UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of
The Securities Exchange Act of 1934

For the quarterly period ended: March 31, 2005

Commission file number 0-14468

FIRST OAK BROOK BANCSHARES, INC.

1400 Sixteenth Street, Oak Brook, IL 60523 — Telephone Number (630) 571-1050
(Address of principal executive offices)

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 þ No o

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

As of May 5, 2005, 9,753,340 shares of the Company’s common stock, par value $2.00 per share, were outstanding.

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FIRST OAK BROOK BANCSHARES, INC. AND SUBSIDIARIES

INDEX

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

FIRST OAK BROOK BANCSHARES, INC. AND SUBSIDIARIES

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CONSOLIDATED BALANCE SHEETS (Continued)

See Accompanying Notes to Consolidated Financial Statements.

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FIRST OAK BROOK BANCSHARES, INC. AND SUBSIDIARIES

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CONSOLIDATED STATEMENTS OF INCOME (Continued)
(Unaudited)

See Accompanying Notes to Consolidated Financial Statements.

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FIRST OAK BROOK BANCSHARES, INC. AND SUBSIDIARIES

See Accompanying Notes to Consolidated Financial Statements.

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FIRST OAK BROOK BANCSHARES, INC. AND SUBSIDIARIES

See Accompanying Notes to Consolidated Financial Statements.

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FIRST OAK BROOK BANCSHARES, INC. AND SUBSIDIARIES

1.	Basis of Presentation

The unaudited consolidated financial statements for the three month period ended March 31, 2005 include the accounts of First Oak Brook Bancshares, Inc. (the “Company”) and its wholly-owned subsidiaries, Oak Brook Bank (the “Bank”) and First Oak Brook Capital Markets, Inc. (“FOBCM”). Also included are the accounts of Oak Real Estate Development Corporation, West Erie, LLC and OBB Real Estate Holdings, LLC, all of which are wholly-owned subsidiaries of the Bank. All intercompany accounts and transactions have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. For further information, refer to the audited consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

The preparation of the accompanying unaudited consolidated financial statements requires management to make estimates and assumptions that effect the amounts reported in the interim financial information. Actual results may differ from those estimates.

2.	Earnings per Share

Basic earnings per share (“EPS”) are computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted EPS are computed by dividing net income by the weighted average number of common shares adjusted for the dilutive effect of weighted average outstanding stock options and restricted stock units.

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The following table sets forth the computation for basic and diluted EPS for the three month period ended March 31, 2005 and 2004:

Weighted average stock options outstanding that were not included in the denominator for diluted EPS totaled 75,000 and 49,934 for the three month period ended March 31, 2005 and 2004, respectively, as their effect would be antidilutive. There were no antidilutive weighted average restricted stock units outstanding at March 31, 2005 and 2004.

3.	Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB No. 25”). As a result, no compensation expense is recognized when options are granted under the Incentive Compensation Plan or when shares are purchased under the Employee Stock Purchase Plan. Had compensation cost for the plans been determined as if the Company had accounted for its stock-based compensation plans consistent with the fair value method of SFAS No. 123R, the Company’s net income and earnings per share would have been reduced.

During the first quarter, the Company granted 6,850 restricted stock units (“RSUs”) under the Incentive Compensation Plan. The RSU awards vest in 20% installments on each of the sixth through tenth anniversaries of the date of grant, subject to accelerated vesting upon death or disability or a change in control, or may be forfeited in certain circumstances. Shares of common stock will be paid on a one-for-one basis with respect to vested RSUs during the calendar year following the calendar year in which the RSU-holder attains age 59, or, if later, the year the RSU vests, subject to earlier distribution in the event of death, disability or a change in control. As required by APB No. 25, compensation expense for the issuance of restricted stock units is recognized over the ten year required service period based on the fair value of the units on the date of grant. The fair value of a unit was $29.42 based on the closing price per share of common stock on the day prior to the grant.

Receipt of the equity awards is conditioned on the recipient being or becoming a party to an agreement with the Company regarding confidentiality, non-solicitation of employees and customers, and prohibited conduct.

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For the purposes of pro forma disclosures, the estimated fair value of the stock options is amortized to expense over the stock options’ vesting period. The Company’s pro forma information follows:

Included in the determination of net income as reported at March 31, 2005 is compensation expense related to RSUs of $3,000 ($2,000 net of tax). There were no RSUs awarded or outstanding during 2004.

4.	Junior Subordinated Notes Issued to Capital Trusts

The Company established three separate statutory trusts in 2003, 2002, and 2000 for the purpose of issuing, in aggregate, $23 million of Trust Preferred Capital Securities (“TRUPS”) as part of three separate pooled trust preferred offerings distributed in institutional private placements. The proceeds from such issuances were used by the trusts to purchase junior subordinated notes of the Company, which are the sole assets of each trust. The Company wholly owns all of the common securities of each trust which, in the aggregate, total $713,000. The equity in the common securities is included in “Other assets” on the consolidated balance sheet.

In accordance with FIN No. 46R, these statutory trusts qualify as variable interest entities for which the Company is not the primary beneficiary and, therefore, are ineligible for consolidation. Accordingly, the statutory trusts were deconsolidated on January 1, 2004, and are now accounted for using the equity method.

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The table below summarizes the outstanding junior subordinated notes and the related TRUPS issued by each trust as of March 31, 2005 (dollars in thousands):

5.	Reclassification

Certain amounts in the 2004 interim consolidated financial statements have been reclassified to conform to their 2005 presentation.

6.	New Accounting Pronouncements

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004) (“SFAS No. 123R”), “Share-Based Payment,” which requires companies to recognize in the income statement the grant-date fair value of stock options and other equity-based compensation issued to employees (shares issued through the Incentive Compensation Plan or the Employee Stock Purchase Plan), but expresses no preference for a type of valuation model. SFAS No. 123R also provides implementation guidance and is effective for most public companies’ interim period beginning after June 14, 2005 (the third quarter for calendar-year-end companies). On April 14, 2005 the Securities and Exchange Commission (the “Commission”) announced the adoption of a new rule that amends the compliance dates for SFAS No. 123R. The Commission’s new rule allows companies to implement SFAS No. 123R at the beginning of their next fiscal year, instead of the next reporting period that begins after June 14, 2005. As such, the Company will adopt SFAS No. 123R on January 1, 2006, the beginning of its next fiscal year.

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

Executive Summary

The Company, primarily through the Bank, operates a single line of business encompassing a general retail and commercial banking business primarily in the Chicago metropolitan area. The Bank is located in a highly competitive market, facing competition for banking and related financial services from many financial intermediaries. The Bank offers a full range of banking products and services and maintains a full-

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service investment management and trust department. The Company also has an investment sales center to execute investment transactions primarily for commercial businesses, not-for-profit organizations, governmental entities and high net worth individuals and families. During the second quarter of 2005, the services and investment products offered by the investment sales center will be assumed by and offered through the Company’s subsidiary, FOBCM.

The profitability of the Company’s operations depends on net interest income, the provision for loan losses, noninterest income, and noninterest expense. Net interest income is dependent on the amounts and yields of interest-earning assets relative to the amounts and costs of interest-bearing liabilities, noninterest-bearing liabilities and capital. Net interest income is sensitive to changes in market rates of interest and to the execution of the Company’s asset/liability management strategy. The provision for loan losses is affected by management’s assessment of the quality and collectibility of the loan portfolio, loss experience, economic and market factors as well as growth in and changes to the composition of the loan portfolio.

Noninterest income consists primarily of service charges from treasury management clients, merchant credit card processing fees, investment management and trust fee income, and to a lesser extent, gains on mortgages sold, securities dealer and annuity commissions and other ancillary income. Noninterest expenses are heavily influenced by offering competitive salaries and benefits, the growth of the Company’s operations and branching structure, merchant credit card interchange expense, advertising expense, professional fees and any necessary provision for loss on other real estate owned. The Company’s primary growth strategy continues to emphasize the expansion of branch locations in the Chicago metropolitan area (and particularly the western suburbs of Chicago). The Company opened its Darien branch in March 2005 and has announced four additional branches planned to open in 2005 and 2006. See “Branch Expansion” for additional information.

Set forth below are significant items that occurred during the first quarter of 2005 and some related 2004 discussion:

	•	Assets at March 31, 2005 were $2.058 billion, down 1% from $2.083 billion at year-end 2004 and up 7% from $1.926 billion at March 31, 2004.
	•	Investments were $834.5 million, down slightly from $841.1 million at December 31, 2004 and up from $755.1 million at March 31, 2004. The Company is redeploying cash flows from the investment portfolio into funding loan growth. See “Investments” for more information.
	•	Loans grew to $1.102 billion, up 3% from $1.072 billion at year-end 2004 and up 14% from $962.9 million at March 31, 2004. See “Loans” for more information.
	•	Deposits were $1.731 billion, up 1% from $1.715 billion at year-end 2004 and up 10% from $1.568 billion at March 31, 2004, primarily due to growth in time deposits. See “Deposits” for more information.
	•	Shareholders’ equity was $128.0 million at March 31, 2005, down from $133.8 million at year-end 2004 and down from $130.7 million at March 31, 2004. The decline is due primarily to market depreciation in the investment portfolio in the first quarter of 2005 and stock repurchases by the Company. See “Capital Resources” for more information.
	•	Net income for the first quarter of 2005 was $4.280 million, down $485,000 as compared to the same period in 2004 due primarily to margin compression. See “Earnings Highlights” for more information.

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	•	No provision for loan losses was recorded for the first quarter of 2005 due to improved asset quality and net recoveries for the quarter. The Management Watch list (including commitments) was $361,000 at March 31, 2005, up slightly from $259,000 at December 31, 2004 and down from $8.8 million at March 31, 2004.
	•	Total Other Real Estate Owned (“OREO”) dropped to $5.130 million at March 31, 2005, down from $9.857 million at year-end 2004 and down from $12.895 million at March 31, 2004 due to continued success in liquidating the remaining inventory of condominium units and parking spaces of the property at 60 W. Erie. See “Asset Quality” for more information.

Application of Critical Accounting Policies

The Company has established various accounting policies which govern the application of accounting principles generally accepted in the United States in preparation of the Company’s consolidated financial statements. Certain accounting policies involve significant judgments and assumptions by management which have a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience, projected results and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates, which could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company.

The Company believes the policies that govern the allowance for loan losses and the deferred tax assets and liabilities are critical accounting policies that require the most significant judgments and estimates used in preparation of its consolidated financial statements. See Item 7, Application of Critical Accounting Policies and Note 1, Significant Accounting Policies, commencing on pages 17 and 57, respectively, of the Company’s 2004 Annual Report on Form 10-K for additional descriptions of the critical accounting policies as well as the other significant accounting policies of the Company.

Earnings Highlights – First Quarter Results

The Company recorded net income for the first quarter of 2005 of $4,280,000 compared with net income of $4,765,000 for the first quarter of 2004. Basic EPS for the first quarter of 2005 were $.43 compared to basic EPS of $.49 for the first quarter of 2004, while first quarter diluted EPS were $.43 for 2005 compared with diluted EPS of $.48 for 2004.

Key performance indicators for the first quarter of 2005 showed an annualized return on average assets (“ROA”) of .84% compared to ROA of 1.04% for the first quarter of 2004. The annualized return on average shareholders’ equity (“ROE”) for the first quarter of 2005 was 13.04% compared to ROE of 15.42% for the first quarter of 2004.

Net interest income is the difference between interest earned on loans, investments, and other earning assets and interest paid on deposits and other interest-bearing liabilities. The net interest spread is the difference between the average rates on interest-earning assets and the average rates on interest-bearing liabilities. The net interest margin represents net interest income divided by average earning assets. The effective rate paid for all funding sources is lower than the rate paid on interest-bearing liabilities alone because a significant portion of the Company’s funding is derived from interest-free sources, primarily demand deposits and shareholders’ equity.

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Average balances and effective interest yields and rates on a tax equivalent basis for the three months ended March 31, 2005 and 2004 were as follows (dollars in thousands):

⁽²⁾ Investment securities are shown at their respective carrying values. Based on the amortized cost, the average balance and weighted-average tax-equivalent yield of total investment securities was $845,564 and 4.32% for the three months ended March 31, 2005; and $761,774 and 4.61% for the three months ended March 31, 2004.

⁽³⁾ Includes average nonaccrual loans.

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The following table indicates the reconciliation of the GAAP interest income to the tax-equivalent interest income as reported in the average balance sheet for the quarters ended March 31, 2005 and 2004:

Net interest income for the first quarter of 2005, on a tax-equivalent basis, decreased $312,000, or 2%, compared to the first quarter of 2004. This decrease is primarily attributable to a 38 basis point decrease in the net interest margin to 2.70% for the first quarter of 2005 from 3.08% for the same period last year, partially offset by a 13% increase in average earning assets. However, on a linked quarter basis the margin is down just 2 basis points from 2.72% for the fourth quarter of 2004.

The changes in net interest income and the net interest margin as compared to the first quarter of 2004 were primarily the result of the following:

RATE

•	For the first quarter of 2005, the yield on average earning assets increased 2 basis points to 4.79% while the cost of interest-bearing liabilities increased 48 basis points to 2.48%. Margin compression was primarily the result of being liability sensitive (liabilities reprice more quickly than assets) as interest rates rose, competitive pressures on loan and deposit pricing and the flattening of the yield curve. The Fed funds rate stayed constant until June 2004, at which time the Federal Reserve began raising rates gradually – doing so seven times for an aggregate increase of 175 basis points by March 2005 (including two times during the first quarter of 2005).
•	The slight increase in the yield on average earning assets is due primarily to the increase in yields on loans partially offset by a decrease in the yield earned on investment securities. The yield on average loans increased 13 basis points due to the rising rate environment and an overall increase in loan fees of $129,000 in the first quarter of 2005 compared to the first quarter of 2004. Although loan fees are amortized to income over the loan period as a normal part of the business, the additional fees associated with the prepayment of loans are less predictable and, during periods of higher prepayment activity, can result in a spike in earnings since these fees are recorded in income when received. The investment portfolio yield declined partially as a result of the overall shortening of the average contractual maturity of the portfolio to 6.3 years at March 31, 2005 from 8.2 years at March 31, 2004.
•	The increase in the cost of average interest-bearing liabilities is due primarily to the rising rate environment. The Federal Reserve increased interest rates on Fed funds 175 basis points since June 30, 2004. This increase was partially offset by growth in public fund time deposits which typically have a relatively lower cost and shorter terms than promotional rate retail time deposits.

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VOLUME

•	Total average earning assets increased $217.7 million, or 13%, compared to the first quarter of 2004. The Company’s average securities portfolio increased by $77.1 million, or 10%, and consists primarily of increases in U.S. Government agency securities ($125.3 million), partially offset by decreases in U.S. Treasuries ($30.8 million) and corporate and other securities ($16.6 million). See “Investment Securities” for further analysis.
•	Average loans for the first quarter of 2005 increased $151.8 million, or 16%, compared to the first quarter of 2004. The increase primarily consists of increases in indirect vehicle loans ($60.2 million), construction loans ($35.5 million), commercial and syndicated loans ($32.5 million), home equity loans ($11.8 million), residential mortgage loans ($8.6 million), and commercial mortgage loans ($3.3 million). See “Loans” for further analysis.
•	Average Fed funds sold and interest-bearing deposits with other banks decreased $11.2 million due primarily to cash flows from deposit growth being primarily invested in loans and readily marketable U.S. Government agency securities rather than in the Fed funds market.
•	Average interest-bearing liabilities increased $184.9 million, or 13%, compared to the first quarter of 2004. Average interest-bearing deposits increased $212.6 million due to growth in time deposits ($184.0 million), money market accounts ($21.1 million), and savings and NOW accounts ($7.5 million). Time deposits were augmented by a $182.9 million average increase in public funds. See “Deposits” for further analysis.
•	Average securities sold under agreements to repurchase and other short-term borrowings decreased $26.7 million due primarily to a $21.2 million average decrease in term repurchase agreements.
•	Average demand deposits increased $17.8 million due primarily to new customer volume, partially offset by closed accounts.

The Company did not record a provision for loan losses for the first quarter of 2005 due primarily to improved asset quality, including the reduction in Management Watch list loans to $361,000 at March 31, 2005 from $8.8 million at March 31, 2004, and net recoveries for the quarter. The Company’s provision for loan losses was $250,000 in the first quarter of 2004. See “Allowance for Loan Losses” and “Asset Quality” for more information.

Total other income increased $172,000, or 4%. Service charges on deposit accounts paid in cash from treasury management clients decreased $250,000, or 21%, due primarily to higher demand deposit balances and higher earnings credit rates being paid on demand deposit account balances. Total treasury management fees, both cash fees and fees offset by earnings credits on deposit balances decreased 2% compared to the first quarter of 2004. The industry shift from paper based payments to lower priced electronic payments continues to put pressure on gross treasury management revenues. Treasury management clients have the option of paying for services either by maintaining noninterest-bearing deposit balances, paying in cash, or in a combination of deposit balances and cash. The treasury management fees included in the financial statements represent only the cash fees paid by treasury management clients. As interest rates rise (as they did beginning in late 2004) so does the value of earnings credits assigned to deposit balances. As a result, deposit balances cover more service charges and cash fees tend to decline in a rising rate environment.

Investment management and trust fees increased $95,000 due primarily to an increase in total trust assets resulting from strong business development results and high client retention rates. Discretionary assets under management climbed to $760.4 million at March 31, 2005, up from $672.4 million at March 31, 2004. Total

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trust assets under administration rose to $951.5 million at March 31, 2005, up from $845.2 million at March 31, 2004.

Merchant credit card processing fees increased $320,000 due primarily to a $16.2 million increase in sales volume (primarily new customers), partially offset by price concessions that resulted from competitive pressures. The number of merchant outlets at March 31, 2005 increased to 595 compared to 455 at March 31, 2004. Merchant credit card interchange expense, included in Other Expenses, increased $302,000 compared to the first quarter of 2004. Continued growth is anticipated due to new high-volume merchant customers brought in during the first quarter of 2005.

Gain on mortgages sold with servicing released increased $71,000 compared to the first quarter of 2004. This increase was due primarily to the Company selling a larger dollar amount of mortgage originations and, to a lesser extent, a change in the compensation structure for originators from solely commission based to a salary plus a fixed incentive per loan. The Company originated a total of $18.6 million in mortgage loans in the first quarter of 2005, of which $6.9 million were sold. During the same period of 2004, the Company originated $16.6 million in mortgage loans, of which $2.0 million were sold. Gain on mortgages sold is shown net of applicable costs of $9,000 for the first quarter of 2005 and 2004. The Company anticipates continued growth in income related to mortgages during the remainder of 2005 due to significant planned advertising for the Company’s new “guaranteed best rate” mortgage and home equity products.

Income from the sale of covered call options decreased $95,000. The Company periodically sells options to securities dealers for the dealers’ right to purchase certain U.S. Treasury or U.S. Government agency securities held within the investment portfolio. These transactions are designed primarily as yield enhancements to increase the total return associated with holding the securities as earning assets. There were no outstanding call options at March 31, 2005.

The Company recorded net investment securities gains of $163,000 for the first quarter of 2005 as compared to $167,000 for the first quarter of 2004. In the first quarter of 2005, the net gains were recorded on sales of $15.2 million in U.S. Government agency securities and $10.0 million in U.S. Treasuries. In 2004, the net gains were primarily recorded on sales of $34.4 million in U.S. Treasuries, $30.8 million in U.S. Government agency and $1.1 million in corporate and other securities. As market opportunities present themselves, the Company periodically sells securities to reposition its investment portfolio in an effort to improve overall yield or adjust the portfolio duration. Gains or losses from investment sales are considered non-recurring by the Company’s management.

Total other expenses increased $915,000, or 9%. Annualized operating expenses as a percentage of average assets improved to 2.2% for 2005 as compared to 2.3% for 2004. Annualized net overhead expenses as a percentage of average earning assets were 1.4% for both 2005 and 2004. The efficiency ratio (other expenses divided by net interest income and other income) was 64.5% in 2005 compared to 58.8% in 2004.

Salaries and employee benefits increased $406,000 due primarily to higher compensation costs and increased costs of employee benefits, especially unemployment and health insurance. The average number of full-time equivalents was 345 for the first quarter of 2005 and 2004.

The combined expense for Occupancy and Equipment increased $17,000. The Company anticipates a continued increase in these expenses due to the opening of the Darien branch in March 2005 and the three additional branches planned to open later in 2005. See “Branch Expansion” for more information.

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Professional fees increased $152,000 due primarily to a reimbursement of legal fees in 2004 related to a fully recovered problem credit and increased ongoing costs in 2005 related to compliance with the Sarbanes-Oxley Act. The Company expects an ongoing higher level of fees in 2005 for corporate governance and audit.

Merchant credit card interchange expense increased $302,000 due primarily to increased sales volume and higher interchange rates. Merchant credit card processing fees, included in Other Income, rose $320,000.

Income Taxes

Income tax expense for the first quarter of 2005 totaled $1,955,000 as compared to $2,266,000 for 2004. When measured as a percentage of income before taxes, the Company’s effective tax rate was 31.4% in 2005 as compared to 32.2% in 2004. Effective tax rates are lower than statutory rates due primarily to the investment in tax-exempt municipal bonds and the increase in the cash surrender value of bank owned life insurance (“BOLI”), both of which are not taxable for Federal income tax purposes. The Company’s provision for income taxes includes Federal income tax expense of 35% applied to taxable income in both 2005 and 2004. The Company had no state tax provision recorded for the first three months of 2005 or 2004 due primarily to significant income from state tax-exempt investment securities (U.S. Treasuries and U.S. Government agency securities), the existence of a state net operating loss carryforward which resulted from a significant charge-off in 2002 and, to a lesser extent, tax planning initiatives.

FINANCIAL CONDITION

Liquidity

Effective management of balance sheet liquidity is necessary to fund growth in earning assets, to meet maturing obligations and depositors’ withdrawal requirements, to pay shareholders’ dividends, and to purchase common stock under stock repurchase programs.

The Company has numerous sources of liquidity including readily marketable investment securities, shorter-term loans within the loan portfolio, principal and interest cash flows from investments and loans, the ability to attract retail and public fund time deposits and to purchase brokered time deposits and access to various other borrowing arrangements.

Available borrowing arrangements are summarized as follows:

The Bank

	•	Fed funds lines aggregating $200 million with six correspondent banks, subject to the continued good financial standing of the Bank. As of March 31, 2005, all $200 million was available for use under these lines.
	•	Reverse repurchase agreement lines aggregating $400 million with four brokerage firms subject to the pledge of specific collateral and the continued good financial standing of the Bank. As of March 31, 2005, all $400 million was available for use under these lines, subject to the availability of collateral. An investment security is pledged towards a reverse repurchase agreement at the time the Bank enters into such agreement.
	•	Advances from the FHLB of Chicago subject to the pledge of specific collateral and ownership of sufficient FHLB of Chicago stock. As of March 31, 2005, advances totaled $134.9 million and approximately $40.0 million remained available to the Bank under the FHLB of Chicago agreements

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		without the pledge of additional collateral. The Bank has pledged substantially all residential mortgage loans, specifically listed multi-family mortgage loans and agency securities towards the advances. Additional advances can be obtained subject to the availability of collateral.
	•	The Bank has a borrowing line of approximately $187.1 million at the discount window of the Federal Reserve Bank, subject to the availability of collateral. The Bank has pledged substantially all construction loans and the majority of commercial mortgage loans against this line. The line was unused at March 31, 2005.

As of March 31, 2005, the Bank has investment securities totaling approximately $69.7 million available to pledge as collateral towards reverse repurchase agreements or additional FHLB of Chicago advances.

Parent Company

	•	The Company has cash, short-term investments and other marketable securities totaling $11.9 million at March 31, 2005.
	•	The Company has an unsecured revolving credit arrangement for $15 million. The line was unused at March 31, 2005. The line was renewed through April 1, 2006 and is anticipated to be renewed annually.

Interest Rate Sensitivity

The business of the Company and the composition of its balance sheet consist of investments in interest-earning assets (primarily loans and investment securities) which are primarily funded by interest-bearing liabilities (deposits and borrowings). Such financial instruments have varying levels of sensitivity to changes in market rates of interest. The net income of the Company depends, to a substantial extent, on the differences between the income the Company receives from loans, investment securities, and other earning assets and the interest expense it pays to obtain deposits and other liabilities. These rates are highly sensitive to many factors that are beyond the control of the Company, including general economic conditions and the policies of various governmental and regulatory authorities, such as the Federal Reserve Bank. In addition, since the Company’s primary source of interest-bearing liabilities are customer deposits, the Company’s ability to manage the types and terms of such deposits may be somewhat limited by customer preferences and local competition in the market in which the Company operates.

The Company manages its overall interest rate sensitivity through various measurement techniques including rate shock analysis. In addition, as part of the risk management process, asset and liability management policies are established and monitored by management. The policy objective is to limit the change in annual net interest income to 10% from an immediate and sustained parallel change in interest rates of plus or minus 200 basis points. However, as a result of interest rate levels at December 31, 2004, the Company assumed rates would not decline 200 basis points. As rates have risen since year end, the Company has again begun to analyze interest rate sensitivity at minus 200 basis points. At March 31, 2005 and December 31, 2004, the Company was within policy objectives based on its models.

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Rate shock analysis assesses the risk of changes in annual net interest income in the event of an immediate and sustained parallel change in market rates. The profile as of March 31, 2005 indicates a 200 basis point increase in interest rates generates a decrease in net interest income of $2,432,000 or a 5.0% reduction in base case projected net interest income. When interest rates are shocked down 200 basis points, a decrease in net interest income of $16,000 of base case projected net interest income would result. These projections should not be relied upon as indicative of actual results that would be experienced if such interest rate changes occurred. The interest rate sensitivity presented includes assumptions that (i) the composition of the Company’s interest sensitive assets and liabilities existing at period end will remain constant over the twelve month measurement period and (ii) that changes in market interest rates are parallel and instantaneous across the yield curve. This analysis is also limited by the fact that it does not include any balance sheet repositioning actions the Company may take, such as lengthening or shortening the duration of the securities portfolio, should severe movements in interest rates occur. These repositioning actions would likely reduce the variability of net interest income shown in the extreme interest rate shock forecasts.

The change in the Company’s interest rate risk profile at March 31, 2005 compared to December 31, 2004 is primarily due to changes in the composition of the balance sheet as well as changes in interest rates from year-end levels.

Commitments

In the normal course of business, there are various outstanding commitments and contingent liabilities, including commitments to extend credit, performance standby letters of credit and financial standby letters of credit (collectively “commitments”) that are not reflected in the consolidated financial statements.

The Company’s exposure to credit loss in the event of nonperformance by the other party to a commitment is limited to its contractual amount. Many commitments expire without being used. Therefore, the amounts stated below do not necessarily represent future cash commitments. Commitments to extend credit are agreements to lend funds to a customer as long as there is no material violation of any condition established in the contract. Specifically, home equity lines are reviewed annually, and the Bank has the ability to deny any future extensions of home equity balances based upon the borrowers’ credit. Performance standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer’s obligation to a third party. Financial standby letters of credit are conditional guarantees of payment to a third party on behalf of a customer of the Company. These commitments are subject to the same credit policies followed for loans recorded in the consolidated financial statements.

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A summary of these commitments to extend credit follows:

Investment Securities

The following table sets forth the carrying value of investment securities held on the dates indicated.

At March 31, 2005, there are no investment securities of any one issuer in excess of 10% of shareholders’ equity other than securities of the U.S. Government and its agencies and the FHLB of Chicago.

The Company’s investment portfolio decreased $6.6 million, or 1%, to $834.5 million at March 31, 2005 from $841.1 million at December 31, 2004. This decrease was primarily in U.S. Government agency securities and state and municipal obligations. The effective duration of the entire portfolio (excluding FHLB of Chicago stock, perpetual preferred stock, money market funds and equity securities, which have no stated maturity) was 3.11 at March 31, 2005 compared to 2.63 at December 31, 2004. The average contractual maturity of the portfolio (with the same exclusions) was 6.3 years at March 31, 2005 and December 31, 2004.

U.S. Treasuries: The Company’s holdings of U.S. Treasuries increased slightly due primarily to investment security transactions. The average contractual maturity of this portfolio decreased slightly to 8.2 years at March 31, 2005 from 8.4 years at December 31, 2004.

U.S. Government agencies: The Company’s holdings of U.S. Government agency securities (including agency mortgage-backed securities and agency collateralized mortgage obligations totaling $42.7 million) decreased

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$5.8 million due primarily to investment securities transactions and an unrealized loss on the portfolio of $10.2 million at March 31, 2005 as a result of market depreciation over the first quarter of 2005. The average contractual maturity of this portfolio was 5.8 years at March 31, 2005 and December 31, 2004.

State and municipal obligations: The Company’s holdings of state and municipal obligations decreased $1.1 million primarily due to investment securities transactions. The average contractual maturity of this portfolio increased slightly to 3.7 years at March 31, 2005 from 3.6 years at December 31, 2004.

Corporate and other securities: The Company’s holdings of corporate and other securities decreased slightly during the first quarter of 2005. At March 31, 2005 the portfolio consisted of $26.9 million in TRUPS, $19.7 million of FHLB of Chicago stock, $8.7 million in Fannie Mae perpetual preferred stock and $3.5 million in money market funds, corporate debt, and equity securities. The average contractual maturity of the TRUPS and corporate debt decreased to 22.3 years at March 31, 2005 from 22.5 years at December 31, 2004. The remaining securities in this portfolio do not have a stated maturity.

Periodically, the Company will sell options to securities dealers for the dealers’ right to purchase certain U.S. Treasuries or U.S. Government agency securities held within the investment portfolio. These transactions are designed primarily as yield enhancements to increase the total return associated with holding the securities as earning assets. The option premium income generated by these transactions is recognized as other noninterest income when received. There were no call options outstanding at March 31, 2005 or December 31, 2004.

The following table presents the total carrying value of callable securities in the portfolio and their respective coupon range by investment type as of March 31, 2005:

None of the U.S. Treasuries have call features as of March 31, 2005.

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Loans

The following table indicates loans outstanding, as of the dates indicated:

Total loans increased $30.8 million as compared to December 31, 2004 due primarily to increases in construction, land acquisition and development, syndicated, residential and indirect vehicle loans. The growth was the result of continued new business development and a solid pipeline.

The commercial and syndicated loan portfolios are primarily secured by business assets. Loans secured by real estate comprise the greatest percentage of total loans. Commercial mortgages and construction, land acquisition and development loans are generally secured by properties in the Chicago metropolitan area. Substantially all of the Company’s residential mortgage loans are secured by first mortgages, and home equity lines are secured primarily by junior liens (and sometimes first liens) on one-to-four family residences in the Chicago metropolitan area. Substantially all of the Company’s combined portfolio of residential mortgages and home equity lines have loan to value ratios of 80% or less of the appraised value. Indirect vehicle loans represent consumer loans made through a network of new car and Harley Davidson dealers. Other than the following descriptions, there is no significant concentration of loans exceeding 10% of total loans in any specific industry or specific region of the United States other than the Chicago metropolitan area.

Commercial loans increased $1.9 million to $118.6 million at March 31, 2005. Included in commercial loans are lease financing receivables totaling $27.2 million and $28.6 million at March 31, 2005 and December 31, 2004, respectively. Commercial loans are comprised of approximately 21% new car dealers; 13% insurance premium receivables; 5% physicians’ practices; 5% construction transportation; and 56% of various other industries in which the Company has no significant concentration.

Syndicated loans increased $12.2 million to $47.1 million at March 31, 2005 due primarily to the outstanding balance on new loans booked totaling $15.6 million, partially offset by payoffs and paydowns. Total exposure to nationally syndicated loans (including unfunded commitments) was $118.1 million and $102.3 million at March 31, 2005 and December 31, 2004, respectively. Of the total exposure, approximately 25% is in the gaming and leisure industry; approximately 24% in the food and dairy industry; and 51% of various other industries in which the Company has no significant concentration.

Construction, land acquisition and development loans increased $13.5 million to $89.3 million at March 31, 2005 due primarily to new loans booked with outstanding balances totaling $20.0 million, partially offset by

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payoffs and paydowns. This portfolio is comprised of approximately 65% construction of 1-4 family detached homes, condominiums and townhouses in the Chicago metropolitan area; 23% retail developments; and 12% multi-family residential projects.

Commercial mortgage loans decreased $7.8 million to $240.1 million at March 31, 2005 due primarily to payoffs totalling $13.7 million, partially offset by new loans booked. This portfolio is comprised of approximately 40% multi-family residential properties; 27% retail properties; 24% owner-occupied office and industrial properties; and 9% non-owner occupied office and industrial properties.

Residential mortgage loans increased $6.0 million to $115.1 million at March 31, 2005 due primarily to new loans booked, offset by payoffs and paydowns. The Company kept $11.7 million of the $18.6 million in 2005 mortgage loan originations for the Bank’s portfolio. The remaining $6.9 million in originations were sold with servicing released to investors. Generally, at the time of origination, the Company makes the determination if the loan will be kept in the portfolio or sold to investors based upon an analysis of the Bank’s need and current market trends.

Indirect auto loans increased $2.0 million to $278.4 million at March 31, 2005 due primarily to $35.2 million in new loans, offset by payoffs and regular paydowns. The Company’s indirect auto portfolio consists of approximately 15,500 loans originated in the Chicago metropolitan area, of which 80% are new vehicles and 20% are used vehicles. The Bank is currently eighth in the Chicago market among banks in new car loan originations. The average life of the indirect auto portfolio is 2.8 years.

Harley-Davidson motorcycle loans increased $3.6 million to $55.1 million at March 31, 2005. The Company’s portfolio consists of approximately 4,700 loans generated in thirteen states as part of a national marketing initiative, of which 58% were originated in Illinois and Wisconsin.

The Company did not have any programs to buy subprime indirect loan paper or any other subprime credit in 2005 or 2004.

Allowance For Loan Losses

The allowance for loan losses is maintained at a level believed adequate by management to absorb estimated probable loan losses. Management’s periodic evaluation of the adequacy of the allowance is based on both quantitative and qualitative factors including: the Company’s past loan loss experience, known and inherent risks in the portfolio, size and composition of the loan portfolio, current economic conditions, historical losses experienced by the industry, value of the underlying collateral, and other relevant factors. Loans which are determined to be uncollectible are charged off against the allowance for loan losses and recoveries of loans that were previously charged off are credited to the allowance. See “Application of Critical Accounting Policies” in the 2004 Annual Report on Form 10-K for further analysis of the Company’s policy on the allowance for loan losses.

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The following table summarizes the loan loss experience for the first three months of 2005 and 2004.

Net recoveries for the first three months of 2005 totaled $3,000 compared to net charge-offs of $88,000 in 2004. In 2005, charge-offs totaled $123,000 which related primarily to the Company’s indirect vehicle portfolio. Recoveries totaled $126,000, including $32,000 in restitution from the 60 W. Erie loan fraud. The remaining recoveries relate primarily to the Company’s indirect vehicle portfolio. In 2004, charge-offs of $157,000 and recoveries of $69,000 related primarily to the indirect vehicle portfolio. Annualized net charge-offs on the average indirect portfolio were 5 basis points for the first quarter of 2005 and 13 basis points for the first quarter of 2004, well below peers.

The Company’s allowance for loan losses was $8.5 million at March 31, 2005 and 2004, representing ..78% and .89% of loans outstanding, respectively. The allowance for loan losses is sufficient to provide for probable losses based on management’s evaluation of the risks inherent in the various loan categories. Management believes the allowance for loan losses is at an adequate level.

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Asset Quality

The following table summarizes the Company’s nonperforming assets (nonaccrual loans, loans which are past due 90 days or more, OREO, and repossessed vehicles):