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United States
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarterly period ending June 30, 2003

OR

For the transition period from __________________ to _________

NORTHERN STATES FINANCIAL CORPORATION

1601 North Lewis Avenue
Waukegan, Illinois 60085
(847) 244-6000
(Address, including zip code, and telephone number, including
area code, of principal executive office)

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).       YES: XXX      NO:

4,305,105 shares of common stock were outstanding
as of June 30, 2003

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NORTHERN STATES FINANCIAL CORPORATION AND SUBSIDIARY
FORM 10-Q
June 30, 2003
INDEX

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PART 1. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

REPORT OF INDEPENDENT ACCOUNTANTS

Board of Directors and Stockholders
Northern States Financial Corporation
Waukegan, Illinois

     We have reviewed the condensed consolidated balance sheet of NORTHERN STATES FINANCIAL CORPORATION as of June 30, 2003 and the related condensed consolidated statements of income for the three and six month periods ended June 30, 2003 and 2002 and the condensed consolidated statements of cash flows for the six month periods ended June 30, 2003 and 2002. These financial statements are the responsibility of the Company’s management.

     We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

     Based on our reviews, we are not aware of any material modifications that should be made to the condensed financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.

     We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of Northern States Financial Corporation as of December 31, 2002, and the related consolidated statements of income, stockholders’ equity and cash flows for the year then ended (not presented herein); and in our report dated February 7, 2003, we expressed an unqualified opinion on those financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2002, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

     /s/ Crowe Chizek and Company LLC

Oak Brook, Illinois
July 24, 2003

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NORTHERN STATES FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, 2003 and December 31, 2002
(In thousands of dollars) (Unaudited)

     The accompanying notes are an integral part of these condensed consolidated financial statements.

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NORTHERN STATES FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three and six months ended June 30, 2003 and 2002
(In thousands of dollars, except per share data) (Unaudited)

     The accompanying notes are an integral part of these condensed consolidated financial statements.

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NORTHERN STATES FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six months ended June 30, 2003 and 2002
(In thousands of dollars) (Unaudited)

     The accompanying notes are an integral part of these condensed consolidated financial statements.

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NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2003

(Dollar amounts in thousands, except per share data)

(Unaudited)

Note 1 - Basis of Presentation

     The accompanying interim condensed consolidated financial statements are prepared without audit and reflect all adjustments which are of a normal and recurring nature and, in the opinion of management, are necessary to present interim financial statements of Northern States Financial Corporation (the “Company”) in accordance with accounting principles generally accepted in the United States of America. The interim financial statements do not purport to contain all the necessary financial disclosures covered by accounting principles generally accepted in the United States of America that might otherwise be necessary for complete financial statements.

     To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses and status of contingencies are particularly subject to change.

     The interim condensed financial statements should be read in conjunction with the audited financial statements and accompanying notes (or “notes thereto”) of the Company for the years ended December 31, 2002, 2001 and 2000. The results of operations for the three and six month periods ended June 30, 2003, are not necessarily indicative of the results to be expected for the full year.

     Net income was utilized to calculate both basic and diluted earnings per share for all periods presented. Information regarding weighted average shares utilized in computing basic and diluted earnings per share follows. It should be noted that all stock options were exercised in early 2002 and there have since been none outstanding.

     On April 17, 2002 it was announced that the Northern States Financial Corporation’s Board of Directors had approved a stock repurchase program that allows the Company to purchase up to 200,000 shares of Northern States Financial Corporation stock either in open market or private transactions. At February 19, 2003, the Company announced that it had approved an additional repurchase program to purchase an additional 200,000 shares of its stock. At June 30, 2003, 167,150 shares of treasury stock had been purchased that the Company carries at cost.

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NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2003

(Dollar amounts in thousands, except per share data)

(Unaudited)

     Information related to stockholders’ equity was as follows:

Note 2 - Commitments, Off-Balance Sheet Risk and Contingencies

     At June 30, 2003 and December 31, 2002, the contract amount of the Company’s off-balance sheet commitments were as follows:

     Since many commitments to make loans expire without being used, the amounts above do not necessarily represent future cash commitments. Collateral obtained upon exercise of the commitments is determined using management’s credit evaluation of the borrower, and may include commercial and residential real estate and other business and consumer assets.

     Commitments to make loans to related parties totaled $577 and $1,006 at June 30, 2003 and December 31, 2002. These commitments were made at the same terms and conditions available to nonrelated parties.

     The Company also has Community Reinvestment Act (CRA) investment commitments outstanding of $871 as of June 30, 2003. The commitment is to be funded over the next six years.

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NORTHERN STATES FINANCIAL CORPORATION

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

     The following discussion focuses on the consolidated financial condition of the Northern States Financial Corporation (the “Company”) at June 30, 2003 and the consolidated results of operations for the three and six month periods ended June 30, 2003, compared to the same period of 2002. The purpose of this discussion is to provide a better understanding of the condensed consolidated financial statements of Northern States Financial Corporation and the operations of its wholly owned subsidiary, the Bank of Waukegan (the “Bank”) and the Bank’s wholly owned subsidiary, Northern States Community Development Corporation (“NSCDC”). This discussion should be read in conjunction with the interim condensed consolidated financial statements and notes thereto included herein.

     The statements contained in this management’s discussion and analysis that are not historical facts are forward-looking statements subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. The Company cautions readers of this report that a number of important factors could cause the Company’s actual results subsequent to June 30, 2003 to differ materially from those expressed in any such forward-looking statements.

FINANCIAL CONDITION

     The consolidated total assets for the Company were $633.7 million at June 30, 2003, decreasing $1.9 million from December 31, 2002. The decrease was attributable to declines to the Company’s cash and cash equivalents that were partially offset by increases to the Company’s securities portfolio.

     The Company’s federal funds sold at June 30, 2003 declined $19.2 million to $1.8 million from $20.9 million at December 31, 2002. The Company’s federal funds sold position decreased in order to fund increases to securities available for sale that were $16.1 million greater than at December 31, 2002. The fair value of securities at June 30, 2003 was $253.0 million of which $222.9 million were pledged to secure repurchase agreements and public deposits. The statement of cash flows shows that $670.8 million in securities were called or matured during the first six months of 2003 compared to only $173.1 million for the same period last year. With interest rates falling the issuers of securities had incentive to call the securities. At June 30, 2003, the Company has $127.9 million in U.S. Government agency securities with call options and an additional $81.0 million that will mature within 90 days.

     The Company’s gross loans and leases declined slightly at June 30, 2003 from December 31, 2002 by $466,000. Loan demand during the first half of 2003 has receded compared to previous years as the economy has slowed and there is uncertainty as to the future. The Company’s commercial loan and real estate construction loans decreased $6.1 million and $5.5 million from year-end as commercial loans were secured by real estate and construction projects were completed. These loans were transferred to the real estate mortgage portfolio to more consistently reflect the underlying collateral of these loans causing real estate mortgages to increase $9.1 million. The Company’s home equity loans increased by $1.0 million indicating the continued popularity of this type of loan because of its tax advantages to the borrower. Installment consumer loans also increased from year-end by $1.2 million. At June 30, 2003, loans to related parties totaled $4.9 million increasing $2.4 million from December 31, 2002.

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NORTHERN STATES FINANCIAL CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

     During the first six months of 2003, deposits at the Company increased slightly by $2.1 million from December 31, 2002. Deposits from municipal and other public entity depositors decreased $8.7 million from year-end. This decline resulted from the normal cyclical nature of public entities drawing down their balances for operational purposes during the early part of the year until real estate tax payments are received during the second half of the year. This decrease was offset by increases to retail and commercial deposits that grew by $7.3 million and $3.1 million during the first half of 2003. Retail customers have increased their deposits due to disenchantment with the stock market and the Company offers competitive interest rates that have helped to increase retail savings and NOW accounts. Deposit balances from related parties totaled $12.7 million at June 30, 2003.

     Securities sold under repurchase agreements and other short-term borrowings at the Company decreased by $3.6 million from December 31, 2002 with balances of $93.6 million at June 30, 2003. Securities sold under repurchase agreements are offered through an overnight repurchase agreement product and a term product with maturities from 7 days to one year. The decrease in repurchase agreements was mainly from the overnight repurchase agreement product that was $5.8 million less at June 30, 2003 compared to the prior year-end. At June 30, 2003 the Company had $2.5 million in federal funds purchased compared to none at December 31, 2002. At June 30, 2003, securities sold under repurchase agreements to related parties totaled $51.7 million. Borrowings from the Federal Home Loan Bank through term advances remained at $6.5 million at June 30, 2003.

     Total stockholders’ equity increased $307,000 to $76.9 million during the six months ended June 30, 2003. The increase is the result of net income of $2,884,000, plus the adjustment in the valuation allowance for the market value of securities available for sale, net of tax, of $33,000, less $285,000 due to the purchase of 10,000 shares of the Company’s common stock as treasury stock and less $2,325,000 paid out as a cash dividend at $.54 per share.

     The tier 1 capital to average asset ratio at June 30, 2003 was 11.90% and the total tier 2 capital to asset ratio, on a risk adjusted basis, amounted to 18.11%, exceeding the minimum required to be well capitalized under prompt corrective action regulations, which minimums are 5.00% and 10.00%. Book value per share was $17.86 at June 30, 2003 as compared to $17.75 at December 31, 2002. On June 30, 2003, the Company and the Bank were in compliance with all applicable regulatory capital requirements.

RESULTS OF OPERATIONS

NET INCOME

     The consolidated net income for the quarter ended June 30, 2003 was $1,502,000, decreasing $592,000 or 28.27% compared to net income of $2,094,000 for the same period the previous year. The annualized return on average assets was .95% for the quarter, a decrease from a return on average assets for the same quarter the previous year of 1.47%. The consolidated net income for the six months ended June 30, 2003 was $2,884,000, a decrease of $1,210,000 over the first half of 2002. The annualized return on average assets for the first six months of 2002 was .91%, decreasing from the return on average assets for the same period the previous year of 1.43%.

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NORTHERN STATES FINANCIAL CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

NET INTEREST INCOME

     Net interest income, the difference between interest income earned on average interest earning assets and interest expense on average interest bearing liabilities, decreased $764,000 to $4,393,000 during the three months ended June 30, 2003, compared to the same three months in 2002.

     One of the major factors affecting net interest income during the second quarter of 2003 was the level of nonaccrual loans and leases. Although nonaccrual loans and leases at June 30, 2003 and June 30, 2002 were the same at $15.3 million, lease pools totaling $11.3 million were placed on non-accrual status at June 30, 2002. The Company had been recognizing income of $290,000 per quarter on these leases pools prior to placing the lease pools on non-accrual status.

     In addition, interest rates during the second quarter of 2003 were lower compared to the second quarter of 2002 contributing to lower net interest income as loans and securities yields dropped to a greater extent than yields on deposits and borrowings. At June 30, 2003 over half of the Company’s loan portfolio are variable rate that are affected by changes to the prime rate. The lower rates are evidenced by the prime lending rate that for much of the second quarter of 2003 was 4.25% with it dropping to 4.00% at the end of the quarter as compared to 4.75% during the same period last year. Table 1, “Analysis of Average Balance and Tax Equivalent Rates for the Three Months ended June 30, 2003 and 2002” shows that the net yield on interest earning assets decreased 93 basis points to 2.91% during the second quarter of 2003 from 3.84% last year.

     Yields on interest earning assets declined during the second quarter of 2003 by 133 basis points compared to the second quarter of 2002. Average loan rates during the second quarter of 2003 were 5.78% and declined 102 basis from the same quarter last year. Yields earned on taxable securities also decreased 182 basis points to 2.81% during the second quarter of 2003 compared to the same period last year. Interest income on taxable securities consequently declined by $505,000 during the second quarter of 2003 compared to last year. The effect of the calls and maturities during the first half of 2003, combined with the calls and maturities that took place during the last six months of 2002, is that the yields on taxable securities have fallen to a much greater extent than loans as new securities were purchased yielding lower interest rates.

     Yields on interest bearing liabilities decreased by 55 basis points during the second quarter of 2003 to 2.00% compared to the second quarter of 2002 yields of 2.55%. The lower rates paid on interest bearing liabilities had the effect of lowering interest expense during the second quarter of 2003 by $285,000 compared to the same quarter of 2002.

     For similar reasons net interest income for the six months ended June 30, 2003 decreased $1,348,000 compared to the same period of 2002. Interest rates during the first 6 months of 2003 declined with the prime rate dropping from 4.25% to 4.00% at June 30, 2003 while, during the same period of 2002, rates remained stable with the prime rate at 4.75% throughout the period. Table 2, “Analysis of Average Balance and Tax Equivalent Rates for the Six Months ended June 30, 2003 and 2002” shows that yields on interest earning assets declined 128 basis points during the first half of 2003 compared to last year. Table 2 shows that rates paid on interest bearing liabilities decreased to a lesser extent, declining only 59 basis points during the first six months of 2003 compared to the same six months of 2002. These developments caused net interest income to decrease.

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NORTHERN STATES FINANCIAL CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

TABLE 1

NORTHERN STATES FINANCIAL CORPORATION
ANALYSIS OF AVERAGE BALANCE AND TAX EQUIVALENT RATES
For the Three Months Ended June 30, 2003 and 2002 – Rates are Annualized
($ 000s)

(1)	–	Interest income on loans includes loan origination and other fees of $129 and $106 for the three months ended June 30, 2003 and 2002.
(2)	–	Tax-exempt income is reflected on a fully tax equivalent basis utilizing a 34% rate.
(3)	–	Non-accrual loans are included in average loans.
(4)	–	Rate information was calculated on the average amortized cost for securities. The three months ended June 30, 2003 and 2002 average balance information includes an average unrealized gain (loss) for taxable securities of $1,779 and ($435) and for tax-advantaged securities of $295 and $192.

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NORTHERN STATES FINANCIAL CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

TABLE 2

NORTHERN STATES FINANCIAL CORPORATION
ANALYSIS OF AVERAGE BALANCE AND TAX EQUIVALENT RATES
For the Six Months Ended June 30, 2003 and 2002 – Rates are Annualized
($ 000s)