United
States


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.   20549


________________________________________________________





FORM
10-Q





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


OF
THE SECURITIES EXCHANGE ACT OF 1934


For the
quarterly period ended March 31, 2009


OR


 ̈      TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d)


OF
THE SECURITIES EXCHANGE ACT OF 1934





For the
transition period from _________  to __________


_________________________________________________________


Commission
File Number 000 - 19300


NORTHERN
STATES FINANCIAL CORPORATION


(Exact
name of Registrant as specified in its charter)


Delaware
                
                36-3449727(State
      of Incorporation)
                
                (I.R.S.
      EmployerIdentification
      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 has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files).        YES:o NO:o


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


Large
Accelerated Filer  ̈    Accelerated
Filer o   Non-accelerated
Filer o 
  (Do not check if a smaller reporting company)   Smaller
reporting company x





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





4,072,255
shares of common stock were outstanding


at May
7, 2009













NORTHERN STATES FINANCIAL
CORPORATION AND SUBSIDIARY
  FORM
10-Q
 For the Quarter Ended March
31, 2009
 INDEX
 
 Page NumberPART
      I.   FINANCIAL INFORMATIONItem
      1.  Financial Statements
                                    2Report
      of Independent Registered Public Accounting Firm
                                    2Condensed
      Consolidated Financial Statements and Notes
                                    3Item
      2.  Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
                                    12Item
      3. Quantitative and Qualitative Disclosures About Market
    Risk
                                    25Item
      4. Controls and Procedures
                                    26PART
      II.   OTHER INFORMATIONItem
      1.  Legal Proceedings
                                    26Item
      1A.  Risk Factors
                                    26Item
      2.  Unregistered Sales of Equity Securities and Use of
      Proceeds
                                    27Item
      3.  Defaults upon Senior Securities
                                    27Item
      4.  Submission of Matters to a Vote of Security
      Holders
                                    27Item
      5.  Other Information
                                    27Item
      6.  Exhibits
                                    27Signatures
                                    29EXHIBIT
      INDEX
                                    30
  1
  PART I. FINANCIAL
INFORMATION
  ITEM 1. FINANCIAL
STATEMENTS.
 
 
 
 
 REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
 Board of
Directors and Stockholders
 Northern
States Financial Corporation
 Waukegan,
Illinois
 
 We have
reviewed the accompanying interim condensed consolidated balance sheet of
NORTHERN STATES FINANCIAL CORPORATION as of March 31, 2009, the condensed
consolidated statements of income for the three month periods ended March 31,
2009 and 2008 and the condensed statements of cash flows and stockholders equity
for the three month periods ended March 31, 2009 and 2008.  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,
PLLC
 
 Chicago,
Illinois
 May 1,
2009
 
  2
  NORTHERN
STATES FINANCIAL CORPORATION
 CONDENSED
CONSOLIDATED BALANCE SHEETS
 March 31,
2009 and December 31, 2008
 (In
thousands of dollars) (Unaudited)
 
 March
      31,
                        2009
                      
                      
                      December
      31,
                        2008AssetsCash
      and due from banks
                      
                      $
                      11,756
                      
                      
                      $
                      14,108Interest
      bearing deposits in financial institutions - maturities less than 90
      days
                      
                      
                      209
                      
                      
                      
                      242Federal
      funds sold
                      
                      
                      37,331
                      
                      
                      
                      7,518Total
      cash and cash equivalents
                      
                      
                      49,296
                      
                      
                      
                      21,868Securities
      available for sale
                      
                      
                      96,556
                      
                      
                      
                      103,194Loans
      and leases
                      
                      
                      475,616
                      
                      
                      
                      480,812Less:
      Allowance for loan and lease losses
                      
                      
                      (11,913
                      )
                      
                      
                      (10,402
                      )Loans
      and leases, net
                      
                      
                      463,703
                      
                      
                      
                      470,410Federal
      Home Loan Bank stock
                      
                      
                      1,757
                      
                      
                      
                      1,757Office
      buildings and equipment, net
                      
                      
                      9,856
                      
                      
                      
                      9,916Other
      real estate owned
                      
                      
                      6,275
                      
                      
                      
                      10,575Goodwill
                      
                      
                      9,522
                      
                      
                      
                      9,522Core
      deposit intangible asset
                      
                      
                      810
                      
                      
                      
                      926Accrued
      interest receivable and other assets
                      
                      
                      14,369
                      
                      
                      
                      12,551Total
      assets
                      
                      $
                      652,144
                      
                      
                      $
                      640,719Liabilities
      and Stockholders' EquityLiabilitiesDepositsDemand
      - noninterest bearing
                      
                      $
                      56,078
                      
                      
                      $
                      57,313Interest
      bearing
                      
                      
                      444,442
                      
                      
                      
                      443,508Total
      deposits
                      
                      
                      500,520
                      
                      
                      
                      500,821Securities
      sold under repurchase agreements
                      
                      
                      38,754
                      
                      
                      
                      42,574Federal
      Home Loan Bank advance
                      
                      
                      20,000
                      
                      
                      
                      20,000Subordinated
      debentures
                      
                      
                      10,000
                      
                      
                      
                      10,000Advances
      from borrowers for taxes and insurance
                      
                      
                      1,206
                      
                      
                      
                      1,011Accrued
      interest payable and other liabilities
                      
                      
                      5,129
                      
                      
                      
                      4,699Total
      liabilities
                      
                      
                      575,609
                      
                      
                      
                      579,105Stockholders'
      EquityCommon
      stock (Par value $0.40 per share, authorized 6,500,000 shares, issued
      4,472,255 shares at March 31, 2009 and December 31, 2008)
                      
                      
                      1,789
                      
                      
                      
                      1,789Preferred
      stock (Par value $0.40 per share, authorized 1,000,000 shares, issued
      17,211 shares with liquidation amounts of $1,000.00 per share at March 31,
      2009)
                      
                      
                      16,550
                      
                      
                      
                      0Warrants
      (584,084 issued and outstanding at March 31, 2009)
                      
                      
                      681
                      
                      
                      
                      0Additional
      paid-in capital
                      
                      
                      11,584
                      
                      
                      
                      11,584Retained
      earnings
                      
                      
                      54,507
                      
                      
                      
                      56,082Treasury
      stock, at cost (400,000 shares at March 31, 2009 and December 31,
      2008)
                      
                      
                      (9,280
                      )
                      
                      
                      (9,280
                      )Accumulated
      other comprehensive income
                      
                      
                      704
                      
                      
                      
                      1,439Total
      stockholders' equity
                      
                      
                      76,535
                      
                      
                      
                      61,614Total
      liabilities and stockholders' equity
                      
                      $
                      652,144
                      
                      
                      $
                      640,719
 
 The
accompanying notes are an integral part of these condensed consolidated
financial statements.
   3
  NORTHERN
STATES FINANCIAL CORPORATION
 CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
 Three
months ended March 31, 2009 and 2008
 (In
thousands of dollars, except per share data) (Unaudited)
 
 Three
      months endedMarch
      31,
                      2009
                    
                    
                    March
      31,
                      2008Interest
      incomeLoans
      (including fee income)
                    
                    $
                    6,434
                    
                    
                    $
                    7,246SecuritiesTaxable
                    
                    
                    1,254
                    
                    
                    
                    1,888Exempt
      from federal income tax
                    
                    
                    98
                    
                    
                    
                    115Federal
      funds sold and other
                    
                    
                    3
                    
                    
                    
                    70Total
      interest income
                    
                    
                    7,789
                    
                    
                    
                    9,319Interest
      expenseTime
      deposits
                    
                    
                    2,255
                    
                    
                    
                    2,826Other
      deposits
                    
                    
                    420
                    
                    
                    
                    479Repurchase
      agreements and federal funds purchased
                    
                    
                    171
                    
                    
                    
                    410Federal
      Home Loan Bank advances
                    
                    
                    27
                    
                    
                    
                    62Subordinated
      debentures
                    
                    
                    123
                    
                    
                    
                    159Total
      interest expense
                    
                    
                    2,996
                    
                    
                    
                    3,936Net
      interest income
                    
                    
                    4,793
                    
                    
                    
                    5,383Provision
      for loan and lease losses
                    
                    
                    1,704
                    
                    
                    
                    263Net
      interest income after provision for loan and lease losses
                    
                    
                    3,089
                    
                    
                    
                    5,120Noninterest
      incomeService
      fees on deposits
                    
                    
                    538
                    
                    
                    
                    634Trust
      income
                    
                    
                    172
                    
                    
                    
                    213Loss
      on sale of other real estate owned
                    
                    
                    (1,673
                    )
                    
                    
                    0Other
      operating income
                    
                    
                    238
                    
                    
                    
                    293Total
      noninterest income
                    
                    
                    (725
                    )
                    
                    
                    1,140Noninterest
      expenseSalaries
      and employee benefits
                    
                    
                    2,101
                    
                    
                    
                    2,216Occupancy
      and equipment, net
                    
                    
                    732
                    
                    
                    
                    634Data
      processing
                    
                    
                    391
                    
                    
                    
                    439FDIC
      insururance
                    
                    
                    152
                    
                    
                    
                    42Legal
                    
                    
                    239
                    
                    
                    
                    84Audit
      and other professional
                    
                    
                    271
                    
                    
                    
                    352Amortization
      of core deposit intangible asset
                    
                    
                    116
                    
                    
                    
                    116Other
      operating expenses
                    
                    
                    821
                    
                    
                    
                    547Total
      noninterest expense
                    
                    
                    4,823
                    
                    
                    
                    4,430Income
      before income taxes
                    
                    
                    (2,459
                    )
                    
                    
                    1,830Income
      tax expense
                    
                    
                    (1,002
                    )
                    
                    
                    629Net
      income (loss)
                    
                    $
                    (1,457
                    )
                    
                    $
                    1,201Dividends
      to preferred stockholders
                    
                    
                    98
                    
                    
                    
                    0Accretion
      of discount on preferred stock
                    
                    
                    20
                    
                    
                    
                    0Net
      income (loss) available to common stockholders
                    
                    $
                    (1,575
                    )
                    
                    $
                    1,201Basic
      earnings (loss) per share
                    
                    $
                    (0.39
                    )
                    
                    $
                    0.29Diluted
      earnings (loss) per share
                    
                    $
                    (0.39
                    )
                    
                    $
                    0.29Comprehensive
      income (loss)
                    
                    $
                    (2,192
                    )
                    
                    $
                    1,358
 
 The
accompanying notes are an integral part of these condensed consolidated
financial statements.
   4
 
 NORTHERN STATES FINANCIAL
CORPORATION
 CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS
 Three
months ended March 31, 2009 and 2008
 (In
thousands of dollars) (Unaudited)
 
 Three
      months endedMarch
      31,
                        2009
                      
                      
                      March
      31,
                        2008Cash
      flows from operating activitiesNet
      income
                      
                      $
                      (1,457
                      )
                      
                      $
                      1,201Adjustments
      to reconcile net income to net cash from operating
    activities:Depreciation
                      
                      
                      157
                      
                      
                      
                      125Amortization
      of other intangible assets
                      
                      
                      116
                      
                      
                      
                      116Provision
      for loan and lease losses
                      
                      
                      1,704
                      
                      
                      
                      263Loss
      on sale of other real estate owned
                      
                      
                      1,673
                      
                      
                      
                      0Net
      change in accrued interest receivable and other assets
                      
                      
                      (1,375
                      )
                      
                      
                      25Net
      change in accrued interest payable and other liabilities
                      
                      
                      332
                      
                      
                      
                      (19
                      )Net
      cash from operating activities
                      
                      
                      1,150
                      
                      
                      
                      1,711Cash
      flows from investing activitiesProceeds
      from maturities and calls of securities available for sale
                      
                      
                      5,448
                      
                      
                      
                      59,526Purchases
      of securities available for sale
                      
                      
                      (38
                      )
                      
                      
                      (45,528
                      )Change
      in loans made to customers
                      
                      
                      3,443
                      
                      
                      
                      (29,843
                      )Property
      and equipment expenditures
                      
                      
                      (97
                      )
                      
                      
                      (102
                      )Improvements
      to other real estate owned
                      
                      
                      (5
                      )
                      
                      
                      0Proceeds
      from sales of other real estate owned
                      
                      
                      4,242
                      
                      
                      
                      0Net
      cash from investing activities
                      
                      
                      12,993
                      
                      
                      
                      (15,947
                      )Cash
      flows from financing activitiesNet
      increase (decrease) in:Deposits
                      
                      
                      (301
                      )
                      
                      
                      8,051Issuance of preferred stock and warrants per TARP
                      
                      
                      17,211
                      
                      
                      
                      0Securities sold under repurchase agreements and federal funds
      purchased
                      
                      
                      (3,820
                      )
                      
                      
                      (2,884
                      )Advances from borrowers for taxes and insurance
                      
                      
                      195
                      
                      
                      
                      172Federal
      Home Loan Bank advances
                      
                      
                      10,000
                      
                      
                      
                      25,000Repayment
      of Federal Home Loan Bank advances
                      
                      
                      (10,000
                      )
                      
                      
                      (25,000
                      )Purchases
      of treasury stock
                      
                      
                      0
                      
                      
                      
                      0Net
      cash from financing activities
                      
                      
                      13,285
                      
                      
                      
                      5,339Net
      change in cash and cash equivalents
                      
                      
                      27,428
                      
                      
                      
                      (8,897
                      )Cash
      and cash equivalents at beginning of period
                      
                      
                      21,868
                      
                      
                      
                      23,634Cash
      and cash equivalents at end of period
                      
                      $
                      49,296
                      
                      
                      $
                      14,737
  The
accompanying notes are an integral part of these condensed consolidated
financial statements.
   5
 
 NORTHERN
STATES FINANCIAL CORPORATION
 CONDENSED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
 Three
months ended March 31, 2009 and 2008
 (In
thousands of dollars, except for per share data) (Unaudited)
 
 Common
                              Stock
                            
                            
                            Preferred
                              Stock
                            
                            
                            Warrants
                            
                            
                            Additional
                              Paid-In
                              Capital
                            
                            
                            Retained
                              Earnings
                            
                            
                            Treasury
                              Stock,
      at Cost
                            
                            
                            Accumulated
                              Other
                              Comprehensive
      Income (Loss)
                            
                            
                            Total
                              Stockholders’
                              EquityBalance,
      December 31, 2007
                            
                            $
                            1,789
                            
                            
                            $
                            0
                            
                            
                            $
                            0
                            
                            
                            $
                            11,584
                            
                            
                            $
                            66,983
                            
                            
                            $
                            (7,202
                            )
                            
                            $
                            300
                            
                            
                            $
                            73,454Net
      income
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1,201
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1,201Purchase
      of 50,000 shares of common stock as treasury stock
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (993
                            )
                            
                            
                            
                            
                            
                            
                            (993
                            )Unrealized
      gain on securities available for sale, net of deferred tax
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            157
                            
                            
                            
                            157Balance,
      March 31, 2008
                            
                            $
                            1,789
                            
                            
                            $
                            0
                            
                            
                            $
                            0
                            
                            
                            $
                            11,584
                            
                            
                            $
                            68,184
                            
                            
                            $
                            (8,195
                            )
                            
                            $
                            457
                            
                            
                            $
                            73,819Balance,
      December 31, 2008
                            
                            $
                            1,789
                            
                            
                            $
                            0
                            
                            
                            $
                            0
                            
                            
                            $
                            11,584
                            
                            
                            $
                            56,082
                            
                            
                            $
                            (9,280
                            )
                            
                            $
                            1,439
                            
                            
                            $
                            61,614Net
      income
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (1,457
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (1,457
                            )Issuance
      of preferred stock and warrants
                            
                            
                            
                            
                            
                            
                            16,530
                            
                            
                            
                            681
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            17,211Accrued
      dividend on preferred stock
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (98
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (98
                            )Accretion
      of preferred stock discount issued
                            
                            
                            
                            
                            
                            
                            20
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (20
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            0Unrealized
      loss on securities available for sale, net of deferred tax
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (735
                            )
                            
                            
                            (735
                            )Balance,
      March 31, 2009
                            
                            $
                            1,789
                            
                            
                            $
                            16,550
                            
                            
                            $
                            681
                            
                            
                            $
                            11,584
                            
                            
                            $
                            54,507
                            
                            
                            $
                            (9,280
                            )
                            
                            $
                            704
                            
                            
                            $
                            76,535
 
 The
accompanying notes are an integral part of these condensed consolidated
financial statements.
   6
 NORTHERN STATES FINANCIAL
CORPORATION
 
 NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
 
 March 31,
2009
 
 (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, valuation of other real estate owned, valuation of
other than temporarily impaired securities 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, 2008 and 2007.  The results
of operations for the three month period ended March 31, 2009 are not
necessarily indicative of the results to be expected for the full
year.
  Net
income (loss) was utilized to calculate earnings (loss) per share for all
periods presented.  During the first three months of 2009, the Company
had preferred stock and common stock equivalents from warrants related to funds
received from the U.S Department of the Treasury (the “Treasury Department”)
through its Capital Purchase Program. However, common stock equivalents from
warrants during the first quarter of 2009 were antidilutive and therefore not
considered in computed diluted earnings per share.  The Company had no
common stock equivalents during the first three months of 2008.  The
average outstanding common shares used for earnings (loss) per share were as
follows:
   7
 NORTHERN STATES FINANCIAL
CORPORATION
 
 NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
 
 March 31,
2009
 
 (Unaudited)
 (Dollars
      in thousands, except per share data)
                    
                    Three
      Months Ended
                      March
      31,2009
                    
                    
                    2008Basic
      earnings per share:Net
      income (loss)
                    
                    $
                    (1,457
                    )
                    
                    $
                    1,201Dividends
      to preferred stockholders
                    
                    
                    98
                    
                    
                    
                    0Accretion
      of discount on preferred stock
                    
                    
                    20
                    
                    
                    
                    0Net
      income available to common stockholders
                    
                    $
                    (1,575
                    )
                    
                    $
                    1,201Weighted
      average common shares outstanding
                    
                    
                    4,072,255
                    
                    
                    
                    4,175,907Basic
      earnings (loss) per share
                    
                    $
                    (0.39
                    )
                    
                    $
                    0.29Diluted
      earnings per share:Net
      income (loss)
                    
                    $
                    (1,457
                    )
                    
                    $
                    1,201Dividends
      to preferred stockholders
                    
                    
                    98
                    
                    
                    
                    0Accretion
      of discount on preferred stock
                    
                    
                    20
                    
                    
                    
                    0Net
      income available to common stockholders
                    
                    $
                    (1,575
                    )
                    
                    $
                    1,201Weighted
      average common shares outstanding
                    
                    
                    4,072,255
                    
                    
                    
                    4,175,907Add:
      Dilutive effect of assumed warrant exercises
                    
                    
                    0
                    
                    
                    
                    0Weighted
      average common and dilutive common shares outstanding
                    
                    
                    4,072,255
                    
                    
                    
                    4,175,907Diluted
      earnings (loss) per share
                    
                    $
                    (0.39
                    )
                    
                    $
                    0.29
 
 Note 2 – Preferred
Stock
 
 On
February 20, 2009, pursuant to the U.S. Department of the Treasury (the
“Treasury Department”) TARP Capital Purchase Program, the Company issued to the
Treasury Department, in exchange for total proceeds of $17,211,000, (i) 17,211
shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series
A (the “Preferred Stock”) par value $.40 per share and a liquidation amount per
share equal to $1,000 per share, and (ii) a ten-year warrant (the “Warrant”) to
purchase up to 584,084 shares of the Company’s common stock (the “Common
Stock”), at an exercise price of $4.42 per share.  The $17,211,000
proceeds were allocated to the Series A Preferred Stock and the Warrant based on
the relative fair value of the instruments.  The difference between
the initial carrying value of $16,530,000 that was allocated to the Series A
Preferred Stock and its redemption value of $17,211,000 will be charged to
retained earnings (with a corresponding increase to the carrying value of the
Series A Preferred Stock) over the first five years of the contract as an
adjustment to the dividend yield using the effective yield
method.  The Series A Preferred Stock is generally non-voting and
qualifies as Tier 1 capital.
  In the
event of a liquidation or dissolution of the Company, the Preferred Stock then
outstanding takes precedence over the Company’s common stock for the payment of
dividends and distribution of assets.
  Dividends
are payable quarterly on the Series A Preferred Stock at an annual dividend rate
of 5% per year for the first five years, and 9% per year
thereafter.  The effective yield of the Series A Preferred Stock
approximates 5.94%.
   8
  NORTHERN STATES FINANCIAL
CORPORATION
 
 NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
 
 March 31,
2009
 
 (Unaudited)
 For as
long as any shares of Series A Preferred Stock are outstanding, no dividends may
be declared or paid on the Company’s common stock unless all accrued and unpaid
dividends for all past dividend periods on the Series A Preferred Stock are
fully paid. Pursuant to the Capital Purchase Program, the Treasury Department’s
consent is required for any increase in dividends on the Company’s common stock
from the amount of the last semi-annual stock dividend declared by the Company
prior to October 14, 2008, unless the Series A Preferred Stock is redeemed in
whole or the Treasury Department has transferred all of the Series A Preferred
Stock it owns to third parties.
  The
Company may not repurchase any common stock of the Company without the prior
consent of the Treasury Department for as long as the shares of Series A
Preferred Stock are outstanding to the Treasury Department or the Treasury
Department transfers all of the Series A Preferred Stock it owns to third
parties.
  Note 3 – Common
Stock
  Information
related to common stock was as follows:
  March
      31,
                        2009
                      
                      
                      December
      31,  2008Par
      value per share
                      
                      $
                      0.40
                      
                      
                      $
                      0.40Authorized
      shares
                      
                      
                      6,500,000
                      
                      
                      
                      6,500,000Issued
      shares
                      
                      
                      4,472,255
                      
                      
                      
                      4,472,255Treasury
      shares
                      
                      
                      400,000
                      
                      
                      
                      400,000Outstanding
      shares
                      
                      
                      4,072,255
                      
                      
                      
                      4,072,255
 
 Pursuant
to the Capital Purchase Program, the Company issued to the Treasury Department a
Warrant to purchase up to 584,084 shares of the Company’s common stock at an
exercise price of $4.42 per share.  Base upon its fair value relative
to the Series A Preferred Stock discussed in Note 2 above of this Quarterly
Report, the Warrant was recorded at a value of $681,000 and is accounted for as
equity.  The Warrant is exercisable, in whole or in part, at any time
and from time to time until the tenth anniversary of the issue
date.
   9
  NORTHERN STATES FINANCIAL
CORPORATION
 
 NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
 
 March 31,
2009
 
 (Unaudited)
 Note 4 – 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.  The Company issued $10 million of subordinated debentures to
Northern States Statutory Trust I, which in turn issued $10 million of trust
preferred securities.  The subordinated debentures mature in September
2035.  From December 2005 until September 15, 2010, the subordinated
debentures bear interest at a rate equal to the sum of the product of 50% times
the 3-month LIBOR plus 1.80%, plus the product of 50% times 6.186%, and
thereafter at a rate equal to the 3-month LIBOR plus 1.80%.  The rate
on the subordinated debentures was 4.65300% at March 31, 2009 and is the
effective rate from March 16, 2009 through June 14, 2009.  For the
three months ended March 31, 2009 and 2008, interest expense on the subordinated
debentures was $123,000 and $159,000, respectively.
  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.
  Note 5 - Recent Accounting
Pronouncements
  In
September 2006, the FASB issued Statement No. 157, “Fair Value Measurements”
(FAS 157).  This Statement defines fair value, establishes a framework
for measuring fair value and expands disclosures about fair value
measurements.  This Statement establishes a fair value hierarchy about
the assumptions used to measure fair value and clarifies assumptions about risk
and the effect of a restriction on the sale or use of an asset.  The
standard was effective for fiscal years beginning after November 15,
2007.  In February 2008, the FASB issued Staff Position (FSP) 157-2,
Effective Date of FASB Statement No. 157.  This FSP delays the
effective date of FAS 157 for all nonfinancial assets and nonfinancial
liabilities, except those that are recognized or disclosed at fair value on a
recurring basis (at least annually) to fiscal years beginning after November 15,
2008, and interim periods within those fiscal years. The impact of adoption was
not material. In October 2008, the FASB issued Staff Position (FSP) 157-3,
“Determining the Fair Value of
a Financial Asset when the Market for That Asset Is Not
Active.”  This FSP clarifies the application of FAS 157 in a
market that is not active.  The impact of adoption was not
material.
   10
  NORTHERN STATES FINANCIAL
CORPORATION
 
 NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
 
 March 31,
2009
 
 (Unaudited)
 In
April 2009, the FASB issued the following three FSPs intended to provide
additional application guidance and enhance disclosures regarding fair value
measurements and impairments of securities:
  FSP FAS
157-4, “Determining Fair Value When the Volume
and Level of Activity for the Asset or Liability Have Significantly Decreased
and Identifying Transactions That Are Not Orderly,” provides additional
guidance for estimating fair value in accordance with SFAS No. 157 when the
volume and level of activity for the asset or liability have decreased
significantly.  FSP FAS 157-4 also provides guidance on identifying
circumstances that indicate a transaction is not orderly.  The provisions
of FSP FAS 157-4 are effective for the Company’s interim period ending on
June 30, 2009.  Management is currently evaluating the effect that the
provisions of FSP FAS 157-4 may have on the Company’s statements of income and
condition.
  FSP FAS
107-1 and APB 28-1, “Interim
Disclosures about Fair Value of Financial Instruments,” requires
disclosures about fair value of financial instruments in interim reporting
periods of publicly traded companies that were previously only required to be
disclosed in annual financial statements.  The provisions of FSP FAS 107-1
and APB 28-1 are effective for the Company’s interim period ending on
June 30, 2009.  As FSP FAS 107-1 and APB 28-1 amends only the
disclosure requirements about fair value of financial instruments in interim
periods, the adoption of FSP FAS 107-1 and APB 28-1 is not expected to affect
the Company’s statements of income and condition.
  FSP FAS
115-2 and FAS 124-2, “Recognition and Presentation of
Other-Than-Temporary Impairments,” amends current other-than-temporary
impairment guidance in GAAP for debt securities to make the guidance more
operational and to improve the presentation and disclosure of
other-than-temporary impairments on debt and equity securities in the financial
statements.  This FSP does not amend existing recognition and measurement
guidance related to other-than-temporary impairments of equity securities. 
The provisions of FSP FAS 115-2 and FAS 124-2 are effective for the Company’s
interim period ending on June 30, 2009.  Management is currently
evaluating the effect that the provisions of FSP FAS 115-2 and FAS 124-2 may
have on the Company’s statements of income and condition.
   11
  NORTHERN STATES FINANCIAL
CORPORATION
 ITEM 2. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
  The
following discussion focuses on the consolidated financial condition of Northern
States Financial Corporation (the “Company”) at March 31, 2009 and the
consolidated results of operations for the three month period ended March 31,
2009, compared with the three month period ended March 31, 2008.  The
purpose of this discussion is to provide a better understanding of the condensed
consolidated financial statements of the Company and the operations of its two
wholly-owned subsidiaries, NorStates Bank (the “Bank”) and NorProperties, Inc.
(“NorProp”), and the Bank’s wholly- owned subsidiary, Northern States Community
Development Corporation (“NSCDC”). This discussion should be read in conjunction
with the interim condensed consolidated unaudited financial statements and notes
thereto included herein.
  Statements
contained in this report that are not historical facts may constitute
forward-looking statements (within the meaning of Section 21E of the
Securities Exchange Act of 1934, as amended), which involve significant risks
and uncertainties.  The Company intends such forward-looking
statements to be covered by the safe harbor provisions for forward-looking
statements contained in the Private Securities Litigation Reform Act of 1995,
and is including this statement for purposes of invoking these safe harbor
provisions.  Forward-looking statements, which are based on certain
assumptions and describe future plans, strategies and expectations of the
Company, are generally identifiable by the use of the words “believe,” “expect,”
“intend,” “anticipate,” “estimate,” “project,” “plan,” or similar
expressions.  The Company’s ability to predict results or the actual
effect of future plans or strategies is inherently uncertain and actual results
may differ from those predicted.  The Company undertakes no obligation
to update these forward-looking statements in the future.  The Company
cautions readers of this report that a number of important factors could cause
the Company’s actual results subsequent to March 31, 2009 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
loans currently on nonaccrual status, unanticipated changes in interest rates,
general economic conditions, increasing regulatory compliance burdens or
potential legislative/regulatory changes, monetary and fiscal policies of the
U.S. Government, including policies of the U.S. Treasury and the Federal Reserve
Board, the quality or composition of the Company’s loan or investment
portfolios, deposit flows, competition, demand for loan products and financial
services in the Company’s market area, and changes in accounting principles,
policies and guidelines.  These risks and uncertainties should be
considered in evaluating forward-looking statements.
 OVERVIEW
  Total
assets at March 31, 2009 were $652.1 million, an increase of $11.4 million, or
1.8 percent, from total assets of $640.7 million at December 31,
2008.  Loans totaled $475.6 million at March 31, 2009, a decrease of
$5.2 million, or 1.1 percent, from loans of $480.8 million at December 31,
2008.  Investment in overnight federal funds sold increased $29.8
million to $37.3 million at March 31, 2009 as compared with $7.5 million at
December 31, 2008, as the Company increased its liquidity levels due in part
from the receipt of $17.2 million in proceeds from the issuance of preferred
stock under the Treasury Department’s TARP Capital Purchase
Program.  These funds increased the Company’s capital levels,
which exceeded the regulatory minimums for capital adequacy at December 31,
2008.
  Deposit
totals at March 31, 2009 of $500.5 million remained relatively unchanged from
December 31, 2008 deposit levels of $500.8 million.  The deposit mix
changed in that core deposits of
   12
  NORTHERN STATES FINANCIAL
CORPORATION
 retail
commercial checking, NOW, savings and money market accounts increased $5.7
million to $212.8 million at March 31, 2009 as compared with $207.1 million in
core deposits at December 31, 2008.  At the same time, higher cost
time deposits declined $9.3 million during the quarter.
  The
Company had a loss for the first quarter of 2009 of $1,457,000 or $0.39 per
share compared with net income of $1,201,000, or $0.29 per share for the same
quarter of 2008.  The loss in the first quarter of 2009 was caused by
a loss of $1,673,000 on the sale of other real estate owned and the provision of
$1,704,000 to the Company’s allowance for loan and lease losses due to declining
real estate values on properties used as collateral on troubled
loans.
  The
Company’s net interest income, the difference between interest earned on loans
and investments and interest paid on deposits and borrowings, decreased 11
percent, or $590,000, to $4.8 million for the first three months of 2009, as
compared with $5.4 million for the same quarter of 2008.  The decline
in net interest income was attributable to nonearning nonaccrual loans that
totaled $37.1 million at March 31, 2009 as compared with $6.7 million at March
31, 2008.  The net interest spread declined to 2.91 percent during the
first quarter of 2009 as compared with 3.11 percent during the same quarter of
2008.
  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.   Factors consid­ered in assessing the adequacy of
the allowance include: changes in the type and volume of the loan and lease
portfolio; review of the larger credits within the Bank; historical loss
experi­ence; current economic trends and conditions; review of the present
value of expected cash flows or fair value of collateral on impaired loans and
leases; portfolio growth; and other factors management deems
appropriate.  Based on management’s analysis, the allowance for loan
and lease losses at March 31, 2009 is adequate to cover probable incurred credit
losses.
  One of
the components of the allowance for loan losses is historical loss
experience.  Due to the increased historical losses during the past
year as compared with previous years, the loss percentages based on the past
recent trailing 12 months has been used as it is believed to be more indicative
of current loan loss estimates.  This differs from year-end 2008 when
a 3-year historic loss average was used and from March 31, 2008 when a 5-year
historic loss average was used.
   13
  NORTHERN STATES FINANCIAL
CORPORATION
 Management
specifically analyzes its nonperforming loans for probable
losses.  The change in the volume of nonperforming loans may
significantly impact the amount of estimated losses specifically allocated to
these loans depending on the adequacy of the loan collateral and the borrowers’
ability to repay the loans.  As specific allocations are done on a
loan-by-loan basis, the amount of the specific allocation is more likely subject
to fluctuation than an allocation for a pool of loans based on historical loss
trends. The amount of the allocations on nonperforming loans may fluctuate in
future periods due to changes in conditions of underlying collateral and changes
in the borrowers’ ability to repay.
  Goodwill
results from business acquisitions and represents the excess of the purchase
price over the fair value of acquired tangible assets and liabilities and
identifiable intangible assets.  Goodwill is assessed for impairment
annually and more often if warranted by circumstances.  Any such
impairment will be recognized in the period identified.
  Other
intangible assets consist of core deposits and acquired customer relationship
intangible assets arising from whole bank and branch acquisitions, which is
periodically evaluated for impairment.  They are initially measured at
fair value and then are amortized on the straight-line method over their
estimated useful life of seven years.
  FINANCIAL
CONDITION
  The
Company’s federal funds sold at March 31, 2009 increased $29.8 million to $37.3
million compared with $7.5 million at December 31, 2008.  The
Company’s federal funds sold position increased from the receipt of $17.2
million in proceeds from the issuance of preferred stock under the Treasury
Department’s TARP Capital Purchase Program while loans declined $5.2 million and
securities investments declined $6.6 million from year-end
2008.  Federal funds sold are excess funds above what is necessary to
maintain at the Federal Reserve that the Company lends/sells to other financial
institutions on an overnight basis.  The Company may use the funds for
its liquidity needs.
  The
Company’s securities available for sale declined $6.6 million to $96.6 million
at March 31, 2009 compared with $103.2 million at year-end 2008.  The
Company did not reinvest the funds into new short-term securities given the
relatively low yields offered.  The Company chose not to purchase
securities of a duration over five years in an effort to mitigate potential
interest rate risk.  At March 31, 2009, securities totaling $75.5
million were pledged to secure public deposits, repurchase agreements and for
other purposes required or permitted by law.
  Loans and
leases totaled $475.6 million at March 31, 2009, decreasing $5.2 million from
$480.8 million at December 31, 2008.  The decrease occurred to
commercial loans that were not secured by real estate, which declined $6.4
million from year-end 2008.  The decline in loans was attributable to
the receipt of normal scheduled principal payments as well as lower loan
demand during the quarter due to borrowers’ concerns about the
economy.  Management is considering various alternatives in order to
increase its loan portfolio in the coming quarters. Approximately 89 percent of
the Bank’s loan portfolio at March 31, 2009 was secured by real
estate.  The Company’s loans to the hotel industry were $68.2 million
at March 31, 2009.    Loans totaling $115.6 million at March
31, 2009 were pledged to secure lines of credit from the Federal Reserve Bank of
Chicago and the Federal Home Loan Bank of Chicago.  Loan commitments
have decreased $11.4 million to $72.0 million at March 31, 2009 compared with
$83.4 million at December 31, 2008, corresponding to the decline in loan demand
during the first quarter of 2009.  Letters of credit also decreased
slightly during the quarter to $7.6 million from $7.8 million at
year-end.  At March 31, 2009, loans to related parties totaled
$879,000 and loan commitments and letters of credit issued to related parties
were $1.2 million.  Loans, loan commitments and letters of credit to
related parties are made on the same terms and conditions that are available to
the public.
   14
  NORTHERN STATES FINANCIAL
CORPORATION
 Deposits
remained stable at March 31, 2009, totaling $500.5 million as compared with
$500.8 million at year-end 2008.  The deposit mix changed in that core
deposits, including retail and commercial checking,  NOW, savings and
money market accounts, which are generally considered more stable and lower cost
deposits, increased $5.7 million to
$212.8 million at March 31, 2009 as compared with $207.1 million in core
deposits at December 31, 2008.  Contributing to the growth of core
deposit was a new “High Yield Checking” NOW account product, in which depositors
earn an APY of 4.50 percent on balances up to $25,000 if certain conditions are
met.  At the same time, higher cost time deposits declined $9.3
million, including a reduction of $1.2 million to brokered time deposits to
$98.0 million, compared with $99.2 million at December 31, 2008.
  Securities
sold under repurchase agreements decreased by $3.8 million to $38.8 million at
March 31, 2009 from $42.6 million at December 31, 2008.  The decline
in repurchase agreement balances increases the Company’s liquidity as it lowers
the amount of securities needed to be pledged.
  During
January 2009, the Company’s stockholders approved an amendment to the
Certificate of Incorporation authorizing the Company to issue preferred
stock.  This was done in conjunction with the Company’s application in
late 2008 to the Treasury Department to participate in the TARP Capital Purchase
Program as the issuance of preferred stock by the Company was a requirement of
the program.  During January 2009, the Company received approval from
the Treasury Department for the TARP funds in the amount of
$17,211,000.
  On
February 20, 2009, as part of the TARP Capital Purchase Program established by
the Treasury Department under the Emergency Economic Stabilization Act of 2008,
as amended by the American Recovery and Reinvestment Act of 2009 (“EESA”), the
Company entered into a Letter Agreement and the Securities Purchase Agreement –
Standard Terms attached thereto (the “Securities Purchase Agreement”) with the
Treasury Department, pursuant to which the Company agreed to issue and sell, and
the Treasury Department agreed to purchase, (i) 17,211 shares of the Company’s
Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Preferred
Stock”) having a liquidation amount per share equal to $1,000, and (ii) a
ten-year warrant (the “Warrant”) to purchase up to 584,084 shares of the
Company’s common stock (the “Common Stock”), or 15% of the aggregate dollar
amount of Preferred Stock purchased by the Treasury Department, at an exercise
price of $4.42 per share, for an aggregate purchase price of $17,211,000 in
cash.  The Preferred Stock pays cumulative dividends at a rate of 5%
per year for the first five years, and 9% per year thereafter.  The
Company may buyback the preferred stock at anytime, subject to the approval of
the Company’s primary regulator and the Treasury Department.  Both the
Preferred Stock and the Warrant will qualify as Tier 1
capital.  Subsequent to March 31, 2009, the Company contributed $16.0
million of these funds to the Bank to further enhance the Bank’s
capital.
  FAIR VALUE
MEASUREMENTS
  The
following tables present information about the Company’s securities that were
measured at fair value on a recurring basis at March 31, 2009, and the valuation
techniques used by the Company to determine the fair values.
  In
general, fair values determined by Level 1 inputs use quoted prices in active
markets for identical securities that the Company has the ability to
access.
  Fair
values determined by Level 2 inputs use other inputs that are observable, either
directly or indirectly.  These Level 2 inputs include quoted prices
for similar securities in active markets, and other inputs such as interest
rates and yield curves that are observable at commonly quoted
intervals.
   15
  NORTHERN STATES FINANCIAL
CORPORATION
 Level 3
inputs are unobservable inputs, including inputs that are available in
situations where there is little, if any, market activity for the related
securities.
  In
instances where inputs used to measure fair value fall into different levels in
the above fair value hierarchy, fair value measurements in their entirety are
categorized based on the lowest level input that is significant to the
valuation. The Company’s assessment of the significance of particular inputs to
these fair value measurements requires judgment and considers factors specific
to each security.
  On an
annual basis the Company validates the measurement of the fair values of its
securities by sending a listing of its securities to an independent securities
valuation firm.  This independent securities valuation firm determines
the fair values of the Company’s securities portfolio that is then compared to
the fair value using the methods outlined.  When this validation was
last done at September 30, 2008, the difference between the fair value reported
and the fair value determined by the independent securities valuation firm was
considered immaterial.
  Disclosures
concerning securities measured at fair value are as follows:
  TABLE
      1NORTHERN
      STATES FINANCIAL CORPORATIONASSETS
      MEASURED AT FAIR VALUE ON A RECURRING BASISAs
      of March 31, 2009($
      000s)Fair
      Value Measurements at Reporting Date UsingQuoted
      Pricesin
      Active
                SignificantMarkets
      for
                Other
                SignificantIdentical
                Observable
                UnobservableAssets
                Inputs
                InputsDescription
                
                
                03/31/09
                
                (Level
      1)
                (Level
      2)
                (Level
      3)Securities
      available for sale
                $
                96,556
                
                $        1,017
                $    95,295
                $              244
 
 Securities
classified within Level 3 consist primarily of collateralized debt obligations
(“CDOs”).  The CDOs were valued using discounted cash flow models that
integrate significant inputs, including prepayment speed, discount and loss
rates which are estimated based on projected performance of the specific
entities that secure the instruments.
   16
  NORTHERN STATES FINANCIAL
CORPORATION
 TABLE
      2NORTHERN
      STATES FINANCIAL CORPORATIONCHANGES
      IN LEVEL 3 MEASURED AT FAIR VALUE ON A RECURRING BASISAs
      of March 31, 2009($
      000s)SecuritiesAvailablefor
      SaleBalance
      at December 31, 2008
                                              
                                              $
                                              2,265Total
      realized and unrealized gains (losses) included in income
                                              
                                              
                                              0Total
      unrealized gains (losses) included in other comprehensive
      income
                                              
                                              
                                              (2,021
                                              )Net
      purchase, sales, calls and maturities
                                              
                                              
                                              0Net
      transfer into Level 3Balance
      at March 31, 2009
                                              
                                              $
                                              244
  The
Company also has assets that under certain conditions are subject to measurement
at fair value on a non-recurring basis. These assets are held to maturity loans
that are considered impaired per Financial Accounting Standard
114.  The Company has estimated the fair values of the impaired loans
using Level 3 inputs, specifically discounted cash flow projections, or, if
collateral dependent, the realizable value of the collateral.
  TABLE
      3NORTHERN
      STATES FINANCIAL CORPORATIONASSETS
      MEASURED AT FAIR VALUE ON A NON-RECURRING BASISAs
      of March 31, 2009($
      000s)Fair
      Value Measurements at Reporting Date UsingQuoted
      Pricesin
      Active
                
                SignificantMarkets
      for
                
                Other
                
                SignificantIdentical
                
                Observable
                
                Unobservable
                
                Total
      ChangeAssets
                
                Inputs
                
                Inputs
                
                for
      the periodDescription
                03/31/09
                
                (Level
      1)
                
                (Level
      2)
                
                (Level
      3)
                
                ended
      03/31/09Impaired
      loans accountedfor
      under FAS 114
                $        23,729
                
                $                -
                
                $                -
                
                $        23,729
                
                $           (2,462)
 
 CAPITAL
RESOURCES
  Total
stockholders’ equity increased $14.9 million to $76.5 million at March 31, 2009,
as compared with $61.6 million at year-end 2008.  The increase was the
result of the receipt of $17.2 million in TARP funds from the Treasury
Department on February 20, 2009.  In exchange for these funds the
Company issued preferred stock and warrants to the Treasury
Department.  During the first quarter of 2009, capital was reduced as
the Company recognized losses for the quarter of $1.5
million.  Capital was also reduced by $98,000 to account for accrued
dividends on the preferred stock for the period February 20, 2009 through March
31, 2009 and by $735,000 due to the decline in the accumulated other
comprehensive income relating to the unrealized loss on securities available for
sale, net of deferred tax.  The book value of the Company’s common
stock at March 31, 2009 was $14.57 per share.
   17
  NORTHERN STATES FINANCIAL
CORPORATION
 On a
consolidated basis, the Company’s Tier 1 to total assets ratio and total capital
to assets ratio, on a risk adjusted basis, were 13.78 percent and 15.04 percent,
respectively, as of March 31, 2009, and exceed the regulatory minimum for
capital adequacy purposes.  Subsequent to March 31, 2009, the
Company’s Board of Directors determined that there would be no semi-annual cash
dividend paid on June 1, 2009 due to the reduced earnings of the Company and in
order to preserve capital.
  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
the growth of deposits and by liquid assets such as cash and due from banks less
any reserve requirements, securities available for sale less any pledged
securities and federal funds sold.  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.  Liquid assets at the Bank consist of
cash and cash equivalents less any Federal Reserve Bank deposit requirements
plus unpledged securities available for sale.  The Bank’s liquid
assets totaled $65.6 million at March 31, 2009, as compared with $46.8 million
at December 31, 2008.
  Management
reviews the liquidity ratio and as well as its sources and uses of funds
weekly.  The liquidity ratio is the net liquid assets divided by net
deposits and short-term liabilities.  At March 31, 2009, this ratio at
the Bank was 12.8 percent and was within management’s internal policy
guidelines.
  Liquidity
management involves the Company’s ability to meet the cash flow requirements of
customers and other operating needs.  The Company needs to have
sufficient cash flow to meet borrowers’ needs to fund loans or the requirements
of depositors wanting to withdraw funds.  The Statements of Cash Flows
shows that for the three months ended March 31, 2009 cash and cash equivalents
increased by $27.4 million to $49.3 million, primarily as the result of the
receipt of $17.2 million in TARP funds.
  Federal
funds sold, interest bearing deposits in banks and available for sale
securities, particularly those of shorter maturities, are principal sources of
liquidity.  Federal funds sold at March 31, 2009 were $37.3 million as
compared with $7.5 million at December 31, 2008.  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 $96.6 million at
March 31, 2009 of which $72.5 million were pledged to secure public deposits and
repurchase agreements as compared with pledged securities of $72.0 million at
December 31, 2008.
  During
the first three months of 2009, the Company had incoming cash flows from
maturities and calls of securities available for sale of $5.4 million while it
had cash outflows for purchases of securities of $38,000.  These
securities activities during the first quarter of 2009 provided liquidity of
$5.4 million.
  An
important source of liquidity to the Company is deposits.  During the
first quarter of 2009 the Company had net outgoing cash flows of $301,000 due to
a slight decline in deposits.  The Company has the ability to increase
deposits by increasing the interest rates it pays on its deposits as compared to
its competition.
   18
  NORTHERN STATES FINANCIAL
CORPORATION
 Another
important source of liquidity to the Company is borrowings.  During
the first quarter of 2009, borrowings through repurchase agreements decreased
$3.8 million.  The Company drew on its line of credit with the Federal
Home Loan Bank of Chicago during the first quarter in the amount of $10.0
million and later paid off this borrowing during the quarter.  At
March 31, 2009, the Company had a line of credit at the Federal Home Loan Bank
of Chicago of $36.0 million of which $20.0 million had been outstanding leaving
$16.0 million available at quarter-end.  At March 31, 2009, the
Company had a line of credit with the Federal Reserve Bank of Chicago of $34.6
million which was available to the Company for liquidity.  Subsequent
to March 31, 2009, the line of credit available to the Company from the Federal
Reserve Bank of Chicago was reduced to $30.9 million as the Federal Reserve Bank
of Chicago reduced the percentage it would lend on certain loans pledged by the
Company.   Additional funds available from three independent
banks at March 31, 2009 total $35.0 million and help ensure the Company’s
ability to meet any funding needs, including any unexpected strain on
liquidity.  Subsequent to March 31, 2009, one of the three independent
banks cancelled the line available to the Bank that had been $15.0 million at
March 31, 2009.
  RESULTS OF
OPERATIONS
  NET
INCOME
  The
Company recognized a loss for the quarter ended March 31, 2009 of $1,457,000
compared with net income of $1,201,000, for the same quarter of
2008.  The loss during the first quarter of 2009 was impacted by a
loss on the sale of other real estate owned of $1.7 million as well as a
provision to the allowance for loan for loan and lease losses of $1.7
million.  For the three months ended March 31, 2009, the annualized
return on average assets was negative 0.91 percent as compared with 0.75 percent
for the same quarter in the previous year.
  NET
INTEREST INCOME
  Net
interest income, the difference between interest income on earning assets and
interest expense on interest bearing liabilities, decreased 11 percent, or
$590,000, to $4.8 million for the first three months of 2009, as compared with
$5.4 million for the same quarter of 2008.  The decline in net
interest income was attributable to increased levels of nonaccrual loans during
the first quarter of 2009 as compared with the same quarter of
2008.
  Average
interest earning assets during the three months ended March 31, 2009 totaled
$604.2 million, $1.8 million less than the levels of average earning assets
during the three months ended March 31, 2008.  As such, the decrease
in interest income was not affected significantly by the lower volume of
interest earning assets during the first quarter of 2009.
  Interest
rates were generally lower during the first quarter of 2009 than during the
first quarter of 2008 and affected net interest income by causing rates earned
on interest earning assets and rates paid on interest bearing liabilities to
decrease during the first quarter of 2009 as compared with the same period last
year.  The lower interest rates were evidenced by a prime lending rate
of 3.25 percent during the entire first quarter of 2009, compared to the prime
rate at the beginning of the first quarter of 2008 of 7.25 percent, which
decreased 200 basis points, to end at 5.25 percent at March 31,
2008.
  During
the first quarter of 2009 the net interest rate spread decreased 20 basis points
to 2.91 percent as compared to 3.11 percent for the same quarter of
2008.  Rates on interest earning assets decreased 99 basis points
during the first quarter of 2009 as compared with the same quarter of
2008.  Rates paid on interest earning assets declined by 79 basis
points during the first quarter of 2009 as compared with the same quarter of
2008.  The reason that rates earned on interest earning assets
declined
   19
  NORTHERN STATES FINANCIAL
CORPORATION
 more than
rates paid on interest earning assets is that nonearning nonaccrual loans
totaled $37.1 million at March 31, 2009 as compared with $6.7 million at March
31, 2008, an increase of $30.4 million. The net yield on interest earning assets
ratio decreased 37 basis points to 3.24 percent for the first quarter 2009 as
compared with 3.61 percent for the same quarter 2008.
    NORTHERN
STATES FINANCIAL CORPORATION
  2009
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    2008Average
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    AverageBalance
                                                    
                                                    
                                                    Interest
                                                    
                                                    
                                                    Rate
                                                    
                                                    
                                                    Balance
                                                    
                                                    
                                                    Interest
                                                    
                                                    
                                                    RateAssetsLoans
      (1)(2)(3)
                                                    
                                                    $
                                                    479,994
                                                    
                                                    
                                                    $
                                                    6,456
                                                    
                                                    
                                                    
                                                    5.38
                                                    %
                                                    
                                                    $
                                                    446,247
                                                    
                                                    
                                                    $
                                                    7,268
                                                    
                                                    
                                                    
                                                    6.51
                                                    %Taxable
      securities (4)
                                                    
                                                    
                                                    96,047
                                                    
                                                    
                                                    
                                                    1,254
                                                    
                                                    
                                                    
                                                    5.38
                                                    %
                                                    
                                                    
                                                    139,266
                                                    
                                                    
                                                    
                                                    1,888
                                                    
                                                    
                                                    
                                                    5.47
                                                    %Tax
      advantaged securities (2) (4)
                                                    
                                                    
                                                    9,418
                                                    
                                                    
                                                    
                                                    149
                                                    
                                                    
                                                    
                                                    6.33
                                                    %
                                                    
                                                    
                                                    11,239
                                                    
                                                    
                                                    
                                                    174
                                                    
                                                    
                                                    
                                                    6.20
                                                    %Federal
      funds sold
                                                    
                                                    
                                                    18,761
                                                    
                                                    
                                                    
                                                    3
                                                    
                                                    
                                                    
                                                    0.06
                                                    %
                                                    
                                                    
                                                    9,227
                                                    
                                                    
                                                    
                                                    70
                                                    
                                                    
                                                    
                                                    3.03
                                                    %Interest
      earning assets
                                                    
                                                    
                                                    604,220
                                                    
                                                    
                                                    
                                                    7,862
                                                    
                                                    
                                                    
                                                    5.23
                                                    %
                                                    
                                                    
                                                    605,979
                                                    
                                                    
                                                    
                                                    9,400
                                                    
                                                    
                                                    
                                                    6.22
                                                    %Noninterest
      earning assets
                                                    
                                                    
                                                    39,319
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    36,648Average
      assets
                                                    
                                                    $
                                                    643,539
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    642,627Liabilities
      and stockholders' equityNOW
      deposits
                                                    
                                                    $
                                                    43,617
                                                    
                                                    
                                                    $
                                                    35
                                                    
                                                    
                                                    
                                                    0.32
                                                    %
                                                    
                                                    $
                                                    43,564
                                                    
                                                    
                                                    $
                                                    39
                                                    
                                                    
                                                    
                                                    0.36
                                                    %Money
      market deposits
                                                    
                                                    
                                                    65,173
                                                    
                                                    
                                                    
                                                    316
                                                    
                                                    
                                                    
                                                    1.94
                                                    %
                                                    
                                                    
                                                    70,172
                                                    
                                                    
                                                    
                                                    350
                                                    
                                                    
                                                    
                                                    2.00
                                                    %Savings
      deposits
                                                    
                                                    
                                                    60,733
                                                    
                                                    
                                                    
                                                    69
                                                    
                                                    
                                                    
                                                    0.45
                                                    %
                                                    
                                                    
                                                    61,531
                                                    
                                                    
                                                    
                                                    90
                                                    
                                                    
                                                    
                                                    0.59
                                                    %Time
      deposits
                                                    
                                                    
                                                    273,466
                                                    
                                                    
                                                    
                                                    2,255
                                                    
                                                    
                                                    
                                                    3.30
                                                    %
                                                    
                                                    
                                                    251,545
                                                    
                                                    
                                                    
                                                    2,826
                                                    
                                                    
                                                    
                                                    4.49
                                                    %Other
      borrowings
                                                    
                                                    
                                                    73,583
                                                    
                                                    
                                                    
                                                    321
                                                    
                                                    
                                                    
                                                    1.74
                                                    %
                                                    
                                                    
                                                    79,230
                                                    
                                                    
                                                    
                                                    631
                                                    
                                                    
                                                    
                                                    3.19
                                                    %Interest
      bearing liabilities
                                                    
                                                    
                                                    516,572
                                                    
                                                    
                                                    
                                                    2,996
                                                    
                                                    
                                                    
                                                    2.32
                                                    %
                                                    
                                                    
                                                    506,042
                                                    
                                                    
                                                    
                                                    3,936
                                                    
                                                    
                                                    
                                                    3.11
                                                    %Demand
      deposits
                                                    
                                                    
                                                    50,692
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    55,507Other
      noninterest bearing liabilities
                                                    
                                                    
                                                    8,503
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    6,963Stockholders'
      equity
                                                    
                                                    
                                                    67,772
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    74,115Average
      liabilities and stockholders' equity
                                                    
                                                    $
                                                    643,539
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    642,627Net
      interest income
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    4,866
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    5,464Net
      interest spread
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    2.91
                                                    %
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    3.11
                                                    %Net
      yield on interest earning assets (4)
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    3.24
                                                    %
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    3.61
                                                    %Interest-bearing
      liabilities to earning assets ratio
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    85.49
                                                    %
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    83.51
                                                    %
 _______________
 (1)
                Interest
      income on loans includes loan origination and other fees of $32,000 and
      $32,000 for the three months ended March 31, 2009 and 2008,
      respectively.
 (2)
                Tax-exempt
      income is reflected on a fully tax equivalent basis utilizing a 34 percent
      tax rate. The tax equivalent adjustment reflected in the above table for
      municipal loans is approximately $22,000 and $22,000 for the three months
      ended March 31, 2009 and 2008, respectively.  The tax equivalent
      adjustment reflected in the above table for municipal securities is
      approximately $51,000 and $59,000 for the three months ended March 31,
      2009 and 2008, respectively.
 (3)
                  Non-accrual
      loans are included in average loans.(4)
                  Rate information was calculated
      on the average amortized cost for securities.  The three months
      ended March 31, 2009 and 2008, average balance information includes
      an average unrealized gain (loss) for taxable securities of $2,743,000 and
      $1,148,000, respectively, and for tax-advantaged securities of($3,000) and $9,000,
respectively.
 20
 NORTHERN STATES FINANCIAL
CORPORATION
 ASSET QUALITY AND THE
PROVISION FOR LOAN AND LEASE LOSSES
  At March
31, 2009, 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 an
allowance of $11.9 million was adequate to cover probable incurred loan and
lease losses as compared with $10.4 million at year-end 2008.  During
the first three months of 2009, $201,000 in loans and leases were charged-off
against the allowance compared with charge-offs of $74,000 during the same
period last year.  Recoveries, during the three months ended March 31,
2009, of loans previously charged-off totaled $9,000 as compared with $34,000 in
recoveries during the same period in 2008.  During the first quarter
of 2009, the provision for loan and lease losses was $1.7 million as compared
with $263,000 during the same quarter of 2008.
  Nonperforming
loans and leases, which include loans and leases on nonaccrual status in
addition to loans and leases 90 days or more past due and still accruing
interest, were $39.5 million at March 31, 2009, or 8.30 percent of total loans
and leases, as compared with $37.1 million at December 31, 2008, or 7.71 percent
of loans and leases.
  At March
31, 2009, loans on nonaccrual status totaled $37.1 million, as compared with
$36.6 million at year-end 2008.  Two loan relationships account for
$26.1 million or 70 percent of total nonaccrual loans at March 31,
2009.  These loans are secured by commercial office and multi-family
apartment buildings on which the borrowers have experienced cash flow problems
due to vacancies.   The Company is taking steps to cure the
delinquencies, including foreclosure.
  During
the first quarter of 2009, the Company received loan payments on other
nonaccrual loans that reduced nonaccrual loans carried at December 31, 2008 by
approximately $650,000.  The Company also took possession of
foreclosed properties securing other nonaccrual loans that had been carried at
year-end at $1.7 million.  After writing down these loans
approximately $200,000 to their fair value, less estimated selling costs, these
loans were transferred to other real estate owned in the amount of $1.5 million.
During the first quarter of 2009, a construction loan totaling $2.5 million and
a loan totaling $353,000, secured by an apartment building, were placed in
nonaccrual status as the borrowers defaulted on their payments.
  Loans and
leases 90 days or more past due and still accruing interest increased to $2.4
million at March 31, 2009 compared with $442,000 at December 31,
2008.  These loans are well secured and in the process of
collection.  During the three months ended March 31, 2009, the Company
took possession of a property that had been securing a loan that had been 90
days or more past due and still accruing interest at December 31, 2008 in the
amount of $108,000.  This amount was transferred to other real estate
owned during the first quarter of 2009.
  Impaired
loans and leases at March 31, 2009 totaled $41.4 million, as compared with $43.8
million at December 31, 2008.  The Company considers a loan or lease
impaired if full principal and interest will not be collected under the
contractual terms of the note.  Nonaccrual loans and leases are
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.  At March 31, 2009, $5.1 million of the Company’s allowance
for loan and lease losses was allocated to impaired loans.
   21
  NORTHERN STATES FINANCIAL
CORPORATION
 Nonperforming
loans inched up during the quarter ended March 31, 2009, as the economy and
decreasing real estate values continued to weaken some loan
relationships.   Management continues to emphasize the early
identification of loan related problems and remains aggressive in pursuing
resolution strategies.  The Company has adopted a more stringent and
disciplined loan underwriting policy in regards to relationship size and out of
market credits.  The Company continues to be an active lender for its
current customers as well as qualifying prospective loan customers.
  TABLE
      5NORTHERN
      STATES FINANCIAL CORPORATIONNONPERFORMING
      ASSETS($
      000's)March
      31,
                      
                      
                      December
      31,2009
                      
                      
                      2008Loans
      and leasesNonaccrual
      status
                      
                      $
                      37,052
                      
                      
                      $
                      36,62490
      days or more past due, still accruing
                      
                      
                      2,442
                      
                      
                      
                      442Total
      nonperforming loans and leases
                      
                      
                      39,474
                      
                      
                      
                      37,066Other
      real estate owned
                      
                      
                      6,275
                      
                      
                      
                      10,575Total
      nonperforming assets
                      
                      $
                      45,749
                      
                      
                      $
                      47,641Nonperforming
      loans and leases as a percentage of total loans, net
      ofunearned income and deferred loan
fees
                      
                      
                      8.30
                      %
                      
                      
                      7.71
                      %Nonperforming
      assets as a percentage of total assets
                      
                      
                      7.02
                      %
                      
                      
                      7.44
                      %Nonperforming
      loans and leases as apercentage of the allowance for loan
      losses
                      
                      
                      331.35
                      %
                      
                      
                      356.34
                      %
 
 Another
component of nonperforming assets is other real estate owned, consisting of
assets acquired through loan foreclosure and repossession. At March 31, 2009,
other real estate owned totaled $6.3 million, a decrease of $4.3 million from
$10.6 million at December 31, 2008.  During the first quarter of 2009,
the Company sold a luxury home that had been valued at $5.9 million for $4.2
million recognizing a $1.7 million loss on the sale.  The Company’s
loss on the sale was due to declining values of luxury homes, large inventory,
and the limited number of buyers for such homes.  In addition, the
foreclosure and transfer of $1.6 million in properties to other real estate
owned from loans contributed to other real estate owned during the quarter ended
March 31, 2009.
  The
properties transferred into other real estate owned during the first quarter of
2009 include a garden center and greenhouses on 28 acres of land carried at
$958,000, a commercial building with apartment units carried at $108,000, a
commercial building consisting of a restaurant/bar carried at $129,000, two
single family homes carried at $210,000 and $195,000 and a vacant lot carried at
$11,000.  The Company is actively pursuing the sale each of its other
real estate owned properties.
  
 22
  NORTHERN STATES FINANCIAL
CORPORATION
 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 in Waukegan, Illinois, overlooking Lake
Michigan, with a carrying value of $1,996,000 at March 31, 2009.  The
Company is attempting to sell this property through the Bank’s subsidiary,
Northern States Community Development Corporation as part of the City of
Waukegan’s lakefront development plans.
  This
property is a former commercial/industrial site and environmental remediation
costs may be incurred in disposing of this property.  During the
fourth quarter of 2008, the Company had an independent environmental consultant
update its opinion as to estimated environmental remediation costs with this
property.  This updated report estimated that there were remaining
costs of $259,000 to achieve acceptable levels of contaminants for
commercial/industrial or restricted residential land use and to prevent
migration of the contaminants to adjoining off-site properties and Lake
Michigan.  The estimated remediation costs had declined from $1.6
million at year-end 2007 as the Company has made environmental improvements to
the property in the amount of $281,000 during 2008 that increased the carrying
value of the property by that amount.  During 2008, the Company also
entered into an agreement with a contractor that provides for low cost delivery
and grading of clean soil to the site for surface capping
purposes.  No determination has 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 remediation costs and as
such, at this time, no liability has been recorded for these estimated
environmental remediation costs.
  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.
  NONINTEREST
INCOME
  Noninterest
income for the three months ended March 31, 2009 was a loss of $725,000 due to
the loss on the sale of other real estate owned of $1.7 million.  When
factoring out the loss on other real estate owned, noninterest income would have
been $948,000 for the first quarter of 2009, decreasing $192,000 as compared
with $1,140,000 for the same quarter of 2008.  The decrease was
primarily from a $96,000 decrease in service fees on deposits due to declining
overdraft fee income and lower retail service charges in order to be competitive
with other financial institutions. Trust fee income was also $41,000 less during
the first quarter of 2009 due to the declining stock market.
  NONINTEREST
EXPENSE
  Noninterest
expense for the quarter ended March 31, 2009 was $4,823,000, increasing $393,000
from $4,430,000 for the same quarter last year.  In comparing
noninterest expenses for the first quarter of 2009 to the same quarter of 2008,
a large part of the increase was attributable to increases of $274,000 to other
operating expenses that totaled $821,000 during the first quarter of 2009 as
compared with $547,000 during the same quarter last year.  Most of the
increase to other operating expenses pertained to increases to the
advertising and other real estate owned expense components of other operating
expenses. The Company increased its advertising outlay during the first quarter
of 2009 by $108,000 compared with the same quarter last year as the
Bank launched a reintroduction of its brand with an updated
look.  Expenses relating to other real estate owned during the three
months ended March 31, 2009 also increased $94,000 as compared with the first
quarter last year as $1.6 million in properties were transferred into other real
estate owned.  The Company also experienced increases to its legal
expenses, FDIC insurance and occupancy and equipment expenses during the first
quarter of 2009 as compared
   23
  NORTHERN STATES FINANCIAL
CORPORATION
 with the
same period of 2008.  The increase in 2009 to nonperforming loans
caused legal expenses to increase $155,000 during the quarter.  FDIC
insurance expense also increased $110,000 during the first quarter of 2009 as
the FDIC increased its premium rates.  The Company expects FDIC
insurance expense will continue to rise during the remainder of
2009.  Occupancy expense increased $98,000 during the first three
months of 2009 due to increased depreciation on the remodeling of the Bank’s
offices in 2008 as well as snow removal expenses.  Offsetting some of
these increases was a decline to salaries and employee benefit expenses of
$115,000 and a decline to audit and other professional fees of $81,000 due to
reduced audit requirements for 2009 as the Company is no longer an accelerated
filer, as defined by the U.S. Securities and Exchange Commission.
  FEDERAL
AND STATE INCOME TAXES
  For the
three months ended March 31, 2009, the Company had a tax benefit of $1,002,000
as compared with income taxes of $629,000 for the same three months last
year.  The tax benefit resulted from the pretax loss of $2.5 million
during the first quarter of 2009.
  During
2008, the Company had an accumulated net operating loss for state income tax
purposes of approximately $615,000, which will be carried forward to reduce
future taxable income.  The net operating loss carried forward will
expire in 2021, if it is not utilized.
  CONTRACTUAL OBLIGATIONS AND
OFF-BALANCE SHEET ARRANGEMENTS
  The
Company has contractual obligations that may not appear on the balance
sheet.  Table 6 presents the Company’s significant fixed and
determinable contractual obligations as of March 31, 2009, by payment date. The
payment amounts in Table 6 represent those amounts contractually due to the
recipient and do not include any unamortized premiums or discounts or similar
carrying amount adjustments.
  TABLE
      6NORTHERN
      STATES FINANCIAL CORPORATIONCONTRACTUAL
      OBLIGATIONSAs
      of March 31, 2009($
      000s)Greater
      than
                                      
                                      
                                      Greater
      than1
      yr. and less
                                      
                                      
                                      3
      yrs. and lessOne
      year
                                      
                                      
                                      than
      or equal
                                      
                                      
                                      than
      or equal
                                      
                                      
                                      Greater
      thanContractual
      obligations
                                      
                                      or
      less
                                      
                                      
                                      to
      3 yrs.
                                      
                                      
                                      to
      5 yrs.
                                      
                                      
                                      5
      yrs.
                                      
                                      
                                      TotalLong-term
      debtFederal
      Home Loan Bankterm
      advances
                                      
                                      $
                                      20,000
                                      
                                      
                                      $
                                      0
                                      
                                      
                                      $
                                      0
                                      
                                      
                                      $
                                      0
                                      
                                      
                                      $
                                      20,000Subordinated
      debentures
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      10,000
                                      
                                      
                                      
                                      10,000Time
      deposits
                                      
                                      
                                      215,614
                                      
                                      
                                      
                                      53,760
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      269,374Other
      contractual obligationsStandby
      letters of credit
                                      
                                      
                                      7,576
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      0
                                      
                                      
                                      
                                      7,576
   24
  NORTHERN STATES FINANCIAL
CORPORATION
 ITEM 3. QUANTITATIVE AND
QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
  The
Company’s primary market risk exposure is interest rate risk and, to a lesser
extent, liquidity risk. Interest rate risk is the exposure of a banking
organization’s financial condition to adverse movements in interest
rates.  The Company seeks to achieve consistent growth in net interest
income and net income while managing volatility that arises from shifts in
interest rates.   The Company’s Asset and Liability Management
Committee (“ALCO”) oversees interest rate risk programs instituted by management
and measurements of interest rate risk to determine that they are within
authorized limits set by the Company’s Board of Directors.
  Evaluating
a financial institution’s exposure to changes in interest rates includes
assessing both the adequacy of the management process used to control interest
rate risk and the organization’s quantitative level of exposure.  When
assessing the interest rate risk management process, the Company seeks to ensure
that appropriate policies, procedures, management information systems and
internal controls are in place to maintain interest rate risk at prudent levels
with consistency and continuity.  Evaluating the quantitative level of
interest rate risk exposure requires the Company to assess the existing and
potential future effects of changes in interest rates on its consolidated
financial condition, including capital adequacy, earnings, liquidity, and, where
appropriate, asset quality.
  The
primary 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.
  Several
ways the Company can manage interest rate risk include: selling existing assets
or repaying certain liabilities and matching repricing periods for new assets
and liabilities, for example, by shortening terms of new loans or
securities.  Financial institutions are also subject to prepayment
risk in a falling rate environment.  For example, a debtor may prepay
financial assets so that the debtor may refinance obligations at new, lower
rates.  Prepayments of assets carrying higher rates reduces the
Company’s interest income and overall asset yields.  The Company
attempts to lessen prepayment risk by having prepayment penalties on commercial
purpose loans.  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
lower yielding securities may remain in the Company’s securities portfolio until
maturity.
  Table 7
shows how interest rate shocks of decreasing rates 1% and 2% and increasing
rates 1% and 2% affect 12 month projected net interest income at March 31, 2009
and December 31, 2008.  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 March
31, 2009 the projected net interest income increases $394,000 when rates are
shocked upward 2% while projected net interest income decreases $865,000 for a
2% downward rate shock.  Interest rates at March 31, 2009, as
evidenced by the prime lending rate at 3.25 percent, its lowest level since
1955, were very low.  Many deposit rates could not go down 200 basis
points with a 2% downward rate shock as the deposit rate would then be
negative.  As such, the rate shocks downward would lower
   25
  NORTHERN STATES FINANCIAL
CORPORATION
 interest
income earned on loans and investments to a greater extent than interest paid on
deposits and borrowings, thereby causing net interest income to
decline.
  At both
March 31, 2009 and December 31, 2008, the percentage changes from the base
forecasted 12-month net interest income are within policy guidelines and show
that interest rate risk was minimal at March 31, 2009.
  TABLE
      7NORTHERN
      STATES FINANCIAL CORPORATIONEFFECT
      OF INTEREST SHOCKS ON NET INTEREST INCOMEas
      of March 31, 2009 and December 31, 2008($000s)Immediate
      Change in Rates-2.00
                  %
                  
                  
                  -1.00
                  %
                  
                  
                  +1.00
                  %
                  
                  
                  +2.00
                  %March
      31, 2009:Dollar
      Change from Base Forecast
                  
                  $
                  (865
                  )
                  
                  $
                  (343
                  )
                  
                  $
                  301
                  
                  
                  $
                  394Percent
      Change from Base Forecast
                  
                  
                  -5.05
                  %
                  
                  
                  -2.00
                  %
                  
                  
                  1.76
                  %
                  
                  
                  2.30
                  %December
      31, 2008:Dollar
      Change from Base Forecast
                  
                  $
                  (656
                  )
                  
                  $
                  (325
                  )
                  
                  $
                  (88
                  )
                  
                  $
                  (250
                  )Percent
      Change from Base Forecast
                  
                  
                  -3.82
                  %
                  
                  
                  -1.89
                  %
                  
                  
                  -0.51
                  %
                  
                  
                  -1.45
                  %
 
 ITEM 4. CONTROLS AND
PROCEDURES.
  The
Company’s management has evaluated, with the participation of the Chairman of
the Board and President, and Vice President and Treasurer, the Company’s
disclosure controls and procedures (as such term is defined in Rule 13a – 15(e)
under the Securities Exchange Act of 1934) as of the end of the period covered
by this report.  Based on that evaluation, the Chairman of the Board
and President, and Vice President and Treasurer have concluded that these
controls and procedures were effective as of such date.  There were no
changes in internal control over financial reporting (as such term is defined in
Rule 13a – 15(f) under the Securities Exchange Act of 1934) that occurred during
the first quarter of 2009 that materially affected, or are reasonably likely to
materially affect, the Company’s internal control over financial
reporting.
  PART II. OTHER
INFORMATION
  ITEM 1.  LEGAL
PROCEEDINGS.
  From time
to time, due to the nature of its business, the Company and its subsidiaries are
often subject to various legal actions.  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.
  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, 2008 in response to Item 1A. to Part
I of Form 10-K.
   26
  NORTHERN STATES FINANCIAL
CORPORATION
 ITEM 2. UNREGISTERED SALES
OF EQUITY SECURITIES AND USE OF PROCEEDS.
  None.
  ITEM 3.  DEFAULTS
UPON SENIOR SECURITIES.
  None.
  ITEM
4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS.
  A special
meeting of stockholders of the Company was held on January 15, 2009, with the
stockholders of record at November 19, 2008 eligible to vote in person or by
proxy, with one vote for each share owned, to act on a proposed amendment to the
Company’s Certificate of Incorporation, as amended, to authorize up to 1,000,000
shares of preferred stock, par value $0.40 per share, and to provide the Board
of Directors with the express authority to fix the number, rights, powers,
preferences, qualifications, limitations and restrictions of each series of
preferred stock. There were 4,072,255 shares of stock outstanding and eligible
to vote as of November 19, 2008.  The proposed amendment was approved
by the stockholders by a vote of 2,561,728 shares FOR approval, with 162,680
shares voting AGAINST, and 16,548 shares ABSTAINING.
  ITEM 5.  OTHER
INFORMATION.
  None.
  ITEM
6.  EXHIBITS.
  (a)           Exhibits.
  Exhibit
3.1 Certificates of Incorporation of the Company, as amended (incorporated
herein by reference to the Company’s Annual Report on Form 10-K for the year
ended December 31, 1994 (File No. 000-19300)).
  Exhibit
3.2 Certificate of Amendment of the Certificate of Incorporation of the Company,
as amended dated April 27, 1998 (incorporated herein by reference to Exhibit 3.2
to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008
(File No. 000-19300) filed on March 25, 2009).
  Exhibit
3.3 Certificate of Amendment of the Certificate of Incorporation of the Company,
as amended dated January 20, 2009 (incorporated herein by reference to Exhibit
3.3 to the Company’s Annual Report on Form 10-K for the year ended December 31,
2008 (File No. 000-19300) filed on March 25, 2009).
  Exhibit
3.4 Certificate of Designations of Fixed Rate Cumulative Perpetual Preferred
Stock, Series A, dated February 18, 2009 (incorporated herein by reference to
Exhibit 3.1 to the Company’s Current Report on Form 8-K (File No. 000-19300)
filed on February 20, 2009).
  Exhibit
3.5 Amended and Restated By-laws of the Company dated April 20, 2004
(incorporated herein by reference to Exhibit 3.2 to the Company’s Quarterly
Report on Form 10-Q (File No. 000-19300) filed on May 10, 2004).
   27
  NORTHERN STATES FINANCIAL
CORPORATION
 Exhibit
4.1 Form of Certificate of the Preferred Stock (incorporated herein by reference
to Exhibit 4.1 to the Company’s Current Report on Form 8-K (File No. 000-19300)
filed on February 20, 2009).
  Exhibit
4.2 Warrant to purchase shares of Common Stock (incorporated herein by reference
to Exhibit 4.2 to the Company’s Current Report on Form 8-K (File No. 000-19300)
filed on February 20, 2009).
  Exhibit
10.1 Letter Agreement including the Securities Purchase Agreement – Standard
Terms Attached thereto, dated February 20, 2009, between the Company and the
U.S. Department of the Treasury, with respect to the issuance and sale of
Preferred Stock and Warrant (incorporated herein by reference to Exhibit 10.1 to
the Company’s Current Report on Form 8-K (File No. 000-19300) filed on February
20, 2009).
  Exhibit
10.2 Side Letter Agreement with the U.S. Department of the Treasury, dated
February 20, 2009, relating to the Letter Agreement and Securities Purchase
Agreement (incorporated herein by reference to Exhibit 10.2 to the Company’s
Current Report on Form 8-K (File No. 000-19300) filed on February 20,
2009).
  Exhibit
10.3 Form of Senior Executive Officer Letter Agreement and Waiver executed by
each of the following executive officers of the Company as required pursuant to
the Securities Purchase Agreement dated February 20, 2009 entered into between
the Company and the U.S. Department of the Treasury; Fred Abdula, Kerry Biegay,
Shelly Christian, Brett Houston, Thomas Nemeth and Scott Yelvington
(incorporated herein by reference to Exhibit 10.3 to the Company’s Annual Report
on Form 10-K for the year ended December 31, 2008 (File No. 000-19300) filed on
March 25, 2009).
  Exhibit
11.1  Statement of Computation of per share earnings. (Contained in
Notes 1 and 3 to the condensed consolidated financial statements.)
  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.
   28
  NORTHERN STATES FINANCIAL
CORPORATION
 FORM
10-Q
 March 31,
2009
  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 May 2009.
  NORTHERN STATES FINANCIAL
      CORPORATION
                  (Registrant)Date: 
      May 8, 2009
                By:
                /s/Fred
      AbdulaFred
      AbdulaChairman
      of the Board ofDirectors
      and President
 Date: 
      May 8, 2009
                  By:
                  /s/Thomas
      M. NemethThomas
      M. NemethVice
      President and Treasurer
 
 29
  NORTHERN STATES FINANCIAL
CORPORATION
 FORM
10-Q
 March 31,
2009
  EXHIBIT
INDEX
 
 
 Exhibits
  Exhibit
3.1 Certificates of Incorporation of the Company, as amended (incorporated
herein by reference to the Company’s Annual Report on Form 10-K for the year
ended December 31, 1994 (File No. 000-19300)).
  Exhibit
3.2 Certificate of Amendment of the Certificate of Incorporation of the Company,
as amended dated April 27, 1998 (incorporated herein by reference to Exhibit 3.2
to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008
(File No. 000-19300) filed on March 25, 2009).
  Exhibit
3.3 Certificate of Amendment of the Certificate of Incorporation of the Company,
as amended dated January 20, 2009 (incorporated herein by reference to Exhibit
3.3 to the Company’s Annual Report on Form 10-K for the year ended December 31,
2008 (File No. 000-19300) filed on March 25, 2009).
  Exhibit
3.4 Certificate of Designations of Fixed Rate Cumulative Perpetual Preferred
Stock, Series A, dated February 18, 2009 (incorporated herein by reference to
Exhibit 3.1 to the Company’s Current Report on Form 8-K (File No. 000-19300)
filed on February 20, 2009).
  Exhibit
3.5 Amended and Restated By-laws of the Company dated April 20, 2004
(incorporated herein by reference to Exhibit 3.2 to the Company’s Quarterly
Report on Form 10-Q (File No. 000-19300) filed on May 10, 2004).
  Exhibit
4.1 Form of Certificate of the Preferred Stock (incorporated herein by reference
to Exhibit 4.1 to the Company’s Current Report on Form 8-K (File No. 000-19300)
filed on February 20, 2009).
  Exhibit
4.2 Warrant to purchase shares of Common Stock (incorporated herein by reference
to Exhibit 4.2 to the Company’s Current Report on Form 8-K (File No. 000-19300)
filed on February 20, 2009).
  Exhibit
10.1 Letter Agreement including the Securities Purchase Agreement – Standard
Terms Attached thereto, dated February 20, 2009, between the Company and the
U.S. Department of the Treasury, with respect to the issuance and sale of
Preferred Stock and Warrant (incorporated herein by reference to Exhibit 10.1 to
the Company’s Current Report on Form 8-K (File No. 000-19300) filed on February
20, 2009).
  Exhibit
10.2 Side Letter Agreement with the U.S. Department of the Treasury, dated
February 20, 2009, relating to the Letter Agreement and Securities Purchase
Agreement (incorporated herein by reference to Exhibit 10.2 to the Company’s
Current Report on Form 8-K (File No. 000-19300) filed on February 20,
2009).
   30
  Exhibit
10.3 Form of Senior Executive Officer Letter Agreement and Waiver executed by
each of the following executive officers of the Company as required pursuant to
the Securities Purchase Agreement dated February 20, 2009 entered into between
the Company and the U.S. Department of the Treasury; Fred Abdula, Kerry Biegay,
Shelly Christian, Brett Houston, Thomas Nemeth and Scott Yelvington
(incorporated herein by reference to Exhibit 10.3 to the Company’s Annual Report
on Form 10-K for the year ended December 31, 2008 (File No. 000-19300) filed on
March 25, 2009).
  Exhibit
11.1  Statement of Computation of per share earnings. (Contained in
Notes 1 and 3 to the condensed consolidated financial statements.)
  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.
   31