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 June 30, 2007
 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
                0-19300
                36-3449727(State
                    of Incorporation)
                (Commission
                (I.R.S.
                    EmployerFile
                    Number)
                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, an
        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
 
 
 4,178,105
        shares of common stock were outstanding
 as
        of
        August 3, 2007
  *Table
            of Contents*




**NORTHERN
      STATES FINANCIAL CORPORATION AND SUBSIDIARY**


**FORM
      10-Q**


**For
      the Quarter Ended June 30, 2007**


**INDEX**







**Page
                  Number**PART
                  I.
              FINANCIAL INFORMATIONItem
                  1.
              
              Financial
                  StatementsReport
                  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
              20Item
                  4.
              
              Controls
                  and
                  Procedures
              22PART
                  II.
              
              OTHER
                  INFORMATIONItem
                  1.
              
              Legal
                  Proceedings
              23Item
                  1A.
              
              Risk
                  Factors
              23Item
                  2.
              
              Unregistered
                  Sales of Equity Securities and Use of
                  Proceeds
              24Item
                  3.
              
              Defaults
                  upon Senior
                  Securities
              24Item
                  4.
              
              Submission
                  of Matters to a Vote of Security
                  Holders
              24Item
                  5.
              
              Other
                  Information
              25Item
                  6.
              
              Exhibits
              25Signatures
              
              26EXHIBIT
                  INDEX
              
              27


1
 *Table
            of Contents*







**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 June 30, 2007, the condensed
      consolidated statements of income for the three and six month periods ended
      June
      30, 2007 and 2006 and the condensed statements of cash flows and stockholders
      equity for the six month periods ended June 30, 2007 and 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,
                IllinoisJuly
              25, 2007










2
 *Table
            of Contents*







NORTHERN
        STATES FINANCIAL CORPORATION


CONDENSED
        CONSOLIDATED BALANCE SHEETS
 June
        30,
        2007 and December 31, 2006
 (In
        thousands of dollars) (Unaudited)


**June
                  30,**
              
              
              **December
                  31,****2007**
              
              
              **2006**AssetsCash
                  and due from banks
              
              $
              14,823
              
              
              $
              19,023Interest
                  bearing deposits in financial institutions - maturities less than
                  90
                  days
              
              
              188
              
              
              
              885Federal
                  funds sold
              
              
              46,593
              
              
              
              10,078Total
                  cash and cash equivalents
              
              
              61,604
              
              
              
              29,986Securities
                  available for sale
              
              
              198,362
              
              
              
              279,056Loans
                  and leases
              
              
              377,847
              
              
              
              373,715Less:
                  Allowance for loan and lease losses
              
              
              (3,729
              )
              
              
              (7,162
              )Loans
                  and leases, net
              
              
              374,118
              
              
              
              366,553Federal
                  Home Loan Bank stock
              
              
              1,445
              
              
              
              1,445Office
                  buildings and equipment, net
              
              
              9,339
              
              
              
              9,394Other
                  real estate owned
              
              
              2,857
              
              
              
              2,983Goodwill
              
              
              9,522
              
              
              
              9,522Core
                  deposit intangible asset
              
              
              1,623
              
              
              
              1,854Accrued
                  interest receivable and other assets
              
              
              7,384
              
              
              
              9,216Total
                  assets
              
              $
              666,254
              
              
              $
              710,009Liabilities
                  and Stockholders' EquityLiabilitiesDepositsDemand
                  - noninterest bearing
              
              $
              56,638
              
              
              $
              58,530Interest
                  bearing
              
              
              440,212
              
              
              
              464,066Total
                  deposits
              
              
              496,850
              
              
              
              522,596Securities
                  sold under repurchase agreements
              
              
              73,419
              
              
              
              86,775Federal
                  Home Loan Bank advances
              
              
              6,500
              
              
              
              11,500Subordinated
                  debentures
              
              
              10,000
              
              
              
              10,000Advances
                  from borrowers for taxes and insurance
              
              
              941
              
              
              
              794Accrued
                  interest payable and other liabilities
              
              
              6,611
              
              
              
              6,881Total
                  liabilities
              
              
              594,321
              
              
              
              638,546Stockholders'
                  EquityCommon
                  stock
              
              
              1,789
              
              
              
              1,789Additional
                  paid-in capital
              
              
              11,584
              
              
              
              11,584Retained
                  earnings
              
              
              66,717
              
              
              
              65,603Treasury
                  stock, at cost
              
              
              (7,202
              )
              
              
              (5,961
              )Accumulated
                  other comprehensive loss
              
              
              (955
              )
              
              
              (1,552
              )Total
                  stockholders' equity
              
              
              71,933
              
              
              
              71,463Total
                  liabilities and stockholders' equity
              
              $
              666,254
              
              
              $
              710,009
   The
        accompanying notes are an integral part of these
        condensed consolidated financial statements.





3
 *Table
            of Contents*




NORTHERN
      STATES FINANCIAL CORPORATION


CONDENSED
      CONSOLIDATED STATEMENTS OF INCOME


Three
      and
      six months ended June 30, 2007 and 2006


(In
      thousands of dollars, except per share data) (Unaudited)





**Three
                    months ended**
              
              
              **Six
                    months ended****June
                    30, 2007**
              
              
              **June
                    30, 2006**
              
              
              **June
                    30, 2007**
              
              
              **June
                    30, 2006**Interest
                  incomeLoans
                  (including fee income)
              
              $
              6,813
              
              
              $
              6,946
              
              
              $
              13,396
              
              
              $
              13,420SecuritiesTaxable
              
              
              2,357
              
              
              
              2,061
              
              
              
              4,979
              
              
              
              4,197Exempt
                  from federal income tax
              
              
              71
              
              
              
              56
              
              
              
              142
              
              
              
              114Federal
                  funds sold and other
              
              
              390
              
              
              
              78
              
              
              
              480
              
              
              
              161Total
                  interest income
              
              
              9,631
              
              
              
              9,141
              
              
              
              18,997
              
              
              
              17,892Interest
                  expenseTime
                  deposits
              
              
              3,070
              
              
              
              2,982
              
              
              
              6,188
              
              
              
              5,814Other
                  deposits
              
              
              930
              
              
              
              1,024
              
              
              
              1,921
              
              
              
              2,002Repurchase
                  agreements and federal funds purchased
              
              
              917
              
              
              
              564
              
              
              
              1,911
              
              
              
              1,267Federal
                  Home Loan Bank advances
              
              
              64
              
              
              
              64
              
              
              
              177
              
              
              
              127Subordinated
                  debentures
              
              
              170
              
              
              
              165
              
              
              
              336
              
              
              
              320Total
                  interest expense
              
              
              5,151
              
              
              
              4,799
              
              
              
              10,533
              
              
              
              9,530Net
                  interest income
              
              
              4,480
              
              
              
              4,342
              
              
              
              8,464
              
              
              
              8,362Provision
                  for loan and lease losses
              
              
              0
              
              
              
              0
              
              
              
              (1,425
              )
              
              
              0Net
                  interest income after provision for loan and lease losses
              
              
              4,480
              
              
              
              4,342
              
              
              
              9,889
              
              
              
              8,362Noninterest
                  incomeService
                  fees on deposits
              
              
              706
              
              
              
              639
              
              
              
              1,362
              
              
              
              1,224Trust
                  income
              
              
              216
              
              
              
              182
              
              
              
              427
              
              
              
              398Other
                  operating income
              
              
              488
              
              
              
              463
              
              
              
              787
              
              
              
              752Total
                  noninterest income
              
              
              1,410
              
              
              
              1,284
              
              
              
              2,576
              
              
              
              2,374Noninterest
                  expenseSalaries
                  and employee benefits
              
              
              2,148
              
              
              
              2,223
              
              
              
              4,449
              
              
              
              4,479Occupancy
                  and equipment, net
              
              
              645
              
              
              
              558
              
              
              
              1,243
              
              
              
              1,174Data
                  processing
              
              
              448
              
              
              
              416
              
              
              
              827
              
              
              
              795Legal
              
              
              83
              
              
              
              88
              
              
              
              222
              
              
              
              190Audit
                  and other professional
              
              
              287
              
              
              
              325
              
              
              
              584
              
              
              
              652Amortization
                  of core deposit intangible asset
              
              
              115
              
              
              
              115
              
              
              
              231
              
              
              
              231Printing
                  and supplies
              
              
              118
              
              
              
              99
              
              
              
              213
              
              
              
              239Other
                  operating expenses
              
              
              492
              
              
              
              551
              
              
              
              887
              
              
              
              1,050Total
                  noninterest expense
              
              
              4,336
              
              
              
              4,375
              
              
              
              8,656
              
              
              
              8,810Income
                  before income taxes
              
              
              1,554
              
              
              
              1,251
              
              
              
              3,809
              
              
              
              1,926Income
                  tax expense
              
              
              507
              
              
              
              339
              
              
              
              1,233
              
              
              
              471Net
                  income
              
              $
              1,047
              
              
              $
              912
              
              
              $
              2,576
              
              
              $
              1,455Earnings
                  per share
              
              $
              0.25
              
              
              $
              0.21
              
              
              $
              0.61
              
              
              $
              0.34Comprehensive
                  income
              
              $
              858
              
              
              $
              764
              
              
              $
              3,173
              
              
              $
              1,490
 
 The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.




4
 *Table
            of Contents*




NORTHERN
        STATES FINANCIAL CORPORATION


CONDENSED
        CONSOLIDATED STATEMENTS OF CASH FLOWS
 Six
          months ended June 30, 2007 and 2006


(In
        thousands of dollars) (Unaudited)


**Six
                  months ended**
              ********
              ****
              **June
                  30, 2007**
              ****
              ****
              **June
                  30, 2006**Cash
                  flows from operating activitiesNet
                  income
              
              $
              2,576
              
              
              $
              1,455Adjustments
                  to reconcile net income to net cash from operating
                  activities:Depreciation
              
              
              292
              
              
              
              294Loss
                  on sale of other real estate owned
              
              
              8
              
              
              
              22Provision
                  for loan and lease losses
              
              
              (1,425
              )
              
              
              0Amortization
                  of other intangible assets
              
              
              231
              
              
              
              231Net
                  change in accrued interest receivable and other assets
              
              
              1,417
              
              
              
              (485
              )Net
                  change in accrued interest payable and other liabilities
              
              
              (270
              )
              
              
              126Net
                  cash from operating activities
              
              
              2,829
              
              
              
              1,643Cash
                  flows from investing activitiesProceeds
                  from maturities and calls of securities available for sale
              
              
              121,620
              
              
              
              49,720Purchases
                  of securities available for sale
              
              
              (39,953
              )
              
              
              (35,344
              )Proceeds
                  from the redemption of Federal Home Loan Bank stock
              
              
              0
              
              
              
              439Change
                  in loans made to customers
              
              
              (6,101
              )
              
              
              4,119Proceeds
                  from sales of other real estate owned
              
              
              118
              
              
              
              408Property
                  and equipment expenditures
              
              
              (237
              )
              
              
              (252
              )Net
                  cash from investing activities
              
              
              75,447
              
              
              
              19,090Cash
                  flows from financing activitiesNet
                  increase (decrease) in:Deposits
              
              
              (25,746
              )
              
              
              (14,654
              )Securities
                  sold under repurchase agreements and federal funds
                  purchased
              
              
              (13,356
              )
              
              
              (15,017
              )Advances
                  from borrowers for taxes and insurance
              
              
              147
              
              
              
              61Federal
                  Home Loan Bank advances
              
              
              10,000
              
              
              
              0Repayment
                  of Federal Home Loan Bank advances
              
              
              (15,000
              )
              
              
              0Purchase
                  of treasury stock
              
              
              (1,241
              )
              
              
              (252
              )Dividends
                  paid
              
              
              (1,462
              )
              
              
              (1,289
              )Net
                  cash used in financing activities
              
              
              (46,658
              )
              
              
              (31,151
              )Net
                  change in cash and cash equivalents
              
              
              31,618
              
              
              
              (10,418
              )Cash
                  and cash equivalents at beginning of period
              
              
              29,986
              
              
              
              29,668Cash
                  and cash equivalents at end of period
              
              $
              61,604
              
              
              $
              19,250
 
 The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.





5
 *Table
            of Contents*





NORTHERN
        STATES FINANCIAL CORPORATION


CONDENSED
        CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY


Six
        months ended June 30, 2007 and 2006
 (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' Equity**Balance,
                  December 31, 2005
              
              $
              1,789
              
              
              $
              11,584
              
              
              $
              65,526
              
              
              $
              (3,487
              )
              
              $
              (4,660
              )
              
              $
              70,752Correction
                  of errors from previous years, January 1, 2006
              
              
              
              
              
              
              
              
              
              
              (245
              )
              
              
              
              
              
              
              
              
              
              
              (245
              )Balance,
                  January 1, 2006, restated
              
              
              1,789
              
              
              
              11,584
              
              
              
              65,281
              
              
              
              (3,487
              )
              
              
              (4,660
              )
              
              
              70,507Net
                  income
              
              
              
              
              
              
              
              
              
              
              1,455
              
              
              
              
              
              
              
              
              
              
              
              1,455Cash
                  dividends ($0.30 per share)
              
              
              
              
              
              
              
              
              
              
              (1,289
              )
              
              
              
              
              
              
              
              
              
              
              (1,289
              )Purchase
                  of 12,000 shares of treasury stock
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (252
              )
              
              
              (252
              )Unrealized
                  gain on securities available for sale, net of deferred tax
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              35
              
              
              
              
              
              
              
              35Balance,
                  June 30, 2006
              
              $
              1,789
              
              
              $
              11,584
              
              
              $
              65,447
              
              
              $
              (3,452
              )
              
              $
              (4,912
              )
              
              $
              70,456Balance,
                  December 31, 2006
              
              $
              1,789
              
              
              $
              11,584
              
              
              $
              65,603
              
              
              $
              (1,552
              )
              
              $
              (5,961
              )
              
              $
              71,463Net
                  income
              
              
              
              
              
              
              
              
              
              
              2,576
              
              
              
              
              
              
              
              
              
              
              
              2,576Cash
                  dividends ($0.35 per share)
              
              
              
              
              
              
              
              
              
              
              (1,462
              )
              
              
              
              
              
              
              
              
              
              
              (1,462
              )Purchase
                  of 55,000 shares of treasury stock
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (1,241
              )
              
              
              (1,241
              )Unrealized
                  gain on securities available for sale, net of deferred tax
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              597
              
              
              
              
              
              
              
              597Balance,
                  June 30, 2007
              
              $
              1,789
              
              
              $
              11,584
              
              
              $
              66,717
              
              
              $
              (955
              )
              
              $
              (7,202
              )
              
              $
              71,933
  The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.





6
 *Table
            of Contents*





**NORTHERN
      STATES FINANCIAL CORPORATION**





**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





For
      the
      Quarter Ended June 30, 2007





(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, 2006 and 2005.  The results
      of operations for the three and six month period ended June 30, 2007, 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 Company had no common stock equivalents during
      the first six months of 2007 and the entire year of 2006.  The average
      outstanding common shares used for earnings per share follows:





**Three
                months ended**
            ****
            ****
            **Six
                months ended****June
                30,**
            ****
            ****
            **June
                30,**
            ****
            ****
            **June
                30,**
            ****
            ****
            **June
                30,**
            ********
            ****
            **2007**
            ****
            ****
            **2006**
            ****
            ****
            **2007**
            ****
            ****
            **2006**Average
                outstanding common shares
            
            
            4,190,193
            
            
            
            4,292,204
            
            
            
            4,200,591
            
            
            
            4,293,646








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, 2007, 30,000 shares of stock were repurchased for a total of $650,000
      and during the three months ended June 30, 2007, 25,000 shares of stock were
      purchased for $591,000.    At June 30, 2007, the Company had
      a total of 294,150 shares of treasury stock that it purchased under these
      programs.  Treasury stock is carried at cost.  The Company
      may purchase 105,850 shares under the remaining stock repurchase
      program.





7
 *Table
            of Contents*







**NORTHERN
        STATES FINANCIAL CORPORATION**
 
 **NOTES
        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 
 For
        the
        Quarter Ended June 30, 2007
 
 (Unaudited)





Information
      related to common stock was as follows:




**June
                30,**
            ****
            ****
            **December
                31,**
            ********
            ****
            **2007**
            ****
            ****
            **2006**Par
                value per share
            
            $
            0.40
            
            
            $
            0.40Authorized
                shares
            
            
            6,500,000
            
            
            
            6,500,000Issued
                shares
            
            
            4,472,255
            
            
            
            4,472,255Treasury
                shares
            
            
            294,150
            
            
            
            239,150Outstanding
                shares
            
            
            4,178,105
            
            
            
            4,233,105








Note
      2
– Subordinated Debentures





During
      September 2005, the Company issued $10 million of trust preferred securities
      through Northern States Statutory Trust I, a wholly-owned grantor trust, 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%.  The rate on the subordinated debentures was 6.673%
      at June 30, 2007 and is the effective rate from June 15, 2007 through September
      16, 2007.  For the three and six months ended June 30, 2007, interest
      expense on the subordinated debentures was $170,000 and $336,000.  For
      the three and six months ended June 30, 2006, interest expense on the
      subordinated debentures was $165,000 and $320,000.





The
      Company has guaranteed the payment of distributions and payments upon
      liquidation or redemption of the trust preferred securities, in each case to
      the
      extent of funds held by the Trust. The Company and the Trust believe that,
      taken
      together, the obligations of the Company under the guarantee, the subordinated
      debentures, and other related agreements provide, in the aggregate, a full,
      irrevocable and unconditional guarantee, on a subordinated basis, of all of
      the
      obligations of the Trust under the trust preferred securities. Subject to
      certain limitations, the Company has the right to defer the payment of interest
      on the subordinated debentures at any time, or from time to time, for a period
      not to exceed 20 consecutive quarters. The trust preferred securities are
      subject to mandatory redemption, in whole or in part, upon repayment of the
      subordinated debentures at maturity or their earlier redemption. The
      subordinated debentures are callable at par beginning in 2010, and earlier
      at
      the discretion of the Company if certain conditions are met, and, in any event,
      only after the Company has obtained Federal Reserve approval, if then required
      under applicable guidelines or regulations.







8
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            of Contents*








**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 June 30, 2007 and the
      consolidated results of operations for the three and six month periods ended
      June 30, 2007, compared with the same periods of 2006.  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 its wholly owned subsidiary, NorStates Bank (the “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.





It
      should
      be noted that the Bank’s wholly owned subsidiary, Waukegan Hotels, LLC (“WHLLC”)
      mentioned in previous filings was dissolved during the second quarter,
      2007.  The Bank formed WHLLC in 2006 in order to operate two motels
      that had been foreclosed upon and were being carried as other real estate
      owned.  These properties were sold in the fourth quarter of 2006 and
      all operations were completed in the first quarter of 2007.





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 June 30, 2007 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 the
      remaining 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 and deposit 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.





OVERVIEW





Total
      assets at June 30, 2007 declined from year-end levels.  Assets totaled
      $666.3 million at June 30, 2006, a decrease of $43.7 million or 6.2 percent
      from
      total assets of $710.0 million at December 31, 2007 as the Company restructured
      its balance sheet to improve earnings.  The restructuring included a
      decrease in the securities portfolio of  $80.7 million since December
      31, 2006 primarily due to maturities of lower yielding U.S. government-sponsored
      agency securities.  The Company redeployed the proceeds from these
      maturities of securities into higher yielding federal funds sold, which
      increased $36.5 million at June 30, 2007 from December 31,
      2006.  Loans and leases increased $4.1 million from year-end
      2006.  Further restructuring incuded decreasing higher cost deposits
      by $25.7 million, securities sold under repurchase agreements by $13.4 million
      and Federal Home Loan Bank advances by $5.0 million as compared with December
      31, 2006 levels.








9
 *Table
            of Contents*








Earnings
      for the three months ended June 30, 2007 were $1,047,000 or $.25 per share,
      as
      compared with $912,000 or $.21 per share for the same quarter of 2006, an
      increase of 14.8 percent.  The earnings improvement in the second
      quarter 2007 compared to the same quarter of the proceeding year is due to
      an
      increase to net interest income of $138,000 along with an increase to
      nonininterest income of $126,000 and a reduction of noninterest expense of
      $39,000.  The growth to net interest income is attributable to the
      Company’s reduction of its lower-earning U.S. government-sponsored securities
      portfolio and decreases to its higher cost interest-bearing deposits and
      securities sold under repurchase agreements since the beginning of the
      year.  The stable interest rate environment in 2007, as compared with
      increases to interest rates during the first half of 2006, also contributed
      to
      the growth to net interest income.  The $138,000 increase to net
      interest income would have been more significant but for the one-time collection
      of $307,000 of interest paid on nonaccrual lease pools during the second quarter
      of 2006.  Noninterest income growth came from greater service fees on
      deposits, which increased $67,000.  Most of the decrease to
      noninterest expense is attributed to a decline in salaries and employee benefits
      as the Company’s restructuring reduced overhead.




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 June 30, 2007 is adequate to cover probable incurred credit
      losses.





One
      of the components used to measure the adequacy of the allowance for loan losses
      is historical loss experience.  In developing its analysis, management
      considers that different loan classifications within the portfolio have
      different loss experience ratios.  For example, loans secured by real
      estate generally experience lower loss experience than loans secured by other
      assets.  As of June 30, 2007, approximately 87 percent of the Bank’s
      loans are secured by real estate.





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.  The amount of the specific allocation is dependent 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








10
 *Table
            of Contents*








basis,
      the amount of the specific allocation is subject to greater 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





During
      2007, management Company has concentrated on increasing the Company’s net
      interest income.  To this end, management has restructured the
      Company’s balance sheet.  The Company’s federal funds sold at June 30,
      2007 increased to $46.5 million from $10.0 million at December 31, 2006, as
      lower yielding U.S. government-sponsored agency securities matured, causing
      a
      reduction to the Company’s securities available for sale of $80.7 million from
      year-end 2006.  The Company redeployed the proceeds into federal funds
      sold as they provide the Company liquidity, flexibility and earned a high yield
      due to the inverted interest rate yield curve for much of first half of
      2007.  An inverted yield curve is where short-term interest rates are
      higher than long-term rates.





The
      reduction of $80.7 million in securities from December 31, 2006 came mainly
      from
      maturities of U.S. government-sponsored agency securities, which decreased
      $80.5
      million from year-end.  The absence of these lower earning securities
      has increased the yield on the remaining government sponsored portfolio to
      4.20
      percent at June 30, 2007 compared with 3.63 percent at December 31,
      2006.  The Company has U.S. government-sponsored agency securities
      with a carrying amount of $79.4 million that yield 3.14 percent that will be
      maturing during the last six months of 2007.  As these lower yielding
      government-sponsored securities mature during the next six months, the Company
      has the opportunity to replace them by purchasing higher yielding securities
      or
      use the funds generated from the maturities to lower the amounts of higher
      cost
      borrowings or time deposits carried on its balance sheet.





The
      Company has entered into a contractual arrangement, effective July 1, 2007,
      with
      First Tennessee Bank NA to provide advisory service to management pertaining
      to
      the administration of the Company’s securities portfolio.  The purpose
      of this engagement is to assist the Company in its goal of increasing the yields
      earned on its securities porfolio.





Loans
      and
      leases are the largest earning asset of the Company and totaled $377.8 million
      at June 30, 2007, increasing $4.1 million from $373.7 million at December 31,
      2006.  The increase in loans and leases was primarily due to the
      booking of a loan totaling $7.9 million secured by a motel to an existing
      customer.  Without this loan, loans and leases would have decreased
      $2.3 million since December 31, 2006.  Loans to the lodging industry
      at June 30, 2007 totaled $21.0 million.  Approximately 87 percent of
      the Bank’s loan portfolio at June 30, 2007 was secured by real estate and a
      majority of the Company’s loans had fixed rates, compared with a year ago, when
      the majority of loans had variable rates or rates that change periodically
      based
      on an index.  This shift to fixed rate loans has occurred in response
      to market competition and borrowers’ requests for fixed rate loans as protection
      against possible increases in general interest rates. Loan commitments have
      increased $37.4 million to $142.9 million at June 30, 2007 compared with $105.5
      million at December 31, 2006 as loans are being approved but borrowers have
      delayed drawing on the loans.  Letters of credit also increased at
      June 30, 2007 to $10.8 million from $8.0 million at year-end.  At June
      30, 2007, loans to related parties totaled $1.8 million.  Loan
      commitments and letters of credit issued to related parties were $1.9 million
      at
      June 30, 2007.  Loans, commitments and letters of credit to related
      parties are made at the same terms and conditions that are available to the
      public.








11
 *Table
            of Contents*








Deposits
      decreased $25.7 million, or 4.9 percent, from year-end 2006.  A
      majority of the decline in deposits resulted from decreases to higher cost
      money
      market accounts and time deposits of $100,000 or greater, which decreased $12.6
      million and $7.5 million, respectively.  Demand, NOW and savings
      accounts also declined $1.9 million, $1.7 million and $2.3 million from December
      31, 2006, respectively.  Most of the decrease to money market accounts
      came from commercial depositors who used the withdrawn funds for business
      purposes or transferred the funds to alternative investments outside of the
      Bank.





The
      Company, as the result of management’s efforts in restructuring the balance
      sheet, has carefully reviewed the Bank’s deposit products and the rates paid on
      those products.  In order to increase its net interest income, the
      Bank reduced rates paid on its deposit products during the first half of
      2007.  At June 30, 2007, rates offered on time deposits of $100,000 or
      greater have declined 20 to 25 basis points from year-end 2006.  Some
      of the reduction to deposit balances from December 31, 2006 can be attributed
      to
      these rate reductions.





Brokered
      deposits totaled $44.2 million at June 30, 2007, which approximate year-end
      levels.  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.  During the next
      twelve months the Company has scheduled maturities of $20.3 million in brokered
      deposits that have a blended rate of 4.85 percent.  The Company
      expects to use proceeds from maturities of lower yielding U.S. government
      sponsored securities during the next six months, to lower the amount of its
      brokered deposits as these deposits mature.





Securities
      sold under repurchase agreements decreased by $13.4 million to $73.4 million
      at
      June 30, 2007 from $86.8 million at December 31, 2006. Federal Home Loan Bank
      term advances also decreased $5.0 million from year-end. The Company reduced
      its
      repurchase agreements and term advance borrowings as higher rates are usually
      paid on these other borrowings than on deposits.  It is expected that
      higher cost securities sold under repurchase agreements will decrease further
      in
      2007.





As
      previously disclosed, included in
      other liabilities at June 30, 2007 is $304,000 related to estimated
      environmental clean-up expenses of a parcel of other real estate owned, which
      had been sold in previous years.  The Company intends to seek
      reimbursement of these expenses from the State of Illinois that has an
      established 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 was $71.9 million at June 30, 2007, increasing $470,000
      from year-end 2006. During the six months ended June 30, 2007 there were
      increases to stockholder’s equity from net income of $2,576,000 and from a
      $597,000 adjustment for the unrealized gain on securities available for sale,
      net of deferred tax.  Stockholders’ equity was decreased during the
      first half of 2007 as a result of the purchase of 55,000 shares of treasury
      stock for a total amount of $1,241,000 and by the payment of a cash dividend
      of
      $.35 per share that totaled $1,462,000.  The book value of the
      Company’s stock at June 30, 2007 was $17.22 per share.





On
      a
      consolidated basis, the Company’s Tier 1 to total average assets ratio and total
      capital to assets ratio, on a risk adjusted basis, were 10.78 percent and 16.17
      percent, respectively, as of June 30, 2007, 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.





LIQUIDITY





The
      Company’s liquidity is measured by the ability to raise funds through deposits,
      borrowed funds, capital or cash flow from the repayment or maturities of loans
      and securities and net profits.   Liquidity is primarily managed through
      deposits, liquid assets such as cash and due from banks less any





12
 *Table
            of Contents*








reserve
      requirements, securities available for sale less any pledged securities and
      federal funds sold.  The Bank’s liquid assets totaled $105.3 million at
      June 30, 2007.  Asset and liability management is the process of
      managing the balance sheet to achieve a mix of earning assets and liabilities
      in
      such a way that achieves an interest rate risk profile acceptable to management
      and assists in achieving a desired level of profitability.  An important
      part of the overall asset and liability management process is providing adequate
      liquidity.





Management
      reviews the liquidity ratio of the Bank monthly.  The liquidity ratio
      is the net liquid assets divided by net deposits and short-term
      liabilities.  At June 30, 2007, this ratio at the Bank was 24.3
      percent and was within management’s internal policy guidelines.





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 or to fund loans to
      borrowers.  The statements of cash flows shows that for the six months
      ended June 30, 2007 cash and cash equivalents increased significantly by $31.6
      million to $61.6 million as federal funds sold increased.





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 June 30, 2007 were $46.6
      million.  This increase in federal funds sold was done by the Company
      for liquidity purposes as securities matured and as the rates paid on federal
      funds sold were competitive due to the inverted yield curve.  The
      Company classifies all of its securities as available for sale, which increases
      the Company's flexibility in that the Company can use its unpledged securities
      to meet liquidity requirements by increasing its repurchase agreement
      balances.  Securities available for sale totaled $198.4 million at
      June 30, 2007 of which $149.0 million were pledged to secure public deposits
      and
      repurchase agreements.





Although
      the Company can sell unpledged securities for liquidity purposes prior to their
      maturity date, the Company, at the present, may have to recognize a loss on
      the
      sale to do so.  At June 30, 2007, the Company has $79.4 million in
      securities issued by government-sponsored entities that will mature in the
      remaining six months of 2007.  It is expected that liquidity will be
      provided by these maturing securities during the balance of 2007 without causing
      recognition of any loss.





During
      the first six months of 2007, the Company had incoming cash flows from
      maturities and calls of securities available for sale of $121.6 million while
      it
      had cash outflows for purchases of securities of $40.0 million.  These
      securities activities during the first half of 2007 provided liquidity of $81.6
      million which was used to restructure the liability components of the Company’s
      balance sheet by decreasing deposits by $25.7 million, repurchase agreements
      by
      $13.4 million and term advance borrowings by $5.0 million.





Other sources of liquidity available to the Company are deposits and
      borrowings.  The Company may use brokered deposits as a source of
      liquidity.  To help ensure the ability to meet its funding needs,
      including any unexpected decreases to liquidity, at June 30, 2007 the Company
      had $25.0 million available through arrangements that allow the Company to
      purchase federal funds from an independent bank.





RESULTS
      OF OPERATIONS





NET
      INCOME


Consolidated net income for the quarter ended June 30, 2007 was $1,047,000,
      increasing $135,000 compared with net income of $912,000 for the same quarter
      of
      2006.  The annualized return on average assets was .62 percent for the
      quarter, increasing from .53 percent for the same quarter the previous
      year.  The increase to net income for the quarter is primarily the
      result of increased net interest income and nointinerest income while
      noninterest expenses declined.  For the six months ended June 30,
      2007, net income was $2,576,000 as compared with $1,455,000 for the first half
      of 2006. The annualized return on








13
 *Table
            of Contents*








average
      assets for the first six months of 2007 was .75%, increasing from .41% for
      the
      same period of 2006.  The increase to net income for the first half of
      2007 is primarily the result of the Company’s reduction of the allowance for
      loan and lease loss and the corresponding reversal of $1,425,000 to the
      provision for loan and leases loss expense as well as increases to net interest
      income.





NET
      INTEREST INCOME





Net
      interest income, the difference between interest income on earning assets and
      interest expense on interest bearing liabilities, increased $138,000 to $4.5
      million during the three months ended June 30, 2007 compared with $4.3 million
      for the same quarter of 2006.  This increase would have been more
      significant but for the one-time collection of $307,000 of interest paid on
      nonaccrual lease pools during the second quarter of 2006.





Net
      interest income during the second quarter of 2007 increased as the Company
      restructured its balance sheet by lowering the balances of and increasing the
      yields earned on its taxable securities.  A portion of the proceeds
      from maturing U.S. government-sponsored securities were used to decrease its
      more costly interest-bearing deposits and borrowings and to increase short-term
      federal funds sold that were yielding competitive rates.   Table
      1 shows that the average yield on taxable securities was 4.22 percent for the
      three months ended June 30, 2007 as compared with 3.29 percent for the same
      period of 2006, while average balances of taxable securities decreased $23.1
      million.  The Company is expecting to further increase the yield
      earned on its taxable securities in 2007 as U.S. government-sponsored securities
      totaling $79.4 million that carry an average yield of 3.14 percent are scheduled
      to mature during the second half of 2007.  The Company has the
      opportunity to redeploy the funds from these maturities into higher yielding
      interest earning assets or to repay higher cost borrowings and time
      deposits.  Yields on federal funds sold were 5.59 percent for the
      second quarter of 2007, increasing from 4.66 percent for the same quarter last
      year while average federal funds sold balances increased $21.2
      million.





Average
      yields on interest earning assets for the second quarter of 2007 increased
      50
      basis points as compared with the same quarter of 2006.  Average rates
      paid on interest bearing liabilities increased to a lesser extent than the
      yields on interest earning assets, only 36 basis points during the second
      quarter of 2007 compared with the same quarter last year.  This caused
      the net interest spread to increase to 2.29 percent for the quarter as compared
      with 2.15 percent for the same quarter the previous year.  The net
      yield on interest earning assets also increased 18 basis points during the
      second quarter of 2007 as compared to the second quarter of last
      year.





The
      Company has taken steps to increase
      its net interest income by constantly reviewing its deposit rates and adjusting
      them if appropriate.  To date in 2007, the Company has lowered the
      rates offered on its time deposits by 20 to 25 basis points.  Although
      lowering rates paid on deposit products may result in some decreases in deposit
      balances, the Company believes this strategy will ultimately result in increased
      net interest income and profitability.  The Company expects that the
      lower deposit rates will cause higher cost brokered deposits to decrease as
      there is $20.3 million of brokered deposits currently being paid an average
      of
      4.85 percent scheduled to mature within the next 12 months.





Table
      2
      shows that during the six months ended June 30, 2007, net interest income on
      a
      fully tax equivalent basis increased $120,000 compared with the same period
      of
      2006.  Again the increase to the rates earned on taxable securities
      and federal funds caused interest earning asset yields to increase to a greater
      extent than the increases to yields paid on interest bearing
      liabilities.  Average yields on interest earning assets increased 52
      basis points during the six months ended June 30, 2007 as compared with the
      same
      six months last year while average rates paid on interest bearing liabilities
      increased by 48 basis points, causing the growth to the net interest
      spread.








14
 *Table
            of Contents*





TABLE
      1




NORTHERN
      STATES FINANCIAL CORPORATION  ANALYSIS OF AVERAGE BALANCE AND TAX EQUIVALENT
      RATES


For
        the
        Three Months Ended  June 30, 2007 and 2006 - Rates are
        Annualized
 ($
        000s)
   **2007**
                        
                        
                        **2006****Average
                              Balance**
                        
                        
                        **Interest**
                        
                        
                        **Rate**
                        
                        
                        **Average
                              Balance**
                        
                        
                        **Interest**
                        
                        
                        **Rate**AssetsLoans
                            (1)(2)(3)
                        
                        $
                        374,025
                        
                        
                        $
                        6,831
                        
                        
                        
                        7.31
                        %
                        
                        $
                        390,179
                        
                        
                        $
                        6,960
                        
                        
                        
                        7.14
                        %Taxable
                            securities (4)
                        
                        
                        222,326
                        
                        
                        
                        2,357
                        
                        
                        
                        4.22
                        %
                        
                        
                        245,377
                        
                        
                        
                        2,061
                        
                        
                        
                        3.29
                        %Tax
                            advantaged securities (2) (4)
                        
                        
                        7,654
                        
                        
                        
                        107
                        
                        
                        
                        5.59
                        %
                        
                        
                        6,247
                        
                        
                        
                        87
                        
                        
                        
                        5.54
                        %Federal
                            funds sold
                        
                        
                        27,915
                        
                        
                        
                        390
                        
                        
                        
                        5.59
                        %
                        
                        
                        6,699
                        
                        
                        
                        78
                        
                        
                        
                        4.66
                        %Interest
                            earning assets
                        
                        
                        631,920
                        
                        
                        
                        9,685
                        
                        
                        
                        6.12
                        %
                        
                        
                        648,502
                        
                        
                        
                        9,186
                        
                        
                        
                        5.62
                        %Noninterest
                            earning assets
                        
                        
                        44,102
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        42,805Average
                            assets
                        
                        $
                        676,022
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        $
                        691,307Liabilities
                            and stockholders' equityNOW
                            deposits
                        
                        $
                        49,653
                        
                        
                        $
                        101
                        
                        
                        
                        .81
                        %
                        
                        $
                        54,216
                        
                        
                        $
                        127
                        
                        
                        
                        0.94
                        %Money
                            market deposits
                        
                        
                        75,691
                        
                        
                        
                        703
                        
                        
                        
                        3.72
                        %
                        
                        
                        73,977
                        
                        
                        
                        705
                        
                        
                        
                        3.81
                        %Savings
                            deposits
                        
                        
                        66,612
                        
                        
                        
                        125
                        
                        
                        
                        .75
                        %
                        
                        
                        77,824
                        
                        
                        
                        192
                        
                        
                        
                        .99
                        %Time
                            deposits
                        
                        
                        252,892
                        
                        
                        
                        3,070
                        
                        
                        
                        4.86
                        %
                        
                        
                        279,734
                        
                        
                        
                        2,982
                        
                        
                        
                        4.26
                        %Other
                            borrowings
                        
                        
                        93,246
                        
                        
                        
                        1,152
                        
                        
                        
                        4.94
                        %
                        
                        
                        67,399
                        
                        
                        
                        793
                        
                        
                        
                        4.71
                        %Interest
                            bearing liabilities
                        
                        
                        538,094
                        
                        
                        
                        5,151
                        
                        
                        
                        3.83
                        %
                        
                        
                        553,150
                        
                        
                        
                        4,799
                        
                        
                        
                        3.47
                        %Demand
                            deposits
                        
                        
                        57,578
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        59,421Other
                            noninterest bearing liabilities
                        
                        
                        8,258
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        7,550Stockholders'
                            equity
                        
                        
                        72,092
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        71,186Average
                            liabilities and stockholders' equity
                        
                        $
                        676,022
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        $
                        691,307Net
                            interest income
                        
                        
                        
                        
                        
                        $
                        4,534
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        $
                        4,387Net
                            interest spread
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        2.29
                        %
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        2.15
                        %Net
                            yield on interest earning assets (4)
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        2.86
                        %
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        2.68
                        %Interest-bearing
                            liabilities to earning assets ratio
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        85.15
                        %
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        85.30
                        %
 (1)
                          –
                      Interest
                          income on loans includes loan origination and other fees
                          of $196 and $173
                          for the three months ended June 30, 2007 and 2006.(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 June 30, 2007 and 2006
                          average balance information includes an average unrealized
                          gain (loss) for
                          taxable securities of ($1,214) and ($5,399) and for tax-advantaged
                          securities of $0 and ($36).


15
 *Table
            of Contents*




TABLE
        2
 
 NORTHERN
        STATES FINANCIAL CORPORATION
 ANALYSIS
        OF AVERAGE BALANCE AND TAX EQUIVALENT RATES
 For
        the
        Six Months Ended  June 30, 2007 and 2006 - Rates are
        Annualized
 ($
        000s)




**2007**
                
                
                **2006****Average
                    Balance**
                
                
                **Interest**
                
                
                **Rate**
                
                
                **Average
                    Balance**
                
                
                **Interest**
                
                
                **Rate**AssetsLoans
                    (1)(2)(3)
                
                $
                373,849
                
                
                $
                13,431
                
                
                
                7.19
                %
                
                $
                393,728
                
                
                $
                13,450
                
                
                
                6.83
                %Taxable
                    securities (4)
                
                
                242,356
                
                
                
                4,979
                
                
                
                4.08
                %
                
                
                250,786
                
                
                
                4,197
                
                
                
                3.28
                %Tax
                    advantaged securities (2) (4)
                
                
                7,711
                
                
                
                215
                
                
                
                5.58
                %
                
                
                6,376
                
                
                
                174
                
                
                
                5.44
                %Federal
                    funds sold
                
                
                17,242
                
                
                
                480
                
                
                
                5.57
                %
                
                
                6,776
                
                
                
                161
                
                
                
                4.75
                %Interest
                    earning assets
                
                
                641,158
                
                
                
                19,105
                
                
                
                5.94
                %
                
                
                657,666
                
                
                
                17,982
                
                
                
                5.42
                %Noninterest
                    earning assets
                
                
                41,777
                
                
                
                
                
                
                
                
                
                
                
                44,982Average
                    assets
                
                $
                682,935
                
                
                
                
                
                
                
                
                
                
                $
                702,648Liabilities
                    and stockholders' equityNOW
                    deposits
                
                $
                49,609
                
                
                $
                198
                
                
                
                .80
                %
                
                $
                53,966
                
                
                $
                273
                
                
                
                1.01
                %Money
                    market deposits
                
                
                76,623
                
                
                
                1,472
                
                
                
                3.84
                %
                
                
                72,725
                
                
                
                1,314
                
                
                
                3.61
                %Savings
                    deposits
                
                
                67,127
                
                
                
                251
                
                
                
                .75
                %
                
                
                77,604
                
                
                
                415
                
                
                
                1.07
                %Time
                    deposits
                
                
                256,727
                
                
                
                6,188
                
                
                
                4.82
                %
                
                
                283,158
                
                
                
                5,814
                
                
                
                4.11
                %Other
                    borrowings
                
                
                96,888
                
                
                
                2,424
                
                
                
                5.00
                %
                
                
                77,613
                
                
                
                1,714
                
                
                
                4.42
                %Interest
                    bearing liabilities
                
                
                546,974
                
                
                
                10,533
                
                
                
                3.85
                %
                
                
                565,066
                
                
                
                9,530
                
                
                
                3.37
                %Demand
                    deposits
                
                
                56,471
                
                
                
                
                
                
                
                
                
                
                
                58,917Other
                    noninterest bearing liabilities
                
                
                7,847
                
                
                
                
                
                
                
                
                
                
                
                7,563Stockholders'
                    equity
                
                
                71,643
                
                
                
                
                
                
                
                
                
                
                
                71,102Average
                    liabilities and stockholders' equity
                
                $
                682,935
                
                
                
                
                
                
                
                
                
                
                $
                702,648Net
                    interest income
                
                
                
                
                
                $
                8,572
                
                
                
                
                
                
                
                
                
                
                $
                8,452Net
                    interest spread
                
                
                
                
                
                
                
                
                
                
                2.09
                %
                
                
                
                
                
                
                
                
                
                
                2.05
                %Net
                    yield on interest earning assets (4)
                
                
                
                
                
                
                
                
                
                
                2.67
                %
                
                
                
                
                
                
                
                
                
                
                2.55
                %Interest-bearing
                    liabilities to earning assets ratio
                
                
                
                
                
                
                
                
                
                
                85.31
                %
                
                
                
                
                
                
                
                
                
                
                85.92
                %


(1)
                  –
              Interest
                  income on loans includes loan origination and other fees of $256
                  and $234
                  for the six months ended June 30, 2007 and 2006.(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 six months ended June 30, 2007 and 2006 average
                  balance information includes an average unrealized gain (loss)
                  for taxable
                  securities of ($1,756) and ($5,420) and for tax-advantaged securities
                  of
                  $1 and ($23).







16
 *Table
            of Contents*








ASSET
      QUALITY AND THE PROVISION FOR LOAN AND LEASE LOSSES





At
      June
      30, 2007, 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, determined that
      the
      current allowance of $3.7 million was adequate to cover probable incurred loan
      and lease losses. The allowance decreased by $3.5 million at June 30, 2007,
      from
      the year-end 2006 allowance of $7.2 million.  During the first six
      months of 2007, $2.1 million in loans and leases were charged off against the
      allowance compared with charge offs of $2.0 million during the same period
      last
      year.  There was $49,000 in recoveries of loans previously charged off
      during the six months ended June 30, 2007 compared with $6,000 in recoveries
      during the same period in 2006.  During the first quarter of 2007, the
      provision for loan and lease losses was reduced by $1.4 million and no provision
      was made during the second quarter of 2007 as compared with no provision during
      the first half of 2006.





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, totaled $6.6 million at June 30, 2007, or 1.75 percent of total loans
      and leases, as compared with $8.2 million at December 31, 2006, or 2.19 percent
      of loans and leases.   The reduction to nonperforming loans at
      June 30, 2007 compared to year-end was $1.6 million or 19 percent.





The
      Company previously disclosed its involvement in certain lease pools purchased
      in
      2000 and 2001 from Commercial Money Center (“CMC”).  At June 30, 2007,
      the nonaccrual lease pools had a carrying value of  $2.0 million and
      are secured by surety bonds issued by RLI Insurance Company. The lease pools
      balances of $4.0 million at December 31, 2006 were reduced during the first
      quarter of 2007 to $2.0 million as $2.0 million of the lease pools were charged
      off against the allowance for loan and lease losses. The Company continues
      its
      litigation against RLI Insurance Company seeking performance under the terms
      of
      the surety bonds.





Also
      on
      nonaccrual status at June 30, 2007 is a $1.5 million loan for a 90-unit
      condominium construction project which has been classified as a nonaccrual
      loan
      since December 31, 2003.  The Company participated in this 90-unit
      condominium construction project with other financial institutions and only
      hold
      a portion of the total outstanding 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 of which the majority
      are insured by a title company.  The bankruptcy trustee during 2006
      released $2.7 million of funds held in the escrow to the Company reducing the
      loan balance.  The bankruptcy trustee is still holding funds in escrow
      until the disputed mechanic liens are resolved.  Due to court delays,
      the mechanic liens issue is not expected to be concluded until the first half
      of
      2008.  Management expects to collect all of the remaining $1.5 million
      loan balance from the bankruptcy trustee.





The
      Company has a restructured nonaccrual loan with a carrying amount of $1.2
      million at June 30, 2007, to a heavy equipment contractor that is secured by
      real estate and equipment.  The restrucured loan agreement allows the
      contractor 4 months to sell the properties.  If the properties are not
      sold in that time period several of the properties will be deeded to the Bank
      in
      lieu of foreclosure.  The Company has specifically allocated $200,000
      of the allowance for loan and lease losses to this loan
      relationship.





Other
      nonaccrual loans at June 30, 2007 are loans totaling $467,000 on a
      restaurant/tavern secured by real estate that the borrower is attempting to
      sell.  Another loan for a foundry in the amount of $349,000 is on
      nonaccrual status to which the Bank has $100,000 of the allowance for loan
      and
      lease losses specifically allocated.   On a nonaccrual loan for
      an entertainment center of  $193,000, the Company has specifically
      allocated the entire balance to the allowance for loan and lease losses and
      expects to chargeoff the loan later in 2007.





Impaired
      loans and leases at June 30, 2007 totaled $5.8 million as compared with $9.5
      million at December 31, 2006.  The Company considers a loan or lease
      impaired if full principal and interest will not





17
 *Table
            of Contents*








be
      collected under the contractual terms of the note.  Nonaccrual loans
      and leases are classified 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 collateral, if the loan
      or
      lease is collateral dependent.





During
      the first quarter of 2007 the Company reduced its allowance for loan and lease
      losses and corresponding provision for loan and lease losses by $1.4
      million.  The Company received payment in full during the quarter
      ended March 31, 2007 on a problem loan with a balance of $1.4 million at
      year-end 2006.  There had been $275,000 of the allowance for loan
      losses specifically allocated to this $1.4 million loan that was no longer
      needed in the allowance. The Company also had one restructured loan included
      as
      impaired at March 31, 2007 in the amount of $1.5 million where $500,000 of
      the
      allowance for loan and lease losses had been specifically allocated to this
      loan.  During the first quarter of 2007 the Company received
      additional collateral in excess of the restructured loan balance and specific
      allocation was no longer necessary allowing $500,000 to be reversed from the
      allowance. This restructured loan was later paid off in full during the second
      quarter of 2007.  The remaining reduction to the allowance and
      provision was attributable to general improvement in the credit quality of
      the
      loan portfolio.





Another
      component of nonperforming assets is other real estate owned, consisting of
      assets acquired through loan foreclosure and repossession. At June 30, 2007,
      other real estate owned totaled $2.9 million, decreasing from $3.0 million
      at
      December 31, 2006.  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.  During the quarter ended March 31, 2007, the Company
      sold a parcel carried as other real estate owned with a carrying value of
      $126,000 at December 31, 2006 for $118,000 and recognized a $8,000 loss on
      the
      sale.  The property consisted of empty lots.





A
      two-story office building in Waukegan, Illinois that had been transferred to
      other real estate owned in 2004 has a carrying value of $1,147,000 as of June
      30, 2007.  A contract to lease/purchase this property had been in
      effect in which the renter/purchaser had been making monthly payments of
      $7,700.  Subsequent to June 30, 2007, the rental period ended and the
      renter/purchaser has declined their option to purchase the property and will
      not
      renew their lease.  The Company is making efforts to sell this
      property.





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 $1,710,000 at June 30,
      2007.  Environmental remediation costs may be incurred in disposing of
      this property.  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.  Subsequent to June 30, 2007, the Company received the
      preliminary results of the brownfield assessment on the
      property.  These preliminary results showed that an end use of
      construction of mid-rise residential housing on the site would allow
      encapsulation of questionable soils at the site at an estimated cost of
      approximately $485,000.  To remediate the property for the
      construction of single family dwellings at the site would require removal of
      the
      soil at an estimated cost of approximately $4.8 million.  No
      determination has yet been made as to the ultimate end use of the property,
      which would need to be approved by the City of Waukegan as part of its Lakefront
      Downtown Master Plan. The appraised value of the property supports the Bank’s
      carrying value plus the estimated cost of encapsulation.  Due to
      uncertainties as to the end use of the property, at this time no liability
      has
      been recorded for these estimated environmental remediation costs.





NONINTEREST
      INCOME





Noninterest
      income for the three months ended June 30, 2007 was $1.4 million compared to
      $1.3 million for the three months ended June 30, 2006, an increase of
      $126,000.  Service fees on deposits increased $67,000 and other trust
      income increased $34,000.  Other operating income during the second
      quarter of 2007, included a gain recognized from the sale of the Bank’s land
      trust area of $148,000.  The





18
 *Table
            of Contents*








land
      trust area was sold as the use of land trusts has dwindled and the overhead
      costs of maintaining the land trust area continue to grow.  The land
      trust area was never considered a separate segment of the
      Company.  The Company’s trust and investment services area was
      unaffected by this sale.  Future trust income is expected to decrease
      approximately $15,000 per quarter due to this sale.  Other operating
      income did not increase for the second quarter of 2007 over the same quarter
      last year due to the land trust area sale as last year one-time life insurance
      proceeds of $75,000 and one-time check printing fees of $69,000 were received
      during the second quarter of 2006.





For
      the
      six months ended June 30, 2007, noninterest income was $2.6 million, an increase
      of $202,000 from the same time period last year.  Contributing to the
      increase was service fees on deposits that were $138,000 greater than for the
      same six months last year.  The Bank’s mortgage banking area that
      generates fee income from taking home mortgage applications that are funded
      by
      other financial entities, had $47,000 more in fee income during the first half
      of 2007 as compared to the same time period last year.





NONINTEREST
      EXPENSE





Noninterest
      expense for the quarter ended June 30, 2007 was $4,336,000, decreasing $39,000
      from the same quarter last year.  The decrease was due to lower salary
      and employee benefits expense of $75,000 due to increased efficiencies as the
      Company’s restructuring of the balance sheet reduced overhead.





The
      Company’s efficiency ratio, noninterest expense divided by the sum of net
      interest income and noninterest income, was 73.6 percent for the second quarter
      of 2007 as compared with 77.8 percent for the same quarter of 2006. The lower
      ratio for the second quarter of 2007 reflects the increased net interest income
      and noninterest income and the decline to noninterest expenses in the second
      quarter of 2007 compared to the same time period last year.





For
      the six months ended June 30, 2007,
      noninterest expense was $8.6 million, decreasing $154,000 from $8.8 million
      for
      the same period last year.  Noninterest expense declined during the
      first half of 2007 as compared with the first half of 2006 primarily due to
      decreases to salaries and other employee benefits of $30,000 and other operating
      expenses of $163,000.  Other operating expenses declined due to a
      reduction to other real estate owned expense of $99,000 as the Bank received
      rent payments on a building it had foreclosed on, in addition to reduced FDIC
      expense of $90,000 as the Bank’s risk rating was upgraded.





FEDERAL
      AND STATE INCOME TAXES





For
      the three months ended June 30, 2007, the Company’s income tax expense was
      $507,000 compared with $339,000 for the same three months last
      year.  As a percentage of pre-tax income, tax expense was 32.6% for
      the three months ended June 30, 2007 and 27.1% for the same period of
      2006.  As a percentage of pre-tax income, tax expense was 32.4% for
      the six months ended June 30, 2007 and 24.5% for the same period of
      2006.  The tax rates increased in 2007 due to the increased levels of
      taxable income of the Company.





The
      Company earned interest income from
      U.S. Treasury and U.S. government-sponsored entity securities not subject to
      state income tax of $2.1 million during the second quarter of 2007 as compared
      with $1.9 million during the same quarter of 2006.   For the
      first half of 2007, U.S. Treasury and U.S. government-sponsored entity
      securities interest not subject to state income tax was $4.4 million as compared
      with $4.0 million during the same quarter of 2006.  It is expected
      that interest on government-sponsored securities will decrease as the balances
      on these securities have decreased $80.5 million since the beginning of 2007.
      The Company has generated state tax credits during the first half quarter of
      2007 of $26,000 as compared with a credit of $161,000 during the first half
      of
      2006 as a result of lower taxable income last year.  The Company needs
      to generate sufficient taxable income for state tax return purposes within
      12
      years in order to use up these tax credits, or the Company will need to reverse
      these credits.





19
 *Table
            of Contents*







CONTRACTUAL
      OBLIGATIONS AND OFF-BALANCE SHEET ARRANGEMENTS





The
      Company has contractual obligations that may not appear on the balance
      sheet.  Table 3 presents the Company’s significant fixed and
      determinable contractual obligations as of June 30, 2007, by payment date.
      The
      payment amounts in Table 3 represent those amounts contractually due to the
      recipient and do not include any unamortized premiums or discounts or similar
      carrying amount adjustments.




TABLE
        3
  NORTHERN
        STATE FINANCIAL CORPORATION
 CONTRACTUAL
        OBLIGATIONS
 As
        of
        June 30, 2007
 ($
        000s)




**One
                      year or less**
                
                
                **Greater
                      than 1 yr. and less than or equal to 3 yrs.**
                
                
                **Greater
                      than 3 yrs. and less than or equal to 5
                      yrs.**
                
                
                **Greater
                      than 5 yrs.**
                
                
                **Total**Contractual
                    obligationsLong-term
                    debtFederal
                    Home Loan Bank advance
                
                $
                6,500
                
                
                $
                0
                
                
                $
                0
                
                
                $
                0
                
                
                $
                6,500Subordinated
                    debentures
                
                
                0
                
                
                
                0
                
                
                
                0
                
                
                
                10,000
                
                
                
                10,000Time
                    deposits
                
                
                192,846
                
                
                
                58,852
                
                
                
                65
                
                
                
                0
                
                
                
                251,763Other
                    contractual obligationsStandby
                    letters of credit
                
                
                10,778
                
                
                
                0
                
                
                
                0
                
                
                
                0
                
                
                
                10,778Community
                    Reinvestment ActInvestment
                    commitment
                
                
                220
                
                
                
                51
                
                
                
                0
                
                
                
                0
                
                
                
                271






**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





20
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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
      4 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
      June
      30, 2007 and December 31, 2006.  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.





At
      June
      30, 2007 the projected net interest income increases $910,000 when rates are
      shocked upward 2% while projected net interest income decreases $1,375,000
      for a
      2% downward rate shock.   At December 31, 2006 projected net
      interest income decreased $800,000 when rates were shocked upward 2% while
      projected net interest income decreased only slightly, by $10,000, for a 2%
      downward rate shock.  The reason for this change is that for the June
      30, 2007 rate shock analysis the Company refined the assumptions used in the
      model regarding its money market accounts and the extent that interest rates
      on
      money market would change during a rate shock.





A
      review
      of the extent that interest rate changes affected money market interest rates
      at
      the Company during the past 10 years showed that when rates went up 100 basis
      points that the money market rates would increase only 45 basis
      points.  Historically, when rates went down 100 basis points, the
      Company only dropped money market rates by 45 basis points as
      well.  These assumptions were used for the June 30, 2007 computer
      simulation.  At December 31, 2006 the assumption used for money market
      interest rates was that for each 100 basis point rate change either up or down
      that the money market rate would correspondingly go up and down 100 basis
      points.   The effect of using the refined assumptions based on
      historical correlations at June 30, 2007 shows net interest income increasing
      with upward rate shocks and net interest income declining with downward rate
      shocks.





At
      both
      June 30, 2007 and December 31, 2006, the percentage changes from the base
      forecasted 12 month net interest income are within policy
      guidelines.






TABLE
        4
 
 NORTHERN
        STATES FINANCIAL CORPORATION
 EFFECT
        OF
        INTEREST SHOCKS ON NET INTEREST INCOME
 as
        of
        June 30, 2007 and December 31, 2006
 ($000s)






**Immediate
                  Change in Rates**
              ********
              ****
              ****
              **-2.00%**
              
              ****
              ****
              **-1.00%**
              
              ****
              ****
              **+1.00%**
              
              ****
              ****
              **+2.00%**June
                  30, 2007:Dollar
                  Change from Base Forecast
              
              $
              (1,375
              )
              
              $
              (697
              )
              
              $
              484
              
              
              $
              910Percent
                  Change from Base Forecast
              
              
              -7.07
              %
              
              
              -3.58
              %
              
              
              2.49
              %
              
              
              4.68
              %December
                  31, 2006:Dollar
                  Change from Base Forecast
              
              $
              (10
              )
              
              $
              (2
              )
              
              $
              (326
              )
              
              $
              (800
              )Percent
                  Change from Base Forecast
              
              
              -0.06
              %
              
              
              -0.01
              %
              
              
              -1.94
              %
              
              
              -4.77
              %







21
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**NORTHERN
      STATES FINANCIAL CORPORATION**








**ITEM
      4. CONTROLS AND PROCEDURES**





The
      Company maintains disclosure controls and procedures that are designed to ensure
      that information required to be disclosed in the reports that the Company files
      or submits under the Securities  Exchange Act of 1934 is recorded,
      processed, summarized, and reported within the time periods specified in the
      SEC's rules and regulations, and that such information is accumulated and
      communicated to the Company's management, including its Chairman of the Board
      and President and Vice President and Treasurer, as appropriate, to allow timely
      decisions regarding required disclosures.





As
      of the
      end of the period covered by this Quarterly Report on Form 10-Q, the Company
      carried out an evaluation, under the supervision and with the participation
      of
      the Company's management, including the Chairman of the Board and President
      and
      Vice President and Treasurer, of the effectiveness of the design and operation
      of the Company’s disclosure controls and procedures pursuant to Securities
      Exchange Act Rule 13a- 15(e) and 15d-15(e). Based upon this evaluation as of
      June 30, 2007, the Chairman of the Board and President and Vice President and
      Treasurer concluded that our disclosure controls and procedures were not
      effective for the reasons more fully described below related to the weakness
      in
      our  internal  control over financial
      reporting  identified during the audit of the 2006 internal control
      over financial reporting evaluation in connection with Section 404 of the
      Sarbanes-Oxley Act of 2002.  Progress continues to be made to
      remediate this material weakness that was identified at December 31,
      2006.  To address the control weakness, the Company performed updated
      procedures to ensure the unaudited quarterly consolidated financial statements
      are prepared in accordance with generally accepted accounting
      principles.  Accordingly, management believes that the consolidated
      financial statements included in this Quarterly Report on Form 10-Q, fairly
      present, in all material respects, our consolidated financial condition,
      consolidated results of operations and cash flows for the periods
      presented.





Management’s
      assessment continued to identify the following material weakness in the
      Company’s internal control over financial reporting as of June 30, 2007 (this
      section of Item 4. “Controls and Procedures” should be read in conjunction with
      Item 9A. “Controls and Procedures,” included in the Company's Form 10-K for the
      year ended December 31, 2006, for additional information on Management's
      Assessment of Internal Control Over Financial Reporting):




1.  Deficiencies
      in the general controls over the reconciliation of the ATM clearing account
      resulted in improper recognition of ATM fee income due to a procedural
      bookkeeping error. The system of monitoring the ATM procedures was not effective
      in preventing the improper recognition of noninterest
      income.  Accordingly, management concluded that this matter represents
      a material weakness of control over financial reporting.




The
      Company identified this deficiency in its internal control over financial
      reporting during the audit of the year ended December 31, 2006 and accordingly,
      this control deficiency is in the process of being remediated. The finding
      discussed above was characterized as a material weakness in accordance with
      the
      rules and regulations of the Securities and Exchange Commission, as a more
      than
      remote possibility that a material misstatement to the Company's interim or
      annual financial statements could occur.  However, the internal
      control weakness identified by management did not cause a material misstatement
      or have an adverse impact to the Company's financial position, results of
      operations or control environment as of and for the three and six months ended
      June 30, 2007.





**Changes
      in Internal Control over Financial Reporting**





To
      address and remediate the material weaknesses in the Company's internal control
      over financial reporting at December 31, 2006, the Company made changes to
      its
      internal controls during the most recently completed fiscal quarter ended June
      30, 2007 that has materially affected, or is reasonable likely to materially
      affect, the Company's internal controls over financial
      reporting.  Management, with the





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**NORTHERN
      STATES FINANCIAL CORPORATION**








oversight
      of the Audit Committee, has addressed the issue and has taken steps to remediate
      the weakness. These remediation measures include changes to accounting
      procedures for the booking of ATM fee income as well as training of those
      persons monitoring and balancing the ATM procedures to insure that these errors
      do not reoccur.





The
      Company believes that the measures above have addressed the matter identified
      as
      a material weakness by management, however, the formal assessment and testing
      procedures have not been completed by management or the Company’s independent
      auditors as of June 30, 2007, and as such, the material weakness continues
      to
      exist.  The Company will continue to monitor the effectiveness of its
      disclosure controls and procedures, including its internal controls and
      procedures, on an ongoing basis and will take further actions, as
      appropriate.





**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.





Between
      November 2000 and
      August 2001, the Company purchased commercial lease pools from Commercial
      Money Center, a now bankrupt equipment leasing company.  The lease
      pools have outstanding balances of $4.0 million at June 30, 2007, but have
      been
      written down to a carrying value of $2.0 million. These lease pools are secured
      by assignments of rental payment streams and surety bonds.  A large
      part of our underwriting decision on these leases was based on the guarantees
      of
      the sureties.  These lease pools were included as impaired loans and
      leases at June 30, 2007 as they were at December 31, 2006, 2005 and 2004. Upon
      default of these lease pools, the Company made demand for payment from RLI
      Insurance Company (“RLI”) under the relevant surety bonds.  RLI (the
“Surety”) has failed to make the payments required under the surety
      bonds.  As a result, in April 2002, the Company filed suit
      against the Surety.  The Company’s complaints alleged that the Surety
      is liable for payment due to the Company under the terms of the
      bonds.  RLI is seeking to rescind on the surety bonds alleging that
      the originator of the leases fraudulently induced the insurers to issue the
      surety bonds, and that the bonds are therefore void.  The Company has
      reviewed these matters with its legal counsel and believes that it has valid
      claims as the Surety undertook the responsibility for all credit and fraud
      underwriting, and waived all defenses associated with the bonds, including
      defenses of fraud. The Company will continue to assert all the rights and
      remedies available to it to obtain payment under the bonds.  However,
      there can be no assurance as to the exact amounts that the Company will
      ultimately succeed in collecting, if any.








**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, 2006, in response to Item 1A. to Part I of Form 10-K.










23
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**NORTHERN
      STATES FINANCIAL CORPORATION**








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





**Issuer
      Purchases of Equity Securities**




The
      following table sets forth
      information in connection with purchases made by, or on behalf of, the Company
      of shares of the Company’s common stock during the quarterly period ended June
      30, 2007.





**Period**
              
              **Total
                  Number of Shares Purchased**
              
              
              **Average
                  Price Paid per Share**
              
              
              **Total
                  Number of Shares Purchased as Part of Publicly Announced
                  Plans**
              
              
              **Maximum
                  Number of Shares that May Yet be Purchased under the
                  Plans**April
                  1, 2007 Through April 30, 2007
              
              
              0
              
              
              $
              0.00
              
              
              
              0
              
              
              
              130,850May
                  1, 2007 Through May 31, 2007
              
              
              25,000
              
              
              
              23.65
              
              
              
              25,000
              
              
              
              105,850June
                  1, 2007 Through June 30, 2007
              
              
              0
              
              
              
              0.00
              
              
              
              0
              
              
              
              105,850**Total**
              
              
              25,000
              
              
              $
              23.65
              
              
              
              25,000
              
              
              
              105,850








(1)
            On
                April 17, 2002, the Company’s Board of Directors authorized the repurchase
                of up to 200,000 shares of the Company’s common stock either in open
                market or private transactions.  On February 19, 2003, the
                Company’s Board of Directors authorized the repurchase of an additional
                200,000 shares. (No time limit has been set for the completion of
                the
                repurchase programs.)








**ITEM
      3.  DEFAULTS UPON SENIOR
      SECURITIES**





None





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





The
      annual meeting of stockholders of
      Northern States Financial Corporation was held on May 17, 2007, with the
      stockholders of record at April 2, 2007 eligible to vote in person or by proxy,
      with one vote for each share owned, to elect directors for a one year term
      each
      and to ratify the appointment of Plante & Moran, PLLC as independent
      auditors of the Company for the year ending December 31, 2007.  There
      were 4,203,105 shares of stock outstanding and eligible to vote as of April
      2,
      2007.  The appointment of Plante & Moran, PLLC as the Company’s
      independent auditors for the year ending December 31, 2007 was
      ratified








24
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**NORTHERN
        STATES FINANCIAL CORPORATION**


by
      a vote
      of 3,833,975 FOR ratification, with 10,498 shares voting AGAINST, and 23,145
      shares ABSTAINING.  The following directors were duly
      elected:





**Votes**
                **FOR**
              **Votes**
                **WITHHELD**Fred
                  Abdula
              3,827,587
              40,032Kenneth
                  W. Balza
              3,825,640
              41,978Theodore
                  A. Bertrand
              3,830,305
              37,313Jack
                  H. Blumberg
              3,761,992
              105,626Frank
                  J. Furlan
              3,774,915
              92,703Harry
                  S. Gaples
              3,819,940
              47,678James
                  A. Hollesteiner
              3,817,440
              50,178Allan
                  J. Jacobs
              3,780,003
              87,615Raymond
                  M. Mota
              3,783,140
              84,478Helen
                  Rumsa
              3,603,164
              54,454











**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.





25
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**NORTHERN
      STATES FINANCIAL CORPORATION**


**FORM
      10-Q**


**For
      the Quarter ended June 30, 2007**

















**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 8th day of August
      2007.











**NORTHERN
      STATES FINANCIAL CORPORATION**


(Registrant)








Date:  August
                        8, 2007
                      By:
                      /s/
                        Fred Abdula
 Fred Abdula
                        Chairman of the Board of
                          Directors and President




Date:  August
                        8, 2007
                      By:
                      /s/
                        Thomas M. Nemeth
 Thomas
                            M. Nemeth
                          Vice
                            President and Treasurer




26
 *Table
            of Contents*





**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.







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