SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OF 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OF 15 (d) FOR THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File Number 0-24100
HMN FINANCIAL, INC.
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(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 Number)
101 North Broadway, Spring Valley, Minnesota 55975-0231
----------------------------------------------- --------------
(Address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code: (507) 346-1100
----------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes (X) No ( )
Indicate the number of shares outstanding of each of the issuer's common stock
as of the latest practicable date.
Class Outstanding at August 3, 1998
--------------------------------- ----------------------------------
Common stock, $0.01 par value 5,413,059
1
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HMN FINANCIAL, INC.
CONTENTS
PART I - FINANCIAL INFORMATION
Page
Item 1:Financial Statements (unaudited)
Consolidated Balance Sheets at
June 30, 1998 and December 31, 1997 3
Consolidated Statements of Income for the
Three Months Ended and Six Months Ended
June 30, 1998 and 1997 4
Consolidated Statement of Comprehensive Income for the
Three Months and Six Months Ended June 30, 1998 and 1997 5
Consolidated Statement of Stockholders' Equity
for the Six Month Period Ended June 30, 1998 5
Consolidated Statements of Cash Flows for
the Six Months Ended June 30, 1998 and 1997 6-7
Notes to Consolidated Financial Statements 8
Item 2:Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 3:Quantitative and Qualitative Disclosures about Market Risk
Discussion included in Item 2 under Market Risk 19
PART II - OTHER INFORMATION
Item 1:Legal Proceedings 27
Item 2:Changes in Securities 27
Item 3:Defaults Upon Senior Securities 27
Item 4:Submission of Matters to a Vote of Security Holders 27
Item 5:Other Information 28
Item 6:Exhibits and Reports on Form 8-K and Form 11-K 28
Signatures 29
2
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PART I - FINANCIAL STATEMENTS
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(unaudited)
<TABLE>
<CAPTION>
June 30, December 31,
ASSETS 1998 1997
-------------- ---------------
<S> <C> <C>
Cash and cash equivalents $ 9,243,228 9,364,635
Securities available for sale:
Mortgage-backed and related
securities (amortized cost
$141,275,891 and $135,598,404) 141,834,917 135,935,482
Other marketable securities
(amortized cost $68,660,843
and $68,356,926) 69,533,759 69,923,477
-------------- -------------
211,368,676 205,858,959
-------------- -------------
Loans held for sale 8,090,619 2,287,265
Loans receivable, net 459,864,902 442,068,600
Federal Home Loan Bank stock, at cost 9,170,100 7,432,200
Real estate, net 9,105 133,939
Premises and equipment, net 6,853,179 5,880,710
Accrued interest receivable 4,554,699 4,038,131
Investment in limited partnerships 5,232,912 5,989,399
Goodwill 4,431,351 4,500,873
Core deposit intangible 1,402,759 1,546,273
Mortgage servicing rights 1,138,532 781,005
Prepaid expenses and other assets 767,990 1,349,521
Due from brokers 3,051,977 0
------------- -------------
Total assets $ 725,180,029 691,231,510
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 467,133,087 467,347,688
Federal Home Loan Bank advances 177,935,737 127,650,021
Accrued interest payable 1,385,320 1,365,064
Advance payments by borrowers for
taxes and insurance 752,713 786,619
Accrued expenses and other liabilities 5,118,915 6,056,356
Due to stockholders of Marshalltown
Financial Corporation 59,464 3,555,352
Due to brokers 1,997,812 0
------------- -------------
Total liabilities 654,383,048 606,761,100
------------- -------------
Commitments and contingencies
Stockholders' equity:
Serial preferred stock:
authorized 500,000 shares;
issued and outstanding none 0 0
Common stock ($.01 par value):
authorized 11,000,000
shares; issued 9,128,568 shares 91,286 91,286
Additional paid-in capital 59,882,524 59,698,662
Retained earnings, subject to
certain restrictions 62,365,656 60,224,253
Accumulated other comprehensive
income 874,336 1,129,818
Unearned employee stock ownership
plan shares (5,802,564) (4,554,280)
Unearned compensation restricted
stock awards (450,698) (600,668)
Treasury stock, at cost 3,698,309
and 2,912,111 shares (46,163,559) (31,518,661)
------------- -------------
Total stockholders' equity 70,796,981 84,470,410
------------- -------------
Total liabilities and
stockholders' equity $ 725,180,029 691,231,510
============= =============
</TABLE>
See accompanying notes to consolidated financial statements.
3
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<PAGE>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
------------------------ -------------------------
<S> <C> <C> <C> <C>
Interest Income:
Loans receivable $ 8,797,708 6,882,628 17,440,080 13,790,870
Securities available for
sale:
Mortgage-backed and
related 2,158,639 2,176,822 4,377,337 4,366,032
Other marketable 1,229,503 917,067 2,185,975 1,502,309
Securities held to maturity:
Mortgage-backed and related 0 0 0 33,400
Other marketable 0 0 0 10,032
Cash equivalents 110,623 87,434 271,947 169,594
Other 149,224 102,011 271,558 196,972
----------- ----------- ----------- -----------
Total interest income 12,445,697 10,165,962 24,546,897 20,069,209
----------- ----------- ----------- -----------
Interest expense:
Deposits 5,721,279 4,670,797 11,424,803 9,243,595
Federal Home Loan Bank
advances 2,454,631 1,626,510 4,539,097 3,077,910
----------- ----------- ----------- -----------
Total interest expense 8,175,910 6,297,307 15,963,900 12,321,505
----------- ----------- ----------- -----------
Net interest income 4,269,787 3,868,655 8,582,997 7,747,704
Provision for loan losses 75,000 75,000 150,000 150,000
----------- ----------- ----------- -----------
Net interest income
after provision
for loan losses 4,194,787 3,793,655 8,432,997 7,597,704
----------- ----------- ----------- -----------
Non-interest income:
Fees and service charges 257,589 100,445 491,345 196,857
Securities gains, net 737,632 113,695 1,634,079 384,612
Gain on sales of loans 351,892 63,614 718,136 217,064
Earnings (loss) in limited
partnerships (989,556) 38,663 (937,613) 112,487
Other 161,145 89,379 274,924 193,070
----------- ----------- ----------- -----------
Total non-interest income 518,702 405,796 2,180,871 1,104,090
----------- ----------- ----------- -----------
Non-interest expense:
Compensation and benefits 1,879,834 1,358,859 3,732,314 2,674,846
Occupancy 358,039 232,451 722,760 473,598
Federal deposit insurance
premiums 72,608 58,924 146,439 117,901
Advertising 135,972 73,658 228,953 151,795
Data processing 164,503 118,803 338,558 243,332
Provision for real estate
losses 0 1,000 0 3,000
Other 831,503 283,260 1,527,459 576,925
----------- ----------- ----------- -----------
Total non-interest
expense 3,442,459 2,126,955 6,696,483 4,241,397
----------- ----------- ----------- -----------
Income before income
tax expense 1,271,030 2,072,496 3,917,385 4,460,397
Income tax expense 487,000 740,276 1,470,000 1,653,697
----------- ----------- ----------- -----------
Net income $ 784,030 1,332,220 2,447,385 2,806,700
=========== =========== =========== ===========
Basic earnings per share $0.16 0.24 0.47 0.51
=========== =========== =========== ===========
Diluted earnings per share $0.14 0.23 0.43 0.48
=========== =========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements
4
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HMN FINANCIAL, INC.
Consolidated Statements of Comprehensive Income
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended June 30,
1998 1997
------------------ ------------------
<S> <C> <C> <C> <C>
Net income $ 784,030 1,332,220
Other comprehensive income,
net of tax:
Unrealized gains on securities:
Unrealized holding gains (losses)
arising during period 295,168 1,481,372
Less: reclassification adjustment
for gains included in net income 452,758 67,685
-------- ---------
Other comprehensive income (loss) (157,590) 1,413,687
-------- ---------
Comprehensive income $ 626,440 2,745,907
======== =========
<CAPTION>
Six Months Ended June 30,
1998 1997
-------------------------------------
<S> <C> <C> <C> <C>
Net income $ 2,447,385 2,806,700
Other comprehensive income,
net of tax:
Unrealized gains (losses)
on securities:
Unrealized holding gains (losses)
arising during period 747,516 734,014
Less: reclassification adjustment
for gains included in net income 1,002,998 228,967
--------- --------
Other comprehensive income (255,482) 505,047
--------- ---------
Comprehensive income $ 2,191,903 3,311,747
========= =========
</TABLE>
See accompanying notes to consolidated financial statements.
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
For the Six Month Period Ended June 30, 1998
(Unaudited)
<TABLE>
<CAPTION>
Accumulated
Additional Other
Common Paid-in Retained Comprehensive
Stock Capital Earnings Income
----------------------------------------------------
<S> <C> <C> <C> <C>
Balance,
December 31, 1997 $ 91,286 59,698,662 60,224,253 1,129,818
Net income 2,447,385
Other comprehensive income (255,482)
Treasury stock purchases
Amortization of
restricted stock awards
Restricted stock awards
cancelled
Restricted stock awards
tax benefit 70,639
Shares purchased for employee
stock ownership plan
Earned employee stock
ownership plan shares 194,458
Employee stock options
exercised (101,765)
Employee stock option
plan tax benefit 22,255
Dividends (305,982)
Fractional shares purchased (1,725)
-------- ---------- ---------- ---------
Balance, June 30, 1998 $ 91,286 59,882,524 62,365,656 874,336
======== ========== ========== =========
<CAPTION>
Unearned
Employee
Stock Unearned
Ownership Compensation Total
Plan Restricted Treasury Stockholders'
Shares Stock Awards Stock Equity
-----------------------------------------------------
<S> <C> <C> <C> <C>
Balance,
December 31, 1997 $(4,554,280) (600,668) (31,518,661) 84,470,410
Net income 2,447,385
Other comprehensive income (255,482)
Treasury stock purchases (14,772,787) (14,772,787)
Amortization of
restricted stock awards 120,848 120,848
Restricted stock awards
cancelled 29,122 (29,122) 0
Restricted stock awards
tax benefit 70,639
Shares purchased for employee
stock ownership plan (1,476,000) (1,476,000)
Earned employee stock
ownership plan shares 227,716 422,174
Employee stock options
exercised 157,002 55,237
Employee stock option
plan tax benefit 22,255
Dividends (305,982)
Fractional shares purchased 9 (1,716)
---------- --------- ----------- ------------
Balance, June 30, 1998 $(5,802,564) (450,698) (46,163,559) 70,796,981
========== ========= =========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
5
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HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1998 1997
------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,447,385 2,806,700
Adjustments to reconcile net income to cash
provided by operating activities:
Provision for loan losses 150,000 150,000
Provision for real estate losses 0 3,000
Depreciation 283,577 207,634
Amortization of (discounts) premiums, net (128,956) (107,808)
Amortization of deferred loan fees (317,266) (183,614)
Amortization of goodwill 90,318 0
Amortization of core deposit intangible 143,514 0
Amortization of other purchase
accounting adjustments 382,014 0
Amortization of mortgage servicing rights 196,683 0
Provision for deferred income taxes 167,000 258,698
Securities gains, net (1,634,079) (384,612)
Gain on sales of real estate (21,777) (3,743)
Gain on sales of loans (718,136) (217,064)
Proceeds from sale of loans held for sale 68,990,372 4,414,601
Disbursements on loans held for sale (53,532,026) (3,142,412)
Amortization of restricted stock awards 120,848 115,324
Amortization of unearned ESOP shares 227,716 192,120
Earned employee stock ownership shares
priced above original cost 194,458 124,410
Increase in accrued interest receivable (516,568) (347,067)
Increase (decrease) in accrued interest payable 20,256 (335,232)
Equity (earnings) loss of limited partnerships 937,613 (112,487)
Decrease (increase) in other assets 581,531 (94,493)
Decrease in other liabilities (795,342) (149,358)
Other, net (6,171) 20,768
----------- -----------
Net cash provided by operating activities 17,262,964 3,215,365
----------- -----------
Cash flows from investing activities:
Proceeds from sales of securities
available for sale 91,763,992 33,311,951
Principal collected on securities
available for sale 16,165,151 6,657,798
Proceeds collected on maturity of
securities available for sale 23,100,000 15,868,412
Purchases of securities available for sale (136,566,747) (60,433,633)
Proceeds from sales of securities held to maturity 0 348,871
Principal collected on securities held to maturity 0 240,441
Proceeds collected on maturity of securities
held to maturity 0 1,000,000
Proceeds from sales of loans receivable 3,047,939 23,666,730
Purchases of mortgage servicing rights (557,536) (370,008)
Purchase of interest in limited partnerships (181,125) (1,938,750)
Purchase of Federal Home Loan Bank stock (1,737,900) (505,500)
Net increase in loans receivable (41,486,818) (26,466,169)
Proceeds from sale of real estate 152,415 35,627
Purchases of premises and equipment (1,256,046) (717,045)
Decrease in due to stockholders of
Marshalltown Financial Corporation (3,495,888) 0
----------- -----------
Net cash used by investing activities (51,052,563) (9,301,275)
----------- -----------
Cash flows from financing activities:
Increase (decrease) in deposits (82,370) 2,908,442
Purchase of treasury stock (14,772,787) (4,109,637)
Increase in unearned ESOP shares (1,476,000) 0
Stock options exercised 55,237 138
Dividends to stockholders (305,982) 0
Fractional shares purchased from stock split (1,716) 0
Proceeds from Federal Home Loan Bank advances 92,500,000 74,800,000
Repayment of Federal Home Loan Bank advances (42,214,284) (66,514,284)
Decrease in advance payments by borrowers
for taxes and insurance (33,906) (12,643)
----------- -----------
Net cash provided by financing activities 33,668,192 7,072,016
----------- -----------
Increase (decrease) in cash and cash equivalents(121,407) 986,106
Cash and cash equivalents, beginning of period 9,364,635 10,583,717
----------- -----------
Cash and cash equivalents, end of period $ 9,243,228 11,569,823
=========== ===========
6
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Supplemental cash flow disclosures:
Cash paid for interest $ 15,943,644 12,656,737
Cash paid for income taxes 967,000 1,445,500
Supplemental noncash flow disclosures:
Loans securitized and transferred to
securities available for sale $ 0 4,781,034
Securities held to maturity transferred to
securities available for sale 0 1,295,147
Loans transferred to loans held for sale 20,553,439 1,694,660
Transfer of loans to real estate 17,105 188,776
Transfer of real estate to loans 0 84,772
Securities purchased with liability
due to broker 1,997,812 1,200,000
Securities sold with payment due from broker 3,051,977 0
</TABLE>
See accompanying notes to consolidated financial statements.
7
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HMN FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
June 30, 1998 and 1997
(1) HMN FINANCIAL, INC.
HMN Financial, Inc. (HMN) is a stock savings bank holding company which owns
100 percent of Home Federal Savings Bank (the Bank or Home Federal). Home
Federal has a community banking philosophy and operates retail banking
facilities in Minnesota and Iowa. The Bank has two wholly owned subsidiaries,
Osterud Insurance Agency, Inc. (OAI) and MSL Financial Corporation (MSL), which
offer financial planning products and services. HMN has two other wholly owned
subsidiaries, Security Finance Corporation (SFC) and HMN Mortgage Services,
Inc. (MSI). SFC invests in commercial loans and commercial real-estate loans
located throughout the United States which were originated by third parties.
MSI operates mortgage banking and mortgage brokerage facilities located in Eden
Prairie and Brooklyn Park, Minnesota.
The consolidated financial statements included herein are for HMN, SFC, MSI,
the Bank and the Bank's wholly owned subsidiaries, OAI and MSL. All significant
intercompany accounts and transactions have been eliminated in consolidation.
(2) BASIS OF PREPARATION
The accompanying unaudited consolidated financial statements were prepared in
accordance with instructions for Form 10-Q and therefore, do not include all
disclosures necessary for a complete presentation of the consolidated balance
sheets, consolidated statements of income, consolidated statements of
stockholders' equity and consolidated statements of cash flows in conformity
with generally accepted accounting principles. However, all adjustments
consisting of only normal recurring adjustments which are, in the opinion of
management, necessary for the fair presentation of the interim financial
statements have been included. The statement of income for the three month and
six month periods ended June 30, 1998 are not necessarily indicative of the
results which may be expected for the entire year.
Certain amounts in the consolidated financial statements for prior periods have
been reclassified to conform with the current period presentation.
(3) NEW ACCOUNTING STANDARDS
Effective January 1, 1998 HMN adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, REPORTING COMPREHENSIVE INCOME. The statement
establishes standards for reporting and display of comprehensive income and its
components in a full set of general-purpose financial statements. The
statement requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be disclosed in the
financial statements. Comprehensive income is defined as the change in equity
during a period from transactions and other events from nonowner sources.
Comprehensive income is the total of net income and other comprehensive income,
which for HMN is comprised entirely of unrealized gains and losses on
securities available for sale.
The gross unrealized holding gains for the second quarter of 1998 were
$482,000, the income tax expense would have been $187,000 and therefore, the
net gain was $295,000. The gross reclassification adjustment for the second
quarter of 1998 was $738,000, the income tax expense would have been $285,000
and therefore, the net reclassification adjustment was $453,000. The gross
unrealized holding gains for the second quarter of 1997 were $2,468,000, the
income tax expense would have been $987,000 and therefore, the net gain was
$1,481,000. The gross reclassification adjustment for the second quarter of
1997 was $114,000, the income tax expense would have been $46,000 and
therefore, the net reclassification adjustment was $68,000.
8
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The gross unrealized holding gains for the six month period ended June 30, 1998
were $1,163,000, the income tax expense would have been $415,000 and therefore,
the net gain was $748,000. The gross reclassification adjustment for the first
six months of 1998 was $1,634,000, the income tax expense would have been
$631,000 and therefore, the net reclassification adjustment was $1,003,000. The
gross unrealized holding gains for the six month period ended June 30, 1997
were $1,233,000, the income tax expense would have been $499,000 and therefore,
the net gain was $734,000. The gross reclassification adjustment for the first
six months of 1997 was $385,000, the income tax expense would have been
$156,000 and therefore, the net reclassification adjustment was $229,000.
In February 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 132, EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT
BENEFITS which revises employers' disclosures about pension and other
postretirement benefit plans. It does not change the measurement or
recognition of those plans. It standardizes the disclosure requirements for
pensions and other postretirement benefits to the extent practicable, requires
additional information on changes in the benefit obligation and fair values of
plan assets that will facilitate financial analysis, and eliminates certain
disclosures that are no longer as useful as they were when FASB Statements No.
87, EMPLOYERS' ACCOUNTING FOR PENSIONS, NO. 88, EMPLOYERS' ACCOUNTING FOR
SETTLEMENT AND CURTAILMENTS OF DEFINED BENEFIT PENSION PLANS AND FOR
TERMINATION BENEFITS, and No. 106, EMPLOYERS' ACCOUNTING FOR POSTRETIREMENT
BENEFITS OTHER THAN PENSIONS, were issued. SFAS No. 132 suggests combined
formats for presentation of pension and other postretirement benefit
disclosures. It is effective for fiscal years beginning after December 15,
1997. Restatement of disclosures for earlier periods provided for comparative
purposes is required unless the information is not readily available. Adopting
the disclosure requirements of SFAS No. 132 will not have a material impact on
HMN's financial condition or the results of its operations.
In June 1998, the FASB issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES, which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, (collectively referred to as derivatives) and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. If certain conditions are met, a derivative
may be specifically designated as (a) a hedge of the exposure to changes in the
fair value of a recognized asset or liability or an unrecognized firm
commitment, (b) a hedge of the exposure to variable cash flows of a forecasted
transaction, or (c) a hedge of the foreign currency exposure of a net
investment in a foreign operation, an unrecognized firm commitment, an
available-for-sale security, or a foreign-currency-denominated forecasted
transaction.
The accounting for changes in the fair value of a derivative (that is, gains
and losses) depends on the intended use of the derivative and the resulting
designation.
- - For a derivative designated as hedging the exposure to changes in the fair
value of a recognized asset or liability or a firm commitment (referred to
as a fair value hedge), the gain or loss is recognized in earnings in the
period of change together with the offsetting loss or gain on the hedged
item attributable to the risk being hedged. The effect of that accounting
is to reflect in earnings the extent to which the hedge is not effective
in achieving offsetting changes in fair value.
- - For a derivative designated as hedging the exposure to variable cash flows
of a forecasted transaction (referred to as a cash flow hedge), the
effective portion of the derivative's gain or loss is initially reported
as a component of other comprehensive income (outside earnings) and
subsequently reclassified into earnings when the forecasted transaction
affects earnings. The ineffective portion of the gain or loss is reported
in earnings immediately.
- - For a derivative designated as hedging the foreign currency exposure of a
net investment in a foreign operation, the gain or loss is reported in
other comprehensive income (outside earnings) as part of the cumulative
translation adjustment. The accounting for a fair value hedge described
above applies to a derivative designated or an available-for-sale
security. Similarly, the accounting for a cash flow hedge described above
applies to a derivative designated as a hedge of the foreign currency
exposure of a foreign-currency-denominated forecasted transaction.
9
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- - For a derivative not designated as a hedging instrument, the gain or loss
is recognized in earnings in the period of change.
Under FASB No. 133, an entity that elects to apply hedge accounting is required
to establish at the inception of the hedge the method it will use for assessing
the effectiveness of the hedging derivative and the measurement approach for
determining the ineffective aspect of the hedge. Those methods must be
consistent with the entity's approach to managing risk.
FASB No. 133 precludes designating a nonderivative financial instrument as a
hedge of an asset, liability, unrecognized firm commitment, or forecasted
transaction except that a nonderivative instrument denominated in a foreign
currency may be designated as a hedge of the foreign currency exposure of an
unrecognized firm commitment denominated in a foreign currency or a net
investment in a foreign operation.
FASB No. 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Initial application should be as of the beginning of an
entity's fiscal quarter; on that date, hedging relationships must be designated
anew and documented pursuant to the provisions of FASB No. 133. HMN is
anticipating that it will adopt FASB No. 133 in the first quarter of 2000 and
is currently studying the impact of adopting the statement on its financial
statements.
(4) STOCK SPLIT AND CASH DIVIDEND
In February of 1998 HMN authorized a three-for-two stock split in the form of a
fifty percent stock dividend subject to stockholder approval to increase HMN's
authorized common stock from 7.0 million shares to 11.0 million shares. At the
annual meeting on April 28, 1998 the stockholders approved the increase in
authorized common stock. The Board of Directors then declared that the stock
dividend be distributed on May 22, 1998 to stockholders of record on May 8,
1998.
The stock split increased HMN's outstanding common shares from 6,085,775 to
9,128,662 shares. Stockholders' equity has been restated to give retroactive
effect to the stock split for all periods presented by reclassifying from
additional paid-in capital to common stock the par value of the additional
shares arising from the stock split. In addition all references in the
Consolidated Financial Statements and Notes thereto to number of shares, per-
share amounts, stock option data and market prices of HMN's common stock have
been restated giving retroactive recognition to the stock split.
A cash dividend of $0.06 per share was paid on June 12, 1998 to stockholders of
record on May 27, 1998.
(5) MERGERS AND ACQUISITIONS
On December 5, 1997 HMN, through its wholly owned subsidiary, Home Federal,
completed its merger (the Merger) with Marshalltown Financial Corporation (MFC)
pursuant to a merger agreement dated July 1, 1997. The aggregate consideration
per the merger agreement was $24.8 million, consisting of $23.7 million for
1.35 million outstanding shares of MFC stock, or $17.51 per share, and $1.1
million for the outstanding MFC options. HMN owned 60,000 shares of MFC stock
with a historical cost of $1.0 million which were cancelled upon the completion
of the merger.
The following Unaudited Pro Forma Condensed Combined Statements of Income for
the three months and six months ended June 30, 1997 combine HMN's income
statement with MFC's income statement. The statement is presented as if the
Merger had been effective at the beginning of the period presented, after
giving effect to certain pro forma adjustments described in the accompanying
notes.
The Unaudited Pro Forma Condensed Combined Statements of Income and notes
thereto (the Information) reflect the application of the purchase method of
accounting for the Merger. Under this method, the assets acquired and
liabilities assumed from MFC and its subsidiaries are recorded at their fair
market values on the date of the Merger. The amount of the purchase price in
excess of the fair market value of the tangible and identifiable intangible
assets acquired less the fair market value of the liabilities assumed is
recorded as
10
<PAGE>
goodwill. Certain historical information of the consolidated MFC has been
reclassified to conform to HMN's financial statement presentation. The
Information is not necessarily indicative of the results of future operations
of the combined entity or the actual results that would have been achieved had
the Merger of MFC been consummated prior to the period indicated.
<TABLE>
<CAPTION>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME
Three months ended June 30, 1997
Pro Forma
----------------------------
HMN MFC Adjustments Combined
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Total interest income $ 10,165,962 2,208,600 (501,075)(1)(2)11,873,487
Total interest expense 6,297,307 1,361,923 96,893 (3)(4) 7,756,123
---------- ---------- ---------- ----------
Net interest income 3,868,655 846,677 (597,968) 4,117,364
Provision for loan losses 75,000 2,500 77,500
Non-interest income 405,796 31,099 436,895
Non-interest expense 2,126,955 544,965 123,561 (5)(6) 2,795,481
---------- ---------- ---------- ----------
Income before income
tax expense 2,072,496 330,311 (721,529) 1,681,278
Income tax expense 740,276 126,600 (243,542) 623,334
---------- ---------- ---------- ----------
Net income $ 1,332,220 203,711 (477,987) 1,057,944
========== ========== ========== ==========
Basic earnings per share $ 0.24 0.14 0.19
Diluted earnings per share $ 0.23 0.14 0.18
Weighted average shares
outstanding:
Basic 5,513,223 1,470,032 5,513,223
Diluted 5,870,132 1,470,860 5,870,132
</TABLE>
<TABLE>
<CAPTION>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME
Six months ended June 30, 1997
Pro Forma
----------------------------
HMN MFC Adjustments Combined
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Total interest income $ 20,069,209 4,408,932 (1,002,150)(1)(2) 23,475,991
Total interest expense 12,321,505 2,726,611 193,785 (3)(4) 15,241,901
----------- ---------- ---------- ----------
Net interest income 7,747,704 1,682,321 (1,195,935) 8,234,090
Provision for loan losses 150,000 5,000 155,000
Non-interest income 1,104,090 67,973 1,172,063
Non-interest expense 4,241,397 1,138,001 247,121 (5)(6) 5,626,519
----------- ---------- ---------- ----------
Income before income
tax expense 4,460,397 607,293 (1,443,056) 3,624,634
Income tax expense 1,653,697 160,504 (470,368) 1,343,833
----------- ---------- ---------- ----------
Net income $ 2,806,700 446,789 (972,688) 2,280,801
=========== ========== ========== ==========
Basic earnings per share $ 0.51 0.30 0.41
Diluted earnings per share $ 0.48 0.30 0.39
Weighted average shares
outstanding:
Basic 5,531,618 1,469,910 5,531,618
Diluted 5,879,360 1,470,717 5,879,360
</TABLE>
Pursuant to the Merger and consistent with GAAP, certain adjustments were
recorded, primarily to accrue for specific, identified costs related to the
merger of MFC. The amounts of the Merger related costs are subject to
revisions as economic conditions change or as more information becomes
available.
HMN expects to achieve operating cost savings primarily through reductions in
staff and the consolidation of certain functions such as data processing,
investments and other back office operations at MFC. The operating cost
savings are expected to be achieved in various amounts at various times during
the years subsequent to the acquisition of MFC and not ratably over, or at the
beginning or end of, such periods. No adjustment has been reflected in the
Unaudited Pro Forma Condensed Combined Statement of Income for the
11
<PAGE>
three months and six months ended June 30, 1997 for the anticipated cost
savings.
(1) Represents amortization of MFC mark-to-market adjustments under the
purchase method of accounting for loans.
(2) Represents amortization of MFC mark-to-market adjustments under the
purchase method of accounting for securities, and the forgone
interest income resulting from the planned sale of $15.8 million of
securities.
(3) Represents amortization of MFC mark-to-market adjustments under the
purchase method of accounting for deposits.
(4) Represents the net interest cost of borrowing $10.0 million to fund
the MFC acquisition.
(5) Represents amortization of goodwill and core deposit intangible.
(6) Represents the additional depreciation on premises and equipment
related to the MFC mark-to-market adjustments.
(6) INVESTMENT IN LIMITED PARTNERSHIP AND MORTGAGE SERVICING IMPAIRMENT
RESERVES
During the second quarter of 1998 HMN established valuation reserves on
mortgage servicing assets and recognized its proportionate share of losses on a
partnership investment after the partnership established valuation reserves on
its mortgage servicing assets; resulting in an aggregate pretax charge to HMN's
second quarter income of $1.3 million. For the six months ended June 30, 1998
year to date pretax income was reduced by $132,000 related to establishing
valuation reserves on mortgage servicing assets and pretax income was reduced
by a $1.14 million charge which recognized HMN's proportionate share of losses
on a partnership investment after the partnership established valuation
reserves on its mortgage servicing assets.
(7) EARNINGS PER SHARE
The following table reconciles the weighted average shares outstanding and the
income available to common shareholders used for basic and diluted EPS:
<TABLE>
<CAPTION>
Three months ended June 30, Six Months ended June 30,
--------------------------- ------------------------
1998 1997 1998 1997
---------------------- ----------------------
<S> <C> <C> <C> <C>
Weighted average number of
common shares outstanding
used in basic earnings per
common share calculation 5,051,205 5,513,223 5,248,262 5,531,618
Net dilutive effect of:
Options 379,759 277,298 391,398 266,195
Restricted stock awards 54,197 79,611 57,773 81,548
--------- --------- --------- ---------
Weighted average number of
shares outstanding
adjusted for effect of
dilutive securities 5,485,161 5,870,132 5,697,433 5,879,361
========= ========= ========= =========
Income available to common
shareholders $ 784,030 1,332,220 2,447,385 2,806,700
Basic earnings per common
share $ 0.16 0.24 0.47 0.51
Diluted earnings per common
share $ 0.14 0.23 0.43 0.48
</TABLE>
The earnings per share calculations reflected above are presented as if the
split had been completed at the beginning of each period presented for the
weighted average number of shares outstanding for each period.
(8) REGULATORY CAPITAL
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.
12
<PAGE>
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, Tier I (Core), and Risk-based capital (as defined
in the regulations) to adjusted total assets and risk-weighted assets (as
defined). Management believes, as of June 30, 1998, that the Bank meets all
capital adequacy requirements to which it is subject.
Management believes that based upon the Bank's capital calculations at June 30,
1998 and other conditions consistent with the Prompt Corrective Actions
Provisions of the OTS regulations, the Bank would be categorized as well
capitalized.
On June 30, 1998 the Bank's tangible assets and adjusted total assets were
$694.7 million and its risk-weighted assets were $329.4 million. The following
table presents the Bank's capital amounts and ratios at June 30, 1998 for
actual capital, required capital and excess capital including ratios in order
to qualify as being well capitalized under the Prompt Corrective Actions
regulations.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
Required to be
Adequately
Actual Capitalized
---------------------- ----------------------
(IN THOUSANDS) Amount Percent Amount Percent
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Bank stockholder's equity $ 47,619
Plus:
Net unrealized loss (gain)
on certain securities
available for sale (659)
Less:
Goodwill and other
intangibles 5,834
Excess mortgage
servicing rights 434
------
Tier I or core capital 40,692 $27,788
Tier I capital to
adjusted total assets 5.86% 4.00%
Tier I capital to risk-
weighted assets 12.35%
Less:
Equity investments and
other assets required to
be deducted 222
Plus:
Allowable allowance for
loan losses 2,890
------
Risk-based capital $43,360 $26,350
======
Risk-based capital to risk-
weighted assets 13.16% 8.00%
<CAPTION>
- ----------------------------------------------------------------------------
Required to be
To Be Well
Capitalized Under
Prompt Corrective
Excess Capital Actions Provision
---------------------- ----------------------
(IN THOUSANDS) Amount Percent Amount Percent
---------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
Bank stockholder's equity $
Plus:
Net unrealized loss (gain)
on certain securities
available for sale
Less:
Goodwill and other
intangibles
Excess mortgage
servicing rights
Tier I or core capital $ 12,904
Tier I capital to
adjusted total assets 1.86% 5.00%
Tier I capital to risk-
weighted assets 6.00%
Less:
Equity investments and
other assets required to
be deducted
Plus:
Allowable allowance for
loan losses
Risk-based capital $ 17,010
Risk-based capital to risk-
weighted assets 5.16% 10.00%
- -----------------------------------------------------------------------------
</TABLE>
The tangible capital of the Bank was in excess of the minimum 2% required at
June 30, 1998, but is not reflected in the table above.
13<PAGE>
<PAGE>
HMN FINANCIAL, INC.
Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
HMN's net income is dependent primarily on its net interest income, which is
the difference between interest earned on its loans and investments and the
interest paid on interest-bearing liabilities. Net interest income is
determined by (i) the difference between the yield earned on interest-earning
assets and rates paid on interest-bearing liabilities (interest rate spread)
and (ii) the relative amounts of interest-earning assets and interest-bearing
liabilities. HMN's interest rate spread is affected by regulatory, economic
and competitive factors that influence interest rates, loan demand and deposit
flows. Net interest margin is calculated by dividing net interest income by
the average interest-earning assets and is normally expressed as a percentage.
Net interest income and net interest margin are affected by changes in interest
rates, the volume and the mix of interest-earning assets and interest-bearing
liabilities, and the level of non-performing assets. HMN's net income is also
affected by the generation of non-interest income, which primarily consists of
gains from the sale of securities, gains from sale of loans, service charges,
fees and other income. In addition, net income is affected by the level of
operating expenses and establishment of a provision for loan losses.
The operations of financial institutions, including the Bank, are significantly
affected by prevailing economic conditions, competition and the monetary and
fiscal policies of governmental agencies. Lending activities are influenced by
the demand for and supply of housing, competition among lenders, the level of
interest rates and the availability of funds. Deposit flows and costs of funds
are influenced by prevailing market rates of interest primarily on competing
investments, account maturities and the levels of personal income and savings
in the market area of the Bank.
STOCK SPLIT
In February of 1998 HMN announced that its Board of Directors had authorized a
three-for-two stock split in the form of a fifty percent stock dividend subject
to stockholder approval at the annual meeting of stockholders held on April 28,
1998 to increase HMN's authorized common stock from 7.0 million shares to 11.0
million shares. At the annual meeting the stockholders approved the increase
in authorized common stock. The Board of Directors then declared that the split
would be distributed on May 22, 1998 to shareholders of record on May 8, 1998.
The financial statements included in this Form 10-Q for the quarter and six
month period ended June 30, 1997 have been presented assuming that the stock
split had taken place at the beginning of those periods. Earnings per share
calculations included in the financial statements were based upon post split
weighted average outstanding share information.
NET INCOME
HMN's net income for the second quarter of 1998 was $784,000, a decrease of
$548,000, compared to net income of $1.3 million for the second quarter of
1997. The decrease in net income was the result of a $1.3 million increase in
non-interest expense which was partially offset by a $401,000 increase in net
interest income and an increase of $113,000 in non-interest income. During the
second quarter of 1998, HMN established valuation reserves on mortgage
servicing assets and recognized its proportionate share of losses on a
partnership investment after the partnership established valuation reserves on
its mortgage servicing assets; resulting in an aggregate pretax charge to HMN's
income of $1.3 million. The charge decreased basic earnings per share and
diluted earnings per share by $0.16 and $0.15, respectively for the second
quarter of 1998. Basic earnings per share for the second quarter of 1998 were
$0.16, a decrease of $0.08, compared to $0.24 basic earnings per share for the
second quarter of 1997. Diluted earnings per share for the second quarter of
1998 were $0.14, a decrease of $0.09, compared to $0.23 diluted earnings per
share for the second
14
<PAGE>
quarter of 1997.
Net income for the six-month period ended June 30, 1998 was $2.4 million, a
decrease of $359,000, compared to $2.8 million for the same six month period of
1997. The decrease in net income was the result of a $2.5 million increase in
non-interest expense which was partially offset by an $835,000 increase in net
interest income and a $1.1 million increase in non-interest income. During the
six month period ended June 30, 1998, HMN recognized a $132,000 pretax charge
relating to establishing valuation reserves on its mortgage servicing assets.
HMN also recognized a pretax charge of $1.14 million on a partnership
investment which established a valuation reserve on the partnership's mortgage
servicing assets. The charges related to mortgage servicing assets decreased
basic earning per share and diluted earnings per share for the six month period
ended June 30, 1998 by $0.16 and $0.14, respectively. Basic earnings per share
for the six month period ended June 30, 1998 were $0.47, compared to $0.51 for
the same six month period in 1997. Diluted earnings per share for the six
month period ended June 30, 1998 were $0.43, compared to $0.48 for the same
period of 1997.
NET INTEREST INCOME
Net interest income for the second quarter of 1998 was $4.3 million, an
increase of $401,000, or 10.4%, compared to $3.9 million for the same quarter
of 1997. Interest income for the second quarter of 1998 was $12.5 million, an
increase of $2.3 million, or 22.4%, compared to $10.2 million for the same
quarter of 1997. Interest income increased primarily due to the Marshalltown
Financial Corporation ("MFC") merger which occurred on December 5, 1997 and the
additional interest earning assets which were purchased with the proceeds from
a $61.2 million increase in average outstanding Federal Home Loan Bank advances
from the second quarter of 1997 to the second quarter of 1998. The average
outstanding balances for interest-earning assets during the second quarter of
1998 compared to the second quarter of 1997 increased by $144.3 million. The
average outstanding balance for loans receivable including loans held for sale
increased by $112.6 million and the average outstanding balances for
securities, FHLB stock, and other interest-earning assets increased by $31.7
million. The increase in interest-earning assets caused interest income to
increase by $2.6 million and was partially off set by a decrease of $304,000 in
interest income due to declining yields earned on interest earning assets.
Interest expense for the second quarter of 1998 was $8.2 million, an increase
of $1.9 million, or 29.8%, compared to $6.3 million for the same quarter of
1997. Average interest-bearing liabilities for the second quarter of 1998
were $633.9 million, an increase of $159.3 million, or 33.6%, compared to
$474.6 million for the second quarter of 1997. The majority of the funds
received from the increase in interest-bearing liabilities were used to
purchase the net increase in average interest-bearing assets, facilitate the
HMN stock repurchases, and purchase loan servicing assets. The increase in
interest-bearing liabilities caused interest expense for the second quarter of
1998 to increase by $2.1 million and was partially off set by a $171,000
decline in interest expense caused by a decline in the interest rates paid on
borrowings and deposits.
Net interest income for the six months ended June 30, 1998 was $8.6 million, an
increase of $835,000, or 10.8%, from $7.7 million for the same period of 1997.
Interest income for the six month period ended June 30, 1998 was $24.5 million,
an increase of $4.5 million, or 22.3%, compared to $20.1 million for the same
period of 1997. Interest income increased primarily due to the MFC merger
which occurred on December 5, 1997 and the additional interest earning assets
which were purchased with the proceeds from a $52.8 million increase in average
outstanding Federal Home Loan Bank advances from the first six months of 1997
to the same period of 1998. The average outstanding balances for interest-
earning assets during the first six months of 1998 compared to the same period
of 1997 increased by $140.7 million. The average outstanding balance for loans
receivable including loans held for sale increased by $105.7 million and the
average outstanding balances for securities, FHLB stock, and other interest-
earning assets increased by $35.0 million. The increase in interest-earning
assets caused interest income to increase by $5.0 million and was partially off
set by a decrease of $558,000 in interest income due to declining yields earned
on interest earning assets. Interest expense for the six months ended June
30, 1998 was $15.9 million, an increase of $3.6 million, or 29.6%, compared to
$12.3 million for the same six month period of 1997. Average interest-bearing
liabilities for the six months ended June 30, 1998 were $620.7 million, an
increase of $151.5 million, or 32.3%, compared to $469.2 million for the same
period of 1997. The majority of the funds received from the
15
<PAGE>
increase in interest-bearing liabilities were used to purchase the net increase
in average interest-bearing assets, facilitate the HMN stock repurchases, and
purchase loan servicing assets. The increase in interest-bearing liabilities
caused interest expense for the six month period of 1998 to increase by $3.9
million and was partially off set by a $249,000 decrease in interest expense
caused by a decline in the interest rates paid on borrowings and deposits.
PROVISION FOR LOAN LOSSES
*The provision for loan losses for the second quarters ended June 30, 1998 and
1997 were both $75,000. The provision for loan losses for the six months ended
June 30, 1998 and 1997 were both $150,000. The provision is the result of
management's evaluation of the loan portfolio, a historically low level of non-
performing loans, minimal loan charge-off experience, and its assessment of the
general economic conditions in the geographic area where properties securing
the loan portfolio are located. Management's evaluation did not reveal
conditions that would cause it to increase the provision for loan losses during
1998 compared to 1997. Future economic conditions and other unknown factors
will impact the need for future provisions for loan losses. As a result, no
assurances can be given that increases in the allowance for loan losses will
not be required during future periods.
A reconciliation of HMN's allowance for loan losses is summarized as follows:
1998 1997
--------- ---------
Balance at January 1, $ 2,748,219 2,340,585
Provision 150,000 150,000
Charge-offs (8,099) (19,009)
Recoveries 1,576 7,250
--------- ---------
Balance at June 30, $ 2,891,696 2,478,826
========= =========
NON-INTEREST INCOME
Non-interest income for the second quarter of 1998 was $519,000, an increase of
$113,000, or 27.8%, from $406,000 for the same quarter of 1997. The increase
in non-interest income was principally due to a $157,000 increase in fees from
mortgage banking activities and service charges, a $624,000 increase in gain
on the sale of securities, a $288,000 increase in gain on the sale of loans and
a $72,000 increase in other income. A general decline of interest rates during
1998 and other favorable economic conditions allowed HMN to sell securities and
loans at a gain. The increases in non-interest income were offset by a $1.0
million decline in earnings from limited partnerships. During the second
quarter of 1998, HMN recognized a charge of $1.14 million as its proportionate
share of a valuation reserve on mortgage servicing assets which were
established by the limited partnership. During the first six months of 1998
the interest rates charged on residential home loans in general have declined.
The decline in rates has caused many borrowers to refinance their home loans
which in turn has caused many mortgage loans to prepay faster than originally
anticipated. The rapid prepayment of mortgage loans and the anticipation that
rapid prepayments would continue into the near future, caused the estimated
value of many mortgage loan servicing assets to decline during the second
quarter of 1998.
Non-interest income for the six months ended June 30, 1998 was $2.2 million, an
increase of $1.1 million, or 97.5%, from $1.1 million for the same period of
1997. The increase in non-interest income was principally due to a $294,000
increase in fees from mortgage banking activities and service charges, a $1.2
million increase in gain on the sale of securities, a $501,000 increase in gain
on the sale of loans and a $82,000 increase in other income. A general decline
of interest rates during 1998 and other favorable economic conditions allowed
HMN to sell securities and loans at a gain. The increases in non-interest
income were offset by a $1.1 million decline in earnings from limited
partnerships. In June of 1998, HMN recognized a charge of $1.14 million as its
proportionate share of a valuation reserve on mortgage servicing assets which
were established by the limited partnership. During the first six months of
1998 the interest rates charged on
* This paragraph contains a forward-looking statement(s). Refer to
information regarding Forward-looking Information on page 23 of this
discussion.
16
<PAGE>
residential home loans in general have declined. The decline in rates has
caused many borrowers to refinance their home loans which in turn has caused
many mortgage loans to be prepay faster than originally anticipated. The rapid
prepayment of mortgage loans and the anticipation that rapid prepayments would
continue into the near future, caused the estimated value of many mortgage loan
servicing assets to decline during the second quarter of 1998.
NON-INTEREST EXPENSE
Non-interest expense was $3.4 million for the second quarter of 1998, an
increase of $1.3 million, or 61.8%, from $2.1 million for the second quarter of
1997. Compensation and benefit expense increased by $521,000 primarily due to
an increase in HMN's work force as a result of the MFC merger, increased staff
added to the mortgage banking operations of MSI and the Bank and normal annual
compensation increases to Bank employees. Occupancy costs increased by
$126,000 due to three buildings added by the MFC merger, the addition of a
mortgage banking office in Brooklyn Park, Minnesota and increased occupancy
costs related to opening a new retail facility in Spring Valley. Other non-
interest expense increased by $548,000 due to additional operating costs
incurred related to the MFC merger, the mortgage banking expansion in Brooklyn
Park, amortization of goodwill and core deposit intangibles of $117,000 related
to the MFC merger and an increase of $165,000 to the mortgage servicing asset
impairment reserve.
Non-interest expense for the six months ended June 30, 1998 was $6.7 million,
an increase of $2.5 million from $4.2 million for the six months ended June 30,
1997. Compensation and benefit expense increased by $1.1 million primarily
due to an increase in HMN's work force as a result of the MFC merger, increased
staff added to the mortgage banking operations of MSI and the Bank and normal
annual compensation increases to Bank employees. Occupancy costs increased by
$249,000 due to three buildings added by the MFC merger, the addition of a
mortgage banking office in Brooklyn Park, Minnesota and increased occupancy
costs related to opening a new retail facility in Spring Valley. Other non-
interest expense increased by $950,000 partly due to additional operating costs
incurred related to the MFC merger, the mortgage banking expansion in Brooklyn
Park, amortization of goodwill and core deposit intangibles of $234,000 related
to the MFC merger and an increase of $132,000 to the mortgage servicing asset
impairment reserve.
INCOME TAX EXPENSE
Income tax expense was $487,000 for the second quarter of 1998, a decrease of
$253,000, from $740,000 for the second quarter of 1997. The decrease is
primarily due to a decrease in taxable income between the two quarters. Income
tax expense was $1.5 million for the six month period ended June 30, 1998, a
decrease of $184,000, from $1.7 million for the same period in 1997. The
decrease is primarily due to a decrease in taxable income between the two six
month periods.
17
<PAGE>
NON-PERFORMING ASSETS
The following table sets forth the amounts and categories of non-performing
assets in the Bank's portfolio at June 30, 1998 and December 31, 1997.
<TABLE>
<CAPTION>
June 30, December 31,
(DOLLARS IN THOUSANDS) 1998 1997
----------- -------------
<S> <C> <C>
Non-Accruing Loans
One-to-four family real estate $ 182 177
Nonresidential real estate 76 79
Commercial business 27 0
Consumer 32 7
--- ---
Total 317 263
--- ---
Accruing loans delinquent 90
days or more 309 402
Foreclosed Assets
Real estate:
One-to-four family 17 142
--- ---
Total non-performing assets $ 643 $ 807
=== ===
Total as a percentage of
total assets 0.09% 0.12%
==== ====
Total non-performing loans $ 626 $ 665
==== ====
Total as a percentage of total
loans receivable, net 0.14% 0.15%
==== ====
</TABLE>
Total non-performing assets at June 30, 1998 were $643,000, a decrease of
$164,000 from $807,000 at December 31, 1997. The decrease of $164,000 was the
result of a $54,000 increase in non-accruing loans, a $93,000 decrease in
accruing loans delinquent 90 days or more, and the sale or redemption of
foreclosed residential homes.
DIVIDENDS
In February of 1998, the Board of Directors of HMN authorized a stock split in
the form of a 50% stock dividend subject to HMN stockholder approval of an
increase in the number of authorized shares of common stock from 7.0 million to
11.0 million. At the annual meeting of stockholders on April 28, 1998 the
stockholders approved the stock split.
HMN also declared a cash dividend of $.06 per share, payable on June 12, 1998
to shareholders of record on May 27, 1998. The net dividend was $305,982.
LIQUIDITY
For the six month period ended June 30, 1998, the net cash provided by
operating activities was $17.3 million. HMN collected $91.8 million from the
sale of securities, it collected $39.3 million in principal repayments or on
the maturity of securities during the period. HMN also collected $3.0 million
on the sale of loans receivable during the period. It purchased $136.6 million
of securities, funded a net increase in loans receivable of $41.5 million,
purchased $1.7 million of FHLB stock, purchased premises and equipment of $1.3
million and paid $3.5 million to the MFC stockholders related to the MFC
merger. HMN had additional net borrowing from the FHLB of $50.3 million and
loaned $1.48 million to its employee stock ownership plan to repurchase HMN
stock for the purpose of providing a benefit to the employees added as a result
of the MFC merger. HMN paid $14.8 million to purchase 791,800 shares of its
own common stock during the first six months of 1998.
*HMN has certificates of deposits with outstanding balances of $255.7 million
that come due over the
* This paragraph contains a forward-looking statement(s). Refer to
information regarding Forward-looking Information on page 23 of this
discussion.
18
<PAGE>
next 12 months. Based upon past experience management anticipates that the
majority of the deposits will renew for another term. HMN believes that
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 due to maturing deposits.
MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
rates. HMN's market risk arises primarily from interest rate risk inherent in
its investing, lending and deposit taking activities. Management actively
monitors and manages its interest rate risk exposure.
HMN's profitability is affected by fluctuations in interest rates. A sudden
and substantial increase in interest rates may adversely impact HMN's earnings
to the extent that the interest rates borne by assets and liabilities do not
change at the same speed, to the same extent, or on the same basis. HMN
monitors how its assets will mature or reprice in comparison to how its
liabilities will mature or reprice. The MATURITY OR REPRICING TABLE located in
the Asset/Liability Management section of this report is used as part of the
monitoring process. HMN also monitors the projected changes in net interest
income that would occur if interest rates were to suddenly change up or down.
The RATE SHOCK TABLE located in the Asset/Liability Management section of this
report discloses HMN's projected changes in net interest income based upon
immediate interest rate changes called rate shocks.
*HMN utilizes a model which uses the discounted cash flows from its interest-
earning assets and its interest-bearing liabilities to calculate the current
market value of those assets and liabilities. The model also calculates the
changes in market value of the interest-earning assets and interest-bearing
liabilities due to different interest rate changes. HMN believes that over the
next twelve months interest rates could conceivably fluctuate in a range of 200
basis points up or down from where the rates were at June 30, 1998. HMN does
not have a trading portfolio. The following table discloses the projected
changes in market value to HMN's interest-earning assets and interest-bearing
liabilities based upon incremental 100 basis point changes in interest rates
from interest rates in effect on June 30, 1998.
* This paragraph contains a forward-looking statement(s). Refer to
information regarding Forward-looking Information on page 23 of this
discussion.
19
<PAGE>
<PAGE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Other than trading portfolio Market Value
--------------------------------------------
(DOLLARS IN THOUSANDS)
Basis point change in interest rates -200 -100 0 +100 +20
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Cash equivalents $ 8,248 8,244 8,234 8,228 8,221
Fixed-rate CMOs 68,588 66,540 66,230 64,813 62,503
Variable-rate CMOs 66,558 68,801 70,350 70,967 70,240
Fixed-rate available for sale
mortgage-backed
and related securities 5,181 5,122 5,062 4,944 4,774
Variable-rate available for sale
mortgage-backed and related
securities 168 164 160 158 157
Fixed-rate available for sale other
marketable securities 85,323 82,340 79,427 76,622 73,923
Variable-rate available for sale other
marketable securities 0 0 0 0 0
Fixed-rate loans held for sale 8,104 8,097 8,091 8,084 8,077
Fixed-rate real estate loans 342,080 338,865 331,664 321,160 309,660
Variable-rate real estate loans 84,636 83,222 81,253 78,973 76,477
Fixed-rate other loans 24,525 24,265 24,025 23,685 23,347
Variable-rate other loans 39,019 39,167 39,444 39,755 39,968
Mortgage servicing 643 793 1,138 1,427 1,561
Limited partnerships 2,606 3,265 4,790 5,420 6,031
------- ------- ------- ------- -------
Total market risk sensitive assets 735,679 728,885 719,868 704,236 684,939
------- ------- ------- ------- -------
NOW deposits 21,591 21,573 21,555 21,537 21,520
Passbook deposits 36,422 34,829 33,369 32,027 30,789
Money market deposits 41,725 40,296 38,993 37,799 36,703
Certificate deposits 379,057 375,320 371,667 368,088 364,586
Fixed-rate Federal Home Loan Bank
advances 143,040 138,438 134,032 129,811 125,767
Variable-rate Federal Home Loan
Bank advances 44,095 44,043 43,992 43,939 43,887
------- ------- ------- ------- -------
Total market risk sensitive
liabilities 665,930 654,499 643,608 633,201 623,252
------- ------- ------- ------- -------
Off-balance sheet financial
instruments:
Commitments to extend credit 48 48 47 46 44
------- ------- ------- ------- -------
Net market risk $ 69,797 74,434 76,307 71,081 61,731
======= ======= ======= ======= =======
Percentage change from current
market value (8.53)% (2.45)% 0.00% (6.85)%(19.10)%
======= ======= ======= ======= =======
- ------------------------------------------------------------------------------
</TABLE>
The preceding table was prepared utilizing the following assumptions (the
"Model 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 6% to 46%, depending on the coupon and period
to maturity. Adjustable rate mortgages ("ARMs") were assumed to prepay at
annual rates of between 11% and 32%, depending on coupon and the period to
maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay at annual
rates of between 17% and 51% 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. 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.
20
<PAGE>
The model assumes that the difference between the current interest rate being
earned or paid compared to a treasury instrument or other interest index with a
similar term to maturity (the "Interest Spread") will remain constant over the
interest changes disclosed in the table. Changes in Interest Spread could
impact projected market value changes. Certain assets, such as ARMs, have
features which restrict changes in interest rates on a short-term basis and
over the life of the assets. The market value of the interest-bearing assets
which are approaching their lifetime interest rate caps could be different from
the values disclosed in the table. In the event of a change in interest rates,
prepayment and early withdrawal levels may 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.
ASSET/LIABILITY MANAGEMENT
*HMN's management reviews the impact that changing interest rates will have on
its net interest income projected for the twelve months following June 30, 1998
to determine if its current level of interest rate risk is acceptable. The
following table projects the estimated annual impact on net interest income of
immediate interest rate changes called rate shocks.
Rate Shock Net Interest Percentage
in Basis Points Income Change
---------------- --------- ----------
+200 17,256 -4.86%
+100 17,682 -2.51%
0 18,138 0.00%
-100 18,001 -0.76%
-200 17,603 -2.95%
The preceding table was prepared utilizing the Model Assumptions regarding
prepayment and decay ratios which were determined by management based upon
their review of historical prepayment speeds and future prepayment projections.
Certain shortcomings are inherent in the method of analysis presented in the
foregoing table. 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 a substantial increase in interest
rates and could impact 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 of Directors of the Bank. 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 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
*This paragraph contains a forward-looking statement(s). Refer to
information regarding Forward-looking Information on page 23 of this
discussion.
21
<PAGE>
less. The Bank generally follows the practice of selling all of its fixed rate
single family loans with contractual maturities of thirty years. At times,
depending on its interest rate sensitivity, the Bank may sell fixed rate single
family loans with shorter contractual maturities than thirty years in order to
reduce interest rate risk and record a gain on the sale of loans.
*The following table sets forth the interest rate sensitivity of HMN's assets
and liabilities at June 30, 1998, 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
(DOLLARS IN THOUSANDS) or Less One Year Years Years
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Cash equivalents $ 8,243 0 0 0
Securities available for sale:
Mortgage-backed and
related securities<F1> 77,859 8,619 33,295 13,946
Other marketable securities 970 443 7,022 37,934
Securities held to maturity:
Mortgage-backed and
related securities<F1> 0 0 0 0
Other marketable securities 0 0 0 0
Loans held for sale, net 8,091 0 0 0
Loans receivable, net:<F1><F2>
Fixed rate one-to-four
family<F3> 33,424 30,028 93,862 60,970
Adjustable rate one-to-
four family<F3> 28,001 17,083 20,052 22,132
Multi family 1,269 1,047 2,563 571
Fixed rate commercial real
estate 6,341 306 471 94
Adjustable rate commercial
real estate 4,816 497 710 0
Commercial business 2,694 1,169 2,669 935
Consumer loans 23,023 1,395 3,702 1,741
Federal Home Loan Bank stock 0 0 0 0
------- ------- ------- -------
Total interest-earning
assets 194,731 60,587 164,346 138,323
------- ------- ------- -------
Non-interest checking 11,135 0 0 0
NOW accounts 21,603 0 0 0
Passbooks 3,612 3,610 10,393 6,653
Money market accounts 2,868 2,866 8,253 5,283
Certificates 170,022 85,711 93,519 17,902
Federal Home Loan Bank
advances 52,536 5,000 24,000 86,000
------- ------- ------- -------
Total interest-bearing
liabilities 261,776 97,187 136,165 115,838
------- ------- ------- -------
Interest-earning assets less
interest-bearing
liabilities $ (67,045) (36,600) 28,181 22,485
======= ======= ======= =======
Cumulative interest-rate
sensitivity gap $ (67,045) (103,645) (75,464) (52,979)
======= ======= ======= =======
Cumulative interest-rate
gap as a percentage of
total assets at
June 30, 1998 (9.25)% (14.29)% (10.41)% (7.31)%
======= ======= ======= =======
Cumulative interest-rate gap
as a percentage of interest
-earning assets at December
31, 1997 (6.36) (15.38)
======= =======
- -----------------------------------------------------------------------------
<CAPTION>
- -----------------------------------------------------------------------------
Maturing or Repricing
-------------------------------------------------
Over 5 No Stated
(DOLLARS IN THOUSANDS) Years Maturity Total
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
Cash equivalents $ 0 0 8,243
Securities available for sale:
Mortgage-backed and
related securities<F1> 7,557 0 141,276
Other marketable securities 12,844 9,448 68,661
Securities held to maturity:
Mortgage-backed and
related securities<F1> 0 0 0
Other marketable securities 0 0 0
Loans held for sale, net 0 0 8,091
Loans receivable, net:<F1><F2>
Fixed rate one-to-four
family<F3> 97,066 0 315,350
Adjustable rate one-to
-four family<F3> 2,936 0 90,204
Multi family 452 0 5,902
Fixed rate commercial real
estate 24 0 7,236
Adjustable rate commercial
real estate 0 0 6,023
Commercial business 95 0 7,562
Consumer loans 619 0 30,480
Federal Home Loan Bank stock 0 9,170 9,170
-------- -------- --------
Total interest-earning
assets 121,593 18,618 698,198
-------- -------- --------
Non-interest checking 0 0 11,135
NOW accounts 0 0 21,603
Passbooks 11,828 0 36,096
Money market accounts 9,388 0 28,658
Certificates 2,487 0 369,641
Federal Home Loan Bank advances 10,400 0 177,936
-------- -------- --------
Total interest-bearing
liabilities 34,103 0 645,069
-------- -------- --------
Interest-earning assets less
interest-bearing liabilities $ 87,490 18,618 53,129
======== ======== ========
Cumulative interest-rate
sensitivity gap $ 34,511 53,129 53,129
======== ======== ========
Cumulative interest-rate gap as a
percentage of total assets at
June 30, 1998 4.76 % 7.33 % 7.33 %
======== ======== ========
Cumulative interest-rate gap as a
percentage of interest-earning assets
at December 31, 1997
<FN>
<FN1>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.
<FN2>Loans receivable are presented net of loans in process and deferred loan
fees.
<FN3>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.
</FN>
</TABLE>
*This paragraph contains a forward-looking statement(s). Refer to
information regarding Forward-looking Information on page 23 of this
discussion.
22
<PAGE>
The preceding table was prepared utilizing the Model Assumptions regarding
prepayment and decay ratios which were determined by management based upon
their review of historical prepayment speeds and future prepayment projections.
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 the Bank's
interest rate risk component.
YEAR 2000 ISSUES
*HMN has inventoried its computer hardware, computer software, third party
vendors and its other non computer equipment and has assessed or is in the
process of assessing whether the items are year 2000 compliant. The hardware
testing has been completed and all non compliant hardware is scheduled for
replacement during the fourth quarter of 1998 at a total estimated cost of
$75,000. The computer software inventory indicated that certain programs were
not compliant and those programs are scheduled to be replaced with year 2000
compliant software during the remainder of 1998 and through the second quarter
of 1999 at an anticipated cost of $80,000. HMN will also test all computer
software to determine that the software is year 2000 compliant. Actual
testing of the software is scheduled to be completed during November of 1998.
The assessment of non computer equipment for year 2000 compliance indicated
that HMN did not have any issues in this area.
*The majority of the Bank's loan and deposit data is supported by a third party
data processing center. Other third party providers support the automated
teller machines owned by the Bank and process the check clearings for the
Bank's negotiable order of withdrawal accounts ("checking accounts"). The Bank
is also reliant upon the Federal Home Loan Bank of Des Moines and the Federal
Reserve System to properly and efficiently conduct its business.
Notwithstanding the Bank's efforts, the failure of any of these third party
vendors to address their year 2000 issues in a timely fashion may have an
adverse effect on the Bank's ability to conduct its business. The Bank's Year
2000 Committee (the "Committee") is working very closely with its data
processing center to ascertain that all software applications and hardware will
be year 2000 compliant by the first or second quarter of 1999. The Committee
is also monitoring the progress other key third party providers are making
toward becoming year 2000 compliant.
The Committee is in the process of developing a contingency plan which
incorporates the actions the Bank will take in situations where the data
processing center or other key third party providers are not able to become
year 2000 compliant and it will have a major impact on the Bank's business.
The contingency plan is anticipated to be completed in the fourth quarter of
1998.
FORWARD-LOOKING INFORMATION
The following paragraphs within Management's Discussion and Analysis of
Financial Condition and Results of Operations contain forward-looking
statements and actual results may differ materially from the expectations
disclosed within this Discussion and Analysis. These forward-looking
statements are subject to risks and uncertainties, including those discussed
below. HMN assumes no obligations to publicly release results of any revision
or updates to these forward-looking statements to reflect future events or
unanticipated occurrences.
* This paragraph contains a forward-looking statement(s). Refer to
information regarding Forward-looking Information on page 23 of this
discussion.
23
<PAGE>
PROVISION FOR LOAN LOSSES
The provision for loan losses for the second quarters ended June 30, 1998
and 1997 were both $75,000. The provision for loan losses for the six
months ended June 30, 1998 and 1997 were both $150,000. The provision is
the result of management's evaluation of the loan portfolio, a
historically low level of non-performing loans, minimal loan charge-off
experience, and its assessment of the general economic conditions in the
geographic area where properties securing the loan portfolio are located.
Management's evaluation did not reveal conditions that would cause it to
increase the provision for loan losses during 1998 compared to 1997.
Future economic conditions and other unknown factors will impact the need
for future provisions for loan losses. As a result, no assurances can be
given that increases in the allowance for loan losses will not be required
during future periods.
LIQUIDITY
HMN has certificates of deposits with outstanding balances of $255.7
million that come due over the next 12 months. Based upon past experience
management anticipates that the majority of the deposits will renew for
another term. HMN believes that 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 due to maturing
deposits.
Competitive pricing by other institutions, the desire of a competitor to
pay interest rates on deposits that are above the current rates paid by
HMN, or desire by customers to put more of their funds into nontraditional
bank products such as stocks and bonds could be circumstances that would
cause the maturing certificates to become a liquidity problem
MARKET RISK
HMN utilizes a model which uses the discounted cash flows from its
interest-earning assets and its interest-bearing liabilities to calculate
the current market value of those assets and liabilities. The model also
calculates the changes in market value of the interest-earning assets and
interest-bearing liabilities due to different interest rate changes. HMN
believes that over the next twelve months interest rates could conceivably
fluctuate in a range of 200 basis points up or down from where the rates
were at June 30, 1998. HMN does not have a trading portfolio. The
following table discloses the projected changes in market value to HMN's
interest-earning assets and interest-bearing liabilities based upon
incremental 100 basis point changes in interest rates from interest rates
in effect on June 30, 1998.
Interest rates could fluctuate in a range of more than 200 basis points up
or down from where the rates were on June 30, 1998 due to the influence of
many unforseen factors not now known to HMN's management.
HMN's actual market value changes for interest earnings assets and
interest bearing liabilities may differ from the projected market values
disclosed in the table mentioned above. Certain shortcomings are inherent
in the method of analysis in the table. 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. The model
assumes that the difference between the current interest rate being earned
or paid compared to a treasury instrument or other interest rate index
with a similar term to maturity (the Interest Spread) will remain constant
over the interest changes disclosed in the table. Changes in Interest
Spread could impact projected market value changes. Certain assets, such
as ARMs, have features which restrict changes in interest rates on a
short-term basis and over the life of the assets. The market value of the
interest-bearing assets which are approaching their life time interest
rate caps could be different from
24
<PAGE>
the values disclosed in the table. In the event of a change in interest
rates, prepayment and early withdrawal levels may 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.
ASSET/LIABILITY MANAGEMENT
HMN's management reviews the impact that changing interest rates will have
on its net interest income projected for the twelve months following June
30, 1998 to determine if its current level of interest rate risk is
acceptable. The following table projects the estimated impact on the net
interest income of immediate interest rate changes called rate shock.
HMN's actual net interest income caused by interest rate changes may
differ from the amounts reflected in the table which projects the
estimated impact on net interest income of immediate interest rate changes
called rate shocks. Certain shortcomings are inherent in the method of
analysis presented in the table. 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 a substantial increase in interest rates and could impact net interest
income.
The table sets forth the interest rate sensitivity of HMN's assets and
liabilities at June 30, 1998, using certain assumptions that described in
more detail below: (A Maturity or Repricing table is presented in the
Asset/Liability Management section.)
HMN's actual maturity and repricing results of its interest-earning assets
and interest-bearing liabilities may differ from the amounts reflected in
the gap table. Certain shortcomings are inherent in the method of
analysis presented in the table. 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 a substantial increase in interest rates and could impact the payment
streams on loans. Substantial changes in interest rates could also impact
the early withdrawal assumptions on certificates and other deposit
accounts.
YEAR 2000 ISSUES
HMN has inventoried its computer hardware, computer software, third party
vendors and its other non computer equipment and has assessed or is in the
process of assessing whether the items are year 2000 compliant. The
hardware testing has been completed and all non compliant hardware is
scheduled for replacement during the fourth quarter of 1998 at a total
estimated cost of $75,000. The computer software inventory indicated that
certain programs were not compliant and those programs are scheduled to be
replaced with year 2000 compliant software during the remainder of 1998
and through the second quarter of 1999 at an anticipated cost of $80,000.
HMN will also test all computer software to determine that the software is
year 2000 compliant. Actual testing of the software is scheduled to be
completed during November of 1998. The assessment of non computer
equipment for year 2000 compliance indicated that HMN did not have any
issues in this area.
The majority of the Bank's loan and deposit data is supported by a third
party data processing center. Other third party providers support the
automated teller machines owned by the Bank and process the check
clearings for the Bank's negotiable order of withdrawal accounts
("checking accounts"). The Bank is also reliant upon the Federal Home
Loan Bank of Des Moines and the Federal Reserve System to properly and
efficiently conduct its business. Notwithstanding the Bank's efforts, the
failure of any of these third party vendors to address their year 2000
issues in a timely fashion may have an adverse effect on the Bank's
ability to conduct its business. The Bank's Year 2000 Committee (the
"Committee") is working very closely with its data processing center to
ascertain that all software applications and hardware will be year 2000
compliant by the first or second quarter of
25
<PAGE>
1999. The Committee is also monitoring the progress other key third party
providers are making toward becoming year 2000 compliant.
While HMN has inventoried and assessed its hardware, software and other
non computer equipment other unforseen issues may come to light in the
future with the above mentioned items that would cause HMN to incur
additional costs in order to become year 2000 compliant.
While HMN has identified and assessed the year 2000 risks related to each
of its major third party vendors and providers, it is monitoring their
activities related to becoming year 2000 compliant. It is still possible
that the vendors and providers may not be year 2000 compliant and the
contingency plan that HMN is developing would not have anticipated the
problem. An example of this situation would be if all the telephone
communication lines became in operative because of a year 2000 issue on
September 9, 1999, the Bank would not be able to process its daily
activity and servicing its customers would be difficult without the
communication lines for any extended period of time. It would be
difficult to have a contingency plan that would allow the Bank to conduct
its business without using the communication lines to transmit its
business activity.
26
<PAGE>
<PAGE>
HMN FINANCIAL, INC.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings.
None.
ITEM 2. Changes in Securities.
Not applicable
ITEM 3. Defaults Upon Senior Securities.
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders.
The Annual Meeting of Stockholders of the Company was held on April
28, 1998 at 10:00 a.m..
The following is a record of the votes cast in the election of two
directors of the Company each with a term to expire in 2001:
BROKER
FOR VOTE WITHHELD NON-VOTES
---------- ------------- ----------
M.F. Schumann 3,156,259 422,320 --
Roger P. Weise 3,152,463 426,116 --
Accordingly, the individuals named above were declared to be duly
elected directors of the Company for terms to expire in 2001,
respectively.
Terms for directors continuing in office are as follows:
TERM EXPIRES
--------------
James B. Gardner 1999
Timothy R. Geisler 1999
Duane D. Benson 2000
Irma R. Rathbun 2000
The following is a record of the votes cast in respect of the
proposal to amend the Company's Certificate of Incorporation,
increasing the number of authorized share of Common Stock from 7
million to 11 million.
NUMBER PERCENTAGE OF VOTES
OF VOTES ACTUALLY CAST
------------ -------------------
FOR 3,443,833 96.24%
AGAINST 110,631 3.09%
ABSTAIN 24,115 .67%
BROKER
NON-VOTES -- 0%
27
<PAGE>
Accordingly, the proposal described above was declared to be duly
adopted by the stockholders of the Company.
The following is a record of the votes cast in respect of the
proposal to ratify the appointment of KPMG Peat Marwick, LLP as the
Company's auditors for the fiscal year ending December 31, 1998.
NUMBER PERCENTAGE OF VOTES
OF VOTES ACTUALLY CAST
------------ -------------------
FOR 3,568,214 99.71%
AGAINST 8,825 .25%
ABSTAIN 1,540 .04%
BROKER
NON-VOTES -- 0%
Accordingly, the proposal described above was declared to be duly
adopted by the stockholders of the Company.
ITEM 5. Other Information.
None.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. See Index to Exhibits on page 30 of this report.
28
<PAGE>
<PAGE>
SIGNATURES
Pursuant to the requirement 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.
Registrant
Date: 8/13/98 /s/ Roger P. Weise
Roger P. Weise,
Chairman, President and
Chief Executive Officer
(Duly Authorized Officer)
Date: 8/13/98 /s/ James B. Gardner
James B. Gardner,
Executive Vice President
(Principal Financial Officer)
29
<PAGE>
<PAGE>
HMN FINANCIAL, INC.
INDEX TO EXHIBITS
FOR FORM 10-Q
Reference Sequential
to Prior Page Numbering
Regulation Filing or Where Attached
S-K Exhibit Exhibits Are
Exhibit Number Located in This
Number Document Attached Hereto Form 10-Q Report
- --------------- ---------------------------- -------------- ------------------
2 Plan of acquisition, reorganization, N/A N/A
arrangement, liquidation or succession.
3(a) Articles of Incorporation *5 N/A
3(b) By-laws *4 N/A
4 Instruments defining the rights of *1 N/A
security holders, Including indentures
5(a) Amendment to the Home Federal Savings *3 N/A
Bank Employees' Savings & Profit Sharing
Plan dated January 28, 1997.
5(b) Amendment to the Adoption Agreement for *3 N/A
Home Federal Savings Bank Employees'
Savings & Profit Sharing Plan and
Trust effective June 17, 1997.
10.1(a) Employment agreement for Mr. Weise *2 N/A
dated June 29, 1994
10.1(b) Extension of employment agreement to 10.1(b) Filed
date of May Board Meeting in May 2001 electronically
10.2(a) Employment agreement for Mr. Gardner *2 N/A
dated June 29, 1994
10.2(b) Extension of employment agreement to 10.2(b) Filed
date of May Board Meeting in May 2001 electronically
11 Computation of Earnings Per Common 11 Filed
Share electronically
27 Financial Data Schedule 27 Filed
electronically
99.1 Financial Statements for Home *6 N/A
Federal Savings Bank Employees'
Savings and Profit Sharing Plan
*1 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.
*2 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.
*3 Filed as an exhibit to the Registrant's Form 10-Q for June 30, 1997
(file no. 0-24100). All previously filed documents are hereby
incorporated by reference in accordance with Item 601 of Regulation
S-K.
*4 Filed as an exhibit to Registrant's Form 10-Q for September 30, 1997
(file no. 0-24100). All previously filed documents are hereby
incorporated by reference in accordance with Item 601 of Regulation
S-K.
*5 Filed as an exhibit to Registrant's Form 10-Q for March 31, 1998
(file no. 0-24100). All previously filed documents are hereby
incorporated by reference in accordance with Item 601 of Regulation
S-K.
*6 Filed as Form 11-K for December 31, 1997 on June 29, 1998 (file no.
0-24100).
30
MEMORANDUM
TO: Roxanne M. Hellickson,
Vice President/Corporate Secretary
FROM: Home Federal Savings Bank
DATE: July 29, 1998
RE: Notice of Extension of Employment Contract
- ----------------------------------------------------------------
The Board of Directors (the Board) of Home Federal Savings Bank
has reviewed your formal performance evaluation performed by
selected members of the Board. In connection therewith and
pursuant to Section 1 of your contract, on May 19, 1998, the
Board determined to extend your employment contract until the May
Board Meeting, 2001.
HOME FEDERAL SAVINGS BANK
By: /s/ M.F. Schumann
---------------------------
M.F. Schumann
EMPLOYEE ACKNOWLEDGMENT
I hereby acknowledge receipt of this notice of extension of
the above-referenced agreement and accept the extension of the
term of such agreement.
EMPLOYEE
Dated: 7-29-98 By: /s/ Roger P. Weise
--------------------- ------------------------
(Correction from 5-19-98) Roger P. Weise
MEMORANDUM
TO: Roxanne M. Hellickson,
Vice President/Corporate Secretary
FROM: Home Federal Savings Bank
DATE: July 29, 1998
RE: Notice of Extension of Employment Contract
- ----------------------------------------------------------------
The Board of Directors (the Board) of Home Federal Savings Bank
has reviewed your formal performance evaluation performed by
selected members of the Board. In connection therewith and
pursuant to Section 1 of your contract, on May 19, 1998, the
Board determined to extend your employment contract until the May
Board Meeting, 2001.
HOME FEDERAL SAVINGS BANK
By: /s/ M.F. Schumann
---------------------------
M.F. Schumann
EMPLOYEE ACKNOWLEDGMENT
I hereby acknowledge receipt of this notice of extension of
the above-referenced agreement and accept the extension of the
term of such agreement.
EMPLOYEE
Dated: 7-29-98 By: /s/ James B. Gardner
--------------------- ------------------------
(Correction from 5-19-98) James B. Gardner
Exhibit 11 - Computation of Earnings Per Common Share
HMN Financial, Inc.
Computation of Earnings Per Common Share
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -----------------------
Computation of Earnings
Per Common Share: 1998 1997 1998 1997
------------------------- -----------------------
Weighted average number
of common shares out-
standing used in basic
earnings per common
share calculation 5,051,205 5,513,223 5,248,262 5,531,618
Net dilutive effect of:
Options 379,759 277,298 391,398 266,195
Restricted stock awards 54,197 79,611 57,773 81,548
--------- --------- --------- ---------
Weighted average number
of shares outstanding
adjusted for effect of
dilutive securities 5,485,161 5,870,132 5,697,433 5,879,361
========= ========= ========= =========
Income available to
common shareholders $ 784,030 1,332,220 2,447,385 2,806,700
Basic earnings per
common share $ 0.16 0.24 0.47 0.51
Diluted earnings per
common share $ 0.14 0.23 0.43 0.48
The earnings per share calculations reflected above are presented as if the
split had been completed at the beginning of each period presented for the
weighted average number of shares outstanding for each period.
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AT JUNE 30, 1998 AND DECEMBER 31, 1997 AND THE
CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE
30, 1998 AND 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 9,243
<INT-BEARING-DEPOSITS> 0
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 211,369
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<COMMON> 91
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<LOANS-NON> 317
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