<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
[NO FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM TO
----- -----
COMMISSION FILE NUMBER 0-24100.
HMN FINANCIAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 41-1777397
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
101 NORTH BROADWAY, PO BOX 231 55975-0231
SPRING VALLEY, MINNESOTA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (507) 346-7345
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(TITLE OF CLASS)
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 twelve months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
requirements for the past 90 days. YES X NO
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
As of March 14, 1997, the Registrant had issued and outstanding 4,209,826
shares of the Registrant's Common Stock. The aggregate market value of the
voting stock held by non-affiliates of the Registrant as of March 14, 1997 was
$76.3 million. (The exclusion from such amount of the market value of the
shares owned by any person shall not be deemed an admission by the Registrant
that such person is an affiliate of the Registrant.)
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the Registrant's Annual Report for the year ended December 31, 1996,
are incorporated by reference in Parts II and IV of this Form 10-K.
Parts of the Registrant's Proxy Statement dated March 13, 1997, are incorporated
by reference in Part III of this Form 10-K.
Exhibit Index is located on page 47.
<PAGE>
TABLE OF CONTENTS
PART I
PAGE
----
Item 1. Business ....................................................... 3
General ................................................... 3
Lending Activities ........................................ 4
Investment Activities ..................................... 19
Sources of Funds .......................................... 23
Other Information
Service Corporations ................................. 27
Competition .......................................... 27
Employees ............................................ 27
Executive Officers ................................... 28
Regulation ................................................ 28
Taxation .................................................. 37
Item 2. Properties ..................................................... 40
Item 3. Legal Proceedings .............................................. 41
Item 4. Submission of Matters to a Vote of Security Holders ............ 41
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters ................................................... 41
Item 6. Selected Financial Data ........................................ 41
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations ..................................... 41
Item 8. Financial Statements and Supplementary Data .................... 41
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure ...................................... 41
PART III
Item 10. Directors and Executive Officers of the Registrant ............. 42
Item 11. Executive Compensation ......................................... 42
Item 12. Security Ownership of Certain Beneficial Owners and Management . 42
Item 13. Certain Relationships and Related Transactions ................. 42
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 43
Signatures .............................................................. 46
Index to Exhibits ....................................................... 47
2
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
HMN Financial, Inc. ("HMN" or the "Corporation"), was incorporated under the
laws of the State of Delaware in March 1994 for the purpose of becoming the
savings and loan holding company of Home Federal Savings Bank ("Home Federal" or
the "Bank") in connection with the Bank's conversion from a federally chartered
mutual savings bank to a federally chartered stock savings bank, pursuant to its
plan of conversion. HMN commenced on May 23, 1994, a Subscription and Community
Offering (the "Offering") of its shares in connection with the conversion of the
Bank. The Offering ended on June 22, 1994, and final approval for the
conversion was received from the Office of Thrift Supervision ("OTS") on June
29, 1994. HMN issued 6,085,775 shares of common stock at a price of $10 per
share. Total proceeds from the conversion were $59,178,342 net of costs
relating to the conversion of $1,679,408, and have been recorded as common stock
and additional paid in capital.
As a community-oriented financial institution, HMN seeks to serve the
financial needs of communities in its market area. HMN's business involves
attracting deposits from the general public and using such deposits to originate
or purchase one-to-four family residential mortgage loans and, to a much lesser
extent, consumer, construction, commercial real estate, commercial business and
multi-family loans. HMN also invests in mortgage-backed and related securities,
investment securities (consisting primarily of U.S. government and government
agency obligations) and other permissible investments. The executive offices of
HMN are located at 101 N. Broadway, PO Box 231, Spring Valley, Minnesota
55975-0231. It's telephone number at that address is (507) 346-7345.
MARKET AREA
HMN serves the Minnesota counties of Fillmore, Freeborn, Houston, Mower,
Olmsted and Winona and portions of Steele, Dodge, Goodhue and Wabasha Counties,
Minnesota, through its main office located in Spring Valley, Minnesota and its
six branch offices located in Albert Lea, Austin, LaCrescent, Rochester and
Winona, Minnesota. The portion of HMN's market area consisting of Rochester and
the contiguous communities is composed of primarily urban and suburban
communities while the balance of HMN's market area consists primarily of rural
areas and small towns. Primary industries in HMN's market area include
manufacturing, agriculture, health care, wholesale and retail trade, service
industries and education. Major employers include IBM, the Mayo Clinic and
Hormel, a food processing company, and various small industrial and other
companies. HMN's market area is also the home of Winona State University,
Rochester Community College, Austin Community College and several
vocational/technical schools.
Based upon 1990 census information, the population of the six primary
counties in the Bank's market area was as follows: Fillmore - 20,800; Freeborn
- - 33,000; Houston - 18,500; Mower - 37,300; Olmsted - 101,000; and Winona -
47,900. Based upon 1990 U.S. Department of Commerce information, per capita
income in these six counties ranged from approximately $15,000 to $21,000.
During the fourth quarter of 1996, HMN opened a mortgage banking office in
Edina, Minnesota. The office will primarily purchase loans from third party
originators located in the seven county metropolitan area of Minneapolis and St.
Paul and sell the loans in the secondary market or place the loans in HMN's loan
portfolio. The new office will also purchase mortgage servicing rights from
third parties for the purpose of generating loan servicing income.
3
<PAGE>
LENDING ACTIVITIES
GENERAL. Historically, the Bank originated 30-year, fixed-rate mortgage
loans secured by one-to-four family residences. Since 1979, in order to reduce
its vulnerability to changes in interest rates, the Bank has emphasized the
origination or purchase of mortgage loans having shorter terms to maturity or
repricing, such as 15-year, fixed-rate residential loans, Adjustable Rate
Mortgage loans ("ARMs") and Graduated Equity Mortgage loans ("GEMs"). Starting
in 1995 and throughout 1996 HMN offered a competitive home equity line of
credit. HMN also offers consumer loans and, to a much lesser extent,
construction, commercial real estate, multi-family and commercial business
loans. See "- Originations, Purchases and Sales of Loans and Mortgage-Backed
and Related Securities."
4
<PAGE>
LOAN PORTFOLIO COMPOSITION. The following information concerning the
composition of the HMN's loan portfolio in dollar amounts and in percentages
(before deductions for loans in process, deferred fees and discounts and
allowances for losses) as of the dates indicated.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------
1996 1995
---------------------- ---------------------
(DOLLARS IN THOUSANDS) AMOUNT PERCENT AMOUNT PERCENT
------- ------- ------ ------- -
<S> <C> <C> <C> <C>
REAL ESTATE LOANS:
- -----------------
One-to-four family ............. $ 321,340 90.19% $ 292,497 90.62%
Multi-family ................... 280 0.08 361 0.11
Commercial ..................... 7,918 2.22 8,744 2.71
Construction or development .... 3,474 0.98 5,082 1.58
---------- ---------- ---------- ----------
Total real estate loans ...... 333,012 93.47 306,684 95.02
---------- ---------- ---------- ----------
OTHER LOANS:
- -----------
Consumer loans:
Savings account ............... 938 0.26 1,210 0.37
Education ..................... 467 0.13 342 0.11
Automobile .................... 566 0.16 671 0.21
Home equity ................... 17,808 5.00 11,506 3.56
Home improvement .............. 585 0.16 785 0.24
Other ......................... 568 0.16 545 0.17
---------- ---------- ---------- ----------
Total consumer loans ......... 20,932 5.87 15,059 4.66
Commercial business loans ..... 2,344 0.66 1,018 0.32
---------- ---------- ---------- ----------
Total other loans ............ 23,276 6.53 16,077 4.98
---------- ---------- ---------- ----------
Total loans ................. 356,288 100.00% 322,761 100.00%
---------- ----------
---------- ----------
LESS:
- ----
Loans in process ............... 2,814 3,531
Unamortized discounts .......... 417 289
Net deferred loan fees ......... 1,695 1,899
Allowance for losses on loans .. 2,340 2,191
---------- ----------
Total loans receivable, net . $349,022 $314,851
---------- ----------
---------- ----------
<CAPTION>
December 31,
---------------------------------------------------------------------------------
1994 1993 1992
----------------------- --------------------- ----------------------
(DOLLARS IN THOUSANDS) AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT
------ ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
REAL ESTATE LOANS:
- -----------------
One-to-four family .............. $ 252,943 91.14% $ 233,009 92.18% $ 223,914 89.86%
Multi-family .................... 311 0.11 349 0.14 709 0.28
Commercial ...................... 8,316 3.00 4,559 1.80 6,512 2.61
Construction or development ..... 2,799 1.01 3,309 1.31 6,879 2.76
---------- ---------- ---------- ---------- ---------- ----------
Total real estate loans ....... 264,369 95.26 241,226 95.43 238,014 95.51
---------- ---------- ---------- ---------- ---------- ----------
OTHER LOANS:
- -----------
Consumer loans:
Savings account ................ 648 0.23 872 0.34 1,153 0.46
Education ...................... 2,007 0.72 1,819 0.72 1,584 0.64
Automobile ..................... 520 0.19 681 0.27 927 0.37
Home equity .................... 7,716 2.78 5,604 2.22 4,623 1.86
Home improvement ............... 870 0.31 912 0.36 1,044 0.42
Other .......................... 502 0.19 586 0.23 684 0.27
---------- ---------- ---------- ---------- ---------- ----------
Total consumer loans .......... 12,263 4.42 10,474 4.14 10,015 4.02
Commercial business loans ...... 897 0.32 1,089 0.43 1,160 0.47
---------- ---------- ---------- ---------- ---------- ----------
Total other loans ............. 13,160 4.74 11,563 4.57 11,175 4.49
---------- ---------- ---------- ---------- ---------- ----------
Total loans .................. 277,529 100.00% 252,789 100.00% 249,189 100.00%
---------- ---------- ----------
---------- ---------- ----------
LESS:
- ----
Loans in process ................ 2,327 2,333 4,576
Unamortized discounts ........... 162 14 32
Net deferred loan fees .......... 2,147 2,507 2,236
Allowance for losses on loans ... 1,893 1,489 831
---------- ---------- ----------
Total loans receivable, net .. $ 271,000 $ 246,446 $ 241,514
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
5
<PAGE>
The following table shows the composition of the HMN's loan portfolio by
fixed and adjustable rate at the dates indicated.
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------
1996 1995
--------------------- ------------------
(DOLLARS IN THOUSANDS) Amount Percent Amount Percent
-------- --------- -------- ---------
<S> <C> <C> <C> <C>
FIXED-RATE LOANS
- ----------------
Real estate:
One-to-four family
GEM ....................................... $ 48,831 13.71% $ 30,175 9.35%
Other ..................................... 187,519 52.63 181,401 56.20
--------- --------- --------- ---------
Total one-to-four family ................. 236,350 66.34 211,576 65.55
Multi-family .............................. 223 0.06 302 0.10
Commercial ................................ 1,276 0.36 1,518 0.47
Construction or development ............... 2,970 0.83 4,848 1.50
--------- --------- --------- ---------
Total fixed-rate real estate loans ....... 240,819 67.59 218,244 67.62
--------- --------- --------- ---------
Consumer loans:
Savings .................................. 938 0.26 1,210 0.37
Education ................................ 434 0.12 299 0.09
Automobile ............................... 566 0.16 671 0.21
Home equity .............................. 5,338 1.50 7,254 2.25
Home improvement ......................... 585 0.16 785 0.24
Other .................................... 568 0.16 545 0.17
--------- --------- --------- ---------
Total consumer loans .................... 8,429 2.36 10,764 3.33
--------- --------- --------- ---------
Commercial business loans ................ 1,344 0.38 1,018 0.32
--------- --------- --------- ---------
Total other loans ....................... 9,773 2.74 11,782 3.65
--------- --------- --------- ---------
Total fixed-rate loans .................. 250,592 70.33 230,026 71.27
--------- --------- --------- ---------
ADJUSTABLE-RATE LOANS
- ---------------------
Real estate:
One-to-four family ........................ 84,990 23.85 80,921 25.07
Multi-family .............................. 57 0.02 59 0.02
Commercial ................................ 6,642 1.87 7,226 2.24
Construction or development ............... 504 0.14 234 0.07
--------- --------- --------- ---------
Total adjustable-rate real estate loans... 92,193 25.88 88,440 27.40
Consumer................................... 12,503 3.51 4,295 1.33
Commercial business loans.................. 1,000 0.28 --- ---
--------- --------- --------- ---------
Total adjustable-rate loans............... 105,696 29.67 92,735 28.73
--------- --------- --------- ---------
Total loans............................... 356,288 100.00% 322,761 100.00%
--------- --------- --------- ---------
--------- ---------
LESS
- ----
Loans in process............................ 2,814 3,531
Unamortized discounts....................... 417 289
Net deferred loan fees...................... 1,695 1,899
Allowance for losses on loans............... 2,340 2,191
--------- ---------
Total loans receivable, net............... $ 349,022 $ 314,851
--------- ---------
--------- ---------
<CAPTION>
December 31,
---------------------------------------------------------------------------
1994 1993 1992
------------------- ------------------- --------------------
(DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent
-------- --------- -------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
FIXED-RATE LOANS
- ----------------
Real estate:
One-to-four family
GEM ....................................... $ 24,769 8.93% $ 22,304 8.83% $ 34,987 14.04
Other ..................................... 168,272 60.63 171,503 67.84 152,513 61.20
--------- --------- --------- --------- --------- ---------
Total one-to-four family ................. 193,041 69.56 193,807 76.67 187,500 75.24
Multi-family .............................. 311 0.11 349 0.13 709 0.28
Commercial ................................ 1,612 0.58 626 0.25 2,418 0.97
Construction or development ............... 1,008 0.37 2,800 1.11 5,558 2.23
--------- --------- --------- --------- --------- ---------
Total fixed-rate real estate loans ....... 195,972 70.62 197,582 78.16 196,185 78.72
--------- --------- --------- --------- --------- ---------
Consumer loans:
Savings .................................. 648 0.23 872 0.34 1,153 0.46
Education ................................ 1,278 0.46 1,819 0.72 1,584 0.64
Automobile ............................... 520 0.19 681 0.27 927 0.37
Home equity .............................. 7,258 2.62 5,604 2.22 4,623 1.86
Home improvement ......................... 870 0.31 912 0.36 1,044 0.42
Other .................................... 502 0.18 586 0.23 684 0.27
--------- --------- --------- --------- --------- ---------
Total consumer loans .................... 11,076 3.99 10,474 4.14 10,015 4.02
--------- --------- --------- --------- --------- ---------
Commercial business loans ................ 897 0.32 1,089 0.43 1,160 0.47
--------- --------- --------- --------- --------- ---------
Total other loans ....................... 11,973 4.31 11,563 4.57 11,175 4.49
--------- --------- --------- --------- --------- ---------
Total fixed-rate loans .................. 207,945 74.93 209,145 82.73 207,360 83.21
--------- --------- --------- --------- --------- ---------
ADJUSTABLE-RATE LOANS
- ---------------------
Real estate:
One-to-four family ........................ 59,901 21.58 39,202 15.51 36,414 14.62
Multi-family .............................. --- --- --- --- --- ---
Commercial ................................ 6,704 2.42 3,933 1.56 4,094 1.64
Construction or development ............... 1,792 0.64 509 0.20 1,321 0.53
--------- --------- --------- --------- --------- ---------
Total adjustable-rate real estate loans... 68,397 24.64 43,644 17.27 41,829 16.79
Consumer................................... 1,187 0.43 --- --- --- ---
Commercial business loans.................. --- --- --- --- --- ---
--------- --------- --------- --------- --------- ---------
Total adjustable-rate loans............... 69,584 25.07 43,644 17.27 41,829 16.79
--------- --------- --------- --------- --------- ---------
Total loans............................... 277,529 100.00% 252,789 100.00% 249,189 100.00%
--------- --------- --------- --------- --------- ---------
--------- --------- ---------
LESS
- ----
Loans in process............................ 2,327 2,333 4,576
Unamortized discounts....................... 162 14 32
Net deferred loan fees...................... 2,147 2,507 2,236
Allowance for losses on loans............... 1,893 1,489 831
--------- --------- ---------
Total loans receivable, net................. $ 271,000 $ 246,446 $ 241,514
--------- --------- ---------
--------- --------- ---------
</TABLE>
6
<PAGE>
The following schedule illustrates the interest rate sensitivity of
HMN's loan portfolio at December 31, 1996. Loans which have adjustable or
renegotiable interest rates are shown as maturing in the period during which the
contract is due. The schedule reflects the effects of estimated prepayments on
the loan portfolio.
<TABLE>
<CAPTION>
Real Estate
-----------
Multi-family and
One-to-four family Commercial Construction
----------------------- ---------------------- ------------------------
Weighted Weighted Weighted
Average Average Average
(DOLLARS IN THOUSANDS) Amount Rate Amount Rate Amount Rate
------ ------- ------ ------ -------- ------
Due During
Years Ending
December 31,
----------------
<S> <C> <C> <C> <C> <C> <C>
1997(1) .................... $ 48,641 7.60% $ 1,551 8.21% $ 539 8.04%
1998 ....................... 48,580 7.58 1,136 8.11 428 8.04
1999 ....................... 30,222 7.58 1,137 8.11 427 8.04
2000 and 2001 .............. 58,102 7.57 1,503 8.08 619 8.04
2002 to 2006 ............... 83,497 7.54 1,975 8.41 897 8.04
2007 to 2021 ............... 49,867 7.48 896 8.04 535 8.04
2022 and following ......... 2,431 7.30 --- --- 29 8.15
------- ----- -----
$ 321,340 $ 8,198 $ 3,474
------- ----- -----
------- ----- -----
<CAPTION>
Commercial
Consumer Business Total
--------------------- -------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
(DOLLARS IN THOUSANDS) Amount Rate Amount Rate Amount Rate
-------- ------- -------- ------ -------- ------
Due During
Years Ending
December 31,
----------------
<S> <C> <C> <C> <C> <C> <C>
1997(1) .................... $ 4,135 8.91% $ 875 9.65% $ 55,741 7.75%
1998 ....................... 2,466 9.20 476 9.49 53,086 7.71
1999 ....................... 2,466 9.20 476 9.49 34,728 7.71
2000 and 2001 .............. 3,286 9.23 324 9.74 63,834 7.69
2002 to 2006 ............... 4,852 8.90 193 10.09 91,414 7.64
2007 to 2021 ............... 3,727 8.75 --- --- 55,025 7.58
2022 and following ......... --- --- --- --- 2,460 7.31
------ ----- -------
$ 20,932 $ 2,344 $ 356,288
------ ----- -------
------ ----- -------
</TABLE>
- -------------
(1) Includes demand loans, loans having no stated maturity, overdraft loans and
education loans.
The total amount of loans due after December 31, 1997 which have
predetermined interest rates is $207 million, while the total amount of loans
due after such dates which have floating or adjustable interest rates is $93.5
million.
7
<PAGE>
Under the Financial Institutions Reform, Recovery and Enforcement Act of
1989 ("FIRREA"), the aggregate amount of loans that the Bank is permitted to
make to any one borrower is generally limited to 15% of unimpaired capital and
surplus (25% if the security for such loan has a "readily ascertainable" value
or 30% for certain residential development loans). At December 31, 1996, based
upon the 15% limitation, the Bank's regulatory loans-to-one borrower limit was
approximately $9.1 million. On the same date, the Bank had no borrowers with
outstanding balances in excess of this amount. At December 31, 1996, the
largest dollar amount outstanding to one borrower or group of related borrowers
was $940,000. This loan, which is secured by a motel located in the Bank's
market area, was performing in accordance with its terms at December 31, 1996.
The Bank's Loan Committee is responsible for review and approval of all
loans over $149,999 originated by the Bank. Approval of one member of the Loan
Committee is required on all loans ranging from $150,000 to $249,999 and the
approval of at least two committee members is required on loans over $250,000 to
$400,000. Loans greater than $400,000 must be approved by the Board of
Directors of the Bank after review and preliminary approval by the Loan
Committee. All loans closed each month are reviewed by the Board of Directors
at the monthly meeting.
Under the Bank's loan policy, the loan officer processing an application is
responsible for ensuring that all documentation is obtained prior to the
submission of the application to the Loan Committee. In addition, the loan
officer verifies that the application meets the Bank's underwriting guidelines
described below. Also, each application is assigned to a reviewing officer who
reviews the file to assure its accuracy and completeness. The Branch Manager
has the authority to approve all loans up to $149,999.
All of the Bank's lending is subject to its written underwriting standards
and to loan origination procedures. Decisions on loan applications are made on
the basis of detailed applications and property valuations (consistent with the
Bank's appraisal policy) by the Bank's staff appraiser or an independent
appraiser. The loan applications are designed primarily to determine the
borrower's ability to repay and the more significant items on the application
are verified through use of credit reports, financial statements, tax returns
and/or confirmations.
Generally, the Bank requires title insurance on its mortgage loans as well
as fire and extended coverage casualty insurance in amounts at least equal to
the principal amount of the loan or the value of improvements on the property,
depending on the type of loan. The Bank also requires flood insurance to
protect the property securing its interest when the property is located in a
flood plain.
ONE-TO-FOUR FAMILY RESIDENTIAL REAL ESTATE LENDING. The cornerstone of
HMN's lending program is the origination of loans secured by mortgages on owner-
occupied one-to-four family residences. At December 31, 1996, $321.3 million,
or 90.19% of HMN's loan portfolio consisted of mortgage loans on one-to-four
family residences. At December 31, 1996, $233.2 million of the one-to-four
family residential loan portfolio was secured by properties located in HMN's
market area. HMN had $88.1 million of purchased one-to-four family loans in its
portfolio which were secured by properties located outside of its market area
(primarily located in the Midwestern United States, or the Southeastern United
States). Generally mortgage loans originated by the Bank are retained and
serviced by it. If a loan has a fixed rate with an original term to maturity of
30 years the loan is generally sold.
Prior to 1979, the Bank originated for retention in its own portfolio 30-
year, fixed-rate loans secured by one-to-four family residential real estate.
Beginning in 1979, the Bank began to emphasize the origination of fixed-rate
loans with terms of 15 years or less for retention in its portfolio. In
addition, in 1982, the Bank began to originate ARMs, subject to market
conditions and consumer preference. Subsequently, the Bank also began to
emphasize GEM originations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Asset/Liability Management" in
the Annual Report attached as Exhibit 13 hereto (the "Annual Report").
HMN currently offers conventional fixed-rate loans with maximum terms of up
to 30 years although HMN generally limits originations of loans with terms
longer than 20 years. The interest rate on such loans is generally
8
<PAGE>
set based on the FHLMC delivery rates, as well as, competitive factors. At
December 31, 1996, HMN had $187.5 million of fixed-rate loans (excluding GEM
loans) or 52.63% of HMN's total loan portfolio with a weighted average
contractual term to maturity of 12.9 years.
HMN also offers one-year ARMs at a margin (generally 275 basis points) over
the yield on the Average Monthly One Year U.S. Treasury Constant Maturity Index
for terms of up to 30 years. The ARM loans currently offered by HMN allow the
borrower to select (subject to pricing) an initial period of one year, three
years, or five years between the loan origination and when the first interest
rate change occurs. Generally the ARMs provide for an up to 200 basis point
annual interest rate change cap and a lifetime cap generally 600 basis points
over the initial rate. HMN's one year ARM loan portfolio typically contains
interest rate floors which are generally equal to the initial rate of the loan.
Initial interest rates offered on the ARM loans during 1996 ranged from 0 to 192
basis points below the fully indexed loan rate. All borrowers are now qualified
for the loan at the fully indexed rate. See "-Delinquencies and Non-Performing
Assets." In the past, the Bank offered one-year ARMs with a margin of 200 to
235 basis points over a specified index and an average annual cap of 145 basis
points. At December 31, 1996, one-to-four family ARMs totaled $85.0 million, or
23.8% of HMN's total loan portfolio.
HMN's originated ARMs do not permit negative amortization of principal, do
not contain prepayment penalties and generally are not convertible into fixed-
rate loans. HMN has $12.7 million of ARM loans purchased from a third party
which are convertible at borrowers option into fixed-rate loans. It has an
agreement with the third party to repurchase the ARM loans which convert to
fixed rates at a stipulated price.
The GEM loans carry required payments which increase after the first year.
Under the GEM loans, the monthly payments required for the first year are
established based on a 30-year amortization schedule. Depending upon the
program selected, the payments may increase in the succeeding years by amounts
ranging from 0% to 5%. Most of the GEM loans originated by HMN provide for at
least three annual payment increases over the first five years of the loan. The
increased payments required under GEM loans are applied to principal and have
the effect of shortening the term to maturity; the GEM loans do not permit
negative amortization. HMN currently offers two GEM programs, one with a
contractual maturity of approximately 15 years and one with a contractual
maturity of approximately 19 years. The GEMs are generally priced based upon
loans with similar contractual maturities. The GEMs have been popular with
consumers who anticipate future increases in income and who desire an
amortization schedule of less than 30 years. HMN believes that GEMs may
increase in popularity in the future if interest rates rise and consumers are
less easily able to afford the higher monthly payments required by 15-year,
fixed-rate loans.
HMN has also originated a limited number of fixed-rate loans with terms up
to 30 years which are insured by the Federal Housing Authority ("FHA").
Commencing in 1994, HMN began to sell all 30-year, fixed-rate FHA-insured loans
originated with servicing released. See "- Originations, Purchases and Sales of
Loans and Mortgage-Backed Securities and Related Securities."
In underwriting one-to-four family residential real estate loans, HMN
evaluates both the borrower's ability to make principal, interest and escrow
payments, the value of the property that will secure the loan and debt to income
ratios. Properties securing one-to-four family residential real estate loans
made by HMN are appraised by independent fee appraisers or by HMN's staff
appraiser. HMN originates residential mortgage loans with loan-to-value ratios
of up to 95% for owner-occupied homes and up to 50% for non-owner occupied
homes; however, private mortgage insurance is required to reduce HMN's exposure
to 80% or less. HMN generally seeks to underwrite its loans in accordance with
secondary market standards.
HMN's residential mortgage loans customarily include due-on-sale clauses
giving the it the right to declare the loan immediately due and payable in the
event that, among other things, the borrower sells or otherwise disposes of the
property subject to the mortgage and the loan is not repaid.
9
<PAGE>
CONSTRUCTION LENDING. HMN makes construction loans to individuals for the
construction of their residences, and to a much lesser extent, to builders for
the construction of one-to-four family residences. It also makes a very limited
number of loans to builders for houses built on speculation. The loan policy
limits the total amount of construction loans outstanding at one time to 2.0% of
assets. At December 31, 1996, HMN had $3.5 million of construction loans
outstanding representing 1.0% of HMN's total loan portfolio.
Almost all loans to individuals for the construction of their residences
are structured as permanent loans. Such loans are made on the same terms as
residential loans, except that during the construction phase, which typically
lasts up to seven months, the borrower pays interest only. The borrower also
pays a construction fee up to $800 at the time of origination. Residential
construction loans are underwritten pursuant to the same guidelines used for
originating residential loans on existing properties.
Construction loans to builders or developers of one-to-four family
residences generally carry terms of up to 15 years with a construction phase of
up to seven months. Such loans generally do not permit the payment of interest
from loan proceeds. At December 31, 1996, HMN had $134,000 of construction
loans to builders or developers. While it anticipates that it will continue to
engage in this type of lending from time to time in the future, HMN currently
expects that its total volume at any one time will be limited.
Construction loans to owner occupants are generally made in amounts of up
to 95% of the lesser of cost or appraised value, but no more than 85% of the
loan proceeds can be disbursed until the building is completed. The loan-to-
value ratios on loans to builders are limited to 70%. Prior to making a
commitment to fund a construction loan, HMN requires an appraisal of the
property and financial data and verification of income on the borrower. It
generally obtains personal guarantees for substantially all of its construction
loans to builders. Personal financial statements of guarantors are also
obtained as part of the loan underwriting process. All construction loans have
been located in HMN's market area.
Construction loans are obtained principally through continued business from
builders and developers who have previously borrowed from the Bank, as well as
referrals from existing customers and walk-in customers. The application
process includes a submission to the Bank of accurate plans, specifications and
costs of the project to be constructed. These items are used as a basis to
determine the appraised value of the subject property.
The nature of construction loans is such that they are more difficult to
evaluate and monitor. The risk of loss on a construction loan is dependent
largely upon the accuracy of the initial estimate of the property's value upon
completion of the project and the estimated cost (including interest) of the
project. If the estimate of value proves to be inaccurate, HMN may be
confronted, at or prior to the maturity of the loan, with a project having a
value which is insufficient to assure full repayment and/or the possibility of
having to make substantial investments to complete and sell the project.
Because defaults in repayment may not occur during the construction period it
may be difficult to identify problem loans at an early stage. In such cases,
HMN may be required to modify the terms of the loan.
COMMERCIAL REAL ESTATE AND MULTI-FAMILY LENDING. HMN originates permanent
commercial real estate and multi-family loans secured by properties located in
its market area. It also purchases commercial real estate loans outside of its
market area that are guaranteed by the Small Business Administration ("SBA") or
originated by other third parties. At December 31, 1996, HMN had $7.9 million
in commercial real estate loans, representing 2.2% of HMN's total loan
portfolio, and $280,000 in multi-family loans, or 0.1% of its total loan
portfolio.
The commercial real estate and multi-family loan portfolio includes loans
secured by motels, apartment buildings, churches, small office buildings, small
business facilities, nursing homes and other non-residential building
properties, substantially all of which are located within HMN's market area.
Permanent commercial real estate and multi-family loans are generally
originated for a maximum term of
10
<PAGE>
20 years and generally have adjustable interest rates. Prior to 1995 commercial
real estate and multi-family loans could have either a fixed interest rate or an
adjustable interest rate. Commercial real estate and multi-family loans are
written in amounts of up to 70% of the lesser of the appraised value of the
property or the purchase price and must have a debt service coverage ratio of at
least 125%. The debt service coverage is the ratio of net cash from operations
before payment of debt to debt service. HMN does not originate construction
loans secured by commercial or multi-family real estate.
Appraisals on properties serving commercial real estate and multi-family
loans originated by HMN are performed by independent appraisers prior to the
time the loan is made. Generally all appraisals on commercial and multi-family
real estate are reviewed by a member of the Bank's Loan Committee. The Bank's
underwriting procedures require verification of the borrower's credit history,
income and financial statements, banking relationships, references and income
projections for the property. It also requires personal guarantees from the
borrowers. In addition, HMN performs an annual on-site inspection on collateral
properties for loans with balances in excess of $250,000.
At December 31, 1996, HMN's two largest commercial real estate loans
totaled $940,000 and $910,000. The first loan was secured by a motel located in
Rochester, Minnesota near the Mayo Clinic. The second commercial real estate
loan was also secured by a motel located in HMN's market area. Both of these
loans were performing at December 31, 1996.
Multi-family and commercial real estate loans generally present a higher
level of risk than loans secured by one-to-four family residences. This greater
risk is due to several factors, including the concentration of principal in a
limited number of loans and borrowers, the effects of general economic
conditions on income producing properties and the increased difficulty of
evaluating and monitoring these types of loans. Furthermore, the repayment of
loans secured by multi-family and commercial real estate is typically dependent
upon the successful operation of the related real estate project. If the cash
flow from the project is reduced (for example, if leases are not obtained or
renewed), the borrower's ability to repay the loan may be impaired. At December
31, 1996, HMN had one commercial real estate loan totaling $83,000 and no multi-
family loans which were 90 days or more delinquent.
CONSUMER LENDING. HMN originates a variety of different types of consumer
loans, including home equity loans (open-end and closed-end), education,
automobile, home improvement, deposit account and other loans for household and
personal purposes. At December 31, 1996, consumer loans totaled $20.9 million,
or 5.9% of total loans outstanding.
Consumer loan terms vary according to the type and value of collateral,
length of contract and creditworthiness of the borrower. HMN's consumer loans
are made at fixed and adjustable interest rates, with terms of up to 20 years
for secured loans and up to three years for unsecured loans.
HMN's home equity loans are written so that the total commitment amount,
when combined with the balance of any other outstanding mortgage liens, may not
exceed 90% of the appraised value of the property. The closed-end home equity
loans are written with fixed or adjustable rates with terms of up to 15 years.
The open-end home equity loans are written with an adjustable rate with terms of
up to 20 years, a 10 year draw period which requires "interest only" payments
and a 10 year repayment period which fully amortizes the outstanding balance.
The consumer may access the open-end home equity loan either by making a
withdrawal at the Bank or writing a check on the home equity line of credit
account. At December 31, 1996, HMN's equity loans totaled $17.8 million, or
5.0% of the total loan portfolio.
11
<PAGE>
The underwriting standards employed by the Bank for consumer loans include
a determination of the applicant's payment history on other debts and ability to
meet existing obligations and payments on the proposed loan. Although
creditworthiness of the applicant is of primary consideration, the underwriting
process also includes a comparison of the value of the security, if any, in
relation to the proposed loan amount. Consumer loans may entail greater credit
risk than do residential mortgage loans, particularly in the case of consumer
loans which are unsecured or are secured by rapidly depreciable assets, such as
automobiles. In such cases, any repossessed collateral for a defaulted consumer
loan may not provide an adequate source of repayment of the outstanding loan
balance as a result of the greater likelihood of damage, loss or depreciation.
In addition, consumer loan collections are dependent on the borrower's
continuing financial stability, and thus are more likely to be affected by
adverse personal circumstances. Furthermore, the application of various federal
and state laws, including bankruptcy and insolvency laws, may limit the amount
which can be recovered on such loans. At December 31, 1996, $7,300 or .03% of
the consumer loan portfolio was non-performing. There can be no assurance that
delinquencies will not increase in the future.
COMMERCIAL BUSINESS LENDING. In order to satisfy the demand for financial
services available to individuals and businesses in its market area, HMN has
maintained a portfolio of commercial business loans primarily to small retail
operations, small manufacturing concerns and professional firms. Most of HMN's
commercial business loans have terms ranging from six months to five years and
carry fixed interest rates. HMN's commercial business loans generally include
personal guarantees and are usually, but not always, secured by business assets
such as inventory, equipment, fixtures, real estate and accounts receivables.
The underwriting process for commercial business loans includes consideration of
the borrower's financial statements, tax returns, projections of future business
operations and inspection of the subject collateral, if any. At December 31,
1996, HMN had $2.3 million of commercial business loans outstanding, or 0.7% of
the total loan portfolio. In addition, on that date, HMN had $20,000 of letters
of credit outstanding.
Unlike residential mortgage loans, which generally are made on the basis of
the borrower's ability to make repayment from his or her employment and other
income, and which are secured by real property whose value tends to be more
easily ascertainable, commercial business loans are of higher risk and typically
are made on the basis of the borrower's ability to make repayment from the cash
flow of the borrower's business. As a result, the availability of funds for the
repayment of commercial business loans may be substantially dependent on the
success of the business itself. Further, the collateral securing the loans may
depreciate over time, may be difficult to appraise and may fluctuate in value
based on the success of the business.
At December 31, 1996, there was one delinquent commercial business loan
totaling $13,000 that was over 90 days delinquent.
ORIGINATIONS, PURCHASES AND SALES OF LOANS AND MORTGAGE-BACKED AND RELATED
SECURITIES
Real estate loans are generally originated by HMN's staff of salaried and
commissioned loan officers. Loan applications are taken and processed in all
branch offices.
While HMN originates both fixed and adjustable-rate loans, its ability to
originate loans is dependent upon the relative customer demand for loans in its
market. Demand is affected by the interest rate environment. During the last
several years, the dollar volume of conventional fixed-rate, one-to-four family
loans has exceeded the dollar volume of GEMs and ARMs. Currently, substantially
all residential mortgage loans originated are retained in the loan portfolio
except 30 year fixed rate loans.
From time to time, in order to supplement loan demand in HMN's market area
and geographically diversify its loan portfolio, HMN purchases real estate loans
from selected sellers, with yields based upon current market rates. HMN
carefully reviews and underwrites all loans to be purchased to ensure that they
meet HMN's underwriting standards. The seller continues to service these
purchased loans. During 1996, HMN originated $56.7 million of real estate and
consumer loans and it purchased $55.8 million of single family residential loans
originated outside of its market area. The majority of the purchased loans have
interest rates that are fixed for a one, three or five year period and then
adjust annually thereafter or were seasoned fixed rate loans. All purchased
loans are reviewed to determine that each loan meets certain underwriting
requirements. Refer to Note 6 of the Notes to Consolidated Financial Statements
in the Annual Report for more information on purchased loans.
12
<PAGE>
HMN has substantial holdings of mortgage-backed and related securities
which are held, depending on the investment intent, in the "available for sale"
or "held to maturity" portfolios. During 1996, the Bank purchased $7.3 million
of mortgaged-backed securities and $50.3 million of mortgage-related securities,
primarily CMOs. See "- Investment Activities." During the same period, HMN
sold $81.1 million of mortgage-backed and related securities.
13
<PAGE>
The following table shows the loan and mortgage-backed and related
securities origination, purchase, sale and repayment activities of HMN for the
periods indicated.
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) Year Ended December 31,
LOANS 1996 1995 1994
--------------------------------------
ORIGINATIONS BY TYPE:
- --------------------
<S> <C> <C> <C>
Adjustable-rate:
Real estate - one-to-four family...................... $ 5,441 2,117 8,891
- multi-family.................................... --- 58 ---
- construction or development..................... 916 691 2,822
Non-real estate - consumer............................ 12,012 4,575 962
-------- -------- --------
Total adjustable-rate............................. 18,369 7,441 12,675
-------- -------- --------
Fixed-rate:
Real estate - one-to-four family..................... 27,036 23,565 23,032
- multi-family.................................... 145 --- ---
- commercial...................................... 30 150 ---
- construction or development..................... 6,181 4,847 3,305
Non-real estate - consumer........................... 4,583 7,267 7,418
- commercial business........................... 430 610 685
-------- -------- --------
Total fixed-rate.................................... 38,405 36,439 34,440
-------- -------- --------
Total loans originated.............................. 56,774 43,880 47,115
-------- -------- --------
PURCHASES:
- ---------
Real estate - one-to-four family...................... 55,839 47,136 17,213
Commercial real estate guaranteed by SBA.............. --- 946 4,073
Non-real estate - commercial business................. 1,500 --- ---
-------- -------- --------
Total purchased................................... 57,339 48,082 21,286
SALES AND REPAYMENTS:
- --------------------
Real estate - one-to-four family...................... 2,310 2,414 ---
Non-real estate - consumer............................ 176 1,791 ---
-------- -------- --------
Total sales....................................... 2,486 4,205 ---
Loans securitized and transferred to securities....... 15,441 --- ---
-------- -------- --------
Transfers to loans held for sale...................... 1,407 --- ---
-------- -------- --------
Principal repayments.................................. 58,262 39,215 39,419
-------- -------- --------
Total reductions.................................. 77,596 43,420 39,419
-------- -------- --------
Decrease in other items, net.......................... (2,990) (3,310) (4,242)
-------- -------- --------
Net increase...................................... $ 33,527 45,232 24,740
-------- -------- --------
-------- -------- --------
MORTGAGE-BACKED AND RELATED SECURITIES
Loans securitized and transferred to securities...... $15,441 --- ---
PURCHASES:
- ---------
Mortgage-backed securities:(1)
Adjustable-rate...................................... --- --- 20,297
Fixed-rate........................................... 7,266 10,139 17,562
CMOs and REMICs:
Adjustable-rate...................................... 6,527 55,321 5,483
Fixed-rate........................................... 43,831 11,881 42,725
-------- -------- --------
Total Purchases................................... 57,624 77,341 86,067
-------- -------- --------
SALES:
- -----
Mortgage-backed securities:(1)
Adjustable-rate...................................... --- 23,073 ---
Fixed-rate........................................... 24,786 11,953 8,373
CMOs and REMICs:
Adjustable-rate...................................... 23,876 9,008 ---
Fixed-rate........................................... 32,487 13,681 7,847
-------- -------- --------
Total Sales....................................... 81,149 57,715 16,220
-------- -------- --------
PRINCIPAL REPAYMENTS:
- --------------------
Decrease in other items, net.......................... 28,915 4,440 45,355
-------- -------- --------
Net increase (decrease).............................. $(36,999) 15,186 24,492
-------- -------- --------
-------- -------- --------
(1) Consists of pass-through securities.
</TABLE>
14
<PAGE>
DELINQUENCIES AND NON-PERFORMING ASSETS
DELINQUENCY PROCEDURES. When a borrower fails to make a required payment
on a loan, HMN attempts to cure the delinquency by contacting the borrower. A
late notice is sent on all loans over 16 days delinquent. Additional written
and verbal contacts may be made with the borrower between 30 and 60 days after
the due date. If the loan is contractually delinquent 90 days, HMN usually
sends a 30-day demand letter to the borrower and, after the loan is
contractually delinquent 120 days, institutes appropriate action to foreclose on
the property. If foreclosed, the property is sold at a sheriff's sale and may
be purchased by HMN. Delinquent consumer loans are generally handled in a
similar manner. HMN's procedures for repossession and sale of consumer
collateral are subject to various requirements under Minnesota consumer
protection laws.
Real estate acquired by HMN as a result of foreclosure or by deed in lieu
of foreclosure is classified as real estate in judgement for six months to one
year and thereafter as real estate owned until it is sold. When property is
acquired or expected to be acquired by foreclosure or deed in lieu of
foreclosure, it is recorded at the lower of cost or estimated fair value, less
the estimated cost of disposition. After acquisition, all costs incurred in
maintaining the property are expensed. Costs relating to the development and
improvement of the property, however, are capitalized to the extent of fair
value less disposition cost.
The following table sets forth HMN's loan delinquencies by type, by amount
and by percentage of type at December 31, 1996.
<TABLE>
<CAPTION>
Loans Delinquent For:
------------------------------------------------- Total Delinquent
60-89 Days 90 Days and Over Loans
---------------------- -------------------------- --------------------------
Percent Percent Percent
of Loan of Loan of Loan
(DOLLARS IN THOUSANDS) Number Amount Category Number Amount Category Number Amount Category
------ ------ -------- ------ ------ -------- ------ ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One-to-four family
real estate............ 8 $ 257 0.08% 6 $ 235 0.07% 14 $ 492 0.15%
Multi-family........... --- --- --- --- --- --- --- --- ---
Commercial............. --- --- --- 1 83 1.05 1 83 1.05
Construction or
development........... --- --- --- --- --- --- --- --- ---
Consumer............... 2 16 0.08 5 7 0.03 7 23 0.11
Commercial
business.............. 1 43 1.83 1 13 0.55 2 56 2.39
----- ----- ----- ------ ----- ------
Total.............. 11 $ 316 0.09% 13 $ 338 0.09% 24 $ 654 0.18%
----- ----- ----- ------ ----- ------
----- ----- ----- ------ ----- ------
</TABLE>
CLASSIFICATION OF ASSETS. Federal regulations require that each savings
institution classify its own assets on a regular basis. In addition, in
connection with examinations of savings institutions, OTS and FDIC examiners
have authority to identify problem assets and, if appropriate, require them to
be classified. There are three classifications for problem assets:
Substandard, Doubtful and Loss. Substandard assets have one or more defined
weaknesses and are characterized by the distinct possibility that the Bank will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of Substandard assets, with the additional characteristics that
the weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified as Loss is considered uncollectible
and of such little value that continuance as an asset on the balance sheet of
the institution is not warranted. Assets classified as Substandard or Doubtful
require the institution to establish prudent general allowances for loan losses.
If an asset or portion thereof is classified as Loss, the institution must
either establish specific allowances for loan losses in the amount of 100% of
the portion of the asset classified as Loss, or charge off such amount. If an
institution does not agree with an examiner's classification of an asset, it may
appeal this determination to the District Director of the OTS. On the basis
of management's review of its assets, at December 31, 1996, the Bank had
classified a total of $493,000 of its loans and other assets as follows:
15
<PAGE>
<TABLE>
<CAPTION>
Commercial Real
One-to-Four Construction or Estate and Commercial
(DOLLARS IN THOUSANDS) Family Development Multi-Family Consumer Business
---------- --------------- -------------- -------- ----------
<S> <C> <C> <C> <C> <C>
Substandard ............. $ 312 --- 83 26 71
Doubtful ................ --- --- --- --- ---
Loss .................... --- --- --- 1 ---
--- --- --- --- ---
Total .............. $ 312 --- 83 27 71
--- --- --- --- ---
</TABLE>
The Bank's classified assets consist of the non-performing loans and loans
and other assets of concern discussed herein. As of the date hereof, these
asset classifications are materially consistent with those of the OTS and FDIC.
NON-PERFORMING ASSETS. Loans are reviewed quarterly and any loan whose
collectibility is doubtful is placed on non-accrual status. Loans are placed on
nonaccrual status when either principal or interest is 90 days or more past due,
unless, in the judgment of management, the loan is well collateralized and in
the process of collection. Interest accrued and unpaid at the time a loan is
placed on non-accrual status is charged against interest income. Subsequent
payments are either applied to the outstanding principal balance or recorded as
interest income, depending on the assessment of the ultimate collectibility of
the loan. Restructured loans include the Bank's troubled debt restructurings
(which involved forgiving a portion of interest or principal on any loans or
making loans at a rate materially less than the market rate). Foreclosed assets
include assets acquired in settlement of loans. The following table sets forth
the amounts and categories of non-performing assets in the Bank's portfolio.
<TABLE>
<CAPTION>
December 31,
--------------------------------------------------------------------
(DOLLARS IN THOUSANDS) 1996 1995 1994 1993 1992
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Non-accruing loans:
Real estate:
One-to-four family................. $ 235 196 178 80 524
Multi-family....................... --- --- --- --- ---
Commercial real estate............. 83 85 --- --- ---
Consumer........................... 7 32 57 58 81
Commercial business................ 13 128 --- --- ---
--- --- --- --- ---
Total............................ 338 441 235 138 605
--- --- --- --- ---
Accruing loans delinquent 90
days or more:
One-to-four family.................. --- --- --- 23 ---
Restructured loans:
Multi-family........................ --- 94 199 --- 280
Foreclosed assets:
Real estate:
One-to-four family................. 23 315 64 316 ---
Commercial real estate............. --- --- --- 95 99
Construction or development........ --- --- --- --- 88
Consumer........................... --- --- --- 10 ---
------ ------ ------ ------ ------
Total............................ 23 315 64 421 187
------ ------ ------ ------ ------
Total non-performing assets........... $ 361 850 498 582 1,072
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Total as a percentage of total
assets............................... 0.07% 0.16% 0.10% 0.14% 0.26%
Total non-performing loans............ $ 338 $ 535 $ 434 $ 161 $ 885
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Total as a percentage of total
loans receivable, net................ 0.10% 0.17% 0.16% 0.07% 0.37%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
</TABLE>
For the year ended December 31, 1996, gross interest income which would
have been recorded had the non-accruing loans been current in accordance with
their original terms amounted to $34,638. The amounts that were included in
interest income on such loans in 1996 were $21,139.
Total non-performing assets were $361,000 at December 31, 1996, a decrease
of $489,000, compared to
16
<PAGE>
$850,000 at December 31, 1995. The decrease in non-performing assets is the
result of the sale of foreclosed assets of $315,000, the charge-off of $72,000
of commercial loans, and the normal inflow and outflow of delinquent loans
caused by borrowers getting behind on their payments and then bringing the loans
current again.
Total non-performing assets were $850,000 at December 31, 1995, an increase
of $352,000, compared to $498,000 at December 31, 1994. The increase was
principally the result of foreclosing on $315,000 of one-to-four family real
estate, troubled commercial business loans of $128,000, and $85,000 of troubled
commercial real estate.
OTHER LOANS OF CONCERN. In addition to the non-performing assets set forth
in the table above, as of December 31, 1996 there were $132,000 loans with
respect to which known information about the possible credit problems of the
borrowers or the cash flows of the secured properties have caused management to
have concerns as to the ability of the borrowers to comply with present loan
repayment terms and which may result in the future inclusion of such items in
the non-performing asset categories.
Management has considered the Bank's non-performing and "of concern" assets
in establishing its allowance for loan losses.
ALLOWANCE FOR LOSSES ON LOANS. The following table sets forth an analysis
of the Bank's allowance for loan losses for the year ended:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) 1996 1995 1994 1993 1992
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Balance at beginning of year .............. $ 2,191 1,893 1,489 831 883
CHARGE-OFFS
Real estate:
One-to-four family ...................... --- (1) (6) (1) (25)
Multi-family ............................ (88) --- --- --- (185)
Commercial real estate .................. --- --- --- --- (7)
Construction or development ............. --- --- --- --- (70)
Consumer ................................ (1) --- --- (1) (1)
Commercial business ..................... (61) (1) --- --- ---
-------- -------- ------- -------- --------
(150) (2) (6) (2) (288)
-------- -------- ------- -------- --------
RECOVERIES
Real estate:
One-to-four family ...................... --- --- --- --- 2
Commercial real estate .................. --- --- --- --- ---
Consumer ................................ --- --- --- --- 1
-------- -------- ------- -------- --------
--- --- --- --- 3
-------- -------- ------- -------- --------
Net charge-offs ........................... (150) (2) (6) (2) (285)
Additions charged to operations ........... 300 300 410 660 233
-------- -------- ------- -------- --------
Balance at end of year .................... $2,341 2,191 1,893 1,489 831
-------- -------- ------- -------- --------
-------- -------- ------- -------- --------
Ratio of net charge-offs during the year to
average loans outstanding during the
year ..................................... 0.05% --- --- --- 0.12%
-------- -------- ------- -------- --------
-------- -------- ------- -------- --------
Ratio of allowance for losses on loans to
total non-performing loans, at end of
year ..................................... 692.60% 409.13% 436.52% 924.84% 93.90%
-------- -------- ------- -------- --------
-------- -------- ------- -------- --------
</TABLE>
17
<PAGE>
The distribution of the Bank's allowance for losses on loans at the dates
indicated is summarized as follows:
<TABLE>
<CAPTION>
December 31,
-----------------------------------------------------------------------------
1996 1995 1994
------------ ------------ ------------
Percent Percent Percent
of Loans of Loans of Loans
in Each in Each in Each
Category Category Category
to Total to Total to Total
(DOLLARS IN THOUSANDS) Amount Loans Amount Loans Amount Loans
------ ------ ------ ------- ------ -------
<S> <C> <C> <C> <C> <C> <C>
Real Estate:
One-to-four family .......... $ 496 90.19% $ 452 90.62% $ 475 92.18%
Multi-family ................ 8 0.08 21 0.11 21 0.14
Commercial real estate....... 113 2.22 125 2.71 128 1.80
Construction or development . 104 0.98 153 1.58 84 1.31
Consumer .................... 473 5.87 286 4.66 280 4.14
Commercial business ......... 29 0.66 37 0.32 27 0.43
Unallocated ................. 1,118 --- 1,117 --- 878 ---
------ ------ ------ ------ ------ ------
Total .................... $ 2,341 100.00% $ 2,191 100.00% $ 1,893 100.00%
------ ------ ------ ------ ------ ------
------ ------ ------ ------ ------ ------
<CAPTION>
December 31,
------------------------------------------------
1993 1992
------------ ------------
Percent Percent
of Loans of Loans
in Each in Each
Category Category
to Total to Total
(DOLLARS IN THOUSANDS) Amount Loans Amount Loans
------ ----- ------ -------
<S> <C> <C> <C> <C>
Real Estate:
One-to-four family .......... $ 374 92.18% $ 208 89.86%
Multi-family ................ 10 0.14 18 0.28
Commercial real estate....... 140 1.80 198 2.61
Construction or development . 1 1.31 2 2.76
Consumer .................... 234 4.14 173 4.02
Commercial business ......... 30 0.43 32 0.47
Unallocated ................. 700 --- 200 ---
------ ------ ------ ------
Total .................... $ 1,489 100.00% $ 831 100.00%
------ ------ ------ ------
------ ------ ------ ------
</TABLE>
18
<PAGE>
The allowance for losses on loans is established through a provision for
losses on loans charged to earnings based on management's evaluation of the risk
inherent in its entire loan portfolio and changes in the nature and volume of
its loan activity. Such evaluation, which includes a review of all loans of
which full collectibility may not be reasonably assured, considers specific
occurrences, general and local economic conditions, loan portfolio composition,
historical and local experience and other factors that warrant recognition in
providing for an adequate allowance for loan losses. In determining the general
reserves under these policies, historical charge-offs and recoveries, changes in
the mix and levels of the various types of loans, the general level of non-
performing assets and the anticipated net realizable values, the current loan
portfolio and current economic conditions are considered. The Bank also
requires additional reserves for all classified loans.
While management believes that it uses the best information available to
determine the allowance for losses on loans, unforeseen market conditions could
result in adjustments to the allowance for losses on loans, and net earnings
could be significantly affected, if circumstances differ substantially from the
assumptions used in making the final determination.
INVESTMENT ACTIVITIES
HMN and the Bank utilize the available for sale securities portfolio in
virtually all aspects of asset/liability management strategy. In making
investment decisions, the Investment/Asset - Liability Committee considers,
among other things, the yield and interest rate objectives, the credit risk
position and the projected cash flow requirements.
The Bank must maintain minimum levels of investments that qualify as liquid
assets under OTS regulations. Liquidity may increase or decrease depending upon
the availability of funds and comparative yields on investments in relation to
the return on loans. Cash flow projections are regularly reviewed and updated
to assure that adequate liquidity is maintained. At December 31, 1996, the
Bank's liquidity ratio (liquid assets as a percentage of net withdrawable
savings deposits and current borrowings) was 12.48%. The Bank's level of
liquidity is a result of management's asset/liability strategy. See "Regulation
- - Liquidity."
SECURITIES. Federally chartered savings institutions have the authority to
invest in various types of liquid assets, including United States Treasury
obligations, securities of various federal agencies, certain certificates of
deposit of insured banks and savings institutions, certain bankers' acceptances,
repurchase agreements and federal funds. Subject to various restrictions,
federally chartered savings institutions may also invest their assets in
commercial paper, investment grade corporate debt securities and mutual funds
whose assets conform to the investments that a federally chartered savings
institution is otherwise authorized to make directly.
The investment strategy of HMN and the Bank has been directed toward a mix
of high-quality assets (primarily government and agency obligations) with short
and intermediate terms to maturity. At December 31, 1996, HMN did not own any
investment securities of a single issuer which exceeded 10% of HMN's
stockholder's equity other than U.S. government or federal agency obligations.
The Bank invests a portion of its liquid assets in interest-earning
overnight deposits of the Federal Home Loan Bank ("FHLB") of Des Moines and
various money market mutual funds. Other investments include high grade medium-
term (up to three years) corporate debt securities, medium-term federal agency
notes, and a variety of other types of mutual funds which invest in adjustable-
rate, mortgage-backed securities, asset-backed securities, repurchase agreements
and U.S. Treasury and agency obligations. HMN invests in the same type of
investment securities as the Bank and also invests in taxable and tax exempt
municipal obligations and corporate equities such as preferred and common stock.
See Notes 4 and 5 of the Notes to Consolidated Financial Statements in the
Annual Report for additional information regarding HMN's securities portfolio.
On January 1, 1994, the Bank adopted Statement of Financial Accounting
Standards No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY
SECURITIES. See Note 2 of the Notes to Consolidated Financial Statements in the
Annual Report for the impact of adopting the accounting standard.
19
<PAGE>
The following table sets forth the composition of HMN's securities
portfolio, excluding mortgage-backed and related securities, at the dates
indicated.
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------
1996
------------------------------------
Amortized Adjusted Market % of
(DOLLARS IN THOUSANDS) Cost To Value Total
----- ----- ------ -----
<S> <C> <C> <C> <C>
Securities available for sale:
U.S. government and agency
obligations .......................... $ 29,600 (322) 29,278 49.93%
Municipal obligations .............. --- --- --- ---
Corporate debt ..................... 1,091 1 1,092 1.86
Corporate equity(1) ................ 7,796 386 8,182 13.96
Stock of federal agencies(1)........ 3,874 49 3,923 6.69
Securities held to maturity:
U.S. agency obligations ............ --- --- ---
Municipal obligations .............. --- --- ---
Corporate debt ..................... 1,000 1,001 1.71
---------- --------- -------
Subtotal ......................... 43,361 43,476 74.15
FHLB stock ........................... 5,434 5,434 9.27
---------- --------- -------
Total investment securities
and FHLB stock .................. 48,795 48,910 83.42
---------- --------- -------
Average remaining life of investment
securities excluding FHLB stock ...... 3.4 years
Other Interest-Earning Assets:
Cash equivalents ................... 9,718 9,718 16.58
Total ............................ $ 58,513 58,628 100.00%
---------- --------- -------
---------- --------- -------
Average remaining life or term
to repricing of investment securities
and other interest-earning assets,
excluding FHLB stock ................ 2.8 years
<CAPTION>
December 31,
---------------------------------------------------
1995
---------------------------------
Amortized Adjusted Market % of
(DOLLARS IN THOUSANDS) Cost To Value Total
----- ----- ------ -----
<S> <C> <C> <C> <C>
Securities available for sale:
U.S. government and agency
obligations .......................... $ 21,896 (566) 21,330 50.58%
Municipal obligations .............. 1,600 1 1,601 3.80
Corporate debt ..................... 851 9 860 2.04
Corporate equity(1) ................ 6,898 174 7,072 16.77
Stock of federal agencies(1)........ 1,004 37 1,041 2.47
Securities held to maturity:
U.S. agency obligations ............ --- --- ---
Municipal obligations .............. 228 229 0.54
Corporate debt ..................... 2,999 2,995 7.10
---------- --------- -------
Subtotal ......................... 35,476 35,128 83.30
FHLB stock ........................... 3,802 3,802 9.02
Total investment securities
and FHLB stock .................. 39,278 38,930 92.32
---------- --------- -------
Average remaining life of investment
securities excluding FHLB stock ...... 3.0 years
Other Interest-Earning Assets:
Cash equivalents ................... 3,238 3,238 7.68
Total ........................... $42,516 42,168 100.00%
---------- --------- -------
---------- --------- -------
Average remaining life or term
to repricing of investment securities
and other interest-earning assets,
excluding FHLB stock ................ 2.7 years
<CAPTION>
December 31,
---------------------------------------------------
1994
---------------------------------
(DOLLARS IN THOUSANDS) Amortized Adjusted Market % of
Cost To Value Total
----- ----- ----- -----
<S> <C> <C> <C> <C>
Securities available for sale:
U.S. government and agency
obligations .......................... $ 23,823 (2,266) $ 21,557 43.20%
Municipal obligations .............. 3,001 (36) 2,965 5.94
Corporate debt ..................... 701 (10) 691 1.38
Corporate equity(1) ................ 5,610 (600) 5,010 10.04
Stock of federal agencies(1)........ 1,004 (20) 984 1.97
Securities held to maturity:
U.S. agency obligations ............ 2,000 1,945 3.90
Municipal obligations .............. --- --- ---
Corporate debt ..................... 6,008 5,875 11.77
---------- --------- -------
Subtotal ......................... 42,147 39,027 78.20
FHLB stock ........................... 3,039 3,039 6.09
---------- --------- -------
and FHLB stock .................. 45,186 42,066 84.29
---------- --------- -------
Average remaining life of investment
securities excluding FHLB stock ...... 2.4 years
Other Interest-Earning Assets:
Cash equivalents ................... 7,842 7,842 15.71%
Total ........................... $ 53,028 49,908 100.00%
---------- --------- -------
---------- --------- -------
Average remaining life or term
to repricing of investment securities
and other interest-earning assets,
excluding FHLB stock ................ 2.0 years
</TABLE>
(1)Average life assigned to corporate equity holdings and stock of federal
agencies is five years.
20
<PAGE>
The composition and maturities of the securities portfolio, excluding FHLB
stock, mortgage-backed and other related securities, are indicated in the
following table.
<TABLE>
<CAPTION>
December 31, 1996
--------------------------------------------------------------------------
Less Than 1 to 5 5 to 10 No Stated Total
1 Year Years Years Maturity Securities
---------- ---------- ---------- ---------- ---------------------------------
Amortized Amortized Amortized Amortized Amortized Adjusted Market
(DOLLARS IN THOUSANDS) Cost Cost Cost Cost Cost To Value
--------- ---------- ---------- ----------- --------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Securities available for sale:
U.S. government securities... $ 2,150 27,450 --- --- 29,600 (322) 29,278
Corporate debt............... 200 476 415 --- 1,091 1 1,092
Corporate equity............. --- --- --- 7,796 7,796 386 8,182
Stock of federal agencies.... --- --- --- 3,874 3,874 49 3,923
Securities held to maturity:
Corporate debt............... 1,000 --- --- --- 1,000 1 1,001
----- ----- ---- ----- ------ ------
Total stock.................... $ 3,350 27,926 415 11,670 43,361 43,476
----- ------ ----- ------ ------ ------
----- ------ ----- ------ ------ ------
Weighted average yield......... 5.93% 6.00% 9.02% 5.92% 6.00%
---- ---- ---- ---- ----
---- ---- ---- ---- ----
</TABLE>
21
<PAGE>
MORTGAGE-BACKED AND RELATED SECURITIES. In order to supplement loan
production (particularly those of interest rate sensitive loans) and achieve its
asset/liability management goals, HMN invests in mortgage-backed and related
securities. All of the mortgage-backed and related securities owned by HMN are
issued, insured or guaranteed either directly or indirectly by a federal agency
or are rated "AA" or higher. At December 31, 1996, HMN had $135.2 million of
mortgage-backed and related securities (including $133.4 million securities
available for sale).
At December 31, 1996 HMN had $43.5 million invested in CMOs which have
floating interest rates that change either monthly or quarterly compared to
$69.8 million at December 31, 1995. HMN decreased its investment in floating
rate CMOs in order to invest in mortgage loans and fund the purchase of HMN
common stock.
The projected weighted average life of the $102.4 million fixed rate CMO
and mortgage-backed security portfolio is approximately 4.0 years using median
prepayment speeds projected by the Bloomberg security system. The contractual
maturities of the mortgage-backed and related securities portfolio without any
prepayment assumptions at December 31, 1996 is as follows:
<TABLE>
<CAPTION>
December 31,
1996
5 Years 5 to 10 10 to 20 Over 20 Balance
(DOLLARS IN THOUSANDS) or Less Years Years Years Outstanding
------- ------- -------- ------- -------------
<S> <C> <C> <C> <C> <C>
Securities available for sale:
Federal Home Loan Mortgage Corporation.. $ --- 315 1,081 412 1,808
Federal National Mortgage Association... --- --- 462 522 984
Collateralized Mortgage Obligations..... 2,625 3,483 26,380 98,075 130,563
Securities held to maturity:
Federal Home Loan Mortgage Corporation.. 467 194 690 53 1,404
Federal National Mortgage Association... 60 98 --- --- 158
Other mortgage-backed securities........ --- --- --- 244 244
------- ------ ------- ------- -------
Total................................ $ 3,152 4,090 28,613 99,306 135,161
------- ------ ------- ------- -------
------- ------ ------- ------- -------
Weighted average yield.................. 6.72% 7.98% 7.11% 6.93% 6.99%
---- ---- ---- ---- ----
---- ---- ---- ---- ----
</TABLE>
At December 31, 1996, HMN did not have any non-agency mortgage-backed or
related securities in excess of 10% of its stockholders' equity, except for an
$11.9 million collateralized mortgage obligation issued by Bear Stearns with an
AAA rating by Moody's.
CMOs are securities derived by reallocating the cash flows from mortgage-
backed securities or pools of mortgage loans in order to create multiple
classes, or tranches, of securities with coupon rates and average lives that
differ from the underlying collateral as a whole. The terms to maturity of any
particular tranche is dependent upon the prepayment speed of the underlying
collateral as well as the structure of the particular CMO. Although a
significant proportion of HMN's CMOs are in tranches which have been structured
(through the use of cash flow priority and "support" tranches) to give somewhat
more predictable cash flows, the cash flow and hence the value of CMOs is
subject to change.
To assess price volatility, the Federal Financial Institutions Examination
Council ("FFIEC") adopted a policy in 1992 which requires an annual "stress"
test of mortgage derivative securities. This policy, which has been adopted by
the OTS, requires the Bank to annually test its CMOs and other mortgage-related
securities to determine whether they are "high-risk" or "nonhigh-risk
securities". At December 31, 1996, the Bank had $17.4 million of CMO's which
were classified as high-risk securities under the OTS guidelines.
22
<PAGE>
Mortgage-backed and related securities can serve as collateral for
borrowings and, through sales and repayments, as a source of liquidity. In
addition, mortgage-backed and related securities available for sale can be sold
to respond to changes in economic conditions. For information regarding the
carrying and market values of HMN's mortgage-backed and related securities
portfolio, see Notes 4 and 5 of the Notes to Consolidated Financial Statements
in the Annual Report.
SOURCES OF FUNDS
GENERAL. The Bank's primary sources of funds are deposits, payments
(including prepayments) of loan principal, interest earned on loans and
securities, repayments of securities, borrowings and other funds provided from
operations.
DEPOSITS. The Bank offers a variety of deposit accounts having a wide
range of interest rates and terms. The Bank's deposits consist of passbook,
NOW, money market, non-interest bearing checking and certificate accounts
(including individual retirement accounts). The Bank relies primarily on
competitive pricing policies and customer service to attract and retain these
deposits.
The variety of deposit accounts offered by the Bank has allowed it to be
competitive in obtaining funds and to respond with flexibility to changes in
consumer demand. As customers have become more interest rate conscious, the
Bank has become more susceptible to short-term fluctuations in deposit flows.
The Bank manages the pricing of its deposits in keeping with its asset/liability
management, profitability and growth objectives. Based on its experience, the
Bank believes that its passbook and NOW accounts are relatively stable sources
of deposits. However, the ability of the Bank to attract and maintain
certificate deposits, and the rates paid on these deposits, has been and will
continue to be significantly affected by market conditions.
The following table sets forth the savings flows at the Bank during the
periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
--------------------------------------
(DOLLARS IN THOUSANDS) 1996 1995 1994
------- -------- --------
<S> <C> <C> <C>
Opening balance................ $ 373,539 350,575 353,581
Deposits....................... 351,330 339,781 384,406
Withdrawals.................... 378,009 331,481 400,090
Interest credited.............. 15,617 14,664 12,678
------- ------- -------
Ending balance............... 362,477 373,539 350,575
------- ------- -------
Net increase (decrease)........ $ (11,062) 22,964 (3,006)
-------- ------- -------
-------- ------- -------
Percent increase (decrease).... (2.96)% 6.55% (0.85)%
-------- ------- -------
-------- ------- -------
</TABLE>
23
<PAGE>
The following table sets forth the dollar amount of savings deposits in the
various types of deposit programs offered by the Bank as of December 31:
<TABLE>
<CAPTION>
1996 1995 1994
-------------------- -------------------- --------------------
Percent Percent Percent
(DOLLARS IN THOUSANDS) Amount of Total Amount of Total Amount of Total
TRANSACTIONS AND SAVINGS DEPOSITS(1): -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Non-interest checking . . . . . . . . . $ 2,389 0.66% $ 2,505 0.67% $ 1,767 0.50%
NOW Accounts - 2.01%(2) . . . . . . . . 17,589 4.85 15,997 4.28 14,456 4.12
Passbook Accounts - 2.50% . . . . . . . 30,070 8.29 29,384 7.86 32,094 9.15
Money Market Accounts - 2.83% . . . . . 16,533 4.56 18,472 4.95 21,984 6.28
--------- --------- --------- --------- --------- --------
Total Non-Certificates . . . . . . . $ 66,581 18.36% $ 66,358 17.76% $ 70,301 20.05%
--------- --------- --------- --------- --------- --------
</TABLE>
<TABLE>
<CAPTION>
CERTIFICATES:
<S> <C> <C> <C> <C> <C> <C>
3.00 - 3.99% . . . . . . . . . . . . $ 425 0.12% $ 0 0.00% $ 19,431 5.54%
4.00 - 4.99% . . . . . . . . . . . . 22,553 6.22 22,440 6.01 72,449 20.67
5.00 - 5.99% . . . . . . . . . . . . 168,040 46.36 152,971 40.95 111,940 31.93
6.00 - 6.99% . . . . . . . . . . . . 76,704 21.16 89,754 24.03 40,597 11.58
7.00 - 7.99% . . . . . . . . . . . . 28,077 7.75 40,721 10.90 21,700 6.19
8.00 - 8.99% . . . . . . . . . . . . 96 0.03 1,294 0.35 12,061 3.44
9.00 - 9.99% . . . . . . . . . . . . 1 --- 1 0.00 462 0.13
10.00% and over . . . . . . . . . . . --- --- 0 0.00 1,634 0.47
--------- --------- --------- --------- --------- --------
Total Certificates . . . . . . . . . 295,896 81.64 307,181 82.24 280,274 79.95
--------- --------- --------- --------- --------- --------
Total Deposits . . . . . . . . . . $ 362,477 100.00% $ 373,539 100.00% $ 350,575 100.00
--------- --------- --------- --------- --------- --------%
--------- --------- --------- --------- --------- --------
</TABLE>
- -----------------------
(1)Reflects rates paid on transaction and savings deposits at December 31, 1996.
(2)The rate on NOW Accounts for 1995 and 1994 was 2.22%.
24
<PAGE>
The following table shows rate and maturity information for the Bank's
certificates of deposit as of December 31, 1996.
<TABLE>
<CAPTION>
3.00- 4.00- 5.00- 6.00-
(DOLLARS IN THOUSANDS) 3.99% 4.99% 5.99% 6.99%
Certificate accounts maturing in quarter ----- ----- ----- -----
ending:
<S> <C> <C> <C> <C>
March 31, 1996 . . . . . . . . . . . . $ 413 12,324 30,530 7,446
June 30, 1996 . . . . . . . . . . . . . 12 6,593 28,824 6,653
September 30, 1996 . . . . . . . . . . --- 1,406 23,632 7,633
December 31, 1996 . . . . . . . . . . . --- 1,635 14,098 4,257
March 31, 1997 . . . . . . . . . . . . --- 403 13,262 7,952
June 30, 1997 . . . . . . . . . . . . . --- 78 11,894 11,956
September 30, 1997 . . . . . . . . . . --- 32 10,187 9,227
December 31, 1997 . . . . . . . . . . . --- 55 10,568 1,044
March 31, 1998 . . . . . . . . . . . . --- --- 8,426 2,382
June 30, 1998 . . . . . . . . . . . . . --- 27 4,758 2,351
September 30, 1998 . . . . . . . . . . --- --- 3,220 2,221
December 31, 1998 . . . . . . . . . . . --- --- 813 514
Thereafter . . . . . . . . . . . . . . --- --- 7,828 13,068
------- ------- ------- -------
Total . . . . . . . . . . . . . . . $ 425 22,553 168,040 76,704
------- ------- ------- -------
------- ------- ------- -------
Percent of total . . . . . . . . . . 0.14% 7.62% 56.80% 25.92%
------ ------ ------ ------
------ ------ ------ ------
<CAPTION>
7.00- 8.00- 9.00- Percent
(DOLLARS IN THOUSANDS) 7.99% 8.99% 9.99% Total of Total
Certificate accounts maturing in quarter ----- ----- ----- ----- --------
ending:
<S> <C> <C> <C> <C> <C>
March 31, 1996 . . . . . . . . . . . . 455 --- --- 51,168 17.28
June 30, 1996 . . . . . . . . . . . . . 277 --- --- 42,359 14.32
September 30, 1996 . . . . . . . . . . 5,386 15 --- 38,072 12.87
December 31, 1996 . . . . . . . . . . . 12,474 --- --- 32,464 10.97
March 31, 1997 . . . . . . . . . . . . 4,734 1 --- 26,352 8.91
June 30, 1997 . . . . . . . . . . . . . 1,801 5 --- 25,734 8.70
September 30, 1997 . . . . . . . . . . 1,322 16 --- 20,784 7.02
December 31, 1997 . . . . . . . . . . . 1,357 20 --- 13,044 4.41
March 31, 1998 . . . . . . . . . . . . 150 27 --- 10,985 3.71
June 30, 1998 . . . . . . . . . . . . . 93 12 1 7,242 2.45
September 30, 1998 . . . . . . . . . . 28 --- --- 5,469 1.85
December 31, 1998 . . . . . . . . . . . --- --- --- 1,327 0.45
Thereafter . . . . . . . . . . . . . . ---
--- --- 20,896 7.06
------- ------- ------- ------- -------
Total . . . . . . . . . . . . . . . 28,077 96 1 295,896 100.00%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Percent of total . . . . . . . . . . 9.49% 0.03% 0.00% 100.00%
------ ----- ------ ------
------ ----- ------ ------
</TABLE>
25
<PAGE>
The following table indicates the amount of the Bank's certificates of
deposit and other deposits by time remaining until maturity as of December 31,
1996.
<TABLE>
<CAPTION>
Maturity
--------------------------
Over Over
3 Months 3 to 6 6 to 12 Over
or Less Months Months 12 months Total
------- ------ ------- --------- -----
<S> <C> <C> <C> <C> <C>
(DOLLARS IN THOUSANDS)
Certificates of deposit less
than $100,000 . . . . . . . . . . $ 39,365 36,325 62,112 122,832 260,634
Certificates of deposit of
$100,000 or more . . . . . . . . . 2,571 1,953 6,241 7,498 18,263
Public funds(1) . . . . . . . . . . 9,232 4,082 2,185 1,500 16,999
------ ------ ------ ------- -------
Total certificates of
deposit . . . . . . . . . . . . $ 51,168 42,360 70,538 131,830 295,896
------ ------ ------ ------- -------
------ ------ ------ ------- -------
</TABLE>
- ---------------
(1)Deposits from governmental and other public entities.
For additional information regarding the composition of the Bank's deposits, see
Note 11 of the Notes to Consolidated Financial Statements in the Annual Report.
For additional information on certificate maturities and the impact on HMN's
liquidity see Liquidity Management on page 21 of the Annual Report.
BORROWINGS. The Bank's other available sources of funds include advances
from the Federal Home Loan Bank ("FHLB") of Des Moines and other borrowings. As
a member of the FHLB of Des Moines, the Bank is required to own capital stock in
the FHLB of Des Moines and is authorized to apply for advances from the FHLB of
Des Moines. Each FHLB credit program has its own interest rate, which may be
fixed or variable, and range of maturities. The FHLB of Des Moines may
prescribe the acceptable uses for these advances, as well as limitations on the
size of the advances and repayment provisions. Consistent with its
asset/liability management strategy, the Bank has utilized FHLB advances from
time to time to extend the term to maturity of its liabilities. Also, the Bank
has used FHLB borrowings to fund loan demand and other investment opportunities
and to offset deposit outflows. At December 31, 1996, the Bank had $106.1
million of FHLB advances outstanding. On such date, the Bank had a collateral
pledge arrangement with the FHLB of Des Moines pursuant to which the Bank may
borrow up to an additional $11.5 million for liquidity purposes. See "Financial
Review - Federal Home Loan Bank Advances" and Note 12 of the Notes to
Consolidated Financial Statements in the Annual Report.
The following table sets forth the maximum month-end balance and average
balance of FHLB advances and other borrowings for the periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
MAXIMUM BALANCE:
FHLB advances . . . . . . . . . . . . . . . . . . . . . . . .$ 106,436 74,534 52,343
FHLB short-term borrowings and open line of credit . . . . . 64,429 42,429 7,329
AVERAGE BALANCE:
FHLB advances . . . . . . . . . . . . . . . . . . . . . . . . 89,656 65,069 40,121
FHLB short-term borrowings . . . . . . . . . . . . . . . . . 47,949 20,812 2,719
</TABLE>
The following table sets forth certain information as to the Bank's FHLB
advances at the dates indicated.
26
<PAGE>
<TABLE>
<CAPTION>
December 31,
-------------------------------
1996 1995 1994
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
FHLB short-term borrowings and open line of credit . . . . . . . . $ 46,429 33,429 6,429
Weighted average interest rate of
FHLB short-term borrowings and open line of credit . . . . . . . . 5.52% 6.05% 5.75%
</TABLE>
SERVICE CORPORATIONS OF THE BANK
As a federally chartered savings bank, the Bank is permitted by OTS
regulations to invest up to 2% of its assets in the stock of, or loans to,
service corporation subsidiaries, and may invest an additional 1% of its assets
in service corporations where such additional funds are used for inner-city or
community development purposes. In addition to investments in service
corporations, federal institutions are permitted to invest an unlimited amount
in operating subsidiaries engaged solely in activities which a federal savings
bank may engage in directly.
Osterud Insurance Agency, Inc. ("OIAI"), a Minnesota corporation, was
organized in 1983. OIAI operated as an insurance agency until 1986 when its
assets were sold. OIAI remained inactive until 1993 when it began offering
credit life insurance, annuity products and mutual fund products to the Bank's
customers and others. At December 31, 1996, the Bank's liability related to
OIAI was $32,700. OIAI recorded a net loss of $6,560 for the year ended
December 31, 1996.
COMPETITION
The Bank faces strong competition both in originating real estate loans and
in attracting deposits. Competition in originating loans comes primarily from
mortgage bankers, commercial banks, credit unions and other savings
institutions, which also make loans secured by real estate located in the Bank's
market area. The Bank competes for loans principally on the basis of the
interest rates and loan fees it charges, the types of loans it originates and
the quality of services it provides to borrowers.
Competition for those deposits is principally from money market and mutual
funds, securities firms, commercial banks and other savings institutions located
in the same communities. The ability of the Bank to attract and retain deposits
depends on its ability to provide an investment opportunity that satisfies the
requirements of investors as to rate of return, liquidity, risk, convenient
locations and other factors. The Bank competes for these deposits by offering a
variety of deposit accounts at competitive rates, convenient business hours and
a customer oriented staff. Based upon deposits at June 30, 1994, the latest
date such information was available, Home Federal's share of deposits held by
thrifts, commercial banks and credit unions in Fillmore, Freeborn, Houston,
Mower, Olmsted and Winona Counties, Minnesota was 21.9%, 17.1%, 9.3%, 17.4%,
6.3% and 3.8%, respectively.
EMPLOYEES
At December 31, 1996, HMN had a total of 109 full-time equivalent
employees. None of the employees of HMN or its subsidiaries are represented by
any collective bargaining unit. Management considers its employee relations to
be good.
EXECUTIVE OFFICERS OF THE REGISTRANT WHO ARE NOT DIRECTORS
Officers are elected annually by the Board of Directors of HMN and the
Bank. The business experience of each executive officer of HMN and the Bank who
is not also a director of HMN is set forth below unless otherwise
27
<PAGE>
indicated. Such individuals have held their current positions for at least five
years.
DWAIN C. JORGENSEN. Mr. Jorgensen, age 48, is Vice President, Controller
and Chief Accounting Officer of HMN and the Bank. Mr. Jorgensen has held such
positions with the Bank since 1989. From 1983 to 1989, Mr. Jorgensen was an
Assistant Vice President and Operations Officer with the Bank.
SUSAN K. KOLLING. Mrs. Kolling, age 45, is Senior Vice President of HMN
and is Senior Vice President of Marketing of the Bank, a position she has held
since 1995. Prior to such time, she served as Vice President from 1992 through
1994 and as a Loan Officer from 1981 through 1991. Mrs. Kolling began her
career with the Bank in 1969.
TIMOTHY P. JOHNSON. Mr. Johnson, age 44, is Treasurer of HMN and the Bank,
a position he has held since 1992. From 1983 to 1992, Mr. Johnson was Chief
Financial Officer of St. Louis Bank for Savings, Duluth, Minnesota.
ROXANNE M. HELLICKSON. Mrs. Hellickson, age 36, is Vice President/Loan
Administrator and Corporate Secretary of HMN and the Bank. She served as
Assistant Secretary of the Bank from 1992 to 1994 and was secretary to the
Bank's President and a loan officer from 1989 to 1992. Mrs. Hellickson began
her career with the Bank in 1979.
REGULATION
GENERAL
The Bank is a federally chartered savings bank, the deposits of which are
federally insured and backed by the full faith and credit of the United States
Government. Accordingly, the Bank is subject to broad federal regulation and
oversight extending to all its operations. The Bank is a member of the FHLB of
Des Moines and is subject to certain limited regulation by the Federal Reserve
Board. The Bank is a member of the Savings Association Insurance Fund ("SAIF")
and the deposits of the Bank are insured by the FDIC. As a result, the FDIC has
certain regulatory and examination authority over the Bank. As the savings and
loan holding company of the Bank, HMN also is subject to federal regulation and
oversight. The purpose of the regulation of HMN and other holding companies is
to protect subsidiary savings associations.
Certain of these regulatory requirements and restrictions are discussed
below.
FEDERAL REGULATION OF SAVINGS ASSOCIATIONS
The OTS has extensive authority over the operations of savings
associations. As part of this authority, the Bank is required to file periodic
reports with the OTS and is subject to periodic examinations by the OTS and the
FDIC. The last regular OTS examination of the Bank was dated April 1996. The
Bank has not been scheduled for an examination in 1997. When these examinations
are conducted by the OTS and the FDIC, the examiners may require the Bank to
provide for higher general or specific loan loss reserves. Financial
institutions in various regions of the United States have been called upon by
examiners to write down assets and to establish increased levels of reserves,
primarily as a result of perceived weaknesses in real estate values and a more
restrictive regulatory climate.
The OTS has established a schedule for the assessment of fees upon all
savings associations to fund the operations of the OTS. The general assessment,
to be paid on a semi-annual basis, is computed upon the savings association's
total assets as reported in the association's latest quarterly thrift financial
report. Savings associations (unlike the Bank) that are classified as
"troubled" (I.E., having a supervisory rating of "4" or "5" or subject to a
conservatorship) are required to pay a 50% premium over the standard assessment.
The Bank's OTS assessment for the year ended December 31, 1996 was approximately
$118,000.
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The OTS also has extensive enforcement authority over all savings
institutions and their holding companies, including the Bank and HMN. This
enforcement authority includes, among other things, the ability to assess civil
money penalties, to issue cease-and-desist or removal orders and to initiate
injunctive actions. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with the OTS. Except under certain
circumstances, public disclosure of final enforcement actions by the OTS is
required.
In addition, the investment, lending and branching authority of the Bank is
prescribed by federal laws and regulations, and it is prohibited from engaging
in any activities not permitted by such laws and regulations. For instance, no
savings institution may invest in non-investment grade corporate debt
securities. In addition, unless approved by the OTS, the permissible level of
investment by federal associations in loans secured by non-residential real
property may not exceed 400% of regulatory capital. Federal savings
associations are also generally authorized to branch nationwide. The Bank is in
compliance with the noted restrictions.
The Bank's general permissible lending limit for loans-to-one-borrower is
equal to the greater of $500,000 or 15% of unimpaired capital and surplus
(except for loans fully secured by certain readily marketable collateral, in
which case this limit is increased to 25% of unimpaired capital and surplus).
At December 31, 1996, the Bank's lending limit under this restriction was $9.1
million. The Bank is in compliance with the loans-to-one borrower limitation.
In December 1991, the Federal Deposit Insurance Corporation Improvement Act
of 1991 ("FDICIA") was enacted into law. FDICIA provides for, among other
things, the recapitalization of the Bank Insurance Fund; adoption of safety and
soundness standards; enhanced federal supervision of depository institutions,
including greater authority for the appointment of a conservator or receiver for
undercapitalized institutions; the establishment of risk-based deposit insurance
premiums; liberalization of the qualified thrift lender test; greater
restrictions on transactions with affiliates; and mandated consumer protection
disclosures with respect to deposit accounts. See "- Insurance of Accounts and
Regulation by the FDIC," "- Regulatory Capital Requirements" and "- Qualified
Thrift Lender Test."
The OTS, as well as the other federal banking agencies, have issued
proposed safety and soundness standards on matters such as loan underwriting and
documentation, internal controls and audit systems, interest rate risk exposure,
compensation and other employee benefits. The proposal also establishes the
maximum ratio of classified assets to total capital (which for this purpose
includes loss allowances exceeding the amount includable for regulatory capital
purposes) at 100% and the minimum level of earnings sufficient to absorb losses
without impairing capital. Earnings will be sufficient if the net income over
the last four quarters is assumed to continue over the next four quarters and
the institution would otherwise remain in capital compliance. Any institution
which fails to comply with these standards must submit a compliance plan. A
failure to submit a plan or to comply with an approved plan will subject the
institution to further enforcement action. The proposal also requires savings
and loan holding companies to ensure that transactions and relationships with
their subsidiary savings associations do not have a detrimental effect on the
safe and sound operation of the association. No assurance can be given as to
the final form of the proposed regulations.
INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC
The Bank is a member of the SAIF, which is administered by the FDIC.
Savings deposits are insured up to applicable limits by the FDIC and such
insurance is backed by the full faith and credit of the United States
Government. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of and to require reporting by FDIC-insured
institutions. It also may prohibit any FDIC-insured institution from engaging
in any activity the FDIC determines by regulation or order to pose a serious
risk to the FDIC. The FDIC also has the authority to initiate enforcement
actions against savings associations, after giving the OTS an opportunity to
take such action, and may terminate the deposit insurance if it determines that
the institution has
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engaged or is engaging in unsafe or unsound practices, or is in an unsafe or
unsound condition.
FDICIA also requires the FDIC to implement a risk-based deposit insurance
assessment system. Pursuant to this requirement, the FDIC adopted a
transitional risk-based assessment system, effective January 1, 1993, under
which all insured depository institutions are placed into one of nine categories
and assessed insurance premiums, ranging from .23% to .31% of deposits, based
upon their level of capital and supervisory evaluation. The permanent system,
adopted in June 1993 and effective January 1, 1994, continued the risk
classification system established under the transitional rule. Under the
system, institutions classified as well capitalized (I.E., a core capital ratio
of at least 5%, a ratio of Tier 1 or core capital to risk-weighted assets ("Tier
1 risk-based capital") of at least 6% and a risk-based capital ratio of at least
10%) and considered healthy would pay the lowest premium while institutions that
are less than adequately capitalized (I.E., core and Tier 1 risk-based capital
ratios of less than 4% or a risk-based capital ratio of less than 8%) and
considered of substantial supervisory concern would pay the highest premium.
Risk classification of all insured institutions will be made by the FDIC for
each semi-annual assessment period.
The FDIC is authorized to increase assessment rates, on a semi-annual
basis, if it determines that the reserve ratio of the SAIF will be less than the
designated reserve ratio of 1.25% of SAIF insured deposits. In setting these
increased assessments, the FDIC must seek to restore the reserve ratio to that
designated reserve level, or such higher reserve ratio as established by the
FDIC. In addition, under FDICIA, the FDIC may impose special assessments on
SAIF members to repay amounts borrowed from the United States Treasury or for
any other reason deemed necessary by the FDIC.
The Deposit Insurance Fund Act of 1996 (DIFA) was enacted on September 30,
1996. DIFA addressed the inadequate funding of the (SAIF). In order to
recapitalize the SAIF, DIFA imposed a one-time assessment on all thrift
institutions. The Bank's assessment was a pretax charge of $2,351,563 and was
recognized in the third quarter of 1996.
DIFA also addressed the funding for the Financing Corp. (FICO) bonds.
Thrifts will pay 6.4 basis points per $100 of deposits from January 1, 1997 to
December 31, 1999. From January 1, 2000 until the FICO bonds are retired in
2019, the estimated assessment to retire the FICO bonds is expected to be 2.5
basis points per $100 of deposits.
DIFA proposed that the Bank Insurance Fund (BIF) and SAIF be merged on
January 1, 1999, provided no insurance depository institution is a savings
association on that date. DIFA also directed the Secretary of the Treasury to
present recommendations to Congress for establishment of a common depository
institution charter by March 31, 1997. At this time, HMN does not know what
effect, if any, the proposed legislation or charter revisions will have on
future operations.
REGULATORY CAPITAL REQUIREMENTS
Federally insured savings associations, such as the Bank, are required to
maintain a minimum level of regulatory capital. The OTS has established capital
standards, including a tangible capital requirement, a leverage ratio (or core
capital) requirement and a risk-based capital requirement applicable to such
savings associations. These capital requirements must be generally as stringent
as the comparable capital requirements for national banks. The OTS is also
authorized to impose capital requirements in excess of these standards on
individual associations on a case-by-case basis.
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity and retained earnings, and certain
noncumulative perpetual preferred stock. In addition, all intangible assets,
other than a limited amount of purchased mortgage servicing rights, must be
deducted from tangible capital. At December 31, 1996, the Bank had $289,000 of
mortgage servicing rights which were required to be deducted from tangible
capital.
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The OTS regulations establish special capitalization requirements for
savings associations that own subsidiaries. Under these regulations certain
subsidiaries are consolidated for capital purposes and others are excluded from
assets and capital. In determining compliance with the capital requirements,
all subsidiaries engaged solely in activities permissible for national banks or
engaged in certain other activities solely as agent for its customers are
"includable" subsidiaries that are consolidated for capital purposes in
proportion to the association's level of ownership, including the assets of
includable subsidiaries in which the association has a minority interest that is
not consolidated for GAAP purposes. For excludable subsidiaries the debt and
equity investments in such subsidiaries are deducted from assets and capital,
with a five-year transition period beginning on July 1, 1990, for investments
made before April 12, 1989. The subsidiary of the Bank is an includable
subsidiary.
At December 31, 1996, the Bank had tangible capital of $61.9 million, or
11.5% of adjusted total assets, which is $53.9 million above the minimum
requirement of 1.5% of adjusted total assets in effect on that date.
The capital standards also require core capital equal to at least 3% of
adjusted total assets (as defined by regulation). Core capital generally
consists of tangible capital plus certain intangible assets, including
supervisory goodwill (which is phased-out over a five-year period) a limited
amount of purchased credit card relationships. As a result of the prompt
corrective action provisions of FDICIA discussed below, however, a savings
association must maintain a core capital ratio of at least 4% to be considered
adequately capitalized unless its supervisory condition is such to allow it to
maintain a 3% ratio.
As required by federal law, the OTS has proposed a rule revising its
minimum core capital requirement to be no less stringent than that imposed on
national banks. The OTS has proposed that only those savings associations rated
a composite one (the highest rating) under the safety and soundness rating
system for savings associations will be permitted to operate at or near the
regulatory minimum leverage ratio of 3%. All other savings associations will be
required to maintain a minimum leverage ratio of 4% to 5%. The OTS will assess
each individual savings association through the supervisory process on a case-
by-case basis to determine the applicable requirement. No assurance can be
given as to the final form of any such regulation, the date of its effectiveness
or the requirement applicable to the Bank.
At December 31, 1996, the Bank had core capital equal to $61.9 million, or
11.5%, of adjusted total assets, which is $45.8 million above the minimum
leverage ratio requirement of 3% as in effect on that date.
The OTS risk-based requirement requires savings associations to have total
capital of at least 8% of risk-weighted assets. Total capital consists of core
capital, as defined above, and supplementary capital. Supplementary capital
consists of certain permanent and maturing capital instruments that do not
qualify as core capital and general valuation loan and lease loss allowances up
to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be
used to satisfy the risk-based requirement only to the extent of core
capital. At December 31, 1996, the Bank had $2.3 million of general loss
reserves, which were included in capital.
Certain exclusions from capital and assets are required to be made for the
purpose of calculating total capital, in addition to the adjustments required
for calculating core capital. Such exclusions consist of equity investments (as
defined by regulation) and that portion of land loans and nonresidential
construction loans in excess of an 80% loan-to-value ratio and reciprocal
holdings of qualifying capital instruments. The Bank had no such exclusions
from capital and assets at December 31, 1996.
In determining the amount of risk-weighted assets, all assets, including
certain off-balance sheet items, will be multiplied by a risk weight, ranging
from 0% to 100%, based on the risk inherent in the type of asset. For example,
the OTS has assigned a risk weight of 50% for prudently underwritten permanent
one-to-four family first lien mortgage loans not more than 90 days delinquent
and having a loan to value ratio of not more than 80% at origination unless
insured to such ratio by an insurer approved by the FNMA or the FHLMC.
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On December 31, 1996, the Bank had total "risk-based" capital of $64.3
million (including $61.9 million in core capital and $2.3 million in qualifying
supplementary capital) and risk-weighted assets of $234.5 million, or total
capital of 27.4% of risk-weighted assets. This amount was $45.6 million above
the 8% requirement in effect on that date.
Under FDICIA, all the federal banking agencies, including the OTS, must
revise their risk-based capital requirements to ensure that such requirements
account for interest rate risk, concentration of credit risk and the risks of
non-traditional activities, and that they reflect the actual performance of and
expected loss on multi-family loans. Such standards must be adopted within 18
months of the enactment of FDICIA.
The OTS had adopted a rule that required every savings association with
more than normal interest rate risk to deduct from its total capital, for
purposes of determining compliance with such requirement, an interest rate risk
component ("IRR component") equal to 50% of its interest-rate risk exposure
multiplied by the present value of its assets. The IRR component is a measure
of the potential decline in the net portfolio value ("NPV") of a savings
association, greater than 2% of the present value of its assets, based upon a
hypothetical 200 basis point increase or decrease in interest rates (whichever
results in a greater decline). NPV is the present value of expected cash flows
from assets, liabilities and off-balance sheet contracts. The rule provided for
a two quarter lag between calculating interest rate risk and recognizing any
deduction from capital. The OTS has decided not to require the IRR component to
be deducted from the capital calculations of all institutions. It has reserved
the right to take the IRR component into account in assessing the capital
requirements for an individual institution. Based upon an IRR component
analysis at December 31, 1996, the Bank was deemed to have more than "normal"
interest rate risk and may, at some time in the future, be required to deduct an
amount from capital. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Asset/Liability Management" in the Annual
Report.
Pursuant to FDICIA, the federal banking agencies, including the OTS, have
adopted regulations authorizing the agencies to require a depository institution
to maintain an additional amount of total capital to account for concentration
of credit risk and the risk of non-traditional activities.
The OTS and the FDIC are authorized and, under certain circumstances,
required to take certain actions against associations that fail to meet capital
requirements. Effective December 19, 1992, the federal banking agencies,
including the OTS, were given additional enforcement authority over
undercapitalized depository institutions. The OTS is generally required to take
action to restrict the activities of an "undercapitalized association"
(generally defined to be one with less than either a 4% core ratio, a Tier 1
risked-based capital ratio or an 8% risk-based capital ratio). Any such
association must submit a capital restoration plan and until such plan is
approved by the OTS may not increase its assets, acquire another institution,
establish a branch or engage in any new activities, and generally may not make
capital distributions. The OTS is authorized to impose the additional
restrictions, discussed below, that are applicable to significantly
undercapitalized associations.
As a condition to the approval of the capital restoration plan, any
company controlling an undercapitalized association must agree that it will
enter into a limited capital maintenance guarantee with respect to the
institution's achievement of its capital requirements.
Any savings association that fails to comply with its capital plan or is
"significantly undercapitalized" (I.E., Tier 1 risk-based or core capital ratios
of less than 3% or a risk-based capital ratio of less than 6%) must be made
subject to one or more additional specified actions and operating restrictions
mandated by FDICIA. These actions and restrictions include requiring the
issuance of additional voting securities; limitations on asset growth; mandated
asset reduction; changes in senior management; divestiture, merger or
acquisition of the association; restrictions on executive compensation; and any
other action the OTS deems appropriate. An association that becomes "critically
undercapitalized" (I.E., a tangible capital ratio of 2% or less) is subject to
further mandatory restrictions on its activities in addition to those applicable
to significantly undercapitalized associations. In addition, the OTS must
appoint a receiver (or conservator with the concurrence of the FDIC) for a
savings association, with certain limited exceptions, within 90 days after it
becomes critically undercapitalized.
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Any undercapitalized association is also subject to other possible
enforcement actions by the OTS or the FDIC. Such actions could include a
capital directive, a cease-and-desist order, civil money penalties, the
establishment of restrictions on all aspects of the association's operations,
the appointment of a receiver or conservator or a forced merger into another
institution.
If the OTS determines that an association is in an unsafe or unsound
condition, or is engaged in an unsafe or unsound practice, it is authorized to
reclassify a well-capitalized association as an adequately capitalized
association, and if the association is adequately capitalized, to impose the
restrictions applicable to an undercapitalized association. If the association
is undercapitalized, the OTS is authorized to impose the restrictions applicable
to a significantly undercapitalized association.
The imposition by the OTS or the FDIC of any of these measures on the Bank
may have a substantial adverse effect on the Bank's operations and profitability
and the value of HMN's stock. HMN shareholders do not have preemptive rights,
and therefore, if HMN is directed by the OTS or the FDIC to issue additional
shares of common stock, such issuance may result in the dilution in the
percentage of ownership of existing stockholders of HMN.
At December 31, 1996 the Bank would be considered to be "well capitalized"
under the prompt corrective actions provisions mentioned above. See Note 16
"Federal Home Loan Bank Investment, Regulatory Liquidity and Regulatory Capital
Requirements" in the Notes to Consolidated Financial Statements in the Annual
Report for more information on the Bank's capital.
LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS
OTS regulations impose various restrictions or requirements on associations
with respect to their ability to pay dividends or make other distributions of
capital. OTS regulations prohibit an association from declaring or paying any
dividends or from repurchasing any of its stock if, as a result, the regulatory
capital of the association would be reduced below the amount required to be
maintained for the liquidation account established in connection with its mutual
to stock conversion.
The OTS utilizes a three-tiered approach to permit associations, based on
their capital level and supervisory condition, to make capital distributions
which include dividends, stock redemptions or repurchases, cash-out mergers and
other transactions charged to the capital account. See "- Regulatory Capital
Requirements."
Generally, Tier 1 associations, which are associations that before and
after the proposed distribution meet their fully phased-in capital requirements,
may make capital distributions during any calendar year equal to the greater of
100% of net income for the year-to-date plus 50% of the amount by which the
lesser of the association's tangible, core or risk-based capital exceeds its
fully phased-in capital requirement for such capital component, as measured at
the beginning of the calendar year, or the amount authorized for a Tier 2
association. However, a Tier 1 association deemed to be in need of more than
normal supervision by the OTS may be downgraded to a Tier 2 or Tier 3
association as a result of such a determination. The Bank meets the
requirements for a Tier 1 association and has not been notified of a need for
more than normal supervision. Tier 2 associations, which are associations that
before and after the proposed distribution meet their current minimum capital
requirements, may make capital distributions of up to 75% of net income over the
most recent four quarter period.
Tier 3 associations (which are associations that do not meet current
minimum capital requirements) that propose to make any capital distribution and
Tier 2 associations that propose to make a capital distribution in excess of the
noted safe harbor level must obtain OTS approval prior to making such
distribution. Tier 2 associations proposing to make a capital distribution
within the safe harbor provisions and Tier 1 associations proposing to make any
capital distribution need only submit written notice to the OTS 30 days prior to
such distribution. As a subsidiary of HMN, the Bank will also be required to
give the OTS 30 days' notice prior to declaring any dividend on its stock. The
OTS may object to the distribution during that 30-day period based on
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safety and soundness concerns. See "- Regulatory Capital Requirements."
The OTS has proposed regulations that would revise the current capital
distribution restrictions. The proposal eliminates the current tiered structure
and the safe-harbor percentage limitations. Under the proposal a savings
association may make a capital distribution without notice to the OTS (unless it
is a subsidiary of a holding company) provided that it has a CAMELS 1 or 2
rating, is not in troubled condition and would remain adequately capitalized (as
defined in the OTS prompt corrective action regulations) following the proposed
distribution. Savings associations that would remain adequately capitalized
following the proposed distribution but do not meet the other noted requirements
must notify the OTS 30 days prior to declaring a capital distribution. The OTS
stated it will generally regard as permissible that amount of capital
distributions that do not exceed 50% of the institution's excess regulatory
capital plus net income to date during the calendar year. A savings association
may not make a capital distribution without prior approval of the OTS and the
FDIC if it is undercapitalized before, or as a result of, such a distribution.
A savings association will be considered in troubled condition if it has a
CAMELS rating of 4 or 5, is subject to an enforcement action relating to its
safety and soundness or financial viability or has been informed in writing by
the OTS that it is in troubled condition. As under the current rule, the OTS
may object to a capital distribution if it would constitute an unsafe or unsound
practice. No assurance may be given as to whether or in what form the
regulations may be adopted.
LIQUIDITY
All savings associations, including the Bank, are required to maintain an
average daily balance of liquid assets equal to a certain percentage of the sum
of its average daily balance of net withdrawable deposit accounts and borrowings
payable in one year or less. For a discussion of what the Bank includes in
liquid assets, see "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Liquidity Management" in the Annual Report. This
liquid asset ratio requirement may vary from time to time (between 4% and 10%)
depending upon economic conditions and savings flows of all savings
associations. At the present time, the minimum liquid asset ratio is 5%.
In addition, short-term liquid assets (E.G., cash, certain time deposits,
certain bankers acceptances and short-term United States Treasury obligations)
currently must constitute at least 1% of the association's average daily balance
of net withdrawable deposit accounts and current borrowings. Penalties may be
imposed upon associations for violations of either liquid asset ratio
requirement. At December 31, 1996, the Bank was in compliance with both
requirements, with an overall liquid asset ratio of 7.4% and a short-term liquid
asset ratio of 1.9%.
ACCOUNTING
An OTS policy statement applicable to all savings associations clarifies
and re-emphasizes that the investment activities of a savings association must
be in compliance with approved and documented investment policies and
strategies, and must be accounted for in accordance with GAAP. Under the policy
statement, management must support its classification of and accounting for
loans and securities (I.E., whether held to maturity, sale or trading) with
appropriate documentation. The Bank is in compliance with these amended rules.
The OTS has adopted an amendment to its accounting regulations, which may
be made more stringent than GAAP, to require that transactions be reported in a
manner that best reflects their underlying economic substance and inherent risk
and that financial reports must incorporate any other accounting regulations or
orders prescribed by the OTS.
QUALIFIED THRIFT LENDER TEST
All savings associations, including the Bank, are required to meet a
qualified thrift lender ("QTL") test to
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avoid certain restrictions on their operations. This test requires a savings
association to have at least 65% of its portfolio assets (which consists of
total assets less intangibles, properties used to conduct the savings
association's business and liquid assets not exceeding 20% of total assets) in
qualified thrift investments on a monthly average for nine out of every 12
months on a rolling basis. Such assets primarily consist of residential housing
related loans and investments. At December 31, 1996, the Bank met the test and
has always met the test since its effectiveness.
Any savings association that fails to meet the QTL test must convert to a
national bank charter, unless it requalifies as a QTL and thereafter remains a
QTL. If an association does not requalify and converts to a national bank
charter, it must remain SAIF-insured until the FDIC permits it to transfer to
the Bank Insurance Fund. If an association that fails the test has not yet
requalified and has not converted to a national bank, its new investments and
activities are limited to those permissible for both a savings association and a
national bank, and it is limited to national bank branching rights in its home
state. In addition, the association is immediately ineligible to receive any
new FHLB borrowings and is subject to national bank limits for payment of
dividends. If such association has not requalified or converted to a national
bank within three years after the failure, it must divest of all investments and
cease all activities not permissible for a national bank. In addition, it must
repay promptly any outstanding FHLB borrowings, which may result in prepayment
penalties. If any association that fails the QTL test is controlled by a
holding company, then within one year after the failure, the holding company
must register as a bank holding company and become subject to all restrictions
on bank holding companies. See "- Holding Company Regulation."
TRANSACTIONS WITH AFFILIATES
Generally, transactions between a savings association or its subsidiaries
and its affiliates are required to be on terms as favorable to the association
as transactions with non-affiliates. In addition, certain of these transactions
are restricted to a percentage of the association's capital. Affiliates of the
Bank include HMN and any company which is under common control with the Bank.
In addition, a savings association may not lend to any affiliate engaged in
activities not permissible for a bank holding company or acquire the securities
of most affiliates. The Bank's subsidiaries are not deemed affiliates, however,
the OTS has the discretion to treat subsidiaries of savings associations as
affiliates on a case by case basis.
Certain transactions with directors, officers or controlling persons are
also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions on
loans to such persons and their related interests. Among other things, such
loans must be made on terms substantially the same as for loans to unaffiliated
individuals.
HOLDING COMPANY REGULATION
HMN is a unitary savings and loan holding company subject to regulatory
oversight by the OTS. As such, HMN is registered and required to file reports
with and subject to regulation and examination by the OTS. In addition, the OTS
has enforcement authority over HMN and its non-savings association subsidiaries
which also permits the OTS to restrict or prohibit activities that are
determined to be a serious risk to the subsidiary savings association.
As a unitary savings and loan holding company, HMN generally is not subject
to activity restrictions. If HMN acquires control of another savings
association as a separate subsidiary, it would become a multiple savings and
loan holding company, and the activities of HMN and any of its subsidiaries
(other than the Bank or any other SAIF-insured savings association) would become
subject to such restrictions unless such other associations which qualify as a
QTL and were acquired in a supervisory acquisition.
If the Bank fails the QTL test, HMN must obtain the approval of the OTS
prior to continuing after such failure, directly or through its other
subsidiaries, any business activity other than those approved for multiple
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savings and loan holding companies or their subsidiaries. In addition, within
one year of such failure HMN must register as, and will become subject to, the
restrictions applicable to bank holding companies. The activities authorized
for a bank holding company are more limited than are the activities authorized
for a unitary or multiple savings and loan holding company. See "- Qualified
Thrift Lender Test."
HMN must obtain approval from the OTS before acquiring control of any other
SAIF-insured association. Such acquisitions are generally prohibited if they
result in a multiple savings and loan holding company controlling savings
associations in more than one state. However, such interstate acquisitions are
permitted based on specific state authorization or in a supervisory acquisition
of a failing savings association.
FEDERAL SECURITIES LAW
The stock of HMN is registered with the SEC under the Securities Exchange
Act of 1934, as amended (the "Exchange Act"). HMN is subject to the
information, proxy solicitation, insider trading restrictions and other
requirements of the SEC under the Exchange Act.
HMN stock held by persons who are affiliates (generally officers, directors
and principal stockholders) of HMN may not be resold without registration or
unless sold in accordance with certain resale restrictions. If HMN meets
specified current public information requirements, each affiliate of HMN is able
to sell in the public market, without registration, a limited number of shares
in any three-month period.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board requires all depository institutions to maintain
non-interest bearing reserves at specified levels against their transaction
accounts (primarily checking, NOW and Super NOW checking accounts). At December
31, 1996, the Bank was in compliance with these reserve requirements. The
balances maintained to meet the reserve requirements imposed by the Federal
Reserve Board may be used to satisfy liquidity requirements that may be imposed
by the OTS. See "- Liquidity."
Savings associations are authorized to borrow from the Federal Reserve Bank
"discount window," but Federal Reserve Board regulations require associations to
exhaust other reasonable alternative sources of funds, including FHLB
borrowings, before borrowing from the Federal Reserve Bank.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the FHLB of Des Moines, which is one of 12 regional
FHLBs, that administers the home financing credit function of savings
associations. Each FHLB serves as a reserve or central bank for its members
within its assigned region. It is funded primarily from proceeds derived from
the sale of consolidated obligations of the FHLB System. It makes loans to
members (I.E., advances) in accordance with policies and procedures established
by the board of directors of the FHLB. These policies and procedures are
subject to the regulation and oversight of the Federal Housing Finance Board.
All advances from the FHLB are required to be fully secured by sufficient
collateral as determined by the FHLB. In addition, all long-term advances are
required to provide funds for residential home financing.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Des Moines. At December 31, 1996, the Bank had $5.4 million in FHLB
stock, which was in compliance with this requirement. In past years, the Bank
has received substantial dividends on its FHLB stock. Over the past five
calendar years such dividends have averaged 7.95% and were 7.01% for calendar
year 1996. For the year ended December 31, 1996, dividends paid by the FHLB of
Des Moines to the Bank totaled $327,000, which constitute a $74,000 increase
from the amount of dividends received in 1995.
Under federal law the FHLBs are required to provide funds for the
resolution of troubled savings
36
<PAGE>
associations and to contribute to low and moderately priced housing programs
through direct loans or interest subsidies on advances targeted for community
investment and low- and moderate-income housing projects. These contributions
have affected adversely the level of FHLB dividends paid and could continue to
do so in the future. These contributions could also have an adverse effect on
the value of FHLB stock in the future. A reduction in value of the Bank's FHLB
stock may result in a corresponding reduction in the Bank's capital.
FEDERAL AND STATE TAXATION
FEDERAL TAXATION. Savings associations such as the Bank that meet certain
definitional tests relating to the composition of assets and other conditions
prescribed by the Internal Revenue Code of 1986, as amended (the "Code"), are
permitted to establish reserves for bad debts and to make annual additions
thereto which may, within specified formula limits, be taken as a deduction in
computing taxable income for federal income tax purposes. The amount of the bad
debt reserve deduction for "non-qualifying loans" is computed under the
experience method. For the year ended December 31, 1996 the amount of the bad
debt reserve deduction for "qualifying real property loans" (generally loans
secured by improved real estate) may be computed only under the experience
method. Prior to January 1, 1996 the bad debt reserve was allowed to be
calculated on either the experience method or the percentage of taxable income
method (based on an annual election).
Under the experience method, the bad debt reserve deduction is an amount
determined under a formula based generally upon the bad debts actually sustained
by the savings association over a period of years.
The percentage of specially computed taxable income that is used to compute
a savings association's bad debt reserve deduction under the percentage of
taxable income method (the "percentage bad debt deduction") is 8%. The
percentage bad debt deduction thus computed is reduced by the amount permitted
as a deduction for non-qualifying loans under the experience method. The
availability of the percentage of taxable income method permits qualifying
savings associations to be taxed at a lower current federal income
tax rate than that applicable to corporations (generally approximately 32%
assuming the maximum percentage bad debt deduction).
If an association's specified assets (generally, loans secured by
residential real estate or deposits, educational loans, cash and certain
government obligations) constitute less than 60% of its total assets, the
association may not deduct any addition to a bad debt reserve and generally must
include existing reserves in income over a four-year period. No representation
can be made as to whether the Bank will meet the 60% test for subsequent taxable
years.
In addition to the regular income tax, corporations, including savings
associations such as the Bank, generally are subject to a minimum tax. An
alternative minimum tax is imposed at a minimum tax rate of 20% on alternative
minimum taxable income, which is the sum of a corporation's regular taxable
income (with certain adjustments) and tax preference items, less any available
exemption. The alternative minimum tax is imposed to the extent it exceeds the
corporation's regular income tax and net operating losses can offset no more
than 90% of alternative minimum taxable income. For taxable years beginning
after 1986 and before 1996, corporations, including savings associations such as
the Bank, are also subject to an environmental tax equal to 0.12% of the excess
of alternative minimum taxable income for the taxable year (determined without
regard to net operating losses and the deduction for the environmental tax) over
$2 million.
To the extent earnings appropriated to a savings association's bad debt
reserves for "qualifying real property loans" and deducted for federal income
tax purposes exceed the allowable amount of such reserves computed under the
experience method and to the extent of the association's supplemental reserves
for losses on loans ("Excess"), such Excess may not, without adverse tax
consequences, be utilized for the payment of cash dividends or other
distributions to a shareholder (including distributions on redemption,
dissolution or liquidation) or for any other purpose (except to absorb bad debt
losses). As of December 31, 1996, the Bank's Excess for tax
37
<PAGE>
purposes totaled approximately $6.6 million.
HMN and its subsidiaries file consolidated federal income tax returns on a
fiscal year basis using the accrual method of accounting. Savings associations,
such as the Bank, that file federal income tax returns as part of a consolidated
group are required by applicable Treasury regulations to reduce their taxable
income for purposes of computing the percentage bad debt deduction for losses
attributable to activities of the non-savings association members of the
consolidated group that are functionally related to the activities of the
savings association member.
HMN was incorporated in 1994 and filed its first consolidated Federal
income tax return with its subsidiaries for the year ended December 31, 1994
during 1995. The return required to be filed for 1996 has been extended and
will be filed by August 1997. The Bank and its consolidated subsidiaries have
been audited by the IRS with respect to consolidated federal income tax returns
through December 31, 1983. With respect to years examined by the IRS, either
all deficiencies have been satisfied or sufficient reserves have been
established to satisfy asserted deficiencies. In the opinion of management, any
examination of still open returns (including returns of subsidiaries and
predecessors of, or entities merged into, the Bank) would not result in a
deficiency which could have a material adverse effect on the consolidated
financial condition of HMN.
MINNESOTA TAXATION. HMN and its subsidiaries that operate in Minnesota are
subject to Minnesota state taxation. A Minnesota corporation's income or loss
is allocated based on a three-factor apportionment of the corporation's
Minnesota gross receipts, payroll and property over the total gross receipts,
payroll and property of all corporations in the unitary group. The corporate
tax rate in Minnesota is 9.8%.
In 1990, Minnesota changed its alternative minimum tax system. The tax is
now based upon Minnesota Alternative Minimum Taxable Income as opposed to the
Minnesota Apportionment Factors method which was in effect from 1987 through
1989. The Minnesota Alternative Minimum Tax rate is 5.8%.
The Bank and it subsidiaries have not been audited by the Minnesota
taxation authorities.
DELAWARE TAXATION. As a Delaware holding company, HMN is exempted from
Delaware corporate income tax but is required to file an annual report with and
pay an annual fee to the State of Delaware. HMN is also subject to an annual
franchise tax imposed by the State of Delaware.
38
<PAGE>
ITEM 2. PROPERTIES
The following table sets forth information concerning the main office and
each branch office of the Bank at December 31, 1996. At December 31, 1996, the
Bank's premises had an aggregate net book value of approximately $2.8 million.
YEAR OWNED OR NET BOOK VALUE AT
LOCATION ACQUIRED LEASED DECEMBER 31, 1996(1)
- -------------------------- -------- -------- --------------------
(In Thousands)
MAIN OFFICE:
101 North Broadway 1975 Owned 371
Spring Valley, Minnesota
FULL SERVICE BRANCHES:
201 Oakland Avenue 1960 Owned 195
Austin, Minnesota
Crossroads Shopping Center 1962 Owned 490
Rochester, Minnesota
4th & Center 1973 Owned 135
Winona, Minnesota
208 South Walnut 1975 Owned 94
LaCrescent, Minnesota
1110 6th St., NW 1982 Owned 882
Rochester, Minnesota
143 West Clark Street 1993 Owned 598
Albert Lea, Minnesota
MORTGAGE BROKERAGE OFFICE:
9973 Valley View Road 1996 Leased ---
Eden Prairie, Minnesota
- ------------------------
(1) Does not include $727,248 of net furniture and equipment distributed
between all the above offices or its subsidiary.
During 1997 the Bank plans to build two retail banking facilities, one in
Spring Valley and the other in Winona, at an estimated cost of $2.5 million.
The facilities will replace the existing retail facilities in both locations.
HMN and the Bank believe that their remaining facilities are adequate to meet
their present needs.
The Bank's depositor and borrower customer files are maintained by an
independent data processing company. The net book value of the data processing
and computer equipment utilized by the Bank at December 31, 1996 was
approximately $405,000.
39
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Bank and HMN are involved as plaintiff or defendant
in various legal proceedings arising in the normal course of its business.
While the ultimate outcome of these various legal proceedings cannot be
predicted with certainty, it is the opinion of management that the resolution of
these legal actions should not have a material effect on HMN's consolidated
financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
SECURITY HOLDER MATTERS
The information on pages 3, 24 and 48 of the Annual Report to Security
Holders for the year ended December 31, 1996 is incorporated herein by
reference.
ITEM 6. SELECTED FINANCIAL DATA
The information on page 12 of the Annual Report to Security Holders for the
year ended December 31, 1996 is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The information on pages 13 through 24 of the Annual Report to Security
Holders for the year ended December 31, 1996 is incorporated herein by
reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information on pages 25 through 47 of the Annual Report to Security
Holders for the year ended December 31, 1996 is incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
40
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information on pages 4 through 7 of the Registrant's definitive Proxy
Statement dated March 13, 1997 is incorporated herein by reference. See
"Business - Executive Officers" in Part I of the Form 10-K for information
regarding executive officers.
ITEM 11. EXECUTIVE COMPENSATION
The information on pages 8 through 14 of the Registrant's definitive Proxy
Statement dated March 13, 1997 is incorporated herein be reference, except for
information contained under the heading "Compensation Committee Report on
Executive Compensation" and "Stockholder Return Performance Presentation".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The information on pages 2 through 4 of the Registrant's definitive Proxy
Statement dated March 13, 1997 is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
41
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K
(a) FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND EXHIBITS
1. Financial Statements
The following information appearing in the Registrant's Annual Report
to Security Holders for the year ended December 31, 1996, is
incorporated by reference in this Form 10-K Annual Report as Exhibit
13.
Pages in
1996 Annual
Annual Report Section Report
--------------------- -----------
Five Year Consolidated Financial Highlights 12
Consolidated Balance Sheets --
December 31, 1996 and 1995 25
Consolidated Statements of Income --
Each of the Years in the Three-Year
Period Ended December 31, 1996 26
Consolidated Statement of Stockholders'
Equity -- Each of the Years in the
Three-Year Period Ended December 31, 1996 27
Consolidated Statements of Cash Flows --
Each of the Years in the Three-Year
Period Ended December 31, 1996 28
Notes to Consolidated Financial Statements 29 - 43
Independent Auditors' Report 44
Other Financial Data 45
Selected Quarterly Financial Data 46 - 47
2. Financial Statement Schedules
All financial statement schedules have been omitted as information is
not required under the related instructions, is not applicable or has
been included in the Notes to Consolidated Financial Statements.
42
<PAGE>
<TABLE>
<CAPTION>
3. Exhibits
Reference Sequential
to Prior Page Numbering
Filing or Where Attached
Exhibit Exhibits Are
Regulation S-K Number Located in This
Exhibit Number Document Attached Hereto Form 10-K Report
- -------------- -------------------------------------------- --------------- ----------------
<S> <C> <C> <C>
2 Plan of acquisition, reorganization, Not applicable Not applicable
arrangement, liquidation or
succession
3 (i) Articles of Incorporation * Not applicable
(ii) By-laws * Not applicable
4 Instruments defining the rights of security * Not applicable
holders, including indentures
9 Voting trust agreement Not applicable Not applicable
10.1 Employment agreement for Mr. Weise ** Not applicable
dated June 29, 1994
10.2 Employment agreement for Mr. Gardner ** Not applicable
dated June 29, 1994
10.3 Directors Deferred Compensation Plan ** Not applicable
10.4 1995 Recognition and Retention Plan *** Not applicable
10.5 1995 Stock Option and Incentive Plan *** Not applicable
11 Statement re: Computation of per share 11 Filed electronically
earnings
12 Statement re: Computation of ratios Not applicable Not applicable
13 Annual Report to Security Holders 13 Filed electronically
16 Letter re: Change in certifying accountant Not applicable Not applicable
18 Letter re: Change in accounting principles Not applicable Not applicable
21 Subsidiaries of Registrant 21 Filed electronically
</TABLE>
43
<PAGE>
<TABLE>
<CAPTION>
Reference Sequential
to Prior Page Numbering
Filing or Where Attached
Exhibit Exhibits Are
Regulation S-K Number Located in This
Exhibit Number Document Attached Hereto Form 10-K Report
- -------------- -------------------------------------------- --------------- ----------------
<S> <C> <C> <C>
22 Published report regarding matters Not applicable Not applicable
submitted to vote of security holders
23 Consent of KPMG Peat Marwick LLP 23 Filed electronically
dated March 25, 1997
24 Power of Attorney Not applicable Not applicable
27 Financial Data Schedule 27 Filed electronically
28 Information from reports furnished to None Not applicable
state insurance regulatory authorities
99 Additional exhibits None Not applicable
----------------
</TABLE>
* Filed April 1, 1994, as exhibits to the Registrant's Form S-1 registration
statement (Registration No. 33-77212) pursuant to the Securities Act of 1933.
All of such previously filed documents are hereby incorporated herein by
reference in accordance with Item 601 of Regulation S-K.
** Filed as an exhibit to the Registrant's Form 10-K for 1994 (file no. 0-
24100). All previously filed documents are hereby incorporated by reference in
accordance with Item 601 of Regulation S-K.
*** Filed as an exhibit to the Registrant's Form 10-K for 1995 (file no. 0-
24100). All previously filed documents are hereby incorporated by reference in
accordance with Item 601 of Regulation S-K.
44
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
HMN FINANCIAL, INC.
Date: March 28, 1997 By: /s/ Roger P. Weise
---------------------------- --------------------------
Roger P. Weise
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
By: /s/ Roger P. Weise By: /s/ Keith A. Hagen
---------------------------- --------------------------
Roger P. Weise, Chairman of the Board, Keith A. Hagen, Director
President and Chief Executive Officer
(Principal Executive and Operating
Officer)
Date: March 28, 1997 Date: March 28, 1997
---------------------------- -------------------------
By: /s/ Irma R. Rathbun By: /s/ Timothy R. Geisler
---------------------------- --------------------------
Irma R. Rathbun, Director Timothy R. Geisler, Director
Date: March 28, 1997 Date: March 28, 1997
---------------------------- -------------------------
By: /s/ M. F. Schumann By: /s/ James B. Gardner
---------------------------- --------------------------
M.F. Schumann, Director James B. Gardner,
Executive Vice President and
Director
(Principal Financial Officer)
Date: March 28, 1997 Date: March 28, 1997
---------------------------- -------------------------
By: /s/ Dwain C. Jorgensen
Dwain C. Jorgensen,
Vice President and Controller
(Principal Accounting Officer)
Date: March 28, 1997
----------------------------
45
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Sequential
Page Numbering
Where Attached
Exhibits Are
Regulation S-K Located in This
Exhibit Number Document Form 10-K Report
- -------------- ----------------------------------- ----------------
<S> <C> <C>
11 Statement re: Computation of per share earnings Filed electronically
13 Annual Report to Security Holders Filed electronically
21 Subsidiaries of Registrant Filed electronically
23 Consent of KPMG Peat Marwick LLP Filed electronically
dated March 25, 1997
27 Financial Data Schedule Filed electronically
</TABLE>
46
<PAGE>
Exhibit 11
Statement Re: Computation of per share earnings
<PAGE>
Exhibit 11
HMN Financial, Inc.
Computation of Earnings Per Common Share
<TABLE>
<CAPTION>
Year Ended December 31,
1996 1995
------------ -----------
<S> <C> <C>
Computation of Earnings Per Common Share for Statements of
Operations:
Net income............................................................ $ 4,274,349 5,620,377
----------- -----------
Weighted average number of common and common share equivalents:
Weighted average common shares outstanding.......................... 4,381,937 5,152,320
Dilutive effect of stock option plans after application of treasury
stock method....................................................... 54,896 19,062
----------- -----------
4,436,833 5,171,382
----------- -----------
Earnings per common share and common share equivalent................. $0.96 1.09
----------- -----------
----------- -----------
Computation of Fully Diluted Earnings Per Common Share and
Common Share Equivalent: (1)
Net income............................................................ $ 4,274,349 5,620,377
----------- -----------
Weighted average number of common and common share
equivalents:
Weighted average common shares outstanding.......................... 4,381,937 5,152,320
Dilutive effect of stock option plans after application of
treasury stock method............................................. 127,629 74,968
----------- -----------
4,509,566 5,227,288
----------- -----------
Earnings per common share and common share equivalent $ 0.95 1.08
----------- -----------
----------- -----------
</TABLE>
(1) This calculation is submitted in accordance with Regulation S-K
Item 601(b)(11) although not required by footnote 2 of paragraph
14 of APB Opinion No. 15 because it results in dilution of less than 3%.
<PAGE>
Five-Year Consolidated Financial Highlights
- -------------------------------------------------------------------------------
Selected Operations Data:(1)
<TABLE>
<CAPTION>
Year Ended December 31,
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 1995 1994 1993 1992
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total interest income........................................... $ 39,864 38,328 32,277 32,427 34,739
Total interest expense.......................................... 24,194 22,555 18,067 18,399 21,018
--------- --------- --------- --------- ---------
Net interest income........................................... 15,670 15,773 14,210 14,028 13,721
Provision for loan losses....................................... 300 300 410 660 233
--------- --------- --------- --------- ---------
Net interest income after provision for loan losses........... 15,370 15,473 13,800 13,368 13,488
--------- --------- --------- --------- ---------
Fees and service charges........................................ 359 325 311 305 265
Securities gains, net........................................... 1,030 416 65 1,180 544
Gain on sales of loans.......................................... 39 102 3 0 0
Other non-interest income....................................... 495 155 216 152 118
--------- --------- --------- --------- ---------
Total non-interest income..................................... 1,923 998 595 1,637 927
SAIF assessment................................................. 2,352 0 0 0 0
Other non-interest expense...................................... 8,157 7,470 6,574 5,976 5,612
--------- --------- --------- --------- ---------
Total non-interest expense.................................... 10,509 7,470 6,574 5,976 5,612
Income tax expense.............................................. 2,510 3,381 3,116 3,799 3,494
--------- --------- --------- --------- ---------
Net income.................................................... $ 4,274 5,620 4,705 5,230 5,309
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Per common share:
Earnings per common share and common share equivalents(2)..... $ 0.96 1.09 0.48
Pro forma earnings per share(3)................................. 0.86
<CAPTION>
Selected Financial Condition Data:(1)
December 31,
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 1995 1994 1993 1992
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total assets.............................................. $ 554,732 537,949 494,868 430,782 418,779
Securities held for sale.................................. 0 0 0 7,598 0
Securities available for sale............................. 175,830 190,320 183,512 71,868 67,831
Securities held to maturity............................... 2,806 16,972 12,678 85,672 94,553
Loans held for sale....................................... 739 0 0 0 0
Loans receivable, net..................................... 349,022 314,851 271,000 246,446 241,514
Deposits.................................................. 362,477 373,539 350,575 353,581 361,913
Federal Home Loan Bank advances........................... 106,079 68,877 51,986 33,964 18,393
Stockholders' equity...................................... 82,099 91,687 89,047 40,046 34,816
Book value per shares excluding net unrealized loss on
securities available for sale........................... $ 18.65 17.34 16.14
Book value per share...................................... 18.52 17.29 14.63
Number of full service offices............................ 7 7 7 7 7
Number of mortgage origination offices.................... 1
Key Ratios(4)
Stockholders' equity to total assets at year end.......... 14.80% 17.04% 17.99% 9.30% 8.31%
Average stockholders' equity to average assets............ 16.12 18.24 14.57 8.82 7.92
Return on stockholders' equity (ratio of net income to
average equity)......................................... 4.82 5.86 6.86 13.79 16.40
Return on assets (ratio of net income to average
assets)................................................. 0.78 1.07 1.00 1.22 1.30
</TABLE>
(1) HMN Financial, Inc. (HMN) completed a public stock offering on June 29,
1994, which generated net proceeds of $59.2 million. HMN purchased all of
the stock of Home Federal Savings Bank (the Bank) with a portion of the
conversion proceeds.The information reflected above represents the financial
condition and the results of operations for the consolidated HMN for 1996,
1995 and 1994 and Bank only information for prior years.
(2) Earnings per common share and common share equivalents for 1994 represents
the period from June 29, 1994 through December 31, 1994.
(3) Pro forma earnings per common share represents the period from January 1,
1994 through December 31, 1994.
(4) Average balances were calculated based upon amortized cost without the
market value impact of SFAS 115.
- --------------------------------------------------------------------------------
12
<PAGE>
FINANCIAL REVIEW
The financial review presents management's discussion and analysis of the
consolidated financial condition and results of operations of HMN Financial,
Inc. and subsidiaries (HMN). This review should be read in conjunction with the
consolidated financial statements and other financial data beginning on page 25.
HMN was incorporated under the laws of the State of Delaware for the purpose
of becoming the savings and loan holding company of Home Federal Savings Bank
(the Bank) in connection with the Bank's conversion from a federally chartered
mutual savings bank to a federally chartered stock savings bank, pursuant to its
plan of conversion. The conversion was completed on June 29, 1994. Refer to Note
15 of the Notes to Consolidated Financial Statements for more information
regarding the Bank's stock conversion.
Information presented for years ended prior to December 31, 1994 reflect the
financial condition and the results of operations of only the consolidated Bank.
RESULTS OF OPERATIONS
HMN reported net income of $4.3 million, or $0.96 per share for 1996
compared to $5.6 million, or $1.09 per share, for 1995 and $4.7 million, or
$0.86 pro forma earnings per share, for 1994. Net income for 1996 compared to
1995 decreased by $1.3 million, or 24%, primarily due to a one time Savings
Association Insurance Fund (SAIF) assessment of $2.35 million which reduced
after tax earnings by $1.46 million and caused annualized earnings per share to
decrease by $0.33 per share. Other changes noted when comparing 1996 to 1995
were net interest income decreased by $103,000, non-interest income increased by
$924,000 due to security gains and other non-recurring income, and was partially
offset by increased non-interest expenses of $687,000 related to compensation
and benefit expenses, occupancy costs and other costs.
Net income for 1995 compared to 1994 increased by $916,000, or 19%,
principally due to an increase in net interest income after provision for loan
losses of $1.7 million, an increase in net security gains of $351,000 and a
$99,000 increase in gain on the sale of loans. The increased revenue was
partially offset by an $896,000 increase in non-interest expense, a $60,000
decrease in non-interest income and an increase in income tax expense of
$265,000. The increase in earnings per share between 1995 and 1994 was also
enhanced by HMN's purchase of its own common stock in the open market during
1995.
Return on average assets was 0.78% for 1996, compared to 1.07% for 1995 and
1.00% for 1994. The return on average assets for 1996 excluding the SAIF
assessment was 1.04%. The return on average assets was also impacted by the
amount of net securities gains recorded in each year.
NET INTEREST INCOME
HMN's net income is dependent primarily on its net interest income, which is
the difference between interest earned on securities, loans and other
interest-earning assets (interest income) and interest paid on deposits and
Federal Home Loan Bank advances (interest expense). Net interest margin is
calculated by dividing net interest income by the average interest-earning
assets. The arithmetic difference between the yield on interest-earning assets
and the cost of interest-bearing liabilities expressed as a percentage is
referred to as the net interest rate spread.
13
<PAGE>
The following table presents the total dollar amount of interest income from
average interest-earning assets and the resultant yields, as well as the
interest expense on average interest-bearing liabilities, expressed both in
dollars and rates. Non-accruing loans have been included in the table as loans
carrying a zero yield.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
----------------------------------------------------------------------------------------------------
1996 1995 1994
-------------------------------- -------------------------------- --------------------------------
Average Interest Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
(DOLLARS IN THOUSANDS) Balance Paid Rate Balance Paid Rate Balance Paid Rate
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Securities held for sale...... $ 0 0 0.00% $ 0 0 0.00% $ 645 25 3.94%
Securities available for sale:
Mortgage-backed and related
securities................ 148,400 10,029 6.76 153,150 10,294 6.72 145,561 9,001 6.18
Other marketable
securities(1)............. 40,549 2,424 5.98 47,289 2,858 6.04 28,122 1,455 5.17
Securities held to maturity:
Mortgage-backed and related
securities................ 10,160 765 7.53 9,242 746 8.07 5,115 449 8.78
Other marketable
securities................ 1,861 104 5.61 6,145 390 6.34 10,615 625 5.89
Loans receivable, net(2)...... 324,958 25,721 7.92 290,243 23,375 8.05 253,044 20,051 7.92
Federal Home Loan Bank
stock....................... 4,671 327 7.01 3,485 253 7.25 3,039 255 8.40
Other including cash
equivalents................. 11,039 494 4.48 8,611 412 4.78 13,995 416 2.98
----------- --------- ----------- --------- ----------- ---------
Total interest-earning
assets...................... $ 541,638 39,864 7.36 $ 518,165 38,328 7.40 $ 460,136 32,277 7.01
----------- --------- -------- ----------- --------- -------- ----------- --------- --------
----------- --------- ----------- --------- ----------- ---------
INTEREST-BEARING LIABILITIES:
Non-interest checking......... $ 2,016 0 0.00% $ 1,735 0 0.00 $ 1,562 0 0.00%
NOW accounts.................. 16,051 323 2.01 14,361 311 2.17 14,628 317 2.17
Passbooks..................... 30,295 760 2.51 30,378 759 2.50 34,504 862 2.50
Money market accounts......... 17,724 501 2.83 19,499 548 2.81 24,892 672 2.70
Certificate accounts.......... 299,903 17,366 5.79 293,844 16,961 5.77 275,801 13,989 5.07
Federal Home Loan Bank
advances.................... 89,656 5,244 5.85 65,069 3,976 6.11 40,121 2,227 5.55
----------- --------- ----------- --------- ----------- ---------
Total interest-bearing
liabilities................. $ 455,645 24,194 5.31 $ 424,886 22,555 5.31 $ 391,508 18,067 4.61
----------- --------- -------- ----------- --------- -------- ----------- --------- --------
----------- --------- ----------- --------- ----------- ---------
Net interest income........... 15,670 15,773 14,210
--------- --------- ---------
--------- --------- ---------
Net interest rate spread...... 2.05% 2.09% 2.40%
-------- -------- --------
-------- -------- --------
Net earning assets............ $ 85,993 $ 93,279 $ 68,628
----------- ----------- -----------
----------- ----------- -----------
Net interest margin........... 2.89% 3.04% 3.09%
-------- -------- --------
-------- -------- --------
Average interest-earning
assets to average
interest-bearing
liabilities................. 118.87% 121.95% 117.53%
-------- -------- --------
-------- -------- --------
</TABLE>
(1) Tax exempt income was not significant; therefore, the yield was not
presented on a tax equivalent basis. There was no tax exempt income earned
in 1996. The tax exempt income was $87,474 in 1995, and $39,000 in 1994.
(2) Calculated net of deferred loan fees, loan discounts, loans in process and
loss reserve. The average balance for 1996 includes $107,000 of loans held
for sale.
- --------------------------------------------------------------------------------
14
<PAGE>
Net interest income for 1996 was $15.7 million, a decrease of $103,000, or
0.7%, from $15.8 million for 1995. Interest income for 1996 was $39.9
million, an increase of $1.5 million, or 4.0%, compared to $38.3 million for
1995. The average interest-earning assets for 1996 were $23.5 million higher
than average interest-earning assets for 1995. The increase in average
interest-earning assets caused HMN to earn additional interest income of $2.0
million which was partially offset by a decrease in interest income of
$483,000 due to a decrease in the yield earned on interest-earning assets.
During 1996 HMN decreased its weighted average securities portfolio by $14.9
million in order to increase its loan portfolio. HMN purchased $55.8 million
of single-family residential loans with a weighted average interest rate of
6.96%. It originated $56.8 million of mortgage and consumer loans with a
weighted average rate of 8.18%. The net impact of the loan purchases and
originations on the loan portfolio after taking into account total loan
payments and payoffs was a $34.7 million increase in the average outstanding
loan portfolio for 1996 compared to 1995. The combined weighted average
interest rate for purchased and originated loans was 7.58% which lowered the
yield on the existing loan portfolio during 1996. Included in the loans
purchased during 1996 were $34.2 million of adjustable rate loans with a
weighted average interest rate of 6.56%. Interest rates in general were lower
during 1996 compared to 1995, therefore new loan originations and purchases
had lower interest rates during 1996 compared to 1995 which caused the yield
on interest-earning assets to decline during 1996. Interest expense for 1996
was $24.2 million, an increase of $1.6 million, or 7.3%, compared to $22.6
million for 1995. Interest expense increased $1.7 million due to a $30.8
million increase in the average outstanding interest-bearing liabilities and
was partially offset by a $121,000 decrease in interest expense due to lower
interest rates. During 1996 HMN had to pay higher interest rates in order to
maintain its certificate accounts, therefore interest expense on certificate
accounts increased despite the fact that interest rates during 1996 were
generally lower than interest rates were during 1995. Average outstanding
FHLB advances increased by $24.6 million during 1996 primarily due to the
purchase of additional interest-earning assets and the stock repurchase
program. The increased average FHLB advances caused interest expense during
1996 to increase by $1.3 million over the interest expense recognized during
1995. HMN's average net earning assets were $86.0 million at December 31,
1996, a decrease of $7.3 million, or 7.8%, compared to $93.3 million for
December 31, 1995. The decrease in net interest-earning assets was primarily
due to HMN's stock repurchase program. Stock repurchases temporarily reduced
interest-earning assets when investments were sold to repurchase HMN's stock.
Other replacement interest-earning assets were purchased later by borrowing
funds from the FHLB. The decrease in net interest-earning assets coupled with
the lower interest rates experienced during 1996 caused HMN's net interest
margin to decline to 2.89% at December 31, 1996 from 3.04% at December 31,
1995.
Net interest income for 1995 was $15.8 million, an increase of $1.6 million,
or 11%, from $14.2 million for 1994. Interest income for 1995 was $38.3 million,
an increase of $6.0 million, or 19%, compared to $32.3 million for 1994.
Interest income increased by $4.6 million due to an increase in total average
interest-earning assets of $58.0 million in 1995 from 1994. The increase in
interest-earning assets was primarily due to having invested the proceeds of the
public offering for the entire year of 1995, versus only a portion of 1994.
Interest income increased by $1.4 million due to a 39 basis point increase in
the yield on interest-earning assets. The increase in yield was the result of
changing the mix of securities in the securities portfolio and the increased
yield in the loan portfolio. Interest expense for 1995 was $22.6 million, an
increase of $4.5 million, or 25%, compared to $18.1 million for 1994. Interest
expense on deposits increased by $2.0 million due to an increase in the rates
paid on deposits and it increased by $696,000 due to an increase in the average
outstanding balance of deposits. Interest expense increased by $1.5 million due
to an increase of $24.9 million in the average outstanding balance of FHLB
advances and it increased by $244,000 due to increased borrowing rates from the
FHLB.
The net interest margin was 3.04% for the year ended December 31, 1995
compared to 3.09% for the year ended December 31, 1994. The decline in margin is
the result of pricing changes made to certificate accounts in order to increase
its deposit base during 1995 and the increased borrowings from the FHLB.
The following schedule presents the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets and
interest-bearing liabilities. It distinguishes between the increase related to
higher outstanding balances and that due to the levels and volatility of
interest rates. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii)
changes in rate (i.e., changes in rate multiplied by old volume).
15
<PAGE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
----------------------------------------------------------------------------
1995 vs. 1996 1994 vs. 1995
------------------------------------- -------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Total Due to Total
------------------------ Increase ------------------------ Increase
(DOLLARS IN THOUSANDS) Volume(1) Rate(1) (Decrease) Volume(1) Rate(1) (Decrease)
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INTEREST-EARNING ASSETS:
Securities held for sale..................... $ (25) 0 (25)
Securities available for sale:
Mortgage-backed and related securities..... (323) 57 (266) 484 809 1,293
Other marketable securities................ (403) (31) (434) 1,125 278 1,403
Securities held to maturity:
Mortgage-backed and related securities..... 59 (40) 19 330 (33) 297
Other marketable securities................ (244) (41) (285) (290) 55 (235)
Loans receivable, net........................ 2,740 (394) 2,346 2,990 334 3,324
Federal Home Loan Bank stock................. 83 (9) 74 (25) 23 (2)
Other including cash equivalents............. 107 (25) 82 7 (11) (4)
----------- --- ----------- ----- ----- -----------
Total interest-earning assets.............. $ 2,019 (483) 1,536 4,596 1,455 6,051
----------- --- ----------- ----- ----- -----------
----------- --- ----------- ----- ----- -----------
INTEREST-BEARING LIABILITIES:
Non-interest checking........................ $ 0 0 0 0 0 0
NOW accounts................................. 30 (18) 12 (6) 0 (6)
Passbooks.................................... (2) 3 1 (102) (1) (103)
Money market accounts........................ (50) 3 (47) (152) 28 (124)
Certificates................................. 351 54 405 956 2,016 2,972
Federal Home Loan Bank advances.............. 1,431 (163) 1,268 1,503 246 1,749
----------- --- ----------- ----- ----- -----------
Total interest-bearing liabilities......... $ 1,760 (121) 1,639 2,199 2,289 4,488
----------- --- ----------- ----- ----- -----------
----------- --- ----------- ----- ----- -----------
Net interest income............................ $ 15,670 15,773
----------- -----------
----------- -----------
</TABLE>
(1) For purposes of this table, changes attributable to both rate and volume
which cannot be segregated, have been allocated proportionately to the
change due to volume and the change due to rate.
The following table sets forth the weighted average yields on the Bank's
interest-earning assets, the weighted average interest rates on interest-bearing
liabilities and the interest rate spread between the weighted average yields and
rates as of the date indicated. Non-accruing loans have been included in the
table as loans carrying a zero yield.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AT DECEMBER 31, 1996
- --------------------------------------------------------------------------------
<S> <C>
WEIGHTED AVERAGE YIELD ON:
Securities available for sale:
Mortgage-backed and related securities................................................ 6.62%
Other marketable securities........................................................... 6.08
Securities held to maturity:
Mortgage-backed and related securities................................................ 8.66
Other marketable securities........................................................... 5.65
Loans receivable, net................................................................... 7.98
Federal Home LoanBank stock............................................................. 7.00
Other interest-earning assets........................................................... 4.62
Combined weighted average yield on interest-earning assets.............................. 7.42
WEIGHTED AVERAGE RATE PAID ON:
Noninterest checking.................................................................... 0.00%
NOW accounts............................................................................ 2.01
Passbooks............................................................................... 2.50
Money market accounts................................................................... 2.83
Certificates............................................................................ 5.76
Federal Home Loan Bank advances......................................................... 5.64
Combined weighted average rate paid on interest-bearing liabilities..................... 5.25
Interest rate spread...................................................................... 2.17
</TABLE>
PROVISION FOR LOSSES ON LOANS
The provision for losses on loans is the result of management's evaluation
of the loan portfolio including its evaluation of national and regional economic
indicators (including the possibility at each year end that there would be an
increase in general interest rates), such as national and regional unemployment
data, single family loan delinquency as reported separately by the Federal
National Mortgage Association (FNMA) and the Federal Home Loan Bank Mortgage
Corporation (FHLMC), local single family con-
16
<PAGE>
struction permits and local economic growth rates and the current regulatory
and general economic environment. HMN will continue to monitor and modify its
allowance for losses as these conditions dictate. Although HMN maintains its
allowance for losses at a level it considers adequate to provide for probable
losses, there can be no assurance that such losses will not exceed the
estimated amount or that additional provisions for loan losses will not be
required in future periods.
The provision for losses on loans for 1996 was $300,000, the same provision
that was recognized for 1995. Based upon management's evaluation of the loan
portfolio and its understanding of the economic conditions in the areas where it
has a concentration of loans, a provision of $300,000 was deemed adequate for
1996. HMN incurred $150,000 of loan charge-offs during 1996 which were primarily
related to two loans which were not single-family residential loans. The
charge-offs were not deemed to be indicative of a trend that would call for a
higher loan loss provision. The provision for losses on loans for 1995 was
$300,000, a decrease of $110,000, or 27%, from $410,000 for 1994. Based upon
management's evaluation of the loan portfolio and its understanding of the
economic conditions in the areas where it has a concentration of loans, the
$300,000 provision for 1995 was deemed adequate.
NON-INTEREST INCOME
Non-interest income was $1.9 million for 1996, an increase of $924,000, or
92.6% compared to $998,000 for 1995 and $595,000 for 1994. The following table
presents certain components of non-interest income:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
Percentage
Year ended December 31, Increase (Decrease)
----------------------------------- ------------------------
(DOLLARS IN THOUSANDS) 1996 1995 1994 1996/1995 1995/1994
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fees and service charges.................................. $ 359 325 311 10.5% 4.5%
Securities gains, net..................................... 1,030 416 65 147.6 540.0
Gain on sales of loans.................................... 39 102 3 (61.8) 3,300.0
Other non-interest income................................. 495 155 216 219.4 (28.2)
--------- --- ---
Total non-interest income............................... $ 1,923 998 595 92.7 67.7
--------- --- ---
--------- --- ---
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
The ability to realize gains on the sale of securities is dependent on the
type of securities in the securities portfolio and upon changes in the general
interest rate environment. During 1996 economic conditions existed which allowed
HMN to sell mortgage-backed securities and common stock in other financial
institutions at a net gain of $1.0 million. Many of the proceeds of the sales
were invested in the loan portfolio. During 1995 interest rates were declining,
therefore HMN was able to sell many of its fixed rate securities at a profit.
During 1994 there was little opportunity to sell securities at a profit,
therefore net security gains were only $65,000. During 1996 HMN had $1.7 million
in proceeds from the sale of primarily 30 year fixed rate loans and recognized a
$39,000 gain. During 1995 HMN sold $2.4 million of fixed rate 30 year loans and
$1.8 million of student loans at a gain of $102,000. Periodically HMN evaluates
its loan portfolio and sells loans that do not meet its long-term
asset/liability goals. The $340,000 increase in other non-interest income
recognized in 1996 compared to 1995 represents a $169,000 increase in
commissions earned on the sale of uninsured products, a $71,000 gain on the sale
of an equity interest in a data processing center, and $100,000 of other
non-recurring income.
NON-INTEREST EXPENSE
The following table presents the components of non-interest expense:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------
Percentage
Year ended December 31, Increase (Decrease)
------------------------------- ------------------------
(DOLLARS IN THOUSANDS) 1996 1995 1994 1996/1995 1995/1994
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Compensation and benefits............................ $ 4,591 4,160 3,473 10.4% 19.8%
Occupancy............................................ 826 698 678 18.3 2.9
Federal deposit insurance premiums................... 800 811 811 (1.4) 0.0
SAIF assessment...................................... 2,352 0 0 N/A N/A
Advertising.......................................... 308 312 270 (1.3) 15.6
Data processing...................................... 489 476 458 2.7 3.9
Provision for real estate losses..................... 2 9 0 (77.8) N/A
Other................................................ 1,141 1,004 884 13.6 13.6
--------- --------- ---------
Total non-interest expense......................... $ 10,509 7,470 6,574 40.7 13.6
--------- --------- ---------
--------- --------- ---------
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
17
<PAGE>
Non-interest expense was $10.5 million for 1996, an increase of $3.0 million,
or 40.7%, from $7.5 million for 1995. The majority of the increase is the
result of a $2.4 million SAIF assessment made during the third quarter of
1996. Compensation and benefit expense increased by $431,000, or 10.4%, and
was the result of adding new employees, normal merit and salary increases, a
full year's impact of stock awards granted under the Recognition and
Retention Plan granted in June of 1995 and the increased expense of the
employee stock option plan related to recognizing benefit expense based upon
the fair value of the shares being awarded in the plan. Occupancy expense for
1996 increased by $128,000, or 18.3%, partly due to building improvements
made during 1995 being depreciated for a full year in 1996 and partly due to
HMN opening a mortgage banking office in Edina, Minnesota during the fourth
quarter of 1996. Other expense increased by $137,000, or 13.6% from 1995 to
1996. The increase is the result of professional fees and other non-recurring
expenses recognized during 1996.
Non-interest expense was $7.5 million for 1995, an increase of $0.9 million,
or 13.6%, compared to $6.6 million for 1994. Compensation and benefits
expense increased by $687,000, or 19.8%, in 1995 from 1994. In June of 1995
HMN initiated a management Recognition and Retention Plan which awarded
84,486 shares of HMN restricted common stock to management and directors. The
stock awards vest over a period of five years and increased benefits expense
by $117,000 for 1995. The Bank awarded employees a one time cash bonus
totaling $115,000 at December 31, 1995. The employee stock ownership plan
(ESOP) was started in June of 1994 and it allocated 33,989 shares to
participants during 1994. In 1995 the ESOP allocated 40,973 shares to
participants. The increased number of shares being allocated and an increase
in the fair value of HMN common stock during 1995 caused benefits expense to
increase by $162,000 over the amount expensed in 1994. Compensation and
benefits expense increased by $293,000 from 1994 to 1995 due to new staff,
raises and merit increases given to employees and management. Advertising
expense for 1995 was $312,000, an increase of $42,000, or 15.6%, from
$270,000 for 1994. The increase is the result of increased advertising
efforts. Other expenses increased by $120,000, or 13.6%, from 1994 to 1995
due primarily to the increased costs of being a public company for a full
year.
INCOME TAXES
HMN recorded income tax expense of $2.5 million in 1996, compared to $3.4
million and $3.1 million for 1995 and 1994, respectively. The decrease in
income tax expense from 1995 to 1996 and the increase from 1994 to 1995 is
primarily the result of changes in taxable income between the years. For more
information on income taxes refer to Note 13 of the Notes to Consolidated
Financial Statements.
FINANCIAL CONDITION
HMN's total assets were $554.7 million at December 31, 1996, compared to
$537.9 million at December 31, 1995. The increase in total assets during 1996
of $16.8 million was primarily due to growth through the origination or
purchase of loans and the purchase of a $2.8 million partnership interest in
mortgage servicing rights.
SECURITIES AVAILABLE FOR SALE
Securities available for sale were $175.8 million at December 31, 1996 a
decrease of $14.5 million, or 7.6%, compared to $190.3 million at December 31,
1995. During 1996 HMN reduced its securities available for sale portfolio in
order to increase its outstanding loan portfolio. For more information on
securites available for sale refer to Notes 2 and 4 of the Notes to Consolidated
Financial Statements.
SECURITIES HELD TO MATURITY
Securities held to maturity were $2.8 million at December 31, 1996 a
decrease of $14.2 million, or 83.4%, compared to $17.0 million at December 31,
1995. The decrease in securities held to maturity during 1996 was primarily due
to the contractual obligation of several County Housing and Redevelopment
Authorities (HRAs) to repurchase $10.4 million of FNMA mortgage-backed
securities from HMN on September 1, 1996. The proceeds from the HRAs repurchase
of the securities and the maturities of the held to maturity porfolio were used
to increase the loan portfolio or reinvested back into the securities portfolio.
For more information on securities held to maturity refer to Notes 2 and 5 of
the Notes to Consolidated Financial Statements.
18
<PAGE>
LOANS RECEIVABLE, NET
The following table sets forth the information on HMN's loan portfolio in
dollar amounts and in percentages (before deductions for loans in process,
deferred fees and discounts and allowances for losses) as of the dates
indicated.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992
(DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
REAL ESTATE LOANS:
One-to-four family............. $ 321,340 90.19% $ 292,497 90.62% $ 252,943 91.14% $ 233,009 92.18% $ 223,914 89.86%
Multi-family................... 280 0.08 361 0.11 311 0.11 349 0.14 709 0.28
Commercial..................... 7,918 2.22 8,744 2.71 8,316 3.00 4,559 1.80 6,512 2.61
Construction or development.... 3,474 0.98 5,082 1.58 2,799 1.01 3,309 1.31 6,879 2.76
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total real estate.......... 333,012 93.47 306,684 95.02 264,369 95.26 241,226 95.43 238,014 95.51
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
OTHER LOANS:
Consumer Loans:
Savings account.............. 938 0.26 1,210 0.37 648 0.23 872 0.34 1,153 0.46
Education.................... 467 0.13 342 0.11 2,007 0.72 1,819 0.72 1,584 0.64
Automobile................... 566 0.16 671 0.21 520 0.19 681 0.27 927 0.37
Home equity.................. 17,808 5.00 11,506 3.56 7,716 2.78 5,604 2.22 4,623 1.86
Home improvement............. 585 0.16 785 0.24 870 0.31 912 0.36 1,044 0.42
Other........................ 568 0.16 545 0.17 502 0.19 586 0.23 684 0.27
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total consumer loans....... 20,932 5.87 15,059 4.66 12,263 4.42 10,474 4.14 10,015 4.02
Commercial business loans...... 2,344 0.66 1,018 0.32 897 0.32 1,089 0.43 1,160 0.47
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total other loans.......... 23,276 6.53 16,077 4.98 13,160 4.74 11,563 4.57 11,175 4.49
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total loans................ 356,288 100.00% 322,761 100.00% 277,529 100.00% 252,789 100.00% 249,189 100.00%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
LESS:
Loans in process............... 2,814 3,531 2,327 2,333 4,576
Unamortized discounts.......... 417 289 162 14 32
Net deferred loan fees......... 1,695 1,899 2,147 2,507 2,236
Allowance for losses........... 2,340 2,191 1,893 1,489 831
--------- --------- --------- --------- ---------
Total loans receivable,
net...................... $ 349,022 $ 314,851 $ 271,000 $ 246,446 $ 241,514
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
One-to-four family real estate loans were $321.3 million at December 31,
1996, an increase of $28.8 million, or 9.8%, compared to $292.5 million for
December 31, 1995. During 1996 HMN had the following one-to-four family real
estate loan activity: originated $32.5 million, purchased $55.8 million,
securitized $15.4 million, sold $2.3 million and received principal repayments
of $41.7 million.
One-to-four family real estate loans increased $39.6 million to $292.5
million at December 31, 1995 from $252.9 million at December 31, 1994. During
1995 HMN had the following one-to-four family real estate loan activity:
originated $25.7 million, purchased $47.1 million, sold $2.4 million and
received principal repayments of $30.8 million.
One-to-four family real estate loans increased $19.9 million to $252.9
million at December 31, 1994 from $233 million at December 31, 1993. During 1994
HMN originated $31.9 million, purchased $17.2 million and received principal
repayments of $29.9 million.
Home equity loans were $17.8 million at December 31, 1996 an increase of
$6.3 million, or 54.8%, compared to $11.5 million for December 31, 1995. The
increase in the home equity loans is due to increased marketing and competitive
pricing of the product in HMN's local markets.
During the second half of 1995 HMN introduced a revolving home equity line
of credit which will loan up to 90% of the equity in a home to the borrower. The
interest rate is prime plus 0.5% for the first three years adjusting to a market
rate thereafter. During 1995 $4.0 million was drawn on these lines by borrowers.
Commercial real estate loans increased $3.8 million to $8.3 million at
December 31, 1994 from $4.6 million at December 31, 1993. During 1994 HMN
purchased $4.0 million of commercial real estate loans guaranteed by the Small
Business Administration (the SBA) and received principal repayments of $200,000.
The SBA loans adjust either monthly or quarterly at prime minus 1.0% or 1.25%.
19
<PAGE>
ALLOWANCES FOR LOAN AND REAL ESTATE LOSSES
HMN recognizes that credit losses will be experienced and that the risk of
loss will vary with, among other things, the type of loans being made, the
creditworthiness of the borrower over the term of the loan, general economic
conditions and, in the case of a secured loan, the quality of the collateral. It
is management's policy to maintain an allowance for loan losses based on, among
other things, the Bank's and the industry's historical loan loss experience,
evaluation of economic conditions, regular reviews of delinquencies and loan
portfolio quality and evolving standards imposed by OTS examiners. HMN increases
its allowance for loan losses by charging provision for loan losses against
income. The methodology for establishing the allowance for loan losses takes
into consideration probable losses that have been identified in connection with
specific loans as well as losses in the loan portfolio that have not yet been
identified but can be expected to occur. Management conducts quarterly reviews
of the loan portfolio and evaluates the need to establish general allowances on
the basis of these reviews.
Management continues to actively monitor the asset quality and to charge off
loans against the allowance for loan losses when appropriate. Although
management believes it uses the best information available to make
determinations with respect to the allowance for loan losses, future adjustments
may be necessary if economic conditions differ substantially from the economic
conditions in the assumptions used to determine the size of the allowance for
losses.
The allowance for loan losses was $2.3 million, or 0.66% of total loans at
December 31, 1996, compared to $2.2 million, or 0.68% of total loans at December
31, 1995, and $1.9 million, or 0.68% of total loans at December 31, 1994. The
following table reflects the activity in the allowance for loan losses and
selected statistics:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
December 31,
-----------------------------------------------------
(DOLLARS IN THOUSANDS) 1996 1995 1994 1993 1992
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at the beginning of year................................... $ 2,191 1,893 1,489 831 883
Provision for losses............................................. 300 300 410 660 233
Charge-offs...................................................... (150) (2) (6) (2) (288)
Recoveries....................................................... 0 0 0 0 3
--------- --------- --------- --------- ---
Net charge-offs................................................ (150) (2) (6) (2) (285)
--------- --------- --------- --------- ---
Balance at end of year............................................. $ 2,341 2,191 1,893 1,489 831
--------- --------- --------- --------- ---
--------- --------- --------- --------- ---
Year end allowance for loan losses as a percent of year end gross
loan balance..................................................... 0.66% 0.68% 0.68% 0.59% 0.33%
Ratio of net loan charge-offs to average loans outstanding......... 0.05 0.00 0.00 0.00 0.12
Allowance for loan losses as a percentage of total assets at year
end.............................................................. 0.42 0.41 0.38 0.35 0.20
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
The ratio of net loan charge-offs to average loans outstanding for each of
the past five years has been very low due to the credit quality of the loan
portfolio.
The following table reflects the activity of the allowance for real estate
losses:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
December 31,
--------------------------------------------------
(DOLLARS IN THOUSANDS) 1996 1995 1994 1993 1992
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at the beginning of year.................. $ 35 37 126 100 0
Provision for losses............................ 2 9 0 45 100
Charge-offs..................................... 0 (11) 0 (19) 0
Recoveries...................................... 0 0 0 0 0
------ --- ----- ---- ---
Net charge-offs............................... 0 (11) 0 (19) 0
------ --- ----- ---- ---
Other........................................... (35) 0 (89) 0 0
------ --- ----- ---- ---
Balance at end of year............................ $ 2 35 37 126 100
------ --- ----- ---- ---
------ --- ----- ---- ---
</TABLE>
Real estate properties acquired or expected to be acquired through loan
foreclosures are initially recorded at the lower of the related loan balance,
less any specific allowance for loss, or fair value less estimated selling
costs. Valuations are periodically performed by management and an allowance for
losses is established if the carrying value of a property exceeds its fair value
less estimated selling costs.
NON-PERFORMING ASSETS
Non-performing assets (comprised of non-accrual loans, restructured loans,
and real estate acquired through foreclosure) totaled $361,000 at December 31,
1996, a decrease of $489,000 compared to $850,000 at December 31, 1995.
Non-performing assets had the following activity during 1996: sales of $314,000,
charge-offs of $61,000, pay-
20
<PAGE>
ments of $128,000, and net transfers to non-performing assets of $14,000.
Non-performing assets are summarized in the following table:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
December 31,
-----------------------------------------------------
(DOLLARS IN THOUSANDS) 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Non-accrual loans........................................... $ 338 441 235 138 605
Accruing loans delinquent 90 days or more................... 0 0 0 23 0
Restructured loans.......................................... 0 94 199 0 280
Foreclosed assets........................................... 23 315 64 421 187
--------- --------- --------- --------- ---------
Total non-performing assets............................... $ 361 850 498 582 1,072
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Non-performing assets as a percentage of total assets......... 0.07% 0.16% 0.10% 0.14% 0.26%
Total non-performing loans.................................... $ 338 535 434 161 885
Non-performing loans as a percentage of loans receivable,
net......................................................... 0.10% 0.17% 0.16% 0.07% 0.37%
Allowance for loan losses to non-performing loans............. 691.84% 409.13% 436.52% 924.84% 93.90%
</TABLE>
The non-performing assets reflected above primarily consist of one-to-four
family mortgage loans or consumer loans except restructured loans in 1992 were
loans secured by multi-family real estate.
DEPOSITS
Deposits were $362.5 million at December 31, 1996, a decrease of $11.1
million, or 3.0%, compared to $373.5 million at December 31, 1995. The decrease
in deposits was all related to the certificate accounts. During 1996 some
depositors were attracted by the higher returns offered by nontraditional bank
products and therefore closed their certificates. Refer to Note 11 of the Notes
to Consolidated Financial Statements for more information on deposits.
FEDERAL HOME LOAN BANK ADVANCES
Advances were $106.1 million at December 31, 1996, an increase of $37.2
million, or 54.0%, compared to $68.9 million at December 31, 1995. During 1996
advances were obtained in order to purchase loans and assist in repurchasing the
stock of HMN in the open market. For additional information refer to
Stockholders' Equity, Asset/Liability Management and Note 12 of the Notes to
Consolidated Financial Statements for information on advances.
STOCKHOLDERS' EQUITY
Stockholders' equity was $82.1 million on December 31, 1996, a decrease of
$9.6 million, or 10.5% from $91.7 million at December 31, 1995. During 1996 HMN
purchased 869,785 shares of its own common stock for a total cost of $14.4
million. The shares were all purchased at a price less than the current book
value of HMN. In June of 1995 the Board of Directors approved a management
Recognition and Retention Plan (RRP) which awarded 84,486 shares of restricted
HMN common stock to management and directors. The restricted stock used for the
RRP was issued from treasury stock and vests over a five year period. As the RRP
participants earn their awards stockholders' equity is credited and compensation
is expensed.
On June 29, 1994, HMN completed a public stock Offering which generated net
proceeds of $59.2 million net of costs of $1.7 million. An ESOP was established
which borrowed $6.1 million from HMN. The loan is treated as a reduction of
stockholders' equity. For more information refer to the Consolidated Statement
of Stockholders' Equity and Note 15 of the Notes to Consolidated Financial
Statements.
REGULATORY CAPITAL REQUIREMENTS
Federal savings institutions are required to satisfy three capital
requirements: (i) a requirement that "tangible capital" equal or exceed 1.5% of
adjusted total assets, (ii) a requirement that "core capital" equal or exceed 3%
of adjusted total assets, and (iii) a requirement that "risk-based capital"
equal or exceed 8% of risk-weighted assets. With certain exceptions, all three
capital standards must generally conform to and be no less stringent than, the
capital standards published by the Comptroller of the Currency for national
banks.
As a result of the Federal Deposit Insurance Corporation Improvement Act of
1991 (FDICIA), banking and thrift regulators are required to take prompt
regulatory action against institutions which are undercapitalized. FDICIA
requires banking and thrift regulators to categorize institutions as "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," or "critically undercapitalized". A savings institution will
be deemed to be well capitalized if it: (i) has a total risk-based capital ratio
of 10% or greater, (ii) has a Tier 1 (core) risk-based capital ratio of 6% or
greater, (iii) has a leverage (core) ratio of 5% or greater, and (iv) is not
subject to any order or written directive by the OTS to meet and maintain a
specific capital level for any capital measure. The Bank is of the opinion that
it is considered well capitalized at December 31, 1996. Refer to Note 15 of the
Notes to Consolidated Financial Statements for a table which reflects the Bank's
capital requirements.
LIQUIDITY MANAGEMENT
HMN manages its liquidity position to ensure that the funding needs of
borrowers and depositors are met timely and in the most cost effective
manner. Asset liquidity is the ability to convert assets to cash through the
maturity of the
21
<PAGE>
asset or the sale of the asset. Liability liquidity results from the ability
of the Bank to attract depositors or borrow funds from third party sources such
as the FHLB. The Bank is required by regulation to maintain a monthly average
minimum asset liquidity ratio of 5%. The Bank has maintained an average monthly
liquidity ratio in excess of the 5% requirement and does not anticipate that it
will fall below the requirement in the future.
The primary investing activities are the origination or purchase of loans
and the purchase of securities. Principal and interest payments on mortgages and
securities are a primary source of cash for HMN. Additional cash can be obtained
by selling securities from the available for sale portfolio or by selling loans.
Loans could also be securitized by FNMA or FHLMC and used as collateral for
additional borrowing with the FHLB.
The primary financing activity is the attraction of retail deposits. The
Bank has the ability to borrow additional funds from the FHLB by pledging
additional securities or loans. Refer to Note 12 of the Notes to Consolidated
Financial Statements for more information on undrawn open lines of credit with
the FHLB and advance maturity.
HMN anticipates that its liquidity requirements for 1997 will be similar to
the cash flows it experienced in 1996 with the exception of $2.5 million for the
construction of two new retail banking facilities and cash needed to fund the
mortgage banking activities located in Edina, Minnesota. The cash required to
fund the mortgage banking activities is anticipated to range from $5.0 million
to $10.0 million at any given time.
HMN's most liquid assets are cash and cash equivalents, which consist of
short-term highly liquid investments with original maturities of less than three
months that are readily convertible to known amounts of cash and
interest-bearing deposits. The level of these assets is dependent on the
operating, financing, and investing activities during any given period.
Cash and cash equivalents at December 31, 1996 were $10.6 million, an
increase of $6.3 million compared to $4.3 million at December 31, 1995. Net cash
provided from operating activities during 1996 was $5.8 million. HMN conducted
the following major investing activities during 1996: proceeds from the sale of
securities available for sale were $101.2 million, principal received on
payments and maturities of securities available for sale was $37.0 million,
purchases were $107.9 million of securities available for sale, principal
received on payments and maturities of securities held to maturity were $14.9
million, purchases of securities held to maturity were $710,000, purchase of
interest in limited partnership was $2.9 million, proceeds from sale of loans
were $1.4 million, purchase of FHLB stock was $1.6 million and net increase in
loans receivable was due primarily to loan originations and loan purchases of
$53.2 million. Net cash used by investing activities during 1996 was $11.7
million. HMN conducted the following major financing activities during 1996:
decrease in deposits of $11.1 million, purchase of treasury stock $14.0 million,
proceeds from FHLB advances $130.0 million and repayments of FHLB advances
totaled $92.8 million. Net cash provided from financing activities was $12.2
million.
HMN has certificates of deposit with outstanding balances of $163.6 million
that come due during 1997. Based upon past experience management anticipates
that the majority of the deposits will renew for another term. Any deposits
which do not renew will be replaced with deposits from other customers, or
funded with advances from the FHLB, or will be funded through the sale of
securities. Management does not anticipate that it will have a liquidity problem
with the deposit maturities.
ASSET/LIABILITY MANAGEMENT
The interest rate sensitivity of assets and liabilities may be analyzed by
examining the extent to which such assets and liabilities will mature or reprice
within the same period. The interest rate sensitivity gap is defined as the
difference between the amount of interest-earning assets maturing or repricing
within a specific time period and the amount of interest-bearing liabilities
maturing or repricing within a specific time period. A gap is considered
positive when the amount of interest rate sensitive assets exceeds the amount of
interest rate sensitive liabilities, and is considered negative when the amount
of interest rate sensitive liabilities exceeds the amount of interest rate
sensitive assets. Generally, during a period of rising interest rates, a
negative gap would adversely affect net interest income while a positive gap
would result in an increase in net interest income. Conversely, during a period
of falling interest rates, a negative gap would result in an increase in net
income and a positive gap would adversely affect net interest income.
In an attempt to manage its exposure to changes in interest rates,
management closely monitors interest rate risk. The Bank has an Asset/Liability
Committee consisting of executive officers which meets at least quarterly to
review the interest rate risk position and projected profitability. The
committee makes recommendations for adjustments to the asset liability position
of the Bank to the Board. This committee also reviews the Bank's portfolio,
formulates investment strategies and oversees the timing and implementation of
transactions to assure attainment of the Board's objectives in the most
effective manner. In addition, the Board reviews on a quarterly basis the Bank's
asset/liability position, including simulations of the effect on the Bank's
capital of various interest rate scenarios.
In managing its asset/liability mix, the Bank, at times, depending on the
relationship between long-and short-term interest rates, market conditions and
consumer preference, may place more emphasis on managing net interest margin
than on better matching the interest rate sensitivity of its assets and
liabilities in an effort to enhance net interest income. Management believes
that the increased net interest income resulting from a mismatch in the maturity
22
<PAGE>
of its asset and liability portfolios can, during periods of declining or stable
interest rates, provide high enough returns to justify the increased exposure to
sudden and unexpected increases in interest rates.
To the extent consistent with its interest rate spread objectives, the Bank
attempts to reduce its interest rate risk and has taken a number of steps to
restructure its assets and liabilities. The Bank has primarily focused its fixed
rate one-to-four family residential lending program on loans with contractual
terms of 20 years or less.
The following table sets forth the interest rate sensitivity of HMN's assets
and liabilities at December 31, 1996, using certain assumptions that are
described in more detail below:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Maturing or Repricing
-------------------------------------------------------------------------------------
Over 6
6 Months Months to Over 1-3 Over 3-5 Over 5 No Stated
(DOLLARS IN THOUSANDS) or Less 1 Year Years Years Years Maturity Total
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Cash equivalents............................ $ 9,584 0 0 0 0 0 9,584
Securities available for sale:
Mortgage-backed and related
securities(1)........................... 48,391 4,848 19,384 15,570 46,281 0 134,474
Other marketable securities............... 17,510 2,886 8,160 5,951 57 7,796 42,360
Securities held to maturity:
Mortgage-backed and related
securities(1)........................... 201 399 532 357 317 0 1,806
Other marketable securities............... 1,000 0 0 0 0 0 1,000
Loans held for sale......................... 739 0 0 0 0 0 739
Loans receivable, net:(1)(2)
Fixed rate one-to-four family(3).......... 20,658 18,857 62,481 44,134 88,538 0 234,668
Adjustable rate one-to-four family(3)..... 31,059 18,948 17,280 19,382 663 0 87,332
Multi-family.............................. 6 4 47 0 0 0 57
Fixed rate commercial real estate......... 173 135 418 269 505 0 1,500
Adjustable rate commercial real estate.... 6,547 94 0 0 0 0 6,641
Commercial business....................... 1,353 220 567 140 65 0 2,345
Consumer loans............................ 14,341 1,266 2,211 855 147 0 18,820
Federal Home Loan Bank stock................ 0 0 0 0 0 5,434 5,434
----------- ----------- ----------- ----------- --------- ----------- ---------
Total interest-earning assets......... 151,562 47,657 111,080 86,658 136,573 13,230 546,760
----------- ----------- ----------- ----------- --------- ----------- ---------
Non-interest checking....................... 2,389 0 0 0 0 0 2,389
NOW accounts................................ 17,589 0 0 0 0 0 17,589
Passbooks................................... 3,174 2,840 8,660 5,543 9,853 0 30,070
Money market accounts....................... 1,745 1,562 4,761 3,047 5,418 0 16,533
Certificates................................ 92,535 71,077 111,329 20,955 0 0 295,896
Federal Home Loan Bank advances............. 59,714 5,714 6,251 34,400 0 0 106,079
----------- ----------- ----------- ----------- --------- ----------- ---------
Total interest-bearing liabilities.... 177,146 81,193 131,001 63,945 15,271 0 468,556
----------- ----------- ----------- ----------- --------- ----------- ---------
Interest-earning assets less
interest-bearing liabilities.............. $ (25,584) (33,536) (19,921) 22,713 121,302 13,230 78,204
----------- ----------- ----------- ----------- --------- ----------- ---------
----------- ----------- ----------- ----------- --------- ----------- ---------
Cumulative interest-rate sensitivity gap.... $ (25,584) (59,120) (79,041) (56,328) 64,974 78,204 78,204
----------- ----------- ----------- ----------- --------- ----------- ---------
----------- ----------- ----------- ----------- --------- ----------- ---------
Cumulative interest-rate gap as a percentage
of total assets at December 31, 1996...... (4.61)% (10.66)% (14.25)% (10.15)% 11.71% 14.10% 14.10%
----------- ----------- ----------- ----------- --------- ----------- ---------
----------- ----------- ----------- ----------- --------- ----------- ---------
Cumulative interest-rate gap as a percentage
of interest-earning assets at December 31,
1995...................................... (1.07) (7.53)
----------- -----------
----------- -----------
Cumulative interest-rate gap as a percentage
of interest-earning assets at December 31,
1994...................................... (2.47) (2.26)
----------- -----------
----------- -----------
</TABLE>
(1) Schedule prepared based upon the earlier of contractual maturity or
repricing date, if applicable, adjusted for scheduled repayments of
principal and projected prepayments of principal based upon experience.
(2) Loans receivable are presented net of loans in process and deferred loan
fees.
(3) Construction and development loans are all one-to-four family loans and
therefore have been included in the fixed rate one-to-four family and
adjustable rate one-to-four family lines.
- --------------------------------------------------------------------------------
23
<PAGE>
The preceding table was prepared utilizing the following assumptions
regarding prepayment and decay ratios which were determined by management based
upon their review of historical prepayment speeds and future prepayment
projections. Fixed rate loans were assumed to prepay at annual rates of between
5% to 24%, depending on the coupon and period to maturity. ARMs were assumed to
prepay at annual rates of between 3% and 12%, depending the on coupon and the
period to maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay
at annual rates of between 8% and 27% depending on the coupon and the period to
maturity. Mortgage-backed securities and Collateralized Mortgage Obligations
(CMOs) were projected to have prepayments based upon the underlying collateral
securing the instrument. Certificate accounts were assumed not to be withdrawn
until maturity. Passbook and money market accounts were assumed to decay at an
annual rate of 20%.
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. Although certain assets and liabilities may have similar
maturities and periods of repricing, they may react in different degrees to
changes in market interest rates. The interest rates on certain types of assets
and liabilities may fluctuate in advance of changes in market interest rates,
while interest rates on other types of assets and liabilities may lag behind
changes in market interest rates. Certain assets, such as adjustable-rate
mortgages, have features which restrict changes in interest rates on a
short-term basis and over the life of the asset. In the event of a change in
interest rates, prepayment and early withdrawal levels would likely deviate
significantly from those assumed in calculating the foregoing table. The ability
of many borrowers to service their debt may decrease in the event of an interest
rate increase.
Refer to Regulatory Capital Requirements above for a discussion of Bank's
interest rate risk component.
DIVIDENDS
HMN has not paid any dividends since its incorporation in March 1994.
However, the Board of Directors may consider a policy of paying cash dividends
in the future. The declaration of dividends are subject to, among other things,
HMN's financial condition and results of operations, the Bank's compliance with
its regulatory capital requirements, including the fully phased-in capital
requirements, tax considerations, industry standards, economic conditions,
regulatory restrictions, general business practices and other factors. Refer to
Note 15 of the Notes to Consolidated Financial Statements for information on
regulatory limitations on dividends from the Bank to HMN.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and Notes presented herein have been
prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operation results primarily in
terms of historical dollars without considering the changes in the relative
purchasing power of money over time due to inflation. The impact of inflation is
reflected in the increased cost of operations. Unlike most industrial companies,
nearly all of the assets and liabilities of HMN are monetary in nature. As a
result, interest rates have a greater impact on HMN's performance than do the
effects of general levels of inflation. Interest rates do not necessarily move
in the same direction or to the same extent as the prices of goods and services.
MERGER AND ACQUISITIONS
From time to time HMN reviews the possibility of acquiring or merging with
different companies which would complement the business conducted by HMN. HMN's
Board of Directors has adopted the policy of not disclosing to the public its
intent to acquire or merge until a formal definitive agreement has been signed
by all parties involved with the transaction.
OUTLOOK
The statements contained in this Outlook are based upon current
expectations. These statements are forward looking, and actual results may
differ materially.
During 1996 HMN opened a mortgage banking office in Edina, Minnesota. The
office will purchase mortgage loans from third party originators for HMN's loan
portfolio or sell the loans in the secondary market. The office will keep the
mortgage loan servicing rights on many of the loans that are sold to the
secondary market and it also intends to purchase mortgage servicing rights from
third parties. The addition of the mortgage banking office is anticipated to
increase the operating expense ratio for HMN to a range of 1.50% to 1.60% of
average total assets. The office is also anticipated to generate income from
loan servicing and from the sale of loans which should, for the first full year
of operation, offset a majority of its operating expenses.
In the future, to the extent that HMN invests in mortgage servicing assets,
its mortgage servicing income will increase but its interest margin may decline
due to the purchase of non-interest earning assets.
24
<PAGE>
Consolidated Balance Sheets
- --------------------------------------------------------------------------------
DECEMBER 31, 1996 AND 1995
<TABLE>
<CAPTION>
1996 1995
ASSETS ------------------------------
<S> <C> <C>
Cash and cash equivalents......................................................... $ 10,583,717 4,334,694
Securities available for sale:
Mortgage-backed and related securities (amortized cost $134,474,167 and
$158,517,548)................................................................. 133,355,278 158,416,201
Other marketable securities (amortized cost $42,360,499 and $32,247,959)........ 42,474,810 31,903,566
-------------- -------------
175,830,088 190,319,767
-------------- -------------
Securities held to maturity:
Mortgage-backed and related securities (fair value $1,904,993 and
$13,931,879).................................................................. 1,805,744 13,744,063
Other marketable securities (fair value $1,000,550 and $3,224,263).............. 999,812 3,227,729
-------------- -------------
2,805,556 16,971,792
-------------- -------------
Loans held for sale............................................................... 739,316 0
Loans receivable, net............................................................. 349,022,236 314,850,684
Federal Home Loan Bank stock, at cost............................................. 5,434,000 3,801,900
Real estate, net.................................................................. 20,610 279,851
Premises and equipment, net....................................................... 3,581,497 3,645,536
Accrued interest receivable....................................................... 3,415,152 3,381,507
Prepaid expenses and other assets................................................. 3,299,427 362,928
-------------- -------------
Total assets.................................................................. $ 554,731,599 537,948,659
-------------- -------------
-------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits.......................................................................... $ 362,476,944 373,539,468
Federal Home Loan Bank advances................................................... 106,078,589 68,876,978
Accrued interest payable.......................................................... 1,542,773 1,562,347
Advance payments by borrowers for taxes and insurance............................. 518,911 550,990
Accrued expenses and other liabilities............................................ 2,014,938 1,732,193
-------------- -------------
Total liabilities............................................................... 472,632,155 446,261,976
-------------- -------------
Commitments and contingencies
Stockholders' equity:
Serial preferred stock ($.01 par value): authorized 500,000 shares; issued and
outstanding none.............................................................. 0 0
Common stock ($.01 par value): authorized 7,000,000; issued shares 6,085,775.... 60,858 60,858
Additional paid-in capital...................................................... 59,428,768 59,285,581
Retained earnings, subject to certain restrictions.............................. 54,645,387 50,371,038
Net unrealized loss on securities available for sale............................ (598,045) (265,358)
Unearned employee stock ownership plan shares................................... (4,938,520) (5,336,150)
Unearned compensation restricted stock awards................................... (793,289) (1,050,305)
Treasury stock, at cost 1,651,615 and 783,850 shares............................ (25,705,715) (11,378,981)
-------------- -------------
Total stockholders' equity.................................................... 82,099,444 91,686,683
-------------- -------------
Total liabilities and stockholders' equity.................................... $ 554,731,599 537,948,659
-------------- -------------
-------------- -------------
</TABLE>
See accompanying notes to consolidated financial statements.
25
<PAGE>
Consolidated Statements of Income
- --------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
-----------------------------------------
<S> <C> <C> <C>
Interest income:
Loans receivable.................................................... $ 25,721,042 23,375,334 20,050,650
Securities available for sale:
Mortgage-backed and related....................................... 10,027,438 10,294,056 9,000,995
Other marketable.................................................. 2,424,628 2,857,884 1,545,302
Securities held to maturity:
Mortgage-backed and related....................................... 765,120 746,100 448,909
Other marketable.................................................. 104,448 389,381 534,523
Cash equivalents.................................................... 494,129 412,259 441,733
Other............................................................... 327,520 253,170 255,122
------------- ------------ ------------
Total interest income........................................... 39,864,325 38,328,184 32,277,234
------------- ------------ ------------
Interest expense:
Deposits............................................................ 18,949,937 18,578,744 15,840,739
Federal Home Loan Bank advances..................................... 5,243,853 3,976,353 2,226,733
------------- ------------ ------------
Total interest expense............................................ 24,193,790 22,555,097 18,067,472
------------- ------------ ------------
Net interest income............................................... 15,670,535 15,773,087 14,209,762
Provision for loan losses............................................. 300,000 300,000 410,000
------------- ------------ ------------
Net interest income after provision for loan losses................. 15,370,535 15,473,087 13,799,762
------------- ------------ ------------
Noninterest income:
Fees and service charges............................................ 359,249 324,492 311,042
Securities gains, net............................................... 1,029,638 415,955 65,027
Gain on sales of loans.............................................. 39,306 102,368 3,219
Other............................................................... 494,507 155,434 215,425
------------- ------------ ------------
Total noninterest income........................................ 1,922,700 998,249 594,713
------------- ------------ ------------
Noninterest expense:
Compensation and benefits........................................... 4,591,367 4,160,248 3,472,955
Occupancy........................................................... 825,609 697,602 678,105
Federal deposit insurance premiums.................................. 799,890 810,432 811,023
SAIF assessment..................................................... 2,351,563 0 0
Advertising......................................................... 308,464 312,366 270,001
Data processing..................................................... 489,045 476,402 458,112
Provision for real estate losses.................................... 2,000 9,327 0
Other............................................................... 1,140,948 1,003,682 883,853
------------- ------------ ------------
Total noninterest expense......................................... 10,508,886 7,470,059 6,574,049
------------- ------------ ------------
Income before income tax expense.................................. 6,784,349 9,001,277 7,820,426
Income tax expense.................................................... 2,510,000 3,380,900 3,115,767
------------- ------------ ------------
Net income........................................................ $ 4,274,349 5,620,377 4,704,659
------------- ------------ ------------
------------- ------------ ------------
Earnings per common share and common share equivalents................ $ 0.96 1.09 0.48
Pro forma earnings per common share................................... $ N/A N/A 0.86
</TABLE>
- ------------------------
N/A Not applicable for the period.
See accompanying notes to consolidated financial statements.
26
<PAGE>
Consolidated Statement of Stockholders' Equity
- --------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
Net
Unrealized
Gain (Loss) Unearned
on Employee Unearned
Additional Securities Stock Compensation Total
Common Paid-In Retained Available Ownership Restricted Treasury Stockholders'
Stock Capital Earnings For Sale Plan Shares Stock Awards Stock Equity
-----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December
31, 1993.......... $ 40,046,002 40,046,002
Cumulative effect
of change in
accounting for
securities
available for
sale, net of tax
effect, at
January 1,
1994............ 566,495 566,495
Net income........ 4,704,659 4,704,659
Change in
unrealized loss
on securities
available for
sale, net of tax
effect.......... (9,741,118) (9,741,118)
Sale of stock..... 60,858 59,117,484 59,178,342
Adoption of
employee stock
ownership
plan............ (6,085,770) (6,085,770)
Earned employee
stock ownership
plan shares..... 38,511 339,890 378,401
-------- ----------- ----------- ----------- ----------- -------------- ----------- --------------
Balance, December
31, 1994.......... 60,858 59,155,995 44,750,661 (9,174,623) (5,745,880) 89,047,011
Net income........ 5,620,377 5,620,377
Change in
unrealized loss
on securities
available for
sale............ 8,909,265 8,909,265
Treasury stock
purchases....... (12,509,667) (12,509,667)
Unearned
compensation
restricted stock
awards.......... 36,319 (1,167,005) 1,130,686 0
Amortization of
restricted stock
awards.......... 116,700 116,700
Earned employee
stock ownership
plan shares..... 93,267 409,730 502,997
-------- ----------- ----------- ----------- ----------- -------------- ----------- --------------
Balance, December
31, 1995.......... 60,858 59,285,581 50,371,038 (265,358) (5,336,150) (1,050,305) (11,378,981) 91,686,683
Net income........ 4,274,349 4,274,349
Change in
unrealized loss
on securities
available for
sale............ (332,687) (332,687)
Treasury stock
purchases....... (14,364,754) (14,364,754)
Stock options
exercised....... (10,817) 63,180 52,363
Restricted stock
awards
cancelled....... (808) 25,968 (25,160) 0
Amortization of
restricted stock
awards.......... 231,048 231,048
Restricted stock
awards tax
benefit......... 13,677 13,677
Earned employee
stock ownership
plan shares..... 141,135 397,630 538,765
-------- ----------- ----------- ----------- ----------- -------------- ----------- --------------
Balance, December
31, 1996.......... $60,858 59,428,768 54,645,387 (598,045) (4,938,520) (793,289) (25,705,715) 82,099,444
-------- ----------- ----------- ----------- ----------- -------------- ----------- --------------
-------- ----------- ----------- ----------- ----------- -------------- ----------- --------------
</TABLE>
See accompanying notes to consolidated financial statements.
27
<PAGE>
Consolidated Statements of Cash Flows
- --------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
1996 1995 1994
-----------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income................................................ $ 4,274,349 5,620,377 4,704,659
Adjustments to reconcile net income to cash provided by
operating activities:
Purchase of securities held for sale...................... 0 0 (3,000,000)
Proceeds from sale of securities held for sale.......... 0 0 10,586,091
Provision for loan losses............................... 300,000 300,000 410,000
Provision for real estate losses........................ 2,000 9,327 0
Depreciation............................................ 378,753 352,580 303,193
Amortization of (discounts) premiums, net............... (129,636) (272,862) 54,279
Amortization of deferred loan fees...................... (440,580) (613,037) (520,752)
Provision for deferred income taxes..................... 110,400 568,050 138,212
Federal Home Loan Bank stock dividend................... 0 (75,100) 0
Securities gains, net................................... (1,029,638) (415,955) (65,027)
Gain on sales of real estate............................ (46,625) (14,241) 0
Gain on sales of loans.................................. (39,306) (102,368) (3,219)
Proceeds from sales of loans originated for sale........ 1,779,361 260,848 0
Amortization of restricted stock awards................. 231,048 116,700 0
Decrease in unearned ESOP shares........................ 397,630 409,730 0
Earned employee stock ownership shares priced above
original cost.......................................... 141,135 93,267 38,511
Increase in accrued interest receivable................. (33,645) (100,280) (663,822)
Increase (decrease) in accrued interest payable......... (19,574) 561,969 89,165
Equity earnings of limited partnership.................. (7,400) 0 0
Increase in other assets................................ (48,974) (173,133) (5,023)
Increase (decrease) in other liabilities................ 35,995 (540,164) (24,633)
Other, net.............................................. (56,470) (35,803) (106,551)
--------------- --------------- ---------------
Net cash provided by operating activities............. 5,798,823 5,949,905 11,935,083
--------------- --------------- ---------------
Cash flows from investing activities:
Proceeds from sales of securities available for sale...... 101,157,643 85,454,779 23,165,770
Principal collected on securities available for sale...... 16,530,585 15,427,074 31,346,252
Proceeds collected on maturity of securities available for
sale.................................................... 20,500,000 18,815,000 200,000
Purchases of securities available for sale................ (107,860,451) (110,993,058) (108,913,073)
Principal collected on securities held to maturity........ 2,276,661 1,076,805 1,949,181
Proceeds collected on maturity of securities held to
maturity................................................ 12,652,343 5,000,000 11,000,000
Purchase of securities held to maturity................... (709,765) (10,993,313) (12,204,562)
Purchase interest in limited partnership.................. (2,880,125) 0 0
Proceeds from sales of loans receivable................... 1,408,015 3,996,710 130,670
Purchase of Federal Home Loan Bank stock.................. (1,632,100) (688,100) 0
Net increase in loans receivable.......................... (53,214,798) (47,904,546) (24,363,821)
Proceeds from sale of real estate......................... 379,789 199,020 144,577
Purchases of premises and equipment....................... (314,714) (458,666) (931,557)
--------------- --------------- ---------------
Net cash used by investing activities................. (11,706,917) (41,068,295) (78,476,563)
--------------- --------------- ---------------
Cash flows from financing activities:
(Decrease) increase in deposits........................... (11,062,524) 22,964,821 (3,006,512)
Purchase of treasury stock................................ (14,002,254) (12,509,667) 0
Increase in unearned ESOP shares.......................... 0 0 (5,745,880)
Stock options exercised................................... 52,363 0 0
Proceeds from sale of common stock........................ 0 0 59,178,342
Proceeds from Federal Home Loan Bank advances............. 130,000,000 82,150,000 25,900,000
Repayment of Federal Home Loan Bank advances.............. (92,798,389) (65,258,747) (7,878,568)
Increase (decrease) in advance payments by borrowers for
taxes and insurance..................................... (32,079) 9,521 39,014
--------------- --------------- ---------------
Net cash provided by financing activities............. 12,157,117 27,355,928 68,486,396
--------------- --------------- ---------------
Increase (decrease) in cash and cash equivalents...... 6,249,023 (7,762,462) 1,944,916
Cash and cash equivalents, beginning of year................ 4,334,694 12,097,156 10,152,240
--------------- --------------- ---------------
Cash and cash equivalents, end of year...................... $ 10,583,717 4,334,694 12,097,156
--------------- --------------- ---------------
--------------- --------------- ---------------
Supplemental cash flow disclosures:
Cash paid for interest.................................... $ 24,213,364 21,993,128 17,978,307
Cash paid for income taxes................................ 2,725,433 2,994,755 2,849,148
Supplemental noncash flow disclosures:
Loans securitized and transferred to securities available
for sale................................................ $ 15,411,803 0 0
Securities held to maturity transferred to securities
available for sale...................................... 0 651,594 72,374,853
Loans transferred to loans held for sale.................. 2,491,820 254,912 0
Transfer of loans to real estate.......................... 188,054 413,853 153,913
Transfer of real estate to loans.......................... 161,954 0 361,054
Treasury stock purchased with liability due to broker..... 362,500 0 0
</TABLE>
See accompanying notes to consolidated financial statements.
28
<PAGE>
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
DECEMBER 31, 1996, 1995 AND 1994
(1) DESCRIPTION OF THE BUSINESS
HMN Financial, Inc. (HMN) was incorporated under the laws of the State of
Delaware for the purpose of becoming the savings and loan holding company of
Home Federal Savings Bank (the Bank) in connection with the Bank's conversion
from a federally chartered mutual savings bank to a federally chartered stock
savings bank, pursuant to its Plan of Conversion. HMN commenced on May 23, 1994,
a Subscription and Community Offering of its shares in connection with the
conversion of the Bank (the Offering). The Offering was closed on June 22, 1994,
and the conversion was consummated on June 29, 1994.
The consolidated financial statements included herein are for HMN, the Bank
and the Bank's wholly owned subsidiaries, Security Finance Corporation (SFC) and
Osterud Insurance Agency, Inc. On December 29, 1995 the Bank sold all
outstanding shares of common stock in SFC to HMN at SFC's fair value. All
significant intercompany accounts and transactions have been eliminated in
consolidation. All financial information prior to June 29, 1994, contained
herein relates solely to the Bank and its subsidiaries.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles. The following items set forth the
significant accounting policies which HMN follows in presenting its financial
statements.
MATERIAL ESTIMATES
In preparing the financial statements, management is required to make
estimates and assumptions that affect the reported amounts of assets and
liabilities as of the date of the balance sheet and revenues and expenses for
the period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to change relate to the
determination of the allowance for losses on loans and the valuation of real
estate acquired in connection with foreclosures or in satisfaction of loans. In
connection with the determination of the allowances for loan and real estate
losses, management obtains independent appraisals for significant properties.
Management believes that the allowances for losses on loans and real estate
are adequate. While management uses available information to recognize losses on
loans and real estate, future additions to the allowances may be necessary based
on changes in economic conditions. In addition, various regulatory agencies, as
an integral part of their examination process, periodically review the
allowances for losses on loans and real estate. Such agencies may require
additions to the allowances based on their judgement about information available
to them at the time of their examination.
CASH EQUIVALENTS
For purposes of the statements of cash flows, HMN considers highly liquid
investments with original maturities of three months or less to be cash
equivalents.
SECURITIES
The Bank adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY
SECURITIES as of January 1, 1994. The adoption of SFAS No. 115 increased
stockholders' equity by $566,495 at January 1, 1994. HMN classifies its debt and
equity securities in one of three categories: trading, available for sale, or
held to maturity. Trading securities are bought and held principally for the
purpose of selling them in the near term. Securities available for sale include
securities that management intends to use as part of its asset/liability
strategy or that may be sold in response to changes in interest rate, changes in
prepayment risk, or similar factors.
Securities available for sale are carried at market value. Net unrealized
gains and losses, net of tax effect, are included as a separate component of
stockholders' equity.
Securities held to maturity are carried at cost, adjusted for amortization
of premiums and discounts, as management has the ability and intent to hold them
to maturity.
Premiums and discounts are amortized using the level-yield method over the
period to maturity. Gains and losses on the sale of securities are determined
using the specific-identification method.
During December 1995, HMN transferred securities with an amortized cost of
$651,594 from securities held to maturity to securities available for sale. The
transfer was made in conformity with A GUIDE TO IMPLEMENTATION OF STATEMENT 115
ON ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES issued by
the Financial Accounting Standards Board (FASB) in November of 1995.
LOANS HELD FOR SALE
Mortgage loans originated or purchased which are intended for sale in the
secondary market are carried at the lower of cost or estimated market value in
the aggregate. Net unrealized losses are recognized through a valuation
allowance by charges to income.
LOANS RECEIVABLE, NET
Loans receivable, net are considered long-term investments and, accordingly
are carried at amortized cost. Loan origination fees received, net of certain
loan origination costs, are deferred as an adjustment to the carrying value of
the related loans, and are amortized into income using the interest method over
the estimated life of the loans.
Discounts on loans are amortized into interest income using the interest
method over the period to contractual maturity, adjusted for estimated
prepayments.
The allowance for loan losses is maintained at an amount considered adequate
to provide for probable losses. The allowance for losses on loans is based on
periodic analysis of the loan portfolio by management. In this analysis,
management considers factors including, but not limited to, specific occurrences
which include loan impairment, gen-
29
<PAGE>
eral economic conditions, loan portfolio composition and historical
experience. Loans are charged off to the extent they are deemed to be
uncollectible.
Interest income is recognized on an accrual basis except when collectibility
is in doubt. When loans are placed on a nonaccrual basis, previously accrued but
unpaid interest is reversed from income. Interest is subsequently recognized as
income to the extent cash is received when, in management's judgement, principal
is collectible.
Effective January 1, 1995, HMN adopted SFAS No. 114, ACCOUNTING BY CREDITORS
FOR IMPAIRMENT OF A LOAN, and SFAS No. 118, ACCOUNTING BY CREDITORS FOR
IMPAIRMENT OF A LOAN--INCOME RECOGNITION AND DISCLOSURES. SFAS No. 114
requires that impaired loans, including all loans that are restructured in a
troubled debt restructuring involving a modification of terms, be measured at
the present value of expected future cash flows discounted at the loan's
initial effective interest rate. The fair value of the collateral of an
impaired collateral-dependent loan or an observable market price, if one
exists, may be used as an alternative to discounting. If the measure of the
impaired loan is less than the recorded investment in the loan, impairment is
to be recognized through the allowance for loan losses. A loan is considered
impaired when, based on current information and events, it is probable that a
creditor will be unable to collect all amounts due according to the
contractual terms of the loan agreement. SFAS No. 118 amends SFAS No. 114 to
allow a creditor to use existing methods for recognizing interest income on
impaired loans and to clarify disclosure requirements. The adoption of SFAS
No. 114 and SFAS No. 118 did not impact HMN's results of operations for 1995
or any prior period. In accordance with SFAS No. 114 and SFAS No. 118, prior
period financial statements have not been restated to reflect the change in
accounting method.
For purposes of SFAS No. 114 and SFAS No. 118 impaired loans are all loans
which are delinquent as to principal and interest for 120 days or greater and
all loans that are restructured in a troubled debt restructuring involving a
modification of terms. All portfolio loans are reviewed on an individual basis.
MORTGAGE SERVICING RIGHTS
Effective January 1, 1996, HMN adopted SFAS No. 122, ACCOUNTING FOR MORTGAGE
SERVICING RIGHTS. HMN recognizes as a separate asset the rights to service
mortgage loans for others whether the servicing rights are acquired through loan
origination or purchase. The fair value of capitalized mortgage servicing rights
is based upon the present value of estimated future cash flows. Based upon
current fair values capitalized mortgage servicing rights are periodically
assessed for impairment, which is recognized in the statement of income during
the period in which the impairment occurs as an adjustment to the corresponding
valuation allowance. For purposes of performing its impairment evaluation, the
corporation stratifies its portfolio on the basis of certain risk
characteristics including loan type and note rate. Capitalized mortgage
servicing rights are amortized over the estimated remaining life of the
underlying loans and take into account appropriate prepayment assumptions. The
effect of adopting SFAS No. 122 did not have a material impact on HMN's
financial condition or the results of its operations during 1996.
REAL ESTATE, NET
Real estate properties acquired through loan foreclosures are initially
recorded at the lower of the related loan balance, less any specific allowance
for loss, or fair value less estimated selling costs. Valuations are
periodically performed by management and an allowance for losses is established
if the carrying value of a property exceeds its fair value less estimated
selling costs.
PREMISES AND EQUIPMENT
Land is carried at cost. Office buildings, improvements, furniture and
equipment are carried at cost less accumulated depreciation.
Depreciation is computed on a straight-line basis over estimated useful
lives of 10 to 40 years for office buildings and improvements and 3 to 12 years
for furniture and equipment.
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF
Effective January 1, 1996, HMN adopted SFAS No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. HMN
reviews long-lived assets and certain identifiable intangibles for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. The effect of adopting SFAS No. 121 on January
1, 1996 did not have a material impact on HMN's financial condition or the
results of its operations.
STOCK-BASED COMPENSATION
Effective January 1, 1996, HMN adopted SFAS No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION. It elected to continue using the accounting methods
prescribed by Accounting Principles Board (APB) Opinion No. 25 and related
interpretations which measure compensation cost using the intrinsic value
method. HMN has included in Note 14, "Employee Benefits" the impact of the fair
value of employee stock-based compensation plans on net income and earnings per
share on a pro forma basis for awards granted after January 1, 1995.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
NEW ACCOUNTING STANDARDS
In June 1996, the Financial Accounting Standards Board (FASB) issued SFAS
No. 125, ACCOUNTING FOR TRANSFERS AND
30
<PAGE>
SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENT OF LIABILITIES. SFAS No. 125
applies to transfers and servicing of financial assets and extinguishments of
liabilities. It requires a financial-components approach that focuses on
control. Under the approach, after a transfer of financial assets, an entity
recognizes the financial and servicing assets it controls and the liabilities
it has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished. In December
1996, the FASB issued SFAS No. 127 which postpones the effective date by one
year for certain provisions of SFAS No. 125. The sections dealing with
secured borrowings and collateral are deferred for all transfers of financial
assets until after December 31, 1997. Likewise transfers related to
repurchase agreements, dollar-rolls, securities lending and similar
transactions are deferred until after December 31, 1997. The effect of
adopting SFAS No. 125 as amended by SFAS No. 127 will not have a material
impact on HMN's financial condition or the results of its operations.
EARNINGS PER SHARE
Earnings per common share and common share equivalents for 1996 and 1995 were
computed by dividing net income ($4,274,349 and $5,620,377) respectively, for
the years then ended by the weighted average common shares and common share
equivalents outstanding (4,436,833 and 5,171,382), respectively. The earnings
per share for 1994 was computed by dividing net income ($2,646,788) from the
date of conversion, June 29, 1994, by the weighted average common shares
outstanding (5,484,414) for the period. Pro forma earnings per common share
were computed by dividing net income ($4,704,659) for the year ended December
31, 1994, by the weighted average common shares outstanding (5,484,414) for
the period.
RECLASSIFICATIONS
Certain amounts in the consolidated financial statements for prior years
have been reclassified to conform with the current-year presentation.
(3) SECURITIES HELD FOR SALE
Proceeds from securities held for sale which were sold during 1994 were
$10,586,091, resulting in gross losses of $27,676 and gross gains of $2,568.
During 1996 and 1995 there were no securities classified as securities held for
sale.
(4) SECURITIES AVAILABLE FOR SALE
A summary of securities available for sale at December 31, 1996 and 1995 is
as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1996:
Mortgage-backed securities:
FHLMC................................................. $ 1,776,252 32,567 0 1,808,819
FNMA.................................................. 968,924 14,833 0 983,757
Collateralized mortgage obligations:
FNMA.................................................. 45,236,461 113,800 596,858 44,753,403
FHLMC................................................. 56,867,103 98,316 1,162,269 55,803,150
Other................................................. 29,625,427 449,747 69,025 30,006,149
-------------- ---------- ---------- -------------
134,474,167 709,263 1,828,152 133,355,278
-------------- ---------- ---------- -------------
Other marketable securities:
U.S. Government and agency obligations................ 29,599,717 33,566 355,602 29,277,681
Corporate debt........................................ 1,090,420 1,218 0 1,091,638
Corporate equity...................................... 11,670,362 555,608 120,479 12,105,491
-------------- ---------- ---------- -------------
42,360,499 590,392 476,081 42,474,810
-------------- ---------- ---------- -------------
$ 176,834,666 1,299,655 2,304,233 175,830,088
-------------- ---------- ---------- -------------
-------------- ---------- ---------- -------------
DECEMBER 31, 1995:
Mortgage-backed securities:
FHLMC................................................. $ 4,977,613 18,820 38,036 4,958,397
FNMA.................................................. 535,740 7,672 0 543,412
Collateralized mortgage obligations:
FNMA.................................................. 51,665,922 389,226 556,569 51,498,579
FHLMC................................................. 79,290,840 361,835 988,110 78,664,565
Other................................................. 22,047,433 734,232 30,417 22,751,248
-------------- ---------- ---------- -------------
158,517,548 1,511,785 1,613,132 158,416,201
-------------- ---------- ---------- -------------
Other marketable securities:
U.S. Government and agency obligations................ 21,894,709 61,494 627,527 21,328,676
Municipal obligations................................. 1,600,000 1,260 0 1,601,260
Corporate debt........................................ 851,275 8,943 0 860,218
Corporate equity...................................... 7,901,975 382,731 171,294 8,113,412
-------------- ---------- ---------- -------------
32,247,959 454,428 798,821 31,903,566
-------------- ---------- ---------- -------------
$ 190,765,507 1,966,213 2,411,953 190,319,767
-------------- ---------- ---------- -------------
-------------- ---------- ---------- -------------
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
31
<PAGE>
Proceeds from securities available for sale which were sold during 1996 were
$101,157,643, resulting in gross gains of $1,235,754 and gross losses of
$206,116. Proceeds from securities available for sale which were sold during
1995 were $85,454,779, resulting in gross gains of $565,441 and gross losses of
$149,486. Proceeds from securities available for sale which were sold during
1994 were $23,165,770, resulting in gross gains of $188,594 and gross losses of
$96,043.
The following table indicates amortized cost and estimated fair value of
securities available for sale at December 31, 1996, based upon contractual
maturity adjusted for scheduled repayments of principal and projected
prepayments of principal based upon current economic conditions and interest
rates. Actual maturities may differ from the maturities in the following table
because obligors may have the right to call or prepay obligations with or
without call or prepayment penalties:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
Amortized Fair
Cost Value
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Due less than one year.................................................. $ 25,830,291 25,753,962
Due after one year through five years................................... 55,385,109 54,729,225
Due after five years through ten years.................................. 36,737,671 36,372,992
After ten years......................................................... 47,211,233 46,868,418
No stated maturity...................................................... 11,670,362 12,105,491
-------------- -------------
Total................................................................. $ 176,834,666 175,830,088
-------------- -------------
-------------- -------------
- -------------------------------------------------------------------------------------------------------
</TABLE>
The allocation of mortgage-backed securities and collateralized mortgage
obligations in the table above is based upon the anticipated future cash flow of
the securities using estimated mortgage prepayment speeds.
(5) SECURITIES HELD TO MATURITY
A summary of securities held to maturity at December 31, 1996 and 1995 is as
follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1996:
Mortgage-backed securities:
FHLMC...................................................... $ 1,403,866 90,477 0 1,494,343
FNMA....................................................... 158,425 9,941 0 168,366
Other...................................................... 243,453 0 1,169 242,284
------------- ----------- ----- ------------
1,805,744 100,418 1,169 1,904,993
------------- ----------- ----- ------------
Other marketable securities:
Corporate debt............................................. 999,812 738 0 1,000,550
------------- ----------- ----- ------------
$ 2,805,556 101,156 1,169 2,905,543
------------- ----------- ----- ------------
------------- ----------- ----- ------------
DECEMBER 31, 1995:
Mortgage-backed securities:
FHLMC...................................................... $ 2,801,354 162,879 0 2,964,233
FNMA....................................................... 10,616,401 15,071 0 10,631,472
Other...................................................... 326,308 9,866 0 336,174
------------- ----------- ----- ------------
13,744,063 187,816 0 13,931,879
------------- ----------- ----- ------------
Other marketable securities:
Municipal obligations...................................... 228,432 337 0 228,769
Corporate debt............................................. 2,999,297 627 4,430 2,995,494
------------- ----------- ----- ------------
3,227,729 964 4,430 3,224,263
------------- ----------- ----- ------------
$ 16,971,792 188,780 4,430 17,156,142
------------- ----------- ----- ------------
------------- ----------- ----- ------------
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
There were no sales of securities held to maturity in 1996, 1995 or 1994.
During 1994, HMN entered into an agreement with several County Housing and
Redevelopment Authorities (HRAs) to purchase FNMA mortgage-backed securities
collateralized by single family loans within the HRAs. The mortgage-backed
securities were required by the agreement to be repurchased by the HRAs on
September 1, 1996. At December 31, 1995, HMN owned $10,386,249 of FNMA
securities purchased under the agreement. In conformity with the agreement the
HRAs purchased all the FNMA securities originally purchased by HMN on September
1, 1996. The HRAs purchase of the FNMA securities is the major reason for the
$11.9 million decrease in mortgage-backed securities between 1995 and 1996.
The following table indicates amortized cost and estimated fair value of
securities held to maturity at December 31, 1996, based upon contractual
maturities adjusted for scheduled repayments of principal and projected
prepayments of principal based upon current economic conditions and interest
rates. Actual maturities may differ from
32
<PAGE>
the maturities in the table because obligors may have the right to call or
prepay obligations with or without call or prepayment penalties:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
Amortized Fair
Cost Value
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Due in one year or less...................................................... $ 1,593,959 1,615,999
Due after one year through five years........................................ 891,215 946,814
Due after five years through ten years....................................... 279,645 298,584
Over ten years............................................................... 40,737 44,146
------------ ----------
Total...................................................................... $ 2,805,556 2,905,543
------------ ----------
------------ ----------
- -------------------------------------------------------------------------------------------------------
</TABLE>
The allocation of mortgage-backed securities in the table above is based
upon the anticipated future cash flow of the securities using estimated mortgage
prepayment speeds.
(6) LOANS RECEIVABLE, NET
A summary of loans receivable at December 31 is as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
1996 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
Residential real estate loans:
Conventional........................................................ $ 320,317,356 291,173,665
FHA................................................................. 2,203,983 3,137,876
VA.................................................................. 2,572,878 3,628,306
-------------- -------------
325,094,217 297,939,847
-------------- -------------
Other loans:
Commercial real estate.............................................. 7,917,882 8,744,027
Consumer............................................................ 18,743,939 12,518,535
Commercial business................................................. 2,344,421 1,017,508
Savings............................................................. 938,308 1,210,058
Education........................................................... 466,576 342,210
Other............................................................... 782,885 988,579
-------------- -------------
31,194,011 24,820,917
-------------- -------------
Total loans....................................................... 356,288,228 322,760,764
Less:
Unamortized discounts............................................... 417,031 289,129
Net deferred loan fees.............................................. 1,694,730 1,898,859
Allowance for losses................................................ 2,340,585 2,190,664
Loans in process.................................................... 2,813,646 3,531,428
-------------- -------------
$ 349,022,236 314,850,684
-------------- -------------
-------------- -------------
Weighted average contractual interest rate............................ 7.67% 7.72%
Commitments to originate, fund or purchase loans...................... $ 24,504,320 7,359,134
- -----------------------------------------------------------------------------------------------------
</TABLE>
Included in total commitments to originate or purchase loans are fixed rate
loans aggregating approximately $2,861,025 and $1,081,900 as of December 31,
1996 and 1995, respectively. The interest rates on these commitments ranged from
7.11% to 8.375% at December 31, 1996 and from 6.86% to 7.375% at December 31,
1995.
At December 31, 1996 and 1995, loans on nonaccrual status totaled $338,310
and $441,400, respectively. Had the loans performed in accordance with their
original terms throughout 1996, the Bank would have recorded gross interest
income of $34,638 for these loans. Interest income of $21,139 has been recorded
on these loans for the year ended December 31, 1996.
At December 31, 1996 there were no loans included in loans receivable, net
with terms that had been modified in troubled debt restructuring. Included in
loans receivable, net are loans with terms that have been modified in troubled
debt restructurings of $94,050 at December 31, 1995.
There were no material commitments to lend additional funds to customers
whose loans were classified as restructured or nonaccrual at December 31, 1996.
At December 31, 1996 and 1995, the recorded investment in loans that are
considered to be impaired under the criteria established by SFAS No. 114 and
SFAS No. 118 were $338,310 and $535,450, respectively, for which the related
allowance for credit losses were $17,571 and $70,097, respectively. The average
investment in impaired loans during 1996 and 1995 were $423,042 and $466,288,
respectively. For the years ended December 31, 1996 and 1995, HMN recognized
interest income on impaired loans of $24,662 and $40,553, respectively. All of
the interest income that was recognized during 1996 and 1995 for impaired loans
was recognized using the cash basis method of income recognition.
The aggregate amount of loans to executive officers and directors of HMN
were $385,023, $169,489 and $90,217 at December 31, 1996, 1995 and 1994,
respectively. During 1996 repayments on loans to executive officers and
directors aggregated $29,509 and loans originated or added due to change in
directors aggregated $245,043.
At December 31, 1996, 1995 and 1994, the Bank was servicing real estate
loans for others with aggregate unpaid principal balances of approximately
$1,417,954, $1,130,649 and $1,484,848, respectively.
The Bank originates residential and commercial real estate and other loans
primarily in southern Minnesota. The Bank also purchases loans from a third
party broker located in the Southeastern United States. At December 31, 1996,
the Bank owned single family residential loans located in the following states:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
Percent
Amount of Total
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Alabama...................................................................... $ 4,266,231 1.3%
Georgia...................................................................... 48,252,600 14.9
Minnesota.................................................................... 233,192,887 71.7
North Carolina............................................................... 14,869,445 4.6
South Carolina............................................................... 7,762,524 2.4
Tennessee.................................................................... 3,349,121 1.0
Other states................................................................. 13,401,409 4.1
-------------- -----
Total...................................................................... $ 325,094,217 100.0%
-------------- -----
-------------- -----
- ----------------------------------------------------------------------------------------------------------
</TABLE>
33
<PAGE>
(7) ALLOWANCE FOR LOAN AND REAL ESTATE LOSSES
The allowance for losses is summarized as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
Loans Real Estate Total
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, December 31, 1993....................................... $ 1,489,082 125,818 1,614,900
Provision for losses........................................... 410,000 0 410,000
Charge-offs.................................................... (5,959) (3) (5,962)
Recoveries..................................................... 20 0 20
Other.......................................................... 0 (88,818) (88,818)
------------ ----------- ----------
Balance, December 31, 1994....................................... 1,893,143 36,997 1,930,140
Provision for losses........................................... 300,000 9,327 309,327
Charge-offs.................................................... (2,612) (11,324) (13,936)
Recoveries..................................................... 133 0 133
------------ ----------- ----------
Balance, December 31, 1995....................................... 2,190,664 35,000 2,225,664
Provision for losses........................................... 300,000 2,000 302,000
Charge-offs.................................................... (150,136) 0 (150,136)
Recoveries..................................................... 57 0 57
Other.......................................................... 0 (35,000) (35,000)
------------ ----------- ----------
Balance, December 31, 1996....................................... $ 2,340,585 2,000 2,342,585
------------ ----------- ----------
------------ ----------- ----------
- --------------------------------------------------------------------------------------------------------
</TABLE>
(8) REAL ESTATE
A summary of real estate at December 31 is as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
1996 1995
- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
Real estate in judgement subject to redemption.................................... $ 22,610 314,851
Real estate acquired through foreclosure.......................................... 0 0
--------- ---------
22,610 314,851
Allowance for losses.............................................................. 2,000 35,000
--------- ---------
$ 20,610 279,851
--------- ---------
--------- ---------
- --------------------------------------------------------------------------------------------------------
</TABLE>
(9) PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31 is as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
1996 1995
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Land......................................................................... $ 726,923 656,845
Office buildings and improvements............................................ 3,704,146 3,651,715
Furniture and equipment...................................................... 1,966,130 1,799,420
------------ ----------
6,397,199 6,107,980
Less accumulated depreciation................................................ 2,815,702 2,462,444
------------ ----------
$ 3,581,497 3,645,536
------------ ----------
------------ ----------
- --------------------------------------------------------------------------------------------------------
</TABLE>
During 1997 HMN will build new retail banking facilities in Spring Valley
and Winona at an estimated total cost of $2,500,000.
(10) ACCRUED INTEREST RECEIVABLE
Accrued interest receivable at December 31 is summarized as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
1996 1995
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Securities available for sale................................................ $ 1,256,214 1,370,568
Securities held to maturity.................................................. 41,730 144,546
Loans receivable............................................................. 2,117,208 1,866,393
------------ ----------
$ 3,415,152 3,381,507
------------ ----------
------------ ----------
- -------------------------------------------------------------------------------------------------------
</TABLE>
34
<PAGE>
(11) DEPOSITS
Deposits and their weighted average interest rates at December 31 are
summarized as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
1996 1995
-------------------------------------------- --------------------------------------------
Weighted Percent of Weighted Percent of
average rate Amount total average rate Amount total
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Non-interest checking............ 0.00% $ 2,389,034 0.7% 0.00% $ 2,505,217 0.7%
NOW accounts..................... 2.01 17,588,877 4.8 2.22 15,997,598 4.3
Passbooks........................ 2.50 30,070,326 8.3 2.50 29,383,919 7.8
Money market accounts............ 2.83 16,532,806 4.6 2.83 18,471,841 5.0
-------------- ----- -------------- -----
66,581,043 18.4 66,358,575 17.8
-------------- ----- -------------- -----
Certificates:
3-3.99%.......................... 425,284 0.1 0 0.0
4-4.99%.......................... 22,552,550 6.2 22,440,013 6.0
5-5.99%.......................... 168,040,084 46.4 152,971,210 40.9
6-6.99%.......................... 76,703,716 21.2 89,753,208 24.0
7-7.99%.......................... 28,077,048 7.7 40,721,309 10.9
Over 8.00%....................... 97,219 0.0 1,295,153 0.4
-------------- ----- -------------- -----
Total certificates............... 5.76 295,895,901 81.6 5.89 307,180,893 82.2
-------------- ----- -------------- -----
Total deposits................... 5.14 $ 362,476,944 100.0% 5.27 $ 373,539,468 100.0%
-------------- ----- -------------- -----
-------------- ----- -------------- -----
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
At December 31, 1996 and 1995, the Bank had $38,226,676 and $41,942,458,
respectively, of deposit accounts with balances at $100,000 or more.
Certificates had the following maturities at December 31:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------
1996 1995
------------------------------ ------------------------------
Amount Amount
(in Weighted (in Weighted
REMAINING TERM TO MATURITY thousands) average rate thousands) Average Rate
- --------------------------------------------- ------------- --------------- ------------- ---------------
<S> <C> <C> <C> <C>
1-6 months................................... $ 92,495 5.38% $ 119,305 5.60%
7-12 months.................................. 71,077 5.95 63,347 5.80
13-36 months................................. 111,369 5.91 109,867 6.25
37-60 months................................. 20,955 6.02 14,195 5.89
Over 60 months............................... 0 0.00 467 6.07
------------- -------------
$ 295,896 5.76 $ 307,181 5.89
------------- -------------
------------- -------------
- -------------------------------------------------------------------------------------------------------------
</TABLE>
At December 31, 1996 mortgage loans and mortgage-backed and related
securities with an amortized cost of approximately $49,731,000 were pledged as
collateral for certain deposits and $2,243,000 of letters of credit from the
Federal Home Loan Bank (FHLB) which were pledged as additional collateral on
Bank deposits.
Interest expense on deposits is summarized as follows for the years ended
December 31:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
1996 1995 1994
-----------------------------------------
<S> <C> <C> <C>
NOW......................................................... $ 323,311 311,359 315,538
Passbook.................................................... 760,083 759,167 862,681
Money Market................................................ 500,811 547,412 673,527
Certificates................................................ 17,365,732 16,960,806 13,988,993
------------- ------------ ------------
$ 18,949,937 18,578,744 15,840,739
------------- ------------ ------------
------------- ------------ ------------
- -------------------------------------------------------------------------------------------------------
</TABLE>
35
<PAGE>
(12) FEDERAL HOME LOAN BANK ADVANCES
Federal Home Loan Bank advances consisted of the following at December 31,
1996 and 1995:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
1996 1995
------------------------- ------------------------
YEAR OF MATURITY Amount Rate Amount Rate
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1996..................................................... $ 33,428,568 6.05%
1997..................................................... $ 46,428,568 5.52% 9,498,389 5.86
1998..................................................... 1,250,021 6.55 1,250,021 6.55
1999..................................................... 5,000,000 5.16 0 0.00
2000..................................................... 19,000,000 6.00 19,000,000 6.00
2001..................................................... 24,000,000 5.51 0 0.00
2003..................................................... 10,400,000 5.89 5,000,000 5.52
-------------- -------------
106,078,589 5.64 68,176,978 5.98
-------------- -------------
Open line of credit...................................... 0 0.00 700,000 5.92
-------------- -------------
$ 106,078,589 5.64 $ 68,876,978 5.98
-------------- -------------
-------------- -------------
- --------------------------------------------------------------------------------------------------------------
</TABLE>
At December 31, 1996, of the $24,000,000 maturing in the year 2001,
$10,000,000 could be called on a semi-annual basis starting in 1997 and
$9,000,000 could be called on a semi-annual basis starting in 1998.
At December 31, 1996 the advances, the open line of credit, and $2,243,000
of letters of credit from the FHLB were collateralized by the Bank's FHLB stock,
mortgage loans with unamortized principal balances of approximately $155,435,000
and securities having a carrying value of $17,300,000. The Bank has a $5,000,000
open line of credit from the FHLB which was not drawn at December 31, 1996. The
Bank also has the ability to draw additional borrowings of $6,470,000 based upon
the securities which are currently pledged.
(13) INCOME TAXES
Income tax expense for the years ended December 31 is as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
1996 1995 1994
------------------------------------
<S> <C> <C> <C>
Current:
Federal....................................................... $ 1,838,158 2,152,628 2,255,581
State......................................................... 561,442 660,222 721,974
------------ ---------- ----------
Total current............................................... 2,399,600 2,812,850 2,977,555
------------ ---------- ----------
Deferred:
Federal....................................................... 83,833 439,945 103,649
State......................................................... 26,567 128,105 34,563
------------ ---------- ----------
Total deferred.............................................. 110,400 568,050 138,212
------------ ---------- ----------
$ 2,510,000 3,380,900 3,115,767
------------ ---------- ----------
------------ ---------- ----------
- ------------------------------------------------------------------------------------------------------
</TABLE>
The reasons for the difference between "expected" income tax expense
utilizing the federal corporate tax rate of 34% and the actual income tax
expense are as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
1996 1995 1994
------------------------------------
<S> <C> <C> <C>
Federal expected income tax expense............................. $ 2,306,677 3,060,434 2,658,945
Items affecting federal income tax:
State income taxes, net of federal income tax benefit......... 388,086 520,296 499,314
Other, net.................................................... (184,763) (199,830) (42,492)
------------ ---------- ----------
$ 2,510,000 3,380,900 3,115,767
------------ ---------- ----------
------------ ---------- ----------
- ------------------------------------------------------------------------------------------------------
</TABLE>
36
<PAGE>
The tax effects of temporary differences that give rise to the deferred tax
assets and deferred tax liabilities are as follows at December 31:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
1996 1995
------------------------
<S> <C> <C>
Deferred tax assets:
Net unrealized loss on market value adjustment to securities available for
sale..................................................................... $ 406,600 180,382
Deferred loan fees......................................................... 377,100 565,597
Allowances for loan and real estate losses................................. 947,200 886,519
Deferred compensation and pension costs.................................... 172,500 118,741
------------ ----------
Total gross deferred tax assets.......................................... 1,903,400 1,751,239
Valuation allowance........................................................ 0 0
------------ ----------
Net deferred tax assets.................................................. 1,903,400 1,751,239
------------ ----------
Deferred tax liabilities:
Tax bad debt reserve over base year........................................ 1,462,000 1,448,548
FHLB stock................................................................. 359,700 359,747
Unamortized discount on loan sale.......................................... 136,200 200,823
Deferred loan costs........................................................ 250,600 138,653
Premises and equipment basis difference.................................... 106,600 139,472
Other...................................................................... 26,200 17,764
------------ ----------
Total gross deferred tax liabilities..................................... 2,341,300 2,305,007
------------ ----------
Net deferred tax liabilities............................................. $ (437,900) (553,768)
------------ ----------
------------ ----------
- ------------------------------------------------------------------------------------------------------
</TABLE>
As the result of recent tax legislation the deferred tax liability related
to the tax bad debt reserve over the base year will be required to be paid in
six equal annual installments of $243,667 starting in 1998.
Retained earnings at December 31, 1996 included approximately $6,559,846 for
which no provision for income taxes has been made. This amount represents
allocations of income to bad debt deductions for tax purposes. Reduction of
amounts so allocated for purposes other than absorbing losses will create income
for tax purposes, which will be subject to the then-current corporate income tax
rate.
(14) EMPLOYEE BENEFITS
Substantially all full-time employees of the Bank are included in a trusteed
noncontributory retirement plan sponsored by the Financial Institutions
Retirement Fund. The actuarial present value of accumulated plan benefits and
net assets available for benefits relating to the Bank's employees is not
available because such information is not accumulated for each participating
institution. No contributions were required in 1996, 1995, or 1994 because the
retirement plan is fully funded. The Bank's policy is to fund retirement plan
costs accrued and there are no unfunded past service costs. For the years ended
December 31, 1996, 1995, and 1994 the amounts charged to operating expenses were
$5,100, $4,222, and $6,084, respectively.
The Bank has a qualified, tax-exempt savings plan with a cash or deferred
feature qualifying under Section 401(k) of the Internal Revenue Code (the
401(k) Plan). All employees who have attained age 21 and completed one year
of employment, during which they worked at least 1,000 hours, are eligible to
participate. Participants are permitted to make salary reduction
contributions to the 401(k) Plan of up to 12% of the participant's annual
salary. Each participant's salary reduction is matched by the Bank in an
amount equal to 25% of the participant's salary reduction up to a maximum
contribution of 8%. Contributions above 8% are not matched by the Bank.
Generally all participant and Bank contributions and earnings are fully and
immediately vested. Effective January 1, 1997, for new employees the Bank's
contributions are vested on a five year cliff basis. The Bank's matching
contributions are expensed when made. The Bank's contributions to the 401(k)
Plan were $41,804, $41,324 and $36,587 in 1996, 1995 and 1994, respectively.
During 1994 HMN adopted an Employee Stock Ownership Plan (the ESOP) which
met the requirements of Section 4975(e)(7) of the Internal Revenue Code and
Section 407(d)(6) of the Employee Retirement Income Security Act of 1974, as
amended (ERISA), and, as such the ESOP was empowered to borrow in order to
finance purchases of the common stock of HMN. The ESOP borrowed $6,085,770 from
HMN to purchase 608,577 shares of common stock of HMN on the date of the
conversion. The ESOP debt requires quarterly payments of principal plus interest
at 7.52%. HMN has committed to make quarterly contributions to the ESOP
necessary to repay the loan including interest. HMN contributed $713,656,
$735,383 and $532,300 to the ESOP, respectively, during 1996, 1995 and 1994.
As the debt is repaid, ESOP shares which were initially pledged as
collateral for its debt, are released from collateral and allocated to active
employees, based on the proportion of debt service paid in the year. HMN
accounts for its ESOP in accordance with Statement of Position 93-6, EMPLOYERS'
ACCOUNTING FOR EMPLOYEE STOCK OWNERSHIP PLANS. Accordingly, the shares pledged
as collateral are reported as unearned ESOP shares in stockholders' equity. As
shares are determined to be ratably released from collateral, HMN reports
compensation expense equal to the cur-
37
<PAGE>
rent market price of the shares, and the shares become outstanding for
earnings per share computations. ESOP compensation benefit expense was
$634,702, $566,395 and $404,580, respectively, for 1996, 1995 and 1994.
All employees of HMN are eligible to participate in the ESOP after they
attain age 21 and complete one year of service during which they worked at least
1,000 hours. A summary of the ESOP share allocation is as follows for the years
ended:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
1996 1995
------------------------
<S> <C> <C>
Shares allocated beginning of year........................................... 74,962 33,989
Shares allocated during year................................................. 39,763 40,973
Shares distributed to participants........................................... (5,361) 0
Unreleased shares............................................................ 493,852 533,615
------------ ----------
Total ESOP shares............................................................ 603,216 608,577
------------ ----------
------------ ----------
Fair value of unreleased shares at December 31............................... $ 8,951,067 8,537,840
- -------------------------------------------------------------------------------------------------------
</TABLE>
In June of 1995, HMN as part of a Recognition and Retention Plan (RRP)
awarded 84,486 shares of restricted common stock to its officers and directors.
The shares vest over a five year period and were issued from treasury stock.
Compensation and benefit expense related to the RRP was $231,048 for 1996 and
$116,700 for 1995. No RRP was in effect for 1994, therefore no compensation and
benefit expense for the RRP was incurred in 1994.
In June 1995, HMN adopted its only stock option plan, the 1995 Stock Option
and Incentive Plan (the SOP). During 1995, options exercisable for 547,713
shares of HMN common stock were granted to certain officers and directors at an
exercise price of $13.81 per share. The options vest over a five year period and
may be exercised within 10 years of the grant date. In December 1996, options
exercisable for 1,000 shares of common stock were granted to officers at an
exercise price of $18.125.
HMN uses the intrinsic value method as described in APB Opinion No. 25 and
related interpretations to account for its stock incentive plans. Accordingly,
no compensation cost has been recognized for the fixed option plan. Proceeds
from stock options exercised are credited to common stock and additional paid-in
capital. There are no charges or credits to expense with respect to the granting
or exercise of options since the options were issued at fair value on the
respective grant dates. Had compensation cost for HMN's stock-based plan been
determined in accordance with the fair value method recommended by SFAS No. 123,
HMN's net income and earnings per share would have been reduced to the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
1996 1995
------------------------
<S> <C> <C>
Net income:
As reported................................................................ $ 4,274,349 5,620,377
Pro forma.................................................................. 3,085,217 4,728,898
Earnings per common share and common share equivalent:
As reported................................................................ $ 0.96 1.09
Pro forma.................................................................. 0.70 0.91
- -------------------------------------------------------------------------------------------------------
</TABLE>
The above disclosed pro forma effects of applying SFAS No. 123 to
compensation costs, may not be representative of the effects on reported pro
forma net income for future years.
The fair value for each option grant for the SOP is estimated on the date of
the grant using the Option Designer Model. The model incorporates the following
assumptions:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
1996 1995
--------------------
<S> <C> <C>
Risk-free interest rate.......................................................... 6.21% 6.28%
Expected life.................................................................... 10 years 10 years
Expected volatility.............................................................. 18.00% 20.00%
Expected dividends............................................................... None None
- -------------------------------------------------------------------------------------------------------
</TABLE>
The fair value of the options granted in 1996 was $8.32 per option. The fair
value of the options granted June 21, 1995 was $6.73 per option. A summary of
stock option activity under the SOP is detailed as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
Weighted
Options average
available Options exercise
for grant outstanding price
-------------------------------------
<S> <C> <C> <C>
December 31, 1994............................................... 0 0
Plan adopted.................................................... 608,577
Granted June 21, 1995........................................... (547,713) 547,713 $ 13.810
---------- ----------- ------------
December 31, 1995............................................... 60,864 547,713 13.810
Exercised....................................................... (4,699) 13.810
Forfeited....................................................... 12,172 (12,172) 13.810
Granted December 11, 1996....................................... (1,000) 1,000 18.125
---------- ----------- ------------
December 31, 1996............................................... 72,036 531,842 $ 13.818
---------- ----------- ------------
---------- ----------- ------------
- -------------------------------------------------------------------------------------------------------
</TABLE>
38
<PAGE>
The following table summarizes information about stock options outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------
Options Outstanding
- -------------------------------------------------
Weighted average Options Exercisable
Exercise Number remaining contractual --------------------
price outstanding life in years Number Price
- --------- ----------- ------------------------- --------- ---------
<S> <C> <C> <C> <C>
$ 13.810 530,842 8.4 104,843 $ 13.81
18.125 1,000 9.9
-----------
531,842
-----------
-----------
- -----------------------------------------------------------------------
</TABLE>
(15) STOCKHOLDERS' EQUITY
HMN was incorporated for the purpose of becoming the savings and loan
holding company of the Bank in connection with the Bank's conversion from a
federally chartered mutual savings bank to a federally chartered stock savings
bank, pursuant to a Plan of Conversion adopted on February 10, 1994. HMN
commenced on May 23, 1994, a Subscription and Community Offering of its shares
in connection with the conversion of the Bank (the Offering). The Offering was
closed on June 22, 1994, and the conversion was consummated on June 29, 1994,
with the issuance of 6,085,775 shares of HMN's common stock at a price of $10
per share. Total proceeds from the conversion of $59,178,342 net of costs
relating to the conversion of $1,679,408, have been recorded as common stock and
additional paid-in capital. HMN received all of the capital stock of the Bank in
exchange for 50% of the net proceeds of the conversion.
Starting in 1995 and continuing throughout 1996, with Board authorization
and approval from the Office of Thrift Supervision (OTS), HMN purchased a total
of 869,785 shares during 1996 and 868,336 shares during 1995 of its own common
stock from the open market for $14,364,754 and $12,509,667, respectively. The
shares were placed in treasury stock. In June of 1995, 84,486 shares were issued
out of treasury stock for restricted stock Retention and Recognition awards.
HMN's certificate of incorporation authorized the issuance of up to 500,000
shares of preferred stock, but to date no shares have been issued.
In order to grant a priority to eligible account holders in the event of
future liquidation, the Bank, at the time of conversion established a
liquidation account equal to its regulatory capital as of September 30, 1993. In
the event of future liquidation of the Bank, an eligible account holder who
continues to maintain their deposit account shall be entitled to receive a
distribution from the liquidation account. The total amount of the liquidation
account will be decreased as the balance of eligible account holders are reduced
subsequent to the conversion, based on an annual determination of such balance.
The Bank may not declare or pay a cash dividend to HMN in excess of 100% of
its net income to date during the current calendar year plus the amount that
would reduce by one-half the Bank's surplus capital ratio at the beginning of
the calendar year without prior notice to the OTS. Additional limitations on
dividends declared or paid on, or repurchases of, the Bank's capital stock are
tied to the Bank's level of compliance with its regulatory capital requirements.
At December 31, 1996 the Bank had received approval from the OTS to pay a
$10,000,000 dividend to HMN. At December 31, 1996 the Bank's board of directors
had not declared the payment of the dividend to HMN.
(16) FEDERAL HOME LOAN BANK INVESTMENT, REGULATORY LIQUIDITY AND REGULATORY
CAPITAL REQUIREMENTS
The Bank, as a member of the Federal Home Loan Bank System, is required to
hold a specified number of shares of capital stock, which is carried at cost, in
the Federal Home Loan Bank of Des Moines. In addition, the Bank is required to
maintain cash and other liquid assets in an amount equal to 5% of its deposit
accounts and other obligations due within one year. The Bank has met these
requirements as of December 31, 1996.
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on HMN's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of the Bank's assets, liabilities,
and certain off-balance sheet items as calculated under regulatory accounting
practices. The Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.
Quantitative measures established by regulations to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
following table) of Tangible, Core, and Risk-based capital (as defined in the
regulations) to total assets (as defined). Management believes, as of December
31, 1996, that the Bank meets all capital adequacy requirements to which it is
subject.
Management believes that based upon the Bank's capital calculations at
December 31, 1996 and other conditions consistent with the Prompt Corrective
Actions Provisions of the OTS regulations, the Bank would be categorized as well
capitalized.
39
<PAGE>
At December 31, 1996 the Bank's capital amounts and ratios are also
presented for actual capital, required capital, and excess capital including
amounts and ratios in order to qualify as being well capitalized under the
Prompt Corrective Actions regulations:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------------------
To Be Well Capitalized
Under Prompt
Corrective Actions
Actual Required Excess Capital Provisions
----------------------- ----------------------- ----------------------- -----------------------
Percent of Percent of Percent of Percent of
(IN THOUSANDS) Amount Assets(1) Amount Assets(1) Amount Assets(1) Amount Assets(1)
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Bank stockholder's
equity................. $ 60,841
Plus:
Net unrealized loss on
certain securities
available for sale... 1,441
Less:
Excess mortgage
servicing rights..... 289
---------
Tangible capital......... 61,993 11.50% $ 8,085 1.50% $ 53,908 10.00%
---------
Tangible capital to
adjusted total assets.. 11.50% $ 26,951 5.00%
Core capital (Tier I).... 61,993 11.50% 16,179 3.00% 45,814 8.50%
Tier I capital to
risk-weighted assets... 26.43% 14,071 6.00%
Plus:
Allowable allowance for
loan losses.......... 2,340
---------
Risk-based capital....... $ 64,333 27.43% 18,761 8.00% 45,572 19.43% 23,452 10.00%
---------
---------
</TABLE>
(1) Based upon the Bank's adjusted total assets for the purpose of the tangible
and core capital ratios and risk-weighted assets for the purpose of the
risk-based capital ratio.
(17) RECENT LEGISLATION AND REGULATORY DEVELOPMENTS
The Deposit Insurance Fund Act of 1996 (DIFA) was enacted on September 30,
1996. DIFA addressed the inadequate funding of the Savings Association Insurance
Fund (SAIF). In order to recapitalize the SAIF, DIFA imposed a one-time
assessment on all thrift institutions. The Bank's assessment was a pretax charge
of $2,351,563 and was recognized in the third quarter of 1996.
DIFA also addressed the funding for the Financing Corp. (FICO) bonds.
Thrifts will pay 6.4 basis points per $100 of deposits from January 1, 1997 to
December 31, 1999. From January 1, 2000 until the FICO bonds are retired in
2019, the estimated assessment to retire the FICO bonds is expected to be 2.5
basis points per $100 of deposits.
DIFA proposed that the Bank Insurance Fund (BIF) and SAIF be merged on
January 1, 1999, provided no insurance depository institution is a savings
association on that date. DIFA also directed the Secretary of the Treasury to
present recommendations to Congress for establishment of a common depository
institution charter by March 31, 1997.
(18) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit. These
instruments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amounts recognized in the balance sheet. The contract
amounts of these instruments reflect the extent of involvement by the Bank.
The Bank's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contract amount of these commitments. The Bank uses the same
credit policies in making commitments as it does for on-balance sheet
instruments.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
Contract amount
--------------------
(IN THOUSANDS) 1996 1995
--------------------
<S> <C> <C>
Financial instruments whose contract amount represents credit risk:
Commitments to extend credit..................................................... $ 24,524 7,394
Commitment of counter party to repurchase FNMA securities........................ 0 10,446
Financial instruments whose contract amount represents interest rate risk:
Commitment to purchase limited partnership interest in mortgage loan servicing
rights......................................................................... 2,120 0
Commitments to purchase FNMA mortgage-backed securities.......................... 0 3,995
- ---------------------------------------------------------------------------------------------------------
</TABLE>
40
<PAGE>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since a portion of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank upon extension of credit, is based on the loan type
and on management's credit evaluation of the borrower. Collateral consists
primarily of residential real estate and personal property.
Commitments to purchase FNMA securities as they are originated by certain
Minnesota county HRAs are entered into in the normal course of business for the
Bank. The obligations to purchase are recognized when the HRAs originate the
FNMA securities. The securities provide a net yield of 6.91% at the time of
funding. In a rising interest rate environment the interest rate risk is the
possibility that the cost of funds used to purchase the FNMA securities would
become greater than the net yield on the securities. The securities were
repurchased by the HRAs at a specified price on September 1, 1996.
(19) FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS,
requires disclosure of estimated fair values of the Bank's financial
instruments, including assets, liabilities and off-balance sheet items for
which it is practicable to estimate fair value. The fair value estimates are
made as of December 31, 1996, and 1995 based upon relevant market
information, if available, and upon the characteristics of the financial
instruments themselves. Because no market exists for a significant portion of
the Bank's financial instruments, fair value estimates are based upon
judgments regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments, and other
factors. The estimates are subjective in nature and involve uncertainties and
matters of significant judgment and therefore cannot be determined with
precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based only on existing financial instruments
without attempting to estimate the value of anticipated future business or the
value of assets and liabilities that are not considered financial instruments.
In addition, the tax ramifications related to the realization of the unrealized
gains and losses can have a significant effect on the fair value estimates and
have not been considered in any of the estimates.
The estimated fair value of the Bank's financial instruments are shown
below. Following the table, there is an explanation of the methods and
assumptions used to estimate the fair value of each class of financial
instruments.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
December 31,
---------------------------------------------------------------------
1996 1995
---------------------------------- ---------------------------------
Carrying Estimated Contract Carrying Estimated Contract
(IN THOUSANDS) amount fair value amount amount fair value amount
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents.................. $ 10,584 10,584 4,335 4,335
Securities available for sale.............. 175,830 175,830 190,320 190,320
Securities held to maturity................ 2,806 2,906 16,972 17,156
Loans held for sale........................ 739 739 0 0
Loans receivable, net...................... 349,022 358,039 314,851 329,970
Federal Home Loan Bank stock............... 5,434 5,434 3,802 3,802
Accrued interest receivable................ 3,415 3,415 3,382 3,382
Financial liabilities:
Deposits................................... 362,477 358,215 373,539 373,152
Federal Home Loan Bank advances............ 106,079 105,484 68,877 69,197
Accrued interest payable................... 1,543 1,543 1,562 1,562
Off-balance sheet financial instruments:
Commitments to extend credit............... 0 16 24,524 0 4 7,394
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
CASH AND CASH EQUIVALENTS
The carrying amount of cash and cash equivalents approximates their fair
value.
SECURITIES AVAILABLE FOR SALE AND SECURITIES HELD TO MATURITY
The fair values of securities are based upon quoted market prices.
LOANS HELD FOR SALE
The fair value of loans held for sale were based upon quoted market prices
for loans with similar interest rates and terms to maturity.
LOANS RECEIVABLE
The fair values of loans receivable were estimated for groups of loans with
similar characteristics. The fair value of the loan
41
<PAGE>
portfolio, with the exception of the adjustable rate portfolio, was
calculated by discounting the scheduled cash flows through the estimated
maturity using anticipated prepayment speeds and using discount rates that
reflect the credit and interest rate risk inherent in each loan portfolio.
The fair value of the adjustable loan portfolio was estimated by grouping the
loans with similar characteristics and comparing the characteristics of each
group to the prices quoted for similar types of loans in the secondary market.
FEDERAL HOME LOAN BANK STOCK
The carrying amount of FHLB stock approximates its fair value.
ACCRUED INTEREST RECEIVABLE
The carrying amount of accrued interest receivable approximates its fair
value since it is short-term in nature and does not present unanticipated credit
concerns.
DEPOSITS
Under SFAS No. 107, the fair value of deposits with no stated maturity such
as checking, savings and money market accounts, is equal to the amount payable
on demand. The fair value of certificates of deposit is based on the discounted
value of contractual cash flows using as discount rates the rates that were
offered by the Bank as of December 31, 1996 and 1995 for deposits with
maturities similar to the remaining maturities of the existing certificates of
deposit.
The fair value estimate for deposits does not include the benefit that
results from the low cost funding provided by the Bank's existing deposits and
long-term customer relationships compared to the cost of obtaining different
sources of funding. This benefit is commonly referred to as the core deposit
intangible.
ACCRUED INTEREST PAYABLE
The carrying amount of accrued interest payable approximates its fair value
since it is short-term in nature.
FEDERAL HOME LOAN BANK ADVANCES
The fair values of advances payable with fixed maturities are estimated
based on discounted cash flow analysis using as discount rates the interest
rates charged by the FHLB at December 31, 1996 and 1995 for borrowings of
similar remaining maturities.
COMMITMENTS TO EXTEND CREDIT
The fair value of commitments to extend credit is estimated using the fees
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present creditworthiness of the
counter parties.
(20) HMN FINANCIAL, INC. FINANCIAL INFORMATION (PARENT COMPANY ONLY)
The parent company's principal assets are its investment in the Bank and
securities. The following are the condensed financial statements for the parent
company only as of December 31, 1996 and 1995 and for the years ended December
31, 1996, 1995, and for the period from June 29, 1994 to December 31, 1994.
CONDENSED BALANCE SHEET
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------
1996 1995
-----------------------------
<S> <C> <C>
ASSETS:
Cash and cash equivalents........................................................ $ 3,655,598 1,578,130
Securities available for sale.................................................... 10,187,092 16,281,995
Loans receivable from subsidiaries............................................... 7,334,000 0
Investment in subsidiaries....................................................... 61,458,395 73,678,260
Accrued interest receivable...................................................... 215,959 152,888
Prepaid expenses and other assets................................................ 17,950 161,271
-------------- -------------
Total assets................................................................... $ 82,868,994 91,852,544
-------------- -------------
-------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Accrued expenses and other liabilities........................................... $ 769,550 165,861
-------------- -------------
Total liabilities.............................................................. 769,550 165,861
-------------- -------------
Serial preferred stock........................................................... 0 0
Common stock..................................................................... 60,858 60,858
Additional paid-in capital....................................................... 59,428,768 59,285,581
Retained earnings................................................................ 54,645,387 50,371,038
Net unrealized loss on securities available for sale............................. (598,045) (265,358)
Unearned employee stock option plan shares....................................... (4,938,520) (5,336,150)
Unearned compensation restricted stock awards.................................... (793,289) (1,050,305)
Treasury stock, at cost, 1,651,615 and 783,850 shares............................ (25,705,715) (11,378,981)
-------------- -------------
Total stockholders' equity..................................................... 82,099,444 91,686,683
-------------- -------------
Total liabilities and stockholders' equity..................................... $ 82,868,994 91,852,544
-------------- -------------
-------------- -------------
</TABLE>
42
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
1996 1995 1994
-----------------------------------
<S> <C> <C> <C>
Interest income............................................................ $ 1,105,218 1,474,107 810,273
Interest expense........................................................... (4,943) (1,083) 0
Securities gains, net...................................................... 229,002 53,058 2,988
Equity in earnings of subsidiary........................................... 3,565,441 4,755,138 4,284,783
Compensation and benefits.................................................. (17,233) (21,775) (4,433)
Occupancy.................................................................. (6,868) (6,353) (3,072)
Advertising................................................................ (670) (276) 0
Data processing............................................................ (1,271) (1,200) (600)
Other...................................................................... (475,127) (380,039) (200,836)
----------- ---------- -----------
Income before income tax expense......................................... 4,393,549 5,871,577 4,889,103
Income tax expense......................................................... 119,200 251,200 184,444
----------- ---------- -----------
Net income............................................................... $ 4,274,349 5,620,377 4,704,659
----------- ---------- -----------
----------- ---------- -----------
CONDENSED STATEMENT OF CASH FLOWS
Cash flows from operating activities:
Net income............................................................... $ 4,274,349 5,620,377 4,704,659
Adjustments to reconcile net income to cash provided by operating
activities:
Equity in earnings of subsidiary....................................... (3,565,441) (4,755,138) (4,284,783)
Amortization of premiums (discounts), net.............................. 9,727 (21,328) (6,590)
Securities gains, net.................................................. (229,002) (53,058) (2,988)
Provision for deferred income taxes.................................... (1,400) (2,500) 0
Earned employee stock ownership shares priced above original cost...... 141,135 93,267 38,511
Decrease in restricted stock awards.................................... 231,048 116,700 0
Decrease in unearned ESOP shares....................................... 397,630 409,730 0
(Increase) decrease in accrued interest receivable..................... (63,071) 76,510 (229,398)
Increase (decrease) in accrued expenses and other liabilities.......... 172,831 (81,860) 163,845
Decrease (increase) in other assets.................................... 143,321 (75,550) (85,721)
Other, net............................................................. 9,737 0 0
----------- ---------- -----------
Net cash provided by operating activities............................ 1,520,864 1,327,150 297,535
----------- ---------- -----------
Cash flows from investing activities:
Proceeds from sales of securities available for sale..................... 5,412,430 8,523,675 377,987
Principal collected on securities available for sale..................... 5,027,241 1,624,106 1,092,087
Proceeds collected on maturity of securities available for sale.......... 1,500,000 4,000,000 0
Purchases of securities available for sale............................... (5,449,176) (7,754,954) (23,847,489)
Purchase of Security Finance Corporation stock........................... 0 (388,762) 0
Investment in HMN Mortgage Services, Inc................................. (250,000) 0 0
Net increase in loans receivable from subsidiaries....................... (7,334,000) 0 0
----------- ---------- -----------
Net cash (used) provided by investing activities..................... (1,093,505) 6,004,065 (22,377,415)
----------- ---------- -----------
Cash flows from financing activities:
Increase in unearned ESOP shares......................................... 0 0 (5,745,880)
Proceeds from sale of common stock....................................... 0 0 59,178,342
Purchase of treasury stock............................................... (14,002,254) (12,509,667) 0
Stock options exercised.................................................. 52,363 0 0
Purchase of Bank stock................................................... 0 0 (29,596,000)
Proceeds from dividends on Bank stock.................................... 15,600,000 4,000,000 1,000,000
----------- ---------- -----------
Net cash provided (used) by financing activities..................... 1,650,109 (8,509,667) 24,836,462
----------- ---------- -----------
Increase (decrease) in cash and cash equivalents..................... 2,077,468 (1,178,452) 2,756,582
Cash and cash equivalents, beginning of period............................. 1,578,130 2,756,582 0
----------- ---------- -----------
Cash and cash equivalents, end of period................................... $ 3,655,598 1,578,130 2,756,582
----------- ---------- -----------
----------- ---------- -----------
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
43
<PAGE>
Independent Auditors' Report
- --------------------------------------------------------------------------------
KPMG Peat Marwick LLP
4200 Norwest Center
90 South Seventh Street
Minneapolis, MN 55402
The Board of Directors
HMN Financial, Inc.
Spring Valley, Minnesota
We have audited the accompanying consolidated balance sheets of HMN
Financial, Inc. and subsidiaries (the Company) as of December 31, 1996 and 1995,
and the related consolidated statements of income, stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 1996.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of HMN
Financial, Inc. and subsidiaries at December 31, 1996 and 1995, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1996, in conformity with generally accepted accounting
principles.
/s/ KPMG Peat Marwick LLP
January 31, 1997
44
<PAGE>
Other Financial Data
- --------------------------------------------------------------------------------
The following table sets forth the maximum month-end balance and average
balance of FHLB advances.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
--------------------------------
(DOLLARS IN THOUSANDS) 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Maximum Balance:
Federal Home Loan Bank advances................................................. $ 106,436 74,534 52,343
Federal Home Loan Bank short-term borrowings and open line of credit............ 64,429 42,429 7,329
Average Balance:
Federal Home Loan Bank advances................................................. 89,656 65,069 40,121
Federal Home Loan Bank short-term borrowings.................................... 47,949 20,812 2,719
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
The following table sets forth certain information as to the Bank's FHLB
advances.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
December 31,
--------------------------------------------------------------------------
1996 1995 1994
------------------------ ----------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
(DOLLARS IN THOUSANDS) Amount Rate Amount Rate Amount Rate
---------- ------------ --------- ------------ --------- ------------
<S> <C> <C> <C> <C> <C> <C>
Federal Home Loan Bank short-term borrowings and
open line of credit............................. $ 46,429 5.52% 33,429 6.05% 6,429 5.75%
Federal Home Loan Bank long-term advances......... 59,650 5.74 35,448 5.91 45,557 5.98
---------- --- --------- --- --------- ---
Total........................................... $ 106,079 5.64 68,877 5.98 51,986 5.95
---------- --- --------- --- --------- ---
---------- --- --------- --- --------- ---
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
At December 31, 1996 there are $10,000,000 of long-term advances which could
be called on a semi-annual basis starting in 1997.
45
<PAGE>
Selected Quarterly Financial Data
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
December 31, September 30, June 30,
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 1996 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Selected Operations Data (3 MONTHS ENDED)
Interest income...................................... $ 10,111 10,014 9,944
Interest expense..................................... 6,174 6,191 5,949
------------- ------------- -------------
Net interest income................................ 3,937 3,823 3,995
Provision for loan losses............................ 75 75 75
------------- ------------- -------------
Net interest income after provision for loan
losses........................................... 3,862 3,748 3,920
------------- ------------- -------------
Noninterest income:
Fees and service charges........................... 105 95 82
Securities gains (losses), net..................... 68 192 268
Gain on sale of loans.............................. 22 10 1
Other noninterest income........................... 129 115 134
------------- ------------- -------------
Total noninterest income......................... 324 412 485
------------- ------------- -------------
Noninterest expense:
Compensation and benefits.......................... 1,211 1,176 1,099
Occupancy.......................................... 230 203 195
Federal deposit insurance premiums................. 163 212 215
SAIF assessment.................................... 0 2,352 0
Advertising........................................ 79 77 79
Data processing.................................... 121 119 121
Provision for real estate losses................... 2 0 0
Other noninterest expense.......................... 341 256 275
------------- ------------- -------------
Total noninterest expense........................ 2,147 4,395 1,984
------------- ------------- -------------
Income before income tax expense................... 2,039 (235) 2,421
Income tax expense................................... 740 (90) 888
------------- ------------- -------------
Net income......................................... $ 1,299 (145) 1,533
------------- ------------- -------------
------------- ------------- -------------
Per common share:
Net income......................................... $ 0.31 (0.03) 0.34
------------- ------------- -------------
------------- ------------- -------------
Financial Ratios:
Return on average assets(1).......................... 0.93% (0.10) 1.13
Return on average equity(1).......................... 6.06 (0.67) 6.77
Average equity to average assets..................... 15.32 15.48 16.64
Net interest margin(1)(2)............................ 2.86 2.77 2.98
(DOLLARS IN THOUSANDS)
- ----------------------------------------------------------------------------------------------------
Selected Financial Condition Data:
Total assets......................................... $ 554,732 565,385 554,979
Securities held for sale............................. 0 0 0
Securities available for sale:
Mortgage-backed and related securities............. 133,355 135,191 148,706
Other marketable securities........................ 42,475 52,516 40,442
Securities held to maturity:
Mortgage-backed and related securities............. 1,806 2,338 13,835
Other marketable securities........................ 1,000 1,000 999
Loans held for sale.................................. 739 0 0
Loans receivable, net................................ 349,022 343,736 331,650
Deposits............................................. 362,477 363,963 363,195
Federal Home Loan Bank advances...................... 106,079 101,833 101,053
Stockholder's equity................................. 82,099 83,669 87,263
- ----------------------------------------------------------------------------------------------------
(1) Annualized.
(2) Net interest income divided by average interest-earning assets.
46
<PAGE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
March 31, December 31, September 30, June 30, March 31,
1996 1995 1995 1995 1995
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Selected Operations Data (3 MONTHS ENDED)
Interest income...................................... 9,795 9,779 9,805 9,636 9,108
Interest expense..................................... 5,880 5,904 5,873 5,657 5,121
------------- ------------- ------------- ------------- -------------
Net interest income................................ 3,915 3,875 3,932 3,979 3,987
Provision for loan losses............................ 75 75 75 75 75
------------- ------------- ------------- ------------- -------------
Net interest income after provision for loan
losses........................................... 3,840 3,800 3,857 3,904 3,912
------------- ------------- ------------- ------------- -------------
Noninterest income:
Fees and service charges........................... 77 82 89 79 74
Securities gains (losses), net..................... 501 280 148 (5) (7)
Gain on sale of loans.............................. 6 3 22 77 0
Other noninterest income........................... 117 56 33 30 37
------------- ------------- ------------- ------------- -------------
Total noninterest income......................... 701 421 292 181 104
------------- ------------- ------------- ------------- -------------
Noninterest expense:
Compensation and benefits.......................... 1,106 1,114 1,108 978 960
Occupancy.......................................... 197 140 192 186 180
Federal deposit insurance premiums................. 210 208 206 198 198
SAIF assessment.................................... 0 0 0 0 0
Advertising........................................ 73 100 74 67 71
Data processing.................................... 128 117 116 121 123
Provision for real estate losses................... 0 9 0 0 0
Other noninterest expense.......................... 269 227 211 287 279
------------- ------------- ------------- ------------- -------------
Total noninterest expense........................ 1,983 1,915 1,907 1,837 1,811
------------- ------------- ------------- ------------- -------------
Income before income tax expense................... 2,558 2,306 2,242 2,248 2,205
Income tax expense................................... 972 869 827 844 841
------------- ------------- ------------- ------------- -------------
Net income......................................... 1,586 1,437 1,415 1,404 1,364
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
Per common share:
Net income......................................... 0.33 0.30 0.28 0.27 0.25
------------- ------------- ------------- ------------- -------------
------------- ------------- ------------- ------------- -------------
Financial Ratios:
Return on average assets(1).......................... 1.18 1.07 1.05 1.07 1.08
Return on average equity(1).......................... 6.91 6.18 5.87 5.82 5.58
Average equity to average assets..................... 17.09 17.38 17.93 18.37 19.34
Net interest margin(1)(2)............................ 2.97 2.94 2.98 3.05 3.21
(DOLLARS IN THOUSANDS)
- ------------------------------------------------------------------------------------------------------------------------------------
Selected Financial Condition Data:
Total assets......................................... 542,012 537,949 529,599 536,742 507,741
Securities held for sale............................. 0 0 0 0 0
Securities available for sale:
Mortgage-backed and related securities............. 163,273 158,416 139,885 154,154 151,407
Other marketable securities........................ 32,245 31,904 51,294 54,091 43,812
Securities held to maturity:
Mortgage-backed and related securities............. 14,115 13,744 10,944 8,623 6,314
Other marketable securities........................ 3,227 3,228 4,652 7,653 7,659
Loans held for sale.................................. 0 0 0 0 0
Loans receivable, net................................ 307,658 314,851 301,866 287,644 278,261
Deposits............................................. 368,393 373,539 363,596 360,844 357,293
Federal Home Loan Bank advances...................... 72,493 68,877 68,900 69,617 56,305
Stockholder's equity................................. 90,879 91,687 92,104 96,127 90,261
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Annualized.
(2) Net interest income divided by average interest-earning assets.
47
<PAGE>
Shareholder Information
- -------------------------------------------------------------------------------
EXECUTIVE OFFICE ANNUAL MEETING
HMN Financial, Inc. The annual meeting of shareholders
101 North Broadway will be held on Tuesday, April 22,
Spring Valley, MN 55975 1997 at 10:00 a.m. (Central Time)
(507) 346-7345 at the
Best Western Apache Hotel
1517 16th St. S.W.
TRANSFER AGENT & REGISTRAR Rochester, MN 55902
Inquiries regarding change of
address, transfer requirements, DIVIDENDS
and lost certificates should be
directed to the transfer agent. No dividends were declared in 1996. For
First National Bank of Boston more information refer to Dividends on
c/o Boston EquiServe page 24
PO Box 8040
Boston, MA 02266-8040 FORM 10-K
(617) 575-3170
HMN Financial's Form 10-K is filed
INVESTOR INFORMATION with the Securities and Exchange
HMN Financial, Inc. Commission and is available without
Attn: Investor Relations charge upon request from
101 North Broadway HMN Financial, Inc.
Spring Valley, MN 55975 Attn: Investor Relations
(507) 346-7345 101 North Broadway
Spring Valley, MN 55975
HMN FINANCIAL, INC. SHARES
The Common Stock of HMN Financial, INDEPENDENT AUDITORS
Inc. is listed on the Nasdaq Stock
Market KPMG Peat Marwick LLP
Symbol: HMNF 4200 Norwest Center
Common shares outstanding 6,085,775, 90 South Seventh St.
of which 1,651,615 are in treasury Minneapolis, MN 55402-3900
stock.
Stockholders of record: 926* LEGAL COUNSEL
Estimated beneficial Faegre & Benson LLP
stockholders: 1,500* 2200 Norwest Center
*As of December 31, 1996 90 South Seventh St.
Minneapolis, MN 55402-3901
48
<PAGE>
<TABLE>
<S> <C> <C>
Directors and Officers
- ---------------------------------------------------------------------------------------
DIRECTORS EXECUTIVE OFFICERS
ROGER P. WEISE IRMA R. RATHBUN ROGER P. WEISE
Chairman of the Board Director President and Chief
President and Chief Retired Vice President Executive Officer
Executive Officer of Home Federal Savings Bank
JAMES B. GARDNER
KEITH A. HAGEN M.F. SCHUMANN Executive Vice President
Director Director and Chief Financial Officer
Retired President of Retired Public Accountant
Home Federal Savings Bank DWAIN C. JORGENSEN
TIMOTHY R. GEISLER Vice President and
JAMES B. GARDNER Director Controller
Director Manager Corporate Tax Unit
Executive Vice President Mayo Clinic, Rochester, MN SUSAN K. KOLLING
and Chief Financial Officer Senior Vice President
ROXANNE M. HELLICKSON
Vice President and
Corporate Secretary
TIMOTHY P. JOHNSON
Treasurer
Corporate Office
- ---------------------------------------------------------------------------------------
HMN Financial, Inc.
101 North Broadway
Spring Valley, MN 55975
(507) 346-7345
Branch Offices of Bank
- ---------------------------------------------------------------------------------------
ALBERT LEA ROCHESTER WINONA
143 West Clark St. Crossroads Shopping Center 4th and Center
Albert Lea, MN 56007 Rochester, MN 55901 Winona, MN 55987
(507) 377-3330 (507) 289-4025 (507) 454-4912
AUSTIN 1110 6th Street NW EDEN PRAIRIE
201 Oakland Avenue West Rochester, MN 55901 Mortgage Origination Office
Austin, MN 55912 (507) 285-1707 9973 Valley View Road
(507) 433-2355 Eden Prairie, MN 55344
SPRING VALLEY
LACRESCENT 101 North Broadway
208 South Walnut Spring Valley, MN 55975
LaCrescent, MN 55947 (507) 346-7345
(507) 895-4090
</TABLE>
<PAGE>
Exhibit 21
Subsidiaries of Registrant
<PAGE>
SUBSIDIARIES OF REGISTRANT
EXHIBIT 21
<TABLE>
<CAPTION>
Date and % of Voting
Shares, Partnership
Interests, Voting Trust
Year & Certificates, Capital
Name & Address State Inc. Contributions Description of Activity
-------------- ---------- ------------- -----------------------
<S> <C> <C> <C>
Home Federal Savings Bank 1934 6/29/94 Federal Chartered Stock
101 North Broadway MN HMN owns 100% of voting Savings Bank
Spring Valley, MN 55975 shares
Osterud Insurance Agency, Inc. 1983 Bank owns 100% Offers credit life and annuity
101 North Broadway MN products to the Bank's
Spring Valley, MN 55975 customers and others
Security Finance Corporation 1929 12/29/95 Dormant development
101 North Broadway MN HMN owns 100% of voting corporation holding
Spring Valley, MN 55975 shares investments in securities and
loans
HMN Mortgage Services, Inc. 1996 7/08/96 Mortgage Banking
9973 Valley View Road MN HMN owns 100% of
Eden Prairie, MN 55344 voting shares
</TABLE>
Home Federal Savings Bank sold six shares of Security Finance Corporation stock
to HMN Financial, Inc. on December 29, 1995. The six shares sold to HMN
Financial, Inc. represents 100% of the total voting shares of Security Finance
Corporation at the time of sale.
<PAGE>
Exhibit 23
Consent of KPMG Peat Marwick LLP
dated March 25, 1997
<PAGE>
KPMG Peat Marwick LLP
4200 Norwest Center
90 South Seventh Street
Minneapolis, MN 55402
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors
HMN Financial, Inc.:
We consent to incorporation by reference of our report dated January 31, 1997,
relating to the consolidated balance sheets of HMN Financial, Inc. as of
December 31, 1996 and 1995, and the related consolidated statements of income,
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1996, which report appears in the December 31, 1996
Form 10-K of HMN Financial, Inc. in the following Registration Statements of HMN
Financial, Inc.: Nos. 33-88228, 33-94388, and 33-94386 on
Form S-8.
/s/ KPMG Peat Marwick LLP
KPMG PEAT MARWICK LLP
Minneapolis, Minnesota
March 25, 1997
54
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 9
<LEGEND>
This schedule contains summary Financial information extracted from The
Consolidated balance sheets at December 31, 1996 and consolidated statements
of income for the twelve months ended December 31, 1996.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 856
<INT-BEARING-DEPOSITS> 9,727
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 175,830
<INVESTMENTS-CARRYING> 2,806
<INVESTMENTS-MARKET> 2,906
<LOANS> 349,762
<ALLOWANCE> 2,341
<TOTAL-ASSETS> 554,732
<DEPOSITS> 362,477
<SHORT-TERM> 46,429
<LIABILITIES-OTHER> 4,077
<LONG-TERM> 59,650
0
0
<COMMON> 61
<OTHER-SE> 82,038
<TOTAL-LIABILITIES-AND-EQUITY> 554,732
<INTEREST-LOAN> 25,721
<INTEREST-INVEST> 13,815
<INTEREST-OTHER> 328
<INTEREST-TOTAL> 39,864
<INTEREST-DEPOSIT> 18,950
<INTEREST-EXPENSE> 24,194
<INTEREST-INCOME-NET> 15,670
<LOAN-LOSSES> 300
<SECURITIES-GAINS> 1,030
<EXPENSE-OTHER> 10,509
<INCOME-PRETAX> 6,784
<INCOME-PRE-EXTRAORDINARY> 6,784
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 4,274
<EPS-PRIMARY> 0.96
<EPS-DILUTED> 0.96
<YIELD-ACTUAL> 7.36
<LOANS-NON> 338
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 132
<ALLOWANCE-OPEN> 2,190
<CHARGE-OFFS> (150)
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 2,341
<ALLOWANCE-DOMESTIC> 1,224
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 1,117
</TABLE>
