**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-K**

 
| **ANNUAL  REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------------------------------------------------------------------------------------|
|                                                                                |
| **For  the fiscal year ended December 31, 2002**                                    |
|                                                                                |
| **Commission file number:  005-57237**                                         |

 

| **FIRST  OTTAWA BANCSHARES, INC.**                                  |
|---------------------------------------------------------------------|
| (Exact name of  Registrant as specified in its charter)             |
|                                                                |   |   |
| **Delaware**                                                        |   | **36-4331185** |
| (State or Other  Jurisdiction  of Incorporation or Organization)    |   | (I.R.S. Employer  Identification No.) |
|                                                                |   |   |
| **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 the Exchange Act: |
| **None**                                                            |
|                                                                |
| Securities registered under Section 12(g) of the Exchange Act:      |
|                                                                |
| **Common Stock, par value $1.00 per  share**                        |
| (Title of Class)                                                    |

 

Indicate by check markwhether the registrant:  (1) has filedall reports 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  ý  No  o

 

Indicate by check mark if disclosure of delinquentfilers in response to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.  ý

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Act). Yes  o  No  ý  

 

The aggregate market value of the voting and non-voting common equityheld by non-affiliates of the registrant, based on the last known sales priceon June 28, 2002, the last business day of the registrant’s most recentlycompleted second fiscal quarter, was approximately $26,973,390.

 

656,956 shares of common stock were outstanding as ofMarch  6, 2003.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portions of Parts II and IV are incorporated byreference from the Registrant’s 2002 Annual Report to Stockholders; and aportion of Part III is incorporated by reference from the Registrant’s ProxyStatement for the Annual Meeting of Stockholders to be held May 21, 2003.

 

Except for those portions of the 2002 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 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 and Related Stockholder Matters |
| 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 on Accounting and Financial Disclosure |
|      |   |
| PART  III |
|      |   |
| Item  10  | Directors  and Executive Officers of the Registrant |
| Item 11   | Executive Compensation |
| Item  12  | Security  Ownership of Certain Beneficial Owners and Management |
| Item  13  | Certain  Relationships and Related Transactions |
| Item 14   | Controls and  Procedures |
|      |   |
| PART  IV  |
|      |   |
| Item 15   | Exhibits,  Financial Statement Schedules and Reports on Form 8-K |

 

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**PART I**

 

**Item 1.****        Business**.

 

First Ottawa Bancshares, Inc. (the “Company”) is abank holding company for its wholly-owned subsidiary, First National Bank ofOttawa (the “Bank”), and the Bank’s wholly owned subsidiary, First OttawaFinancial Corporation.  The Company wasorganized during 1999 and on October 1, 1999 exchanged 100% of its commonstock for 100% of the Bank’s common stock. This exchange was accounted for as an internal reorganization.  All references to the combined Company,unless otherwise indicated, at or before October 1, 1999, refer to theBank.  As of December 31, 2002, theCompany had total assets of $240.7 million, total deposits of $193.8 million,loans, including loans held for sale, net of unearned income, of $111.5 millionand total stockholders’ equity of $25.2 million.  For the year ended December 31, 2002, the Company had interestincome of $13.1 million and net income of $2.3 million, which amounted to netincome per share of $3.47.

 

The Company conducts a general banking businessembracing most of the services, both commercial and consumer, which banks maylawfully provide, including the following principal services:  the acceptance of deposits for demand,savings, and time accounts and the servicing of such accounts; commercial,agricultural, consumer, and real estate lending, including installment loans,personal lines of credit, and overdraft protection; trust operations; farmmanagement; safe deposit operations; and an extensive variety of additionalservices tailored to the needs of individual customers, including the sale oftraveler’s checks, cashier’s checks, and foreign currency and other specialservices.  Loans, both commercial andconsumer, are provided on either a secured or unsecured basis to corporations,partnerships, and individuals. Commercial lending covers such areas as business, industry, capital,agriculture, inventory, and real estate, with the latter including residentialproperties.  Consumer loans are made fora variety of purposes including automobile purchases, recreational vehiclepurchases, consumer goods, installment loans, and other types of loans.

 

The Company is located in the City of Ottawa, Illinois(population 17,500) in LaSalle County in Illinois.  A substantial portion of the Company’s business is dependent uponthe economic conditions in this market area. LaSalle County is the second largest county by area in the state ofIllinois.  Ottawa is located innortheastern Illinois approximately 80 miles southwest of Chicago andapproximately 65 miles north of Bloomington. Ottawa may be accessed byInterstate 80; U.S. Route 6; State Routes 23 and 71; and recently completedInterstate 39, which is located 11 miles west of Ottawa.  The city is also serviced by two railroadsand the Ottawa Airport.

 

Ottawa is the county seat of LaSalle County.  Accordingly, many county, state, and othergovernmental offices are located in Ottawa.

 

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LaSalle County has a diverse economy with a balance inagriculture, transportation and industry. Grain terminals on the Illinois Deep Waterway at Ottawa provide a directdistribution point for agricultural products to overseas markets via the Gulfof Mexico and the St. Lawrence Seaway. LaSalle County annually ranks in the top 10 counties in Illinois forcorn and soybean production.  LaSalleCounty, the site of the largest producer of silica sand in the United States,has a diverse manufacturing sector which includes, in addition to the productionof silica sand, the manufacture of residential glass, automotive and industrialbelts and equipment, electronic typewriters and computer printers, plastics,office supplies, and rubber products. Many of these companies conduct business in national and, in someinstances, international markets.

 

The Ottawa area is continuing to expand.  Many developments have had a significantimpact on the area economy, including a new County Office Building on the northedge of Ottawa and several new and expanded shopping center projects.

 

The Company has purchased real estate in Morris,Illinois with the intention of establishing a full service branch facility inthat community.  Construction completionand the branch opening are expected to occur in May 2003. The Company continuesto explore expansion opportunities within its existing market area and insurrounding areas. In addition, an extensive remodeling project of the mainbanking facility was completed in the third quarter of 2002.

 

***Lending Activities***.  The Company relies on interest income fromlending activities as a major source of revenue.  The Company has a community bank focus - serving the credit needsof the local community.  Because of thislocal focus, the Company has a flexible process for handling loan requestsrather than being tied to rigid standards. The discussions below regarding lending policies reflect generalguidelines and may vary on a case-by-case basis depending on the borrower’scredit history and the type and size of loan. During the approval process for loans it originates, the Companyassesses both the applicant’s ability to repay the loan and the value of anycollateral securing the loan.  TheCompany verifies the applicant’s ability to repay the loan by using creditreports, financial statements, confirmations, and other items, includingappraisals.

 

Seven loan officers have the authority to handle alllending activities of the Company.  Eachlending officer has authority to approve extensions of credit up to theirindividual lending limit.  The Companyhas an Officers Loan Committee (consisting of Assistant Vice Presidents, VicePresidents, Executive Vice Presidents and the President of the Bank) whichapproves loans of up to $500,000.  Allloans between $500,000 and $1,500,000 are sent to the Director’s Loan Committeefor approval.  The Director’s LoanCommittee is also responsible for monitoring concentration of credits, problemand past due loans, and charge-offs of uncollectible loans; formulatingrecommendations for the Board of Directors regarding loan policy modifications,loan classifications, and charge-offs; and establishing interest rate andfee guidelines. All loans in excess of $1,500,000 are reviewed and approved bythe Board of Directors.  The Board ofDirectors also is responsible for directing and supervising the Director’s LoanCommittee, policy review, and oversight of the loan and investment functions ofthe Company.  The Board of Directorsalso monitors the adequacy of the Company’s loan loss reserves.

 

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***Loan Portfolio Composition***.  The Company’s gross loan portfolio,including loans held for sale, totaled $111.5 million at December 31,2002, representing 57.6% of the Company’s total deposits at that date.  The Company’s loan portfolio at December 31,2002 included $46.7 million for real estate purposes, $29.1 million forconsumer purposes, and $34.0 million for commercial and agricultural purposes.

 

Certain risks, including the risk of non-payment, areassociated with each type of loan.  Theprimary risks associated with consumer loans relate to the borrower, such asthe risk of a borrower’s unemployment as a result of deteriorating economicconditions or the amount and nature of a borrower’s other existingindebtedness, and the value of the collateral securing the loan if the Companymust take possession of the collateral. Consumer loans also have risks associated with concentrations of loansin a single type of loan.  The primaryrisks associated with commercial 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 in addressing and managingthese types of risks is to follow its loan policies and underwriting practices,which include (i) granting loans on a sound and collectible basis;(ii) investing funds profitably for the benefit of the stockholders andthe protection of depositors; (iii) serving the legitimate needs of thecommunity and the Company’s general market area while maintaining a balancebetween maximum yield and minimum risk; (iv) ensuring that primary andsecondary sources of repayment are adequate in relation to amount of the loan;(v) developing and maintaining adequate diversification of the loanportfolio as a whole and of the loans within each loan category;(vi) ensuring that each loan is properly documented and, if appropriate,secured or guaranteed by government agencies; and (vii) developing andapplying adequate collections procedures.

 

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All table amounts throughout the Form 10-K are inthousands except share and per share data.

 

The following table presents the components of theCompany’s loan portfolio as of December 31 for each year shown.

 
|                                       |   | **2002** |    | **2001** |   | **2000** |   | **1999** |    | **1998** |   |
|--------------------------------------------|--------|----------|---------|----------|--------|----------|--------|----------|---------|----------|--------|
|                                       |   |     |    |     |   |     |   |     |    |     |   |
| Real estate  loans                         |   | $        | 46,699  |     | $      | 47,322   |   | $        | 56,109  |     | $      | 59,560 |   | $ | 58,136 |   |
|                                       |   |     |    |     |   |     |   |     |    |     |   |
| Commercial and  agricultural loans         |   | 33,950   |    | 29,361   |   | 16,266   |   | 15,222   |    | 15,013   |   |
|                                       |   |     |    |     |   |     |   |     |    |     |   |
| Installment  loans, net of unearned income |   | 19,951   |    | 24,595   |   | 39,441   |   | 48,751   |    | 41,898   |   |
|                                       |   |     |    |     |   |     |   |     |    |     |   |
| Home equity  lines of credit               |   | 9,120    |    | 6,795    |   | 5,143    |   | 4,219    |    | 3,812    |   |
|                                       |   |     |    |     |   |     |   |     |    |     |   |
| Total loans                                |   | 109,720  |    | 108,073  |   | 116,959  |   | 127,752  |    | 118,859  |   |
|                                       |   |     |    |     |   |     |   |     |    |     |   |
| Deferred loan  fees                        |   | (77      | )       | (40      | )      | (40      | )      | (46      | )       | (58      | )      |
|                                       |   |     |    |     |   |     |   |     |    |     |   |
| Loans, net of  deferred loan fees          |   | 109,643  |    | 108,033  |   | 116,919  |   | 127,706  |    | 118,801  |   |
|                                       |   |     |    |     |   |     |   |     |    |     |   |
| Allowance for  loan losses                 |   | (1,167   | )       | (1,109   | )      | (1,108   | )      | (1,059   | )       | (1,029   | )      |
|                                       |   |     |    |     |   |     |   |     |    |     |   |
| Loans, net                                 |   | $        | 108,476 |     | $      | 106,924  |   | $        | 115,811 |     | $      | 126,647 |   | $ | 117,772 |   |
|                                       |   |     |    |     |   |     |   |     |    |     |   |
| Loans held for  sale                       |   | $        | 1,811   |     | $      | 1,475    |   | $        | 693     |     | $      | 1,738 |   | $ | 563 |   |

 

Maturities (based on contractualterms) of the Company’s commercial and construction loan portfolio at December31, 2002 are summarized below:

 
|                         |   | **One Year  or Less** |   | **One to  Five Years** |   | **Over  Five Years** |   | **Total** |   |
|------------------------------|--------|-----------------------|--------|------------------------|--------|----------------------|--------|-----------|--------|
|                         |   |                  |   |                   |   |                 |   |      |   |
| Commercial and  agricultural |   | $                     | 10,924 |                   | $      | 8,694                |   | $         | 13,998 |   | $ | 33,616 |   |
|                         |   |                  |   |                   |   |                 |   |      |   |
| Construction                 |   | 334                   |   | —                 |   | —               |   | 334       |   |
|                         |   |                  |   |                   |   |                 |   |      |   |
| Total                        |   | $                     | 11,258 |                   | $      | 8,694                |   | $         | 13,998 |   | $ | 33,950 |   |

 

At December 31, 2002, of the total loans thatmature in more than one year, $54.9 million, or 58.7%, bear interest at fixedrates and $38.6 million, or 41.3%, bear interest at variable rates.

 

***Consumer Loans***.  Generally, one of the Company’s sevenlending officers process consumer installment loans.  The Company makes consumer loans for various purposes, includingpersonal, family, and nonbusiness reasons such as automobile loans andrecreational vehicle loans, on both a direct and indirect basis.  Consumer loans totaled approximately $29.1million at December 31, 2002, or approximately 26.1% of the Company’stotal loan portfolio.  Approximately66.0% of the Company’s consumer loans were automobile loans, and of theseloans, approximately

 

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89.5% were made indirectly by the Company through automobiledealers.  The Company’s consumer loansare fixed-rate loans with final maturities of five years or less.  At December 31, 2002, the Company had 14consumer loans totaling $96,000 that were past due in excess of 90 days.

 

In approving consumer loans, lending officers considerthe borrower’s past credit history, the borrower’s ability to repay the debt,the collateral offered, and local economic conditions that 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 to borrowers based uponsatisfactory income, indebtedness levels, and credit records and experience.

 

***Commercial, Agricultural, and Real Estate Lending***.  Six of the Company’s seven lending officersservice most of the commercial, agricultural, and real estate loans.  Three loan officers principally servicecommercial loans, two officers principally service agricultural loans, andthree officers principally service residential mortgage loans.  However, because of the Company’s flexiblelending practices, any of the loan officers may service loans in thecommercial, agricultural, and real estate areas.

 

Commercial and Agricultural.  At December 31, 2002, the Company’scommercial and agricultural loans totaled $33.9 million or approximately 30.4%of the total loan portfolio of the Company. The primary lending area of the Company is within a five-mile radius ofthe Company’s offices.  The majority ofagricultural and commercial non-real estate loans are written for one tofive years, may bear interest at a fixed or variable rate and are amortizedover a 15-year to 20-year period.  Thefixed rate generally is established by the Company’s Real Estate Departmentafter considering the cost of funds to the Company as well as the rates ofcompeting institutions.  The variablerate is generally based upon the national prime rate as disclosed in *The WallStreet Journal*.  Principaland interest payments on commercial loans generally are required monthly;whereas, payments on agricultural loans vary greatly from monthly, quarterly,semi-annually, and annually.  AtDecember 31, 2002, the Company had 1 commercial non-real-estate loan totaling$79,000 past due in excess of 90 days. There were no agriculturalnon-real-estate loans at December 31, 2002 that were past due in excess of 90days.

 

All commercial and agricultural borrowers, bothexisting and new, are required by policy to have a current financial statementno older than one year.  Borrowers alsoare required to provide

 

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the Company with recent tax returns and pro forma projections.  Using certain computer programs and the datasupplied by borrowers, the loan officers produce additional financialinformation utilized in analyzing the loans and the borrowers.  The general nature of the collateralsecuring the Company’s commercial and agricultural loans consists of equipment,farm products, crops, inventory, chattel paper, accounts receivable, andgeneral intangibles.  The Company’s loan-to-valueratio with respect to agricultural and commercial non-real-estate loansaverages 66 2/3% to 75% of the value of the collateral securing the loan.

 

Real Estate Lending.The Company’s primary real estate lending consists of residential loans with asmall portion in agricultural and commercial real estate loans.  Real estate loans at December 31, 2002totaled approximately $46.7 million or approximately 41.9% of the Company’stotal loan portfolio.  All borrowersrequesting a real estate loan are required to submit an application which isreviewed by the lending officer.  A creditinvestigation is performed and an analysis of the borrower’s ability to repayis conducted.  Subsequently, aninspection and appraisal of the real property is conducted to determine whetheror not the property is of sufficient value to meet the Company’s suggestedmaximum loan-to-value ratio of 80% to 85% of the lesser of the appraisedvalue or the purchase price of the property securing the loan.  Under certain federal guaranteed loanprograms utilized by the Company, the maximum loan-to-­value ratio ishigher.  With respect to loans securedby commercial or industrial real estate, the Company analyzes the potential forenvironmental liability concerns and, depending upon the circumstances, theCompany may require additional information or testing.  Commercial and agricultural real estateloans are generally originated under the same policies and procedures asdiscussed above for commercial and agricultural non-real-estate loans.

 

The Company’s residential real estate loans consist of15-year, 20-year and 30-year fixed-rate and variable-rate loans withamortization periods equal to the maturity of the loan.  The Company’s fixed-rate loans with biweeklypayments account for approximately 26.5% of all the residential real estateloans of the Company. The biweekly loan program amortizes 25year loans inapproximately 18.9 years.  The Companyalso originates a variety of loans that are sold into the secondary marketthrough Federal Home Loan Mortgage Corporation (“Freddie Mac”) and privateinvestors.  These loans are underwrittento meet all Freddie Mac requirements. The Company retains servicing rights on loans sold into the secondarymarket.  At December 31, 2002,mortgage loans serviced for the secondary market totaled approximately $22.5million.

 

At December 31, 2002, the Company had 8 real estatemortgage loans totaling $946,000 past due in excess of 90 days.

 

***Interest Rates and Fees***.  Interest rates and fees charged on theCompany’s loans are affected primarily by the market demand for loans and thesupply of money available for lending purposes.  These factors are affected by, among other things, generaleconomic conditions and the policies of the federal government, including theFederal Reserve Board, legislative tax policies, and governmental budgetarymatters.

 

***Non-Performing Loans***.  When a borrower fails to make a required paymenton a loan and does not cure the delinquency within 30 days, the loan isclassified as delinquent.  In thisevent, the normal procedure followed by the Company is to make contact with theborrower at prescribed

 

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intervals in an effort to bring the loan to a current status.  In most cases, delinquencies are curedpromptly, but, if not, the Company normally records a notice of default,subject to any required prior notice to the borrower, and commences foreclosureproceedings when loan payments are 120 days past due.

 

At December 31, 2002, the Company had 76 loansdelinquent for 30 to 90 days in an aggregate principal amount of $1.7 millionand representing 1.5% of the total loan portfolio.  At December 31, 2002, the Company had 23 loans totaling $1.1  million delinquent for more than 90 days.

 

It is the Company’s policy to discontinue the accrualof interest income on any loan when, in accordance with banking regulations orin the opinion of management, there is reasonable doubt as to thecollectibility of interest or principal. Interest on these loans is credited to income only when the collectionof principal has been reasonably assured and only to the extent interestpayments are received.  If managementfeels collection of both interest and principal is probable, the loan is nottransferred to nonaccrual status.  AtDecember 31, 2002, there were 14 loans totaling $364,000 on nonaccrual status.

 

As a result of economic conditions and other factorsbeyond the Company’s control, the Company’s future loss and delinquencyexperience cannot be predicted with certainty.

 

The nonperforming assets of the Company as of December31 are indicated below:

 
|                                                                                               |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|----------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
|                                                                                               |   |     |   |     |   |     |   |     |   |     |   |
| Non-accrual  loans                                                                                 |   | $        | 364    |     | $      | 387      |   | $        | 467    |     | $      | 397 |   | $ | 299 |   |
| Loans ninety  days past due and still accruing interest                                            |   | 757      |   | 860      |   | 2,177    |   | 1,543    |   | 1,140    |   |
| Other real  estate owned                                                                           |   | 204      |   | —   |   | 169      |   | 113      |   | 94       |   |
|                                                                                               |   |     |   |     |   |     |   |     |   |     |   |
| Total  nonperforming assets                                                                        |   | $        | 1,325  |     | $      | 1,247    |   | $        | 2,813  |     | $      | 2,053 |   | $ | 1,533 |   |
|                                                                                               |   |     |   |     |   |     |   |     |   |     |   |
| Nonperforming loans as  a percentage of total loans, net of unearned income and deferred loan fees |   | 1.02     | %      | 1.17     | %      | 2.26     | %      | 1.52     | %      | 1.21     | %      |
|                                                                                               |   |     |   |     |   |     |   |     |   |     |   |
| Nonperforming  assets as a percentage of total assets                                              |   | .55      |   | .54      |   | 1.25     |   | .85      |   | .62      |   |
|                                                                                               |   |     |   |     |   |     |   |     |   |     |   |
| Nonperforming  loans as a percentage of the allowance for loan losses                              |   | 96.06    |   | 112.44   |   | 238.63   |   | 183.19   |   | 139.84   |   |

 

The effect of nonaccrual loans upon interest income isnot deemed to be material by management. Loans are placed in nonaccrual status when 90 days past due, unless theyare fully secured and in the process of collection.  At December 31, 2002, there were no other loans classified asproblem loans that were not included above. At December 31, 2002, there were no

 

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other assets classified as problem assets other than the loans shownabove.  Management also maintains aloans requiring attention report that includes loans greater than 60 daysdelinquent or other loans as deemed necessary by the Company’s internal loanreview or the loan committee.  The totalof loans requiring attention as of December 31, 2002 was $4.2 million.

 

***Allowance for Losses on Loans***.  In originating loans, the Company recognizesthat losses will be experienced on loans and that the risk of loss will varywith, among other things, the type of loan being made, the creditworthiness ofthe borrower over the term of the loan, general economic conditions and, in thecase of a secured loan, the quality of the security for the loan.  The Company maintains an allowance for loanlosses to absorb probable incurred credit losses inherent in the loanportfolio.  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 and estimatedcollateral values, and economic conditions.

 

The loan portfolio and other credit exposures areregularly reviewed by management to evaluate the adequacy of the allowance forloan losses.  The methodology forassessing the appropriateness of the allowance includes comparisons to actuallosses, 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.

 

In connection with assessing the allowance, lossfactors are applied to various pools of outstanding loans.  The Company segregates the loan portfolioaccording to risk characteristics (i.e., mortgage loans, commercial realestate, agricultural, business, consumer, etc.) and risk gradings.  Loss factors are derived using the Company’shistorical loss experience and may be adjusted for significant factors that, inmanagement’s judgment, affect the collectibility of the portfolio as of theevaluation date.  Commercial real estateand commercial business loans are individually evaluated for impairment andspecific reserves are allocated as needed in accordance with Statement ofFinancial Accounting Standards No. 114 and No. 118.

 

In addition, management assesses the allowance usingfactors that cannot be associated with specific credit or loan categories.  These factors include management’ssubjective evaluation of local and economic and business conditions, portfolioconcentration and changes in the character and size of the loan portfolio.  The allowance methodology reflectsmanagement’s objective that the overall allowance appropriately reflects amargin for the imprecision necessarily inherent in the estimates of expectedcredit 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 $126,000 in2002 after decreasing by $1.6 million during 2001.  Management considered this information along with other portfoliotrends in concluding on the adequacy of the allowance for

 

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loan losses at December 31, 2002. At December 31, 2002, thebalance in the allowance was $1.2 million, or 1.1% of gross loansoutstanding.  Management has concludedthat the allowance for loan losses is adequate at December 31, 2002.However, there can be no assurance that the allowance for loan losses isadequate to cover all losses.

 

The Company had two properties resulting from foreclosures classified as other realestate owned at December 31, 2002. Other real estate is carried at the lower ofcost or estimated market value which was $204,000 at year end.

 

***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 the five years ended December31, 2002 is summarized as follows:

 
|                                                  |   | **2002** |   | **2001** |   | **2000** |   | **1999** |   | **1998** |   |
|-------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|----------|--------|----------|--------|
|                                                  |   |     |   |     |   |     |   |     |   |     |   |
| Balance  at beginning of year                         |   | $        | 1,109  |     | $      | 1,108    |   | $        | 1,059  |     | $      | 1,029 |   | $ | 800 |   |
| Charge-offs                                           |   |     |   |     |   |     |   |     |   |     |   |
| Real Estate                                           |   | 46       |   | 111      |   | 135      |   | —   |   | —   |   |
| Commercial                                            |   | 6        |   | 35       |   | 39       |   | 121      |   | 123      |   |
| Installment                                           |   | 181      |   | 254      |   | 341      |   | 351      |   | 231      |   |
| Total  charge-offs                                    |   | 233      |   | 400      |   | 515      |   | 472      |   | 354      |   |
|                                                  |   |     |   |     |   |     |   |     |   |     |   |
| Recoveries                                            |   |     |   |     |   |     |   |     |   |     |   |
| Real Estate                                           |   | 39       |   | 4        |   | —   |   | —   |   | —   |   |
| Commercial                                            |   | 63       |   | 6        |   | 27       |   | 21       |   | 19       |   |
| Installment                                           |   | 69       |   | 91       |   | 177      |   | 97       |   | 104      |   |
| Total recoveries                                      |   | 171      |   | 101      |   | 204      |   | 118      |   | 123      |   |
| Net charge-offs                                       |   | 62       |   | 299      |   | 311      |   | 354      |   | 231      |   |
| Provision                                             |   | 120      |   | 300      |   | 360      |   | 384      |   | 460      |   |
|                                                  |   |     |   |     |   |     |   |     |   |     |   |
| Balance at end  of year                               |   | $        | 1,167  |     | $      | 1,109    |   | $        | 1,108  |     | $      | 1,059 |   | $ | 1,029 |   |
|                                                  |   |     |   |     |   |     |   |     |   |     |   |
| Net charge-offs to  average total loans               |   | .06      | %      | .26      | %      | .25      | %      | .29      | %      | .19      | %      |
| Allowance for  loan losses to total loans at year-end |   | 1.06     |   | 1.03     |   | .95      |   | .83      |   | .87      |   |

 

The Company’s allocation of the allowance for loanlosses as of December 31 is presented below:

 

9

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|                              |   | **2002**   |   | **2001**                     |   | **2000**   |   | **1999**                     |   | **1998**   |   |
|-----------------------------------|--------|------------|--------|------------------------------|--------|------------|--------|------------------------------|--------|------------|--------|
|                              |   | **Amount** |   | **Percent  of Total  Loans** |   | **Amount** |   | **Percent  of Total  Loans** |   | **Amount** |   | **Percent  of Total  Loans** |   | **Amount** |   | **Percent  of Total  Loans** |   | **Amount** |   | **Percent  of Total  Loans** |   |
|                              |   |       |   |                         |   |       |   |                         |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Real estate loans                 |   | $          | 281    |                         | 42.56  | %          | $      | 308                          |   | 43.78      | %      | $ | 378 |   | 47.97 | % | $ | 175 |   | 46.62 | % | $ | 184 |   | 48.91 | % |
|                              |   |       |   |                         |   |       |   |                         |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Commercial and agricultural loans |   | 307        |   | 30.94                        |   | 380        |   | 27.62                        |   | 291        |   | 13.91 |   | 458 |   | 11.92 |   | 371 |   | 12.63 |   |
|                              |   |       |   |                         |   |       |   |                         |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Installment loans                 |   | 236        |   | 26.50                        |   | 287        |   | 28.60                        |   | 297        |   | 38.12 |   | 328 |   | 41.46 |   | 333 |   | 38.46 |   |
|                              |   |       |   |                         |   |       |   |                         |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Unallocated                       |   | 343        |   | N/A                          |   | 134        |   | N/A                          |   | 142        |   | N/A |   | 98 |   | N/A |   | 141 |   | N/A |   |
|                              |   |       |   |                         |   |       |   |                         |   |       |   |   |   |   |   |   |   |   |   |   |   |
| Balance at end of year            |   | $          | 1,167  |                         | 100.00 | %          | $      | 1,109                        |   | 100.00     | %      | $ | 1,108 |   | 100.00 | % | $ | 1,059 |   | 100.00 | % | $ | 1,029 |   | 100.00 | % |

 

***Investment Activities.*****Theinvestment policies of the Company as established by the Board of Directorsattempt to provide and maintain liquidity, generate a favorable return oninvestments without incurring undue interest rate and credit risk, andcomplement the Company’s lending activities. The policies provide the authority to invest in United States Treasuryand federal agency securities, mortgage-backed securities, municipalsecurities, equity securities, and Certificates of Deposits.

 

***Approximately*** $21.3 million of theUnited States government agency notes held at December 31, 2002 are callable atthe option of the issuer, which present prepayment risk to the Company.

 

As of ***December*** 31, 2002, the Company had approximately $7.7million invested in municipalities located within LaSalle County, Illinois.

 

The Company purchased $4.9 million of Index PoweredCertificates of Deposit during 2001 and 2002. These deposits were placed withmultiple issuers so that $4.0 million of the principal deposited is insuredthrough the FDIC and the remaining $900,000 is collateralized with a letter ofcredit from the single issuing institution. Income returns are not guaranteedfor these instruments, however principal is guaranteed if held to maturity.

 

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***Securities Portfolio.***The followingtable shows the maturity distribution of the available-for-sale securities portfolioand the weighted average yield of the portfolio at December 31, 2002.  The carrying amounts of the portfolio atDecember 31, 2002 are found in Note 2 to the financial statements included inthe Annual Report to Stockholders.

 
|                                                         |   | **One Year  or Less** |   | **Weighted  Average  Yield** |   | **One to  Five  Yield** |   | **Weighted  Average  Yield** |   | **Five  to Ten  Years** |   | **Weighted  Average  Yield** |   | **Over  Ten  Years** |   | **Weighted  Average  Yield** |   | **Total** |   | **Weighted  Average  Yield** |   |
|--------------------------------------------------------------|--------|-----------------------|--------|------------------------------|--------|-------------------------|--------|------------------------------|--------|-------------------------|--------|------------------------------|--------|----------------------|--------|------------------------------|--------|-----------|--------|------------------------------|--------|
|                                                         |   |                  |   |                         |   |                    |   |                         |   |                    |   |                         |   |                 |   |                         |   |      |   |                         |   |
| U.S. Treasury securities                                     |   | $                     | — |                         | — | %                       | $      | 3,584                        |   | 4.10                    | %      | $                            | — |                 | — | %                            | $      | —    |   | —                       | %      | $ | 3,584 |   | 4.10 | % |
| U.S. Government agencies                                     |   | 1,028                 |   | 4.58                         |   | 62,953                  |   | 4.68                         |   | 1,033                   |   | 6.16                         |   | —               |   | —                       |   | 65,014    |   | 4.70                         |   |
| States and political subdivisions                            |   | 2,940                 |   | 7.23                         |   | 7,536                   |   | 7.57                         |   | 2,472                   |   | 6.55                         |   | 4,014                |   | 6.64                         |   | 16,962    |   | 7.28                         |   |
| Mortgage-backed securities and collateralized obligations(1) |   | 1,209                 |   | 1.36                         |   | 5,907                   |   | 5.54                         |   | 380                     |   | 4.08                         |   | 186                  |   | 2.22                         |   | 7,682     |   | 4.71                         |   |
|                                                         |   |                  |   |                         |   |                    |   |                         |   |                    |   |                         |   |                 |   |                         |   |      |   |                         |   |
| Corporate bonds                                              |   | —                |   | —                       |   | 2,415                   |   | 5.86                         |   | —                  |   | —                       |   | —               |   | —                       |   | 2,415     |   | 5.86                         |   |
| Equity securities                                            |   | 3,228                 |   | N/A                          |   | —                  |   | —                       |   | —                  |   | —                       |   | —               |   | —                       |   | 3,228     |   | N/A                          |   |
|                                                         |   |                  |   |                         |   |                    |   |                         |   |                    |   |                         |   |                 |   |                         |   |      |   |                         |   |
| Total securities                                             |   | $                     | 8,405  |                         | 5.33   | %                       | $      | 82,395                       |   | 5.02                    | %      | $                            | 3,885  |                 | 6.20   | %                            | $      | 4,200     |   | 6.44                         | %      | $ | 98,885 |   | 5.17 | % |

 

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(1)  Mortgage-backed securitiesreflect the contractual maturity of the related instrument.

 

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***Deposits****. *The principal deposit services offered by the Company aredemand, savings, and time deposit accounts and programs, which includeinterest-bearing and non-interest-bearing demand deposits and individualretirement accounts.  The Company hashad a stable deposit base.  Managementbelieves that this stability is due to the Company’s emphasis on being a locallyowned and operated bank and by providing quality, personalized service to itscustomers.

 

The following shows the Company’s average balances andrates paid during the years shown.

 
|                                 |   | **For the  Years Ended December 31,** |    |
|--------------------------------------|--------|---------------------------------------|---------|
|                                 |   | **2002**                              |    | **2001** |   | **2000** |   |
|                                 |   | **Average  Balance**                  |    | **Percent  of  Deposits** |   | **Rate** |   | **Average  Balance** |   | **Percent  of  Deposits** |   | **Rate** |   | **Average  Balance** |   | **Percent  of  Deposits** |   | **Rate** |   |
|                                 |   |                                  |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Noninterest- bearing demand deposits |   | $                                     | 19,879  |   | 11.6 | % | — | % | $ | 18,782 |   | 11.3 | % | — | % | $ | 20,284 |   | 11.3 | % | — | % |
| Interest-bearing demand deposits     |   | 42,056                                |    | 24.6 |   | 1.39 |   | 33,607 |   | 20.3 |   | 1.86 |   | 38,056 |   | 21.2 |   | 2.45 |   |
| Savings accounts                     |   | 18,388                                |    | 10.7 |   | 1.70 |   | 16,654 |   | 10.1 |   | 1.96 |   | 17,928 |   | 10.0 |   | 2.04 |   |
| Time deposits accounts               |   | 90,909                                |    | 53.1 |   | 4.61 |   | 96,615 |   | 58.3 |   | 5.71 |   | 103,171 |   | 57.5 |   | 5.59 |   |
|                                 |   |                                  |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                 |   | $                                     | 171,232 |   | 100.0 | % | 2.79 | % | $ | 165,658 |   | 100.0 | % | 3.90 | % | $ | 179,439 |   | 100.0 | % | 3.94 | % |
|                                      |        |                                       |         |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The distribution of the major components of depositsas of December 31, 2002 and 2001 is summarized in the balance sheets includedin the 2002 consolidated financial statements, which consolidated financialstatements are incorporated herein by reference. The following is a maturitydistribution of time certificates of deposit of $100,000 or more at December31, 2002:

 
|                            |   | **Balance** |   | **Percentage** |   |
|---------------------------------|--------|-------------|--------|----------------|--------|
| Maturity                        |   |        |   |           |   |
| Three months or less            |   | $           | 7,798  |           | 32.75  | % |
| Over three months to six months |   | 4,182       |   | 17.56          |   |
| Over six months to one year     |   | 7,398       |   | 31.07          |   |
| Over one year                   |   | 4,435       |   | 18.62          |   |
|                            |   |        |   |           |   |
| Total                           |   | $           | 23,813 |           | 100.00 | % |

 

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***Borrowings.***The Company’s other availablesources of funds include financing arrangements for securities sold underagreements to repurchase, federal funds purchased lines, and Federal Home LoanBank borrowings. Total borrowings decreased $23.1 million in 2002. Thisdecrease was a result of a $3.5 million decrease in borrowed funds, due to therepayment of Federal Home Loan Bank advances and $29.2 million decrease inrepurchase agreements due to a change in products offered by the Bank.Decreases in repurchase agreements and advances were partially offset by a $9.6million increase in federal funds purchased. Physical control is maintained forall securities sold under repurchase agreements. Information concerningsecurities sold under agreements to repurchase is summarized as follows:

 
|                                                   |   | **2002** |   | **2001** |   | **2000** |   |
|--------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                                   |   |     |   |     |   |     |   |
| Balance at December 31                                 |   | $        | 1,622  |     | $      | 30,849   |   | $ | 24,638 |   |
| Weighted average interest rate  during the year        |   | 1.86     | %      | 4.16     | %      | 6.06     | %      |
| Weighted average interest rate at  the end of the year |   | 2.04     | %      | 2.31     | %      | 6.10     | %      |
| Maximum month-end balance                              |   | $        | 37,594 |     | $      | 33,203   |   | $ | 26,772 |   |
| Average balance for the year                           |   | 25,567   |   | 27,062   |   | 19,111   |   |

 

***Trust.***The Company’s trust departmentprimarily services LaSalle County and surrounding counties.  At December 31, 2002, the trust departmenthad 337 trust accounts under management, 249 of which were discretionaryaccounts.  The trust department providesa full complement of asset management services for personal trusts, estates,and agencies.  The trust department hadassets under management of approximately $45.7 million at December 31, 2002, ofwhich $36.5 million was in discretionary accounts.

 

The Company, in conjunction with its trust department,also provides farm management services. At December 31, 2002, the department managed 45 farms.  The department manages or directsapproximately 8,200 acres of farmland in LaSalle County, Illinois andsurrounding counties.

 

***Competition***. The Company has activecompetition in all product and service areas in which it presentlyengages.  The Company not only competesfor commercial and individual deposits, loans, and trust business with otherLaSalle County, Illinois banks, but also with savings and loan associations,credit unions, and other financial service companies located in and aroundLaSalle County.  There are approximately15 commercial banks and 6 savings institutions with offices in LaSalle County,Illinois.  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.

 

***Employees.***  As of December 31, 2002, the Company had 83 employees, consistingof 69 full-time employees and 14 part-time employees.  None of the employees are subject to acollective bargaining agreement, and management believes it has excellentrelations with its staff.

 

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***Stock Repurchases.***OnDecember 31, 2001, the Company concluded a tender offer by acquiring 3,925common shares for an aggregate purchase price of $196,000. During 2002, theCompany repurchased 1,400 shares of its common stock for an aggregate purchaseprice of $74,000.

 

**Supervisionand Regulation**

 

***General*.**Financialinstitutions, their holding companies and their affiliates are extensivelyregulated under federal and state law. As a result, the growth and earnings performance of the Company may beaffected not only by management decisions and general economic conditions, butalso by the requirements of federal and state statutes and by the regulationsand policies of various bank regulatory authorities, including the Office ofthe Comptroller of the Currency (the “OCC”), the Board of Governors of theFederal Reserve System (the ”Federal Reserve”) and the FederalDeposit Insurance Corporation (the “FDIC”). Furthermore, taxation laws administered by the Internal Revenue Serviceand state taxing authorities and securities laws administered by the Securitiesand Exchange Commission (the ”SEC”) and state securities authorities havean impact on the business of the Company. The effect of these statutes,regulations and regulatory policies may be significant, and cannot be predictedwith 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.

 

The following is a summary of the material elements ofthe regulatory framework that applies to the Company and its subsidiaries.  It does not describe all of the statutes,regulations and regulatory policies that apply, nor does it restate all of therequirements of those statutes, regulations and regulatory policies that aredescribed. As such, the following is qualified in its entirety by reference toapplicable law.  Any change inapplicable statutes, regulations or regulatory policies may have a materialeffect on the business of the Company and its subsidiaries.

 

**TheCompany**

 

***General****. *The Company, as the sole shareholder of the Bank, is a bankholding company.  As a bank holdingcompany, the Company is registered with, and is subject to regulation by, theFederal Reserve under the Bank Holding Company Act of 1956, as amended (the“BHCA”).  In accordance with FederalReserve policy, the Company is expected to act as a source of financialstrength to the Bank and to commit resources to support the Bank incircumstances where the Company might not otherwise do so.  Under the BHCA, the Company is subject toperiodic examination by the Federal Reserve. The Company is also required to file with the Federal Reserve periodicreports of the Company’s operations and such additional information regarding

 

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the Company and its subsidiaries as the Federal Reserve may require.

 

***Acquisitions, Activities and Change in Control.***The primary purpose of a bank holding company is to control and managebanks.****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 (including deposit concentrationlimits established by the BHCA), the Federal Reserve may allow a bank holdingcompany to acquire banks located in any state of the United States. Inapproving interstate acquisitions, the Federal Reserve is required to giveeffect to applicable state law limitations on the aggregate amount of depositsthat may be held by the acquiring bank holding company and its insureddepository institution affiliates in the state in which the target bank islocated (provided that those limits do not discriminate against out-of-statedepository institutions or their holding companies) and state laws that requirethat the target bank have been in existence for a minimum period of time (notto exceed five years) before being acquired by an out-of-state bank holdingcompany.

 

The BHCA generally prohibits the Company from acquiringdirect or indirect ownership or control of more than 5% of the voting shares ofany company that is not a bank and from engaging in any business other thanthat of banking, managing and controlling banks or furnishing services to banksand their subsidiaries.  This generalprohibition is subject to a number of exceptions. The principal exceptionallows bank holding companies to engage in, and to own shares of companiesengaged in, certain businesses found by the Federal Reserve to be “so closelyrelated to banking ... 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 computer servicebureau (including software development), and mortgage banking and brokerage.The BHCA generally does not place territorial restrictions on the domesticactivities of non-bank subsidiaries of bank holding companies.

 

Additionally, bank holding companies that meet certaineligibility requirements prescribed by the BHCA and elect to operate asfinancial holding companies may engage in, or own shares in companies engagedin, a wider range of nonbanking activities, including securities and insuranceunderwriting and sales, merchant banking and any other activity that theFederal Reserve, in consultation with the Secretary of the Treasury, determinesby regulation or order is financial in nature, incidental to any such financialactivity or complementary to any such financial activity and does not pose asubstantial risk to the safety or soundness of depository institutions or thefinancial system generally.  As of thedate of this filing, the Company has neither applied for nor received approvalto operate as a financial holding company.

 

Federal law also prohibits any person or company fromacquiring “control” of an FDIC-insured depository institution or its holdingcompany without prior notice to the appropriate federal bank regulator.  “Control” is conclusively presumed to existupon the acquisition of 25% or more of the outstanding voting securities of abank or bank holding company, but may arise under certain circumstances at 10%ownership.

 

***Capital Requirements****.*  Bank holding companies are required to maintainminimum levels of capital in accordance with Federal Reserve capital adequacyguidelines.  If capital levels

 

15

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fall below the minimum required levels, a bank holding company, amongother things, may be denied approval to acquire or establish additional banksor non-bank businesses.

 

The Federal Reserve’s capital guidelines establish thefollowing minimum regulatory capital requirements for bank holdingcompanies:  (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,Tier 1 capital consists primarily of permanent stockholders’ equity lessintangible assets (other than certain loan servicing rights and purchasedcredit card relationships). Total capital consists primarily of Tier 1 capitalplus certain other debt and equity instruments that do not qualify as Tier 1capital and a portion of the company’s allowance for loan and lease losses.

 

The risk-based and leverage standards described aboveare minimum requirements. Higher capital levels will be required if warrantedby the particular circumstances or risk profiles of individual bankingorganizations. 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 above the minimum levels.  As of December 31, 2002, the Company hadregulatory capital in excess of the Federal Reserve’s minimum requirements.

 

***Dividend Payments.**** *The Company’s ability to pay dividends to its shareholdersmay be affected by both general corporate law considerations and policies ofthe Federal Reserve applicable to bank holding companies*.* As a Delaware corporation,the Company is subject to the limitations of the Delaware General CorporationLaw (the ”DGCL”). The DGCL allows the Company to pay dividends only out ofits surplus (as defined and computed in accordance with the provisions of theDGCL) or if the Company has no such surplus, out of its net profits for thefiscal year in which the dividend is declared and/or the preceding fiscal year.Additionally, policies of the Federal Reserve caution that a bank holdingcompany should not pay cash dividends that exceed its net income or that canonly be funded in ways that weaken the bank holding company’s financial health,such as by borrowing.  The FederalReserve also possesses enforcement powers over bank holding companies and theirnon-bank subsidiaries to prevent or remedy actions that represent unsafe orunsound practices or violations of applicable statutes and regulations.  Among these powers is the ability toproscribe the payment of dividends by banks and bank holding companies.

 

***Federal Securities Regulation****.*  The Company’s common stock is registeredwith the SEC under the Securities Act of 1933, as amended, and the SecuritiesExchange Act of 1934, as amended (the ”Exchange Act”).  Consequently, the Company is subject to theinformation, proxy solicitation, insider trading and other restrictions andrequirements of the SEC under the Exchange Act.

 

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**The Bank**

 

***General.*** The Bank is a national bank,chartered by the OCC under the National Bank Act.  The deposit accounts of the Bank are insured by the FDIC’sBank Insurance Fund (“BIF”), 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 BIF, also has regulatory authority over the Bank.

 

***Deposit Insurance.* **As an FDIC-insured institution, the Bankis required to pay deposit insurance premium assessments to the FDIC.  The FDIC has adopted a risk-based assessmentsystem under which all insured depository institutions are placed into one ofnine categories and assessed insurance premiums based upon their respectivelevels of capital and results of supervisory evaluations.  Institutions classified as well-capitalized(as defined by the FDIC) and considered healthy pay the lowest premium whileinstitutions that are less than adequately capitalized (as defined by the FDIC)and considered of substantial supervisory concern pay the highest premium.  Risk classification of all insuredinstitutions is made by the FDIC for each semi-annual assessment period.

 

During the year ended December 31, 2002, BIFassessments ranged from 0% of deposits to 0.27% of deposits.  For the semi-annual assessment periodbeginning January 1, 2003, BIF assessment rates will continue to range from 0%of deposits to 0.27% of deposits.

 

***FICO Assessments.***  Since1987, a portion of the deposit insurance assessments paid by members of theFDIC’s Savings Association Insurance Fund (“SAIF”) has been used to coverinterest payments due on the outstanding obligations of the FinancingCorporation (“FICO”). FICO was created in 1987 to finance the recapitalizationof the Federal Savings and Loan Insurance Corporation, the SAIF’s predecessorinsurance fund. As a result of federal legislation enacted in 1996, beginningas of January 1, 1997, both SAIF members and BIF members became subject toassessments to cover the interest payments on outstanding FICO obligationsuntil the final maturity of such obligations in 2019.  These FICO assessments are in addition to amounts assessed by theFDIC for deposit insurance. During the year ended December 31, 2002, theFICO assessment rate for BIF and SAIF members was approximately 0.02% 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 (as determined by the composite rating assigned to the bank as aresult of its most recent OCC examination).** **Duringthe year ended December 31, 2002, the Bank paid supervisory assessments to theOCC totaling $71,000.

 

***Capital Requirements.* **Banks are generally required to maintaincapital levels in excess of other businesses. The OCC has established thefollowing minimum capital standards for national banks, such as the Bank: (i) aleverage requirement consisting of a minimum ratio of Tier 1 capital

 

17

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to total assets of 3% for the most highly-rated banks with a minimumrequirement of at least 4% for all others; and (ii) a risk-based capitalrequirement consisting of a minimum ratio of total capital to totalrisk-weighted assets of 8% and a minimum ratio of Tier 1 capital to totalrisk-weighted assets of 4%.  Forpurposes of these capital standards, the components of Tier 1 capital and totalcapital are the same as those for bank holding companies discussed above.

 

The capital requirements described above are minimumrequirements.  Higher capital levelswill be required if warranted by the particular circumstances or risk profilesof individual institutions.  Forexample, regulations of the OCC provide that additional capital may be requiredto take adequate account of, among other things, interest rate risk or therisks posed by concentrations of credit, nontraditional activities orsecurities trading activities.

 

Further, federal law and regulations provide variousincentives for financial institutions to maintain regulatory capital at levelsin excess of minimum regulatory requirements. For example, a financialinstitution that is “well-capitalized” may qualify for exemptions from priornotice or application requirements otherwise applicable to certain types ofactivities and may qualify for expedited processing of other required noticesor applications. Additionally, one of the criteria that determines a bankholding company’s eligibility to operate as a financial holding company is arequirement that all of its financial institution subsidiaries be“well-capitalized”.  Under theregulations of the OCC, in order to be “well-capitalized” a financial institutionmust maintain a ratio of total capital to total risk-weighted assets of 10% orgreater, a ratio of Tier 1 capital to total risk-weighted assets of 6% orgreater and a ratio of Tier 1 capital to total assets of 5% or greater.

 

Federal law also provides the federal bankingregulators with broad power to take prompt corrective action to resolve theproblems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institutionin question is “adequately capitalized,” “undercapitalized,” “significantlyundercapitalized” or “critically undercapitalized,” in each case as defined byregulation.  Depending upon the capitalcategory to which an institution is assigned, the regulators’ corrective powersinclude:  (i) requiring the institutionto submit a capital restoration plan; (ii) limiting the institution’s assetgrowth and restricting its activities; (iii) requiring the institution to issueadditional capital stock (including additional voting stock) or to be acquired;(iv) restricting transactions between the institution and its affiliates; (v)restricting the interest rate the institution may pay on deposits; (vi)ordering a new election of directors of the institution; (vii) requiring thatsenior executive officers or directors be dismissed; (viii) prohibiting theinstitution from accepting deposits from correspondent banks; (ix) requiringthe institution to divest certain subsidiaries; (x) prohibiting the payment ofprincipal or interest on subordinated debt; and (xi) ultimately, appointing areceiver for the institution.

 

As of December 31, 2002: (i) the Bank was not subjectto a directive from the OCC to increase its capital to an amount in excess ofthe minimum regulatory 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 fundsfor the Company is dividends from the Bank. Under the National Bank Act, anational bank may pay dividends out of its undivided profits in

 

18

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such amounts and at such times as the bank’s board of directors deemsprudent.  Without prior OCC approval,however, a national bank may not pay dividends in any calendar year that, inthe aggregate, exceed the bank’s year-to-date net income plus the bank’sretained net income for the two preceding years.

 

The payment of dividends by any financial institutionis affected by the requirement to maintain adequate capital pursuant toapplicable capital adequacy guidelines and regulations, and a financialinstitution generally is prohibited from paying any dividends if, followingpayment thereof, the institution would be undercapitalized.  As described above, the Bank exceeded itsminimum capital requirements under applicable guidelines as of December 31,2002.  Notwithstanding the availabilityof funds for dividends, however, the OCC may prohibit the payment of anydividends by the Bank if the OCC determines such payment would constitute anunsafe or unsound practice.

 

***Insider Transactions.* **The Bank is subject to certainrestrictions imposed by federal law on extensions of credit to the Company, oninvestments in the stock or other securities of the Company and the acceptanceof the stock or other securities of the Company as collateral for loans made bythe Bank. Certain limitations and reporting requirements are also placed onextensions of credit by the Bank to its directors and officers, to thedirectors and officers of the Company, to principal stockholders of theCompany, and to “related interests” of such directors, officers and principalstockholders.  In addition, federal lawand regulations may affect the terms upon which any person who is a director orofficer of the Company or the Bank or a principal stockholder of the Companymay obtain credit from banks with which the Bank maintains correspondentrelationships.

 

***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.

 

In general, the safety and soundness guidelinesprescribe the goals to be achieved in each area, and each institution isresponsible for establishing its own procedures to achieve those goals.  If an institution fails to comply with anyof the standards set forth in the guidelines, the institution’s primary federalregulator may require the institution to submit a plan for achieving andmaintaining compliance. If an institution fails to submit an acceptablecompliance plan, or fails in any material respect to implement a complianceplan that has been accepted by its primary federal regulator, the regulator isrequired to issue an order directing the institution to cure the deficiency.Until the deficiency cited in the regulator’s order is cured, the regulator mayrestrict the institution’s rate of growth, require the institution to increaseits capital, restrict the rates the institution pays on deposits or require theinstitution to take any action the regulator deems appropriate under thecircumstances. Noncompliance with the standards established by the safety andsoundness guidelines may also constitute grounds for other enforcement actionby the federal banking regulators, including cease and desist orders and civilmoney penalty assessments.

 

***Branching Authority.*** National banksheadquartered in Illinois, such as the Bank, have the same branching rights inIllinois as banks chartered under Illinois law, subject to OCC approval.

 

19

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Illinois law grants Illinois-chartered banks the authority to establishbranches anywhere in the State of Illinois, subject to receipt of all requiredregulatory approvals.

 

State and national banks are allowed to establishinterstate branch networks through acquisitions of other banks, subject tocertain conditions, including limitations on the aggregate amount of depositsthat may be held by the surviving bank and all of its insured depositoryinstitution affiliates.  Theestablishment of new interstate branches or the acquisition of individualbranches of a bank in another state (rather than the acquisition of anout-of-state bank in its entirety) is allowed only if specifically authorizedby state law.  Illinois permitsinterstate mergers subject to certain conditions, including a conditionrequiring an Illinois bank involved in an interstate merger to have been inexistence and continuous operation for more than five years.

 

***Financial Subsidiaries. ***Under Federal law and OCC regulations, national banks are authorized toengage, through “financial subsidiaries,” in any activity that is permissiblefor a financial holding company and any activity that the Secretary of theTreasury, in consultation with the Federal Reserve, determines is financial innature or incidental to any such financial activity, except (i) insuranceunderwriting, (ii) real estate development or real estate investment activities(unless otherwise permitted by law), (iii) insurance company portfolioinvestments and (iv) merchant banking. The authority of a national bank to invest in a financial subsidiary issubject to a number of conditions, including, among other things, requirementsthat the bank must be well-managed and well-capitalized (after deducting fromcapital the bank’s outstanding investments in financial subsidiaries).  The Bank has neither applied for norreceived approval to establish any financial subsidiaries.

 

***Federal Reserve System.***  Federal Reserve regulations, as presently ineffect, require depository institutions to maintain non-interest earningreserves against their transaction accounts (primarily NOW and regular checkingaccounts), as follows:  for transactionaccounts aggregating $42.1 million or less, the reserve requirement is 3% oftotal transaction accounts; and for transaction accounts aggregating in excessof $42.1 million, the reserve requirement is $1.083 million plus 10% of theaggregate amount of total transaction accounts in excess of $42.1 million.  The first $6.0 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 the foregoing requirements.

 

**Item 2.****        Properties**.

 

The Company’s main office is located at 701-705LaSalle Street, Ottawa, Illinois.  Thebuilding is comprised of approximately 15,000 square feet.  The main office building is a two-storystructure constructed principally of masonry which was opened in 1865.  The Company also operates three branchoffice facilities. A limited service branch, which contains eight drive-inlanes, is located at 300 West Madison Street, Ottawa, Illinois, and twofull-service branches are located at 601 State Street, Ottawa, Illinois and2771 North Columbus Street, Ottawa, Illinois.

 

The Company purchased real estate in Morris, Illinoiswith the intention of establishing a full service branch facility in thatcommunity.  Estimated completion anddate of operation will be May 2003. In addition, an extensive remodelingproject of the main banking facility was

 

20

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concluded in the third quarter of 2002. The Company believes that itsfacilities are otherwise adequate to serve its present needs.  The main banking office and branch officesare owned by the Company in fee and are unencumbered.

 

**Item 3.****        LegalProceedings.**

 

The Company is from time to time a party to legalproceedings in the ordinary course of business that are incident to thebusiness of banking. The Company is not engaged in any legal proceedings of amaterial nature at the present time.

 

**Item4.****        Submissionof Matters to a Vote of Security Holders.**

 

No matters were submitted to a vote of securityholders during the quarter ended December 31, 2002.

 

21

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**PART II**

 

**Item 5.****        MarketFor Registrant’s Common Equity and Related Stockholder Matters**

 

See page 42 of the 2002 Annual Report to Stockholders(filed as Exhibit 13.1 of this report) which is incorporated herein byreference.

 

**Item 6.****        Selected Financial Data**

 

The information set forth under the caption “SelectedConsolidated Financial Data” on page 1 of the 2002 Annual Report toStockholders (filed as Exhibit 13.1 of this report) is incorporated herein byreference.

 

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

 

The information set forth under the caption“Management’s Discussion and Analysis of Financial Condition and Results ofOperations” on pages 2 through 14 of the 2002 Annual Report to Stockholders(filed as Exhibit 13.1 of this report) is incorporated herein by reference.

 

**Item 7A.     Quantitative and Qualitative Disclosuresabout Market Risk**

 

The information set forth under the caption“Quantitative and Qualitative Disclosures about Market Risk” on page 9 of the2002 Annual Report to Stockholders (filed as Exhibit 13.1 of this report) isincorporated herein by reference.

 

**Item 8.****        Financial Statements andSupplementary Data**

 

The consolidated financial statements of theRegistrant and the Independent Auditors’ Report as set forth on pages 15through 41 of the 2002 Annual Report to Stockholders (filed as Exhibit 13.1 ofthis report) are incorporated herein by reference:

 
|                                                                                                        |   | **Annual Report to Stockholders  Page** |
|-------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|
|                                                                                                        |   |                                    |
| Independent Auditors’ Report                                                                           |   | 15                                      |
|                                                                                                        |   |                                    |
| Consolidated Balance Sheets as of December 31, 2002 and 2001                                                |   | 16                                      |
|                                                                                                        |   |                                    |
| Consolidated Statements of Income for the years ended December 31, 2002,  2001, and 2000                    |   | 17                                      |
|                                                                                                        |   |                                    |
| Consolidated Statements of Stockholders’ Equity for the years ended  December 31, 2002, 2001, and 2000 |   | 18                                      |

 

22

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|                                                                                          |   |
|-----------------------------------------------------------------------------------------------|--------|
| Consolidated  Statements of Cash Flows for the years ended December 31, 2002, 2001, and  2000 | 19     |
|                                                                                          |   |
| Notes to the  Consolidated Financial Statements                                               | 20     |
|                                                                                          |   |
| Parent Company  Only Financial Statements                                                     | 39     |

 

The portions of the 2002 Annual Report to Stockholderswhich are not specifically incorporated by reference as a part of this Form10-K are not deemed to be a part of this report.

 

**Item9.****        Changesin and Disagreements with accountants on Accounting and Financial Disclosure**

 

None.

 

23

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**PART III**

 

**Item10.****                Directorsand Executive Officers at the Registrant**

 

The information set forth under the captions“Information Regarding Nominees and Executive Officers” and “Section 16Beneficial Ownership Reporting Compliance” of the Registrant’s Proxy Statement,relating to the 2003 Annual Meeting of Stockholders is incorporated herein byreference.

 

**Item11.****                ExecutiveCompensation**

 

The information set forth under the caption “ExecutiveCompensation” of the Registrant’s Proxy Statement, relating to the 2003 AnnualMeeting of Stockholders is incorporated herein by reference, except for the“Stockholder’s Performance Table” and the “Board Compensation Committee’sReport on Compensation”, which are not hereby incorporated.

 

**Item 12.****                Security Ownershipof Certain Beneficial Owners and Management**

 

The information set forth under the caption “SecurityOwnership of Certain Beneficial Owners and Management” of the Registrant’sProxy Statement, relating to the 2003 Annual Meeting of Stockholders isincorporated herein by reference.

 

**Equity Compensation Plan Information**

 

The table below sets forth the following informationas of December 31, 2002 for (i) all compensation plans previously approved bythe Company’s shareholders and (ii) all compensation plans not previouslyapproved by the Company’s shareholders:

 
| (a)    | the number of securities to be issued upon the  exercise of outstanding options, warrants and rights;                                                                                      |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                       |
| (b)    | the weighted-average exercise price of such  outstanding options, warrants and rights;                                                                                                     |
|   |                                                                                                                                                                                       |
| (c)    | other than securities to be issued upon the exercise  of such outstanding options, warrants and rights, the number of securities  remaining available for future issuance under the plans. |

 

24

----

 

EQUITY COMPENSATION PLANINFORMATION

 
| **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     |   | 0                                                                            |   | 0                                                             |   | 150,000                                                             |   |
|                                                        |   |                                                                         |   |                                                          |   |                                                                |   |
| Equity  compensation plans not approved by security holders |   | 0                                                                            |   | 0                                                             |   | 0                                                                   |   |
|                                                        |   |                                                                         |   |                                                          |   |                                                                |   |
| **Total**                                                   |   | 0                                                                            |   | 0                                                             |   | 150,000                                                             |   |

 

**Item13.****                CertainRelationships and Related Transactions**

 

The information set forth under the caption “CertainRelationships and Related Transactions” of the Registrant’s Proxy Statement,relating to the 2003 Annual Meeting of Stockholders is incorporated herein byreference.

 

**Item14.****                Controlsand Procedures**

 

Based upon an evaluation within the 90 days prior tothe filing date of this report, the Company’s Chief Executive Officer andPrincipal Financial Officer concluded that the Company’s disclosure controlsand procedures are effective.  Therehave been no significant changes in the Company’s internal controls or in otherfactors that could significantly affect the Company’s internal controlssubsequent to the date of the evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

25

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**PART IV**

 

**Item****15.  Exhibits,Financial Statement Schedules, and Reports on Form 8-k**

 
| (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                                                                                                                                              | Severance Agreement with Donald J. Harris* |
|   |                                                                        |                                                                                                                                              |   |
|   |                                                                        | 13.1                                                                                                                                              | Annual Report to Stockholders |
|   |                                                                        |                                                                                                                                              |   |
|   |                                                                        | 21.1                                                                                                                                              | Subsidiaries |
|   |                                                                        |                                                                                                                                              |   |
|   |                                                                        | 24.1                                                                                                                                              | Power of Attorney |
|   |                                                                        |                                                                                                                                              |   |
|   |                                                                        | 99.1                                                                                                                                              | Certification of Chief Executive Officer |
|   |                                                                        |                                                                                                                                              |   |
|   |                                                                        | 99.2                                                                                                                                              | Certification of Chief Financial Officer |
|   |                                                                        |                                                                                                                                              |   |
|        |
|   | *  Indicates  management contract or compensation plan or arrangement. |
|        |                                                                             |                                                                                                                                                   |  |  |

 

26

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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/ Donald J. Harris |   |
|   |                               | Donald J. Harris, Principal Financial Officer |

 

Date:  March28, 2003

 

In accordance with the Exchange Act, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

 

 
| **Signature**              |   | **Title**                                                           |   | **Date**       |   |
|----------------------------|--------|---------------------------------------------------------------------|--------|----------------|--------|
|                       |   |                                                                |   |           |   |
| /s/ Joachim  Brown         |   | Director and President/                                             |   | March 28, 2003 |   |
| Joachim Brown              |   | Chief Executive Officer                                             |   |           |   |
|                       |   |                                                                |   |           |   |
| /s/ Bradley J.  Armstrong* |   | Director                                                            |   | March 28, 2003 |   |
| Bradley J.  Armstrong      |   |                                                                |   |           |   |
|                       |   |                                                                |   |           |   |
| /s/ John L.  Cantlin*      |   | Director                                                            |   | March 28, 2003 |   |
| John L. Cantlin            |   |                                                                |   |           |   |
|                       |   |                                                                |   |           |   |
| /s/ Patty P.  Godfrey*     |   | Director                                                            |   | March 28, 2003 |   |
| Patty P. Godfrey           |   |                                                                |   |           |   |
|                       |   |                                                                |   |           |   |
| /s/ Thomas E.  Haeberle*   |   | Director                                                            |   | March 28, 2003 |   |
| Thomas E.  Haeberle        |   |                                                                |   |           |   |
|                       |   |                                                                |   |           |   |
| /s/ Donald J.  Harris*     |   | Director and Executive                                              |   | March 28, 2003 |   |
| Donald J. Harris           |   | Vice President, Cashier and  Trust Officer/Chief Operating  Officer |   |           |   |
|                       |   |                                                                |   |           |   |
| /s/ Erika L.  Schmidt*     |   | Director                                                            |   | March 28, 2003 |   |
| Erika L. Schmidt           |   |                                                                |   |           |   |

 

27

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| /s/ Thomas P.  Rooney* |               | Director |                | March 28, 2003 |           |
|------------------------|--------------------|----------|---------------------|----------------|----------------|
| Thomas P. Rooney       |               |     |                |           |           |
|                   |               |     |                |           |           |
| /s/ William J.  Walsh* |               | Director |                | March 28, 2003 |           |
| William J. Walsh       |               |     |                |           |           |
|                   |               |     |                |           |           |
|                        |
| *   By       | /s/ Joachim  Brown |     | Individually and as |           | March 28, 2003 |   |
|                   | Joachim Brown      |     | Attorney-in-Fact    |           |           |   |

 

28

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|                       | I, Joachim J. Brown, Chief Executive Officer of the  Company, certify that: |
|----------------------------|-----------------------------------------------------------------------------|
|                       |                                                                        |
|                       | 1.                                                                          | I have reviewed this  annual report on Form 10-K of First Ottawa Bancorp, Inc.; |
|                       |                                                                        |   |
|                       | 2.                                                                          | Based on my knowledge,  this annual report does not contain any untrue statement of a material fact  or omit to state a material fact necessary to make the statements made, in  light of the circumstances under which such statements were made, not  misleading with respect to the period covered by this annual report; |
|                       |                                                                        |   |
|                       | 3.                                                                          | Based on my knowledge, the  financial statements, and other financial information included in the Report,  fairly present in all material respects the financial condition, results of  operations and cash flows of the registrant as of, and for, the periods  presented in this annual report; |
|                       |                                                                        |   |
|                       | 4.                                                                          | The registrant’s other  certifying officers and I are responsible for establishing and maintaining  disclosure controls and procedures (as defined in Exchange Act Rules 13a-14  and 15d-14) for the registrant and we have: |
|                       |                                                                        |   |
|                       |                                                                        | a. | designed such disclosure  controls and procedures to ensure that material information relating to the  registrant, including its consolidated subsidiaries, is made known to us by  others within those entities, particularly during the period in which this  annual report is being prepared; |
|                       |                                                                        |   |   |
|                       |                                                                        | b. | evaluated the  effectiveness of the registrant’s disclosure controls and procedures as of a  date within 90 days prior to the filing date of this annual report (the  “Evaluation Date”); and |
|                       |                                                                        |   |   |
|                       |                                                                        | c. | presented in this annual  report our conclusions about the effectiveness of the disclosure controls and  procedures based on our evaluation as of the Evaluation Date; |
|                       |                                                                        |   |   |
|                       | 5.                                                                          | The registrant’s other  certifying officers and I have disclosed, based on our most recent  evaluation, to the registrant’s auditors and the audit committee of  registrant’s board of directors (or persons performing the equivalent  function): |
|                       |                                                                        |   |   |
|                       |                                                                        | a. | all significant  deficiencies in the design or operation of internal controls which could  adversely affect the registrant’s ability to record, process, summarize and  report financial data and have identified for the registrant’s auditors any  material weaknesses in internal controls; and |
|                       |                                                                        |   |   |
|                       |                                                                        | b. | any fraud, whether or not  material, that involves management or other employees who have a significant  role in the registrant’s internal controls; and |
|                       |                                                                        |   |   |
|                       | 6.                                                                          | The registrant’s other  certifying officers and I have indicated in this annual report whether or not  there were significant changes in internal controls or in other factors that  could significantly affect internal controls subsequent to date of their  evaluation, including any corrective actions with regard to significant  deficiencies and material weaknesses. |
|                       |                                                                        |   |   |
| Date:  March 28, 2003 |
|                            |                                                                             |  |  |  |  |

#  

 
|   | /s/ Joachim J. Brown                       |   |
|--------|--------------------------------------------|--------|
|   | Joachim J. Brown 

Chief Executive Officer |   |

 

29

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|                       | I, Donald J. Harris, Principal Financial Officer of  the Company, certify that: |
|----------------------------|---------------------------------------------------------------------------------|
|                       |                                                                            |
|                       | 1.                                                                              | I have reviewed this  annual report on Form 10-K of First Ottawa Bancorp, Inc.; |
|                       |                                                                            |   |
|                       | 2.                                                                              | Based on my knowledge,  this annual report does not contain any untrue statement of a material fact  or omit to state a material fact necessary to make the statements made, in  light of the circumstances under which such statements were made, not  misleading with respect to the period covered by this annual report; |
|                       |                                                                            |   |
|                       | 3.                                                                              | Based on my knowledge, the  financial statements, and other financial information included in the Report,  fairly present in all material respects the financial condition, results of  operations and cash flows of the registrant as of, and for, the periods  presented in this annual report; |
|                       |                                                                            |   |
|                       | 4.                                                                              | The registrant’s other  certifying officers and I are responsible for establishing and maintaining  disclosure controls and procedures (as defined in Exchange Act Rules 13a-14  and 15d-14) for the registrant and we have: |
|                       |                                                                            |   |
|                       |                                                                            | a. | designed such disclosure  controls and procedures to ensure that material information relating to the  registrant, including its consolidated subsidiaries, is made known to us by  others within those entities, particularly during the period in which this  annual report is being prepared; |
|                       |                                                                            |   |   |
|                       |                                                                            | b. | evaluated the  effectiveness of the registrant’s disclosure controls and procedures as of a  date within 90 days prior to the filing date of this annual report (the  “Evaluation Date”); and |
|                       |                                                                            |   |   |
|                       |                                                                            | c. | presented in this annual  report our conclusions about the effectiveness of the disclosure controls and  procedures based on our evaluation as of the Evaluation Date; |
|                       |                                                                            |   |   |
|                       | 5.                                                                              | The registrant’s other  certifying officers and I have disclosed, based on our most recent  evaluation, to the registrant’s auditors and the audit committee of  registrant’s board of directors (or persons performing the equivalent  function): |
|                       |                                                                            |   |   |
|                       |                                                                            | d. | all significant  deficiencies in the design or operation of internal controls which could  adversely affect the registrant’s ability to record, process, summarize and  report financial data and have identified for the registrant’s auditors any  material weaknesses in internal controls; and |
|                       |                                                                            |   |   |
|                       |                                                                            | e. | any fraud, whether or not  material, that involves management or other employees who have a significant  role in the registrant’s internal controls; and |
|                       |                                                                            |   |   |
|                       | 6.                                                                              | The registrant’s other  certifying officers and I have indicated in this annual report whether or not  there were significant changes in internal controls or in other factors that  could significantly affect internal controls subsequent to date of their  evaluation, including any corrective actions with regard to significant  deficiencies and material weaknesses. |
|                       |                                                                            |   |   |
| Date:  March 28, 2003 |
|                            |                                                                                 |  |  |  |  |

 

#  

|   | /s/ Donald J. Harris                          |   |
|--------|-----------------------------------------------|--------|
|   | Donald J. Harris  Principal Financial Officer |   |

 

30

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**EXHIBITINDEX**

 
| **Exhibit  Number** |   | **Description**                                                             |   | **Incorporated by  Reference to**                                                                                |   | **Attached  Hereto** |   |
|---------------------|--------|-----------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------------------------|--------|----------------------|--------|
|                |   |                                                                        |   |                                                                                                             |   |                 |   |
| 3(i)                |   | Certificate of Incorporation of First Ottawa  Bancshares, Inc. (as amended) |   |                                                                                                             |   | X                    |   |
|                |   |                                                                        |   |                                                                                                             |   |                 |   |
| 3(ii)               |   | By-Laws of First Ottawa Bancshares, Inc.                                    |   |                                                                                                             |   | X                    |   |
|                |   |                                                                        |   |                                                                                                             |   |                 |   |
| 10.1                |   | Employment Agreement for J. Brown                                           |   |                                                                                                             |   | X                    |   |
|                |   |                                                                        |   |                                                                                                             |   |                 |   |
| 10.2                |   | Severance Agreement with Donald J. Harris                                   |   | the registrant’s annual  report on Form 10-K for the year ended December 31, 2001 (SEC file no.  000-30495) |   |                 |   |
|                |   |                                                                        |   |                                                                                                             |   |                 |   |
| 13.1                |   | 2002 Annual Report to Stockholders                                          |   |                                                                                                             |   | X                    |   |
|                |   |                                                                        |   |                                                                                                             |   |                 |   |
| 21.1                |   | Subsidiaries                                                                |   |                                                                                                             |   | X                    |   |
|                |   |                                                                        |   |                                                                                                             |   |                 |   |
| 24.1                |   | Power of Attorney                                                           |   |                                                                                                             |   | X                    |   |
|                |   |                                                                        |   |                                                                                                             |   |                 |   |
| 99.1                |   | Certification of Chief Executive Officer                                    |   |                                                                                                             |   | X                    |   |
|                |   |                                                                        |   |                                                                                                             |   |                 |   |
| 99.2                |   | Certification of Chief Financial Officer                                    |   |                                                                                                             |   | X                    |   |

 

E-1

----