FIRST OTTAWA BANCSHARES INC
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Submission of Matters to a Vote of Security   Holders                       PART   II
Market for the Registrant’s Common Equity,   Related Stockholder Matters and Issuer Purchases of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of   Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures   about Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with   Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information                       PART   III
Directors and Executive Officers of the   Registrant
Executive Compensation
Security Ownership of Certain Beneficial   Owners and Management and Related Stockholder Matters
Certain Relationships and Related   Transactions
Principal Accountant Fees and Services                       PART   IV
Exhibits and Financial Statement Schedules                 PART I   Item 1.    Business.   First Ottawa Bancshares, Inc. (the “Company”) is a bank holding company for its wholly-owned subsidiary, First National Bank of Ottawa (the “Bank”), and the Bank’s wholly owned subsidiary, First Ottawa Financial Corporation. The Company was organized during 1999 and on October 1, 1999 exchanged 100% of its common stock for 100% of the Bank’s common stock. This exchange was accounted for as an internal reorganization. All references to the combined Company, unless otherwise indicated, at or before October 1, 1999, refer to the Bank. As of December 31, 2005, the Company had total assets of $278.7 million, total deposits of $239.9 million, loans, including loans held for sale, of $152.9 million and total stockholders’ equity of $22.9 million. For the year ended December 31, 2005, the Company had interest income of $13.9 million and net income of $2.5 million, which amounted to basic net income per share of $3.92, and diluted net income per share of $3.90.   The Company conducts a general banking business embracing most of the services, both commercial and consumer, which banks may lawfully provide, including the following principal services:  the acceptance of deposits for demand, savings, and time accounts and the servicing of such accounts; commercial, agricultural, consumer, and real estate lending, including installment loans, personal lines of credit, and overdraft protection; trust operations; farm management; safe deposit operations; and an extensive variety of additional services tailored to the needs of individual customers, including the sale of traveler’s checks, cashier’s checks, and foreign currency and other special services. Loans, both commercial and consumer, are provided on either a secured or unsecured basis to corporations, partnerships, and individuals. Commercial lending covers such areas as business, industry, capital, agriculture, inventory, and real estate, with the latter including residential properties. Consumer loans are made for a variety of purposes including automobile purchases, recreational vehicle purchases, consumer goods, installment loans, and other types of loans.   The Company is located in the city of Ottawa, Illinois (population 17,500) in LaSalle County in Illinois. A substantial portion of the Company’s business is dependent upon the economic conditions in this market area. LaSalle County is the second largest county by area in the state of Illinois. Ottawa is located in northeastern Illinois approximately 80 miles southwest of Chicago and approximately 65 miles north of Bloomington. Ottawa may be accessed by Interstate 80; U.S. Route 6; State Routes 23 and 71; and recently completed Interstate 39, which is located 11 miles west of Ottawa. The city is also serviced by two railroads and the Ottawa Airport.   Ottawa is the county seat of LaSalle County. Accordingly, many county, state, and other governmental offices are located in Ottawa.   1        LaSalle County has a diverse economy with a balance in agriculture, transportation and industry. Grain terminals on the Illinois Deep Waterway at Ottawa provide a direct distribution point for agricultural products to overseas markets via the Gulf of Mexico and the St. Lawrence Seaway. LaSalle County annually ranks in the top 10 counties in Illinois for corn and soybean production. LaSalle County, the site of the largest producer of silica sand in the United States, has a diverse manufacturing sector which includes, in addition to the production of silica sand, the manufacture of residential glass, automotive and industrial belts and equipment, electronic typewriters and computer printers, plastics, office supplies, and rubber products. Many of these companies conduct business in national and, in some instances, international markets.   The LaSalle County economy is continuing to expand. Many developments have had a significant impact on the area economy, including a new County Office Building on the north edge of Ottawa and several new and expanded shopping center projects.   The Bank purchased and assumed substantially all of the deposit liabilities of two branch offices located in Streator, Illinois from First Midwest Bank (collectively, the “Branches”) on November 14, 2003. Approximately $69.3 million of deposits and the related cash balances were transferred to the Bank via cash transfers from First Midwest Bank. In connection with the acquisition of such deposit liabilities and related cash balances, the Bank also acquired certain other assets of the Branches, including real estate, furniture and fixtures and approximately $11.8 million of the loans carried on the books of the Branches. Many of the employees remained with the Branches and became employees of the Bank.   The Company opened full service banking facilities in 2003 in the city of Morris, Illinois, and in 2005 in the city of Yorkville, Illinois. The Company continues to explore expansion opportunities within its existing market area and in surrounding areas.   Lending Activities. The Company relies on interest income from lending activities as a major source of revenue. The Company has a community bank focus — serving the credit needs of the local community. Because of this local focus, the Company has a flexible process for handling loan requests rather than being tied to rigid standards. The discussions below regarding lending policies reflect general guidelines and may vary on a case-by-case basis depending on the borrower’s credit history and the type and size of loan. During the approval process for loans it originates, the Company assesses both the applicant’s ability to repay the loan and the value of any collateral securing the loan. The Company verifies the applicant’s ability to repay the loan by using credit reports, financial statements, confirmations, and other items, including appraisals.   Twelve loan officers have the authority to handle all lending activities of the Company. Each lending officer has authority to approve extensions of credit up to their individual lending limit. The Company has an Officers Loan Committee (consisting of Loan Officers, the Chief Lending Officer, and the President of the Bank) which approves loans of up to $1,000,000. All loans between $1,000,000 and $2,000,000 are sent to the Director’s Loan Committee for approval. The Director’s Loan Committee is also responsible for monitoring concentration of credits, problem and past due loans, and charge-offs of uncollectible loans; formulating recommendations for the Board of Directors regarding loan policy modifications, loan classifications, and charge-offs. All loans in excess of $2,000,000 are reviewed and approved by the Board of Directors. The Board of Directors also is responsible for directing and supervising the Director’s Loan Committee, policy   2        review, and oversight of the loan and investment functions of the Company. The Board of Directors also monitors the adequacy of the Company’s loan loss reserves.   Loan Portfolio Composition. The Company’s gross loan portfolio, totaled $152.9 million at December 31, 2005, representing 63.7% of the Company’s total deposits at that date. The Company’s loan portfolio at December 31, 2005 included $95.5 million for real estate purposes, $23.7 million for consumer purposes, and $33.7 million for commercial and agricultural purposes.   Certain risks, including the risk of non-payment, are associated with each type of loan. The primary risks associated with consumer loans relate to the borrower, such as the risk of a borrower’s unemployment as a result of deteriorating economic conditions or the amount and nature of a borrower’s other existing indebtedness, and the value of the collateral securing the loan if the Company must take possession of the collateral. Consumer loans also have risks associated with concentrations of loans in a single type of loan. The primary risks associated with commercial loans are the experience and quality of the borrower’s management, the business climate, and the impact of economic factors. With respect to agricultural loans, the primary risks are weather, market conditions, and, like commercial loans, the quality of the borrower’s management. Risks associated with real estate loans include concentrations of loans in a loan type such as commercial or agricultural and fluctuating land values.   The Company’s strategy in addressing and managing these types of risks is to follow its loan policies and underwriting practices, which include (i) granting loans on a sound and collectible basis; (ii) investing funds profitably for the benefit of the stockholders and the protection of depositors; (iii) serving the legitimate needs of the community and the Company’s general market area while maintaining a balance between maximum yield and minimum risk; (iv) ensuring that primary and secondary sources of repayment are adequate in relation to amount of the loan; (v) developing and maintaining adequate diversification of the loan portfolio as a whole and of the loans within each loan category; (vi) ensuring that each loan is properly documented and, if appropriate, secured or guaranteed by government agencies; and (vii) developing and applying adequate collections procedures.   3        All table amounts throughout the Form 10-K are in thousands except share and per share data.   The following table presents the components of the Company’s loan portfolio as of December 31 for each year shown.              2005       2004       2003       2002       2001                                                           Real estate loans       $   95,469       $   74,225       $   70,839       $   46,622       $   47,282                                                           Commercial and agricultural loans       33,686       28,341       24,197       33,950       29,361                                                           Installment loans, net of unearned income       11,585       17,575       22,812       19,951       24,595                                                           Home equity lines of credit       12,120       12,651       12,456       9,120       6,795                                                           Total Loans       152,860       132,792       130,304       109,643       108,033                                                           Allowance for loan losses       (1,344   )   (1,174   )   (1,049   )   (1,167   )   (1,109   )                                                       Loans, net       $   151,516       $   131,618       $   129,255       $   108,476       $   106,924                                                           Loans held for sale       $   —       $   1,701       $   1,644       $   1,811       $   1,475          Maturities (based on contractual terms) of the Company’s commercial and construction loan portfolio at December 31, 2005 are summarized below:              One Year   or Less       One to   Five Years       Over   Five Years       Total                                                   Commercial and agricultural       $   15,634       $   8,856       $   9,196       $   33,686                                                   Construction       7,950       4,133       2,332       14,415                                                   Total       $   23,584       $   12,989       $   11,528       $   48,101          At December 31, 2005, of the total loans that mature in more than one year, $65.8 million, or 65.7%, bear interest at fixed rates and $34.3 million, or 34.3%, bear interest at variable rates.   Consumer Loans. The Company makes consumer loans for various purposes, including personal, family, and nonbusiness reasons such as automobile loans and recreational vehicle loans, on both a direct and indirect basis. Consumer loans totaled approximately $23.7 million at December 31, 2005, or approximately 15.5% of the Company’s total loan portfolio. Approximately 40.0% of the Company’s consumer loans were automobile loans, and of these loans, approximately 67.8% were made indirectly by the Company through automobile dealers. At December 31, 2005, the Company had 11 consumer loans totaling $101,000 that were past due in excess of 90 days. Management feels the Company is well collateralized and expects no loss in excess of specific allocations on the loans.   4        In approving consumer loans, lending officers consider the borrower’s past credit history, the borrower’s ability to repay the debt, the collateral offered, and local economic conditions that could affect the borrower’s income. Loans being originated for new borrowers must be accompanied by a completed application dated and signed by the borrower, giving the details of the loan request. Total debts, along with the gross monthly income of the borrower, are required to be shown on the application. A brief cash flow analysis is performed by the loan officer showing the amount of the borrower’s income available for debt service based on current debts plus the new loan request. Generally, debt service to gross income should not exceed 40%. New credit reports are obtained on all borrowers with each loan request. The value of collateral on loans secured by used automobiles is generally determined by using industry-accepted used car guides. In connection with used automobile loans, the Company generally requires a 90% loan-to-value ratio; however, depending upon various factors, including the credit experience of the Company with the borrower, the Company may extend credit in excess of the value of the used automobile. A loan-to-value ratio of 90% of sticker price is generally required for new automobile loans. Boats, mobile homes, recreational vehicles, and similar items generally require a loan-to-value ratio of 70% to 80% of the current market value of the collateral. Unsecured consumer loans are granted to borrowers based upon satisfactory income, indebtedness levels, and credit records and experience.   Commercial, Agricultural, and Real Estate Lending.   Commercial and Agricultural. At December 31, 2005, the Company’s commercial and agricultural loans totaled $33.7 million, or approximately 22.0% of the total loan portfolio of the Company. The majority of agricultural and commercial non-real estate loans are written for one to five years, may bear interest at a fixed or variable rate and are amortized over a 15-year to 20-year period. Fixed rates are established by the Company’s management after considering the cost of funds to the Company as well as the rates of competing institutions. The variable rate is generally based upon the national prime rate as disclosed in The Wall Street Journal. Principal and interest payments on commercial loans generally are required monthly; whereas, payments on agricultural loans vary from monthly, quarterly, semi-annually, and annually. At December 31, 2005, the Company had 3 commercial non-real estate loans totaling $29,000 that were past due in excess of 90 days. There were 4 agricultural non-real estate loans totaling $513,000 at December 31, 2005 that were past due in excess of 90 days. Management feels the Company is well collateralized and expects no loss in excess of specific allocations on the loans.   All commercial and agricultural borrowers, both existing and new, are required by policy to have a current financial statement no older than one year. Borrowers also are required to provide the Company with recent tax returns and pro forma projections. Using certain computer programs and the data supplied by borrowers, the loan officers produce additional financial information utilized in analyzing the loans and the borrowers. The general nature of the collateral securing the Company’s commercial and agricultural loans consists of equipment, farm products, crops, inventory, chattel paper, accounts receivable, and general intangibles. The Company’s loan-to-value ratio with respect to agricultural and commercial non-real estate loans averages 66 2/3% to 75% of the value of the collateral securing the loan.   Real Estate Lending. The Company’s primary real estate lending consists of commercial loans with a small portion in residential and agricultural real estate loans. Real estate loans at   5        December 31, 2005 totaled approximately $95.5 million or approximately 62.5% of the Company’s total loan portfolio. All borrowers requesting a real estate loan are required to submit an application which is reviewed by the lending officer. A credit investigation is performed and an analysis of the borrower’s ability to repay is conducted. Subsequently, an inspection and appraisal of the real property is conducted to determine whether or not the property is of sufficient value to meet the Company’s suggested maximum loan-to-value ratio of 80% to 85% of the lesser of the appraised value or the purchase price of the property securing the loan. Under certain federal guaranteed loan programs utilized by the Company, the maximum loan-to-value ratio is higher. With respect to loans secured by commercial or industrial real estate, the Company analyzes the potential for environmental liability concerns and, depending upon the circumstances, the Company may require additional information or testing. Commercial and agricultural real estate loans are generally originated under the same policies and procedures as discussed above for commercial and agricultural non-real estate loans.   The Company’s residential real estate loans consist of 15-year, 20-year and 30-year fixed-rate and variable-rate loans with amortization periods equal to the maturity of the loan. The Company’s fixed-rate loans with biweekly payments account for approximately 59.7% of all the residential real estate loans of the Company. The biweekly loan program amortizes 25 year loans in approximately 18.9 years. The Company also originates a variety of loans that are sold into the secondary market through Federal Home Loan Mortgage Corporation (“Freddie Mac”) and private investors. These loans are underwritten to meet all Freddie Mac requirements. The Company retains servicing rights on loans sold into the secondary market. At December 31, 2005, mortgage loans serviced for the secondary market totaled approximately $32.8 million.   At December 31, 2005, the Company had 8 personal real estate mortgage loans totaling $627,000, and 3 commercial real estate loans totaling $67,000, past due in excess of 90 days. Management feels the Company is well collateralized and expects no loss in excess of specific allocations on the loans.   Interest Rates and Fees. Interest rates and fees charged on the Company’s loans are affected primarily by the market demand for loans and the supply of money available for lending purposes. These factors are affected by, among other things, general economic conditions and the policies of the federal government, including the Federal Reserve Board, legislative tax policies, and governmental budgetary matters.   Non-Performing Loans. When a borrower fails to make a required payment on a loan and does not cure the delinquency within 30 days, the loan is classified as delinquent. In this event, the normal procedure followed by the Company is to make contact with the borrower at prescribed intervals in an effort to bring the loan to a current status. In most cases, delinquencies are cured promptly, but, if not, the Company normally records a notice of default, subject to any required prior notice to the borrower, and commences foreclosure proceedings when loan payments are 120 days past due.   At December 31, 2005, the Company had 59 loans delinquent for 30 to 90 days in an aggregate principal amount of $2.0 million and representing 1.3% of the total loan portfolio. At   6        December 31, 2005, the Company had 29 loans totaling $1.3 million delinquent for more than 90 days.   It is the Company’s policy to discontinue the accrual of interest income on any loan when, in accordance with banking regulations or in the opinion of management, there is reasonable doubt as to the collectibility of interest or principal. Interest on these loans is credited to income only when the collection of principal is reasonably assured and only to the extent interest payments are received. If management feels collection of both interest and principal is probable, the loan is not transferred to nonaccrual status. At December 31, 2005, there were no loans on nonaccrual status.   As a result of economic conditions and other factors beyond the Company’s control, the Company’s future loss and delinquency experience cannot be predicted with certainty.   The nonperforming assets of the Company as of December 31 are indicated below:              2005       2004       2003       2002       2001                                                           Non-accrual loans       $   —       $   161       $   137       $   364       $   387         Loans ninety days past due and still   accruing interest       1,337       727       293       757       860         Other real estate owned       88       —       —       204       —                                                           Total nonperforming assets       $   1,425       $   888       $   430       $   1,325       $   1,247                                                           Nonperforming loans as a percentage of   total loans       .88   %   .66   %   .33   %   1.02   %   1.17   %                                                       Nonperforming assets as a percentage of   total assets        .51       .31       .15       .55       .54                                                           Nonperforming loans as a percentage of the   allowance for loan losses       99.48       75.64       40.99       96.06       112.44          The effect of nonaccrual loans upon interest income is not deemed to be material by management. Loans are placed in nonaccrual status when 90 days past due, unless they are fully secured and in the process of collection. At December 31, 2005, there were other impaired loans with specific reserve allocations classified as problem loans that were not included above. Management also maintains a report on loans requiring attention that includes loans greater than 60 days delinquent or other loans as deemed necessary by the Company’s internal loan review or the loan committee. The total of loans requiring attention as of December 31, 2005 was $4.3 million.   Allowance for Losses on Loans. In originating loans, the Company recognizes that losses will be experienced on loans and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan.   7        The Company maintains an allowance for loan losses to absorb probable incurred credit losses inherent in the loan portfolio. The allowance for loan losses represents management’s estimate of probable incurred losses based on information available as of the date of the financial statements. The allowance for loan losses is based on management’s evaluation of the collectibility of the loan portfolio, including past loan loss experience, known and inherent risks in the nature and volume of the portfolio, information about specific borrower situations, estimated collateral values, and economic conditions.   The loan portfolio and other credit exposures are regularly reviewed by management to evaluate the adequacy of the allowance for loan losses. The methodology for assessing the appropriateness of the allowance includes comparisons to actual losses, industry data and economic conditions. In addition, the regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to make additional provisions for estimated losses based upon judgments different from those of management.   In connection with assessing the allowance, loss factors are applied to various pools of outstanding loans. The Company segregates the loan portfolio according to risk characteristics (i.e., mortgage loans, commercial real estate, agricultural, business, consumer, etc.) and risk gradings. Loss factors are derived using the Company’s historical loss experience and may be adjusted for significant factors that, in management’s judgment, affect the collectibility of the portfolio as of the evaluation date. Commercial real estate and commercial business loans are individually evaluated for impairment and specific reserves are allocated as needed in accordance with Statement of Financial Accounting Standards No. 114 and No. 118.   In addition, management assesses the allowance using factors that cannot be associated with specific credit or loan categories. These factors include management’s subjective evaluation of local and economic and business conditions, portfolio concentration and changes in the character and size of the loan portfolio. The allowance methodology reflects management’s objective that the overall allowance appropriately reflects a margin for the imprecision necessarily inherent in the estimates of expected credit losses.   The allowance for loan losses is established through a charge to operations at the time loan value becomes impaired or, in the judgment of management, other subjective factors warrant additional reserves. As noted in the previous table, nonperforming loans increased by $449,000 in 2005 after increasing by $458,000 during 2004. Management considered this information along with other portfolio trends when considering the adequacy of the allowance for loan losses at December 31, 2005. At December 31, 2005, the balance in the allowance was $1.3 million, or .88% of gross loans outstanding. Management has concluded that the allowance for loan losses is adequate at December 31, 2005. However, there can be no assurance that the allowance for loan losses is adequate to cover all losses.   The Company had 1 property valued at $88,000, resulting from foreclosure, classified as other real estate owned at December 31, 2005. Other real estate is generally carried at the lower of cost or estimated market value.   8        Summary of Loan Loss Experience. The allowance for loan losses is maintained by management at a level considered adequate to cover losses that are currently anticipated based upon past loss experience, general economic conditions, information about specific borrower situations, including their financial position and collateral values, and other factors and estimates which are subject to change over time.   Loan loss experience for the five years ended December 31, 2005 is summarized as follows:              2005       2004       2003       2002       2001                                                           Balance of the allowance for loan losses at   beginning of year       $   1,174       $   1,049       $   1,167       $   1,109       $   1,108         Charge-offs                                                 Real Estate       —       63       66       46       111         Commercial       71       —       50       6       35         Installment       145       210       303       181       254         Total charge-offs       216       273       419       233       400                                                           Recoveries                                                 Real Estate       8       —       16       39       4         Commercial       16       4       57       63       6         Installment       62       94       108       69       91         Total recoveries       86       98       181       171       101         Net charge-offs       130       175       238       62       299         Provision       300       300       120       120       300                                                           Balance at end of year       $   1,344       $   1,174       $   1,049       $   1,167       $   1,109                                                           Net charge-offs to average total loans       .09   %   .13   %   .21   %   .06   %   .26   %     Allowance for loan losses to total loans at   year-end       .88       .87       .80       1.06       1.03          9        The Company’s allocation of the allowance for loan losses as of December 31 is presented below:              2005       2004       2003       2002       2001                 Amount       Percent   of Total   Loans       Amount       Percent   of Total   Loans       Amount       Percent   of Total   Loans       Amount       Percent   of Total   Loans       Amount       Percent   of Total   Loans                                                                                                   Real estate loans       $   131       62.45   %   $   234       19.88   %   $   444       54.37   %   $   281       42.56   %   $   308       43.78   %                                                                                               Commercial and   agricultural loans       613       22.04       519       44.24       209       18.57       307       30.94       380       27.62                                                                                                   Installment loans       141       15.51       185       15.79       242       27.06       236       26.50       287       28.60                                                                                                   Unallocated       459       N/A       236       N/A       154       N/A       343       N/A       134       N/A                                                                                                   Balance at end of   year       $   1,344       100.00   %   $   1,174       100.00   %   $   1,049       100.00   %   $   1,167       100.00   %   $   1,109       100.00   %      Investment Activities. The investment policies of the Company as established by the Board of Directors attempt to provide and maintain liquidity, generate a favorable return on investments without incurring undue interest rate and credit risk, and complement the Company’s lending activities. The policies provide the authority to invest in United States Treasury and federal agency securities, mortgage-backed securities, municipal securities, equity securities, and Certificates of Deposits.   Approximately $1.0 million of the United States government agency notes held at December 31, 2005 are callable at the option of the issuer, which present limited prepayment risk to the Company.   As of December 31, 2005, the Company had approximately $4.3 million invested in municipalities located within LaSalle County, Illinois.   The Company purchased $7.9 million of Index Powered Certificates of Deposit between 2002 and 2005. These deposits were placed with multiple issuers so that $7.0 million of the principal deposited is insured through the FDIC and the remaining $900,000 is collateralized with a letter of credit from the single issuing institution. Income returns are not guaranteed for these instruments, however principal is guaranteed if held to maturity.   10        Securities Portfolio. The following table shows the maturity distribution of the available-for-sale securities portfolio and the weighted average yield of the portfolio at December 31, 2005.              One Year   or Less       Weighted   Average   Yield       One to   Five   Years       Weighted   Average   Yield       Five   to Ten   Years       Weighted   Average   Yield       Over   Ten   Years       Weighted   Average   Yield       Total       Weighted   Average   Yield                                                                                                   U.S. Treasury   securities       $   —       —   %   $   9,802       3.26   %   $   —       —   %   $   —       —   %   $   9,802       3.26   %     U.S. Government   agencies       4,253       4.37       35,152       3.51       —       —       —       —       39,405       3.60         States and   political subdivisions       2,022       7.59       19,411       4.49       838       6.38       2,925       6.75       25,196       3.54         Mortgage-backed   securities and collateralized obligations (1)       137       4.29       9,732       4.46       —       —       —       —       9,869       4.46                                                                                                   Corporate bonds       100       5.98       3,219       2.87       —       —       —       —       3,319       2.96         Equity securities       3,040       N/A       —       —       —       —       —       —       3,040       N/A                                                                                                   Total securities       $   9,552       5.41   %   $   77,316       3.82   %   $   838       6.38   %   $   2,925       6.75   %   $   90,631       3.61   %       (1)  Mortgage-backed securities reflect the contractual maturity of the related instrument.   11        Deposits. The Company offers deposit services including demand, savings, and time deposit accounts and programs, which include interest-bearing and non-interest-bearing demand deposits and individual retirement accounts. The Company has had a stable deposit base. Management believes that this stability is due to the Company’s emphasis on being a locally owned and operated bank and by providing quality, personalized service to its customers.   The following shows the Company’s average balances and rates paid during the years shown.              For the   Years Ended December 31,                 2005       2004       2003                 Average   Balance       Percent   of   Deposits       Rate       Average   Balance       Percent   of   Deposits       Rate       Average   Balance       Percent   of   Deposits       Rate                                                                                           Noninterest- bearing demand deposits       $   31,153       11.9   %   —   %   $   29,815       11.0   %   —   %   $   20,775       10.2   %   —   %     Interest-bearing demand and money market   accounts       98,826       37.7       1.39       107,136       39.5       1.17       69,435       34.1       1.02         Savings accounts       27,083       10.3       .52       29,121       10.8       .59       21,158       10.4       .98         Time deposits accounts       105,301       40.1       2.88       105,002       38.7       2.60       92,110       45.3       3.57                 $   262,363       100.0   %   1.73   %   $   271,074       100.0   %   1.53   %   $   203,478       100.0   %   2.07   %      The distribution of the major components of deposits as of December 31, 2005 and 2004 is summarized in the balance sheets included in the 2005 consolidated financial statements, which consolidated financial statements are incorporated herein by reference. The following is a maturity distribution of time certificates of deposit of $100,000 or more at December 31, 2005:              Balance       Percentage                                   Maturity                         Three months or less       $   10,357       33.0   %     Over three months to six months       3,630       11.6         Over six months to one year       5,041       16.0         Over one year       12,392       39.4                                   Total       $   31,420       100.0   %      12        Borrowings. The Company’s other available sources of funds include financing arrangements for securities sold under agreements to repurchase, federal funds purchased lines, and Federal Home Loan Bank borrowings. Total borrowings increased $5.8 million in 2005. This increase was a result of a $7.1 million increase in federal funds purchased, partially offset by a $559,000 decrease in other borrowings and a $750,000 decrease in repurchase agreements. The Bank maintains physical control of all securities sold under repurchase agreements. Information concerning securities sold under agreements to repurchase is summarized as follows:              2005       2004       2003                                           Balance at December 31       $   —       $   750       $   —         Weighted average interest rate during the   year       1.63   %   1.63   %   2.11   %     Weighted average interest rate at the end   of the year       —   %   1.63   %   —   %     Maximum month-end balance       $   750       $   750       $   1,545         Average balance for the year       232       215       475          Trust. The Company’s trust department primarily services LaSalle County and surrounding counties. At December 31, 2005, the trust department had 250 accounts under management, 158 of which were discretionary accounts. The trust department provides a full complement of asset management services for personal trusts, estates, and agencies. The trust department had assets under management of approximately $60.3 million at December 31, 2005, of which $51.1 million was in discretionary accounts.   The Company, in conjunction with its trust department, also provides farm management services. At December 31, 2005, the department managed 44 farms. The department manages or directs approximately 6,582 acres of farmland in LaSalle County, Illinois and surrounding counties.   Competition. The Company has active competition in all product and service areas in which it presently engages. The Company not only competes for commercial and individual deposits, loans, and trust business with other LaSalle County, Illinois banks, but also with savings and loan associations, credit unions, and other financial service companies located in and around LaSalle County. Many of these competitors may not be subject to the same regulatory restrictions as the Company. There are approximately 16 commercial banks and 6 savings institutions with offices in LaSalle County, Illinois. The principal methods of competition in the banking and financial services industry are quality of services to the customer; ease of access to services; and pricing of services, including interest rates paid on deposits, interest rates charged on borrowings, and fees charged for fiduciary services. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services.   Employees. As of December 31, 2005, the Company had 99 employees, consisting of 86 full-time employees and 13 part-time employees. None of the employees are subject to a collective bargaining agreement, and management believes it has excellent relations with its staff.   13        Stock Repurchases. During 2005 and 2004, the Company repurchased 1,260 and 1,018 shares of its common stock for an aggregate purchase price of $89,000 and $71,000.   Website. The Company maintains a website at www.firstottawa.com. The Company makes available free of charge on or through its website, the annual report on Form 10K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after the Company electronically files such material with, or furnish it to, the Securities and Exchange Commission. The Company will also provide copies of its filings free of charge upon written request to: Ms. Cheryl Gage, Corporate Secretary, First Ottawa Bancshares, Inc. 701-705 LaSalle Street, P.O. Box 657, Ottawa, Illinois 61350. Additionally, all of the Company’s filings with the Securities and Exchange Commission are also available, free of charge, through the SEC’s website at www.sec.gov.   Code of Business Conduct and Ethics. The Company has a code of business conduct and ethics in place that applies to all of its directors and employees. The code sets forth the standard of ethics that the Company expects all of its directors and employees to follow, including the Chief Executive Officer and Chief Financial Officer. The code of business conduct and ethics is posted on the Company’s website at www.firstottawa.com. The Company intends to satisfy the disclosure requirements under Item 5.05 of Form 8-K regarding any amendment to or waiver of the code with respect to the Chief Executive Officer and Chief Financial Officer, and persons performing similar functions, by posting such information on its website.   Supervision and Regulation   General   Financial institutions, their holding companies and their affiliates are extensively regulated under federal and state law. As a result, the growth and earnings performance of the Company may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various bank regulatory authorities, including the Office of the Comptroller of the Currency (the ”OCC”), the Board of Governors of the Federal Reserve System (the ”Federal Reserve”) and the Federal Deposit Insurance Corporation (the “FDIC”). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities and securities laws administered by the Securities and Exchange Commission (the ”SEC”) and state securities authorities have an impact on the business of the Company. The effect of these statutes, regulations and regulatory policies may be significant, and cannot be predicted with a high degree of certainty.   Federal and state laws and regulations generally applicable to financial institutions regulate, among other things, the scope of business, the kinds and amounts of investments, reserve requirements, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers and consolidations and the payment of dividends. This system of supervision and regulation establishes a comprehensive framework for the respective operations of the Company and its subsidiaries and is intended primarily for the protection of the FDIC-insured deposits and depositors of the Bank, rather than shareholders.   14        The following is a summary of the material elements of the regulatory framework that applies to the Company and its subsidiaries.  It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those statutes, regulations and regulatory policies that are described. As such, the following is qualified in its entirety by reference to applicable law.  Any change in applicable statutes, regulations or regulatory policies may have a material effect on the business of the Company and its subsidiaries.   The Company   General.  The Company, as the sole shareholder of the Bank, is a bank holding company.  As a bank holding company, the Company is registered with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “BHCA”).  In accordance with Federal Reserve policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Company might not otherwise do so.  Under the BHCA, the Company is subject to periodic examination by the Federal Reserve.  The Company is also required to file with the Federal Reserve periodic reports of the Company’s operations and such additional information regarding the Company and its subsidiaries as the Federal Reserve may require.   Acquisitions, Activities and Change in Control.  The primary purpose of a bank holding company is to control and manage banks. The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company.  Subject to certain conditions (including deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company.   The BHCA generally prohibits the Company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries.  This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve to be “so closely related to banking ... as to be a proper incident thereto.”  This authority would permit the Company to engage in a variety of banking-related businesses, including the operation of a thrift, consumer finance, equipment leasing, the operation of a computer service bureau (including software development), and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding companies.   Additionally, bank holding companies that meet certain eligibility requirements prescribed   15        by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature, incidental to any such financial activity or complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally.  As of the date of this filing, the Company has not applied for approval to operate as a financial holding company.   Federal law also prohibits any person or company from acquiring “control” of an FDIC-insured depository institution or its holding company without prior notice to the appropriate federal bank regulator.  “Control” is conclusively presumed to exist upon the acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances at 10% ownership.   Capital Requirements.  Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines.  If capital levels fall below the minimum required levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.   The Federal Reserve’s capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: (i) a risk-based requirement expressed as a percentage of total assets weighted according to risk; and (ii) a leverage requirement expressed as a percentage of total assets.  The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%.  The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% for all others.  For purposes of these capital standards, Tier 1 capital consists primarily of permanent stockholders’ equity less intangible assets (other than certain loan servicing rights and purchased credit card relationships). Total capital consists primarily of Tier 1 capital plus certain other debt and equity instruments that do not qualify as Tier 1 capital and a portion of the company’s allowance for loan and lease losses.   The risk-based and leverage standards described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities.  Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 capital less all intangible assets), well above the minimum levels.  As of December 31, 2005, the Company had regulatory capital in excess of the Federal Reserve’s minimum requirements.   Dividend Payments.  The Company’s ability to pay dividends to its shareholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies. As a Delaware corporation, the Company is subject to the   16        limitations of the Delaware General Corporation Law (the ”DGCL”). The DGCL allows the Company to pay dividends only out of its surplus (as defined and computed in accordance with the provisions of the DGCL) or if the Company has no such surplus, out of its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. Additionally, policies of the Federal Reserve caution that a bank holding company should not pay cash dividends that exceed its net income or that can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing.  The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations.  Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.   Federal Securities Regulation.  The Company’s common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the ”Exchange Act”).  Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.   The Bank   General.  The Bank is a national bank, chartered by the OCC under the National Bank Act.  The deposit accounts of the Bank are insured by the FDIC’s Bank Insurance Fund (“BIF”), and the Bank is a member of the Federal Reserve System.  As a national bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the OCC, the chartering authority for national banks. The FDIC, as administrator of the BIF, also has regulatory authority over the Bank.   Deposit Insurance.  As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC.  The FDIC has adopted a risk-based assessment system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their respective levels of capital and results of supervisory evaluations.  Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern pay the highest premium.  Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period.   During the year ended December 31, 2005, BIF assessments ranged from 0% of deposits to 0.27% of deposits.  For the semi-annual assessment period beginning January 1, 2006, BIF assessment rates will continue to range from 0% of deposits to 0.27% of deposits.   FICO Assessments.  Since 1987, a portion of the deposit insurance assessments paid by members of the FDIC’s Savings Association Insurance Fund (“SAIF”) has been used to cover interest payments due on the outstanding obligations of the Financing Corporation (“FICO”). FICO was created in 1987 to finance the recapitalization of the Federal Savings and Loan Insurance Corporation, the SAIF’s predecessor insurance fund. As a result of federal legislation enacted in 1996, beginning as of January 1, 1997, both SAIF members and BIF members became   17        subject to assessments to cover the interest payments on outstanding FICO obligations until the final maturity of such obligations in 2019.  These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. During the year ended December 31, 2005, the FICO assessment rate for BIF and SAIF members was approximately 0.01% of deposits.   Supervisory Assessments.  National banks are required to pay supervisory assessments to the OCC to fund the operations of the OCC.  The amount of the assessment is calculated using a formula that takes into account the bank’s size and its supervisory condition (as determined by the composite rating assigned to the bank as a result of its most recent OCC examination).  During the year ended December 31, 2005, the Bank paid supervisory assessments to the OCC totaling $87,000.   Capital Requirements.  Banks are generally required to maintain capital levels in excess of other businesses. The OCC has established the following minimum capital standards for national banks, such as the Bank: (i) a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with a minimum requirement of at least 4% for all others; and (ii) a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 capital to total risk-weighted assets of 4%.  In general, the components of Tier 1 capital and total capital are the same as those for bank holding companies discussed above.   The capital requirements described above are minimum requirements.  Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions.  For example, regulations of the OCC provide that additional capital may be required to take adequate account of, among other things, interest rate risk or the risks posed by concentrations of credit, nontraditional activities or securities trading activities.   Further, federal law and regulations provide various incentives for financial institutions to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a financial institution that is “well-capitalized” may qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities and may qualify for expedited processing of other required notices or applications. Additionally, one of the criteria that determines a bank holding company’s eligibility to operate as a financial holding company is a requirement that all of its financial institution subsidiaries be “well-capitalized.”  Under the regulations of the OCC, in order to be “well-capitalized” a financial institution must maintain a ratio of total capital to total risk-weighted assets of 10% or greater, a ratio of Tier 1 capital to total risk-weighted assets of 6% or greater and a ratio of Tier 1 capital to total assets of 5% or greater.   Federal law also provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions.  The extent of the regulators’ powers depends on whether the institution in question is “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation.  Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired;   18        (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rate the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.   As of December 31, 2005: (i) the Bank was not subject to a directive from the OCC to increase its capital to an amount in excess of the minimum regulatory capital requirements; (ii) the Bank exceeded its minimum regulatory capital requirements under OCC capital adequacy guidelines; and (iii) the Bank was “well-capitalized,” as defined by OCC regulations.   Dividends.  The primary source of funds for the Company is dividends from the Bank. Under the National Bank Act, a national bank may pay dividends out of its undivided profits in such amounts and at such times as the bank’s board of directors deems prudent.  Without prior OCC approval, however, a national bank may not pay dividends in any calendar year that, in the aggregate, exceed the bank’s year-to-date net income plus the bank’s retained net income for the two preceding years.   The payment of dividends by any financial institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized.  As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2005.  As of December 31, 2005, approximately $536,000 was available to be paid as dividends by the Bank.  Notwithstanding the availability of funds for dividends, however, the OCC may prohibit the payment of any dividends by the Bank if the OCC determines such payment would constitute an unsafe or unsound practice.   Insider Transactions.  The Bank is subject to certain restrictions imposed by federal law on extensions of credit to the Company, on investments in the stock or other securities of the Company and the acceptance of the stock or other securities of the Company as collateral for loans made by the Bank. Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to the directors and officers of the Company, to principal stockholders of the Company, and to “related interests” of such directors, officers and principal stockholders.  In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of the Company or the Bank or a principal stockholder of the Company may obtain credit from banks with which the Bank maintains correspondent relationships.   Safety and Soundness Standards.  The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions.  The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.   In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals.   19        If an institution fails to comply with any of the standards set forth in the guidelines, the institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the institution’s rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments.   Branching Authority.  National banks headquartered in Illinois, such as the Bank, have the same branching rights in Illinois as banks chartered under Illinois law, subject to OCC approval.  Illinois law grants Illinois-chartered banks the authority to establish branches anywhere in the State of Illinois, subject to receipt of all required regulatory approvals.   Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger.  The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is permitted only in those states the laws of which expressly authorize such expansion.   Financial Subsidiaries.  Under Federal law and OCC regulations, national banks are authorized to engage, through “financial subsidiaries,” in any activity that is permissible for a financial holding company and any activity that the Secretary of the Treasury, in consultation with the Federal Reserve, determines is financial in nature or incidental to any such financial activity, except (i) insurance underwriting, (ii) real estate development or real estate investment activities (unless otherwise permitted by law), (iii) insurance company portfolio investments and (iv) merchant banking.  The authority of a national bank to invest in a financial subsidiary is subject to a number of conditions, including, among other things, requirements that the bank must be well-managed and well-capitalized (after deducting from capital the bank’s outstanding investments in financial subsidiaries).  The Bank has not applied for approval to establish any financial subsidiaries.   Federal Reserve System.  Federal Reserve regulations, as presently in effect, require depository institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts), as follows: for transaction accounts aggregating $48.3 million or less, the reserve requirement is 3% of total transaction accounts; and for transaction accounts aggregating in excess of $48.3 million, the reserve requirement is $1.215 million plus 10% of the aggregate amount of total transaction accounts in excess of $48.3 million.  The first $7.8 million of otherwise reservable balances are exempted from the reserve requirements.  These reserve requirements are subject to annual adjustment by the Federal Reserve.  The Bank is in compliance with the foregoing requirements.   20        Recent Regulatory Developments On February 8, 2006, President Bush signed the Federal Deposit Insurance Reform Act of 2005 (“FDIRA”) into law as part of the Deficit Reduction Act of 2005.  On February 15, 2006, President Bush signed into law the technical and conforming amendments designed to implement FDIRA.  FDIRA provides for legislative reforms to modernize the federal deposit insurance system.   Among other things, FDIRA: (i) merges the Bank Insurance Fund (the “BIF”) and the Savings Association Insurance Fund (the “SAIF”) of the Federal Deposit Insurance Corporation (the “FDIC”) into a new Deposit Insurance Fund (the ”DIF”); (ii) allows the FDIC, after March 31, 2010, to increase deposit insurance coverage by an adjustment for inflation and requires the FDIC’s Board of Directors, not later than April 1, 2010 and every five years thereafter, to consider whether such an increase is warranted; (iii) increases the deposit insurance limit for certain employee benefit plan deposits from $100,000 to $250,000, subject to adjustments for inflation after March 31, 2010, and provides for pass-through insurance coverage for such deposits; (iv) increases the deposit insurance limit for certain retirement account deposits from $100,000 to $250,000, subject to adjustments for inflation after March 31, 2010; (v) allows the FDIC’s Board of Directors to set deposit insurance premium assessments in any amount the Board of Directors deems necessary or appropriate, after taking into account various factors specified in FDIRA; (vi) replaces the fixed designated reserve ratio of 1.25% with a reserve ratio range of 1.15%-1.50%, with the specific reserve ratio to be determined annually by the FDIC by regulation; (vii) permits the FDIC to revise the risk-based assessment system by regulation; (viii) requires the FDIC, at the end of any year in which the reserve ratio of the DIF exceeds 1.50% of estimated insured deposits, to declare a dividend payable to insured depository institutions in an amount equal to 100% of the amount held by the DIF in excess of the amount necessary to maintain the DIF’s reserve ratio at 1.50% of estimated insured deposits or to declare a dividend equal to 50% of the amount in excess of the amount necessary to maintain the reserve ratio at 1.35% if the reserve ratio is between 1.35%-1.50% of estimated insured deposits; and (ix) provides a one-time credit based upon the assessment base of the institution on December 31, 1996 to each insured depository institution that was in existence as of December 31, 1996 and paid a deposit insurance assessment prior to that date (or a successor to any such institution).   The merger of the BIF and the SAIF will take effect no later than July 1, 2006, while the remaining provisions are not effective until the FDIC issues final regulations.  FDIRA requires the FDIC to issue final regulations no later than 270 days after enactment: (i) designating a reserve ratio; (ii) implementing increases in deposit insurance coverage; (iii) implementing the dividend requirement; (iv) implementing the one-time assessment credit; and (v) providing for assessments in accordance with FDIRA.   Item 1A.   Risk Factors   In addition to the other information in this Annual Report on Form 10-K, shareholders or prospective investors should carefully consider the following risk factors:   Our business is concentrated in and dependent upon the continued growth and welfare of the LaSalle County market area.   21        While we continue to expand our market area and presence into the surrounding counties of Grundy and Kendall, we operate primarily in LaSalle County, and as a result, our financial condition, results of operations and cash flows are subject to changes in the economic conditions in this market area.  We have developed a particularly strong presence in Ottawa and its surrounding communities.  Our success depends upon the business activity, population, income levels, deposits and real estate activity in this area. Although our customers’ business and financial interests may extend well beyond its market area, adverse economic conditions that affect the market area could reduce our growth rate, affect the ability of our customers to repay their loans to us and generally affect our financial condition and results of operations. Because of our geographic concentration, we are less able than other regional or national financial institutions to diversify our credit risks across multiple markets.   We may experience difficulties in managing our growth and our growth strategy involves risks that may negatively impact our net income.   As part of our general growth strategy, we may expand into additional communities or attempt to strengthen our position in our current market and in surrounding areas by opening new branches and acquiring existing branches of other financial institutions.  To the extent that we undertake additional branch openings and acquisitions, we are likely to continue to experience the effects of higher operating expenses relative to operating income from the new operations, which may have an adverse effect on our levels of reported net income, return on average equity and return on average assets.  Other effects of engaging in such growth strategies may include potential diversion of our management’s time and attention and general disruption to our business.   Although we do not have any current plans to do so, we may also acquire banks and related businesses that we believe provide a strategic fit with our business or engage in de novo bank formations.  To the extent that we grow through acquisitions and de novo bank formations, we cannot assure you that we will be able to adequately and profitably manage this growth. Acquiring other banks and businesses will involve similar risks to those commonly associated with branching, but may also involve additional risks, including:   •                                          potential exposure to unknown or contingent liabilities of banks and businesses we acquire;   •                                          exposure to potential asset quality issues of the acquired bank or related business;   •                                          difficulty and expense of integrating the operations and personnel of banks and businesses we acquire; and   •                                          the possible loss of key employees and customers of the banks and businesses we acquire.   We face intense competition in all phases of our business from other banks and financial institutions.   The banking and financial services business in our market is highly competitive.  Our competitors include large regional banks, local community banks, savings and loan associations, securities and brokerage companies, mortgage companies, insurance companies, finance companies, money market mutual funds, credit unions and other non-bank financial service providers. Many of these competitors are not subject to the same regulatory restrictions as we are   22        and are able to provide customers with a feasible alternative to traditional banking services.  Additionally, technological advances may enable more companies to provide financial services, increasing competition among financial service providers.   Increased competition in our market may also result in a decrease in the amounts of our loans and deposits, reduced spreads between loan rates and deposit rates or loan terms that are more favorable to the borrower.  Any of these results could have a material adverse effect on our ability to grow and remain profitable.  If increased competition causes us to significantly discount the interest rates we offer on loans or increase the amount we pay on deposits, our net interest income could be adversely impacted.  If increased competition causes us to relax our underwriting standards, we could be exposed to higher losses from lending activities.  Additionally, many of our competitors are much larger in total assets and capitalization, have greater access to capital markets and larger lending limits and offer a broader range of financial services than we can offer.   Interest rates and other conditions impact our results of operations.   Our profitability is in part a function of the spread between the interest rates earned on investments and loans and the interest rates paid on deposits and other interest-bearing liabilities.  Like most banking institutions, our net interest spread and margin will be affected by general economic conditions and other factors, including fiscal and monetary policies of the federal government, that influence market interest rates and our ability to respond to changes in such rates.  At any given time, our assets and liabilities will be such that they are affected differently by a given change in interest rates.  As a result, an increase or decrease in rates, the length of loan terms or the mix of adjustable and fixed rate loans in our portfolio could have a positive or negative effect on our net income, capital and liquidity.  We measure interest rate risk under various rate scenarios and using specific criteria and assumptions.  A summary of this process, along with the results of our net interest income simulations is presented at “Quantitative and Qualitative Disclosures About Market Risk” included under Item 7A of Part II of this Form 10-K.  Although we believe our current level of interest rate sensitivity is reasonable and effectively managed, significant fluctuations in interest rates may have an adverse effect on our business, financial condition and results of operations.   We must effectively manage our credit risk.   There are risks inherent in making any loan, including risks inherent in dealing with individual borrowers, risks of nonpayment, risks resulting from uncertainties as to the future value of collateral and risks resulting from changes in economic and industry conditions.  We attempt to minimize our credit risk through prudent loan application approval procedures, careful monitoring of the concentration of our loans within specific industries and periodic independent reviews of outstanding loans by our credit review department.  However, we cannot assure you that such approval and monitoring procedures will reduce these credit risks.   The majority of the bank’s loan portfolio is invested in commercial real estate, residential real estate, general commercial, agricultural and consumer lending.  We may assume greater lending risks than financial institutions that have a lesser concentration of such loans.  Our lending   23        activity and the risks commonly associated with such lending, including the risk of non-payment, are further described in the “Business” section included under Item 1 of Part I of this Form 10-K.   Our allowance for credit losses may prove to be insufficient to absorb potential losses in our loan portfolio.   We established our allowance for credit losses in consultation with management and maintain it at a level considered adequate by management to absorb credit losses that are inherent in the portfolio.  The amount of future credit losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and such losses may exceed current estimates.  At December 31, 2005, our allowance for credit losses as a percentage of total loans was .88% and as a percentage of total non-performing loans was approximately 99.5%.  Although management believes that the allowance for credit losses is adequate to absorb losses on any existing loans that may become uncollectible, we cannot predict credit losses with certainty, and we cannot assure you that our allowance for credit losses will prove sufficient to cover actual credit losses in the future.  Credit losses in excess of our reserves may adversely affect our business, financial condition and results of operations.  Additional information regarding our allowance for credit losses and the methodology we use to determine an appropriate level of reserves is located in the “Management’s Discussion and Analysis” section included under Item 7 of Part II of this Form 10-K.   Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available when it is needed.   We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations.  We anticipate that our existing capital resources will satisfy our capital requirements for the foreseeable future.  However, we may at some point need to raise additional capital to support our continued growth. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance.  Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us.  If we cannot raise additional capital when needed, our ability to further expand our operations through internal growth, branching, de novo bank formations and/or acquisitions could be materially impaired.   Our community banking strategy relies heavily on our management team, and the unexpected loss of key managers may adversely affect our operations.   Much of our success to date has been influenced strongly by our ability to attract and to retain senior management experienced in banking and financial services and familiar with the communities in our market area.  Our ability to retain executive officers, the current management teams, branch managers and loan officers will continue to be important to the successful implementation of our strategy.  It is also critical, as we grow, to be able to attract and retain qualified additional management and loan officers with the appropriate level of experience and knowledge about our market area to implement our community-based operating strategy.  The unexpected loss of services of any key management personnel, or the inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business, financial   24        condition and results of operations.   Government regulation can result in limitations on our operations.   We operate in a highly regulated environment and are subject to supervision and regulation by a number of governmental regulatory agencies, including the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation.  Regulations adopted by these agencies, which are generally intended to provide protection for depositors and customers rather than for the benefit of shareholders, govern a comprehensive range of matters relating to ownership and control of our shares, our acquisition of other companies and businesses, permissible activities for us to engage in, maintenance of adequate capital levels and other aspects of our operations. These bank regulators possess broad authority to prevent or remedy unsafe or unsound practices or violations of law. The laws and regulations applicable to the banking industry could change at any time and we cannot predict the effects of these changes on our business and profitability. Increased regulation could increase our cost of compliance and adversely affect profitability.  For example, new legislation or regulation may limit the manner in which we may conduct our business, including our ability to offer new products, obtain financing, attract deposits, make loans and achieve satisfactory interest spreads.   There is a limited trading market for our common shares, and you may not be able to resell your shares at or above the price shareholders paid for them.   The trading in our common shares has less liquidity than many other companies quoted on the national securities exchanges or markets.  A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the market of willing buyers and sellers of our common shares at any given time.  This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control.  We cannot assure you that volume of trading in our common shares will increase in the future.   System failure or breaches of our network security could subject us to increased operating costs as well as litigation and other liabilities.   The computer systems and network infrastructure we use could be vulnerable to unforeseen problems.  Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers.  Any damage or failure that causes an interruption in our operations could have a material adverse effect on our financial condition and results of operations.  Computer break-ins, phishing and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us and may cause existing and potential customers to refrain from doing business with us.  Although we, with the help of third-party service providers, intend to continue to implement security technology and establish operational procedures to prevent such damage, there can be no assurance that these security measures will be successful. In addition, advances in computer capabilities, new discoveries in the field of   25        cryptography or other developments could result in a compromise or breach of the algorithms we and our third-party service providers use to encrypt and protect customer transaction data.  A failure of such security measures could have a material adverse effect on our financial condition and results of operations.   We are subject to certain operational risks, including, but not limited to, customer or employee fraud and data processing system failures and errors.   Employee errors and misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to financial claims for negligence.   We maintain a system of internal controls and insurance coverage to mitigate against operational risks, including data processing system failures and errors and customer or employee fraud. Should our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, financial condition and results of operations.   Item 1B.   None   26        Item 2.   Properties.   The Company’s main office is located at 701-705 LaSalle Street, Ottawa, Illinois.  The building is comprised of approximately 15,000 square feet.  The main office building is a two-story structure constructed principally of masonry which was opened in 1865.  The Company also operates six branch office facilities. A limited service branch, which contains eight drive-in lanes, is located at 300 West Madison Street, Ottawa, Illinois, and six full-service branches are located at 601 State Street, Ottawa, Illinois; 2771 North Columbus Street, Ottawa, Illinois; 1771 North Division Street, Morris, Illinois; 2324 North Bloomington Street, Streator, Illinois; 401 East Main Street, Streator, Illinois; and 1459 Cannonball Trail, Yorkville, Illinois. The main banking office and branch offices are owned by the Company in fee and are unencumbered.   Item 3.   Legal Proceedings.   The Company is from time to time a party to legal proceedings in the ordinary course of business that are incident to the business of banking. The Company is not engaged in any legal proceedings of a material nature at the present time.   Item 4.   Submission of Matters to a Vote of Security Holders.   No matters were submitted to a vote of security holders during the quarter ended December 31, 2005.   27        PART II   Item 5.           Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   See page — of the 2005 Annual Report to Stockholders (filed as Exhibit 13.1 of this report) which is incorporated herein by reference.   Item 6.   Selected Financial Data   The information set forth under the caption “Selected Consolidated Financial Information” on page 1 of the 2005 Annual Report to Stockholders (filed as Exhibit 13.1 of this report) is incorporated herein by reference.   Item 7.          Management’s Discussion and Analysis of Financial Condition and Results of Operations   The information set forth under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages 2 through 11 of the 2005 Annual Report to Stockholders (filed as Exhibit 13.1 of this report) is incorporated herein by reference.   Item 7A.Quantitative and Qualitative Disclosures about Market Risk   The information set forth under the caption “Quantitative and Qualitative Disclosures about Market Risk” on page 12 of the 2005 Annual Report to Stockholders (filed as Exhibit 13.1 of this report) is incorporated herein by reference.   28        Item 8.   Financial Statements and Supplementary Data   The consolidated financial statements of the Registrant and the Report of Independent Registered Public Accounting Firm as set forth on pages 17 through 42 of the 2005 Annual Report to Stockholders (filed as Exhibit 13.1 of this report) are incorporated herein by reference:              Annual Report to   Stockholders Page         Report of Independent Registered Public   Accounting Firm       17                           Consolidated Balance Sheets as of December   31, 2005 and 2004       18                           Consolidated Statements of Income for the   years ended December 31, 2005, 2004, and 2003       19                           Consolidated Statements of Stockholders’   Equity for the years ended December 31, 2005, 2004, and 2003       20                           Consolidated Statements of Cash Flows for   the years ended December 31, 2005, 2004, and 2003       21                           Notes to the Consolidated Financial   Statements       22          The portions of the 2005 Annual Report to Stockholders which are not specifically incorporated by reference as a part of this Form 10-K are not deemed to be a part of this report.   Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   None.   Item 9A.Controls and Procedures   An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Exchange Act) as of December 31, 2005. Based on that evaluation, the Company’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective. There have been no significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls.   Item 9B.Other Information   None   29        PART III   Item 10. Directors and Executive Officers at the Registrant   The information set forth under the captions “Information Regarding Nominees and Executive Officers”, “Corporate Governance and the Board of Directors” and “Section 16 Beneficial Ownership Reporting Compliance” of the Registrant’s Proxy Statement, relating to the 2006 Annual Meeting of Stockholders is incorporated herein by reference.   Item 11. Executive Compensation   The information set forth under the caption “Executive Compensation” of the Registrant’s Proxy Statement, relating to the 2006 Annual Meeting of Stockholders is incorporated herein by reference, except for the “Stockholder’s Performance Table” and the “Board Compensation Committee’s Report on Compensation”, which are not hereby incorporated.   Item 12.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   The information set forth under the caption “Security Ownership of Certain Beneficial Owners and Management” of the Registrant’s Proxy Statement, relating to the 2006 Annual Meeting of Stockholders is incorporated herein by reference.   Equity Compensation Plan Information   The table below sets forth the following information as of December 31, 2005 for (i) all compensation plans previously approved by the Company’s stockholders and (ii) all compensation plans not previously approved by the Company’s stockholders:   (a)   the number of securities to be issued upon the exercise of outstanding options, warrants and rights;    (b)   the weighted-average exercise price of such outstanding options, warrants and rights;    (c)   other than securities to be issued upon the exercise of such outstanding options, warrants and rights, the number of securities remaining available for future issuance under the plans.    30        EQUITY COMPENSATION PLAN INFORMATION      Plan category       Number   of securities to   be issued upon exercise   of outstanding options       Weighted-average   exercise   price of outstanding   options       Number   of securities   remaining available for   future issuance                                           Equity   compensation plans approved by security holders       21,000       $   62.55       129,000         Equity   compensation plans not approved by security holders       0       0       0         Total       21,000       $   62.55       129,000          Item 13.     Certain Relationships and Related Transactions   The information set forth under the caption “Certain Relationships and Related Transactions” of the Registrant’s Proxy Statement, relating to the 2006 Annual Meeting of Stockholders is incorporated herein by reference.   Item 14.     Principal Accounting Fees and Services   The information set forth under the caption “Independent Public Accountants” of the Registrant’s Proxy Statement relating to the 2006 Annual Meeting of Shareholders is incorporated herein by reference.   31        PART IV   Item 15.  Exhibits and Financial Statement Schedules   (a)          1.     Financial Statements   All financial statements of the Registrant are incorporated herein by reference as set forth under Item 8, Part II of this report on Form 10-K.   2.     Financial Statement Schedules   Not applicable.   3.     Exhibits (Numbered in accordance with Item 601 of Regulation S-K)   The following exhibits are filed as part of this report:      3(i)       Certificate of Incorporation of First Ottawa   Bancshares, Inc.                   3(ii)       By-Laws   of First Ottawa Bancshares, Inc.                   10.1       Employment   Agreement for J. Brown*                   10.2       Executive   Officer Bonus Plan*                   10.3       Employment   Agreement for Donald Harris*                   10.4       Stock   Incentive Plan                   10.5       Summary   of Director Fees                   10.6       Form   of Supplemental Nonqualified Retirement Agreement                   10.7       Employment   Agreement for Patrick Fayhee*                   10.8       Employment   Agreement for Steven Gonzalo*                   10.9       Employment   Agreement for Vincent Easi*                   13.1       Annual   Report to Stockholders                   21.1       Subsidiaries                   31.1       Certification   of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)                   31.2       Certification of Chief   Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)                   32.1       Certification   of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted   Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                   32.2       Certification   of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted   Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002       *  Indicates management contract or compensation plan or arrangement.   32        SIGNATURE   In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.            FIRST   OTTAWA BANCSHARES, INC.                   By:   /s/ Joachim   Brown                 Joachim Brown,   President and Chief   Executive Officer (Principal Executive   Officer)                       By:   /s/ Vincent   G. Easi                 Vincent G.   Easi, Principal Financial Officer           Date:   March 28,   2006               In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.        Signature       Title       Date                           /s/ Joachim   Brown           Director and   President/       March 28,   2006     Joachim   Brown       Chief   Executive Officer                                   /s/ Bradley   J. Armstrong           Director       March 28,   2006     Bradley J. Armstrong                                           /s/ John L.   Cantlin           Director       March 28,   2006     John L. Cantlin                                           /s/ Patty P.   Godfrey           Director       March 28,   2006     Patty P. Godfrey                                           /s/ Thomas   E. Haeberle           Director       March 28,   2006     Thomas E.   Haeberle                                           /s/ Donald   J. Harris           Director and   Executive       March 28,   2006     Donald J.   Harris       Vice   President, Chief Operating                     Officer                        33           /s/ Thomas   P. Rooney           Director       March 28,   2006     Thomas P.   Rooney                                           /s/ William   J. Walsh           Director       March 28,   2006     William J.   Walsh                               34        EXHIBIT INDEX      Exhibit   Number       Description       Incorporated   by Reference to       Attached Hereto     3(i)       Certificate of Incorporation of First Ottawa Bancshares, Inc. (as   amended)       Form 10K for the year ended 12/31/2002                                           3(ii)       By-Laws of First Ottawa Bancshares, Inc.       Form 10K for the year ended 12/31/2003                                           10.1       Employment Agreement for J. Brown       Form 10K for the year ended 12/31/2002                                           10.2       Executive Officer Bonus Plan       Form 10K for the year ended 12/31/2002                                           10.3       Employment Agreement for Donald Harris       Form 8-K filed on June 10, 2005                                           10.4       Stock Incentive Plan       Form S-8 dated 8/1/03                                           10.5       Summary of Director Fees       Form 10K for the year ended 12/31/2004                                           10.6       Form of Supplemental Nonqualified Retirement Agreement       Form 10K for the year ended 12/31/2004                                           10.7       Employment Agreement for Patrick Fayhee       Form 8-K filed on June 10, 2005                                           10.8       Employment Agreement for Steven Gonzalo       Form 8-K filed on June 10, 2005                                           10.9       Employment Agreement for Vincent Easi       Form 8-K filed on June 10, 2005                                           13.1       2005 Annual Report to Stockholders               X                                   21.1       Subsidiaries               X                                   31.1       Certification of Chief Exectutive Officer               X                                   31.2       Certification of Chief Financial Officer               X                                   32.1       Certification of Chief Exectutive Officer               X                                   32.2       Certification of Chief Financial Officer               X      35         EX-13.1 2 a06-2311_1ex13d1.htm ANNUAL REPORT TO SECURITY HOLDERS       Exhibit 13.1   FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARY           SELECTED CONSOLIDATED FINANCIAL INFORMATION   The following table sets forth selected consolidated financial and other data of First Ottawa Bancshares, Inc. and its wholly owned subsidiary, the First National Bank of Ottawa (the Bank) and the Bank’s wholly owned subsidiary, First Ottawa Financial Corporation, together referred to as the Company. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto included herein. All dollar amounts are in thousands, except per share information.              Year Ended December 31,                 2005       2004       2003       2002       2001         Statement of Income Data:                                                 Total interest income       $   13,908       $   13,537       $   12,651       $   13,092       $   14,921         Total interest expense       4,613       4,200       4,384       5,733       7,773         Net interest income       9,295       9,337       8,267       7,359       7,148         Provision for loan losses       300       300       120       120       300         Noninterest income       2,842       3,195       2,592       2,444       2,457         Noninterest expenses       8,501       8,807       7,413       6,718       6,732         Income before income taxes       3,336       3,425       3,326       2,965       2,573         Provision for income taxes       791       797       867       678       460                                                           Net income       $   2,545       $   2,628       $   2,459       $   2,287       $   2,113                                                           Per Share Data:                                                 Net income – basic       $   3.92       $   4.03       $   3.75       $   3.47       $   3.19         Net income – diluted       3.90       4.03       3.75       3.47       3.19         Cash dividends declared       3.00       3.00       3.00       3.00       3.00         Book value at end of year (1)       37.43       36.54       35.54       34.97       34.53                                                           Selected Financial Ratios:                                                 Return on average assets (1)       .87   %   .88   %   1.00   %   .99   %   .94   %     Return on average equity (1)       10.50       11.05       10.50       9.73       9.18         Dividend payout ratio       76.53       74.44       79.79       86.46       94.04         Average equity to average assets (1)       8.30       7.96       9.56       10.20       10.29         Net interest margin (tax equivalent)       3.70       3.60       3.89       3.77       3.74         Allowance for loan   losses to total loans at the end of period       .88       .88       .80       1.06       1.01         Nonperforming loans to   total loans at the end of period (2)       .87       1.55       2.04       1.83       1.15         Net loans charged off   to average total loans       .09       .13       .21       .06       .25                                                           Balance   Sheet Data:                                                 Total assets       $   278,739       $   288,659       $   294,490       $   240,662       $   232,565         Total earning assets       253,641       262,618       276,767       223,324       216,927         Average assets       290,765       299,665       247,961       232,335       224,653         Gross loans, including   loans held for sale       152,860       134,493       131,948       111,454       109,508         Allowance for loan   losses       1,344       1,174       1,049       1,167       1,109         Total deposits       239,881       253,964       264,921       193,767       165,267         Federal funds purchased   and securities sold under agreements to repurchase       12,700       6,350       —       16,322       25,899         Shareholders’ equity       22,858       23,852       24,655       25,183       22,907           (1)               Excludes unrealized gain (loss) on securities available—for–sale. (2)               Includes total nonaccrual loans, impaired loans, and all other loans 90 days past due and still accruing interest.   1        MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS    The following discussion and analysis is intended as a review of significant factors affecting the financial condition and results of operations of the Company for the periods indicated. The discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto and the Selected Consolidated Financial Data presented herein. In addition to historical information, the following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward–looking statements that involve risks and uncertainties. The Company’s actual results could differ significantly from those anticipated in these forward–looking statements as a result of certain factors discussed elsewhere in this report, including under “Risk Factors” in Item I.A. of our Form 10-K.   Overview   The Company’s principal business is conducted by the Bank and consists of a full range of community–based financial services, including commercial and retail banking. The profitability of the Company’s operations depends primarily on its net interest income, provision for loan losses, other income, and other expenses. Net interest income is the difference between the income the Company receives on its loan and securities portfolios and its cost of funds, which consists of interest paid on deposits and borrowings. The provision for loan losses reflects the cost of credit risk in the Company’s loan portfolio. Other income consists of service charges on deposit accounts, trust and farm management fee income, securities gains (losses), gains (losses) on sales of loans, and other income. Other expenses include salaries and employee benefits, as well as occupancy and equipment expenses and other noninterest expenses.   Net interest income is dependent on the amounts and yields of interest–earning assets as compared to the amounts of and rates on interest–bearing liabilities. Net interest income is sensitive to changes in market rates of interest and the Company’s asset/liability management procedures in coping with such changes. The provision for loan losses is dependent upon management’s assessment of the collectibility of the loan portfolio under current economic conditions.   Net income was $2.5 million for the year ended December 31, 2005 compared to $2.6 million for the year ended December 31, 2004. The return on average assets was .87% in 2005 compared to .88% in 2004. The return on average equity decreased to 10.50% in 2005 from 11.05% in 2004. This resulted primarily from the decrease in net income partially offset by the change in average equity due to stock repurchases in 2005 and 2004.    Net income was $2.6 million for the year ended December 31, 2004 compared to $2.5 million for the year ended December 31, 2003. The return on average assets was .88% in 2004 compared to 1.00% in 2003. The return on average equity increased to 11.05% in 2004 from 10.50% in 2003. This resulted primarily from the increase in net income and the change in average equity due to stock repurchases in 2004 and 2003.    2        Critical Accounting Policies   The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. The Company’s significant accounting policies are described in detail in the notes to the Company’s consolidated financial statements for the year ended December 31, 2005. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions. The financial position and results of operations can be affected by these estimates and assumptions and are integral to the understanding of reported results. Critical accounting policies are those policies that management believes are the most important to the portrayal of the Company’s financial condition and results, and they require management to make estimates that are difficult, subjective, or complex.   Allowance for Credit Losses– The allowance for credit losses provides coverage for probable losses inherent in the Company’s loan portfolio. Management evaluates the adequacy of the allowance for credit losses each quarter based on changes, if any, in underwriting activities, the loan portfolio composition (including product mix and geographic, industry or customer–specific concentrations), trends in loan performance, regulatory guidance and economic factors. This evaluation is inherently subjective, as it requires the use of significant management estimates. Many factors can affect management’s estimates of specific and expected losses, including volatility of default probabilities, rating migrations, loss severity and economic conditions. The allowance is increased through provisions charged to operating earnings and reduced by net charge–offs.   The Company determines the amount of the allowance based on relative risk characteristics of the loan portfolio. The allowance recorded for commercial loans is based on reviews of individual credit relationships and an analysis of the migration of commercial loans and actual loss experience. The allowance recorded for homogeneous consumer loans is based on an analysis of loan mix, risk characteristics of the portfolio, fraud loss and bankruptcy experiences, and historical losses, adjusted for current trends, for each homogeneous category or group of loans. The allowance for credit losses relating to impaired loans is based on the loan’s observable market price, the collateral for certain collateral–dependent loans, or the discounted cash flows using the loan’s effective interest rate.   Regardless of the extent of the Company’s analysis of customer performance, portfolio trends or risk management processes, certain inherent but undetected losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions, the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends. Volatility of economic or customer–specific conditions affecting the identification and estimation of losses for larger non–homogeneous credits and the sensitivity of assumptions utilized to establish allowances for homogenous groups of loans are among other factors. The Company estimates a range of inherent losses related to the existence of these exposures. The estimates are based upon the Company’s evaluation of imprecise risk associated with the commercial and consumer allowance levels and the estimated impact of the current economic environment.   3        Mortgage Servicing Rights– Mortgage servicing rights (“MSRs”) associated with loans originated and sold, where servicing is retained, are capitalized and included in other intangible assets in the consolidated balance sheet. The value of the capitalized servicing rights represents the present value of the future servicing fees arising from the right to service loans in the portfolio. Critical accounting policies for MSRs relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of MSRs requires the development and use of a number of estimates, including anticipated principal amortization and prepayments of that principal balance. Events that may significantly affect the estimates used are changes in interest rates, mortgage loan prepayment speeds and the payment performance of the underlying loans. The carrying value of the MSRs is periodically reviewed for impairment based on a determination of fair value. For purposes of measuring impairment, the servicing rights are compared to a valuation prepared based on a discounted cash flow methodology, utilizing current prepayment speeds and discount rates. Impairment, if any, is recognized through a valuation allowance and is recorded as amortization of intangible assets.   Derivatives– As a part of the Company’s funding strategy, derivative financial instruments, all of which are interest rate swap arrangements, are used to reduce exposure to changes in interest rates for certain financial instruments. These derivatives are accounted for by recognizing the fair value of the contracts on the balance sheet. The valuation of these derivatives is considered critical because carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for the interest rate swaps and related deposit products are provided by third parties.   Additionally, the Company has purchased certificate of deposits which contain an equity related embedded derivative component. The initial investment in the certificate of deposit is not at risk but the return on the investment is based on appreciation in the S&P 500 Index. Accordingly, the fair value of the embedded derivative is recorded at fair value as an adjustment to the certificate of deposit and interest income.   Stock Compensation– Grants under the Company’s stock incentive plan are accounted for under the provisions of Statement of Accounting Standards (SFAS) No. 123, applying the fair value method and the use of an option pricing model to estimate the value of the options granted. The stock options are granted with an exercise price equal to the market price at the date of grant. Resulting compensation expense, under the stock options, is measured and recorded based on the estimated value of the options.    4        Consolidated Financial Condition   Total assets at December 31, 2005 were $278.7 million compared to $288.7 million at December 31, 2004, a decrease of $10.0 million, or 3.5%. Despite the decrease in our total assets, our total loans increased 15.11% in 2005. Commercial and agricultural loans increased $5.3 million during 2005 due to an effort by management to increase the size of the commercial loan portfolio. Real estate loans also increased by $21.2 million during 2005, again due to an effort by management to increase the size of the portfolio. These increases were partially offset by the decrease in installment loans of $6.0 million due to a general decline in indirect lending volume and more stringent underwriting guidelines on consumer loans. Loans held for sale decreased by $1.7 million as refinancing activity cooled during 2005 as a result of the increase in interest rates throughout 2005 from the historical low levels of 2003. Contributing to the decrease in total assets was a $1.1 million decrease in cash and cash equivalents due to a reduction in the reserve amount required by the Federal Reserve Bank. Investment securities decreased by $14.0 million, and certificates of deposit held for investment purposes decreased by $13.1 million. Premises and equipment increased by $400,000 due to capital expenditures on existing buildings and the construction of a new Yorkville, Illinois branch facility. The increase in loans was funded by a decrease in securities and increases in federal funds purchased. Total borrowings increased $5.8 million as a result of a $7.1 million increase in federal funds purchased, a $559,000 decrease in other borrowings, and a $750,000 decrease in securities sold under repurchase agreements. Total deposits decreased $14.1 million. This decrease was primarily a result of management’s decision to reduce the number of special rate deposit products which were offered to attract customers in new markets in 2004.    Total equity was $22.9 million at December 31, 2005 compared to $23.9 million at December 31, 2004. The decrease was primarily the result of a decrease in the unrealized gain on securities available–for–sale, net of tax, of $1.5 million, dividends declared of $1.9 million and by the repurchase of Company common stock for $89,000. The decrease was partially offset by net income of $2.5 million.    Consolidated Results of Operations   2005 Compared to 2004   Net Interest Income. Net interest income was $9.3 million in 2005 and 2004. Interest income on earning assets increased $371,000 in 2005 from 2004. This increase was primarily attributable to increased interest income earned on the loan portfolio of $1.1 million, tax exempt securities of $50,000, and federal funds sold of $193,000. The increases were attributable to increases in average balances and also average tax–equivalent yields available in the marketplace in 2005. Increases were offset by decreased interest income earned on taxable securities of $904,000, and certificates of deposit held for investment of $78,000. Interest expense on interest–bearing liabilities increased $413,000 as a result of an increase in the average rate paid on liabilities of 25 basis points, from 1.73% in 2004 to 1.98% in 2005. The net interest margin on a tax equivalent basis increased to 3.70% in 2005 from 3.60% in 2004. The primary reason for the increase in the net interest margin was the result of a gradual reallocation to loans which earn at higher rates than other types of interest-bearing assets.   5        Provision for Loan Losses. The provision for loan losses remained constant at $300,000 in 2005 and 2004. As of December 31, 2005, the allowance for loan losses totaled $1.3 million, or ..88% of total loans, compared to $1.2 million, or .88% of total loans, at December 31, 2004. The increase in the allowance for loan losses in 2005 was influenced by the continued growth in the loan portfolio.   The amounts of the provision and allowance for loan losses are influenced by current economic conditions, actual loss experience, industry trends and other factors, including real estate values in the Company’s market area and management’s assessment of current collection risks within the loan portfolio. Along with other financial institutions, management shares a concern for the outlook of the economy for 2006. Even though there are indications of emerging strength, it is uncertain if this strength is sustainable. If it is not sustainable, borrowers may experience difficulty, and the level of non–performing loans, charge-offs, and delinquencies could rise and require increases in the provision. The allowance for loan losses represents management’s estimate of probable incurred losses based on information available as of the date of the financial statements. The allowance for loan losses is based on management’s evaluation of the collectibility of the loan portfolio, including past loan loss experience, known and inherent risks in the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, and economic conditions.    Management has concluded that the allowance for loan losses is adequate at December 31, 2005. However, there can be no assurance that the allowance for loan losses will be adequate to cover all losses.   Noninterest Income. The Company’s noninterest income decreased $353,000, or 11.0%, compared to 2004. Noninterest income decreased primarily due to gains on securities sold of $172,000 in 2005, a decrease of $293,000 compared to 2004, as the Company sold a large amount of securities for a gain in 2004. Gains on loan sales to the secondary market decreased $163,000 to $91,000 in 2005 compared to 2004 as a result of fewer originations of residential real estate loans in 2004 because of the general increase in interest rates in 2005. Service charges on deposit accounts increased modestly by $23,000, or 2.1%, to $1.1 million. Other income increased by $68,000, or 7.5%, compared to 2004. This increase is primarily due to a $188,000 increase in the market value of derivatives related to index powered certificates of deposit held for investments and for customers of the Bank. Trust and farm management fee income increased modestly by $12,000, to $496,000 in 2005 compared to 2004.   Noninterest Expense. The Company’s noninterest expense was $8.5 million in 2005 and $8.8 million for 2004. Salaries and benefits, which is the largest component of noninterest expense, remained constant at $4.7 million. Increases in occupancy and equipment expense of $10,000, data expense of $37,000, and supplies expense of $46,000 were offset by decreases in professional fees of $40,000, amortization of core deposit intangible expense of $80,000, and other expenses of $279,000. Other expense was reduced due to decreased collection expenses, decreased secondary mortgage market expenses, decreased directors’ life insurance expense and decreased miscellaneous loan expenses. Income tax expense decreased by $6,000 compared to the prior year. The Company’s effective tax rate increased slightly due to an increase in state income tax expense.   6        Income Taxes. The Company’s tax rate varied from statutory rates principally due to interest income from tax–exempt securities and loans. The Company’s effective tax rate was 23.7% and 23.3% for 2005 and 2004.   2004 Compared to 2003   Net Interest Income. Net interest income was $9.3 million in 2004 compared to $8.3 million in 2003, an increase of $1.0 million, or 12.9%. Interest income on earning assets increased $886,000 in 2004 from 2003. All classifications of interest earning assets experienced growth in 2004 when compared to 2003. The increases were attributable to increases in average balances and also average tax–equivalent yields available in the marketplace in 2004. Interest expense on interest–bearing liabilities decreased $184,000 as a result of a decrease in the average rate paid on liabilities of 54 basis points, from 2.26% in 2003 to 1.72% in 2004. The net interest margin on a tax equivalent basis decreased to 3.60% in 2004 from 3.89% in 2003. The primary reason for the decrease in the net interest margin was the result of lower rates earned on interest-bearing assets during the low rate environment experienced throughout 2004.   Provision for Loan Losses. The provision for loan losses increased to $300,000 in 2004  compared to $120,000 in 2003. As of December 31, 2004, the allowance for loan losses totaled $1.2 million, or .88% of total loans, compared to $1.1 million, or .80% of total loans, at December 31, 2003. The increase in the provision for loan losses in 2004 was influenced heavily by the acquisition of $11.4 million of Streator branch loans in the fourth quarter of 2003.   The amounts of the provision and allowance for loan losses are influenced by current economic conditions, actual loss experience, industry trends and other factors, including real estate values in the Company’s market area and management’s assessment of current collection risks within the loan portfolio. Along with other financial institutions, management shares a concern for the outlook of the economy for 2005. Even though there are indications of emerging strength, it is uncertain if this strength is sustainable. If it is not sustainable, borrowers may experience difficulty, and the level of non–performing loans, charge-offs, and delinquencies could rise and require increases in the provision. The allowance for loan losses represents management’s estimate of probable incurred losses based on information available as of the date of the financial statements. The allowance for loan losses is based on management’s evaluation of the collectibility of the loan portfolio, including past loan loss experience, known and inherent risks in the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, and economic conditions.    Management has concluded that the allowance for loan losses is adequate at December  31, 2004. However, there can be no assurance that the allowance for loan losses will be adequate to cover all losses.   7        Noninterest Income. The Company’s noninterest income increased $603,000, or 23.3% compared to 2003. Noninterest income increased primarily due to gains on securities sold of $465,000 in 2004, an increase of $448,000 over 2003. Service charges on deposit accounts increased by $223,000, or 25.8%, to $1.1 million. Increases in service charge income are attributable to higher average balances and an increase in the average number of accounts during 2004. Other income increased by $399,000, or 79.2% compared to 2003. This increase is primarily due to a $301,000 increase in the market value of derivatives related to index powered certificates of deposit held for investments and for customers of the bank. Trust and farm management fee income increased modestly by $12,000, to $484,000 in 2004 compared to 2003. Gains on loan sales to the secondary market decreased $479,000 to $254,000 in 2004 compared to 2003. Due to the rate structure in early 2004 and the large amount of loans that refinanced during 2002 and 2003, gains on sale of loans during 2004 were significantly less than 2003.   Noninterest Expense. The Company’s noninterest expense was $8.8 million in 2004 and $7.4 million for 2003. Salaries and benefits, which is the largest component of noninterest expense, increased $529,000, or 12.8%, to $4.7 million. Increases in occupancy and equipment expense of $327,000, professional fees of $65,000 and other expenses of $299,000, contributed to the $1.4 million increase in noninterest expense for the year. Increased salaries and benefits were primarily a result of additional personnel retained in the acquisition of the two branches in Streator in November 2003. The increase in occupancy and equipment expenses was due primarily to increased depreciation on capital expenditures related to the renovation of the main banking facility in Ottawa, the acquisition of the Streator facilities, and the construction of the Morris facility. Increased professional fees were a result of the increase in audit costs and consulting costs associated with establishing new banking branches. Increases in other expenses resulted primarily from increased mortgage banking expenses of $53,000, and additional insurance expenses related to added facilities of $98,000. Data expenses decreased $166,000, or 33.2% from 2003, and were a result of a platform conversion which was completed in November 2003. The Company also experienced decreases in supplies expense of $25,000, and advertising expense of $72,000, during 2004.   Income Taxes. The Company’s tax rate varied from statutory rates principally due to interest income from tax–exempt securities and loans. The Company’s effective tax rate was 23.3% and 26.1% for 2004 and 2003.   8        The components of the changes in net interest income are shown below. Changes in net interest income are allocated between amounts attributed to changes in rate and changes in volume for the various categories of interest–earning assets and interest–bearing liabilities.   Analysis of Changes in Interest Income and Expense ($000s)              2005 – 2004       2004 – 2003                 Increase (Decrease)       Increase (Decrease)                 Total   Change       Change   Due to   Volume       Change   Due to   Rate       Total   Change       Change   Due to   Volume       Change   Due to   Rate         INTEREST INCOME                                                                                                                   Loans       $   1,136       $   708       $   428       $   242       $   1,019       $   (777   )     Investment CDs       (78   )   (101   )   23       276       290       (14   )     Securities       (828   )   (701   )   (127   )   441       989       (548   )     Federal funds sold       193       107       86       8       3       5         Total interest income       423       13       410       967       2,301       (1,334   )                                                               INTEREST EXPENSE                                                                                                                   NOW and money market       116       (114   )   230       546       441       105         Savings       (31   )   (11   )   (20   )   (36   )   47       (83   )     Time deposits       297       9       288       (555   )   336       (891   )     Repurchase agreements       2       —       2       (8   )   (2   )   (6   )     Borrowings       (4   )   (20   )   16       (134   )   (195   )   61         Federal funds purchased       33       18       15       2       3       (1   )     Total interest expense       413       (118   )   531       (185   )   630       (815   )                                                               Net interest earnings       10       131       (121   )   1,152       1,671       (519   )     Tax equivalent adjustment       (52   )   —       (52   )   (82   )   —       (82   )                                                               Net interest earnings   after tax equivalent adjustment       $   (42   )   $   131       $   (173   )   $   1,070       $   1,671       $   (601   )      Volume/rate variances are allocated to the volume variance and the rate variance on an absolute basis. Tax–exempt income is reflected on a fully tax–equivalent basis utilizing a 34% rate for municipal securities and tax–exempt loans.   Interest–Earning Assets and Interest–Bearing Liabilities   The following table sets forth the average balances, net interest income and expense, and average yields and rates for the Company’s interest–earning assets and interest–bearing liabilities for the indicated years on a tax–equivalent basis assuming a 34% tax rate.   9        Analysis of Average Balances, Tax Equivalent Yields and Rates Years Ended December 31, 2005, 2004, and 2003 (in Thousands)              2005       2004       2003                 Average   Balance (4)       Interest       Average   Rate       Average   Balance (4)       Interest       Average   Rate       Average   Balance (4)       Interest       Average   Rate         ASSETS                                                                                                                                                                   Loans (1) (3)       $   141,807       $   9,467       6.68   %   $   131,191       $   8,331       6.35   %   $   115,140       $   8,089       7.03   %     Investment CDs       17,685       555       3.14       20,910       633       3.03       11,341       357       3.15         Securities (2) (5)       100,187       4,209       4.20       116,892       5,037       4.31       93,944       4,596       4.89         Federal funds sold       6,635       233       3.51       3,589       40       1.11       3,308       32       .97         Interest–earning assets       266,314       14,464       5.43       272,582       14,041       5.15       223,733       13,074       5.84         Noninterest–earning   assets (6)       29,365                       27,083                       24,228                                                                                                           Average assets       $   295,679                       $   299,665                       $   247,961                                                                                                           LIABILITIES AND SHAREHOLDERS’   EQUITY                                                                                                                                                                   NOW and money market       $   98,826       1,370       1.39       $   107,136       1,254       1.17       $   69,435       708       1.02         Savings       27,083       140       .52       29,121       171       .59       21,158       207       .98         Time deposits       105,301       3,034       2.88       105,002       2,737       2.61       92,110       3,292       3.57         Repurchase agreements       232       4       1.72       215       2       .93       475       10       2.11         Federal funds purchased       1,715       57       3.32       1,175       24       2.04       10,713       158       1.47         Borrowings       126       8       6.35       438       12       2.74       313       10       3.19         Interest–bearing   liabilities       233,283       4,613       1.98       243,087       4,200       1.73       194,204       4,385       2.26                                                                                           Net interest income (2)               9,851                       9,841                       8,689                 Net yield on interest–   earning assets                       3.70                       3.61                       3.88         Interest–bearing   liabilities to earning assets ratio                       87.60                       89.18                       86.80         Noninterest–bearing liabilities       38,959                       32,185                       28,331                                                                                                           Shareholders’ equity       23,487                       24,393                       24,426                         Average liabilities and   shareholders’ equity       $   295,679                       $   299,665                       $   246,961                         Tax equivalent adjustment               556                       504                       422                 Net interest income as   reported in the consolidated statements of income               $   9,295                       $   9,337                       $   8,267                   (1)          Interest income on loans includes loan origination and other fees of $136 for 2005, $168 for 2004, and $275 for 2003. (2)          Loan and securities income is reflected on a fully tax–equivalent basis utilizing a 34% rate for municipal securities and tax–exempt loans. (3)          Non–accrual loans are included in average loans. (4)          Average balances are derived from the average daily balances. (5)          Rate information is calculated based upon average amortized cost. (6)          Average balance information includes an average valuation allowance for securities of $(1,228), $909, and $3,375, respectively.   10        Impact of Accounting Changes   Shared-Based Payment   In December 2004, the FASB issued SFAS No. 123, Revised, Share-Based Payment (SFAS 123(R)), which requires all public companies to record compensation cost for stock options and other awards provided to employees in return for employee service. The cost of the options is measured at the fair value of the options when granted and is expensed over the employee service period, which is normally the vesting period of the options granted. The Company adopted SFAS 123(R) on January 1, 2006. Future compensation cost and the impact on the Company’s results of operation as a result of any future option grants will depend on the level of any future option grants, the related vesting period, and the calculation of the fair value of the options granted as of the grant date. As such, the Company cannot currently estimate compensation expense relating to future awards.   Since the Company previously accounted for its stock options in accordance with SFAS No. 123, the adoption of SFAS No. 123(R) is not expected to have a significant impact on the Company’s financial condition or results of operations.    The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments   In January 2003, the Emerging Issues Task Force (EITF) began a project to provide additional guidance on when a market value decline on debt and marketable equity securities should be considered other-than-temporary. Currently, declines in market value that are considered to be other-than-temporary require that a loss be recognized through the income statement. In March 2004, the FASB ratified the consensus reached by the EITF in Issue 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF 03-1). EITF 03-1 provides guidance for determining when an investment is considered impaired, whether impairment is other-than-temporary, and measurement of an impairment loss. In September 2004, the FASB issued a staff position (FSP 03-1-1) which delayed the effective date for the measurement and recognition guidance of EITF 03-1 due to additional proposed guidance.    In June 2005, the FASB decided not to provide additional guidance on the meaning of other-than-temporary impairment, but directed the FASB staff to issue a FASB Staff Position (FSP) titled FSP 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The final FSP supersedes EITF 03-1 and EITF Topic No. D-44, Recognition of Other-Than-Temporary Impairment Upon the Planned Sale of a Security Whose Cost Exceeds Fair Value. FSP FAS 115-1 replaces guidance in EITF 03-1 on loss recognition with references to existing other-than-temporary impairment guidance, such as FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS No. 115). FSP FAS 115-1 also clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell has not been made.   FSP FAS 115-1 was effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. The Company has consistently followed the loss recognition guidance in SFAS No. 115, so the adoption of FSP FAS 115-1 did not have a significant impact on the Company’s financial condition or results of operations.    Earnings Per Share   On September 30, 2005, the FASB issued a proposed amendment to SFAS No. 128, Earnings per Share, to clarify guidance for mandatorily convertible instruments, the treasury stock method, contingently issuable shares, and contracts that may be settled in cash or shares. The primary impact on the Company of the proposed Statement would be a change to the treasury stock method for year-to-date diluted earnings per share.   11        FIRST OTTAWA BANCSHARES, INC. AND SUBSIDIARY MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK   The Company uses overall risk sensitivity to monitor and manage exposure to sudden changes in interest rates. The Company’s overall interest rate sensitivity is demonstrated by a net interest income analysis. Net interest income analysis measures the change in net interest income in the event of hypothetical changes in interest rates. This analysis assesses the risk of change in net interest income in the event of sudden and sustained 1.0% increases and decreases in market interest rates. The tables below present the Company’s projected changes in net income for the various rate shock levels for the periods ended December 31, 2005 and 2004.              2005 Net Interest Income                 Amount       Change       Percentage   Change                 (Dollars in Thousands)         +100 bp       $   2,812       $   (68   )   (2.4   )%     Base       2,880       —       —         –100 bp       2,943       63       2.2   %                             2004 Net Interest Income                 Amount       Change       Percentage   Change                 (Dollars in Thousands)         +100 bp       $   2,045       $   (100   )   (4.7   )%     Base       2,145       —       —         –100 bp       2,287       142       6.6   %                  As shown above, at December 31, 2005, the effect of an immediate 100 basis point increase in interest rates would decrease the Company’s net income by 2.4%, or approximately $68,000. The effect of an immediate 100 basis point decrease in rates would increase the Company’s net interest income by 2.2%, or approximately $63,000. The Company’s Board of Directors has set a risk tolerance limit of 10% of estimated net interest income for the succeeding 12 months based on an immediate 200 basis point change in market prices.   Interest rate sensitivity reflected modest exposure in an increasing rate environment at the end of 2005 and 2004. Overall net interest income sensitivity decreased in 2005 compared to 2004.   12        Liquidity and Capital Resources   The Company’s primary sources of funds are deposits, repurchase agreements, and proceeds from principal and interest payments on loans and securities. While maturities and scheduled amortization of loans and securities and calls of securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions, and competition. The Company generally manages the pricing of its deposits to be competitive and to increase core deposit relationships.   Liquidity management is both a daily and long–term responsibility of management. The Company adjusts its investments in liquid assets based upon management’s assessment of (i) expected loan demand, (ii) expected deposit flows, (iii) yields available on interest–earning deposits and securities, and (iv) the objectives of its asset/liability management program. Excess liquid assets are invested generally in interest–earning overnight deposits and short– and intermediate–term U.S. Government and agency obligations.   The Company’s cash flows are comprised of three primary classifications:  cash flows from operating activities, investing activities, and financing activities. Cash flows provided by operating activities were $4.6 million, $4.4 million, and $1.9 million for the years ended December 31, 2005, 2004, and 2003. Net cash from investing activities consisted primarily of principal collections on loans and proceeds from maturation and sales of securities offset by disbursements for loan originations and the purchase of securities. In 2003, cash flows from investing activities were also affected by the $51.2 million in cash received in connection with the branch acquisition. Net cash from financing activities consisted primarily of changes in net deposits and short–term borrowings partially offset by dividends paid and the purchase of Company stock.   The Company’s most liquid assets are cash and short–term investments. The levels of these assets are dependent on the Company’s operating, financing, lending, and investing activities during any given year. At December 31, 2005, cash and short–term investments totaled $6.9 million. The Company has other sources of liquidity if a need for additional funds arises, including securities maturing within one year and the repayment of loans. The Company may also utilize the sale of securities available–for–sale, federal funds lines of credit from correspondent banks, and borrowings from the Federal Home Loan Bank of Chicago and  Marshall and Ilsley Bank.   13        The following table discloses contractual obligations and commercial commitments of the Company as of December 31, 2005:                      Less Than                       After                 Total       1 Year       1 – 3 Years       4 – 5 Years       5 Years         Lines of credit(1)       $   13,143       $   7,900       $   3,143       $   751       $   1,349         Data processing contract payable       688       198       490       —       —         Standby letters of credit(1)       721       721       —       —       —                                                                   $   14,552       $   8,819       $   3,633       $   751       $   1,349                               (1)  Represents amounts committed to customers.   During 2005 and 2004, the Company repurchased 1,260 and 1,018 shares of common stock for $89,000 and $71,000.   Capital provides the foundation for future growth. Regulatory agencies have developed minimum guidelines by which the adequacy of a financial institution’s capital may be evaluated. At December 31, 2005, all of the Company’s ratios exceeded the levels required under regulatory guidelines as shown in Note 15 of the Consolidated Financial Statements.   Facilities   First Ottawa Bancshares, Inc. is the holding company for First National Bank of Ottawa. The Company is headquartered in Ottawa, Illinois and operates four offices in Ottawa, two branches in Streator, a branch in Morris and a recently opened branch in Yorkville.    Impact of Inflation and Changing Prices   The financial statements and related data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on the operations of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution’s performance than does inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.   14        SAFE HARBOR STATEMENT   This document contains, and future oral and written statements of the Company and its management may contain, forward–looking statements, within the meaning of such term in the Private Securities Litigation Reform Act of 1995, with respect to the financial condition, results of operations, plans, objectives, future performance and business of the Company. Forward–looking statements, which may be based upon beliefs, expectations and assumptions of the Company’s management and on information currently available to management, are generally identifiable by the use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,” “may,” “will,” “would,” “could,” “should” or other similar expressions. Additionally, all statements in this document, including forward–looking statements, speak only as of the date they are made, and the Company undertakes no obligation to update any statement in light of new information or future events.   The Company’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Company and its subsidiaries include, but are not limited to, the following:   •                                         The strength of the United States economy in general and the strength of the local economies in which the Company conducts its operations which may be less favorable than expected and may result in, among other things, a deterioration in the credit quality and value of the Company’s assets.   •                                         The economic impact of past and any future terrorist attacks, acts of war or threats thereof and the response of the United States to any such threats and attacks.   •                                         The effects of, and changes in, federal, state and local laws, regulations and policies affecting banking, securities, insurance and monetary and financial matters.   •                                         The effects of changes in interest rates (including the effects of changes in the rate of prepayments of the Company’s assets) and the policies of the Board of Governors of the Federal Reserve System.   •                                         The ability of the Company to compete with other financial institutions as effectively as the Company currently intends due to increases in competitive pressures in the financial services sector.   •                                         The inability of the Company to obtain new customers and to retain existing customers.   •                                         The timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet.    15        •                                         Technological changes implemented by the Company and by other parties, including third party vendors, which may be more difficult or more expensive than anticipated or which may have unforeseen consequences to the Company and its customers.   •                                         The ability of the Company to develop and maintain secure and reliable electronic systems.   •                                         The ability of the Company to retain key executives and employees and the difficulty that the Company may experience in replacing key executives and employees in an effective manner.   •                                         Consumer spending and saving habits which may change in a manner that affects the Company’s business adversely.   •                                         Business combinations and the integration of acquired businesses which may be more difficult or expensive than expected.   •                                         The costs, effects and outcomes of existing or future litigation.   •                                         Changes in accounting policies and practices, as may be adopted by state and federal regulatory agencies and the Financial Accounting Standards Board.   •                                         The ability of the Company to manage the risks associated with the foregoing as well as anticipated.   These risks and uncertainties should be considered in evaluating forward–looking statements and undue reliance should not be placed on such statements. Additional information concerning the Company and its business, including other factors that could materially affect the Company’s financial results, is included in the Company’s Form 10-K under Item I.A. entitled “Risk Factors” and in other filings with the Securities and Exchange Commission.   16        REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   To the Board of Directors and Shareholders First Ottawa Bancshares, Inc. Ottawa, Illinois   We have audited the accompanying consolidated balance sheets of First Ottawa Bancshares, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.   We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.   In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Ottawa Bancshares, Inc. as of December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.                     BKD, LLP           Indianapolis, Indiana     January 20, 2006      17        FIRST OTTAWA BANCSHARES, INC.  CONSOLIDATED BALANCE SHEETS December 31, 2005 and 2004 (In thousands, except share and per share data)              2005       2004         Assets                         Cash and due from banks       $   6,857       $   7,930         Interest–bearing demand   deposits       —       —         Cash and cash   equivalents       6,857       7,930         Certificates of deposit       11,494       24,647         Investment securities   available for sale       90,631       104,652         Loans held for sale       —       1,701         Loans, net of allowance   for loan losses of $1,344 and $1,174       151,516       131,618         Premises and equipment       8,024       7,624         Interest receivable and   other assets       10,217       10,487                                   Total assets       $   278,739       $   288,659                                   Liabilities and Shareholders’ Equity                                                   Liabilities                         Deposits       $   239,881       $   253,964         Federal funds purchased       12,700       5,600         Securities sold under   agreement to repurchase       —       750         Other borrowings       —       559         Other liabilities       3,300       3,934         Total liabilities       255,881       264,807                                   Commitments and Contingencies                                                   Shareholders’ Equity                         Preferred stock, $1 par   value Authorized and unissued – 20,000 shares       —       —         Common stock, $1 par   value, 1,000,000 shares authorized and 750,000 issued       750       750         Additional paid–in   capital       4,039       4,018         Retained earnings       25,258       24,662         Treasury stock, at cost   – 100,651 and 99,391 shares       (5,745   )   (5,656   )     Accumulated other   comprehensive income (loss)       (1,444   )   78         Total shareholders’   equity       22,858       23,852                                   Total liabilities and   shareholders’ equity       $   278,739       $   288,659          See notes to consolidated financial statements.   18        FIRST OTTAWA BANCSHARES, INC.  CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2005, 2004 and 2003 (In thousands, except share and per share data)              2005       2004       2003         Interest and Dividend Income                                 Loans receivable       $   9,428       $   8,318       $   8,057         Investment securities                                 Taxable       2,688       3,592       3,457         Exempt from federal tax       1,004       954       748         Federal funds sold       233       40       32         Interest–bearing   deposits       555       633       357         Total interest and   dividend income       13,908       13,537       12,651                                           Interest Expense                                 Deposits       4,544       4,162       4,207         Repurchase agreements       4       2       10         Federal funds purchased       57       24       158         Other interest expense       8       12       9         Total interest expense       4,613       4,200       4,384                                           Net Interest Income       9,295       9,337       8,267         Provision for loan   losses       300       300       120         Net Interest Income After Provision for Loan   Losses       8,995       9,037       8,147                                           Noninterest Income                                 Service fee income       1,112       1,089       866         Trust and farm   management fee income       496       484       472         Net realized gains on   sales of available–for–sale securities       172       465       —         Net gains on sales of   loans       91       254       733         Other income       971       903       521         Total noninterest   income       2,842       3,195       2,592                                           Noninterest Expenses                                 Salaries and employee   benefits       4,651       4,651       4,122         Occupancy and equipment   expense       1,280       1,270       943         Data processing fees       371       334       500         Supplies       211       165       190         Professional fees       444       484       419         Amortization of core   deposit intangibles       319       399       34         Other expenses       1,225       1,504       1,205         Total noninterest   expenses       8,501       8,807       7,413                                           Income Before Income Tax       3,336       3,425       3,326         Income tax expense       791       797       867                                           Net Income       $   2,545       $   2,628       $   2,459                                           Earnings Per Share – Basic       $   3.92       $   4.03       $   3.75                                           Earnings Per Share – Diluted       $   3.90       $   4.03       $   3.75                                           Average Shares Outstanding       649,830       651,561       655,243          See notes to consolidated financial statements.   19        FIRST OTTAWA BANCSHARES, INC.  CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY Years Ended December 31, 2005, 2004 and 2003 (In thousands, except share and per share data)              Common   Stock       Additional   Paid–in   Capital       Retained   Earnings       Treasury   Stock       Accumulated   Other   Comprehensive   Income   (Loss)       Total         Balances, January 1, 2003       $   750       $   4,000       $   23,491       $   (5,270   )   $   2,212       $   25,183         Comprehensive income                                                         Net income                       2,459                       2,459         Other comprehensive   income, net of tax – unrealized losses on securities                                       (718   )   (718   )     Comprehensive income                                               1,741         Cash dividends ($3.00   per share)                       (1,962   )                   (1,962   )     Stock options vested               8                               8         Purchase of 5,329   treasury shares                               (315   )           (315   )                                                               Balances, December 31, 2003       750       4,008       23,988       (5,585   )   1,494       24,655         Comprehensive income                                                         Net income                       2,628                       2,628         Other comprehensive   income, net of tax – unrealized losses on securities                                       (1,416   )   (1,416   )     Comprehensive income                                               1,212         Cash dividends ($3.00   per share)                       (1,954   )                   (1,954   )     Stock options vested               10                               10         Purchase of 1,018   treasury shares                               (71   )           (71   )                                                               Balances, December 31, 2004       750       4,018       24,662       (5,656   )   78       23,852         Comprehensive income                                                         Net income                       2,545                       2,545         Other comprehensive   income, net of tax – unrealized losses on securities                                       (1,522   )   (1,522   )     Comprehensive income                                               1,023         Cash dividends ($3.00   per share)                       (1,949   )                   (1,949   )     Stock options vested               21                               21         Purchase of 1,260   treasury shares                               (89   )           (89   )                                                               Balances, December 31, 2005       $   750       $   4,039       $   25,258       $   (5,745   )   $   (1,444   )   $   22,858          See notes to consolidated financial statements.   20        FIRST OTTAWA BANCSHARES, INC.  CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2005, 2004 and 2003 (In thousands, except per share data)              2005       2004       2003         Operating Activities                                 Net income       $   2,545       $   2,628       $   2,459         Items not requiring   (providing) cash                                 Provision for loan   losses       300       300       120         Premium amortization on   securities, net       421       502       189         Derivative valuation   adjustment       (373   )   (411   )   —         Depreciation and   amortization       822       871       335         Loans originated for   sale, net       518       197       900         Gains on sales of   securities, net       (172   )   (465   )   —         Gains on sales of loans   held for sale       (91   )   (254   )   (733   )     Change in                                 Interest receivable and   other assets       419       791       (1,465   )     Interest payable and   other liabilities       151       241       70         Net cash provided by   operating activities       4,540       4,400       1,875                                           Investing Activities                                 Purchases of securities   available for sale       (4,729   )   (32,247   )   (43,703   )     Proceeds from   maturities and paydowns of securities available for sale       9,364       21,616       27,879         Proceeds from sales of   securities available for sale       6,830       17,230       —         Purchases of   certificates of deposit       (3,460   )   (18,086   )   (8,090   )     Proceeds from   maturities of certificates of deposit       16,986       7,040       7,885         Net change in loans       (19,392   )   (2,804   )   (9,295   )     Purchases of premises   and equipment       (903   )   (543   )   (2,537   )     Cash received in branch   acquisition       —       —       52,163         Net cash provided by   (used in) investing activities       4,696       (7,794   )   24,302                                           Financing Activities                                 Net change in                                 Deposits       (14,083   )   (10,957   )   1,866         Federal funds purchased       7,100       5,600       (14,700   )     Securities sold under   agreements to repurchase       (750   )   750       (1,622   )     Proceeds from   borrowings       27       70       —         Repayment of borrowings       (586   )   (1   )   (162   )     Purchase of treasury   stock       (89   )   (71   )   (315   )     Stock options vested       21       10       —         Cash dividends       (1,949   )   (1,954   )   (1,973   )     Net cash used in   financing activities       (10,309   )   (6,553   )   (16,906   )                                       Net Change in Cash and Cash Equivalents       (1,073   )   (9,947   )   9,271                                           Cash and Cash Equivalents, Beginning of Year       7,930       17,877       8,606                                           Cash and Cash Equivalents, End of Year       $   6,857       $   7,930       $   17,877                                           Additional Cash Flows Information                                 Interest paid       $   4,482       $   4,460       $   4,552         Income tax paid, net of   refunds       729       158       821         Transfers from loans to   foreclosed real estate       468       141       174                                           Assets acquired and   liabilities assumed in branch acquisition:                                 Loans       —       —       11,774         Premises and equipment       —       —       780         Goodwill and core   deposit intangibles       —       —       4,553         Other assets, net       —       —       18         Deposits       —       —       (69,288   )      See notes to consolidated financial statements.   21        FIRST OTTAWA BANCSHARES, INC.  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005, 2004 and 2003 (Table dollar amounts in thousands, except per share data)   NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES   Nature of Operations and Principles of Consolidation:  First Ottawa Bancshares, Inc. is a bank holding company whose principal activity is the ownership and management of its wholly–owned subsidiary, First National Bank of Ottawa (Bank). The Bank is primarily engaged in providing a full range of banking and financial services to individual and corporate customers in LaSalle, Grundy and surrounding counties in Illinois. The Bank is subject to competition from other financial institutions. The Bank is subject to the regulation of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities. The consolidated financial statements include First Ottawa Bancshares, Inc. and the Bank, and the Bank’s wholly owned subsidiary, First Ottawa Financial Corporation, together referred to as the Company. Intercompany transactions and balances are eliminated in consolidation.   Use of Estimates:  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 losses, fair values of financial instruments, derivatives, and status of contingencies are particularly subject to change.   Securities:  Securities are classified as available–for–sale when they might be sold before maturity. Securities available–for–sale are carried at fair value, with unrealized holding gains and losses reported, net of tax, as other comprehensive income. Equity securities include Federal Home Loan Bank stock and Federal Reserve Bank stock, which are restricted securities that are carried at cost, and a mutual fund investment that is carried at fair value. Securities are written down to fair value, with a charge to expense, when a decline in fair value is not temporary.   Realized gains and losses on sales are determined using the amortized cost of the specific security sold. Interest income includes amortization of purchase premiums and discounts.   Declines in the fair value of securities below their cost that are other-than-temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the Company’s ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value.   Derivatives:  All derivative instruments are recorded at their fair values and the change in the fair value of a derivative is included in interest income. If derivative instruments are designated as hedges of fair values, both the change in the fair value of the hedge and the hedged item are included in current earnings. Fair value adjustments related to cash flow hedges are recorded in other comprehensive income and reclassified to earnings when the hedged transaction is reflected in earnings. Ineffective portions of hedges are reflected in earnings as they occur.   Loans Held for Sale:  Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.   Loans:  Loans are reported at the principal balance outstanding, net of deferred loan fees and costs and the allowance for loan losses. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost, net of deferred loan fees, or estimated fair value in the aggregate. Interest income is not reported when full loan repayment is in doubt, typically when payments are past due over 90 days. Payments received on such loans are reported as principal reductions.   Allowance for Loan Losses:  The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required based on past loan loss experience, known and inherent risks in the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.   22        Loan impairment is reported when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller–balance loans of similar nature, such as residential mortgage and consumer loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the loan’s observable market price or the fair value of collateral if the loan is collateral dependent. Loans are evaluated for impairment when payments are delayed, typically 90 days or more, or when the internal grading system indicates a doubtful classification.   Premises and Equipment:  Asset cost is reported net of accumulated depreciation. Buildings and related components are depreciated using the straight–line method with useful lives ranging from 7 to 39 years. Furniture, fixtures and equipment are depreciated using the straight–line method with useful lives ranging from 5 to 15 years. These assets are reviewed for impairment when events indicate that the carrying amount may not be recoverable. Maintenance and repairs are charged to expense and improvements are capitalized.   Other Real Estate:  Real estate owned, other than that used in the normal course of business, is carried at the lower of cost basis (fair value at date of foreclosure) or fair value less estimated costs to sell. Any reduction to fair value from a related loan at the time of acquisition is accounted for as a loan loss. Any subsequent reductions in fair value less estimated costs to sell are recorded by charges to expense and a corresponding valuation allowance on the related real estate.   Mortgage Servicing Rights:  Servicing rights are recognized as assets for the allocated value of servicing rights retained on loans sold and are classified with interest receivable and other assets in the consolidated balance sheets. Servicing rights are expensed in proportion to and over the period of estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights using groupings of the underlying loans as to interest rates and then, secondarily, as to geographic and prepayment characteristics. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market–based assumptions. Any impairment of a grouping is reported as a valuation allowance. There was no such valuation allowance recorded at December 31, 2005 and 2004, and mortgage servicing rights were not material at either date.   Intangible Assets:   Core deposit intangibles are being amortized on an accelerated basis over 11 years and are periodically evaluated as to the recoverability of their carrying value.   Goodwill:   Goodwill is reviewed for impairment annually with any loss recognized through the income statement.   Stock Options:  The Company has a stock–based compensation plan, which is more fully described in Note 12. The Company accounts for this plan under the recognition and measurement principles of Statement of Financial Accounting Standards No. 123, Accounting for Stock–Based Compensation, using the fair value method. The value of options granted under this plan is charged to expense over the vesting period of the grants.   Income Taxes:  Income tax expense is the sum of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.   Earnings Per Share:  Basic earnings per share is calculated based on the weighted-average common shares outstanding during the year.    23        Fair Values of Financial Instruments:  Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed separately. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. The fair value estimates of existing on– and off–balance–sheet financial instruments do not include the value of anticipated future business or the values of assets and liabilities not considered financial instruments.   Comprehensive Income:  Comprehensive income includes both net income and other comprehensive income (loss). Other comprehensive income (loss) includes the changes in unrealized gains and losses on securities available–for–sale, and minimum pension liability, net of deferred income taxes.   Reclassifications:  Some items in the prior years’ financial statements were reclassified to conform to the current presentation.   Pending Accounting Pronouncements   Shared-Based Payment   In December 2004, the FASB issued SFAS No. 123, Revised, Share-Based Payment (SFAS 123(R)), which requires all public companies to record compensation cost for stock options and other awards provided to employees in return for employee service. The cost of the options is measured at the fair value of the options when granted and is expensed over the employee service period, which is normally the vesting period of the options granted. The Company adopted SFAS 123(R) on January 1, 2006. Future compensation cost and the impact on the Company’s results of operation as a result of any future option grants will depend on the level of any future option grants, the related vesting period, and the calculation of the fair value of the options granted as of the grant date. As such, the Company cannot currently estimate compensation expense relating to future awards.   Since the Company previously accounted for its stock options in accordance with SFAS No. 123, the adoption of SFAS No. 123(R) is not expected to have a significant impact on the Company’s financial condition or results of operations.    The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments   In January 2003, the Emerging Issues Task Force (EITF) began a project to provide additional guidance on when a market value decline on debt and marketable equity securities should be considered other-than-temporary. Currently, declines in market value that are considered to be other-than-temporary require that a loss be recognized through the income statement. In March 2004, the FASB ratified the consensus reached by the EITF in Issue 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (EITF 03-1). EITF 03-1 provides guidance for determining when an investment is considered impaired, whether impairment is other-than-temporary, and measurement of an impairment loss. In September 2004, the FASB issued a staff position (FSP 03-1-1) which delayed the effective date for the measurement and recognition guidance of EITF 03-1 due to additional proposed guidance.    In June 2005, the FASB decided not to provide additional guidance on the meaning of other-than-temporary impairment, but directed the FASB staff to issue a FASB Staff Position (FSP) titled FSP 115-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The final FSP supersedes EITF 03-1 and EITF Topic No. D-44, Recognition of Other-Than-Temporary Impairment Upon the Planned Sale of a Security Whose Cost Exceeds Fair Value. FSP FAS 115-1 replaces guidance in EITF 03-1 on loss recognition with references to existing other-than-temporary impairment guidance, such as FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS No. 115). FSP FAS 115-1 also clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell has not been made.   24        FSP FAS 115-1 was effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. The Company has consistently followed the loss recognition guidance in SFAS No. 115, so the adoption of FSP FAS 115-1 did not have a significant impact on the Company’s financial condition or results of operations.   Earnings Per Share   On September 30, 2005, the FASB issued a proposed amendment to SFAS No. 128, Earnings per Share, to clarify guidance for mandatorily convertible instruments, the treasury stock method, contingently issuable shares, and contracts that may be settled in cash or shares. The primary impact on the Company of the proposed Statement would be a change to the treasury stock method for year-to-date diluted earnings per share.   NOTE 2 – BUSINESS COMBINATION   On November 14, 2003, the Company assumed substantially all of the deposit liabilities and certain loans and other assets of two branch offices located in Streator, Illinois from First Midwest Bank. As a result of the acquisition, the Company has an opportunity to increase its customer base and continue to increase its market share.    The acquisition was accounted for under the purchase method of accounting. All assets and liabilities were recorded at their fair values as of November 14, 2003, including goodwill of $2,446,000 which is deductible for tax purposes. Additionally, core deposit intangibles totaling $2,027,000 were recognized and will be amortized over 11 years using a declining balance method. The purchase accounting adjustments are being amortized over the life of the respective asset or liability. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.      Loans       $   11,774         Premises and equipment       780         Goodwill and core deposit intangibles       4,553         Other assets, net       18         Deposits       (69,288   )                       Net liabilities assumed   and cash received       $   (52,163   )      The accumulated amortization of the core deposit intangibles at December 31, 2005 totaled $751,000. Estimated amortization expense for each of the following three years is $255,000, $204,000 and $163,000.   NOTE 3 – SECURITIES AVAILABLE FOR SALE              Amortized   Cost       Gross   Unrealized   Gains       Gross   Unrealized   Losses       Fair    Value         December 31, 2005                                         U. S. Treasury       $   10,086       $   —       $   (284   )   $   9,802         Federal agencies       40,364       2       (961   )   39,405         State and municipal       25,455       225       (484   )   25,196         Mortgage–backed   securities and collateralized mortgage obligations       10,082       43       (256   )   9,869         Corporate obligations       3,416       —       (97   )   3,319         Marketable equity   securities       3,086       —       (46   )   3,040                                                   Total investment   securities       $   92,489       $   270       $   (2,128   )   $   90,631          25                   Amortized   Cost       Gross   Unrealized   Gains       Gross   Unrealized   Losses       Fair    Value         December 31, 2004                                         U. S. Treasury       $   10,103       $   1       $   (45   )   $   10,059         Federal agencies       47,482       345       (226   )   47,601         State and municipal       26,250       576       (244   )   26,582         Mortgage–backed   securities and collateralized mortgage obligations       12,252       120       (32   )   12,340         Corporate obligations       4,686       20       (53   )   4,653         Marketable equity   securities       3,431       14       (28   )   3,417                                                   Total investment   securities       $   104,204       $   1,076       $   (628   )   $   104,652                           As of December 31, 2005 and 2004, the Company had approximately $4,269,000 and $4,505,000 invested in bonds issued by municipalities located within LaSalle County, Illinois.   Securities with an approximate carrying value of $58,012,000 and $59,097,000 were pledged at December 31, 2005 and 2004 to secure trust and public deposits, repurchase agreements, and for other purposes as required or permitted by law.   The fair value of contractual maturities of securities available for sale at December 31, 2005 were as follows. Securities not due at a single maturity date, primarily mortgage–backed and equity securities, are shown separately.              Amortized   Cost       Fair   Value         Within one year       $   6,366       $   5,975         One to five years       69,309       67,133         Five to ten years       815       1,689         After ten years       2,831       2,925                 79,321       77,722         Mortgage–backed securities and collateralized   mortgage obligations       10,082       9,869         Marketable equity securities       3,086       3,040         Totals       $   92,489       $   90,631          Information regarding realized gains and losses on sales of securities available for sale follows:              2005       2004       2003         Gross gains       $   178       $   465       $   —         Gross losses       6       —       —         Tax expense       58       158       —                       Certain investments in debt and marketable equity securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at December 31, 2005 and 2004 was $79.3 million and $48.9 million, which was approximately 87.4% and 47.1% of the Company’s available–for–sale investment portfolio at those dates. These declines primarily resulted from increases in market interest rates.   26        Based on evaluation of available evidence, including recent changes in market interest rates, management  believes the declines in fair value for these securities are temporary. Should the impairment of any of these securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other–than–temporary impairment is identified.   The following table shows our investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.              Less than 12 Months       12 Months or More       Total         Description of   Securities       Fair   Value       Unrealized   Losses       Fair   Value       Unrealized   Losses       Fair   Value       Unrealized   Losses                                                                   December 31, 2005                                                                                                                   U. S. Treasury       $   —       $   —       $   9,802       $   284       $   9,802       $   284         Federal agencies       14,711       238       23,691       723       38,402       961         State and municipal       4,774       34       11,646       450       16,420       484         Mortgage–backed   securities and collateralized mortgage obligations       4,970       151       3,388       105       8,358       256         Corporate obligations       —       —       3,319       97       3,319       97         Marketable equity   securities       —       —       3,040       46       3,040       46         Total temporarily   impaired securities       $   24,455       $   423       $   54,886       $   1,705       $   79,341       $   2,128                                                                   December 31,   2004                                                                                                                   U. S. Treasury       $   8,062       $   45       $   —       $   —       $   8,062       $   45         Federal agencies       20,130       226       —       —       20,130       226         State and municipal       11,353       244       —       —       11,353       244         Mortgage–backed securities   and collateralized mortgage obligations       5,458       31       6       1       5,464       32         Corporate obligations       3,328       53       —       —       3,328       53         Marketable equity   securities       —       —       546       28       546       28         Total temporarily   impaired securities       $   48,331       $   599       $   552       $   29       $   48,883       $   628          27        NOTE 4 – LOANS   Major classifications of loans as of December 31, 2005 and 2004 are summarized as follows:              2005       2004         Real estate       $   95,469       $   74,225         Commercial and agricultural       33,686       28,341         Installment       11,585       17,575         Home equity lines of credit       12,120       12,651         Total loans       152,860       132,792         Allowance for loan losses       (1,344   )   (1,174   )                               Net loans       $   151,516       $   131,618          Certain executive officers, directors, and their related interests are loan customers of the Company. A summary of such loans made by the Company in the ordinary course of business and made on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons is as follows:      Balance at January 1,   2005       $   1,655         New loans       1,511         Repayments       (715   )                       Balance at December 31, 2005       $   2,451          Information regarding impaired loans at December 31, 2005 and 2004 is as follows:              2005       2004         Impaired loans with an allowance       $   2,342       $   2,017         Impaired loans for   which the discounted cash flows or collateral value exceeds the carrying   value of the loan       87       44                                   Total impaired loans       $   2,429       $   2,061                                   Allowance for impaired loans included in the Company’s   allowance for loan losses       $   497       $   493                     2005       2004       2003         Average balance of impaired loans       $   2,039       $   2,074       $   1,599         Interest income recognized on impaired loans       169       127       157         Interest income recognized on impaired loans – cash   basis       126       107       153                       Nonperforming loans were as follows at December 31:              2005       2004         Loans past due over 90 days still on accrual       $   1,337       $   727         Nonaccrual loans       —       161                    28        NOTE 5 – ALLOWANCE FOR LOAN LOSSES   Activity in the allowance for loan losses is summarized as follows for the years ended December 31:              2005       2004       2003         Allowance for loan losses                                 Balances, January 1       $   1,174       $   1,049       $   1,167         Provision for losses       300       300       120         Recoveries on loans       86       98       181         Loans charged off       (216   )   (273   )   (419   )                                       Balances, December 31       $   1,344       $   1,174       $   1,049                        NOTE 6 – LOAN SALES AND SERVICING   The Company sells mortgage loans with servicing retained to the Federal Home Loan Mortgage Corporation (FHLMC) and the Illinois Housing Development Authority (IHDA). The Company realized gross proceeds from the sales of mortgage loans totaling $4,637,000, $9,133,000 and $26,296,000 in 2005, 2004 and 2003. Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of these loans are summarized as follows:              2005       2004                                   Loans serviced for                         Freddie Mac       $   32,757       $   35,698         IHDA       —       732                                           $   32,757       $   36,430                     Following is an analysis of the changes in originated mortgage servicing rights:              2005       2004       2003         Mortgage Servicing Rights                                 Balances, January 1       $   380       $   445       $   301         Servicing rights   capitalized       49       89       256         Amortization of   servicing rights       (101   )   (154   )   (112   )                                       Balances, December 31       $   328       $   380       $   445                        29        NOTE 7 – PREMISES AND EQUIPMENT    Premises and equipment consisted of the following at December 31:              2005       2004         Cost                         Land       $   1,791       $   1,816         Buildings and land   improvements       7,428       6,809         Equipment       4,606       4,307         Construction in   progress       —       46         Total cost       13,825       12,978         Accumulated depreciation and amortization       (5,801   )   (5,354   )                               Net       $   8,024       $   7,624          NOTE 8 – DEPOSITS   Deposits consisted of the following at December 31:              2005       2004         Noninterest–bearing demand       $   30,436       $   31,582         Interest–bearing demand       57,624       61,613         Savings       24,847       28,235         Money market savings       26,184       38,252         Certificates and other time deposits of $100,000 or   more       31,420       22,462         Other certificates and time deposits       69,370       71,820                                   Total deposits       $   239,881       $   253,964                     At December 31, 2005, the scheduled maturities of certificates of deposit were as follows:      2006       $   57,698         2007       19,630         2008       15,803         2009       5,626         2010       2,033                                   $   100,790          Deposits held by the Company from related parties at December 31, 2005 and 2004 totaled $2.3 million and $2.2 million, respectively.   30        NOTE 9 – BORROWINGS   The Company has a note payable that consists of a $2,000,000 unsecured line of credit with Marshall & Ilsley Bank, maturing on August 25, 2006. The outstanding balance under the line of credit was $0 and $559,000 at December 31, 2005 and 2004. Interest is payable quarterly at LIBOR plus 165 basis points (5.96% and 4.07% at December 31, 2005 and 2004).   NOTE 10 – SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE   Securities sold under agreements to repurchase are financing arrangements. Physical control is maintained for all securities sold under repurchase agreements. The average balance during 2005 and 2004 was $232,000 and $215,000 with an interest rate of 1.63% for both years. The maximum month–end balance during 2005 and 2004 was $750,000 for both years.   NOTE 11 – BENEFIT PLANS   The Bank has a noncontributory defined-benefit pension plan covering all employees who meet the eligibility requirements. In 1999, all plan benefits were frozen. The Bank’s funding policy is to make the minimum annual contribution that is required by applicable regulations, plus such amounts as the Bank may determine to be appropriate from time to time. The Bank expects to contribute approximately $200,000 to the plan in 2005. The Bank uses a December 31 measurement date for the plan.   The following tables set forth the Bank’s pension plan’s funded status and amounts actuarially determined for the years indicated:              2005       2004         Change in benefit obligation                         Beginning benefit   obligation       $   1,868       $   1,842         Interest cost       112       117         Actuarial loss       141       146         Settlements       (108   )   (107   )     Benefits paid       (126   )   (130   )                               Ending benefit   obligation       $   1,887       $   1,868                                   Change in plan assets                         Beginning fair value       $   1,507       $   1,431         Actual return       49       113         Employer contribution       209       200         Settlements       (108   )   (107   )     Benefits paid       (126   )   (130   )                               Ending fair value       $   1,531       $   1,507                                   Funded status       $   (356   )   $   (361   )     Unrecognized net actuarial loss       (436   )   (269   )                               Prepaid (accrued) benefit cost       $   80       $   (92   )                               Accumulated benefit obligation       $   1,887       $   1,868          31        Other amounts recognized in the balance sheets:              2005       2004         Accumulated other comprehensive loss       $   (217   )   $   (217   )                           2005       2004       2003         Assumptions used to determine benefit obligations                                 Discount rate       5.75   %   6.00   %   6.25   %     Expected return on plan   assets       7.0       7.0       7.0                                           Assumptions used to determine benefit costs                                 Discount rate       6.00   %   6.25   %   6.25   %     Expected return on plan   assets       7.0       7.0       7.0          The Company has estimated the long–term rate of return on plan assets based primarily on historical returns on plan assets, adjusted for changes in target portfolio allocations and recent changes in long–term interest rates based on publicly available information.              2005       2004       2003         Components of net periodic benefit cost                                 Interest cost       $   112       $   117       $   114         Return on plan assets       (106   )   (97   )   (82   )     Amortization       8       3       9                                           Net expense       $   14       $   23       $   41          The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid as of December 31, 2005:              Pension   Benefits         2005       $   132         2006       126         2007       119         2008       118         2009       112         Thereafter       553                 Plan assets are held by a bank–administered trust fund, which invests the plan assets in accordance with the provisions of the plan agreement. The permitted investments as established by the plan agreement include, but are not limited to, common and preferred stocks, open–end or closed–end mutual funds, bonds and other evidences of indebtedness or ownership, and real estate or any interest therein.   32        Asset allocation is primarily based on a strategy to provide stable earnings while attempting to recognize potentially higher returns through limited investments in equity securities. Plan assets are rebalanced periodically. At December 31, 2005 and 2004, allocations by percentages were as follows:              2005       2004         Equity mutual funds       64.2   %   63.8   %     Fixed income mutual funds       17.7       22.3         GNMA pool       .4       .6         Money market funds and other       4.8       13.3         Time Certificates of Deposit       13.0       —          At December 31, 2005 and 2004, market values of plan assets were as follows:              2005       2004         Equity mutual funds       $   983       $   961         Fixed income mutual funds       271       336         GNMA pool       5       9         Money market funds and other       73       201         Time Certificates of Deposit       199       —                    The Bank has a directors’ retirement plan which provides retirement benefits primarily to former members of the Board of Directors. The Bank also maintains a supplemental executive retirement plan that provides benefits to certain key executive officers and directors in accordance with the plan document. The Bank accrued expenses related to these plans totaling  $105,000, $126,000 and $188,000 in 2005, 2004 and 2003.   The Company’s 401(k) profit-sharing plan covers eligible employees with more than one year of service, as defined, and who are at least 21 years of age. The plan allows employee contributions. The Company may make a matching contribution equal to a percentage of salary deferral and discretionary profit-sharing contributions. The matching percentage is limited to 6% of compensation. The Company’s contributions, which are made following the end of the calendar year, totaled $140,000, $140,000 and $122,000 for 2005, 2004 and 2003.   NOTE  12 –  STOCK OPTION PLAN   The Company grants selected executives and other key employees and directors incentive and non–qualified stock option awards which vest and become fully exercisable at the discretion of the Board of Directors as the options are granted. The Company is authorized to grant options for up to 150,000 shares of the Company’s common stock. The exercise price of the options, which have a ten year life, may not be less than the market price of the Company’s stock on the date of grant.   33        The following is a summary of the status of the Company’s stock option plan and changes in that plan for 2005, 2004 and  2003. The Company had no grants outstanding prior to 2003.              2005       2004       2003         Options       Shares       Weighted–   Average   Exercise Price       Shares       Weighted–   Average   Exercise Price       Shares       Weighted–   Average   Exercise Price         Outstanding, beginning   of year       14,500       $   59.21       6,750       $   56.00       —       $             Granted       6,500       70.00       7,750       62.00       6,750       56.00                                                                   Outstanding, end of   year       21,000       62.55       14,500       59.21       6,750       56.00                                                                   Options exercisable at   year end       5,313               1,684               —                                                                           Weighted–average fair   value of options granted during the year               $   3.26               $   1.30               $   7.36          At December 31, 2004, certain information by exercise price for options outstanding and exercisable is as follows:      Exercise   Price           Number    of Shares       Weighted–   Average   Remaining   Contractual   Life       Number of   Shares   Exercisable         $   56.00           6,750       7.5 years       3,375         62.00           7,750       8.5 years       1,938         70.00           6,500       9.5 years       —                      The fair value of each option grant was estimated on the grant date using an option–pricing model with the following assumptions:              2005       2004       2003                                           Risk–free interest rates       4.37   %   4.21   %   3.27   %     Dividend yields       4.29   %   4.35   %   4.96   %     Volatility factors of expected market price of   common stock       5.37   %   3.06   %   23.55   %     Weighted–average expected life of the options       10 years       9.5 years       9.5 years          34        NOTE  13 –  EARNINGS PER SHARE   Earnings per share (EPS) were computed as follows:              Year Ended December 31,   2005                 Income       Weighted-   Average   Shares       Per Share   Amount         Net income       $   2,545       $   649,830                 Basic earnings per   share                                 Income available to   common stockholders                       $   3.92                                           Effect of dilutive   securities                                 Stock options       —       2,629                 Diluted earnings per   share                                         Income available to   common stockholders and assumed conversions       $   2,545       652,459       $   3.90                                   Year Ended December 31,   2004                 Income       Weighted-   Average   Shares       Per Share   Amount         Net income       $   2,628       $   651,561                 Basic earnings per   share                                 Income available to   common stockholders                       $   4.03                                           Effect of dilutive   securities                                 Stock options       —       1,172                 Diluted earnings per   share                                         Income available to   common stockholders and assumed conversions       $   2,628       652,733       $   4.03                                   Year Ended December 31,   2003                 Income       Weighted-   Average   Shares       Per Share   Amount         Net income       $   2,459       $   655,243                 Basic earnings per   share                                 Income available to   common stockholders                       $   3.75                                           Effect of dilutive   securities                                 Stock options       —       —                 Diluted earnings per   share                                         Income available to common   stockholders and assumed conversions       $   2,459       655,243       $   3.75                        35        NOTE 14 – INCOME TAXES   The balance sheets included the following amounts of deferred tax assets and liabilities at December 31:              2005       2004       2003         Income tax expense                                 Currently payable                                 Federal       $   721       $   337       $   619         State       88       (58   )   (8   )     Deferred       (18   )   518       256                                           Total income tax   expense       $   791       $   797       $   867                                           Reconciliation of federal statutory to actual tax   expense                                 Federal statutory   income tax at 34%       $   1,134       $   1,165       $   1,131         Tax–exempt income       (415   )   (330   )   (261   )     Nondeductible interest   expense       —       24       21         Effect of state income   taxes and other items, net       72       (62   )   (24   )                                       Actual tax expense       $   791       $   797       $   867                                           Effective tax rate       23.7   %   23.3   %   26.1   %      The components of the deferred asset (liability) included on the balance sheets are as follows:              2005       2004         Assets                         Unrealized losses on   securities available for sale       $   632       $   —         Allowance for loan   losses       341       270         Deferred compensation       278       259         Pension costs       —       201         Minimum pension   liability       133       137         Other       52       49         Total assets       1,436       916                                   Liabilities                         FHLB stock       (118   )   (98   )     Depreciation       (622   )   (584   )     Mortgage servicing   rights       (135   )   (157   )     Unrealized gain on   securities available for sale       —       (152   )     Other       (84   )   (112   )     Total liabilities       (959   )   (1,103   )                                               $   (477   )   $   (187   )      36        NOTE 15 – DERIVATIVES   The Company uses derivatives to fix future cash flows for interest payments on some of its floating rate certificates of deposit. In this regard, the Company has entered into an interest rate swap with the FHLB of Chicago to fix the interest rate on a specific certificate of deposit product. At December 31, 2005, the Company had $2.8 million of certificates of deposit, which mature in 2006 through 2010, in which it pays the FHLB a weighted-average interest rate of 3.77% and will receive an interest rate from the FHLB based on the appreciation of the S&P 500 Index. This interest received from the FHLB will be paid to the customer. The assets and liabilities in this transaction are being netted and the expense recorded in interest expense on deposits.   In addition to the above, the Company also purchased $7.9 million of certificates of deposit which are included in the certificates of deposit caption on the consolidated balance sheet. These investments have a five year term from date of purchase. The investments that individually do not exceed $100,000 are insured by the FDIC. Investments that individually exceed $100,000 are guaranteed by a standby letter of credit issued by the FHLB of Pittsburgh with no interest. The initial investment is not at risk but the return on the investment is based on a calculation of the appreciation in the S&P 500 Index. The fair value of this embedded derivative is recorded in certificates of deposit and the fair value adjustment is included in other income. At December 31, 2005, the Bank had allocated $1.2 million to this asset and recorded a valuation allowance of $116,000.   NOTE 16 – COMMITMENTS, OFF–BALANCE–SHEET RISK, AND CONTINGENCIES   There are various contingent liabilities that are not reflected in the consolidated financial statements, including claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these claims and legal actions is not expected to have a material effect on financial condition or results of operations.   The Bank is required to maintain reserve funds in cash and/or on deposit with the Federal Reserve Bank. The reserve required at December 31, 2005 was $370,000.   Some financial instruments are used in the normal course of business to meet the financing needs of customers. These financial instruments include commitments to extend credit, standby letters of credit, and financial guarantees. These involve, to varying degrees, credit and interest–rate risk in excess of the amounts reported in the financial statements.   Exposure to credit loss if the other party does not perform is represented by the contractual amount for commitments to extend credit, standby letters of credit, and financial guarantees written. The same credit policies are used for commitments and conditional obligations are used for loans. Collateral or other security is normally required to support financial instruments with credit risk.   Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being used, the total commitments do not necessarily represent future cash requirements. Standby letters of credit and financial guarantees written are conditional commitments to guarantee a customer’s performance to a third party.   37        A summary of the notional or contractual amounts of financial instruments with off–balance–sheet risk at year end follows:              2005       2004                                   Unused lines of credit       $   13,143       $   12,163         Standby letter of credit       721       171                    At December 31, 2005, all of the commitments to extend credit were at variable rates of interest.   NOTE 17 – FAIR VALUES OF FINANCIAL INSTRUMENTS   The following methods and assumptions were used to estimate fair values for financial instruments. The carrying amount is considered to estimate fair value for cash and due from banks, demand, NOW, money market and savings deposits, federal funds purchased, securities sold under repurchase agreements, accrued interest receivable and payable, and variable rate loans or deposits. Securities fair values are based on quoted market prices or, if no quotes are available, on the rate and term of the security and on information about the issuer. The fair value of loans held for sale and derivatives are based on quoted market prices. For fixed rate loans or deposits, the fair value is estimated by discounted cash flow analysis using current market rates for the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values, where applicable. The fair value of off–balance–sheet items is based on the fees or cost that would currently be charged to enter into or terminate such agreements and is not material.   The carrying values and estimated fair values of the Company’s financial instruments as of December 31, 2005 and 2004 were as follows:              2005       2004                 Carrying   Amount       Fair   Value       Carrying   Amount       Fair   Value         Assets                                         Cash and cash   equivalents       $   6,857       $   6,857       $   7,930       $   7,930         Certificates of deposit   and related derivative       11,494       11,209       24,647       24,647         Securities available   for sale       90,631       90,631       104,652       104,652         Loans held for sale       —       —       1,701       1,701         Loans       151,516       151,460       131,618       132,474         Interest receivable       2,031       2,031       1,932       1,932                                                   Liabilities                                         Deposits with no stated   maturities       139,091       124,917       159,682       146,178         Time deposits       100,790       102,508       94,282       96,519         Federal funds purchased       12,700       12,700       5,600       5,600         Securities sold under   agreement to repurchase       —       —       750       752         Other borrowings       —       —       559       559         Interest payable       702       702       571       571                          38        NOTE 18 – REGULATORY AND CAPITAL MATTERS   The Company may pay dividends without restriction under the current Federal Reserve regulations so long as it remains “adequately capitalized” after such payment. The Bank is subject to statutory dividend restrictions which provide, in general, that the Bank may pay the current year’s earnings and the prior two years’ retained earnings without the prior approval of the Office of the Comptroller of Currency. At December 31, 2005, the Bank’s stockholder’s equity totaled $22,363,000, of which $21,827,000 was not available for payment of dividends, without prior regulatory approval.   The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off–balance–sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.   The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If  undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required.   The Company’s only activity is ownership of the Bank, and, therefore, its capital, capital ratios, and minimum required levels of capital are materially the same as the Bank’s. The actual capital levels and minimum required levels for the Company were:              Actual       Required for Adequate   Capital       To Be Well   Capitalized                 Amount       Ratio       Amount       Ratio       Amount       Ratio         December 31, 2005                                                         Total risk–based   capital (to risk–weighted assets)       $   21,786       11.9   %   $   14,672       8.0   %   $   18,340       10.0   %     Tier 1 capital (to   risk–weighted assets)       20,442       11.2   %   7,336       4.0   %   11,004       6.0   %     Tier 1 capital (to   average assets)       20,442       7.2   %   11,331       4.0   %   14,163       5.0   %                                                               December 31, 2004                                                         Total risk–based   capital (to risk–weighted assets)       $   20,769       12.2   %   $   13,600       8.0   %   $   16,991       10.0   %     Tier 1 capital (to   risk–weighted assets)       19,595       11.5   %   6,800       4.0   %   10,200       6.0   %     Tier 1 capital (to   average assets)       19,595       6.7   %   11,670       4.0   %   14,588       5.0   %      At December 31, 2005, the Company and the Bank were categorized as well capitalized and management is not aware of any conditions or events since the most recent notification that would change the Company’s or Bank’s category.   39        NOTE 19 – OTHER COMPREHENSIVE LOSS               2005       2004       2003         Unrealized losses on securities                                 Unrealized holding losses   arising during the year       $   (2,135   )   $   (1,680   )   $   (1,086   )     Less: reclassification   adjustment for gains realized in net income       172       465       —         Tax effect       785       729       368                                           Other comprehensive   loss       $   (1,522   )   $   (1,416   )   $   (718   )      NOTE 20 – PARENT COMPANY FINANCIAL STATEMENTS   The following are the condensed balance sheets, statements of income and cash flows for First Ottawa Bancshares, Inc.    Condensed Balance Sheets              2005       2004         Assets                         Cash on deposit with   Bank       $   1,733       $   1,304         Investment in common   stock of Bank       22,364       24,031         Other assets       59       404                                           Total assets       $   24,156       $   25,739                                   Liabilities                         Note payable       $   —       $   559         Dividends payable       1,298       1,303         Other liabilities       —       25                 1,298       1,887                                   Shareholders’ Equity       22,858       23,852                                   Total liabilities and   shareholders’ equity       $   24,156       $   25,739          40        Condensed Statements of Income              2005       2004       2003         Income - dividends from Bank       $   2,649       $   2,003       $   2,502                                           Other income - gain on the   sale of investments       124       —       —                                           Expenses       83       85       109                                           Income   before income tax and equity in undistributed income of subsidiary       2,690       1,918       2,393                                           Income tax benefit       —       29       33                                           Income before equity in undistributed income of   subsidiary       2,690       1,947       2,426                                           Equity in undistributed income of subsidiary       (145   )   681       33                                           Net Income       $   2,545       $   2,628       $   2,459          Condensed Statements of Cash Flows              2005       2004       2003         Operating Activities                                 Net income       $   2,545       $   2,628       $   2,459         Item not requiring   (providing) cash                                 Equity in undistributed   earnings of Bank       145       (681   )   (33   )     Gains on sales of   securities, net       (124   )   —       —         Other       14       1,295       (1,302   )     Net cash provided by   operating activities       2,580       3,242       1,124                                           Investing   Activity - proceeds from sales of securities available for   sale       469       —       —                                           Financing Activities                                 Purchase of treasury   shares       (89   )   (71   )   (315   )     Loan proceeds   (payments), net       (603   )   69       (161   )     Cash dividends       (1,949   )   (1,954   )   (1,973   )     Vested stock options       21       10       8         Net cash used in   financing activities       (2,620   )   (1,946   )   (2,441   )                                       Net Change in Cash and Cash Equivalents       429       1,296       (1,317   )                                       Cash and Cash Equivalents, Beginning of Year       1,304       8       1,325                                           Cash and Cash Equivalents, End of Year       $   1,733       $   1,304       $   8          41        NOTE 21 – QUARTERLY FINANCIAL DATA (UNAUDITED)              Interest   Income       Interest   Expense       Net Interest   Income       Provision       Securities   Gains       Net   Income       Basic       Diluted         2005                                                                         First quarter       $   3,278       $   1,013       2,265       $   75       $   30       $   495       $   0.76       $   0.76         Second quarter       3,375       1,101       2,274       75       24       571       0.88       0.88         Third quarter       3,635       1,224       2,411       75       —       660       1.02       1.01         Fourth quarter       3,620       1,275       2,345       75       118       819       1.26       1.25         2004                                                                         First quarter       $   3,369       1,097       2,272       $   75       $   111       $   479       $   0.74       $   0.74         Second quarter       3,373       1,041       2,332       75       72       578       0.88       0.88         Third quarter       3,398       1,035       2,363       75       159       677       1.04       1.04         Fourth quarter       3,397       1,027       2,370       75       123       894       1.37       1.37                                     42        FIRST OTTAWA BANCSHARES, INC. SHAREHOLDERS INFORMATION   ANNUAL MEETING   The Annual Meeting of Shareholders will be held at 3 p.m., local time on May 17, 2006 at the corporate headquarters located at 701 LaSalle Street, Ottawa, Illinois 61350.   PRICE RANGE OF COMMON STOCK   As of February 7, 2006, there were approximately 539 shareholders of record and 649,349 outstanding shares of common stock.   The Company’s common stock is not traded on any national or regional securities exchange and there is no established public trading market for it. Transactions in the Company’s common stock have been infrequent. To the knowledge of the Company’s management, during 2004, 2005 and the first month of 2006, an aggregate of approximately 129,603 shares of the Company’s common stock was transferred in approximately 117 separate transactions, excluding the 1,018 shares purchased by the Company in 2004 at $70 per share, and the 620 shares purchased at $70 per share and the 640 shares purchased at $72 per share by the Company in 2005. These transfers represented both transfers for consideration (i.e., sales) and transfers for no consideration (e.g., gifts, estate transfers, etc.). The Company’s management is unable to differentiate such transfers and has limited knowledge of the sale prices for transfers involving consideration. The last price known to the Company’s management was a sale of 30 shares on February 6, 2006 at $78 per share.   The following dividends per share were paid on the Company’s common stock on the dates indicated: January 1, 2004 – $2.00; July 1, 2004 – $1.00; January 1, 2005 – $2.00; July 1, 2005 – $1.00; January 1, 2006 – $2.00.   WEB SITE FOR UNITED STATES SECURITIES AND EXCHANGE COMMISSION FILINGS   All reports filed electronically by the Company with the United Stated Securities Exchange Commission (the “SEC”), including the annual report on Form 10–K, quarterly reports on Form 10–Q, and current events reports on Form 8–K, as well as any amendments to those reports are accessible at no cost on our internet site at www.firstottawa.com and on the SEC’s web site at www.sec.gov. We will also provide you with a copy free of charge by contacting Cheryl Gage, Corporate Secretary, First Ottawa Bancshares, Inc., 701 LaSalle Street, Ottawa, Illinois 61350.   CORPORATE GOVERNANCE   The Company’s corporate governance practices are described in the following documents, which are available on the Company’s Web site at www.firstottawa.com or which may be obtained in print form through the investor relations department: Code of Business Conduct and Ethics, Audit Committee Charter, Nominating and Corporate Governance Committee Charter, and Compensation Committee Charter.   43         EX-21.1 3 a06-2311_1ex21d1.htm SUBSIDIARIES OF THE REGISTRANT       Exhibit 21.1   Subsidiaries of the Registrant      Parent       Subsidiary       Percent of Ownership       State of   Incorporation or   Organization         First Ottawa   Bancshares, Inc.       The First   National Bank of Ottawa       100   %   National Bank, Illinois         The First   National Bank of Ottawa       First Ottawa   Financial Corp.       100   %   Delaware                  EX-31.1 4 a06-2311_1ex31d1.htm 302 CERTIFICATION       Exhibit 31.1   I, Joachim J. Brown, certify that:   1.                                       I have reviewed this annual report on Form 10-K of First Ottawa Bancshares, Inc.;   2.                                        Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;   3.                                        Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;   4.                                        The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-15(e)) for the registrant and have:   a)                                         Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;   b)                                        Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and   c)                                         Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting, and;   5.                                        The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):   a)                                      All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize, and report financial information; and   b)                                    Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.      Date:   March 28,   2006   /s/ Joachim   J. Brown                     Joachim J.   Brown                 President   and Chief Executive Officer                     EX-31.2 5 a06-2311_1ex31d2.htm 302 CERTIFICATION       Exhibit 31.2   I, Vincent G. Easi, certify that:   1.                                       I have reviewed this annual report on Form 10-K of First Ottawa Bancshares, Inc.;   2.                                        Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;   3.                                        Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;   4.                                        The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-15(e)) for the registrant and have:   a)                                         Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;   b)                                        Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and   c)                                         Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting, and;   5.                                        The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):   a)                                      All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize, and report financial information; and   b)                                    Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.      Date:   March 28,   2006   /s/ Vincent   G. Easi                     Vincent G.   Easi                 Chief   Financial Officer                     EX-32.1 6 a06-2311_1ex32d1.htm 906 CERTIFICATION       Exhibit 32.1   CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002   In connection with the Annual Report of First Ottawa Bancshares, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Joachim J. Brown, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:   (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and   (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.      /s/ Joachim J. Brown                     Joachim J. Brown     Chief Executive Officer     March 28, 2006              EX-32.2 7 a06-2311_1ex32d2.htm 906 CERTIFICATION       Exhibit 32.2   CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002   In connection with the Annual Report of First Ottawa Bancshares, Inc. (the “Company”) on Form 10-K for the period ending December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Vincent G. Easi, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:   (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and   (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.        /s/   Vincent G. Easi                     Vincent   G. Easi     Chief   Financial Officer     March   28, 2006              GRAPHIC 8 g23111ka01i001.jpg GRAPHIC  begin 644 g23111ka01i001.jpg M_]C_X``02D9)1@`!`0$`8`!@``#_VP!#``H'!P@'!@H("`@+"@H+#A@0#@T- M#AT5%A$8(Q\E)"(?(B$F*S7J#A(6&AXB)BI*3E)66EYB9FJ*CI*6FIZBI MJK*SM+6VM[BYNL+#Q,7&Q\C)RM+3U-76U]C9VN'BX^3EYN?HZ>KQ\O/T]?;W M^/GZ_]H`"`$!```_`/9:***************KW]]!IMA/?7)80P(7?:,G`[`= MS6&%UO4'A?4-5&BKVQRLIE4RJ?;*L,$57M=;N8+V+3]/3O"GAZYDL;!(;:SB M>7R+=,;B!GH.I..M!X;&ZD,^N:O=1S(H;+&X9UN] MHHHIDLL<,9DED6-!U9S@#\:<"",@Y!I:*S=>T*T\1:8VGWK2K$S!\Q/M.1T] MB/8@BL)/A]`KKC4?*1&W*;>PMHI`?7>$R/PK>TO0;#2&DEMT=[F;'FW,\ADE MDQZL><>W2KS0Q/*DKQ(TD>=CE02N>N#VS2NB2H4D175NJL,@TRZA:XM984GD MMVD0J)8\;DSW&01G\*S=*\,Z=I5RUX@FNKUEVM>7+XFM(9K/4O[,M4%QNLH'D^T2Y(" M,5Z*O7!ZDCL*9JOB75;K3O\`B4:-JULQG1)IYK/YXXCG)]7$K>(]5TRZ>9<9: MU:7R`1R(T)"`]?FP3TKN=.L8],TVUL(6=H[6%8D9SEB%``)]^*LT44444444 34444444444444444444445__V3\_ ` end    -----END PRIVACY-ENHANCED MESSAGE-----