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 March 31, 2012

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to __________

Commission File Number 000 - 19300

NORTHERN STATES FINANCIAL CORPORATION

(Exact name of Registrant as specified in its charter)

Delaware		36-3449727
(State of Incorporation)		(I.R.S. Employer Identification No.)

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: x NO: o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES: x NO: o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer o	Accelerated Filer o	Non-accelerated Filer o	Smaller reporting company x
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES: o NO: x

4,277,755 shares of common stock were outstanding at April 30, 2012

NORTHERN STATES FINANCIAL CORPORATION AND SUBSIDIARY

FORM 10-Q

For the Quarter Ended March 31, 2012

INDEX

PART I. FINANCIAL INFORMATION

		Page Number
Item 1.	Financial Statements

	Report of Independent Registered Public Accounting Firm	2

	Condensed Consolidated Financial Statements and Notes	3

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	46

Item 4.	Controls and Procedures	47

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	48

Item 1A.	Risk Factors	48

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	48

Item 3.	Defaults Upon Senior Securities	48

Item 4.	Mine Safety Disclosures	48

Item 5.	Other Information	48

Item 6.	Exhibits	49

Signatures		50

EXHIBIT INDEX		51

Index

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Northern States Financial Corporation

Waukegan, Illinois

We have reviewed the accompanying interim condensed consolidated balance sheet of NORTHERN STATES FINANCIAL CORPORATION as of March 31, 2012, the condensed consolidated statements of operations and comprehensive income (loss) for the three month periods ended March 31, 2012 and 2011 and the condensed statements of cash flows and stockholders equity for the three month periods ended March 31, 2012 and 2011. These interim financial statements are the responsibility of the company's management.

We conducted our review in accordance with standards of the Public Company Accounting Oversight Board (United States). 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 the standards of the Public Company Accounting Oversight Board, 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 review, we are not aware of any material modifications that should be made to the accompanying interim condensed financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

/s/ Plante & Moran, PLLC

Chicago, Illinois
May 1, 2012

Index

NORTHERN STATES FINANCIAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

March 31, 2012 and December 31, 2011

(In thousands of dollars) (Unaudited)

	March 31,			December 31,
	2012			2011
Assets
Cash and due from banks	$	7,442		$	5,313
Interest bearing deposits in financial institutions -maturities less than 90 days		29,925			32,520
Total cash and cash equivalents		37,367			37,833
Securities available for sale		85,232			87,140
Loans and leases, net of deferred fees		316,833			322,713
Less: Allowance for loan and lease losses		(19,026	)		(18,984	)
Loans and leases, net		297,807			303,729
Federal Home Loan Bank stock		1,434			1,801
Office buildings and equipment, net		8,926			9,069
Other real estate owned		17,859			19,342
Accrued interest receivable		1,481			1,401
Other assets		2,846			2,675
Total assets	$	452,952		$	462,990

Liabilities and Stockholders' Equity
Liabilities
Deposits
Demand - noninterest bearing	$	70,695		$	67,955
Interest bearing		321,142			329,676
Total deposits		391,837			397,631
Securities sold under repurchase agreements		16,639			19,455
Subordinated debentures		10,310			10,310
Advances from borrowers for taxes and insurance		1,960			1,222
Accrued interest payable and other liabilities		6,634			5,833
Total liabilities		427,380			434,451

Stockholders' Equity
Common stock (Par value $0.40 per share, authorized 6,500,000 shares, issued 4,472,255 at March 31, 2012 and December 31, 2011. Shares outstanding of 4,277,755 at March 31, 2012 and December 31, 2011)		1,789			1,789
Preferred stock (Par value $0.40 per share, authorized 1,000,000 shares, issued 17,211 shares with liquidation amounts of $1,000.00 per share at March 31, 2012 and December 31, 2011)		16,939			16,904
Warrants (584,084 issued and outstanding at March 31, 2012and December 31, 2011)		681			681
Additional paid-in capital		7,084			7,054
Retained earnings		2,371			5,489
Treasury stock, at cost (194,500 shares at March 31, 2012 and December 31, 2011)		(4,512	)		(4,512	)
Accumulated other comprehensive income (loss), net		1,220			1,134
Total stockholders' equity		25,572			28,539
Total liabilities and stockholders' equity	$	452,952		$	462,990

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

Index

NORTHERN STATES FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

Three months ended March 31, 2012 and 2011

(In thousands of dollars, except per share data) (Unaudited)

	Three months ended
	March 31,			March 31,
	2012			2011
Interest income
Loans (including fee income)	$	4,098		$	4,835
Securities
Taxable		506			562
Exempt from federal income tax		30			36
Federal funds sold and other		14			16
Total interest income		4,648			5,449
Interest expense
Time deposits		204			623
Other deposits		87			91
Repurchase agreements and federal funds purchased		8			30
Subordinated debentures		65			57
Total interest expense		364			801
Net interest income		4,284			4,648
Provision for loan and lease losses		1,400			1,200
Net interest income after provision for loan and lease losses		2,884			3,448
Noninterest income
Service fees on deposits		383			413
Trust income		149			194
Net (loss) gain on sale of other real estate owned		(216	)		67
Other than temporary impairment of securities		0			(143	)
Noncredit portion of other than temporary impairment of securities		0			(20	)
Other operating income		335			322
Total noninterest income		651			833
Noninterest expense
Salaries and employee benefits		1,761			1,793
Occupancy and equipment, net		600			673
Data processing		572			507
Legal		180			205
FDIC insurance		256			381
Audit and other professional		290			286
Printing and supplies expense		68			80
Write-down of other real estate owned		1,972			673
Other real estate owned expense		126			233
Loan and collection		99			108
Other operating expenses		451			444
Total noninterest expense		6,375			5,383
Loss before income taxes		(2,840	)		(1,102	)
Income tax expense		0			0
Net loss		(2,840	)		(1,102	)
Dividends to preferred stockholders		243			230
Accretion of discount on preferred stock		35			34
Net loss available to common stockholders	$	(3,118	)	$	(1,366	)

Basic loss per share	$	(0.73	)	$	(0.32	)

Diluted loss per share	$	(0.73	)	$	(0.32	)

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

Index

NORTHERN STATES FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Three months ended March 31, 2012 and 2011

(In thousands of dollars) (Unaudited)

	Three months ended
	March 31,			March 31,
	2012			2011

Net loss	$	(2,840	)	$	(1,102	)
Other comprehensive income:
Unrealized gains on securities available for sale, net of tax		86			331
Comprehensive loss	$	(2,754	)	$	(771	)

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

Index

NORTHERN STATES FINANCIAL CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

Three months ended March 31, 2012 and 2011

(In thousands of dollars) (Unaudited)

	Common Stock		Preferred Stock		Warrants		Additional Paid-In Capital			Retained Earnings			Treasury Stock, at Cost			Accumulated Other Comprehensive Income (Loss), Net			Total Stockholders' Equity
Balance, December 31, 2010	$	1,789	$	16,768	$	681	$	11,584		$	13,250		$	(9,280	)	$	(1,507	)	$	33,285
Net loss											(1,102	)								(1,102	)
Accrued dividend on preferred stock											(230	)								(230	)
Accretion of preferred stock discount issued				34							(34	)								0
Restricted stock awards from treasury stock								(4,814	)					4,814						0
Restricted stock awards expense								152												152
Unrealized net gain on securities available for sale																	331			331
Balance, March 31, 2011	$	1,789	$	16,802	$	681	$	6,922		$	11,884		$	(4,466	)	$	(1,176	)	$	32,436

Balance, December 31, 2011	$	1,789	$	16,904	$	681	$	7,054		$	5,489		$	(4,512	)	$	1,134		$	28,539
Net loss											(2,840	)								(2,840	)
Accrued dividend on preferred stock											(243	)								(243	)
Accretion of preferred stock discount issued				35							(35	)								0
Restricted stock awards expense								30												30
Unrealized net gain on securities available for sale																	86			86
Balance, March 31, 2012	$	1,789	$	16,939	$	681	$	7,084		$	2,371		$	(4,512	)	$	1,220		$	25,572

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

Index

NORTHERN STATES FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Three months ended March 31, 2012 and 2011

(In thousands of dollars) (Unaudited)

	Three months ended
	2012			2011
Cash flows from operating activities
Net loss	$	(2,840	)	$	(1,102	)
Adjustments to reconcile net loss to net cash from operating activities:
Depreciation		173			171
Net impairment loss on securities		0			163
Provision for loan and lease losses		1,400			1,200
Write-down of other real estate owned		1,972			673
Net loss (gain) on sale of other real estate owned		216			(67	)
Restricted stock awards expense		30			152
Net change in accrued interest receivable and other assets		407			781
Net change in accrued interest payable and other liabilities		(164	)		(172	)
Net cash provided from operating activities		1,194			1,799
Cash flows from investing activities
Proceeds from maturities, calls and principal reductions of securities available for sale		2,058			1,739
Redemptions of Federal Home Loan Bank stock		367			0
Changes in loans made to customers		3,069			10,622
Property and equipment expenditures		(30	)		(24	)
Proceeds from sale of other real estate owned		748			1,544
Net cash provided from investing activities		6,212			13,881
Cash flows from financing activities
Net increase (decrease) in:
Deposits		(5,794	)		5,429
Securities sold under repurchase agreements and other short-term borrowings		(2,816	)		(7,371	)
Advances from borrowers for taxes and insurance		738			790
Net cash used in financing activities		(7,872	)		(1,152	)
Net change in cash and cash equivalents		(466	)		14,528
Cash and cash equivalents at beginning of period		37,833			30,357
Cash and cash equivalents at end of period	$	37,367		$	44,885

Supplemental disclosures
Cash paid for interest	$	408		$	930
Noncash transfer of loans to other real estate owned		1,453			61
Noncash accrual of preferred dividends		243			230

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

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(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. Estimates and assumptions used for the allowance for loan and lease losses, valuation of other real estate owned, valuation of other than temporarily impaired securities, valuation of deferred tax assets and status of contingencies are particularly subject to change.

The interim condensed consolidated 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, 2011 and 2010 included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the Securities and Exchange Commission. The results of operations for the three month period ended March 31, 2012 included herein are not necessarily indicative of the results to be expected for the full year 2012.

Net loss available to common stockholders was utilized to calculate loss per share for all periods presented. During the periods presented, the Company had preferred stock and common stock equivalents from warrants related to funds received from the U.S Department of the Treasury (the “Treasury Department”) through its Capital Purchase Program. However, common stock equivalents from warrants during the periods presented were antidilutive and, therefore, not considered in computing diluted loss per share.

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

(Dollars in thousands, except per share data)	Three Months Ended
	March 31,
	2012			2011
Basic earnings per share:
Net loss	$	(2,840	)	$	(1,102	)
Dividends accrued to preferred stockholders		243			230
Accretion of discount on preferred stock		35			34
Net loss available to common stockholders	$	(3,118	)	$	(1,366	)
Weighted average common shares outstanding		4,277,755			4,270,553
Basic loss per share	$	(0.73	)	$	(0.32	)

Diluted earnings per share:
Net loss	$	(2,840	)	$	(1,102	)
Dividends accrued to preferred stockholders		243			230
Accretion of discount on preferred stock		35			34
Net loss available to common stockholders	$	(3,118	)	$	(1,366	)
Weighted average common shares outstanding		4,277,755			4,270,553
Add: Dilutive effect of common stock equivalents		0			0
Weighted average common and dilutive common shares outstanding..		4,277,755			4,270,553
Diluted loss per share	$	(0.73	)	$	(0.32	)

Note 2 – Preferred Stock

On February 20, 2009, pursuant to the Treasury Department’s TARP Capital Purchase Program, the Company issued to the Treasury Department, in exchange for total proceeds of $17,211,000, (i) 17,211 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”), par value $.40 per share and a liquidation amount equal to $1,000 per share, and (ii) a ten-year warrant (the “Warrant”) to purchase up to 584,084 shares of the Company’s common stock, at an exercise price of $4.42 per share. The $17,211,000 proceeds were allocated to the Series A Preferred Stock and the Warrant based on the relative fair value of the instruments. The fair value of the preferred stock was estimated using an approximate 12% discount rate and a five-year expected life. A fair value of $681,000 was estimated for the warrants using a Black-Sholes valuation. The assumptions used in the Black-Sholes valuation were as follows: $4.42 strike price based on the contract, approximately 53% for the calculated volatility, 3.1% for the weighted average dividends, five years for the expected term and 2% for the risk free rate.

The difference between the initial carrying value of $16,530,000 that was allocated to the Series A Preferred Stock and its redemption value of $17,211,000 will be charged to retained earnings (with a corresponding increase to the carrying value of the Series A Preferred Stock) over the first five years as an adjustment to the dividend yield using the effective yield method. The Series A Preferred Stock is generally non-voting and qualifies as Tier 1 capital.

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

In the event of a liquidation or dissolution of the Company, the Series A Preferred Stock then outstanding takes precedence over the Company’s common stock for the payment of dividends and distribution of assets.

Dividends are payable quarterly on the Series A Preferred Stock at an annual dividend rate of 5% per year for the first five years, and 9% per year thereafter. The effective yield of the Series A Preferred Stock is approximately 5.94%. In November 2009, the Company notified the Treasury Department of its intent to suspend its dividend payments on its Series A Preferred Stock. The suspension of the dividend has continued through March 31, 2012. At March 31, 2012, the accumulated dividends payable to the Treasury Department totaled $2.4 million which includes compounding on unpaid dividends at 5.00%. The suspension of dividend payments is permissible under the terms of the TARP Capital Purchase Program, but the dividend is a cumulative dividend and failure to pay dividends for six dividend periods triggers board of director appointment rights for the holder of the Series A Preferred Stock. At March 31, 2012, the Company had suspended ten dividend payments and expects that the Treasury Department will appoint two directors in 2012. In January 2011, the Company agreed to allow a Treasury Department representative to attend its Board of Directors meetings as an observer.

For as long as any shares of Series A Preferred Stock are outstanding, no dividends may be declared or paid on the Company’s common stock unless all accrued and unpaid dividends for all past dividend periods on the Series A Preferred Stock are fully paid. Pursuant to the Capital Purchase Program, the Treasury Department’s consent is required for any increase in dividends on the Company’s common stock above the amount of $0.40 per share, the last semi-annual common stock dividend declared by the Company prior to October 14, 2008, unless the Series A Preferred Stock is redeemed in whole or until the Treasury Department has transferred all of the Series A Preferred Stock it owns to third parties.

The Company may not repurchase any of its common stock without the prior consent of the Treasury Department for as long as the shares of Series A Preferred Stock are outstanding to the Treasury Department or until the Treasury Department transfers all of the Series A Preferred Stock it owns to third parties.

Note 3 – Common Stock

Information related to common stock at the dates indicated was as follows:

	March 31, 2012		December 31, 2011
Par value per share	$	0.40	$	0.40
Authorized shares		6,500,000		6,500,000
Issued shares		4,472,255		4,472,255
Treasury shares		194,500		194,500
Outstanding shares		4,277,755		4,277,755

Pursuant to the Capital Purchase Program, the Company issued to the Treasury Department a Warrant to purchase up to 584,084 shares of the Company’s common stock at an exercise price of $4.42 per share. Based upon its fair value relative to the Series A Preferred Stock discussed in Note 2 above, the Warrant was recorded at a value of $681,000 and is accounted for as equity. The Warrant is exercisable, in whole or in part, at any time and from time to time until the tenth anniversary of the issue date.

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

The 2009 Restricted Stock Plan (the "Plan") authorizes the issuance of 400,000 shares of the Company's common stock to be issued in whole or in part from treasury shares or authorized and unissued shares not reserved for any other purpose. Awards under the Plan may be made to directors and employees of both the Company and its subsidiaries an d may consist of restricted stock with associated voting rights and the right to receive dividends. Awards may also be issued as stock units not having voting rights or the right to receive dividends until the terms of the award are satisfied and the shares of the Company's stock are actually issued; however, dividends may be credited to a restricted stock award. The terms and conditions of each award is set forth and described in an award agreement between the Company and the participant.

In January 2011, 207,500 shares of restricted stock were issued pursuant to the 2009 Restricted Stock Plan from the Company’s treasury stock. During the second and third quarters of 2011, employees, who left the Company, forfeited 2,000 shares of restricted stock, which were returned to treasury stock lowering the total shares issued pursuant to the Plan to 205,500 shares. Of the 80,000 shares issued to directors, 70,000 shares vested during the first quarter of 2011, while the remaining 10,000 shares fully vest in January 2013. A total of 125,500 restricted stock shares granted to employees of the Company will fully vest in January 2013. The expense attributable to these restricted stock awards recognized during the three months ended March 31, 2012 and 2011 totaled $30,000 and $152,000, respectively.

Note 4 – Securities

At March 31, 2012 and December 31, 2011, the Company had the following securities in its investment portfolio:

			Gross Unrealized
March 31, 2012 ($000's)	Fair Value		Gain		Loss

States and political subdivisions	$	2,984	$	102	$	(8	)
Mortgage-backed securities		77,995		1,698		0
Equity securities		4,253		150		0

Total securities available for sale	$	85,232	$	1,950	$	(8	)

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

			Gross Unrealized
December 31, 2011 ($000's)	Fair Value		Gains		Losses

States and political subdivisions	$	3,117	$	112	$	(10	)
Mortgage-backed securities		79,762		1,533		0
Equity securities		4,261		157		0

Total securities available for sale	$	87,140	$	1,802	$	(10	)

At March 31, 2012, the Company had pledged securities of $51.2 million as compared to $57.0 million at December 31, 2011. Securities are pledged to secure public deposits, repurchase agreements and for other purposes as required or permitted by law.

Contractual maturities of securities available for sale at March 31, 2012 are set forth below. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately:

	Fair
March 31, 2012 ($000's)	Value

Due in one year or less	$	124
Due after one year through five years		544
Due after five years through ten years		1,167
Due after ten years		1,149
		2,984
Mortgage-backed securities		77,995
Equity securities		4,253

Total securities available for sale	$	85,232

During the quarter ended March 31, 2012, the Company did not recognize any other than temporary impairment loss as compared with $163,000 recognized during the quarter ended March 31, 2011. For the quarter ended March 31, 2011, the Company recognized $134,000 of impairment losses on Collateralized Debt Obligations ("CDOs") classified as other bonds based on cash flow analyses pursuant to guidelines on recognition of impairment losses and wrote off the remaining carrying value of these securities. The Company also recognized $29,000 of other than temporary impairment loss on its FNMA and FHLMC preferred stocks, writing off the remaining carrying value of these securities during the first quarter of 2011.

Index

At March 31, 2012 and December 31, 2011, the Company had six and seven individual securities, respectively in an unrealized loss position. The securities with unrealized losses at March 31, 2012 and December 31, 2011, aggregated by investment category and length of time that individual securities have been in a continuous loss position, were as follows:

	Less than 12 Months					12 Months or More				Total
	Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
March 31, 2012 ($000's)	Value		Losses			Value		Losses		Value		Losses

States and political subdivisions	$	817	$	(8	)	$	0	$	0	$	817	$	(8	)
Total temporarily impaired	$	817	$	(8	)	$	0	$	0	$	817	$	(8	)

	Less than 12 Months					12 Months or More				Total
	Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
December 31, 2011 ($000's)	Value		Losses			Value		Losses		Value		Losses

States and political subdivisions	$	941	$	(10	)	$	0	$	0	$	941	$	(10	)
Total temporarily impaired	$	941	$	(10	)	$	0	$	0	$	941	$	(10	)

Management has the intent and ability to hold these securities in an unrealized loss position for the foreseeable future. Management believes that it is unlikely that the Company will be required to sell the securities while they are in an unrealized loss position.

Note 5 – Subordinated Debentures

During September 2005, the Company issued $10.3 million of subordinated debentures to Northern States Statutory Trust I, a wholly-owned grantor trust, which in turn issued $10.3 million of trust preferred securities. The Company is required to hold $310,000 of the trust preferred securities as Common Securities while the remaining $10 million were issued as Capital Securities. The subordinated debentures mature in September 2035. The subordinated debentures currently and until maturity bear an interest rate of the 3-month London Interbank Offered Rate (“LIBOR”) plus 1.80% adjusted quarterly. The rate on the subordinated debentures was 2.27365% at March 31, 2012, which is the effective rate from March 15, 2012 through June 14, 2012. For the three months ended March 31, 2012 and 2011, interest expense on the subordinated debentures was $65,000 and $57,000, respectively.

The Company has guaranteed the payment of distributions and payments upon liquidation or redemption of the trust preferred securities, in each case to the extent of funds held by the Trust. The Company and the Trust believe that, taken together, the obligations of the Company under the guarantee, the subordinated debentures, and other related agreements provide, in the aggregate, a full, irrevocable and unconditional guarantee, on a subordinated basis, of all of the obligations of the Trust under the trust preferred securities. Subject to certain limitations, the Company has the right to defer the payment of interest on the junior subordinated debentures at any time, or from time to time, for a period not to exceed 20 consecutive quarters. In November 2009, the Company notified the trustee that holds the Company’s junior subordinated debentures relating to its outstanding trust preferred securities that the Company would be deferring its regularly scheduled quarterly interest payments. The Company has continued to defer its quarterly interest payments through March 31, 2012. As of March 31, 2012, the Company had deferred ten quarterly payments and accrued interest payable on the subordinated debentures totaled $808,000. During the deferral period, the Company may not pay any dividends on its common or preferred stock. The trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the subordinated debentures at maturity or their earlier redemption. The subordinated debentures were callable at par beginning on September 15, 2010 at the discretion of the Company if certain conditions are met, and in any event, only after the Company obtains Federal Reserve approval, if required under applicable guidelines or regulations. Subject to certain exceptions, the Company may not without the consent of the Treasury Department engage in repurchases of the Company’s common stock or trust preferred securities until all shares of Series A Preferred Stock issued to the Treasury Department have been redeemed or transferred by the Treasury Department.

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

Regulations allow bank holding companies and banks to include subordinated debentures, subject to some limitations, as a component of capital for the purpose of meeting certain regulatory requirements.

Note 6 – Allowance for Loan and Lease Losses and Credit Disclosures

The allowance for loan and lease losses (“ALLL”) is a valuation allowance for probable incurred credit losses, increased by the provision for loan and lease losses and decreased by charge-offs net of recoveries. The ALLL represents one of the most significant estimates in the Bank’s financial condition. Accordingly, the Bank endeavors to provide a comprehensive and systematic approach for determining management’s current judgment about the credit quality of the loan portfolio.

At the end of each quarter, or more frequently if warranted, the Bank analyzes its loan portfolio to determine the level of ALLL needed to be maintained. Management believes this analysis results in a prudent, conservative ALLL that falls within an acceptable range of estimated credit losses. The ALLL covers estimated credit losses on individually evaluated loans that are determined to be impaired as well as estimated credit losses inherent in the remainder of the loan portfolio.

Senior management and other lenders review all Watch and Substandard credits to determine if a loan is impaired. A loan is considered impaired if it is probable that full principal and interest will not be collected within the contractual terms of the original note. For loans that are individually evaluated and determined to be impaired, the Bank calculates the amount of impairment based on whether repayment of the loan is dependent on operating cash flow or on the underlying collateral. The decision of which method to use is determined by looking at a number of factors, including the size of the loan and other available information. If the loan is to be repaid primarily from the operating cash flow from the borrower, the impairment analysis calculates the present value of the expected future cash flows discounted at the loan’s effective interest rate and compares the result to the recorded investment. Collateral-dependent loans are measured against the fair value of the collateral less the costs to sell.

As of December 31, 2011, management further refined its methodology for calculating the amount in the ALLL by segregating a component of loans considered to be “high risk” but lack sufficient weakness to be considered impaired. These loans are assigned a specific percentage allocation, adjusted by environmental and qualitative factors management believes may affect the repayment of these loans. The impact to the ALLL for the creation of this additional pool of loans was not significant at December 31, 2011 and March 31, 2012.

The remaining unimpaired loan portfolio is segmented into groups based on loan types having similar risk characteristics. Estimated loan losses for these groups are determined using historical loss experience and adjusted for other environmental and qualitative factors the Bank deems significant that would likely cause estimated credit losses to differ from the group’s historical loss experience.

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

Allocations of the ALLL may be made for specific loans and leases, but the entire allowance is available for any loan or lease that, in management’s judgment, should be charged-off. Loan and lease losses are charged against the allowance when management believes the uncollectibility of a loan or lease balance is confirmed.

It is the Company’s policy to administer and pursue charged-off borrowers with the same diligence as other loans. Charging off an exposure is an accounting entry and does not affect the borrower’s obligation to repay the indebtedness. Administration of charged-off exposure is governed by maximization of recoveries, and borrowers will be pursued until, in the opinion of management, future costs of collection exceed probable future recoveries.

Activity in the allowance for loan and lease losses for the three months ended March 31, 2012 and 2011 is set forth below:


For the Three Months Ended	Beginning										Ending
March 31, 2012 ($000's)	Balance					Recoveries		Provision			Balance
	Allowance					to Loans		Charges to			Allowance
	for Loan		Loans			Previously		Operating			for Loan
	Losses		Charged Off			Charged Off		Expense			Losses

Commercial	$	792	$	(6	)	$	0	$	326		$	1,112
Real estate-construction		3,149		(1,228	)		0		(68	)		1,853
Real estate-mortgage 1-4 family		865		(76	)		1		63			853
Real estate-mortgage 5+ family		1,646		0			0		68			1,714
Real estate-mortgage commercial		12,018		0			0		689			12,707
Home equity		500		(48	)		0		321			773
Leases		0		0			0		0			0
Installment		14		(1	)		0		1			14

Total	$	18,984	$	(1,359	)	$	1	$	1,400		$	19,026

For the Three Months Ended	Beginning										Ending
March 31, 2011 ($000's)	Balance					Recoveries		Provision			Balance
	Allowance					to Loans		Charges to			Allowance
	for Loan		Loans			Previously		Operating			for Loan
	Losses		Charged Off			Charged Off		Expense			Losses

Commercial	$	1,013	$	0		$	4	$	182		$	1,199
Real estate-construction		2,842		(1	)		0		(567	)		2,274
Real estate-mortgage 1-4 family		988		(254	)		0		(18	)		716
Real estate-mortgage 5+ family		1,025		0			0		884			1,909
Real estate-mortgage commercial		11,977		(750	)		0		721			11,948
Home equity		468		0			0		(3	)		465
Leases		0		0			0		0			0
Installment		23		(4	)		1		1			21

Total	$	18,336	$	(1,009	)	$	5	$	1,200		$	18,532

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

Nonaccrual Loans: Accrual of uncollectible income on problem loans inflates income and, if recognized in an untimely fashion, can have a dramatic negative impact on earnings. Any loan meeting one of the following criteria is placed in a nonaccrual status and all related interest earned but not collected is reversed:

The loan is maintained on a cash basis because of deterioration in the financial condition of the borrower.

The borrower is in bankruptcy and the exposure is not fully secured and in the process of collection.

Full payment of principal or interest is not expected.

The loan has been in default for a period of ninety (90) days or more unless the asset is both well secured and in the process of collection.

Loans meeting any of the criteria above may be exempted from this policy if unanimously agreed upon and duly documented by the Directors Loan Committee. In general, all accrued and earned but not collected interest on an exposure placed on nonaccrual status is charged-off to income. A loan may be returned to accrual status when at least six (6) consecutive months of timely payments have been received and there is evidence to support the payments will continue.

The Company is attempting to work with nonaccrual borrowers to resolve the issues, but in many cases the Company may have to foreclose on the properties securing these loans if the loans are secured by real estate.

Troubled Debt Restructuring: Restructuring of loans is undertaken to improve the likelihood that the loan will be repaid in full under the modified terms in accordance with a reasonable repayment schedule. All restructured loans are evaluated to determine whether the loans should be reported as a TDR. A loan is a TDR when the Company, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower by modifying or renewing a loan that the Company would not otherwise consider. To make this determination the Bank must determine whether (a) the borrower is experiencing financial difficulties and (b) the Company granted the borrower a concession. This determination requires consideration of all of the facts and circumstances surrounding the modification. An overall general decline in the economy or some deterioration in a borrower’s financial condition does not automatically mean the borrower is experiencing financial difficulties.

Some of the factors reviewed to determine whether the borrower is experiencing financial difficulties are: 1) is the borrower currently in default on any of its debts; 2) has the borrower declared or in the process of declaring bankruptcy; or 3) absent the current modification, would the borrower more than likely default. Factors to consider in determining whether the Company has granted a concession include: lowering the interest rate, extending the maturity date, forgiving debt, reducing accrued interest or changing the payment to interest only for an extended period of time.

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

For regulatory purposes, a restructured loan classified as a TDR need not continue to be reported as such in calendar years after the year in which the restructuring took place if the loan yields a market rate and is in compliance with the loan’s modified terms. In determining whether the rate is a market rate the Company considers the riskiness of the transaction, the structure of the loan, the borrower’s financial condition, financial support of the guarantor and protection provided by the collateral. The Company also considers rates given to other borrowers for similar loans as well as what competitors are offering. To be in compliance with the modified loan terms the borrower should demonstrate the ability to repay under the modified terms for a period of at least six months and provide evidence to support that payments will continue.

Loan Rating System: Senior management and the Bank’s lenders use a loan rating system to determine the credit risks of the Bank’s loan and leases with the following loan ratings:

Pass: A Pass loan has no apparent weaknesses.

Watch: A Watch loan has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. Loan collection is not in jeopardy yet, but continued adverse trends may cause it to be. Typical characteristics of Watch assets include: increasing debt; liquidity problems; negative trends in operating cash flow; collateral dependent with advances outside policy guidelines; and/or sporadic payment performance.

Substandard: A Substandard loan is inadequately protected by the current sound net worth and paying capacity of the borrower or of the collateral pledged, if any. These loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt and have a distinct possibility that the Company may sustain some loss if the deficiencies are not corrected.

Nonaccrual: Loans in this category have the same characteristics as those classified Substandard with the added characteristic that further erosion in the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The likelihood of loss is yet to be fully determined due to the borrower’s inability or refusal to provide updated financial information, appraisals or additional collateral.

Doubtful: Loans in this category have the weaknesses of those classified Substandard where collection and/or liquidation in full, on the basis of currently existing conditions, is highly questionable or improbable. Treatment as “loss” is deferred until exact status can be determined.

Loss: Loans classified loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless loan even though partial recovery may be affected in the future.

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

Below shows the allocation of the allowance for loan and lease losses by segment to loans and leases individually and collectively evaluated for impairment:

					Allowance				Allowance
					for Loan				for Loan
					Losses				Losses
	Ending				Allocated to				Allocated to
	Balance		Loans		Loans		Loans		Loans
`	Total		Individually		Individually		Collectively		Collectively
	Loans		Evaluated		Evaluated		Evaluated		Evaluated
	and		for		for		for		for
At March 31, 2012 ($000's)	Leases		Impairment		Impairment		Impairment		Impairment

Commercial	$	15,523	$	647	$	612	$	14,876	$	500
Real estate-construction		27,811		14,262		956		13,549		897
Real estate-mortgage 1-4 family		34,155		4,264		368		29,891		485
Real estate-mortgage 5+ family		35,621		3,983		0		31,638		1,714
Real estate-mortgage commercial		181,610		53,766		9,394		127,844		3,313
Home equity		20,740		761		345		19,979		428
Leases		259		0		0		259		0
Installment		1,355		0		0		1,355		14

Balance at March 31, 2012	$	317,074	$	77,683	$	11,675	$	239,391	$	7,351

					Allowance				Allowance
					for Loan				for Loan
					Losses				Losses
	Ending				Allocated to				Allocated to
	Balance		Loans		Loans		Loans		Loans
	Total		Individually		Individually		Collectively		Collectively
	Loans		Evaluated		Evaluated		Evaluated		Evaluated
	and		for		for		for		for
At December 31, 2011 ($000's)	Leases		Impairment		Impairment		Impairment		Impairment

Commercial	$	15,827	$	655	$	273	$	15,172	$	519
Real estate-construction		28,504		6,876		2,044		21,628		1,105
Real estate-mortgage 1-4 family		35,758		5,163		396		30,595		469
Real estate-mortgage 5+ family		35,977		3,987		0		31,990		1,646
Real estate-mortgage commercial		183,881		54,074		8,561		129,807		3,457
Home equity		21,266		443		141		20,823		359
Leases		295		0		0		295		0
Installment		1,476		0		0		1,476		14

Balance at December 31, 2011	$	322,984	$	71,198	$	11,415	$	251,786	$	7,569

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

Below shows the age analysis of the past due loans and leases by segment and class at March 31, 2012 and December 31, 2011:

													Greater
													Than
													90 Days Past
At March 31, 2012 ($000's)							Greater				Total		Due and
			30-59 Days		60-89 Days		Than 90 Days		Total		Loans and		Still
	Current		Past Due		Past Due		Past Due		Past Due		Leases		Accruing

Commercial	$	14,889	$	92	$	0	$	542	$	634	$	15,523	$	0
Real estate-construction
1-4 family		9,824		60		0		5,953		6,013		15,837		4,230
Other		10,022		68		0		1,884		1,952		11,974		0
Real estate-mortgage
1-4 family		32,070		548		108		1,429		2,085		34,155		474
Real estate-mortgage
5+ family		30,445		1,193		0		3,983		5,176		35,621		0
Real estate-mortgage commercial
Owner occupied		52,887		603		0		7,901		8,504		61,391		50
Non-owner occupied		70,388		951		0		2,081		3,032		73,420		1,057
Hotel industry		46,799		0		0		0		0		46,799		0
Home equity		19,552		431		58		699		1,188		20,740		0
Leases		259		0		0		0		0		259		0
Installment		1,319		21		0		15		36		1,355		15

Balance at March 31, 2012	$	288,454	$	3,967	$	166	$	24,487	$	28,620	$	317,074	$	5,826

													Greater
													Than
													90 Days Past
At December 31, 2011 ($000's)							Greater				Total		Due and
			30-59 Days		60-89 Days		Than 90 Days		Total		Loans and		Still
	Current		Past Due		Past Due		Past Due		Past Due		Leases		Accruing

Commercial	$	15,273	$	6	$	0	$	548	$	554	$	15,827	$	0
Real estate-construction
1-4 family		14,084		0		0		2,716		2,716		16,800		152
Other		9,820		0		0		1,884		1,884		11,704		0
Real estate-mortgage
1-4 family		32,539		1,672		284		1,263		3,219		35,758		0
Real estate-mortgage
5+ family		32,227		0		0		3,750		3,750		35,977		0
Real estate-mortgage commercial
Owner occupied		53,911		265		471		7,850		8,586		62,497		0
Non-owner occupied		73,162		575		227		450		1,252		74,414		0
Hotel industry		46,970		0		0		0		0		46,970		0
Home equity		20,288		206		71		701		978		21,266		322
Leases		295		0		0		0		0		295		0
Installment		1,442		15		3		16		34		1,476		16

Balance at December 31, 2011	$	300,011	$	2,739	$	1,056	$	19,178	$	22,973	$	322,984	$	490

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

The Company utilizes a loan rating system as a means of identifying problem and potential loans. Below shows the loan ratings of loans and leases by segment and class at March 31, 2012 and December 31, 2011:

At March 31, 2012 ($000's)	Pass		Watch		Substandard		Nonaccrual		Total

Commercial	$	12,247	$	2,622	$	112	$	542	$	15,523
Real estate-construction
1-4 Family		2,222		168		11,724		1,723		15,837
Other		490		2,647		6,953		1,884		11,974
Real estate-mortgage 1-4 family		25,007		5,020		3,174		954		34,155
Real estate-mortgage 5+ family		24,783		6,855		0		3,983		35,621
Real estate-mortgage commercial
Owner occupied		30,827		12,838		9,876		7,850		61,391
Non-owner occupied		40,545		17,984		13,866		1,025		73,420
Hotel industry		3,754		9,219		33,826		0		46,799
Home equity		18,556		793		628		763		20,740
Leases		259		0		0		0		259
Installment		1,355		0		0		0		1,355
Balance at March 31, 2012	$	160,045	$	58,146	$	80,159	$	18,724	$	317,074

At December 31, 2011 ($000's)	Pass		Watch		Substandard		Nonaccrual		Total

Commercial	$	12,587	$	2,247	$	445	$	548	$	15,827
Real estate-construction
1-4 Family		2,345		4,230		7,662		2,563		16,800
Other		277		6,602		2,941		1,884		11,704
Real estate-mortgage 1-4 family		25,430		4,968		4,097		1,263		35,758
Real estate-mortgage 5+ family		25,105		6,885		0		3,987		35,977
Real estate-mortgage commercial
Owner occupied		31,778		12,211		10,186		8,322		62,497
Non-owner occupied		41,096		20,031		12,837		450		74,414
Hotel industry		3,784		9,358		33,828		0		46,970
Home equity		19,527		792		504		443		21,266
Leases		247		48		0		0		295
Installment		1,476		0		0		0		1,476
Balance at December 31, 2011	$	163,652	$	67,372	$	72,500	$	19,460	$	322,984

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

The following tables present loans and leases by segment and class individually evaluated for impairment at March 31, 2012 and December 31, 2011 and the average recorded investment and investment income recognized for the three months ended March 31, 2012 and for the year ended December 31, 2011:

($000's)							For the Three Months
	At March 31. 2012						Ended March 31, 2012
			Unpaid				Average		Investment
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized

With no related allowance recorded:
Commercial	$	0	$	0	$	0	$	0	$	0
Real estate-construction
1-4 family		5,953		7,181		0		3,693		0
Other		4,746		6,479		0		2,071		0
Real estate-mortgage 1-4 family		2,072		2,072		0		1,897		13
Real estate-mortgage 5+ family		3,983		3,983		0		3,984		0
Real estate-mortgage commercial
Owner occupied		3,879		3,879		0		4,193		41
Non-owner occupied		4,403		4,403		0		4,085		33
Hotel industry		6,151		6,151		0		6,153		74
Home equity		30		30		0		63		0
Leases		0		0		0		0		0
Installment		0		0		0		0		0
With an allowance recorded:
Commercial		647		1,408		612		652		0
Real estate-construction
1-4 family		2,413		2,413		873		2,413		27
Other		1,150		1,150		83		1,150		0
Real estate-mortgage 1-4 family		2,192		2,192		368		2,326		14
Real estate-mortgage 5+ family		0		0		0		0		0
Real estate-mortgage commercial
Owner occupied		10,916		10,916		3,135		10,919		39
Non-owner occupied		8,661		8,661		585		8,662		93
Hotel industry		19,756		23,355		5,674		19,756		193
Home equity		731		731		345		561		0
Leases		0		0		0		0		0
Installment		0		0		0		0		0

Total:
Commercial	$	647	$	1,408	$	612	$	652	$	0
Real estate-construction		14,262		17,223		956		9,327		27
Real estate-mortgage 1-4 family		4,264		4,264		368		4,223		27
Real estate-mortgage 5+ family		3,983		3,983		0		3,984		0
Real estate-mortgage commercial		53,766		57,365		9,394		53,768		473
Home equity		761		761		345		624		0
Leases		0		0		0		0		0
Installment		0		0		0		0		0
Total	$	77,683	$	85,004	$	11,675	$	72,578	$	527

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

($000's)							For the Year
	At December 31. 2011						Ended December 31, 2011
			Unpaid				Average		Investment
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized

With no related allowance recorded:
Commercial	$	0	$	0	$	0	$	152	$	0
Real estate-construction
1-4 family		34		34		0		4,607		176
Other		734		2,468		0		1,109		0
Real estate-mortgage 1-4 family		2,039		2,039		0		3,391		96
Real estate-mortgage 5+ family		3,987		3,987		0		8,856		38
Real estate-mortgage commercial
Owner occupied		5,254		5,254		0		6,333		185
Non-owner occupied		3,927		3,927		0		10,281		408
Hotel industry		3,034		3,034		0		2,758		132
Home equity		30		30		0		67		20
Leases		0		0		0		0		0
Installment		0		0		0		0		0
With an allowance recorded:
Commercial		655		1,416		273		1,026		1
Real estate-construction
1-4 family		4,958		4,958		1,960		4,861		103
Other		1,150		1,150		84		1,150		22
Real estate-mortgage 1-4 family		3,124		3,124		396		2,899		131
Real estate-mortgage 5+ family		0		0		0		0		0
Real estate-mortgage commercial
Owner occupied		10,319		10,319		2,974		9,549		97
Non-owner occupied		746		746		458		746		2
Hotel industry		30,794		34,393		5,129		31,523		1,139
Home equity		413		413		141		1,621		2
Leases		0		0		0		0		0
Installment		0		0		0		6		1

Total:
Commercial	$	655	$	1,416	$	273	$	1,178	$	1
Real estate-construction		6,876		8,610		2,044		11,727		301
Real estate-mortgage 1-4 family		5,163		5,163		396		6,290		227
Real estate-mortgage 5+ family		3,987		3,987		0		8,856		38
Real estate-mortgage commercial		54,074		57,673		8,561		61,190		1,963
Home equity		443		443		141		1,688		22
Leases		0		0		0		0		0
Installment		0		0		0		6		1
Total	$	71,198	$	77,292	$	11,415	$	90,935	$	2,553

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

The following table presents the number of loans and leases modified as TDRs by segment and class during the three month period ended March 31, 2012, the outstanding recorded balances at the time modified and the outstanding recorded investment balances at March 31, 2012:

At March 31, 2012 ($000's)	Troubled Debt Restructurings
			Pre-Modification		Post-Modification
			Outstanding		Outstanding
	Number of		Recorded		Recorded
Troubled Debt Restructurings	Loans		Investment		Investment

Commercial		1	$	109	$	106
Real estate-construction
1-4 family		2		4,230		4,230
Other		1		4,012		4,012
Real estate-mortgage 1-4 family		13		1,777		1,770
Real estate-mortgage 5+ family		0		0		0
Real estate-mortgage commercial
Owner occupied		5		4,909		4,895
Non-owner occupied		2		2,755		2,753
Hotel industry		1		5,433		5,500
Home equity		0		0		0
Leases		0		0		0
Installment		0		0		0

Total		25	$	23,225	$	23,266

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

The following table presents the number of loans and leases modified as TDRs by segment and class during the twelve month period ended March 31, 2012 that subsequently defaulted during the three month period ended March 31, 2012 and the outstanding recorded investment balance at March 31, 2012. For disclosure in this table, defaulted TDRs are those TDR loans greater than 90 days or more past due and still accruing or on nonaccrual status.

March 31, 2012 ($000s)	Troubled Debt Restructurings that Subsequently Defaulted
Troubled Debt Restructurings	Number of Loans		Recorded Investment

Commercial		0	$	0
Real estate-construction
1-4 Family		2		4,230
Other		0		0
Real estate-mortgage 1-4 family		0		0
Real estate-mortgage 5+ family		0		0
Real estate-mortgage commercial
Owner occupied		1		412
Non-owner occupied		0		0
Hotel industry		0		0
Home equity		0		0
Leases		0		0
Installment		0		0

Total at March 31, 2012		3	$	4,642

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

Note 7 - Fair Value Measurement

The table below shows information about the Company's securities that were measured at fair value and the valuation techniques used by the Company to determine fair values.

In general, fair values determined by Level 1 inputs use a quoted price in active markets for identical securities that the Company had the ability to access.

Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar securities in active markets, and other input such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related securities.

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest input that is significant to the valuation. The Company's assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each security.

On an annual basis the Company validates the measurement of the fair values of its securities with an independent securities valuation firm. This independent securities valuation firm determines the fair values of the securities portfolio that is then compared to the fair value using the methods outlined. When this validation was last done on September 30, 2011, the difference between the fair value reported and the fair value determined by the independent securities valuation firm was considered immaterial.

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

Securities Available for Sale ($000's)			Fair Value Measurements at Reporting Date Using
			Quoted Prices
			in Active		Significant
			Markets for		Other		Significant
			Identical		Observable		Unobservable
			Assets		Inputs		Inputs
	Total		(Level 1)		(Level 2)		(Level 3)

States and political subdivisions	$	2,984	$	0	$	2,167	$	817
Mortgage-backed securities		77,995		0		77,995		0
Equity securities		4,253		4,253		0		0
At March 31, 2012	$	85,232	$	4,253	$	80,162	$	817

States and political subdivisions	$	3,117	$	0	$	2,172	$	945
Mortgage-backed securities		79,762		0		79,762		0
Equity securities		4,261		4,261		0		0
At December 31, 2011	$	87,140	$	4,261	$	81,934	$	945

Index

NORTHERN STATES FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2012

(Unaudited)

The Company's change in Level 3 securities measured at fair value on a recurring basis was as follows:

	Securities
	Available
	for Sale ($000's)
Balance at December 31, 2011	$	945
Total realized and unrealized gains (losses) included in income		0
Total unrealized gains (losses) included in other comprehensive income		0
Net purchase, sales, calls and maturities		(128	)
Net transfer into Level 3		0
Balance at March 31, 2012	$	817

		Securities
		Available
		for Sale ($000's)
Balance at December 31, 2010		$	20
Total realized and unrealized gains (losses) included in income			(163	)
Total unrealized gains (losses) included in other comprehensive income			143
Net purchase, sales, calls and maturities			0
Net transfer into Level 3			0
Balance at March 31, 2011	<

NORTHERN STATES FINANCIAL CORP /DE/ 10-Q