The following discussion focuses on the consolidated financial condition of Northern States Financial Corporation (the "Company") at March 31, 2009 and the consolidated results of operations for the three month period ended March 31, 2009, compared with the three month period ended March 31, 2008. The purpose of this discussion is to provide a better understanding of the condensed consolidated financial statements of the Company and the operations of its two wholly-owned subsidiaries, NorStates Bank (the "Bank") and NorProperties, Inc. ("NorProp"), and the Bank's wholly- owned subsidiary, Northern States Community Development Corporation ("NSCDC"). This discussion should be read in conjunction with the interim condensed consolidated unaudited financial statements and notes thereto included herein.

Statements contained in this report that are not historical facts may constitute forward-looking statements (within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended), which involve significant risks and uncertainties. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and is including this statement for purposes of invoking these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are generally identifiable by the use of the words "believe," "expect," "intend," "anticipate," "estimate," "project," "plan," or similar expressions. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain and actual results may differ from those predicted. The Company undertakes no obligation to update these forward-looking statements in the future. The Company cautions readers of this report that a number of important factors could cause the Company's actual results subsequent to March 31, 2009 to differ materially from those expressed in forward-looking statements. Factors that could cause actual results to differ from those predicted and could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, the potential for further deterioration in the credit quality of the Company's loan and lease portfolios, uncertainty regarding the Company's ability to ultimately recover on loans currently on nonaccrual status, unanticipated changes in interest rates, general economic conditions, increasing regulatory compliance burdens or potential legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the Company's loan or investment portfolios, deposit flows, competition, demand for loan products and financial services in the Company's market area, and changes in accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements.

OVERVIEW

Total assets at March 31, 2009 were $652.1 million, an increase of $11.4 million, or 1.8 percent, from total assets of $640.7 million at December 31, 2008. Loans totaled $475.6 million at March 31, 2009, a decrease of $5.2 million, or 1.1 percent, from loans of $480.8 million at December 31, 2008. Investment in overnight federal funds sold increased $29.8 million to $37.3 million at March 31, 2009 as compared with $7.5 million at December 31, 2008, as the Company increased its liquidity levels due in part from the receipt of $17.2 million in proceeds from the issuance of preferred stock under the Treasury Department's TARP Capital Purchase Program. These funds increased the Company's capital levels, which exceeded the regulatory minimums for capital adequacy at December 31, 2008.

Deposit totals at March 31, 2009 of $500.5 million remained relatively unchanged from December 31, 2008 deposit levels of $500.8 million. The deposit mix changed in that core deposits of

retail commercial checking, NOW, savings and money market accounts increased $5.7 million to $212.8 million at March 31, 2009 as compared with $207.1 million in core deposits at December 31, 2008. At the same time, higher cost time deposits declined $9.3 million during the quarter.

The Company had a loss for the first quarter of 2009 of $1,457,000 or $0.39 per share compared with net income of $1,201,000, or $0.29 per share for the same quarter of 2008. The loss in the first quarter of 2009 was caused by a loss of $1,673,000 on the sale of other real estate owned and the provision of $1,704,000 to the Company's allowance for loan and lease losses due to declining real estate values on properties used as collateral on troubled loans.

The Company's net interest income, the difference between interest earned on loans and investments and interest paid on deposits and borrowings, decreased 11 percent, or $590,000, to $4.8 million for the first three months of 2009, as compared with $5.4 million for the same quarter of 2008. The decline in net interest income was attributable to nonearning nonaccrual loans that totaled $37.1 million at March 31, 2009 as compared with $6.7 million at March 31, 2008. The net interest spread declined to 2.91 percent during the first quarter of 2009 as compared with 3.11 percent during the same quarter of 2008.

CRITICAL ACCOUNTING POLICIES

Certain critical accounting policies involve estimates and assumptions by management. To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan and lease losses is a critical accounting policy for the Company because management must make estimates of losses and these estimates are subject to change.

The allowance for loan and lease losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan and lease losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required using past loan and lease loss experience, the nature and volume of the portfolio, information about specific borrower situations, estimated collateral values, economic conditions and other factors. Allocations of the allowance may be made for specific loans and leases, but the entire allowance is available for any loan or lease that, based on management's judgment, should be charged-off.

Management analyzes the adequacy of the allowance for loan and lease losses at least quarterly. Factors consid­ered in assessing the adequacy of the allowance include: changes in the type and volume of the loan and lease portfolio; review of the larger credits within the Bank; historical loss experi­ence; current economic trends and conditions; review of the present value of expected cash flows or fair value of collateral on impaired loans and leases; portfolio growth; and other factors management deems appropriate. Based on management's analysis, the allowance for loan and lease losses at March 31, 2009 is adequate to cover probable incurred credit losses.

One of the components of the allowance for loan losses is historical loss experience. Due to the increased historical losses during the past year as compared with previous years, the loss percentages based on the past recent trailing 12 months has been used as it is believed to be more indicative of current loan loss estimates. This differs from year-end 2008 when a 3-year historic loss average was used and from March 31, 2008 when a 5-year historic loss average was used.

Management specifically analyzes its nonperforming loans for probable losses. The change in the volume of nonperforming loans may significantly impact the amount of estimated losses specifically allocated to these loans depending on the adequacy of the loan collateral and the borrowers' ability to repay the loans. As specific allocations are done on a loan-by-loan basis, the amount of the specific allocation is more likely subject to fluctuation than an allocation for a pool of loans based on historical loss trends. The amount of the allocations on nonperforming loans may fluctuate in future periods due to changes in conditions of underlying collateral and changes in the borrowers' ability to repay.

Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed for impairment annually and more often if warranted by circumstances. Any such impairment will be recognized in the period identified.

Other intangible assets consist of core deposits and acquired customer relationship intangible assets arising from whole bank and branch acquisitions, which is periodically evaluated for impairment. They are initially measured at fair value and then are amortized on the straight-line method over their estimated useful life of seven years.

FINANCIAL CONDITION

The Company's federal funds sold at March 31, 2009 increased $29.8 million to $37.3 million compared with $7.5 million at December 31, 2008. The Company's federal funds sold position increased from the receipt of $17.2 million in proceeds from the issuance of preferred stock under the Treasury Department's TARP Capital Purchase Program while loans declined $5.2 million and securities investments declined $6.6 million from year-end 2008. Federal funds sold are excess funds above what is necessary to maintain at the Federal Reserve that the Company lends/sells to other financial institutions on an overnight basis. The Company may use the funds for its liquidity needs.

The Company's securities available for sale declined $6.6 million to $96.6 million at March 31, 2009 compared with $103.2 million at year-end 2008. The Company did not reinvest the funds into new short-term securities given the relatively low yields offered. The Company chose not to purchase securities of a duration over five years in an effort to mitigate potential interest rate risk. At March 31, 2009, securities totaling $75.5 million were pledged to secure public deposits, repurchase agreements and for other purposes required or permitted by law.

Loans and leases totaled $475.6 million at March 31, 2009, decreasing $5.2 million from $480.8 million at December 31, 2008. The decrease occurred to commercial loans that were not secured by real estate, which declined $6.4 million from year-end 2008. The decline in loans was attributable to the receipt of normal scheduled principal payments as well as lower loan demand during the quarter due to borrowers' concerns about the economy. Management is considering various alternatives in order to increase its loan portfolio in the coming quarters. Approximately 89 percent of the Bank's loan portfolio at March 31, 2009 was secured by real estate. The Company's loans to the hotel industry were $68.2 million at March 31, 2009. Loans totaling $115.6 million at March 31, 2009 were pledged to secure lines of credit from the Federal Reserve Bank of Chicago and the Federal Home Loan Bank of Chicago. Loan commitments have decreased $11.4 million to $72.0 million at March 31, 2009 compared with $83.4 million at December 31, 2008, corresponding to the decline in loan demand during the first quarter of 2009. Letters of credit also decreased slightly during the quarter to $7.6 million from $7.8 million at year-end. At March 31, 2009, loans to related parties totaled $879,000 and loan commitments and letters of credit issued to related parties were $1.2 million. Loans, loan commitments and letters of credit to related parties are made on the same terms and conditions that are available to the public.

Deposits remained stable at March 31, 2009, totaling $500.5 million as compared with $500.8 million at year-end 2008. The deposit mix changed in that core deposits, including retail and commercial checking, NOW, savings and money market accounts, which are generally considered more stable and lower cost deposits, increased $5.7 million to $212.8 million at March 31, 2009 as compared with $207.1 million in core deposits at December 31, 2008. Contributing to the growth of core deposit was a new "High Yield Checking" NOW account product, in which depositors earn an APY of 4.50 percent on balances up to $25,000 if certain conditions are met. At the same time, higher cost time deposits declined $9.3 million, including a reduction of $1.2 million to brokered time deposits to $98.0 million, compared with $99.2 million at December 31, 2008.

Securities sold under repurchase agreements decreased by $3.8 million to $38.8 million at March 31, 2009 from $42.6 million at December 31, 2008. The decline in repurchase agreement balances increases the Company's liquidity as it lowers the amount of securities needed to be pledged.

During January 2009, the Company's stockholders approved an amendment to the Certificate of Incorporation authorizing the Company to issue preferred stock. This was done in conjunction with the Company's application in late 2008 to the Treasury Department to participate in the TARP Capital Purchase Program as the issuance of preferred stock by the Company was a requirement of the program. During January 2009, the Company received approval from the Treasury Department for the TARP funds in the amount of $17,211,000.

On February 20, 2009, as part of the TARP Capital Purchase Program established by the Treasury Department under the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009 ("EESA"), the Company entered into a Letter Agreement and the Securities Purchase Agreement - Standard Terms attached thereto (the "Securities Purchase Agreement") with the Treasury Department, pursuant to which the Company agreed to issue and sell, and the Treasury Department agreed to purchase, (i) 17,211 shares of the Company's Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the "Preferred Stock") having a liquidation amount per share equal to $1,000, and (ii) a ten-year warrant (the "Warrant") to purchase up to 584,084 shares of the Company's common stock (the "Common Stock"), or 15% of the aggregate dollar amount of Preferred Stock purchased by the Treasury Department, at an exercise price of $4.42 per share, for an aggregate purchase price of $17,211,000 in cash. The Preferred Stock pays cumulative dividends at a rate of 5% per year for the first five years, and 9% per year thereafter. The Company may buyback the preferred stock at anytime, subject to the approval of the Company's primary regulator and the Treasury Department. Both the Preferred Stock and the Warrant will qualify as Tier 1 capital. Subsequent to March 31, 2009, the Company contributed $16.0 million of these funds to the Bank to further enhance the Bank's capital.

FAIR VALUE MEASUREMENTS

The following tables present information about the Company's securities that were measured at fair value on a recurring basis at March 31, 2009, and the valuation techniques used by the Company to determine the fair values.

In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical securities that the Company has 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 inputs 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 level 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 by sending a listing of its securities to an independent securities valuation firm. This independent securities valuation firm determines the fair values of the Company's securities portfolio that is then compared to the fair value using the methods outlined. When this validation was last done at September 30, 2008, the difference between the fair value reported and the fair value determined by the independent securities valuation firm was considered immaterial.

Disclosures concerning securities measured at fair value are as follows:

                                            TABLE 1

                             NORTHERN STATES FINANCIAL CORPORATION
                      ASSETS MEASURED AT FAIR VALUE ON A RECURRING BASIS
                                     As of March 31, 2009
                                           ($ 000s)

                                              Fair Value Measurements at Reporting Date Using
                                              Quoted Prices
                                                in Active        Significant
                                               Markets for          Other        Significant
                                                Identical        Observable      Unobservable
                                                  Assets           Inputs           Inputs
     Description                 03/31/09       (Level 1)         (Level 2)       (Level 3)
Securities available for sale  $   96,556       $    1,017         $  95,295        $       244

Securities classified within Level 3 consist primarily of collateralized debt obligations ("CDOs"). The CDOs were valued using discounted cash flow models that integrate significant inputs, including prepayment speed, discount and loss rates which are estimated based on projected performance of the specific entities that secure the instruments.

                                       TABLE 2
                        NORTHERN STATES FINANCIAL CORPORATION
           CHANGES IN LEVEL 3 MEASURED AT FAIR VALUE ON A RECURRING BASIS
                                As of March 31, 2009
                                      ($ 000s)
                                                                          Securities
                                                                          Available
                                                                           for Sale
Balance at December 31, 2008                                             $      2,265
Total realized and unrealized gains (losses) included in income                     0
Total unrealized gains (losses) included in other comprehensive income         (2,021 )
Net purchase, sales, calls and maturities                                           0
Net transfer into Level 3
Balance at March 31, 2009                                                $        244

The Company also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets are held to maturity loans that are considered impaired per Financial Accounting Standard
114. The Company has estimated the fair values of the impaired loans using Level 3 inputs, specifically discounted cash flow projections, or, if collateral dependent, the realizable value of the collateral.

                                          TABLE 3

                           NORTHERN STATES FINANCIAL CORPORATION
                   ASSETS MEASURED AT FAIR VALUE ON A NON-RECURRING BASIS
                                    As of March 31, 2009
                                          ($ 000s)

                               Fair Value Measurements at Reporting Date
                                                 Using
                               Quoted
                               Prices
                              in Active      Significant
                             Markets for        Other         Significant
                              Identical       Observable      Unobservable    Total Change
                               Assets           Inputs           Inputs      for the period
  Description   03/31/09      (Level 1)       (Level 2)        (Level 3)     ended 03/31/09
  Impaired
  loans
  accounted
    for under  $    23,729    $        -      $        -       $    23,729    $      (2,462)
  FAS 114

CAPITAL RESOURCES

Total stockholders' equity increased $14.9 million to $76.5 million at March 31, 2009, as compared with $61.6 million at year-end 2008. The increase was the result of the receipt of $17.2 million in TARP funds from the Treasury Department on February 20, 2009. In exchange for these funds the Company issued preferred stock and warrants to the Treasury Department. During the first quarter of 2009, capital was reduced as the Company recognized losses for the quarter of $1.5 million. Capital was also reduced by $98,000 to account for accrued dividends on the preferred stock for the period February 20, 2009 through March 31, 2009 and by $735,000 due to the decline in the accumulated other comprehensive income relating to the unrealized loss on securities available for sale, net of deferred tax. The book value of the Company's common stock at March 31, 2009 was $14.57 per share.

On a consolidated basis, the Company's Tier 1 to total assets ratio and total capital to assets ratio, on a risk adjusted basis, were 13.78 percent and 15.04 percent, respectively, as of March 31, 2009, and exceed the regulatory minimum for capital adequacy purposes. Subsequent to March 31, 2009, the Company's Board of Directors determined that there would be no semi-annual cash dividend paid on June 1, 2009 due to the reduced earnings of the Company and in order to preserve capital.

LIQUIDITY

The Company's liquidity is measured by the ability to raise funds through deposits, borrowed funds, capital or cash flow from the repayment or maturities of loans and securities and net profits. Liquidity is primarily managed through the growth of deposits and by liquid assets such as cash and due from banks less any reserve requirements, securities available for sale less any pledged securities and federal funds sold. Asset and liability management is the process of managing the balance sheet to achieve a mix of earning assets and liabilities in such a way that achieves an interest rate risk profile acceptable to management and assists in achieving a desired level of profitability. An important part of the overall asset and liability management process is providing adequate liquidity. Liquid assets at the Bank consist of cash and cash equivalents less any Federal Reserve Bank deposit requirements plus unpledged securities available for sale. The Bank's liquid assets totaled $65.6 million at March 31, 2009, as compared with $46.8 million at December 31, 2008.

Management reviews the liquidity ratio and as well as its sources and uses of funds weekly. The liquidity ratio is the net liquid assets divided by net deposits and short-term liabilities. At March 31, 2009, this ratio at the Bank was 12.8 percent and was within management's internal policy guidelines.

Liquidity management involves the Company's ability to meet the cash flow requirements of customers and other operating needs. The Company needs to have sufficient cash flow to meet borrowers' needs to fund loans or the requirements of depositors wanting to withdraw funds. The Statements of Cash Flows shows that for the three months ended March 31, 2009 cash and cash equivalents increased by $27.4 million to $49.3 million, primarily as the result of the receipt of $17.2 million in TARP funds.

Federal funds sold, interest bearing deposits in banks and available for sale securities, particularly those of shorter maturities, are principal sources of liquidity. Federal funds sold at March 31, 2009 were $37.3 million as compared with $7.5 million at December 31, 2008. The Company classifies all of its securities as available for sale, which increases the Company's flexibility in that the Company can use its unpledged securities to meet liquidity requirements by increasing its repurchase agreement balances. Securities available for sale totaled $96.6 million at March 31, 2009 of which $72.5 million were pledged to secure public deposits and repurchase agreements as compared with pledged securities of $72.0 million at December 31, 2008.

During the first three months of 2009, the Company had incoming cash flows from maturities and calls of securities available for sale of $5.4 million while it had cash outflows for purchases of securities of $38,000. These securities activities during the first quarter of 2009 provided liquidity of $5.4 million.

An important source of liquidity to the Company is deposits. During the first quarter of 2009 the Company had net outgoing cash flows of $301,000 due to a slight decline in deposits. The Company has the ability to increase deposits by increasing the interest rates it pays on its deposits as compared to its competition.

Another important source of liquidity to the Company is borrowings. During the first quarter of 2009, borrowings through repurchase agreements decreased $3.8 million. The Company drew on its line of credit with the Federal Home Loan Bank of Chicago during the first quarter in the amount of $10.0 million and later paid off this borrowing during the quarter. At March 31, 2009, the Company had a line of credit at the Federal Home Loan Bank of Chicago of $36.0 million of which $20.0 million had been outstanding leaving $16.0 million available at quarter-end. At March 31, 2009, the Company had a line of credit with the Federal Reserve Bank of Chicago of $34.6 million which was available to the Company for liquidity. Subsequent to March 31, 2009, the line of credit available to the Company from the Federal Reserve Bank of Chicago was reduced to $30.9 million as the Federal Reserve Bank of Chicago reduced the percentage it would lend on certain loans pledged by the Company. Additional funds available from three independent banks at March 31, 2009 total $35.0 million and help ensure the Company's ability to meet any funding needs, including any unexpected strain on liquidity. Subsequent to March 31, 2009, one of the three independent banks cancelled the line available to the Bank that had been $15.0 million at March 31, 2009.

RESULTS OF OPERATIONS

. . .