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

FORM 10-Q

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 periods as the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

As of May 13, 2003, there were 3,423,006 shares of Common Stock, no par value, outstanding.

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FIRST NORTHERN COMMUNITY BANCORP

INDEX

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PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET

(in thousands, except share amounts)

See notes to unaudited condensed consolidated financial statements.

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UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share amounts)

See notes to unaudited condensed consolidated financial statements.    

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Unaudited Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Income

See notes to unaudited condensed consolidated financial statements.

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UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

See notes to unaudited condensed consolidated financial statements.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2003 and December 31, 2002

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ITEM 2.

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

FORWARD-LOOKING STATEMENTS

This document contains 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, and are subject to the “safe harbor” created by those sections. Forward-looking statements include the information concerning possible or assumed future results of operations of the Company set forth under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  Forward-looking statements also include statements in which words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” estimate,” “consider,” or similar expressions are used, or similar expressions and includes assumptions concerning the Company’s operations, future results, and prospects. These forward-looking statements are based upon current expectations and are subject to risk, uncertainties and assumptions, which are difficult to predict. Therefore, actual outcomes and results may differ materially from those set forth in or implied by the forward-looking statements and related assumptions.  Some factors that may cause actual results to differ from the forward-looking statements include the following: (i) the effect of changing regional and national economic conditions; (ii) uncertainty regarding the economic outlook resulting from the continuing war on terrorism, as well as actions taken or to be taken by the United States or other governments as a result of further acts or threats of terrorism; (iii) significant changes in interest rates and prepayment speeds; (iv) credit risks of commercial, agricultural, real estate, consumer, and other lending activities; (v) changes in federal and state banking or other laws and regulations; and (vi) other external developments which could materially impact the Company’s operational and financial performance.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.  The Company undertakes no obligation to update any forward-looking statements to reflect events or circumstances arising after the date on which they are made.  For additional information concerning risks and uncertainties related to the Company and its operations, please refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

The following is a discussion and analysis of the significant changes in the Company’s Unaudited Condensed Consolidated Balance Sheets and of the significant changes in income and expenses reported in the Company’s Unaudited Condensed Consolidated Statements of Income and Comprehensive Income as of and for the three-month periods ended March 31, 2003 and 2002 and should be read in conjunction with the Company’s consolidated 2002 financial statements and the notes thereto, along with other financial information included in this document.

SUMMARY

The Company recorded net income of $1,573,000 for the three-month period ended March 31, 2003, representing an increase of $313,000 or 24.8% over net income of $1,260,000 for the same period in 2002. 

The increase in net income over the three-month period ended March 31, 2003 as compared to the same period a year ago, resulted primarily from an increase in net interest income and other operating income which was partially offset by increases in other operating expenses and an increase in provision for loan losses.

On January 23, 2003, the Board of Directors of the Company declared a 6% stock dividend payable as of March 31, 2003 to shareholders of record as of February 28, 2003.  Earnings per share amounts have been adjusted to reflect the effect of the stock dividend.

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CHANGES IN FINANCIAL CONDITION

The assets of the Company set forth in the Unaudited Condensed Consolidated Balance Sheet showed a $2,334,000 decrease in cash and due from banks, a $8,645,000 increase in federal funds sold, a $2,939,000 decrease in investment securities, a $879,000 increase in loans, a $344,000 decrease in loans held for sale, a $206,000 increase in premises and equipment, and a $646,000 increase in accrued interest receivable and other assets from December 31, 2002 to March 31, 2003.   The reason for the decrease in cash and due from banks was due to a decrease in items in process of collection.  The increase in federal funds sold was due to an increase in deposits, which was partially offset by a reduction in investment securities from sales, maturities and calls.  The decrease in investment securities was due to proceeds from sales, maturities and calls.  The proceeds from the sale of investment securities were temporarily used to increase fed funds.  The increase in loans was due to an increase in financed equipment leases, consumer, home equity lines of credit, and small business administration real estate loans, which was partially offset by a decrease in real estate and real estate commercial and construction financing.  The fluctuations were due to the demand for certain loan products by the Bank’s borrowers.  The decrease in loans held for sale was in real estate loans and was due, for the most part, to an increase in the sale of loans. The bank sold approximately $48,000,000 in residential mortgage loans during the first three months of 2003, which was offset by approximately $47,000,000 in loan originations.  The increase in premises and equipment was due to leasehold improvements associated with the opening of a new branch.  The increase in accrued interest receivable and other assets was due to an increase in computer software, amortized costs on leases, prepaid expenses, increases in cash surrender value of bank-owned life insurance and branch settlement, which was partially offset by decreased securities interest receivables and a decrease in loan interest receivables.

The liabilities of the Company set forth in the Unaudited Condensed Consolidated Balance Sheet showed an increase in total deposits of $6,550,000 compared to year-end 2002 deposit totals.  The increase in deposits was due to higher demand and savings and money market deposit totals combined with lower interest-bearing transaction deposit totals. The fluctuations were due to cyclical changes in deposit requirements of the Bank’s depositors.  Other liabilities decreased $2,699,000 from December 31, 2002 to March 31, 2003.  The decrease in other liabilities was due to decreased income taxes payable, treasury tax and loan notes, accrued profit sharing, and incentive compensation expenses, which were partially offset by increases in accrued retirement expense and deferred compensation expense.

CHANGES IN RESULTS OF OPERATIONS

Interest Income

The reduction in general market rates reduced the Company’s yields on earning assets.  The Federal Open Market Committee lowered the federal funds rate by 50 basis points during the past twelve months.

Interest income on loans for the three-month period ended March 31 2003 is up 24.1% over the same period for 2002, from $5,283,000 to $6,558,000.  The increase over the three-month period ended March 31, 2003 as compared to the same period a year ago, was primarily due to an increase in average loans which was partially offset by a 45 basis point decrease in loan yields.

Interest income on investment securities for the three-month period ended March 31, 2003 is down 27.1% over the same period for 2002, from $1,311,000 to $956,000.  The decrease over the three-month period ended March 31, 2003 as compared to the same period a year ago, was primarily due to a decrease in average investment securities.

Interest income on federal funds sold for the three-month period ended March 31, 2003 is down 77.7% over the same period for 2002 from $130,000 to $29,000.  The decrease in federal funds income over the three-month period ended March 31, 2003 as compared to the same period a year ago was primarily due to a decrease in average federal funds sold and by a 48 basis point decrease in federal funds rates. 

Interest Expense

The reduction in general market rates reduced the Company’s cost of funds.  The Federal Open Market Committee lowered the federal funds rate by more than 50 basis points during the past twelve months.

Interest expense on deposits and other borrowings for the three-month period ended March 31, 2003 is down 35.1% over the same period for 2002 from $1,213,000 to $787,000.  The decrease in interest expense over the three-month period ended March 31, 2003 was primarily due to a 70 basis point decrease in deposit rates, which was partially offset by increased average interest bearing deposits. 

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Provision for Loan Losses

There was a provision for loan losses of $670,000 for the three-month period ending March 31, 2003 compared to no provision for the same period in 2002.  The increase in the provision was due to an increase in average loans combined with an increase of $5,549,000 in non-accrual loans.  The March 31, 2003 allowance for loan losses of approximately $7,980,000 is 2.5% of total loans (excluding loans held for sale) compared to $7,285,000 or 2.3% of total loans (excluding loans held for sale) at December 31, 2002.  The allowance for loan losses is maintained at a level considered adequate by management to provide for possible loan losses.

Other Operating Income

Other operating income was up 92% for the three-month period ended March 31, 2003 over the same period in 2002 from $1,020,000 to $1,963,000.  This increase was primarily due to gains on service charges, sales of loans, mortgage brokerage income, realized gains on available for sale securities and other miscellaneous income.  Mortgage brokerage income and gains on sales of loans accounted for most of the increase in other operating income due to the significant demand for mortgage and construction financing during the current low interest environment over the same period in 2002.  The increase in service charges on deposit accounts was due to an increase in overdraft charges and service charges on business analysis accounts.  The increase in realized gains on available for sale securities was due to the sale of a corporate bond that was previously written down due to a decline in value. The bank sold approximately $48,000,000 in residential mortgage loans during the first three months of 2003, as compared to $17,000,000 in 2002.  The increase in other miscellaneous income was due, for the most part, to a gain on other real estate owned of $47,000.

Other Operating Expense

Total other operating expense was up 21.4% for the three-month period ending March 31, 2003 over the same period in 2002 from $4,648,000 to $5,642,000.

The main reasons for the increase in other operating expense in the three-month period ending March 31, 2003 were a combination of the following:  increases in salaries and benefits, occupancy and equipment costs, data processing costs, advertising costs, and other miscellaneous expense.  The increase in salaries and benefits was due to increases in:  the number of employees needed for branch and department expansion; merit salary increases; payroll taxes; stock option compensation expense; worker’s compensation expense; group insurance; and increases in profit sharing and incentive compensation provisions due to increased profits and number of employees combined with increases in commissions for real estate loans.  The increase in occupancy and equipment was due to increased rent expense, furniture and equipment, and leasehold depreciation, utilities and computer hardware depreciation.  The increase in data processing costs was due to increased expenses associated with trust accounting, maintaining and monitoring the Bank’s data communications network, and Internet banking system.  The increase in advertising was due to increased marketing efforts for a new branch and department expansion as compared to the same period in 2002.  The increase in other miscellaneous expense was due to:  increased insurance costs; contributions; accounting and audit fees; miscellaneous loan and lease expense; and amortization expense of the investment in unconsolidated subsidiary for the affordable housing tax credit investment; which were partially offset by decreased subscriptions, stationary and supplies costs, broker fees, business travel costs, correspondent bank fees, postage costs, consulting fees, employee training costs and sundry losses.

Off-Balance Sheet Commitments

The following table shows the distribution of the Company’s undisbursed loan commitments at the dates indicated.

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Asset Quality

The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix.  The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of current collateral values, and to maintain an adequate allowance for loan losses at all times.

It is generally the Company’s policy to discontinue interest accruals once a loan is past due for a period of ninety days as to interest or principal payments.  When a loan is placed on non-accrual, interest accruals cease and uncollected accrued interest is reversed and charged against current income.  Payments received on non-accrual loans are applied against principal.  A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected.

Non-accrual loans amounted to $6,505,000 at March 31,2003 and were comprised of thirteen commercial loans, four agricultural loans and four installment loans.  At December 31, 2002, non-accrual loans amounted to $552,000 and were comprised of ten commercial loans, one agricultural loan and three installment loans.  At March 31, 2002, non-accrual loans amounted to $956,000 and were comprised of ten commercial loans and one installment loan.  The increase in non-accrual loans at March 31, 2003 over the balance at December 31, 2002 was due to five commercial loans and three agricultural loans being added to this category.  Nearly all of the increase in non-accrual loans can be attributed to relationships with two of the Bank’s business customers, consisting of 5 commercial loans and 3 agricultural loans.  The Company’s management believes that nearly $5,400,000 of such non-accrual loans are adequately collateralized and the Company would be reasonably likely to recover the outstanding principal and accrued but unpaid interest attributable to such non-accrual loans if the Company foreclosed on the collateral.  The Company is pursuing additional collateral to secure the remaining balance of such non-accrual loans.  No assurance can be given that the existing or any additional collateral will be sufficient to secure full recovery of the obligations owed under these loans.

At March 31,2003, the Company had loans 90 days past due and still accruing totaling $363,000.  Such loans amounted to $8,000 at December 31, 2002 and $66,000 at March 31, 2002.

Allowance for Loan Losses

The Allowance for Loan Losses is maintained at a level believed by management to be adequate to provide for losses that can be reasonably anticipated.  The allowance is increased by provisions charged to operating expense and reduced by net charge-offs.  The Bank makes credit reviews of the loan portfolio and considers current economic conditions, loan loss experience, and other factors in determining the adequacy of the reserve balance.  The allowance for loan losses is based on estimates and actual losses may vary from current estimates.

The following table summarizes the loan loss experience of the Company for the three months ended March 31, 2003 and 2002, and for the year ended December 31, 2002.

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Analysis of the Allowance for Loan Losses
(Dollars in Thousands)

Deposits

Deposits are the Company’s primary source of funds.  At March 31, 2003, the Company had the following deposit mix:  of 20% in savings deposits, 26% in time deposits, 26% in interest-bearing checking accounts and 28% in noninterest-bearing demand accounts.  Noninterest-bearing demand deposits enhance the Company’s net interest income by lowering its costs of funds.

The Company obtains deposits primarily from the communities it serves.  No material portion of its deposits has been obtained from or is dependent on any one person or industry.  The Company accepts deposits in excess of $100,000 from customers.  These deposits are priced to remain competitive. 

Maturities of time certificates of deposits of $100,000 or more outstanding at March 31, 2003 and December 31, 2002 are summarized as follows:

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Liquidity and Capital Resources

To be able to serve our market area, the Company must maintain adequate liquidity and adequate capital.  Liquidity is measured by various ratios, with the most common being the ratio of net loans to deposits (including loans held for sale).  This ratio was 79.2% on March 31, 2003.  In addition, on March 31, 2003, the Company had the following short term investments:  $24,360,000 in federal funds sold; $10,606,000 in securities due within one year; and $32,898,000 in securities due in one to five years.

To meet unanticipated funding requirements, the Company maintains short-term unsecured lines of credit with other banks totaling $20,700,000.

The Company approved a new stock repurchase program effective April 30, 2002 to replace the Company’s previous stock purchase plan that expired on the same date. The new stock repurchase program, which will remain in effect until April 30, 2004, allows repurchases by the Company in an aggregate of up to 4% of the Company’s outstanding shares of common stock over each rolling 12-month period.  The Company repurchased 18,167 shares of the Company’s outstanding common stock during the first three months of 2003.

The Company’s primary source of liquidity on a stand-alone basis is dividends from the Bank.  Dividends from the Bank are subject to regulatory restrictions.

As of March 31, 2003, the Bank’s capital ratios exceeded applicable regulatory requirements.  The following tables present the capital ratios for the Bank, compared to the standards for well-capitalized depository institutions, as of March 31, 2003 (amounts in thousands except percentage amounts).