United
      States


**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      D.C. 20549


_________________________________________________________





**FORM
      10-Q**





**ý** **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)**


**OF
      THE SECURITIES EXCHANGE ACT OF 1934**


For
      the
      quarterly period ended March 31, 2006


OR


** ̈** **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)**


**OF
      THE SECURITIES EXCHANGE ACT OF 1934**





For
      the
      transition period from _________ to __________


_________________________________________________________





**NORTHERN
      STATES FINANCIAL CORPORATION**


(Exact
      name of Registrant as specified in its charter)




Delaware
                (State
                  of Incorporation)
              0-19300
                (Commission
                  File Number)
              36-3449727
                (I.R.S.
                  Employer
                Identification
                  No.)
 1601
      North Lewis Avenue


Waukegan,
      Illinois 60085


(847)
      244-6000


(Address,
      including zip code, and telephone number, including


area
      code, of principal executive office)


_________________________________________________________





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months, (or for 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: **ý** NO: ** ̈**





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


Large
      Accelerated Filer ** ̈** Accelerated Filer **ý** Non-accelerated Filer ** ̈**





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Act).  YES: ** ̈**  NO: **ý**








4,295,105
      shares of common stock were outstanding


as
      of May
      5, 2006










**NORTHERN
      STATES FINANCIAL CORPORATION AND SUBSIDIARY**


**FORM
      10-Q**


**For
      the Quarter Ended March 31, 2006**


**INDEX**





Page
                  NumberPART
                    I.
                FINANCIAL
                    INFORMATIONItem 1.
                Financial
                    Statements
                2Report
                    of Independent Registered Public Accounting
                    Firm
                2Condensed
                    Consolidated Financial Statements and
                    Notes
                3Item 2.
                Management’s
                    Discussion and Analysis of Financial
                    Condition and Results of Operations
                9Item 3.
                Quantitative
                    and Qualitative Disclosures About
                    Market Risk
                18Item 4.
                Controls
                    and Procedures
                20PART
                    II.
                OTHER
                    INFORMATIONItem 1.
                Legal
                    Proceedings
                20Item
                    1A.
                Risk
                    Factors
                20Item 2.
                Unregistered
                    Sales of Equity Securities and Use
                    of Proceeds
                21Item 3.
                Defaults
                    upon Senior Securities
                21Item 4.
                Submission
                    of Matters to a Vote of Security
                    Holders
                21Item 5.
                Other
                    Information
                21Item 6.
                Exhibits
                21Signatures
                22EXHIBIT
                    INDEX
                23




1




**PART
      I. FINANCIAL INFORMATION**





**ITEM
      1. FINANCIAL STATEMENTS**













REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
      FIRM








Board
      of
      Directors and Stockholders


Northern
      States Financial Corporation


Waukegan,
      Illinois





We
      have
      reviewed the accompanying interim condensed consolidated balance sheet of NORTHERN
      STATES FINANCIAL CORPORATION as of
      March 31, 2006, the condensed consolidated statements of income for the three
      month period ended March 31, 2006 and the condensed statements of cash flows
      and
      stockholders equity for the three month period ended March 31, 2006. These
      interim financial statements are the responsibility of the company's
      management.





We
      conducted our review in accordance with standards of the Public Company
      Accounting Oversight Board (United States). A review of interim financial
      information consists principally of applying analytical procedures and making
      inquiries of persons responsible for financial and accounting matters. It is
      substantially less in scope than an audit conducted in accordance with the
      standards of the Public Company Accounting Oversight Board, the objective of
      which is the expression of an opinion regarding the financial statements taken
      as a whole. Accordingly, we do not express such an opinion.





Based
      on
      our review, we are not aware of any material modifications that should be made
      to the accompanying interim condensed financial statements for them to be in
      conformity with accounting principles generally accepted in the United States
      of
      America.







/s/
              Plante & Moran, PLLCChicago,
                Illinois
              May 8, 2006


2
 *Index*




NORTHERN
          STATES FINANCIAL CORPORATION
 CONDENSED
          CONSOLIDATED BALANCE SHEETS
 March
          31,
          2006 and December 31, 2005
 (In
          thousands of dollars) (Unaudited)
 Assets
                  
                  
                  March
                      31, 2006
                  
                  
                  December
                      31,2005Cash
                      and due from banks
                  
                  $
                  20,456
                  
                  $
                  23,586Interest
                      bearing deposits in financial institutions - maturities less
                      than 90
                      days
                  
                  
                  224
                  
                  
                  120Federal
                      funds sold
                  
                  
                  10,988
                  
                  
                  5,962Total
                      cash and cash equivalents
                  
                  
                  31,668
                  
                  
                  29,668Securities
                      available for sale
                  
                  
                  251,676
                  
                  
                  265,067Loans
                      and leases
                  
                  
                  397,264
                  
                  
                  400,502Less:
                      Allowance for loan and lease losses
                  
                  
                  (10,618
                  )
                  
                  (10,618
                  )Loans and leases, net
                  
                  
                  386,646
                  
                  
                  389,884Federal
                      Home Loan Bank stock
                  
                  
                  2,086
                  
                  
                  2,086Office
                      buildings and equipment, net
                  
                  
                  9,513
                  
                  
                  9,427Other
                      real estate owned
                  
                  
                  4,431
                  
                  
                  4,431Goodwill
                  
                  
                  9,522
                  
                  
                  9,522Core
                      deposit intangible asset
                  
                  
                  2,202
                  
                  
                  2,318Accrued
                      interest receivable and other assets
                  
                  
                  9,987
                  
                  
                  10,125Total
                      assets
                  
                  $
                  707,731
                  
                  $
                  722,528Liabilities
                      and Stockholders' EquityLiabilitiesDepositsDemand
                      - noninterest bearing
                  
                  $
                  57,136
                  
                  $
                  63,329Interest
                      bearing
                  
                  
                  487,476
                  
                  
                  491,120Total
                      deposits
                  
                  
                  544,612
                  
                  
                  554,449Securities
                      sold
                      under repurchase agreements
                  
                  
                  66,410
                  
                  
                  73,093Federal
                      Home Loan Bank advances
                  
                  
                  6,500
                  
                  
                  6,500Subordinated
                      debentures
                  
                  
                  10,000
                  
                  
                  10,000Advances
                      from
                      borrowers for taxes and insurance
                  
                  
                  1,222
                  
                  
                  830Accrued
                      interest payable and other liabilities
                  
                  
                  7,509
                  
                  
                  6,904Total
                      liabilities
                  
                  
                  636,253
                  
                  
                  651,776Stockholders'
                      EquityCommon
                      stock
                  
                  
                  1,789
                  
                  
                  1,789Additional
                      paid-in capital
                  
                  
                  11,584
                  
                  
                  11,584Retained
                      earnings
                  
                  
                  66,069
                  
                  
                  65,526Accumulated
                      other comprehensive loss
                  
                  
                  (3,304
                  )
                  
                  (3,487
                  )Treasury
                      stock,
                      at cost
                  
                  
                  (4,660
                  )
                  
                  (4,660
                  )Total
                      stockholders' equity
                  
                  
                  71,478
                  
                  
                  70,752Total
                      liabilities and stockholders' equity
                  
                  $
                  707,731
                  
                  $
                  722,528
 The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.


3
 *Index*




NORTHERN
        STATES FINANCIAL CORPORATION
 CONDENSED
        CONSOLIDATED STATEMENTS OF INCOME
 Three
        months ended March 31, 2006 and 2005
 (In
        thousands of dollars, except per share data) (Unaudited)


Three
                    months endedMarch
                    31,
                  2006
                
                March
                    31,
                  2005Interest
                    incomeLoans
                    (including fee income)
                
                $
                6,474
                
                $
                6,503SecuritiesTaxable
                
                
                2,136
                
                
                1,903Exempt
                    from federal income tax
                
                
                58
                
                
                83Federal
                    funds sold and other
                
                
                83
                
                
                93Total
                    interest income
                
                
                8,751
                
                
                8,582Interest
                    expenseTime
                    deposits
                
                
                2,832
                
                
                2,017Other
                    deposits
                
                
                978
                
                
                539Repurchase
                    agreements and federal funds purchased
                
                
                703
                
                
                315Federal
                    Home Loan Bank advances
                
                
                63
                
                
                95Subordinated
                    debentures
                
                
                155
                
                
                0Total
                    interest expense
                
                
                4,731
                
                
                2,966Net
                    interest income
                
                
                4,020
                
                
                5,616Provision
                    for loan and lease losses
                
                
                0
                
                
                653Net
                    interest income after provision for loan and lease losses
                
                
                4,020
                
                
                4,963Noninterest
                    incomeService
                    fees on deposits
                
                
                585
                
                
                554Trust
                    income
                
                
                216
                
                
                194Loss
                    on
                    sale of securities available for sale
                
                
                0
                
                
                (169
                )Other
                    operating income
                
                
                289
                
                
                290Total
                    noninterest income
                
                
                1,090
                
                
                869Noninterest
                    expenseSalaries
                    and
                    employee benefits
                
                
                2,256
                
                
                2,250Occupancy
                    and
                    equipment, net
                
                
                616
                
                
                508Data
                    processing
                
                
                379
                
                
                376Legal
                
                
                102
                
                
                72Audit
                    and other professional
                
                
                327
                
                
                313Amortization
                    of
                    core deposit intangible asset
                
                
                116
                
                
                116Printing
                    and
                    supplies
                
                
                140
                
                
                93Other
                    operating expenses
                
                
                499
                
                
                626Total
                    noninterest expense
                
                
                4,435
                
                
                4,354Income
                    (loss) before income taxes
                
                
                675
                
                
                1,478Income
                    tax expense (benefit)
                
                
                132
                
                
                453Net
                    income
                
                $
                543
                
                $
                1,025Earnings
                    per share
                
                $
                0.13
                
                $
                0.24Comprehensive
                    income (loss)
                
                $
                726
                
                
                ($624
                )




The
      accompanying notes are an integral part of these
      condensed consolidated financial statements.




4
 *Index*




NORTHERN
        STATES FINANCIAL CORPORATION
 CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS
 Three
        months ended March 31, 2006 and 2005
 (In
        thousands of dollars) (Unaudited)


Three
                  months endedMarch
                  31,
                2006
              
              March
                  31,
                2005Cash
                  flows from operating activitiesNet
                  income
              
              $
              543
              
              $
              1,025Adjustments
                  to
                  reconcile net income to net cash from operating
                  activities:Depreciation
              
              
              144
              
              
              134Loss
                  on
                  sale of securities available for sale
              
              
              0
              
              
              169Provision
                  for
                  loan and lease losses
              
              
              0
              
              
              653Proceeds
                  from
                  sale of loans
              
              
              0
              
              
              86Loans
                  originated for sale
              
              
              0
              
              
              (86
              )Amortization
                  of
                  other intangible assets
              
              
              116
              
              
              116Net change
                  in accrued interest receivable and other assets
              
              
              (705
              )
              
              (523
              )Net
                  change in accrued interest payable and other liabilities
              
              
              1,314
              
              
              463Net cash from operating activities
              
              
              1,412
              
              
              2,037Cash
                  flows from investing activitiesProceeds
                  from
                  sales of securities available for sale
              
              
              0
              
              
              6,127Proceeds
                  from
                  maturities and calls of securities available for sale
              
              
              42,033
              
              
              15,163Purchases
                  of
                  securities available for sale
              
              
              (28,344
              )
              
              (15,511
              )Change
                  in loans made to customers
              
              
              3,252
              
              
              16,477Property
                  and
                  equipment expenditures
              
              
              (225
              )
              
              0Proceeds
                  from
                  sales of other real estate owned
              
              
              0
              
              
              (41
              )Net cash from investing activities
              
              
              16,716
              
              
              22,215Cash
                  flows from financing activitiesNet
                  increase (decrease) in:Deposits
              
              
              (9,837
              )
              
              5,365Securities
                  sold
                  under repurchase agreements and federal funds purchased
              
              
              (6,683
              )
              
              (16,693
              )Advances
                  from
                  borrowers for taxes and insurance
              
              
              392
              
              
              444Federal
                  Home Loan Bank advances
              
              
              0
              
              
              15,000Repayment
                  of
                  Federal Home Loan Bank advances
              
              
              0
              
              
              (15,000
              )Net
                  cash from financing activities
              
              
              (16,128
              )
              
              (10,884
              )Net
                  change in cash and cash equivalents
              
              
              2,000
              
              
              13,368Cash
                  and cash equivalents at beginning of period
              
              
              29,668
              
              
              29,299Cash
                  and cash equivalents at end of period
              
              $
              31,668
              
              $
              42,667
  The
          accompanying notes are an integral part of these
          condensed consolidated financial statements.


5
 *Index*




NORTHERN
        STATES FINANCIAL CORPORATION
 CONDENSED
        CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
 Three
        months ended March 31, 2006 and 2005
 (In
        thousands of dollars, except for per share data) (Unaudited)


Common
                  Stock
                
                Additional
                  Paid-In
                  Capital
                
                Retained
                  Earnings
                
                Accumulated
                  Other
                  Comprehensive
                  Loss
                
                Treasury
                  Stock,
                    at Cost
                
                Total
                  Stockholders'
                  EquityBalance,
                    December 31, 2004
                
                $
                1,789
                
                $
                11,584
                
                $
                66,102
                
                
                ($1,633
                )
                
                ($4,660
                )
                $
                73,182Net
                    income
                
                
                
                
                
                
                
                
                1,025
                
                
                
                
                
                
                
                
                1,025Unrealized
                    loss on securities available for
                  sale, net of deferred tax
                
                
                
                
                
                
                
                
                
                
                
                (1,649
                )
                
                
                
                
                (1,649
                )Balance,
                    March 31, 2005
                
                $
                1,789
                
                $
                11,584
                
                $
                67,127
                
                
                ($3,282
                )
                
                ($4,660
                )
                $
                72,558Balance,
                    December 31, 2005
                
                $
                1,789
                
                $
                11,584
                
                $
                65,526
                
                
                ($3,487
                )
                
                ($4,660
                )
                $
                70,752Net
                    income
                
                
                
                
                
                
                
                
                543
                
                
                
                
                
                
                
                
                543Unrealized
                    gain on securities available for
                  sale,
                    net of deferred tax
                
                
                
                
                
                
                
                
                
                
                
                183
                
                
                
                
                
                183Balance,
                    March 31, 2006
                
                $
                1,789
                
                $
                11,584
                
                $
                66,069
                
                
                ($3,304
                )
                
                ($4,660
                )
                $
                71,478




The
        accompanying notes are an integral part of these
        condensed consolidated financial statements.




6
 *Index*




**NORTHERN
        STATES FINANCIAL CORPORATION**
  **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





March
      31,
      2006





(Unaudited)






Note
      1
      - Basis of Presentation





The
      accompanying interim condensed consolidated financial statements are prepared
      without audit and reflect all adjustments which are of a normal and recurring
      nature and, in the opinion of management, are necessary to present interim
      financial statements of Northern States Financial Corporation (the "Company")
      in
      accordance with accounting principles generally accepted in the United States
      of
      America. The interim financial statements do not purport to contain all the
      necessary financial disclosures covered by accounting principles generally
      accepted in the United States of America that might otherwise be necessary
      for
      complete financial statements.





To
      prepare financial statements in conformity with accounting principles generally
      accepted in the United States of America, management makes estimates and
      assumptions based on available information. These estimates and assumptions
      affect the amounts reported in the financial statements and the disclosures
      provided, and future results could differ. The allowance for loan and lease
      losses and status of contingencies are particularly subject to
      change.





The
      interim condensed financial statements should be read in conjunction with the
      audited financial statements and accompanying notes (or "notes thereto") of
      the
      Company for the years ended December 31, 2005 and 2004. The results of
      operations for the three month period ended March 31, 2006, are not necessarily
      indicative of the results to be expected for the full year.





Net
      income was utilized to calculate earnings per share for all periods presented.
      The average outstanding common shares utilized in computing earnings per share
      were 4,295,105 for the three month periods ended March 31, 2006 and 2005. The
      Company had no common stock equivalents during the first three months of 2006
      and the entire year of 2005.





On
      April
      17, 2002, the Company announced that its Board of Directors had approved a
      stock
      repurchase program that allows the Company to purchase up to 200,000 shares
      of
      Northern States Financial Corporation stock either in open market or private
      transactions. On February 19, 2003, the Company announced that its Board of
      Directors had approved an additional repurchase program to purchase 200,000
      additional shares of its stock. During the three months ended March 31, 2006,
      no
      shares of stock were repurchased. At March 31, 2006, the Company had a total
      of
      177,150 shares of treasury stock that it purchased under these programs.
      Treasury stock is carried at cost.




7
 *Index*




**NORTHERN
        STATES FINANCIAL CORPORATION**
 
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 
 March
        31,
        2006
 
 (Unaudited)


Information
      related to common stock was as follows:





March
                31, 2006
            
            December
                31, 2005Par
                value per share
            
            $
            0.40
            
            $
            0.40Authorized
                shares
            
            
            6,500,000
            
            
            6,500,000Issued
                shares
            
            
            4,472,255
            
            
            4,472,255Treasury
                shares
            
            
            177,150
            
            
            177,150Outstanding
                shares
            
            
            4,295,105
            
            
            4,295,105







Note
      2 -
      Subordinated Debentures




During
      September 2005, the Company issued $10 million of trust preferred securities
      through Northern States Statutory Trust I, an unconsolidated wholly-owned
      grantor trustee. The Company issued $10 million of subordinated debentures
      to
      Northern States Statutory Trust I, which in turn issued $10 million of trust
      preferred securities. The subordinated debentures mature in September 2035.
      From
      December 2005 until September 15, 2010, the subordinated debentures bear
      interest at a rate equal to the sum of the product of 50% times the 3-month
      LIBOR plus 1.80%, plus the product of 50% times 6.186%, and thereafter at a
      rate
      equal to the 3-month LIBOR plus 1.80%. For the three months ended March 31,
      2006, interest expense on the subordinated debentures was $155,000. The
      subordinated debentures and trust preferred securities are callable at par
      after
      five years.





Regulations
      allow bank holding companies and banks to include subordinated debentures,
      subject to some limitations, as a component of capital for the purpose of
      meeting certain regulatory requirements. In September 2005, the Company
      contributed $2.0 million of the proceeds from the trust preferred securities
      and
      related subordinated debentures to the Bank in order to increase the Bank’s
      capital.




8
 *Index*


**NORTHERN
      STATES FINANCIAL CORPORATION**

















**ITEM
      2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
      CONDITION**


**AND
      RESULTS OF OPERATIONS**














The
      following discussion focuses on the consolidated financial condition of Northern
      States Financial Corporation (the “Company”) at March 31, 2006 and the
      consolidated results of operations for the three month period ended March 31,
      2006, compared with the same periods of 2005. The Company on November 10, 2005
      merged its two wholly owned subsidiaries, the Bank of Waukegan and First State
      Bank of Round Lake and named the resulting bank subsidiary NorStates Bank (the
      “Bank”). The purpose of this discussion is to provide a better understanding of
      the condensed consolidated financial statements of Northern States Financial
      Corporation and the operations of NorStates Bank and the Bank’s wholly owned
      subsidiary, Northern States Community Development Corporation (“NSCDC”). This
      discussion should be read in conjunction with the interim condensed consolidated
      unaudited financial statements and notes thereto included herein.





Statements
      contained in this report that are not historical facts may constitute
      forward-looking statements (within the meaning of Section 21E of the Securities
      Exchange Act of 1934, as amended), which involve significant risks and
      uncertainties. The Company intends such forward-looking statements to be covered
      by the safe harbor provisions for forward-looking statements contained in the
      Private Securities Litigation Reform Act of 1995, and is including this
      statement for purposes of invoking these safe harbor provisions. Forward-looking
      statements, which are based on certain assumptions and describe future plans,
      strategies and expectations of the Company, are generally identifiable by the
      use of the words "believe," "expect," "intend," "anticipate," "estimate,"
      "project," "plan," or similar expressions. The Company's ability to predict
      results or the actual effect of future plans or strategies is inherently
      uncertain and actual results may differ from those predicted. The Company
      undertakes no obligation to update these forward-looking statements in the
      future. The Company cautions readers of this report that a number of important
      factors could cause the Company’s actual results subsequent to March 31, 2006 to
      differ materially from those expressed in forward-looking statements. Factors
      that could cause actual results to differ from those predicted and could have
      a
      material adverse effect on the operations of the Company and its subsidiaries
      include, but are not limited to, the potential for further deterioration in
      the
      credit quality of the Company’s loan and lease portfolios, uncertainty regarding
      the Company’s ability to ultimately recover on the surety bonds relating to
      equipment lease pools and other loans currently on nonaccrual status,
      unanticipated changes in interest rates, general economic conditions, increasing
      regulatory compliance burdens or potential legislative/regulatory changes,
      monetary and fiscal policies of the U.S. Government, including policies of
      the
      U.S. Treasury and the Federal Reserve Board, the quality or composition of
      the
      Company’s loan or investment portfolios, deposit flows, competition, demand for
      loan products and financial services in the Company’s market area, and changes
      in accounting principles, policies and guidelines. These risks and uncertainties
      should be considered in evaluating forward-looking statements.




9
 *Index*




NORTHERN
      STATES FINANCIAL
      CORPORATION


**MANAGEMENT’S
        DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION** **AND
        RESULTS OF OPERATIONS**




OVERVIEW





Total
      assets at March 31, 2006 declined from year-end levels. Assets totaled $707.7
      million at March 31, 2006, a decrease of $14.8 million or 2.1 percent from
      total
      assets of $722.5 million at December 31, 2005. Securities decreased $13.4
      million and loans and leases declined $3.2 million from year-end 2005. Deposits
      decreased $9.8 million compared to December 31, 2005, while securities sold
      under repurchase agreements declined $6.7 million.





Earnings
      for the first quarter of 2006 were $543,000 or $.13 per share, as compared
      with
      $.24 per share, or $1.0 million for the first quarter of 2005. Earnings during
      the first quarter of 2006 were affected unfavorably by a decrease in net
      interest income of $1.6 million as rates paid on deposits continued to rise
      at a
      faster pace than rates earned on loans and securities. Also affecting net
      interest income were increased levels of nonaccrual loans, that earn no
      interest, that totaled $21.4 million at March 31, 2006 compared with $16.8
      million at March 31, 2005.





There
      was
      no provision for loan and lease loss expense during the first quarter of 2006
      as
      compared with $653,000 during the same quarter last year. Based on its analysis
      of the allowance for loan and lease losses at March 31, 2006, management
      believes that the allowance of $10.6 million is adequate to cover probable
      incurred loan and lease losses.





CRITICAL
      ACCOUNTING POLICIES





Certain
      critical accounting policies involve estimates and assumptions by management.
      To
      prepare financial statements in conformity with accounting principles generally
      accepted in the United States of America, management makes estimates and
      assumptions based on available information. These estimates and assumptions
      affect the amounts reported in the financial statements and the disclosures
      provided, and future results could differ. The allowance for loan and lease
      losses is a critical accounting policy for the Company because management must
      make estimates of losses and these estimates are subject to change.





The allowance for loan and lease losses is a valuation allowance for probable
      incurred credit losses, increased by the provision for loan and lease losses
      and
      decreased by charge-offs less recoveries. Management estimates the allowance
      balance required using past loan and lease loss experience, the nature and
      volume of the portfolio, information about specific borrower situations,
      estimated collateral values, economic conditions and other factors. Allocations
      of the allowance may be made for specific loans and leases, but the entire
      allowance is available for any loan or lease that, based on management’s
      judgment, should be charged-off.





Management
      analyzes the adequacy of the allowance for loan and lease losses at least
      quarterly. Loans and leases judged to be impaired, with probable incurred loss
      exposure, that are no longer accruing interest, and historical net loss
      percentages are reviewed in the analysis of the allowance for loan and lease
      losses. Factors considered in assessing the adequacy of the allowance include:
      changes in the type and volume of the loan and lease portfolio; review of the
      larger credits within the Bank; historical loss experience; current economic
      trends and conditions; review of the present value of expected cash flows or
      fair value of collateral on impaired loans and leases; portfolio growth; and
      other factors management deems appropriate. Based on management’s analysis, the
      allowance for loan and lease losses at March 31, 2006 is adequate to cover
      probable incurred credit losses.





One
      of
      the components of the allowance for loan losses is historical loss experience.
      Different loan classifications within the portfolio have different loss
      experience ratios. For example, loans secured by




10
 *Index*




**NORTHERN
        STATES FINANCIAL CORPORATION**




**MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**


**AND
      RESULTS OF OPERATIONS**




real
      estate generally have a better loss experience than loans secured by other
      assets. Changes in the classification between periods can impact the allocation
      for historical losses.





Management
      specifically analyzes its nonperforming loans for probable losses. The change
      in
      the volume of nonperforming loans may significantly impact the amount of
      estimated losses specifically allocated to these loans depending on the adequacy
      of the loan collateral and the borrowers’ ability to repay the loans. As
      specific allocations are done on a loan-by-loan basis, the amount of the
      specific allocation is more likely subject to fluctuation than an allocation
      for
      a pool of loans based on historical loss trends. The amount of the allocations
      on nonperforming loans may fluctuate in future periods due to changes in
      conditions of underlying collateral and changes in the borrowers’ ability to
      repay.





Goodwill
      results from business acquisitions and represents the excess of the purchase
      price over the fair value of acquired tangible assets and liabilities and
      identifiable intangible assets. Goodwill is assessed for impairment quarterly
      and any such impairment will be recognized in the period
      identified.





Other
      intangible assets consist of core deposit and acquired customer relationship
      intangible assets arising from whole bank and branch acquisitions, which is
      periodically evaluated for impairment. They are initially measured at fair
      value
      and then are amortized on the straight-line method over their estimated useful
      life of seven years.





FINANCIAL
      CONDITION





The
      Company’s federal funds sold at March 31, 2006 increased $5.0 million to $11.0
      million compared with $6.0 million at December 31, 2005. The Company’s federal
      funds sold position increased as the Company’s securities available for sale
      declined $13.4 million to $251.7 million from $265.1 million at year-end 2005.





Loans
      and
      leases totaled $397.3 million at March 31, 2006, decreasing $3.2 million from
      $400.5 million at December 31, 2005. Approximately 82% of the Bank’s loans are
      secured by real estate. Although the majority of the Company’s loans have
      variable rates or the rate changes periodically based on index, more borrowers
      have recently been requesting fixed rate loans as they perceive further interest
      rate increases during 2006. Loans to the lodging industry at March 31, 2006
      totaled $24.2 million. Loan commitments have decreased $12.9 million to $83.4
      million at March 31, 2006 compared with $96.3 million at December 31, 2005
      as
      some borrowers have allowed the loan commitments issued to them to lapse. At
      March 31, 2006, loans to related parties totaled $2.5 million, $200,000 less
      than at December 31, 2005. Loan commitments to related parties were $1.6 million
      at March 31, 2006.




Deposits
      decreased $9.8 million from year-end 2005. Most of the decline in deposits
      was
      in brokered certificates of deposits that decreased $7.8 million from year-end
      and totaled $42.0 million at March 31, 2006. Brokered deposits are time deposits
      placed in the Bank by a broker from depositors outside the Bank’s geographic
      area. These deposits usually bear an interest rate of 10 to 15 basis points
      greater than the terms and conditions offered to local depositors. The Company
      has sought to lower the amount of brokered deposits to decrease its interest
      expense.





Securities
      sold under repurchase agreements decreased by $6.7 million to $66.4 million
      at
      March 31, 2006 from $73.1 million at December 31, 2005, primarily as a result
      of
      the transfer by certain customers of their funds to other financial instruments.
      During 2005, a customer who had liquidated its business and who has subsequently
      moved out of the area had placed $20.0 million of the sales proceeds in
      securities sold under repurchase agreements. It is expected, during the second
      quarter of 2006, that this customer will draw a portion out of these funds
      from
      the Bank, further lowering the amount of repurchase agreements.




11
 *Index*




**NORTHERN
        STATES FINANCIAL CORPORATION**
  **MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
        RESULTS OF OPERATIONS**




As
      previously disclosed, included in other liabilities at March 31, 2006 is
      $393,000 related to estimated
      environmental clean-up expenses of a parcel of other real estate sold in
      previous years. The Company intends to seek reimbursement of these expenses
      from
      the State of Illinois that has a fund for this type of cleanup. However, there
      can be no assurance that the Company will be successful in obtaining any such
      reimbursement.





CAPITAL




Total
      stockholders’ equity increased $726,000 to $71.5 million during the three months
      ended March 31, 2006. The increase is the result of a $183,000 adjustment for
      the unrealized gain on securities available for sale, net of deferred tax,
      and
      net income of $543,000 during the quarter.





On
      a
      consolidated basis, the Company’s Tier 1 to total assets ratio and total capital
      to assets ratio, on a risk adjusted basis, were 10.32% and 16.24%, respectively,
      as of March 31, 2006 and exceed the regulatory minimum for capital adequacy
      purposes. Management believes that the capital position of both the Company
      and
      the Bank are adequate for current projected needs.





At
      March
      31, 2006, Tier 1 capital ratios of the Company include the effect of the
      issuance of $10.0 million in trust preferred securities on September 15, 2005.
      The trust preferred securities were funded by $10.0 million carried as
      subordinated debentures. Federal Reserve guidelines limit the amount of trust
      preferred securities that can be included in Tier 1 capital to 25% of total
      Tier
      1 capital. During 2005, the Company contributed $2.0 million of proceeds from
      the trust preferred issuance to the Bank as common equity. No such limitations
      apply to the Bank’s capital adequacy computations.





LIQUIDITY





Liquidity
      management involves the Company’s ability to meet the cash flow requirements of
      customers. The Company needs to have sufficient cash flow to meet the
      requirements of depositors wanting to withdraw funds. The Company’s liquidity
      position has improved since December 31, 2005 as measured by increases in the
      amount of federal funds sold and decreases in the amount of pledged securities.
      The statements of cash flows show that for the three months ended March 31,
      2006, that cash and cash equivalents increased $2.0 million to $31.7
      million.





Federal
      funds sold, interest bearing deposits in banks and available for sale
      securities, particularly those of shorter maturities, are principal sources
      of
      liquidity. Federal funds sold at March 31, 2006 were $11.0 million. The Company
      sells excess funds overnight to money center banks. The Company classifies
      all
      of its securities as available for sale, which increases the Company's
      flexibility in that the Company can sell any of its unpledged securities to
      meet
      liquidity requirements. Securities available for sale had a carrying value
      of
      $251.7 million at March 31, 2006, of which $162.8 million was pledged to secure
      public deposits and repurchase agreements. At December 31, 2005, the Company’s
      securities totaled $265.1 million of which $189.7 million was
      pledged.





During
      the first quarter of 2006, the Company had incoming cash flows from maturities
      and calls of securities available for sale of $42.0 million while it had cash
      outflows for purchases of securities of $28.3 million. These securities
      activities during the first quarter of 2006 provided liquidity of $13.7 million
      that was used to meet the decreases to deposits of $9.8 million and the decline
      in repurchase agreements of $6.7 million.





Other
      sources of liquidity available to the Company are deposits and borrowings.
      The
      Company also uses brokered deposits as a source of liquidity. To help ensure
      the
      ability to meet its funding needs, including any unexpected strain on liquidity,
      the Company has arrangements that allow it to purchase $25.0 million in federal
      funds from an independent bank.




12
 *Index*




**NORTHERN
        STATES FINANCIAL CORPORATION**
  **MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
        RESULTS OF OPERATIONS**
  RESULTS
      OF OPERATIONS





NET
      INCOME





Consolidated
      net income for the quarter ended March 31, 2006 was $543,000, decreasing
      $482,000 compared with net income of $1,025,000 for the same quarter of 2005.
      The annualized return on average assets was .30% for the quarter, declining
      from
      .55% for the same quarter the previous year. The decline to net income for
      the
      quarter is primarily the result of a decrease in net interest income.





NET
      INTEREST INCOME





Net
      interest income, the difference between interest income on earning assets and
      interest expense on interest bearing liabilities, decreased $1.6 million to
      $4.0
      million during the three months ended March 31, 2006 compared with $5.6 million
      for the same period of 2005.





A
      factor
      affecting net interest income was the decline in average loans during the first
      quarter of 2006 compared with the same quarter of 2005. Loans, generally, earn
      higher interest rates than other interest earning assets of the Company. Average
      loans declined $38.9 million during the first quarter of 2006 due to loan
      payoffs and a decline in loan demand as compared with the same quarter last
      year. Another factor affecting net interest income was the increased level
      of
      nonaccrual loans that totaled $21.4 million at March 31, 2006 compared with
      $16.8 million at March 31, 2005.





Also
      adversely affecting net interest income during the first quarter of 2006 were
      increasing rates paid on interest bearing liabilities. The rates paid on
      interest bearing liabilities increased 132 basis points during the first quarter
      of 2006 to 3.28% as compared with 1.96% during the same quarter of 2005.
      Interest rates on time deposits increased 147 basis points from the same quarter
      last year due to competitive pressures. Interest expense on time deposits during
      the first quarter of 2006 was $815,000 greater than it was during the first
      quarter of 2005. Interest expense for other borrowings, which include the
      Federal Home Loan term advance, securities sold under repurchase agreements,
      federal funds purchased and the subordinated debentures increased by $511,000
      during the three months ended March 31, 2006 compared with the same period
      of
      2005.





The
      Company has taken steps to increase its net interest income by lowering some
      of
      its deposit rates. In March 2006, the Company lowered the rate paid on its
      savings and regular NOW deposit products by 25 basis points. Interest rates
      paid
      on lower balanced money market and certificate of deposits were also decreased
      from 10 to 25 basis points. As lower balance certificates mature, they will
      renew at the slightly lower rates. The Company is also attempting to lower
      the
      amount of brokered deposits that are paid higher interest rates.




13
 *Index*




**NORTHERN
        STATES FINANCIAL CORPORATION**
  **MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
        RESULTS OF OPERATIONS**


TABLE
      1





NORTHERN
      STATES FINANCIAL CORPORATION


ANALYSIS
      OF AVERAGE BALANCE AND TAX EQUIVALENT RATES


For
      the
      Three Months Ended March 31, 2006 and 2005 - Rates are Annualized


($
      000s)


2006
              
              2005Average
                Balance
              
              Interest
              
              Rate
              
              Average
                Balance
              
              Interest
              
              RateAssetsLoans
                  (1)(2)(3)
              
              $
              397,277
              
              $
              6,490
              
              
              6.53
              %
              $
              436,189
              
              $
              6,521
              
              
              5.98
              %Taxable
                  securities (4)
              
              
              256,195
              
              
              2,136
              
              
              3.27
              %
              
              238,186
              
              
              1,903
              
              
              3.15
              %Tax
                  advantaged securities (2) (4)
              
              
              6,505
              
              
              87
              
              
              5.34
              %
              
              10,048
              
              
              126
              
              
              5.03
              %Federal
                  funds sold
              
              
              6,853
              
              
              83
              
              
              4.84
              %
              
              15,005
              
              
              93
              
              
              2.48
              %Interest
                  earning assets
              
              
              666,830
              
              
              8,796
              
              
              5.23
              %
              
              699,428
              
              
              8,643
              
              
              4.92
              %Noninterest
                  earning assets
              
              
              47,159
              
              
              
              
              
              
              
              
              47,181Average
                  assets
              
              $
              713,989
              
              
              
              
              
              
              
              $
              746,609Liabilities
                  and stockholders' equityNOW
                  deposits
              
              $
              53,716
              
              $
              146
              
              
              1.09
              %
              $
              63,556
              
              $
              116
              
              
              0.73
              %Money
                  market deposits
              
              
              71,473
              
              
              609
              
              
              3.41
              %
              
              63,611
              
              
              238
              
              
              1.50
              %Savings
                  deposits
              
              
              77,384
              
              
              223
              
              
              1.15
              %
              
              82,990
              
              
              185
              
              
              0.89
              %Time
                  deposits
              
              
              286,582
              
              
              2,832
              
              
              3.95
              %
              
              325,817
              
              
              2,017
              
              
              2.48
              %Other
                  borrowings
              
              
              87,827
              
              
              921
              
              
              4.19
              %
              
              69,095
              
              
              410
              
              
              2.37
              %Interest
                  bearing liabilities
              
              
              576,982
              
              
              4,731
              
              
              3.28
              %
              
              605,069
              
              
              2,966
              
              
              1.96
              %Demand
                  deposits
              
              
              58,413
              
              
              
              
              
              
              
              
              62,119Other
                  noninterest bearing liabilities
              
              
              7,576
              
              
              
              
              
              
              
              
              5,860Stockholders'
                  equity
              
              
              71,018
              
              
              
              
              
              
              
              
              73,561Average
                  liabilities and stockholders' equity
              
              $
              713,989
              
              
              
              
              
              
              
              $
              746,609Net interest income
              
              
              
              
              $
              4,065
              
              
              
              
              
              
              
              $
              5,677Net interest margin
              
              
              
              
              
              
              
              
              1.95
              %
              
              
              
              
              
              
              
              2.96
              %Net
                  yield on interest earning assets (4)
              
              
              
              
              
              
              
              
              2.42
              %
              
              
              
              
              
              
              
              3.23
              %Interest-bearing
                  liabilitiesto
                  earning assets ratio
              
              
              
              
              
              
              
              
              86.53
              %
              
              
              
              
              
              
              
              86.51
              %




(1)
                -
            Interest
                income on loans includes loan origination and other fees of $61 and
                $99
                for the three months ended March 31, 2006 and
                2005.


(2)
                -
            Tax-exempt
                income is reflected on a fully tax equivalent basis utilizing a 34%
                tax
                rate.


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


(4)
                -
            Rate
                information was calculated on the average amortized cost for securities.
                The three months ended March 31, 2006 and 2005 average balance information
                includes an average unrealized gain (loss) for taxable securities
                of
                ($5,441) and ($3,214) and for tax-advantaged securities of ($10)
                and
                $35.




14
 *Index*




**NORTHERN
        STATES FINANCIAL CORPORATION**
  **MANAGEMENT'S
        DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
        RESULTS OF OPERATIONS**


ASSET
      QUALITY AND THE PROVISION FOR LOAN AND LEASE LOSSES




Management, with the concurrence of the Board of Directors, after carefully
      reviewing the adequacy of the allowance for loan and lease losses and the levels
      of nonperforming and impaired loans and leases, found that no provision for
      loan
      and lease losses was necessary for the quarter ended March 31, 2006, compared
      with $653,000 for the same period of 2005.





At
      March
      31, 2006, the allowance for loan and lease losses was $10.6 million, unchanged
      from year-end 2005. During the first three months of 2006, $6,000 in loans
      were
      charged off against the allowance compared with $536,000 during the same period
      last year. There was $6,000 in recoveries of loans previously charged off during
      the three months ended March 31, 2006 compared with $64,000 in recoveries during
      the same period in 2005.





Nonperforming
      loans and leases, which includes loans and leases on nonaccrual status in
      addition to loans and leases 90 days or more past due and still accruing
      interest, were $21.7 million at March 31, 2006, or 5.46% of total loans and
      leases, as compared with $21.9 million at December 31, 2005, or 5.47% of loans
      and leases.





The
      Company previously disclosed its involvement in certain lease pools purchased
      in
      2000 and 2001 from Commercial Money Center (“CMC”). These lease pools were
      secured by both the leased equipment and surety bonds issued by ACE/Illinois
      Union and RLI Insurance Company. The lease pools are carried on nonaccrual
      status and totaled $9.3 million at March 31, 2006. In September 2005, the
      Company filed Motions for Judgement on the Pleadings in its CMC litigations
      against the sureties. At that time, the court granted the Motion for Judgement
      on the Pleadings against ACE/Illinois Union; however, the Bank’s motion against
      the RLI sureties was denied. ACE/Illinois Union insures the lease pools totaling
      $5.2 million at March 31, 2006 and RLI acts as the sureties on lease pools
      totaling $4.1 million. On October 31, 2005, the court directed all parties
      involved in the CMC litigation to engage in mediation. Mediation has concluded,
      and the Bank and the Company expect to enter into a settlement agreement with
      one of the sureties, subject to approval by the court, during the second quarter
      2006. No assurance can be given as to the exact amounts that will be ultimately
      collected by the Bank, if any, as a result of the mediation. At March 31, 2006,
      the Company had $1.9 million of its allowance for loan leases losses allocated
      to the lease pools purchased from CMC.





Included
      as a nonperforming loans at March 31, 2006, is a $4.3 million nonaccrual loan
      that is for a 90-unit condominium construction project. The Company participated
      in this 90-unit condominium project with other financial institutions and only
      has a portion of the total loan. The construction project experienced
      substantial cost overruns and the principal borrowers declared bankruptcy.
      The
      construction project has been completed and all of the units have been sold,
      with the bankruptcy trustee holding the sale proceeds in escrow. There are
      disputed mechanic liens which the majority are insured by a title company.
      Once
      the mechanic liens issue is resolved, the bankruptcy trustee is expected to
      release the sales proceeds from escrow and management expects to collect all
      of
      the $4.3 million loan balance.





The
      Company has nonaccrual loans totaling $4.2 million on an entertainment center
      that is partially secured by leasehold improvements and equipment. The principal
      guarantors of the loans have declared personal bankruptcy and the cash flows
      from the entertainment center are insufficient to service the loans. Also on
      nonaccrual status are loans on two motels totaling $3.5 million in which the
      borrower has had deterioration to their financial condition. The Company has
      taken steps to foreclose on these motels.





Impaired
      loans and leases at March 31, 2006 totaled $31.9 million. The Company considers
      a loan or lease impaired if full principal and interest will not be collected
      under the contractual terms of the note. Nonaccrual loans and leases are
      included as impaired. Impaired loans and leases are carried at the present
      value
      of expected cash flows discounted at the loan's effective interest rate or
      at
      the fair value of the




15
 *Index*
  **NORTHERN
          STATES FINANCIAL CORPORATION**
  **MANAGEMENT'S
          DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
          RESULTS OF OPERATIONS**




collateral,
      if the loan or lease is collateral dependent. Included as impaired loans at
      March 31, 2006 are $10.5 million of restructured loans that the terms and
      conditions of the loans have been adjusted due to deterioration in the financial
      condition of the borrowers. Payments have been received on the restructured
      based on the modified terms of the loans and these restructured loans, although
      classified as impaired, are not included as nonperforming loans. The amount
      of
      the allowance for loan and lease losses specifically allocated for impaired
      loans and leases was $7.4 million at March 31, 2006 compared with $7.6 million
      at December 31, 2005.





Another
      component of nonperforming assets is other real estate owned, consisting of
      assets acquired through loan foreclosure and repossession. At March 31, 2006,
      other real estate owned totaled $4.4 million, remaining unchanged from December
      31, 2005. The fair value of other real estate owned is reviewed by management
      at
      least quarterly to help ensure the reasonableness of its carrying value, which
      is lower of cost or the fair value less estimated selling costs.




Other
      real estate owned includes a property acquired in 1987 through the receipt
      of
      deed in lieu of foreclosure. This property is a former commercial/industrial
      site located overlooking Lake Michigan in Waukegan, Illinois, with a carrying
      value of $1,783,000 at March 31, 2006. Environmental remediation costs may
      be
      incurred in disposing of this property, and the amount of any such costs may
      depend on the future use of the property, such as commercial, residential,
      or
      recreational purposes. There is no requirement to undertake any remediation
      activities at this time. Further, there is no pending or threatened litigation
      regarding the property’s environmental issues, nor are there any threatened or
      pending governmental orders, assessments or actions regarding the same. The
      property is currently undergoing a brownfield assessment funded by a government
      grant. The grant money is to be used for the brownfield assessment but not
      for
      any remediation that may be needed. The objective of the brownfield assessment
      is to obtain the environmental data needed to determine the appropriate remedial
      actions, if any, for the property to achieve a “No Further Remediation Letter”
from the Illinois EPA Site Remediation Program. The end use of the property
      is
      mixed use residential development consistent with the City of Waukegan’s
      Lakefront Downtown Master Plan. The results of the brownfield assessment are
      expected later in 2006. Until the results of the assessment are known, it is
      not
      practical to estimate any remediation costs. Thus, no liability has been
      recorded for environmental remediation costs.





NONINTEREST
      INCOME





Noninterest
      income for the three months ended March 31, 2006 was $1,090,000 compared to
      $869,000 for the three months ended March 31, 2005. The increase is attributable
      to a loss the Company recognized last year, during the first quarter of 2005,
      of
      $169,000 on the sale of securities available for sale that had been carried
      at
      $6.3 million prior to the sale. There were no sales of securities available
      for
      sale during the first quarter of 2006.





NONINTEREST
      EXPENSE





Noninterest
      expense for the quarter ended March 31, 2006 was $4,435,000, increasing $81,000
      from the same quarter last year. The Company’s efficiency ratio, noninterest
      expense divided by the sum of net interest income and noninterest income, was
      86.8% for the first quarter of 2006 as compared with 67.1% for the same quarter
      of 2005 and was affected by the decreased net interest income.





Occupancy
      and equipment expenses increased $108,000 during the first quarter of 2006
      as
      compared with the same quarter of 2005. Maintenance expenses increased during
      the quarter as some cosmetic repairs were done to the buildings as part of
      the
      merger and name change. Utilities expense also increased due to energy price
      increases. It is expected that depreciation expense will increase in 2006 as
      the
      cost of new signage begins to be depreciated.





16
 *Index*
  **NORTHERN
          STATES FINANCIAL CORPORATION**
  **MANAGEMENT'S
          DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION**
 **AND
          RESULTS OF OPERATIONS**




Due
      to
      the merger and name change of the banks on November 10, 2005, all of the forms
      of the Company needed to be changed. As a result printing and supplies expense
      for the first quarter of 2006 increased $47,000 over the same quarter last
      year.
      This expense is expected to decrease for the balance of 2006 as the initial
      orders for printing and supplies due to the name change have been
      completed.




The
      increase in occupancy and equipment and printing and supplies expenses was
      offset by decreases to the Company’s other operating of $127,000 during the
      first quarter of 2006 as compared with the same quarter last year. Decreased
      loan and collection expenses and marketing expenses account for much of the
      decline in other operating expenses during the three months ended March 31,
      2006. It is expected that marketing expenses will increase during the second
      quarter of 2006 as the Company expands its efforts to increase its loans and
      core deposits.





FEDERAL
      AND STATE INCOME TAXES





For
      the
      three months ended March 31, 2006, the Company had a tax expense of $132,000
      as
      compared with $453,000 for the same three months last year. As a percentage
      of
      pre-tax income, tax expense was 19.6% for the three months ended March 31,
      2006
      and 30.6% for the same period of 2005.


Interest
      income on U.S. Treasury and U.S. government-sponsored entity securities that
      are
      not subject to state income tax was $2.1 million for the three months ended
      March 31, 2006 and contributed to the lower tax rate for the
      quarter.





CONTRACTUAL
      OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS





The
      Company has contractual obligations that may not appear on the balance sheet.
      Table 2 presents the Company’s significant fixed and determinable contractual
      obligations as of March 31, 2006, by payment date. The payment amounts in Table
      2 represent those amounts contractually due to the recipient and do not include
      any unamortized premiums or discounts or similar carrying amount adjustments.





TABLE
      2





NORTHERN
      STATE FINANCIAL CORPORATION


CONTRACTUAL
      OBLIGATIONS


As
      of
      March 31, 2006


($
      000s)




Greater
                than
            
            Greater
                than1
                yr. and less
            
            3
                yrs. and lessOne
                year
            
            than
                or equal
            
            than
                or equal
            
            Greater
                thanContractual
                obligations
            
            or
                less
            
            to
                3 yrs.
            
            to
                5 yrs.
            
            5
                yrs.
            
            TotalLong-term
                debtFederal
                Home Loan Bank advance
            
            $
            0
            
            $
            6,500
            
            $
            0
            
            $
            0
            
            $
            6,500Subordinated
                debentures
            
            
            0
            
            
            0
            
            
            0
            
            
            10,000
            
            
            10,000Time
                deposits
            
            
            214,319
            
            
            52,079
            
            
            16,165
            
            
            0
            
            
            282,563Other
                contractual obligationsStandby
                letters of credit
            
            
            6,384
            
            
            0
            
            
            0
            
            
            0
            
            
            6,384Community
                Reinvestment Act
                investment commitment
            
            
            118
            
            
            524
            
            
            0
            
            
            0
            
            
            642





17
 *Index*




NORTHERN
      STATES FINANCIAL
      CORPORATION




**ITEM
      3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
      MARKET RISK**




The
      Company’s primary market risk exposure is interest rate risk and, to a lesser
      extent, liquidity risk. Interest rate risk is the exposure of a banking
      organization’s financial condition to adverse movements in interest rates. The
      Company seeks to achieve consistent growth in net interest income and net income
      while managing volatility that arises from shifts in interest rates. The
      Company’s Asset and Liability Management Committee (“ALCO”) oversees interest
      rate risk programs instituted by management and measurements of interest rate
      risk to determine that they are within authorized limits set by the Company’s
      Board of Directors.





Evaluating
      a financial institution’s exposure to changes in interest rates includes
      assessing both the adequacy of the management process used to control interest
      rate risk and the organization’s quantitative level of exposure. When assessing
      the interest rate risk management process, the Company seeks to ensure that
      appropriate policies, procedures, management information systems and internal
      controls are in place to maintain interest rate risk at prudent levels with
      consistency and continuity. Evaluating the quantitative level of interest rate
      risk exposure requires the Company to assess the existing and potential future
      effects of changes in interest rates on its consolidated financial condition,
      including capital adequacy, earnings, liquidity, and, where appropriate, asset
      quality.





One
      approach used by management to analyze interest rate risk is to periodically
      evaluate the “shock” to net interest income of an assumed instantaneous decrease
      and increase in rates of 1% and 2% using computer simulation to show the effect
      of rate changes on the base 12 month projected net interest income. This
      approach falls under the broad definition of asset/liability management. The
      Company's primary asset/liability management technique is the interest rate
      shock.





Several
      ways the Company can manage interest rate risk include: selling existing assets
      or repaying certain liabilities and matching repricing periods for new assets
      and liabilities, for example, by shortening terms of new loans or securities.
      Financial institutions are also subject to prepayment risk in a falling rate
      environment. For example, a debtor may prepay financial assets so that the
      debtor may refinance obligations at new, lower rates. Prepayments of assets
      carrying higher rates reduce the Company’s interest income and overall asset
      yields. A large portion of an institution’s liabilities may be short term or due
      on demand, while most of its assets may be invested in longer-term loans or
      securities. Accordingly, the Company seeks to have in place sources of cash
      to
      meet short-term demands. These funds can be obtained by increasing deposits,
      borrowing, or selling assets.





Financial
      institutions are also subject to interest rate risk in a rising rate
      environment. Call features on securities may not be exercised and the lower
      yielding securities may remain in the Company’s securities portfolio until
      maturity.





Table
      3
      shows how interest rate shocks of decreasing rates 1% and 2% and increasing
      rates 1% and 2% affect projected 12 month projected net interest income at
      March
      31, 2006 and December 31, 2005. The computer simulation model used to do the
      interest rate shocks and calculate the effect on projected net interest income
      takes into consideration maturity and repricing schedules of the various assets
      and liabilities as well as call provisions on the Company’s securities.
      Increasing interest rates were projected in the model for calculation of the
      base forecasted net interest income, with prime rate rising from 7.75% during
      the second quarter of 2006 to 8.50% during the first quarter of 2007. Current
      policy set by the Board of Directors limits exposure to projected net interest
      income from interest rate shocks of plus or minus 2% to plus or minus 10% of
      the
      base projected forecasted 12 month net interest income.





18
 *Index*
  NORTHERN
        STATES FINANCIAL
        CORPORATION


**QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**





At
      March
      31, 2006 the projected net interest income increases $659,000 when rates are
      shocked downward 2% while projected net interest income decreases $976,000
      for a
      2% upward rate shock. Projected net interest income increases when rates are
      shocked downward 2% as there more rate sensitive liabilities repricing than
      rate
      sensitive assets during the next twelve months. The percentage changes from
      the
      base forecasted 12 month net interest income are within policy
      guidelines.








TABLE
      3





NORTHERN
      STATES FINANCIAL CORPORATION


EFFECT
      OF
      INTEREST SHOCKS ON NET INTEREST INCOME


as
      of
      March 31, 2006 and December 31, 2005


($000s)




Immediate
                Change in Rates-2.00%
            
            -1.00%
            
            +1.00%
            
            +2.00%March
                31, 2006:Dollar
                Change from Base Forecast
            
            $
            659
            
            $
            381
            
            
            ($440
            )
            
            ($976
            )Percent
                Change from Base Forecast
            
            
            3.10
            %
            
            1.79
            %
            
            -2.07
            %
            
            -4.59
            %December
                31, 2005:Dollar
                Change from Base Forecast
            
            $
            758
            
            $
            396
            
            
            ($489
            )
            
            ($1,062
            )Percent
                Change from Base Forecast
            
            
            3.64
            %
            
            1.90
            %
            
            -2.35
            %
            
            -5.09
            %





19
 *Index*





**NORTHERN
      STATES FINANCIAL CORPORATION**








**ITEM
      4. CONTROLS AND PROCEDURES**





As
      of the
      end of the period covered by this report, an evaluation was carried out under
      the supervision and with the participation of Northern States Financial
      Corporation’s management, including our Chairman of the Board and President and
      Vice President and Treasurer, of the effectiveness of our disclosure controls
      and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
      Securities Exchange Act of 1934). Based on and as of the date of their
      evaluation, our Chairman of the Board and President and Vice President and
      Treasurer have concluded that the Company’s disclosure controls and procedures
      are effective, in all material respects, to ensure that information required
      to
      be disclosed by Northern States Financial Corporation in reports that it files
      or submits under the Exchange Act is recorded, processed, summarized and
      reported within the time periods specified in Securities and Exchange Commission
      rules and forms and are effective to ensure that material information related
      to
      the Company and its subsidiaries required to be disclosed in the reports that
      the Company files or submits under the Exchange Act is accumulated and
      communicated to the Company’s management, including our Chairman of the Board
      and President and Vice President and Treasurer, to allow timely decisions
      regarding required disclosure.





There
      was
      no change in the Company’s internal control over financial reporting that
      occurred during the three months ended March 31, 2006, that has materially
      affected, or is reasonably likely to materially affect, the Company’s internal
      control over financial reporting.








**PART
      II. OTHER INFORMATION**




**ITEM
      1. LEGAL PROCEEDINGS**




From
      time
      to time, due to the nature of its business, the Company and its subsidiaries
      are
      often subject to various legal actions. Other than as described below, these
      legal actions, whether pending or threatened, arise through the normal course
      of
      business and neither the Company nor any of its subsidiaries are currently
      involved in any proceedings that would, in management’s judgement, have a
      material adverse effect on the Company’s business, results of operation,
      financial condition or cash flows.





In
      September 2005, the Company filed Motions for Judgement on the Pleadings in
      its
      Commercial Money Center litigations against the sureties. At that time, the
      court granted the Motion for Judgement on the Pleadings against ACE/Illinois
      Union; however, the Bank’s motion against the RLI sureties was denied.
      ACE/Illinois Union insures the lease pools that amounted to $5.2 million at
      March 31, 2006 and RLI acts as the sureties on lease pools totaling $4.1 million
      at March 31, 2006. On October 31, 2005, the court directed all parties involved
      in the Commercial Money Center litigation to engage in mediation. Mediation
      has
      concluded, and the Company and Bank expects to enter into a settlement agreement
      with ACE/Illinois Union, subject to approval by the court, during the second
      quarter 2006. No assurance can be given as to the exact amounts that will be
      ultimately collected by the Bank, if any, as a result of the
      settlement.




**ITEM
      1A. RISK FACTORS**





There
      have been no material changes to the risk factors relating to the Company from
      those risk factors previously disclosed in the Company’s Annual Report on Form
      10-K for its fiscal year ended December 31, 2005, in response to Item 1A. to
      Part I of Form 10-K.





20
 *Index*




**NORTHERN
      STATES FINANCIAL CORPORATION**








**ITEM
      2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE
      OF PROCEEDS**





**Issuer
      Purchases of Equity Securities**




There
      were no purchases made by, or on behalf of, the Company of shares of the
      Company’s common stock during the quarterly period ended March 31,
      2006.








**ITEM
      3. DEFAULTS UPON SENIOR
      SECURITIES**





None ****








**ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS**





None








**ITEM
      5. OTHER
      INFORMATION**





None








**ITEM
      6. EXHIBITS**





(a)
            Exhibits.





Exhibit
      3.1 Articles of Incorporation of the Company, as amended to date. (Filed with
      Company’s annual report on Form 10-K for the year ended December 31, 1994
      (Commission File 0-19300) and incorporated herein by reference.)





Exhibit
      3.2 By-Laws of the Company, as amended and restated to date. (Filed with
      Company’s quarterly report on Form 10-Q for the quarter ended March 31, 2004
      (Commission File 0-19300) and incorporated herein by reference.)





Exhibit
      4.1 Certain instruments defining the rights of holders of long-term debt of
      the
      Company and certain of its subsidiaries, none of which authorize a total amount
      of indebtedness in excess of 10% of the total assets of the Company and its
      subsidiaries on a consolidated basis, have not been filed as exhibits. The
      Company hereby agrees to furnish a copy of any of these agreements to the SEC
      upon request.





Exhibit
      31.1 Section 302 Certification of Chairman of the Board and
      President.





Exhibit
      31.2 Section 302 Certification of Vice President and Treasurer.





Exhibit
      32.1 Section 906 Certification.





21
 *Index*


**NORTHERN
      STATES FINANCIAL CORPORATION**


**FORM
      10-Q**


**March
      31, 2006**

















**SIGNATURES**














Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report on Form 10-Q to be signed on its behalf by the
      undersigned hereunto duly authorized, on this 9th day of May 2006.





**NORTHERN
                  STATES FINANCIAL CORPORATION**
                (Registrant)
  Date:  
                  May 9,
                  2006
                By:
                /s/
                  Fred
                  Abdula
  Fred Abdula
                  Chairman of the Board
                    of
                  Directors and
                    President
 Date:  
                        May 9,
                        2006
                      By:
                      /s/
                        Thomas
                        M. Nemeth
  Thomas M.
                          Nemeth
                        Vice President and
                          Treasurer
 22
 *Index*


**NORTHERN
      STATES FINANCIAL CORPORATION**


**FORM
      10-Q**


**March
      31, 2006**








**EXHIBIT
      INDEX**








Exhibits




Exhibit
      3.1 Articles of Incorporation of the Company, as amended to date. (Filed with
      Company’s annual report on Form 10-K for the year ended December 31, 1994
      (Commission File 0-19300) and incorporated herein by reference.)





Exhibit
      3.2 By-Laws of the Company, as amended and restated to date. (Filed with
      Company’s quarterly report on Form 10-Q for the quarter ended March 31, 2004
      (Commission File 0-19300) and incorporated herein by reference.)





Exhibit
      4.1 Certain instruments defining the rights of holders of long-term debt of
      the
      Company and certain of its subsidiaries, none of which authorize a total amount
      of indebtedness in excess of 10% of the total assets of the Company and its
      subsidiaries on a consolidated basis, have not been filed as exhibits. The
      Company hereby agrees to furnish a copy of any of these agreements to the SEC
      upon request.





Exhibit
      31.1 Section 302 Certification of Chairman of the Board and
      President.





Exhibit
      31.2 Section 302 Certification of Vice President and Treasurer.





Exhibit
      32.1 Section 906 Certification.





23