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, 2010
 
 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:  ̈             NO:
 ̈
 
 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 o    Accelerated
Filer  ̈      Non-accelerated
Filer  ̈ (Do not
check if a smaller reporting company)
 Smaller
reporting company ý
 
 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 4,
2010
 
 
 
  NORTHERN STATES FINANCIAL
CORPORATION AND SUBSIDIARY
 FORM
10-Q
 For the Quarter
Ended March 31, 2010
 INDEX
 
 Page
      NumberPART I.   FINANCIAL
      INFORMATIONItem 1.  Financial
      StatementsReport of Independent Registered Public
      Accounting Firm
                                      2Condensed Consolidated Financial Statements
      and Notes
                                      3Item 2.  Management’s Discussion and
      Analysis of Financial Condition and Results of
    Operations
                                      15Item 3. Quantitative and Qualitative Disclosures
      About Market Risk
                                      33Item 4. Controls and Procedures
                                      35PART II.   OTHER
    INFORMATIONItem 1.  Legal
Proceedings
                                      35Item 1A.  Risk
    Factors
                                      35Item 2.  Unregistered Sales of Equity
      Securities and Use of Proceeds
                                      35Item 3.  Defaults upon Senior
      Securities
                                      35Item 4.  (Removed and
      Reserved)
                                      35Item 5.  Other
      Information
                                      35Item 6.  Exhibits
                                      36Signatures
                                      37EXHIBIT INDEX
                                      38
 
 1
 Table of
Contents
 
 PART I.
FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL
STATEMENTS.
    
 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRM
 
 
 Board of
Directors and Stockholders
 Northern
States Financial Corporation
 Waukegan,
Illinois
  We have
reviewed the accompanying interim condensed consolidated balance sheet of
NORTHERN STATES FINANCIAL CORPORATION as of March 31, 2010, the condensed
consolidated statements of income for the three month periods ended March 31,
2010 and 2009 and the condensed statements of cash flows and stockholders equity
for the three month periods ended March 31, 2010 and 2009.  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
 April 29,
2010
 
 
 2
 Table
of Contents
  NORTHERNSTATES FINANCIAL
CORPORATION
 CONDENSED
CONSOLIDATED BALANCE SHEETS
 March 31,
2010 and December 31, 2009
 (In
thousands of dollars) (Unaudited)
  March 31,
                                                      2010
                                                    
                                                    
                                                    December
      31,
                                                      2009AssetsCash
      and due from banks
                                                    
                                                    $
                                                    9,955
                                                    
                                                    
                                                    $
                                                    10,646Interest
      bearing deposits in financial institutions -
                                                      maturities less than 90 days
                                                    
                                                    
                                                    3,414
                                                    
                                                    
                                                    
                                                    2,760Federal
      funds sold
                                                    
                                                    
                                                    29,839
                                                    
                                                    
                                                    
                                                    20,788Total
      cash and cash equivalents
                                                    
                                                    
                                                    43,208
                                                    
                                                    
                                                    
                                                    34,194Securities
      available for sale
                                                    
                                                    
                                                    96,814
                                                    
                                                    
                                                    
                                                    133,421Loans
      and leases
                                                    
                                                    
                                                    409,501
                                                    
                                                    
                                                    
                                                    431,286Less:
      Allowance for loan and lease losses
                                                    
                                                    
                                                    (21,122
                                                    )
                                                    
                                                    
                                                    (18,027
                                                    )Loans
      and leases, net
                                                    
                                                    
                                                    388,379
                                                    
                                                    
                                                    
                                                    413,259Federal
      Home Loan Bank stock
                                                    
                                                    
                                                    1,801
                                                    
                                                    
                                                    
                                                    1,801Office
      buildings and equipment, net
                                                    
                                                    
                                                    9,596
                                                    
                                                    
                                                    
                                                    9,719Other
      real estate owned
                                                    
                                                    
                                                    27,089
                                                    
                                                    
                                                    
                                                    19,198Core
      deposit intangible asset
                                                    
                                                    
                                                    346
                                                    
                                                    
                                                    
                                                    462Accrued
      interest receivable and other assets
                                                    
                                                    
                                                    8,512
                                                    
                                                    
                                                    
                                                    10,236Total
      assets
                                                    
                                                    $
                                                    575,745
                                                    
                                                    
                                                    $
                                                    622,290Liabilities
      and Stockholders' EquityLiabilitiesDepositsDemand
      - noninterest bearing
                                                    
                                                    $
                                                    61,150
                                                    
                                                    
                                                    $
                                                    58,001Interest
      bearing
                                                    
                                                    
                                                    415,344
                                                    
                                                    
                                                    
                                                    459,235Total
      deposits
                                                    
                                                    
                                                    476,494
                                                    
                                                    
                                                    
                                                    517,236Securities
      sold under repurchase agreements
                                                    
                                                    
                                                    43,265
                                                    
                                                    
                                                    
                                                    49,364Subordinated
      debentures
                                                    
                                                    
                                                    10,000
                                                    
                                                    
                                                    
                                                    10,000Advances
      from borrowers for taxes and insurance
                                                    
                                                    
                                                    1,375
                                                    
                                                    
                                                    
                                                    898Accrued
      interest payable and other liabilities
                                                    
                                                    
                                                    4,923
                                                    
                                                    
                                                    
                                                    4,491Total
      liabilities
                                                    
                                                    
                                                    536,057
                                                    
                                                    
                                                    
                                                    581,989Stockholders'
      EquityCommon
      stock (Par value $0.40 per share, authorized 6,500,000
      shares,
                                                      issued
      4,472,255 shares and outstanding 4,072,255 at March 31, 2010
                                                      and December 31, 2009)
                                                    
                                                    
                                                    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, 2010 and December 31, 2009)
                                                    
                                                    
                                                    16,672
                                                    
                                                    
                                                    
                                                    16,641Warrants
      (584,084 issued and outstanding at March 31, 2010
                                                      and December 31, 2009)
                                                    
                                                    
                                                    681
                                                    
                                                    
                                                    
                                                    681Additional
      paid-in capital
                                                    
                                                    
                                                    11,584
                                                    
                                                    
                                                    
                                                    11,584Retained
      earnings
                                                    
                                                    
                                                    18,383
                                                    
                                                    
                                                    
                                                    20,632Treasury
      stock, at cost (400,000 shares at March 31, 2010
                                                      and
      December 31, 2009)
                                                    
                                                    
                                                    (9,280
                                                    )
                                                    
                                                    
                                                    (9,280
                                                    )Accumulated
      other comprehensive income
                                                    
                                                    
                                                    (141
                                                    )
                                                    
                                                    
                                                    (1,746
                                                    )Total
      stockholders' equity
                                                    
                                                    
                                                    39,688
                                                    
                                                    
                                                    
                                                    40,301Total
      liabilities and stockholders' equity
                                                    
                                                    $
                                                    575,745
                                                    
                                                    
                                                    $
                                                    622,290
  The
accompanying notes are an integral part of these condensed consolidated
financial statements.
   3
 Table
of Contents
  NORTHERN
STATES FINANCIAL CORPORATION
 CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
 Three
months ended March 31, 2010 and 2009
 (In
thousands of dollars, except per share data) (Unaudited)
 Three
      months endedMarch
      31,
                    2010
                  
                  
                  March
      31,
                    2009Interest
      incomeLoans
      (including fee income)
                  
                  $
                  5,179
                  
                  
                  $
                  6,434SecuritiesTaxable
                  
                  
                  1,015
                  
                  
                  
                  1,254Exempt
      from federal income tax
                  
                  
                  76
                  
                  
                  
                  98Federal
      funds sold and other
                  
                  
                  6
                  
                  
                  
                  3Total
      interest income
                  
                  
                  6,276
                  
                  
                  
                  7,789Interest
      expenseTime
      deposits
                  
                  
                  1,284
                  
                  
                  
                  2,255Other
      deposits
                  
                  
                  204
                  
                  
                  
                  420Repurchase
      agreements and federal funds purchased
                  
                  
                  76
                  
                  
                  
                  171Federal
      Home Loan Bank advances
                  
                  
                  8
                  
                  
                  
                  27Subordinated
      debentures
                  
                  
                  104
                  
                  
                  
                  123Total
      interest expense
                  
                  
                  1,676
                  
                  
                  
                  2,996Net
      interest income
                  
                  
                  4,600
                  
                  
                  
                  4,793Provision
      for loan and lease losses
                  
                  
                  3,713
                  
                  
                  
                  1,704Net
      interest income after provision for
                    loan
      and lease losses
                  
                  
                  887
                  
                  
                  
                  3,089Noninterest
      incomeService
      fees on deposits
                  
                  
                  550
                  
                  
                  
                  538Trust
      income
                  
                  
                  191
                  
                  
                  
                  172Gain
      on sale of securities
                  
                  
                  653
                  
                  
                  
                  0Gain
      (loss) on sale of other real estate owned
                  
                  
                  138
                  
                  
                  
                  (1,673
                  )Other
      than temporary impairment of securities
                  
                  
                  (208
                  )
                  
                  
                  0Noncredit
      portion of other than temporary
                    impairment
      of securities
                  
                  
                  (20
                  )
                  
                  
                  0Other
      operating income
                  
                  
                  307
                  
                  
                  
                  238Total
      noninterest income
                  
                  
                  1,611
                  
                  
                  
                  (725
                  )Noninterest
      expenseSalaries
      and employee benefits
                  
                  
                  1,795
                  
                  
                  
                  2,101Occupancy
      and equipment, net
                  
                  
                  629
                  
                  
                  
                  732Data
      processing
                  
                  
                  454
                  
                  
                  
                  391FDIC
      insururance
                  
                  
                  337
                  
                  
                  
                  152Legal
                  
                  
                  162
                  
                  
                  
                  239Audit
      and other professional
                  
                  
                  283
                  
                  
                  
                  271Amortization
      of core deposit intangible asset
                  
                  
                  116
                  
                  
                  
                  116Other
      operating expenses
                  
                  
                  719
                  
                  
                  
                  821Total
      noninterest expense
                  
                  
                  4,495
                  
                  
                  
                  4,823Income
      before income taxes
                  
                  
                  (1,997
                  )
                  
                  
                  (2,459
                  )Income
      tax expense
                  
                  
                  0
                  
                  
                  
                  (1,002
                  )Net
      loss
                  
                  $
                  (1,997
                  )
                  
                  $
                  (1,457
                  )Dividends
      to preferred stockholders
                  
                  
                  221
                  
                  
                  
                  98Accretion
      of discount on preferred stock
                  
                  
                  31
                  
                  
                  
                  20Net
      loss to common stockholders
                  
                  $
                  (2,249
                  )
                  
                  $
                  (1,575
                  )Basic
      loss per share
                  
                  $
                  (0.55
                  )
                  
                  $
                  (0.39
                  )Diluted
      loss per share
                  
                  $
                  (0.55
                  )
                  
                  $
                  (0.39
                  )Comprehensive
      loss
                  
                  $
                  (392
                  )
                  
                  $
                  (2,192
                  )
  The
accompanying notes are an integral part of these condensed consolidated
financial statements.
   4
 Table
of Contents
  NORTHERN
STATES FINANCIAL CORPORATION
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
 Three
months ended March 31, 2010 and 2009
 (In
thousands of dollars) (Unaudited)
  Three
      months endedMarch
      31,
                    2010
                  
                  
                  March
      31,
                    2009Cash
      flows - operating activitiesNet
      loss
                  
                  $
                  (1,997
                  )
                  
                  $
                  (1,457
                  )Adjustments
      to reconcile net loss to net cash from
                    operating
      activities:Depreciation
                  
                  
                  163
                  
                  
                  
                  157Amortization
      of other intangible assets
                  
                  
                  116
                  
                  
                  
                  116Provision
      for loan and lease losses
                  
                  
                  3,713
                  
                  
                  
                  1,704Net
      gain on sales of securities
                  
                  
                  (653
                  )
                  
                  
                  0Impairment
      loss on securities
                  
                  
                  228
                  
                  
                  
                  0Net
      (gains)/losses on sale of other real estate owned
                  
                  
                  (138
                  )
                  
                  
                  1,673Net
      change in accrued interest receivable and other assets
                  
                  
                  727
                  
                  
                  
                  (1,375
                  )Net
      change in accrued interest payable and other liabilities
                  
                  
                  211
                  
                  
                  
                  332Net
      cash - operating activities
                  
                  
                  2,370
                  
                  
                  
                  1,150Cash
      flows - investing activitiesProceeds
      from maturities, calls and principal reductionsof
      securities available for sale
                  
                  
                  3,589
                  
                  
                  
                  5,448Proceeds
      from sales of securities available for sale
                  
                  
                  41,193
                  
                  
                  
                  0Purchases
      of securities available for sale
                  
                  
                  (5,148
                  )
                  
                  
                  (38
                  )Change
      in loans made to customers
                  
                  
                  13,111
                  
                  
                  
                  3,443Property
      and equipment expenditures
                  
                  
                  (40
                  )
                  
                  
                  (97
                  )Improvements
      to other real estate owned
                  
                  
                  (29
                  )
                  
                  
                  (5
                  )Proceeds
      from sales of other real estate owned
                  
                  
                  332
                  
                  
                  
                  4,242Net
      cash - investing activities
                  
                  
                  53,008
                  
                  
                  
                  12,993Cash
      flows - financing activitiesNet
      increase (decrease) in:Deposits
                  
                  
                  (40,742
                  )
                  
                  
                  (301
                  )Securities
      sold under repurchase agreements
                    and
      federal funds purchased
                  
                  
                  (6,099
                  )
                  
                  
                  (3,820
                  )Advances
      from borrowers for taxes and insurance
                  
                  
                  477
                  
                  
                  
                  195Proceeds
      from issuance of preferred stock
                  
                  
                  0
                  
                  
                  
                  17,211Federal
      Home Loan Bank advances
                  
                  
                  0
                  
                  
                  
                  10,000Repayment
      of Federal Home Loan Bank advances
                  
                  
                  0
                  
                  
                  
                  (10,000
                  )Net
      cash - financing activities
                  
                  
                  (46,364
                  )
                  
                  
                  13,285Net
      change in cash and cash equivalents
                  
                  
                  9,014
                  
                  
                  
                  27,428Cash
      and cash equivalents at beginning of period
                  
                  
                  34,194
                  
                  
                  
                  21,868Cash
      and cash equivalents at end of period
                  
                  $
                  43,208
                  
                  
                  $
                  49,296Noncash
      transfer of loans to other real estate owned
                  
                  $
                  8,056
                  
                  
                  $
                  1,610
  The
accompanying notes are an integral part of these condensed consolidated
financial statements.
  
 5
 Table
of Contents
 
 NORTHERN
STATES FINANCIAL CORPORATION
 CONDENSED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
 Three
months ended March 31, 2010 and 2009
 (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, 2008
                    
                    $
                    1,789
                    
                    
                    $
                    0
                    
                    
                    $
                    0
                    
                    
                    $
                    11,584
                    
                    
                    $
                    56,082
                    
                    
                    $
                    (9,280
                    )
                    
                    $
                    1,439
                    
                    
                    $
                    61,614Net
      loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (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
                    
                    
                    $
                    76,535Balance,
      December 31, 2009
                    
                    $
                    1,789
                    
                    
                    $
                    16,641
                    
                    
                    $
                    681
                    
                    
                    $
                    11,584
                    
                    
                    $
                    20,632
                    
                    
                    $
                    (9,280
                    )
                    
                    $
                    (1,746
                    )
                    
                    $
                    40,301Net
      loss
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (1,997
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (1,997
                    )Accrued
      dividend on preferred stock
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (221
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (221
                    )Accretion
      of preferred stock discount issued
                    
                    
                    
                    
                    
                    
                    31
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (31
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    0Unrealized gain
      on securities available for sale, net of deferred tax
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,605
                    
                    
                    
                    1,605Balance, March
      31, 2010
                    
                    $
                    1,789
                    
                    
                    $
                    16,672
                    
                    
                    $
                    681
                    
                    
                    $
                    11,584
                    
                    
                    $
                    18,383
                    
                    
                    $
                    (9,280
                    )
                    
                    $
                    (141
                    )
                    
                    $
                    39,688
   6
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
  NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
  March 31,
2010
  (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, valuation of deferred tax assets 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, 2009 and 2008 included in the Company’s
Annual Report on Form 10-K for the year ended December 31, 2009 as filed with
the Securities and Exchange Commission.  The results of operations for
the three month period ended March 31, 2010 included herein are not necessarily
indicative of the results to be expected for the full year 2010.
  Net
income (loss) was utilized to calculate earnings (loss) per share for all
periods presented.  During the periods presented, 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 periods presented were antidilutive and,
therefore, not considered in computing diluted earnings per
share.  The average outstanding common shares used for earnings (loss)
per share were as follows:
 7
 Table
of Contents
   NORTHERN STATES FINANCIAL
CORPORATION
  NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
  March 31,
2010
  (Unaudited)
    (Dollars
      in thousands, except per share data)
                
                Three
      Months EndedMarch
      31,2010
                
                
                2009Basic
      earnings per share:Net
      loss
                
                $
                (1,997
                )
                
                $
                (1,457
                )Dividends
      accrued to preferred stockholders
                
                
                221
                
                
                
                98Accretion
      of discount on preferred stock
                
                
                31
                
                
                
                20Net
      loss available to common stockholders
                
                $
                (2,249
                )
                
                $
                (1,575
                )Weighted
      average common shares outstanding
                
                
                4,072,255
                
                
                
                4,072,255Basic
      loss per share
                
                $
                (0.55
                )
                
                $
                (0.39
                )Diluted
      earnings per share:Net
      loss
                
                $
                (1,997
                )
                
                $
                (1,457
                )Dividends
      accrued to preferred stockholders
                
                
                221
                
                
                
                98Accretion
      of discount on preferred stock
                
                
                31
                
                
                
                20Net
      loss available to common stockholders
                
                $
                (2,249
                )
                
                $
                (1,575
                )Weighted
      average common shares outstanding
                
                
                4,072,255
                
                
                
                4,072,255Add:
      Dilutive effect of common stock equivalents
                
                
                0
                
                
                
                0Weighted
      average common and dilutive common
                  shares
      outstanding
                
                
                4,072,255
                
                
                
                4,072,255Diluted
      loss per share
                
                $
                (0.55
                )
                
                $
                (0.39
                )
    Note 2 – Preferred
Stock
 On February
20, 2009, pursuant to the Treasury Department’s 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 “Series A 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, 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 fair
value of the preferred stock was estimated using an approximate 12% discount
rate and a five-year expected life.  A fair value of $681,000 was
estimated for the warrants using a Black-Sholes valuation.  The
assumptions used in the Black-Sholes valuation were as follows: $4.42 strike
price based on the contract, approximately 53% for the calculated volatility,
3.1% for the weighted average dividends, five years for the expected term and 2%
for the risk free rate.
  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 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.
 
  8
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
  NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
  March 31,
2010
  (Unaudited)
 In the
event of a liquidation or dissolution of the Company, the Series A 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%.  In November 2009, the Company notified the
Treasury Department of its intent to suspend its dividend payments on its Series
A Preferred Stock.  At November 15, 2009, the Company suspended its
dividend payment to the Treasury Department of $215,000.  The
suspension of dividend payments is permissible under the terms of the TARP
Capital Purchase Program, but the dividend is a cumulative dividend and failure
to pay dividends for six dividend periods would trigger board of director
appointment rights for the holder of the Series A Preferred
Stock.
 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 $0.40 per share, 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 of
its common stock 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 at the dates indicated was as follows:
 
 
 March
      31,
                          2010
                      
                      
                      December 31,
                          2009Par
      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.  Based upon its fair value relative
to the Series A Preferred Stock discussed in Note 2 above, 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
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
  NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
  March 31,
2010
  (Unaudited)
  Note 4 –
Securities
 At March
31, 2010 and December 31, 2009, the Company had the following securities in its
investment securities portfolio:
 Gross
      UnrealizedMarch
      31, 2010  ($000's)
                    
                    Fair
      Value
                    
                    
                    Gain
                    
                    
                    LossU.S.
      Treasury
                    
                    $
                    1,002
                    
                    
                    $
                    2
                    
                    
                    $
                    —States
      and political subdivisions
                    
                    
                    5,157
                    
                    
                    
                    90
                    
                    
                    
                    (14
                    )Mortgage-backed
      securities
                    
                    
                    86,560
                    
                    
                    
                    377
                    
                    
                    
                    (191
                    )Other
      bonds
                    
                    
                    17
                    
                    
                    
                    —
                    
                    
                    
                    (534
                    )Equity
      securities
                    
                    
                    4,078
                    
                    
                    
                    24
                    
                    
                    
                    —Total
      securities available-for-sale
                    
                    $
                    96,814
                    
                    
                    $
                    493
                    
                    
                    $
                    (739
                    )
   Gross
      UnrealizedDecember
      31, 2009  ($000's)
                    
                    Fair
      Value
                    
                    
                    Gains
                    
                    
                    LossesU.S.
      Treasury
                    
                    $
                    1,006
                    
                    
                    $
                    7
                    
                    
                    $
                    —States
      and political subdivisions
                    
                    
                    9,641
                    
                    
                    
                    193
                    
                    
                    
                    (27
                    )Mortgage-backed
      securities
                    
                    
                    118,729
                    
                    
                    
                    207
                    
                    
                    
                    (2,477
                    )Other
      bonds
                    
                    
                    37
                    
                    
                    
                    —
                    
                    
                    
                    (742
                    )Equity
      securities
                    
                    
                    4,008
                    
                    
                    
                    —
                    
                    
                    
                    (9
                    )Total
      securities available-for-sale
                    
                    $
                    133,421
                    
                    
                    $
                    407
                    
                    
                    $
                    (3,255
                    )
  
 During
the first quarter of 2010 the Company sold investment securities, classified as
available for sale, for liquidity purposes.  These securities had a
carrying value of $40.5 million and the Company recognized a $653,000 gain
receiving $41.2 million in proceeds.  There were no sales of
securities available for sale during the three months ended March 31,
2009.  Contractual maturities of securities available for sale at
March 31, 2010 were as follows. Securities not due at a single maturity date,
primarily mortgage-backed securities, are shown separately.
 March
      31, 2010  ($000's)
                              
                              FairValueDue
      in one year or less
                              
                              $
                              2,967Due
      after one year through five years
                              
                              
                              667Due
      after five years through ten years
                              
                              
                              718Due
      after ten years
                              
                              
                              1,8246,176Mortgage-backed
      securities
                              
                              
                              86,560Equity
      securities
                              
                              
                              4,078Total
      securities available-for-sale
                              
                              $
                              96,814
   10
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
  NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
  March 31,
2010
  (Unaudited)
 At March
31, 2010 and December 31, 2009, there were 11 and 20 securities, respectively,
in an unrealized loss position.  Securities with unrealized losses at
March 31, 2010, aggregated by investment category and length of time that
individual securities have been in a continuous loss position are as
follows:
 
 Less than 12 Months
                                    
                                    
                                    12 Months or More
                                    
                                    
                                    TotalMarch
      31, 2010  ($000’s)
                                    
                                    FairValue
                                    
                                    
                                    UnrealizedLosses
                                    
                                    
                                    FairValue
                                    
                                    
                                    UnrealizedLosses
                                    
                                    
                                    FairValue
                                    
                                    
                                    UnrealizedLossesStates
      and political subdivisions
                                    
                                    $
                                    170
                                    
                                    
                                    $
                                    (1
                                    )
                                    
                                    $
                                    776
                                    
                                    
                                    $
                                    (13
                                    )
                                    
                                    $
                                    946
                                    
                                    
                                    $
                                    (14
                                    )Mortgage-backed
      securities
                                    
                                    
                                    35,148
                                    
                                    
                                    
                                    (191
                                    )
                                    
                                    
                                    —
                                    
                                    
                                    
                                    —
                                    
                                    
                                    
                                    35,148
                                    
                                    
                                    
                                    (191
                                    )Other
      bonds
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    17
                                    
                                    
                                    
                                    (534
                                    )
                                    
                                    
                                    17
                                    
                                    
                                    
                                    (534
                                    )Total
      temporarily impaired
                                    
                                    $
                                    35,318
                                    
                                    
                                    $
                                    (192
                                    )
                                    
                                    $
                                    793
                                    
                                    
                                    $
                                    (547
                                    )
                                    
                                    $
                                    36,111
                                    
                                    
                                    $
                                    (739
                                    )
    Less than 12 Months
                                  
                                  
                                  12 Months or More
                                  
                                  
                                  TotalDecember
      31, 2009  ($000’s)
                                  
                                  FairValue
                                  
                                  
                                  UnrealizedLosses
                                  
                                  
                                  FairValue
                                  
                                  
                                  UnrealizedLosses
                                  
                                  
                                  FairValue
                                  
                                  
                                  UnrealizedLossesStates
      and political subdivisions
                                  
                                  $
                                  616
                                  
                                  
                                  $
                                  (7
                                  )
                                  
                                  $
                                  771
                                  
                                  
                                  $
                                  (20
                                  )
                                  
                                  $
                                  1,387
                                  
                                  
                                  $
                                  (27
                                  )Mortgage-backed
      securities
                                  
                                  
                                  100,181
                                  
                                  
                                  
                                  (2,477
                                  )
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  100,181
                                  
                                  
                                  
                                  (2,477
                                  )Other
      bonds
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  37
                                  
                                  
                                  
                                  (742
                                  )
                                  
                                  
                                  37
                                  
                                  
                                  
                                  (742
                                  )Equity
      securities
                                  
                                  
                                  3,965
                                  
                                  
                                  
                                  (9
                                  )
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  3,965
                                  
                                  
                                  
                                  (9
                                  )Total
      temporarily impaired
                                  
                                  $
                                  104,762
                                  
                                  
                                  $
                                  (2,493
                                  )
                                  
                                  $
                                  808
                                  
                                  
                                  $
                                  (762
                                  )
                                  
                                  $
                                  105,570
                                  
                                  
                                  $
                                  (3,255
                                  )
 
 
 At March
31, 2010, for those securities in a loss position, the Company does not have the
intent to sell these securities and the Company believes it is unlikely that the
Company will be required to sell these securities while they are in a loss
position.
 
 The other
bonds consist of Collateralized Debt Obligations (“CDOs”).  During
2010, the Company had recognized impairment losses of $228,000 on these CDOs
using cash flow analysis pursuant to the current guidelines on recognition of
impairment losses.
 
 The
Company’s investment in CDOs at March 31, 2010 consisted of three securities;
PreTSL XXII, PreTSL XXIV and PreTSL XXVII.  The Company’s CDOs consist
of various tranches of each security with tranches having various risk factors
and repayment schedules with an “A” tranche having the least risk and “D” and
“Income Notes” having the highest risk.  For PreTSL XXII, the
Company’s tranche level is “Mezzanine Class C-2” and at March 31, 2010,
approximately 26.5% of the issuers of the debt underlying PreTSL XXII were in
default or deferring payments on their debt as compared with 24.5% at year-end
2009.  For PreTSL XXIV, the Company’s tranche level is “Mezzanine
Class D” and at March 31, 2010, approximately 31.4% of the issuers of the debt
underlying PreTSL XXIV were in default or deferring payments on their debt as
compared with 29.4% at year-end 2009.  For PreTSL XXVII, the Company’s
tranche level is “Mezzanine Class C-1” and at March 31, 2010, approximately
25.1% of the issuers of the debt underlying PreTSL XXVII were in default or
deferring payments on their debt as compared with 21.2% at year-end
2009.
   11
 Table of
Contents
 NORTHERN STATES FINANCIAL
CORPORATION
  NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
  March 31,
2010
  (Unaudited)
 Note 5 – 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 4.12152% at March 31, 2010, which is the
effective rate from March 15, 2010 through June 14,
2010.    For the three months ended March 31, 2010 and 2009,
interest expense on the subordinated debentures was $104,000 and $123,000,
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 junior subordinated debentures at any time, or from time to time, for a
period not to exceed 20 consecutive quarters.  In November 2009, the
Company notified the trustee that holds the Company’s junior subordinated
debentures relating to its outstanding trust preferred securities that the
Company would be deferring its regularly scheduled quarterly interest
payments.  During the deferral period, the Company may not pay any
dividends on its common or preferred stock. 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.  Subject to certain exceptions,
the Company may not without the consent of the Treasury Department engage in
repurchases of the Company’s common stock or trust preferred securities for
three years or, if earlier, the date on which all shares of Series A Preferred
Stock issued to the Treasury Department have been redeemed or transferred by the
Treasury Department.
 
 Note 6 – Subsequent
Events
 
 During
the fourth quarter of 2009, the Federal Deposit Insurance Corporation (the
“FDIC”) and the Illinois Department of Financial and Professional Regulation
(the “IDFPR”) conducted a risk management review of the Bank.  As a
result of that review, during the first quarter of 2010, the FDIC and the IDFPR
advised management of their decision to propose that the Bank be required to
enter into a joint Consent Order.
 On April
16, 2010, the Bank and the FDIC and the IDFPR entered into a final joint Consent
Order.  Pursuant to the Consent Order, among other things, the Bank
has agreed to undertake the following:
 12
 Table
of Contents
 NORTHERN STATES FINANCIAL
CORPORATION
  NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
  March 31,
2010
  (Unaudited)
 (1)
                              increase
      the participation of the Bank’s Board of Directors in overseeing and
      supervising the affairs and activities of the Bank, including holding
      meetings of the Board no less frequently than
  monthly;
  (2)
                                  adopt
      and implement a program for monitoring compliance with the Consent Order,
      including establishing a committee comprised of at least three outside
      Bank board members responsible for such
  oversight;
 
 (3)
                                  maintain
      a Tier 1 capital to total assets ratio of at least 8% and a total
      risk-based capital ratio of at least
12%;
 
 (4)
                                  prohibit
      the extension of additional credit to or for the benefit of any existing
      borrower with a loan that has been previously charged-off or classified
      “loss” by the examiners, as well as prohibit the extension of additional
      credit in any amount in excess of $10,000 to any existing borrower with an
      outstanding classified or “special mention” loan unless the Board of
      Directors or a committee thereof determines the loan to be in the best
      interests of the Bank;
 
 (5)
                                  adopt
      a written action plan with respect to each classified asset and delinquent
      loan in excess of $1,000,000 for the purpose of reducing the Bank’s risk
      position with respect to such
asset;
 
 (6)
                                  correct
      all deficiencies in the loans listed as “special mention” by the
      examiners;
 
 (7)
                                  adopt
      a written action plan to reduce and manage concentrations of credit
      identified by the examiners, including procedures that provide for the
      ongoing measurement and monitoring of the concentrations of credit, the
      performance of portfolio stress testing analysis and the setting of
      concentration limits commensurate with the Bank’s capital levels and
      overall risk profile;
 
 (8)
                                  provide
      for quarterly reviews of and adjustments to the allowance for loan and
      lease losses in accordance with bank regulatory
  guidelines;
 
 (9)
                                  implement
      revised written lending and collection policies as indicated by the
      examiners, as well as revised loan grading and review procedures,
      including procedures for periodic confirmation of the accuracy and
      completeness of the watch list and all risk grade assignments,
      identification of loan relationships that warrant special management
      attention, and identification and tracking of credit and collateral
      documentation exceptions;
 
 (10)
                                  adopt
      a written profit plan and comprehensive budget containing formal goals and
      strategies to reduce discretionary expenses and to improve the Bank’s
      overall earnings;
 
 (11)
                                  adopt
      a written contingency funding/liquidity plan which includes identification
      of the sources of liquid assets available to meet the Bank’s contingency
      funding needs over one-, two- and three-month time
    horizons;
 
 (12)
                                  adopt
      a revised investment policy and interest rate risk policy to address the
      recommendations of the examiners;
 
 The
Consent Order also prohibits the payment of any dividends by the Bank to the
Company without the prior written consent of both the FDIC and the
IDFPR.
 13
 Table
of Contents
 NORTHERN STATES FINANCIAL
CORPORATION
  NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS
  March 31,
2010
  (Unaudited)
 Because
the Consent Order establishes specific capital amounts to be maintained by the
Bank, the Bank may not be considered better than “adequately capitalized” for
capital adequacy purposes, even if the Bank exceeds the levels of capital set
forth in the Consent Order. Currently, the Bank exceeds the capital levels
established by the FDIC and the IDFPR in the Consent Order.
 As an
adequately capitalized institution, the Bank may not accept, renew or roll over
brokered deposits without prior approval of the FDIC.  Brokered
deposits also include deposits with rates of interest that are more than 75
basis points above the rate applicable to the applicable market of the Bank as
determined by the FDIC.  The Bank has also applied for a designation
by the FDIC that the Bank is operating in a high rate area, which if approved
would give the Bank additional flexibility in offering competitive interest
rates on deposits.
 Any
material failure to comply with the provisions of the Consent Order could result
in additional enforcement actions by the FDIC as allowed by 12 U.S.C. §1818
and the IDFPR. While the Company intends to take such actions as may be
necessary to enable the Bank to comply with the requirements of the Consent
Order, there can be no assurance that the Bank will be able to comply fully with
the provisions of the Consent Order, or that efforts to comply with the Consent
Order will not have adverse effects on the operations and financial condition of
the Company and the Bank.
 
 Note 7 – Management
Plans
 
 Management
and the Board of Directors are committed to complying with the terms of the
Consent Order, and has already taken, and continues to take, numerous steps to
address these matters.  The Bank will report to the FDIC and the IDFPR
quarterly regarding its progress in complying with the provisions included in
the Consent Order.  Compliance with the terms of the Consent Order
will be an ongoing priority for management of the Bank.
 The Bank
continues to dedicate significant resources to effectively identify, monitor,
and manage problem assets and reduce real estate loan
concentrations.  A liquidity plan is being developed to identify the
sources of liquid assets available to meet the Bank’s contingency
funding.  Dividends have already been restricted and the Company has
suspended its dividend payments on its Series A Preferred Stock issued to the
Treasury Department as is permissible under the terms of the TARP Capital
Purchase Program.  The Bank’s Tier 1 to average assets ratio and total
capital to assets ratio, on a risk adjusted basis, were 8.11 percent and 12.43
percent, respectively, as of March 31, 2010 which were above the capital
levels required by the Consent Order of 8.00 percent and 12.00 percent,
respectively.
  In view
of these matters, the Bank’s ability to improve its financial condition is
dependent upon the success of management’s plans to address concerns regardingprofitability
and asset quality.  The Bank’s management believes they have taken
appropriate steps aimed at returning the Bank to profitability and improving
asset quality.  Management’s success will ultimately be determined by
its implementation of its plans, as well as factors beyond its control, such as
the economy and the real estate
market.
 14
 Table
of Contents
 NORTHERN STATES FINANCIAL
CORPORATION
  ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITIONAND RESULTS OF OPERATIONS.
  The
following discussion focuses on the consolidated financial condition of Northern
States Financial Corporation (the “Company”) at March 31, 2010 and the
consolidated results of operations for the three month period ended March 31,
2010, compared with the three month period ended March 31, 2009.  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, 2010 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, the Company’s ability to comply with the provisions of the Consent
Order, 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, liquidity issues,
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, 2010 were $575.7 million, a decrease of $46.6 million from
total assets of $622.3 million at December 31, 2009.  Loans totaled
$409.5 million at March 31, 2010, a decrease of $21.8 million, or 5.1 percent,
from loans of $431.3 million at December 31, 2009.  Loans decreased as
$8.1 million in loans were transferred to other real estate owned and as the
Company received scheduled principal loan payments and loan payoffs received in
the normal course of business.  Investment in overnight federal funds
sold increased to $29.8 million at March 31, 2010, as compared with $20.8
million at December 31, 2009, as the Company managed its liquidity
levels.  During the first quarter of 2010, the Company sold $40.5
million of investment securities, classified as available for sale, for
liquidity purposes.  The Company recognized a $653,000 gain from the
sale of the securities while receiving $41.2 million in proceeds.  As
a consequence, the Company’s securities portfolio was reduced to $96.8 million
at March 31, 2010 as compared with $133.4 million at year-end
2009.
   15
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
 Deposits
totaled $476.5 million at March 31, 2010, decreasing $40.7 million from $517.2
million in deposits at December 31, 2009.  Much of the reduction to
deposits came from decreases to brokered time deposits of $20.2 million, to
$74.7 million at March 31, 2010, compared with $94.9 million at December 31,
2009.  During the first quarter of 2010, the Company decreased its
brokered time deposits in expectation of entering into the Consent Order, as
described in Note 6 above.  Deposits, net of brokered time deposits,
declined $20.4 million to $401.8 million at March 31, 2010 as compared with
$422.2 million at December 31, 2009.  The decrease to deposits net of
brokered time deposits was primarily due to seasonal reductions to public and
commercial deposits.
 The
Company had a loss for the three months ended March 31, 2010 of $2.0 million, or
$.55 per share, compared with a loss of $1.5 million, or $0.39 per share for the
same three months of 2009.  The loss in the first quarter of 2010 was
due primarily to the provision to the allowance for loan and lease losses of
$3.7 million, as compared with a provision of $1.7 million during the first
quarter of 2009.  The first quarter 2010 provision of $3.7 million was
primarily allocated to hotel/motel loan relationships where the borrowers have
experienced cash flow difficulties.
 The
Company’s noninterest income increased $2.3 million during the quarter ended
March 31, 2010 to $1.6 million as compared with a loss to noninterest income of
$725,000 during the same quarter of 2009.  This loss to noninterest
income during the first quarter of 2009 was the result of the Company
recognizing a loss on the sale of other real estate owned of $1.7
million.  Noninterest income also increased during the first quarter
of 2010 as the Company recognized a gain of $653,000 on the sale of $40.5
million of securities available for sale.
 The
Company’s noninterest expense was reduced $328,000 during the first quarter of
2010 as compared to the same quarter of 2009.  The lower first quarter
2010 noninterest expense was due to decreases to salaries and employee benefits
of $306,000 as executive salaries were reduced and the number of Company
employees March 31, 2010 declined by 13 as compared with staff levels at March
31, 2009.
 
 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 analyzes the adequacy of
the allowance for loan and lease losses at least quarterly. In its analysis
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, the present value of expected cash flows and
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.  Based on management’s analysis,
management believes the allowance for loan and lease losses at March 31, 2010 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
couple years, the loss percentages used were based on the recent trailing 12
months as it is believed to be more indicative of current loan loss
estimates.
   16
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
 Management
specifically analyzes its impaired loans for probable losses.  The
change in the volume of impaired 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.
 
 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.  These assets were initially measured at fair value and
are being amortized on the straight-line method over their estimated useful life
of seven years.
 The
Company analyzed its net deferred tax asset that totaled $14.5 million at March
31, 2010 due to its recent losses prior to income taxes.  The analysis
of the deferred tax asset requires income projections into the future as well as
any income tax refunds that the Company may be able to receive.  The
Company’s deferred tax asset valuation allowance was $14.5 million at March 31,
2010 based on its analysis as compared with $13.7 million at December 31,
2009.  The Company will need to continue to analyze its deferred tax
asset quarterly.
 FINANCIAL
CONDITION
 
 The
Company’s federal funds sold at March 31, 2010 increased to $29.8 million
compared with $20.8 million at December 31, 2009 as the Company managed its
liquidity.  The Company’s federal funds sold position increased
primarily as the result of the receipt of $41.2 million in proceeds from the
sale of investment securities classified as available for
sale.  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 also uses these funds
for its liquidity needs.
 The
Company’s securities available for sale declined $36.6 million, or 27.4 percent,
to $96.8 million at March 31, 2010 compared with $133.4 million at year-end
2009.  The Company’s investments in mortgage-backed securities
decreased $32.2 million to $86.5 million at March 31, 2010 as compared with
$118.7 million at December 31, 2009.  The Company’s investments in
state and political subdivision securities decreased $4.5 million to $5.2
million at March 31, 2010 as compared with $9.6 million at December 31,
2009.  These decreases to the Company’s investment securities
portfolio were the primarily the result of the sale of $37.1 million of
mortgage-backed securities and $3.4 million of securities issued by state and
political subdivisions during the first quarter of 2010, which together totaled
$40.5 million. The Company sold these securities for liquidity purposes and
recognized a gain of $653,000 on the sale of the securities.  At March
31, 2010, securities totaling $79.3 million were pledged to secure public
deposits, repurchase agreements and for other purposes required or permitted by
law.
 Loans and
leases totaled $409.5 million at March 31, 2010, decreasing $21.8 million from
$431.3 million at December 31, 2009.  The decrease was due in part to
$8.1 million in loans that were transferred to other real estate
owned.  The balance of the decrease to loans and leases was due to
scheduled principal loan payments, loan payoffs and lower borrower demands
attributed to the poor economy and to stricter loan
underwriting.
 Approximately
93 percent of the Bank’s loan portfolio at March 31, 2010 was secured by real
estate.  The Company’s loans to the hotel industry totaled $71.6
million at March 31, 2010.    Loans totaling $37.0 million
at March 31, 2010 were pledged to secure a line of credit from the Federal Home
Loan Bank of Chicago.  At March 31, 2010, loans totaling $130.5
million had payment schedules where only interest is collected until the loans
mature as compared with $121.7 million in loans at December 31,
2009.  At March 31, 2010, $25.9 million of the loans having interest
only payments consisted of home equity loans.
 17
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
 Loan
commitments have decreased $10.4 million to $48.3 million at March 31, 2010,
compared with $58.7 million at December 31, 2009, corresponding with the decline
in loan demand during the first quarter of 2010.  Letters of credit
also decreased during the three months ended March 31, 2010, to $6.2 million
from $6.5 million at year-end.  At March 31, 2010, loans to related
parties totaled $281,000 and loan commitments and letters of credit issued to
related parties were $774,000.  Loans, loan commitments and letters of
credit to related parties are made on the same terms and conditions that are
available to the public.
 
 Deposits
totaled $476.5 million at March 31, 2010, decreasing $40.7 million or 7.9
percent from $517.2 million at year-end 2009.   Brokered time
deposits decreased $20.2 million to $74.7 million or 15.7 percent of total
deposits at March 31, 2010 as compared with $94.9 million or 18.4 percent of
total deposits at December 31, 2009.  The decrease to brokered time
deposits was planned as the Company lowered its dependence on brokered deposits
in expectation of entering into the Consent Order. The Company expects to have
further reductions to its brokered time deposits during 2010.
  Because
the Consent Order establishes specific capital amounts to be maintained by the
Bank, the Bank may not be considered better than “adequately capitalized” for
capital adequacy purposes, even if the Bank exceeds the levels of capital set
forth in the Consent Order. Currently, the Bank exceeds the capital levels
established by the FDIC and the IDFPR in the Consent Order.
 
 As an
adequately capitalized institution, the Bank may not accept, renew or roll over
brokered deposits without prior approval of the FDIC.  Brokered
deposits also include deposits with rates of interest that are more than 75
basis points above the rate applicable to the applicable market of the Bank as
determined by the FDIC.  As of March 31, 2010, 15.67 percent of the
Bank’s deposits were brokered deposits.  The Bank believes it will be
able to find alternative funding sources for these brokered deposits as they
come due.  Replacement funding sources for the maturing brokered
deposits include, among other sources: the growth of core deposits from current
and new retail and commercial customers; scheduled repayments on existing loans;
and the possible sale of investment securities.  Furthermore, the Bank
has applied for a designation by the FDIC that the Bank is operating in a high
rate area, which if approved would give the Bank additional flexibility in
offering competitive interest rates on deposits.  However, other
depositors, including some local government entities, may not maintain their
deposits at the Bank if the Bank is no longer well
capitalized.
 Total
deposits also declined during the first quarter of 2010 due to the reduction to
public deposits that decreased $7.0 million to $49.8 million at March 31, 2010
from $56.8 million at December 31, 2009.  Public deposit balances
seasonally decline during the first half of the year as the public entities draw
down their balances prior to the receipt of real estate tax collections late in
the second quarter.  Also, it is expected that the Consent Order may
cause some public depositors to further lower their deposit levels held at the
Bank.   Commercial deposits also declined $4.5 million from
year-end as commercial customers drew down their balances for business
reasons.
 Offsetting
some of these decreases in deposits was increases to noninterest-bearing demand
deposits.  These noninterest-bearing demand deposits increased $3.2
million to $61.2 million at March 31, 2010 as compared with $58.0 million at
year-end 2009 as the Company continues its efforts to increase core
deposits.
 The
Company’s total retail NOW accounts also increased $2.0 million from year-end
2009 due to the Company’s “High Yield Checking Account” NOW product. This NOW
product deposits totaled $18.8 million at March 31, 2010.  An interest
rate of 3.50 percent interest was paid on this product during the first quarter
of 2010 on the first $25,000 in the account if certain requirements are met such
as e-statements and debit card usage.   As a result of the
Consent Order, these “High Yield Checking” accounts are deemed to be brokered
deposits due to the premium rate being offered.  As a consequence,
subsequent to March 31, 2010, the Bank lowered the rate offered on this account
product to 1.10 percent in order to keep this
 18
 Table
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 NORTHERN STATES FINANCIAL
CORPORATION
 
 
 account
product from being considered a brokered deposit.  The Company expects
that the balances in this account product may decrease as a result of this
change.
  Securities
sold under repurchase agreements declined $6.1 million at March 31, 2010 to
$43.3 million as compared with $49.4 million at December 31,
2009.  The decrease was due largely to one customer who lowered their
repurchase agreement at the Company for business reasons by $5.5 million at
March 31, 2010 as compared with December 31, 2009.
 FAIR VALUE
MEASUREMENTS
  The
following tables present information about the Company’s securities in its
investment portfolio that were measured at fair value on a recurring basis at
March 31, 2010, and the valuation techniques used by the Company to determine
the fair values.
  TABLE
1
  NORTHERN
STATES FINANCIAL CORPORATION
 ASSETS
MEASURED AT FAIR VALUE ON A RECURRING BASIS
 SECURITIES
AVAILABLE FOR SALE
 ($
000s)
   Securities
      Available for Sale
                  
                  
                  
                  
                  Fair
      Value Measurements at Reporting Date UsingTotal
                  
                  
                  Quoted
      Prices
                    in
      Active
                    Markets
      for
                    Identical
                    Assets
                    (Level
      1)
                  
                  
                  Significant
                    Other
                    Observable
                    Inputs
                    (Level
      2)
                  
                  
                  Significant
                    Unobservable
                    Inputs
                    (Level
      3)U.S.
      Treasury
                  
                  $
                  1,002
                  
                  
                  $
                  1,002States
      and political subdivisions
                  
                  
                  5,157
                  
                  
                  
                  
                  
                  
                  
                  5,157Mortgage
      - backed securities
                  
                  
                  86,560
                  
                  
                  
                  
                  
                  
                  
                  86,560Other
      bonds
                  
                  
                  17
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  17Equity
      securities
                  
                  
                  4,078
                  
                  
                  
                  
                  
                  
                  
                  4,078Total
      at March 31, 2010
                  
                  $
                  96,814
                  
                  
                  $
                  1,002
                  
                  
                  $
                  95,795
                  
                  
                  $
                  17U.S.
      Treasury
                  
                  $
                  1,006
                  
                  
                  $
                  1,006States
      and political subdivisions
                  
                  
                  9,641
                  
                  
                  
                  
                  
                  
                  
                  9,641Mortgage
      - backed securities
                  
                  
                  118,729
                  
                  
                  
                  
                  
                  
                  
                  118,729Other
      bonds
                  
                  
                  37
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  37Equity
      securities
                  
                  
                  4,008
                  
                  
                  
                  
                  
                  
                  
                  4,008Total
      at December 31, 2009
                  
                  $
                  133,421
                  
                  
                  $
                  1,006
                  
                  
                  $
                  132,378
                  
                  
                  $
                  37
  19
 Table
of Contents
 NORTHERN STATES FINANCIAL
CORPORATION
 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.
 
 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, 2009, the difference between the fair value reported
and the fair value determined by the independent securities valuation firm was
considered immaterial.
 TABLE
2
  NORTHERN
STATES FINANCIAL CORPORATION
 CHANGES
IN LEVEL 3 MEASURED AT FAIR VALUE ON A RECURRING BASIS
 SECURITIES
AVAILABLE FOR SALE
 ($
000s)
  Securities
                          Available
                          for
      SaleBalance
      at December 31, 2009
                      
                      $
                      37Total
      realized and unrealized gains (losses) included in income
                      
                      
                      (228
                      )Total
      unrealized gains (losses) included in other comprehensive
      income
                      
                      
                      208Net
      purchase, sales, calls and maturities
                      
                      
                      0Net
      transfer into Level 3
                      
                      
                      0Balance
      at March 31, 2010
                      
                      $
                      17
 Securities
                                  Available
                                  for
      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 3
                              
                              
                              0Balance
      at March 31, 2009
                              
                              $
                              244
 20
 Table
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 NORTHERN STATES FINANCIAL
CORPORATION
    There
were no changes between securities from Level 1 to Level 2 during the three
months ended March 31, 2010.  The Company’s change in Level 3
securities available for sale measured on a recurring basis are shown in Table
2.
 Securities
classified within Level 3 consist primarily of collateralized debt obligations
(“CDOs”).  The CDOs were valued using accounting guidelines to
determine other than temporary impairment losses.  The impairment
losses on the CDOs were due to defaults and deferral of payments by the
financial institutions and insurance companies that issued the debt underlying
the securities.  The Company used cash flow analyses at March 31, 2010
that assume that 3.00 percent of the debt that underlies the CDOs will default
within the next 9 months and that annually thereafter, there will be defaults of
1.25 percent annually and recoveries of .15 percent annually lagging two years
after the defaults.  The Company believes that these estimates are
supportable based on its analyses of actual defaults and deferrals and the
actual financial condition of the debtors underlying the
CDOs.
 TABLE
3
  NORTHERN
STATES FINANCIAL CORPORATION
 ASSETS
MEASURED AT FAIR VALUE ON A NON-RECURRING BASIS
 IMPAIRED
LOANS
 ($
000s)
   Impaired
      Loans
                    
                    
                    
                    
                    Fair
      Value Measurements at Reporting Date UsingTotal
                    
                    
                    Quoted
      Prices
                      in
      Active
                      Markets
      for
                      Identical
                      Assets
                      (Level
      1)
                    
                    
                    Significant
                      Other
                      Observable
                      Inputs
                      (Level
      2)
                    
                    
                    Significant
                      Unobservable
                      Inputs
                      (Level
      3)At
      March 31, 2010
                    
                    $
                    40,284
                    
                    
                    $
                    —
                    
                    
                    $
                    —
                    
                    
                    $
                    40,284At
      December 31, 2009
                    
                    $
                    25,447
                    
                    
                    $
                    —
                    
                    
                    $
                    —
                    
                    
                    $
                    25,447
  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 standards regarding impairment of
assets.  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 net realizable value of the
collateral.
 During
the first quarter of 2010 and during 2009, the Company recorded adjustments to
certain collateral dependent loans that were measured for impairment in
accordance with accounting guidelines.  Such amounts are generally
based on the estimated underlying collateral values less estimated costs to sell
that support the loan.  In cases where the carrying value of the loans
exceed the estimated fair value of the collateral less estimated costs, an
impairment loss was recognized. These adjustments to impaired loans for the
first quarter 2010 totaled $3.1 million as additional allocations to the
allowance for loan and lease losses.
 
 21
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
  During
2009, the Company recorded adjustments to certain properties carried as other
real estate owned that were measured for impairment in accordance with
accounting guidelines.  Such amounts are generally based on the
underlying fair value of the properties less estimated costs to
sell.  In cases where the carrying value of the properties exceed the
estimated fair value of the property less estimated costs, an impairment loss
was recognized.  During the quarter ended March 31, 2010, there was no
impairment loss recognized on the Company’s other real estate
owned.
 
 
 
 TABLE
4
 
 NORTHERN
STATES FINANCIAL CORPORATION
 ASSETS
MEASURED AT FAIR VALUE ON A NON-RECURRING BASIS
 IMPAIRED
OTHER REAL ESTATE OWNED
 ($
000s)
 
 Impaired
      Other Real Estate Owned
                                  
                                  
                                  
                                  
                                  Fair
      Value Measurements at Reporting Date UsingTotal
                                  
                                  
                                  Quoted
      Prices
                                    in
      Active
                                    Markets
      for
                                    Identical
                                    Assets
                                    (Level
      1)
                                  
                                  
                                  Significant
                                    Other
                                    Observable
                                    Inputs
                                    (Level
      2)
                                  
                                  
                                  Significant
                                    Unobservable
                                    Inputs
                                    (Level
      3)At
      March 31, 2010
                                  
                                  $
                                  13,185
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  13,185At
      December 31, 2009
                                  
                                  $
                                  13,185
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  —
                                  
                                  
                                  $
                                  13,185
 The
following methods and assumptions were used to estimate fair values for
financial instruments.  Securities fair values are based on quoted
market prices, are based on observable inputs, including prices for similar
securities in active markets and interest rates and yield curves at commonly
quoted intervals, or are based on unobservable inputs, including inputs that are
available in situations where there is little, if any, market activity for the
related securities.  It is estimated that cash and cash equivalents,
accrued interest receivable and accrued interest payable are carried at fair
value.  For loans and leases, deposits, securities sold under
repurchase agreements and the subordinated debentures, the fair value is
estimated by discounted cash flow analysis using market rates for the estimated
life and credit.  Fair values for impaired loans are estimated using
discounted cash flow analyses or underlying collateral values, where
applicable.  The fair value of off-balance sheet items are based on
the fees or costs that would currently be charged to enter or terminate such
arrangements and the fair values are not
material.
 22
 Table
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  NORTHERN STATES FINANCIAL
CORPORATION
 TABLE
5 
 NORTHERN
STATES FINANCIAL CORPORATION
 FAIR
VALUE OF FINANCIAL INSTRUMENTS
 As
of March 31, 2010
 ($
000s)
 
 
 March
      31, 2010
                    
                    Carrying
                      Value
                    
                    
                    Estimated
                      Fair
      ValueFinancial
      assets:Cash
      and cash equivalents
                    
                    $
                    43,208
                    
                    
                    $
                    43,208Securities
      available for sale
                    
                    
                    96,814
                    
                    
                    
                    96,814Loans
      and leases, net
                    
                    
                    388,379
                    
                    
                    
                    396,294Federal
      Home Loan Bank stock
                    
                    
                    1,801
                    
                    
                    
                    1,801Accrued
      interest receivable
                    
                    
                    1,840
                    
                    
                    
                    1,840Financial
      liabilities:Deposits
                    
                    $
                    (476,494
                    )
                    
                    $
                    (477,741
                    )Securities
      sold under repurchase agreement
                    
                    
                    (43,265
                    )
                    
                    
                    (43,104
                    )Subordinated
      debentures
                    
                    
                    (10,000
                    )
                    
                    
                    (6,826
                    )Advances
      from borrowers for taxes and insurance
                    
                    
                    (1,375
                    )
                    
                    
                    (1,375
                    )Accrued
      interest payable
                    
                    
                    (1,588
                    )
                    
                    
                    (1,588
                    )
 
 
 December
      31, 2009
                    
                    Carrying
                      Value
                    
                    
                    Estimated
                      Fair
      ValueFinancial
      assets:Cash
      and cash equivalents
                    
                    $
                    34,194
                    
                    
                    $
                    34,194Securities
      available for sale
                    
                    
                    133,421
                    
                    
                    
                    133,421Loans
      and leases, net
                    
                    
                    413,259
                    
                    
                    
                    418,085Federal
      Home Loan Bank stock
                    
                    
                    1,801
                    
                    
                    
                    1,801Accrued
      interest receivable
                    
                    
                    2,203
                    
                    
                    
                    2,203Financial
      liabilities:Deposits
                    
                    $
                    (517,236
                    )
                    
                    $
                    (519,606
                    )Securities
      sold under repurchase agreement
                    
                    
                    (49,364
                    )
                    
                    
                    (49,244
                    )Subordinated
      debentures
                    
                    
                    (10,000
                    )
                    
                    
                    (6,728
                    )Advances
      from borrowers for taxes and insurance
                    
                    
                    (898
                    )
                    
                    
                    (898
                    )Accrued
      interest payable
                    
                    
                    (1,773
                    )
                    
                    
                    (1,773
                    )
 CAPITAL
RESOURCES
 Total
stockholders’ equity decreased $613,000 to $39.7 million at March 31, 2010, as
compared with $40.3 million at year-end 2009.  The decrease was the
result of losses for the first three months of 2010 of $2.0 million and the
accrual of dividends that totaled $221,000.   Also increasing
capital by $1.6 million during the three months ended March 31, 2010 was
increases to the accumulated other comprehensive income relating to the
unrealized gains on securities available for sale, net of deferred
tax.
 23
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
 The book
value of the Company’s outstanding common stock at March 31, 2010 was $5.52 per
share, compared with $5.67 at December 31, 2009.
 
 On a
consolidated basis, the Company’s Tier 1 to average assets ratio and total
capital to assets ratio, on a risk adjusted basis, were 8.10 percent and 12.46
percent, respectively, as of March 31, 2010.  The Bank’s Tier 1
to average assets ratio and total capital to assets ratio, on a risk adjusted
basis, were 8.11 percent and 12.43 percent, respectively, as of March 31,
2010 which were above the capital levels required by the Consent Order of 8.00
percent and 12.00 percent, respectively.
 At the
Company’s annual meeting of stockholders held on May 21, 2009, the stockholders
approved the 2009 Restricted Stock Plan (“Plan”).  The goal of the
Plan is to promote the Company’s long-term financial success, increase
stockholder value and enhance our ability to attract and retain employees and
directors.  The Plan authorizes the issuance of up to 400,000 shares
of the Company’s common stock, which is approximately 10 percent of the
Company’s total shares currently issued and outstanding, in connection with
incentive compensation awards.  Shares of the Company’s common stock
issued under the Plan as awards may consist of treasury shares or authorized and
unissued shares not reserved for any other purpose. Awards under the Plan may be
made to directors and employees of both the Company and its subsidiaries and may
consist of restricted stock with associated voting rights and the right to
receive dividends.   Awards may also be issued as restricted
stock units not having voting rights or the right to receive dividends until the
terms of the award are satisfied and shares of the Company’s common stock are
actually issued; however, dividends may be credited to a restricted stock unit
award.  The terms and conditions of each award will be set forth and
described in an award agreement between the Company and the
participant.  No awards have been issued under the Plan as of March
31, 2010.
 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 $53.1 million at March 31, 2010, as compared with $64.4 million
at December 31, 2009.
 As
required by the Consent Order, management is in the process of developing a
liquidity plan that identifies the sources of liquid assets available to meet
the Bank’s contingency funding over one-, two- and three-month time
horizons.  This liquidity plan looks at the Bank’s ability to meet the
cash flow requirements of customers and other operating needs and seeks to
manage liquidity to meet these requirements.  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, 2010, cash and
cash equivalents increased by $9.0 million to $43.2 million, primarily as the
result of the proceeds from the sale of securities of $41.2
million.
 The
Consent Order also restricts payments of dividends from the Bank to the Company
and as such this conserves liquidity at the Bank.  Dividends from the
Bank are needed to fund the dividend payments to the Company’s preferred and
common stockholders and the interest payments on its subordinated
debentures.   Due to this restriction, among other factors, it is
expected that the Company will continue to suspend dividend payments on its
Series A Preferred Stock issued under the TARP Capital Purchas Program for the
balance of 2010 and there will be no dividends to common stockholders in
2010.  Also, the Company will continue to defer interest payments on
its subordinated debentures.  The dividends on the
 24
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
 
 Series A
Preferred Stock and the interest payments on the subordinated debentures, if
paid, would total an estimated $1.3 million for 2010.
 
 As part
of the liquidity plan being developed, management reviews the liquidity ratio 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, 2010, this ratio at the Bank was 12.0
percent, compared with 13.6 percent at year-end 2009, and was within
management’s internal policy guidelines.
 The
liquidity plan being developed will consider the liquidity provided by scheduled
principal payments by loan customers as well as estimated anticipated payoffs of
loans as the Bank attempts to lower its concentrations of loans to the hotel
industry.  The Bank expects to receive liquidity from loans of
approximately $3.0 million per month.
 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, 2010 were $29.8 million as
compared with $20.8 million at December 31, 2009.
 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 selling the unpledged securities or by
increasing its repurchase agreement balances.  During the first
quarter of 2010, liquidity of $41.2 million was made available through the sale
of securities available for sale. Securities available for sale totaled $96.8
million at March 31, 2010, of which $79.3 million were pledged to secure public
deposits and repurchase agreements, as compared with pledged securities of $94.2
million at December 31, 2009.  The liquidity plan being developed
anticipates that additional unpledged securities available for sale may be sold
for liquidity purposes in 2010.
 An
important source of liquidity to the Company is deposits.  Under the
Consent Order, the Bank must limit its brokered time deposits and lower the
interest rates paid on its “High Yield Checking” NOW account
product.  As a result of the Consent Order, the Bank is not permitted
to pay a rate of interest on deposit products that is more than 75 basis points
above the rate applicable to the applicable market of the Bank as determined by
the FDIC.  The liquidity plan being developed anticipates that
brokered time deposits, “High Yield Checking” NOW accounts and public deposits
may decrease from their current levels due in part to Bank compliance with the
Consent Order. The Bank expects that a portion of these deposit reductions will
be offset by continued growth from core deposits to new retail and commercial
customers.  The Bank has applied for a classification by the FDIC that
the Bank is operating in a high rate area, which, if approved, would give the
Bank additional flexibility in offering competitive rates on
deposits.  However, it is expected that deposits will decline during
the balance of 2010 and liquidity available from this source will be
limited.
 Another
important source of liquidity to the Company is borrowings.  The
Bank’s liquidity plan being developed considers the Bank’s line of credit
available at the Federal Home Loan Bank of Chicago which was $18.0 million at
March 31, 2010.  The Company has pledged loans totaling $37.0 million
at March 31, 2010 as security for potential borrowings the Company may incur by
drawing on the line of credit at the Federal Home Loan Bank of
Chicago.  Additional funds from available lines of credit at two
independent banks at March 31, 2010 totaling $20.0 million may also supplement
the Company’s ability to meet any funding needs, including any unexpected strain
on liquidity.
 25
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
   RESULTS OF
OPERATIONS
 
 NET
INCOME
 
 The
Company recognized a loss for the quarter ended March 31, 2010 of $2.0 million,
as compared with a loss of $1.5 million for the same quarter of
2009.  The loss during the first quarter of 2010 was primarily
impacted by a provision for loan and lease losses of $3.7 million. Other factors
affecting the loss for the three months ended March 31, 2010, include an
impairment charge of $228,000 taken on collateralized debt obligations of trust
preferred securities issued by financial institutions and the current inability
to recognize a tax benefit of $810,000 on the loss for the
quarter.
   NET
INTEREST INCOME
 
 Net
interest income, the difference between interest income on earning assets and
interest expense on interest bearing liabilities, decreased 4.0 percent, or
$193,000, to $4.6 million for the three months ended March 31, 2010, as compared
with $4.8 million for the same quarter of 2009.  The decline in net
interest income was attributable to decreases to interest earning assets,
changes to the mix of earning assets and increased levels of nonearning
nonaccrual loans during the first quarter of 2010 as compared with the same
quarter of 2009.
 Average
interest earning assets during the three months ended March 31, 2010 totaled
$575.9 million, a decrease of $28.3 million from average earning assets of
$604.2 million during the three months ended March 31, 2009.  The
decrease to average earning assets contributed to the decline in interest income
on a fully tax equivalent basis of $1.5 million, to $6.3 million for the first
quarter of 2010 as compared with $7.8 for the same quarter of
2009.
 The mix
of average interest earning assets shows that higher earning average loan
balances during the first quarter of 2010 totaled $424.0 million or 73.6 percent
of total average earning assets as compared with $480.0 million or 79.4 percent
of total average earning assets for the same quarter of
2009.   Lower interest earning taxable securities averaged $124.8
million or 21.6 percent of total average earning assets during the first quarter
of 2010, as compared with $96.0 million or 15.9 percent of total average earning
assets for the same quarter of 2009.  This change in mix contributed
to the decrease to interest income and to the decline of 83 basis points on the
yield on interest earning assets for the first quarter of 2010, which was 4.40
percent as compared with 5.23 percent for the same quarter of 2009.
  At March
31, 2010, the Company had $47.9 million of nonaccrual loans, a $10.9 million
increase as compared with $37.0 million of nonaccrual loans at March 31,
2009.  These increased nonaccrual loans were a factor in that the
average loan yield for the first quarter of 2010 was 4.91 percent, 47 basis
points less than for the same quarter of 2009.
 26
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
  TABLE
6
  NORTHERN
STATES FINANCIAL CORPORATION
 ANALYSIS
OF AVERAGE BALANCE AND TAX EQUIVALENT RATES
 For the
Three Months Ended March 31, 2010 and 2009 - Rates are
Annualized
 ($
000s)
   2010
                                  
                                  
                                  2009Average
                                    Balance
                                  
                                  
                                  Interest
                                  
                                  
                                  Rate
                                  
                                  
                                  Average
                                    Balance
                                  
                                  
                                  Interest
                                  
                                  
                                  RateAssetsLoans
      (1)(2)(3)
                                  
                                  $
                                  424,021
                                  
                                  
                                  $
                                  5,206
                                  
                                  
                                  
                                  4.91
                                  %
                                  
                                  $
                                  479,994
                                  
                                  
                                  $
                                  6,456
                                  
                                  
                                  
                                  5.38
                                  %Taxable
      securities (4)
                                  
                                  
                                  124,836
                                  
                                  
                                  
                                  1,015
                                  
                                  
                                  
                                  3.24
                                  %
                                  
                                  
                                  96,047
                                  
                                  
                                  
                                  1,254
                                  
                                  
                                  
                                  5.38
                                  %Tax
      advantaged securities (2) (4)
                                  
                                  
                                  7,663
                                  
                                  
                                  
                                  115
                                  
                                  
                                  
                                  6.15
                                  %
                                  
                                  
                                  9,418
                                  
                                  
                                  
                                  149
                                  
                                  
                                  
                                  6.33
                                  %Federal
      funds sold
                                  
                                  
                                  19,454
                                  
                                  
                                  
                                  6
                                  
                                  
                                  
                                  0.12
                                  %
                                  
                                  
                                  18,761
                                  
                                  
                                  
                                  3
                                  
                                  
                                  
                                  0.06
                                  %Interest
      earning assets
                                  
                                  
                                  575,974
                                  
                                  
                                  
                                  6,342
                                  
                                  
                                  
                                  4.40
                                  %
                                  
                                  
                                  604,220
                                  
                                  
                                  
                                  7,862
                                  
                                  
                                  
                                  5.23
                                  %Noninterest
      earning assets
                                  
                                  
                                  35,157
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  39,319Average
      assets
                                  
                                  $
                                  611,131
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  643,539Liabilities
      and stockholders' equityNOW
      deposits
                                  
                                  $
                                  62,629
                                  
                                  
                                  $
                                  107
                                  
                                  
                                  
                                  0.68
                                  %
                                  
                                  $
                                  43,617
                                  
                                  
                                  $
                                  35
                                  
                                  
                                  
                                  0.32
                                  %Money
      market deposits
                                  
                                  
                                  55,296
                                  
                                  
                                  
                                  82
                                  
                                  
                                  
                                  0.59
                                  %
                                  
                                  
                                  65,173
                                  
                                  
                                  
                                  316
                                  
                                  
                                  
                                  1.94
                                  %Savings
      deposits
                                  
                                  
                                  61,882
                                  
                                  
                                  
                                  15
                                  
                                  
                                  
                                  0.10
                                  %
                                  
                                  
                                  60,733
                                  
                                  
                                  
                                  69
                                  
                                  
                                  
                                  0.45
                                  %Time
      deposits
                                  
                                  
                                  261,194
                                  
                                  
                                  
                                  1,284
                                  
                                  
                                  
                                  1.97
                                  %
                                  
                                  
                                  273,466
                                  
                                  
                                  
                                  2,255
                                  
                                  
                                  
                                  3.30
                                  %Other
      borrowings
                                  
                                  
                                  59,809
                                  
                                  
                                  
                                  188
                                  
                                  
                                  
                                  1.26
                                  %
                                  
                                  
                                  73,583
                                  
                                  
                                  
                                  321
                                  
                                  
                                  
                                  1.74
                                  %Interest
      bearing liabilities
                                  
                                  
                                  500,810
                                  
                                  
                                  
                                  1,676
                                  
                                  
                                  
                                  1.34
                                  %
                                  
                                  
                                  516,572
                                  
                                  
                                  
                                  2,996
                                  
                                  
                                  
                                  2.32
                                  %Demand
      deposits
                                  
                                  
                                  58,331
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  50,692Other
      noninterest bearing liabilities
                                  
                                  
                                  7,614
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  8,503Stockholders'
      equity
                                  
                                  
                                  44,376
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  67,772Average
      liabilities and
                                    stockholders'
      equity
                                  
                                  $
                                  611,131
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  643,539Net
      interest income
                                  
                                  
                                  
                                  
                                  
                                  $
                                  4,666
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  4,886Net
      interest spread
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  3.06
                                  %
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  2.91
                                  %Net
      yield on interest earning assets (4)
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  3.24
                                  %
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  3.24
                                  %Interest-bearing
      liabilities
                                    to
      earning assets ratio
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  86.95
                                  %
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  85.49
                                  %
  (1)
      -
                                  Interest
      income on loans includes loan origination and other fees of $20,000 and
      $32,000 for the three months ended March 31, 2010 and 2009,
      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 $27,000 and $22,000 for the three months
      ended March 31, 2010 and 2009, respectively.  The tax equivalent
      adjustment reflected in the above table for municipal securities is
      approximately $39,000 and $51,000 for the three months ended March 31,
      2010 and 2009, 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, 2010 and 2009
      average balance information includes an average unrealized gain
      (loss) for taxable securities of ($519,000) and $2,743,000 and for
      tax-advantaged securities of $188,000 and ($3,000),
      respectively.
 
 27
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
  ASSET
QUALITY AND THE PROVISION FOR LOAN AND LEASE LOSSES
 
 At March
31, 2010, 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 $21.1 million was adequate to cover probable incurred loan and
lease losses, as compared with $18.0 million at year-end 2009.  The
Company’s allowance for loan and lease losses to total loans ratio was 5.16
percent at March 31, 2010.
 During
the first quarter of 2010, $624,000 in loans and leases were charged-off against
the allowance compared with charge-offs of $201,000 during the same period last
year.  During the first quarter of 2010, recoveries of loans
previously charged-off totaled $6,000, as compared with $9,000 in recoveries
during the same period in 2009.  During the first quarter of 2010, the
provision for loan and lease losses was $3.7 million as compared with $1.7
million during the same quarter of 2009.
 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 $49.8 million at March 31, 2010, or 12.18 percent of total loans
and leases, as compared with $41.6 million at December 31, 2009, or 9.65 percent
of loans and leases.  The increase to nonperforming loans was
attributable to the continued poor economic climate and to the continued decline
in real estate prices.  Many borrowers have experienced cash flow
problems as unemployment rates have increased due to the economy, causing the
borrowers to become delinquent with their loan
payments.
 During
the first quarter of 2010, nonaccrual loans increased $6.3 million to $47.9
million at March 31, 2010, as compared with $41.6 million at year-end
2009.  Three loan relationships totaling $8.3 million were placed on
nonaccrual status during the first quarter of 2010.  A loan
relationship totaling $4.7 million for apartment complexes in Chicago was placed
on nonaccrual basis as increased vacancies and damage to one of the buildings by
the tenants has caused cash flow difficulties to the
borrowers.  Another loan relationship, totaling $3.2 million, was
placed on nonaccrual status as the motel securing the loan has had declining
room occupancy rates causing the borrower to experienced cash flow problems. The
other loan relationship totaling $475,000 is secured by vacant land that was to
be sold for real estate construction of single family homes.  The
inability to sell any of the lots has caused the borrower to have cash flow
difficulties and consequently the loan was placed on nonaccrual
status.  During the quarter ended March 31, 2010, the Company placed
two nonaccrual loan relationships totaling $1.9 million back onto accrual status
as the borrowers demonstrated ability to make payments is accordance to their
loan contracts.
 Loans and
leases 90 days or more past due and still accruing interest increased to $1.9
million at March 31, 2010 compared with $30,000 at December 31,
2009.  These loans are well secured and in the process of
collection.
 Impaired
loans and leases at March 31, 2010 totaled $82.1 million, as compared with $56.2
million at December 31, 2009, an increase of $25.9 million.  The
Company considers a loan or lease impaired if full principal and interest will
not be collected under the contractual terms of the note.  Nonaccrual
loans and leases are 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, 2010, $12.5
million of the allowance for loan and lease losses was allocated to the impaired
loans.
 At March
31, 2010, the Company’s impaired loans increased $25.9 million as $25.0 million
in hotels loans were classified as impaired during the first quarter of
2010.  At March 31, 2010, these hotel loans were still on accrual
basis and payments had been made up to date.  However, these hotel
loans have
  28
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
   shown
cash flow problems due to higher vacancy rates that have reduced the collateral
value of the hotels.  Of these hotel loans, $22.3 million have been
restructured during the first quarter of 2010 to reduce the payments in order to
assist the borrower in keeping their loan payments current.
 
 The $25.0
million in hotel loans placed on impaired status during the three months ended
March 31, 2010 were to three principal borrowers.  One borrower’s
hotel loans total $13.4 million that were restructured for which $1.8 million of
the allowance for loan and lease losses was allocated.  Another
borrower’s hotel loan totaled $8.9 million that was restructured and had an
allocation of the allowance for loan and lease losses of $1.5
million.  The third borrower’s hotel loan was $2.7 million and has not
been restructured.  This loan had an allocation of $486,000 at March
31, 2010.
 
 
 TABLE
7
  NORTHERN
STATES FINANCIAL CORPORATION
  NONPERFORMING
ASSETS
  ($
000’s)
   March
      31,
                        2010
                      
                      
                      December
      31,
                        2009Loans
      and leasesNonaccrual
      status
                      
                      $
                      47,978
                      
                      
                      $
                      41,58990
      days or more past due, still accruing
                      
                      
                      1,901
                      
                      
                      
                      30Total
      nonperforming loans and leases
                      
                      
                      49,879
                      
                      
                      
                      41,619Other
      real estate owned
                      
                      
                      27,089
                      
                      
                      
                      19,198Total
      nonperforming assets
                      
                      $
                      76,968
                      
                      
                      $
                      60,817Nonperforming
      loans and leases as a
                        percentage
      of total loans, net of
                        unearned
      income and deferred loan fees
                      
                      
                      12.18
                      %
                      
                      
                      9.65
                      %Nonperforming
      assets as a percentage
                        of
      total assets
                      
                      
                      13.37
                      %
                      
                      
                      9.77
                      %Nonperforming
      loans and leases as a
                        percentage
      of the allowance for loan losses
                      
                      
                      236.15
                      %
                      
                      
                      230.87
                      %
   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.
 Another
component of nonperforming assets is other real estate owned, consisting of
assets acquired through loan foreclosure and repossession. At March 31, 2010,
other real estate owned totaled $27.1 million, an increase of $7.9 million from
$19.2 million at December 31, 2009.  During the three months ended
March 31, 2010, the Company sold one property carried at $194,000 and recognized
a net gain on the sale of this property of $138,000 and net proceeds of
$332,000.  The Company had additions to other real estate owned as
$8.1 million was transferred from loans that were secured by lumber yards during
the three months ended March 31, 2010.  The Company came into
possession of the lumber yards as the customer has effectively abandoned the
properties and closed the business.
 29
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
  TABLE
8
  NORTHERN
STATES FINANCIAL CORPORATION
 OTHER
REAL ESTATE OWNED
 ($
000s)
 March
      31,
                          2010
                        
                        
                        December
      31,
                          2009Real
      estate - construction and
                          land
      development
                        
                        $
                        3,948
                        
                        
                        $
                        3,765Real
      estate - 1-4 family
                        
                        
                        1,527
                        
                        
                        
                        1,680Real
      estate - commercial
                        
                        
                        21,614
                        
                        
                        
                        13,753Total
      other real estate owned
                        
                        $
                        27,089
                        
                        
                        $
                        19,198
 
 
 Three
      months endedMarch
      31,
                          2010
                        
                        
                        March
      31,
                          2009Balance
      beginning of the period
                        
                        $
                        19,198
                        
                        
                        $
                        10,575Additions
                        
                        
                        8,056
                        
                        
                        
                        1,610Improvements
                        
                        
                        29
                        
                        
                        
                        5Sales
      proceeds
                        
                        
                        (332
                        )
                        
                        
                        (4,242
                        )Gains
      (losses) on sales
                        
                        
                        138
                        
                        
                        
                        (1,673
                        )Write-downs
                        
                        
                        0
                        
                        
                        
                        0Balance
      at end of period
                        
                        $
                        27,089
                        
                        
                        $
                        6,275
 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 $2.1 million at March 31,
2010.  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.
 
 Environmental
remediation costs may be incurred in disposing of this
property.  During the fourth quarter of 2009, 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 $104,000 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.  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.
 30
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
    Noninterest
income for the three months ended March 31, 2010 was $1.6 million as compared
with a loss of $725,000 for the three months ended March 31, 2009, an increase
of $2.3 million. During the first quarter of 2010 the Company booked a gain on
the sale of other real estate owned of $138,000 as compared with a loss of $1.7
million for the same quarter last year, which resulted in a loss to noninterest
income during the first quarter of 2009.  Noninterest income also
increased during the first quarter of 2010 as the Company recognized a gain of
$653,000 on the sale of $40.5 million of securities available for
sale.
   NONINTEREST
EXPENSE
 
 Noninterest
expense for the quarter ended March 31, 2010 was $4.5 million, decreasing
$328,000 from $4.8 million for the same quarter last year. The lower 2010
noninterest expense was primarily due to decreases to salaries and employee
benefits of $306,000 for the first quarter of 2010 as compared with the same
quarter of 2009 as executive salaries were reduced during 2010 and the number of
employees declined by 13 at March 31, 2010 as compared with staff levels at
March 31, 2009.  Combined reductions of $180,000 for occupancy and
legal expenses for the first quarter of 2010 as compared with the same quarter
of 2009 were largely offset by increases to FDIC insurance premiums of $185,000
during the same time periods.
 FEDERAL
AND STATE INCOME TAXES
 
 For the
three months ended March 31, 2010, the Company calculated an income tax benefit
totaling $810,000 on the first quarter 2010 pretax loss of $2.0
million.  The Company booked the tax benefit $810,000 as a deferred
tax asset.  However, per accounting pronouncements, the Company
credited a deferred tax asset valuation allowance in the first quarter of 2010
by $810,000 and, as a result, did not recognize any tax benefit during the
quarter.  In order to take advantage of the tax benefits for its
losses, the Company must show sustained profitability in future
periods.  At March 31, 2010, the Company has a deferred tax asset of
$14.5 million that was offset by a deferred tax asset valuation allowance for
the same amount.  During the first quarter of 2009, the Company
recognized a tax benefit of $1.0 million on its pretax loss of $1.5
million.
  REGULATORY
ISSUES
 
 Following
a joint examination of the Bank by the Federal Deposit Insurance Corporation
(“FDIC”) and the Illinois Department of Financial and Professional Regulation
(“IDFPR”), the Board of Directors of the Bank approved and signed on September
21, 2009, a memorandum of understanding (“MOU”) concerning its commitment to
enhance certain areas of the Bank’s operation as identified during the
regulators’ examination of the Bank.
  The MOU
provides an understanding among the FDIC, IDFPR and the Bank, that the Bank
will, among other things, adopt written plans to: (1) formulate and implement a
profit plan and budget, including goals and strategies for improving earnings;
(2) create a written plan to monitor, improve and lessen risks from the Bank’s
substandard assets; (3) implement steps to correct loan administration
weaknesses; and (iv) maintain the Bank’s Leverage Ratio at a level at or
exceeding 8 percent while the MOU is in effect.  The Bank’s Leverage
Ratio was 8.11 percent at March 31, 2010.  Pursuant to the MOU, the
Bank will submit quarterly progress reports to the FDIC and the IDFPR with
respect to the matters outlined in the MOU.
 31
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 NORTHERN STATES FINANCIAL
CORPORATION
 Following
a review of the Company by the Federal Reserve Bank of Chicago (“Federal
Reserve”), the Board of Directors of the Company adopted a Board Resolution
dated November 17, 2009 whereby the Company agreed to obtain written approval
from the Federal Reserve prior to (1) paying dividends to common or preferred
stockholders (2) increasing holding company level debt or subordinated
debentures issued in conjunction with trust preferred securities obligations and
(3) paying interest on its existing subordinated
debentures.
 In
response, in November 2009, the Company notified the U.S. Treasury Department
(“Treasury”) of its intent to suspend its dividend payments on its Fixed Rate
Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”). The
suspension of the dividend payments is permissible under the terms of the
Troubled Asset Relief Program (“TARP”) Capital Purchase Program (“CPP”), but the
dividend is a cumulative dividend and failure to pay dividends for six dividend
periods would trigger board of director appointment rights for the holder of the
Series A Preferred Stock. While dividends are being deferred on the preferred
stock issued under the TARP Capital Purchase Program, the Company may not pay
dividends on its common stock. Also, per the Board Resolution, in November 2009,
the Company notified the trustee that holds the Company’s junior subordinated
debentures relating to its trust preferred securities that the Company would be
deferring its regularly scheduled quarterly interest payments. The Company has
the right to defer the payment of interest on the junior subordinated debentures
at any time, for a period not to exceed 20 consecutive quarters. During the
deferral period, the Company may not pay any dividends on its common or
preferred stock. Accordingly, the Company may not now pay dividends on its
common stock for the foreseeable future.
 
 On April
16, 2010, the Bank and the FDIC and the IDFPR entered into a final joint Consent
Order.  Various items required of the Bank, as agreed to under
the Consent Order, are described in Note 6 “Subsequent Events” in this document
in the notes to interim condensed consolidated financial
statements.
 
 Because
the Consent Order establishes specific capital amounts to be maintained by the
Bank, the Bank may not be considered better than “adequately capitalized” for
capital adequacy purposes, even if the Bank exceeds the levels of capital set
forth in the Consent Order. Currently, the Bank exceeds the capital levels
established by the FDIC and the IDFPR in the Consent
Order.
 
 As an
adequately capitalized institution, the Bank may not accept, renew or roll over
brokered deposits without prior approval of the FDIC.  Brokered
deposits also include deposits with rates of interest that are more than 75
basis points above the rate applicable to the applicable market of the Bank as
determined by the FDIC.  As of March 31, 2010, 15.67 percent of the
Bank’s deposits were brokered deposits.  The Bank believes it will be
able to find alternative funding sources for these brokered deposits as they
come due.  Replacement funding sources for the maturing brokered
deposits include, among other sources: the growth of core deposits from current
and new retail and commercial customers; scheduled repayments on existing loans;
and the possible sale of investment securities.  The Bank has also
applied for a designation by the FDIC that the Bank is operating in a high rate
area, which if approved would give the Bank additional flexibility in offering
competitive interest rates on deposits.
 
 Any
material failure to comply with the provisions of the Consent Order could result
in additional enforcement actions by the FDIC as allowed by 12 U.S.C. §1818 and
the IDFPR. While the Company intends to take such actions as may be necessary to
enable the Bank to comply with the requirements of the Consent Order, there can
be no assurance that the Bank will be able to comply fully with the provisions
of the Consent Order, or that efforts to comply with the Consent Order will not
have adverse effects on the operations and financial condition of the Company
and the Bank.
 
 Management
and the Board of Directors are committed to complying with the terms of the
Consent Order, and have already taken, and continue to take, numerous steps to
address these matters.  The Bank will report to the FDIC and the IDFPR
quarterly regarding its progress in complying with the provisions
 32
 Table
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  NORTHERN STATES FINANCIAL
CORPORATION
  included
in the Consent Order.  Compliance with the terms of the Consent Order
will be an ongoing priority for management of the Bank.   See
also Note 7-“Management Plans” to the interim consolidated financial
statement included herein.
 
 CONTRACTUAL OBLIGATIONS AND
OFF-BALANCE SHEET ARRANGEMENTS
 The
Company has contractual obligations that may not appear on the balance
sheet.  Table 9 presents the Company’s significant fixed and
determinable contractual obligations as of March 31, 2010, by payment
date.  The payment amounts in Table 9 represent those amounts contractually
due to the recipient and do not include any unamortized premiums or discounts or
similar carrying amount adjustments.
 TABLE
9
  NORTHERN
STATES FINANCIAL CORPORATION
 CONTRACTUAL
OBLIGATIONS
 As of
March 31, 2010
 ($
000s)
  
 Contractual
      obligations
                      
                      One
      year
                          or
      less
                      
                      
                      Greater
      than
                          1
      yr. and less
                          than
      or equal
                          to
      3 yrs.
                      
                      
                      Greater
      than
                          3
      yrs. and less
                          than
      or equal
                          to
      5 yrs.
                      
                      
                      Greater
      than
                          5
      yrs.
                      
                      
                      TotalLong-term
      debtSubordinated
      debentures
                      
                      $
                      0
                      
                      
                      $
                      0
                      
                      
                      $
                      0
                      
                      
                      $
                      10,000
                      
                      
                      $
                      10,000Time
      deposits
                      
                      
                      197,655
                      
                      
                      
                      37,850
                      
                      
                      
                      0
                      
                      
                      
                      0
                      
                      
                      
                      235,505Other
      contractual obligationsStandby
      letters of credit
                      
                      
                      6,189
                      
                      
                      
                      0
                      
                      
                      
                      0
                      
                      
                      
                      0
                      
                      
                      
                      6,189
  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 verifying 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%
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  NORTHERN STATES FINANCIAL
CORPORATION
  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 reduce 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 10
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, 2010
and December 31, 2009.  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.
   TABLE
10
  NORTHERN
STATES FINANCIAL CORPORATION
 EFFECT OF
INTEREST SHOCKS ON NET INTEREST INCOME
 as of
March 31, 2010 and December 31, 2009
 ($000s)
  Immediate
      Change in Rates-2.00
                                %
                                
                                
                                -1.00
                                %
                                
                                
                                +1.00
                                %
                                
                                
                                +2.00
                                %March
      31, 2010:Dollar
      Change from Base Forecast
                                
                                $
                                (1,009
                                )
                                
                                $
                                (182
                                )
                                
                                $
                                229
                                
                                
                                $
                                432Percent
      Change from Base Forecast
                                
                                
                                -5.85
                                %
                                
                                
                                -1.06
                                %
                                
                                
                                1.33
                                %
                                
                                
                                2.50
                                %December 31,
      2009:
 Dollar
      Change from Base Forecast
                        
                        $
                        (427
                        )
                        
                        $
                        (17
                        )
                        
                        $
                        (2
                        )
                        
                        $
                        (59
                        )Percent
      Change from Base Forecast
                        
                        
                        -2.35
                        %
                        
                        
                        -0.09
                        %
                        
                        
                        -0.01
                        %
                        
                        
                        -0.33
                        %
 At March
31, 2010 the projected annual net interest income increases $432,000 when rates
are shocked upward 2% while projected net interest income decreases $1,009,000
for a 2% downward rate shock.  Interest rates at March 31, 2010 were
very low, as evidenced by the prime lending rate being at 3.25 percent, its
lowest level since 1955.  Many deposit rates could not go down 200
basis points as the deposit rate would then become negative.  As such,
the rate shocks downward would lower 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.   Management
believes that it is highly unlikely that rates will decrease further in the near
future.
 34
 Table
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  NORTHERN STATES FINANCIAL
CORPORATION
 At both
March 31, 2010 and December 31, 2009, 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, 2010.
 ITEM
4.CONTROLS AND PROCEDURES.
 
 The
Company’s management has evaluated, with the participation of the President and
Chief Executive Officer, and Vice President and Chief Financial Officer, 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
President and Chief Executive Officer, and Vice President and Chief Financial
Officer 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 2010 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 judgment, have a material adverse effect
on the Company’s business, results of operations, 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, 2009 in response to Item 1A. to Part
I of Form 10-K.
 ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND
USE OF PROCEEDS.
 
 None.
 
 ITEM
3.DEFAULTS UPON SENIOR SECURITIES.
 
 None.
 
 ITEM
4.(REMOVED
AND RESERVED).
 
 
  ITEM 5. OTHER
INFORMATION.
 
 None.
  35
 Table
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  NORTHERN STATES FINANCIAL
CORPORATION
 ITEM
6.EXHIBITS.
  (a)
                    Exhibits.Exhibit
      3.1 Certificate 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
      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 President and Chief Executive
      Officer.Exhibit
      31.2 Section 302 Certification of Vice President and Chief Financial
      Officer.Exhibit
      32.1 Section 906
Certification.
  36
 Table
of Contents
 NORTHERN STATES FINANCIAL
CORPORATION
 FORM
10-Q
 March 31,
2010
    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.
 
  NORTHERN
STATES FINANCIAL CORPORATION
 (Registrant)
     Date:  May 4,
      2010
                By: 
      /s/ Scott
      Yelvington
                  Scott
      Yelvington
                  President and Chief Executive
                  OfficerDate:  May 4,
      2010
                By: 
      /s/ Brett
      Houston
                  Brett Houston
                  Vice President and Chief Financial
                  Officer
   37
 Table
of Contents
  NORTHERN STATES FINANCIAL
CORPORATION
 FORM
10-Q
 March 31,
2010
   EXHIBIT INDEX
  Exhibits
  Exhibit
3.1 Certificate 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
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 President and Chief Executive
Officer.
  Exhibit
31.2 Section 302 Certification of Vice President and Chief Financial
Officer.
  Exhibit
32.1 Section 906 Certification.
   38