UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

[X]       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2002
Commission file number 0-37053

FIRST FEDERAL BANCSHARES, INC.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation or organization)

37-1397683
(IRS Employer Identification No.)

109 East Depot Street, Colchester, Illinois 62326
(Address of Principal Executive Offices) (Zip Code)

(309) 776-3225
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [ X ]

State the number of shares outstanding of each of the issuer’s classes of common equity as of the latest practicable date.

As of November 12, 2002 the Registrant had outstanding 1,809,230 shares of common stock.

FIRST FEDERAL BANCSHARES, INC.

Form 10-Q Quarterly Report

Index

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

First Federal Bancshares, Inc. and Subsidiary
Consolidated Statements of Financial Condition
(in thousands of dollars, except share data)
(unaudited)

See notes to consolidated financial statements.

1

First Federal Bancshares, Inc. and Subsidiary
Consolidated Statements of Income
(in thousands of dollars, except share data)
(unaudited)

See notes to consolidated financial statements.

2

First Federal Bancshares, Inc. and Subsidiary
Consolidated Statements of Shareholders’ Equity
Nine months ended September 30, 2001 and 2002
(in thousands of dollars, except share data)
(unaudited)

See notes to consolidated financial statements.

3

First Federal Bancshares, Inc. and Subsidiary
Consolidated Statements of Cash Flows
(in thousands of dollars)
(unaudited)

See notes to consolidated financial statements.

4

FIRST FEDERAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2002
(table amounts in thousands of dollars, except share data)

Note 1 – Basis of Presentation

The accompanying interim consolidated financial statements have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain disclosures required by accounting principles generally accepted in the United States of America are not included herein. These interim statements should be read in conjunction with the Company’s Annual Report on Form 10-KSB. The December 31, 2001 balance sheet presented herein has been derived from the audited financial statements included in the Company’s Annual Report on Form 10-KSB, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

Interim statements are subject to possible adjustment in connection with the annual audit of the Company for the year ending December 31, 2002. In the opinion of management of the Company, the accompanying unaudited interim consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the consolidated financial position and consolidated results of operations for the periods presented. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.

Note 2 – Earnings Per Share

For purposes of per share calculations, the Company had 1,807,840 and 2,242,500 shares of common stock outstanding at September 30, 2002 and 2001. Basic earnings per share for the three months ended September 30, 2002 and 2001 were computed by dividing net income by the weighted average number of shares outstanding. Diluted earnings per share for the three and nine months ended September 30, 2002 and 2001 were computed by dividing net income by the weighted average number of shares outstanding, adjusted for the dilutive effect of the outstanding stock options and stock awards. Computations for basic and diluted earnings per share are provided below.

See notes to consolidated financial statements.

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Note 3 – Recent Developments – New Accounting Pronouncements

Financial Accounting Standards Board (FASB), in July 2001, issued SFAS 142, “Goodwill and Other Intangible Assets”, which requires that goodwill no longer be amortized to earnings, but instead be reviewed for impairment. The amortization of goodwill by the Company ceased upon adoption of the Statement, which became effective at January 1, 2002. Adoption of SFAS 142 has not had a material effect on the Company’s financial statements.

Effective January 1, 2003, SFAS 143, “Accounting for Asset Retirement Obligations”, will apply. The statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period incurred. Adoption of SFAS 143 is not expected to have a material effect on the financial position and operations of the Company.

The Company adopted SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” on January 1, 2002. The statement requires that the Company recognize an impairment loss on long-lived assets when the carrying amount is not recoverable and the measurement of the impairment loss is the difference between the carrying amount and the fair value of the asset. Adoption of SFAS 144 did not have a material effect on the Company’s financial statements.

On October 1, 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 147, “Acquisitions of Certain Financial Institutions.” SFAS No. 147 is effective October 1, 2002, and may be early applied. SFAS No. 147 supersedes SFAS No. 72, “Accounting for Certain Acquisitions of Banking or Thrift Institutions.” SFAS No. 147 provides guidance on the accounting for the acquisition of a financial institution, and applies to all such acquisitions except those between two or more mutual enterprises. Under SFAS No. 147, the excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired in a financial institution

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business combination represents goodwill that should be accounted for under SFAS No. 142, “Goodwill and Other Intangible Assets.” If certain criteria are met, the amount of the unidentifiable intangible asset resulting from prior financial institutions acquisitions is to be reclassified to goodwill upon adoption of this Statement. Financial institutions meeting conditions outlined in SFAS No. 147 are required to restate previously issued financial statements. The objective of the restatement is to present the balance sheet and income statement as if the amount accounted for under SFAS No. 72 as an unidentifiable intangible asset had been reclassified to goodwill as of the date the Company adopted SFAS No. 142. Adoption of SFAS No. 147 on October 1, 2002 did not have a material effect on the Company’s consolidated financial position or results of operations.

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

SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Reform Act of 1995 as amended, and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identifiable by use of the words such as “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. 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 affect on the operations and future prospects of the Company and its wholly-owned subsidiaries include, but are not limited to, changes in: interest rates; general economic conditions; legislative/regulatory provisions; monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board; the quality or composition of the loan or investment portfolios; demand for loan products; deposit flows; competition; demand for financial services in the Company’s market area; and accounting principles, policies, and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning the Company and its business, including additional factors that could materially affect the Company’s financial results, is included in the Company’s filings with the Securities and Exchange Commission.

The following discussion compares the financial condition of First Federal Bancshares, Inc. (Company) and its wholly owned subsidiary, First Federal Bank (Bank), at September 30, 2002 to its financial condition at December 31, 2001 and the results of its operations for the three-month and nine-month periods ended September 30, 2002 to the same period in 2001. This discussion should be read in conjunction with the interim financial statements and footnotes included herein.

FINANCIAL CONDITION

Total assets were $242.2 million at September 30, 2002 and December 31, 2001. During the nine months ended September 30, 2002, cash and cash equivalents increased $7.2 million, which reflects excess operating cash resulting from the timing of loan prepayments and an increase in customer deposits. Loans decreased $5.7 million primarily as a result of portfolio loans refinancing into the Federal Home Loan Bank Mortgage Partnership Finance fixed rate program and also to other competitors due to the lower interest rate environment. Securities available-for-sale decreased $16.5 million and securities held-to maturity increased $14.8 million. The increase in held-to-maturity securities was primarily a result of proceeds from principal paydowns and maturities of securities available-for-sale being reinvested in securities held-to-maturity.

The allowance for loan losses was $596,000 at September 30, 2002 and $534,000 at December 31, 2001. There were no impaired loans at either date. The allowance for loan losses represented .56% of total loans and 67.70% of nonperforming loans at September 30, 2002 compared to .47% of total loans and 59.01% of nonperforming loans at December 31, 2001. Nonperforming assets totaled $965,000 and $1,120,000 at September 30, 2002 and December 31, 2001, respectively. The ratio of non-performing assets to total assets at September 30, 2002 was .41% compared to ..46% at December 31, 2001.

Total liabilities at September 30, 2002 were $201.4 million compared to $198.5 million at December 31, 2001, an increase of $2.9 million, primarily due to an increase in customer deposits of $2.6 million. The increased funds from customer deposits have been invested in interest-earning deposits at other institutions until such time as the funds can be redeployed into loans receivable or securities.

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Shareholders’ equity at September 30, 2002 was $40.8 million compared to $43.7 million at December 31, 2001, a decrease of $2.9 million. The decrease primarily reflects the repurchase of treasury stock totaling $5.6 million, offset by net income of $1.5 million and unrealized gains on available-for-sale securities, net of tax, of $1.2 million.

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2002 AND
SEPTEMBER 30, 2001

Net income increased $30,000 to $497,000 for the quarter ended September 30, 2002 compared to the same period in 2001. The increase in net income was primarily a result of an increase in net interest income, offset by a decrease in noninterest income and increases in noninterest expense and the income tax provision.

Net interest income was $1.7 million for the quarter ended September 30, 2002 compared to $1.6 million for the same prior year period. The increase in net interest income was primarily a result of an increase in the net interest spread and the net interest margin to 2.42% and 2.89%, respectively, for the quarter ended September 30, 2002 from 1.71% and 2.61% for the same period in 2001. The average yield on interest-earning assets decreased to 5.40% for the quarter ended September 30, 2002 from 6.46% for the same quarter in 2001, while the average yield on interest-bearing liabilities decreased to 2.98% for the quarter ended September 30, 2002 from 4.74% for the same period in 2001. These decreases reflect the overall decrease in market rates from the prior year. The increase in the spread and the margin was due largely to the decrease in the cost of funds exceeding the decrease in the yield on interest-earning assets as interest-earning assets and interest-bearing liabilities repriced downward in reaction to the continued decreasing interest rate environment.

The provision for loan losses was zero for the quarter ended September 30, 2002 and $48,000 for the same period in 2001. The decrease in the provision for loan losses can be attributed to the overall decrease in the loan portfolio due to repayments and refinancings.

On a quarterly basis, management of the Company meets to review the allowance for loan losses. Management classifies loans in compliance with regulatory classifications. Classified loans are individually reviewed to arrive at specific reserves for those loans. Once the specific portion of the allowance is calculated, management calculates a historical portion for each loan category based on loan loss history, peer data, current economic conditions and trends in the portfolio, including delinquencies and impairments, as well as changes in the composition of the loan portfolio. Although management believes that the allowance for loan losses reflected probable incurred losses on existing loans at September 30, 2002, there can be no assurance that such losses will not exceed estimated amounts. Future adjustments to the allowance may be necessary due to economic, operating, regulatory and other conditions that may be beyond the Company’s control. The allowance for loan losses as of September 30, 2002 was maintained at a level that represents management’s best estimate of losses in the loan portfolio and such losses were both probable and reasonably estimatable.

Noninterest income was $97,000 for the three-month period ended September 30, 2002 compared to $139,000 for the same period in 2001. The decrease in noninterest income was primarily a result of a $36,000 decrease in other income and a $13,000 decrease in net gains on the sale of securities partially offset by a $7,000 increase in other fee income. Other income was increased during the three-month period ended September 30, 2001 due to a refund from Nasdaq. The refund inflated the prior year period, which explains the decrease during this three-month period ended September 30, 2002.

Noninterest expense was $1.0 million and $914,000 for the quarters ended September 30, 2002 and 2001. The increase in noninterest expense primarily reflects an increase in compensation and benefits expense of $120,000 associated with an increase in salaries of $20,000, an increase of $22,000 in employee benefits including health insurance and retirement funds, and expense of $68,000 associated with the restricted stock awards granted in October of 2001. Occupancy and equipment expense increased $23,000, along with small increases in data processing, advertising and professional fees, offset by a decrease in other

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noninterest expense of $62,000 as a result of lower real estate owned expense and decreases in the write off of uncollectible deposits during the three months ended September 30, 2002 compared to the same period in 2001.

The Company’s federal income tax expense increased $11,000 to $293,000 for the quarter ended September 30, 2002 compared to the same period in 2001. Income tax expense was approximately 37% and 38% of pretax income in both periods, respectively.

RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2002 AND SEPTEMBER 30, 2001

Net income decreased $85,000 to $1.5 million for the nine months ended September 30, 2002 compared to the same period in 2001. Return on average assets was .83% for the nine months ended September 30, 2002 compared to ..84% for the nine months ended September 30, 2001.

Net interest income was $5.2 million for the nine months ended September 30, 2002 compared to $5.0 million for the same period in 2001. The increase in net interest income was primarily a result of an increase in the net interest spread and the net interest margin to 2.41% and 2.92%, respectively, for the nine months ended September 30, 2002 from 1.85% and 2.79% for the nine months ended September 30, 2001. The average yield on interest-earning assets decreased to 5.46% for the nine months ended September 30, 2002 from 6.75% for the same period in 2001 while the average yield on interest-bearing liabilities decreased to 3.05% for the nine months ended September 30, 2002 from 4.90% for the same period in 2001. These decreases reflect an overall decrease in the market rates from 2001. The increase in the spread and the margin was due largely to the decrease in the cost of funds exceeding the decrease in the yield on earning assets as interest-earning assets and interest-bearing liabilities repriced downward in reaction to the continued decreasing interest rate environment.

The provision for loan losses was $7,000 for the nine months ended September 30, 2002 and $48,000 for the same period in 2001. The decrease in the provision for loan losses can be attributed to the overall decrease in the loan portfolio due to the repayments and refinancings.

Noninterest income was $306,000 for the nine-month period ended September 30, 2002 compared to $449,000 for the prior period. The decrease in noninterest income was primarily a result of a decrease in net gain on the sale of securities in the amount of $101,000 and a $39,000 decrease in other income due to a refund from Nasdaq in 2001, which inflated other income during the nine-months ended September 30, 2001.

Noninterest expense was $3.1 million and $2.8 million for the nine months ended September 30, 2002 and 2001. The increase in noninterest expense primarily reflects an increase in compensation and benefits expense of $394,000 associated with an increase in salaries of $105,000, an increase of $56,000 in employee benefits including health insurance and retirement funds, and expense of $203,000 associated with the restricted stock awards granted in October of 2001. Data processing expense increased $58,000 due to the implementation of new products such as internet banking. Other noninterest expenses decreased $157,000 as a result of decreases in real estate owned expense and repossessed asset expense, a decrease in Illinois franchise tax expense, a decrease in amortization of goodwill due to the fact that goodwill was fully amortized in 2001, and small decreases in other miscellaneous expenses.

The company’s federal income tax expense decreased $83,000 to $905,000 for the nine months ended September 30, 2002 compared to the same period in 2001. Income tax expense was approximately 38% of pretax income in both periods.

LIQUIDITY

The Company must maintain an adequate level of liquidity to ensure the availability of sufficient funds to fund loan originations and deposit withdrawals, to satisfy other financial commitments, and to take advantage of investment opportunities. The Company invests excess funds in overnight deposits and

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other short-term interest-bearing assets to provide liquidity to meet these needs. At September 30, 2002, cash and cash equivalents totaled $25.5 million. At September 30, 2002, the Company had commitments to fund loans of $742,000. At the same time, certificates of deposit which are scheduled to mature in one year or less totaled $90.3 million. Management believes, based on past experience, that a significant portion of those deposits will remain with the Company. Based on the foregoing, in addition to the Company’s high level of core deposits and capital, the Company considers its liquidity and capital resources sufficient to meet its outstanding short-term and long-term needs.

CAPITAL RESOURCES

The Bank is subject to capital-to-asset requirements in accordance with bank regulations. The following table summarizes the Bank’s regulatory capital requirements versus actual capital as of September 30, 2002:

ADDITION

The Company is in the process of building a two-story addition to its office building located at 101 N. 36^th Street in Quincy, Illinois. The projected cost is estimated at $725,000. The addition will house the commercial loan department and corporate offices plus add needed storage space and area for projected growth of the Quincy loan departments.

MERGER

On June 4, 2002, the Company, and PFSB Bancorp, Inc. (“PFSB Bancorp”), the parent company of Palmyra Savings, entered into an Agreement and Plan of Merger pursuant to which PFSB Bancorp will merge with and into First Federal Bancshares. Concurrently with the merger, Palmyra Savings will merge with and into the Bank. The merger, which is valued at approximately $9.2 million, is expected to close in the fourth quarter of 2002 pending the necessary regulatory and shareholder approvals. The transaction will increase the Company’s assets to approximately $305 million and increase its number of banking offices from six to nine. Under the terms of the transaction, shareholders of PFSB Bancorp will be entitled to receive either $21.00 in cash, shares of the Company common stock, or a combination of both in exchange for their shares of PFSB Bancorp common stock.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Qualitative Aspects of Market Risk. The Company’s most significant form of market risk is interest rate risk. The principal objectives of the Company’s interest rate risk management are to evaluate the interest rate risk inherent in certain balance sheet accounts, determine the level of risk appropriate given the Company’s business strategy, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with the Board of Director’s approved guidelines. The Company has an Asset/Liability Committee, responsible for reviewing its asset/liability policies and interest rate risk position, which meets monthly and reports trends and interest rate risk position to the Board of Directors quarterly. The extent of the movement of interest rates is uncertainty that could have a negative impact on the earnings of the Company.

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The Company has used the following strategies to manage interest rate risk: (1) emphasizing the origination of adjustable-rate and balloon loans and not originating long-term, fixed-rate loans for retention in its portfolio; (2) emphasizing shorter term consumer loans; (3) introducing floating-rate commercial business loans tied to the prime rate; (4) maintaining a high quality securities portfolio that provides adequate liquidity and flexibility to take advantage of opportunities that may arise from fluctuations in market interest rates, the overall maturity of which is monitored in relation to the repricing of its loan portfolio; and (5) using Federal Home Loan Bank advances to better structure maturities of its interest rate sensitive liabilities. The Company currently does not participate in hedging programs, interest rate swaps or other activities involving the use of off-balance sheet derivative financial instruments.

Quantitative Aspects of Market Risk. The Company primarily utilizes an interest sensitivity analysis prepared by the Office of Thrift Supervision to review the level of interest rate risk of the Bank. This analysis measures interest rate risk by computing changes in the net portfolio value of the Bank’s cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. Net portfolio value represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This analysis assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained 100 to 300 basis point increase or decrease in market interest rates with no effect given to any steps that management might take to counter the effect of that interest rate movement. The following table, which is based on information provided to the Bank by the Office of Thrift Supervision, presents the change in the Bank’s net portfolio value at June 30, 2002, that would occur upon an immediate change in interest rates based on Office of Thrift Supervision assumptions, but without giving effect to any steps that management might take to counteract that change. All model outputs associated with the –300 and –200 bp scenarios are not applicable because of the abnormally low prevailing interest rate environment.

The Office of Thrift Supervision uses certain assumptions in assessing the interest rate risk of savings associations. These assumptions relate to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under differing interest rate scenarios, among others.

As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, if interest rates change, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the table.

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ITEM 4. CONTROLS AND PROCEDURES

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PART II — OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

15.

CERTIFICATIONS

I, James J. Stebor, certify that:

The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

Date: November 12, 2002

/s/ James J. Stebor
James J. Stebor
President and Chief Executive Officer

CERTIFICATIONS

I, Cathy D. Pendell, certify that: