**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

**FORM 10-K**

**ANNUAL REPORT UNDER SECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

**Forthe fiscal year ended December 31, 2006**

**Commissionfile number:  005-57237**

**FIRST OTTAWA BANCSHARES, INC.**

(Exact name of Registrantas specified in its charter)

| **Delaware**                     |   | **36-4331185**                        |
|----------------------------------|--------|---------------------------------------|
| (State or Other  Jurisdiction of |   | (I.R.S. Employer  Identification No.) |
| Incorporation or  Organization)  |   |                                  |

 

| **701-705 LaSalle Street**                |   | ** ** |
|-------------------------------------------|--------|------------|
| **Ottawa,  Illinois**                     |   | **61350**  |
| (Address of  Principal Executive Offices) |   | (ZIP Code) |

 

**(815) 434-0044**

(Registrant Telephone Number,

including Area Code)

**Securities registered under Section 12(b) of theExchange Act:**

**None**

**Securities registered under Section12(g) of the Exchange Act:**

**Common Stock, par value$1.00 per share**

(Title of Class)

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act. Yes oNo x

Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Exchange Act. Yes oNo x

Indicate by check mark whetherthe registrant:  (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the past 12 months (or for such shorter period thatthe registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark if disclosure of delinquent filers in responseto Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. x

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct). Yes o No x

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

| Large accelerated  filer o |   | Accelerated  filer o |   | Non-accelerated  filer x |
|---------------------------------|--------|---------------------------|--------|-------------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Exchange Act Rule 12b-2). Yes oNo x

Theaggregate market value of the voting and non-voting common equity held bynon-affiliates of the registrant, based on the last known sales price on orprior to June 30, 2006, the last business day of the registrant’s most recentlycompleted second fiscal quarter, was $44,754,160.

649,670 shares of common stock were outstanding as ofMarch  14, 2007.

**DOCUMENTSINCORPORATED BY REFERENCE**

TheRegistrant’s 2006 Annual Report to Stockholders is incorporated by reference inParts II and IV and the Registrant’s Proxy Statement for the Annual Meeting ofStockholders to be held May 16, 2007 is incorporated by reference in Part III.

Except for those portions of the 2006 Annual Reportincorporated by reference, the Annual Report is not deemed filed as part ofthis Report.

 

 

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INDEX
| PART I   |   |                                                                                                                         |   |   |
|----------|--------|------------------------------------------------------------------------------------------------------------------------------|--------|--------|
|     |   |                                                                                                                         |   |   |
| Item  1  |   | Business                                                                                                                     |   |   |
| Item  1A |   | Risk  Factors                                                                                                                |   |   |
| Item 1B  |   | Unresolved  Staff Comments                                                                                                   |   |   |
| Item  2  |   | Properties                                                                                                                   |   |   |
| Item 3   |   | Legal Proceedings                                                                                                            |   |   |
| Item 4   |   | Submission of  Matters to a Vote of Security Holders                                                                         |   |   |
|     |   |                                                                                                                         |   |   |
| PART II  |   |                                                                                                                         |   |   |
|     |   |                                                                                                                         |   |   |
| Item 5   |   | Market for the  Registrant’s Common Equity, Related Stockholder Matters  and Issuer Purchases of Equity Securities |   |   |
| Item 6   |   | Selected Financial  Data                                                                                                     |   |   |
| Item 7   |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                  |   |   |
| Item 7A  |   | Quantitative and Qualitative Disclosures about Market  Risk                                                                  |   |   |
| Item 8   |   | Financial Statements and Supplementary Data                                                                                  |   |   |
| Item 9   |   | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                                        |   |   |
| Item 9A  |   | Controls and Procedures                                                                                                      |   |   |
| Item  9B |   | Other  Information                                                                                                           |   |   |
|     |   |                                                                                                                         |   |   |
| PART III |   |                                                                                                                         |   |   |
|     |   |                                                                                                                         |   |   |
| Item 10  |   | Directors, Executive Officers and Corporate Governance                                                                       |   |   |
| Item 11  |   | Executive Compensation                                                                                                       |   |   |
| Item 12  |   | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                              |   |   |
| Item 13  |   | Certain Relationships and Related Transactions and  Director Independence                                                    |   |   |
| Item 14  |   | Principal Accountant Fees and Services                                                                                       |   |   |
|     |   |                                                                                                                         |   |   |
| PART IV  |   |                                                                                                                         |   |   |
|     |   |                                                                                                                         |   |   |
| Item 15  |   | Exhibits and Financial Statement Schedules                                                                                   |   |   |

 

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**PART I**

**Item 1.        Business**.

FirstOttawa Bancshares, Inc. (the “Company”) is a bank holding company for itswholly-owned subsidiary, First National Bank of Ottawa (the “Bank”), and theBank’s wholly owned subsidiary, First Ottawa Financial Corporation.  The Company was organized in 1999 and onOctober 1, 1999 exchanged 100% of its common stock for 100% of the Bank’scommon stock.  This exchange wasaccounted for as an internal reorganization. All references to the combined Company, unless otherwise indicated, ator before October 1, 1999, refer to the Bank. As of December 31, 2006, the Company had total assets of $278.1 million,total deposits of $250.3 million, loans, including loans held for sale, of$160.9 million and total stockholders’ equity of $23.5 million.  For the year ended December 31, 2006, theCompany had interest income of $14.9 million and net income of $2.2 million,which amounted to basic net income per share of $3.59, and diluted net incomeper share of $3.59.

TheCompany conducts a general banking business embracing most of the services,both commercial and consumer, which banks may lawfully provide, including thefollowing principal services:  theacceptance of deposits for demand, savings, and time accounts and the servicingof such accounts; commercial, agricultural, consumer, and real estate lending,including installment loans, personal lines of credit, and overdraftprotection; trust operations; farm management; safe deposit operations; and anextensive variety of additional services tailored to the needs of individualcustomers, including the sale of traveler’s checks, cashier’s checks, andforeign currency and other special services. Loans, both commercial and consumer, are provided on either a secured orunsecured basis to corporations, partnerships, and individuals.  Commercial lending covers such areas asbusiness, industry, capital, agriculture, inventory, and real estate, with thelatter including residential properties. Consumer loans are made for a variety of purposes including automobilepurchases, recreational vehicle purchases, consumer goods, installment loans,and other types of loans.

TheCompany is located in north-central Illinois, with corporate offices in Ottawa,Illinois in LaSalle County, approximately 80 miles southwest of Chicago.  All branches are in Illinois within 45 milesof the corporate offices:  Streator,LaSalle County; Morris and Minooka, Grundy County; Yorkville, Kendall County.  Ottawa, Morris, and Yorkville are the countyseats of their respective counties, all with associated governmental officesand workforce.  Ottawa and Streator arethe principal cities of the 5th largest, bypopulation, Micropolitan Statistical Area in the United States, as determinedby the 2000 U.S. census. The recognition of population concentration, largerthan many metropolitan areas, has added to interest in the region fordevelopers and those exploring relocation or expansion. The market areas areserved by major transportation routes, Interstates 80, 88, 39, and 55, as well asrail, and the Illinois River waterway system.

Themarket areas incorporate diverse economic sectors including agriculture,transportation, industry, and mining, primarily high quality silica sand.  The sand deposits have encouraged extensiveglass manufacturing in the area.  The variouseconomies are generally

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expanding withdevelopment, both commercial and residential, attractive due to relativelyinexpensive real estate costs and the proximity to the metropolitan urban andsuburban concentrations in the Chicago, Naperville, and Joliet corridor.  The central location, transportation routes,and lack of congestion also make the area desirable for distribution andwarehousing.  The Illinois River waterwayprovides preferable market opportunities and pricing for the agriculturalsector.  The unusual geographic terrainand parklands have spurred tourism in the area, drawing in excess of 1 millionvisitors per year.

TheCompany opened a full service banking facility in 2005 in the city ofYorkville, Illinois. The Company also opened a loan production office in 2006in the city of Minooka, Illinois. The Company continues to explore expansionopportunities within its existing market area and in surrounding areas.

***Lending Activities***.  TheCompany relies on interest income from lending activities as a major source ofrevenue.  The Company has a communitybank focus — serving the credit needs of the local community.  Because of this local focus, the Company hasa flexible process for handling loan requests rather than being tied to rigidstandards.  The discussions belowregarding lending policies reflect general guidelines and may vary on acase-by-case basis depending on the borrower’s credit history and the type andsize of loan.  During the approvalprocess for loans it originates, the Company assesses both the applicant’sability to repay the loan and the value of any collateral securing theloan.  The Company verifies the applicant’sability to repay the loan by using credit reports, financial statements,confirmations, and other items, including appraisals.

Thirteenloan officers have the authority to handle all lending activities of theCompany.  Each lending officer hasauthority to approve extensions of credit up to their individual lending limit.  The Company has an Officers Loan Committee(consisting of Loan Officers, the Chief Lending Officer, and the President ofthe Bank) which approves loans of up to $1,000,000.  All loans between $1,000,000 and $2,000,000are sent to the Director’s Loan Committee for approval.  The Director’s Loan Committee is alsoresponsible for monitoring concentration of credits, problem and past dueloans, and charge-offs of uncollectible loans; formulatingrecommendations for the Board of Directors regarding loan policy modifications,loan classifications, and charge-offs. All loans in excess of $2,000,000are reviewed and approved by the Board of Directors.  The Board of Directors also is responsiblefor directing and supervising the Director’s Loan Committee, policy review, andoversight of the loan and investment functions of the Company.  The Board of Directors also monitors theadequacy of the Company’s loan loss reserves.

***Loan Portfolio Composition***.  TheCompany’s gross loan portfolio, totaled $160.9 million at December 31,2006, representing 64.3% of the Company’s total deposits at that date.  The Company’s loan portfolio at December 31,2006 included $102.5 million for real estate purposes, $18.8 million forconsumer purposes, and $39.6 million for commercial and agricultural purposes.

Certain risks, including therisk of non-payment, are associated with each type of loan.  The primary risks associated with consumerloans relate to the borrower, such as the risk of a borrower’s unemployment asa result of deteriorating economic conditions or the amount and nature of aborrower’s other existing indebtedness, and the value of the collateralsecuring the loan if the Company must take possession of the collateral.  Consumer loans also have risks associatedwith concentrations of loans in a single type of loan.  The primary risks associated with commercial

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loans are the experience and quality of the borrower’smanagement, the business climate, and the impact of economic factors.  With respect to agricultural loans, theprimary risks are weather, market conditions, and, like commercial loans, thequality of the borrower’s management. Risks associated with real estate loans include concentrations of loansin a loan type such as commercial or agricultural and fluctuating land values.

The Company’s strategy inaddressing and managing these types of risks is to follow its loan policies andunderwriting practices, which include (i) granting loans on a sound andcollectible basis; (ii) investing funds profitably for the benefit of thestockholders and the protection of depositors; (iii) serving thelegitimate needs of the community and the Company’s general market area whilemaintaining a balance between maximum yield and minimum risk;(iv) ensuring that primary and secondary sources of repayment are adequatein relation to amount of the loan; (v) developing and maintaining adequatediversification of the loan portfolio as a whole and of the loans within eachloan category; (vi) ensuring that each loan is properly documented and, ifappropriate, secured or guaranteed by government agencies; and(vii) developing and applying adequate collections procedures.

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All table amounts throughout the Form 10-Kare in thousands except share and per share data.

Thefollowing table presents the components of the Company’s loan portfolio as ofDecember 31 for each year shown.
| ** **                                 | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Real estate loans                          |       | $        | 102,516    |     | $          | 95,469   |       | $        | 74,225     |     | $          | 70,839 |   | $ | 46,622 |   |
|                                       |       |     |       |     |       |     |       |     |       |     |       |
| Commercial and  agricultural loans         |       | 39,610   |       | 33,686   |       | 28,341   |       | 24,197   |       | 33,950   |       |
|                                       |       |     |       |     |       |     |       |     |       |     |       |
| Installment loans, net  of unearned income |       | 7,401    |       | 11,585   |       | 17,575   |       | 22,812   |       | 19,951   |       |
|                                       |       |     |       |     |       |     |       |     |       |     |       |
| Home equity lines of  credit               |       | 11,411   |       | 12,120   |       | 12,651   |       | 12,456   |       | 9,120    |       |
|                                       |       |     |       |     |       |     |       |     |       |     |       |
| Total Loans                                |       | 160,938  |       | 152,860  |       | 132,792  |       | 130,304  |       | 109,643  |       |
|                                       |       |     |       |     |       |     |       |     |       |     |       |
| Allowance for loan  losses                 |       | (1,463   | )          | (1,344   | )          | (1,174   | )          | (1,049   | )          | (1,167   | )          |
|                                       |       |     |       |     |       |     |       |     |       |     |       |
| Loans, net                                 |       | $        | 159,475    |     | $          | 151,516  |       | $        | 131,618    |     | $          | 129,255 |   | $ | 108,476 |   |
|                                       |       |     |       |     |       |     |       |     |       |     |       |
| Loans held for sale                        |       | $        | —     |     | $          | —   |       | $        | 1,701      |     | $          | 1,644 |   | $ | 1,811 |   |

 

Maturities(based on contractual terms) of the Company’s commercial and construction loanportfolio at December 31, 2006 are summarized below:

|                              | ** ** | **One Year** | ** ** | **One to**     | ** ** | **Over**            | ** ** | ** ** | ** ** |
|------------------------------|------------|-------------------|------------|---------------------|------------|---------------------|------------|------------|------------|
| ** **                   | ** ** | **or Less**  | ** ** | **Five Years** | ** ** | **Five Years** | ** ** | **Total**  | ** ** |
| Commercial and  agricultural |       | $                 | 12,987     |                | $          | 17,154              |       | $          | 9,469      |   | $ | 39,610 |   |
|                         |       |              |       |                |       |                |       |       |       |
| Construction                 |       | 5,392             |       | 4,227               |       | 2,718               |       | 12,337     |       |
|                         |       |              |       |                |       |                |       |       |       |
| Total                        |       | $                 | 18,379     |                | $          | 21,381              |       | $          | 12,187     |   | $ | 51,947 |   |

 

AtDecember 31, 2006, of the total loans that mature in more than one year,$65.9 million, or 60.1%, bear interest at fixed rates and $43.7 million, or39.9%, bear interest at variable rates.

***Consumer Loans***.  The Companymakes consumer loans for various purposes, including personal, family, andnonbusiness reasons such as automobile loans and recreational vehicle loans, onboth a direct and indirect basis. Consumer loans totaled approximately $18.8 million at December 31,2006, or approximately 11.7% of the Company’s total loan portfolio.  Approximately 30.5% of the Company’s consumerloans were automobile loans, and of these loans, approximately 58.0% were madeindirectly by the Company through automobile dealers.  At December 31, 2006, the Company had noconsumer loans that were past due in excess of 90 days.

Inapproving consumer loans, lending officers consider the borrower’s past credithistory, the borrower’s ability to repay the debt, the collateral offered, andlocal economic conditions that 

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could affect theborrower’s income.  Loans beingoriginated for new borrowers must be accompanied by a completed applicationdated and signed by the borrower, giving the details of the loan request.  Total debts, along with the gross monthlyincome of the borrower, are required to be shown on the application.  A brief cash flow analysis is performed bythe loan officer showing the amount of the borrower’s income available for debtservice based on current debts plus the new loan request.  Generally, debt service to gross incomeshould not exceed 40%. New credit reports are obtained on all borrowers witheach loan request.  The value ofcollateral on loans secured by used automobiles is generally determined byusing industry-accepted used car guides. In connection with used automobile loans, the Company generally requiresa 90% loan-to-value ratio; however, depending upon various factors,including the credit experience of the Company with the borrower, the Companymay extend credit in excess of the value of the used automobile.  A loan-to-value ratio of 90% ofsticker price is generally required for new automobile loans.  Boats, mobile homes, recreational vehicles,and similar items generally require a loan-to-value ratio of 70% to80% of the current market value of the collateral.  Unsecured consumer loans are granted toborrowers based upon satisfactory income, indebtedness levels, and creditrecords and experience.

***Commercial, Agricultural,and Real Estate Lending***.

Commercial and Agricultural.  At December 31, 2006, the Company’scommercial and agricultural loans totaled $39.6 million, or approximately 24.6%of the total loan portfolio of the Company. The majority of agricultural and commercial non-real estate loansare written for one to five years. These loans may bear interest at a fixed orvariable rate and are amortized over a 15-year to 20-year period. Fixed ratesare established by the Company’s management after considering the cost of fundsto the Company as well as the rates of competing institutions.  The variable rate is generally based upon thenational prime rate as disclosed in *The Wall Street Journal*.  Principal and interest payments on commercialloans generally are required monthly; whereas, payments on agricultural loansvary from monthly, quarterly, semi-annually, and annually.  At December 31, 2006, the Company had twocommercial non-real estate loans totaling $106,000 that were past due in excess of 90days. There were no agricultural non-real estate loans at December 31,2006 that were past due in excess of 90 days. Management feels the Company is wellcollateralized and expects no loss in excess of specific allocations on theloans.

All commercial and agriculturalborrowers, both existing and new, are required by policy to have a currentfinancial statement no older than one year. Borrowers also are required to provide the Company with recent taxreturns and pro forma projections.  Usingcertain computer programs and the data supplied by borrowers, the loan officersproduce additional financial information utilized in analyzing the loans andthe borrowers.  The general nature of thecollateral securing the Company’s commercial and agricultural loans consists ofequipment, farm products, crops, inventory, chattel paper, accounts receivable,and general intangibles.  The Company’sloan-to-value ratio with respect to agricultural and commercial non-realestate loans averages 66 2/3% to 75% of the value of the collateral securingthe loan.

Real Estate Lending. The Company’s primary real estate lendingconsists of commercial loans with a small portion in residential andagricultural real estate loans.  Realestate loans at December 31, 2006 totaled approximately $102.5 million or approximately63.7% of the Company’s total loan portfolio. All borrowers requesting a real estate loan are required to submit 

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an application which is reviewed by the lendingofficer.  A credit investigation isperformed and an analysis of the borrower’s ability to repay is conducted.  Subsequently, an inspection and appraisal ofthe real property is conducted to determine whether or not the property is ofsufficient value to meet the Company’s suggested maximum loan-to-valueratio of 80% to 85% of the lesser of the appraised value or the purchase priceof the property securing the loan.  Undercertain federal guaranteed loan programs utilized by the Company, the maximumloan-to-­value ratio is higher. With respect to loans secured by commercial or industrial real estate,the Company analyzes the potential for environmental liability concerns and,depending upon the circumstances, the Company may require additionalinformation or testing.  Commercial andagricultural real estate loans are generally originated under the same policiesand procedures as discussed above for commercial and agricultural non-realestate loans.

The Company’s residential realestate loans consist of 15-year, 20-year and 30-year fixed-rate andvariable-rate loans with amortization periods equal to the maturity ofthe loan.  The Company’s fixed-rateloans with biweekly payments account for approximately 54.6% of all theresidential real estate loans of the Company. The biweekly loan programamortizes 25 year loans in approximately 18.9 years.  The Company also originates a variety ofloans that are sold into the secondary market through Federal Home LoanMortgage Corporation (“Freddie Mac”) and private investors.  These loans are underwritten to meet allFreddie Mac requirements.  The Companyretains servicing rights on loans sold into the secondary market.  At December 31, 2006, mortgage loansserviced for the secondary market totaled approximately $30.3 million.

At December 31, 2006, the Company had three personal real estatemortgage loans totaling $156,000, and four commercial real estate loanstotaling $405,000, past due in excess of 90 days. Management feels the Company is wellcollateralized and expects no loss in excess of specific allocations on theloans.

***Interest Rates and Fees***.  Interestrates and fees charged on the Company’s loans are affected primarily by themarket demand for loans and the supply of money available for lendingpurposes.  These factors are affected by,among other things, general economic conditions and the policies of the federalgovernment, including the Federal Reserve Board, legislative tax policies, andgovernmental budgetary matters.

***Non-Performing Loans***.  When aborrower fails to make a required payment on a loan and does not cure thedelinquency within 30 days, the loan is classified as delinquent.  In this event, the normal procedure followedby the Company is to make contact with the borrower at prescribed intervals inan effort to bring the loan to a current status.  In most cases, delinquencies are cured promptly,but, if not, the Company normally records a notice of default, subject to anyrequired prior notice to the borrower, and commences foreclosure proceedingswhen loan payments are 120 days past due.

At December 31, 2006, theCompany had 50 loans delinquent for 30 to 90 days in an aggregate principalamount of $895,000 and representing 0.6% of the total loan portfolio.  At December 31, 2006, the Company had nineloans totaling $667,000 delinquent for more than 90 days.

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It is the Company’s policy todiscontinue the accrual of interest income on any loan when, in accordance withbanking regulations or in the opinion of management, there is reasonable doubtas to the collectibility of interest or principal.  Interest on these loans is credited to incomeonly when the collection of principal is reasonably assured and only to theextent interest payments are received. If management feels collection of both interest and principal isprobable, the loan is not transferred to nonaccrual status.  At December 31, 2006, there were three loanstotaling $362,000 on nonaccrual status. Management feels the Company is well collateralized and expects noloss in excess of specific allocations on the loans.

As a result of economicconditions and other factors beyond the Company’s control, the Company’s futureloss and delinquency experience cannot be predicted with certainty.

Thenonperforming assets of the Company as of December 31 are indicated below:

|                                                                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Non-accrual loans                                                    |       | $        | 362        |     | $          | —   |       | $        | 161        |     | $          | 137 |   | $ | 364 |   |
| Loans ninety days past  due and still accruing interest              |       | 305      |       | 1337     |       | 727      |       | 293      |       | 757      |       |
| Other real estate owned                                              |       | 118      |       | 88       |       | —   |       | —   |       | 204      |       |
|                                                                 |       |     |       |     |       |     |       |     |       |     |       |
| Total nonperforming  assets                                          |       | $        | 785        |     | $          | 1,425    |       | $        | 888        |     | $          | 430 |   | $ | 1,325 |   |
|                                                                 |       |     |       |     |       |     |       |     |       |     |       |
| Nonperforming loans as  a percentage of total loans                  |       | .49      | %          | .88      | %          | .66      | %          | .33      | %          | 1.02     | %          |
|                                                                 |       |     |       |     |       |     |       |     |       |     |       |
| Nonperforming assets as  a percentage of total assets                |       | .28      |       | .51      |       | .31      |       | .15      |       | .55      |       |
|                                                                 |       |     |       |     |       |     |       |     |       |     |       |
| Nonperforming loans as a percentage of the allowance for loan losses |       | 45.59    |       | 99.48    |       | 75.64    |       | 40.99    |       | 96.06    |       |

 

The effect ofnonaccrual loans upon interest income is not deemed to be material bymanagement.  Loans are placed innonaccrual status when 90 days past due, unless they are fully secured and inthe process of collection.  At December31, 2006, there were other impaired loans with specific reserve allocationsclassified as problem loans that were not included above.  Management also maintains a report on loansrequiring attention that includes loans greater than 60 days delinquent orother loans as deemed necessary by the Company’s internal loan review or theloan committee.  The total of loansrequiring attention as of December 31, 2006 was $7.9 million.

***Allowance for Losses on Loans***.  Inoriginating loans, the Company recognizes that losses will be experienced onloans and that the risk of loss will vary with, among other things, the type ofloan being made, the creditworthiness of the borrower over the term of the loan,general economic conditions and, in the case of a secured loan, the quality ofthe security for the loan.  The Companymaintains an allowance for loan losses to absorb probable incurred creditlosses 

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inherent in theloan portfolio.  The allowance for loanlosses represents management’s estimate of probable incurred losses based oninformation available 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, estimatedcollateral values, and economic conditions.

Theloan portfolio and other credit exposures are regularly reviewed by managementto evaluate the adequacy of the allowance for loan losses.  The methodology for assessing theappropriateness of the allowance includes comparisons to actual losses,industry data and economic conditions. In addition, the regulatory agencies, as an integral part of theirexamination process, periodically review the Company’s allowance for loanlosses.  Such agencies may require theCompany to make additional provisions for estimated losses based upon judgmentsdifferent from those of management.

Inconnection with assessing the allowance, loss factors are applied to variouspools of outstanding loans.  The Companysegregates the loan portfolio according to risk characteristics (i.e., mortgageloans, commercial real estate, agricultural, business, consumer, etc.) and riskgradings.  Loss factors are derived usingthe Company’s historical loss experience and may be adjusted for significantfactors that, in management’s judgment, affect the collectibility of theportfolio as of the evaluation date. Commercial real estate and commercial business loans are individuallyevaluated for impairment and specific reserves are allocated as needed inaccordance with Statement of Financial Accounting Standards No. 114 and No.118.

Inaddition, management assesses the allowance using factors that cannot beassociated with specific credit or loan categories.  These factors include management’s subjectiveevaluation of local and economic and business conditions, portfolioconcentration and changes in the character and size of the loan portfolio.  The allowance methodology reflects management’sobjective that the overall allowance appropriately reflects a margin for theimprecision necessarily inherent in the estimates of expected credit losses.

The allowance for loan losses is established through acharge to operations at the time loan value becomes impaired or, in thejudgment of management, other subjective factors warrant additional reserves.As noted in the previous table, nonperforming loans decreased by $670,000 in2006 after increasing by $449,000 during 2005. Management considered this information along with other portfolio trendswhen considering the adequacy of the allowance for loan losses atDecember 31, 2006. At December 31, 2006, the balance in the allowancefor loan losses was $1.5 million, or .91% of gross loans outstanding.  Management has concluded that the allowancefor loan losses is adequate at December 31, 2006. However, there can be noassurance that the allowance for loan losses is adequate to cover all losses.

The Company had two properties valued at $118,000,resulting from foreclosure, classified as other real estate owned at December31, 2006. Other real estate is generally carried at the lower of cost orestimated market value.

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***Summary of Loan Loss Experience.***Theallowance for loan losses is maintained by management at a level consideredadequate to cover losses that are currently anticipated based upon past lossexperience, general economic conditions, information about specific borrowersituations, including their financial position and collateral values, and otherfactors and estimates which are subject to change over time.

Loan loss experience for thefive years ended December 31, 2006 is summarized as follows:

|                                                                | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Balance of the  allowance for loan losses at beginning of year |       | $   | 1,344      |     | $     | 1,174    |       | $   | 1,049      |     | $     | 1,167 |   | $  | 1,109 |   |
| Charge-offs                                                    |       |     |       |     |       |     |       |     |       |     |       |
| Real Estate                                                    |       | 2        |       | —   |       | 63       |       | 66       |       | 46       |       |
| Commercial                                                     |       | 34       |       | 71       |       | —   |       | 50       |       | 6        |       |
| Installment                                                    |       | 81       |       | 145      |       | 210      |       | 303      |       | 181      |       |
| Total  charge-offs                                             |       | 117      |       | 216      |       | 273      |       | 419      |       | 233      |       |
|                                                           |       |     |       |     |       |     |       |     |       |     |       |
| Recoveries                                                     |       |     |       |     |       |     |       |     |       |     |       |
| Real Estate                                                    |       | 1        |       | 8        |       | —   |       | 16       |       | 39       |       |
| Commercial                                                     |       | 9        |       | 16       |       | 4        |       | 57       |       | 63       |       |
| Installment                                                    |       | 46       |       | 62       |       | 94       |       | 108      |       | 69       |       |
| Total recoveries                                               |       | 56       |       | 86       |       | 98       |       | 181      |       | 171      |       |
| Net charge-offs                                                |       | 61       |       | 130      |       | 175      |       | 238      |       | 62       |       |
| Provision                                                      |       | 180      |       | 300      |       | 300      |       | 120      |       | 120      |       |
|                                                           |       |     |       |     |       |     |       |     |       |     |       |
| Balance at end of year                                         |       | $        | 1,463      |     | $          | 1,344    |       | $        | 1,174      |     | $          | 1,049 |   | $ | 1,167 |   |
|                                                           |       |     |       |     |       |     |       |     |       |     |       |
| Net charge-offs to  average  total loans                  |       | .04      | %          | .09      | %          | .13      | %          | .21      | %          | .06      | %          |
| Allowance for loan losses to  total loans at year-end     |       | .91      |       | .88      |       | .87      |       | .80      |       | 1.06     |       |

 

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TheCompany’s allocation of the allowance for loan losses as of December 31 ispresented below:
| ** **                        | ** ** | **2006**   | ** ** | **2005**          | ** ** | **2004**   | ** ** | **2003**          | ** ** | **2002**   | ** ** |
|-----------------------------------|------------|------------|------------|-------------------|------------|------------|------------|-------------------|------------|------------|------------|
| ** **                        | ** ** | ** ** | ** ** | **Percent**       | ** ** | ** ** | ** ** | **Percent**       | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | **Percent** | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **of Total** | ** ** | ** ** | ** ** | **of Total** | ** ** | ** ** | ** ** | **of Total** | ** ** | ** ** | ** ** | **of Total** | ** ** | ** ** | ** ** | **of Total** | ** ** |
| ** **                        | ** ** | **Amount** | ** ** | **Loans**         | ** ** | **Amount** | ** ** | **Loans**         | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** |
| Real estate loans                 |       | $     | 253        |              | 63.7       | %          | $     | 131               |       | 62.45      | %          | $  | 234 |   | 19.88 | % | $  | 444 |   | 54.37 | % | $  | 281 |   | 42.56 | % |
|                              |       |       |       |              |       |       |       |              |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Commercial and agricultural loans |       | 633        |       | 24.6              |       | 613        |       | 22.04             |       | 519        |       | 44.24 |   | 209 |   | 18.57 |   | 307 |   | 30.94 |   |
|                              |       |       |       |              |       |       |       |              |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Installment loans                 |       | 97         |       | 11.7              |       | 141        |       | 15.51             |       | 185        |       | 15.79 |   | 242 |   | 27.06 |   | 236 |   | 26.50 |   |
|                              |       |       |       |              |       |       |       |              |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Unallocated                       |       | 480        |       | N/A               |       | 459        |       | N/A               |       | 236        |       | N/A |   | 154 |   | N/A |   | 343 |   | N/A |   |
|                              |       |       |       |              |       |       |       |              |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Balance at end of year            |       | $     | 1,463      |              | 100.00     | %          | $     | 1,344             |       | 100.00     | %          | $  | 1,174 |   | 100.00 | % | $  | 1,049 |   | 100.00 | % | $  | 1,167 |   | 100.00 | % |

 

***Investment Activities.*****The investmentpolicies of the Company as established by the Board of Directors attempt toprovide and maintain liquidity, generate a favorable return on investmentswithout incurring undue interest rate and credit risk, and complement theCompany’s lending activities.  Thepolicies provide the authority to invest in United States Treasury and federalagency securities, mortgage-backed securities, municipal securities, equitysecurities, and Certificates of Deposits.

Approximately $1.1 million of the United Statesgovernment agency notes held at December 31, 2006 are callable at the option ofthe issuer, which present limited prepayment risk to the Company.

As of December 31, 2006, the Company had approximately$2.6 million invested in municipalities located within LaSalle County,Illinois.

The Company purchased $4.9 million of Index PoweredCertificates of Deposit between 2002 and 2006. These deposits were placed withmultiple issuers so that all of the principal deposited is insured through theFDIC. Income returns are not guaranteed for these instruments, howeverprincipal is guaranteed if held to maturity.

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***Securities Portfolio.***Thefollowing table shows the maturity distribution of the available-for-salesecurities portfolio and the weighted average yield of the portfolio atDecember 31, 2006.
| ** **                                                     | ** ** | ** **        | ** ** | **Weighted** | ** ** | **One to** | ** ** | **Weighted** | ** ** | **Five**        | ** ** | **Weighted** | ** ** | **Over**  | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
|----------------------------------------------------------------|------------|-------------------|------------|--------------|------------|-----------------|------------|--------------|------------|-----------------|------------|--------------|------------|-----------|------------|--------------|------------|------------|------------|--------------|------------|
| ** **                                                     | ** ** | **One Year** | ** ** | **Average**  | ** ** | **Five**        | ** ** | **Average**  | ** ** | **to Ten** | ** ** | **Average**  | ** ** | **Ten**   | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average**  | ** ** |
| ** **                                                     | ** ** | **or Less**  | ** ** | **Yield**    | ** ** | **Years**       | ** ** | **Yield**    | ** ** | **Years**       | ** ** | **Yield**    | ** ** | **Years** | ** ** | **Yield**    | ** ** | **Total**  | ** ** | **Yield**    | ** ** |
| U.S. Treasury  securities                                      |       | $                 | 1,966      |         | 3.03       | %               | $          | 7,867        |       | 3.32            | %          | $            | —     |      | —     | %            | $          | —     |       | —       | %          | $ | 9,833 |   | 3.26 | % |
| U.S. Government  agencies                                      |       | 9,050             |       | 3.06         |       | 25,590          |       | 3.66         |       | —          |       | —       |       | —    |       | —       |       | 34,640     |       | 3.50         |       |
| States and political  subdivisions                             |       | 3,164             |       | 4.82         |       | 20,899          |       | 3.19         |       | 448             |       | 4.72         |       | —    |       | —       |       | 24,511     |       | 3.43         |       |
| Mortgage-backed  securities and collateralized obligations (1) |       | 396               |       | 5.11         |       | 7,142           |       | 4.30         |       | 194             |       | 8.43         |       | 4         |       | 6.25         |       | 7,736      |       | 4.44         |       |
| Corporate bonds                                                |       | 2,368             |       | 2.78         |       | 839             |       | 3.10         |       | —          |       | —       |       | —    |       | —       |       | 3,207      |       | 2.86         |       |
| Equity securities                                              |       | 3,158             |       | N/A          |       | —          |       | —       |       | —          |       | —       |       | —    |       | —       |       | 3,158      |       | N/A          |       |
|                                                           |       |              |       |         |       |            |       |         |       |            |       |         |       |      |       |         |       |       |       |         |       |
| Total securities                                               |       | $                 | 20,102     |         | 3.39       | %               | $          | 62,337       |       | 3.53            | %          | $            | 642        |      | 5.80       | %            | $          | 4          |       | 6.25         | %          | $ | 83,085 |   | 3.51 | % |

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(1) Mortgage-backed securities reflect the contractual maturity of therelated instrument.

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***Deposits****.*The Company offers deposit services includingdemand, savings, and time deposit accounts and programs, which includeinterest-bearing and non-interest-bearing demand deposits and individualretirement accounts.  The Company has hada stable deposit base.  Management believesthat this stability is due to the Company’s emphasis on being a locally ownedand operated bank and by providing quality, personalized service to itscustomers.

The following shows the Company’saverage balances and rates paid during the years shown.
| ** **                                         | ** ** | **For the Years Ended December 31,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                         | ** ** | **2006**                                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                         | ** ** | ** **                                                    | ** ** | **Percent** | ** ** | ** ** | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** | ** ** | ** ** | **Percent** | ** ** | ** ** | ** ** |
| ** **                                         | ** ** | **Average**                                                   | ** ** | **of** | ** ** | ** ** | ** ** | **Average** | ** ** | **of** | ** ** | ** ** | ** ** | **Average** | ** ** | **of** | ** ** | ** ** | ** ** |
| ** **                                         | ** ** | **Balance**                                                   | ** ** | **Deposits** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Deposits** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Deposits** | ** ** | **Rate** | ** ** |
| Noninterest-bearing demand   deposits         |       | $                                                             | 30,173     |   | 11.8 | % | — | % | $ | 31,153 |   | 11.9 | % | — | % | $ | 29,815 |   | 11.0 | % | — | % |
| Interest-bearing demand  and money market accounts |       | 93,042                                                        |       | 36.5 |   | 2.19 |   | 98,826 |   | 37.7 |   | 1.39 |   | 107,136 |   | 39.5 |   | 1.17 |   |
| Savings accounts                                   |       | 25,067                                                        |       | 9.8 |   | .52 |   | 27,083 |   | 10.3 |   | .52 |   | 29,121 |   | 10.8 |   | .59 |   |
| Time deposits accounts                             |       | 106,750                                                       |       | 41.9 |   | 3.81 |   | 105,301 |   | 40.1 |   | 2.88 |   | 105,002 |   | 38.7 |   | 2.60 |   |
|                                               |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                               |       | $                                                             | 255,032    |   | 100.0 | % | 2.80 | % | $ | 262,363 |   | 100.0 | % | 1.73 | % | $ | 271,074 |   | 100.0 | % | 1.53 | % |

 

Thedistribution of the major components of deposits as of December 31, 2006 and 2005is summarized in the balance sheets included in the 2006 consolidated financialstatements, which consolidated financial statements are incorporated herein byreference. The following is a maturity distribution of time certificates ofdeposit of $100,000 or more at December 31, 2006:

|                                 | ** ** | **Balance** | ** ** | **Percentage** | ** ** |
|---------------------------------|------------|-------------|------------|----------------|------------|
| Maturity                        |       |        |       |           |       |
| Three months or less            |       | $           | 12,925     |           | 33.6       | % |
| Over three months to six months |       | 8,165       |       | 21.2           |       |
| Over six months to one year     |       | 3,942       |       | 10.2           |       |
| Over one year                   |       | 13,452      |       | 35.0           |       |
|                            |       |        |       |           |       |
| Total                           |       | $           | 38,484     |           | 100.0      | % |

 

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***Borrowings.***The Company’s other available sources of funds includefinancing arrangements for securities sold under agreements to repurchase,federal funds purchased lines, and Federal Home Loan Bank borrowings. Total borrowingsdecreased $12.7 million in 2006. This decrease was a result of a $12.7 milliondecrease in federal funds purchased. The Bank maintains physical control of allsecurities sold under repurchase agreements. There were no outstandingsecurities sold under agreements to repurchase during 2006. Informationconcerning securities sold under agreements to repurchase is summarized asfollows:

|                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Balance at  December 31                                      |       | $        | —     |     | $          | —   |       | $ | 750 |   |
| Weighted average  interest rate  during the year        |       | —   | %          | 1.63     | %          | 1.63     | %          |
| Weighted average  interest rate at the  end of the year |       | —   | %          | —   | %          | 1.63     | %          |
| Maximum  month-end balance                                   |       | $        | —     |     | $          | 750      |       | $ | 750 |   |
| Average balance for the  year                                |       | —   |       | 232      |       | 215      |       |

 

***Trust.***The Company’s trust department primarilyservices LaSalle County and surrounding counties.  At December 31, 2006, the trust departmenthad 344 accounts under management, 168 of which were discretionaryaccounts.  The trust department providesa full complement of asset management services for personal trusts, estates,and agencies.  At December 31, 2006, thetrust department had assets under management of approximately $76.0 million, ofwhich $57.0 million was in discretionary accounts.

The Company, in conjunction withits trust department, also provides farm management services.  At December 31, 2006, the department managed53 farms.  The department manages ordirects approximately 5,947 acres of farmland in LaSalle County, Illinois andsurrounding counties.

***Competition***. The Company has active competition in allproduct and service areas in which it presently engages.  The Company not only competes for commercialand individual deposits, loans, and trust business with other LaSalle, Grundy,and Kendall County, Illinois banks, but also with savings and loanassociations, credit unions, and other financial service companies located inand around LaSalle, Grundy and Kendall County. Many of these competitors may not be subject to the same regulatoryrestrictions as the Company. There are approximately 16 commercial banks andsix savings institutions with offices in LaSalle County, ten commercial banksand three savings institutions in Grundy County, and 12 commercial banks inKendall County.  The principal methods ofcompetition in the banking and financial services industry are quality ofservices to the customer; ease of access to services; and pricing of services,including interest rates paid on deposits, interest rates charged onborrowings, and fees charged for fiduciary services. The financial services industry is alsolikely to become more competitive as further technological  advances enable more companies to providefinancial services.

***Employees.***  As ofDecember 31, 2006, the Company had 96 employees, consisting of 82 full-timeemployees and 14 part-time employees. None of the employees are subject to a collective bargaining agreement,and management believes it has excellent relations with its staff.

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***Stock Repurchases.***During 2006 and 2005, the Company repurchased300 and 1,260 shares of its common stock for aggregate purchase prices of$22,000 and $89,000, respectively.

## **Website.**The Company maintains a website atwww.firstottawa.com.  The Company makesavailable free of charge on or through its website, the annual report on Form 10K,quarterly reports on Form 10-Q, current reports on Form 8-K and amendments tothose reports filed or furnished pursuant to Section 13(a) or 15(d) of theExchange Act as soon as reasonably practicable after the Company electronicallyfiles such material with, or furnish it to, the Securities and ExchangeCommission.  The Company will alsoprovide copies of its filings free of charge upon written request to: Ms.Cheryl Gage, Corporate Secretary, First Ottawa Bancshares, Inc. 701-705 LaSalleStreet, P.O. Box 657, Ottawa, Illinois 61350. Additionally, all of the Company’sfilings with the Securities and Exchange Commission are also available, free ofcharge, through the SEC’s website at www.sec.gov.

**Codeof Business Conduct and Ethics.**The Company has a code ofbusiness conduct and ethics in place that applies to all of its directors andemployees.  The code sets forth thestandard of ethics that the Company expects all of its directors and employeesto follow, including the Chief Executive Officer and Chief FinancialOfficer.  The code of business conductand ethics is posted on the Company’s website at www.firstottawa.com.  The Company intends to satisfy the disclosurerequirements under Item 5.05 of Form 8-K regarding any amendment to or waiverof the code with respect to the Chief Executive Officer and Chief FinancialOfficer, and persons performing similar functions, by posting such informationon its website.

**Supervision and Regulation**

# General

Financial institutions, their holding companies and their affiliatesare extensively regulated under federal and state law.  As a result, the growth and earningsperformance of the Company may be affected not only by management decisions andgeneral economic conditions, but also by the requirements of federal and statestatutes and by the regulations and policies of various bank regulatoryauthorities, including the Office of the Comptroller of the Currency (the “OCC”),the Board of Governors of the Federal Reserve System (the “Federal Reserve”)and the Federal Deposit Insurance Corporation (the “FDIC”).  Furthermore, taxation laws administered bythe Internal Revenue Service and state taxing authorities and securities lawsadministered by the Securities and Exchange Commission (the “SEC”) andstate securities authorities have an impact on the business of the Company. Theeffect of these statutes, regulations and regulatory policies may besignificant, and cannot be predicted with a high degree of certainty.

Federal and state laws and regulations generallyapplicable to financial institutions regulate, among other things, the scope ofbusiness, the kinds and amounts of investments, reserve requirements, capitallevels relative to operations, the nature and amount of collateral for loans,the establishment of branches, mergers and consolidations and the payment ofdividends. This system of supervision and regulation establishes acomprehensive framework for the respective operations of the Company and itssubsidiaries and is intended primarily for the protection of the FDIC-insureddeposits and depositors of the Bank, rather than shareholders.

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The following is a summaryof the material elements of the regulatory framework that applies to theCompany and its subsidiaries.  It doesnot describe all of the statutes, regulations and regulatory policies thatapply, nor does it restate all of the requirements of those statutes,regulations and regulatory policies that are described. As such, the followingis qualified in its entirety by reference to applicable law.  Any change in applicable statutes,regulations or regulatory policies may have a material effect on the businessof the Company and its subsidiaries.

**TheCompany**

***General.**** *The Company, as thesole shareholder of the Bank, is a bank holding company.  As a bank holding company, the Company isregistered with, and is subject to regulation by, the Federal Reserve under theBank Holding Company Act of 1956, as amended (the “BHCA”).  In accordance with Federal Reservepolicy, the Company is expected to act as a source of financial strength to theBank and to commit resources to support the Bank in circumstances where theCompany might not otherwise do so.  Underthe BHCA, the Company is subject to periodic examination by the Federal Reserve.  The Company is also required to file with theFederal Reserve periodic reports of the Company’s operations and suchadditional information regarding the Company and its subsidiaries as theFederal Reserve may require.

***Acquisitions, Activities and Change inControl.***** **The primary purpose of abank holding company is to control and manage banks.****TheBHCA generally requires the prior approval of the Federal Reserve for anymerger involving a bank holding company or any acquisition by a bank holdingcompany of another bank or bank holding company.  Subject to certain conditions (includingdeposit concentration limits established by the BHCA), the Federal Reserve mayallow a bank holding company to acquire banks located in any state of theUnited States. In approving interstate acquisitions, the Federal Reserve isrequired to give effect to applicable state law limitations on the aggregateamount of deposits that may be held by the acquiring bank holding company andits insured depository institution affiliates in the state in which the targetbank is located (provided that those limits do not discriminate againstout-of-state depository institutions or their holding companies) and state lawsthat require that the target bank have been in existence for a minimum periodof time (not to exceed five years) before being acquired by an out-of-statebank holding company.

TheBHCA generally prohibits the Company from acquiring direct or indirectownership or control of more than 5% of the voting shares of any company thatis not a bank and from engaging in any business other than that of banking,managing and controlling banks or furnishing services to banks and theirsubsidiaries.  This general prohibitionis subject to a number of exceptions. The principal exception allows bankholding companies to engage in, and to own shares of companies engaged in,certain businesses found by the Federal Reserve to be “so closely related tobanking ... as to be a proper incident thereto.”  This authority would permit the Company toengage in a variety of banking-related businesses, including the operation of athrift, consumer finance, equipment leasing, the operation of a computerservice bureau (including software development), and mortgage banking andbrokerage. The BHCA generally does not place territorial restrictions on thedomestic activities of non-bank subsidiaries of bank holding companies.

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Additionally,bank holding companies that meet certain eligibility requirements prescribed bythe BHCA and elect to operate as financial holding companies may engage in, orown shares in companies engaged in, a wider range of nonbanking activities,including securities and insurance underwriting and sales, merchant banking andany other activity that the Federal Reserve, in consultation with the Secretaryof the Treasury, determines by regulation or order is financial in nature,incidental to any such financial activity or complementary to any suchfinancial activity and does not pose a substantial risk to the safety orsoundness of depository institutions or the financial system generally.  As of the date of this filing, the Companyhas not applied for approvalto operate as a financial holding company.

Federal law also prohibits any person or companyfrom acquiring “control” of an FDIC-insured depository institution or itsholding company without prior notice to the appropriate federal bankregulator.  “Control” is conclusivelypresumed to exist upon the acquisition of 25% or more of the outstanding votingsecurities of a bank or bank holding company, but may arise under certaincircumstances at 10% ownership.

***Capital Requirements.***  Bankholding companies are required to maintain minimum levels of capital inaccordance with Federal Reserve capital adequacy guidelines.  If capital levels fall below the minimumrequired levels, a bank holding company, among other things, may be deniedapproval to acquire or establish additional banks or non-bank businesses.

TheFederal Reserve’s capital guidelines establish the following minimum regulatorycapital requirements for bank holding companies: (i) a risk-based requirementexpressed as a percentage of total assets weighted according to risk; and (ii)a leverage requirement expressed as a percentage of total assets.  The risk-based requirement consists of aminimum ratio of total capital to total risk-weighted assets of 8% and a minimumratio of Tier 1 capital to total risk-weighted assets of 4%.  The leverage requirement consists of aminimum ratio of Tier 1 capital to total assets of 3% for the most highly ratedcompanies, with a minimum requirement of 4% for all others.  For purposes of these capital standards, Tier1 capital consists primarily of permanent stockholders’ equity less intangibleassets (other than certain loan servicing rights and purchased credit cardrelationships). Total capital consists primarily of Tier 1 capital plus certainother debt and equity instruments that do not qualify as Tier 1 capital and aportion of the company’s allowance for loan and lease losses.

The risk-based and leverage standards describedabove are minimum requirements. Higher capital levels will be required ifwarranted by the particular circumstances or risk profiles of individualbanking organizations. For example, the Federal Reserve’s capital guidelinescontemplate that additional capital may be required to take adequate accountof, among other things, interest rate risk, or the risks posed byconcentrations of credit, nontraditional activities or securities tradingactivities.  Further, any bankingorganization experiencing or anticipating significant growth would be expectedto maintain capital ratios, including tangible capital positions (*i.e.*, Tier 1 capital less all intangible assets), well abovethe minimum levels.  As of December 31,2006, the Company had regulatory capital in excess of the Federal Reserve’sminimum requirements.

***Dividend Payments******.**** *The Company’s abilityto pay dividends to its shareholders may be affected by both general corporatelaw considerations and policies of the Federal Reserve 

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applicable to bank holding companies*.* As a Delaware corporation, the Company is subject to thelimitations of the Delaware General Corporation Law (the ”DGCL”). The DGCLallows the Company to pay dividends only out of its surplus (as defined andcomputed in accordance with the provisions of the DGCL) or if the Company hasno such surplus, out of its net profits for the fiscal year in which thedividend is declared and/or the preceding fiscal year. Additionally, policiesof the Federal Reserve caution that a bank holding company should not pay cashdividends unless its net income available to common shareholders over the pastyear has been sufficient to fully fund the dividends and the prospective rateof earnings retention appears consistent with its capital needs, asset quality,and overall financial condition.  TheFederal Reserve also possesses enforcement powers over bank holding companiesand their non-bank subsidiaries to prevent or remedy actions that representunsafe or unsound practices or violations of applicable statutes andregulations.  Among these powers is theability to proscribe the payment of dividends by banks and bank holdingcompanies.

***Federal Securities Regulation******.***  TheCompany’s common stock is registered with the SEC under the Securities Act of1933, as amended, and the Securities Exchange Act of 1934, as amended(the ”Exchange Act”).  Consequently,the Company is subject to the information, proxy solicitation, insider tradingand other restrictions and requirements of the SEC under the Exchange Act.

**The Bank**

***General.***  The Bank is a national bank, chartered by theOCC under the National Bank Act. The deposit accounts of the Bank are insured by the FDIC’s DepositInsurance Fund (“DIF”), and the Bank is a member of the Federal ReserveSystem.  As a national bank, the Bank issubject to the examination, supervision, reporting and enforcement requirementsof the OCC, the chartering authority for national banks. The FDIC, asadministrator of the DIF, also has regulatory authority over the Bank.

***Deposit Insurance.***** **As an FDIC-insured institution,the Bank is required to pay deposit insurance premium assessments to the FDIC.The FDIC has adopted a risk-based assessment system under which insureddepository institutions are assigned to one of four risk assessment categoriesbased upon their respective levels of capital, supervisory evaluations andother financial factors. Institutions that are well-capitalized and exhibitminimal or no supervisory weaknesses pay the lowest premium while institutionsthat are less than adequately capitalized and considered of substantialsupervisory concern pay the highest premium. An institution’srisk-classification is determined by the FDIC.

Forthe past several years, FDIC insurance assessments ranged from 0% to 0.27% oftotal deposits. Pursuant to regulatory amendments adopted by the FDIC,effective January 1, 2007, insurance assessments will range from 0.05% to 0.43%of total deposits (unless subsequently adjusted by the FDIC). FDIC-insuredinstitutions that were in existence as of December 31, 1996, and paid anFDIC-insurance assessment prior to that date (“eligible institutions”), as wellas successors to eligible institutions, will be entitled to a credit that maybe applied to offset insurance premium assessments due for assessment periodsbeginning on and after January 1, 2007. The amount of an eligible institution’sassessment credit will be equal to the institution’s pro rata share (based onits assessment base as of December 31, 1996, as compared to the 

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aggregateassessment base of all eligible institutions as of December 31, 1996) of theaggregate amount the FDIC would have collected if it had imposed an assessmentof 10.5 basis points on the combined assessment base of all institutionsinsured by the FDIC as of December 31, 2001. Subject to certain statutorylimitations, an institution’s assessment credit may be applied to offset thefull amount of premiums assessed in 2007, but may not be applied to more than90% of the premiums assessed in 2008, 2009 or 2010. The FDIC will track theamount of an institution’s assessment credit and automatically apply it to theinstitution’s premium assessment to the maximum extent permitted by federallaw.

***FICO Assessments.***     The FinancingCorporation (“FICO”) is a mixed-ownership governmental corporation chartered bythe former Federal Home Loan Bank Board pursuant to the Federal Savings andLoan Insurance Corporation Recapitalization Act of 1987 to function as afinancing vehicle for the recapitalization of the former Federal Savings andLoan Insurance Corporation.  FICO issued30-year non-callable bonds of approximately $8.2 billion that mature by2019.  Since 1996, federal legislationhas required that all FDIC-insured depository institutions pay assessments tocover interest payments on FICO’s outstanding obligations.  These FICO assessments are in addition toamounts assessed by the FDIC for deposit insurance. During the yearended December 31, 2006, the FICO assessment rate was approximately 0.01%of deposits.

***Supervisory Assessments.***  National banks are required to paysupervisory assessments to the OCC to fund the operations of the OCC.  The amount of the assessment is calculatedusing a formula that takes into account the bank’s size and its supervisorycondition. During the year ended December 31, 2006, the Bank paid supervisoryassessments to the OCC totaling $86,000.

***Capital Requirements.***** **Banks are generally required to maintain capitallevels in excess of other businesses. The OCC has established the followingminimum capital standards for national banks, such as the Bank: (i) a leveragerequirement consisting of a minimum ratio of Tier 1 capital to total assets of3% for the most highly-rated banks with a minimum requirement of at least 4%for all others; and (ii) a risk-based capital requirement consisting of aminimum ratio of total capital to total risk-weighted assets of 8% and aminimum ratio of Tier 1 capital to total risk-weighted assets of 4%.  In general, the components of Tier 1 capitaland total capital are the same as those for bank holding companies discussedabove.

Thecapital requirements described above are minimum requirements.  Higher capital levels will be required ifwarranted by the particular circumstances or risk profiles of individualinstitutions.  For example, regulationsof the OCC provide that additional capital may be required to take adequateaccount of, among other things, interest rate risk or the risks posed byconcentrations of credit, nontraditional activities or securities tradingactivities.

Further, federal law andregulations provide various incentives for financial institutions to maintainregulatory capital at levels in excess of minimum regulatory requirements.For example, a financial institution that is “well-capitalized” mayqualify for exemptions from prior notice or application requirements otherwiseapplicable to certain types of activities and may qualify for expeditedprocessing of other required notices or applications. Additionally, one of thecriteria that determines a bank holding company’s eligibility to operate as afinancial holding company is a requirement that all of its financialinstitution subsidiaries be “well-capitalized.”  Under the 

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regulations of the OCC, inorder to be “well-capitalized” a financial institution must maintain aratio of total capital to total risk-weighted assets of 10% or greater, a ratioof Tier 1 capital to total risk-weighted assets of 6% or greater and a ratio ofTier 1 capital to total assets of 5% or greater.

Federal law also provides the federal banking regulators with broadpower to take prompt corrective action to resolve the problems of undercapitalizedinstitutions.  The extent of theregulators’ powers depends on whether the institution in question is “adequatelycapitalized,” “undercapitalized,” “significantly undercapitalized” or “criticallyundercapitalized,” in each case as defined by regulation.  Depending upon the capital category to whichan institution is assigned, the regulators’ corrective powers include: (i)requiring the institution to submit a capital restoration plan; (ii) limitingthe institution’s asset growth and restricting its activities; (iii) requiringthe institution to issue additional capital stock (including additional votingstock) or to be acquired; (iv) restricting transactions between the institutionand its affiliates; (v) restricting the interest rate the institution may payon deposits; (vi) ordering a new election of directors of the institution;(vii) requiring that senior executive officers or directors be dismissed;(viii) prohibiting the institution from accepting deposits from correspondentbanks; (ix) requiring the institution to divest certain subsidiaries; (x)prohibiting the payment of principal or interest on subordinated debt; and (xi)ultimately, appointing a receiver for the institution.

As of December 31, 2006: (i)the Bank was not subject to a directive from the OCC to increase its capital toan amount in excess of the minimumregulatory capital requirements; (ii) the Bank exceeded its minimumregulatory capital requirements under OCC capital adequacy guidelines; and(iii) the Bank was “well-capitalized,” as defined by OCC regulations.

***Dividends.***  The primary source of funds for the Companyis dividends from the Bank. Under the National Bank Act, a national bank maypay dividends out of its undivided profits in such amounts and at such times asthe bank’s board of directors deems prudent. Without prior OCC approval, however, a national bank may not paydividends in any calendar year that, in the aggregate, exceed the bank’syear-to-date net income plus the bank’s retained net income for the two precedingyears.

Thepayment of dividends by any financial institution is affected by therequirement to maintain adequate capital pursuant to applicable capitaladequacy guidelines and regulations, and a financial institution generally isprohibited from paying any dividends if, following payment thereof, theinstitution would be undercapitalized. As described above, the Bank exceeded its minimum capital requirementsunder applicable guidelines as of December 31, 2006.  As of December 31, 2006, approximately$351,000 was available to be paid as dividends by the Bank.  Notwithstanding the availability of funds fordividends, however, the OCC may prohibit the payment of any dividends by theBank if the OCC determines such payment would constitute an unsafe or unsoundpractice.

***Insider Transactions.***** **The Bank is subject to certain restrictionsimposed by federal law on extensions of credit to the Company, on investmentsin the stock or other securities of the Company and the acceptance of the stockor other securities of the Company as collateral for loans made by the Bank.Certain limitations and reporting requirements are also placed on extensions ofcredit by the Bank to its directors and officers, to the directors and officersof the Company, to principal 

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shareholdersof the Company, and to “related interests” of such directors, officers andprincipal shareholders.  In addition,federal law and regulations may affect the terms upon which any person who is adirector or officer of the Company or the Bank or a principal shareholder ofthe Company may obtain credit from banks with which the Bank maintainscorrespondent relationships.

***Safety and Soundness Standards.***  The federal banking agencies have adoptedguidelines that establish operational and managerial standards to promote thesafety and soundness of federally insured depository institutions.  The guidelines set forth standards forinternal controls, information systems, internal audit systems, loandocumentation, credit underwriting, interest rate exposure, asset growth,compensation, fees and benefits, asset quality and earnings.

Ingeneral, the safety and soundness guidelines prescribe the goals to be achievedin each area, and each institution is responsible for establishing its ownprocedures to achieve those goals.  If aninstitution fails to comply with any of the standards set forth in theguidelines, the institution’s primary federal regulator may require theinstitution to submit a plan for achieving and maintaining compliance. If aninstitution fails to submit an acceptable compliance plan, or fails in anymaterial respect to implement a compliance plan that has been accepted by itsprimary federal regulator, the regulator is required to issue an orderdirecting the institution to cure the deficiency. Until the deficiency cited inthe regulator’s order is cured, the regulator may restrict the institution’srate of growth, require the institution to increase its capital, restrict therates the institution pays on deposits or require the institution to take anyaction the regulator deems appropriate under the circumstances. Noncompliancewith the standards established by the safety and soundness guidelines may alsoconstitute grounds for other enforcement action by the federal bankingregulators, including cease and desist orders and civil money penaltyassessments.

***Branching Authority.***  National banks headquartered in Illinois,such as the Bank, have the same branching rights in Illinois as banks charteredunder Illinois law, subject to OCC approval. Illinois law grants Illinois-chartered banks the authority to establishbranches anywhere in the State of Illinois, subject to receipt of all requiredregulatory approvals.

Federal law permits stateand national banks to merge with banks in other states subject to:(i) regulatory approval; (ii) federal and state deposit concentrationlimits; and (iii) state law limitations requiring the merging bank to have beenin existence for a minimum period of time (not to exceed five years) prior tothe merger.  The establishment of newinterstate branches or the acquisition of individual branches of a bank inanother state (rather than the acquisition of an out-of-state bank in itsentirety) is permitted only in those states the laws of which expresslyauthorize such expansion.

***Financial Subsidiaries. ***UnderFederal law and OCC regulations, national banks are authorized to engage,through “financial subsidiaries,” in any activity that is permissible for afinancial holding company and any activity that the Secretary of the Treasury,in consultation with the Federal Reserve, determines is financial in nature orincidental to any such financial activity, except (i) insurance underwriting,(ii) real estate development or real estate investment activities (unlessotherwise permitted by law), (iii) insurance company portfolio investments and(iv) merchant banking.  Theauthority of a national bank to invest in a financial subsidiary is subject toa number of conditions, including, among other things, requirements that the bankmust be well-managed and well-capitalized (after deducting from capital thebank’s outstanding investments in 

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financialsubsidiaries).  The Bank has not appliedfor approval to establish any financial subsidiaries.

***Federal Reserve System.***  Federal Reserve regulations, aspresently in effect, require depository institutions to maintain non-interestearning reserves against their transaction accounts (primarily NOW and regularchecking accounts), as follows: for transaction accounts aggregating $45.8 millionor less, the reserve requirement is 3% of total transaction accounts; and fortransaction accounts aggregating in excess of $45.8 million, the reserverequirement is $1.119 million plus 10% of the aggregate amount of totaltransaction accounts in excess of $45.8 million.  The first $8.5 million of otherwisereservable balances are exempted from the reserve requirements.  These reserve requirements are subject toannual adjustment by the Federal Reserve. The Bank is in compliance with theforegoing requirements.

**Item 1.A.   Risk Factors**

In addition to theother information in this Annual Report on Form 10-K, shareholders orprospective investors should carefully consider the following risk factors:

**Our business is concentrated in and dependent upon the continued growthand welfare of the LaSalle County market area.**

While we continue to expand our market area and presence into thesurrounding counties of Grundy and Kendall, we operate primarily in LaSalleCounty, and as a result, our financial condition, results of operations andcash flows are subject to changes in the economic conditions in this marketarea.  We have developed a particularlystrong presence in Ottawa and its surrounding communities.  Our success depends upon the businessactivity, population, income levels, deposits and real estate activity in thisarea. Although our customers’ business and financial interests may extend wellbeyond its market area, adverse economic conditions that affect the market areacould reduce our growth rate, affect the ability of our customers to repaytheir loans to us and generally affect our financial condition and results ofoperations. Because of our geographic concentration, we are less able thanother regional or national financial institutions to diversify our credit risksacross multiple markets.

**We mayexperience difficulties in managing our growth and our growth strategy involvesrisks that may negatively impact our net income.**

As part of our general growth strategy, we may expand into additionalcommunities or attempt to strengthen our position in our current market and insurrounding areas by opening new branches and acquiring existing branches ofother financial institutions.  To theextent that we undertake additional branch openings and acquisitions, we arelikely to continue to experience the effects of higher operating expensesrelative to operating income from the new operations, which may have an adverseeffect on our levels of reported net income, return on average equity andreturn on average assets.  Other effectsof engaging in such growth strategies may include potential diversion of ourmanagement’s time and attention and general disruption to our business.

Although we do not have any current plans to do so, we may also acquirebanks and related businesses that we believe provide a strategic fit with ourbusiness or engage in de novo bank 

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formations.  To the extent thatwe grow through acquisitions and de novo bank formations, we cannot assure youthat we will be able to adequately and profitably manage this growth. Acquiringother banks and businesses will involve similar risks to those commonlyassociated with branching, but may also involve additional risks, including:

·                                          potential exposure to unknown or contingentliabilities of banks and businesses we acquire;

·                                          exposure to potential asset quality issues ofthe acquired bank or related business;

·                                          difficulty and expense of integrating theoperations and personnel of banks and businesses we acquire; and

·                                          the possible loss of key employees andcustomers of the banks and businesses we acquire.

**We face intense competition in all phases of our business from otherbanks and financial institutions.**

The banking andfinancial services business in our market is highly competitive.  Our competitors include large regional banks,local community banks, savings and loan associations, securities and brokeragecompanies, mortgage companies, insurance companies, finance companies, moneymarket mutual funds, credit unions and other non-bank financial serviceproviders. Many of these competitors are not subject to the same regulatoryrestrictions as we are and are able to provide customers with a feasiblealternative to traditional banking services. Additionally, technological advances may enable more companies toprovide financial services, increasing competition among financial serviceproviders.

Increasedcompetition in our market may also result in a decrease in the amounts of ourloans and deposits, reduced spreads between loan rates and deposit rates orloan terms that are more favorable to the borrower.  Any of these results could have a materialadverse effect on our ability to grow and remain profitable.  If increased competition causes us tosignificantly discount the interest rates we offer on loans or increase theamount we pay on deposits, our net interest income could be adverselyimpacted.  If increased competitioncauses us to relax****ourunderwriting standards, we could be exposed to higher losses from lendingactivities.  Additionally, many of ourcompetitors are much larger in total assets and capitalization, and thereforehave greater access to capital markets and larger lending limits and offer abroader range of financial services than we can offer.

**Interestrates and other conditions impact our results of operations.**

Our profitability is in part a function of the spread between theinterest rates earned on investments and loans and the interest rates paid ondeposits and other interest-bearing liabilities.  Like most banking institutions, our netinterest spread and margin will be affected by general economic conditions andother factors, including fiscal and monetary policies of the federalgovernment, that influence market interest rates and our ability to respond tochanges in such rates.  At any giventime, our assets and liabilities will be such that they are affecteddifferently by a given change in interest rates.  As a result, an increase or decrease inrates, the length of loan terms or the mix of adjustable and fixed rate loansin our portfolio could have a positive or negative effect on our net income,capital and liquidity.  We measureinterest rate risk under 

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various ratescenarios and using specific criteria and assumptions.  A summary of this process, along with theresults of our net interest income simulations is presented at “Quantitativeand Qualitative Disclosures About Market Risk” included under Item 7A of PartII of this Form 10-K.  Although webelieve our current level of interest rate sensitivity is reasonable and effectivelymanaged, significant fluctuations in interest rates may have an adverse effecton our business, financial condition and results of operations.

**We musteffectively manage our credit risk.**

There are risks inherent in making any loan,including risks inherent in dealing with individual borrowers, risks ofnonpayment, risks resulting from uncertainties as to the future value ofcollateral and risks resulting from changes in economic and industryconditions.  We attempt to minimize ourcredit risk through prudent loan application approval procedures, carefulmonitoring of the concentration of our loans within specific industries andperiodic independent reviews of outstanding loans by our credit reviewdepartment.  However, we cannot assureyou that such approval and monitoring procedures will reduce these creditrisks.

The majority of the Bank’s loan portfolio isinvested in commercial real estate, residential real estate, generalcommercial, agricultural, and consumer lending. We may assume greater lending risks than financial institutions thathave a lesser concentration of such loans. Our lending activity and the risks commonly associated with suchlending, including the risk of non-payment, are further described in the “Business”section included under Item 1 of Part I of this Form 10-K.

**Our allowance for credit losses may prove to be insufficient to absorbpotential losses in our loan portfolio.**

We established our allowance for credit losses in consultation withmanagement and maintain it at a level considered adequate by management toabsorb credit losses that are inherent in the portfolio.  The amount of future credit losses issusceptible to changes in economic, operating and other conditions, includingchanges in interest rates, which may be beyond our control, and such losses mayexceed current estimates.  AtDecember 31, 2006, our allowance for credit losses as a percentage oftotal loans was .91% and as a percentage of total non-performing loans was approximately219.3%.  Although management believesthat the allowance for credit losses is adequate to absorb losses on anyexisting loans that may become uncollectible, we cannot predict credit losseswith certainty, and we cannot assure you that our allowance for credit losseswill prove sufficient to cover actual credit losses in the future.  Credit losses in excess of our reserves mayadversely affect our business, financial condition and results ofoperations.  Additional informationregarding our allowance for credit losses and the methodology we use todetermine an appropriate level of reserves is located in the “Management’sDiscussion and Analysis” section included under Item 7 of Part II of this Form10-K.

**Our continued pace of growth may require us to raise additional capitalin the future, but that capital may not be available when it is needed.**

We are required by federal and state regulatory authorities to maintainadequate levels of capital to support our operations.  We anticipate that our existing capitalresources will satisfy our 

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capital requirements for the foreseeable future.  However, we may at some point need to raiseadditional capital to support our continued growth. Our ability to raiseadditional capital, if needed, will depend on conditions in the capital marketsat that time, which are outside our control, and on our financialperformance.  Accordingly, we cannotassure you of our ability to raise additional capital, if needed, on termsacceptable to us.  If we cannot raiseadditional capital when needed, our ability to further expand our operationsthrough internal growth, branching, de novo bank formations and/or acquisitionscould be materially impaired.

**Our community banking strategy relies heavily on our management team,and the unexpected loss of key managers may adversely affect our operations.**

Much of our success to date has been influenced strongly by our abilityto attract and to retain senior management experienced in banking and financialservices and familiar with the communities in our market area.  Our ability to retain executive officers, thecurrent management teams, branch managers and loan officers will continue to beimportant to the successful implementation of our strategy.  It is also critical, as we grow, to be able toattract and retain qualified additional management and loan officers with theappropriate level of experience and knowledge about our market area toimplement our community-based operating strategy.  The unexpected loss of services of any keymanagement personnel, or the inability to recruit and retain qualifiedpersonnel in the future, could have an adverse effect on our business,financial condition and results of operations.

**Governmentregulation can result in limitations on our operations.**

We operate in a highly regulated environment and are subject tosupervision and regulation by a number of governmental regulatory agencies,including the Federal Reserve, the OCC and the FDIC.  Regulations adopted by these agencies, whichare generally intended to provide protection for depositors and customersrather than for the benefit of shareholders, govern a comprehensive range ofmatters relating to ownership and control of our shares, our acquisition ofother companies and businesses, permissible activities for us to engage in,maintenance of adequate capital levels and other aspects of our operations.These bank regulators possess broad authority to prevent or remedy unsafe orunsound practices or violations of law. The laws and regulations applicable tothe banking industry could change at any time and we cannot predict the effectsof these changes on our business and profitability. Increased regulation couldincrease our cost of compliance and adversely affect profitability.  For example, new legislation or regulationmay limit the manner in which we may conduct our business, including ourability to offer new products, obtain financing, attract deposits, make loansand achieve satisfactory interest spreads.

**There is a limited trading market for our common shares, and you maynot be able to resell your shares at or above the price shareholders paid forthem.**

The trading in our common shares has less liquidity than many othercompanies quoted on the national securities exchanges or markets.  A public trading market having the desiredcharacteristics of depth, liquidity, and orderliness depends on the presence inthe market of willing buyers and sellers of our common shares at any giventime.  This presence depends on theindividual decisions of investors and general economic and market conditionsover which we have no control.  We cannotassure you that volume of trading in our common shares will 

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increase in the future.

**System failure or breaches of our network security could subject us toincreased operating costs as well as litigation and other liabilities.**

The computer systems and networkinfrastructure we use could be vulnerable to unforeseen problems.  Our operations are dependent upon our abilityto protect our computer equipment against damage from physical theft, fire,power loss, telecommunications failure or a similar catastrophic event, as wellas from security breaches, denial of service attacks, viruses, worms and otherdisruptive problems caused by hackers. Any damage or failure that causes an interruption in our operationscould have a material adverse effect on our financial condition and results ofoperations.  Computer break-ins, phishingand other disruptions could also jeopardize the security of information storedin and transmitted through our computer systems and network infrastructure,which may result in significant liability to us and may cause existing andpotential customers to refrain from doing business with us.  Although we, with the help of third-partyservice providers, intend to continue to implement security technology andestablish operational procedures to prevent such damage, there can be noassurance that these security measures will be successful. In addition,advances in computer capabilities, new discoveries in the field of cryptographyor other developments could result in a compromise or breach of the algorithmswe and our third-party service providers use to encrypt and protect customertransaction data.  A failure of suchsecurity measures could have a material adverse effect on our financialcondition and results of operations.

**We are subject to certain operational risks,including, but not limited to, customer or employee fraud and data processingsystem failures and errors.**

Employeeerrors and misconduct could subject us to financial losses or regulatory sanctionsand seriously harm our reputation. Misconduct by our employees could includehiding unauthorized activities from us, improper or unauthorized activities onbehalf of our customers or improper use of confidential information. It is notalways possible to prevent employee errors and misconduct, and the precautionswe take to prevent and detect this activity may not be effective in all cases.Employee errors could also subject us to financial claims for negligence.

We maintain a system of internal controls andinsurance coverage to mitigate against operational risks, including dataprocessing system failures and errors and customer or employee fraud. Shouldour internal controls fail to prevent or detect an occurrence, or if anyresulting loss is not insured or exceeds applicable insurance limits, it couldhave a material adverse effect on our business, financial condition and resultsof operations.

**Item 1.B.**

None

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**Item 2.        Properties**.

The Company’s main office islocated at 701-705 LaSalle Street, Ottawa, Illinois.  The building is comprised of approximately15,000 square feet.  The main officebuilding is a two-story structure constructed principally of masonrywhich was opened in 1865.  The Companyalso operates eight branch office facilities. A limited service branch, whichcontains eight drive-in lanes, is located at 300 West Madison Street,Ottawa, Illinois, a loan production office located at 426 Mondamin Street, Unit1, Minooka, Illinois, and six full-service branches are located at 601 StateStreet, Ottawa, Illinois; 2771 North Columbus Street, Ottawa, Illinois; 1771North Division Street, Morris, Illinois; 2324 North Bloomington Street,Streator, Illinois; 401 East Main Street, Streator, Illinois; and 1459Cannonball Trail, Yorkville, Illinois. The main banking office and branchoffices are owned by the Company in fee and are unencumbered. The loanproduction office space is leased for a three year term with renewal optionsfor years four and five.

**Item 3.        Legal Proceedings.**

TheCompany is from time to time a party to legal proceedings in the ordinarycourse of business that are incident to the business of banking. The Company isnot engaged in any legal proceedings of a material nature at the present time.

**Item 4.        Submission of Matters to a Vote of Security Holders.**

No matters were submitted to avote of security holders during the quarter ended December 31, 2006.

 

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**PART II**

**Item 5.****                       Market For Registrant’s Common Equity, RelatedStockholder Matters and Issuer Purchases of Equity Securities**

Seepage 43 of the 2006 Annual Report to Stockholders (filed as Exhibit 13.1 ofthis report) which is incorporated herein by reference.

**Issuer Purchases of Equity Securities**

 
| **Period**                                  | ** ** | **Total Number of   Shares Purchased** | ** ** | **Average Price Paid   per Share** | ** ** | **Total Number of   Shares Purchased   as Part of Publicly   Announced Plans or  Programs** | ** ** | **Maximum Number   of Shares that May   Yet Be Purchased   Under the Plans or   Programs** | ** ** |
|---------------------------------------------|------------|------------------------------------------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| December 1, 2006  through December 31, 2006 |       | 300                                                        |       | $                                                      | 71.27      |                                                                                                                                               | 0          |                                                                                                                                                        | 0          |   |
| Total                                       |       | 300                                                        |       | $                                                      | 71.27      |                                                                                                                                               | 0          |                                                                                                                                                        | 0          |   |

 

**Item 6.        SelectedFinancial Data**

Theinformation set forth under the caption “Selected Consolidated FinancialInformation” on page 1 of the 2006 Annual Report to Stockholders (filed asExhibit 13.1 of this report) is incorporated herein by reference.

**Item 7.****                       Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

Theinformation set forth under the caption “Management’s Discussion and Analysisof Financial Condition and Results of Operations” on pages 2 through 12 of the2006 Annual Report to Stockholders (filed as Exhibit 13.1 of this report) isincorporated herein by reference.

**Item 7A.****              Quantitative and QualitativeDisclosures about Market Risk**

Theinformation set forth under the caption “Quantitative and QualitativeDisclosures about Market Risk” on page 13 of the 2006 Annual Report toStockholders (filed as Exhibit 13.1 of this report) is incorporated herein byreference.

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**Item 8.        FinancialStatements and Supplementary Data**

Theconsolidated financial statements of the Registrant and the Report ofIndependent Registered Public Accounting Firm as set forth on pages 17 through42 of the 2006 Annual Report to Stockholders (filed as Exhibit 13.1 of thisreport) are incorporated herein by reference:
| ** **                                                                                                   | ** ** | Annual Report to | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                                   | ** ** | **Stockholders Page** | ** ** |
| Report of  Independent Registered Public Accounting Firm                                                     |       | 17                         |       |
| Consolidated  Balance Sheets as of December 31, 2006 and 2005                                                |       | 18                         |       |
| Consolidated  Statements of Income for the years ended December 31, 2006, 2005, and 2004                     |       | 19                         |       |
| Consolidated  Statements of Stockholders’ Equity for the years ended December 31, 2006,  2005, and 2004 |       | 20                         |       |
| Consolidated Statements  of Cash Flows for the years ended December 31, 2006, 2005, and 2004                 |       | 21                         |       |
| Notes to the Consolidated Financial Statements                                                               |       | 22                         |       |

 

Theportions of the 2006 Annual Report to Stockholders which are not specificallyincorporated by reference as a part of this Form 10-K are not deemed to be apart of this report.

**Item 9.        Changesin and Disagreements with Accountants on Accounting and Financial Disclosure**

None.

**Item 9A.     Controlsand Procedures**

Anevaluation was performed under the supervision and with the participation ofthe Company’s management, including the Chief Executive Officer and ChiefFinancial Officer, of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures (as defined in Rule 13a-15(e)promulgated under the Exchange Act) as of December 31, 2006. Based on thatevaluation, the Company’s management, including the Chief Executive Officer andChief Financial Officer, concluded that the Company’s disclosure controls andprocedures were effective. There have been no significant changes in theCompany’s internal controls or in other factors that could significantly affectinternal controls.

**Item 9B.     OtherInformation**

None

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**PART III**

**Item 10.     Directors and Executive Officers and Corporate Governance**

The information set forth underthe captions “Information Regarding Nominees and Executive Officers”, “CorporateGovernance and the Board of Directors” and “Section 16 Beneficial OwnershipReporting Compliance” of the Registrant’s Proxy Statement, relating to the 2007Annual Meeting of Stockholders is incorporated herein by reference.

**Item 11.     Executive Compensation**

The information set forth underthe caption “Executive Compensation” of the Registrant’s Proxy Statement,relating to the 2007 Annual Meeting of Stockholders is incorporated herein byreference, except for the “Stockholder’s Performance Table” and the “BoardCompensation Committee’s Report on Compensation,” which are not herebyincorporated.

**Item 12.****                SecurityOwnership of Certain Beneficial Owners and Management and Related StockholderMatters**

The information set forth under the caption “SecurityOwnership of Certain Beneficial Owners and Management” of the Registrant’sProxy Statement, relating to the 2007 Annual Meeting of Stockholders isincorporated herein by reference.

** Equity CompensationPlan Information**

 The table below sets forth the followinginformation as of December 31, 2006 for (i) all compensation plans previouslyapproved by the Company’s stockholders and (ii) all compensation plans not previouslyapproved by the Company’s stockholders:

(a)             the number ofsecurities to be issued upon the exercise of outstanding options, warrants andrights; 

(b)            the weighted-averageexercise price of such outstanding options, warrants and rights; 

(c)             other than securitiesto be issued upon the exercise of such outstanding options, warrants andrights, the number of securities remaining available for future issuance underthe plans. 

 

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EQUITY COMPENSATION PLAN INFORMATION

** **
| **Plan category**                                            | ** ** | **Number of securities to  be issued upon exercise  of outstanding options** | ** ** | **Weighted-average   exercise  price of outstanding   options** | ** ** | **Number of securities   remaining available for  future issuance** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------|------------|
|  Equity compensation plans approved by  security holders     |       | 30,690                                                                                                               |       | $                                                                                   | 67.22      |                                                                                              | 118,500    |   |
|  Equity compensation plans not approved by  security holders |       | 0                                                                                                                    |       | 0                                                                                   |       | 0                                                                                                 |       |
| ** Total**                                                   |       | 30,690                                                                                                               |       | $                                                                                   | 67.22      |                                                                                              | 118,500    |   |

 

**Item 13.     CertainRelationships and Related Transactions and Director Independence**

The information set forth under the caption “CertainRelationships and Related Transactions and Director Independence” of theRegistrant’s Proxy Statement, relating to the 2007 Annual Meeting ofStockholders is incorporated herein by reference.

**Item 14.     PrincipalAccounting Fees and Services**

The information set forth under the caption “IndependentPublic Accountants” of the Registrant’s Proxy Statement relating to the 2007Annual Meeting of Shareholders is incorporated herein by reference.

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**PART IV**
| **Item  15.** |   | **Exhibits and Financial Statement Schedules** |
|---------------|--------|------------------------------------------------|
|          |   |                                           |   |   |
| (a)           |   | 1.                                             |   | Financial  Statements |
|          |   |                                           |   | All  financial statements of the Registrant are incorporated herein by reference  as set forth under Item 8, Part II of this report on Form 10-K. |
|          |   | 2.                                             |   | Financial  Statement Schedules |
|          |   |                                           |   | Not  applicable. |
|          |   | 3.                                             |   | Exhibits  (Numbered in accordance with Item 601 of Regulation S-K) |
|          |   |                                           |   | The  following exhibits are filed as part of this report: |
|          |   |                                           |   | 3 (i) |   | Certificate of Incorporation of First Ottawa  Bancshares, Inc. |
|          |   |                                           |   | 3 (ii) |   | By-Laws of First Ottawa Bancshares, Inc. |
|          |   |                                           |   | 10.1 |   | Employment Agreement for J. Brown* |
|          |   |                                           |   | 10.2 |   | Executive  Officer Bonus Plan* |
|          |   |                                           |   | 10.3 |   | Employment  Agreements for Executive Officers* |
|          |   |                                           |   | 10.4 |   | Stock Incentive  Plan |
|          |   |                                           |   | 10.5 |   | Summary of  Director Fees |
|          |   |                                           |   | 10.6 |   | Form of  Supplemental Nonqualified Retirement Agreement |
|          |   |                                           |   | 13.1 |   | 2006 Annual  Report to Stockholders |
|          |   |                                           |   | 21.1 |   | Subsidiaries |
|          |   |                                           |   | 23.1 |   | Consent of BKD  LLP |
|          |   |                                           |   | 31.1 |   | Certification of  Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) |
|          |   |                                           |   | 31.2 |   | Certification of  Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a) |
|          |   |                                           |   | 32.1 |   | Certification of  Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|          |   |                                           |   | 32.2 |   | Certification of  Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

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*                    Indicatesmanagement contract or compensation plan or arrangement.

31

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** SIGNATURE**

In accordance with Section 13 or 15(d) of the ExchangeAct, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.
|        | **FIRST OTTAWA BANCSHARES, INC.** |
|--------|-----------------------------------|
|   | By:                               | /s/ Joachim Brown |
|   |                              | Joachim Brown, President and Chief Executive Officer  (Principal Executive Officer) |
|   | By:                               | /s/ Vincent G. Easi |
|   |                              | Vincent G. Easi, Principal Financial Officer |

 

Date:           March 25, 2007

Inaccordance with the Exchange Act, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and onthe dates indicated.
| Signature                 | ** ** | **Title**                               | ** ** | **Date**       |
|---------------------------|------------|-----------------------------------------|------------|----------------|
| /s/ Joachim Brown         |       | Director and President/                 |       | March 25, 2007 |
| Joachim Brown             |       | Chief Executive Officer                 |       |           |
| /s/ Bradley J.  Armstrong |       | Director                                |       | March 25, 2007 |
| Bradley J. Armstrong      |       |                                    |       |           |
| /s/ John L. Cantlin       |       | Director                                |       | March 25, 2007 |
| John L. Cantlin           |       |                                    |       |           |
| /s/ Patty P. Godfrey      |       | Director                                |       | March 25, 2007 |
| Patty P. Godfrey          |       |                                    |       |           |
| /s/ Thomas E. Haeberle    |       | Director                                |       | March 25, 2007 |
| Thomas E. Haeberle        |       |                                    |       |           |
| /s/ Donald J. Harris      |       | Director and Executive                  |       | March 25, 2007 |
| Donald J. Harris          |       | Vice President, Chief Operating Officer |       |           |

 

32

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| /s/ Thomas P. Rooney |   | Director |   | March 25, 2007 |
|----------------------|--------|----------|--------|----------------|
| Thomas P. Rooney     |   |     |   |           |
| /s/ William J. Walsh |   | Director |   | March 25, 2007 |
| William J. Walsh     |   |     |   |           |

 

33

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**EXHIBIT INDEX**
| Exhibit   Number | ** ** | **Description**                                                             | ** ** | **Incorporated by Reference to**       | ** ** | **Attached  Hereto** |
|------------------|------------|-----------------------------------------------------------------------------|------------|----------------------------------------|------------|----------------------|
| 3(i)             |       | Certificate of Incorporation of First Ottawa  Bancshares, Inc. (as amended) |       | Form 10K for the year ended 12/31/2002 |       |                 |
| 3(ii)            |       | By-Laws of First Ottawa Bancshares, Inc.                                    |       | Form 10K for the year ended 12/31/2003 |       |                 |
| 10.1             |       | Employment Agreement for J. Brown                                           |       | Form 10K for the year ended 12/31/2002 |       |                 |
| 10.2             |       | Executive Officer Bonus Plan                                                |       | Form 10K for the year ended 12/31/2002 |       |                 |
| 10.3             |       | Employment Agreements for Executive Officers                                |       | Form 8K dated 6/10/05                  |       |                 |
| 10.4             |       | Stock Incentive Plan                                                        |       | Form S-8 dated 8/1/03                  |       |                 |
| 10.5             |       | Summary of Director Fees                                                    |       | Form 10K for the year ended 12/31/2004 |       |                 |
| 10.6             |       | Form of Supplemental Nonqualified Retirement  Agreement                     |       | Form 10K for the year ended 12/31/2004 |       |                 |
| 13.1             |       | 2006 Annual Report to Stockholders                                          |       |                                   |       | X                    |
| 21.1             |       | Subsidiaries                                                                |       |                                   |       | X                    |
| 23.1             |       | Consent of BKD LLP                                                          |       |                                   |       | X                    |
| 31.1             |       | Certification of Chief Executive Officer                                    |       |                                   |       | X                    |
| 31.2             |       | Certification of Chief Financial Officer                                    |       |                                   |       | X                    |
| 32.1             |       | Certification of Chief Executive Officer                                    |       |                                   |       | X                    |
| 32.2             |       | Certification of Chief Financial Officer                                    |       |                                   |       | X                    |

 

 

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