 156 on January 1, 2006. Adoption of SFAS No. 156 is not expected to have a significant impact onthe Company’s financial condition or results of operation.

**Statement of Financial AccountingStandards (SFAS) No. 158, Employers’ Accounting for Defined Benefit Pension andOther Postretirement Plan—an amendment of SFAS No. 87, 88, 106 and 132(r).**

In September, 2006, theFinancial Accounting Standards Board (FASB) issued SFAS No. 158.  This statement requires an entity thatsponsors one or more single-employer defined benefit plans to recognize thefunded status of a benefit plan (measured as the difference between the fairvalue of plan assets and the benefit obligation) in its statement of financialposition.  For a pension plan, thebenefit obligation is the projected benefit obligation and for any other planthe benefit obligation is the accumulated postretirement benefitobligation.  Additionally, all itemspreviously deferred when applying SFAS No. 87 or SFAS No. 106 will now berecognized as a component of accumulated other comprehensive income, net ofapplicable taxes.  SFAS No. 158 will notchange the components of net periodic benefit cost.  SFAS No. 158 will require plan asset andbenefit obligations to be measured primarily as of the balance sheet date.  The effective date for the recognition of thefunded status on the balance sheet is for fiscal years ending after December15, 2006 while the effective date for the requirement that the measurement dateof plan assets and the benefit obligation be the same as the balance sheet dateis for fiscal years ending after December 15, 2008.

**Future Accounting Pronouncements**

**Emerging Issues Task Force Issue06-4.** In September2006, the Emerging Issues Task Force (EITF) reached a consensus regarding theaccounting for entities with split-dollar life insurance arrangements thatprovide an employee with a specified benefit that is not limited to an employee’sactive service period.  In reaching itsconsensus, the EITF determined that an employer should recognize as a liabilitythe future benefits to be provided to employees beyond the employees activeservice period.  In the case ofsplit-dollar plan that provides a death benefit to the employees designatedbeneficiary and the benefit is provided to the employee beyond their activeservice period, an entity should accrue a liability during the employee’sactive service period for the cost of maintaining the life insurance policyduring the employee’s retirement period.  EITF 06-4 is effective for fiscal years beginning after December 15,2007 with earlier application permitted. Entities should recognize the effects of applying EITF 06-4 either as achange in accounting principle through a cumulative-effect adjustment toretained earnings or other components of equity as of the beginning of the yearof adoption or as a change in accounting principle through retrospectiveapplication to all prior periods.

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**QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

The Company uses overallrisk sensitivity to monitor and manage exposure to sudden changes in interestrates.  The Company’s overall interestrate sensitivity is demonstrated by a net interest income analysis.  Net interest income analysis measures thechange in net interest income in the event of hypothetical changes in interestrates.  This analysis assesses the riskof change in net interest income in the event of sudden and sustained 1.0%increases and decreases in market interest rates.  The tables below present the Company’sprojected changes in net income for the various rate shock levels for theperiods ended December 31, 2006 and 2005.
| ** **   | ** ** | **2006 Net Interest Income** | ** ** |
|--------------|------------|---------------------------------------------|------------|
| ** **   | ** ** | ** **                                  | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| ** **   | ** ** | **Amount**                                  | ** ** | **Change** | ** ** | **Change** | ** ** |
| ** **   | ** ** | **(Dollars in Thousands)**        | ** ** |
|         |       |                                        |       |   |   |   |   |
| +100 bp      |       | $                                           | 2,564      |   | $ | (36 | ) | (1.4 | )% |
| Base         |       | 2,600                                       |       | — |   | — |   |
| –100 bp |       | 2,683                                       |       | 83 |   | 3.2 | % |
|              |            |                                             |            |  |  |  |  |  |  |

 
| ** **   | ** ** | **2005 Net Interest Income** | ** ** |
|--------------|------------|---------------------------------------------|------------|
| ** **   | ** ** | ** **                                  | ** ** | ** ** | ** ** | **Percentage** | ** ** |
| ** **   | ** ** | **Amount**                                  | ** ** | **Change** | ** ** | **Change** | ** ** |
| ** **   | ** ** | **(Dollars in Thousands)**        | ** ** |
|         |       |                                        |       |   |   |   |   |
| +100 bp      |       | $                                           | 2,812      |   | $ | (68 | ) | (2.4 | )% |
| Base         |       | 2,880                                       |       | — |   | — |   |
| –100 bp |       | 2,943                                       |       | 63 |   | 2.2 | % |
|              |            |                                             |            |  |  |  |  |  |  |

 

As shown above, atDecember 31, 2006, the effect of an immediate 100 basis point increase ininterest rates would decrease the Company’s net income by 1.4%, orapproximately $36,000.  The effect of animmediate 100 basis point decrease in rates would increase the Company’s netinterest income by 3.2%, or approximately $83,000.  The Company’s Board of Directors has set arisk tolerance limit of 10% of estimated net interest income for the succeeding12 months based on an immediate 200 basis point change in market prices.

Interest rate sensitivityreflected modest exposure in an increasing rate environment at the end of 2006and 2005.  Overall net interest incomesensitivity decreased in 2006 compared to 2005.

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**Liquidity and Capital Resources**

The Company’s primarysources of funds are deposits, repurchase agreements, and proceeds fromprincipal and interest payments on loans and securities.  While maturities and scheduled amortizationof loans and securities and calls of securities are predictable sources offunds, deposit flows and mortgage prepayments are greatly influenced by generalinterest rates, economic conditions, and competition.  The Company generally manages the pricing ofits deposits to be competitive and to increase core deposit relationships.

Liquidity management isboth a daily and long-termresponsibility of management.  TheCompany adjusts its investments in liquid assets based upon management’sassessment of (i) expected loan demand, (ii) expected deposit flows,(iii) yields available on interest-earning deposits and securities, and (iv) theobjectives of its asset/liability management program.  Excess liquid assets are invested generallyin interest-earningovernight deposits and short-and intermediate-termU.S. Government and agency obligations.

The Company’s cash flowsare comprised of three primary classifications: cash flows from operating activities, investing activities, and financingactivities.  Cash flows provided byoperating activities were $2.6 million, $4.6 million, and $4.4 million for theyears ended December 31, 2006, 2005 and 2004. Net cash from investing activities consisted primarily of principalcollections on loans and proceeds from maturation and sales of securitiesoffset by disbursements for loan originations and the purchase ofsecurities.  Net cash from financingactivities consisted primarily of changes in net deposits and short-term borrowings partially offsetby dividends paid and the purchase of Company stock.

The Company’s most liquidassets 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 December 31, 2006, cash and short-term investments totaled$10.6 million.  The Company has othersources of liquidity if a need for additional funds arises, includingsecurities maturing within one year and the repayment of loans.  The Company may also utilize the sale ofsecurities available-for-sale, federal funds linesof credit from correspondent banks, and borrowings from the Federal Home LoanBank of Chicago and  Marshall and IlsleyBank.

14

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The following tablediscloses contractual obligations and commercial commitments of the Company asof December 31, 2006:
| ** **                        | ** ** | ** ** | ** ** | **Less Than** | ** ** | ** **         | ** ** | ** **         | ** ** | **After**        | ** ** |
|-----------------------------------|------------|------------|------------|--------------------|------------|--------------------|------------|--------------------|------------|------------------|------------|
| ** **                        | ** ** | **Total**  | ** ** | **1 Year**    | ** ** | **1-3 Years** | ** ** | **4-5 Years** | ** ** | **5 Years** | ** ** |
| Lines of credit(1)                |       | $          | 17,850     |               | $          | 11,663             |       | $                  | 3,918      |             | $          | 113 |   | $ | 2,156 |   |
| Data processing contract  payable |       | 1,539      |       | 223                |       | 445                |       | 445                |       | 426              |       |
| Standby letters of  credit(1)     |       | 513        |       | 513                |       |               |       |               |       |             |       |
|                              |       | $          | 19,902     |               | $          | 12,399             |       | $                  | 4,363      |             | $          | 558 |   | $ | 2,582 |   |

----

(1)  Represents amounts committed to customers.

During 2006 and 2005, theCompany repurchased 300 and 1,260 shares of common stock for $22,000 and$89,000.

Capital provides thefoundation for future growth.  Regulatoryagencies have developed minimum guidelines by which the adequacy of a financialinstitution’s capital may be evaluated. At December 31, 2006, all of the Company’s ratios exceeded the levelsrequired under regulatory guidelines as shown in Note 15 of the ConsolidatedFinancial Statements.

**Facilities**

First Ottawa Bancshares,Inc. is the holding company for First National Bank of Ottawa.  The Company is headquartered in Ottawa,Illinois and operates four offices in Ottawa, two branches in Streator, abranch in Morris, a branch in Yorkville and a recently opened loan productionoffice in Minooka.

**Impact of Inflation and ChangingPrices**

The financial statementsand related data presented herein have been prepared in accordance withaccounting principles generally accepted in the United States of America, whichrequire the measurement of financial position and operating results in terms ofhistorical dollars without considering changes in the relative purchasing powerof money over time due to inflation.  Theprimary impact of inflation on the operations of the Company is reflected in increasedoperating costs.  Unlike most industrialcompanies, virtually all of the assets and liabilities of a financialinstitution are monetary in nature.  As aresult, interest rates generally have a more significant impact on a financialinstitution’s performance than does inflation. Interest rates do not necessarily move in the same direction or to thesame extent as the prices of goods and services.

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**SAFEHARBOR STATEMENT**

Thisdocument (including information incorporated by reference) contains, and futureoral and written statements of the Company and its management may contain,forward-looking statements, within the meaning of such term in the PrivateSecurities Litigation Reform Act of 1995, with respect to the financialcondition, results of operations, plans, objectives, future performance andbusiness of the Company.  Forward-lookingstatements, which may be based upon beliefs, expectations and assumptions ofthe 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” orother similar expressions.  Additionally,all statements in this document, including forward-looking statements, speakonly as of the date they are made, and the Company undertakes no obligation toupdate any statement in light of new information or future events.

The Company’sability to predict results or the actual effect of future plans or strategiesis inherently uncertain. The factors which could have a material adverse effecton the operations and future prospects of the Company and its subsidiaries aredetailed in the “Risk Factors” section included under Item 1a. of Part I of ourForm 10-K.  In addition to the riskfactors described in that section, there are other factors that may impact anypublic company, including ours, which could have a material adverse effect onthe operations and future prospects of the Company and its subsidiaries.  These risks and uncertainties should beconsidered in evaluating forward-looking statements and undue reliance shouldnot be placed on such statements.

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**Report ofIndependent Registered Public Accounting Firm**

Audit Committee, Board of Directors and Stockholders

First Ottawa Bancshares, Inc.

Ottawa, Illinois

We have audited theaccompanying consolidated balance sheets of First Ottawa Bancshares, Inc. as ofDecember 31, 2006 and 2005, and the related consolidated statements of income,shareholders’ equity and cash flows for each of the three years in the periodended December 31, 2006.  These financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States).  Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of First Ottawa Bancshares, Inc. asof December 31, 2006 and 2005, and the results of its operations and its cashflows for each of the three years in the period ended December 31, 2006, inconformity with accounting principles generally accepted in the United Statesof America.
| ****                   |
|------------------------|
| BKD, LLP               |
|                   |
|                   |
| Indianapolis,  Indiana |
| March 12, 2007         |

** **

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FIRST OTTAWABANCSHARES, INC.

CONSOLIDATED BALANCESHEETS

December 31, 2006 and2005

(In thousands,except share and per share data)
| ** **                                                                                                                                                                                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **Assets**                                                                                                                                                                                                 |       |     |       |     |       |
| ** **                                                                                                                                                                                                 |       |     |       |     |       |
| Cash and due  from banks                                                                                                                                                                                   |       | $        | 7,544      |     | $          | 6,857 |   |
| Interest-bearing  demand deposits                                                                                                                                                                          |       | 3,100    |       | —   |       |
| Cash and cash  equivalents                                                                                                                                                                                 |       | 10,644   |       | 6,857    |       |
| Certificates of  deposit                                                                                                                                                                                   |       | 6,135    |       | 11,494   |       |
| Investment  securities available for sale                                                                                                                                                                  |       | 83,085   |       | 90,631   |       |
| Loans, net of  allowance for loan losses of $1,463 and $1,344                                                                                                                                              |       | 159,475  |       | 151,516  |       |
| Premises and  equipment                                                                                                                                                                                    |       | 7,753    |       | 8,024    |       |
| Interest  receivable and other assets                                                                                                                                                                      |       | 10,961   |       | 10,217   |       |
|                                                                                                                                                                                                       |       |     |       |     |       |
| Total assets                                                                                                                                                                                               |       | $        | 278,053    |     | $          | 278,739 |   |
|                                                                                                                                                                                                       |       |     |       |     |       |
| **Liabilities and Shareholders’  Equity**                                                                                                                                                             |       |     |       |     |       |
| ** **                                                                                                                                                                                                 |       |     |       |     |       |
| **Liabilities**                                                                                                                                                                                            |       |     |       |     |       |
| Deposits                                                                                                                                                                                                   |       | $        | 250,341    |     | $          | 239,881 |   |
| Federal funds  purchased                                                                                                                                                                                   |       | —   |       | 12,700   |       |
| Other  liabilities                                                                                                                                                                                         |       | 4,203    |       | 3,300    |       |
| Total  liabilities                                                                                                                                                                                         |       | 254,544  |       | 255,881  |       |
|                                                                                                                                                                                                       |       |     |       |     |       |
| **Commitments  and Contingencies**                                                                                                                                                                         |       |     |       |     |       |
| ** **                                                                                                                                                                                                 |       |     |       |     |       |
| **Shareholders’  Equity**                                                                                                                                                                             |       |     |       |     |       |
| Preferred stock,  $1 par value                                                                                                                                                                             |       |     |       |     |       |
| Authorized and  unissued — 20,000 shares                                                                                                                                                              |       | —   |       | —   |       |
| Common stock, $1  par value, 1,000,000 shares authorized and 750,000 issued                                                                                                                                |       | 750      |       | 750      |       |
| Additional paid-in  capital                                                                                                                                                                                |       | 4,103    |       | 4,039    |       |
| Retained  earnings                                                                                                                                                                                         |       | 25,644   |       | 25,258   |       |
| Treasury stock,  at cost — 100,951 and 100,651 shares                                                                                                                                                 |       | (5,767   | )          | (5,745   | )          |
| Accumulated  other comprehensive income (loss) (2006 unrealized loss on securities of  $987, pension funded status $234, 2005 unrealized loss on securities of  $1,227, minimum pension liability of $217) |       | (1,221   | )          | (1,444   | )          |
| Total  shareholders’ equity                                                                                                                                                                           |       | 23,509   |       | 22,858   |       |
|                                                                                                                                                                                                       |       |     |       |     |       |
| Total liabilities and shareholders’  equity                                                                                                                                                           |       | $        | 278,053    |     | $          | 278,739 |   |

 

See notes toconsolidated financial statements.

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FIRST OTTAWABANCSHARES, INC.

CONSOLIDATEDSTATEMENTS OF INCOME

Years Ended December 31,2006, 2005 and 2004

(In thousands,except share and per share data)
| ** **                                                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Interest  and Dividend Income**                                      |       |     |       |     |       |     |       |
| Loans receivable                                                       |       | $        | 11,201     |     | $          | 9,428    |       | $ | 8,318 |   |
| Investment securities                                                  |       |     |       |     |       |     |       |
| Taxable                                                                |       | 2,211    |       | 2,688    |       | 3,592    |       |
| Exempt from federal tax                                                |       | 906      |       | 1,004    |       | 954      |       |
| Federal funds sold                                                     |       | 371      |       | 233      |       | 40       |       |
| Interest-bearing deposits                                              |       | 239      |       | 555      |       | 633      |       |
| Total interest and dividend income                                     |       | 14,928   |       | 13,908   |       | 13,537   |       |
|                                                                   |       |     |       |     |       |     |       |
| **Interest  Expense**                                                  |       |     |       |     |       |     |       |
| Deposits                                                               |       | 6,238    |       | 4,544    |       | 4,162    |       |
| Repurchase agreements                                                  |       | —   |       | 4        |       | 2        |       |
| Federal funds purchased                                                |       | 123      |       | 57       |       | 24       |       |
| Other interest expense                                                 |       | —   |       | 8        |       | 12       |       |
| Total interest expense                                                 |       | 6,361    |       | 4,613    |       | 4,200    |       |
|                                                                   |       |     |       |     |       |     |       |
| **Net  Interest Income**                                               |       | 8,567    |       | 9,295    |       | 9,337    |       |
| Provision for loan losses                                              |       | 180      |       | 300      |       | 300      |       |
| **Net  Interest Income After Provision for Loan Losses**               |       | 8,387    |       | 8,995    |       | 9,037    |       |
| ** **                                                             |       |     |       |     |       |     |       |
| **Noninterest  Income**                                                |       |     |       |     |       |     |       |
| Service fee income                                                     |       | 965      |       | 1,112    |       | 1,089    |       |
| Trust and farm management fee income                                   |       | 540      |       | 496      |       | 484      |       |
| Net realized gains (losses) on sales of available-for-sale  securities |       | (13      | )          | 172      |       | 465      |       |
| Net gains on sales of loans                                            |       | 31       |       | 91       |       | 254      |       |
| Other income                                                           |       | 1,253    |       | 971      |       | 903      |       |
| Total noninterest income                                               |       | 2,776    |       | 2,842    |       | 3,195    |       |
|                                                                   |       |     |       |     |       |     |       |
| **Noninterest  Expenses**                                              |       |     |       |     |       |     |       |
| Salaries and employee benefits                                         |       | 4,547    |       | 4,651    |       | 4,651    |       |
| Occupancy and equipment expense                                        |       | 1,259    |       | 1,280    |       | 1,270    |       |
| Data processing fees                                                   |       | 393      |       | 371      |       | 334      |       |
| Supplies                                                               |       | 148      |       | 211      |       | 165      |       |
| Professional fees                                                      |       | 348      |       | 444      |       | 484      |       |
| Amortization of core deposit intangibles                               |       | 255      |       | 319      |       | 399      |       |
| Other expenses                                                         |       | 1,125    |       | 1,225    |       | 1,504    |       |
| Total noninterest expenses                                             |       | 8,075    |       | 8,501    |       | 8,807    |       |
|                                                                   |       |     |       |     |       |     |       |
| **Income  Before Income Tax**                                          |       | 3,088    |       | 3,336    |       | 3,425    |       |
| Income tax expense                                                     |       | 753      |       | 791      |       | 797      |       |
|                                                                   |       |     |       |     |       |     |       |
| **Net  Income**                                                        |       | $        | 2,335      |     | $          | 2,545    |       | $ | 2,628 |   |
| ** **                                                             |       |     |       |     |       |     |       |
| **Earnings  Per Share — Basic**                                   |       | $        | 3.59       |     | $          | 3.92     |       | $ | 4.03 |   |
| ** **                                                             |       |     |       |     |       |     |       |
| **Earnings  Per Share — Diluted**                                 |       | $        | 3.59       |     | $          | 3.90     |       | $ | 4.03 |   |
| ** **                                                             |       |     |       |     |       |     |       |
| **Average Shares Outstanding**                                         |       | 649,605  |       | 649,830  |       | 651,561  |       |

 

See notes to consolidatedfinancial statements.

19

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FIRST OTTAWABANCSHARES, INC.

CONSOLIDATED STATEMENTSOF SHAREHOLDERS’ EQUITY

Years EndedDecember 31, 2006, 2005 and 2004

(In thousands, except share and per share data)
| ** **                                                                     | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Retained  Earnings** | ** ** | **Treasury  Stock** | ** ** | **Accumulated  Other  Comprehensive  Income  (Loss)** | ** ** | **Total** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|---------------------|------------|-------------------------------------------------------|------------|-----------|------------|
| **Balances,  January 1, 2004**                                                 |       | $                 | 750        |                             | $          | 4,008                  |       | $                   | 23,988     |                                                  | (5,585     | )         | $          | 1,494 |   | $ | 24,655 |   |
| Comprehensive income                                                           |       |              |       |                             |       |                   |       |                |       |                                                  |       |      |       |
| Net income                                                                     |       |              |       |                             |       | 2,628                  |       |                |       |                                                  |       | 2,628     |       |
| Other comprehensive income, net of tax — unrealized  losses on securities |       |              |       |                             |       |                   |       |                |       | (1,416                                                | )          | (1,416    | )          |
| Comprehensive income                                                           |       |              |       |                             |       |                   |       |                |       |                                                  |       | 1,212     |       |
| Cash dividends ($3.00 per share)                                               |       |              |       |                             |       | (1,954                 | )          |                |       |                                                  |       | (1,954    | )          |
| Stock options vested                                                           |       |              |       | 10                               |       |                   |       |                |       |                                                  |       | 10        |       |
| Purchase of 1,018 treasury shares                                              |       |              |       |                             |       |                   |       | (71                 | )          |                                                  |       | (71       | )          |
|                                                                           |       |              |       |                             |       |                   |       |                |       |                                                  |       |      |       |
| **Balances,  December 31, 2004**                                               |       | 750               |       | 4,018                            |       | 24,662                 |       | (5,656              | )          | 78                                                    |       | 23,852    |       |
| Comprehensive income                                                           |       |              |       |                             |       |                   |       |                |       |                                                  |       |      |       |
| Net income                                                                     |       |              |       |                             |       | 2,545                  |       |                |       |                                                  |       | 2,545     |       |
| Other comprehensive income, net of tax — unrealized  losses on securities |       |              |       |                             |       |                   |       |                |       | (1,522                                                | )          | (1,522    | )          |
| Comprehensive income                                                           |       |              |       |                             |       |                   |       |                |       |                                                  |       | 1,023     |       |
| Cash dividends ($3.00 per share)                                               |       |              |       |                             |       | (1,949                 | )          |                |       |                                                  |       | (1,949    | )          |
| Stock options vested                                                           |       |              |       | 21                               |       |                   |       |                |       |                                                  |       | 21        |       |
| Purchase of 1,260 treasury shares                                              |       |              |       |                             |       |                   |       | (89                 | )          |                                                  |       | (89       | )          |
|                                                                           |       |              |       |                             |       |                   |       |                |       |                                                  |       |      |       |
| **Balances,  December 31, 2005**                                               |       | 750               |       | 4,039                            |       | 25,258                 |       | (5,745              | )          | (1,444                                                | )          | 22,858    |       |
| Comprehensive income                                                           |       |              |       |                             |       |                   |       |                |       |                                                  |       |      |       |
| Net income                                                                     |       |              |       |                             |       | 2,335                  |       |                |       |                                                  |       | 2,335     |       |
| Other comprehensive income, net of tax — unrealized  gains on securities  |       |              |       |                             |       |                   |       |                |       | 240                                                   |       | 240       |       |
| Comprehensive income                                                           |       |              |       |                             |       |                   |       |                |       |                                                  |       | 2,575     |       |
| Cash dividends ($3.00 per share)                                               |       |              |       |                             |       | (1,949                 | )          |                |       |                                                  |       | (1,949    | )          |
| Stock options vested                                                           |       |              |       | 38                               |       |                   |       |                |       |                                                  |       | 38        |       |
| Stock options exercised                                                        |       |              |       | 26                               |       |                   |       |                |       |                                                  |       | 26        |       |
| Purchase of 300 treasury shares                                                |       |              |       |                             |       |                   |       | (22                 | )          |                                                  |       | (22       | )          |
| Adjustment to initially apply FASB Statement No.  158, net of tax              |       |              |       |                             |       |                   |       |                |       | (17                                                   | )          | (17       | )          |
|                                                                           |       |              |       |                             |       |                   |       |                |       |                                                  |       |      |       |
| **Balances, December 31, 2006**                                                |       | $                 | 750        |                             | $          | 4,103                  |       | $                   | 25,644     |                                                  | $          | (5,767    | )          | $ | (1,221 | ) | $ | 23,509 |   |
|                                                                                |            |                   |            |                                  |            |                        |            |                     |            |                                                       |            |           |            |  |  |  |  |  |  |

 

See notes toconsolidated financial statements.

20

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FIRST OTTAWABANCSHARES, INC.

CONSOLIDATEDSTATEMENTS OF CASH FLOWS

Years EndedDecember 31, 2006, 2005 and 2004

(In thousands, except per share data)
| ** **                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Operating  Activities**                                               |       |     |       |     |       |     |       |
| Net income                                                              |       | $        | 2,335      |     | $          | 2,545    |       | $ | 2,628 |   |
| Items not requiring (providing) cash                                    |       |     |       |     |       |     |       |
| Provision for loan losses                                               |       | 180      |       | 300      |       | 300      |       |
| Premium amortization on securities, net                                 |       | 380      |       | 421      |       | 502      |       |
| Derivative valuation adjustment                                         |       | (325     | )          | (373     | )          | (411     | )          |
| Depreciation and amortization                                           |       | 696      |       | 822      |       | 871      |       |
| Loans originated for sale                                               |       | (1,453   | )          | (4,119   | )          | (8,936   | )          |
| Proceeds from sale of loans                                             |       | 868      |       | 4,637    |       | 9,133    |       |
| Gains/losses on sales of securities, net                                |       | 13       |       | (172     | )          | (465     | )          |
| Gains on sales of loans held for sale                                   |       | (31      | )          | (91      | )          | (254     | )          |
| Stock options vested                                                    |       | 38       |       | 21       |       | 10       |       |
| Change in                                                               |       |     |       |     |       |     |       |
| Interest receivable and other assets                                    |       | (956     | )          | 419      |       | 791      |       |
| Interest payable and other liabilities                                  |       | 903      |       | 151      |       | 241      |       |
| Net cash provided by operating activities                               |       | 2,648    |       | 4,561    |       | 4,410    |       |
|                                                                    |       |     |       |     |       |     |       |
| **Investing  Activities**                                               |       |     |       |     |       |     |       |
| Purchases of securities available for sale                              |       | (3,212   | )          | (4,729   | )          | (32,247  | )          |
| Proceeds from maturities and paydowns of securities  available for sale |       | 6,481    |       | 9,364    |       | 21,616   |       |
| Proceeds from sales of securities available for sale                    |       | 4,247    |       | 6,830    |       | 17,230   |       |
| Purchases of certificates of deposit                                    |       | —   |       | (3,460   | )          | (18,086  | )          |
| Proceeds from maturities of certificates of deposit                     |       | 5,684    |       | 16,986   |       | 7,040    |       |
| Net change in loans                                                     |       | (7,723   | )          | (19,392  | )          | (2,804   | )          |
| Net purchases of premises and equipment                                 |       | (153     | )          | (903     | )          | (543     | )          |
| Net cash provided by (used in) investing activities                     |       | 5,324    |       | 4,696    |       | (7,794   | )          |
|                                                                    |       |     |       |     |       |     |       |
| **Financing  Activities**                                               |       |     |       |     |       |     |       |
| Net change in                                                           |       |     |       |     |       |     |       |
| Deposits                                                                |       | 10,460   |       | (14,083  | )          | (10,957  | )          |
| Federal funds purchased                                                 |       | (12,700  | )          | 7,100    |       | 5,600    |       |
| Securities sold under agreements to repurchase                          |       | —   |       | (750     | )          | 750      |       |
| Proceeds from borrowings                                                |       | —   |       | 27       |       | 70       |       |
| Repayment of borrowings                                                 |       | —   |       | (586     | )          | (1       | )          |
| Purchase of treasury stock                                              |       | (22      | )          | (89      | )          | (71      | )          |
| Stock options exercised                                                 |       | 26       |       | —   |       | —   |       |
| Cash dividends                                                          |       | (1,949   | )          | (1,949   | )          | (1,954   | )          |
| Net cash used in financing activities                                   |       | (4,185   | )          | (10,330  | )          | (6,563   | )          |
|                                                                    |       |     |       |     |       |     |       |
| **Net  Change in Cash and Cash Equivalents**                            |       | 3,787    |       | (1,073   | )          | (9,947   | )          |
| ** **                                                              |       |     |       |     |       |     |       |
| **Cash  and Cash Equivalents, Beginning of Year**                       |       | 6,857    |       | 7,930    |       | 17,877   |       |
| ** **                                                              |       |     |       |     |       |     |       |
| **Cash  and Cash Equivalents, End of Year**                             |       | $        | 10,644     |     | $          | 6,857    |       | $ | 7,930 |   |
| ** **                                                              |       |     |       |     |       |     |       |
| **Additional  Cash Flows Information**                                  |       |     |       |     |       |     |       |
| Interest paid                                                           |       | $        | 6,030      |     | $          | 4,482    |       | $ | 4,460 |   |
| Income tax paid, net of refunds                                         |       | 821      |       | 729      |       | 158      |       |
| Transfers from loans to foreclosed real estate                          |       | 200      |       | 468      |       | 141      |       |

 

See notes toconsolidated financial statements.

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FIRST OTTAWABANCSHARES, INC.

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

December 31, 2006,2005 and 2004

(Table dollar amounts inthousands, except per share data)

**NOTE 1 — SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

Nature of Operations andPrinciples of Consolidation: First Ottawa Bancshares, Inc. is a bank holding company whose principalactivity is the ownership and management of its wholly-owned subsidiary, First National Bank ofOttawa (Bank).  The Bank is primarilyengaged in providing a full range of banking and financial services toindividual and corporate customers in LaSalle, Grundy and surrounding countiesin Illinois.  The Bank is subject tocompetition from other financial institutions. The Bank is subject to the regulation of certain federal and stateagencies and undergoes periodic examinations by those regulatoryauthorities.  The consolidated financialstatements include First Ottawa Bancshares, Inc. and the Bank, and the Bank’swholly owned subsidiary, First Ottawa Financial Corporation, together referredto as the Company.  Intercompanytransactions and balances are eliminated in consolidation.

Use of Estimates:  To prepare financial statements in conformitywith accounting principles generally accepted in the United States of America,management makes estimates and assumptions based on available information.  These estimates and assumptions affect theamounts reported in the financial statements and the disclosures provided, andfuture results could differ.  Theallowance for loan losses, fair values of financial instruments, derivatives,and status of contingencies are particularly subject to change.

Securities:  Securities are classified as available-for-sale when they might be sold beforematurity.  Securities available-for-saleare carried at fair value, with unrealized holding gains and losses reported,net of tax, as other comprehensive income. Equity securities include Federal Home Loan Bank stock and FederalReserve Bank stock, which are restricted securities that are carried at cost,and a mutual fund investment that is carried at fair value.  Securities are written down to fair value,with a charge to expense, when a decline in fair value is not temporary.

Realized gains and losseson sales are determined using the amortized cost of the specific securitysold.  Interest income includesamortization of purchase premiums and discounts.

Declines in the fairvalue of securities below their cost that are other-than-temporary arereflected as realized losses. In estimating other-than-temporary losses,management considers: (1) the length of time and extent that fair value hasbeen less than cost, (2) the financial condition and near term prospects of theissuer, and (3) the Company’s ability and intent to hold the security for aperiod sufficient to allow for any anticipated recovery in fair value.

Derivatives:  All derivative instruments are recorded attheir fair values and the change in the fair value of a derivative is includedin interest income.  If derivativeinstruments are designated as hedges of fair values, both the change in thefair value of the hedge and the hedged item are included in currentearnings.  Fair value adjustments relatedto cash flow hedges are recorded in other comprehensive income and reclassifiedto earnings when the hedged transaction is reflected in earnings.  Ineffective portions of hedges are reflectedin earnings as they occur.

Loans Held for Sale:  Mortgage loans originated and intended forsale in the secondary market are carried at the lower of cost or fair value inthe aggregate.  Net unrealized losses, ifany, are recognized through a valuation allowance by charges to income.

Loans:  Loans are reported at the principal balanceoutstanding, net of deferred loan fees and costs and the allowance for loanlosses.  Interest income is reported onthe interest method and includes amortization of net deferred loan fees andcosts over the loan term.  Mortgage loansoriginated and intended for sale in the secondary market are carried at thelower of cost, net of deferred loan fees, or estimated fair value in theaggregate.  Interest income is notreported when full loan repayment is in doubt, typically when payments are pastdue over 90 days.  Payments received onsuch loans are reported as principal reductions.

Allowance for Loan Losses:  The allowance for loan losses is establishedas losses are estimated to have occurred through a provision for loan lossescharged to income.  Loan losses arecharged against the allowance when management believes the uncollectibility ofa loan balance is confirmed.  Subsequentrecoveries, if any, are credited to the allowance.  Management estimates the allowance balancerequired based on past loan loss experience, known and inherent risks in theportfolio, information about specific borrower situations and estimatedcollateral values, economic conditions, and other factors.  Allocations of the allowance may be made forspecific loans, but the entire allowance is available for any loan that, inmanagement’s judgment, should be charged off.

22

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Loan impairment isreported when full payment under the loan terms is not expected.  Impairment is evaluated in total for smaller-balanceloans of similar nature, such as residential mortgage and consumer loans, andon an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so thatthe loan is reported, net, at the present value of estimated future cash flowsusing the loan’s existing rate or at the loan’s observable market price or thefair value of collateral if the loan is collateral dependent.  Loans are evaluated for impairment whenpayments are delayed, typically 90 days or more, or when the internal gradingsystem indicates a doubtful classification.

Premises and Equipment:  Asset cost is reported net of accumulateddepreciation.  Buildings and relatedcomponents are depreciated using the straight-line method with useful lives rangingfrom 7 to 39 years.  Furniture, fixturesand equipment are depreciated using the straight-line method with useful lives rangingfrom 5 to 15 years.  These assets arereviewed for impairment when events indicate that the carrying amount may notbe recoverable.  Maintenance and repairsare charged to expense and improvements are capitalized.

Other Real Estate:  Real estate owned, other than that used inthe normal course of business, is carried at the lower of cost basis (fairvalue at date of foreclosure) or fair value less estimated costs to sell.  Any reduction to fair value from a relatedloan at the time of acquisition is accounted for as a loan loss.  Any subsequent reductions in fair value lessestimated costs to sell are recorded by charges to expense and a correspondingvaluation allowance on the related real estate.

Mortgage Servicing Rights:  Servicing rights are recognized as assets forthe allocated value of servicing rights retained on loans sold and areclassified with interest receivable and other assets in the consolidatedbalance sheets.  Servicing rights are expensedin proportion to and over the period of estimated net servicing revenues.  Impairment is evaluated based on the fairvalue of the rights using groupings of the underlying loans as to interestrates and then, secondarily, as to geographic and prepaymentcharacteristics.  Fair value is determinedusing prices for similar assets with similar characteristics, when available,or based upon discounted cash flows using market-based assumptions.  Any impairment of a grouping is reported as avaluation allowance.  There was no suchvaluation allowance recorded at December 31, 2006 and 2005, and mortgageservicing rights were not material at either date.

Intangible Assets:   Core deposit intangibles are being amortizedon an accelerated basis over 11 years and are periodically evaluated as to therecoverability of their carrying value.

Goodwill:   Goodwill is reviewed for impairment annuallywith any loss recognized through the income statement.

Stock Options:  The Company has a stock-based compensation plan, which is morefully described in Note 12.  The Companyaccounts for this plan under the recognition and measurement principles ofStatement of Financial Accounting Standards No. 123®, *Share*-*BasedPayment*, using the fair value method.  The value of options granted under this planis charged to expense over the vesting period of the grants.

Income Taxes:  Income tax expense is the sum of the currentyear income tax due or refundable and the change in deferred tax assets andliabilities.  Deferred tax assets andliabilities are the expected future tax consequences of temporary differencesbetween the carrying amounts and tax bases of assets and liabilities, computedusing enacted tax rates.  A valuationallowance, if needed, reduces deferred tax assets to the amount expected to berealized.

Earnings Per Share:  Basic earnings per share is calculated basedon the weighted-average common shares outstanding during the year.

23

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Fair Values of FinancialInstruments:  Fairvalues of financial instruments are estimated using relevant market informationand other assumptions, as more fully disclosed separately.  Fair value estimates involve uncertaintiesand matters of significant judgment regarding interest rates, credit risk,prepayments, and other factors, especially in the absence of broad markets forparticular items.  Changes in assumptionsor in market conditions could significantly affect the estimates.  The fair value estimates of existing on- and off-balance-sheet financial instruments do notinclude the value of anticipated future business or the values of assets andliabilities not considered financial instruments.

Comprehensive Income:  Comprehensive income includes both net incomeand other comprehensive income (loss). Other comprehensive income (loss) includes the changes in unrealizedgains and losses on securities available-for-sale,and minimum pension liability, net of deferred income taxes.

Reclassifications:  Some items in the prior years’ financialstatements were reclassified to conform to the current presentation.

##### Pending Accounting Pronouncements

**EmergingIssues Task Force Issue 06-4.** In September 2006, the EmergingIssues Task Force (EITF) reached a consensus regarding the accounting forentities with split-dollar life insurance arrangements that provide an employeewith a specified benefit that is not limited to an employee’s active serviceperiod.  In reaching its consensus, theEITF determined that an employer should recognize as a liability the futurebenefits to be provided to employees beyond the employees active serviceperiod.  In the case of split-dollar planthat provides a death benefit to the employees designated beneficiary and thebenefit is provided to the employee beyond their active service period, anentity should accrue a liability during the employee’s active service periodfor the cost of maintaining the life insurance policy during the employee’sretirement period.   EITF 06-4 iseffective for fiscal years beginning after December 15, 2007 with earlierapplication permitted.  Entities shouldrecognize the effects of applying EITF 06-4 either as a change in accountingprinciple through a cumulative-effect adjustment to retained earnings or othercomponents of equity as of the beginning of the year of adoption or as a changein accounting principle through retrospective application to all prior periods.

**NOTE 2 — SECURITIES AVAILABLE FORSALE**

 
| ** **                                                          | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair   Value** | ** ** |
|---------------------------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|-----------------------|------------|
| **December  31, 2006**                                              |       |                |       |                         |       |                          |       |                  |       |
| U. S. Treasury                                                      |       | $                   | 10,070     |                         | $          | —                        |       | $                     | (237       | ) | $ | 9,833 |   |
| Federal agencies                                                    |       | 35,294              |       | —                       |       | (654                          | )          | 34,640                |       |
| State and municipal                                                 |       | 24,829              |       | 139                          |       | (457                          | )          | 24,511                |       |
| Mortgage-backed securities and collateralized  mortgage obligations |       | 7,948               |       | 24                           |       | (236                          | )          | 7,736                 |       |
| Corporate obligations                                               |       | 3,250               |       | —                       |       | (43                           | )          | 3,207                 |       |
| Marketable equity securities                                        |       | 3,190               |       | —                       |       | (32                           | )          | 3,158                 |       |
|                                                                |       |                |       |                         |       |                          |       |                  |       |
| Total investment  securities                                        |       | $                   | 84,581     |                         | $          | 163                           |       | $                     | (1,659     | ) | $ | 83,085 |   |

 

24

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** **
| ** **                                                          | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair   Value** | ** ** |
|---------------------------------------------------------------------|------------|---------------------|------------|------------------------------|------------|-------------------------------|------------|-----------------------|------------|
| **December  31, 2005**                                              |       |                |       |                         |       |                          |       |                  |       |
| U. S. Treasury                                                      |       | $                   | 10,086     |                         | $          | —                        |       | $                     | (284       | ) | $ | 9,802 |   |
| Federal agencies                                                    |       | 40,364              |       | 2                            |       | (961                          | )          | 39,405                |       |
| State and municipal                                                 |       | 25,455              |       | 225                          |       | (484                          | )          | 25,196                |       |
| Mortgage-backed securities and collateralized  mortgage obligations |       | 10,082              |       | 43                           |       | (256                          | )          | 9,869                 |       |
| Corporate obligations                                               |       | 3,416               |       | —                       |       | (97                           | )          | 3,319                 |       |
| Marketable equity securities                                        |       | 3,086               |       | —                       |       | (46                           | )          | 3,040                 |       |
|                                                                |       |                |       |                         |       |                          |       |                  |       |
| Total investment  securities                                        |       | $                   | 92,489     |                         | $          | 270                           |       | $                     | (2,128     | ) | $ | 90,631 |   |

 

As of December 31,2006 and 2005, the Company had approximately $2,632,000 and $4,269,000 investedin bonds issued by municipalities located within LaSalle County, Illinois.

Securities with anapproximate carrying value of $50,174,000 and $58,012,000 were pledged atDecember 31, 2006 and 2005 to secure trust and public deposits, and for otherpurposes as required or permitted by law.

The fair value of contractualmaturities of securities available for sale at December 31, 2006 were asfollows.  Securities not due at a singlematurity date, primarily mortgage-backed and equity securities, are shownseparately.
| ** **                                                          | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
|---------------------------------------------------------------------|------------|---------------------|------------|-----------------|------------|
| Within one year                                                     |       | $                   | 16,676     |            | $          | 16,547 |   |
| One to five  years                                                  |       | 56,320              |       | 55,196          |       |
| Five to ten  years                                                  |       | 447                 |       | 448             |       |
| After ten years                                                     |       | —              |       | —          |       |
|                                                                |       |                |       |            |       |
| Mortgage-backed  securities and collateralized mortgage obligations |       | 7,948               |       | 7,736           |       |
| Marketable  equity securities                                       |       | 3,190               |       | 3,158           |       |
|                                                                |       |                |       |            |       |
| Totals                                                              |       | $                   | 84,581     |            | $          | 83,085 |   |

 

Informationregarding realized gains and losses on sales of securities available for salefollows:
| ** **   | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------|------------|----------|------------|----------|------------|----------|------------|
| Gross gains  |       | $        | 4          |     | $          | 178      |       | $ | 465 |   |
| Gross losses |       | 17       |       | 6        |       | —   |       |
| Tax expense  |       | (4       | )          | 58       |       | 158      |       |
|              |            |          |            |          |            |          |            |  |  |  |

 

Certain investments in debt and marketable equitysecurities are reported in the financial statements at an amount less thantheir historical cost.  Total fair valueof these investments at December 31, 2006 and 2005 was $74.8 million and$79.3 million, which was approximately 90.0% and 87.4% of the Company’savailable-for-sale investment portfolio at thosedates.  These declines primarily resultedfrom increases in market interest rates.

25

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Based on evaluation of available evidence, includingrecent changes in market interest rates, management  believes the declines in fair value for thesesecurities are temporary.  Should theimpairment of any of these securities become other than temporary, the costbasis of the investment will be reduced and the resulting loss recognized innet income in the period the other-than-temporary impairment is identified.

The following table shows our investments’ grossunrealized losses and fair value, aggregated by investment category and lengthof time that individual securities have been in a continuous unrealized lossposition.
| ** **                                                          | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total**       | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------------|------------|
| **Description of  Securities**                                 | ** ** | **Fair  Value**                        | ** ** | **Unrealized  Losses**               | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** |
| **December  31, 2006**                                              | ** ** | ** **                             | ** ** | ** **                           | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| U. S. Treasury                                                      |       | $                                      | —     |                                 | $          | —          |       | $ | 9,833 |   | $ | 237 |   | $ | 9,833 |   | $ | 237 |   |
| Federal agencies                                                    |       | —                                 |       | —                               |       | 34,640          |       | 654 |   | 34,640 |   | 654 |   |
| State and municipal                                                 |       | 1,555                                  |       | 16                                   |       | 15,258          |       | 441 |   | 16,813 |   | 457 |   |
| Mortgage-backed securities and collateralized  mortgage obligations |       | 35                                     |       | 1                                    |       | 7,099           |       | 235 |   | 7,134 |   | 236 |   |
| Corporate obligations                                               |       | —                                 |       | —                               |       | 3,207           |       | 43 |   | 3,207 |   | 43 |   |
| Marketable equity securities                                        |       | —                                 |       | —                               |       | 3,158           |       | 32 |   | 3,158 |   | 32 |   |
|                                                                |       |                                   |       |                                 |       |            |       |   |   |   |   |   |   |
| Total temporarily impaired securities                               |       | $                                      | 1,590      |                                 | $          | 17              |       | $ | 73,195 |   | $ | 1,642 |   | $ | 74,785 |   | $ | 1,659 |   |
|                                                                |       |                                   |       |                                 |       |            |       |   |   |   |   |   |   |
|                                                                |       |                                   |       |                                 |       |            |       |   |   |   |   |   |   |
| **December  31, 2005**                                              | ** ** | ** **                             | ** ** | ** **                           | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| U. S. Treasury                                                      |       | $                                      | —     |                                 | $          | —          |       | $ | 9,802 |   | $ | 284 |   | $ | 9,802 |   | $ | 284 |   |
| Federal agencies                                                    |       | 14,711                                 |       | 238                                  |       | 23,691          |       | 723 |   | 38,402 |   | 961 |   |
| State and municipal                                                 |       | 4,774                                  |       | 34                                   |       | 11,646          |       | 450 |   | 16,420 |   | 484 |   |
| Mortgage-backed securities and collateralized  mortgage obligations |       | 4,970                                  |       | 151                                  |       | 3,388           |       | 105 |   | 8,358 |   | 256 |   |
| Corporate obligations                                               |       | —                                 |       | —                               |       | 3,319           |       | 97 |   | 3,319 |   | 97 |   |
| Marketable equity securities                                        |       | —                                 |       | —                               |       | 3,040           |       | 46 |   | 3,040 |   | 46 |   |
|                                                                |       |                                   |       |                                 |       |            |       |   |   |   |   |   |   |
| Total  temporarily impaired securities                              |       | $                                      | 24,455     |                                 | $          | 423             |       | $ | 54,886 |   | $ | 1,705 |   | $ | 79,341 |   | $ | 2,128 |   |

 

26

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**NOTE 3 —LOANS**

Major classifications ofloans as of December 31, 2006 and 2005 are summarized as follows:
| ** **                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
| Real estate                  |       | $        | 102,516    |     | $          | 95,469 |   |
| Commercial and  agricultural |       | 39,610   |       | 33,686   |       |
| Installment                  |       | 7,401    |       | 11,585   |       |
| Home equity lines  of credit |       | 11,411   |       | 12,120   |       |
| Total loans                  |       | 160,938  |       | 152,860  |       |
| Allowance for  loan losses   |       | (1,463   | )          | (1,344   | )          |
|                         |       |     |       |     |       |
| Net loans                    |       | $        | 159,475    |     | $          | 151,516 |   |

 

Certain executiveofficers, directors, and their related interests are loan customers of theCompany.  A summary of such loans made bythe Company in the ordinary course of business and made on substantially thesame terms (including interest rates and collateral) as those prevailing at thetime for comparable transactions with other persons is as follows:
| Balance at January 1, 2006    |   | $      | 2,451  |   |
|-------------------------------|--------|--------|--------|--------|
| New loans                     |   | 744    |   |
| Repayments                    |   | (764   | )      |
|                          |   |   |   |
| Balance at  December 31, 2006 |   | $      | 2,431  |   |

 

Informationregarding impaired loans at December 31, 2006 and 2005 is as follows:
| ** **                                                                                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Impaired loans  with an allowance                                                                               |       | $        | 1,328      |     | $          | 2,342 |   |
| Impaired loans  for which the discounted cash flows or collateral value exceeds the carrying  value of the loan |       | 225      |       | 87       |       |
|                                                                                                            |       |     |       |     |       |
| Total impaired loans                                                                                            |       | $        | 1,553      |     | $          | 2,429 |   |
|                                                                                                            |       |     |       |     |       |
| Allowance for impaired  loans included in the Company’s allowance for loan losses                          |       | $        | 386        |     | $          | 497 |   |

 
| ** **                                                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Average balance  of impaired loans                              |       | $        | 2,269      |     | $          | 2,039    |       | $ | 2,074 |   |
| Interest income  recognized on impaired loans                   |       | 149      |       | 169      |       | 127      |       |
| Interest income  recognized on impaired loans — cash basis |       | 102      |       | 126      |       | 107      |       |
|                                                                 |            |          |            |          |            |          |            |  |  |  |

 

Nonperformingloans were as follows at December 31:
| ** **                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
| Loans past due  over 90 days still on accrual |       | $        | 305        |     | $          | 1,337 |   |
| Nonaccrual loans                              |       | 362      |       | —   |       |
|                                               |            |          |            |          |            |  |  |

 

27

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**NOTE 4 —ALLOWANCE FOR LOAN LOSSES**

Activity in theallowance for loan losses is summarized as follows for the years ended December31:
| ** **                 | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|----------|------------|
| Allowance for  loan losses |       |     |       |     |       |     |       |
| Balances,  January 1       |       | $        | 1,344      |     | $          | 1,174    |       | $ | 1,049 |   |
| Provision for  losses      |       | 180      |       | 300      |       | 300      |       |
| Recoveries on  loans       |       | 56       |       | 86       |       | 98       |       |
| Loans charged  off         |       | (117     | )          | (216     | )          | (273     | )          |
|                       |       |     |       |     |       |     |       |
| Balances, December 31      |       | $        | 1,463      |     | $          | 1,344    |       | $ | 1,174 |   |

 

**NOTE 5 — LOANSALES AND SERVICING**

The Company sellsmortgage loans with servicing retained to the Federal Home Loan MortgageCorporation (FHLMC).  The Companyrealized gross proceeds from the sales of mortgage loans totaling $868,000,$4,637,000 and $9,133,000 in 2006, 2005 and 2004.  Mortgage loans serviced for others are notincluded in the accompanying consolidated balance sheets.  The unpaid principal balances of these loansare summarized as follows:
| ** **                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
| Loans serviced for Freddie  Mac |       | $        | 30,255     |     | $          | 32,757 |   |
|                                 |            |          |            |          |            |  |  |

 

Following is ananalysis of the changes in originated mortgage servicing rights:
| ** **                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Mortgage  Servicing Rights       |       |     |       |     |       |     |       |
| Balances, January 1              |       | $        | 328        |     | $          | 380      |       | $ | 445 |   |
| Servicing rights capitalized     |       | 14       |       | 49       |       | 89       |       |
| Amortization of servicing rights |       | (39      | )          | (101     | )          | (154     | )          |
|                             |       |     |       |     |       |     |       |
| Balances,  December 31           |       | $        | 303        |     | $          | 328      |       | $ | 380 |   |

 

28

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**NOTE 6 — PREMISES AND EQUIPMENT**

Premises andequipment consisted of the following at December 31:

|                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|
| Cost                                       |       |     |       |     |       |
| Land                                       |       | $        | 1,791      |     | $          | 1,791 |   |
| Buildings and  land improvements           |       | 7,512    |       | 7,428    |       |
| Equipment                                  |       | 4,656    |       | 4,606    |       |
| Construction in  progress                  |       | 19       |       | —   |       |
| Total cost                                 |       | 13,978   |       | 13,825   |       |
| Accumulated  depreciation and amortization |       | (6,225   | )          | (5,801   | )          |
| Net                                        |       | $        | 7,753      |     | $          | 8,024 |   |

 

**NOTE 7 —DEPOSITS**

Deposits consistedof the following at December 31:

|                                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|
| Noninterest-bearing  demand                               |       | $        | 29,954     |     | $          | 30,436 |   |
| Interest-bearing demand                                   |       | 53,864   |       | 57,624   |       |
| Savings                                                   |       | 24,062   |       | 24,847   |       |
| Money market savings                                      |       | 38,266   |       | 26,184   |       |
| Certificates and other  time deposits of $100,000 or more |       | 38,484   |       | 31,420   |       |
| Other certificates and  time deposits                     |       | 65,711   |       | 69,370   |       |
| Total deposits                                            |       | $        | 250,341    |     | $          | 239,881 |   |

 

At December 31,2006, the scheduled maturities of certificates of deposit were as follows:

| 2007   |   | $      | 69,191  |   |
|--------|--------|--------|---------|--------|
| 2008   |   | 20,041 |    |
| 2009   |   | 7,462  |    |
| 2010   |   | 2,098  |    |
| 2011   |   | 5,403  |    |
|   |   | $      | 104,195 |   |

 

Deposits held by theCompany from related parties at December 31, 2006 and 2005 totaled $3.8 millionand $2.3 million, respectively.

29

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**NOTE 8 — BORROWINGS**

The Company has a notepayable that consists of a $2,000,000 unsecured line of credit with Marshall& Ilsley Bank, maturing on August 25, 2007. The outstanding balance under the line of credit was $0 atDecember 31, 2006 and 2005. Interest is payable quarterly at LIBOR plus 165 basis points (7.04% and5.96% at December 31, 2006 and 2005).

**NOTE 9 — SECURITIES SOLD UNDERAGREEMENTS TO REPURCHASE**

Securities sold underagreements to repurchase are financing arrangements.  Physical control is maintained for allsecurities sold under repurchase agreements. The average balance during 2006 and 2005 was $0 and $232,000 with aninterest rate of 1.63% for 2005.  Themaximum month-end balance during 2006 and 2005 was $0 and $750,000.

**NOTE 10 —BENEFIT PLANS**

The Bank has anoncontributory defined-benefit pension plan covering all employees who meet theeligibility requirements.  In 1999, allplan benefits were frozen.  The Bank’sfunding policy is to make the minimum annual contribution that is required byapplicable regulations, plus such amounts as the Bank may determine to beappropriate from time to time.  The Bankexpects to contribute approximately $200,000 to the plan in 2007.  The Bank uses a December 31 measurement datefor the plan.

The followingtables set forth the Bank’s pension plan’s funded status and amountsactuarially determined for the years indicated:

|                               | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Change in benefit  obligation |       |     |       |     |       |
| Beginning  benefit obligation |       | $        | 1,887      |     | $          | 1,868 |   |
| Interest cost                 |       | 103      |       | 112      |       |
| Actuarial loss                |       | (21      | )          | 141      |       |
| Settlements                   |       | —   |       | (108     | )          |
| Benefits paid                 |       | (117     | )          | (126     | )          |
|                          |       |     |       |     |       |
| Ending benefit  obligation    |       | $        | 1,852      |     | $          | 1,887 |   |

 

| Change in plan assets  |   |   |   |   |   |
|------------------------|--------|--------|--------|--------|--------|
| Beginning fair  value  |   | $      | 1,531  |   | $      | 1,507 |   |
| Actual return          |   | 118    |   | 49     |   |
| Employer  contribution |   | 268    |   | 209    |   |
| Settlements            |   | — |   | (108   | )      |
| PBGC Premium           |   | — |   | — |   |
| Benefits paid          |   | (117   | )      | (126   | )      |
|                   |   |   |   |   |   |
| Ending fair  value     |   | $      | 1,800  |   | $      | 1,531 |   |
|                   |   |   |   |   |   |
| Funded status          |   | $      | (52    | )      | $      | (356 | ) |

 

30

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Amounts recognized in the balance sheets:

|            | ** ** | **Pension Benefits** | ** ** |
|------------|------------|---------------------------|------------|
| ** ** | ** ** | **2006**                  | ** ** | **2005** | ** ** |
| Liability  |       | $                         | (52        | ) | $ | (356 | ) |
|            |            |                           |            |  |  |  |  |

 

Amounts recognized in accumulated other comprehensiveincome:

|            | ** ** | **Pension Benefits** | ** ** |
|------------|------------|---------------------------|------------|
| ** ** | ** ** | **2006**                  | ** ** | **2005** | ** ** |
| Net loss   |       | $                         | 390        |   | $ | 436 |   |
|            |            |                           |            |  |  |  |  |

 

Components of netperiodic benefit cost:

|                        | ** ** | **Pension Benefits** | ** ** |
|------------------------|------------|---------------------------|------------|
| ** **             | ** ** | **2006**                  | ** ** | **2005** | ** ** |
| Employer contributions |       | $                         | 268        |   | $ | 209 |   |
| Benefits paid          |       | 117                       |       | 127 |   |
| Benefit costs          |       | 10                        |       | 14 |   |
|                        |            |                           |            |  |  |  |  |

 

Other changes in plan assets and benefit obligationsrecognized in other comprehensive income:

|                                    | ** ** | **Pension Benefits** | ** ** |
|------------------------------------|------------|---------------------------|------------|
| ** **                         | ** ** | **2006**                  | ** ** | **2005** | ** ** |
| Amounts arising during the  period |       |                      |       |   |   |
| Net (gain) loss                    |       | $                         | (46        | ) | $ | 167 |   |
|                                    |            |                           |            |  |  |  |  |

 

|                                                    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Assumptions used to  determine benefit obligations |       |     |       |     |       |     |       |
| Discount rate                                      |       | 5.75     | %          | 5.75     | %          | 6.00     | %          |
| Expected return  on plan assets                    |       | 7.0      |       | 7.0      |       | 7.0      |       |
|                                               |       |     |       |     |       |     |       |
| Assumptions used to  determine benefit costs       |       |     |       |     |       |     |       |
| Discount rate                                      |       | 5.75     | %          | 6.00     | %          | 6.25     | %          |
| Expected return on plan  assets                    |       | 7.0      |       | 7.0      |       | 7.0      |       |

 

31

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The Company hasestimated the long-term rate of return on plan assets based primarily onhistorical returns on plan assets, adjusted for changes in target portfolioallocations and recent changes in long-term interest rates based on publiclyavailable information.

|                                          | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Components of net  periodic benefit cost |       |     |       |     |       |     |       |
| Interest cost                            |       | $        | 103        |     | $          | 112      |       | $ | 117 |   |
| Return on plan  assets                   |       | (108     | )          | (106     | )          | (97      | )          |
| Amortization                             |       | 15       |       | 8        |       | 3        |       |
|                                     |       |     |       |     |       |     |       |
| Net expense                              |       | $        | 10         |     | $          | 14       |       | $ | 23 |   |

 

The followingbenefit payments, which reflect expected future service, as appropriate, areexpected to be paid as of December 31, 2006:

|            | ** ** | **Pension  Benefits** | ** ** |
|------------|------------|-----------------------|------------|
| 2007       |       | $                     | 123        |   |
| 2008       |       | 117                   |       |
| 2009       |       | 116                   |       |
| 2010       |       | 110                   |       |
| 2011       |       | 118                   |       |
| Thereafter |       | 541                   |       |
|            |            |                       |            |  |

 

Plan assets areheld by a bank-administered trust fund, which invests the plan assets inaccordance with the provisions of the plan agreement.  The permitted investments as established bythe plan agreement include, but are not limited to, common and preferredstocks, open-end or closed-end mutual funds, bonds and other evidences ofindebtedness or ownership, and real estate or any interest therein.

Asset allocationis primarily based on a strategy to provide stable earnings while attempting torecognize potentially higher returns through limited investments in equitysecurities.  Plan assets are rebalancedperiodically.  At December 31, 2006 and2005, allocations by percentages were as follows:

|                               | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
|                          |       |     |       |     |       |
| Equity mutual funds           |       | 58.3     | %          | 64.2     | %          |
| Fixed income mutual  funds    |       | 15.5     |       | 17.7     |       |
| GNMA pool                     |       | .3       |       | .4       |       |
| Money market funds and  other |       | 20.4     |       | 4.8      |       |
| Time Certificates of Deposit  |       | 5.5      |       | 13.0     |       |

 

32

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At December 31,2006 and 2005, market values of plan assets were as follows:

|                               | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Equity mutual funds           |       | $        | 1,050      |     | $          | 983 |   |
| Fixed income mutual  funds    |       | 279      |       | 271      |       |
| GNMA pool                     |       | 5        |       | 5        |       |
| Money market funds and  other |       | 367      |       | 73       |       |
| Time Certificates of Deposit  |       | 99       |       | 199      |       |
|                               |            |          |            |          |            |  |  |

 

The followingtable summarizes the impact of applying FASB Statement No. 158 as of December31, 2006.

|                                         | ** ** | **Before  Application of  Statement 158** | ** ** | **Adjustments** | ** ** | **After  Application of  Statement 158** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------|------------|-----------------|------------|----------------------------------------------------|------------|
| Pension liability                       |       | $                                                   | 119        |            | $          | (67                                                | )          | $ | 52 |   |
| Deferred income taxes                   |       | 137                                                 |       | 18              |       | 155                                                |       |
| Total liabilities                       |       | 254,629                                             |       | (85             | )          | 254,544                                            |       |
| Accumulated other  comprehensive income |       | (1,204                                              | )          | (17             | )          | (1,221                                             | )          |
| Total shareholders’ equity         |       | 23,424                                              |       | 85              |       | 23,509                                             |       |
|                                         |            |                                                     |            |                 |            |                                                    |            |  |  |  |

 

The Bank has adirectors’ retirement plan which provides retirement benefits primarily toformer members of the Board of Directors. The Bank also maintains a supplemental executive retirement plan thatprovides benefits to certain key executive officers and directors in accordancewith the plan document.  The Bank accruedexpenses related to these plans totaling $90,000, $105,000 and $126,000 in 2006, 2005 and 2004.

The Company’s 401(k)profit-sharing plan covers eligible employees with more than one year ofservice, as defined, and who are at least 21 years of age.  The plan allows employee contributions.  The Company may make a matching contribution equalto a percentage of salary deferral and discretionary profit-sharing contributions.  The matching percentage is limited to 6% ofcompensation.  The Company’scontributions, which are made following the end of the calendar year, totaled$151,000, $140,000 and $140,000 for 2006, 2005 and 2004.

**NOTE  11 —STOCK OPTION PLAN**

The Company grants selected executives and other keyemployees and directors incentive and non-qualified stock option awards whichvest and become fully exercisable at the discretion of the Board of Directorsas the options are granted.  The Companyis authorized to grant options for up to 150,000 shares of the Company’s commonstock.  The exercise price of theoptions, which have a ten year life, may not be less than the market price ofthe Company’s stock on the date of grant.

33

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The following is a summary of the status of theCompany’s stock option plan and changes in that plan for 2006, 2005 and  2004. The Company had no grants outstanding prior to 2003.

|                                                                | ** ** | **2006**   | ** ** |
|----------------------------------------------------------------|------------|------------|------------|
| **Options**                                                    | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Weighted-  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
| Outstanding, beginning  of year                                |       | 21,000     |       | $ | 62.55 |   |   |   |   |   |
| Granted                                                        |       | 10,500     |       | 76.00 |   |   |   |   |   |
| Exercised                                                      |       | 434        |       | 60.57 |   |   |   |   |   |
| Forfeited or expired                                           |       | 376        |       | 63.39 |   |   |   |   |   |
|                                                           |       |       |       |   |   |   |   |   |   |
| Outstanding, end of  year                                      |       | 30,690     |       | 67.22 |   | 8.19 |   | $ | 174 |   |
|                                                           |       |       |       |   |   |   |   |   |   |
| Options exercisable at  year end                               |       | 9,928      |       |   |   | 7.18 |   | $ | 108 |   |
|                                                           |       |       |       |   |   |   |   |   |   |
| Weighted-average fair value of options granted during the year |       |       |       | $ | 11.78 |   |   |   |   |   |

 

The weighted-average grant-date fair value of optionsgranted during the years 2006, 2005 and 2004 was $11.78, $3.26 and $1.30,respectively.  The total intrinsic valueof options exercised during the years ended December 31, 2006 was $9,324.

The fair value of each option grant was estimated on the grant dateusing an option-pricing model with the following assumptions:

|                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004**  | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|-----------|------------|
| Risk-free interest  rates                                    |       | 4.29     | %          | 4.37     | %          | 4.21      | %          |
| Dividend yields                                              |       | 3.94     | %          | 4.29     | %          | 4.35      | %          |
| Volatility factors of  expected market price of common stock |       | 5.00     | %          | 5.37     | %          | 3.06      | %          |
| Weighted-average expected life of the options                |       | 10 years |       | 10 years |       | 9.5 years |       |

 

34

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**NOTE  12 —EARNINGS PER SHARE**

Earnings per share (EPS) were computed as follows:

|                                                                  | ** ** | **Year Ended December 31, 2006** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                       | ** ** | **Income**                                           | ** ** | **Weighted-  Average  Shares** | ** ** | **Per Share  Amount** | ** ** |
| Net income                                                       |       | $                                                    | 2,335      |   | 649,605 |   |   |   |
| Basic earnings per  share                                        |       |                                                 |       |   |   |   |   |
| Income available  to common stockholders                         |       |                                                 |       |   |   | $ | 3.59 |   |
|                                                             |       |                                                 |       |   |   |   |   |
| Effect of dilutive  securities                                   |       |                                                 |       |   |   |   |   |
| Stock options                                                    |       | —                                               |       | 1,577 |   |   |   |
| Diluted earnings per  share                                      |       |                                                 |       |   |   |   |   |
| Income available to  common stockholders and assumed conversions |       | $                                                    | 2,335      |   | 651,182 |   | $ | 3.59 |   |

 

|                                                                  | ** ** | **Year Ended December 31, 2005** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                       | ** ** | **Income**                                           | ** ** | **Weighted-  Average  Shares** | ** ** | **Per Share  Amount** | ** ** |
| Net income                                                       |       | $                                                    | 2,545      |   | $ | 649,830 |   |   |   |
| Basic earnings per  share                                        |       |                                                 |       |   |   |   |   |
| Income available  to common stockholders                         |       |                                                 |       |   |   | $ | 3.92 |   |
|                                                             |       |                                                 |       |   |   |   |   |
| Effect of dilutive  securities                                   |       |                                                 |       |   |   |   |   |
| Stock options                                                    |       | —                                               |       | 2,629 |   |   |   |
| Diluted earnings per  share                                      |       |                                                 |       |   |   |   |   |
| Income available to  common stockholders and assumed conversions |       | $                                                    | 2,545      |   | 652,459 |   | $ | 3.90 |   |
|                                                                  |            |                                                      |            |  |  |  |  |  |  |  |

 

|                                                                  | ** ** | **Year Ended December 31, 2004** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                       | ** ** | **Income**                                           | ** ** | **Weighted-  Average  Shares** | ** ** | **Per Share  Amount** | ** ** |
| Net income                                                       |       | $                                                    | 2,628      |   | $ | 651,561 |   |   |   |
| Basic earnings per  share                                        |       |                                                 |       |   |   |   |   |
| Income available  to common stockholders                         |       |                                                 |       |   |   | $ | 4.03 |   |
|                                                             |       |                                                 |       |   |   |   |   |
| Effect of dilutive  securities                                   |       |                                                 |       |   |   |   |   |
| Stock options                                                    |       | —                                               |       | 1,172 |   |   |   |
| Diluted earnings per  share                                      |       |                                                 |       |   |   |   |   |
| Income available  to common stockholders and assumed conversions |       | $                                                    | 2,628      |   | 652,733 |   | $ | 4.03 |   |
|                                                                  |            |                                                      |            |  |  |  |  |  |  |  |

** **

35

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**NOTE 13 —INCOME TAXES**

The balance sheetsincluded the following amounts of deferred tax assets and liabilities atDecember 31:

|                                                            | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Income tax expense                                         |       |     |       |     |       |     |       |
| Currently  payable                                         |       |     |       |     |       |     |       |
| Federal                                                    |       | $        | 672        |     | $          | 721      |       | $ | 337 |   |
| State                                                      |       | 119      |       | 88       |       | (58      | )          |
| Deferred                                                   |       | (38      | )          | (18      | )          | 518      |       |
|                                                       |       |     |       |     |       |     |       |
| Total income tax  expense                                  |       | $        | 753        |     | $          | 791      |       | $ | 797 |   |
|                                                       |       |     |       |     |       |     |       |
| Reconciliation of  federal statutory to actual tax expense |       |     |       |     |       |     |       |
| Federal  statutory income tax at 34%                       |       | $        | 1,050      |     | $          | 1,134    |       | $ | 1,165 |   |
| Tax-exempt  income                                         |       | (344     | )          | (415     | )          | (330     | )          |
| Nondeductible  interest expense                            |       |     |       | —   |       | 24       |       |
| Effect of state  income taxes and other items, net         |       | 47       |       | 72       |       | (62      | )          |
|                                                       |       |     |       |     |       |     |       |
| Actual tax  expense                                        |       | $        | 753        |     | $          | 791      |       | $ | 797 |   |
|                                                       |       |     |       |     |       |     |       |
| Effective tax rate                                         |       | 25.2     | %          | 23.7     | %          | 23.3     | %          |

 

The components of the deferred asset (liability) included on thebalance sheets are as follows:

|                                                     | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|
| **Assets**                                          |       |     |       |     |       |
| Unrealized  losses on securities available for sale |       | $        | 509        |     | $          | 632 |   |
| Allowance for  loan losses                          |       | 385      |       | 341      |       |
| Deferred  compensation                              |       | 295      |       | 278      |       |
| Minimum pension  liability                          |       | 49       |       | 133      |       |
| Other                                               |       | 36       |       | 52       |       |
| Total assets                                        |       | 1,274    |       | 1,436    |       |
|                                                |       |     |       |     |       |
| **Liabilities**                                     |       |     |       |     |       |
| FHLB stock                                          |       | (116     | )          | (118     | )          |
| Depreciation                                        |       | (567     | )          | (622     | )          |
| Mortgage  servicing rights                          |       | (120     | )          | (135     | )          |
| Other                                               |       | (84      | )          | (84      | )          |
| Total  liabilities                                  |       | (887     | )          | (959     | )          |
|                                                |       |     |       |     |       |
|                                                |       | $        | 387        |     | $          | 477 |   |

 

36

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**NOTE 14 —DERIVATIVES**

The Company usesderivatives to fix future cash flows for interest payments on some of itsfloating rate certificates of deposit. In this regard, the Company has entered into an interest rate swap withthe FHLB of Chicago to fix the interest rate on a specific certificate ofdeposit product.  At December 31, 2006,the Company had $2.2 million of certificates of deposit, which mature in 2007through 2011, in which it pays the FHLB a weighted-average interest rate of3.88% and will receive an interest rate from the FHLB based on the appreciationof the S&P 500 Index.  This interestreceived from the FHLB will be paid to the customer.  The assets and liabilities in thistransaction are being netted and the expense recorded in interest expense ondeposits.

In addition to theabove, the Company also purchased $4.9 million of certificates of deposit whichare included in the certificates of deposit caption on the consolidated balancesheet.  These investments have a five yearterm from date of purchase.  Theinvestments that individually do not exceed $100,000 are insured by the FDIC.The initial investment is not at risk but the return on the investment is basedon a calculation of the appreciation in the S&P 500 Index. The fair valueof this embedded derivative is recorded in certificates of deposit and the fairvalue adjustment is included in other income. At December 31, 2006, the Bank had allocated $1.3 million to this assetand recorded a valuation allowance of $285,000.

**NOTE 15 —COMMITMENTS, OFF-BALANCE-SHEET RISK, AND CONTINGENCIES**

There are variouscontingent liabilities that are not reflected in the consolidated financialstatements, including claims and legal actions arising in the ordinary courseof business.  In the opinion ofmanagement, after consultation with legal counsel, the ultimate disposition ofthese claims and legal actions is not expected to have a material effect onfinancial condition or results of operations.

The Bank isrequired to maintain reserve funds in cash and/or on deposit with the FederalReserve Bank.  The reserve required atDecember 31, 2006 was $350,000.

Some financialinstruments are used in the normal course of business to meet the financingneeds of customers.  These financial instrumentsinclude commitments to extend credit, standby letters of credit, and financialguarantees.  These involve, to varyingdegrees, credit and interest-rate risk in excess of the amounts reported in thefinancial statements.

Exposure to creditloss if the other party does not perform is represented by the contractualamount for commitments to extend credit, standby letters of credit, andfinancial guarantees written.  The samecredit policies are used for commitments and conditional obligations are used forloans.  Collateral or other security isnormally required to support financial instruments with credit risk.

Commitments toextend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the commitment.  Commitments generally have fixed expirationdates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected toexpire without being used, the total commitments do not necessarily representfuture cash requirements.  Standbyletters of credit and financial guarantees written are conditional commitmentsto guarantee a customer’s performance to a third party.

A summary of thenotional or contractual amounts of financial instruments with off-balance-sheetrisk at year end follows:

|                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Unused lines of credit   |       | $        | 17,850     |     | $          | 13,143 |   |
| Standby letter of credit |       | 513      |       | 721      |       |
|                          |            |          |            |          |            |  |  |

 

At December 31,2006, all of the commitments to extend credit were at variable rates ofinterest.

37

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**NOTE 16 —FAIR VALUES OF FINANCIAL INSTRUMENTS**

The followingmethods and assumptions were used to estimate fair values for financialinstruments.  The carrying amount isconsidered to estimate fair value for cash and due from banks, demand, NOW,money market and savings deposits, federal funds purchased, securities soldunder repurchase agreements, accrued interest receivable and payable, andvariable rate loans or deposits. Securities fair values are based on quoted market prices or, if noquotes are available, on the rate and term of the security and on informationabout the issuer.  The fair value ofloans held for sale and derivatives are based on quoted market prices.  For fixed rate loans or deposits, the fairvalue is estimated by discounted cash flow analysis using current market ratesfor the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flowanalysis or underlying collateral values, where applicable.  The fair value of off-balance-sheet items isbased on the fees or cost that would currently be charged to enter into orterminate such agreements and is not material.

The carryingvalues and estimated fair values of the Company’s financial instruments as ofDecember 31, 2006 and 2005 were as follows:

|                                                 | ** ** | **2006**             | ** ** | **2005**        | ** ** |
|-------------------------------------------------|------------|----------------------|------------|-----------------|------------|
| ** **                                      | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** |
| **Assets**                                      |       |                 |       |            |       |   |   |   |   |
| Cash and cash  equivalents                      |       | $                    | 10,644     |            | $          | 10,644 |   | $ | 6,857 |   | $ | 6,857 |   |
| Certificates of  deposit and related derivative |       | 6,135                |       | 6,135           |       | 11,494 |   | 11,209 |   |
| Securities  available for sale                  |       | 83,085               |       | 83,085          |       | 90,631 |   | 90,631 |   |
| Loans held for  sale                            |       | —               |       | —          |       | — |   | — |   |
| Loans                                           |       | 159,475              |       | 156,644         |       | 151,516 |   | 151,460 |   |
| Interest  receivable                            |       | 2,120                |       | 2,120           |       | 2,031 |   | 2,031 |   |
|                                            |       |                 |       |            |       |   |   |   |   |
| **Liabilities**                                 |       |                 |       |            |       |   |   |   |   |
| Deposits with no  stated maturities             |       | 146,146              |       | 146,146         |       | 139,091 |   | 139,091 |   |
| Time deposits                                   |       | 104,195              |       | 104,811         |       | 100,790 |   | 102,508 |   |
| Federal funds  purchased                        |       | —               |       | —          |       | 12,700 |   | 12,700 |   |
| Interest payable                                |       | 1,033                |       | 1,033           |       | 702 |   | 702 |   |
|                                                 |            |                      |            |                 |            |  |  |  |  |  |  |  |  |

 

**NOTE 17 —REGULATORY AND CAPITAL MATTERS**

The Company maypay dividends without restriction under the current Federal Reserve regulationsso long as it remains “adequately capitalized” after such payment.  The Bank is subject to statutory dividendrestrictions which provide, in general, that the Bank may pay the current year’searnings and the prior two years’ retained earnings without the prior approvalof the Office of the Comptroller of Currency. At December 31, 2006, the Bank’s stockholder’s equity totaled$23,509,000, of which $23,158,000 was not available for payment of dividends,without prior regulatory approval.

The Company andthe Bank are subject to various regulatory capital requirements administered bythe federal banking agencies.  Capitaladequacy guidelines and prompt corrective action regulations involve quantitativemeasures of assets, liabilities, and certain off-balance-sheet items calculatedunder regulatory accounting practices. Capital amounts and classifications are also subject to qualitativejudgments by regulators about components, risk weightings, and other factors,and the regulators can lower classifications in certain cases.  Failure to meet various capital requirementscan initiate regulatory action that could have a direct material effect on thefinancial statements.

** **

38

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The promptcorrective action regulations provide five classifications, including wellcapitalized, adequately capitalized, undercapitalized, significantlyundercapitalized, and critically undercapitalized, although these terms are notused to represent overall financial condition. If adequately capitalized, regulatory approval is required to acceptbrokered deposits.  If  undercapitalized, capital distributions arelimited, as is asset growth and expansion, and plans for capital restorationare required.

The Company’s onlyactivity is ownership of the Bank, and, therefore, its capital, capital ratios,and minimum required levels of capital are materially the same as the Bank’s.   The actual capital levels and minimumrequired levels for the Company were:

|                                                     | ** ** | **Actual** | ** ** | **Required for Adequate  Capital** | ** ** | **To Be Well  Capitalized** | ** ** |
|-----------------------------------------------------|------------|------------|------------|----------------------------------------------|------------|---------------------------------------|------------|
| ** **                                          | ** ** | **Amount** | ** ** | **Ratio**                                    | ** ** | **Amount**                            | ** ** | **Ratio** | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| **December 31, 2006**                               |       |       |       |                                         |       |                                  |       |   |   |   |   |   |   |
| Total risk-based  capital (to risk-weighted assets) |       | $          | 22,668     |                                         | 12.0       | %                                     | $          | 15,144 |   | 8.0 | % | $ | 18,930 |   | 10.0 | % |
| Tier 1 capital (to risk-weighted  assets)           |       | 21,205     |       | 11.2                                         | %          | 7,572                                 |       | 4.0 | % | 11,358 |   | 6.0 | % |
| Tier 1 capital (to  average assets)                 |       | 21,205     |       | 7.5                                          | %          | 11,321                                |       | 4.0 | % | 14,152 |   | 5.0 | % |
| ** **                                          |       |       |       |                                         |       |                                  |       |   |   |   |   |   |   |
| **December 31, 2005**                               |       |       |       |                                         |       |                                  |       |   |   |   |   |   |   |
| Total risk-based  capital (to risk-weighted assets) |       | $          | 21,786     |                                         | 11.9       | %                                     | $          | 14,672 |   | 8.0 | % | $ | 18,340 |   | 10.0 | % |
| Tier 1 capital (to risk-weighted  assets)           |       | 20,442     |       | 11.2                                         | %          | 7,336                                 |       | 4.0 | % | 11,004 |   | 6.0 | % |
| Tier 1 capital (to average assets)                  |       | 20,442     |       | 7.2                                          | %          | 11,331                                |       | 4.0 | % | 14,163 |   | 5.0 | % |

 

At December 31, 2006,the Company and the Bank were categorized as well capitalized and management isnot aware of any conditions or events since the most recent notification thatwould change the Company’s or Bank’s category.

**NOTE 18 —OTHER COMPREHENSIVE INCOME (LOSS)**

|                                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Unrealized gains  (losses) on securities                                     |       |     |       |     |       |     |       |
| Unrealized  holding gains (losses) arising during the year                   |       | $        | 351        |     | $          | (2,135   | )          | $ | (1,680 | ) |
| Less:  reclassification adjustment for gains (losses) realized in net income |       | (13      | )          | 172      |       | 465      |       |
| Tax effect                                                                   |       | (124     | )          | 785      |       | 729      |       |
|                                                                         |       |     |       |     |       |     |       |
| Other comprehensive  income (loss)                                           |       | $        | 240        |     | $          | (1,522   | )          | $ | (1,416 | ) |

 

39

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**NOTE 19 —PARENT COMPANY FINANCIAL STATEMENTS**

The following arethe condensed balance sheets, statements of income and cash flows for FirstOttawa Bancshares, Inc.

| Condensed Balance Sheets               | ** ** |
|--------------------------------------------------|------------|
| ** **                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
| **Assets**                                       |       |   |   |   |   |
| Cash on deposit  with Bank                       |       | $ | 1,569 |   | $ | 1,733 |   |
| Investment in  common stock of Bank              |       | 23,083 |   | 22,364 |   |
| Other assets                                     |       | 157 |   | 59 |   |
|                                             |       |   |   |   |   |
| Total assets                                     |       | $ | 24,809 |   | $ | 24,156 |   |
|                                             |       |   |   |   |   |
| **Liabilities**                                  |       |   |   |   |   |
| Note payable                                     |       | $ | — |   | $ | — |   |
| Dividends  payable                               |       | 1,300 |   | 1,298 |   |
|                                             |       | 1,300 |   | 1,298 |   |
|                                             |       |   |   |   |   |
| **Shareholders’ Equity**                    |       | 23,509 |   | 22,858 |   |
| ** **                                       |       |   |   |   |   |
| Total liabilities and  shareholders’ equity |       | $ | 24,809 |   | $ | 24,156 |   |

 

| Condensed Statements of Income                                  | ** ** |
|--------------------------------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Income –**  dividends from Bank                                         |       | $ | 1,949 |   | $ | 2,649 |   | $ | 2,003 |   |
| ** **                                                                     |       |   |   |   |   |   |   |
| **Other income –**  gain on the sale of investments                       |       | — |   | 124 |   | — |   |
| ** **                                                                     |       |   |   |   |   |   |   |
| **Expenses**                                                                   |       | 110 |   | 83 |   | 85 |   |
| ** **                                                                     |       |   |   |   |   |   |   |
| **Income before income tax and  equity in undistributed income of subsidiary** |       | 1,839 |   | 2,690 |   | 1,918 |   |
| ** **                                                                     |       |   |   |   |   |   |   |
| **Income tax benefit**                                                         |       | — |   | — |   | 29 |   |
| ** **                                                                     |       |   |   |   |   |   |   |
| **Income before equity in  undistributed income of subsidiary**                |       | 1,839 |   | 2,690 |   | 1,947 |   |
| ** **                                                                     |       |   |   |   |   |   |   |
| **Equity in undistributed income  of subsidiary**                              |       | 496 |   | (145 | ) | 681 |   |
| ** **                                                                     |       |   |   |   |   |   |   |
| **Net Income**                                                                 |       | $ | 2,335 |   | $ | 2,545 |   | $ | 2,628 |   |

 

40

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| Condensed Statements of Cash Flows                             | ** ** |
|------------------------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** |
| ** **                                                                         | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Operating Activities**                                                           |       |   |   |   |   |   |   |
| Net income                                                                         |       | $ | 2,335 |   | $ | 2,545 |   | $ | 2,628 |   |
| Item not  requiring (providing) cash                                               |       |   |   |   |   |   |   |
| Equity in  undistributed earnings of Bank                                          |       | (496 | ) | 145 |   | (681 | ) |
| Gains on sales  of securities, net                                                 |       | — |   | (124 | ) | — |   |
| Vested stock  options                                                              |       | 38 |   | 21 |   | 10 |   |
| Other                                                                              |       | (96 | ) | 14 |   | 1,295 |   |
| Net cash  provided by operating activities                                         |       | 1,781 |   | 2,601 |   | 3,252 |   |
|                                                                               |       |   |   |   |   |   |   |
| **Investing Activity –**proceeds  from sales of securities available for sale |       | — |   | 469 |   | — |   |
| ** **                                                                         |       |   |   |   |   |   |   |
| **Financing Activities**                                                           |       |   |   |   |   |   |   |
| Purchase of  treasury shares                                                       |       | (22 | ) | (89 | ) | (71 | ) |
| Loan proceeds  (payments), net                                                     |       | — |   | (603 | ) | 69 |   |
| Cash dividends                                                                     |       | (1,949 | ) | (1,949 | ) | (1,954 | ) |
| Options  exercised                                                                 |       | 26 |   | — |   | — |   |
| Net cash used in  financing activities                                             |       | (1,945 | ) | (2,641 | ) | (1,956 | ) |
|                                                                               |       |   |   |   |   |   |   |
| **Net Change in Cash and Cash  Equivalents**                                       |       | (164 | ) | 429 |   | 1,296 |   |
| ** **                                                                         |       |   |   |   |   |   |   |
| **Cash and Cash Equivalents,  Beginning of Year**                                  |       | 1,733 |   | 1,304 |   | 8 |   |
| ** **                                                                         |       |   |   |   |   |   |   |
| **Cash and Cash Equivalents, End of Year**                                         |       | $ | 1,569 |   | $ | 1,733 |   | $ | 1,304 |   |

 

41

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**NOTE 20 —QUARTERLY FINANCIAL DATA (UNAUDITED)**
| ** **     | ** ** | **Interest  Income** | ** ** | **Interest  Expense** | ** ** | **Net Interest  Income** | ** ** | **Provision** | ** ** | **Securities  Gains** | ** ** | **Net  Income** | ** ** | **Basic** | ** ** | **Diluted** | ** ** |
|----------------|------------|----------------------|------------|-----------------------|------------|-------------------------------|------------|---------------|------------|-----------------------|------------|-----------------|------------|-----------|------------|-------------|------------|
| **2006**       |       |                 |       |                  |       |                          |       |          |       |                  |       |            |       |      |       |        |       |
| First quarter  |       | $                    | 3,558      |                  | $          | 1,410                         |       | 2,148         |       | $                     | 45         |            | $          | (13       | )          | $           | 520        |   | $ | 0.80 |   | $ | 0.80 |   |
| Second quarter |       | 3,629                |       | 1,470                 |       | 2,159                         |       | 45            |       | —                |       | 436             |       | 0.67      |       | 0.67        |       |
| Third quarter  |       | 3,872                |       | 1,675                 |       | 2,197                         |       | 45            |       | —                |       | 655             |       | 1.01      |       | 1.01        |       |
| Fourth quarter |       | 3,869                |       | 1,806                 |       | 2,063                         |       | 45            |       | —                |       | 754             |       | 1.11      |       | 1.11        |       |
| **2005**       |       |                 |       |                  |       |                          |       |          |       |                  |       |            |       |      |       |        |       |
| First quarter  |       | $                    | 3,278      |                  | $          | 1,013                         |       | 2,265         |       | $                     | 75         |            | $          | 30        |       | $           | 495        |   | $ | 0.76 |   | $ | 0.76 |   |
| Second quarter |       | 3,375                |       | 1,101                 |       | 2,274                         |       | 75            |       | 24                    |       | 571             |       | 0.88      |       | 0.88        |       |
| Third quarter  |       | 3,635                |       | 1,224                 |       | 2,411                         |       | 75            |       | —                |       | 660             |       | 1.02      |       | 1.01        |       |
| Fourth quarter |       | 3,620                |       | 1,275                 |       | 2,345                         |       | 75            |       | 118                   |       | 819             |       | 1.26      |       | 1.25        |       |

 

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FIRST OTTAWA BANCSHARES,INC.SHAREHOLDERS INFORMATION

ANNUAL MEETING

The Annual Meetingof Shareholders will be held at 3 p.m., local time on May 16, 2007 at thecorporate headquarters located at 701 LaSalle Street, Ottawa, Illinois 61350.

PRICE RANGE OF COMMONSTOCK

As of February 9,2007, there were approximately 540 shareholders of record and 649,483outstanding shares of common stock.

The Company’scommon stock is not traded on any national or regional securities exchange andthere is no established public trading market for it.  Transactions in the Company’s common stockhave been infrequent.  To the knowledgeof the Company’s management, during 2005, 2006 and the first month of 2007, anaggregate of approximately 24,745 shares of the Company’s common stock wastransferred in approximately 42 separate transactions, excluding 620 sharespurchased at $70 per share and the 640 shares purchased at $72 per share by theCompany in 2005, and the 300 shares purchased by the Company at $71.27 pershare in 2006.  These transfersrepresented both transfers for consideration (i.e., sales) and transfers for noconsideration (e.g., gifts, estate transfers, etc.).  The Company’s management is unable todifferentiate such transfers and has limited knowledge of the sale prices fortransfers involving consideration.  Thelast price known to the Company’s management was a sale of 100 shares onFebruary 9, 2007 at $78 per share.

The followingdividends per share were paid on the Company’s common stock on the datesindicated: January 1, 2005 – $2.00; July 1, 2005 – $1.00; January 1, 2006 –$2.00; July 1, 2006 – $1.00; January 1, 2007 – $2.00.

WEB SITE FOR UNITED STATES SECURITIES AND EXCHANGECOMMISSION FILINGS

All reports filed electronically by the Company withthe United Stated Securities Exchange Commission (the “SEC”), including theannual report on Form 10-K, quarterly reports on Form 10-Q, and current eventsreports on Form 8-K, as well as any amendments to those reports are accessibleat no cost on our internet site at www.firstottawa.com and on the SEC’s website at www.sec.gov.  We will alsoprovide you with a copy free of charge by contacting Cheryl Gage, CorporateSecretary, First Ottawa Bancshares, Inc., 701 LaSalle Street, Ottawa, Illinois61350.

CORPORATE GOVERNANCE

The Company’scorporate governance practices are described in the following documents, whichare available on the Company’s Web site at www.firstottawa.com or which may beobtained in print form through the investor relations department: Code ofBusiness Conduct and Ethics, Audit Committee Charter, Nominating and CorporateGovernance Committee Charter, and Compensation Committee Charter.

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**StockholderReturn Performance Graph**

The followinggraph shows a comparison of cumulative total returns for First Ottawa, theNasdaq Stock Market and an index of Midwestern bank stocks which are quoted onthe OTC-Bulletin Board and on Pink Sheets. The cumulative total stockholder return computations assume theinvestment of $100 on December 31, 2001 and the reinvestment of alldividends.  Figures for First Ottawa’scommon stock represent inter-dealer quotations, without retail markups, markdowns or commissions and do not necessarily represent actual transactions.  The graph was prepared at our request by SNLSecurities L.L.C., Charlottesville, Virginia.

***First Ottawa Bancshares, Inc.***

****

 
| *** ***                       | *** *** | **Period Ending** | *** *** |
|------------------------------------|--------------|------------------------|--------------|
| **Index**                          | ** **   | **12/31/01**           | ** **   | **12/31/02** | ** ** | **12/31/03** | ** ** | **12/31/04** | ** ** | **12/31/05** | ** ** | **12/31/06** | ** ** |
| First Ottawa  Bancshares, Inc.     |         | 100.00                 |         | 110.23 |   | 135.14 |   | 163.71 |   | 190.39 |   | 204.35 |   |
| NASDAQ Composite                   |         | 100.00                 |         | 68.76 |   | 103.67 |   | 113.16 |   | 115.57 |   | 127.58 |   |
| SNL Midwest OTC-BB and  Pink Banks |         | 100.00                 |         | 128.26 |   | 161.90 |   | 192.90 |   | 200.83 |   | 211.50 |   |

 

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