UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549







FORM
10-K





Annual
Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934




For
      the fiscal year ended December 31, 2007.
            Commission
      File Number 0-32637.







AMES
NATIONAL CORPORATION


(Exact
name of registrant as specified in its charter)





IOWA
            
            42-1039071(State
      or other jurisdiction of incorporation or organization)
            
            (I.R.S.
      Employer Identification No.)405
      FIFTH STREET, AMES, IOWA
            
            50010(Address
      of principal executive offices)
            
            (Zip
      Code)





(515)
232-6251


(Registrant's
telephone number, including area code)





Securities
registered pursuant to Section 12(b) of the Exchange Act:  NONE





Securities
registered pursuant to Section 12(g) of the Exchange Act:





COMMON
STOCK, $2.00 PAR VALUE


(Title of
Class)





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.    Yes   ̈    No  x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange
Act.    Yes   ̈    No  x





Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Exchange Act during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been subject
to such filing requirements for the past 90
days.  Yes  xNo   ̈





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





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





Large
      accelerated filer   ̈
              Accelerated
      filer   x
              Non-accelerated
      filer    ̈
              Smaller
      reporting company  ̈


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




As of June 30, 2007, the aggregate
market value of voting stock held by non-affiliates of the registrant, based
upon the closing sale price for the registrant’s common stock in the NASDAQ
Capital Market, was $190,747,798.  Shares of common stock beneficially
owned by each executive officer and director of the Company and by each person
who beneficially owns 5% or more of the outstanding common stock have been
excluded on the basis that such persons may be deemed to be an affiliate of the
registrant.  This determination of affiliate status is not necessarily
a conclusive determination for any other purpose.





The number of shares outstanding of the
registrant’s common stock on February 29, 2008, was 9,429,580.





DOCUMENTS
INCORPORATED BY REFERENCE




Portions of the registrant’s definitive
proxy statement, as filed with the Securities and Exchange Commission on March
19, 2008, are incorporated by reference into Part III of this Form
10-K.







1


TABLE OF CONTENTS





Part
      IItem
      1.
            BusinessItem
      1A.
            Risk FactorsItem
      1B.
            Unresolved Staff CommentsItem
      2.
            PropertiesItem
      3.
            Legal ProceedingsItem
      4.
            Submission of Matters to a Vote of
    ShareholdersPart
      IIItem
      5.
            Market for Registrant’s Common Equity, Related Shareholder
      Matters and Issuer Purchases of Equity SecuritiesItem
      6.
            Selected Financial DataItem
      7.
            Management’s Discussion and Analysis of Financial Condition and
      Results of OperationsItem
      7A.
            Quantitative and Qualitative Disclosures about Market
      RiskItem
      8.
            Financial Statements and Supplementary DataItem
      9.
            Changes in and Disagreements with Accountants on Accounting and
      Financial DisclosureItem
      9A.
            Controls and ProceduresItem
      9B.
            Other InformationPart
      IIIItem
      10.
            Directors, Executive Officers and Corporate
      GovernanceItem
      11.
            Executive CompensationItem
      12.
            Security Ownership of Certain Beneficial Owners and Management
      and Related Shareholder MattersItem
      13.
            Certain Relationships and Related Transactions and Director
      IndependenceItem
      14.
            Principal Accountant Fees and ServicesPart
      IVItem
      15.
            Exhibits and Financial Statement Schedules


2
 Table of Contents


PART
I





ITEM 1.  BUSINESS





General





Ames
National Corporation (the "Company") is an Iowa corporation and bank holding
company registered under the Bank Holding Company Act of 1956, as
amended.  The Company owns 100% of the stock of five banking
subsidiaries consisting of two national banks and three state-chartered banks,
as described below.  All of the Company’s operations are conducted in
the State of Iowa and primarily within the central Iowa counties of Boone,
Marshall, Polk and Story where the Company’s banking subsidiaries are
located.  The Company does not engage in any material business
activities apart from its ownership of its banking subsidiaries.  The
principal executive offices of the Company are located at 405 Fifth Street,
Ames, Iowa 50010 and its telephone number is (515) 232-6251.





The
Company was organized and incorporated on January 21, 1975 under the laws of the
State of Iowa to serve as a holding company for its principal banking
subsidiary, First National Bank, Ames, Iowa ("First National") located in Ames,
Iowa.  In 1983, the Company acquired the stock of the State Bank &
Trust Co. ("State Bank") located in Nevada, Iowa; in 1991, the Company, through
a newly-chartered state bank known as Boone Bank & Trust Co. ("Boone Bank"),
acquired certain assets and assumed certain liabilities of the former Boone
State Bank & Trust Company located in Boone, Iowa; in 1995, the Company
acquired the stock of the Randall-Story State Bank (”Randall-Story Bank”)
located in Story City, Iowa; and in 2002, the Company chartered and commenced
operations of a new national banking organization, United Bank & Trust NA
(“United Bank”), located in Marshalltown, Iowa.  First National, State
Bank, Boone Bank, Randall-Story Bank and United Bank are each operated as a
wholly owned subsidiary of the Company.  These five financial
institutions are referred to in this Form 10-K collectively as the “Banks” and
individually as a “Bank”.





The
principal sources of Company revenue are: (i) interest and fees earned on loans
made by the Banks; (ii) service charges on deposit accounts maintained at the
Banks; (iii) interest on fixed income investments held by the Banks; (iv) fees
on trust services provided by those Banks exercising trust powers; and (v)
securities gains and dividends on equity investments held by the Company and the
Banks.





The
Banks’ lending activities consist primarily of short-term and medium-term
commercial and residential real estate loans, agricultural and business
operating loans and lines of credit, equipment loans, vehicle loans, personal
loans and lines of credit, home improvement loans and secondary mortgage loan
origination.  The Banks also offer a variety of demand, savings and
time deposits, cash management services, merchant credit card processing, safe
deposit boxes, wire transfers, direct deposit of payroll and social security
checks and automated teller machine access.  Four of the five Banks
also offer trust services.





The
Company provides various services to the Banks which include, but are not
limited to, management assistance, internal auditing services, human resources
services and administration, compliance management, marketing assistance and
coordination, loan review and assistance with respect to computer systems and
procedures.




3
 Table of Contents








First
National Bank, Ames, Iowa.  First National is a nationally-chartered,
commercial bank insured by the Federal Deposit Insurance Corporation (the
“FDIC”).  It was organized in 1903 and became a wholly owned
subsidiary of the Company in 1975 through a bank holding company reorganization
whereby the then shareholders of First National exchanged all of their First
National stock for stock in the Company.  First National provides
full-service banking to businesses and residents within the Ames community and
surrounding area. It provides a variety of products and services designed to
meet the needs of the market it serves. It has an experienced staff of bank
officers including many who have spent the majority of their banking careers
with First National and who emphasize long-term customer relationships. First
National conducts business out of three full-service offices and one super
market location, all located in the city of Ames and a new full-service office
built in Ankeny, Iowa that opened in April of 2007.





As of
December 31, 2007, First National had capital of $41,394,000 and 95 full-time
equivalent employees. Full-time equivalents represent the number of people a
business would employ if all its employees were employed on a full-time basis.
It is calculated by dividing the total number of hours worked by all full and
part-time employees by the number of hours a full-time individual would work for
a given period of time. First National had net income of $5,887,000 in 2007,
$5,938,000 in 2006 and $6,417,000 in 2005. Total assets as of December 31, 2007,
2006 and 2005 were $466,908,000, $423,517,000 and $413,412,000,
respectively.





State
Bank & Trust Co., Nevada, Iowa.  State Bank is an Iowa,
state-chartered, FDIC insured commercial bank.  State Bank was
acquired by the Company in 1983 through a stock transaction whereby the then
shareholders of State Bank exchanged all their State Bank stock for stock in the
Company.  State Bank was organized in 1939 and provides full-serve
banking to businesses and residents within the Nevada area from its main Nevada
location and two offices, one in McCallsburg, Iowa and the other in Colo,
Iowa.  It is strong in agricultural, commercial and residential real
estate lending.





As of
December 31, 2007, State Bank had capital of $11,689,000 and 23 full-time
equivalent employees. It had net income of $1,352,000 in 2007, $1,310,000 in
2006 and $1,401,000 in 2005. Total assets as of December 31, 2007, 2006 and 2005
were $107,585,000, $114,266,000 and $112,626,000, respectively.





Boone
Bank & Trust Co., Boone, Iowa.  Boone Bank is an Iowa,
state-chartered, FDIC insured commercial bank. Boone Bank was organized in 1992
by the Company under a new state charter in connection with a purchase and
assumption transaction whereby Boone Bank purchased certain assets and assumed
certain liabilities of the former Boone State Bank & Trust Company in
exchange for a cash payment.  It provides full service banking to
businesses and residents within the Boone community and surrounding
area.  It is actively engaged in agricultural, consumer and commercial
lending, including real estate, operating and equipment loans.  It
conducts business from its main office and a full service branch office, both
located in Boone.


4
 Table of Contents


As of
December 31, 2007, Boone Bank had capital of $12,541,000 and 26 full-time
equivalent employees.  It had net income of $1,586,000 in 2007,
$1,636,000 in 2006 and $1,849,000 in 2005. Total assets as of December 31, 2007,
2006 and 2005 were $97,574,000, $103,225,000 and $108,780,000,
respectively.





Randall-Story
State Bank, Story City, Iowa.  Randall-Story Bank is an Iowa,
state-chartered, FDIC insured commercial bank.  Randall-Story Bank was
acquired by the Company in 1995 through a stock transaction whereby the then
shareholders of Randall-Story Bank exchanged all their Randall-Story Bank stock
for stock in the Company.  Randall-Story Bank was organized in 1928
and provides full-service banking to Story City and the surrounding area. While
its primary emphasis is in agricultural lending, Randall-Story Bank also
provides the traditional lending services typically offered by community
banks.  The bank closed its office in Randall, Iowa in 2006 as the
result of the community’s declining population base.





As of
December 31, 2007, Randall-Story Bank had capital of $8,148,000 and 14 full-time
equivalent employees.  It had net income of $969,000 in 2007, $902,000
in 2006 and $869,000 in 2005. Total assets as of December 31, 2007, 2006 and
2005 were $72,762,000, $73,777,000 and $70,371,000, respectively.





United Bank & Trust NA,
Marshalltown, Iowa. United Bank is a nationally-chartered, commercial bank
insured by the FDIC. It was newly chartered in June of 2002 and offers a broad
range of deposit and loan products, as well as Internet banking and trust
services to customers located in the Marshalltown and surrounding Marshall
County area.





As of December 31, 2007, United Bank
had capital of $8,588,000 and 22 full-time equivalent employees. United Bank had
net income of $104,000 in 2007, a loss of in 2006 of $58,000, and net income in
2005 of $124,000.  Total assets as of December 31, 2007, 2006 and 2005
were $106,736,000, $100,511,000 and $94,684,000, respectively.





Business
Strategy and Operations





As a
locally owned, multi-bank holding company, the Company emphasizes strong
personal relationships to provide products and services that meet the needs of
the Banks’ customers. The Company seeks to achieve growth and maintain a strong
return on equity. To accomplish these goals, the Banks focus on small to medium
size businesses that traditionally wish to develop an exclusive relationship
with a single bank. The Banks, individually and collectively, have the size to
give the personal attention required by business owners, in addition to the
credit expertise to help businesses meet their goals.





The Banks
offer a full range of deposit services that are typically available in most
financial institutions, including checking accounts, savings accounts and time
deposits of various types, ranging from money market accounts to longer-term
certificates of deposit. One major goal in developing the Banks' product mix is
to keep the product offerings as simple as possible, both in terms of the number
of products and the features and benefits of the individual services. The
transaction accounts and time certificates are tailored to each Bank's principal
market area at rates competitive in that Bank’s market.  In addition,
retirement accounts such as IRAs (Individual Retirement Accounts) are available.
The FDIC insures all deposit accounts up to the maximum amount. The Banks
solicit these accounts from small-to-medium sized businesses in their respective
primary trade areas, and from individuals who live and/or work within these
areas.  No material portion of the Banks' deposits has been obtained
from a single person or from a few persons.  Therefore, the Company
does not believe that the loss of the deposits of any person or of a few persons
would have an adverse effect on the Banks' operations or erode their deposit
base.


5
 Table of Contents


Loans are
provided to creditworthy borrowers regardless of their race, color, national
origin, religion, sex, age, marital status, disability, receipt of public
assistance or any other basis prohibited by law.  The Banks intend to
fulfill this commitment while maintaining prudent credit
standards.  In the course of fulfilling this obligation to meet the
credit needs of the communities which they serve, the Banks give consideration
to each credit application regardless of the fact that the applicant may reside
in a low to moderate income neighborhood, and without regard to the geographic
location of the residence, property or business within their market
areas.





The Banks
provide innovative, quality financial products, such as Internet banking and
trust services that meet the banking needs of their customers and communities.
The loan programs and acceptance of certain loans may vary from time-to-time
depending on the funds available and regulations governing the banking industry.
The Banks offer all basic types of credit to their local communities and
surrounding rural areas, including commercial, agricultural and consumer
loans.  The types of loans within these categories are as
follows:





Commercial
Loans. Commercial loans are typically made to sole proprietors, partnerships,
corporations and other business entities such as municipalities and individuals
where the loan is to be used primarily for business purposes. These loans are
typically secured by assets owned by the borrower and often times involve
personal guarantees given by the owners of the business.  The types of
loans the Banks offer include:





-
            financing
      guaranteed under Small Business Administration
  programs


-
            operating
      and working capital loans


-
            loans
      to finance equipment and other capital
purchases


-
            commercial
      real estate loans


-
            business
      lines of credit


-
            term
      loans


-
            loans
      to professionals


-
            letters
      of credit





Agricultural
Loans.  The Banks, by nature of their location in central Iowa, are
directly and indirectly involved in agriculture and agri-business
lending.  This includes short-term seasonal lending associated with
cyclical crop and livestock production, intermediate term lending for machinery,
equipment and breeding stock acquisition and long-term real estate lending.
These loans are typically secured by the crops, livestock, equipment or real
estate being financed.  The basic tenet of the Banks' agricultural
lending philosophy is a blending of strong, positive cash flow supported by an
adequate collateral position, along with a demonstrated capacity to withstand
short-term negative impact if necessary.  Applicable governmental
subsidies and affiliated programs are utilized if warranted to accomplish these
parameters.  Approximately 14% of the Banks' loans have been made for
agricultural purposes.  The Banks have not experienced a material
adverse effect on their business as a result of defaults on agricultural loans
and do not anticipate at the present time experiencing any such effect in the
future.


6
 Table of Contents


Consumer
Loans. Consumer loans are typically available to finance home improvements and
consumer purchases, such as automobiles, household furnishings, boats and
education.  These loans are made on both a secured and an unsecured
basis.  The following types of consumer loans are
available:








-
            automobiles
      and trucks


-
            boats
      and recreational vehicles


-
            personal
      loans and lines of credit


-
            home
      equity lines of credit


-
            home
      improvement and rehabilitation
loans


-
            consumer
      real estate loans





Other
types of credit programs, such as loans to nonprofit organizations, to public
entities, for community development and to other governmental offered programs
also are available.





First
National, Boone Bank, State Bank and United Bank offer trust services typically
found in a commercial bank with trust powers, including the administration of
estates, conservatorships, personal and corporate trusts and agency
accounts.  The Banks also provide farm management, investment and
custodial services for individuals, businesses and non-profit
organizations.





The Banks
earn income from the origination of residential mortgages that are sold in the
secondary real estate market without retaining the mortgage servicing
rights.





The Banks
offer traditional banking services, such as safe deposit boxes, wire transfers,
direct deposit of payroll and social security checks, automated teller machine
access and automatic drafts (ACH) for various accounts.





Credit
Management





The
Company strives to achieve sound credit risk management. In order to achieve
this goal, the Company has established uniform credit policies and underwriting
criteria for the Banks’ loan portfolios. The Banks diversify in the types of
loans offered and are subject to regular credit examinations, annual internal
and external loan audits and annual review of large loans, as well as quarterly
reviews of loans experiencing deterioration in credit quality. The Company
attempts to identify potential problem loans early, charge off loans promptly
and maintain an adequate allowance for loan losses. The Company has established
credit guidelines for the Banks’ lending portfolios which include guidelines
relating to the more commonly requested loan types, as follows:





Commercial
Real Estate Loans - Commercial real estate loans, including construction and
development loans, are normally based on loan to appraisal value ratios of 80%
and secured by a first priority lien position. Loans are typically subject to
interest rate adjustments no less frequently than 5 years from
origination.  Fully amortized monthly repayment terms normally do not
exceed twenty years.  Projections and cash flows that show ability to
service debt within the amortization period are required. Property and casualty
insurance is required to protect the Banks’ collateral interests. Commercial
and construction real estate loans represent approximately 41% of the loan
portfolio. Major risk factors for commercial real estate loans, as well as the
other loan types described below, include a geographic concentration in central
Iowa; the dependence of the local economy upon several large governmental
entities, including Iowa State University and the Iowa Department of
Transportation; and the health of Iowa’s agricultural sector that is dependent
on weather conditions and government programs.


7
 Table of Contents


Commercial
and Agricultural Operating Lines - These loans are made to businesses and farm
operations with terms up to twelve months. The credit needs are generally
seasonal with the source of repayment coming from the entity’s normal business
cycle. Cash flow reviews are completed to establish the ability to service the
debt within the terms of the loan. A first priority lien on the general assets
of the business normally secures these types of loans. Loan to value limits vary
and are dependent upon the nature and type of the underlying collateral and the
financial strength of the borrower. Crop and hail insurance is required for most
agricultural borrowers. Loans are generally guaranteed by the
principal(s).





Commercial
and Agricultural Term Loans – These loans are made to businesses and farm
operations to finance equipment, breeding stock and other capital expenditures.
Terms are generally the lesser of five years or the useful life of the
asset.  Term loans are normally secured by the asset being financed
and are often additionally secured with the general assets of the business. Loan
to value is generally 75% of the cost or value of the assets.  Loans
are normally guaranteed by the principal(s). Commercial and agricultural
operating and term loans represent approximately 24% of the loan
portfolio.





Residential
First Mortgage Loans – Proceeds of these loans are used to buy or refinance the
purchase of residential real estate with the loan secured by a first lien on the
real estate. Most of the residential mortgage loans originated by the Banks
(including servicing rights) are sold in the secondary mortgage market due to
the higher interest rate risk inherent in the 15 and 30 year fixed rate terms
consumers prefer. Loans that are originated and not sold in the secondary market
generally have higher interest rates and have rate adjustment periods of no
longer than seven years. The maximum amortization of first mortgage residential
real estate loans is 30 years. The loan-to-value ratios normally do not exceed
80% without credit enhancements such as mortgage insurance. Property insurance
is required on all loans to protect the Banks’ collateral position. Loans
secured by one to four family residential properties represent approximately 22%
of the loan portfolio.





Home
Equity Term Loans – These loans are normally for the purpose of home improvement
or other consumer purposes and are secured by a junior mortgage on residential
real estate. Loan-to-value ratios normally do not exceed 90% of market
value.





Home
Equity Lines of Credit - The Banks offer a home equity line of credit with a
maximum term of 60 months. These loans are secured by a junior mortgage on the
residential real estate and normally do not exceed a loan-to-market value ratio
of 90% with the interest adjusted quarterly.





Consumer
Loans – Consumer loans are normally made to consumers under the following
guidelines.  Automobiles - loans on new and used automobiles generally
will not exceed 80% and 75% of the value, respectively.  Recreational
vehicles and boats - 66% of the value.  Mobile home - maximum term on
these loans is 180 months with the loan-to-value ratio generally not exceeding
66%.  Each of these loans is secured by a first priority lien on the
assets and requires insurance to protect the Banks’ collateral
position.  Unsecured - The term for unsecured loans generally does not
exceed 12 months. Consumer and other loans represent approximately 5% of the
loan portfolio.


8
 Table of Contents


Employees





At
December 31, 2007, the Banks had a total of 180 full-time equivalent employees
and the Company had an additional 12 full-time employees. The Company and Banks
provide their employees with a comprehensive program of benefits, including
comprehensive medical and dental plans, long-term and short-term disability
coverage, and a 401(k) profit sharing plan. Management considers its relations
with employees to be satisfactory.  Unions represent none of the
employees.





Market
Area





The
Company operates five commercial banks with locations in Story, Boone, Polk and
Marshall Counties in central Iowa.





First
National is located in Ames, Iowa with a population of 50,731.  The
major employers are Iowa State University, Ames Laboratories, Iowa Department of
Transportation, Mary Greeley Medical Center, National Veterinary Services
Laboratory, Ames Community Schools, City of Ames, Barilla, Sauer-Danfoss and
McFarland Clinic.  First National’s primary business includes
providing retail banking services and business and consumer lending. First
National has a minimum exposure to agricultural lending.





Boone
Bank is located in Boone, Iowa with a population of 12,800.  Boone is
the county seat of Boone County.  The major employers are Fareway
Stores, Inc., Patterson Dental Supply Co., Union Pacific Railroad, and
Communication Data Services. Boone Bank provides lending services to the
agriculture, commercial and real estate markets.





State
Bank is located in Nevada, Iowa with a population of 6,658. Nevada is the county
seat of Story County.  The major employers are Print Graphics, General
Financial Supply, Central Iowa Printing, Burke Corporation and
Almaco.  State Bank provides various types of loans with a major
agricultural presence.  It provides a wide variety of banking services
including trust, deposit, ATM, and merchant card processing.





Randall-Story
Bank is located in Story City, Iowa with a population of 3,228.  The
major employers are Bethany Manor, American Packaging, Precision Machine and
Record Printing.  Located in a major agricultural area, it has a
strong presence in this type of lending.  As a full service commercial
bank it provides a full line of products and services.





United Bank is located in Marshalltown,
Iowa with a population of 26,123. The major employers are Swift & Co.,
Fisher Controls International, Lennox Industries and Marshalltown Medical &
Surgical Center.  The Bank offers a full line of loan, deposit, and
trust services. Loan services include primarily commercial and consumer types of
credit including operating lines, equipment loans, automobile financing and real
estate loans.


9
 Table of Contents


Competition





The
geographic market area served by the Banks is highly competitive with respect to
both loans and deposits. The Banks compete principally with other commercial
banks, savings and loan associations, credit unions, mortgage companies, finance
divisions of auto and farm equipment companies, agricultural suppliers and other
financial service providers. Some of these competitors are local, while others
are statewide or nationwide.  The major commercial bank competitors
include F & M Bank, U.S. Bank National Association and Wells Fargo Bank,
each of which have a branch office or offices within the Banks’ primary trade
areas. Among the advantages such larger banks have are their ability to finance
extensive advertising campaigns and to allocate their investment assets to
geographic regions of higher yield and demand. These larger banking
organizations have much higher legal lending limits than the Banks and thus are
better able to finance large regional, national and global commercial
customers.





In order
to compete with the other financial institutions in their primary trade areas,
the Banks use, to the fullest extent possible, the flexibility which is accorded
by independent status.  This includes an emphasis on specialized
services, local promotional activity and personal contacts by the Banks'
officers, directors and employees.  In particular, the Banks compete
for deposits principally by offering depositors a wide variety of deposit
programs, convenient office locations, hours and other services.  The
Banks compete for loans primarily by offering competitive interest rates,
experienced lending personnel and quality products and services.





As of
December 31, 2007, there were 29 FDIC insured institutions having approximately
70 offices or branch offices within Boone, Story, and Marshall County, Iowa
where the Banks' offices are primarily located.  First National, State
Bank and Randall-Story Bank together have the largest percentage of deposits in
Story County and Boone Bank has the highest percentage of deposits in Boone
County.





The Banks
also compete with the financial markets for funds.  Yields on
corporate and government debt securities and commercial paper affect the ability
of commercial banks to attract and hold deposits.  Commercial banks
also compete for funds with equity, money market, and insurance products offered
by brokerage and insurance companies. This competitive trend will likely
continue in the future.





The
Company anticipates bank competition will continue to change materially over the
next several years as more financial institutions, including the major regional
and national banks, continue to consolidate.  Credit unions, which are
not subject to income taxes, have a significant competitive advantage and
provide additional competition in the Company’s local markets.





Supervision
and Regulation





The
following discussion generally refers to certain statutes and regulations
affecting the banking industry. These references provide brief summaries and
therefore do not purport to be complete and are qualified in their entirety by
reference to those statutes and regulations. In addition, due to the numerous
statutes and regulations that apply to and regulate the banking industry, many
are not referenced below.


10
 Table of Contents


USA
Patriot Act.  The USA Patriot Act was enacted in 2001 which, together
with regulations issued pursuant to this act, substantially broadened previously
existing anti-money laundering law and regulation, increased compliance, due
diligence and reporting obligations for financial institutions, created new
crimes and penalties and required federal banking agencies, in reviewing merger
and other acquisition transactions, to consider the effectiveness of the parties
in combating money laundering activities.  The Act requires all
financial institutions to establish certain anti-money laundering compliance and
due diligence programs that are reasonably designed to detect and report
instances of money laundering.  The Company believes its compliance
policies, procedures and controls satisfy the material requirements of the
Patriot Act and regulations.





Sarbanes-Oxley
Act.  The Sarbanes-Oxley Act was enacted in 2002 to, among other
things, increase corporate responsibility and to protect investors by improving
the accuracy and reliability of corporate disclosures pursuant to the federal
securities laws.  This act generally applies to all companies that are
required to file periodic reports with the Securities and Exchange Commission
under the Securities Exchange Act of 1934.  The Act implements
significant changes in the responsibilities of officers and directors of public
companies and makes certain changes to the corporate reporting obligation of
those companies and their external auditors.  Among the requirements
and prohibitions addressed by the act are certifications required by CEOs and
CFOs of periodic reports filed with the SEC; accelerated reporting of stock
transactions by directors, officers and large shareholders; prohibitions against
personal loans from companies to directors and executive officers (except loans
made in the ordinary course of business); requirements for public companies’
audit committees; requirements for auditor independence; the forfeiture of
bonuses or other incentive-based compensation and profits from the sale of an
issuer’s securities by directors and executive officers in the 12-month period
following initial publication of any financial statements that later require
restatement; various increased criminal penalties for violations of securities
laws; and the creation of a public company accounting oversight
board.  Rules adopted by the SEC to implement various provisions of
the act include CEO and CFO certifications related to fair presentation of
financial statements and financial information in public filings, as well as
management’s evaluation of disclosure controls and procedures; disclosure of
whether any audit committee members qualify as a “financial expert”; disclosures
related to audit committee composition and auditor pre-approval policies;
disclosure related to adoption of a written code of ethics; reconciling non-GAAP
financial information with GAAP in public communications; disclosure of
off-balance sheet transactions; and disclosure related to director independence
and the director nomination process.  The Company has adopted
modifications to its corporate governance procedures to comply with the
provisions of the act and regulations.





The
Company and the Banks are subject to extensive federal and state regulation and
supervision. Regulation and supervision of financial institutions is primarily
intended to protect depositors and the FDIC rather than shareholders of the
Company. The laws and regulations affecting banks and bank holding companies
have changed significantly over recent years, particularly with the passage of
the Financial Services Modernization Act. There is reason to expect that similar
changes will continue in the future. Any change in applicable laws, regulations
or regulatory policies may have a material effect on the business, operations
and prospects of the Company. The Company is unable to predict the nature or the
extent of the effects on its business and earnings that any fiscal or monetary
policies or new federal or state legislation may have in the
future.


11
 Table of Contents


The
Company





The
Company is a bank holding company by virtue of its ownership of the Banks, and
is registered as such with the Board of Governors of the Federal Reserve System
(the "Federal Reserve"). The Company is subject to regulation under the Bank
Holding Company Act of 1956, as amended (the "BHCA"), which subjects the Company
and the Banks to supervision and examination by the Federal Reserve. Under the
BHCA, the Company files with the Federal Reserve annual reports of its
operations and such additional information as the Federal Reserve may
require.





Source of
Strength to the Banks. The Federal Reserve takes the position that a bank
holding company is required to serve as a source of financial and managerial
strength to its subsidiary banks and may not conduct its operations in an unsafe
or unsound manner. In addition, it is the Federal Reserve's position that in
serving as a source of strength to its subsidiary banks, bank holding companies
should use available resources to provide adequate capital funds to its
subsidiary banks during periods of financial stress or adversity. It should also
maintain the financial flexibility and capital raising capacity to obtain
additional resources for providing assistance to its subsidiary banks. A bank
holding company's failure to meet its obligations to serve as a source of
strength to its subsidiary banks will generally be considered by the Federal
Reserve to be an unsafe and unsound banking practice or a violation of the
Federal Reserve's regulations or both.





Federal
Reserve Approval. Bank holding companies must obtain the approval of the Federal
Reserve before they: (i) acquire direct or indirect ownership or control of any
voting stock of any bank if, after such acquisition, they would own or control,
directly or indirectly, more than 5% of the voting stock of such bank; (ii)
merge or consolidate with another bank holding company; or (iii) acquire
substantially all of the assets of any additional banks.





Non-Banking
Activities. With certain exceptions, the BHCA also prohibits bank holding
companies from acquiring direct or indirect ownership or control of voting stock
in any company other than a bank or a bank holding company unless the Federal
Reserve finds the company's business to be incidental to the business of
banking. When making this determination, the Federal Reserve in part considers
whether allowing a bank holding company to engage in those activities would
offer advantages to the public that would outweigh possible adverse
effects.  A bank holding company may engage in permissible non-banking
activities on a de novo basis, if the holding company meets certain criteria and
notifies the Federal Reserve within ten (10) business days after the activity
has commenced.





Under the
Financial Services Modernization Act, eligible bank holding companies may elect
(with the approval of the Federal Reserve) to become a "financial holding
company."  Financial holding companies are permitted to engage in
certain financial activities through affiliates that had previously been
prohibited activities for bank holding companies.  Such financial
activities include securities and insurance underwriting and merchant
banking.  At this time, the Company has not elected to become a
financial holding company, but may choose to do so at some time in the
future.





Control
Transactions. The Change in Bank Control Act of 1978, as amended, requires a
person or group of persons acquiring "control" of a bank holding company to
provide the Federal Reserve with at least 60 days prior written notice of the
proposed acquisition. Following receipt of this notice, the Federal Reserve has
60 days to issue a notice disapproving the proposed acquisition, but the Federal
Reserve may extend this time period for up to another 30 days. An acquisition
may be completed before the disapproval period expires if the Federal Reserve
issues written notice of its intent not to disapprove the
action.  Under a rebuttable presumption established by the Federal
Reserve, the acquisition of 10% or more of a class of voting stock of a bank
holding company with a class of securities registered under Section 12 of the
Securities Exchange Act of 1934, as amended, would constitute the acquisition of
control. In addition, any "company" would be required to obtain the approval of
the Federal Reserve under the BHCA before acquiring 25% (or 5% if the "company"
is a bank holding company) or more of the outstanding shares of the Company, or
otherwise obtain control over the Company.


12
 Table of Contents


Affiliate
Transactions. The Company and the Banks are deemed affiliates within the meaning
of the Federal Reserve Act, and transactions between affiliates are subject to
certain restrictions. Generally, the Federal Reserve Act: (i) limits the extent
to which the financial institution or its subsidiaries may engage in "covered
transactions" with an affiliate; and (ii) requires all transactions with an
affiliate, whether or not "covered transactions," to be on terms substantially
the same, or at least as favorable to the institution or subsidiary, as those
provided to a non-affiliate. The term "covered transaction" includes the making
of loans, purchase of assets, issuance of a guarantee and similar
transactions.





State Law
on Acquisitions.  Iowa law permits bank holding companies to make
acquisitions throughout the state.  However, Iowa currently has a
deposit concentration limit of 15% on the amount of deposits in the state that
any one banking organization can control and continue to acquire banks or bank
deposits (by acquisitions), which applies to all depository institutions doing
business in Iowa.





Banking
Subsidiaries





Applicable
federal and state statutes and regulations governing a bank's operations relate,
among other matters, to capital adequacy requirements, required reserves against
deposits, investments, loans, legal lending limits, certain interest rates
payable, mergers and consolidations, borrowings, issuance of securities, payment
of dividends, establishment of branches and dealings with affiliated
persons.





First
National and United Bank are national banks subject to primary federal
regulation and supervision by the Office of the Comptroller of the Currency (the
"OCC").  The FDIC, as an insurer of the deposits, also has some
limited regulatory authority over First National and United Bank. State Bank,
Boone Bank and Randall-Story Bank are state banks subject to regulation and
supervision by the Iowa Division of Banking. The three state Banks are also
subject to regulation and examination by the FDIC, which insures their
respective deposits to the maximum extent permitted by law. The federal laws
that apply to the Banks regulate, among other things, the scope of their
business, their investments, their reserves against deposits, the timing of the
availability of deposited funds and the nature and amount of and collateral for
loans. The laws and regulations governing the Banks generally have been
promulgated to protect depositors and the deposit insurance fund of the FDIC and
not to protect stockholders of such institutions or their holding
companies.


13
 Table of Contents


The OCC
and FDIC each has authority to prohibit banks under their supervision from
engaging in what it considers to be an unsafe and unsound practice in conducting
their business.  The Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA") requires federal banking regulators to adopt regulations
or guidelines in a number of areas to ensure bank safety and soundness,
including internal controls, credit underwriting, asset growth, management
compensation, ratios of classified assets to capital and earnings. FDICIA also
contains provisions which are intended to change independent auditing
requirements, restrict the activities of state-chartered insured banks, amend
various consumer banking laws, limit the ability of "undercapitalized banks" to
borrow from the Federal Reserve's discount window, require regulators to perform
periodic on-site bank examinations and set standards for real estate
lending.


Borrowing
Limitations. Each of the Banks is subject to limitations on the aggregate amount
of loans that it can make to any one borrower, including related entities.
Subject to numerous exceptions based on the type of loans and collateral,
applicable statutes and regulations generally limit loans to one borrower of 15%
of total equity and reserves. Each of the Banks is in compliance with applicable
loans to one borrower requirements.





FDIC
Insurance. Generally, customer deposit accounts in banks are insured by the FDIC
for up to a maximum amount of $100,000 for single accounts, $250,000 for
self-directed retirement accounts, $100,000 for joint accounts, and $100,000 for
qualifying revocable trust accounts. The FDIC has adopted a risk-based insurance
assessment system under which depository institutions contribute funds to the
FDIC insurance fund based on their risk classification.  The FDIC may
terminate the deposit insurance of any insured depository institution if it
determines after an administrative hearing that the institution has engaged or
is engaging in unsafe or unsound practices, is in an unsafe or unsound condition
to continue operations or has violated any applicable law.





Capital
Adequacy Requirements. The Federal Reserve, the FDIC and the OCC (collectively,
the "Agencies") have adopted risk-based capital guidelines for banks and bank
holding companies that are designed to make regulatory capital requirements more
sensitive to differences in risk profiles among banks and bank holding companies
and account for off-balance sheet items. Failure to achieve and maintain
adequate capital levels may give rise to supervisory action through the issuance
of a capital directive to ensure the maintenance of required capital levels.
Each of the Banks is in compliance with applicable capital level
requirements.





The
current guidelines require all federally regulated banks to maintain a minimum
risk-based total capital ratio equal to 8%, of which at least 4% must be Tier 1
capital.  Tier 1 capital includes common shareholders' equity,
qualifying perpetual preferred stock and minority interests in equity accounts
of consolidated subsidiaries, but excludes goodwill and most other intangibles
and the allowance for loan and lease losses.  Tier 2 capital includes
the excess of any preferred stock not included in Tier 1 capital, mandatory
convertible securities, hybrid capital instruments, subordinated debt and
intermediate term preferred stock, 45% of unrealized gain of equity securities
and general reserve for loan and lease losses up to 1.25% of risk weighted
assets.  None of the Banks has received any notice indicating that it
will be subject to higher capital requirements.





Under
these guidelines, banks' assets are given risk weights of 0%, 20%, 50% or
100%.  Most loans are assigned to the 100% risk category, except for
first mortgage loans fully secured by residential property and, under certain
circumstances, residential construction loans (both carry a 50%
rating).  Most investment securities are assigned to the 20% category,
except for municipal or state revenue bonds (which have a 50% rating) and direct
obligations of or obligations guaranteed by the United States Treasury or United
States Government Agencies (which have a 0% rating).


14
 Table of Contents


The
Agencies have also implemented a leverage ratio, which is equal to Tier 1
capital as a percentage of average total assets less intangibles, to be used as
a supplement to the risk based guidelines.  The principal objective of
the leverage ratio is to limit the maximum degree to which a bank may leverage
its equity capital base.  The minimum required leverage ratio for top
rated institutions is 3%, but most institutions are required to maintain an
additional cushion of at least 100 to 200 basis points.  Any
institution operating at or near the 3% level is expected to be a strong banking
organization without any supervisory, financial or operational weaknesses or
deficiencies.  Any institutions experiencing or anticipating
significant growth would be expected to maintain capital ratios, including
tangible capital positions, well above the minimum levels.





Prompt
Corrective Action. Regulations adopted by the Agencies impose even more
stringent capital requirements. The FDIC and other Agencies must take certain
"prompt corrective action" when a bank fails to meet capital requirements. The
regulations establish and define five capital levels: (i) "well-capitalized,"
(ii) "adequately capitalized," (iii) "undercapitalized," (iv) "significantly
undercapitalized" and (v) "critically undercapitalized." Increasingly severe
restrictions are imposed on the payment of dividends and management fees, asset
growth and other aspects of the operations of institutions that fall below the
category of being "adequately capitalized".  Undercapitalized
institutions are required to develop and implement capital plans acceptable to
the appropriate federal regulatory agency. Such plans must require that any
company that controls the undercapitalized institution must provide certain
guarantees that the institution will comply with the plan until it is adequately
capitalized. As of February 28, 2008, neither the Company nor any of the Banks
were subject to any regulatory order, agreement or directive to meet and
maintain a specific capital level for any capital measure. Furthermore, as of
that same date, each of the Banks was categorized as “well capitalized” under
regulatory prompt corrective action provisions.





Restrictions
on Dividends. Dividends paid to the Company by the Banks is the major source of
Company cash flow. Various federal and state statutory provisions limit the
amount of dividends banking subsidiaries are permitted to pay to their holding
companies without regulatory approval. Federal Reserve policy further limits the
circumstances under which bank holding companies may declare dividends. For
example, a bank holding company should not continue its existing rate of cash
dividends on its common stock unless its net income is sufficient to fully fund
each dividend and its prospective rate of earnings retention appears consistent
with its capital needs, asset quality and overall financial condition. In
addition, the Federal Reserve and the FDIC have issued policy statements which
provide that insured banks and bank holding companies should generally pay
dividends only out of current operating earnings.  Federal and state
banking regulators may also restrict the payment of dividends by
order.





First
National Bank, as a national bank, generally may pay dividends, without
obtaining the express approval of the Office of the Comptroller of the Currency,
in amount up to its retained net profits for the preceding two calendar years
plus retained net profits up to the date of any dividend declaration in the
current calendar year.  Retained net profits as defined by the OCC,
consists of net income less dividends declared during the
period.  Boone Bank, Randall-Story Bank and State Bank are also
restricted under Iowa law to paying dividends only out of their undivided
profits.  Additionally, the payment of dividends by the Banks is
affected by the requirement to maintain adequate capital pursuant to applicable
capital adequacy guidelines and regulations, and the Banks generally are
prohibited from paying any dividends if, following payment thereof, the Bank
would be undercapitalized.


15
 Table of Contents


Reserves
Against Deposits. The Federal Reserve requires all depository institutions to
maintain reserves against their transaction accounts (primarily checking
accounts) and non-personal time deposits.  Generally, reserves of 3%
must be maintained against total transaction accounts of $45,800,000 or less
(subject to an exemption not in excess of the first $8,500,000 of transaction
accounts).  A reserve of $1,374,000 plus 10% of amounts in excess of
$45,800,000 must be maintained in the event total transaction accounts exceed
$45,800,000. The balances maintained to meet the reserve requirements imposed by
the Federal Reserve may be used to satisfy applicable liquidity
requirements.  Because required reserves must be maintained in the
form of vault cash or a noninterest bearing account at a Federal Reserve Bank,
the effect of this reserve requirement is to reduce the earning assets of the
Banks.




Regulatory
Enforcement Authority





The
enforcement powers available to federal and state banking regulators are
substantial and include, among other things, the ability to assess civil
monetary penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions against banking organizations and institution-affiliated
parties. In general, enforcement actions must be initiated for violations of
laws and regulations and unsafe or unsound practices. Other actions, or
inactions, may provide the basis for enforcement action, including misleading or
untimely reports filed with regulatory authorities. Applicable law also requires
public disclosure of final enforcement actions by the federal banking
agencies.





National
Monetary Policies





In
addition to being affected by general economic conditions, the earnings and
growth of the Banks are affected by the regulatory authorities’ policies,
including the Federal Reserve. An important function of the Federal Reserve is
to regulate the money supply, credit conditions and interest rates. Among the
instruments used to implement these objectives are open market operations in
U.S. Government securities, changes in reserve requirements against bank
deposits and the Federal Reserve Discount Rate, which is the rate charged member
banks to borrow from the Federal Reserve Bank. These instruments are used in
varying combinations to influence overall growth and distribution of credit,
bank loans, investments and deposits, and their use may also affect interest
rates charged on loans or paid on deposits.





The
monetary policies of the Federal Reserve have had a material impact on the
operating results of commercial banks in the past and are expected to have a
similar impact in the future. Also important in terms of effect on banks are
controls on interest rates paid by banks on deposits and types of deposits that
may be offered by banks. The Depository Institutions Deregulation Committee,
created by Congress in 1980, phased out ceilings on the rate of interest that
may be paid on deposits by commercial banks and savings and loan associations,
with the result that the differentials between the maximum rates banks and
savings and loans can pay on deposit accounts have been eliminated. The effect
of deregulation of deposit interest rates has been to increase banks' cost of
funds and to make banks more sensitive to fluctuation in market
rates.


16
 Table of Contents


Availability
of Information on Company Website





The
Company files periodic reports with the Securities and Exchange Commission
(“SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Q
and current reports on Form 8-K.  The Company makes available on or
through its website free of charge all periodic reports filed by the Company
with the SEC, including any amendments to such reports, as soon as reasonably
practicable after such reports have been electronically filed with the
SEC.  The address of the Company’s website on the Internet is: www.amesnational.com.





The
Company will provide a paper copy of these reports free of charge upon written
or telephonic request directed to John P. Nelson, Vice President and Secretary,
405 Fifth Street, Ames, Iowa 50010 or (515) 232-6251 or by email request at
info@amesnational.com.  The
information found on the Company’s website is not part of this or any other
report the Company files with the SEC.


17
 Table of Contents


Executive
Officers of Company and Banks





The
following table sets forth summary information about the executive officers of
the Company and certain executive officers of the Banks. Unless otherwise
indicated, each executive officer has served in his current position for the
past five years.





Name
            Age
            Position
      with the Company or Bank and Principal Occupation and Employment During
      the Past Five YearsScott
      T. Bauer
            45
            Named
      President of First National Bank in 2007.  Previously served as
      Executive Vice President and Senior Vice President of First National
      Bank.Kevin
      G. Deardorff
            53
            Vice
      President & Technology Director of the Company.Leo
      E. Herrick
            66
            President
      of United Bank commencing June, 2002. Previously, employed as Chairman of
      the Board and President of F&M Bank-Iowa, Marshalltown,
      Iowa.Daniel
      L. Krieger
            71
            Chairman
      of the Company since 2003 and President of Company from 1997 to 2007.
      Previously served as President of First National. Also serves as a
      Director of the Company, Chairman of the Board and Trust Officer of First
      National and Chairman of the Board of Boone Bank and United
      Bank.Stephen
      C. McGill
            53
            President
      of State Bank since 2003.  Previously served as Senior Vice
      President of State Bank.  Director of State Bank & Trust
      Co.John
      P. Nelson
            41
            Vice
      President, Secretary and Treasurer of Company. Also serves as Director of
      Randall-Story Bank.Thomas
      H. Pohlman
            57
            Named
      President of the Company in 2007.  Previously served as Chief
      Operating Officer of the Company in 2006 and President of First National
      from 1999 to 2007. Director of the Company and First National Bank &
      State Bank & Trust Co,Jeffrey
      K. Putzier
            46
            President
      of Boone Bank since 1999.   Director of Boone Bank &
      Trust Co.Harold
      E. Thompson
            62
            President
      of Randall Story Bank since 2003.  Previously served as
      Executive Vice President of Randall-Story State Bank.  Director
      of Randall-Story State Bank.Terrill
      L. Wycoff
            64
            Executive
      Vice President of First National since 2000. Director of First National
      Bank.


18
 Table of Contents


ITEM
1A. RISK FACTORS





Set forth
below is a description of risk factors related to the Company’s business,
provided to enable investors to assess, and be appropriately apprised of,
certain risks and uncertainties the Company faces in conducting its
business.  An investor should carefully consider the risks described
below and elsewhere in this Report, which could materially and adversely affect
the Company’s business, results of operations or financial
condition.  The risks and uncertainties discussed below are also
applicable to forward-looking statements contained in this Report and in other
reports filed by the Company with the Securities and Exchange
Commission.  Given these risks and uncertainties, investors are
cautioned not to place undue reliance on forward-looking
statements.





General
Business, Economic and Political Conditions.





The
Company’s earnings are affected by general business, economic and political
conditions.  For example, a depressed economic environment increases
the likelihood of lower employment levels and recession, which could adversely
affect Company earnings.  General business and economic conditions
that could affect the Company include short-term and long-term interest rates,
inflation, fluctuations in both debt and equity capital markets and the strength
of the national and local economies in which the Company
operates.  Political conditions can also affect the Company’s earnings
through the introduction of new regulatory schemes and changes in tax
laws.





Rising
Interest Rates





Increases
in interest rates may negatively impact the Company’s net interest margin if
interest expense increases more quickly than interest income.  The
Company’s earning assets (primarily its loan and investment portfolio) have
longer maturities than its interest bearing liabilities (primarily its deposits
and other borrowings).  Therefore, in a rising interest rate
environment, interest expense will increase more quickly than interest income,
as the interest bearing liabilities reprice more quickly than earning
assets.  In response to this challenge, the Banks model quarterly the
changes in income that would result from various changes in interest
rates.  Management believes Bank earning assets have the appropriate
maturity and repricing characteristics to optimize earnings and the Banks’
interest rate risk positions.





Concentration
of Operations




The
Company’s operations are concentrated in central Iowa. As a result of this
geographic concentration, the Company’s results may correlate to the economic
conditions in this area. Deterioration in economic conditions, particularly in
the industries on which this area depends (including agriculture which, in turn,
is dependent upon weather conditions and government support programs), may
adversely affect the quality of the Company’s loan portfolio and the demand for
the Company’s products and services, and accordingly, its results of
operations.


19
 Table of Contents


Risks
Associated with Loans




A
significant source of risk for the Company arises from the possibility that
losses will be sustained because borrowers, guarantors and related parties may
fail to perform in accordance with the terms of their loans. The Company has
underwriting and credit monitoring procedures and credit policies, including the
establishment and review of the allowance for loan losses, that management
believes are appropriate to minimize this risk by assessing the likelihood of
nonperformance, tracking loan performance and diversifying the Company’s loan
portfolio. Such policies and procedures, however, may not prevent unexpected
losses that could adversely affect results of operations.




Competition
with Larger Financial Institutions





The
banking and financial services business in the Company’s market area continues
to be a competitive field and is becoming more competitive as a result
of:





·
            changes
      in regulations;





·
            changes
      in technology and product delivery systems;
and





·
            the
      accelerating pace of consolidation among financial services
      providers.





It may be
difficult to compete effectively in the Company’s market, and results of
operations could be adversely affected by the nature or pace of change in
competition. The Company competes for loans, deposits and customers with various
bank and non-bank financial services providers, many of which are much larger in
total assets and capitalization, have greater access to capital markets and
offer a broader array of financial services.




Trading
Volume




The
trading volume in the Company’s common stock on the Nasdaq Capital Market is
relatively limited compared to those of larger companies listed on the Nasdaq
Capital Market, the Nasdaq Global Markets, the New York Stock Exchange or other
consolidated reporting systems or stock exchanges. A change in the supply or
demand for the Company’s common stock may have a more significant impact on the
price of the Company’s stock than for more actively traded
companies.




Technological
Advances




The
financial services industry is undergoing technological changes with frequent
introductions of new technology-driven products and services. In addition to
improving customer services, the effective use of technology increases
efficiency and enables financial institutions to reduce costs. The Company’s
future success will depend, in part, on its ability to address the needs of its
customers by using technology to provide products and services that will satisfy
customer demands for convenience, as well as to create additional efficiencies
in the Company’s operations. Many of our competitors have substantially greater
resources than the Company to invest in technological
improvements.


20
 Table of Contents


Government
Regulations




Current
and future legislation and the policies established by federal and state
regulatory authorities will affect the Company’s operations. The Company and its
Banks are subject to extensive supervision of, and examination by, federal and
state regulatory authorities which may limit the Company’s growth and the return
to our shareholders by restricting certain activities, such as:





·
            the
      payment of dividends to the Company’s
  shareholders;





·
            the
      payment of dividends to the Company from the
  Banks;





·
            possible
      mergers with or acquisitions of or by other
  institutions;





·
            investment
      policies;





·
            loans
      and interest rates on loans;





·
            interest
      rates paid on deposits;





·
            expansion
      of branch offices; and/or





·
            the
      possibility to provide or expand securities or trust
    services.





The
Company cannot predict what changes, if any, will be made to existing federal
and state legislation and regulations or the effect that any changes may have on
future business and earnings prospects. The cost of compliance with regulatory
requirements may adversely affect the Company’s net income.





Equity
Prices





A substandard performance in the
Company’s equity portfolio could lead to a reduction in the historical level of
realized security gains, thereby negatively impacting the Company’s
earnings.  The Company invests capital that may be utilized for future
expansion in a portfolio of primarily financial stocks with an estimated fair
market value of approximately $10 million as of December 31,
2007.  The Company focuses on stocks that have historically
paid dividends in an effort to lessen the negative effects of a bear
market.








ITEM
1B. UNRESOLVED STAFF COMMENTS





The
Company has not received any written comments from the staff of the SEC
regarding its periodic or current reports filed in 2007 under the Exchange
Act.


21
 Table of Contents


ITEM
2.  PROPERTIES





The Company's office is housed in the
main office of First National located at 405 Fifth Street, Ames, Iowa and
occupies approximately 3,357 square feet. A lease agreement between the Company
and First National provides the Company will make available for use by First
National an equal amount of interior space at the Company’s building located at
2330 Lincoln Way in lieu of rental payments. The main office is owned by First
National consists of approximately 45,000 square feet and includes a
drive-through banking facility. In addition to its main office, First National
conducts its business through two full-service offices, the University office
and the North Grand office, and one super-market location, the Cub Food office.
A new full-service office opened in April of 2007 in Ankeny, Iowa and occupies
approximately 14,000 square feet. The University office is located in a 16,000
square foot multi-tenant property owned by the Company. A 24-year lease
agreement with the Company has been modified in 2002 to provide that an equal
amount of interior space will be made available to the Company at First
National’s main office at 405 Fifth Street in lieu of rental payments. First
National will continue to rent the drive-up facilities of approximately 1,850
square feet at this location for $1,200 per month. The Cub Foods office is
leased by First National under a 20 year lease with a five year initial term and
three, five year renewal options. The current annual rental payment is $21,000.
All of the properties owned by the Company and First National are free of any
mortgages.





State
Bank conducts its business from its main office located at 1025 Sixth Street,
Nevada, Iowa and from two additional full-service offices located in McCallsburg
and Colo, Iowa.  All of these properties are owned by State Bank free
of any mortgage.





Boone
Bank conducts its business from its main office located at 716 Eighth Street,
Boone, Iowa and from one additional full-service office also located in Boone,
Iowa.  All properties are owned by Boone Bank free of any
mortgage.





Randall-Story Bank conducts its
business from its main office located at 606 Broad Street, Story City, Iowa
which is owned by Randall-Story Bank free of any mortgage.





United Bank conducts its business from
its main office located at 2101 South Center Street, Marshalltown,
Iowa.  The 5,200 square foot premise was constructed in
2002.  In 2005, United Bank purchased an office location at 29 S.
Center Street in Marshalltown that is 1,972 square feet. In 2007, United Bank
purchased a commercial building located at 10 Westwood Drive, in Marshalltown
that is 2,304 square feet for future expansion. All properties are owned by
United Bank free of any mortgage.





The property the Company owns is
located at 2330 Lincoln Way, Ames, Iowa consisting of a multi tenant building of
approximately 16,000 square feet.  First National leases 5,422 square
feet of this building to serve as its University Office.  4,131 square
feet of the remaining space is currently leased to five tenants who occupy the
space for business purposes; the remaining 3,536 square feet of rentable space
is currently unoccupied.  The Company owns a real estate property
adjacent to 2330 Lincoln Way at 2318 Lincoln Way which consists of a single
story commercial building with 2,400 square feet of leased space that is
currently leased by one tenant for business purposes.


22
 Table of Contents


ITEM
3.  LEGAL PROCEEDINGS





The Banks are from time to time parties
to various legal actions arising in the normal course of
business.  The Company believes that there is no threatened or pending
proceeding against the Company or the Banks, which, if determined adversely,
would have a material adverse effect on the business or financial condition of
the Company or the Banks.





ITEM
4.  SUBMISSION OF MATTERS TO A VOTE OF
SHAREHOLDERS





There were no matters submitted to a
vote of the shareholders of the Company during the fourth quarter of
2007.






PART
II





ITEM
5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED
SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES





On February 29, 2008, the Company had
approximately 561 shareholders of record and an estimated 946 additional
beneficial owners whose shares were held in nominee titles through brokerage or
other accounts.  The Company’s common stock is traded on the NASDAQ
Capital Market under the symbol “ATLO”.  Trading in the Company’s
common stock is, however, relatively limited.








Based on
information provided to and gathered by the Company on an informal basis, the
Company believes that the high and low sales price for the common stock on a per
share basis during the last two years is as follows:





2007
            
            2006Market
      Price
            
            Market
      PriceQuarter
            
            High
            
            
            Low
            
            Quarter
            
            High
            
            
            Low1st
            
            $
            22.44
            
            
            $
            20.56
            
            1st
            
            $
            28.57
            
            
            $
            22.852nd
            
            $
            23.19
            
            
            $
            21.00
            
            2nd
            
            $
            26.00
            
            
            $
            19.753rd
            
            $
            21.70
            
            
            $
            19.06
            
            3rd
            
            $
            22.75
            
            
            $
            21.414th
            
            $
            21.75
            
            
            $
            17.64
            
            4th
            
            $
            22.69
            
            
            $
            19.82





The Company declared aggregate annual
cash dividends in 2007 and 2006 of $10,183,000 and $9,801,000, respectively, or
$1.08 per share in 2007 and $1.04 per share in 2006.  In February
2008, the Company declared an aggregate cash dividend of $2,640,000 or $.28 per
share.  Quarterly dividends declared during the last two years were as
follows:


23
 Table of Contents





2007
            
            
            2006Quarter
            
            Cash
      dividends
              declared
      per share
            
            
            Cash
      dividends
              declared
      per share1st
            
            $
            0.27
            
            
            $
            0.262nd
            
            
            0.27
            
            
            
            0.263rd
            
            
            0.27
            
            
            
            0.264th
            
            
            0.27
            
            
            
            0.26





The decision to declare any such cash
dividends in the future and the amount thereof rests within the discretion of
the Board of Directors of the Company and will be subject to, among other
things, the future earnings, capital requirements and financial condition of the
Company and certain regulatory restrictions imposed on the payment of dividends
by the Banks.  Such restrictions are discussed in greater detail in
Management’s Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources and in Note 11 of the Company’s
financial statements included herein.





The Board
of Directors of the Company approved a stock repurchase program on November 14,
2007.  The Company has a strong capital position and this program
provides an opportunity to repurchase Company stock on the open market when it
is deemed to be favorably priced for repurchase.  The program
authorizes the repurchase of up to 100,000 shares during the calendar year 2008,
or approximately 1% of 9,429,580 shares of common stock presently
outstanding.  The repurchases will be made in open market transactions
at the discretion of management using Company cash.  The timing and
actual number of shares purchased will depend on a variety of factors such as
price, the Company’s liquidity position and other market
conditions.  The program may be limited or discontinued at any time
without notice.  The Company did not repurchase any shares in
2007.


24
 Table of Contents


The following performance graph
provides information regarding cumulative, five-year total return on an indexed
basis of the Company's Common Stock as compared with the NASDAQ Composite Index,
the SNL Midwest OTC Bulletin Board Bank Index (“Midwest OTC Bank Index”) and the
SNL NASDAQ Bank Index prepared by SNL Financial L.C. of Charlottesville,
Virginia. The Midwest OTC Bank Index reflects the performance of 140 bank
holding companies operating principally in the Midwest as selected by SNL
Financial. The SNL NASDAQ Bank Index is comprised of 363 bank and bank holding
companies listed on the NASDAQ market throughout the United States. The indexes
assume the investment of $100 on December 31, 2002 in the Common Stock, the
NASDAQ Composite Index, Midwest OTC Bank Index and the NASDAQ Bank Index with
all dividends reinvested. The Company’s stock price performance shown in the
following graph is not indicative of future stock price
performance.











Period
      EndingIndex
            
            12/31/02
            
            
            12/31/03
            
            
            12/31/04
            
            
            12/31/05
            
            
            12/31/06
            
            
            12/31/07Ames
      National Corporation
            
            
            100.00
            
            
            
            129.84
            
            
            
            186.07
            
            
            
            183.66
            
            
            
            157.00
            
            
            
            153.47NASDAQ
      Composite
            
            
            100.00
            
            
            
            150.01
            
            
            
            162.89
            
            
            
            165.13
            
            
            
            180.85
            
            
            
            198.60SNL
      NASDAQ Bank
            
            
            100.00
            
            
            
            129.08
            
            
            
            147.94
            
            
            
            143.43
            
            
            
            161.02
            
            
            
            126.42Midwest
      OTC Bank Index
            
            
            100.00
            
            
            
            126.23
            
            
            
            150.40
            
            
            
            156.59
            
            
            
            164.90
            
            
            
            160.97


25
 Table of Contents


ITEM 6.  SELECTED FINANCIAL
DATA





The
following financial data of the Company for the five years ended December 31,
2003 through 2007 is derived from the Company's historical audited financial
statements and related footnotes. The information set forth below should be read
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operation" and the consolidated financial statements and related
notes contained elsewhere in this Annual Report.





Year
      Ended December 31(dollars
      in thousands, except per share amounts)
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003STATEMENT
      OF INCOME DATAInterest
      income
            
            $
            47,562
            
            
            $
            44,296
            
            
            $
            41,306
            
            
            $
            37,354
            
            
            $
            35,314Interest
      expense
            
            
            23,537
            
            
            
            21,306
            
            
            
            15,933
            
            
            
            10,564
            
            
            
            10,339Net
      interest income
            
            
            24,025
            
            
            
            22,990
            
            
            
            25,373
            
            
            
            26,790
            
            
            
            24,975Provision
      (credit) for loan losses
            
            
            (94
            )
            
            
            (183
            )
            
            
            331
            
            
            
            479
            
            
            
            645Net
      interest income after provision (credit) forloan
      losses
            
            
            24,119
            
            
            
            23,173
            
            
            
            25,042
            
            
            
            26,311
            
            
            
            24,330Noninterest
      income
            
            
            7,208
            
            
            
            6,674
            
            
            
            5,613
            
            
            
            5,269
            
            
            
            6,435Noninterest
      expense
            
            
            16,776
            
            
            
            15,504
            
            
            
            15,210
            
            
            
            14,935
            
            
            
            14,819Income
      before provision for income tax
            
            
            14,551
            
            
            
            14,343
            
            
            
            15,445
            
            
            
            16,645
            
            
            
            15,946Provision
      for income tax
            
            
            3,542
            
            
            
            3,399
            
            
            
            3,836
            
            
            
            4,255
            
            
            
            4,321Net
      Income
            
            $
            11,009
            
            
            $
            10,944
            
            
            $
            11,609
            
            
            $
            12,390
            
            
            $
            11,625




2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003DIVIDENDS
      AND EARNINGS PER SHARE DATACash
      dividends declared
            
            $
            10,183
            
            
            $
            9,801
            
            
            $
            9,417
            
            
            $
            7,590
            
            
            $
            7,142Cash
      dividends declared per share
            
            $
            1.08
            
            
            $
            1.04
            
            
            $
            1.00
            
            
            $
            0.81
            
            
            $
            0.76Basic
      and diluted earnings per share
            
            $
            1.17
            
            
            $
            1.16
            
            
            $
            1.23
            
            
            $
            1.32
            
            
            $
            1.24Weighted
      average shares outstanding
            
            
            9,427,503
            
            
            
            9,422,402
            
            
            
            9,415,599
            
            
            
            9,405,705
            
            
            
            9,393,672BALANCE
      SHEET DATATotal
      assets
            
            $
            861,591
            
            
            $
            838,853
            
            
            $
            819,384
            
            
            $
            839,753
            
            
            $
            752,786Net
      loans
            
            
            463,651
            
            
            
            429,123
            
            
            
            440,318
            
            
            
            411,639
            
            
            
            355,533Deposits
            
            
            690,119
            
            
            
            680,356
            
            
            
            668,342
            
            
            
            658,176
            
            
            
            619,549Stockholders'
      equity
            
            
            110,021
            
            
            
            112,923
            
            
            
            109,227
            
            
            
            110,924
            
            
            
            107,325Equity
      to assets ratio
            
            
            12.77
            %
            
            
            13.46
            %
            
            
            13.33
            %
            
            
            13.21
            %
            
            
            14.26
            %FIVE
      YEAR FINANCIAL PERFORMANCENet
      income
            
            $
            11,009
            
            
            $
            10,944
            
            
            $
            11,609
            
            
            $
            12,390
            
            
            $
            11,625Average
      assets
            
            
            843,788
            
            
            
            818,450
            
            
            
            831,198
            
            
            
            793,076
            
            
            
            726,945Average
      stockholders' equity
            
            
            111,371
            
            
            
            109,508
            
            
            
            109,802
            
            
            
            108,004
            
            
            
            104,141Return
      on assets (net income divided by average assets)
            
            
            1.30
            %
            
            
            1.34
            %
            
            
            1.40
            %
            
            
            1.56
            %
            
            
            1.60
            %Return
      on equity  (net income divided by average
equity)
            
            
            9.89
            %
            
            
            9.99
            %
            
            
            10.57
            %
            
            
            11.47
            %
            
            
            11.16
            %Net
      interest margin (net interest income divided by average earning
      assets)
            
            
            3.39
            %
            
            
            3.29
            %
            
            
            3.56
            %
            
            
            3.97
            %
            
            
            4.02
            %Efficiency
      ratio (noninterest expense divided by noninterest income plus net interest
      income)
            
            
            53.71
            %
            
            
            52.27
            %
            
            
            49.09
            %
            
            
            46.59
            %
            
            
            47.18
            %Dividend
      payout ratio (dividends per share divided by net income per
      share)
            
            
            92.31
            %
            
            
            89.66
            %
            
            
            81.30
            %
            
            
            61.27
            %
            
            
            61.46
            %Dividend
      yield (dividends per share divided by closing year-end market
      price)
            
            
            5.54
            %
            
            
            4.95
            %
            
            
            3.89
            %
            
            
            3.01
            %
            
            
            3.91
            %Equity
      to assets ratio (average equity divided by average assets)
            
            
            13.20
            %
            
            
            13.38
            %
            
            
            13.21
            %
            
            
            13.62
            %
            
            
            14.33
            %


26
 Table of Contents


ITEM
      7.
            MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
      RESULTS OF OPERATIONS





Overview





Ames
National Corporation (Company) is a bank holding company established in 1975
that owns and operates five bank subsidiaries (Banks) in central
Iowa.  The following discussion is provided for the consolidated
operations of the Company and its Banks, First National, State Bank, Boone Bank,
Randall-Story Bank and United Bank. The purpose of this discussion is to focus
on significant factors affecting the Company's financial condition and results
of operations.





The
Company does not engage in any material business activities apart from its
ownership of the Banks and managing its own bond and equity
portfolio.  Products and services offered by the Banks are for
commercial and consumer purposes, including loans, deposits and trust
services.  The Banks also offer investment services through a
third-party broker dealer.  The Company employs twelve individuals to
assist with financial reporting, human resources, marketing, audit, compliance,
technology systems and the coordination of management activities, in addition to
180 full-time equivalent individuals employed by the Banks.





The
Company’s primary competitive strategy is to utilize seasoned and competent Bank
management and local decision-making authority to provide customers with prompt
response times and flexibility in the products and services
offered.  This strategy is viewed as providing an opportunity to
increase revenues through creating a competitive advantage over other financial
institutions.  The Company also strives to remain operationally
efficient to improve profitability while enabling the Company to offer more
competitive loan and deposit rates.





The
principal sources of Company revenues and cashflow are: (i) interest and fees
earned on loans made by the Banks; (ii) service charges on deposit accounts
maintained at the Banks; (iii) interest on fixed income investments held by the
Banks; (iv) fees on trust services provided by those Banks exercising trust
powers; and (v) securities gains and dividends on equity investments held by the
Company and the Banks.  The Company’s principal expenses are: (i)
interest expense on deposit accounts and other borrowings; (ii) salaries and
employee benefits; (iii) data processing costs associated with maintaining the
Banks’ loan and deposit functions; and (iv) occupancy expenses for maintaining
the Banks’ facilities.  The largest component contributing to the
Company’s net income is net interest income, which is the difference between
interest earned on earning assets (primarily loans and investments) and interest
paid on interest bearing liabilities (primarily deposit accounts and other
borrowings).  One of management’s principal functions is to manage the
spread between interest earned on earning assets and interest paid on interest
bearing liabilities in an effort to maximize net interest income while
maintaining an appropriate level of interest rate risk.





The
Company reported net income of $11,009,000 for the year ended December 31, 2007
compared to $10,944,000 and $11,609,000 reported for the years ended December
31, 2006 and 2005, respectively. This represents a increase of 0.6% when
comparing 2007 to 2006 with net interest income improving 4% but nearly offset
by higher non-interest expense associated with opening the Ankeny office of
First National. The decline in net income in 2006 from 2005 of 6% was primarily
the result of lower net interest income which, in turn, resulted from higher
market interest rates that caused deposit interest expense to increase more
quickly than interest income on earning assets.  Earnings per share
for 2007 were $1.17 compared to $1.16 in 2006 and $1.23 in 2005.  All
of the Company’s five Banks had profitable operations during
2007.


27
 Table of Contents


The
Company’s return on average equity for 2007 was 9.89% compared to 9.99% and
10.57% in 2006 and 2005, respectively, and the return on average assets for 2007
was 1.30% compared to 1.34% in 2006 and 1.40% in 2005.  A higher level
of average equity and average assets in 2007 compared to 2006 caused both the
return on average equity and return on average assets to decline in 2007
compared to the previous year.   Lower net interest income was
the primary contributor to the lower the return on average equity and return on
average assets in 2006 compared to 2005.





The
following discussion will provide a summary review of important items relating
to:





·
            Challenges


·
            Key
      Performance Indicators


·
            Industry
      Results


·
            Income
      Statement Review


·
            Balance
      Sheet Review


·
            Asset
      Quality Review and Credit Risk
Management


·
            Liquidity
      and Capital Resources


·
            Interest
      Rate Risk


·
            Inflation


·
            Forward-Looking
      Statements





Challenges





Management
has identified certain challenges that may negatively impact the Company’s
revenues and profitability in the future and is attempting to position the
Company to best respond to those challenges.





·
            Banks
      have historically earned higher levels of net interest income by investing
      in longer term loans and securities at higher yields and paying lower
      deposit expense rates on shorter maturity deposits.  However,
      the difference between the yields on short term and long term investments
      was very low for much of 2006 and 2007, making it more difficult to manage
      net interest margins. If the yield curve was to flatten or invert in 2008,
      the Company’s net interest margin may compress and net interest income may
      be negatively impacted.  Historically, management has been able
      to position the Company’s assets and liabilities to earn a satisfactory
      net interest margin during periods when the yield curve is flat or
      inverted by appropriately managing credit spreads on loans and maintaining
      adequate liquidity to provide flexibility in an effort to hold down
      funding costs.  Management would seek to follow a similar
      approach in dealing with this challenge in
2008.





·
            While
      interest rates declined in the latter part of 2007 and may continue to
      decline during 2008, interest rates may eventually increase and may
      present a challenge to the Company.  Increases in interest rates
      may negatively impact the Company’s net interest margin if interest
      expense increases more quickly than interest income.  The
      Company’s earning assets (primarily its loan and investment portfolio)
      have longer maturities than its interest bearing liabilities (primarily
      deposits and other borrowings); therefore, in a rising interest rate
      environment, interest expense will increase more quickly than interest
      income as the interest bearing liabilities reprice more quickly than
      earning assets.  In response to this challenge, the Banks model
      quarterly the changes in income that would result from various changes in
      interest rates.  Management believes Bank earning assets have
      the appropriate maturity and repricing characteristics to optimize
      earnings and the Banks’ interest rate risk
  positions.


28
 Table of Contents


·
            The
      Company’s market in central Iowa has numerous banks, credit unions, and
      investment and insurance companies competing for similar business
      opportunities.  This competitive environment will continue to
      put downward pressure on the Banks’ net interest margins and thus affect
      profitability.  Strategic planning efforts at the Company and
      Banks continue to focus on capitalizing on the Banks’ strengths in local
      markets while working to identify opportunities for improvement to gain
      competitive advantages.





·
            A
      substandard performance in the Company’s equity portfolio could lead to a
      reduction in the historical level of realized security gains, thereby
      negatively impacting the Company’s earnings.  The Company
      invests capital that may be utilized for future expansion in a portfolio
      of primarily financial and utility stocks with an estimated fair market
      value of approximately $10 million as of December 31, 2007.  The
      Company focuses on stocks that have historically paid dividends in an
      effort to lessen the negative effects of a bear
      market.  However, this strategy did not prove successful in 2007
      as problems in the residential mortgage industry caused a significant
      decline in the market value of the Company’s financial
      stocks.  The Company had $9 million in money market account
      balances (at the holding company level on an unconsolidated basis) as of
      December 31, 2007 as a result of fourth quarter 2007 stock sales to divest
      of several stocks in the portfolio.  Those proceeds will be
      reinvested in 2008 as suitable investments are
      identified.  Unrealized gains in the Company’s equity portfolio
      totaled $3.3 million as of December 31, 2007 after recognizing realized
      gains of $1.4 in the portfolio during the year.  This compares
      to unrealized gains of $9.5 million (at the holding company level on an
      unconsolidated basis) as of December 31, 2006 after recognizing realized
      gains of $1.1 million during 2006.





·
            The
      economic conditions for commercial real estate developers in the Des
      Moines metropolitan area deteriorated in 2007 and contributed to the
      Company’s increased level of non-performing loans.  Presently,
      the Company has $2.6 million in impaired loans with two Des Moines
      development companies with specific reserves totaling $89,000; however,
      $402,000 was charged-off in the fourth quarter of 2007 relating to one of
      these borrowers.  The Company has additional customer
      relationships with real estate developers in the Des Moines area that may
      become impaired in the future if economic conditions do not improve or
      become worse.  The Company has a limited number of such credits
      and is actively engaged with the customers to minimize credit
      risk.


29
 Table of Contents


Key
Performance Indicators





Certain
key performance indicators for the Company and the industry are presented in the
following chart.  The industry figures are compiled by the Federal
Deposit Insurance Corporation (FDIC) and are derived from 8,533 commercial banks
and savings institutions insured by the FDIC.  Management reviews
these indicators on a quarterly basis for purposes of comparing the Company’s
performance from quarter to quarter against the industry as a
whole.





Selected
Indicators for the Company and the Industry





Year
      Ended December 31,2007
            
            
            2006
            
            
            2005Company
            
            
            Industry
            
            
            Company
            
            
            Industry
            
            
            Company
            
            
            IndustryReturn
      on assets
            
            
            1.30
            %
            
            
            0.86
            %
            
            
            1.34
            %
            
            
            1.28
            %
            
            
            1.40
            %
            
            
            1.28
            %Return
      on equity
            
            
            9.89
            %
            
            
            8.17
            %
            
            
            9.99
            %
            
            
            12.34
            %
            
            
            10.57
            %
            
            
            12.46
            %Net
      interest margin
            
            
            3.39
            %
            
            
            3.29
            %
            
            
            3.29
            %
            
            
            3.31
            %
            
            
            3.56
            %
            
            
            3.49
            %Efficiency
      ratio
            
            
            53.71
            %
            
            
            59.37
            %
            
            
            52.27
            %
            
            
            56.79
            %
            
            
            49.09
            %
            
            
            57.24
            %Capital
      ratio
            
            
            13.20
            %
            
            
            7.98
            %
            
            
            13.38
            %
            
            
            8.23
            %
            
            
            13.21
            %
            
            
            8.25
            %





Key
performance indicators include:





·
            Return
      on Assets





This
ratio is calculated by dividing net income by average assets.  It is
used to measure how effectively the assets of the Company are being utilized in
generating income.  The Company’s return on assets ratio is in line
with that of the industry; however, this ratio has declined in 2007 as compared
to 2006 and 2005 as the result of a higher level of average assets.





·
            Return
      on Equity





This
ratio is calculated by dividing net income by average equity.  It is
used to measure the net income or return the Company generated for the
shareholders’ equity investment in the Company.  The Company’s return
on equity ratio is below that of the industry primarily as a result the higher
level of capital the Company maintains for future growth and
acquisitions.


30
 Table of Contents


·
            Net
      Interest Margin





This
ratio is calculated by dividing net interest income by average earning
assets.  Earning assets consist primarily of loans and investments
that earn interest.  This ratio is used to measure how well the
Company is able to maintain interest rates on earning assets above those of
interest-bearing liabilities, which is the interest expense paid on deposit
accounts and other borrowings.  The Company’s net interest margin is
in line with peer bank averages and has improved since 2006 as a result of
higher volume and yields on loans and investments.





·
            Efficiency
      Ratio





This
ratio is calculated by dividing noninterest expense by net interest income and
noninterest income.  The ratio is a measure of the Company’s ability
to manage noninterest expenses.  The Company’s efficiency ratio
compares favorably to the industry average but is higher than in 2006 primarily
as a result of the initial non-interest expenses incurred by the opening of
First National’s Ankeny office.





·
            Capital
      Ratio





The
capital ratio is calculated by dividing average total equity capital by average
total assets.  It measures the level of average assets that are funded
by shareholders’ equity.  Given an equal level of risk in the
financial condition of two companies, the higher the capital ratio, generally
the more financially sound the company.  The Company’s capital ratio
is significantly higher than the industry average.





Industry
Results





The FDIC
Quarterly Banking Profile reported the following results for the fourth quarter
of 2007:




Quarterly
Net Income Declines to a 16-Year Low





Record-high
loan-loss provisions, record losses in trading activities and goodwill
impairment expenses combined to dramatically reduce earnings at a number of
FDIC-insured institutions in the fourth quarter of 2007. Fourth-quarter net
income of $5.8 billion was the lowest amount reported by the industry since the
fourth quarter of 1991, when earnings totaled $3.2 billion. It was $29.4 billion
(83.5%) less than insured institutions earned in the fourth quarter of 2006. The
average return on assets (ROA) in the quarter was 0.18%, down from 1.20% a year
earlier. This is the lowest quarterly ROA since the fourth quarter of 1990, when
it was a negative 0.19%. Insured institutions set aside a record $31.3 billion
in provisions for loan losses in the fourth quarter, more than three times the
$9.8 billion they set aside in the fourth quarter of 2006. Trading losses
totaled $10.6 billion, marking the first time that the industry has posted a
quarterly net trading loss. In the fourth quarter of 2006, the industry had
trading revenue of $4.0 billion. Expenses for goodwill and other intangibles
totaled $7.4 billion, compared to $1.6 billion a year earlier. Against these
negative factors, net interest income remained one of the few positive elements
in industry performance. Net interest income for the fourth quarter totaled
$92.0 billion, an 11.8-percent ($9.7-billion) year-over-year
increase.


31
 Table of Contents


Net
Charge-Off Rate Rises to Five-Year High





Net
charge-offs registered a sharp increase in the fourth quarter, rising to $16.2
billion, compared to $8.5 billion in the fourth quarter of 2006. The annualized
net charge-off rate in the fourth quarter was 0.83%, the highest since the
fourth quarter of 2002. Net charge-offs were up year-over-year in all major loan
categories except loans to the farm sector (agricultural production loans and
real estate loans secured by farmland). Net charge-offs of loans to commercial
and industrial (C&I) borrowers were $1.6 billion (104.5%) higher than in the
fourth quarter of 2006. Net charge-offs of residential mortgage loans were up by
$1.3 billion (144.2%), and charge-offs of home equity lines of credit were $1.0
billion (378.4%) higher. Credit card charge-offs were up by $1.0 billion
(33.0%), and charge-offs of other loans to individuals increased by $1.1 billion
(58.4%).





Growth in
Noncurrent Loans Accelerates





Despite
the heightened level of charge-offs, the rising trend in noncurrent loans that
began in mid-2006 continued to gain momentum in the fourth quarter. Total
noncurrent loans — loans 90 days or more past due or in nonaccrual status — rose
by $26.9 billion (32.5%) in the last three months of 2007. This is the largest
percentage increase in a single quarter in the 24 years for which noncurrent
loan data are available. Eight institutions accounted for half of the total
increase in noncurrent loans in the fourth quarter, but noncurrent loans were up
at half of all insured institutions. The percentage of loans that were
noncurrent at year-end was 1.39%, the highest level since the third quarter of
2002. The fourth-quarter increase in noncurrent loans was led by noncurrent
residential mortgage loans, which grew by $11.1 billion (31.7%). The percentage
of residential mortgage loans that were noncurrent rose from 1.57% to 2.06%
during the quarter and is now at the highest level in the 17 years that
noncurrent mortgage data have been reported. Noncurrent real estate construction
and development loans increased by $8.4 billion (73.2%), noncurrent credit card
loans rose by $1.9 billion (26.0%), noncurrent home equity loans were up by $1.6
billion (43.1%), and noncurrent other loans to individuals increased by $1.2
billion (26.6%). Only the farm loan categories registered declines in noncurrent
amounts.





Income
Statement Review





The
following highlights a comparative discussion of the major components of net
income and their impact for the last three years.





Critical
Accounting Policy





The
discussion contained in this Item 7 and other disclosures included within this
report are based on the Company’s audited consolidated financial
statements.  These statements have been prepared in accordance with
accounting principles generally accepted in the United States of
America.  The financial information contained in these statements is,
for the most part, based on the financial effects of transactions and events
that have already occurred. However, the preparation of these statements
requires management to make certain estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses.


32
 Table of Contents


The
Company’s significant accounting policies are described in the “Notes to
Consolidated Financial Statements” accompanying the Company’s audited financial
statements.  Based on its consideration of accounting policies that
involve the most complex and subjective estimates and judgments, management has
identified the allowance for loan losses to be the Company’s most critical
accounting policy.





The
allowance for loan losses is established through a provision for loan losses
that is treated as an expense and charged against earnings.  Loans are
charged against the allowance for loan losses when management believes that
collectibility of the principal is unlikely. The Company has policies and
procedures for evaluating the overall credit quality of its loan portfolio,
including timely identification of potential problem loans.  On a
quarterly basis, management reviews the appropriate level for the allowance for
loan losses, incorporating a variety of risk considerations, both quantitative
and qualitative.  Quantitative factors include the Company’s
historical loss experience, delinquency and charge-off trends, collateral
values, known information about individual loans and other
factors.  Qualitative factors include the general economic environment
in the Company’s market area.  To the extent actual results differ
from forecasts and management’s judgment, the allowance for loan losses may be
greater or lesser than future charge-offs.





In
December of 2006, the Office of the Comptroller of the Currency and other
federal banking regulatory agencies issued an inter-agency policy statement to
provide guidance to boards of directors and management concerning the process
for reviewing and determining the allowance for loan losses and to ensure
consistency of that process with generally accepted accounting
principles.  In response, the Company amended its Loan Policy in
November of 2007 to implement the guidance contained in the policy
statement.  Under the amended Loan Policy, the judgments utilized by
management in establishing specific reserves for problem credits have now become
more influenced by the lack of payment performance and net collateral shortfalls
in the event of collateral liquidation.  Previously, the Loan Policy
had focused more on general weaknesses that resulted in loans being adversely
classified by federal banking regulatory agencies and establishing specific
reserves in line with historic regulatory accepted levels, which typically lead
to higher levels of specific reserves for such credits.  As a result
of implementing the guidance contained in the amended Loan Policy, specific
reserves as of December 31, 2007 declined when compared to specific reserves as
of December 31, 2006; however, the effect of the implementation on the overall
allowance for loan losses was not significant.  For further discussion
concerning the allowance for loan losses and the process of establishing
specific reserves, see the section of this Report entitled Asset Quality Review
and Credit Risk Management – Analysis of the Allowance for Loan
Losses.


33
 Table of Contents


Average
Balances and Interest Rates





The
following two tables are used to calculate the Company’s net interest
margin.  The first table includes the Company’s average assets and the
related income to determine the average yield on earning assets.  The
second table includes the average liabilities and related expense to determine
the average rate paid on interest bearing liabilities.  The net
interest margin is equal to the interest income less the interest expense
divided by average earning assets.





ASSETS2007
            
            
            2006
            
            
            2005Average
            
            
            
            
            
            
            
            
            Average
            
            
            
            
            
            
            
            
            Average(dollars
      in thousands)
            
            balance
            
            
            Revenue
            
            
            Yield
            
            
            balance
            
            
            Revenue
            
            
            Yield
            
            
            balance
            
            
            Revenue
            
            
            YieldInterest-earning
      assetsLoans
      1Commercial
            
            $
            78,241
            
            
            $
            6,201
            
            
            
            7.93
            %
            
            $
            70,581
            
            
            $
            5,490
            
            
            
            7.78
            %
            
            $
            66,581
            
            
            $
            4,286
            
            
            
            6.44
            %Agricultural
            
            
            31,964
            
            
            
            2,696
            
            
            
            8.43
            %
            
            
            33,054
            
            
            
            2,758
            
            
            
            8.34
            %
            
            
            29,772
            
            
            
            2,143
            
            
            
            7.20
            %Real
      estate
            
            
            321,225
            
            
            
            21,209
            
            
            
            6.60
            %
            
            
            306,991
            
            
            
            19,655
            
            
            
            6.40
            %
            
            
            310,438
            
            
            
            18,912
            
            
            
            6.09
            %Consumer
      and other
            
            
            22,658
            
            
            
            1,523
            
            
            
            6.72
            %
            
            
            27,540
            
            
            
            1,691
            
            
            
            6.14
            %
            
            
            29,206
            
            
            
            1,638
            
            
            
            5.61
            %Total
      loans (including fees)
            
            $
            454,088
            
            
            $
            31,629
            
            
            
            6.97
            %
            
            $
            438,166
            
            
            $
            29,594
            
            
            
            6.75
            %
            
            $
            435,997
            
            
            $
            26,979
            
            
            
            6.19
            %Investment
      securitiesTaxable
            
            $
            205,203
            
            
            $
            9,858
            
            
            
            4.80
            %
            
            $
            212,897
            
            
            $
            9,195
            
            
            
            4.32
            %
            
            $
            216,785
            
            
            $
            8,823
            
            
            
            4.07
            %Tax-exempt
      2
            
            
            137,109
            
            
            
            8,930
            
            
            
            6.51
            %
            
            
            123,427
            
            
            
            7,913
            
            
            
            6.41
            %
            
            
            126,323
            
            
            
            8,006
            
            
            
            6.34
            %Total
      investment securities
            
            $
            342,312
            
            
            $
            18,788
            
            
            
            5.49
            %
            
            $
            336,324
            
            
            $
            17,108
            
            
            
            5.09
            %
            
            $
            343,108
            
            
            $
            16,829
            
            
            
            4.90
            %Interest
      bearing deposits with banks
            
            $
            864
            
            
            $
            37
            
            
            
            4.28
            %
            
            $
            4,114
            
            
            $
            139
            
            
            
            3.38
            %
            
            $
            7,037
            
            
            $
            169
            
            
            
            2.40
            %Federal
      funds sold
            
            
            4,630
            
            
            
            233
            
            
            
            5.03
            %
            
            
            4,229
            
            
            
            224
            
            
            
            5.30
            %
            
            
            4,833
            
            
            
            131
            
            
            
            2.71
            %Total
      interest-earning assets
            
            $
            801,894
            
            
            $
            50,687
            
            
            
            6.32
            %
            
            $
            782,833
            
            
            $
            47,065
            
            
            
            6.01
            %
            
            $
            790,975
            
            
            $
            44,108
            
            
            
            5.58
            %Noninterest-earning
      assetsCash
      and due from banks
            
            $
            18,086
            
            
            
            
            
            
            
            
            
            
            $
            17,056
            
            
            
            
            
            
            
            
            
            
            $
            22,885Premises
      and equipment, net
            
            
            13,618
            
            
            
            
            
            
            
            
            
            
            
            11,005
            
            
            
            
            
            
            
            
            
            
            
            9,229Other,
      less allowance for loan losses
            
            
            10,190
            
            
            
            
            
            
            
            
            
            
            
            7,556
            
            
            
            
            
            
            
            
            
            
            
            8,109Total
      noninterest-earning assets
            
            $
            41,894
            
            
            
            
            
            
            
            
            
            
            $
            35,617
            
            
            
            
            
            
            
            
            
            
            $
            40,223TOTAL
      ASSETS
            
            $
            843,788
            
            
            
            
            
            
            
            
            
            
            $
            818,450
            
            
            
            
            
            
            
            
            
            
            $
            831,1981
      Average loan balance includes nonaccrual loans, if any. Interest
      income collected on nonaccrual loans has been included.2
      Tax-exempt income has been adjusted to a tax-equivalent basis using an
      incremental tax rate of 35%.




34
 Table of Contents


Average
Balances and Interest Rates(continued)








LIABILITIES
      AND STOCKHOLDERS' EQUITY2007
                
                
                2006
                
                
                2005Average
                
                
                Revenue/
                
                
                Yield/
                
                
                Average
                
                
                Revenue/
                
                
                Yield/
                
                
                Average
                
                
                Revenue/
                
                
                Yield/(dollars
      in thousands)
                
                balance
                
                
                expense
                
                
                rate
                
                
                balance
                
                
                expense
                
                
                rate
                
                
                balance
                
                
                expense
                
                
                rateInterest-bearing
      liabilitiesDepositsSavings,
      NOW accounts, and money markets
                
                $
                309,787
                
                
                $
                7,734
                
                
                
                2.50
                %
                
                $
                314,567
                
                
                $
                8,250
                
                
                
                2.62
                %
                
                $
                323,334
                
                
                $
                5,757
                
                
                
                1.78
                %Time
      deposits < $100,000
                
                
                179,740
                
                
                
                7,996
                
                
                
                4.45
                %
                
                
                182,241
                
                
                
                7,071
                
                
                
                3.88
                %
                
                
                173,966
                
                
                
                5,530
                
                
                
                3.18
                %Time
      deposits > $100,000
                
                
                107,600
                
                
                
                5,325
                
                
                
                4.95
                %
                
                
                99,123
                
                
                
                4,422
                
                
                
                4.46
                %
                
                
                90,687
                
                
                
                3,095
                
                
                
                3.41
                %Total
      deposits
                
                $
                597,127
                
                
                $
                21,055
                
                
                
                3.53
                %
                
                $
                595,931
                
                
                $
                19,743
                
                
                
                3.31
                %
                
                $
                587,987
                
                
                $
                14,382
                
                
                
                2.45
                %Other
      borrowed funds
                
                
                57,047
                
                
                
                2,482
                
                
                
                4.35
                %
                
                
                36,388
                
                
                
                1,563
                
                
                
                4.30
                %
                
                
                56,443
                
                
                
                1,551
                
                
                
                2.75
                %Total
      Interest-bearing liabilities
                
                $
                654,174
                
                
                $
                23,537
                
                
                
                3.60
                %
                
                $
                632,319
                
                
                $
                21,306
                
                
                
                3.37
                %
                
                $
                644,430
                
                
                $
                15,933
                
                
                
                2.47
                %Noninterest-bearing
      liabilitiesDemand
      deposits
                
                $
                70,459
                
                
                
                
                
                
                
                
                
                
                $
                70,095
                
                
                
                
                
                
                
                
                
                
                $
                69,577Other
      liabilities
                
                
                7,784
                
                
                
                
                
                
                
                
                
                
                
                6,528
                
                
                
                
                
                
                
                
                
                
                
                7,389Stockholders'
      equity
                
                $
                111,371
                
                
                
                
                
                
                
                
                
                
                $
                109,508
                
                
                
                
                
                
                
                
                
                
                $
                109,802TOTAL
      LIABILITIES ANDSTOCKHOLDERS'
      EQUITY
                
                $
                843,788
                
                
                
                
                
                
                
                
                
                
                $
                818,450
                
                
                
                
                
                
                
                
                
                
                $
                831,198Net
      interest income
                
                
                
                
                
                $
                27,150
                
                
                
                3.39
                %
                
                
                
                
                
                $
                25,759
                
                
                
                3.29
                %
                
                
                
                
                
                $
                28,177
                
                
                
                3.56
                %Spread
      AnalysisInterest
      income/average assets
                
                
                
                
                
                $
                50,687
                
                
                
                6.01
                %
                
                
                
                
                
                $
                47,065
                
                
                
                5.75
                %
                
                
                
                
                
                $
                44,108
                
                
                
                5.31
                %Interest
      expense/average assets
                
                
                
                
                
                
                23,537
                
                
                
                2.79
                %
                
                
                
                
                
                
                21,306
                
                
                
                2.60
                %
                
                
                
                
                
                
                15,931
                
                
                
                1.92
                %Net
      interest income/average assets
                
                
                
                
                
                
                27,150
                
                
                
                3.22
                %
                
                
                
                
                
                
                25,759
                
                
                
                3.15
                %
                
                
                
                
                
                
                28,177
                
                
                
                3.39
                %


35
 Table of Contents


Rate and
Volume Analysis





The rate
and volume analysis is used to determine how much of the change in interest
income or expense is the result of a change in volume or a change in interest
rate.  For example, commercial loan interest income increased $711,000
in 2007 compared to 2006.  An increased volume of commercial loans
added $604,000 in income in 2007 and higher interest rates increased interest
income in 2007 by $107,000.





The
following table sets forth, on a tax-equivalent basis, a summary of the changes
in net interest income resulting from changes in volume and rates.








(dollars
      in thousands)
            
            2007
      Compared to 2006
            
            
            2006
      Compared to 2005Volume
            
            
            Rate
            
            
            Total 1
            
            
            Volume
            
            
            Rate
            
            
            TotalInterest
      incomeLoansCommercial
            
            $
            604
            
            
            $
            107
            
            
            $
            711
            
            
            $
            270
            
            
            $
            934
            
            
            $
            1,204Agricultural
            
            
            (92
            )
            
            
            30
            
            
            
            (62
            )
            
            
            253
            
            
            
            362
            
            
            
            615Real
      estate
            
            
            928
            
            
            
            626
            
            
            
            1,554
            
            
            
            (212
            )
            
            
            955
            
            
            
            743Consumer
      and other
            
            
            (318
            )
            
            
            150
            
            
            
            (168
            )
            
            
            (97
            )
            
            
            150
            
            
            
            53Total
      loans (including fees)
            
            $
            1,122
            
            
            $
            913
            
            
            $
            2,035
            
            
            $
            214
            
            
            $
            2,401
            
            
            $
            2,615Investment
      securitiesTaxable
            
            $
            (339
            )
            
            $
            1,002
            
            
            $
            663
            
            
            $
            (161
            )
            
            $
            533
            
            
            $
            372Tax-exempt
            
            
            891
            
            
            
            126
            
            
            
            1,017
            
            
            
            (182
            )
            
            
            89
            
            
            
            (93
            )Total
      investment securities
            
            $
            552
            
            
            $
            1,128
            
            
            $
            1,680
            
            
            $
            (343
            )
            
            $
            622
            
            
            
            279Interest
      bearing deposits with banks
            
            
            (154
            )
            
            
            53
            
            
            
            (101
            )
            
            $
            (84
            )
            
            $
            53
            
            
            $
            (31
            )Federal
      funds sold
            
            
            21
            
            
            
            (13
            )
            
            
            8
            
            
            
            (18
            )
            
            
            112
            
            
            
            94Total
      Interest-earning assets
            
            $
            1,541
            
            
            $
            2,081
            
            
            $
            3,622
            
            
            $
            (231
            )
            
            $
            3,188
            
            
            $
            2,957Interest-bearing
      liabilitiesDepositsSavings,
      NOW accounts, and money markets
            
            $
            (156
            )
            
            $
            (360
            )
            
            $
            (516
            )
            
            $
            (160
            )
            
            $
            2,653
            
            
            $
            2,493Time
      deposits < $100,000
            
            
            (98
            )
            
            
            1,023
            
            
            
            925
            
            
            
            274
            
            
            
            1,267
            
            
            
            1,541Time
      deposits > $100,000
            
            
            395
            
            
            
            508
            
            
            
            903
            
            
            
            308
            
            
            
            1,020
            
            
            
            1,328Total
      deposits
            
            $
            141
            
            
            $
            1,171
            
            
            $
            1,312
            
            
            $
            422
            
            
            $
            4,940
            
            
            $
            5,362Other
      borrowed funds
            
            
            901
            
            
            
            18
            
            
            
            919
            
            
            
            (672
            )
            
            
            683
            
            
            
            11Total
      Interest-bearing liabilities
            
            $
            1,042
            
            
            $
            1,189
            
            
            $
            2,231
            
            
            $
            (250
            )
            
            $
            5,623
            
            
            $
            5,373Net
      interest income/earning assets
            
            $
            499
            
            
            $
            892
            
            
            $
            1,391
            
            
            $
            19
            
            
            $
            (2,435
            )
            
            $
            (2,416
            )





1 The
change in interest due to both volume and yield/rate has been allocated to
change due to volume and change due to yield/rate in proportion to the absolute
value of the change in each.


36
 Table of Contents


Net
Interest Income





The
Company’s largest component contributing to net income is net interest income,
which is the difference between interest earned on earning assets (which are
primarily loans and investments) and interest paid on interest bearing
liabilities (which are primarily deposits accounts and other
borrowings).  The volume of and yields earned on earning assets and
the volume of and the rates paid on interest bearing liabilities determine net
interest income.  Refer to the tables preceding this paragraph for
additional detail.  Interest earned and interest paid is also affected
by general economic conditions, particularly changes in market interest rates,
and by government policies and the action of regulatory
authorities.  Net interest income divided by average earning assets is
referred to as net interest margin.  For the years December 31, 2007,
2006 and 2005, the Company's net interest margin was 3.39%, 3.29% and 3.56%,
respectively.





Net
interest income during 2007, 2006 and 2005 totaled $24,025,000, $22,990,000 and
$25,373,000, respectively, representing a 5% increase in 2007 compared to 2006
and a 9% decrease in 2006 from 2005.  Net interest income improved in
2007 compared to 2006 as the yields and volumes improved on loans and
investments.  The decline in net interest income in 2006 compared to
2005 was the result of higher market interest rates causing interest expense to
increase more quickly than interest income.





The high
level of competition in the local markets and will continue to put downward
pressure on the net interest margin of the Company. Currently, the Company’s
largest market, Ames, Iowa, has ten banks, two thrifts, four credit unions and
several other financial investment companies. Multiple banks are also located in
the Company’s other communities creating similarly competitive
environments.





Provision
for Loan Losses





The
provision for loan losses reflects management's judgment of the expense to be
recognized in order to maintain an adequate allowance for loan
losses.  The Company’s
credit for loan losses for the year ending December 31, 2007 was $94,000
compared to a credit for loan losses of $183,000 during the same period last
year. A reduction in the specific reserves for problem credits allowed a
decrease in the required level of the allowance for loan losses calculated by
the Banks for 2007 and 2006.  The decrease in estimated allowance in
2006 created the credit for loan losses compared to the$331,000 of
provision expense for loan losses during 2005.  Refer to the Asset
Quality and Credit Risk Management discussion for additional details with regard
to loan loss provision expense.





Management
believes the allowance for loan losses to be adequate to absorb probable losses
in the current portfolio. This statement is based upon management's continuing
evaluation of inherent risks in the current loan portfolio, current levels of
classified assets and general economic factors. The Company will continue to
monitor the allowance and make future adjustments to the allowance as conditions
dictate.


37
 Table of Contents


Noninterest
Income and Expense





Total noninterest income is comprised
primarily of fee-based revenues from trust and agency services, bank-related
service charges on deposit activities, net securities gains generated primarily
by the Company’s equity holdings, merchant and ATM fees related to electronic
processing of merchant and cash transactions and secondary market
income.





Noninterest
income during 2007, 2006 and 2005 totaled $7,208,000, $6,674,000 and $5,613,000,
respectively, representing an 8% increase in 2007 from 2006 and a 19% increase
in 2006 from 2005.  The higher non-interest income in 2007 compared to
2006 related to higher realized gains on the sale of securities and improved
trust department income.  The increase in 2006 is primarily the result
of a first quarter $471,000 gain on the foreclosure of a commercial real estate
property where the fair market value determined by an independent appraisal
exceeded the loan carrying amount, an increase in realized gains on the sale of
securities in the Company's equity portfolio, and higher trust department
income.





Noninterest expense for the Company
consists of all operating expenses other than interest expense on deposits and
other borrowed funds.  Historically, the Company has not had any
material expenses relating to discontinued operations, extraordinary losses or
adjustments from a change in accounting principles.  Salaries and
employee benefits are the largest component of the Company’s operating expenses
and comprise 60% of noninterest expenses in 2007.





Noninterest
expense during 2007, 2006 and 2005 totaled $16,776,000, $15,504,000 and
$15,210,000, respectively, representing an 8% increase in 2007 compared to a 2%
increase in 2006.  The primary reason for the increase in 2007 was the
opening of First National’s Ankeny office in April of
2007.   Lower incentive compensation for senior officers of the
Company and Banks contributed to the limited increase in noninterest expense in
2006 compared to 2005.  The percentage of noninterest expense to
average assets was 1.99% in 2007, compared to 1.89% and 1.83% during 2006 and
2005, respectively.





Provision
for Income Taxes





The
provision for income taxes for 2007, 2006 and 2005 was $3,542,000, $3,399,000
and $3,836,000, respectively. This amount represents an effective tax rate of
24% during 2007, compared to 24% and 25% for 2006 and 2005,
respectively.  The Company's marginal federal tax rate is currently
35%.  The difference between the Company's effective and marginal tax
rate is primarily related to investments made in tax exempt
securities.





Balance
Sheet Review





The
Company’s assets are comprised primarily of loans and investment
securities.  Average earning asset maturity or repricing dates are
less than five years for the combined portfolios as the assets are funded for
the most part by short term deposits with either immediate availability or less
than one year average maturities.  This exposes the Company to risk
with regard to changes in interest rates that are more fully explained in Item
7A of this report “Quantitative and Qualitative Disclosures about Market
Risk”.


38
 Table of Contents


Total
assets increased to $861,591,000 in 2007 compared to $838,853,000 in 2006, a 3%
increase.  The loan portfolio grew $35 million, offset by a decline of
$15 million in the Company’s investment portfolio when comparing year end 2007
and 2006.




Loan
Portfolio





Net loans
for the year ended December 31, 2007 totaled $463,651,000,upfrom the $429,123,000 as of
December 31, 2006, an increase of 8%. The increase in loan volume can be
primarily attributed to higher origination in 2007 of commercial and commercial
real estate loans.  Loans are the primary contributor to the Company’s
revenues and cash flows.  The average yield on loans was 148 and 166
basis points higher in 2007 and 2006, respectively, in comparison to the average
tax-equivalent investment portfolio yields.





Types of
Loans





The
following table sets forth the composition of the Company's loan portfolio for
the past five years ending at December 31, 2007.




(dollars
      in thousands)
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Real
      EstateConstruction
            
            $
            46,730
            
            
            $
            30,600
            
            
            $
            23,973
            
            
            $
            21,042
            
            
            $
            13,1261-4
      family residential
            
            
            104,380
            
            
            
            103,620
            
            
            
            102,043
            
            
            
            97,612
            
            
            
            84,645Commercial
            
            
            147,023
            
            
            
            139,149
            
            
            
            153,920
            
            
            
            160,176
            
            
            
            150,723Agricultural
            
            
            33,684
            
            
            
            31,092
            
            
            
            30,606
            
            
            
            27,443
            
            
            
            24,297Commercial
            
            
            78,616
            
            
            
            73,760
            
            
            
            71,430
            
            
            
            57,189
            
            
            
            38,555Agricultural
            
            
            36,133
            
            
            
            33,434
            
            
            
            32,216
            
            
            
            30,713
            
            
            
            27,815Consumer
      and other
            
            
            23,002
            
            
            
            24,276
            
            
            
            33,340
            
            
            
            24,584
            
            
            
            23,242Total
      loans
            
            
            469,568
            
            
            
            435,931
            
            
            
            447,528
            
            
            
            418,759
            
            
            
            362,403Deferred
      loan fees, net
            
            
            137
            
            
            
            276
            
            
            
            445
            
            
            
            644
            
            
            
            819Total
      loans net of deferred fees
            
            $
            469,431
            
            
            $
            435,655
            
            
            $
            447,083
            
            
            $
            418,115
            
            
            $
            361,584





The
Company's loan portfolio consists of real estate loans, commercial loans,
agricultural loans and consumer loans.  As of December 31, 2007, gross
loans totaled approximately $470 million, which equals approximately 68% of
total deposits and 55% of total assets.  The Company’s peer group
(consisting of 405 bank holding companies with total assets of $500 to $1,000
million) loan to deposit ratio as of December 31, 2007 was a much higher
92%.  The primary factor relating to the lower loan to deposit ratio
for the Company compared to peer group averages is a more conservative
underwriting philosophy.  As of December 31, 2007, the majority of the
loans were originated directly by the Banks to borrowers within the Banks’
principal market areas. There are no foreign loans outstanding during the years
presented.


39
 Table of Contents


Real
estate loans include various types of loans for which the Banks hold real
property as collateral and consist of loans primarily on commercial properties
and single family residences.  Real estate loans typically have fixed
rates for up to five years, with the Company’s loan policy permitting a maximum
fixed rate maturity of up to 15 years.  The majority of construction
loan volume is to contractors to construct commercial buildings and these loans
generally have maturities of up to 12 months.  The Banks originate
residential real estate loans for sale to the secondary market for a
fee.





Commercial
loans consist primarily of loans to businesses for various purposes, including
revolving lines to finance current operations, floor-plans, inventory and
accounts receivable; capital expenditure loans to finance equipment and other
fixed assets; and letters of credit. These loans generally have short
maturities, have either adjustable or fixed rates and are unsecured or secured
by inventory, accounts receivable, equipment and/or real estate.





Agricultural
loans play an important part in the Banks’ loan portfolios.  Iowa is a
major agricultural state and is a national leader in both grain and livestock
production.  The Banks play a significant role in their communities in
financing operating, livestock and real estate activities for area
producers.





Consumer
loans include loans extended to individuals for household, family and other
personal expenditures not secured by real estate.  The majority of the
Banks’ consumer lending is for vehicles, consolidation of personal debts,
household appliances and improvements.





The
interest rates charged on loans vary with the degree of risk and the amount and
maturity of the loan.  Competitive pressures, market interest rates,
the availability of funds and government regulation further influence the rate
charged on a loan. The Banks follow a loan policy, which has been approved by
both the board of directors of the Company and the Banks, and is overseen by
both Company and Bank management.  These policies establish lending
limits, review and grading criteria and other guidelines such as loan
administration and allowance for loan losses.  Loans are approved by
the Banks’ board of directors and/or designated officers in accordance with
respective guidelines and underwriting policies of the
Company.  Credit limits generally vary according to the type of loan
and the individual loan officer’s experience.  Loans to any one
borrower are limited by applicable state and federal banking
laws.


40
 Table of Contents


Maturities
and Sensitivities of Loans to Changes in Interest Rates as of December 31,
2007





The
contractual maturities of the Company's loan portfolio are as shown below.
Actual maturities may differ from contractual maturities because individual
borrowers may have the right to prepay loans with or without prepayment
penalties.








After
      oneyear
      butWithin
            
            
            within
            
            
            After(dollars
      in thousands)
            
            one year
            
            
            five years
            
            
            five years
            
            
            TotalReal
      EstateConstruction
            
            $
            32,275
            
            
            $
            12,842
            
            
            $
            1,613
            
            
            $
            46,7301-4
      family residential
            
            
            9,407
            
            
            
            40,652
            
            
            
            54,321
            
            
            
            104,380Commercial
            
            
            56,581
            
            
            
            58,300
            
            
            
            32,142
            
            
            
            147,023Agricultural
            
            
            3,168
            
            
            
            4,477
            
            
            
            26,039
            
            
            
            33,684Commercial
            
            
            27,221
            
            
            
            39,745
            
            
            
            11,650
            
            
            
            78,616Agricultural
            
            
            25,270
            
            
            
            10,122
            
            
            
            741
            
            
            
            36,133Consumer
      and other
            
            
            2,292
            
            
            
            16,868
            
            
            
            3,842
            
            
            
            23,002Total
      loans
            
            $
            156,214
            
            
            $
            183,006
            
            
            $
            130,348
            
            
            $
            469,568




After
      oneyear
      butwithin
            
            
            Afterfive years
            
            
            five yearsLoan
      maturities after one year with:Fixed
      rates
            
            
            
            
            
            $
            153,616
            
            
            $
            36,455Variable
      rates
            
            
            
            
            
            
            29,390
            
            
            
            93,893$
            183,006
            
            
            $
            130,348





Loans
Held For Sale





Mortgage
origination funding awaiting delivery to the secondary market totaled $345,000
and $526,000 as of December 31, 2007 and 2006,
respectively.  Residential mortgage loans are originated by the Banks
and sold to several secondary mortgage market outlets based upon customer
product preferences and pricing considerations.  The mortgages are
sold in the secondary market to eliminate interest rate risk and to generate
secondary market fee income.  It is not anticipated at the present
time that loans held for sale will become a significant portion of total
assets.





Investment
Portfolio





Total
investments as of December 31, 2007 were $339,942,000, a decrease of $15 million
or 4% from the prior year end.  As of December 31, 2007 and 2006, the
investment portfolio comprised 39% and 42% of total assets,
respectively.


41
 Table of Contents


The
following table presents the market values, which represent the carrying values
due to the available-for-sale classification, of the Company’s investment
portfolio as of December 31, 2007, 2006 and 2005, respectively.  This
portfolio provides the Company with a significant amount of
liquidity.








(dollars
      in thousands)
            
            2007
            
            
            2006
            
            
            2005U.S.
      treasury securities
            
            $
            524
            
            
            $
            509
            
            
            $
            516U.S.
      government agencies
            
            
            95,597
            
            
            
            123,192
            
            
            
            134,288U.S.
      government mortgage-backed securities
            
            
            26,877
            
            
            
            16,553
            
            
            
            19,988States
      and political subdivisions
            
            
            133,283
            
            
            
            119,908
            
            
            
            88,385Corporate
      bonds
            
            
            64,953
            
            
            
            60,624
            
            
            
            59,567Equity
      securities
            
            
            18,708
            
            
            
            33,786
            
            
            
            30,766Total
            
            $
            339,942
            
            
            $
            354,572
            
            
            $
            333,510





Investments
in states and political subdivisions represent purchases of municipal bonds
located primarily in the state of Iowa and contiguous states.





Investment
in other securities includes corporate debt obligations of companies located and
doing business throughout the United States.  The debt obligations
were all within the credit ratings acceptable under the Company’s investment
policy with the exception of the corporate debt obligations of one corporation
that has a Moody’s sub investment quality rating of Ba3 as of December 31,
2007.  These corporate bonds had a fair market and carrying value as
of December 31, 2007 of $713,000 and $750,000, respectively, and mature in
November of 2008.  The Company does not consider the corporate bonds
to be other than temporarily impaired as of December 31, 2007.  As of
December 31, 2007, the Company did not have securities from a single issuer,
except for the United States Government or its agencies, which exceeded 10% of
consolidated stockholders’ equity. The equity securities portfolio consists
primarily of financial and utility stocks as of December 31, 2007, 2006, and
2005.


42
 Table of Contents


Investment
Maturities as of December 31, 2007





The
investments in the following table are reported by contractual maturity.
Expected maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without prepayment
penalties.








After
      one
            
            
            After
      fiveyear
      but
            
            
            years
      butWithin
            
            
            within
            
            
            within
            
            
            After(dollars
      in thousands)
            
            one year
            
            
            five years
            
            
            ten years
            
            
            ten years
            
            
            TotalU.S.
      treasury securities
            
            
            -
            
            
            $
            524
            
            
            
            -
            
            
            
            -
            
            
            $
            524U.S.
      government agencies
            
            $
            19,470
            
            
            
            36,926
            
            
            $
            35,692
            
            
            $
            3,509
            
            
            
            95,597U.S.
      government mortgage-backed securities
            
            
            3,748
            
            
            
            6,787
            
            
            $
            9,003
            
            
            $
            7,339
            
            
            
            26,877States
      and political subdivisions
            
            
            19,576
            
            
            
            47,994
            
            
            
            52,030
            
            
            
            13,683
            
            
            
            133,283Corporate
      bonds
            
            
            17,482
            
            
            
            23,018
            
            
            
            24,453
            
            
            
            -
            
            
            
            64,953Total
            
            $
            60,276
            
            
            $
            115,249
            
            
            $
            121,178
            
            
            $
            24,531
            
            
            $
            321,234Weighted
      average yieldU.S.
      treasury
            
            
            -
            
            
            
            5.20
            %
            
            
            -
            
            
            
            -
            
            
            
            5.20
            %U.S.
      government agencies
            
            
            3.73
            %
            
            
            4.80
            %
            
            
            5.54
            %
            
            
            5.13
            %
            
            
            4.87
            %U.S
      government mortgage-backed securities
            
            
            3.61
            %
            
            
            4.14
            %
            
            
            5.32
            %
            
            
            5.48
            %
            
            
            4.79
            %States
      and political subdivisions*
            
            
            5.88
            %
            
            
            6.30
            %
            
            
            6.39
            %
            
            
            6.47
            %
            
            
            6.29
            %Corporate
      bonds
            
            
            4.78
            %
            
            
            5.79
            %
            
            
            5.73
            %
            
            
            -
            
            
            
            5.50
            %Total
            
            
            4.73
            %
            
            
            5.58
            %
            
            
            5.93
            %
            
            
            5.98
            %
            
            
            5.58
            %








*Yields
on tax-exempt obligations of states and political subdivisions have been
computed on a tax-equivalent basis.





Deposits





Total
deposits equaled $690,119,000 and $680,356,000 as of December 31, 2007 and 2006,
respectively.  The increase of $9,763,000 can be attributed to deposit
growth at First National and United Bank.  The deposit category seeing
the largest balance increases was demand and the large time certificates of
deposit accounts.





The
Company’s primary source of funds is customer deposits. The Company attempts to
attract noninterest-bearing deposits, which are a low-cost funding source. In
addition, the Banks offer a variety of interest-bearing accounts designed to
attract both short-term and longer-term deposits from customers.
Interest-bearing accounts earn interest at rates established by Bank management
based on competitive market factors and the Company’s need for funds. While
nearly 73% of the Banks’ certificates of deposit mature in the next year, it is
anticipated that a majority of these certificates will be
renewed.  Rate sensitive certificates of deposits in excess of
$100,000 are subject to somewhat higher volatility with regard to renewal volume
as the Banks adjust rates based upon funding needs. In the event a substantial
volume of certificates are not renewed, the Company has sufficient liquid assets
and borrowing lines to fund significant runoff. A sustained reduction in deposit
volume would have a significant negative impact on the Company’s operation and
liquidity. The Company has $2,558,000 of brokered deposits as of December 31,
2007 and $7,406,000 as of December 31, 2006.


43
 Table of Contents


Average
Deposits by Type





The
following table sets forth the average balances for each major category of
deposit and the weighted average interest rate paid for deposits during the
years ended December 31, 2007, 2006 and 2005.





2007
            
            
            2006
            
            
            2005(dollars
      in thousands)
            
            Amount
            
            
            Rate
            
            
            Amount
            
            
            Rate
            
            
            Amount
            
            
            RateNoninterest
      bearing demand deposits
            
            $
            70,459
            
            
            
            -
            
            
            $
            70,095
            
            
            
            -
            
            
            $
            69,577
            
            
            
            -Interest
      bearing demand deposits
            
            
            152,898
            
            
            
            2.29
            %
            
            
            153,619
            
            
            
            2.44
            %
            
            
            154,156
            
            
            
            1.63
            %Money
      market deposits
            
            
            130,548
            
            
            
            3.06
            %
            
            
            134,078
            
            
            
            3.16
            %
            
            
            141,492
            
            
            
            2.12
            %Savings
      deposits
            
            
            26,341
            
            
            
            0.86
            %
            
            
            26,870
            
            
            
            0.99
            %
            
            
            27,686
            
            
            
            0.90
            %Time
      certificates < $100,000
            
            
            179,740
            
            
            
            4.45
            %
            
            
            182,241
            
            
            
            3.88
            %
            
            
            173,966
            
            
            
            3.18
            %Time
      certificates > $100,000
            
            
            107,600
            
            
            
            4.95
            %
            
            
            99,123
            
            
            
            4.46
            %
            
            
            90,687
            
            
            
            3.41
            %$
            667,586
            
            
            
            
            
            
            $
            666,026
            
            
            
            
            
            
            $
            657,564





Deposit
Maturity





The
following table shows the amounts and remaining maturities of time certificates
of deposit that had balances of $100,000 and over as of December 31, 2007, 2006
and 2005.








(dollars
      in thousands)
            
            2007
            
            
            2006
            
            
            20053
      months or less
            
            $
            31,926
            
            
            $
            33,393
            
            
            $
            25,933Over
      3 through 12 months
            
            
            50,646
            
            
            
            45,898
            
            
            
            47,279Over
      12 through 36 months
            
            
            23,723
            
            
            
            20,047
            
            
            
            26,431Over
      36 months
            
            
            2,894
            
            
            
            2,893
            
            
            
            1,399Total
            
            $
            109,189
            
            
            $
            102,231
            
            
            $
            101,042




Borrowed
Funds





Borrowed
funds that may be utilized by the Company are comprised of Federal Home Loan
Bank (FHLB) advances, federal funds purchased, Treasury, Tax, and Loan option
notes, and repurchase agreements.  Borrowed funds are an alternative
funding source to deposits and can be used to fund the Company’s assets and
unforeseen liquidity needs.  FHLB advances are loans from the FHLB
that can mature daily or have longer maturities for fixed or floating rates of
interest.  Federal funds purchased are borrowings from other banks
that mature daily.  Securities sold under agreement to repurchase
(repurchase agreements) are similar to deposits as they are funds lent by
various Bank customers; however, the bank pledges investment securities to
secure such borrowings.  The Company has repurchase agreements that
reprice daily and longer term maturities.  Treasury, Tax, and Loan
option notes consist of short term borrowing of tax deposits from the federal
government and are not a significant source of borrowing for the
Company.


44
 Table of Contents


The
following table summarizes the outstanding amount of, and the average rate on,
borrowed funds as of December 31, 2007, 2006 and 2005.





2007
            
            
            2006
            
            
            2005Average
            
            
            
            
            
            Average
            
            
            
            
            
            Average(dollars
      in thousands)
            
            Balance
            
            
            Rate
            
            
            Balance
            
            
            Rate
            
            
            Balance
            
            
            RateFederal
      funds purchased and repurchase agreements
            
            $
            30,033
            
            
            
            3.39
            %
            
            $
            34,728
            
            
            
            4.42
            %
            
            $
            34,660
            
            
            
            3.38
            %Other
      short-term borrowings
            
            
            737
            
            
            
            4.94
            %
            
            
            1,470
            
            
            
            4.92
            %
            
            
            2,861
            
            
            
            4.52
            %FHLB
      term advances
            
            
            4,000
            
            
            
            4.67
            %
            
            
            2,000
            
            
            
            5.03
            %
            
            
            -
            
            
            
            -
            %Term
      repurchase agreements
            
            
            20,000
            
            
            
            4.24
            %
            
            
            -
            
            
            
            -
            %
            
            
            -
            
            
            
            -
            %Total
            
            $
            54,770
            
            
            
            3.81
            %
            
            $
            38,198
            
            
            
            4.47
            %
            
            $
            37,521
            
            
            
            3.46
            %


45
 Table of Contents


Average
Annual Borrowed Funds





The
following table sets forth the average amount of, the average rate paid and
maximum outstanding balance on, borrowed funds for the years ended December 31,
2007, 2006 and 2005.





2007
            
            
            2006
            
            
            2005Average
            
            
            Average
            
            
            Average
            
            
            Average
            
            
            Average
            
            
            Average(dollars
      in thousands)
            
            Balance
            
            
            Rate
            
            
            Balance
            
            
            Rate
            
            
            Balance
            
            
            RateFederal
      funds purchased& repurchase agreements
            
            $
            46,447
            
            
            
            4.28
            %
            
            $
            34,692
            
            
            
            4.24
            %
            
            $
            55,337
            
            
            
            2.72
            %Other
      short-term borrowings
            
            
            967
            
            
            
            5.86
            %
            
            
            1,029
            
            
            
            5.73
            %
            
            
            1,096
            
            
            
            4.29
            %FHLB
      term advances
            
            
            2,414
            
            
            
            4.97
            %
            
            
            667
            
            
            
            5.03
            %
            
            
            -
            
            
            
            -
            %Term
      repurchase agreements
            
            
            7,219
            
            
            
            4.42
            %
            
            
            -
            
            
            
            -
            %
            
            
            -
            
            
            
            -
            %Total
            
            $
            57,047
            
            
            
            4.35
            %
            
            $
            36,388
            
            
            
            4.30
            %
            
            $
            56,443
            
            
            
            2.75
            %Maximum
      Amount Outstanding during the yearFederal
      funds purchased and repurchase agreements
            
            $
            58,457
            
            
            
            
            
            
            $
            44,928
            
            
            
            
            
            
            $
            70,489Other
      short-term borrowings
            
            $
            1,684
            
            
            
            
            
            
            $
            2,415
            
            
            
            
            
            
            $
            5,000FHLB
      term advances
            
            $
            4,000
            
            
            
            
            
            
            $
            2,000
            
            
            
            
            
            
            $
            -Term
      repurchase agreements
            
            $
            24,000
            
            
            
            
            
            
            $
            -
            
            
            
            
            
            
            $
            -




Off-Balance-Sheet
Arrangements





The
Company is party to financial instruments with off-balance-sheet risk in the
normal course of business.  These financial instruments include
commitments to extend credit and standby letters of credit that assist customers
with their credit needs to conduct business.  The instruments involve,
to varying degrees, elements of credit risk in excess of the amount recognized
in the balance sheet.  As of December 31, 2007, the most likely impact
of these financial instruments on revenues, expenses, or cash flows of the
Company would come from unidentified credit risk causing higher provision
expense for loan losses in future periods.  These financial
instruments are not expected to have a significant impact on the liquidity or
capital resources of the Company.  For additional information, see
footnote 10 of the “Notes to Consolidated Statements” and the “Liquidity and
Capital Resources” section of this discussion.


46
 Table of Contents


Contractual
Obligations





The
following table sets forth the balance of contractual obligations by maturity
period as of December 31, 2007 (in thousands).





Payments
      due by periodLess
      than
            
            
            1-3
            
            
            3-5
            
            
            More
      thanContractual
      Obligations
            
            Total
            
            
            1
      year
            
            
            years
            
            
            years
            
            
            5
      yearsDeposits
            
            $
            690,119
            
            
            $
            612,661
            
            
            $
            67,789
            
            
            $
            9,611
            
            
            $
            58Federal
      funds purchased and securities sold under agreements to
      repurchase
            
            
            30,033
            
            
            
            30,033
            
            
            
            -
            
            
            
            -
            
            
            
            -Other
      short-term borrowings
            
            
            737
            
            
            
            737
            
            
            
            -
            
            
            
            -
            
            
            
            -Long-term
      borrowings
            
            
            24,000
            
            
            
            -
            
            
            
            16,000
            
            
            
            8,000
            
            
            
            -Operating
      lease obligation
            
            
            84
            
            
            
            21
            
            
            
            42
            
            
            
            21
            
            
            
            -Purchase
      obligations
            
            
            1,683
            
            
            
            778
            
            
            
            905
            
            
            
            -
            
            
            
            -Total
            
            $
            746,656
            
            
            $
            644,230
            
            
            $
            84,736
            
            
            $
            17,632
            
            
            $
            58





Purchase
obligations include data processing and Internet banking services contracts that
include termination provisions that would accelerate all future payments in the
event the Company changed service providers prior to the contracts’
expirations.





Asset
Quality Review and Credit Risk Management





The
Company’s credit risk is centered in the loan portfolio, which on December 31,
2007 totaled $463,651,000 as compared to $429,123,000 as of December 31, 2006,
an increase of 8%.  Net loans comprise 54% of total assets as of the
end of 2007.  The object in managing loan portfolio risk is to reduce
the risk of loss resulting from a customer’s failure to perform according to the
terms of a transaction and to quantify and manage credit risk on a portfolio
basis.  As the following chart indicates, the Company’s non-performing
assets have increased from their historically low levels and total $7,395,000 as
of December 31, 2007.  The Company’s level of problem assets as a
percentage of assets of 0.88% as December 31, 2007 are slightly lower than the
average for FDIC insured institutions as of December 31, 2007 of
0.90%.  Though non-performing assets have increased, management
believes that the allowance for loan losses remains adequate based on its
analysis of the non-performing assets and the portfolio as a
whole.


47
 Table of Contents


Non-performing
Assets





The
following table sets forth information concerning the Company's non-performing
assets for the past five years ending December 31, 2007.








(dollars
      in thousands)
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Non-performing
      assets:Nonaccrual
      loans
            
            $
            3,249
            
            
            $
            291
            
            
            $
            606
            
            
            $
            1,896
            
            
            $
            1,756Loans
      90 days or more past due and still accruing
            
            
            1,300
            
            
            
            758
            
            
            
            83
            
            
            
            80
            
            
            
            431Total
      non-performing loans
            
            
            4,549
            
            
            
            1,049
            
            
            
            689
            
            
            
            1,976
            
            
            
            2,187Other
      real estate owned
            
            
            2,846
            
            
            
            2,808
            
            
            
            1,742
            
            
            
            772
            
            
            
            159Total
      non-performing assets
            
            $
            7,395
            
            
            $
            3,857
            
            
            $
            2,431
            
            
            $
            2,748
            
            
            $
            2,346




The
accrual of interest on non-accrual and other impaired loans is discontinued at
90 days or when, in the opinion of management, the borrower may be unable to
meet payments as they become due. When interest accrual is discontinued, all
unpaid accrued interest is reversed. Interest income is subsequently recognized
only to the extent cash payments are received. Interest income on restructured
loans is recognized pursuant to the terms of the new loan agreement. Interest
income on other impaired loans is monitored and based upon the terms of the
underlying loan agreement. However, the recorded net investment in impaired
loans, including accrued interest, is limited to the present value of the
expected cash flows of the impaired loan or the observable fair market value of
the loan’s collateral.





At
December 31, 2007 and 2006, the Company had non-performing loans of
approximately $4,549,000 and $1,049,000, respectively.  The economic
conditions for commercial real estate developers in the Des Moines metropolitan
area deteriorated in 2007 and contributed to the Company’s increased level of
non-performing loans.  Presently, the Company has $2.6 million in
impaired loans with two Des Moines development companies with specific reserves
totaling $89,000; however, $402,000 was charged-off in the fourth quarter of
2007 relating to one of these borrowers.  The Company has additional
customer relationships with real estate developers in the Des Moines area that
may become impaired in the future if economic conditions do not improve or
become worse.  The Company has a limited number of such credits and is
actively engaged with the customers to minimize credit risk.





Impaired loan totaled $5,485,000 as of
December 31, 2007 and were $936,000 higher than the non-performing loans as of
the same date.  During 2007, the Company revised it process for
determining whether a loan is impaired.  Previously, the Company
considered impaired loans to generally include the non-performing loans
consisting of non accrual loans and loans past due 90 days or more and still
accruing.  Under the revised approach, the Company now considers other
loans that may or may not meet the former criteria but are considered to meet
the definition of impaired.  For example, one credit relationship is
not currently meeting the definition of non-performing as the result of
principal payments not being more than 90 day past due.  Management
has concluded that the borrower is unable to make timely payments; however,
present collateral margins have precluded the established of specific reserves
or placing the loan on non-accrual status.While this change
resulted in more loans being reported as impaired this period, the Company does
not believe that the change had a significant impact on the overall allowance
for loan losses.


48
 Table of Contents


The
allowance for loan losses related to these impaired loans was approximately
$247,000 and $142,000 at December 31, 2007 and 2006,
respectively.  The average balances of impaired loans for the years
ended December 31, 2007 and 2006, were $2,486,000 and $1,729,000,
respectively.  For the years ended December 31, 2007, 2006, and 2005,
interest income, which would have been recorded under the original terms of such
loans, was approximately $346,000, $42,000, and $41,000, respectively, with
$180,000, $1,000, and $0, respectively, recorded.  Loans greater than
90 days past due and still accruing interest were approximately $1,300,000 and
$758,000 at December 31, 2007 and 2006, respectively.





Summary
of the Allowance for Loan Losses





The
provision for loan losses represents an expense charged against earnings to
maintain an adequate allowance for loan losses. The allowance for loan losses is
management’s best estimate of probable losses inherent in the loan portfolio as
of the balance sheet date. Factors considered in establishing an appropriate
allowance include: an assessment of the financial condition of the borrower; a
realistic determination of value and adequacy of underlying collateral; the
condition of the local economy and the condition of the specific industry of the
borrower; an analysis of the levels and trends of loan categories; and a review
of delinquent and classified loans.





The
adequacy of the allowance for loan losses is evaluated quarterly by management
and the respective Bank boards. This evaluation focuses on specific loan
reviews, changes in the type and volume of the loan portfolio given the current
economic conditions and historical loss experience. Any one of the following
conditions may result in the review of a specific loan: concern about whether
the customer’s cash flow or collateral are sufficient to repay the loan;
delinquent status; criticism of the loan in a regulatory examination; the
accrual of interest has been suspended; or other reasons, including when the
loan has other special or unusual characteristics which warrant special
monitoring.





While
management uses available information to recognize losses on loans, further
reductions in the carrying amounts of loans may be necessary based on changes in
local economic conditions.  In addition, regulatory agencies, as an
integral part of their examination process, periodically review the estimated
losses on loans.  Such agencies may require the Company to recognize
additional losses based on their judgment about information available to them at
the time of their examination.


49
 Table of Contents


Analysis
of the Allowance for Loan Losses





The
Company’s policy is to charge-off loans when, in management’s opinion, the loan
is deemed uncollectible, although concerted efforts are made to maximize future
recoveries.  The following table sets forth information regarding
changes in the Company's allowance for loan losses for the most recent five
years.








(dollars
      in thousands)
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Balance
      at beginning of period
            
            $
            6,533
            
            
            $
            6,765
            
            
            $
            6,476
            
            
            $
            6,051
            
            
            $
            5,758Charge-offs:Real
      EstateConstruction
            
            
            402
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            241-4
      Family Residential
            
            
            1
            
            
            
            6
            
            
            
            -
            
            
            
            19
            
            
            
            5Commercial
            
            
            25
            
            
            
            -
            
            
            
            28
            
            
            
            93
            
            
            
            -Agricultural
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Commercial
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            3
            
            
            
            392Agricultural
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Consumer
      and other
            
            
            299
            
            
            
            99
            
            
            
            119
            
            
            
            115
            
            
            
            43Total
      Charge-offs
            
            
            727
            
            
            
            105
            
            
            
            147
            
            
            
            230
            
            
            
            464Recoveries:Real
      EstateConstruction
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -1-4
      Family Residential
            
            
            1
            
            
            
            1
            
            
            
            -
            
            
            
            -
            
            
            
            -Commercial
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Agricultural
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Commercial
            
            
            21
            
            
            
            6
            
            
            
            33
            
            
            
            13
            
            
            
            100Agricultural
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Consumer
      and other
            
            
            47
            
            
            
            49
            
            
            
            72
            
            
            
            163
            
            
            
            12Total
      Recoveries
            
            
            69
            
            
            
            56
            
            
            
            105
            
            
            
            176
            
            
            
            112Net
      charge-offs
            
            
            658
            
            
            
            49
            
            
            
            42
            
            
            
            54
            
            
            
            352Additions
      (deductions) charged (credited) to operations
            
            
            (94
            )
            
            
            (183
            )
            
            
            331
            
            
            
            479
            
            
            
            645Balance
      at end of period
            
            $
            5,781
            
            
            $
            6,533
            
            
            $
            6,765
            
            
            $
            6,476
            
            
            $
            6,051Average
      Loans Outstanding
            
            $
            454,088
            
            
            $
            438,166
            
            
            $
            435,997
            
            
            $
            385,347
            
            
            $
            349,812Ratio
      of net charge-offs during the period to average loans
      outstanding
            
            
            0.14
            %
            
            
            0.01
            %
            
            
            0.01
            %
            
            
            0.01
            %
            
            
            0.10
            %Ratio
      of allowance for loan losses to total loans net of deferred
      fees
            
            
            1.23
            %
            
            
            1.50
            %
            
            
            1.51
            %
            
            
            1.55
            %
            
            
            1.67
            %


50
 Table of Contents


The
allowance for loan losses decreased to $5,781,000 at the end of 2007 in
comparison to the allowance of $6,533,000 at year end 2006 as a result of net
charge-offs of $658,000 in 2007 and a reduction in specific reserves for problem
credits.  Areduction
in the specific reserve for a problem credit and declining loan demand allowed
for a decrease in the required level of the allowance for loan losses calculated
by the Banks for year end 2006 compared to 2005.The increase in the
reserve levels in 2005 compared to 2004 can be attributed to the growth in the
Company’s commercial loan portfolio at First National and United
Bank.  The increase in the reserve levels in 2004 compared to 2003
relate primarily to general reserves established by First National.





General
reserves for loan categories normally range from 0.89% to 1.77% of the
outstanding loan balances. As loan volume increases, the general reserve levels
increase with that growth. As the previous table indicates, negative loan
provisions have been utilized in 2007 and 2006 as specific reserves for problem
credits have declined, in part, due to charge-off of problem
credits.  The allowance relating to commercial real estate, 1-4 family
residential and commercial loans are the largest reserve components.
Construction and commercial real estate loans have higher general reserve levels
than 1-4 family and agricultural real estate loans as management perceives more
risk in this type of lending. Elements contributing to the higher risk level
include a higher percentage of watch and problem loans, higher past due
percentages, declining collateral values and less favorable economic conditions
for those portfolios.  As of December 31, 2007, commercial real estate
loans have general reserves ranging from 1.09% to 1.42%.  The level of
non performing loans as of December 31, 2007 has increased since 2006 but
remains at a manageable level.





Loans
that the Banks have identified as having higher risk levels are reviewed
individually in an effort to establish adequate loss reserves. These reserves
are considered specific reserves and are directly impacted by the credit quality
of the underlying loans. Normally, as the actual or expected level of
non-performing loans increase, the specific reserves also increase. For December
31, 2007, however, specific reserves decreased to $247,000 from the $1,477,000
reserved at year end 2006, in part, due to the charge-off of credits with
specific reserves, an improved condition of certain credits and a change in the
Company’s method of determining specific reserves.  The revised
methodology resulted from implementing guidance provided by federal regulatory
agencies as more fully described in this management discussion under Critical
Accounting Policy.





For
December 31, 2006, specific reserves increased $534,000 or 2% compared to year
end 2005 levels as the volume of problem credits increased in
2006.  As of December 31, 2005, specific reserves increased $76,000
over 2004 as the level of watch credits increased.  As of December 31,
2004, specific reserves decreased $431,000 or 24% over year end 2003 as the
result of improved loan quality. As of December 31, 2003, specific reserves
increased $146,000 or 9% over year end 2002.  The specific reserves
are dependent upon assumptions regarding the liquidation value of collateral and
the cost of recovering collateral including legal fees. Changing the amount of
specific reserves on individual loans has historically had the largest impact on
the reallocation of the reserve among different parts of the
portfolio.





Other
factors that are considered when determining the adequacy of the reserve include
historical losses; watch, substandard and impaired loan volume; collecting past
due loans; loan growth; loan to value ratios; loan administration; collateral
values and economic factors. The Company’s concentration risks include
geographic concentration in central Iowa; the local economy’s dependence upon
several large governmental entity employers, including Iowa State University and
the Iowa Department of Transportation; and the health of Iowa’s agricultural
sector that, in turn, is dependent on weather conditions and government
programs.  However, no assurances can be made that losses will remain
at the relatively favorable levels experienced over the past five
years.


51
 Table of Contents


Allocation
of the Allowance for Loan Losses





The
following table sets forth information concerning the Company’s allocation of
the allowance for loan losses.





(dollars
      in thousands)
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004
            
            
            2003Amount
            
            
            
            %*
            
            
            Amount
            
            
            
            %*
            
            
            Amount
            
            
            
            %*
            
            
            Amount
            
            
            
            %*
            
            
            Amount
            
            
            
            %*Balance
      at end of period applicable to:Real
      EstateConstruction
            
            $
            733
            
            
            
            9.92
            %
            
            $
            372
            
            
            
            7.02
            %
            
            $
            258
            
            
            
            5.36
            %
            
            $
            429
            
            
            
            5.02
            %
            
            $
            196
            
            
            
            3.62
            %1-4
      familyresidential
            
            
            1,061
            
            
            
            22.23
            %
            
            
            1,231
            
            
            
            23.77
            %
            
            
            1,127
            
            
            
            22.80
            %
            
            
            1,021
            
            
            
            23.31
            %
            
            
            948
            
            
            
            23.36
            %Commercial
            
            
            1,964
            
            
            
            31.39
            %
            
            
            2,396
            
            
            
            31.92
            %
            
            
            2,534
            
            
            
            34.39
            %
            
            
            2,676
            
            
            
            38.25
            %
            
            
            2,663
            
            
            
            41.59
            %Agricultural
            
            
            407
            
            
            
            7.17
            %
            
            
            428
            
            
            
            7.13
            %
            
            
            421
            
            
            
            6.84
            %
            
            
            486
            
            
            
            6.55
            %
            
            
            458
            
            
            
            6.70
            %Commercial
            
            
            943
            
            
            
            16.74
            %
            
            
            983
            
            
            
            16.92
            %
            
            
            1,158
            
            
            
            15.96
            %
            
            
            809
            
            
            
            13.66
            %
            
            
            775
            
            
            
            10.64
            %Agricultural
            
            
            466
            
            
            
            7.69
            %
            
            
            499
            
            
            
            7.67
            %
            
            
            511
            
            
            
            7.20
            %
            
            
            360
            
            
            
            7.33
            %
            
            
            488
            
            
            
            7.68
            %Consumer
      and other
            
            
            207
            
            
            
            4.85
            %
            
            
            276
            
            
            
            5.57
            %
            
            
            390
            
            
            
            7.45
            %
            
            
            302
            
            
            
            5.87
            %
            
            
            255
            
            
            
            6.41
            %Unallocated
            
            
            -
            
            
            
            
            
            
            
            348
            
            
            
            
            
            
            
            366
            
            
            
            
            
            
            
            393
            
            
            
            
            
            
            
            268$
            5,781
            
            
            
            100
            %
            
            $
            6,533
            
            
            
            100
            %
            
            $
            6,765
            
            
            
            100
            %
            
            $
            6,476
            
            
            
            100
            %
            
            $
            6,051
            
            
            
            100
            %





* Percent
of loans in each category to total loans.





Liquidity
and Capital Resources





Liquidity
management is the process by which the Company, through its Banks’ Asset and
Liability Committees (ALCO), ensures that adequate liquid funds are available to
meet its financial commitments on a timely basis, at a reasonable cost and
within acceptable risk tolerances. These commitments include funding credit
obligations to borrowers, funding of mortgage originations pending delivery to
the secondary market, withdrawals by depositors, maintaining adequate collateral
for pledging for public funds, trust deposits and borrowings, paying dividends
to shareholders, payment of operating expenses, funding capital expenditures and
maintaining deposit reserve requirements.




Liquidity
is derived primarily from core deposit growth and retention; principal and
interest payments on loans; principal and interest payments, sale, maturity and
prepayment of investment securities; net cash provided from operations; and
access to other funding sources. Other funding sources include federal funds
purchased lines, Federal Home Loan Bank (FHLB) advances and other capital market
sources.




52
 Table of Contents


As of
December 31, 2007, the level of liquidity and capital resources of the Company
remain at a satisfactory level and compare favorably to that of other FDIC
insured institutions.  Management believes that the Company's
liquidity sources will be sufficient to support its existing operations for the
foreseeable future.


The
liquidity and capital resources discussion will cover the follows
topics:





·
            Review
      of the Company’s Current Liquidity
Sources


·
            Review
      of the Consolidated Statements of Cash
Flows


·
            Review
      of Company Only Cash Flows


·
            Review
      of Commitments for Capital Expenditures, Cash Flow Uncertainties and Known
      Trends in Liquidity and Cash Flows
Needs


·
            Capital
      Resources





Review of
the Company’s Current Liquidity Sources





Liquid
assets of cash on hand, balances due from other banks, federal funds sold and
interest-bearing deposits in financial institutions for December 31, 2007, 2006
and 2005 totaled $32,179,000, $31,154,000 and $24,376,000,
respectively.  The higher balance of liquid assets as of December 31,
2007 relates to a higher level of due from banks balances associated with checks
in the process of collection.





Other
sources of liquidity available to the Banks include available borrowings with
the Federal Home Loan Bank of Des Moines, Iowa of $42,551,000 and federal funds
borrowing capacity at correspondent banks of $99,500,000.  As of
December 31, 2007, the Company had outstanding FHLB advances of $4,000,000,
Treasury Tax and Loan option notes of $737,000, and securities sold under
agreement to repurchase daily and term of $30,033,000, and $20,000,000,
respectively.





Total
investments as of December 31, 2007 were $339,942,000 compared to $354,572,000
as of year end 2006.  As of December 31, 2007 and 2006, the investment
portfolio as a percentage of total assets was 39% and 42%,
respectively.  This provides the Company with a significant amount of
liquidity since all investments are classified as available for sale as of
December 31, 2007 and 2006 and have pretax net unrealized gains of $2,999,000
and $9,075,000, respectively.





The
investment portfolio serves an important role in the overall context of balance
sheet management in terms of balancing capital utilization and liquidity. The
decision to purchase or sell securities is based upon the current assessment of
economic and financial conditions, including the interest rate environment,
liquidity and credit considerations. The portfolio’s scheduled maturities
represent a significant source of liquidity.





Review of
the Consolidated Statements of Cash Flows





Operating cash flows for December 31,
2007, 2006 and 2005 totaled $10,764,000, $11,055,000 and $9,472,000,
respectively. The decrease in operating cash flows in 2007 compared to 2006
included a smaller increase of accrued expenses.  The primary reason
for the increase in operating cash flows in 2006 compared to 2005 was the source
of cash provided by loans held for sale and higher accrued expenses and other
liabilities.


53
 Table of Contents


Net cash provided by (used in)
investing activities for December 31, 2007, 2006 and 2005 was ($17,576,000),
($15,751,000) and $14,558,000, respectively.  The net cash used in
investing activities in 2007 was primarily utilized to fund increased loan
demand while maturing and sold investments exceeded investment purchases for the
year.  The source of cash provided by loans in 2006 compared to the
investment in loans in 2005 was the largest variance in comparing the two years
investing activities.





Net cash provided by (used in)
financing activities for December 31, 2007, 2006 and 2005 totaled $16,346,000,
$3,113,000 and ($24,697,000), respectively.  In 2007, other borrowings
were the primary source of funds, while in 2006; deposit growth was the primary
source of cash flows.  A decline in securities sold under agreements
to repurchase was the primary use of financing funds in 2005.  As of
December 31, 2007, the Company did not have any external debt financing, off
balance sheet financing arrangements or derivative instruments linked to its
stock.





Review of
Company Only Cash Flows





The
Company’s liquidity on an unconsolidated basis is heavily dependent upon
dividends paid to the Company by the Banks. The Company requires adequate
liquidity to pay its expenses and pay stockholder dividends. In 2007, dividends
from the Banks amounted to $8,849,000 compared to $8,734,000 in 2006. Various
federal and state statutory provisions limit the amount of dividends banking
subsidiaries are permitted to pay to their holding companies without regulatory
approval.  Federal Reserve policy further limits the circumstances
under which bank holding companies may declare dividends. For example, a bank
holding company should not continue its existing rate of cash dividends on its
common stock unless its net income is sufficient to fully fund each dividend and
its prospective rate of earnings retention appears consistent with its capital
needs, asset quality and overall financial condition. In addition, the Federal
Reserve and the FDIC have issued policy statements which provide that insured
banks and bank holding companies should generally pay dividends only out of
current operating earnings.  Federal and state banking regulators may
also restrict the payment of dividends by order.





First
National and United Bank, as national banks, generally may pay dividends,
without obtaining the express approval of the Office of the Comptroller of the
Currency (“OCC”), in an amount up to their retained net profits for the
preceding two calendar years plus retained net profits up to the date of any
dividend declaration in the current calendar year.  Retained net
profits, as defined by the OCC, consists of net income less dividends declared
during the period.  Boone Bank, Randall-Story Bank and State Bank are
also restricted under Iowa law to paying dividends only out of their undivided
profits.  United Bank is not expected to generate sufficient earnings
to pay any dividends in 2008.  Additionally, the payment of dividends
by the Banks is affected by the requirement to maintain adequate capital
pursuant to applicable capital adequacy guidelines and regulations, and the
Banks generally are prohibited from paying any dividends if, following payment
thereof, the Bank would be undercapitalized.


54
 Table of Contents


The
Company has unconsolidated interest bearing deposits and marketable investment
securities totaling $30,345,000 that are presently available to provide
additional liquidity to the Banks.





Review of
Commitments for Capital Expenditures, Cash Flow Uncertainties and Known Trends
in Liquidity and Cash Flows Needs





No
material capital expenditures or material changes in the capital resource mix
are anticipated at this time.  Commitments to extend credit totaled
$96,753,000 as of December 31, 2007 compared to a total of $79,629,000 at the
end of 2006.  The timing of these credit commitments varies with the
underlying borrowers; however, the Company has satisfactory liquidity to fund
these obligations as of December 31, 2007.  The primary cash flow
uncertainty would be a sudden decline in deposits causing the Banks to liquidate
securities.  Historically, the Banks have maintained an adequate level
of short term marketable investments to fund the temporary declines in deposit
balances.  There are no known trends in liquidity and cash flow needs
as of December 31, 2007 that are a concern to management.





Capital
Resources





The
Company’s total stockholders’ equity decreased to $110,021,000 at December 31,
2007, from $112,923,000 at December 31, 2006.  At December 31, 2007
and 2006, stockholders’ equity as a percentage of total assets was 12.8% and
13.5%, respectively.  Total equity decreased primarily due to
depreciation in the Company’s investment portfolio.  The capital
levels of the Company currently exceed applicable regulatory guidelines as of
December 31, 2007.





The Board
of Directors of the Company approved a stock repurchase program on November 14,
2007.  The Company has a strong capital position and this program
provides an opportunity to repurchase Company stock on the open market when it
is deemed to be favorably priced for repurchase.  The program
authorizes the repurchase of up to 100,000 shares during the calendar year 2008,
or approximately 1% of 9,429,580 shares of common stock presently
outstanding.  The repurchases will be made in open market transactions
at the discretion of management using Company cash.  The timing and
actual number of shares purchased will depend on a variety of factors such as
price, the Company’s liquidity position and other market
conditions.  The program may be limited or discontinued at any time
without notice.  The Company did not repurchase any shares in
2007.








Interest
Rate Risk





Interest
rate risk refers to the impact that a change in interest rates may have on the
Company’s earnings and capital. Management’s objectives are to control interest
rate risk and to ensure predictable and consistent growth of earnings and
capital. Interest rate risk management focuses on fluctuations in net interest
income identified through computer simulations to evaluate volatility, varying
interest rate, spread and volume assumptions. The risk is quantified and
compared against tolerance levels.


55
 Table of Contents


The
Company uses a third-party computer software simulation modeling program to
measure its exposure to potential interest rate changes.  For various
assumed hypothetical changes in market interest rates, numerous other
assumptions are made such as prepayment speeds on loans, the slope of the
Treasury yield curve, the rates and volumes of the Company’s deposits and the
rates and volumes of the Company’s loans.  This analysis measures the
estimated change in net interest income in the event of hypothetical changes in
interest rates.





Another
measure of interest rate sensitivity is the gap ratio.  This ratio
indicates the amount of interest-earning assets repricing within a given period
in comparison to the amount of interest-bearing liabilities repricing within the
same period of time.  A gap ratio of 1.0 indicates a matched position,
in which case the effect on net interest income due to interest rate movements
will be minimal.  A gap ratio of less than 1.0 indicates that more
liabilities than assets reprice within the time period and a ratio greater than
1.0 indicates that more assets reprice than liabilities.





The
simulation model process provides a dynamic assessment of interest rate
sensitivity, whereas a static interest rate gap table is compiled as of a point
in time. The model simulations differ from a traditional gap analysis, as a
traditional gap analysis does not reflect the multiple effects of interest rate
movement on the entire range of assets and liabilities and ignores the future
impact of new business strategies.





Inflation





The
primary impact of inflation on the Company’s operations is to increase asset
yields, deposit costs and operating overhead. Unlike most industries, virtually
all of the assets and liabilities of a financial institution are monetary in
nature. As a result, interest rates generally have a more significant impact on
a financial institution’s performance than they would on non-financial
companies.  Although interest rates do not necessarily move in the
same direction or to the same extent as the price of goods and services,
increases in inflation generally have resulted in increased interest rates. The
effects of inflation can magnify the growth of assets and, if significant,
require that equity capital increase at a faster rate than would be otherwise
necessary.





Forward-Looking
Statements and Business Risks





The
discussion in the foregoing Management Discussion and Analysis and elsewhere in
this Report contains forward-looking statements about the Company, its business
and its prospects.  Forward-looking statements can be identified by
the fact that they do not relate strictly to historical or current
facts.  They often include use of the words “believe”, “expect”,
“anticipate”, “intend”, “plan”, “estimate” or words of similar meaning, or
future or conditional verbs such as “will”, “would”, “should”, “could” or
“may”.  Forward-looking statements, by their nature, are subject to
risks and uncertainties.  A number of factors, many of which are
beyond the Company's control, could cause actual conditions, events or results
to differ significantly from those described in the forward-looking
statements.  Such risks and uncertainties with respect to the Company
include, but are not limited to, those related to the economic conditions,
particularly in the concentrated geographic area in which the Company and the
Banks operate, competitive products and pricing, adequacy of the allowance for
loan losses established by the Banks, fiscal and monetary policies of the U.S.
government, changes in governmental regulations affecting financial
institutions, (including regulatory fees and capital requirements), changes in
prevailing interest rates, credit risk management and asset/liability
management, the financial and securities markets and the availability of and
costs associated with sources of liquidity. Additional
risks and uncertainties that could affect forward-looking statements are
discussed in Item 1A of this Report under the heading "Risk
Factors".  Undue reliance should not be placed on these
forward-looking statements.


56
 Table of Contents


These
factors may not constitute all factors that could cause actual results to differ
materially from those discussed in any forward-looking statement.  The
Company operates in a continually changing business environment and new facts
emerge from time to time.   It cannot predict such factors nor
can it assess the impact, if any, of such factors on its financial position or
its results of operations.  Accordingly, forward-looking statements
should not be relied upon as a predictor of actual results.  The
Company disclaims any responsibility to update any forward-looking statement
provided in this document.





ITEM
7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK





The
Company’s market risk is comprised primarily of interest rate risk arising from
its core banking activities of making loans and taking
deposits.  Interest rate risk is the risk that changes in market
interest rates may adversely affect the Company’s net interest
income.  Management continually develops and applies strategies to
mitigate this risk.  Management does not believe that the Company’s
primary market risk exposure and how that exposure was managed in 2007 changed
when compared to 2006.





Based on
a simulation modeling analysis performed as of December 31, 2007, the following
table presents the estimated change in net interest income in the event of
hypothetical changes in interest rates for the various rate shock
levels:





Net
Interest Income at Risk





Estimated
Change in Net Interest Income for Year Ending December 31, 2007








(dollars
      in thousands)
            
            $ Change
            
            
            % Change+200
      Basis Points
            
            
            (1,716
            )
            
            
            (6.2
            )%+100
      Basis Points
            
            
            (752
            )
            
            
            (2.7
            )%-100
      Basis Points
            
            
            731
            
            
            
            2.6
            %-200
      Basis Points
            
            
            1,203
            
            
            
            4.3
            %





As shown
above, at December 31, 2007, the estimated effect of an immediate 200 basis
point increase in interest rates would decrease the Company’s net interest
income by 6.2% or approximately $1,716,000 in 2007. The estimated effect of an
immediate 200 basis point decrease in rates would increase the Company’s net
interest income by 4.3% or approximately $1,203,000 in 2007. The Company’s Asset
Liability Management Policy establishes parameters for a 200 basis point change
in interest rates. Under this policy, the Company and the Banks’ objective is to
properly structure the balance sheet to prevent a 200 basis point change in
interest rates from causing a decline in net interest income by more than 15% in
one year compared to the base year that hypothetically assumes no change in
interest rates.





Computations
of the prospective effects of hypothetical interest rate changes are based on
numerous assumptions. Actual values may differ from those projections set forth
above. Further, the computations do not contemplate any actions the Company may
undertake in response to changes in interest rates. Current interest rates on
certain liabilities are at a level that does not allow for significant repricing
should market interest rates decline considerably.


57
 Table of Contents


Contractual
Maturity or Repricing





The
following table sets forth the estimated maturity or re-pricing, and the
resulting interest sensitivity gap, of the Company's interest-earning assets and
interest-bearing liabilities and the cumulative interest sensitivity gap at
December 31, 2007. The expected maturities are presented on a contractual basis.
Actual maturities may differ from contractual maturities because of prepayment
assumptions, early withdrawal of deposits and competition.





Less
      than
            
            
            Three
            
            
            One
      to
            
            
            Overthree
            
            
            months
      to
            
            
            five
            
            
            five
            
            
            Cumulative(dollars
      in thousands)
            
            months
            
            
            one year
            
            
            years
            
            
            years
            
            
            TotalInterest
      - earning assetsInterest-bearing
      deposits with banks
            
            $
            635
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            635Federal
      funds sold
            
            
            5,500
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            5,500Investments
      *
            
            
            12,257
            
            
            
            48,018
            
            
            
            115,247
            
            
            
            164,420
            
            
            
            339,942Loans
            
            
            132,382
            
            
            
            23,832
            
            
            
            183,099
            
            
            
            130,255
            
            
            
            469,568Loans
      held for sale
            
            
            345
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            345Total
      interest - earning assets
            
            $
            151,119
            
            
            $
            71,850
            
            
            $
            298,346
            
            
            $
            294,675
            
            
            $
            815,990Interest
      - bearing liabilitiesInterest
      bearing demand deposits
            
            $
            160,672
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            160,672Money
      market and savings deposits
            
            
            162,292
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            162,292Time
      certificates < $100,000
            
            
            36,654
            
            
            
            89,833
            
            
            
            50,839
            
            
            
            -
            
            
            
            177,326Time
      certificates > $100,000
            
            
            31,926
            
            
            
            50,645
            
            
            
            26,561
            
            
            
            58
            
            
            
            109,190Other
      borrowed funds
            
            
            30,770
            
            
            
            -
            
            
            
            24,000
            
            
            
            -
            
            
            
            54,770Total
      interest - bearing liabilities
            
            $
            422,314
            
            
            $
            140,478
            
            
            $
            101,400
            
            
            $
            58
            
            
            $
            664,250Interest
      sensitivity gap
            
            $
            (271,195
            )
            
            $
            (68,628
            )
            
            $
            196,946
            
            
            $
            294,617
            
            
            $
            151,740Cumulative
      interest sensitivity gap
            
            $
            (271,195
            )
            
            $
            (339,823
            )
            
            $
            (142,877
            )
            
            $
            151,740
            
            
            $
            151,740Cumulative
      interest sensitivity gap as a percent of total assets
            
            
            -31.48
            %
            
            
            -39.44
            %
            
            
            -16.58
            %
            
            
            17.61
            %








*Investments
with maturities over 5 years include the market value of equity securities of
$18,708.


58
 Table of Contents


As of
December 31, 2007, the Company’s cumulative gap ratios for assets and
liabilities repricing within three months and within one year were a negative
31% and 39%, respectively, meaning more liabilities than assets are scheduled to
reprice within these periods.  This situation suggests that a decrease
in market interest rates may benefit net interest income and that an increase in
interest rates may negatively impact the Company.  The liability
sensitive gap position is largely the result of classifying the interest bearing
NOW accounts, money market accounts and savings accounts as immediately
repriceable.  Certain shortcomings are inherent in the method of
analysis presented in the foregoing table.  For example, although
certain assets and liabilities may have similar maturities and periods to
repricing, they may react differently to changes in market interest
rates.  Also, interest rates on assets and liabilities may fluctuate
in advance of changes in market interest rates, while interest rates on other
assets and liabilities may follow changes in market interest
rates.  Additionally, certain assets have features that restrict
changes in the interest rates of such assets, both on a short-term basis and
over the lives of such assets.


59
 Table of Contents


ITEM
8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA








MANAGEMENT’S
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING





The
management of Ames National Corporation is responsible for establishing and
maintaining adequate internal control over financial reporting.  Ames
National Corporation’s internal control system was designed to provide
reasonable assurance to the Company’s management and board of directors
regarding the preparation and fair presentation of published financial
statements.  Because of its inherent limitations, internal control
over financial reporting may not prevent or detect
misstatements.  Also, projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.





Ames
National Corporation’s management assessed the effectiveness of the Company’s
internal control over financial reporting as of December 31,
2007.   In making this assessment, it used the criteria set forth
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
in Internal Control-Integrated
Framework.   Based on our assessment we determined that,
as of December 31, 2007, the Company’s internal control over financial reporting
is effective based on those criteria.





The
Company’s internal control over financial reporting as of December 31, 2007 has
been audited by Clifton Gunderson LLP, an independent registered public
accounting firm, as stated in their report which appears herein.











/s/ Thomas H. PohlmanThomas
      H. Pohlman,  President(Principal
      Executive Officer)/s/ John P. NelsonJohn
      P. Nelson, Vice President(Principal
      Financial Officer)


60
 Table of Contents


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM








The Board
of Directors


Ames
National Corporation


Ames,
Iowa








We have
audited the accompanying consolidated balance sheets of Ames National
Corporation and subsidiaries as of December 31, 2007 and 2006, and the related
consolidated statements of income, stockholders’ equity and cash flows for the
years then ended.  These consolidated financial statements are the
responsibility of the Company’s management.  Our responsibility is to
express an opinion of these consolidated financial statements based on our
audits.  The consolidated statements of income, stockholders’ equity
and cash flows of Ames National Corporation and subsidiaries for the year ended
December 31, 2005 were audited by other auditors whose report dated January 20,
2006 was unqualified.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Ames National Corporation
and subsidiaries as of December 31, 2007 and 2006, and the results of their
operations and their cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of
America.





We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), Ames National Corporation and subsidiaries’
internal control over financial reporting as of December 31, 2007, based on
criteria established in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), and our report dated February 25, 2008 expressed an
unqualified opinion.








/s/
Clifton Gunderson LLP








West Des
Moines, Iowa


February
25, 2008


61
 Table of Contents


REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM











The Board
of Directors


Ames
National Corporation


Ames,
Iowa





We have
audited Ames National Corporation and subsidiaries internal control over
financial reporting as of December 31, 2007, based on criteria established in
Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).   Ames National Corporation’s
management is responsible for maintaining effective internal control over the
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting included in the accompanying Management’s
Report on Internal Control Over Financial Reporting.  Our
responsibility is to express an opinion on the Company’s internal control over
financial reporting based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States).   Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether effective internal control over financial reporting was maintained in
all material respects.   Our audit of internal control over
financial reporting included obtaining an understanding of internal control over
financial reporting,  assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk.  Our audit also included
performing such other procedures as we considered necessary in the
circumstances.   We believe that our audit provides a reasonable
basis for our opinion.





A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles.   A company’s
internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of
the company; (2) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management
and directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use or disposition
of the company’s assets that could have a material effect on the financial
statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements.  Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.


62
 Table of Contents


In our
opinion, Ames National Corporation maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2007,
based upon criteria established in Internal Control- Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).





We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Ames
National Corporation and subsidiaries as of December 31, 2007 and 2006, and the
related consolidated statements of income, stockholders’ equity and cash flows
for the years then ended and our report dated February 25, 2008 expressed an
unqualified opinion.







/s/
Clifton Gunderson LLP








West Des
Moines, Iowa


February
25, 2008


63
 Table of Contents




McGladrey &
Pullen


Certified Public Accountants






Report
of Independent Registered Public Accounting Firm








To the
Board of Directors


Ames
National Corporation


Ames,
Iowa





We have
audited the consolidated statements of operations, stockholders’ equity and cash
flows of Ames National Corporation and subsidiaries for the year ended December
31, 2005.  These financial statements are the responsibility of the
Company’s management.  Our responsibility is to express an opinion on
these financial statements based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audit provides a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the results of operations and cash flows of Ames
National Corporation and subsidiaries for the year ended December 31, 2005, in
conformity with U.S. generally accepted accounting principles.








/s/
McGladrey & Pullen LLP


January
20, 2006


64
 Table of Contents





AMES
      NATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED
      BALANCE SHEETSDecember
      31, 2007 and 2006ASSETS
            
            2007
            
            
            2006Cash
      and due from banks
            
            $
            26,044,577
            
            
            $
            16,510,082Federal
      funds sold
            
            
            5,500,000
            
            
            
            13,100,000Interest
      bearing deposits in financial institutions
            
            
            634,613
            
            
            
            1,544,306Securities
      available-for-sale
            
            
            339,942,064
            
            
            
            354,571,864Loans
      receivable, net
            
            
            463,651,000
            
            
            
            429,122,541Loans
      held for sale
            
            
            344,970
            
            
            
            525,999Bank
      premises and equipment, net
            
            
            13,446,865
            
            
            
            12,617,741Accrued
      income receivable
            
            
            8,022,900
            
            
            
            7,871,365Deferred
      income taxes
            
            
            929,326
            
            
            
            -Other
      assets
            
            
            3,074,833
            
            
            
            2,989,090Total
      assets
            
            $
            861,591,148
            
            
            $
            838,852,988LIABILITIES
      AND STOCKHOLDERS' EQUITYLIABILITIESDepositsDemand,
      noninterest bearing
            
            $
            80,638,995
            
            
            $
            77,638,264NOW
      accounts
            
            
            160,672,326
            
            
            
            158,584,115Savings
      and money market
            
            
            162,291,544
            
            
            
            159,401,753Time,
      $100,000 and over
            
            
            109,189,660
            
            
            
            102,230,631Other
      time
            
            
            177,326,270
            
            
            
            182,501,710Total
      deposits
            
            
            690,118,795
            
            
            
            680,356,473Federal
      funds purchased and securities sold under agreementsto
      repurchase
            
            
            30,033,321
            
            
            
            34,727,897Other
      short-term borrowings
            
            
            737,420
            
            
            
            1,470,116Long-term
      borrowings
            
            
            24,000,000
            
            
            
            2,000,000Dividend
      payable
            
            
            2,545,987
            
            
            
            2,450,503Deferred
      income taxes
            
            
            -
            
            
            
            1,187,948Accrued
      expenses and other liabilities
            
            
            4,135,102
            
            
            
            3,736,739Total
      liabilities
            
            
            751,570,625
            
            
            
            725,929,676STOCKHOLDERS'
      EQUITYCommon
      stock, $2 par value, authorized 18,000,000 shares; 9,429,580 and 9,425,013
      shares issued and outstanding as of December 31, 2007 and 2006,
      respectively
            
            
            18,859,160
            
            
            
            18,850,026Additional
      paid-in capital
            
            
            22,588,691
            
            
            
            22,498,904Retained
      earnings
            
            
            66,683,016
            
            
            
            65,856,627Accumulated
      other comprehensive income-net unrealized gain on securities
      available-for-sale
            
            
            1,889,656
            
            
            
            5,717,755Total
      stockholders' equity
            
            
            110,020,523
            
            
            
            112,923,312Total
      liabilities and stockholders' equity
            
            $
            861,591,148
            
            
            $
            838,852,988





See Notes
to Consolidated Financial Statements.


65
 Table of Contents





AMES
      NATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF INCOMEYears
      Ended December 31, 2007, 2006 and 20052007
            
            
            2006
            
            
            2005Interest
      and dividend income:Loans,
      including fees
            
            $
            31,629,493
            
            
            $
            29,593,896
            
            
            $
            26,979,358Securities:Taxable
            
            
            9,304,036
            
            
            
            8,830,356
            
            
            
            8,558,156Tax-exempt
            
            
            4,828,248
            
            
            
            4,226,941
            
            
            
            4,190,268Federal
      funds sold
            
            
            232,723
            
            
            
            224,882
            
            
            
            130,182Dividends
            
            
            1,567,578
            
            
            
            1,419,617
            
            
            
            1,447,663Total
      interest and dividend income
            
            
            47,562,078
            
            
            
            44,295,692
            
            
            
            41,305,627Interest
      expense:Deposits
            
            
            21,055,100
            
            
            
            19,742,379
            
            
            
            14,380,214Other
      borrowed funds
            
            
            2,482,030
            
            
            
            1,563,149
            
            
            
            1,552,894Total
      interest expense
            
            
            23,537,130
            
            
            
            21,305,528
            
            
            
            15,933,108Net
      interest income
            
            
            24,024,948
            
            
            
            22,990,164
            
            
            
            25,372,519Provision
      (credit) for loan losses
            
            
            (94,100
            )
            
            
            (182,686
            )
            
            
            331,282Net
      interest income after provision (credit) for loan losses
            
            
            24,119,048
            
            
            
            23,172,850
            
            
            
            25,041,237Noninterest
      income:Trust
      department income
            
            
            2,014,277
            
            
            
            1,462,734
            
            
            
            1,375,308Service
      fees
            
            
            1,855,964
            
            
            
            1,840,699
            
            
            
            1,796,503Securities
      gains, net
            
            
            1,466,697
            
            
            
            1,135,136
            
            
            
            795,780Gain
      on sales of loans held for sale
            
            
            743,009
            
            
            
            564,819
            
            
            
            606,277Merchant
      and ATM fees
            
            
            553,644
            
            
            
            645,517
            
            
            
            570,914Gain
      on sale or foreclosure of real estate
            
            
            -
            
            
            
            482,203
            
            
            
            -Other
            
            
            574,759
            
            
            
            542,924
            
            
            
            468,410Total
      noninterest income
            
            
            7,208,350
            
            
            
            6,674,032
            
            
            
            5,613,192Noninterest
      expense:Salaries
      and employee benefits
            
            
            10,041,947
            
            
            
            9,408,293
            
            
            
            9,208,902Data
      processing
            
            
            2,239,595
            
            
            
            2,185,478
            
            
            
            2,126,040Occupancy
      expenses
            
            
            1,292,424
            
            
            
            1,159,750
            
            
            
            1,148,738Other
      operating expenses
            
            
            3,202,281
            
            
            
            2,750,341
            
            
            
            2,726,222Total
      noninterest expense
            
            
            16,776,247
            
            
            
            15,503,862
            
            
            
            15,209,902Income
      before income taxes
            
            
            14,551,151
            
            
            
            14,343,020
            
            
            
            15,444,527Provision
      for income taxes
            
            
            3,542,049
            
            
            
            3,399,403
            
            
            
            3,835,992Net
      income
            
            $
            11,009,102
            
            
            $
            10,943,617
            
            
            $
            11,608,535Basic
      earnings per share
            
            $
            1.17
            
            
            $
            1.16
            
            
            $
            1.23





See Notes to Consolidated Financial
Statements.




66
 Table of Contents


AMES
      NATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF STOCKHOLDERS’ EQUITYYears
      Ended December 31, 2007, 2006 and 2005AccumulatedAdditional
            
            
            
            
            
            
            
            
            Other
            
            
            TotalComprehensive
            
            
            Common
            
            
            Paid-in
            
            
            Retained
            
            
            Treasury
            
            
            Comprehensive
            
            
            Stockholders'Income
            
            
            Stock
            
            
            Capital
            
            
            Earnings
            
            
            Stock
            
            
            Income
            
            
            EquityBalance,
      December 31, 2004
            
            
            
            
            $
            18,919,380
            
            
            $
            22,225,516
            
            
            $
            63,200,352
            
            
            $
            (889,020
            )
            
            $
            7,467,712
            
            
            $
            110,923,940Comprehensive
      income:Net
      income
            
            $
            11,608,535
            
            
            
            -
            
            
            
            -
            
            
            
            11,608,535
            
            
            
            -
            
            
            
            -
            
            
            
            11,608,535Other
      comprehensive income, unrealized losses on securities, net of
      reclassification adjustment, net of tax benefit
            
            
            (4,175,858
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (4,175,858
            )
            
            
            (4,175,858
            )Total
      comprehensive income
            
            $
            7,432,677Cash
      dividends declared, $1.00 per share
            
            
            
            
            
            
            -
            
            
            
            -
            
            
            
            (9,417,253
            )
            
            
            -
            
            
            
            -
            
            
            
            (9,417,253
            )Retirement
      of treasury stock
            
            
            
            
            
            
            (96,984
            )
            
            
            (113,932
            )
            
            
            (678,104
            )
            
            
            889,020
            
            
            
            -
            
            
            
            -Sale
      of 8,073 shares of common stock
            
            
            
            
            
            
            16,146
            
            
            
            271,791
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            287,937Balance,
      December 31, 2005
            
            
            
            
            
            
            18,838,542
            
            
            
            22,383,375
            
            
            
            64,713,530
            
            
            
            -
            
            
            
            3,291,854
            
            
            
            109,227,301Comprehensive
      income:Net
      income
            
            $
            10,943,617
            
            
            
            -
            
            
            
            -
            
            
            
            10,943,617
            
            
            
            -
            
            
            
            -
            
            
            
            10,943,617Other
      comprehensive income, unrealized gain on securities, net of
      reclassification adjustment, net of tax
            
            
            2,425,901
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            2,425,901
            
            
            
            2,425,901Total
      comprehensive income
            
            $
            13,369,518Cash
      dividends declared, $1.04 per share
            
            
            
            
            
            
            -
            
            
            
            -
            
            
            
            (9,800,520
            )
            
            
            -
            
            
            
            -
            
            
            
            (9,800,520
            )Sale
      of 5,742 shares of common stock
            
            
            
            
            
            
            11,484
            
            
            
            115,529
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            127,013Balance,
      December 31, 2006
            
            
            
            
            
            
            18,850,026
            
            
            
            22,498,904
            
            
            
            65,856,627
            
            
            
            -
            
            
            
            5,717,755
            
            
            
            112,923,312Comprehensive
      income:Net
      income
            
            $
            11,009,102
            
            
            
            -
            
            
            
            -
            
            
            
            11,009,102
            
            
            
            -
            
            
            
            -
            
            
            
            11,009,102Other
      comprehensive income, unrealized losses on securities, net of
      reclassification adjustment, net of tax benefit
            
            
            (3,828,099
            )
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            (3,828,099
            )
            
            
            (3,828,099
            )Total
      comprehensive income
            
            $
            7,181,003Cash
      dividends declared, $1.08 per share
            
            
            
            
            
            
            -
            
            
            
            -
            
            
            
            (10,182,713
            )
            
            
            -
            
            
            
            -
            
            
            
            (10,182,713
            )Sale
      of 4,567 shares of common stock
            
            
            
            
            
            
            9,134
            
            
            
            89,787
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            98,921Balance,
      December 31, 2007
            
            
            
            
            
            $
            18,859,160
            
            
            $
            22,588,691
            
            
            $
            66,683,016
            
            
            $
            -
            
            
            $
            1,889,656
            
            
            $
            110,020,523





See Notes
to Consolidated Financial Statements.


67
 Table of Contents





AMES
      NATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF CASH FLOWSYears
      Ended December 31, 2007, 2006 and 20052007
            
            
            2006
            
            
            2005CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income
            
            $
            11,009,102
            
            
            $
            10,943,617
            
            
            $
            11,608,535Adjustments
      to reconcile net income to net cash provided by operating
      activities:Provision
      (credit) for loan losses
            
            
            (94,100
            )
            
            
            (182,686
            )
            
            
            331,282Amortization
      and accretion
            
            
            (244,069
            )
            
            
            131,704
            
            
            
            478,244Depreciation
            
            
            1,086,400
            
            
            
            973,257
            
            
            
            915,213Provision
      for deferred taxes
            
            
            130,978
            
            
            
            107,200
            
            
            
            (226,170
            )Securities
      gains, net
            
            
            (1,466,697
            )
            
            
            (1,135,136
            )
            
            
            (795,778
            )Change
      in assets and liabilities:Decrease
      (increase) in loans held for sale
            
            
            181,029
            
            
            
            455,281
            
            
            
            (675,561
            )Increase
      in accrued income receivable
            
            
            (151,535
            )
            
            
            (1,237,570
            )
            
            
            (371,371
            )Increase
      in other assets
            
            
            (85,743
            )
            
            
            (798,438
            )
            
            
            (1,022,681
            )Increase
      (decrease) in accrued expenses and other liabilities
            
            
            398,363
            
            
            
            1,798,232
            
            
            
            (770,194
            )Net
      cash provided by operating activities
            
            
            10,763,728
            
            
            
            11,055,461
            
            
            
            9,471,519CASH
      FLOWS FROM INVESTING ACTIVITIESPurchase
      of securities available-for-sale
            
            
            (88,955,529
            )
            
            
            (69,015,999
            )
            
            
            (59,049,297
            )Proceeds
      from sale of securities available-for-sale
            
            
            23,445,749
            
            
            
            6,013,192
            
            
            
            24,937,433Proceeds
      from maturities and calls of securities available-for-sale
            
            
            75,773,995
            
            
            
            46,795,165
            
            
            
            57,750,361Net
      decrease in interest bearing deposits in financial
      institutions
            
            
            909,693
            
            
            
            4,439,236
            
            
            
            3,591,632Net
      decrease (increase) in federal funds sold
            
            
            7,600,000
            
            
            
            (12,800,000
            )
            
            
            19,565,000Net
      decrease (increase) in loans
            
            
            (34,434,359
            )
            
            
            11,377,830
            
            
            
            (29,081,652
            )Purchase
      of bank premises and equipment, net
            
            
            (1,915,524
            )
            
            
            (2,560,158
            )
            
            
            (3,155,417
            )Net
      cash provided by (used in) investing activities
            
            
            (17,575,975
            )
            
            
            (15,750,734
            )
            
            
            14,558,060CASH
      FLOWS FROM FINANCING ACTIVITIESIncrease
      in deposits
            
            
            9,762,322
            
            
            
            12,014,138
            
            
            
            10,166,496Increase
      (decrease) in federal funds purchased and securities sold under agreements
      to repurchase
            
            
            (4,694,576
            )
            
            
            67,914
            
            
            
            (29,412,492
            )Proceeds
      from other borrowings, net
            
            
            21,267,304
            
            
            
            608,986
            
            
            
            2,861,130Dividends
      paid
            
            
            (10,087,229
            )
            
            
            (9,704,835
            )
            
            
            (8,599,597
            )Proceeds
      from issuance of stock
            
            
            98,921
            
            
            
            127,013
            
            
            
            287,937Net
      cash provided by (used in) financing activities
            
            
            16,346,742
            
            
            
            3,113,216
            
            
            
            (24,696,526
            )Net
      increase (decrease) in cash and cash equivalents
            
            
            9,534,495
            
            
            
            (1,582,057
            )
            
            
            (666,947
            )CASH AND
      DUE FROM BANKSBeginning
            
            
            16,510,082
            
            
            
            18,092,139
            
            
            
            18,759,086Ending
            
            $
            26,044,577
            
            
            $
            16,510,082
            
            
            $
            18,092,139





(Continued)


68
 Table of Contents





AMES
      NATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED
      STATEMENTS OF CASH FLOWS (Continued)Years
      Ended December 31, 2007, 2006 and 2005


2007
            
            
            2006
            
            
            2005SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATIONCash
      payments for:Interest
            
            $
            23,456,721
            
            
            $
            21,064,363
            
            
            $
            15,154,109Income
      taxes
            
            
            3,691,664
            
            
            
            3,461,781
            
            
            
            3,979,665




See Notes
to Consolidated Financial Statements.


69
 Table of Contents


Notes
to Consolidated Financial Statements







Note
      1.
            Summary
      of Significant Accounting Policies




Description of
business:  Ames National Corporation and subsidiaries (the
Company) operates in the commercial banking industry through its subsidiaries in
Ames, Boone, Story City, Nevada and Marshalltown, Iowa.  Loan and
deposit customers are located primarily in Story, Boone, Hamilton and Marshall
Counties and adjacent counties in Iowa.





Segment
information:  The Company uses the “management approach” for
reporting information about segments in annual and interim financial
statements.  The management approach is based on the way the chief
operating decision-maker organizes segments within a company for making
operating decisions and assessing performance.  Based on the
“management approach” model, the Company has determined that its business is
comprised of one operating segment: banking.  The banking segment
generates revenues through personal, business, agricultural and commercial
lending, management of the investment securities portfolio, providing deposit
account services and providing trust services.





Consolidation:  The
consolidated financial statements include the accounts of Ames National
Corporation (the Parent Company) and its wholly-owned subsidiaries, First
National Bank, Ames, Iowa; State Bank & Trust Co., Nevada, Iowa; Boone Bank
& Trust Co., Boone, Iowa; Randall-Story State Bank, Story City, Iowa; and
United Bank & Trust NA, Marshalltown, Iowa (collectively, the
Banks).  All significant intercompany transactions and balances have
been eliminated in consolidation.





Use of
estimates:  The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period.  Actual results
could differ from those estimates.  Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses and fair value of financial
instruments.





Cash and cash
equivalents:  For purposes of reporting cash flows, cash and
cash equivalents include cash on hand and amounts due from banks.  The
Company reports net cash flows for customer loan transactions, deposit
transactions and short-term borrowings with maturities of 90 days or
less.





Securities
available-for-sale:  The Company classifies all securities as
available for sale.  Available for sale securities are those the
Company may decide to sell if needed for liquidity, asset-liability management
or other reasons.  Available for sale securities are reported at fair
value, with net unrealized gains and losses reported as other comprehensive
income or loss and as a separate component of stockholders’ equity, net of
tax.





Gains and
losses on the sale of securities are determined using the specific
identification method based on amortized cost and are reflected in results of
operation at the time of sale.  Interest and dividend income, adjusted
by amortization of purchase premium or discount over the estimated life of the
security using the level yield method, is included in income as
earned.





Declines
in the fair value of available for sale securities below their cost that are
deemed to be other-than-temporary are reflected in earnings as realized
losses.  In estimating other-than-temporary impairment losses,
management considers (1) the length of time and the extent to which the fair
value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Company to retain
its investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value.


70
 Table of Contents


Loans held for
sale:  Loans held for sale are the loans the Banks have the
intent to sell in the foreseeable future.  They are carried at the
lower of aggregate cost or market value.  Net unrealized losses, if
any, are recognized through a valuation allowance by charges to
income.  Gains and losses on sales of loans are recognized at
settlement dates and are determined by the difference between the sale proceeds
and the carrying value of the loans.





Loans:  Loans
are stated at the principal amount outstanding, net of deferred loan fees and
the allowance for loan losses.  Interest on loans is credited to
income as earned based on the principal amount outstanding.  The
Banks’ policy is to discontinue the accrual of interest income on any loan 90
days or more past due unless the loans are well collateralized and in the
process of collection.  Income on nonaccrual loans is subsequently
recognized only to the extent that cash payments are received. Nonaccrual loans
are returned to an accrual status when, in the opinion of management, the
financial position of the borrower indicates there is no longer any reasonable
doubt as to timely payment of principal or interest.





Allowance for loan
losses:  The allowance for loan losses is maintained at a level
deemed appropriate by management to provide for known and inherent risks in the
loan portfolio.  The allowance is based upon a continuing review of
past loan loss experience, current economic conditions, the underlying
collateral value securing the loans and other adverse situations that may affect
the borrower’s ability to repay.  Loans which are deemed to be
uncollectible are charged off and deducted from the
allowance.  Recoveries on loans charged-off and the provision for loan
losses are added to the allowance.  This evaluation is inherently
subjective and requires estimates that are susceptible to significant revisions
as more information becomes available.





The
allowance consists primarily of specific and general/unallocated
components.  The specific component relates to loans that are
classified either as doubtful, substandard or special mention and meet the
definition of impaired.  For impaired loans, an allowance is
established when the discounted cash flows (or collateral value or observable
market price) of the impaired loan is lower than the carrying value of that
loan.  The general component covers the remaining loans and is based
on historical loss experience adjusted for qualitative factors, including
internal factors such as remaining classified loan volume, delinquency trends of
the loan portfolios and loan growth.  External environmental factors
considered include the current state of the overall collateral values and other
economic factors as identified.  The unallocated component of the
allowance will also provide a margin for the imprecision inherent in the
methodologies utilized in the estimation of the allowance.





A loan is
considered impaired when, based on current information and events, it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement.  Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due.  Smaller balance
homogeneous loans are evaluated for impairment in total.  Such loans
include residential first mortgage loans secured by one-to-four family
residences, residential construction loans, and automobile
loans.  Commercial and agricultural loans and mortgage loans secured
by other properties are evaluated individually for impairment when analysis of
borrower operating results and financial condition indicates that underlying
cash flows of the borrower’s business are not adequate to meet its debt service
requirements.  Often this is associated with a delay or shortfall in
payments of 90 days or more.  Nonaccrual loans are often also
considered impaired.  Impaired loans, or portions thereof, are charged
off when deemed uncollectible.


71
 Table of Contents


Premises and
equipment:  Premises and equipment are stated at cost less
accumulated depreciation.  Depreciation expense is computed using
straight-line and accelerated methods over the estimated useful lives of the
respective assets.  Depreciable lives range from 3 to 7 years for
equipment and 15 to 39 years for premises.





Trust department
assets:  Property held for customers in fiduciary or agency
capacities is not included in the accompanying consolidated balance sheets, as
such items are not assets of the Banks.





Income
taxes:  Deferred income taxes are provided on temporary
differences between financial statement and income tax
reporting.  Temporary differences are differences between the amounts
of assets and liabilities reported for financial statement purposes and their
tax bases.  Deferred tax assets are recognized for temporary
differences that will be deductible in future years’ tax returns and for
operating loss and tax credit carryforwards.  Deferred tax assets are
reduced by a valuation allowance if it is deemed more likely than not that some
or all of the deferred tax assets will not be realized.  Deferred tax
liabilities are recognized for temporary differences that will be taxable in
future years’ tax returns.  Benefits from tax positions taken or
expected to be taken in a tax return are not recognized if the likelihood that
the tax position would be sustained upon examination by a taxing authority is
considered to be 50 percent or less.





The
Company files a consolidated federal income tax return, with each entity
computing its taxes on a separate company basis.  For state tax
purposes, the Banks file franchise tax returns, while the Parent Company files a
corporate income tax return.





On
January 1, 2007, the Company adopted the provisions of Financial Accounting
Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income
Taxes(FIN 48).  The Company believes that the adoption and
application of FIN 48 was not significant to the 2007 consolidated financial
statements.  The Company has adopted the policy of classifying
interest and penalties as income tax expense.





Comprehensive
income:  Accounting principles generally require that
recognized revenue, expenses, gains and losses be included in net
income.  Although certain changes in assets and liabilities, such as
unrealized gains and losses on available-for-sale securities, are reported as a
separate component of the stockholders’ equity section of the consolidated
balance sheet, such items, along with net income, are components of
comprehensive income.  Gains and losses on available-for-sale
securities are reclassified to net income as the gains or losses are realized
upon sale of the securities.  Other-than-temporary impairment charges
are reclassified to net income at the time of the charge.





Financial instruments with
off-balance-sheet risk:  The Company, in the normal course of
business, makes commitments to make loans which are not reflected in the
consolidated financial statements.  A summary of these commitments is
disclosed in Note 10.





Transfers of financial
assets:  Transfers of financial assets are accounted for as
sales, when control over the assets has been surrendered.  Control
over transferred assets is deemed to be surrendered when (1) the assets have
been isolated from the Company, (2) the transferee obtains the right (free of
conditions that constrain it from taking advantage of that right) to pledge or
exchange the transferred assets, and (3) the Company does not maintain effective
control over the transferred assets through an agreement to repurchase them
before their maturity.





Fair value of financial
instruments:  The following methods and assumptions were used
by the Company in estimating fair value disclosures:


72
 Table of Contents


Cash and due from banks,
federal funds sold and interest-bearing deposits in financial
institutions:  The recorded amount of these assets approximates
fair value.





Securities
available-for-sale:  Fair values of securities
available-for-sale are based on bid prices published in financial newspapers,
bid quotations received from securities dealers, or quoted market prices of
similar instruments, adjusted for differences between the quoted instruments and
the instruments being valued.





Loans held for
sale:  The fair value of loans held for sale is based on
prevailing market prices.





Loans:  The
fair value of loans is calculated by discounting scheduled cash flows through
the estimated maturity using estimated market discount rates, which reflect the
credit and interest rate risk inherent in the loan.  The estimate of
maturity is based on the historical experience, with repayments for each loan
classification modified, as required, by an estimate of the effect of current
economic and lending conditions.  The effect of nonperforming loans is
considered in assessing the credit risk inherent in the fair value
estimate.





Deposit
liabilities:  Fair values of deposits with no stated maturity,
such as noninterest-bearing demand deposits, savings and NOW accounts, and money
market accounts, are equal to the amount payable on demand as of the respective
balance sheet date.  Fair values of certificates of deposit are based
on the discounted value of contractual cash flows.  The discount rate
is estimated using the rates currently offered for deposits of similar remaining
maturities.  The fair value estimates do not include the benefit that
results from the low-cost funding provided by the deposit liabilities compared
to the cost of borrowing funds in the market.





Other short-term
borrowings:  The carrying amounts of other short-term
borrowings approximate fair value because of the generally short-term nature of
the instruments.





Long-term
borrowings:Fair
values of long-term borrowings are estimated using discounted cash flow analysis
based on interest rates currently being offered with similar terms.





Accrued income receivable
and accrued interest payable:  The carrying amounts of accrued
income receivable and interest payable approximate fair value.





Commitments to extend credit
and standby letters of credit:  The fair values of commitments
to extend credit and standby letters of credit are based on fees currently
charged to enter into similar agreements, taking into account the remaining
terms of the agreement and credit worthiness of the
counterparties.  The carry value and fair value of the commitments to
extend credit and standby letters of credit are not considered
significant.





Limitations:  Fair
value estimates are made at a specific point in time, based on relevant market
information and information about the financial instrument.  Because
no market exists for a significant portion of the Company’s financial
instruments, fair value estimates are based on judgments regarding future
expected loss experience, current economic conditions, risk characteristics of
various financial instruments, and other factors.  These estimates are
subjective in nature and involve uncertainties and matters of significant
judgment and, therefore, cannot be determined with precision.  Changes
in assumptions could significantly affect the estimates.


73
 Table of Contents


Earnings per
share:  Basic earnings per share computations for the years
ended December 31, 2007, 2006 and 2005, were determined by dividing net income
by the weighted-average number of common shares outstanding during the years
then ended.  The Company had no potentially dilutive securities
outstanding during the periods presented.





The
following information was used in the computation of basic earnings per share
for the years ended December 31, 2007, 2006, and 2005.





2007
            
            
            2006
            
            
            2005Basic
      earning per share computation:Net
      income
            
            $
            11,009,102
            
            
            $
            10,943,617
            
            
            $
            11,608,535Weighted
      average common shares
      outstanding
            
            
            9,427,503
            
            
            
            9,422,402
            
            
            
            9,415,599Basic
      EPS
            
            $
            1.17
            
            
            $
            1.16
            
            
            $
            1.23








Stock
Split:On June
15, 2005, shareholders of the Company approved an amendment to the Restated
Articles of Incorporation increasing the Company’s authorized common stock from
6 million to 18 million shares and reducing the par value of such common stock
from $5.00 to $2.00 per share.  The purpose of the amendment was to
provide a sufficient number of shares of authorized common stock to accommodate
a 3-for-1 stock split previously approved by the Board of Directors of the
Company on May 11, 2005.  The stock split was effective July 15, 2005
for holders of record as of July 1, 2005.  Share and per share data
for all periods presented have been restated to reflect the stock
split.





New Accounting
Pronouncements:  The following new accounting pronouncements
may affect future financial reporting by the Company:




In
September 2006, the FASB issued Statement No. 157 (SFAS No. 157), Fair Value Measurements. SFAS
No. 157 defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles, and expands disclosures about fair
value measurements. SFAS No. 157 applies to other accounting pronouncements that
require or permit fair value measurements and does not require any new fair
value measurements. SFAS No. 157 is effective for fiscal years beginning after
November 15, 2007 generally for financial assets and liabilities, and is
effective for fiscal years beginning after November 15, 2008 generally for
non-financial assets and liabilities. The Company does not expect that the
adoption of SFAS No. 157 will have a material effect on its financial position
or results of operations.




In
February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (SFAS No. 159). SFAS No. 159 permits
entities to choose to measure many financial instruments and certain other items
at fair value that are not currently required to be measured at fair value.
Subsequent unrealized gains and losses on items for which the fair value option
has been elected will be reported in earnings. The provisions of SFAS No. 159
are effective for financial statements issued for fiscal years beginning after
November 15, 2007. The Company is evaluating if it will adopt the fair value
option of SFAS No. 159 and what impact the adoption will have on the
consolidated financial statements if adopted.







Note
      2.
            Restrictions
      on Cash and Due from Banks




The
Federal Reserve Bank requires member banks to maintain certain cash and due from
bank reserves.  The subsidiary banks’ reserve requirements totaled
approximately $2,665,000 and $2,847,000 at December 31, 2007 and 2006,
respectively.


74
 Table of Contents




Note
      3.
            Debt
      and Equity Securities




The
amortized cost of securities available for sale and their approximate fair
values are summarized below:








Gross
            
            
            GrossAmortized
            
            
            Unrealized
            
            
            Unrealized
            
            
            EstimatedCost
            
            
            Gains
            
            
            Losses
            
            
            Fair
      Value2007:U.S.
      treasury
            
            $
            497,277
            
            
            $
            26,883
            
            
            $
            -
            
            
            $
            524,160U.S.
      government agencies
            
            
            94,500,440
            
            
            
            1,207,999
            
            
            
            (111,206
            )
            
            
            95,597,233U.S.
      government mortgage-backed securities
            
            
            27,064,931
            
            
            
            27,833
            
            
            
            (215,392
            )
            
            
            26,877,372State
      and political subdivisions
            
            
            132,698,746
            
            
            
            963,002
            
            
            
            (379,397
            )
            
            
            133,282,351Corporate
      bonds
            
            
            65,455,863
            
            
            
            527,546
            
            
            
            (1,030,111
            )
            
            
            64,953,298Equity
      securities
            
            
            16,725,353
            
            
            
            3,326,847
            
            
            
            (1,344,550
            )
            
            
            18,707,650$
            336,942,610
            
            
            $
            6,080,110
            
            
            $
            (3,080,656
            )
            
            $
            339,942,064








Gross
            
            
            GrossAmortized
            
            
            Unrealized
            
            
            Unrealized
            
            
            EstimatedCost
            
            
            Gains
            
            
            Losses
            
            
            Fair
      Value2006:U.S.
      treasury
            
            $
            496,493
            
            
            $
            12,199
            
            
            $
            -
            
            
            $
            508,692U.S.
      government agencies
            
            
            124,156,765
            
            
            
            451,183
            
            
            
            (1,415,960
            )
            
            
            123,191,988U.S.
      government mortgage-backed securities
            
            
            17,027,697
            
            
            
            16,233
            
            
            
            (491,241
            )
            
            
            16,552,689State
      and political subdivisions
            
            
            119,698,521
            
            
            
            969,283
            
            
            
            (759,686
            )
            
            
            119,908,118Corporate
      bonds
            
            
            60,204,400
            
            
            
            853,289
            
            
            
            (433,822
            )
            
            
            60,623,867Equity
      securities
            
            
            23,912,185
            
            
            
            9,914,125
            
            
            
            (39,800
            )
            
            
            33,786,510$
            345,496,061
            
            
            $
            12,216,312
            
            
            $
            (3,140,509
            )
            
            $
            354,571,864


75
 Table of Contents


The
amortized cost and estimated fair value of debt securities available-for-sale as
of December 31, 2007, are shown below by contractual
maturity.  Expected maturities will differ from contractual maturities
because issuers may have the right to call or prepay obligations with or without
call or prepayment penalties.





Amortized
            
            
            EstimatedCost
            
            
            Fair
      ValueDue
      in one year or less
            
            $
            60,466,254
            
            
            $
            60,275,160Due
      after one year through five years
            
            
            114,175,977
            
            
            
            115,247,320Due
      after five years through ten years
            
            
            121,075,039
            
            
            
            121,180,900Due
      after ten years
            
            
            24,499,987
            
            
            
            24,531,034320,217,257
            
            
            
            321,234,414Equity
      securities
            
            
            16,725,353
            
            
            
            18,707,650$
            336,942,610
            
            
            $
            339,942,064





At
December 31, 2007 and 2006, securities with a carrying value of approximately
$148,124,970 and $163,497,000, respectively, were pledged as collateral on
public deposits, securities sold under agreements to repurchase and for other
purposes as required or permitted by law.  Securities sold under
agreements to repurchase are held by the Company’s safekeeping
agent.





For the
years ended December 31, 2007, 2006, and 2005, proceeds from sales of
available-for-sale securities amounted to $23,445,749, $6,013,192, and
$24,937,433, respectively.  Gross realized gains and gross realized
losses on sales of available-for-sale securities were $4,369,185 and $2,902,488,
respectively, in 2007, $1,333,136 with no losses, respectively, in 2006, and
$1,287,962 and $236,182, respectively, in 2005.  The tax provision
applicable to the net realized gains and losses amounted to approximately
$587,000, $454,000, and $318,000, respectively.  Other-than-temporary
impairments recognized as a component of income were $0 in 2007, $198,000 in
2006, and $256,000 in 2005.





The
components of other comprehensive income (loss) - net unrealized gains (losses)
on securities available-for-sale for the years ended December 31, 2007, 2006,
and 2005, were as follows:





2007
            
            
            2006
            
            
            2005Unrealized
      holding gains (losses) arising during the period
            
            $
            (4,609,651
            )
            
            $
            4,985,773
            
            
            $
            (5,832,566
            )Reclassification
      adjustment for net gains realized in net income
            
            
            (1,466,697
            )
            
            
            (1,135,136
            )
            
            
            (795,780
            )Net
      unrealized gains (losses) before tax effect
            
            
            (6,076,348
            )
            
            
            3,850,637
            
            
            
            (6,628,346
            )Tax
      effect
            
            
            2,248,249
            
            
            
            (1,424,736
            )
            
            
            2,452,488Other
      comprehensive income -Net unrealized gains (losses)on
      securities
            
            $
            (3,828,099
            )
            
            $
            2,425,901
            
            
            $
            (4,175,858
            )


76
 Table of Contents


Unrealized
losses and fair value, aggregated by investment category and length of time that
individual securities have been in a continuous unrealized loss position are
summarized as follows:





Less
      than 12 Months
            
            
            12
      Months or More
            
            
            TotalFair
            
            
            Unrealized
            
            
            Fair
            
            
            Unrealized
            
            
            Fair
            
            
            UnrealizedValue
            
            
            Losses
            
            
            Value
            
            
            Losses
            
            
            Value
            
            
            Losses2007:Securities
      available for sale:U.S.
      government agencies
            
            $
            2,497,127
            
            
            $
            (2,873
            )
            
            $
            22,807,372
            
            
            $
            (108,334
            )
            
            $
            25,304,499
            
            
            $
            (111,207
            )U.S.
      government mortgage- backed securities
            
            
            12,696,160
            
            
            
            (71,106
            )
            
            
            8,706,270
            
            
            
            (144,286
            )
            
            
            21,402,430
            
            
            
            (215,392
            )State
      and political subsidivisions
            
            
            14,067,294
            
            
            
            (84,174
            )
            
            
            26,526,618
            
            
            
            (295,222
            )
            
            
            40,593,912
            
            
            
            (379,396
            )Corporate
      obligations
            
            
            21,577,269
            
            
            
            (786,802
            )
            
            
            14,392,174
            
            
            
            (243,309
            )
            
            
            35,969,443
            
            
            
            (1,030,111
            )Equity
      securities
            
            
            6,336,950
            
            
            
            (1,344,550
            )
            
            
            -
            
            
            
            -
            
            
            
            6,336,950
            
            
            
            (1,344,550
            )$
            57,174,800
            
            
            $
            (2,289,505
            )
            
            $
            72,432,434
            
            
            $
            (791,151
            )
            
            $
            129,607,234
            
            
            $
            (3,080,656
            )






Less
      than 12 Months
            
            
            12
      Months or More
            
            
            TotalFair
            
            
            Unrealized
            
            
            Fair
            
            
            Unrealized
            
            
            Fair
            
            
            UnrealizedValue
            
            
            Losses
            
            
            Value
            
            
            Losses
            
            
            Value
            
            
            Losses2006:Securities
      available for sale:U.S.
      government agencies
            
            $
            5,314,107
            
            
            $
            (19,792
            )
            
            $
            83,914,199
            
            
            $
            (1,396,168
            )
            
            $
            89,228,306
            
            
            $
            (1,415,960
            )U.S.
      government mortgage- backed securities
            
            
            187
            
            
            
            -
            
            
            
            15,709,012
            
            
            
            (491,241
            )
            
            
            15,709,199
            
            
            
            (491,241
            )State
      and political subsidivisions
            
            
            13,580,743
            
            
            
            (51,720
            )
            
            
            39,705,322
            
            
            
            (707,966
            )
            
            
            53,286,065
            
            
            
            (759,686
            )Corporate
      obligations
            
            
            1,964,337
            
            
            
            (29,997
            )
            
            
            23,139,560
            
            
            
            (403,825
            )
            
            
            25,103,897
            
            
            
            (433,822
            )Equity
      securities
            
            
            960,200
            
            
            
            (39,800
            )
            
            
            -
            
            
            
            -
            
            
            
            960,200
            
            
            
            (39,800
            )$
            21,819,574
            
            
            $
            (141,309
            )
            
            $
            162,468,093
            
            
            $
            (2,999,200
            )
            
            $
            184,287,667
            
            
            $
            (3,140,509
            )




At
December 31, 2007, 280 debt securities have unrealized losses of
$1,736,106.  These unrealized losses are generally due to changes in
interest rates or general market conditions.  In analyzing an issuers’
financial condition, management considers whether the securities are issued by
the federal government or its agencies, whether downgrades by bond rating
agencies have occurred, and industry analysts’ reports.  Unrealized
losses on equity securities totaled $1,344,550 as of December 31,
2007.  Management analyzed the financial condition of the equity
issuers and considered the general market conditions and other factors in
concluding that the unrealized losses on equity securities were not other than
temporary.


77
 Table of Contents







Note
      4.
            Loans
      Receivable




The
composition of loans receivable is as follows:





2007
            
            
            2006Commercial
      and agricultural
            
            $
            114,748,926
            
            
            $
            107,193,787Real
      estate - mortgage
            
            
            285,468,860
            
            
            
            273,861,154Real
      estate - construction
            
            
            46,568,105
            
            
            
            30,599,880Consumer
            
            
            9,472,218
            
            
            
            11,834,070Other
            
            
            13,310,271
            
            
            
            12,442,698469,568,380
            
            
            
            435,931,589Less:Allowance
      for loan losses
            
            
            (5,780,678
            )
            
            
            (6,532,617
            )Deferred
      loan fees
            
            
            (136,702
            )
            
            
            (276,431
            )$
            463,651,000
            
            
            $
            429,122,541





Changes
in the allowance for loan losses are as follows:





2007
            
            
            2006
            
            
            2005Balance,
      beginning
            
            $
            6,532,617
            
            
            $
            6,765,356
            
            
            $
            6,475,530Provision
      (credit) for loan losses
            
            
            (94,100
            )
            
            
            (182,686
            )
            
            
            331,282Recoveries
      of loans charged-off
            
            
            68,802
            
            
            
            55,055
            
            
            
            105,400Loans
      charged-off
            
            
            (726,641
            )
            
            
            (105,108
            )
            
            
            (146,856
            )Balance,
      ending
            
            $
            5,780,678
            
            
            $
            6,532,617
            
            
            $
            6,765,356




Loans are
made in the normal course of business to certain directors and executive
officers of the Company and to their affiliates.  The terms of these
loans, including interest rates and collateral, are similar to those prevailing
for comparable transactions with others and do not involve more than a normal
risk of collectibility.  Loan transactions with related parties were
as follows:





2007
            
            
            2006Balance,
      beginning of year
            
            $
            22,100,213
            
            
            $
            28,505,102New
      loans
            
            
            20,355,673
            
            
            
            9,804,923Repayments
            
            
            (18,259,135
            )
            
            
            (12,961,377
            )Change
      in status
            
            
            (10,131,626
            )
            
            
            (3,248,435
            )Balance,
      end of year
            
            $
            14,065,125
            
            
            $
            22,100,213


78
 Table of Contents


At
December 31, 2007 and 2006, the Company had impaired loans of approximately
$5,485,000 and $1,049,000, respectively.  The allowance for loan
losses related to these impaired loans was approximately $247,000 and $142,000
at December 31, 2007 and 2006, respectively.  The average balances of
impaired loans for the years ended December 31, 2007, 2006, and 2005 were
$2,486,000, $1,729,000, and $1,645,000 respectively.  For the years
ended December 31, 2007, 2006, and 2005, interest income, which would have been
recorded under the original terms of such loans, was approximately $346,000,
$42,000, and $41,000, respectively, with $180,000, $1,000, and $0, respectively,
recorded.  Loans greater than 90 days past due and still accruing
interest were approximately $1,300,000 and $758,000 at December 31, 2007 and
2006, respectively.  There are no other potential problem loans that
cause management to have serious doubts as to the ability of such borrowers to
comply with the present loan repayment terms.





The
amount the Company will ultimately realize from these loans could differ
materially from their carrying value because of future developments affecting
the underlying collateral or the borrowers’ ability to repay the
loans.  As of December 31, 2007, there were no material commitments to
lend additional funds to customers whose loans were classified as
impaired.







Note
      5.
            Bank
      Premises and Equipment




The major
classes of bank premises and equipment and the total accumulated depreciation
are as follows:





2007
            
            
            2006Land
            
            $
            2,426,383
            
            
            $
            3,032,448Buildings
      and improvements
            
            
            14,534,553
            
            
            
            12,622,808Furniture
      and equipment
            
            
            7,029,181
            
            
            
            6,522,48723,990,117
            
            
            
            22,177,743Less
      accumulated depreciation
            
            
            10,543,252
            
            
            
            9,560,002$
            13,446,865
            
            
            $
            12,617,741







Note
      6.
            Deposits




At
December 31, 2007, the maturities of time deposits are as follows:





2008
            
            $
            209,051,0472009
            
            
            44,480,8182010
            
            
            23,312,1272011
            
            
            4,540,7342012
            
            
            5,072,897Thereafter
            
            
            58,307$
            286,515,930


79
 Table of Contents


Interest
expense on deposits is summarized as follows:





2007
            
            
            2006
            
            
            2005NOW
      accounts
            
            $
            2,050,655
            
            
            $
            2,362,608
            
            
            $
            2,009,186Savings
      and money market
            
            
            5,683,264
            
            
            
            5,886,737
            
            
            
            3,745,885Time,
      $100,000 and over
            
            
            5,325,045
            
            
            
            4,421,595
            
            
            
            3,094,834Other
      time
            
            
            7,996,136
            
            
            
            7,071,439
            
            
            
            5,530,309$
            21,055,100
            
            
            $
            19,742,379
            
            
            $
            14,380,214





Deposits
from related parties held by the Company at December 31, 2007 and 2006 amounted
to approximately $12,000,000 and $9,400,000, respectively.







Note
      7.
            Borrowings




Federal
funds purchased are unsecured and mature daily.  Securities sold under
repurchase agreements are short-term and are secured by
investments.  Short-term borrowings as of December 31, 2007 and 2006
consisted of Treasury, Tax and Loan option notes secured by investment
securities.





At
December 31, 2007 and 2006, long-term borrowings consisted of the
following:





2007
            
            
            2006Amount
            
            
            Interest
      Rate
            
            
            Amount
            
            
            Interest
      RateFHLB
      advances maturing in:2009
            
            $
            2,000,000
            
            
            
            4.31
            %2010
            
            
            1,000,000
            
            
            
            5.01
            %
            
            $
            1,000,000
            
            
            
            5.01
            %2011
            
            
            1,000,000
            
            
            
            5.04
            %
            
            
            1,000,000
            
            
            
            5.04
            %Total
      FHLB advances
            
            $
            4,000,000
            
            
            
            4.67
            %
            
            $
            2,000,000
            
            
            
            4.67
            %Term
      repurchase agreements maturing in:2009
            
            $
            6,000,000
            
            
            
            4.40
            %
            
            
            -
            
            
            
            -2010
            
            
            7,000,000
            
            
            
            4.26
            %
            
            
            -
            
            
            
            -2012
            
            
            7,000,000
            
            
            
            4.09
            %
            
            
            -
            
            
            
            -Total
      term repurchase agreements
            
            $
            20,000,000
            
            
            
            4.24
            %
            
            
            -
            
            
            
            -Total
      long-term borrowings
            
            $
            24,000,000
            
            
            
            4.31
            %
            
            $
            2,000,000
            
            
            
            4.67
            %





Term
repurchase agreements are securities sold under agreement to repurchase, have
maturity dates greater than one year, and can be called by the issuing financial
institution on a quarterly basis after the expiration of the original lock-out
periods ranging from 3 to 12 months.  The final lock-out period
expires in September of 2008.





FHLB
borrowings are collateralized by certain 1-4 family residential real estate
loans and the short-term and term repurchase agreements are collateralized with
U.S. government agencies and mortgage-backed securities with a fair market value
of $56,520,000.  At December 31, 2007, the Banks had available
borrowings with the Federal Home Loan Bank of Des Moines, Iowa of
$42,551,000.


80
 Table of Contents




Note
      8.
            Employee
      Benefit Plans




The
Company has a stock purchase plan with the objective of encouraging equity
interests by officers, employees, and directors of the Company and its
subsidiaries to provide additional incentive to improve banking performance and
retain qualified individuals.  The purchase price of the shares is the
fair market value of the stock based upon current market trading
activity.  The terms of the plan provide for the issuance of up to
42,000 shares of common stock per year for a ten-year period commencing in 1999
and continuing through 2008.





The
Company has a qualified 401(k) profit-sharing plan.  The Company
matches employee contributions up to a maximum of 2% of qualified compensation
and also contributes an amount equal to 5% of the participating employee’s
compensation.  In addition, contributions can be made on a
discretionary basis by the Company on behalf of the employees.  For
the years ended December 31, 2007, 2006 and 2005, Company contributions to the
plan were approximately $613,000, $579,000, and $623,000,
respectively.  The plan covers substantially all
employees.







Note
      9.
            Income
      Taxes




The
components of income tax expense are as follows:





2007
            
            
            2006
            
            
            2005Federal:Current
            
            $
            2,726,253
            
            
            $
            2,633,706
            
            
            $
            3,282,266Deferred
            
            
            111,616
            
            
            
            90,186
            
            
            
            (202,533
            )2,837,869
            
            
            
            2,723,892
            
            
            
            3,079,733State:Current
            
            
            684,818
            
            
            
            658,497
            
            
            
            779,897Deferred
            
            
            19,362
            
            
            
            17,014
            
            
            
            (23,638
            )704,180
            
            
            
            675,511
            
            
            
            756,259Income
      tax expense
            
            $
            3,542,049
            
            
            $
            3,399,403
            
            
            $
            3,835,992


81
 Table of Contents


Total
income tax expense differed from the amounts computed by applying the U.S.
federal income tax rate of 35% to income before income taxes as a result of the
following:


2007
            
            
            2006
            
            
            2005Income
      taxes at 35% federal tax rate
            
            $
            5,092,903
            
            
            $
            5,020,058
            
            
            $
            5,405,585Increase
      (decrease) resulting from:Tax-exempt
      interest and dividends
            
            
            (1,942,031
            )
            
            
            (1,797,533
            )
            
            
            (1,860,143
            )State
      taxes, net of federal tax benefit
            
            
            435,391
            
            
            
            437,893
            
            
            
            460,694Other
            
            
            (44,214
            )
            
            
            (261,015
            )
            
            
            (170,144
            )Total
      income tax expense
            
            $
            3,542,049
            
            
            $
            3,399,403
            
            
            $
            3,835,992





The tax
effects of temporary differences that give rise to significant portions of the
deferred tax assets and deferred liabilities are as follows:





2007
            
            
            2006Deferred
      tax assets:Allowance
      for loan losses
            
            $
            1,639,108
            
            
            $
            1,921,102Other
      items
            
            
            770,441
            
            
            
            595,1682,409,549
            
            
            
            2,516,270Deferred
      tax liabilities:Net
      unrealized gains on securities available for sale
            
            
            (1,109,799
            )
            
            
            (3,358,048
            )Other
            
            
            (370,424
            )
            
            
            (346,170
            )(1,480,223
            )
            
            
            (3,704,218
            )Net
      deferred tax assets (liabilities)
            
            $
            929,326
            
            
            $
            (1,187,948
            )








At
December 31, 2007 and 2006, income taxes currently payable of approximately
$186,000 and $95,000, respectively, are included in accrued expenses and other
liabilities.





The
Company and its subsidiaries file one income tax return in the U.S. federal
jurisdiction and separate individual tax returns for the state of
Iowa.  The Company is no longer subject to U.S. federal income and
state tax examinations for years before 2003.




The
Company adopted the provisions of FASB FIN 48, Accounting for Uncertainty in Income
Taxes, on January 1, 2007.  Management has determined that the
Company has no material uncertain tax positions that would require recognition
under FIN 48.  The Company had no significant unrecognized tax
benefits as of December 31, 2007 that, if recognized, would affect the effective
tax rate.  The Company had recorded no accrued interest or penalties
as of or for the year ended December 31, 2007.  The Company had no
positions for which it deemed that it is reasonably possible that the total
amounts of the unrecognized tax benefit will significantly increase or decrease
within the 12 months of December 31, 2007.






Note
      10.
            Commitments,
      Contingencies and Concentrations of Credit
Risk




The
Company is party to financial instruments with off-balance-sheet risk in the
normal course of business.  These financial instruments include
commitments to extend credit and standby letters of credit.  These
instruments involve, to varying degrees, elements of credit risk in excess of
the amount recognized in the balance sheet.


82
 Table of Contents


The
Company’s exposure to credit loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amount of those
instruments.  The Company uses the same credit policies in making
commitments and conditional obligations as they do for on-balance-sheet
instruments.  A summary of the Company’s commitments is as
follows:




2007
            
            
            2006Commitments
      to extend credit
            
            $
            96,753,000
            
            
            $
            79,629,000Standby
      letters of credit
            
            
            1,021,000
            
            
            
            1,995,000$
            97,774,000
            
            
            $
            81,624,000





Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Since many of
the commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash
requirements.  The Banks evaluate each customer’s creditworthiness on
a case-by-case basis.  The amount of collateral obtained, if deemed
necessary by the Banks upon extension of credit, is based on management’s credit
evaluation of the party.





Standby
letters of credit are conditional commitments issued by the Banks to guarantee
the performance of a customer to a third-party.  Those guarantees are
primarily issued to support public and private borrowing
arrangements.  The credit risk involved in issuing letters of credit
is essentially the same as that involved in extending loan facilities to
customers.  Collateral held varies and is required in instances which
the Banks deem necessary.  In the event the customer does not perform
in accordance with the terms of the agreement with the third party, the Banks
would be required to fund the commitment.  The maximum potential
amount of future payments the Banks could be required to make is represented by
the contractual amount shown in the summary above.  If the commitments
were funded, the Banks would be entitled to seek recovery from the
customer.





At
December 31, 2007, the banks have established liabilities totalling $233,000 to
cover estimated credit losses for off-balance-sheet loan commitments and standby
letters of credit.  No liabilities had been recorded for these
estimated credit losses as of December 31, 2006.





In the
normal course of business, the Company is involved in various legal
proceedings.  In the opinion of management, any liability resulting
from such proceedings would not have a material adverse effect on the Company’s
financial statements.





Concentrations
of credit risk:  The Banks originate real estate, consumer, and
commercial loans, primarily in Story, Boone, Hamilton and Marshall Counties,
Iowa, and adjacent counties.  Although the Banks have diversified loan
portfolios, a substantial portion of their borrowers’ ability to repay loans is
dependent upon economic conditions in the Banks’ market areas.







Note
      11.
            Regulatory
      Matters




The
Company and its subsidiary banks are subject to various regulatory capital
requirements administered by the federal banking agencies.  Failure to
meet minimum capital requirements can initiate certain mandatory -and possible additional
discretionary -actions by
regulators that, if undertaken, could have a direct material effect on the
Company’s and Banks’ financial statements.  Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and the Banks must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities and certain off-balance-sheet
items as calculated under regulatory accounting practices.  The
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other
factors.  Prompt corrective action provisions are not applicable to
bank holding companies.


83
 Table of Contents


Quantitative
measures established by regulation to ensure capital adequacy require the
Company and each subsidiary bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined).  Management believes, as of
December 31, 2007 and 2006, that the Company and each subsidiary bank met all
capital adequacy requirements to which they are subject.


84
 Table of Contents


As of
December 31, 2007, the most recent notification from the federal banking
regulators categorized the subsidiary banks as well capitalized under the
regulatory framework for prompt corrective action.  To be categorized
as adequately capitalized, the Banks must maintain minimum total risk-based,
Tier I risk-based, and Tier I leverage ratios as set forth in the
table.  Management believes there are no conditions or events since
that notification that have changed the institution’s category.  The
Company’s and each of the subsidiary bank’s actual capital amounts and ratios as
of December 31, 2007 and 2006, are also presented in the table.





To
      Be WellCapitalized
      UnderFor
      Capital
            
            
            Prompt
      CorrectiveActual
            
            
            Adequacy
      Purposes
            
            
            Action
      ProvisionsAmount
            
            
            Ratio
            
            
            Amount
            
            
            Ratio
            
            
            Amount
            
            
            RatioAs
      of December 31, 2007:Total
      capital (to risk- weighted assets):Consolidated
            
            $
            113,020
            
            
            
            18.6
            %
            
            $
            48,618
            
            
            
            8.0
            %
            
            
            N/A
            
            
            
            N/ABoone
      Bank & Trust
            
            
            13,222
            
            
            
            17.0
            
            
            
            6,234
            
            
            
            8.0
            
            
            $
            7,792
            
            
            
            10.0
            %First
      National Bank
            
            
            43,796
            
            
            
            14.2
            
            
            
            24,601
            
            
            
            8.0
            
            
            
            30,751
            
            
            
            10.0Randall-Story
      State Bank
            
            
            8,680
            
            
            
            14.5
            
            
            
            4,795
            
            
            
            8.0
            
            
            
            5,994
            
            
            
            10.0State
      Bank & Trust
            
            
            12,552
            
            
            
            14.6
            
            
            
            6,865
            
            
            
            8.0
            
            
            
            8,581
            
            
            
            10.0United
      Bank & Trust
            
            
            9,474
            
            
            
            13.7
            
            
            
            5,547
            
            
            
            8.0
            
            
            
            6,933
            
            
            
            10.0Tier
      1 capital (to risk- weighted assets):Consolidated
            
            $
            107,239
            
            
            
            17.6
            %
            
            $
            24,309
            
            
            
            4.0
            %
            
            
            N/A
            
            
            
            N/ABoone
      Bank & Trust
            
            
            12,383
            
            
            
            15.9
            
            
            
            3,117
            
            
            
            4.0
            
            
            $
            4,675
            
            
            
            6.0
            %First
      National Bank
            
            
            41,006
            
            
            
            13.3
            
            
            
            12,300
            
            
            
            4.0
            
            
            
            18,450
            
            
            
            6.0Randall-Story
      State Bank
            
            
            8,058
            
            
            
            13.4
            
            
            
            2,398
            
            
            
            4.0
            
            
            
            3,596
            
            
            
            6.0State
      Bank & Trust
            
            
            11,690
            
            
            
            13.6
            
            
            
            3,432
            
            
            
            4.0
            
            
            
            5,149
            
            
            
            6.0United
      Bank & Trust
            
            
            8,606
            
            
            
            12.4
            
            
            
            2,773
            
            
            
            4.0
            
            
            
            4,160
            
            
            
            6.0Tier
      1 capital (to average- weighted assets):Consolidated
            
            $
            107,239
            
            
            
            12.6
            %
            
            $
            33,963
            
            
            
            4.0
            %
            
            
            N/A
            
            
            
            N/ABoone
      Bank & Trust
            
            
            12,383
            
            
            
            12.6
            
            
            
            3,945
            
            
            
            4.0
            
            
            $
            4,931
            
            
            
            5.0
            %First
      National Bank
            
            
            41,006
            
            
            
            9.3
            
            
            
            17,668
            
            
            
            4.0
            
            
            
            22,085
            
            
            
            5.0Randall-Story
      State Bank
            
            
            8,058
            
            
            
            11.3
            
            
            
            2,861
            
            
            
            4.0
            
            
            
            3,576
            
            
            
            5.0State
      Bank & Trust
            
            
            11,690
            
            
            
            10.6
            
            
            
            4,425
            
            
            
            4.0
            
            
            
            5,531
            
            
            
            5.0United
      Bank & Trust
            
            
            8,606
            
            
            
            8.1
            
            
            
            4,275
            
            
            
            4.0
            
            
            
            5,343
            
            
            
            5.0


85
 Table of Contents





To
      Be WellCapitalized
      UnderFor
      Capital
            
            
            Prompt
      CorrectiveActual
            
            
            Adequacy Purposes
            
            
            Action ProvisionsAmount
            
            
            Ratio
            
            
            Amount
            
            
            Ratio
            
            
            Amount
            
            
            RatioAs
      of December 31, 2006:Total
      capital (to risk- weighted assets):Consolidated
            
            $
            113,738
            
            
            
            18.8
            %
            
            $
            48,299
            
            
            
            8.0
            %
            
            
            N/A
            
            
            
            N/ABoone
      Bank & Trust
            
            
            13,405
            
            
            
            16.3
            
            
            
            6,594
            
            
            
            8.0
            
            
            $
            8,243
            
            
            
            10.0
            %First
      National Bank
            
            
            44,420
            
            
            
            15.3
            
            
            
            23,247
            
            
            
            8.0
            
            
            
            29,059
            
            
            
            10.0Randall-Story
      State Bank
            
            
            8,497
            
            
            
            15.8
            
            
            
            4,302
            
            
            
            8.0
            
            
            
            5,378
            
            
            
            10.0State
      Bank & Trust
            
            
            12,449
            
            
            
            15.0
            
            
            
            6,625
            
            
            
            8.0
            
            
            
            8,282
            
            
            
            10.0United
      Bank & Trust
            
            
            8,729
            
            
            
            12.5
            
            
            
            5,609
            
            
            
            8.0
            
            
            
            7,011
            
            
            
            10.0Tier
      1 capital (to risk- weighted assets):Consolidated
            
            $
            107,205
            
            
            
            17.8
            %
            
            $
            24,149
            
            
            
            4.0
            %
            
            
            N/A
            
            
            
            N/ABoone
      Bank & Trust
            
            
            12,477
            
            
            
            15.1
            
            
            
            3,297
            
            
            
            4.0
            
            
            $
            4,946
            
            
            
            6.0
            %First
      National Bank
            
            
            41,106
            
            
            
            14.1
            
            
            
            11,623
            
            
            
            4.0
            
            
            
            17,435
            
            
            
            6.0Randall-Story
      State Bank
            
            
            7,874
            
            
            
            14.6
            
            
            
            2,151
            
            
            
            4.0
            
            
            
            3,227
            
            
            
            6.0State
      Bank & Trust
            
            
            11,538
            
            
            
            13.9
            
            
            
            3,313
            
            
            
            4.0
            
            
            
            4,969
            
            
            
            6.0United
      Bank & Trust
            
            
            7,842
            
            
            
            11.2
            
            
            
            2,804
            
            
            
            4.0
            
            
            
            4,207
            
            
            
            6.0Tier
      1 capital (to average- weighted assets):Consolidated
            
            $
            107,205
            
            
            
            13.0
            %
            
            $
            33,103
            
            
            
            4.0
            %
            
            
            N/A
            
            
            
            N/ABoone
      Bank & Trust
            
            
            12,477
            
            
            
            12.0
            
            
            
            4,167
            
            
            
            4.0
            
            
            $
            5,209
            
            
            
            5.0
            %First
      National Bank
            
            
            41,106
            
            
            
            9.9
            
            
            
            16,662
            
            
            
            4.0
            
            
            
            20,830
            
            
            
            5.0Randall-Story
      State Bank
            
            
            7,874
            
            
            
            11.2
            
            
            
            2,824
            
            
            
            4.0
            
            
            
            3,530
            
            
            
            5.0State
      Bank & Trust
            
            
            11,538
            
            
            
            10.2
            
            
            
            4,538
            
            
            
            4.0
            
            
            
            5,673
            
            
            
            5.0United
      Bank & Trust
            
            
            7,842
            
            
            
            8.0
            
            
            
            3,946
            
            
            
            4.0
            
            
            
            4,932
            
            
            
            5.0








Federal
and state banking regulations place certain restrictions on dividends paid and
loans or advances made by the Banks’ to the Company.  Dividends paid
by each Bank to the Company would be prohibited if the effect thereof would
cause the Bank’s capital to be reduced below applicable minimum capital
requirements.  Management believes that these restrictions currently
do not have a significant impact on the Company.


86
 Table of Contents




Note
      12.
            Fair
      Value of Financial Instruments




The
estimated fair values of the Company’s financial instruments (as described in
Note 1) were as follows:





2007
            
            
            2006Carrying
            
            
            Fair
            
            
            Carrying
            
            
            FairAmount
            
            
            Value
            
            
            Amount
            
            
            ValueFinancial
      assets:Cash
      and due from banks
            
            $
            26,044,577
            
            
            $
            26,044,577
            
            
            $
            16,510,082
            
            
            $
            16,510,082Federal
      funds sold
            
            
            5,500,000
            
            
            
            5,500,000
            
            
            
            13,100,000
            
            
            
            13,100,000Interest-bearing
      deposits
            
            
            634,613
            
            
            
            634,613
            
            
            
            1,544,306
            
            
            
            1,544,306Securities
      available-for-sale
            
            
            339,942,064
            
            
            
            339,942,064
            
            
            
            354,571,864
            
            
            
            354,571,864Loans,
      net
            
            
            463,651,000
            
            
            
            460,401,295
            
            
            
            429,122,541
            
            
            
            418,432,339Loans
      held for sale
            
            
            344,970
            
            
            
            344,970
            
            
            
            525,999
            
            
            
            525,999Accrued
      income receivable
            
            
            8,022,900
            
            
            
            8,022,900
            
            
            
            7,871,365
            
            
            
            7,871,365Financial
      liabilities:Deposits
            
            $
            690,118,795
            
            
            $
            691,523,351
            
            
            $
            680,356,473
            
            
            $
            679,713,963Federal
      funds purchased and securities sold under agreement to
      repurchase
            
            
            30,033,321
            
            
            
            30,033,321
            
            
            
            34,727,897
            
            
            
            34,727,897Other
      short-term borrowings
            
            
            737,420
            
            
            
            737,420
            
            
            
            1,470,116
            
            
            
            1,470,116Long-term
      borrowings
            
            
            24,000,000
            
            
            
            24,528,680
            
            
            
            2,000,000
            
            
            
            2,000,000Accrued
      interest payable
            
            
            2,402,594
            
            
            
            2,402,594
            
            
            
            2,322,185
            
            
            
            2,322,185


87
 Table of Contents




Note
      13.
            Ames
      National Corporation (Parent Company Only) Financial
      Statements




Information
relative to the Parent Company’s balance sheets at December 31, 2007 and 2006,
and statements of income and cash flows for each of the years in the three-year
period ended December 31, 2007, is as follows:





CONDENSED
      BALANCE SHEETSDecember
      31, 2007 and 20062007
            
            
            2006ASSETSCash
      and due from banks
            
            $
            78,323
            
            
            $
            35,174Interest-bearing
      deposits in banks
            
            
            9,987,887
            
            
            
            299,654Securities
      available-for-sale
            
            
            20,357,493
            
            
            
            36,059,486Investment
      in bank subsidiaries
            
            
            82,359,583
            
            
            
            80,524,802Loans
      receivable, net
            
            
            200,000
            
            
            
            1,247,000Premises
      and equipment, net
            
            
            696,812
            
            
            
            751,992Accrued
      income receivable
            
            
            209,179
            
            
            
            247,502Other
      assets
            
            
            67,126
            
            
            
            10,000Total
      assets
            
            $
            113,956,403
            
            
            $
            119,175,610LIABILITIESDividends
      payable
            
            $
            2,545,987
            
            
            $
            2,450,503Deferred
      income taxes
            
            
            1,046,720
            
            
            
            3,358,619Accrued
      expenses and other liabilities
            
            
            343,173
            
            
            
            443,176Total
      liabilities
            
            
            3,935,880
            
            
            
            6,252,298STOCKHOLDERS'
      EQUITYCommon
      stock
            
            $
            18,859,160
            
            
            $
            18,850,026Additional
      paid-in capital
            
            
            22,588,691
            
            
            
            22,498,904Retained
      earnings
            
            
            66,683,016
            
            
            
            65,856,627Accumulated
      other comprehensive income
            
            
            1,889,656
            
            
            
            5,717,755Total
      stockholders' equity
            
            
            110,020,523
            
            
            
            112,923,312Total
      liabilities and stockholders' equity
            
            $
            113,956,403
            
            
            $
            119,175,610


88
 Table of Contents





CONDENSED
      STATEMENTS OF INCOMEYears
      Ended December 31, 2007, 2006 and 20052007
            
            
            2006
            
            
            2005Operating
      income:Equity
      in net income of bank subsidiaries
            
            $
            9,897,030
            
            
            $
            9,728,640
            
            
            $
            10,660,583Interest
            
            
            600,495
            
            
            
            690,704
            
            
            
            570,325Dividends
            
            
            1,045,125
            
            
            
            919,039
            
            
            
            993,460Rents
            
            
            84,058
            
            
            
            81,306
            
            
            
            35,665Securities
      gains, net
            
            
            1,459,228
            
            
            
            1,333,136
            
            
            
            1,130,07213,085,936
            
            
            
            12,752,825
            
            
            
            13,390,105Provision
      (credit) for loan losses
            
            
            (16,000
            )
            
            
            -
            
            
            
            -Operating
      income after provision (credit)for loan losses
            
            
            13,101,936
            
            
            
            12,752,825
            
            
            
            13,390,105Operating
      expenses
            
            
            1,942,834
            
            
            
            1,609,208
            
            
            
            1,696,570Income
      before income taxes
            
            
            11,159,102
            
            
            
            11,143,617
            
            
            
            11,693,535Income
      tax expense
            
            
            150,000
            
            
            
            200,000
            
            
            
            85,000Net
      income
            
            $
            11,009,102
            
            
            $
            10,943,617
            
            
            $
            11,608,535




89
 Table of Contents





CONDENSED
      STATEMENTS OF CASH FLOWSYears
      Ended December 31, 2007, 2006 and 20052007
            
            
            2006
            
            
            2005CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income
            
            $
            11,009,102
            
            
            $
            10,943,617
            
            
            $
            11,608,535Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
            
            
            61,462
            
            
            
            65,498
            
            
            
            64,216Provision
      for loan losses
            
            
            (16,000
            )
            
            
            -
            
            
            
            -Amortization
      and accretion, net
            
            
            (22,618
            )
            
            
            (18,575
            )
            
            
            (5,757
            )Provision
      for deferred taxes
            
            
            (42,065
            )
            
            
            (22,320
            )
            
            
            (50,652
            )Securities
      gains, net
            
            
            (1,459,228
            )
            
            
            (1,333,136
            )
            
            
            (1,130,072
            )Equity
      in net income of bank subsidiaries
            
            
            (9,897,030
            )
            
            
            (9,728,640
            )
            
            
            (10,660,583
            )Dividends
      received from bank subsidiaries
            
            
            8,849,000
            
            
            
            8,734,000
            
            
            
            8,634,000Decrease
      (increase) in accrued income receivable
            
            
            38,323
            
            
            
            (9,614
            )
            
            
            (77,351
            )Decrease
      (increase) in other assets
            
            
            (57,126
            )
            
            
            225,584
            
            
            
            (92,646
            )Increase
      (decrease) in accrued expense payable and other
liabilities
            
            
            (100,003
            )
            
            
            (206,319
            )
            
            
            311,454Net
      cash provided by operating activities
            
            
            8,363,817
            
            
            
            8,650,095
            
            
            
            8,601,144CASH
      FLOWS FROM INVESTING ACTIVITIESPurchase
      of securities available-for-sale
            
            
            (5,887,840
            )
            
            
            (7,130,088
            )
            
            
            (8,893,910
            )Proceeds
      from sale of securities available-for-sale
            
            
            14,436,995
            
            
            
            4,629,061
            
            
            
            7,830,546Proceeds
      from maturities and calls of securities available-for-sale
            
            
            2,500,000
            
            
            
            2,335,000
            
            
            
            800,000Decrease
      (increase) in interest bearing deposits in banks
            
            
            (9,688,233
            )
            
            
            1,316,834
            
            
            
            1,101,638Decrease
      (increase) in loans
            
            
            1,063,000
            
            
            
            -
            
            
            
            (170,000
            )Purchase
      of bank premises and equipment
            
            
            (6,282
            )
            
            
            (36,059
            )
            
            
            (406,588
            )Investment
      in bank subsidiaries
            
            
            (750,000
            )
            
            
            (160,000
            )
            
            
            (550,000
            )Net
      cash provided by (used in) investing activities
            
            
            1,667,640
            
            
            
            954,748
            
            
            
            (288,314
            )CASH
      FLOWS FROM FINANCING ACTIVITIESDividends
      paid
            
            
            (10,087,229
            )
            
            
            (9,704,835
            )
            
            
            (8,599,597
            )Proceeds
      from issuance of stock
            
            
            98,921
            
            
            
            127,013
            
            
            
            287,937Net
      cash used in financing activities
            
            
            (9,988,308
            )
            
            
            (9,577,822
            )
            
            
            (8,311,660
            )Net
      increase in cash and cash equivalents
            
            
            43,149
            
            
            
            27,021
            
            
            
            1,170CASH
      AND DUE FROM BANKSBeginning
            
            
            35,174
            
            
            
            8,153
            
            
            
            6,983Ending
            
            $
            78,323
            
            
            $
            35,174
            
            
            $
            8,153


90
 Table of Contents




Note
      14.
            Selected
      Quarterly Financial Data
(Unaudited)




2007March 31
            
            
            June 30
            
            
            September 30
            
            
            December 31Total
      interest income
            
            $
            11,525,367
            
            
            $
            11,910,093
            
            
            $
            12,003,252
            
            
            $
            12,123,366Total
      interest expense
            
            
            5,817,365
            
            
            
            6,006,434
            
            
            
            6,022,049
            
            
            
            5,691,282Net
      interest income
            
            
            5,708,002
            
            
            
            5,903,659
            
            
            
            5,981,203
            
            
            
            6,432,084Provision
      (credit) for loan losses
            
            
            9,728
            
            
            
            143,877
            
            
            
            (264,131
            )
            
            
            16,426Net
      income
            
            
            2,521,014
            
            
            
            2,827,431
            
            
            
            2,938,539
            
            
            
            2,722,118Basic
      and diluted earnings per common share
            
            
            0.27
            
            
            
            0.30
            
            
            
            0.31
            
            
            
            0.292006March 31
            
            
            June 30
            
            
            September 30
            
            
            December 31Total
      interest income
            
            $
            10,629,614
            
            
            $
            10,977,629
            
            
            $
            11,264,945
            
            
            $
            11,423,504Total
      interest expense
            
            
            4,778,803
            
            
            
            5,225,682
            
            
            
            5,608,475
            
            
            
            5,692,568Net
      interest income
            
            
            5,850,811
            
            
            
            5,751,947
            
            
            
            5,656,470
            
            
            
            5,730,936Provision
      (credit) for loan losses
            
            
            29,624
            
            
            
            (302,854
            )
            
            
            45,859
            
            
            
            44,685Net
      income
            
            
            2,912,368
            
            
            
            2,764,818
            
            
            
            2,545,572
            
            
            
            2,720,859Basic
      and diluted earnings per common share
            
            
            0.31
            
            
            
            0.29
            
            
            
            0.27
            
            
            
            0.29







Note
      15.
            Stock
      Repurchase Program




The Board
of Directors of the Company approved a stock repurchase program on November 14,
2007.  The Company has a strong capital position and this program
provides an opportunity to repurchase Company stock on the open market when it
is deemed to be favorably priced for repurchase.  The program
authorizes the repurchase of up to 100,000 shares during the calendar year 2008,
or approximately 1% of 9,429,580 shares of common stock presently
outstanding.  The repurchases will be made in open market transactions
at the discretion of management using Company cash.  The timing and
actual number of shares purchased will depend on a variety of factors such as
price, the Company’s liquidity position and other market
conditions.  The program may be limited or discontinued at any time
without notice.  The Company did not repurchase any shares in
2007.


91
 Table of Contents


ITEM
9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE





On
February 8, 2006, the Audit Committee of the Company approved the dismissal of
McGladrey & Pullen, LLP (“McGladrey”) as the Company’s independent
accountants.  The dismissal was later ratified by the Board of
Directors of the Company.  The dismissal was effective upon the
issuance of McGladrey’s report on the consolidated financial statements of the
Company for the year ended December 31, 2005.





The audit reports of McGladrey on the
consolidated financial statements of the Company for the years ended December
31, 2005 and 2004 do not contain an adverse opinion or disclaimer of opinion,
nor were they qualified or modified as to uncertainty, audit scope or accounting
principles.





During the audits of the financial
statements for the years ended December 31, 2005 and 2004, there were no
disagreements with McGladrey on any matter of accounting principles or
practices, financial statement disclosure or auditing scope or procedure, which
agreement, if not resolved to McGladrey’s satisfaction, would have caused
McGladrey to make reference to the subject matter of the disagreement in
connection with its reports.





The Company requested that McGladrey
furnish it with a letter addressed to the Securities and Exchange Commission
(“SEC”) stating whether or not McGladrey agreed with the above
statements.  A copy of McGladrey’s letter to the SEC dated February
13, 2006 is filed as Exhibit 16 to a Form 8-K filed with the SEC on February 13,
2006.





The Audit Committee of the Company
approved the engagement of Clifton Gunderson LLP as the Company’s new
independent accountants effective with the completion of December 31, 2005
audit.  The engagement of Clifton Gunderson LLP was later ratified by
the Board of Directors.





ITEM
9A.  CONTROLS AND PROCEDURES





As of the
end of the period covered by this report, an evaluation was performed under the
supervision and with the participation of the Company’s Chief Executive Officer
and Chief Financial Officer of the effectiveness of the Company’s disclosure
controls and procedures (as defined in Exchange Act Rule
13a-15(e)).  Based on that evaluation, the Chief Executive Officer and
the Chief Financial Officer have concluded that the Company’s current disclosure
controls and procedures are effective to ensure that information required to be
disclosed by the Company in the reports that it files or submits under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported,
within the time periods specified in the Securities and Exchange Commission’s
rules and forms.





Management’s
annual report on internal control over financial reporting is contained in Item
8 of this Report.




92
 Table of Contents


There
were no changes in the Company’s internal control over financial reporting that
occurred during the quarter ended December 31, 2007 that have materially
affected, or are reasonably likely to materially affect, the Company’s internal
control over financial reporting.





ITEM
9B.  OTHER INFORMATION





None.





PART
III





ITEM
10.   DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE





Directors





Refer to
the information under the caption "Information Concerning Nominees for Election
as Directors" and "Information Concerning Directors Other Than Nominees"
contained in the Company's definitive proxy statement prepared in connection
with its Annual Meeting of Shareholders to be held April 30, 2008, as filed with
the SEC on March 19, 2008 (the "Proxy Statement"), which information is
incorporated herein by this reference.





Executive
Officers





The
information required by Item 10 regarding the executive officers appears in Item
1 of Part I of this Report under the heading “Executive Officers of the Company
and Banks”.





Section
16(a) Beneficial Ownership Reporting Compliance





Refer to the information under the
caption “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy
Statement, which information is incorporated herein by this
reference.





Audit
Committee





The Company has established an Audit
Committee as a standing committee of the Board of Directors.  Refer to
the information under the caption “Information Concerning the Board of Directors
– Board Committees” in the Proxy Statement, which information is incorporated
herein by this reference.





Audit
Committee Financial Expert





The Board
of Directors of the Company has determined that Warren R. Madden, a member of
the Audit Committee, qualifies as an "audit committee financial expert" under
applicable SEC rules.  The Board of Directors has further determined
that Mr. Madden qualifies as an "independent" director under applicable SEC
rules and the corporate governance rules of the NASDAQ stock
market.  The Board's affirmative determination was based, among other
things, upon Mr. Madden's experience as Vice President of Finance and Business
of Iowa State University, a position in which he functions as the principal
financial officer of the University.


93
 Table of Contents


Code of
Ethics





The
Company has adopted an Ethics and Confidentiality Policy that applies to all
directors, officers and employees of the Company, including the Chief Executive
Officer and the Chief Financial Officer of the Company. A copy of this policy is
posted on the Company's website at www.amesnational.com.  In
the event that the Company makes any amendments to, or grants any waivers of, a
provision of the Ethics and Confidentiality Policy that requires disclosure
under applicable SEC rules, the Company intends to disclose such amendments or
waiver and the reasons therefor on its website.





ITEM
11.   EXECUTIVE COMPENSATION





Refer to the information under the
caption “Executive Compensation” in the Proxy Statement, which information is
incorporated herein by this reference.





ITEM
      12.
            SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
      AND RELATED SHAREHOLDER MATTERS





Refer to the information under the
caption “Security Ownership of Management and Certain Beneficial Owners” in the
Proxy Statement, which information is incorporated herein by this
reference.  The Company does not maintain any equity compensation
plans covering its officers or employees or the officers or employees of the
Banks.





ITEM
      13.
            CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
      INDEPENDENCE





Refer to the information under the
caption “Loans to Directors and Executive Officers and Related Party
Transactions” and “Information Concerning the Board of Directors – Director
Independence” in the Proxy Statement, which information is incorporated herein
by this reference.





ITEM
14.   PRINCIPAL ACCOUNTANT FEES AND
SERVICES





Refer to
the information under the caption "Relationship with Registered Public
Accounting Firm" in the Proxy Statement, which information is incorporated
herein by this reference.


94
 Table of Contents


PART
IV





ITEM
15.  EXHIBITS AND FINANCIAL STATEMENT
SCHEDULES





(a)
            List
      of Financial Statements and Schedules.1.
            Financial
      StatementsReport
      of Clifton Gunderson LLP, Independent Registered Public Accounting
      FirmReport
      of McGladrey & Pullen LLP, Independent Registered Public Accounting
      FirmConsolidated
      Balance Sheets, December 31, 2007 and 2006Consolidated  Statements
      of Income for the Years ended December 31, 2007, 2006 and
    2005Consolidated
      Statements of Stockholders' Equity for the Years ended December 31, 2007,
      2006 and 2005Consolidated
      Statements of Cash Flows for the Years ended December 31, 2007, 2006 and
      2005Notes
      to Consolidated Financial Statements2.
            Financial
      Statement SchedulesAll
      schedules are omitted because they are not applicable or not required, or
      because the required information is included in the consolidated financial
      statements or notes thereto.(b)
            
            List
      of Exhibits.3.1
            -  
         Restated Articles of Incorporation of the Company, as amended
      (incorporated by reference to Exhibit 3.1 to Form 8-K as filed June 16,
      2005)3.2
            -   
        Bylaws of the Company, as amended (incorporated by reference to
      Exhibit 3.2 to Form 8-K as filed February 19, 2008)10.1
            -    
       Management Incentive Compensation Plan (incorporated by reference to
      Exhibit 10 filed with the Company’s Annual Report on Form 10K for the year
      ended December 31, 2002)*16
            - 
          Letter regarding change in certifying Accountant
      (incorporated by reference to Exhibit 16 to Form 8-K as filed February 13,
      2006)21
            -  
         Subsidiaries of the Registrant23.1
            -   
        Consent of Independent Registered Public Accounting
      Firm23.2
            -    
       Consent of Independent Registered Public Accounting
    Firm31.1
            -   
        Certification of Principal Executive Officer Pursuant to
      Section 302 of the Sarbanes-Oxley Act of 200231.2
            -    
       Certification of Principal Financial Officer Pursuant to Section 302
      of the Sarbanes-Oxley Act of 200232.1
            -   
        Certification of Principal Executive Officer Pursuant to 18 U.S.C.
      Section 135032.2
            -    
       Certification of Principal Financial Officer Pursuant to 18 U.S.C.
      Section 1350*  
         Indicates a management compensatory plan or
      arrangement.




95
 Table of Contents





SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.





AMES
      NATIONAL CORPORATIONMarch
      14, 2008
            By:
            /s/ThomasH.PohlmanThomas
      H. Pohlman, President


96
 Table of Contents




Pursuant
to the requirements of the Securities Exchange Act of 1934, as amended, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated and on March 14, 2008.




/s/
      Thomas H. PohlmanThomas
      H. Pohlman, President and Director(Principal
      Executive Officer)/s/
      John P. NelsonJohn
      P. Nelson, Vice President(Principal
      Financial and Accounting Officer)/s/
      Daniel L. KriegerDaniel
      L. Krieger, Chairman of the Board/s/
      Betty A. Baudler HorrasBetty
      A. Baudler Horras, Director/s/
      Robert L. CramerRobert
      L. Cramer, Director/s/
      Douglas C. GustafsonDouglas
      C. Gustafson, Director/s/
      Charles D. JonsCharles
      D. Jons, Director/s/
      Steven D. ForthSteven
      D. Forth, Director/s/
      James R. Larson IIJames
      R. Larson II, Director/s/
      Warren R. MaddenWarren
      R. Madden, Director/s/
      Larry A. RaymonLarry
      A. Raymon, Director/s/
      Fred C. SamuelsonFred
      C. Samuelson, Director/s/
      Marvin J. WalterMarvin
      J. Walter, Director


97
 Table of Contents


EXHIBIT
INDEX





The
following exhibits are filed herewith:





Exhibit No.
            
            Description21
            
            -Subsidiaries
      of the Registrant23.1
            
            -Consent
      of Independent Registered Public Accounting Firm.23.2
            
            -Consent
      of Independent Registered Public Accounting Firm.31.1
            
            -Certification
      of Principal Executive Officer pursuant to Section 302 of the Sarbanes
      Oxley Act of 200231.2
            
            -Certification
      of Principal Financial Officer pursuant to Section 302 of the Sarbanes
      Oxley Act of 200232.1
            
            -Certification
      of Principal Executive Officer pursuant to 18 U.S.C. Section
      135032.2
            
            -Certification
      of Principal Financial Officer pursuant to 18 U.S.C. Section
      1350






98