<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[NO FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM _____ TO ______
COMMISSION FILE NUMBER 0-24100.
HMN FINANCIAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 41-1777397
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
101 NORTH BROADWAY, PO BOX 231 55975-0231
SPRING VALLEY, MINNESOTA (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (507) 346-1100
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(TITLE OF CLASS)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
requirements for the past 90 days. YES X NO
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [X]
As of March 19, 1998, the Registrant had issued and outstanding 4,144,368
shares of the Registrant's Common Stock. The aggregate market value of the
voting stock held by non-affiliates of the Registrant as of March 19, 1998 was
$97.8 million. (The exclusion from such amount of the market value of the
shares owned by any person shall not be deemed an admission by the Registrant
that such person is an affiliate of the Registrant.)
DOCUMENTS INCORPORATED BY REFERENCE
Parts of the Registrant's Annual Report for the year ended December 31, 1997,
are incorporated by reference in Parts II and IV of this Form 10-K. Parts of
the Registrant's Proxy Statement dated March 30, 1998, are incorporated by
reference in Part III of this Form 10-K.
<PAGE>
TABLE OF CONTENTS
PART I
<TABLE>
PAGE
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<S> <C>
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . 3
General . . . . . . . . . . . . . . . . . . . . . . 3
Lending Activities . . . . . . . . . . . . . . . . 4
Investment Activities . . . . . . . . . . . . . . 21
Sources of Funds . . . . . . . . . . . . . . . . 25
Other Information
Service Corporations . . . . . . . . . . . . . 29
Competition . . . . . . . . . . . . . . . . . 29
Employees . . . . . . . . . . . . . . . . . . 30
Executive Officers . . . . . . . . . . . . . . 30
Regulation . . . . . . . . . . . . . . . . . . . 30
Taxation . . . . . . . . . . . . . . . . . . . . 40
Item 2. Properties . . . . . . . . . . . . . . . . . . . . 42
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . 43
Item 4. Submission of Matters to a Vote of Security Holders 43
PART II
Item 5. Market for the Registrant's Common Stock and
Related Stockholder Matters . . . . . . . . . . . 43
Item 6. Selected Financial Data . . . . . . . . . . . . . . 43
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . 43
Item 7A. Quantitative and Qualitative Disclosure About
Market Risk. . . . . . . . . . . . . . . . . . . . 43
Item 8. Financial Statements and Supplementary Data . . . . 44
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure . . . . . . . 44
PART III
Item 10. Directors and Executive Officers of the
Registrant . . . . . . . . . . . . . . . . . . . . 44
Item 11. Executive Compensation . . . . . . . . . . . . . . 44
Item 12. Security Ownership of Certain Beneficial Owners
and Management . . . . . . . . . . . . . . . . . . 44
Item 13. Certain Relationships and Related Transactions . . . 44
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K . . . . . . . . . . . . . . . 45
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . 48
Index to Exhibits . . . . . . . . . . . . . . . . . . . . . . 49
</TABLE>
2
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
HMN Financial, Inc. ("HMN" or the "Corporation"), was incorporated under
the laws of the State of Delaware in March 1994 for the purpose of becoming the
savings and loan holding company of Home Federal Savings Bank ("Home Federal" or
the "Bank") in connection with the Bank's conversion from a federally chartered
mutual savings bank to a federally chartered stock savings bank. 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.
On December 5, 1997 HMN, through its wholly owned subsidiary, the Bank,
completed its merger with Marshalltown Financial Corporation (MFC) pursuant
to a merger agreement dated July 1, 1997. Refer to Note 2 of the Notes to
Consolidated Financial Statements in the Annual Report for information on
assets acquired in the merger, HMN's Current Report on Form 8-K dated
December 5, 1997, filed on December 10, 1997 (file no. 0-24100) for a copy of
the merger agreement and HMN's Current Report on Form 8-K dated December 5,
1997, filed on February 11, 1998 (file no. 0-24100) for a copy of financial
statements of the acquired company and pro forma financial information.
As a community-oriented financial institution, HMN seeks to serve the
financial needs of communities in its market area. HMN's business involves
attracting deposits from the general public and using such deposits to originate
or purchase one-to-four family residential mortgage loans and, to a lesser
extent, consumer, construction, commercial real estate, commercial business and
multi-family loans. HMN also invests in mortgage-backed and related securities,
investment securities (consisting primarily of U.S. government and government
agency obligations) and other permissible investments. The executive offices of
HMN are located at 101 N. Broadway, PO Box 231, Spring Valley, Minnesota 55975-
0231. It's telephone number at that address is (507) 346-1100.
MARKET AREA
HMN serves the Minnesota counties of Fillmore, Freeborn, Houston, Mower,
Olmsted and Winona and portions of Steele, Dodge, Goodhue and Wabasha Counties,
Minnesota, through its main office located in Spring Valley, Minnesota and its
six branch offices located in Albert Lea, Austin, LaCrescent, Rochester and
Winona, Minnesota. The portion of HMN's market area consisting of Rochester and
the contiguous communities is composed of primarily urban and suburban
communities, while the balance of HMN's market area consists primarily of rural
areas and small towns. Primary industries in HMN's market area include
manufacturing, agriculture, health care, wholesale and retail trade, service
industries and education. Major employers include IBM, the Mayo Clinic, Hormel,
a food processing company, and various small industrial and other companies.
HMN's market area is also the home of Winona State University, Rochester
Community College, Austin Community College and several vocational/technical
schools.
HMN serves the Iowa counties of Marshall and Tama through its branch offices
located in Marshalltown and Toledo. Major industries in the area are Swift &
Company pork - processors, Fisher Controls Int. - valve and regulator
manufacturing, Lennox Industries - furnace and air conditioner manufacturing,
Iowa Veterans Home - hospital care, Marshall Community School District -
education, Marshall Medical & Surgical Center - hospital care and Meskwaki
Casino - gaming operation.
3
<PAGE>
Based upon 1990 census information, the population of the six primary counties
in the Bank's market area was as follows: Fillmore - 20,800; Freeborn - 33,000;
Houston - 18,500; Mower - 37,300; Olmsted - 101,000; and Winona - 47,900. Based
upon 1990 U.S. Department of Commerce information, per capita income in these
six counties ranged from approximately $15,000 to $21,000.
Based upon 1990 census information, the population of Marshall County was
38,280 and the population of Tama County was 17,419. Based upon 1990 U.S.
Department of Commerce information, per capita income of the above mentioned
Iowa counties ranged from $11,300 to $12,800.
During the fourth quarter of 1996, HMN opened a mortgage banking office in
Edina, Minnesota which has subsequently moved to Eden Prairie. The office
primarily purchases loans from third party originators located in the seven
county metropolitan area of Minneapolis and St. Paul and sells the loans in the
secondary market or place the loans in HMN's loan portfolio. The new office
also purchases mortgage servicing rights from third parties for the purpose of
generating loan servicing income.
LENDING ACTIVITIES
GENERAL. Historically, the Bank originated 30-year, fixed-rate mortgage loans
secured by one-to-four family residences. Since 1979, in order to reduce its
vulnerability to changes in interest rates, the Bank has emphasized the
origination or purchase of mortgage loans having shorter terms to maturity or
repricing, such as 15-year, fixed-rate residential loans, Adjustable Rate
Mortgage loans ("ARMs") and Graduated Equity Mortgage loans ("GEMs"). Starting
in 1995 and throughout 1997 HMN offered a competitive home equity line of
credit. HMN also offers consumer loans and, to a lesser extent, construction,
commercial real estate, multi-family and commercial business loans. See "-
Originations, Purchases and Sales of Loans and Mortgage-Backed and Related
Securities."
4
<PAGE>
LOAN PORTFOLIO COMPOSITION. The following information concerning the
composition of HMN's loan portfolio in dollar amounts and in percentages (before
deductions for loans in process, deferred fees and discounts and allowances for
losses) as of the dates indicated.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------ ------------------ --------------------- ----------------- -----------------
(DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
-------- ------- -------- ------- ------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
REAL ESTATE LOANS:
One-to-four family . . . $395,668 87.58% $321,340 90.19% $292,497 90.62% $252,943 91.14% $233,009 92.18%
Multi-family . . . . . . 2,717 0.60 280 0.08 361 0.11 311 0.11 349 0.14
Commercial . . . . . . . 10,572 2.34 7,918 2.22 8,744 2.71 8,316 3.00 4,559 1.80
Construction or
development . . . . . 5,725 1.27 3,474 0.98 5,082 1.58 2,799 1.01 3,309 1.31
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total real estate
loans . . . . . . . 414,682 91.79 333,012 93.47 306,684 95.02 264,369 95.26 241,226 95.43
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
OTHER LOANS:
Consumer loans:
Savings account . . . . 1,362 0.30 938 0.26 1,210 0.37 648 0.23 872 0.34
Education . . . . . . . 123 0.03 467 0.13 342 0.11 2,007 0.72 1,819 0.72
Automobile . . . . . . 2,438 0.54 566 0.16 671 0.21 520 0.19 681 0.27
Home equity line . . . 19,490 4.31 11,881 3.33 3,509 1.09 0 0.00 0 0.00
Home equity . . . . . . 7,176 1.59 5,927 1.67 7,997 2.47 7,716 2.78 5,604 2.22
Home improvement . . . 652 0.14 585 0.16 785 0.24 870 0.31 912 0.36
Other . . . . . . . . . 624 0.14 568 0.16 545 0.17 502 0.19 586 0.23
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total consumer loans 31,865 7.05 20,932 5.87 15,059 4.66 12,263 4.42 10,474 4.14
Commercial business
loans . . . . . . . . 5,226 1.16 2,344 0.66 1,018 0.32 897 0.32 1,089 0.43
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total other loans . . 37,091 8.21 23,276 6.53 16,077 4.98 13,160 4.74 11,563 4.57
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total loans . . . 451,773 100.00% 356,288 100.00% 322,761 100.00% 277,529 100.00% 252,789 100.00%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
LESS:
Loans in process . . . . 4,562 2,814 3,531 2,327 2,333
Unamortized discounts . 547 417 289 162 14
Net deferred loan fees . 1,847 1,695 1,899 2,147 2,507
Allowance for losses on
loans . . . . . . . . 2,748 2,340 2,191 1,893 1,489
-------- -------- -------- -------- --------
Total loans
receivable, net $442,069 $349,022 $314,851 $271,000 $246,446
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
5
<PAGE>
The following table shows the composition of HMN's loan portfolio by
fixed and adjustable rate at the dates indicated.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
---------------- ---------------- ---------------- ---------------- ----------------
(DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ ------- ------ ------- ------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
FIXED-RATE LOANS
Real estate:
One-to-four family
GEM . . . . . . . . . . . . $ 53,258 11.79% $ 48,831 13.71% $ 30,175 9.35% $ 24,769 8.93% $ 22,304 8.83%
Other . . . . . . . . . . . 256,263 56.72 187,519 52.63 181,401 56.20 168,272 60.63 171,503 67.84
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total one-to-four family . 309,521 68.51 236,350 66.34 211,576 65.55 193,041 69.56 193,807 76.67
Multi-family . . . . . . . . 2,490 0.55 223 0.06 302 0.10 311 0.11 349 0.13
Commercial . . . . . . . . . 1,914 0.42 1,276 0.36 1,518 0.47 1,612 0.58 626 0.25
Construction or development . 3,180 0.71 2,970 0.83 4,848 1.50 1,008 0.37 2,800 1.11
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total fixed-rate real
estate loans . . . . . . 317,105 70.19 240,819 67.59 218,244 67.62 195,972 70.62 197,582 78.16
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Consumer loans:
Savings . . . . . . . . . . . 1,362 0.30 938 0.26 1,210 0.37 648 0.23 872 0.34
Education . . . . . . . . . . 0 0.00 434 0.12 299 0.09 1,278 0.46 1,819 0.72
Automobile . . . . . . . . . 2,437 0.54 566 0.16 671 0.21 520 0.19 681 0.27
Home equity . . . . . . . . . 6,701 1.48 5,338 1.50 7,254 2.25 7,258 2.62 5,604 2.22
Home improvement . . . . . . 652 0.14 585 0.16 785 0.24 870 0.31 912 0.36
Other . . . . . . . . . . . . 612 0.14 568 0.16 545 0.17 502 0.18 586 0.23
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total consumer loans . . . 11,764 2.60 8,429 2.36 10,764 3.33 11,076 3.99 10,474 4.14
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Commercial business loans . . 5,226 1.16 1,344 0.38 1,018 0.32 897 0.32 1,089 0.43
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total other loans . . . . . 16,990 3.76 9,773 2.74 11,782 3.65 11,973 4.31 11,563 4.57
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total fixed-rate loans . . 334,095 73.95 250,592 70.33 230,026 71.27 207,945 74.93 209,145 82.73
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
ADJUSTABLE-RATE LOANS
Real estate:
One-to-four family . . . . . 86,147 19.07 84,990 23.85 80,921 25.07 59,901 21.58 39,202 15.51
Multi-family . . . . . . . . 227 0.05 57 0.02 59 0.02 0 0.00 0 0.00
Commercial . . . . . . . . . 8,658 1.92 6,642 1.87 7,226 2.24 6,704 2.42 3,933 1.56
Construction or development . 2,545 0.56 504 0.14 234 0.07 1,792 0.64 509 0.20
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total adjustable-rate real
estate loans . . . . . . 97,577 21.60 92,193 25.88 88,440 27.40 68,397 24.64 43,644 17.27
Consumer . . . . . . . . . . . 20,101 4.45 12,503 3.51 4,295 1.33 1,187 0.43 0 0.00
Commercial business loans . . 0 0.00 1,000 0.28 0 0.00 0 0.00 0 0.00
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total adjustable-rate loans 117,678 26.05 105,696 29.67 92,735 28.73 69,584 25.07 43,644 17.27
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
Total loans . . . . . . . . 451,773 100.00% 356,288 100.00% 322,761 100.00% 277,529 100.00% 252,789 100.00%
------ ------ ------ ------ ------
------- ------ ------- ------ ------- ------ ------- ------ ------- ------
LESS
Loans in process . . . . . . . 4,562 2,814 3,531 2,327 2,333
Unamortized discounts . . . . 547 417 289 162 14
Net deferred loan fees . . . . 1,847 1,695 1,899 2,147 2,507
Allowance for losses on loans 2,748 2,340 2,191 1,893 1,489
-------- -------- -------- -------- --------
Total loans receivable, net $442,069 $349,022 $314,851 $271,000 $246,446
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
</TABLE>
6
<PAGE>
The following schedule illustrates the interest rate sensitivity of
HMN's loan portfolio at December 31, 1997. Loans which have adjustable or
renegotiable interest rates are shown as maturing in the period during which
the contract is due. Scheduled repayments of principal are reflected in the
year in which they are scheduled to be paid.
<TABLE>
<CAPTION>
Real Estate
------------------------------------------------------
Multi-family and Commercial
One-to-four family Commercial Construction Consumer Business Total
------------------ ---------------- ---------------- ---------------- ----------------- ----------------
Weighted Weighted Weighted Weighted Weighted Weighted
Average Average Average Average Average Average
(DOLLARS IN Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate Amount Rate
THOUSANDS) ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- ------ --------
Due During
Years Ending
December 31,
------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1998(1) . . . . . . $ 23,133 7.31% $ 738 7.66% $ 1,018 8.73% $ 4,102 8.95% $ 946 8.66% $29,937 7.63%
1999 . . . . . . . 23,470 7.24 1,004 7.95 46 7.91 2,065 8.74 908 8.46 27,493 7.42
2000 . . . . . . . 23,334 7.19 794 7.66 57 7.91 1,705 8.65 1,179 8.72 27,069 7.36
2001 and 2002 . . . 46,695 7.31 1,879 8.37 151 7.92 2,224 8.66 1,138 8.12 52,087 7.43
2003 to 2007 . . . 116,578 7.35 4,398 8.55 609 7.93 21,343 8.99 1,055 10.21 143,983 7.65
2008 to 2022 . . . 146,861 7.52 4,476 7.95 3,139 7.83 426 9.23 0 0.00 154,902 7.54
2023 and following. 15,597 7.46 0 0.00 705 8.08 0 0.00 0 0.00 16,302 7.49
-------- ------- ------- ------- ------ -------
$395,668 $13,289 $ 5,725 $31,865 $5,226 $451,773
-------- ------- ------- ------- ------ -------
-------- ------- ------- ------- ------ -------
- - --------------------
</TABLE>
(1) Includes demand loans, loans having no stated maturity, overdraft loans
and education loans.
The total amount of loans due after December 31, 1999 which have
predetermined interest rates is $307.7 million, while the total amount of
loans due after such dates which have floating or adjustable interest rates
is $114.1 million. Construction or development loans for one-to-four family
dwellings totaled $3.3 million, multi-family totaled $1.0 million, and
non-residential totaled $1.4 million.
7
<PAGE>
Under the Financial Institutions Reform, Recovery and Enforcement Act of
1989 ("FIRREA"), the aggregate amount of loans that the Bank is permitted to
make to any one borrower is generally limited to 15% of unimpaired capital
and surplus (25% if the security for such loan has a "readily ascertainable"
value or 30% for certain residential development loans). At December 31,
1997, based upon the 15% limitation, the Bank's regulatory loans-to-one
borrower limit was approximately $9.2 million. On the same date, the Bank
had no borrowers with outstanding balances in excess of this amount. At
December 31, 1997, the largest dollar amount outstanding to one borrower or
group of related borrowers was $960,000. This loan, which is secured by a
commercial office building in Des Moines, was performing in accordance with
its terms at December 31, 1997.
The Bank's Loan Committee is responsible for review and approval of all
loans over the FHLMC/FNMA conforming loan dollar limits (the Limit)
originated by the Bank. At December 31, 1997 the Limit was $214,600. Approval
of one member of the Loan Committee is required on all loans ranging from the
Limit to $500,000. Loans greater than $500,000 must be approved by the Board
of Directors of the Bank or its Executive Committee after review and
preliminary approval by the Loan Committee. All loans closed each month are
reviewed by the Board of Directors at the monthly meeting.
Under the Bank's loan policy, the loan officer processing an application
is responsible for ensuring that all documentation is obtained prior to the
submission of the application to the Loan Committee. In addition, the loan
officer verifies that the application meets the Bank's underwriting
guidelines described below. Also, each application is assigned to a
reviewing officer who reviews the file to assure its accuracy and
completeness. The Branch Manager or the designated underwriter has the
authority to approve all conforming loans up to the Limit.
All of the Bank's lending is subject to its written underwriting
standards and to loan origination procedures. Decisions on loan applications
are made on the basis of detailed applications and property valuations
(consistent with the Bank's appraisal policy) by the Bank's staff appraiser
or an independent appraiser. The loan applications are designed primarily to
determine the borrower's ability to repay. The more significant items on the
application are verified through use of credit reports, financial statements,
tax returns and/or confirmations. During 1997 the Bank introduced the Home
Credit Plus Program which relies on the credit score of the loan applicant
instead of income, asset and employment verification procedures. The Bank
also offers low or alternative documentation underwriting procedures which
conform to FNMA underwriting guidelines.
Generally, the Bank requires title insurance on its mortgage loans as
well as fire and extended coverage casualty insurance in amounts at least
equal to the principal amount of the loan or the value of improvements on the
property, depending on the type of loan. The Bank also requires flood
insurance to protect the property securing its interest when the property is
located in a flood plain.
ONE-TO-FOUR FAMILY RESIDENTIAL REAL ESTATE LENDING. The cornerstone of
HMN's lending program is the origination of loans secured by mortgages on
owner-occupied one-to-four family residences. At December 31, 1997, $395.7
million, or 87.58% of HMN's loan portfolio consisted of mortgage loans on
one-to-four family residences. At December 31, 1997, $282.7 million of the
residential loan portfolio was secured by properties located in HMN's market
area. HMN had $120.0 million of purchased one-to-four family loans in its
portfolio which were secured by properties located outside of its market area
(primarily located in the Midwestern United States or the Southeastern United
States). On December 5, 1997 the Bank merged with Marshalltown Financial
Corporation ("MFC"). The Loan Portfolio Composition table includes for
December 31, 1997 $62.9 million of one-to-four family residential loans, $2.3
of multi-family residential, $2.1 million of commercial real estate and $2.6
million of consumer loans which were acquired in the MFC merger.
8
<PAGE>
Prior to 1979, the Bank originated for retention in its own portfolio
30-year fixed-rate loans secured by one-to-four family residential real
estate. Beginning in 1979, the Bank began to emphasize the origination of
fixed-rate loans with terms of 15 years or less for retention in its
portfolio. In addition, in 1982, the Bank began to originate ARMs, subject
to market conditions and consumer preference. Subsequently, the Bank also
began to emphasize GEM originations. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Asset/Liability
Management" in the Annual Report attached as Exhibit 13 hereto (the "Annual
Report").
HMN currently offers conventional fixed-rate loans with maximum terms of
up to 30 years although HMN generally sells originations of loans with terms
to maturity of 30 years. The interest rate on such loans is generally set
based on the FHLMC delivery rates, as well as, other competitive factors.
At December 31, 1997, HMN had $256.3 million of fixed-rate one-to-four family
loans (excluding GEM loans) or 56.72% of HMN's total loan portfolio with a
weighted average contractual term to maturity of 13.5 years.
HMN also offers one-year ARMs at a margin (generally 275 basis points)
over the yield on the Average Monthly One Year U.S. Treasury Constant
Maturity Index for terms of up to 30 years. The ARM loans currently offered
by HMN allow the borrower to select (subject to pricing) an initial period of
one year, three years, or five years between the loan origination and when
the first interest rate change occurs. Generally the ARMs provide for an up
to 200 basis point annual interest rate change cap and a lifetime cap
generally 600 basis points over or under the initial rate. Initial interest
rates offered on the ARM loans during 1997 ranged from 72 to 188 basis points
below the fully indexed loan rate. All borrowers are now qualified for the
loan at the fully indexed rate. See "-Delinquencies and Non-Performing
Assets." In the past, the Bank offered one-year ARMs with a margin of 200 to
235 basis points over a specified index and an average annual cap of 145
basis points. At December 31, 1997, one-to-four family ARMs totaled $86.1
million, or 19.07% of HMN's total loan portfolio.
HMN's originated ARMs do not permit negative amortization of principal,
do not contain prepayment penalties and generally are not convertible into
fixed-rate loans. HMN has $2.7 million of ARM loans purchased from a third
party which are convertible at borrower's option into fixed-rate loans. It
has an agreement with the third party to repurchase the ARM loans which
convert to fixed rates at a stipulated price.
The GEM loans carry required payments which increase after the first
year. Under the GEM loans, the monthly payments required for the first year
are established based on a 30-year amortization schedule. Depending upon the
program selected, the payments may increase in the succeeding years by
amounts ranging from 0% to 5%. Most of the GEM loans originated by HMN
provide for at least three annual payment increases over the first five years
of the loan. The increased payments required under GEM loans are applied to
principal and have the effect of shortening the term to maturity; the GEM
loans do not permit negative amortization. HMN currently offers two GEM
programs, one with a contractual maturity of approximately 17 years and one
with a contractual maturity of approximately 22 years. The GEMs are
generally priced based upon loans with similar contractual maturities. The
GEMs have been popular with consumers who anticipate future increases in
income and who desire an amortization schedule of less than 30 years. HMN
believes that GEMs may increase in popularity in the future if interest rates
rise and consumers are less easily able to afford the higher monthly payments
required by 15-year, fixed-rate loans.
HMN has also originated a limited number of fixed-rate loans with terms
up to 30 years which are insured by the Federal Housing Authority ("FHA"),
Veterans Administration ("VA") and Minnesota Home Finance Administration
("MHFA").
In underwriting one-to-four family residential real estate loans, HMN
evaluates both the borrower's ability to make principal, interest and escrow
payments, the value of the property that will secure the loan and debt to
income ratios. Properties securing one-to-four family residential real
estate loans made by HMN are appraised by independent fee appraisers or by
HMN's staff appraiser. HMN originates residential mortgage
9
<PAGE>
loans with loan-to-value ratios of up to 95% for owner-occupied homes and up
to 70% for non-owner occupied homes; however, private mortgage insurance is
required to reduce HMN's exposure to 80% or less. HMN generally seeks to
underwrite its loans in accordance with secondary market standards.
HMN's residential mortgage loans customarily include due-on-sale clauses
giving it the right to declare the loan immediately due and payable in the
event that, among other things, the borrower sells or otherwise disposes of
the property subject to the mortgage and the loan is not repaid.
CONSTRUCTION LENDING. HMN makes construction loans to individuals for
the construction of their residences, and to a much lesser extent, to
builders for the construction of one-to-four family residences. It also
makes a very limited number of loans to builders for houses built on
speculation. The loan policy limits the total amount of construction loans
outstanding at one time to 2.0% of assets. At December 31, 1997, HMN had
$5.7 million of construction loans outstanding representing 1.3% of HMN's
total loan portfolio.
Almost all loans to individuals for the construction of their residences
are structured as permanent loans. Such loans are made on the same terms as
residential loans, except that during the construction phase, which typically
lasts up to seven months, the borrower pays interest only. The borrower also
pays a construction fee up to $800 at the time of origination. Residential
construction loans are underwritten pursuant to the same guidelines used for
originating residential loans on existing properties.
Construction loans to builders or developers of one-to-four family
residences generally carry terms of up to 15 years with a construction phase
of up to seven months. Such loans generally do not permit the payment of
interest from loan proceeds. At December 31, 1997, HMN had no construction
loans to builders or developers.
Construction loans to owner occupants are generally made in amounts of
up to 95% of the lesser of cost or appraised value, but no more than 85% of
the loan proceeds can be disbursed until the building is completed. The
loan-to-value ratios on loans to builders are limited to 70%. Prior to
making a commitment to fund a construction loan, HMN requires an appraisal of
the property and financial data and verification of income on the borrower.
It generally obtains personal guarantees for substantially all of its
construction loans to builders. Personal financial statements of guarantors
are also obtained as part of the loan underwriting process. All construction
loans have been located in HMN's market area.
Construction loans are obtained principally through continued business
from builders and developers who have previously borrowed from the Bank, as
well as referrals from existing customers and walk-in customers. The
application process includes a submission to the Bank of accurate plans,
specifications and costs of the project to be constructed. These items are
used as a basis to determine the appraised value of the subject property.
The nature of construction loans is such that they are more difficult to
evaluate and monitor. The risk of loss on a construction loan is dependent
largely upon the accuracy of the initial estimate of the property's value
upon completion of the project and the estimated cost (including interest) of
the project. If the estimate of value proves to be inaccurate, HMN may be
confronted, at or prior to the maturity of the loan, with a project having a
value which is insufficient to assure full repayment and/or the possibility
of having to make substantial investments to complete and sell the project.
Because defaults in repayment may not occur during the construction period it
may be difficult to identify problem loans at an early stage. In such cases,
HMN may be required to modify the terms of the loan.
COMMERCIAL REAL ESTATE AND MULTI-FAMILY LENDING. HMN originates
permanent commercial real estate and multi-family loans secured by properties
located in its market area. It also purchases commercial real estate loans
outside of its market area that are guaranteed by the Small Business
Administration ("SBA") or originated by other third parties. At December 31,
1997, HMN had $10.6 million in commercial real
10
<PAGE>
estate loans, representing 2.3% of HMN's total loan portfolio, and $2.7
million in multi-family loans, or 0.6% of its total loan portfolio.
The commercial real estate and multi-family loan portfolio includes
loans secured by motels, apartment buildings, churches, small office
buildings, small business facilities, nursing homes and other non-residential
building properties primarily located in Minnesota or Iowa.
Permanent commercial real estate and multi-family loans are generally
originated for a maximum term of 15 years and generally have adjustable
interest rates. Prior to 1995 commercial real estate and multi-family loans
could have either a fixed interest rate or an adjustable interest rate.
Commercial real estate and multi-family loans are written in amounts of up to
70% of the lesser of the appraised value of the property or the purchase
price and must have a debt service coverage ratio of at least 125%. The debt
service coverage is the ratio of net cash from operations before payment of
debt to debt service. HMN does not originate construction loans secured by
commercial or multi-family real estate, but may purchase participation
interests in third party originated construction loans secured by commercial
or multi-family real estate.
Appraisals on properties serving commercial real estate and multi-family
loans originated by HMN are performed by independent appraisers prior to the
time the loan is made. Generally all appraisals on commercial and
multi-family real estate are reviewed by a member of the Bank's Loan
Committee. The Bank's underwriting procedures require verification of the
borrower's credit history, income and financial statements, banking
relationships, references and income projections for the property. It also
requires personal guarantees from the borrowers. In addition, HMN performs
an annual on-site inspection on collateral properties for loans with balances
in excess of $250,000.
At December 31, 1997, HMN's two largest commercial real estate loans
totaled $960,000 and $882,000. The first loan is secured by a commercial
office building located in Des Moines, Iowa and the second loan is secured by
a motel located in Rochester, Minnesota near the Mayo Clinic. Both of these
loans were performing at December 31, 1997.
Multi-family and commercial real estate loans generally present a higher
level of risk than loans secured by one-to-four family residences. This
greater risk is due to several factors, including the concentration of
principal in a limited number of loans and borrowers, the effects of general
economic conditions on income producing properties and the increased
difficulty of evaluating and monitoring these types of loans. Furthermore,
the repayment of loans secured by multi-family and commercial real estate is
typically dependent upon the successful operation of the related real estate
project. If the cash flow from the project is reduced (for example, if
leases are not obtained or renewed), the borrower's ability to repay the loan
may be impaired. At December 31, 1997, HMN had one commercial real estate
loan totaling $79,000 and no multi-family loans which were 90 days or more
delinquent.
CONSUMER LENDING. HMN originates a variety of different types of
consumer loans, including home equity loans (open-end and closed-end),
education, automobile, home improvement, deposit account and other loans for
household and personal purposes. At December 31, 1997, consumer loans
totaled $31.9 million, or 7.05% of total loans outstanding.
Consumer loan terms vary according to the type and value of collateral,
length of contract and creditworthiness of the borrower. HMN's consumer
loans are made at fixed and adjustable interest rates, with terms of up to 20
years for secured loans and up to three years for unsecured loans.
HMN's home equity loans are written so that the total commitment amount,
when combined with the balance of any other outstanding mortgage liens, may
not exceed 90% of the appraised value of the property. The closed-end home
equity loans are written with fixed or adjustable rates with terms of up to
15 years. The open-end home equity lines are written with an adjustable rate
with terms of up to 20 years, a 10 year
11
<PAGE>
draw period which requires "interest only" payments and a 10 year repayment
period which fully amortizes the outstanding balance. The consumer may access
the open-end home equity line either by making a withdrawal at the Bank or
writing a check on the home equity line of credit account. At December 31,
1997, HMN's home equity loans totaled $7.2 million, or 1.6% of the total loan
portfolio and the home equity lines totaled $19.5 million, or 4.3% of the
total loan portfolio.
The underwriting standards employed by the Bank for consumer loans
include a determination of the applicant's payment history on other debts and
ability to meet existing obligations and payments on the proposed loan.
Although creditworthiness of the applicant is of primary consideration, the
underwriting process also includes a comparison of the value of the security,
if any, in relation to the proposed loan amount. Consumer loans may entail
greater credit risk than do residential mortgage loans, particularly in the
case of consumer loans which are unsecured or are secured by rapidly
depreciable assets, such as automobiles. In such cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source
of repayment of the outstanding loan balance as a result of the greater
likelihood of damage, loss or depreciation. In addition, consumer loan
collections are dependent on the borrower's continuing financial stability,
and thus are more likely to be affected by adverse personal circumstances.
Furthermore, the application of various federal and state laws, including
bankruptcy and insolvency laws, may limit the amount which can be recovered
on such loans. At December 31, 1997, $44,000 of the consumer loan portfolio
was non-performing. There can be no assurance that delinquencies will not
increase in the future.
COMMERCIAL BUSINESS LENDING. In order to satisfy the demand for
financial services available to individuals and businesses in its market
area, HMN has maintained a portfolio of commercial business loans primarily
to small retail operations, small manufacturing concerns and professional
firms. Most of HMN's commercial business loans have terms ranging from six
months to five years and carry fixed interest rates. HMN's commercial
business loans generally include personal guarantees and are usually, but not
always, secured by business assets such as inventory, equipment, fixtures,
real estate and accounts receivables. The underwriting process for commercial
business loans includes consideration of the borrower's financial statements,
tax returns, projections of future business operations and inspection of the
subject collateral, if any. HMN has also purchased participation interests
in commercial business loans from third party originators. The underlying
collateral for the loans are generally equipment and generally have repayment
periods of less than ten years. At December 31, 1997, HMN had $5.2 million of
commercial business loans outstanding, or 1.3% of the total loan portfolio.
In addition, on that date, HMN had $20,000 of letters of credit outstanding.
Unlike residential mortgage loans, which generally are made on the basis
of the borrower's ability to make repayment from his or her employment and
other income, and which are secured by real property whose value tends to be
more easily ascertainable, commercial business loans are of higher risk and
typically are made on the basis of the borrower's ability to make repayment
from the cash flow of the borrower's business. As a result, the availability
of funds for the repayment of commercial business loans may be substantially
dependent on the success of the business itself. Further, the collateral
securing the loans may depreciate over time, may be difficult to appraise and
may fluctuate in value based on the success of the business. At December 31,
1997, there were no delinquent commercial business loans.
12
<PAGE>
ORIGINATIONS, PURCHASES AND SALES OF LOANS AND MORTGAGE-BACKED AND RELATED
SECURITIES
Real estate loans are generally originated by HMN's staff of salaried
and commissioned loan officers. Loan applications are taken and processed in
all branch offices.
While HMN originates both fixed and adjustable-rate loans, its ability
to originate loans is dependent upon the relative customer demand for loans
in its market. Demand is affected by the interest rate environment. During
the last several years, the dollar volume of conventional fixed-rate,
one-to-four family loans has exceeded the dollar volume of GEMs and ARMs.
Currently, substantially all residential mortgage loans originated by the
Bank are retained in the loan portfolio except 30 year fixed rate loans.
In order to supplement loan demand in HMN's market area and
geographically diversify its loan portfolio, HMN purchases real estate loans
from selected sellers, with yields based upon current market rates. HMN
carefully reviews and underwrites all loans to be purchased to ensure that
they meet HMN's underwriting standards. The seller generally continues to
service these purchased loans. During 1997, HMN originated $70.3 million of
real estate and consumer loans and it purchased $67.2 million of single
family residential loans originated outside of its market area. The majority
of the purchased loans have interest rates that are fixed for a one, three or
five year period and then adjust annually thereafter or were 15 year fixed
rate loans. All purchased loans are reviewed to determine that each loan
meets certain underwriting requirements. Refer to Note 5 of the Notes to
Consolidated Financial Statements in the Annual Report for more information
on purchased loans.
HMN has substantial holdings of mortgage-backed and related securities
which are held, depending on the investment intent, in the "available for
sale" portfolio. During 1997, HMN purchased $3.4 million of mortgaged-backed
securities and $24.0 million of mortgage-related securities, primarily CMOs.
See "- Investment Activities." During the same period, HMN sold $67.9
million of mortgage-backed and related securities.
13
<PAGE>
The following table shows the loan and mortgage-backed and related
securities origination, purchase, sale and repayment activities of HMN for the
periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
(DOLLARS IN THOUSANDS)
LOANS 1997 1996 1995
-------------------------
<S> <C> <C> <C>
ORIGINATIONS BY TYPE:
Adjustable-rate:
Real estate - one-to-four family . . . . . . . . $ 1,987 5,441 2,117
- multi-family . . . . . . . . . . . 0 0 58
- commercial . . . . . . . . . . . . 1,000 0 0
- construction or development . . . 375 916 691
Non-real estate - consumer . . . . . . . . . . . 16,871 12,012 4,575
--------- ------ ------
Total adjustable-rate . . . . . . . . . . 20,233 18,369 7,441
--------- ------ ------
Fixed-rate:
Real estate - one-to-four family . . . . . . . . 32,024 27,036 23,565
- multi-family . . . . . . . . . . . 263 145 0
- commercial . . . . . . . . . . . . 50 30 150
- construction or development . . . 6,539 6,181 4,847
Non-real estate - consumer . . . . . . . . . . . 7,579 4,583 7,267
- commercial business . . . . . 1,409 430 610
--------- ------ ------
Total fixed-rate . . . . . . . . . . . . . 47,864 38,405 36,439
--------- ------ ------
Total loans originated . . . . . . . . . . 68,097 56,774 43,880
--------- ------ ------
Purchases:
Real estate - one-to-four family . . . . . . . . 67,213 55,839 47,136
Commercial real estate guaranteed by SBA . . . . 0 0 946
Construction or development . . . . . . . . . . 2,425 0 0
Non-real estate - commercial business . . . . . 2,174 1,500 0
--------- ------ ------
Total purchased . . . . . . . . . . . . . 71,812 57,339 48,082
ACQUISITION:
Real estate - one-to-four family . . . . . . . . 63,328 0 0
- multi-family . . . . . . . . . . . 2,308 0 0
- commercial . . . . . . . . . . . . 2,099 0 0
Non-real estate - consumer . . . . . . . . . . . 2,599 0 0
--------- ------ ------
Total loans acquired . . . . . . . . . . . 70,334 0 0
TRANSFERS FROM LOANS HELD FOR SALE . . . . . . . . 96 0 0
SALES AND REPAYMENTS:
Real estate - one-to-four family . . . . . . . . 8,969 2,310 2,414
Non-real estate - consumer . . . . . . . . . . . 339 176 1,791
--------- ------ ------
Total sales . . . . . . . . . . . . . . . 9,308 2,486 4,205
Loans securitized and transferred to securities 16,526 15,441 0
Transfers to loans held for sale . . . . . . . . 21,211 1,407 0
Principal repayments . . . . . . . . . . . . . . 64,846 58,262 39,215
--------- ------ ------
Total reductions . . . . . . . . . . . . . 111,891 77,596 43,420
--------- ------ ------
Increase (decrease) in other items, net . . . . (2,963) (2,990) (3,310)
--------- ------ ------
Net increase . . . . . . . . . . . . . . . $ 95,485 33,527 45,232
--------- ------ ------
--------- ------ ------
MORTGAGE-BACKED AND RELATED SECURITIES
Loans securitized and transferred to $ 16,526 15,441 0
securities . . . . . . . . . . . . . . . .
PURCHASES:
Mortgage-backed securities:(1)
Adjustable-rate . . . . . . . . . . . . . . . . 0 0 0
Fixed-rate . . . . . . . . . . . . . . . . . . 3,426 7,266 10,139
CMOs and REMICs:
Adjustable-rate . . . . . . . . . . . . . . . . 3,417 6,527 55,321
Fixed-rate . . . . . . . . . . . . . . . . . . 20,617 43,831 11,881
--------- ------ ------
Total purchases . . . . . . . . . . . . . . 27,460 57,624 77,341
--------- ------ ------
ACQUISITION:
Adjustable rate . . . . . . . . . . . . . . . . 12,522 0 0
Fixed rate . . . . . . . . . . . . . . . . . . . 25,738 0 0
--------- ----- ------
Total acquisitions . . . . . . . . . . . . 38,260 0 0
--------- ------ ------
</TABLE>
14
<PAGE>
<TABLE>
<S> <C> <C> <C>
SALES:
Mortgage-backed securities:(1)
Adjustable-rate . . . . . . . . . . . . . . . . 9,535 0 23,073
Fixed-rate . . . . . . . . . . . . . . . . . . 344 24,786 11,953
CMOs and REMICs:
Adjustable-rate . . . . . . . . . . . . . . . . 26,486 23,876 9,008
Fixed-rate . . . . . . . . . . . . . . . . . . 31,529 32,487 13,681
--------- ------ ------
Total sales . . . . . . . . . . . . . . . . 67,894 81,149 57,715
--------- ------ ------
PRINCIPAL REPAYMENTS:
Decrease in other items, net . . . . . . . . . . 13,578 28,915 4,440
--------- ------ ------
Net increase (decrease) . . . . . . . . . . . $ 774 (36,999) 15,186
--------- ------ ------
--------- ------ ------
- - -------------------
</TABLE>
(1) Consists of pass-through securities.
15
<PAGE>
DELINQUENCIES AND NON-PERFORMING ASSETS
DELINQUENCY PROCEDURES. When a borrower fails to make a required
payment on a loan, HMN attempts to cure the delinquency by contacting the
borrower. A late notice is sent on all loans over 16 days delinquent.
Additional written and verbal contacts may be made with the borrower between
30 and 60 days after the due date. If the loan is contractually delinquent
90 days, HMN usually sends a 30-day demand letter to the borrower and, after
the loan is contractually delinquent 120 days, institutes appropriate action
to foreclose on the property. If foreclosed, the property is sold at a
sheriff's sale and may be purchased by HMN. Delinquent consumer loans are
generally handled in a similar manner. HMN's procedures for repossession and
sale of consumer collateral are subject to various requirements under state
consumer protection laws.
Real estate acquired by HMN as a result of foreclosure or by deed in
lieu of foreclosure is classified as real estate in judgement for six months
to one year and thereafter as real estate owned until it is sold. When
property is acquired or expected to be acquired by foreclosure or deed in
lieu of foreclosure, it is recorded at the lower of cost or estimated fair
value, less the estimated cost of disposition. After acquisition, all costs
incurred in maintaining the property are expensed. Costs relating to the
development and improvement of the property, however, are capitalized to the
extent of fair value less disposition cost.
The following table sets forth HMN's loan delinquencies by type, by
amount and by percentage of type at December 31, 1997.
<TABLE>
<CAPTION>
Loans Delinquent For:
------------------------------------------------------------------- Total Delinquent
60-89 Days 90 Days and Over Loans
------------------------------ ------------------------------- ----------------------------
Percent Percent Percent
of Loan of Loan of Loan
(DOLLARS IN THOUSANDS) Number Amount Category Number Amount Category Number Amount Category
------ ------ -------- ------ ------ -------- ------ ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
One-to-four family
real estate . . . . 5 $ 412 0.10 % 8 $ 541 0.14% 13 $ 953 0.24%
Multi-family . . . . 0 0 0.00 0 0 0.00 0 0 0.00
Commercial . . . . . 0 0 0.00 1 79 0.75 1 79 0.75
Construction or
development . . . . 0 0 0.00 0 0 0.00 0 0 0.00
Consumer . . . . . . 3 26 0.08 6 45 0.14 9 71 0.22
Commercial
business . . . . . . 0 0 0.00 0 0 0.00 0 0 0.00
--- ----- --- ----- --- ------
Total . . . . . . 8 $ 438 0.10 % 15 $ 665 0.15% 23 $1,103 0.24%
--- ----- --- ----- --- ------
--- ----- --- ----- --- ------
</TABLE>
CLASSIFICATION OF ASSETS. Federal regulations require that each savings
institution classify its own assets on a regular basis. In addition, in
connection with examinations of savings institutions, OTS and FDIC examiners
have authority to identify problem assets and, if appropriate, require them
to be classified. There are three classifications for problem assets:
Substandard, Doubtful and Loss. Substandard assets have one or more defined
weaknesses and are characterized by the distinct possibility that the Bank
will sustain some loss if the deficiencies are not corrected. Doubtful
assets have the weaknesses of Substandard assets, with the additional
characteristics that the weaknesses make collection or liquidation in full on
the basis of currently existing facts, conditions and values questionable,
and there is a high possibility of loss. An asset classified as Loss is
considered uncollectible and of such little value that continuance as an
asset on the balance sheet of the institution is not warranted. Assets
classified as Substandard or Doubtful require the institution to establish
prudent general allowances for loan losses. If an asset or portion thereof is
classified as Loss, the institution must either establish specific allowances
for loan losses in the amount of 100% of the portion of the asset classified
as Loss, or charge off such amount. If an institution does not agree with an
examiner's classification of an asset, it may appeal this determination to
the District Director of the OTS. On the basis of management's review of its
assets, at December 31, 1997, the Bank had classified a total of $901,000 of
its loans and other assets as follows:
16
<PAGE>
<TABLE>
<CAPTION>
One-to- Commercial Real
(DOLLARS IN Four Construction or Estate and Commercial
THOUSANDS) Family Development Multi-Family Consumer Business
------- --------------- ---------------- -------- ----------
<S> <C> <C> <C> <C> <C>
Substandard . . . . . $ 722 0 79 53 45
Doubtful . . . . . . 0 0 0 0 0
Loss . . . . . . . . 0 0 0 2 0
--- --- --- --- ---
Total . . . . . . $ 722 0 79 55 45
--- --- --- --- ---
--- --- --- --- ---
</TABLE>
The Bank's classified assets consist of the non-performing loans and
loans and other assets of concern discussed herein. As of the date hereof,
these asset classifications are materially consistent with those of the OTS
and FDIC.
NON-PERFORMING ASSETS. Loans are reviewed quarterly and any loan
whose collectibility is doubtful is placed on non-accrual status. Loans are
placed on nonaccrual status when either principal or interest is 90 days or
more past due, unless, in the judgment of management, the loan is well
collateralized and in the process of collection. Interest accrued and unpaid
at the time a loan is placed on non-accrual status is charged against
interest income. Subsequent payments are either applied to the outstanding
principal balance or recorded as interest income, depending on the assessment
of the ultimate collectibility of the loan. Restructured loans include the
Bank's troubled debt restructurings (which involved forgiving a portion of
interest or principal on any loans or making loans at a rate materially less
than the market rate). Foreclosed assets include assets acquired in
settlement of loans. The following table sets forth the amounts and
categories of non-performing assets in the Bank's portfolio.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995 1994 1993
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Non-accruing loans:
Real estate:
One-to-four family . . . . . $ 177 235 196 178 80
Multi-family . . . . . . . . 0 0 0 0 0
Commercial real estate . . . 79 83 85 0 0
Consumer . . . . . . . . . . 7 7 32 57 58
Commercial business . . . . 0 13 128 0
--- --- --- --- ---
Total . . . . . . . . . . 263 338 441 235 138
--- --- --- --- ---
Accruing loans delinquent 90
One-to-four family . . . . . 365 0 0 0 23
Consumer . . . . . . . . . . 37 0 0 0 0
--- --- --- --- ---
Total . . . . . . . . . . 402 0 0 0 23
--- --- --- --- ---
Restructured loans:
Multi-family . . . . . . . . 0 0 94 199 0
Foreclosed assets:
Real estate:
One-to-four family . . . . . 142 23 315 64 316
Commercial real estate . . . 0 0 0 0 95
Construction or development 0 0 0 0 0
Consumer . . . . . . . . . . 0 0 0 0 10
--- --- --- --- ---
Total . . . . . . . . . . 142 23 315 64 421
--- --- --- --- ---
Total non-performing assets . . $ 807 361 850 498 582
--- --- --- --- ---
--- --- --- --- ---
Total as a percentage of total
assets . . . . . . . . . . . . 0.12 % 0.07 % 0.16 % 0.10 % 0.14%
---- ---- ---- ---- ----
---- ---- ---- ---- ----
Total non-performing loans . . $ 665 $ 338 $ 535 $ 434 $ 161
---- ---- ---- ---- ----
---- ---- ---- ---- ----
Total as a percentage of total
loans receivable, net . . . . 0.15 % 0.10 % 0.17 % 0.16 % 0.07%
---- ---- ---- ---- ----
---- ---- ---- ---- ----
</TABLE>
17
<PAGE>
For the year ended December 31, 1997, gross interest income which would
have been recorded had the non-accruing loans been current in accordance with
their original terms amounted to $27,690. The amounts that were included in
interest income on such loans during 1997 were $14,444.
Total non-performing assets were $807,000 at December 31, 1997, an
increase of $446,000, compared to $361,000 at December 31, 1996. The
increase in non-performing assets is primarily the result of three
one-to-four family purchased loans totaling $365,000 that are behind on their
payments by more than 90 days and the foreclosure of two one-to-four family
mortgages totaling $142,000. The decrease in the non-accruing loans is the
result of the normal inflow and outflow of delinquent loans caused by
borrowers getting behind on their payments and then bringing the loans
current again.
Total non-performing assets were $361,000 at December 31, 1996, a
decrease of $489,000, compared to $850,000 at December 31, 1995. The
decrease in non-performing assets is the result of the sale of foreclosed
assets of $315,000, the charge-off of $72,000 of commercial loans, and the
normal inflow and outflow of delinquent loans caused by borrowers getting
behind on their payments and then bringing the loans current again.
OTHER LOANS OF CONCERN. In addition to the non-performing assets set
forth in the table above, as of December 31, 1997 there were $94,000 of loans
with respect to which known information about the possible credit problems of
the borrowers or the cash flows of the secured properties have caused
management to have concerns as to the ability of the borrowers to comply with
present loan repayment terms and which may result in the future inclusion of
such items in the non-performing asset categories.
Management has considered the Bank's non-performing and "of concern"
assets in establishing its allowance for loan losses.
18
<PAGE>
ALLOWANCE FOR LOSSES ON LOANS. The following table sets forth an
analysis of the Bank's allowance for loan losses for the year ended:
<TABLE>
<CAPTION>
(DOLLARS IN THOUSANDS) 1997 1996 1995 1994 1993
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Balance at beginning of year . . . $2,341 2,191 1,893 1,489 831
MFC allowance for losses acquired . 122 0 0 0 0
CHARGE-OFFS
Real estate:
One-to-four family . . . . . . . (4) 0 (1) (6) (1)
Multi-family . . . . . . . . . . 0 (88) 0 0 0
Consumer . . . . . . . . . . . . (7) (1) 0 0 (1)
Commercial business . . . . . . . (12) (61) (1) 0 0
------ ------ ------ ------ ------
(23) (150) (2) (6) (2)
------ ------ ------ ------ ------
RECOVERIES
Real estate:
Commercial business . . . . . . . 8 0 0 0 0
------ ------ ------ ------ ------
8 0 0 0 0
Net charge-offs . . . . . . . . . . (15) (150) (2) (6) (2)
Additions charged to operations . . 300 300 300 410 660
------ ------ ------ ------ ------
Balance at end of year . . . . . . $2,748 2,341 2,191 1,893 1,489
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Ratio of net charge-offs during the
year to average loans outstanding
during the year . . . . . . . . . . 0.01% 0.05% 0.00% 0.00% 0.00%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
Ratio of allowance for losses on
loans to total non-performing loans,
at end of year . . . . . . . . . . 413.17 691.84 409.13 436.52 924.84
------ ------ ------ ------ ------
------ ------ ------ ------ ------
</TABLE>
19
<PAGE>
The distribution of the Bank's allowance for losses on loans at the dates
indicated is summarized as follows:
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
------------------- ------------------- ------------------ ------------------- ------------------
Percent Percent Percent Percent Percent
of Loans of Loans of Loans of Loans of Loans
in Each in Each in Each in Each in Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
(DOLLARS IN THOUSANDS) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate:
One-to-four family . . $ 560 87.58% $ 496 90.19% $ 452 90.62% $ 475 92.18% $ 374 92.18%
Multi-family . . . . . . 80 0.60 8 0.08 21 0.11 21 0.14 10 0.14
Commercial real estate . 198 2.34 113 2.22 125 2.71 128 1.80 140 1.80
Construction or
development. . . . . . . 172 1.27 104 0.98 153 1.58 84 1.31 1 1.31
Consumer . . . . . . . . 527 7.05 473 5.87 286 4.66 280 4.14 234 4.14
Commercial business . . . 46 1.16 29 0.66 37 0.32 27 0.43 30 0.43
Unallocated . . . . . . . 1,165 0.00 1,118 0.00 1,117 0.00 878 0.00 700 0.00
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total . . . . . . . .$ 2,748 100.00% $ 2,341 100.00% $ 2,191 100.00% $ 1,893 100.00% $ 1,489 100.00%
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
</TABLE>
20
<PAGE>
The allowance for losses on loans is established through a provision for
losses on loans charged to earnings based on management's evaluation of the
risk inherent in its entire loan portfolio and changes in the nature and
volume of its loan activity. Such evaluation, which includes a review of all
loans of which full collectibility may not be reasonably assured, considers
specific occurrences, general and local economic conditions, loan portfolio
composition, historical and local experience and other factors that warrant
recognition in providing for an adequate allowance for loan losses. In
determining the general reserves under these policies, historical charge-offs
and recoveries, changes in the mix and levels of the various types of loans,
the general level of non-performing assets and the anticipated net realizable
values, the current loan portfolio and current economic conditions are
considered. The Bank also requires additional reserves for all classified
loans.
While management believes that it uses the best information available to
determine the allowance for losses on loans, unforeseen market conditions
could result in adjustments to the allowance for losses on loans, and net
earnings could be significantly affected, if circumstances differ
substantially from the assumptions used in making the final determination.
INVESTMENT ACTIVITIES
HMN and the Bank utilize the available for sale securities portfolio in
virtually all aspects of asset/liability management strategy. In making
investment decisions, the Investment/Asset - Liability Committee considers,
among other things, the yield and interest rate objectives, the credit risk
position and the projected cash flow requirements.
The Bank must maintain minimum levels of investments that qualify as
liquid assets under OTS regulations. Liquidity may increase or decrease
depending upon the availability of funds and comparative yields on
investments in relation to the return on loans. Cash flow projections are
regularly reviewed and updated to assure that adequate liquidity is
maintained. At December 31, 1997, the Bank's liquidity ratio (liquid assets
as a percentage of net withdrawable savings deposits and current borrowings)
was 19.39%. The Bank's level of liquidity is a result of management's
asset/liability strategy. See "Regulation - Liquidity."
SECURITIES. Federally chartered savings institutions have the authority
to invest in various types of liquid assets, including United States Treasury
obligations, securities of various federal agencies, certain certificates of
deposit of insured banks and savings institutions, certain bankers'
acceptances, repurchase agreements and federal funds. Subject to various
restrictions, federally chartered savings institutions may also invest their
assets in commercial paper, investment grade corporate debt securities and
mutual funds whose assets conform to the investments that a federally
chartered savings institution is otherwise authorized to make directly.
The investment strategy of HMN and the Bank has been directed toward a
mix of high-quality assets (primarily government and agency obligations) with
short and intermediate terms to maturity. At December 31, 1997, HMN did not
own any investment securities of a single issuer which exceeded 10% of HMN's
stockholder's equity other than U.S. government or federal agency obligations.
The Bank invests a portion of its liquid assets in interest-earning
overnight deposits of the Federal Home Loan Bank ("FHLB") of Des Moines and
various money market mutual funds. Other investments include high grade
medium-term (up to three years) corporate debt securities, medium-term
federal agency notes, and a variety of other types of mutual funds which
invest in adjustable-rate, mortgage-backed securities, asset-backed
securities, repurchase agreements and U.S. Treasury and agency obligations.
HMN invests in the same type of investment securities as the Bank and also
invests in taxable and tax exempt municipal obligations and corporate
equities such as preferred and common stock. See Notes 3 and 4 of the Notes
to Consolidated Financial Statements in the Annual Report for additional
information regarding HMN's securities portfolio.
21
<PAGE>
The following table sets forth the composition of HMN's securities
portfolio, excluding mortgage-backed and related securities, at the dates
indicated.
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------------------------
1997 1996
------------------------------------------ --------------------------------------------
Amortized Adjusted Market % of Amortized Adjusted Market % of
(DOLLARS IN THOUSANDS) Cost To Value Total Cost To Value Total
--------- -------- ------ ----- --------- -------- ------ -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Securities available for sale:
U.S. government and agency
obligations . . . . . . . . . . $ 43,403 (60) 43,343 49.98% $29,600 (322) 29,278 49.93%
Municipal obligations . . . . . . 0 0 0 0.00 0 0 0 0.00
Corporate debt . . . . . . . . . 2,903 0 2,903 3.35 1,091 1 1,092 1.86
Corporate equity(1) . . . . . . . 8,017 1,021 9,038 10.42 7,796 386 8,182 13.96
Stock of federal agencies(1). . . 14,034 605 14,639 16.88 3,874 49 3,923 6.69
Securities held to maturity:
U.S. agency obligations . . . . . 0 0 0.00 0 0 0.00
Municipal obligations . . . . . . 0 0 0.00 0 0 0.00
Corporate debt . . . . . . . . . 0 0 0.00 1,000 1,001 1.71
--------- ------ ----- --------- ------ -----
Subtotal . . . . . . . . . . . 68,357 69,923 80.63 43,361 43,476 74.15
FHLB stock . . . . . . . . . . 7,432 7,432 8.57 5,434 5,434 9.27
--------- ------ ----- --------- ------ -----
Total investment securities
and FHLB stock. . . . . . . . . 75,789 77,355 89.20 48,795 48,910 83.42
--------- ------ ----- --------- ------ -----
Average remaining life of
investment securities excluding
FHLB stock. . . . . . . . . . . . 2.5 years 3.4 years
Other Interest-earning Assets:
Cash equivalents . . . . . . . . 9,365 9,365 10.80 9,718 9,718 16.58
--------- ------ ----- --------- ------ -----
Total . . . . . . . . . . . . . $ 85,154 86,720 100.00% $58,513 58,628 100.00%
--------- ------ ----- --------- ------ -----
--------- ------ ----- --------- ------ -----
Average remaining life or term
to repricing of investment
securities and other
interest-earning assets,
excluding FHLB stock . . . . . 2.3 years 2.8 years
<CAPTION>
December 31,
------------------------------------------
1995
------------------------------------------
Amortized Adjusted Market % of
(DOLLARS IN THOUSANDS) Cost To Value Total
--------- -------- ------ -----
<S> <C> <C> <C> <C>
Securities available for sale:
U.S. government and agency
obligations . . . . . . . . . . $ 21,896 (566) 21,330 50.58%
Municipal obligations . . . . . . 1,600 1 1,601 3.80
Corporate debt . . . . . . . . . 851 9 860 2.04
Corporate equity(1) . . . . . . . 6,898 174 7,072 16.77
Stock of federal agencies(1). . . 1,004 37 1,041 2.47
Securities held to maturity:
U.S. agency obligations . . . . . 0 0 0.00
Municipal obligations . . . . . . 228 229 0.54
Corporate debt . . . . . . . . . 2,999 2,995 7.10
--------- ------ -----
Subtotal . . . . . . . . . . . 35,476 35,128 83.30
FHLB stock . . . . . . . . . . . . 3,802 3,802 9.02
--------- ------ -----
Total investment securities
and FHLB stock . . . . . . . . 39,278 38,930 92.32
Average remaining life of
investment securities excluding
FHLB stock . . . . . . . . . . . 3.0 years
Other Interest-earning Assets:
Cash equivalents . . . . . . . . $ 3,238 3,238 7.68
--------- ------ -----
Total . . . . . . . . . . . . . 42,516 42,168 100.00%
--------- ------ -----
--------- ------ -----
Average remaining life or term
to repricing of investment
securities and other
interest-earning assets,
excluding FHLB stock . . . . . . . 2.7 years
</TABLE>
(1)Average life assigned to corporate equity holdings and stock of federal
agencies is five years.
22
<PAGE>
The composition and maturities of the securities portfolio, excluding
FHLB stock, mortgage-backed and other related securities, are indicated in
the following table.
<TABLE>
<CAPTION>
December 31, 1997
------------------------------------------------------------------------------------------
After 1 After 5
1 Year through 5 through 10 No Stated Total
or Less Years Years Maturity Securities
--------- --------- --------- --------- ------------------------------------
Amortized Amortized Amortized Amortized Amortized Adjusted Market
(DOLLARS IN THOUSANDS) Cost Cost Cost Cost Cost To Value
--------- --------- --------- --------- --------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Securities available for sale:
U.S. government securities . . . . $ 11,482 31,921 0 0 43,403 (60) 43,343
Corporate debt . . . . . . . . . . 993 910 1,000 0 2,903 0 2,903
Corporate equity . . . . . . . . . 0 0 0 8,017 8,017 1,021 9,038
Stock of federal agencies . . . . . 0 0 0 14,034 14,034 605 14,639
--------- --------- --------- --------- --------- ---------
Total stock . . . . . . . . . . . . . $ 12,475 32,831 1,000 22,051 68,357 69,923
--------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- ---------
Weighted average yield . . . . . . . 4.22% 6.46% 8.80% 6.12% 5.98%
</TABLE>
23
<PAGE>
MORTGAGE-BACKED AND RELATED SECURITIES. In order to supplement loan
production (particularly those of interest rate sensitive loans) and achieve
its asset/liability management goals, HMN invests in mortgage-backed and
related securities. All of the mortgage-backed and related securities owned
by HMN are issued, insured or guaranteed either directly or indirectly by a
federal agency or are rated "AA" or higher. At December 31, 1997, HMN had
$135.9 million of mortgage-backed and related securities all classified as
available for sale, compared to $135.2 at December 31, 1996, of which $133.4
million were classified as available for sale.
At December 31, 1997, HMN had $23.3 million invested in CMOs which have
floating interest rates that change either monthly or quarterly compared to
$43.5 million at December 31, 1996 and $69.8 million at December 31, 1995.
HMN decreased its investment in floating rate CMOs in order to invest in
mortgage loans and meet other cash needs.
The projected weighted average life of the $61.8 million fixed rate CMO
security portfolio is approximately 2.5 years using median prepayment speeds
projected by the Bloomberg security system. The contractual maturities of
the mortgage-backed and related securities portfolio without any prepayment
assumptions at December 31, 1997 is as follows:
<TABLE>
<CAPTION>
December 31,
1997
5 Years 5 to 10 10 to 20 Over 20 Balance
(Dollars in Thousands) or Less Years Years Years Outstanding
-------- -------- -------- -------- -----------
<S> <C> <C> <C> <C> <C>
Securities available for sale:
Federal Home Loan Mortgage Corporation. . . . $ 17,256 1,409 4,166 7,249 30,080
Federal National Mortgage Association . . . . 3,444 1,922 2,629 6,345 14,340
Government National Mortgage Association. . . 0 17 2,621 3,581 6,219
Other mortgage-backed securities. . . . . . . 0 0 0 185 185
Collateralized Mortgage Obligations . . . . . 2,793 3,736 25,583 52,999 85,111
-------- -------- -------- -------- --------
Total . . . . . . . . . . . . . . . . . . $ 23,493 7,084 34,999 70,359 135,935
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Weighted average yield . . . . . . . . . . . 6.33% 7.23% 7.02% 6.78% 6.79%
</TABLE>
At December 31, 1997, HMN did not have any non-agency mortgage-backed or
related securities in excess of 10% of its stockholders' equity, except for a
$12.0 million collateralized mortgage obligation issued by Bear Stearns with
an AAA rating by Moody's.
CMOs are securities derived by reallocating the cash flows from
mortgage-backed securities or pools of mortgage loans in order to create
multiple classes, or tranches, of securities with coupon rates and average
lives that differ from the underlying collateral as a whole. The terms to
maturity of any particular tranche is dependent upon the prepayment speed of
the underlying collateral as well as the structure of the particular CMO.
Although a significant proportion of HMN's CMOs are in tranches which have
been structured (through the use of cash flow priority and "support"
tranches) to give somewhat more predictable cash flows, the cash flow and
hence the value of CMOs is subject to change.
To assess price volatility, the Federal Financial Institutions
Examination Council ("FFIEC") adopted a policy in 1992 which requires an
annual "stress" test of mortgage derivative securities. This policy, which
has been adopted by the OTS, requires the Bank to annually test its CMOs and
other mortgage-related securities to determine whether they are "high-risk"
or "nonhigh-risk securities". At December 31, 1997, the Bank had $6.7
million of CMO's which were classified as high-risk securities under the OTS
guidelines.
Mortgage-backed and related securities can serve as collateral for
borrowings and, through sales and repayments, as a source of liquidity. In
addition, mortgage-backed and related securities available for sale can be
sold to respond to changes in economic conditions. For information regarding
the carrying and
24
<PAGE>
market values of HMN's mortgage-backed and related securities portfolio, see
Notes 3 and 4 of the Notes to Consolidated Financial Statements in the Annual
Report.
MERGERS AND ACQUISITIONS. On December 5, 1997 HMN, through its wholly
owned subsidiary, the Bank, completed its merger with Marshalltown Financial
Corporation (MFC) pursuant to a merger agreement dated July 1, 1997. Refer to
Note 2 of the Notes to Consolidated Financial Statements in the Annual Report
for information on assets acquired in the merger.
SOURCES OF FUNDS
GENERAL. The Bank's primary sources of funds are deposits, payments
(including prepayments) of loan principal, interest earned on loans and
securities, repayments of securities, borrowings and other funds provided
from operations.
DEPOSITS. The Bank offers a variety of deposit accounts having a wide
range of interest rates and terms. The Bank's deposits consist of passbook,
NOW, money market, non-interest bearing checking and certificate accounts
(including individual retirement accounts). The Bank relies primarily on
competitive pricing policies and customer service to attract and retain these
deposits.
The variety of deposit accounts offered by the Bank has allowed it to be
competitive in obtaining funds and to respond with flexibility to changes in
consumer demand. As customers have become more interest rate conscious, the
Bank has become more susceptible to short-term fluctuations in deposit flows.
The Bank manages the pricing of its deposits in keeping with its
asset/liability management, profitability and growth objectives. Based on
its experience, the Bank believes that its passbook and NOW accounts are
relatively stable sources of deposits. However, the ability of the Bank to
attract and maintain certificate deposits, and the rates paid on these
deposits, has been and will continue to be significantly affected by market
conditions.
The following table sets forth the savings flows at the Bank during the
periods indicated.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Opening balance . . . . . . . . . . . $ 362,477 373,539 350,575
MFC deposits acquired . . . . . . . . . 103,612 0 0
Deposits . . . . . . . . . . . . . . . 370,761 351,330 339,781
Withdrawals . . . . . . . . . . . . . . 385,002 378,009 331,481
Interest credited . . . . . . . . . . . 15,500 15,617 14,664
---------- ---------- ----------
Ending balance . . . . . . . . . . . 467,348 362,477 373,539
---------- ---------- ----------
Net increase (decrease) . . . . . . . $ 104,871 (11,062) 22,964
---------- ---------- ----------
---------- ---------- ----------
Percent increase (decrease) . . . . . . 28.93% (2.96)% 6.55%
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
25
<PAGE>
The following table sets forth the dollar amount of savings deposits in
the various types of deposit programs offered by the Bank as of December 31:
<TABLE>
<CAPTION>
1997 1996 1995
---------------------- ----------------------- ----------------------
Percent Percent Percent
(DOLLARS IN THOUSANDS) Amount of Total Amount of Total Amount of Total
--------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
TRANSACTIONS AND SAVINGS DEPOSITS(1):
Non-interest checking . . . . . . . . . . . . $ 3,833 0.82% $ 2,389 0.66% $ 2,505 0.67%
NOW Accounts - 1.5% (2) . . . . . . . . . . . 23,144 4.95 17,589 4.85 15,997 4.28
Passbook Accounts - 2.62%(3). . . . . . . . . 36,199 7.75 30,070 8.29 29,384 7.86
Money Market Accounts - 3.34% (4) . . . . . . 24,807 5.31 16,533 4.56 18,472 4.95
--------- -------- --------- -------- --------- --------
Total Non-Certificates . . . . . . . . . . $ 87,983 18.83% $ 66,581 18.36% $ 66,358 17.76%
--------- -------- --------- -------- --------- --------
CERTIFICATES:
3.00 - 3.99% . . . . . . . . . . . . . . . $ 727 0.15% $ 425 0.12% $ 0 0.00%
4.00 - 4.99% . . . . . . . . . . . . . . . 24,155 5.17 22,553 6.22 22,440 6.01
5.00 - 5.99% . . . . . . . . . . . . . . . 162,916 34.86 168,040 46.36 152,971 40.95
6.00 - 6.99% . . . . . . . . . . . . . . . 178,847 38.27 76,704 21.16 89,754 24.03
7.00 - 7.99% . . . . . . . . . . . . . . . 11,627 2.49 28,077 7.75 40,721 10.90
8.00 - 8.99% . . . . . . . . . . . . . . . 1,091 0.23 96 0.03 1,294 0.35
9.00 - 9.99% . . . . . . . . . . . . . . . 2 0.00 1 0.00 1 0.00
10.00% and over . . . . . . . . . . . . . . . 0 0.00 0 0.00 0 0.00
--------- -------- --------- -------- --------- --------
Total Certificates . . . . . . . . . . . . 379,365 81.17 295,896 81.64 307,181 82.24
--------- -------- --------- -------- --------- --------
Total Deposits . . . . . . . . . . . . . $ 467,348 100.00% $ 362,477 100.00% $ 373,539 100.00%
--------- -------- --------- -------- --------- --------
--------- -------- --------- -------- --------- --------
</TABLE>
- - -----------------------------
(1) Reflects rates paid on transaction and savings deposits at December 31,
1997.
(2) The rate on NOW Accounts for 1996 was 2.01% and 1995 was 2.22%.
(3) The rate on Passbook Accounts for 1996 and 1995 was 2.50%.
(4) The rate on Money Market Accounts for 1996 and 1995 was 2.83%.
26
<PAGE>
The following table shows rate and maturity information for the Bank's
certificates of deposit as of December 31, 1997.
<TABLE>
<CAPTION>
3.00- 4.00- 5.00- 6.00- 7.00- 8.00- 9.00- Percent
(DOLLARS IN THOUSANDS) 3.99% 4.99% 5.99% 6.99% 7.99% 8.99% 9.99% Total of Total
----- ----- ----- ----- ----- ----- ----- ------- --------
Certificate accounts maturing in
quarter ending:
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
March 31, 1998 . . . . . . . . . $ 709 8,756 38,831 10,304 5,525 594 0 64,719 17.05
June 30, 1998 . . . . . . . . . . 18 6,845 30,059 17,525 1,906 95 0 56,448 14.88
September 30, 1998 . . . . . . . 0 2,769 29,934 31,065 1,407 93 0 65,268 17.20
December 31, 1998 . . . . . . . . 0 3,690 16,620 51,060 1,476 50 0 72,896 19.22
March 31, 1999 . . . . . . . . . 0 494 14,321 21,027 473 247 0 36,562 9.64
June 30, 1999 . . . . . . . . . . 0 587 7,057 8,933 241 12 2 16,832 4.44
September 30, 1999 . . . . . . . 0 403 5,324 5,745 335 0 0 11,807 3.11
December 31, 1999 . . . . . . . . 0 420 3,031 1,662 264 0 0 5,377 1.42
March 31, 2000 . . . . . . . . . 0 136 1,287 1,383 0 0 0 2,806 0.74
June 30, 2000 . . . . . . . . . . 0 55 1,402 1,562 0 0 0 3,019 0.80
September 30, 2000 . . . . . . . 0 0 2,256 13,675 0 0 0 15,931 4.20
December 31, 2000 . . . . . . . . 0 0 2,789 3,536 0 0 0 6,325 1.67
Thereafter . . . . . . . . . . . 0 0 10,005 11,370 0 0 0 21,375 5.63
------- ------ ------- ------- ------ ----- ---- ------- -------
Total . . . . . . . . . . . $ 727 24,155 162,916 178,847 11,627 1,091 2 379,365 100.00%
------- ------ ------- ------- ------ ----- ---- ------- -------
------- ------ ------- ------- ------ ----- ---- ------- -------
Percent of total . . . . . . . 0.19% 6.37% 42.95% 47.14% 3.06% 0.29% 0.00% 100.00%
------- ------ ------- ------- ------ ----- ---- -------
------- ------ ------- ------- ------ ----- ---- -------
</TABLE>
27
<PAGE>
The following table indicates the amount of the Bank's certificates of
deposit and other deposits by time remaining until maturity as of December
31, 1997.
<TABLE>
<CAPTION>
Maturity
----------------------------------------
Over Over
3 Months 3 to 6 6 to 12 Over
or Less Months Months 12 months Total
-------- ------ ------- --------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Certificates of deposit less
than $100,000 . . . . . . . . $ 51,964 48,648 126,772 111,159 338,543
Certificates of deposit of
$100,000 or more . . . . . . . . 5,120 4,277 8,025 8,874 26,296
Public funds (1) . . . . . . . . . 7,635 3,523 3,368 0 14,526
--------- ------ ------- ------- -------
Total certificates of
deposit . . . . . . . . . . $ 64,719 56,448 138,165 120,033 379,365
--------- ------ ------- ------- -------
--------- ------ ------- ------- -------
</TABLE>
- - ---------------
(1)Deposits from governmental and other public entities.
For additional information regarding the composition of the Bank's deposits,
see Note 11 of the Notes to Consolidated Financial Statements in the Annual
Report. For additional information on certificate maturities and the impact
on HMN's liquidity see Liquidity Management starting on page 20 of the Annual
Report.
BORROWINGS. The Bank's other available sources of funds include
advances from the Federal Home Loan Bank ("FHLB") of Des Moines and other
borrowings. As a member of the FHLB of Des Moines, the Bank is required to
own capital stock in the FHLB of Des Moines and is authorized to apply for
advances from the FHLB of Des Moines. Each FHLB credit program has its own
interest rate, which may be fixed or variable, and range of maturities. The
FHLB of Des Moines may prescribe the acceptable uses for these advances, as
well as limitations on the size of the advances and repayment provisions.
Consistent with its asset/liability management strategy, the Bank has
utilized FHLB advances from time to time to extend the term to maturity of
its liabilities. Also, the Bank has used FHLB borrowings to fund loan demand
and other investment opportunities and to offset deposit outflows. At
December 31, 1997, the Bank had $127.7 million of FHLB advances outstanding.
On such date, the Bank had a collateral pledge arrangement with the FHLB of
Des Moines pursuant to which the Bank may borrow up to an additional $150.0
million for liquidity purposes. See "Financial Review - Federal Home Loan
Bank Advances" and Note 10 of the Notes to Consolidated Financial Statements
in the Annual Report.
The following table sets forth the maximum month-end balance and average
balance of FHLB advances and other borrowings for the periods indicated.
<TABLE>
<CAPTION>
Year Ended
December 31,
--------------------------
1997 1996 1995
(DOLLARS IN THOUSANDS) ------ ------ ------
<S> <C> <C> <C>
MAXIMUM BALANCE:
FHLB advances . . . . . . . . . . . . . . . . $128,007 106,436 74,534
FHLB short-term borrowings and open line of
credit . . . . . . . . . . . . . . . . . . . . 60,429 64,429 42,429
AVERAGE BALANCE:
FHLB advances . . . . . . . . . . . . . . . . . 112,500 89,656 65,069
FHLB short-term borrowings . . . . . . . . . . 45,598 47,949 20,812
</TABLE>
28
<PAGE>
The following table sets forth certain information as to the Bank's FHLB
advances at the dates indicated.
<TABLE>
<CAPTION>
December 31,
------------------------
1997 1996 1995
------ ------ ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
FHLB short-term borrowings . . . . . . . . . . $43,250 46,429 33,429
Weighted average interest rate of
FHLB short-term borrowings . . . . . . . . . . . 5.85% 5.52% 6.05%
</TABLE>
SERVICE CORPORATIONS OF THE BANK
As a federally chartered savings bank, the Bank is permitted by OTS
regulations to invest up to 2% of its assets in the stock of, or loans to,
service corporation subsidiaries, and may invest an additional 1% of its
assets in service corporations where such additional funds are used for
inner-city or community development purposes. In addition to investments in
service corporations, federal institutions are permitted to invest an
unlimited amount in operating subsidiaries engaged solely in activities which
a federal savings bank may engage in directly.
Osterud Insurance Agency, Inc. ("OIAI"), a Minnesota corporation, was
organized in 1983. OIAI operated as an insurance agency until 1986 when its
assets were sold. OIAI remained inactive until 1993 when it began offering
credit life insurance, annuity products and mutual fund products to the
Bank's customers and others. At December 31, 1997, the Bank's liability
related to OIAI was $21,000. OIAI recorded net income of $12,000 for the
year ended December 31, 1997.
MSL Financial Corporation ("MSL") was acquired in the MFC merger. MSL
offered annuity products to MFC customers and also has an investment in FHLMC
preferred stock.
COMPETITION
The Bank faces strong competition both in originating real estate loans
and in attracting deposits. Competition in originating loans comes primarily
from mortgage bankers, commercial banks, credit unions and other savings
institutions, which also make loans secured by real estate located in the
Bank's market area. The Bank competes for loans principally on the basis of
the interest rates and loan fees it charges, the types of loans it originates
and the quality of services it provides to borrowers.
Competition for those deposits is principally from money market and
mutual funds, securities firms, commercial banks and other savings
institutions located in the same communities. The ability of the Bank to
attract and retain deposits depends on its ability to provide an investment
opportunity that satisfies the requirements of investors as to rate of
return, liquidity, risk, convenient locations and other factors. The Bank
competes for these deposits by offering a variety of deposit accounts at
competitive rates, convenient business hours and a customer oriented staff.
OTHER CORPORATIONS OWNED BY HMN
HMN has two other wholly owned subsidiaries, HMN Mortgage Services, Inc.
("MSI") and Security Finance Corporation ("SFC"). MSI operates a mortgage
banking and mortgage brokerage facilities located in Eden Prairie and
Brooklyn Park, Minnesota. Eden Prairie and Brooklyn Park are located in the
Minneapolis/St. Paul Metropolitan area. MSI's primary function is to
originate and/or purchase single family residential loans for resale on the
secondary market to FNMA, FHLMC or other third parties. It also from
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time to time purchases mortgage servicing rights from other lenders. SFC
invests in commercial loans and commercial real estate loans located
throughout the United States which were originated by third parties.
EMPLOYEES
At December 31, 1997, HMN had a total of 150 full-time equivalent
employees. None of the employees of HMN or its subsidiaries are represented
by any collective bargaining unit. Management considers its employee
relations to be good.
EXECUTIVE OFFICERS OF THE REGISTRANT WHO ARE NOT DIRECTORS
Officers are elected annually by the Board of Directors of HMN and the
Bank. The business experience of each executive officer of HMN and the Bank
who is not also a director of HMN is set forth below. Unless otherwise
indicated, such individuals have held their current positions for at least
five years.
DWAIN C. JORGENSEN. Mr. Jorgensen, age 49, is Vice President,
Controller and Chief Accounting Officer of HMN and the Bank. Mr. Jorgensen
has held such positions with the Bank since 1989. From 1983 to 1989, Mr.
Jorgensen was an Assistant Vice President and Operations Officer with the
Bank.
SUSAN K. KOLLING. Mrs. Kolling, age 46, is Senior Vice President of HMN
and is Senior Vice President of Marketing of the Bank, a position she has
held since 1995. Prior to such time, she served as Vice President from 1992
through 1994 and as a Loan Officer from 1981 through 1991. Mrs. Kolling
began her career with the Bank in 1969.
TIMOTHY P. JOHNSON. Mr. Johnson, age 45, is Vice President and
Treasurer of HMN and the Bank, a position he has held since 1997. Prior to
such time, he served as Treasurer from 1992 to 1997. From 1983 to 1992, Mr.
Johnson was Chief Financial Officer of St. Louis Bank for Savings, Duluth,
Minnesota.
ROXANNE M. HELLICKSON. Mrs. Hellickson, age 37, is Vice President/Loan
Administrator and Corporate Secretary of HMN and the Bank. She served as
Assistant Secretary of the Bank from 1992 to 1994 and was secretary to the
Bank's President and a loan officer from 1989 to 1992. Mrs. Hellickson began
her career with the Bank in 1979.
REGULATION
GENERAL
The Bank is a federally chartered savings bank, the deposits of which
are federally insured and backed by the full faith and credit of the United
States Government. Accordingly, the Bank is subject to broad federal
regulation and oversight extending to all its operations. The Bank is a
member of the FHLB of Des Moines and is subject to certain limited regulation
by the Federal Reserve Board. The Bank is a member of the Savings
Association Insurance Fund ("SAIF") and the deposits of the Bank are insured
by the FDIC. As a result, the FDIC has certain regulatory and examination
authority over the Bank. As the savings and loan holding company of the
Bank, HMN also is subject to federal regulation and oversight. The purpose
of the regulation of HMN and other holding companies is to protect subsidiary
savings associations.
Certain of these regulatory requirements and restrictions are discussed
below.
FEDERAL REGULATION OF SAVINGS ASSOCIATIONS
The OTS has extensive authority over the operations of savings
associations. As part of this authority, the Bank is required to file
periodic reports with the OTS and is subject to periodic examinations
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by the OTS and the FDIC. The last regular OTS examination of the Bank was
dated May 1997. The Bank has not been scheduled for an examination in 1998,
except for an on-site year 2000 examination which started on March 23, 1998.
When these examinations are conducted by the OTS and the FDIC, the examiners
may require the Bank to provide for higher general or specific loan loss
reserves. Financial institutions in various regions of the United States
have been called upon by examiners to write down assets and to establish
increased levels of reserves, primarily as a result of perceived weaknesses
in real estate values and a more restrictive regulatory climate.
The OTS has established a schedule for the assessment of fees upon all
savings associations to fund the operations of the OTS. The general
assessment, to be paid on a semi-annual basis, is computed upon the savings
association's total assets as reported in the association's latest quarterly
thrift financial report. Savings associations (unlike the Bank) that are
classified as "troubled" (I.E., having a supervisory rating of "4" or "5" or
subject to a conservatorship) are required to pay a 50% premium over the
standard assessment. The Bank's OTS assessment for the year ended December
31, 1997 was approximately $122,000.
The OTS also has extensive enforcement authority over all savings
institutions and their holding companies, including the Bank and HMN. This
enforcement authority includes, among other things, the ability to assess
civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions. In general, these enforcement actions may be
initiated for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement
action, including misleading or untimely reports filed with the OTS. Except
under certain circumstances, public disclosure of final enforcement actions
by the OTS is required.
In addition, the investment, lending and branching authority of the Bank
is prescribed by federal laws and regulations, and it is prohibited from
engaging in any activities not permitted by such laws and regulations. For
instance, no savings institution may invest in non-investment grade corporate
debt securities. In addition, unless approved by the OTS, the permissible
level of investment by federal associations in loans secured by
non-residential real property may not exceed 400% of regulatory capital.
Federal savings associations are also generally authorized to branch
nationwide. The Bank is in compliance with the noted restrictions.
The Bank's general permissible lending limit for loans-to-one-borrower
is equal to the greater of $500,000, or 15%, of unimpaired capital and
surplus (except for loans fully secured by certain readily marketable
collateral, in which case this limit is increased to 25% of unimpaired
capital and surplus). At December 31, 1997, the Bank's lending limit under
this restriction was $9.2 million. The Bank is in compliance with the
loans-to-one borrower limitation.
In December 1991, the Federal Deposit Insurance Corporation Improvement
Act of 1991 ("FDICIA") was enacted into law. FDICIA provides for, among
other things, the recapitalization of the Bank Insurance Fund; adoption of
safety and soundness standards; enhanced federal supervision of depository
institutions, including greater authority for the appointment of a
conservator or receiver for undercapitalized institutions; the establishment
of risk-based deposit insurance premiums; liberalization of the qualified
thrift lender test; greater restrictions on transactions with affiliates; and
mandated consumer protection disclosures with respect to deposit accounts.
See "- Insurance of Accounts and Regulation by the FDIC," "- Regulatory
Capital Requirements" and "- Qualified Thrift Lender Test."
The OTS, as well as the other federal banking agencies, have issued
proposed safety and soundness standards on matters such as loan underwriting
and documentation, internal controls and audit systems, interest rate risk
exposure, compensation and other employee benefits. The proposal also
establishes the maximum ratio of classified assets to total capital (which
for this purpose includes loss allowances exceeding the amount includable for
regulatory capital purposes) at 100% and the minimum level of earnings
sufficient to absorb losses without impairing capital. Earnings will be
sufficient if the net income over the last four
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quarters is assumed to continue over the next four quarters and the
institution would otherwise remain in capital compliance. Any institution
which fails to comply with these standards must submit a compliance plan. A
failure to submit a plan or to comply with an approved plan will subject the
institution to further enforcement action. The proposal also requires savings
and loan holding companies to ensure that transactions and relationships with
their subsidiary savings associations do not have a detrimental effect on the
safe and sound operation of the association. No assurance can be given as to
the final form of the proposed regulations.
The Bank is subject to a wide array of other laws and regulations, both
federal and state, including, but not limited to, usury laws, the CRA and
regulations thereunder, the Equal Credit Opportunity Act and Regulation B,
Regulation E Electronic Funds Transfer requirements, the Truth-in-Lending Act
and Regulation Z, the Real Estate Settlement Procedures Act and Regulation X.
The Bank is also subject to laws and regulations that may impose liablitiy on
lenders and owners for clean-up costs and other costs stemming from hazardous
waste located on property securing real estate loans made by lenders or on
real estate that is owned by lenders following a foreclosure or otherwise.
INSURANCE OF ACCOUNTS AND REGULATION BY THE FDIC
The Bank is a member of the SAIF, which is administered by the FDIC.
Savings deposits are insured up to applicable limits by the FDIC and such
insurance is backed by the full faith and credit of the United States
Government. As insurer, the FDIC imposes deposit insurance premiums and is
authorized to conduct examinations of and to require reporting by
FDIC-insured institutions. It also may prohibit any FDIC-insured institution
from engaging in any activity the FDIC determines by regulation or order to
pose a serious risk to the SAIF. The FDIC also has the authority to initiate
enforcement actions against savings associations, after giving the OTS an
opportunity to take such action, and may terminate the deposit insurance if
it determines that the institution has engaged or is engaging in unsafe or
unsound practices, or is in an unsafe or unsound condition.
FDICIA also requires the FDIC to implement a risk-based deposit
insurance assessment system. Pursuant to this requirement, the FDIC adopted
a transitional risk-based assessment system, effective January 1, 1993, under
which all insured depository institutions are placed into one of nine
categories and assessed insurance premiums, ranging from .23% to .31% of
deposits, based upon their level of capital and supervisory evaluation. The
permanent system, adopted in June 1993 and effective January 1, 1994,
continued the risk classification system established under the transitional
rule. Under the system, institutions classified as well capitalized (I.E., a
core capital ratio of at least 5%, a ratio of Tier 1 or core capital to
risk-weighted assets ("Tier 1 risk-based capital") of at least 6% and a
risk-based capital ratio of at least 10%) and considered healthy would pay
the lowest premium while institutions that are less than adequately
capitalized (I.E., core and Tier 1 risk-based capital ratios of less than 4%
or a risk-based capital ratio of less than 8%) and considered of substantial
supervisory concern would pay the highest premium. Risk classification of all
insured institutions will be made by the FDIC for each semi-annual assessment
period.
The FDIC is authorized to increase assessment rates, on a semi-annual
basis, if it determines that the reserve ratio of the SAIF will be less than
the designated reserve ratio of 1.25% of SAIF insured deposits. In setting
these increased assessments, the FDIC must seek to restore the reserve ratio
to that designated reserve level, or such higher reserve ratio as established
by the FDIC. In addition, under FDICIA, the FDIC may impose special
assessments on SAIF members to repay amounts borrowed from the United States
Treasury or for any other reason deemed necessary by the FDIC.
The Deposit Insurance Fund Act of 1996 (DIFA) was enacted on September
30, 1996. DIFA addressed the inadequate funding of the (SAIF). In order to
recapitalize the SAIF, DIFA imposed a one-time assessment on all thrift
institutions. The Bank's assessment was a pretax charge of $2,351,563 and
was recognized in the third quarter of 1996.
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DIFA also addressed the funding for the Financing Corp. (FICO) bonds.
Thrifts will pay 6.4 basis points per $100 of deposits from January 1, 1997
to December 31, 1999. From January 1, 2000 until the FICO bonds are retired
in 2019, the estimated assessment to retire the FICO bonds is expected to be
2.5 basis points per $100 of deposits.
DIFA proposed that the Bank Insurance Fund (BIF) and SAIF be merged on
January 1, 1999, provided no insurance depository institution is a savings
association on that date. At this time, HMN does not know what effect, if
any, the proposed legislation or charter revisions will have on future
operations.
REGULATORY CAPITAL REQUIREMENTS
Federally insured savings associations, such as the Bank, are required
to maintain a minimum level of regulatory capital. The OTS has established
capital standards, including a tangible capital requirement, a leverage ratio
(or core capital) requirement and a risk-based capital requirement applicable
to such savings associations. These capital requirements must be generally
as stringent as the comparable capital requirements for national banks. The
OTS is also authorized to impose capital requirements in excess of these
standards on individual associations on a case-by-case basis.
The capital regulations require tangible capital of at least 1.5% of
adjusted total assets (as defined by regulation). Tangible capital generally
includes common stockholders' equity and retained earnings, and certain
noncumulative perpetual preferred stock. In addition, all intangible assets,
other than a limited amount of purchased mortgage servicing rights, must be
deducted from tangible capital. At December 31, 1997, the Bank had goodwill
of $6.0 million and $510,000 of mortgage servicing rights which were required
to be deducted from stockholders' equity to arrive at tangible capital.
The OTS regulations establish special capitalization requirements for
savings associations that own subsidiaries. Under these regulations certain
subsidiaries are consolidated for capital purposes and others are excluded
from assets and capital. In determining compliance with the capital
requirements, all subsidiaries engaged solely in activities permissible for
national banks or engaged in certain other activities solely as agent for its
customers are "includable" subsidiaries that are consolidated for capital
purposes in proportion to the association's level of ownership, including the
assets of includable subsidiaries in which the association has a minority
interest that is not consolidated for GAAP purposes. For excludable
subsidiaries the debt and equity investments in such subsidiaries are
deducted from assets and capital. The subsidiary of the Bank is an includable
subsidiary.
At December 31, 1997, the Bank had tangible capital of $54.1 million, or
8.2% of adjusted total assets, which is $44.2 million above the minimum
requirement of 1.5% of adjusted total assets in effect on that date.
The capital standards also require core capital equal to at least 3% of
adjusted total assets (as defined by regulation). Core capital generally
consists of tangible capital plus certain intangible assets. As a result of
the prompt corrective action provisions of FDICIA discussed below, however, a
savings association must maintain a core capital ratio of at least 4% to be
considered adequately capitalized unless its supervisory condition is such to
allow it to maintain a 3% ratio.
As required by federal law, the OTS has proposed a rule revising its
minimum core capital requirement to be no less stringent than that imposed on
national banks. The OTS has proposed that only those savings associations
rated a composite one (the highest rating) under the safety and soundness
rating system for savings associations will be permitted to operate at or
near the regulatory minimum leverage ratio of 3%. All other savings
associations will be required to maintain a minimum leverage ratio of 4% to
5%. The OTS will assess each individual savings association through the
supervisory process on a case-by-case basis to determine the applicable
requirement. No assurance can be given as to the final form of any such
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regulation, the date of its effectiveness or the requirement applicable to
the Bank.
At December 31, 1997, the Bank had core capital equal to $54.1 million,
or 8.2%, of adjusted total assets, which is $34.3 million above the minimum
leverage ratio requirement of 3% as in effect on that date.
The OTS risk-based requirement requires savings associations to have
total capital of at least 8% of risk-weighted assets. Total capital consists
of core capital, as defined above, and supplementary capital. Supplementary
capital consists of certain permanent and maturing capital instruments that
do not qualify as core capital and general valuation loan and lease loss
allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary
capital may be used to satisfy the risk-based requirement only to the extent
of core capital. At December 31, 1997, the Bank had $2.7 million of general
loss reserves, which were included in capital.
Certain exclusions from capital and assets are required to be made for
the purpose of calculating total capital, in addition to the adjustments
required for calculating core capital. Such exclusions consist of equity
investments (as defined by regulation) and that portion of land loans and
nonresidential construction loans in excess of an 80% loan-to-value ratio and
reciprocal holdings of qualifying capital instruments. At December 31, 1997
the Bank had $266,000 of exclusions from capital.
In determining the amount of risk-weighted assets, all assets, including
certain off-balance sheet items, will be multiplied by a risk weight, ranging
from 0% to 100%, based on the risk inherent in the type of asset. For
example, the OTS has assigned a risk weight of 50% for prudently underwritten
permanent one-to-four family first lien mortgage loans not more than 90 days
delinquent and having a loan to value ratio of not more than 80% at
origination unless insured to such ratio by an insurer approved by the FNMA
or the FHLMC.
On December 31, 1997, the Bank had total "risk-based" capital of $56.6
million and risk-weighted assets of $303.4 million, or total capital of 18.7%
of risk-weighted assets. This amount was $32.4 million above the 8%
requirement in effect on that date.
Under FDICIA, all the federal banking agencies, including the OTS, were
required to revise their risk-based capital requirements to ensure that such
requirements account for interest rate risk, concentration of credit risk and
the risks of non-traditional activities, and that they reflect the actual
performance of and expected loss on multi-family loans. Such standards were
adopted with the enactment of FDICIA.
The OTS had adopted a rule that required every savings association with
more than normal interest rate risk to deduct from its total capital, for
purposes of determining compliance with such requirement, an interest rate
risk component ("IRR component") equal to 50% of its interest-rate risk
exposure multiplied by the present value of its assets. The IRR component is
a measure of the potential decline in the net portfolio value ("NPV") of a
savings association, greater than 2% of the present value of its assets,
based upon a hypothetical 200 basis point increase or decrease in interest
rates (whichever results in a greater decline). NPV is the present value of
expected cash flows from assets, liabilities and off-balance sheet contracts.
The rule provided for a two quarter lag between calculating interest rate
risk and recognizing any deduction from capital. The OTS has decided not to
require the IRR component to be deducted from the capital calculations of all
institutions. It has reserved the right to take the IRR component into
account in assessing the capital requirements for an individual institution.
Based upon an IRR component analysis at December 31, 1997, the Bank was
deemed to have more than "normal" interest rate risk and may, at some time in
the future, be required to deduct an amount from capital. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Asset/Liability Management" in the Annual Report.
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Pursuant to FDICIA, the federal banking agencies, including the OTS,
have adopted regulations authorizing the agencies to require a depository
institution to maintain an additional amount of total capital to account for
concentration of credit risk and the risk of non-traditional activities.
The OTS and the FDIC are authorized and, under certain circumstances,
required to take certain actions against associations that fail to meet
capital requirements. Effective December 19, 1992, the federal banking
agencies, including the OTS, were given additional enforcement authority over
undercapitalized
depository institutions. The OTS is generally required to take action to
restrict the activities of an "undercapitalized association" (generally
defined to be one with less than either a 4% core ratio, a Tier 1
risked-based capital ratio or an 8% risk-based capital ratio). Any such
association must submit a capital restoration plan and until such plan is
approved by the OTS may not increase its assets, acquire another institution,
establish a branch or engage in any new activities, and generally may not
make capital distributions. The OTS is authorized to impose the additional
restrictions, discussed below, that are applicable to significantly
undercapitalized associations.
As a condition to the approval of the capital restoration plan, any
company controlling an undercapitalized association must agree that it will
enter into a limited capital maintenance guarantee with respect to the
institution's achievement of its capital requirements.
Any savings association that fails to comply with its capital plan or is
"significantly undercapitalized" (I.E., Tier 1 risk-based or core capital
ratios of less than 3% or a risk-based capital ratio of less than 6%) must be
made subject to one or more additional specified actions and operating
restrictions mandated by FDICIA. These actions and restrictions include
requiring the issuance of additional voting securities; limitations on asset
growth; mandated asset reduction; changes in senior management; divestiture,
merger or acquisition of the association; restrictions on executive
compensation; and any other action the OTS deems appropriate. An association
that becomes "critically undercapitalized" (I.E., a tangible equity to total
asset ratio of 2% or less) is subject to further mandatory restrictions on
its activities in addition to those applicable to significantly
undercapitalized associations. In addition, the OTS must appoint a receiver
(or conservator with the concurrence of the FDIC) for a savings association,
with certain limited exceptions, within 90 days after it becomes critically
undercapitalized.
Any undercapitalized association is also subject to other possible
enforcement actions by the OTS or the FDIC. Such actions could include a
capital directive, a cease-and-desist order, civil money penalties, the
establishment of restrictions on all aspects of the association's operations,
the appointment of a receiver or conservator or a forced merger into another
institution.
If the OTS determines that an association is in an unsafe or unsound
condition, or is engaged in an unsafe or unsound practice, it is authorized
to reclassify a well-capitalized association as an adequately capitalized
association, and if the association is adequately capitalized, to impose the
restrictions applicable to an undercapitalized association. If the
association is undercapitalized, the OTS is authorized to impose the
restrictions applicable to a significantly undercapitalized association.
The imposition by the OTS or the FDIC of any of these measures on the
Bank may have a substantial adverse effect on the Bank's operations and
profitability and the value of HMN's stock. HMN shareholders do not have
preemptive rights, and therefore, if HMN is directed by the OTS or the FDIC
to issue additional shares of common stock, such issuance may result in the
dilution in the percentage of ownership of existing stockholders of HMN.
At December 31, 1997 the Bank would be considered to be "well
capitalized" under the prompt corrective actions provisions mentioned above.
See Note 16 "Federal Home Loan Bank Investment, Regulatory Liquidity and
Regulatory Capital Requirements" in the Notes to Consolidated Financial
Statements in the Annual Report for more information on the Bank's capital.
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LIMITATIONS ON DIVIDENDS AND OTHER CAPITAL DISTRIBUTIONS
OTS regulations impose various restrictions or requirements on
associations with respect to their ability to pay dividends or make other
distributions of capital. OTS regulations prohibit an association from
declaring or paying any dividends or from repurchasing any of its stock if,
as a result, the regulatory capital of the association would be reduced below
the amount required to be maintained for the liquidation account established
in connection with its mutual to stock conversion.
The OTS utilizes a three-tiered approach to permit associations, based
on their capital level and supervisory condition, to make capital
distributions which include dividends, stock redemptions or repurchases,
cash-out mergers and other transactions charged to the capital account. See
"- Regulatory Capital Requirements."
Generally, Tier 1 associations, which are associations that before and
after the proposed distribution meet their fully phased-in capital
requirements, may make capital distributions during any calendar year equal
to the greater of 100% of net income for the year-to-date plus 50% of the
amount by which the lesser of the association's tangible, core or risk-based
capital exceeds its fully phased-in capital requirement for such capital
component, as measured at the beginning of the calendar year, or the amount
authorized for a Tier 2 association. However, a Tier 1 association deemed to
be in need of more than normal supervision by the OTS may be downgraded to a
Tier 2 or Tier 3 association as a result of such a determination. The Bank
meets the requirements for a Tier 1 association and has not been notified of
a need for more than normal supervision. Tier 2 associations, which are
associations that before and after the proposed distribution meet their
current minimum capital requirements, may make capital distributions of up to
75% of net income over the most recent four quarter period.
Tier 3 associations (which are associations that do not meet current
minimum capital requirements) that propose to make any capital distribution
and Tier 2 associations that propose to make a capital distribution in excess
of the noted safe harbor level must obtain OTS approval prior to making such
distribution. Tier 2 associations proposing to make a capital distribution
within the safe harbor provisions and Tier 1 associations proposing to make
any capital distribution need only submit written notice to the OTS 30 days
prior to such distribution. As a subsidiary of HMN, the Bank will also be
required to give the OTS 30 days' notice prior to declaring any dividend on
its stock. The OTS may object to the distribution during that 30-day period
based on safety and soundness concerns. See "- Regulatory Capital
Requirements."
The OTS has proposed regulations that would revise the current capital
distribution restrictions. The proposal eliminates the current tiered
structure and the safe-harbor percentage limitations. Under the proposal a
savings association may make a capital distribution without notice to the OTS
(unless it is a subsidiary of a holding company) provided that it has a
CAMELS 1 or 2 rating, is not in troubled condition and would remain
adequately capitalized (as defined in the OTS prompt corrective action
regulations) following the proposed distribution. Savings associations that
would remain adequately capitalized following the proposed distribution but
do not meet the other noted requirements must notify the OTS 30 days prior to
declaring a capital distribution. The OTS stated it will generally regard as
permissible that amount of capital distributions that do not exceed 50% of
the institution's excess regulatory capital plus net income to date during
the calendar year. A savings association may not make a capital distribution
without prior approval of the OTS and the FDIC if it is undercapitalized
before, or as a result of, such a distribution. A savings association will be
considered in troubled condition if it has a CAMELS rating of 4 or 5, is
subject to an enforcement action relating to its safety and soundness or
financial viability or has been informed in writing by the OTS that it is in
troubled condition. As under the current rule, the OTS may object to a
capital distribution if it would constitute an unsafe or unsound practice.
No assurance may be given as to whether or in what form the regulations may
be adopted.
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In March of 1998, the Bank received confirmation from OTS that a
dividend from the Bank to HMN of $15.0 million could be paid during 1998 and
not violate the dividend limitations mentioned above.
LIQUIDITY
All savings associations, including the Bank, are required to maintain
an average daily balance of liquid assets equal to a certain percentage of
the sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. For a discussion of what the Bank
includes in liquid assets, see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity Management" in the
Annual Report. This liquid asset ratio requirement may vary from time to
time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings associations. At the present time, the minimum liquid
asset ratio is 4%.
In addition, short-term liquid assets (E.G., cash, certain time
deposits, certain bankers acceptances and short-term United States Treasury
obligations) currently must constitute at least 1% of the association's
average daily balance of net withdrawable deposit accounts and current
borrowings. Penalties may be imposed upon associations for violations of
either liquid asset ratio requirement. At December 31, 1997, the Bank had an
overall liquid asset ratio of 19.4% and a short-term liquid asset ratio of
6.4%.
ACCOUNTING
An OTS policy statement applicable to all savings associations clarifies
and re-emphasizes that the investment activities of a savings association
must be in compliance with approved and documented investment policies and
strategies, and must be accounted for in accordance with GAAP. Under the
policy statement, management must support its classification of and
accounting for loans and securities (I.E., whether held to maturity, sale or
trading) with appropriate documentation. The Bank is in compliance with
these amended rules.
The OTS has adopted an amendment to its accounting regulations, which
may be made more stringent than GAAP, to require that transactions be
reported in a manner that best reflects their underlying economic substance
and inherent risk and that financial reports must incorporate any other
accounting regulations or orders prescribed by the OTS.
QUALIFIED THRIFT LENDER TEST
All savings associations, including the Bank, are required to meet a
qualified thrift lender ("QTL") test to avoid certain restrictions on their
operations. This test requires a savings association to have at least 65% of
its portfolio assets (which consists of total assets less intangibles,
properties used to conduct the savings association's business and liquid
assets not exceeding 20% of total assets) in qualified thrift investments on
a monthly average for nine out of every 12 months on a rolling basis. For
HMN such assets primarily consist of residential housing related loans and
investments. At December 31, 1997, the Bank met the test and has always met
the test since its effectiveness.
Any savings association that fails to meet the QTL test must convert to
a national bank charter, unless it requalifies as a QTL and thereafter
remains a QTL. If an association does not requalify and converts to a
national bank charter, it must remain SAIF-insured until the FDIC permits it
to transfer to the Bank Insurance Fund. If an association that fails the
test has not yet requalified and has not converted to a national bank, its
new investments and activities are limited to those permissible for both a
savings association and a national bank, and it is limited to national bank
branching rights in its home state. In addition, the association is
immediately ineligible to receive any new FHLB borrowings and is subject to
national bank limits for payment of dividends. If such association has not
requalified or converted to a national bank within three years after the
failure, it must divest of all investments and cease all activities not
permissible for a national
37
<PAGE>
bank. In addition, it must repay promptly any outstanding FHLB borrowings,
which may result in prepayment penalties. If any association that fails the
QTL test is controlled by a holding company, then within one year after the
failure, the holding company must register as a bank holding company and
become subject to all restrictions on bank holding companies. See "- Holding
Company Regulation."
TRANSACTIONS WITH AFFILIATES
Generally, transactions between a savings association or its
subsidiaries and its affiliates are required to be on terms as favorable to
the association as transactions with non-affiliates. In addition, certain of
these transactions are restricted to a percentage of the association's
capital. Affiliates of the Bank include HMN and any company which is under
common control with the Bank. In addition, a savings association may not lend
to any affiliate engaged in activities not permissible for a bank holding
company or acquire the securities of most affiliates. The Bank's
subsidiaries are not deemed affiliates, however, the OTS has the discretion
to treat subsidiaries of savings associations as affiliates on a case by case
basis.
Certain transactions with directors, officers or controlling persons are
also subject to conflict of interest regulations enforced by the OTS. These
conflict of interest regulations and other statutes also impose restrictions
on loans to such persons and their related interests. Among other things,
such loans must be made on terms substantially the same as for loans to
unaffiliated individuals.
HOLDING COMPANY REGULATION
HMN is a unitary savings and loan holding company subject to regulatory
oversight by the OTS. As such, HMN is registered and required to file
reports with and subject to regulation and examination by the OTS. In
addition, the OTS has enforcement authority over HMN and its non-savings
association subsidiaries which also permits the OTS to restrict or prohibit
activities that are determined to be a serious risk to the subsidiary savings
association.
As a unitary savings and loan holding company, HMN generally is not
subject to activity restrictions. If HMN acquires control of another savings
association as a separate subsidiary, it would become a multiple savings and
loan holding company, and the activities of HMN and any of its subsidiaries
(other than the Bank or any other SAIF-insured savings association) would
become subject to such restrictions unless such other associations qualify as
QTLs and were acquired in a supervisory acquisition.
If the Bank fails the QTL test, HMN must obtain the approval of the OTS
prior to continuing after such failure, directly or through its other
subsidiaries, any business activity other than those approved for multiple
savings and loan holding companies or their subsidiaries. In addition,
within one year of such failure HMN must register as, and will become subject
to, the restrictions applicable to bank holding companies. The activities
authorized for a bank holding company are more limited than are the
activities authorized for a unitary or multiple savings and loan holding
company. See "- Qualified Thrift Lender Test."
HMN must obtain approval from the OTS before acquiring control of any
other SAIF-insured association. Such acquisitions are generally prohibited
if they result in a multiple savings and loan holding company controlling
savings associations in more than one state. However, such interstate
acquisitions are permitted based on specific state authorization or in a
supervisory acquisition of a failing savings association.
FEDERAL SECURITIES LAW
The stock of HMN is registered with the SEC under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). HMN is subject to the
information, proxy solicitation, insider trading restrictions and other
requirements of the SEC under the Exchange Act.
38
<PAGE>
HMN stock held by persons who are affiliates (generally officers,
directors and principal stockholders) of HMN may not be resold without
registration or unless sold in accordance with certain resale restrictions.
If HMN meets specified current public information requirements, each
affiliate of HMN is able to sell in the public market, without registration,
a limited number of shares in any three-month period.
FEDERAL RESERVE SYSTEM
The Federal Reserve Board requires all depository institutions to
maintain non-interest bearing reserves at specified levels against their
transaction accounts (primarily checking, NOW and Super NOW checking
accounts). At December 31, 1997, the Bank was in compliance with these
reserve requirements. The balances maintained to meet the reserve
requirements imposed by the Federal Reserve Board may be used to satisfy
liquidity requirements that may be imposed by the OTS. See "- Liquidity."
Savings associations are authorized to borrow from the Federal Reserve
Bank "discount window," but Federal Reserve Board regulations require
associations to exhaust other reasonable alternative sources of funds,
including FHLB borrowings, before borrowing from the Federal Reserve Bank.
FEDERAL HOME LOAN BANK SYSTEM
The Bank is a member of the FHLB of Des Moines, which is one of 12
regional FHLBs, that administers the home financing credit function of
savings associations. Each FHLB serves as a reserve or central bank for its
members within its assigned region. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the FHLB System. It
makes loans to members (I.E., advances) in accordance with policies and
procedures established by the board of directors of the FHLB. These policies
and procedures are subject to the regulation and oversight of the Federal
Housing Finance Board. All advances from the FHLB are required to be fully
secured by sufficient collateral as determined by the FHLB. In addition, all
long-term advances are required to provide funds for residential home
financing.
As a member, the Bank is required to purchase and maintain stock in the
FHLB of Des Moines. At December 31, 1997, the Bank had $7.4 million in FHLB
stock, which was in compliance with this requirement. In past years, the
Bank has received dividends on its FHLB stock. Over the past five calendar
years such dividends have averaged 7.41% and were 7.00% for calendar year
1997. For the year ended December 31, 1997, dividends paid by the FHLB of
Des Moines to the Bank totaled $421,000.
Under federal law the FHLBs are required to provide funds for the
resolution of troubled savings associations and to contribute to low and
moderately priced housing programs through direct loans or interest subsidies
on advances targeted for community investment and low- and moderate-income
housing projects. These contributions have affected adversely the level of
FHLB dividends paid and could continue to do so in the future. These
contributions could also have an adverse effect on the value of FHLB stock in
the future. A reduction in value of the Bank's FHLB stock may result in a
corresponding reduction in the Bank's capital.
39
<PAGE>
FEDERAL AND STATE TAXATION
FEDERAL TAXATION.
HMN and its subsidiaries file consolidated federal income tax returns on
a calendar year basis using the accrual method of accounting. Prior to 1996,
savings institutions were subject to special bad debt reserve rules and
certain other rules. During this period of time, a savings institution that
held 60% or more of its assets in "qualifying assets" (as defined in the
Internal Revenue Code) was permitted to maintain reserves for bad debts and
to make annual additions to such reserves that qualified as deductions from
taxable income, HMN was in compliance with this requirement.
A qualifying thrift institution could elect annually to compute its
allowable additons to bad debt reserves under either the percentage of
taxable income method or the experience method. The percentage of taxable
income method of calculating bad debt reserves limited the applicable
percentage deduction to 8% of taxable income and could not cause the reserves
to exceed 6% of qualifying loans at the end of the taxable year. HMN used the
experience method to calculate additions to tax bad debt reserves through tax
year 1995.
Beginning in 1996, the favorable bad debt method described above was
repealed putting savings insitutions on the same tax bad debt method as
commercial banks. This legislation requires recapture of the amount of the
tax bad debt reserves to the extent that they exceed the adjusted base year
reserve ("the applicable excess reserves"). The applicable excess reserves
are recaptured over a six-year period. This recapture period can be deferred
for a period of up to two years to the extent that a certain residential
lending test is met. HMN has previously provided taxes for the applicable
excess reserves.
In addition to the regular income tax, corporations, including savings
associations such as the Bank, generally are subject to a minimum tax. An
alternative minimum tax is imposed at a minimum tax rate of 20% on
alternative minimum taxable income, which is the sum of a corporation's
regular taxable income (with certain adjustments) and tax preference items,
less any available exemption. The alternative minimum tax is imposed to the
extent it exceeds the corporation's regular income tax and net operating
losses can offset no more than 90% of alternative minimum taxable income.
To the extent earnings appropriated to a savings association's bad debt
reserves for "qualifying real property loans" and deducted for federal income
tax purposes before 1988 exceed the allowable amount of such reserves
computed under the experience method and to the extent of the association's
supplemental reserves for losses on loans ("Excess"), such Excess may not,
without adverse tax consequences, be utilized for the payment of cash
dividends or other distributions to a shareholder (including distributions on
redemption, dissolution or liquidation) or for any other purpose (except to
absorb bad debt losses). As of December 31, 1997, the Bank's Excess for tax
purposes totaled approximately $8.8 million.
HMN was incorporated in 1994 and filed its first consolidated Federal
income tax return with its subsidiaries for the year ended December 31, 1994.
The return required to be filed for 1997 has been extended and will be filed
by September 1998. The Bank and its consolidated subsidiaries have been
audited by the IRS with respect to consolidated federal income tax returns
through December 31, 1983. With respect to years examined by the IRS, either
all deficiencies have been satisfied or sufficient reserves have been
established to satisfy asserted deficiencies. In the opinion of management,
any examination of still open returns (including returns of subsidiaries and
predecessors of, or entities merged into, the Bank) would not result in a
deficiency which could have a material adverse effect on the consolidated
financial condition of HMN.
MINNESOTA TAXATION. HMN and its subsidiaries that operate in Minnesota
are subject to Minnesota state taxation. A Minnesota corporation's income or
loss is allocated based on a three-factor apportionment of the corporation's
Minnesota gross receipts, payroll and property over the total gross receipts,
payroll and property of all corporations in the unitary group. The corporate
tax rate in Minnesota is 9.8%. The Minnesota Alternative Minimum Tax rate is
5.8%.
40
<PAGE>
The Bank and it subsidiaries have not been audited by the Minnesota
taxation authorities.
IOWA TAXATION. On December 5, 1997 the Bank acquired MFC and its
subsidiaries which were located in the state of Iowa. The Bank is now subject
to Iowa Franchise tax on an apportionment basis weighted based upon deposits
located within Iowa to total deposits of the Bank. Income apportioned to Iowa
is subject to a 5% tax rate.
DELAWARE TAXATION. As a Delaware holding company, HMN is exempted from
Delaware corporate income tax but is required to file an annual report with
and pay an annual fee to the State of Delaware. HMN is also subject to an
annual franchise tax imposed by the State of Delaware.
41
<PAGE>
ITEM 2. PROPERTIES
The following table sets forth information concerning the main office
and each branch office of HMN at December 31, 1997. At December 31, 1997,
HMN's premises had an aggregate net book value of approximately $4.6 million.
<TABLE>
<CAPTION>
YEAR OWNED OR NET BOOK VALUE AT
LOCATION ACQUIRED LEASED DECEMBER 31, 1997(1)
- - ------------------------------ -------- -------- --------------------
(In Thousands)
<S> <C> <C> <C>
MAIN OFFICE:
101 North Broadway 1975 Owned 341
Spring Valley, Minnesota
FULL SERVICE BRANCHES:
201 Oakland Avenue 1960 Owned 176
Austin, Minnesota
Crossroads Shopping Center 1962 Owned 500
Rochester, Minnesota
4th & Center 1973 Owned 123
Winona, Minnesota
208 South Walnut 1975 Owned 90
LaCrescent, Minnesota
1110 6th St., NW 1982 Owned 878
Rochester, Minnesota
143 West Clark Street 1993 Owned 582
Albert Lea, Minnesota
303 W. Main St. 1997 Owned 636
Marshalltown, Iowa
119 W. High St. 1997 Leased 3
Toledo, Iowa
29 S. Center 1997 Owned 159
Marshalltown, Iowa
MORTGAGE BANKING/BROKERAGE OFFICES:
9973 Valley View Road 1996 Leased ---
Eden Prairie, Minnesota
7101 Northland Circle, Suite 105 1997 Leased ---
Brooklyn Park, Minnesota
</TABLE>
- - ---------------------
(1) Does not include $955,163 of net furniture and equipment distributed
between all of the above offices or its subsidiaries.
42
<PAGE>
During 1997 HMN purchased land totaling $392,700 in order to build new
retail banking facilities in Spring Valley and Winona. During 1997 HMN spent
$700,000 for construction in process on the two banking facilities. During
1998 HMN will spend approximately $2,200,000 to complete its building
projects and provide the buildings with furniture and equipment. The
facilities will replace the existing retail facilities in both locations.
HMN believes that its remaining facilities are adequate to meet their present
needs.
The Bank's depositor and borrower customer files are maintained by an
independent data processing company. The net book value of the data
processing and computer equipment utilized by the Bank at December 31, 1997
was approximately $575,000.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Bank and HMN are involved as plaintiff or
defendant in various legal proceedings arising in the normal course of its
business. While the ultimate outcome of these various legal proceedings
cannot be predicted with certainty, it is the opinion of management that the
resolution of these legal actions should not have a material effect on HMN's
consolidated financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SECURITY HOLDER
MATTERS
The information on pages 26, 48 and the back cover page of the Annual
Report to Security Holders for the year ended December 31, 1997 is
incorporated herein by reference.
ITEM 6. SELECTED FINANCIAL DATA
The information on page 11 of the Annual Report to Security Holders for
the year ended December 31, 1997 is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information on pages 12 through 26 of the Annual Report to Security
Holders for the year ended December 31, 1997 is incorporated herein by
reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The information on pages 21 through 23 of the Annual Report to Security
Holders for the year ended December 31, 1997 is incorporated herein by
reference.
43
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information on pages 27 through 48 of the Annual Report to Security
Holders for the year ended December 31, 1997 is incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information on pages 5 through 8 of the Registrant's definitive
Proxy Statement dated March 30, 1998 is incorporated herein by reference.
See "Business - Executive Officers" in Part I of the Form 10-K for
information regarding executive officers.
ITEM 11. EXECUTIVE COMPENSATION
The information on pages 8 through 14 of the Registrant's definitive
Proxy Statement dated March 30, 1998 is incorporated herein be reference,
except for information contained under the heading "Compensation Committee
Report on Executive Compensation".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information on pages 2 through 4 of the Registrant's definitive
Proxy Statement dated March 30, 1998 is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
44
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND EXHIBITS
1. Financial Statements
The following information appearing in the Registrant's Annual
Report to Security Holders for the year ended December 31, 1997,
is incorporated by reference in this Form 10-K Annual Report as
Exhibit 13.
<TABLE>
<CAPTION>
Pages in
1997 Annual
Annual Report Section Report
--------------------- -----------
<S> <C>
Five Year Consolidated Financial Highlights 11
Consolidated Balance Sheets --
December 31, 1997 and 1996 27
Consolidated Statements of Income --
Each of the Years in the Three-Year
Period Ended December 31, 1997 28
Consolidated Statement of Stockholders'
Equity -- Each of the Years in the
Three-Year Period Ended December 31, 1997 29
Consolidated Statements of Cash Flows --
Each of the Years in the Three-Year
Period Ended December 31, 1997 30
Notes to Consolidated Financial Statements 31 - 44
Independent Auditors' Report 45
Selected Quarterly Financial Data 46 - 47
Other Financial Data 48
Common Stock Price Information 48
</TABLE>
2. Financial Statement Schedules
All financial statement schedules have been omitted as information is
not required under the related instructions, is not applicable or has
been included in the Notes to Consolidated Financial Statements.
45
<PAGE>
3. Exhibits
<TABLE>
<CAPTION>
Reference Sequential
to Prior Page Numbering
Filing or Where Attached
Exhibit Exhibits Are
Regulation S-K Number Located in This
Exhibit Number Document Attached Hereto Form 10-K Report
-------------- ---------------------------- --------------- ----------------
<S> <C> <C> <C>
2 Agreement and Plan of Merger ***** Not applicable
dated July 1, 1997
3 (i) Articles of Incorporation * Not applicable
(ii) By-laws ****** Not applicable
4 Instruments defining the rights of security * Not applicable
holders, including indentures
9 Voting trust agreement Not applicable Not applicable
10.1 + Employment agreement for Mr. Weise ** Not applicable
dated June 29, 1994
Extension of Employment Contract ******* Not applicable
10.2 + Employment agreement for Mr. Gardner ** Not applicable
dated June 29, 1994
Extension of Employment Contract ******* Not applicable
10.3 + Directors Deferred Compensation Plan ** Not applicable
10.4 + 1995 Recognition and Retention Plan *** Not applicable
10.5 + 1995 Stock Option and Incentive Plan *** Not applicable
11 Statement re: Computation of per share 11 Filed electronically
earnings
12 Statement re: Computation of ratios Not applicable Not applicable
13 Annual Report to Security Holders 13 Filed electronically
16 Letter re: Change in certifying accountant Not applicable Not applicable
18 Letter re: Change in accounting principles Not applicable Not applicable
21 Subsidiaries of Registrant 21 Filed electronically
+ Management contract of compensatory arrangement.
</TABLE>
46
<PAGE>
<TABLE>
<CAPTION>
Reference Sequential
to Prior Page Numbering
Filing or Where Attached
Exhibit Exhibits Are
Regulation S-K Number Located in This
Exhibit Number Document Attached Hereto Form 10-K Report
-------------- ---------------------------- --------------- ----------------
<S> <C> <C> <C>
22 Published report regarding matters Not applicable Not applicable
submitted to vote of security holders
23 Consent of KPMG Peat Marwick LLP 23 Filed electronically
dated March 26, 1998
24 Power of Attorney Not applicable Not applicable
27.1 Finacial Data Schedule 27.1 Filed electronically
Year ended 1997
27.2 Financial Data Schedule 27.2 Filed electronically
Restated for quarters ended March 31, 1997
June 30, 1997 and September 30, 1997
27.3 Financial Data Schedule 27.3 Filed electronically
Restated for March 31, 1996, June 30, 1996
September 30, 1996 and December 31, 1996
27.4 Financial Data Schedule 27.4 Filed electronically
Restated for the year ended December 31, 1995
28 Information from reports furnished to None Not applicable
state insurance regulatory authorities
99 Additional exhibits None Not applicable
</TABLE>
- - -------------
* Filed April 1, 1994, as exhibits to the Registrant's Form S-1 registration
statement (Registration No. 33-77212) pursuant to the Securities Act of 1933.
All of such previously filed documents are hereby incorporated herein by
reference in accordance with Item 601 of Regulation S-K.
** Filed as an exhibit to the Registrant's Form 10-K for 1994 (file no.
0-24100). All previously filed documents are hereby incorporated by
reference in accordance with Item 601 of Regulation S-K.
*** Filed as an exhibit to the Registrant's Form 10-K for 1995 (file no.
0-24100). All previously filed documents are hereby incorporated by
reference in accordance with Item 601 of Regulation S-K.
****Filed as an exhibit to the Registrant's Form 10-K for 1996 (file no.
0-24100). All previously filed documents are hereby incorporated by
reference in accordance with Item 601 of Regulation S-K.
*****Filed as an exhibit to Current Report of Form 8-K dated July 1, 1997,
filed on July 10, 1997. All previously filed documents are hereby
incorporated by reference.
******Filed as an exhibit to the Registrant's Form 10-Q for the third quarter
of 1997 (file no. 0-24100). All previously filed documents are hereby
incorporated by reference.
*******Filed as an exhibit to the Registrant's Form 10-Q for the second
quarter of 1997 (file no. 0-24100). All previously filed documents are hereby
incorporated by reference.
47
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
HMN FINANCIAL, INC.
Date: March 31, 1998 By: /s/ Roger P. Weise
----------------------------- -------------------------------------
Roger P. Weise
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
By: /s/ Roger P. Weise By: /s/ James B. Gardner
----------------------------- -------------------------------------
Roger P. Weise, Chairman of James B. Gardner,
the Board, President and Chief Executive Vice President and Director
Executive Officer (Principal (Principal Financial Officer)
Executive and Operating
Officer)
Date: March 31, 1998 Date: March 31, 1998
----------------------------- -----------------------------------
By: /s/ Irma R. Rathbun By: /s/ Timothy R. Geisler
------------------------------- -------------------------------------
Irma R. Rathbun, Director Timothy R. Geisler, Director
Date: March 31, 1998 Date: March 31, 1998
----------------------------- -----------------------------------
By: /s/ M. F. Schumann By: /s/ Duane D. Benson
------------------------------- -------------------------------------
M.F. Schumann, Director Duane D. Benson, Director
Date: March 31, 1998 Date: March 31, 1998
----------------------------- -----------------------------------
By: /s/ Dwain C. Jorgensen
-------------------------------
Dwain C. Jorgensen,
Vice President and Controller
(Principal Accounting Officer)
Date: March 31, 1998
-----------------------------
48
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Sequential
Page Numbering
Where Attached
Exhibits Are
Regulation S-K Located in This
Exhibit Number Document Form 10-K Report
-------------- ------------------------------------- ----------------
<S> <C> <C>
11 Statement re: Computation of per share earnings Filed electronically
13 Annual Report to Security Holders Filed electronically
21 Subsidiaries of Registrant Filed electronically
23 Consent of KPMG Peat Marwick LLP Filed electronically
dated March 26, 1998
27.1 Finacial Data Schedule Filed electronically
Year ended 1997
27.2 Financial Data Schedule Filed electronically
Restated for quarters ended March 31, 1997,
June 30, 1997 and September 30, 1997
27.3 Financial Data Schedule Filed electronically
Restated for March 31, 1996, June 30, 1996,
September 30, 1996 and December 31, 1996
27.4 Financial Data Schedule Filed electronically
Restated for the year ended December 31, 1995
</TABLE>
49
<PAGE>
Exhibit 11
HMN Financial, Inc.
Computation of Earnings Per Common Share
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------
1997 1996 1995
-----------------------------------------
<S> <C> <C> <C>
Computation of Earnings Per Common Share:
Weighted average number of common shares out-
standing used in basic earnings per common
share calculation . . . . . . . . . . . . . . 3,683,458 4,315,410 5,109,989
Net dilutive effect of:
Options . . . . . . . . . . . . . . . . . . . 209,388 54,838 19,062
Restricted stock awards . . . . . . . . . . . 50,767 67,003 42,887
---------- --------- ----------
Weighted average number of shares outstanding
adjusted for effect of dilutive securities. . 3,943,613 4,437,251 5,171,938
---------- --------- ----------
---------- --------- ----------
Income available to common shareholders. . . . $5,578,866 4,274,349 5,620,377
Basic earnings per common share . . . . . . . $1.51 0.99 1.10
Diluted earnings per common share . . . . . . $1.41 0.96 1.09
</TABLE>
<PAGE>
FIVE-YEAR CONSOLIDATED FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
SELECTED OPERATIONS DATA:(1)
YEAR ENDED DECEMBER 31,
--------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1995 1994 1993
- - ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total interest income....................................... $ 41,090 39,864 38,328 32,277 32,427
Total interest expense...................................... 25,643 24,194 22,555 18,067 18,399
------- ------ ------ ------ ------
Net interest income...................................... 15,447 15,670 15,773 14,210 14,028
Provision for loan losses................................... 300 300 300 410 660
------- ------ ------ ------ ------
Net interest income after provision for loan losses...... 15,147 15,370 15,473 13,800 13,368
------- ------ ------ ------ ------
Fees and service charges.................................... 487 359 325 311 305
Securities gains, net....................................... 1,250 1,030 416 65 1,180
Gain on sales of loans...................................... 469 39 102 3 0
Other non-interest income................................... 516 495 155 216 152
------- ------ ------ ------ ------
Total non-interest income................................ 2,722 1,923 998 595 1,637
SAIF assessment............................................. 0 2,352 0 0 0
Other non-interest expense.................................. 9,022 8,157 7,470 6,574 5,976
------- ------ ------ ------ ------
Total non-interest expense............................... 9,022 10,509 7,470 6,574 5,976
Income tax expense.......................................... 3,268 2,510 3,381 3,116 3,799
------- ------ ------ ------ ------
Net income............................................... $ 5,579 4,274 5,620 4,705 5,230
------- ------ ------ ------ ------
------- ------ ------ ------ ------
Earnings per share:
Basic.................................................... $ 1.51 0.99 1.10
Diluted.................................................. 1.41 0.96 1.09
Basic and diluted (1994: June 29 through
December 31)........................................... 0.48 N/A
Pro forma basic and diluted
(January 1 through December 31)........................ 0.86 N/A
<CAPTION>
SELECTED FINANCIAL CONDITION DATA:(1)
DECEMBER 31,
---------------------------------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1995 1994 1993
- - ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Total assets................................................ $691,232 554,732 537,949 494,868 430,782
Securities held for sale.................................... 0 0 0 0 7,598
Securities available for sale............................... 205,859 175,830 190,320 183,512 71,868
Securities held to maturity................................. 0 2,806 16,972 12,678 85,672
Loans held for sale ........................................ 2,287 739 0 0 0
Loans receivable, net....................................... 442,069 349,022 314,851 271,000 246,446
Deposits.................................................... 467,348 362,477 373,539 350,575 353,581
Federal Home Loan Bank advances............................. 127,650 106,079 68,877 51,986 33,964
Stockholders' equity........................................ 84,470 82,099 91,687 89,047 40,046
Book value per share........................................ 20.38 18.52 17.29 14.63 N/A
Tangible book value per share............................... 18.92 18.52 17.29 14.63 N/A
Number of full service offices.............................. 10 7 7 7 7
Number of mortgage origination offices...................... 2 1 0 0 0
Key Ratios(2)
Stockholders' equity to total assets at year end............ 12.22% 14.80% 17.04% 17.99% 9.30%
Average stockholders' equity to average assets.............. 14.36 16.12 18.24 14.57 8.82
Return on stockholders' equity
(ratio of net income to average equity).................. 6.84 4.82 5.86 6.86 13.79
Return on assets
(ratio of net income to average assets).................. 0.98 0.78 1.07 1.00 1.22
- - ---------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) HMN Financial, Inc. (HMN) completed a public stock offering on June 29,
1994, which generated net proceeds of $59.2 million. HMN purchased all of
the stock of Home Federal Savings Bank (the Bank) with a portion of the
conversion proceeds. The information represents the financial condition
and the results of operations for the consolidated HMN for 1997, 1996, 1995
and 1994 and Bank only information for 1993.
(2) Average balances were calculated based upon amortized cost without the
market value impact of SFAS 115.
N/A Not applicable because the bank was not a publicly held corporation.
On December 5, 1997 HMN acquired Marshalltown Financial Corporation, refer to
Note 2 of the Notes to Consolidated Financial Statements for details
on the acquisition.
- - --------------------------------------------------------------------------------
HMN FINANCIAL, INC. 11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
FINANCIAL REVIEW
The financial review presents management's discussion and analysis of the
consolidated financial condition and results of operations of HMN Financial,
Inc. and subsidiaries (HMN). This review should be read in conjunction with the
consolidated financial statements and other financial data beginning on page 27.
HMN was incorporated under the laws of the State of Delaware for the
purpose of becoming the savings and loan holding company of Home Federal Savings
Bank (the Bank) in connection with the Bank's conversion from a federally
chartered mutual savings bank to a federally chartered stock savings bank,
pursuant to its plan of conversion. The conversion was completed on June 29,
1994. Refer to Note 15 of the Notes to Consolidated Financial Statements for
more information regarding the Bank's stock conversion.
Information presented for years ended prior to December 31, 1994 reflect
the financial condition and the results of operations of only the consolidated
Bank.
RESULTS OF OPERATIONS
Net income for the year ended December 31, 1997 was $5.6 million, an increase of
$1.3 million, or 31%, from $4.3 million for the year ended December 31, 1996.
Basic earnings per share was $1.51 for the year ended December 31, 1997, an
increase of $0.52 per share, or 53%, from $0.99 basic earnings per share for
December 31, 1996. Diluted earnings per share was $1.41 for the year ended
December 31, 1997, an increase of $0.45 per share, or 47%, from $0.96 diluted
earnings per share for the year ended in 1996. In September of 1996, Congress
enacted the Savings Association Insurance Fund (SAIF) legislation which assessed
a one time charge against all SAIF insured institutions in order to recapitalize
the fund. The Bank was assessed $2.35 million which was charged directly to
earnings and reduced after tax earnings by $1.46 million. The assessment reduced
basic earnings per share and diluted earnings per share for the year ended 1996
by $0.34 and $0.33, respectively.
Net income for the year ended December 31, 1996 was $4.3 million, a
decrease of $1.3 million, or 24%, from $5.6 million for the year ended December
31, 1995. Basic earnings per share was $0.99 for the year ended December 31,
1996, a decrease of $0.11 per share from basic earnings per share of $1.10 for
the year ended December 31, 1995. Diluted earnings per share was $0.96 for the
year ended December 31, 1996, a decrease of $0.13 per share from $1.09 for the
year ended in 1995. The SAIF assessment of $2.35 million was the primary reason
for the decline in net income from 1995 to 1996. Other changes noted were net
interest income decreased by $103,000, non-interest income increased by $924,000
due to security gains and other non-recurring income, and was partially offset
by increased non-interest expenses of $687,000 related to compensation and
benefit expenses, occupancy costs and other costs.
Return on average assets was 0.98%, 0.78% and 1.07% for 1997, 1996 and
1995, respectively. The return on average assets for 1996, excluding the SAIF
assessment, was 1.04%. Return on average equity was 6.84%, 4.82% and 5.86%, for
1997, 1996 and 1995, respectively.
NET INTEREST INCOME
HMN's net income is dependent primarily on its net interest income, which is
the difference between interest earned on securities, loans and other
interest-earning assets (interest income) and interest paid respectively on
deposits and Federal Home Loan Bank advances (interest expense). Net interest
margin is calculated by dividing net interest income by the average
interest-earning assets. The arithmetic difference between the yield on
interest-earning assets and the cost of interest-bearing liabilities
expressed as a percentage is referred to as the net interest rate spread.
12
<PAGE>
The following table presents the total dollar amount of interest income
from average interest-earning assets and the resultant yields, as well as the
interest expense on average interest-bearing liabilities, expressed both in
dollars and rates. Non-accruing loans have been included in the table
as loans carrying a zero yield.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------------------------------------
1997 1996
------------------------------------- ------------------------------------
Average Interest Average Interest
Outstanding Earned/ Yield/ Outstanding Earned/ Yield/
(DOLLARS IN THOUSANDS) Balance Paid Rate Balance Paid Rate
- - --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Securities available for sale:
Mortgage-backed and
related securities................... $121,805 8,256 6.78% $148,400 10,027 6.76%
Other marketable securities(1)......... 61,977 3,699 5.97 40,549 2,425 5.98
Securities held to maturity:
Mortgage-backed and
related securities................... 379 33 8.82 10,160 765 7.53
Other marketable securities............ 167 10 6.00 1,861 104 5.61
Loans held for sale..................... 2,426 175 7.22 107 8 7.61
Loans receivable, net(2)................ 355,657 28,154 7.92 324,851 25,713 7.92
Federal Home Loan Bank stock............ 6,007 421 7.00 4,671 328 7.01
Other interest-earning assets
including cash equivalents............. 8,413 342 4.07 11,039 494 4.48
-------- ------ -------- ------
Total interest-earning assets........... $556,831 41,090 7.38 $541,638 39,864 7.36
-------- ------ ---- -------- ------ ----
-------- ------ -------- ------
Interest-bearing liabilities:
Noninterest checking.................... $ 2,626 0 0.00% $2,016 0 0.00%
NOW accounts............................ 17,306 257 1.49 16,051 323 2.01
Passbooks............................... 29,893 763 2.55 30,295 760 2.51
Money market accounts................... 16,879 490 2.90 17,724 501 2.83
Certificate accounts.................... 303,926 17,546 5.77 299,903 17,366 5.79
Federal Home Loan
Bank advances.......................... 112,500 6,587 5.85 89,656 5,244 5.85
-------- ------ -------- ------
Total interest-bearing liabilities...... $483,130 25,643 5.31 $455,645 24,194 5.31
-------- ------ ---- -------- ------ ----
-------- ------ -------- ------
Net interest income..................... 15,447 15,670
------ ------
------ ------
Net interest rate spread................ 2.07% 2.05%
---- ----
---- ----
Net earning assets...................... $ 73,701 $ 85,993
-------- --------
-------- --------
Net interest margin..................... 2.77% 2.89%
---- ----
---- ----
Average interest-earning assets to
average interest-bearing
liabilities............................ 115.25% 118.87%
------ ------
------ ------
<CAPTION>
Year Ended December 31,
--------------------------------------
1995
--------------------------------------
Average Interest
Outstanding Earned/ Yield/
(DOLLARS IN THOUSANDS) Balance Paid Rate
- - -------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest-earning assets:
Securities available for sale:
Mortgage-backed and
related securities................... $153,150 10,294 6.72%
Other marketable securities(1)......... 47,289 2,858 6.04
Securities held to maturity:
Mortgage-backed and
related securities................... 9,242 746 8.07
Other marketable securities............ 6,145 390 6.34
Loans held for sale..................... 0 0 0.00
Loans receivable, net(2)................ 290,243 23,375 8.05
Federal Home Loan Bank stock............ 3,485 253 7.25
Other interest-earning assets
including cash equivalents............. 8,611 412 4.78
-------- ------
Total interest-earning assets........... $518,165 38,328 7.40
-------- ------ ----
-------- ------
Interest-bearing liabilities:
Noninterest checking.................... $1,735 0 0.00%
NOW accounts............................ 14,361 311 2.17
Passbooks............................... 30,378 759 2.50
Money market accounts................... 19,499 548 2.81
Certificate accounts.................... 293,844 16,961 5.77
Federal Home Loan
Bank advances.......................... 65,069 3,976 6.11
-------- ------
Total interest-bearing liabilities...... $424,886 22,555 5.31
-------- ------ ----
-------- ------
Net interest income..................... 15,773
------
------
Net interest rate spread................ 2.09%
----
----
Net earning assets...................... $ 93,279
--------
--------
Net interest margin..................... 3.04%
----
----
Average interest-earning assets to
average interest-bearing
liabilities............................ 121.95%
------
------
</TABLE>
(1) Tax exempt income was not significant; therefore, the yield was not
presented on a tax equivalent basis. The tax exempt income was $9,400 for
1997 and $87,474 in 1995. There was no tax exempt income earned in 1996.
(2) Calculated net of deferred loan fees, loan discounts, loans in process and
loss reserve.
- - --------------------------------------------------------------------------------
HMN FINANCIAL, INC. 13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
Net interest income for the year ended December 31, 1997 was $15.4 million,
a decrease of $223,000, or 1.4%, from $15.7 million for the same year ended in
1996. Interest income for the year ended December 31, 1997 was $41.1 million, an
increase of $1.2 million, or 3.1%, compared to $39.9 million for the year ended
in 1996. The increased interest income was primarily due to increased loan
purchases, originations and, to a minor extent, loans added as a result of the
acquisition of Marshalltown Financial Corporation (MFC)(1). Average outstanding
loans receivable for 1997 increased by $30.8 million over average outstanding
loans receivable for 1996. HMN has been increasing its investment in loans in
order to increase interest income. Interest income earned on the security
portfolio decreased by $1.3 million primarily because securities were sold or
matured and the proceeds were reinvested into loans or other assets. The average
outstanding securities portfolio decreased by $16.7 million from $201.0 million
at December 31, 1996 to $184.3 million at December 31, 1997. Interest expense
for the year ended December 31, 1997 was $25.6 million, an increase of $1.4
million, or 6.0%, from $24.2 million for the year ended December 31, 1996.
Interest expense increased during 1997 due to additional advances from the FHLB
which were used to fund loan purchases and the purchase of MFC. The increase in
interest expense totally offset the increase in interest income and therefore
caused net interest income for the year ended December 31, 1997 to decline by
$223,000 from the year ended December 31, 1996.
Net interest income for 1996 was $15.7 million, a decrease of $103,000,
or 0.7%, from $15.8 million for 1995. Interest income for 1996 was $39.9
million, an increase of $1.5 million, or 4.0%, compared to $38.3 million for
1995. The average interest-earning assets for 1996 were $23.5 million higher
than average interest-earning assets for 1995. The increase in average
interest-earning assets caused HMN to earn additional interest income of $2.0
million which was partially offset by a decrease in interest income of
$483,000 due to a decrease in the yield earned on interest-earning assets.
During 1996 HMN decreased its weighted average securities portfolio by $14.9
million in order to increase its loan portfolio. HMN purchased $55.8 million
of single-family residential loans with a weighted average interest rate of
6.96%. It originated $56.8 million of mortgage and consumer loans with a
weighted average rate of 8.18%. The net impact of the loan purchases and
originations on the loan portfolio after taking into account total loan
payments and payoffs was a $34.7 million increase in the average outstanding
loan portfolio for 1996 compared to 1995. The combined weighted average
interest rate for purchased and originated loans was 7.58% which lowered the
yield on the existing loan portfolio during 1996. Included in the loans
purchased during 1996 were $34.2 million of adjustable rate loans with a
weighted average interest rate of 6.56%. Interest rates in general were lower
during 1996 compared to 1995, therefore new loan originations and purchases
had lower interest rates during 1996 compared to 1995, which caused the yield
on interest-earning assets to decline during 1996. Interest expense for 1996
was $24.2 million, an increase of $1.6 million, or 7.3%, compared to $22.6
million for 1995. Interest expense increased $1.7 million due to a $30.8
million increase in the average outstanding interest-bearing liabilities and
was partially offset by a $121,000 decrease in interest expense due to lower
interest rates. During 1996 HMN had to pay higher interest rates in order to
maintain its certificate accounts, therefore interest expense on certificate
accounts increased despite the fact that interest rates during 1996 were
generally lower than interest rates were during 1995. Average outstanding
FHLB advances increased by $24.6 million during 1996 primarily due to the
purchase of additional interest-earning assets and the stock repurchase
program. The increased average FHLB advances caused interest expense during
1996 to increase by $1.3 million over the interest expense recognized during
1995. HMN's average net earning assets were $86.0 million at December 31,
1996, a decrease of $7.3 million, or 7.8%, compared to $93.3 million for
December 31, 1995. The decrease in net interest-earning assets was primarily
due to HMN's stock repurchase program. Stock repurchases temporarily reduced
interest-earning assets when investments were sold to repurchase HMN's stock.
Other replacement interest-earning assets were purchased later by borrowing
funds from the FHLB.
Net interest margin was 2.77%, 2.89% and 3.04% for the years ended
December 31, 1997, 1996 and 1995, respectively. Average net earning assets
were $73,701, $85,993 and $93,279 for the years ended December 31, 1997, 1996
and 1995. During 1995 HMN began purchasing its own common stock in the open
market. During 1997, 1996 and 1995 it paid $6.0 million, $14.4 million and
$12.5 million, respectively to purchase its own common stock in the open
market. During 1996 and throughout 1997 HMN has been increasing its
investment in assets which were not interest-earning assets. The income on
these assets is included in non-interest income. The impact of the stock
repurchase program, when coupled with purchasing investments which are not
interest-earning assets, caused HMN's net interest-earning assets to decline,
which in turn caused net interest margin to decline.
(1) Refer to Note 2 of the Notes to Consolidated Financial Statements for more
information on the MFC acquisition.
14
<PAGE>
The following schedule presents the dollar amount of changes in interest
income and interest expense for major components of interest-earning assets
and interest-bearing liabilities. It distinguishes between the increase
related to higher outstanding balances and that due to the levels and
volatility of interest rates. For each category of interest-earning assets
and interest-bearing liabilities, information is provided on changes
attributable to (i) changes in volume (i.e., changes in volume multiplied by
old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old
volume).
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------------------
1996 vs. 1997 1995 vs. 1996
-----------------------------------------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due To
---------------------------------- ----------------------------------
Total Total
Increase Increase
(DOLLARS IN THOUSANDS) Volume(1) Rate(2) (Decrease) Volume(1) Rate(2) (Decrease)
- - -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Securities available for sale:
Mortgage-backed and related securities $(1,817) 46 (1,771) (323) 56 (267)
Other marketable securities.......... 1,286 (12) 1,274 (403) (30) (433)
Securities held to maturity:
Mortgage-backed and related securities (890) 158 (732) 59 (40) 19
Other marketable securities.......... (102) 8 (94) (244) (42) (286)
Loans held for sale, net............. 167 0 167 8 0 8
Loans receivable, net.................. 2,439 2 2,441 2,732 (394) 2,338
Federal Home Loan Bank stock........... 93 0 93 83 (8) 75
Other including cash equivalents....... (110) (42) (152) 107 (25) 82
------- ----- ------- ----- ----- ------
Total interest-earning assets........ $ 1,066 160 1,226 2,019 (483) 1,536
------- ----- ------- ----- ----- ------
------- ----- ------- ----- ----- ------
Interest-bearing liabilities:
Noninterest checking................... $ 0 0 0 0 0 0
NOW accounts........................... 28 (94) (66) 30 (18) 12
Passbooks.............................. (10) 13 3 (2) 3 1
Money market accounts.................. (26) 15 (11) (50) 3 (47)
Certificates........................... 232 (52) 180 351 54 405
Federal Home Loan Bank advances........ 1,337 6 1,343 1,431 (163) 1,268
------- ----- ------- ----- ----- ------
Total interest-bearing liabilities... $ 1,561 (112) 1,449 1,760 (121) 1,639
------- ----- ------- ----- ----- ------
------- ----- ------- ----- ----- ------
Net interest income..................... $15,447 15,670
------- ------
------- ------
</TABLE>
(1) For purposes of this table, changes attributable to both rate and volume
which cannot be segregated, have been allocated proportionately to the
change due to volume and the change due to rate.
- - --------------------------------------------------------------------------------
The following table sets forth the weighted average yields on HMN's
interest-earning assets, the weighted average interest rates on interest-bearing
liabilities and the interest rate spread between the weighted average yields and
rates as of the date indicated. Non-accruing loans have been included in the
table as loans carrying a zero yield.
<TABLE>
<CAPTION>
- - ---------------------------------------------------------------------------------------------------------------
AT DECEMBER 31, 1997
- - ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Weighted average yield on: Weighted average rate on:
Securities available for sale: Non-interest checking..................... 0.00%
Mortgage-backed and related NOW accounts.............................. 1.50
securities....................... 6.50% Passbooks................................. 2.62
Other marketable securities......... 6.09 Money market accounts..................... 3.34
Loans held for sale.................... 7.67 Certificates.............................. 5.82
Loans receivable, net................ 7.73 Federal Home Loan Bank advances........... 5.80
Federal Home Loan Bank stock........... 7.00 Combined weighted average rate on
Other interest-earning assets.......... 4.68 interest-bearing liabilities........... 5.29
Combined weighted average yield on Interest rate spread...................... 1.98%
interest-earning assets............. 7.27
- - ---------------------------------------------------------------------------------------------------------------
</TABLE>
HMN FINANCIAL, INC. 15
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
PROVISION FOR LOSSES ON LOANS
The provision for losses on loans is the result of management's evaluation of
the loan portfolio including its evaluation of national and regional economic
indicators (including the possibility at each year end that there would be an
increase in general interest rates), such as national and regional unemployment
data, single family loan delinquencies as reported separately by the Federal
National Mortgage Association (FNMA) and the Federal Home Loan Bank Mortgage
Corporation (FHLMC), local single family construction permits and local economic
growth rates and the current regulatory and general economic environment. HMN
will continue to monitor and modify its allowance for losses as these conditions
dictate. Although HMN maintains its allowance for losses at a level it considers
adequate to provide for probable losses, there can be no assurance that such
losses will not exceed the estimated amount or that additional provisions for
loan losses will not be required in future periods.
The provision for losses on loans for 1997 and 1996 was $300,000 for each
year. The provision for losses on loans for 1995 was $300,000, a decrease of
$110,000, from $410,000 for 1994. Based upon management's evaluation of the loan
portfolio and its understanding of the economic conditions in the areas where it
has a concentration of loans, a provision of $300,000 was deemed adequate for
each of the years in the three year period ended December 31, 1997. HMN incurred
$22,700 of loan charge-offs during 1997 and it also recovered $7,825 on loans
previously charged-off. The loan charge-offs were not significant for 1997 and
general economic conditions in the markets served by HMN did not cause
management to determine that a change in the provision was required. HMN
incurred $150,000 of loan charge-offs during 1996 which were primarily related
to two loans which were not single-family residential loans. The charge-offs
were not deemed to be indicative of a trend that would call for a higher loan
loss provision. For information on the allowance for loan losses refer to Note 6
of the Notes to Consolidated Financial Statements.
NON-INTEREST INCOME
Non-interest income was $2.7 million for 1997, an increase of $800,000, or 41.5%
compared to $1.9 million for 1996 and $998,000 for 1995. The following table
presents certain components of non-interest income:
<TABLE>
<CAPTION>
- - ---------------------------------------------------------------------------------------------
Percentage
Year Ended December 31, Increase (Decrease)
-------------------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995 1997/1996 1996/1995
- - ---------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Fees and service charges................ $ 487 359 325 35.7% 10.5%
Securities gains, net................... 1,250 1,030 416 21.4 147.6
Gain on sales of loans.................. 469 39 102 1,102.6 (61.8)
Other non-interest income............... 516 495 155 4.2 219.4
------ ----- ---
Total non-interest income............ $2,722 1,923 998 41.5 92.7
------ ----- ---
------ ----- ---
- - ---------------------------------------------------------------------------------------------
</TABLE>
Fees and service charges earned for the year ended December 31, 1997
increased by $128,000 over the amount earned in 1996 due to an increase in fees
earned on loan servicing activities and increased fees on deposit accounts. The
$34,000 increase in fees and service charges for the year ended December 31,
1996 over the amount earned in 1995 was also related to increased fees on
deposit accounts.
The ability to realize gains on the sale of securities is dependent on
the type of securities in the securities portfolio and upon changes in the
general interest rate environment. During 1997 and 1996 economic conditions
existed which allowed HMN to sell securities at a net gain of $1.25 million
and $1.0 million, respectively. The proceeds from the securities sold during
1997 were invested in the loan portfolio, used to acquire MFC, invested in
other assets or reinvested in securities. During 1995 economic conditions did
not warrant the sale of securities to the same extent as were sold in 1996 or
1997.
During 1997, HMN became more active in the mortgage banking business and
recognized $469,000 profit from the sale of $46.5 million of primarily single
family mortgage loans. During 1996, HMN received $1.7 million in proceeds from
the sale of primarily 30 year fixed rate loans and recognized a $39,000 gain.
During 1995 HMN sold $2.4 million of fixed rate 30 year loans and $1.8 million
of student loans at a gain of $102,000. Periodically HMN evaluates its loan
portfolio and sells loans that do not meet its long-term asset/liability goals.
The net $21,000 increase in other non-interest income recognized in 1997
compared to 1996 represents fees and commissions earned on financial planning
services and income earned on equity investments in limited partnerships. The
$340,000 increase in other non-interest income recognized in 1996 compared to
1995 represents a $169,000 increase in commissions earned on the sale of
uninsured products, a $71,000 gain on the sale of an equity interest in a data
processing center, and $100,000 of other non-recurring income.
16
<PAGE>
NON-INTEREST EXPENSE
Non-interest expense for the year ended December 31, 1997 was $9.0 million, a
decrease of $1.5 million, or 14.1%, from $10.5 million for the year ended in
1996 and $7.5 million for 1995. The following table presents the components of
non-interest expense:
<TABLE>
<CAPTION>
- - -------------------------------------------------------------------------------------------------
Percentage
Year Ended December 31, Increase (Decrease)
-----------------------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995 1997/1996 1996/1995
- - -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Compensation and benefits............... $5,590 4,591 4,160 21.8% 10.4%
Occupancy............................... 983 826 698 19.0 18.3
Federal deposit insurance premiums...... 238 800 811 (70.3) (1.4)
SAIF assessment......................... 0 2,352 0 (100.0) N/A
Advertising............................. 316 308 312 2.6 (1.3)
Data processing......................... 509 489 476 4.1 2.7
Provision for real estate losses........ 18 2 9 800.0 (77.8)
Other................................... 1,368 1,141 1,004 19.9 13.6
------ ------ -----
Total non-interest expense........... $9,022 10,509 7,470 (14.1) 40.7
------ ------ -----
------ ------ -----
- - -------------------------------------------------------------------------------------------------
</TABLE>
The $1.5 million decrease in non-interest expense from 1996 to 1997 was due
to the one time SAIF assessment of $2.35 million not repeating itself in
1997. As a result of the SAIF assessment recapitalizing the SAIF, the FDIC
insurance premium expense decreased by $561,000 from 1996 to 1997. The
decrease in non-interest expense was partially offset by a $999,000 increase
in compensation and benefits, an increase in occupancy of $158,000 and an
increase in other expense of $227,000. Compensation and benefits expense
increased as a result of adding new employees in mortgage banking activities,
the purchase of MFC and normal merit and salary increases to existing
employees. Occupancy increased for the year ended December 31, 1997 compared
to 1996 because of the purchase of MFC and depreciation resulting from
continued remodeling and updating of offices for new technological advances.
Non-interest expense was $10.5 million for 1996, an increase of $3.0 million,
or 40.7%, from $7.5 million for 1995. The majority of the increase is the result
of a $2.35 million SAIF assessment made during the third quarter of 1996.
Compensation and benefit expense increased by $431,000, or 10.4%, and was the
result of adding new employees, normal merit and salary increases, a full year's
impact of stock awards granted under the Recognition and Retention Plan granted
in June of 1995 and the increased expense of the employee stock option plan
related to recognizing benefit expense based upon the fair value of the shares
being awarded in the plan. Occupancy expense for 1996 increased by $128,000, or
18.3%, partly due to building improvements made during 1995 being depreciated
for a full year in 1996 and partly due to HMN opening a mortgage banking office
in Eden Prairie, Minnesota during the fourth quarter of 1996. Other expense
increased by $137,000, or 13.6% from 1995 to 1996. The increase is the result of
professional fees and other non-recurring expenses recognized during 1996.
INCOME TAXES
HMN recorded income tax expense of $3.3 million in 1997, compared to $2.5
million and $3.4 million for 1996 and 1995, respectively. The increase in income
tax expense from 1996 to 1997 and the decrease from 1995 to 1996 is primarily
the result of changes in taxable income between the years. For more information
on income taxes refer to Note 12 of the Notes to Consolidated Financial
Statements.
FINANCIAL CONDITION
LOANS RECEIVABLE, NET
The table on the following page, sets forth the information on HMN's loan
portfolio in dollar amounts and in percentages (before deductions for loans in
process, deferred fees and discounts and allowances for losses) as of the dates
indicated.
HMN FINANCIAL, INC. 17
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
<TABLE>
<CAPTION>
- - ---------------------------------------------------------------------------------------------------------------------------------
December 31,
-------------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
----------------- ----------------- ----------------- ----------------- -----------------
(DOLLARS IN THOUSANDS) Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
- - ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
REAL ESTATE LOANS:
One-to-four family........ $395,668 87.58% $321,340 90.19% $292,497 90.62% $252,943 91.14% $233,009 92.18%
Multi-family.............. 2,717 0.60 280 0.08 361 0.11 311 0.11 349 0.14
Commercial................ 10,572 2.34 7,918 2.22 8,744 2.71 8,316 3.00 4,559 1.80
Construction or
development ............ 5,725 1.27 3,474 0.98 5,082 1.58 2,799 1.01 3,309 1.31
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate..... 414,682 91.79 333,012 93.47 306,684 95.02 264,369 95.26 241,226 95.43
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
OTHER LOANS:
Consumer Loans:
Savings account......... 1,362 0.30 938 0.26 1,210 0.37 648 0.23 872 0.34
Education............... 123 0.03 467 0.13 342 0.11 2,007 0.72 1,819 0.72
Automobile.............. 2,438 0.54 566 0.16 671 0.21 520 0.19 681 0.27
Home equity line........ 19,490 4.31 11,881 3.33 3,509 1.09 0 0.00 0 0.00
Home equity............. 7,176 1.59 5,927 1.67 7,997 2.47 7,716 2.78 5,604 2.22
Home
improvement........... 652 0.14 585 0.16 785 0.24 870 0.31 912 0.36
Other................... 624 0.14 568 0.16 545 0.17 502 0.19 586 0.23
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans . 31,865 7.05 20,932 5.87 15,059 4.66 12,263 4.42 10,474 4.14
Commercial business
loans................... 5,226 1.16 2,344 0.66 1,018 0.32 897 0.32 1,089 0.43
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total other loans..... 37,091 8.21 23,276 6.53 16,077 4.98 13,160 4.74 11,563 4.57
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans........... 451,773 100.00% 356,288 100.00% 322,761 100.00% 277,529 100.00% 252,789 100.00%
------ ------ ------ ------ ------
------ ------ ------ ------ ------
LESS:
Loans in process.......... 4,562 2,814 3,531 2,327 2,333
Unamortized
discounts............... 547 417 289 162 14
Net deferred
loan fees............... 1,847 1,695 1,899 2,147 2,507
Allowance
for losses.............. 2,748 2,340 2,191 1,893 1,489
-------- -------- -------- -------- --------
Total loans
receivable, net....... $442,069 $349,022 $314,851 $271,000 $246,446
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
- - ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
One-to-four family real estate loans were $395.7 million at December 31,
1997, an increase of $74.4 million, or 23.1%, compared to $321.3 million at
December 31, 1996. During 1997 HMN had the following one-to-four family real
estate loan activity: originated $34.0 million, purchased $67.2 million,
securitized $16.6 million, acquired from MFC $63.3 million, sold $9.0 million
and received principal repayments of $64.5 million.
One-to-four family real estate loans were $321.3 million at December 31,
1996, an increase of $28.8 million, or 9.8%, compared to $292.5 million at
December 31, 1995. During 1996 HMN had the following one-to-four family real
estate loan activity: originated $32.5 million, purchased $55.8 million,
securitized $15.4 million, sold $2.3 million and received principal
repayments of $41.8 million.
One-to-four family real estate loans increased $39.6 million to $292.5
million at December 31, 1995 from $252.9 million at December 31, 1994. During
1995 HMN had the following one-to-four family real estate loan activity:
originated $25.7 million, purchased $47.1 million, sold $2.4 million and
received principal repayments of $30.8 million.
One-to-four family real estate loans increased $19.9 million to $252.9
million at December 31, 1994 from $233 million at December 31, 1993. During
1994 HMN originated $31.9 million, purchased $17.2 million and received
principal repayments of $29.2 million.
Home equity line loans were $19.5 million at December 31, 1997, an
increase of $7.6 million, or 64.0%, compared to $11.9 million at December 31,
1996 and $3.5 million at December 31, 1995. During the second half of 1995
the Bank introduced these revolving home equity lines of credit which loan up
to 90% of the equity
18
<PAGE>
in a home to the borrower. The interest rate has always been competitive and the
customers have liked the convenient features of the program. HMN has focused its
marketing efforts on its customers to promote the home equity line
of credit.
HMN purchases commercial business loans and commercial real estate loans
primarily from third party originators in the form of participation
interests. The increase in commercial real estate loans and commercial
business loans in the table above is primarily due to the purchase of
participation interests or loans acquired in 1997 in connection with the
acquisition of MFC.
ALLOWANCES FOR LOAN AND REAL ESTATE LOSSES
HMN recognizes that credit losses will be experienced and that the risk of
loss will vary with, among other things, the type of loans being made, the
creditworthiness of the borrower over the term of the loan, general economic
conditions and, in the case of a secured loan, the quality of the collateral.
It is management's policy to maintain an allowance for loan losses based on,
among other things, the Bank's and the industry's historical loan loss
experience, evaluation of economic conditions, regular reviews of
delinquencies and loan portfolio quality and evolving standards imposed by
OTS examiners. HMN increases its allowance for loan losses by charging
provision for loan losses against income. The methodology for establishing
the allowance for loan losses takes into consideration probable losses that
have been identified in connection with specific loans as well as losses in
the loan portfolio that have not yet been identified but can be expected to
occur. Management conducts quarterly reviews of the loan portfolio and
evaluates the need to establish general allowances on the basis of these
reviews.
Management continues to actively monitor the asset quality and to charge
off loans against the allowance for loan losses when appropriate. Although
management believes it uses the best information available to make
determinations with respect to the allowance for loan losses, future
adjustments may be necessary if economic conditions differ substantially from
the economic conditions in the assumptions used to determine the size of the
allowance for losses.
The allowance for loan losses was $2.7 million, or 0.62%, of total loans
at December 31, 1997, compared to $2.3 million, or 0.66% of total loans at
December 31, 1996, and $2.2 million, or 0.68% of total loans at December 31,
1995. The following table reflects the activity in the allowance for loan
losses and selected statistics:
<TABLE>
<CAPTION>
- - ---------------------------------------------------------------------------------------------------------------------------
December 31,
-------------------------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995 1994 1993
- - ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at the beginning of year.............................. $2,341 2,191 1,893 1,489 831
MFC allowance for loan losses acquired...................... 122 0 0 0 0
Provision for losses........................................ 300 300 300 410 660
Charge-offs................................................. (23) (150) (2) (6) (2)
Recoveries.................................................. 8 0 0 0 0
------ ----- ----- ----- -----
Net charge-offs........................................... (15) (150) (2) (6) (2)
------ ----- ----- ----- -----
Balance at end of year........................................ $2,748 2,341 2,191 1,893 1,489
------ ----- ----- ----- -----
------ ----- ----- ----- -----
Year end allowance for loan losses as a percent of
year end gross loan balance................................. 0.62% 0.66% 0.68% 0.68% 0.59%
Ratio of net loan charge-offs to average loans outstanding.... 0.01 0.05 0.00 0.00 0.00
Allowance for loan losses as a percentage of total
assets at year end.......................................... 0.40 0.42 0.41 0.38 0.35
- - ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
The ratio of net loan charge-offs to average loans outstanding for each of
the past five years has been very low due to the credit quality of the loan
portfolio.
The following table reflects the activity of the allowance for real estate
losses:
<TABLE>
<CAPTION>
- - ---------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995 1994 1993
- - --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at the beginning of year............................ $ 2 35 37 126 100
Provision for losses...................................... 18 2 9 0 45
Charge-offs............................................... (12) 0 (11) 0 (19)
Recoveries................................................ 0 0 0 0 0
------ ----- ----- ----- -----
Net charge-offs......................................... (12) 0 (11) 0 (19)
------ ----- ----- ----- -----
Other..................................................... 0 (35) 0 (89) 0
------ ----- ----- ----- -----
Balance at the end of year.................................. $ 8 2 35 37 126
------ ----- ----- ----- -----
------ ----- ----- ----- -----
- - --------------------------------------------------------------------------------------------------------------------------
</TABLE>
HMN FINANCIAL, INC. 19
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
Real estate properties acquired or expected to be acquired through loan
foreclosures are initially recorded at the lower of the related loan balance,
less any specific allowance for loss, or fair value less estimated selling
costs. Valuations are periodically performed by management and an allowance for
losses is established if the carrying value of a property exceeds its fair value
less estimated selling costs.
NON-PERFORMING ASSETS
Non-performing assets (comprised of non-accrual loans, restructured loans,
and real estate acquired through foreclosure) totaled $807,000 at December
31, 1997, an increase of $446,000 compared to $361,000 at December 31, 1996.
Non-performing assets had the following activity during 1997: sales of
$42,000, charge-offs of $35,000, payments of $80,000 and net transfers to
non-performing assets of $603,000.
Non-performing assets at December 31, 1996 were $361,000, a decrease of
$489,000, compared to $850,000 at December 31, 1995. Non-performing assets had
the following activity during 1996: sales of $314,000, charge-offs of $61,000,
payments of $128,000, and net transfers to non-performing assets of $14,000.
Non-performing assets are summarized in the following table:
<TABLE>
<CAPTION>
- - --------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995 1994 1993
- - --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Non-accrual loans......................................... $263 338 441 235 138
Accruing loans delinquent 90 days or more................. 402 0 0 0 23
Restructured loans........................................ 0 0 94 199 0
Foreclosed assets......................................... 142 23 315 64 421
--- --- --- --- ---
Total non-performing assets............................. $807 361 850 498 582
--- --- --- --- ---
--- --- --- --- ---
Non-performing assets as a percentage of total assets....... 0.12% 0.07% 0.16% 0.10% 0.14%
Total non-performing loans.................................. $665 338 535 434 161
Non-performing loans as a percentage of
loans receivable, net..................................... 0.15% 0.10% 0.17% 0.16% 0.07%
Allowance for loan losses to non-performing loans........... 413.17% 691.84% 409.13% 436.52% 924.84%
- - --------------------------------------------------------------------------------------------------------------------------
</TABLE>
The non-performing assets reflected above primarily consist of one-to-four
family mortgage loans or consumer loans.
STOCKHOLDERS' EQUITY
Stockholders' equity was $84.5 million on December 31, 1997, an increase of $2.4
million, or 2.9%, from $82.1 million at December 31, 1996. During 1997 HMN
purchased 298,334 shares of its own common stock for a total cost of $6.4
million. During 1995 the Board of Directors approved a management Recognition
and Retention Plan (RRP) which awarded 84,486 shares of restricted HMN common
stock to management and directors. The restricted stock used for the RRP was
issued from treasury stock and vests over a five year period. As the RRP
participants earn their awards stockholders' equity is credited and compensation
is expensed.
On June 29, 1994, HMN completed a public stock Offering which generated net
proceeds of $59.2 million net of costs of $1.7 million. An ESOP was established
which borrowed $6.1 million from HMN. The loan is treated as a reduction of
stockholders' equity. For more information refer to the Consolidated Statement
of Stockholders' Equity and Note 15 of the Notes to Consolidated Financial
Statements.
REGULATORY CAPITAL REQUIREMENTS
Federal savings institutions are required to satisfy three capital
requirements: (i) a requirement that "tangible capital" equal or exceed 1.5%
of adjusted total assets, (ii) a requirement that "core capital" equal or
exceed 3% of adjusted total assets, and (iii) a requirement that "risk-based
capital" equal or exceed 8% of risk-weighted assets. With certain exceptions,
all three capital standards must generally conform to and be no less
stringent than, the capital standards published by the Comptroller of the
Currency for national banks.
As a result of the Federal Deposit Insurance Corporation Improvement Act of
1991 (FDICIA), banking and thrift regulators are required to take prompt
regulatory action against institutions which are undercapitalized. FDICIA
requires banking and thrift regulators to categorize institutions as "well
capitalized," "adequately capitalized," "undercapitalized," "significantly
undercapitalized," or "critically undercapitalized". A savings institution will
be deemed to be well capitalized if it: (i) has a total risk-based capital ratio
of 10% or greater, (ii) has a Tier 1 (core) risk-based capital ratio of 6% or
greater, (iii) has a leverage (core) ratio of 5% or greater, and (iv) is not
subject to any order or written directive by the OTS to meet and maintain a
specific capital level for any capital measure. The Bank is of the opinion that
it is considered well capitalized at December 31, 1997. Refer to Note 16 of the
Notes to Consolidated Financial Statements for a table which reflects the Bank's
capital compared to its capital requirements.
LIQUIDITY
HMN manages its liquidity position to ensure that the funding needs of borrowers
and depositors are met timely and in the most cost effective manner. Asset
liquidity is the ability
20
<PAGE>
to convert assets to cash through the maturity of the asset or the sale of the
asset. Liability liquidity results from the ability of the Bank to attract
depositors or borrow funds from third party sources such as the FHLB. The Bank
is required by regulation to maintain a monthly average minimum asset liquidity
ratio of 4%. The Bank has maintained an average monthly liquidity ratio in
excess of the 4% requirement and does not anticipate that it will fall below the
requirement in the future.
The primary investing activities are the origination or purchase of loans
and the purchase of securities. Principal and interest payments on mortgages and
securities are a primary source of cash for HMN. Additional cash can be obtained
by selling securities from the available for sale portfolio or by selling loans.
Loans could also be securitized by FNMA or FHLMC and used as collateral for
additional borrowing with the FHLB. In December of 1997 HMN, through its wholly
owned subsidiary, acquired Marshalltown Financial Corporation (MFC) by
purchasing MFC's outstanding stock with cash. Refer to Note 2 of the Notes to
Financial Statements for more details related to the acquisition.
The primary financing activity is the attraction of retail deposits. The
Bank has the ability to borrow additional funds from the FHLB by pledging
additional securities or loans. Refer to Note 11 of the Notes to Consolidated
Financial Statements for more information on undrawn open lines of credit and
additional advances that could be drawn upon based upon existing collateral
levels with the FHLB. Information on outstanding advance maturities is also
included in Note 11.
*HMN anticipates that its liquidity requirements for 1998 will be similar
to the cash flows it experienced in 1997 with the exception of the MFC
acquisition and construction disbursements for completion of the Spring Valley
retail banking facility and a new retail banking facility in Winona.
Construction disbursements are estimated to total $2.2 million on a combined
basis for Spring Valley and Winona and additional other expenditures of $1.0
million for premises and equipment. HMN has agreed to loan $1.5 million to the
HMN Employee Stock Ownership Plan to allow it to purchase additional shares of
HMN common stock. The Bank will need $3.6 million to purchase the outstanding
MFC common stock and options not tendered to the settlement agent at December
31, 1997. The cash needed to fund the mortgage banking activities of HMN
Mortgage Services, Inc. will range from $5.0 million to $15.0 million during
1998.
HMN's most liquid assets are cash and cash equivalents, which consist of
short-term highly liquid investments with original maturities of less than
three months that are readily convertible to known amounts of cash and
interest-bearing deposits. The level of these assets is dependent on the
operating, financing, and investing activities during any given period.
Cash and cash equivalents at December 31, 1997 were $9.4 million, a
decrease of $1.2 million compared to $10.6 million at December 31, 1996. Net
cash provided from operating activities during 1997 was $6.6 million. HMN
conducted the following major investing activities during 1997: proceeds from
the sale of securities available for sale were $94.5 million, principal
received on payments and maturities of securities available for sale was
$49.1 million, purchases were $103.1 million of securities available for
sale, principal received on payments and maturities of securities held to
maturity were $1.2 million, purchases of interests in limited partnerships
were $2.4 million, proceeds from sale of loans were $24.8 million, purchases
of mortgage servicing rights were $845,000, purchase of FHLB stock was
$803,000 and net increase in loans receivable was due primarily to loan
originations and loan purchases of $68.6 million. HMN spent $1.9 million for
the purchase of premises and equipment and it expended net cash for the
acquisition of MFC of $16.8 million. Net cash used by investing activities
during 1997 was $24.4 million. HMN conducted the following major financing
activities during 1997: increase in deposits of $1.3 million, purchase of
treasury stock $6.4 million, proceeds from FHLB advances $151.8 million and
repayments of FHLB advances totaled $130.2 million. Net cash provided from
financing activities was $16.6 million.
*HMN has certificates of deposit with outstanding balances of $258.6
million that come due during 1998. 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 below 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 occur if interest rates were to suddenly
change up or down. The RATE SHOCK TABLE located below 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.
*This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 25 of this discussion.
HMN FINANCIAL, INC. 21
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
*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 December 31, 1997. 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 December 31, 1997.
<TABLE>
<CAPTION>
Other than trading portfolio Market Value
(DOLLARS IN THOUSANDS) --------------------------------------------------------
Basis point change in interest rates -200 -100 0 +100 +200
- - --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Cash equivalents............................................ $ 8,371 8,364 8,357 8,350 8,344
Fixed-rate CMOs............................................. 62,590 62,313 61,989 60,415 58,215
Variable-rate CMOs.......................................... 22,821 23,022 22,922 22,259 21,413
Fixed-rate available for sale mortgage-backed
and related securities.................................... 31,450 31,188 30,844 30,458 29,995
Variable-rate available for sale
mortgage-backed and related securities.................... 20,316 19,973 19,728 19,505 19,231
Fixed-rate available for sale other
marketable securities..................................... 72,987 71,229 69,433 67,717 66,081
Variable-rate available for sale other
marketable securities..................................... 6,963 6,949 6,935 6,920 6,906
Fixed-rate loans held for sale.............................. 2,291 2,289 2,287 2,285 2,283
Fixed-rate real estate loans................................ 327,871 325,548 317,189 306,082 294,462
Variable-rate real estate loans............................. 89,328 88,745 87,874 86,869 85,507
Fixed-rate other loans...................................... 18,227 18,065 17,916 17,666 17,427
Variable-rate other loans................................... 30,891 30,811 30,746 30,687 30,626
------- ------- ------- ------- -------
Total market risk sensitive assets.......................... 694,106 688,496 676,220 659,213 640,490
------- ------- ------- ------- -------
NOW deposits................................................ 26,957 26,935 26,912 26,890 26,868
Passbook deposits........................................... 36,121 34,472 32,969 31,596 30,336
Money market deposits....................................... 25,466 24,264 23,173 22,178 21,269
Certificate deposits........................................ 388,929 385,056 381,261 377,539 373,887
Fixed-rate Federal Home Loan Bank advances.................. 82,581 80,329 78,176 76,116 74,144
Variable-rate Federal Home Loan Bank advances............... 49,052 49,011 48,971 48,931 48,890
------- ------- ------- ------- -------
Total market risk sensitive liabilities..................... 609,106 600,067 591,462 583,250 575,394
------- ------- ------- ------- -------
Off-balance sheet financial instruments:
Commitments to extend credit................................ 52 51 50 48 46
Net market risk............................................. $ 85,052 88,480 84,808 76,011 65,142
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Percentage change from current market value................. 0.29% 4.33% 0.00% (10.37)% (23.19)%
------- ------- ------- ------- -------
------- ------- ------- ------- -------
- - --------------------------------------------------------------------------------------------------------------------------
</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 31%, depending on the coupon and period to maturity. ARMs were
assumed to prepay at annual rates of between 12% and 22%, depending on coupon
and the period to maturity. Growing Equity Mortgage (GEM) loans were assumed to
prepay at annual rates of between 16% and 38% 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%.
*This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 25 of this discussion.
22
<PAGE>
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. 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 December 31,
1997 to determine if its current level of interest rate risk is acceptable. The
following table projects the estimated impact on net interest income of
immediate interest rate changes called rate shocks.
<TABLE>
<CAPTION>
- - -----------------------------------------------------------------------
Rate Shock Net Interest Percentage
in Basis Points Income Change
- - -----------------------------------------------------------------------
<S> <C> <C>
+200 $17,758,000 (3.20)%
+100 18,182,000 (0.89)%
0 18,345,000 0.00%
-100 18,544,000 1.08%
-200 18,370,000 0.14%
- - -----------------------------------------------------------------------
</TABLE>
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 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.
*This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 26 of this discussion.
HMN FINANCIAL, INC. 23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
The following gap table sets forth the interest rate sensitivity of HMN's
assets and liabilities at December 31, 1997, using certain assumptions that are
described in more detail below:
<TABLE>
<CAPTION>
- - ----------------------------------------------------------------------------------------------------------------------------------
Maturing or Repricing
---------------------------------------------------------------------
Over 6
6 Months Months to Over 1-3 Over 3-5 Over 5 No Stated
(DOLLARS IN THOUSANDS) or Less One Year Years Years Years Maturity Total
- - ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Cash equivalents............................................ $ 8,365 0 0 0 0 0 8,365
Securities available for sale:
Mortgage-backed and
related securities(1)..................................... 48,009 17,552 40,545 20,162 9,330 0 135,598
Other marketable securities............................... 24,723 11,555 8,392 10,670 0 13,017 68,357
Loans held for sale......................................... 2,287 0 0 0 0 0 2,287
Loans receivable, net:(1)(2)
Fixed rate one-to-four family(3).......................... 26,548 24,107 79,925 55,659 119,091 0 305,330
Adjustable rate one-to-four family(3)..................... 25,158 34,420 15,792 14,355 1,528 0 91,253
Multi family.............................................. 386 291 991 429 600 0 2,697
Fixed rate commercial real estate....................... 824 370 1,020 244 76 0 2,534
Adjustable rate commercial real estate.................... 7,118 366 727 0 0 0 8,211
Commercial business....................................... 2,059 642 1,717 767 42 0 5,227
Consumer loans.......................................... 22,325 1,660 3,457 1,643 480 0 29,565
Federal Home Loan Bank stock................................ 0 0 0 0 0 7,432 7,432
------- ------- -------- ------- ------- ------- -------
Total interest-earning assets........................... 167,802 90,963 152,566 103,929 131,147 20,449 666,856
------- ------- -------- ------- ------- ------- -------
Non-interest checking....................................... 3,833 0 0 0 0 0 3,833
NOW accounts................................................ 23,143 0 0 0 0 0 23,143
Passbooks................................................... 3,822 3,418 10,426 6,672 11,861 0 36,199
Money market accounts....................................... 2,622 2,342 7,145 4,572 8,127 0 24,808
Certificates................................................ 119,627 139,004 99,852 18,342 2,540 0 379,365
Federal Home Loan Bank advances............................. 58,714 8,536 29,000 21,000 10,400 0 127,650
------- ------- -------- ------- ------- ------- -------
Total interest-bearing liabilities...................... 211,761 153,300 146,423 50,586 32,928 0 594,998
------- ------- -------- ------- ------- ------- -------
Interest-earning assets less
interest-bearing liabilities.............................. $ (43,959) (62,337) 6,143 53,343 98,219 20,449 71,858
------- ------- -------- ------- ------- ------- -------
------- ------- -------- ------- ------- ------- -------
Cumulative interest-rate
sensitivity gap........................................... $ (43,959) (106,296) (100,153) (46,810) 51,409 71,858 71,858
------- ------- -------- ------- ------- ------- -------
------- ------- -------- ------- ------- ------- -------
Cumulative interest-rate gap as a
percentage of total assets at
December 31, 1997......................................... (6.36)% (15.38)% (14.49)% (6.77)% 7.44% 10.40% 10.40%
------- ------- -------- ------- ------- ------- -------
------- ------- -------- ------- ------- ------- -------
Cumulative interest-rate gap as a
percentage of total assets at
December 31, 1996......................................... (4.61) (10.66)
------- -------
------- -------
- - ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Schedule prepared based upon the earlier of contractual maturity or
repricing date, if applicable, adjusted for scheduled repayments of
principal and projected prepayments of principal based upon experience.
(2) Loans receivable are presented net of loans in process and deferred loan
fees.
(3) Construction and development loans are all one-to-four family loans and
therefore have been included in the fixed rate one-to-four family and
adjustable rate one-to-four family lines.
24
<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. Fixed
rate loans were assumed to prepay at annual rates of between 6% to 31%,
depending on the coupon and period to maturity. ARMs were assumed to prepay at
annual rates of between 12% and 22%, depending on coupon and the period to
maturity. GEM loans were assumed to prepay at annual rates of between 16% and
38% depending on the coupon and the period to maturity. Mortgage-backed
securities and CMOs were projected to have prepayments based upon the underlying
collateral securing the instrument. Certificate accounts were assumed not to be
withdrawn until maturity. Passbook and money market accounts were assumed to
decay at an annual rate of 20%.
Certain shortcomings are inherent in the method of analysis presented in
the foregoing table. Although certain assets and liabilities may have similar
maturities and periods of repricing, they may react in different degrees to
changes in market interest rates. The interest rates on certain types of
assets and liabilities may fluctuate in advance of changes in market interest
rates, while interest rates on other types of assets and liabilities may lag
behind changes in market interest rates. Certain assets, such as
adjustable-rate mortgages, have features which restrict changes in interest
rates on a short-term basis and over the life of the asset. In the event of a
change in interest rates, prepayment and early withdrawal levels would likely
deviate significantly from those assumed in calculating the foregoing table.
The ability of many borrowers to service their debt may decrease in the event
of an interest rate increase.
Refer to Regulatory Capital Requirements above for a discussion of the
Bank's interest rate risk component.
YEAR 2000
*The Bank has formed a committee which has analyzed its exposure to year 2000
computer hardware and software issues. A major portion of the Bank's data
processing is provided by a third party vender which is committed to being year
2000 compliant by early 1999. The committee is monitoring the data processing
vender's progress on year 2000 issues. The committee reviewed all hardware and
software used internally by HMN or any of its subsidiaries and determined which
hardware and/or software would need to be replaced by the year 2000. The cost of
becoming year 2000 compliant is not deemed to be material.
FORWARD-LOOKING INFORMATION
The following statements 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.
LIQUIDITY HMN anticipates that its liquidity requirements for 1998 will
be similar to the cash flows it experienced in 1997 with the exception of
the MFC acquisition and construction disbursements for completion of the
Spring Valley retail banking facility and a new retail banking facility in
Winona. Construction disbursements are estimated to total $2.2 million on a
combined basis for Spring Valley and Winona and additional other
expenditures of $1.0 million for premises and equipment. The cash needed to
fund the mortgage banking activities of HMN Mortgage Services, Inc. will
range from $5.0 million to $15.0 million during 1998.
Construction costs could increase due to unknown construction supply
issues or unforeseen labor issues. The mortgage banking activities of MSI
may exceed the estimated range of $5 million to $15 million due to
additional loan originations generated in its market area. In either
situation mentioned above additional cash would be generated from the sale
of securities or the advances from the FHLB.
HMN has certificates of deposit with outstanding balances of $258.6
million that come due during 1998. Based upon past experience management
anticipates that the majority of the deposits will renew for another term.
Any deposits which do not renew will be replaced with deposits from other
customers, or funded with advances from the FHLB, or will be funded through
the sale of securities. Management does not anticipate that it will have a
liquidity problem 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 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 December 31, 1997.
Actual interest rates could fluctuate by more than 200 basis points up
or down from rates in effect on December 31, 1997 due to unanticipated
occurrences such as the start of another war in the gulf. Many Asian
countries are experiencing economic difficulties which may have a larger
impact on the economy of the United States than is currently anticipated
and thereby cause general interest rates to fluctuate by more than 200
basis points.
*This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 26 of this discussion.
HMN FINANCIAL, INC. 25
<PAGE>
HMN's actual market value changes for interest earning assets and
interest bearing liabilities may differ from the projected market values
disclosed in the table in the Market Risk section.
Certain shortcomings are inherent in the method of analysis in the table
presented in the Market Risk section above. 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 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
December 31, 1997 to determine if its current level of interest rate risk
is acceptable. 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. HMN's actual maturing 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
each of the tables. 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 tables. 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.
YEAR 2000
The cost of becoming year 2000 compliant is not deemed to be material.
The estimated costs are dependent upon HMN's third party data processing
center successfully converting its hardware and software to be year 2000
compliant. The data processing center may not successfully complete their
conversion which may cause HMN's cost to substantially increase.
DIVIDENDS
HMN has not paid any dividends since its incorporation in March 1994. However,
the Board of Directors may consider a policy of paying cash dividends in the
future. The declaration of dividends are subject to, among other things, HMN's
financial condition and results of operations, the Bank's compliance with its
regulatory capital requirements, including the fully phased-in capital
requirements, tax considerations, industry standards, economic conditions,
regulatory restrictions, general business practices and other factors. Refer to
Note 15 of the Notes to Consolidated Financial Statements for information on
regulatory limitations on dividends from the Bank to HMN.
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.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and Notes presented herein have been
prepared in accordance with generally accepted accounting principles, which
require the measurement of financial position and operation results that are
primarily in terms of historical dollars without considering the changes in the
relative purchasing power of money over time due to inflation. The impact of
inflation is reflected in the increased cost of operations. Unlike most
industrial companies, nearly all of the assets and liabilities of HMN are
monetary in nature. As a result, interest rates have a greater impact on HMN's
performance than do the effects of general levels of inflation. Interest rates
do not necessarily move in the same direction or to the same extent as the
prices of goods and services.
MERGER AND ACQUISITIONS
From time to time HMN reviews the possibility of acquiring or merging with
different companies which would complement the business conducted by HMN. HMN's
Board of Directors has adopted the policy of not disclosing to the public its
intent to acquire or merge until a formal definitive agreement has been signed
by all parties involved with the transaction except as otherwise required by
law.
On December 5, 1997 HMN, through its wholly owned subsidiary, Home Federal
Savings Bank, completed its merger with Marshalltown Financial Corporation
pursuant to a merger agreement dated July 1, 1997. Refer to Note 2 of the Notes
to Consolidated Financial Statements for more information on the merger.
26
<PAGE>
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, 1997 AND 1996 1997 1996
- - --------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash and cash equivalents....................................................... $ 9,364,635 10,583,717
Securities available for sale:
Mortgage-backed and related securities
(amortized cost $135,598,404 and $134,474,167)........................... 135,935,482 133,355,278
Other marketable securities
(amortized cost $68,356,926 and $42,360,499)............................. 69,923,477 42,474,810
------------ -----------
205,858,959 175,830,088
------------ -----------
Securities held to maturity:
Mortgage-backed and related securities
(fair value $0 and $1,904,993)........................................... 0 1,805,744
Other marketable securities
(fair value $0 and $1,000,550)........................................... 0 999,812
------------ -----------
0 2,805,556
------------ -----------
Loans held for sale............................................................. 2,287,265 739,316
Loans receivable, net........................................................... 442,068,600 349,022,236
Federal Home Loan Bank stock, at cost........................................... 7,432,200 5,434,000
Real estate, net................................................................ 133,939 20,610
Premises and equipment, net..................................................... 5,880,710 3,581,497
Accrued interest receivable..................................................... 4,038,131 3,415,152
Investment in limited partnerships.............................................. 5,989,399 2,887,525
Goodwill...................................................................... 4,500,873 0
Core deposit intangible......................................................... 1,546,273 0
Investment in mortgage servicing rights......................................... 781,005 4,681
Prepaid expenses and other assets............................................... 1,349,521 407,221
------------ -----------
Total assets .............................................................. $691,231,510 554,731,599
------------ -----------
------------ -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits........................................................................ $467,347,688 362,476,944
Federal Home Loan Bank advances................................................. 127,650,021 106,078,589
Accrued interest payable........................................................ 1,365,064 1,542,773
Advance payments by borrowers for taxes and insurance........................... 786,619 518,911
Accrued expenses and other liabilities.......................................... 6,056,356 2,014,938
Due to stockholders of Marshalltown Financial Corporation....................... 3,555,352 0
------------ -----------
Total liabilities.......................................................... 606,761,100 472,632,155
------------ -----------
Commitments and contingencies
Stockholders' equity:
Serial preferred stock ($.01 par value): authorized 500,000 shares;
issued and outstanding none.............................................. 0 0
Common stock ($.01 par value): authorized shares 7,000,000;
issued shares 6,085,775.................................................. 60,858 60,858
Additional paid-in capital................................................. 59,729,090 59,428,768
Retained earnings, subject to certain restrictions......................... 60,224,253 54,645,387
Net unrealized gain (loss) on securities available for sale................ 1,129,818 (598,045)
Unearned employee stock ownership plan shares.............................. (4,554,280) (4,938,520)
Unearned compensation restricted stock awards.............................. (600,668) (793,289)
Treasury stock, at cost 1,941,407 and 1,651,615............................ (31,518,661) (25,705,715)
------------ -----------
Total stockholders' equity............................................... 84,470,410 82,099,444
------------ -----------
Total liabilities and stockholders' equity................................. $691,231,510 554,731,599
------------ -----------
------------ -----------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
HMN FINANCIAL, INC. 27
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 1997 1996 1995
- - -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Interest income:
Loans receivable........................................................... $28,328,864 25,721,042 23,375,334
Securities available for sale:
Mortgage-backed and related.............................................. 8,255,402 10,027,438 10,294,056
Other marketable......................................................... 3,699,378 2,424,628 2,857,884
Securities held to maturity:
Mortgage-backed and related.............................................. 33,400 765,120 746,100
Other marketable......................................................... 10,032 104,448 389,381
Cash equivalents........................................................... 342,433 494,129 412,259
Other...................................................................... 420,722 327,520 253,170
----------- ---------- ----------
Total interest income.................................................... 41,090,231 39,864,325 38,328,184
----------- ---------- ----------
Interest expense:
Deposits................................................................... 19,056,164 18,949,937 18,578,744
Federal Home Loan Bank advances............................................ 6,586,855 5,243,853 3,976,353
----------- ---------- ----------
Total interest expense................................................... 25,643,019 24,193,790 22,555,097
----------- ---------- ----------
Net interest income...................................................... 15,447,212 15,670,535 15,773,087
Provision for loan losses....................................................... 300,000 300,000 300,000
----------- ---------- ----------
Net interest income after provision for loan losses........................ 15,147,212 15,370,535 15,473,087
----------- ---------- ----------
Noninterest income:
Fees and service charges................................................... 487,085 359,249 324,492
Securities gains, net...................................................... 1,249,569 1,029,638 415,955
Gain on sales of loans..................................................... 469,461 39,306 102,368
Other...................................................................... 516,244 494,507 155,434
----------- ---------- ----------
Total noninterest income................................................. 2,722,359 1,922,700 998,249
----------- ---------- ----------
Noninterest expense:
Compensation and benefits.................................................. 5,590,297 4,591,367 4,160,248
Occupancy.................................................................. 983,238 825,609 697,602
Federal deposit insurance premiums......................................... 238,654 799,890 810,432
SAIF assessment............................................................ 0 2,351,563 0
Advertising................................................................ 315,771 308,464 312,366
Data processing............................................................ 508,930 489,045 476,402
Provision for real estate losses........................................... 18,000 2,000 9,327
Other...................................................................... 1,367,815 1,140,948 1,003,682
----------- ---------- ----------
Total noninterest expense................................................ 9,022,705 10,508,886 7,470,059
----------- ---------- ----------
Income before income tax expense......................................... 8,846,866 6,784,349 9,001,277
Income tax expense.............................................................. 3,268,000 2,510,000 3,380,900
----------- ---------- ----------
Net income............................................................... $5,578,866 4,274,349 5,620,377
----------- ---------- ----------
----------- ---------- ----------
Basic earnings per share........................................................ $ 1.51 0.99 1.10
----------- ---------- ----------
----------- ---------- ----------
Diluted earnings per share...................................................... $ 1.41 0.96 1.09
----------- ---------- ----------
----------- ---------- ----------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
28
<PAGE>
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Net Unearned
Unrealized Employee
Gain (Loss) Stock
Additional on Securities Ownership
YEARS ENDED DECEMBER 31, Common Paid-In Retained Available for Plan
1997, 1996 AND 1995 Stock Capital earnings Sale Shares
- - ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance,
December 31, 1994....................... $60,858 59,155,995 44,750,661 (9,174,623) (5,745,880)
Net income............................. 5,620,377
Change in unrealized
loss on securities
available for sale.................... 8,909,265
Treasury stock
purchases.............................
Unearned compensation
restricted stock awards............... 36,319
Amortization of
restricted stock awards...............
Earned employee stock
ownership plan shares................. 93,267 409,730
--------- ---------- ---------- ---------- -----------
Balance,
December 31, 1995....................... $60,858 59,285,581 50,371,038 (265,358) (5,336,150)
Net income............................. 4,274,349
Change in unrealized
loss on securities
available for sale.................... (332,687)
Treasury stock
purchases.............................
Stock options exercised................ (10,817)
Restricted stock awards
cancelled............................. (808)
Amortization of
restricted stock awards...............
Restricted stock
awards tax benefit.................... 13,677
Earned employee stock
ownership plan shares................. 141,135 397,630
--------- ---------- ---------- ---------- -----------
Balance,
December 31, 1996....................... 60,858 59,428,768 54,645,387 (598,045) (4,938,520)
Net income............................. 5,578,866
Change in unrealized
loss on securities
available for sale.................... 1,727,863
Treasury stock
purchases.............................
Amoritization of
restricted stock awards...............
Recognition and retention..............
awards granted........................ 2,250
Stock options exercised................ (82,009)
Restricted stock awards
tax benefit........................... 61,092
Stock option tax benefit .............. 20,751
Earned employee stock
ownership plan shares................. 298,238 384,240
--------- ---------- ---------- ---------- -----------
Balance,
December 31, 1997....................... $60,858 59,729,090 60,224,253 1,129,818 (4,554,280)
--------- ---------- ---------- ---------- -----------
--------- ---------- ---------- ---------- -----------
<CAPTION>
Unearned
Compensation Total Stock-
YEARS ENDED DECEMBER 31, Restricted Treasury holders'
1997, 1996 AND 1995 Stock Awards Stock Equity
- - -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance,
December 31, 1994....................... 89,047,011
Net income............................. 5,620,377
Change in unrealized
loss on securities
available for sale.................... 8,909,265
Treasury stock
purchases............................. (12,509,667) (12,509,667)
Unearned compensation
restricted stock awards............... (1,167,005) 1,130,686 0
Amortization of
restricted stock awards............... 116,700 116,700
Earned employee stock
ownership plan shares................. 502,997
----------- ------------- ------------
Balance,
December 31, 1995....................... (1,050,305) (11,378,981) 91,686,683
Net income............................. 4,274,349
Change in unrealized
loss on securities
available for sale.................... (332,687)
Treasury stock
purchases............................. (14,364,754) (14,364,754)
Stock options exercised................ 63,180 52,363
Restricted stock awards
cancelled............................. 25,968 (25,160) 0
Amortization of
restricted stock awards............... 231,048 231,048
Restricted stock
awards tax benefit.................... 13,677
Earned employee stock
ownership plan shares................. 538,765
----------- ------------- ------------
Balance,
December 31, 1996....................... (793,289) (25,705,715) 82,099,444
Net income............................. 5,578,866
Change in unrealized
loss on securities
available for sale.................... 1,727,863
Treasury stock
purchases............................. (5,988,450) (5,988,450)
Amoritization of
restricted stock awards............... 231,621 231,621
Recognition and retention..............
awards granted........................ (39,000) 36,750 0
Stock options exercised................ 138,754 56,745
Restricted stock awards
tax benefit........................... 61,092
Stock option tax benefit .............. 20,751
Earned employee stock
ownership plan shares................. 682,478
----------- ------------- ------------
Balance,
December 31, 1997....................... (600,668) (31,518,661) 84,470,410
----------- ------------- ------------
----------- ------------- ------------
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
HMN FINANCIAL, INC. 29
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 1997 1996 1995
- - -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income................................................................. $ 5,578,866 4,274,349 5,620,377
Adjustments to reconcile net income to cash provided by operating
activities:
Provision for loan losses................................................ 300,000 300,000 300,000
Provision for real estate losses......................................... 18,000 2,000 9,327
Depreciation............................................................. 434,493 378,753 352,580
Amortization of (discounts) premiums, net................................ (216,978) (129,636) (272,862)
Amortization of deferred loan fees....................................... (410,111) (440,580) (613,037)
Amortization of goodwill................................................. 13,858 0 0
Amortization of core deposit intangible.................................. 20,727 0 0
Amortization of loans and deposits mark, net............................. 38,379 0 0
Amortization of mortgage servicing rights................................ 39,514 0 0
Provision for deferred income taxes...................................... 83,895 110,400 568,050
Federal Home Loan Bank stock dividend.................................... 0 0 (75,100)
Securities gains, net.................................................... (1,249,569) (1,029,638) (415,955)
Gain on sales of real estate............................................. (3,743) (46,625) (14,241)
Gain on sales of loans................................................... (469,461) (39,306) (102,368)
Proceeds from sales of loans held for sale............................... 21,626,615 1,779,361 260,848
Disbursements on loans held for sale..................................... (18,753,844) 0 0
Principal collected on loans held for sale............................... (1,946) 0 0
Amortization of restricted stock awards.................................. 231,621 231,048 116,700
Amortization of unearned ESOP shares..................................... 384,240 397,630 409,730
Earned employee stock ownership shares priced above original cost........ 298,238 141,135 93,267
Decrease (increase) in accrued interest receivable....................... 190,834 (33,645) (100,280)
Increase (decrease) in accrued interest payable.......................... (1,720,271) (19,574) 561,969
Equity earnings of limited partnerships.................................. (220,278) (7,400) 0
Increase in other assets................................................. (745,309) (48,974) (173,133)
Increase (decrease) in other liabilities................................. 1,218,475 35,995 (540,164)
Other, net............................................................... (99,980) (56,470) (35,803)
------------ ------------ -----------
Net cash provided by operating activities.............................. 6,586,265 5,798,823 5,949,905
------------ ------------ -----------
Cash flows from investing activities:
Proceeds from sales of securities available for sale....................... 94,462,303 101,157,643 85,454,779
Principal collected on securities available for sale....................... 15,028,627 16,530,585 15,427,074
Proceeds collected on maturity of securities available for sale............ 34,118,412 20,500,000 18,815,000
Purchases of securities available for sale................................. (103,102,213) (107,860,451) (110,993,058)
Proceeds from sales of securities held to maturity......................... 348,871 0 0
Principal collected on securities held to maturity......................... 240,441 2,276,661 1,076,805
Proceeds collected on maturity of securities held to maturity.............. 1,000,000 12,652,343 5,000,000
Purchases of securities held to maturity................................... 0 (709,765) (10,993,313)
Proceeds from sales of loans receivable.................................... 24,806,862 1,408,015 3,996,710
Purchases of mortgage servicing rights..................................... (844,601) 0 0
Purchase interest in limited partnerships.................................. (2,438,750) (2,880,125) 0
Purchase of Federal Home Loan Bank stock................................... (802,700) (1,632,100) (688,100)
Net increase in loans receivable........................................... (68,579,885) (53,214,798) (47,904,546)
Proceeds from sale of real estate.......................................... 35,627 379,789 199,020
Purchases of premises and equipment........................................ (1,856,365) (314,714) (458,666)
Acquisition of Marshalltown Financial Corporation, net of cash acquired.... (16,822,639) 0 0
------------ ------------ -----------
Net cash used by investing activities.................................... (24,406,010) (11,706,917) (41,068,295)
------------ ------------ -----------
Cash flows from financing activities:
Increase (decrease) in deposits............................................ 1,258,293 (11,062,524) 22,964,821
Purchase of treasury stock................................................. (6,350,950) (14,002,254) (12,509,667)
Stock options exercised.................................................... 56,745 52,363 0
Proceeds from Federal Home Loan Bank advances.............................. 151,800,000 130,000,000 82,150,000
Repayment of Federal Home Loan Bank advances............................... (130,228,568) (92,798,389) (65,258,747)
Increase (decrease) in advance payments by borrowers for taxes and insurance 65,143 (32,079) 9,521
------------ ------------ -----------
Net cash provided by financing activities................................ 16,600,663 12,157,117 27,355,928
------------ ------------ -----------
Increase (decrease) in cash and cash equivalents......................... (1,219,082) 6,249,023 (7,762,462)
Cash and cash equivalents, beginning of year.................................... 10,583,717 4,334,694 12,097,156
------------ ------------ -----------
Cash and cash equivalents, end of year.......................................... $ 9,364,635 10,583,717 4,334,694
------------ ------------ -----------
------------ ------------ -----------
Supplemental cash flow disclosures:
Cash paid for interest..................................................... $ 27,363,290 24,213,364 21,993,128
Cash paid for income taxes................................................. 3,000,500 2,725,433 2,994,755
Supplemental noncash flow disclosures:
Loans securitized and transferred to securities available for sale......... $ 16,526,399 15,411,803 0
Securities held to maturity transferred to securities available for sale... 1,295,147 0 651,594
Loans transferred to loans held for sale................................... 4,346,602 2,491,820 254,912
Loans transferred to loans held for investment............................. 95,503 0 0
Transfer of loans to real estate........................................... 232,071 188,054 413,853
Transfer of real estate to loans........................................... 84,772 161,954 0
Treasury stock purchased with liability due to broker...................... 0 362,500 0
Due to stockholders of Marshalltown Financial Corporation.................. 3,555,352 0 0
</TABLE>
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997, 1996 AND 1995
NOTE 1 DESCRIPTION OF THE BUSINESS AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
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. The consolidated financial statements have been prepared in
conformity with generally accepted accounting principles. The following items
set forth the significant accounting policies which HMN follows in presenting
its financial statements.
MATERIAL ESTIMATES In preparing the financial statements, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the date of the balance sheet and revenues and
expenses for the period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to change relate to
the determination of the allowance for losses on loans and the valuation of real
estate acquired in connection with foreclosures or in satisfaction of loans. In
connection with the determination of the allowances for loan and real estate
losses, management obtains independent appraisals for significant properties.
Management believes that the allowances for losses on loans and real estate
are adequate. While management uses available information to recognize losses on
loans and real estate, future additions to the allowances may be necessary based
on changes in economic conditions. In addition, various regulatory agencies, as
an integral part of their examination process, periodically review the
allowances for losses on loans and real estate. Such agencies may require
additions to the allowances based on their judgement about information available
to them at the time of their examination.
CASH EQUIVALENTS For purposes of the statements of cash flows, HMN considers
highly liquid investments with original maturities of three months or less to be
cash equivalents.
SECURITIES HMN classifies its debt and equity securities in one of three
categories: trading, available for sale, or held to maturity. Trading securities
are bought and held principally for the purpose of selling them in the near
term. Securities available for sale include securities that management intends
to use as part of its asset/liability strategy or that may be sold in response
to changes in interest rate, changes in prepayment risk, or similar factors.
Securities held to maturity represent securities which HMN has the positive
intent and ability to hold to maturity.
Securities available for sale are carried at market value. Net unrealized
gains and losses, net of tax effect, are included as a separate component of
stockholders' equity.
Securities held to maturity are carried at cost, adjusted for amortization
of premiums and discounts, as management has the ability and intent to hold them
to maturity.
Premiums and discounts are amortized using the level-yield method over
the period to maturity. Gains and losses on the sale of securities are
determined using the specific-identification method.
LOANS HELD FOR SALE Mortgage loans originated or purchased which are
intended for sale in the secondary market are carried at the lower of cost or
estimated market value in the aggregate. Gains are recognized on settlement
date. Net unrealized losses are recognized through a valuation allowance by
charges to income.
LOANS RECEIVABLE, NET Loans receivable, net are considered long-term
investments and, accordingly are carried at amortized cost. Loan origination
fees received, net of certain loan origination costs, are deferred as an
adjustment to the carrying value of the related loans, and are amortized into
income using the interest method over the estimated life of the loans.
Discounts on loans are amortized into interest income using the interest
method over the period to contractual maturity, adjusted for estimated
prepayments.
The allowance for loan losses is maintained at an amount considered
adequate to provide for probable losses. The allowance for losses on loans is
based on periodic analysis of the loan portfolio by management. In this
analysis, management considers factors including, but not limited to, specific
occurrences which include loan impairment, general economic conditions, loan
portfolio composition and historical experience. Loans are charged off to the
extent they are deemed to be uncollectible.
Interest income is recognized on an accrual basis except when
collectibility is in doubt. When loans are placed on a nonaccrual basis,
generally when the loan is 90 days past due, previously accrued but unpaid
interest is reversed from income. Interest is subsequently recognized as income
to the extent cash is received when, in management's judgement, principal is
collectible.
All impaired loans, including all loans that are restructured in a troubled
debt restructuring involving a modification of terms, are measured at the
present value of expected future cash flows discounted at the loan's initial
effective interest rate. The fair value of the collateral of an impaired
collateral-dependent loan or an observable market price, if one exists, may be
used as an alternative to discounting. If the measure of the impaired loan is
less than the recorded investment in the loan, impairment will be recognized
through the allowance for loan losses. A loan is considered impaired when, based
on current information and events, it is probable that a creditor will be unable
to collect all amounts due according to the contractual terms of the loan
agreement. Impaired loans are all loans which are delinquent as to principal and
interest for 120 days or greater and all loans that are restructured in a
troubled debt restructuring involving a modification of terms. All portfolio
loans are reviewed on an individual basis.
HMN FINANCIAL, INC. 31
<PAGE>
MORTGAGE SERVICING RIGHTS Effective January 1, 1996, HMN adopted Statement of
Financial Accounting Standards (SFAS) No. 122, ACCOUNTING FOR MORTGAGE SERVICING
RIGHTS. HMN recognizes as a separate asset the rights to service mortgage loans
for others whether the servicing rights are acquired through loan origination or
purchase. The fair value of capitalized mortgage servicing rights is based upon
the present value of estimated future cash flows. Based upon current fair values
capitalized mortgage servicing rights are periodically assessed for impairment,
which is recognized in the statement of income during the period in which the
impairment occurs as an adjustment to the corresponding valuation allowance. For
purposes of performing its impairment evaluation, HMN stratifies its portfolio
on the basis of certain risk characteristics including loan type and note rate.
Capitalized mortgage servicing rights are amortized over the estimated remaining
life of the underlying loans and take into account appropriate prepayment
assumptions. The effect of adopting SFAS No. 122 did not have a material impact
on HMN's financial condition or the results of its operations during 1996. In
June, 1996 SFAS No. 122 was superceded by SFAS No. 125.
In June 1996, the Financial Accounting Standards Board (FASB) issued
SFAS No. 125, ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENT OF LIABILITIES. SFAS No. 125 applies to transfers and
servicing of financial assets and extinguishments of liabilities. It requires
a financial-components approach that focuses on control. Under the approach,
after a transfer of financial assets, an entity recognizes the financial and
servicing assets it controls and the liabilities it has incurred,
derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. In December 1996, the FASB issued
SFAS No. 127 which postpones the effective date by one year for certain
provisions of SFAS No. 125. The sections dealing with secured borrowings and
collateral are deferred for all transfers of financial assets until after
December 31, 1997. Likewise transfers related to repurchase agreements,
dollar-rolls, securities lending and similar transactions are deferred until
after December 31, 1997. The effect of adopting SFAS No. 125 as amended by
SFAS No. 127 did not have a material impact on HMN's financial condition or
the results of its operations.
REAL ESTATE, NET Real estate properties acquired through loan
foreclosures are initially recorded at the lower of the related loan balance,
less any specific allowance for loss, or fair value less estimated selling
costs. Valuations are periodically performed by management and an allowance for
losses is established if the carrying value of a property exceeds its fair value
less estimated selling costs.
PREMISES AND EQUIPMENT Land is carried at cost. Office buildings, improvements,
furniture and equipment are carried at cost less accumulated depreciation.
Depreciation is computed on a straight-line basis over estimated useful
lives of 10 to 40 years for office buildings and improvements and 3 to 12 years
for furniture and equipment.
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF
Effective January 1, 1996, HMN adopted SFAS No. 121, ACCOUNTING FOR THE
IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF. HMN
reviews long-lived assets and certain identifiable intangibles for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. The effect of adopting SFAS No. 121 on January
1, 1996 did not have a material impact on HMN's financial condition or the
results of its operations.
INTANGIBLE ASSETS Goodwill resulting from acquisitions is amortized on a
straight line basis over 25 years. Deposit base intangible is amortized on an
accelerated basis as the certificates of deposit mature over the next eleven
years. Management reviews intangible assets for impairment as events or
circumstances indicate that the assets may not be recoverable.
STOCK-BASED COMPENSATION Effective January 1, 1996, HMN adopted SFAS No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION. It elected to continue using the
accounting methods prescribed by Accounting Principles Board (APB) Opinion No.
25 and related interpretations which measure compensation cost using the
intrinsic value method. HMN has included in Note 13, "Employee Benefits" the
impact of the fair value of employee stock-based compensation plans on net
income and earnings per share on a pro forma basis for awards granted after
January 1, 1995.
INCOME TAXES Deferred tax assets and liabilities are recognized for the future
tax consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
NEW ACCOUNTING STANDARDS Refer to "Earnings per Share" below for information on
adopting SFAS No. 128.
In July 1997, the FASB issued SFAS No. 130, REPORTING COMPREHENSIVE INCOME
which establishes standards of disclosure and financial statement display for
reporting total comprehensive income and the individual components thereof.
Comprehensive income is defined as the change in equity (net assets) of a
business enterprise during a period from transactions and other events and
circumstances from nonowner sources. It includes all changes in equity during a
period except those resulting from investments by owners and distributions to
owners. As used in SFAS No. 130, the term comprehensive income thus encompasses
net income. The term other comprehensive income refers to components of
comprehensive income that are excluded from net income under generally accepted
accounting principles. Comprehensive income may be presented in any of the
following financial statements: in a separate statement of comprehensive income;
in a statement of changes in equity; or below the total of net income or loss in
the income statement. SFAS No. 130 is effective for fiscal years beginning after
December 15, 1997, with earlier application permitted. Comparative statements
for previous years must be reclassified, although reclassification adjustments
are not required to be shown for such earlier periods. Management will be
adopting SFAS No. 130 on January 1, 1998 and will report comprehensive income in
statements issued for financial reporting periods occurring during 1998.
In July 1997, the FASB issued SFAS No. 131, DISCLOSURES
ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION which establishes new
standards for determining a reportable segment and for disclosing information
regarding each such segment. The amount of each segment item reported should be
the measure reported to the chief operating decision maker for purposes of
making decisions about allocating resources to the segment and assessing its
performance. Adjustments and eliminations made in preparing an enterprise's
general-purpose financial statements and allocations of revenues, expenses and
gains or losses should be included in determining reported segment profit or
loss only if they are included in the measure of the segment's profit or loss
that is used by the chief operating decision maker. Similarly, only those assets
that are included in the measure of the segment's assets that is used by the
chief operating decision maker should be reported for
32
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
that segment. SFAS No. 131 is effective for fiscal years beginning after
December 15, 1997, with earlier application encouraged. Management will disclose
segment information starting with financial reporting periods occurring during
1998.
In February 1998, the FASB issued SFAS No. 132, EMPLOYERS' DISCLOSURES
ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS which revises employers'
disclosures about pension and other post retirement 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. Management is currently studying the impact of
adopting SFAS No. 132.
EARNINGS PER SHARE In February 1997, the FASB issued SFAS No. 128, EARNINGS PER
SHARE. SFAS No. 128 establishes standards for computing and presenting earnings
per share (EPS) and applies to entities with publicly held common stock or
potential common stock. SFAS No. 128 simplifies the standards for computing
earnings per share previously found in APB Opinion No. 15, EARNINGS PER SHARE,
and makes them comparable to international EPS standards. It replaces the
presentation of primary EPS with a presentation of basic EPS. It also requires
dual presentation of basic and diluted EPS on the face of the income statement
for all entities with complex capital structures and requires a reconciliation
of the numerator and denominator of the basic EPS computation to the numerator
and denominator of the diluted EPS computation.
Basic EPS excludes dilution and is computed by dividing income available
to common stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution that
could occur if securities or other contracts to issue common stock were
exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity. Diluted EPS is
computed similarly to fully diluted EPS pursuant to APB Opinion No. 15. HMN
adopted SFAS No. 128 effective December 31, 1997 and, in conformity with SFAS
No. 128, has restated all prior-period EPS data presented in this financial
statement.
The following table reconciles the weighted average shares outstanding and
the income available to common shareholders used for basic and diluted EPS:
<TABLE>
<CAPTION>
- - -------------------------------------------------------------------------------------------------
Year Ended December 31,
-------------------------------------------
1997 1996 1995
-------------------------------------------
<S> <C> <C> <C>
Weighted average number of
common shares outstanding
used in basic earnings per
common share calculation.......................... 3,683,458 4,315,410 5,109,989
Net dilutive effect of:
Options........................................... 209,388 54,838 19,062
Restricted stock awards........................... 50,767 67,003 42,887
---------- ----------- ---------
Weighted average number
of shares outstanding adjusted
for effect of dilutive securities................. 3,943,613 4,437,251 5,171,938
---------- ----------- ---------
---------- ----------- ---------
Income available to common
shareholders...................................... $5,578,866 4,274,349 5,620,377
Basic earnings per
common share...................................... $1.51 0.99 1.10
Diluted earnings per
common share...................................... $1.41 0.96 1.09
- - -------------------------------------------------------------------------------------------------
</TABLE>
In February of 1998 HMN announced that its Board of Directors voted to
request stockholder approval at the annual meeting of stockholders to be held on
April 28, 1998 for an increase in HMN's authorized common stock from 7.0 million
shares to 11.0 million shares. Subject to stockholder approval of the increase,
the Board has authorized a three-for-two stock split of its common stock, to be
effected in the form of a fifty percent stock dividend. The record date and
distribution date for such dividend are expected to be set by the Board
immediately following the annual stockholders' meeting.
RECLASSIFICATIONS Certain amounts in the consolidated financial statements for
prior years have been reclassified to conform with the current year
presentation.
NOTE 2 BUSINESS COMBINATIONS 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 purchase method of accounting was used to record the merger
transaction.
The transaction was funded through a combination of the sale of securities,
and short-term borrowings from the Federal Home Loan Bank of Des Moines
("FHLB"). Pursuant to the merger agreement, the Bank is obligated to provide
cash to MFC stockholders when they submit their MFC stock or outstanding MFC
options. As of December 31, 1997 MFC stockholders had not submitted 216,165
shares or options for $3,555,352.
The merger consideration of $24.8 million plus the cancellation of 60,000
shares of MFC common stock owned by HMN with a historical cost of $1.0 million
was allocated as follows:
HMN FINANCIAL, INC. 33
<PAGE>
<TABLE>
- - ---------------------------------------------------------------------------
<S> <C>
Cash and cash equivalents............................. $ 5,437,603
Investment securities................................. 48,580,533
Loans receivable, net................................. 69,759,162
Federal Home Loan Bank stock, at cost................. 1,195,500
Premises and equipment................................ 744,793
Goodwill.............................................. 4,514,730
Core deposit intangible .............................. 1,567,000
Other assets.......................................... 2,210,518
Deposits.............................................. (103,580,493)
Net deferred tax liabilities.......................... (1,003,330)
Other liabilities .................................... (3,578,464)
-------------
Purchase price...................................... $ 25,847,552
-------------
-------------
- - ---------------------------------------------------------------------------
</TABLE>
The following Unaudited Pro Forma Condensed Combined Statements of Income
for the years ended December 31, 1997 and 1996 combine HMN's income statement
for the year ended December 31 with MFC's income statement for the year ended
September 30. The statements are presented as if the Merger had been effective
at the beginning of each period presented, after giving effect to certain pro
forma adjustments described in the accompanying notes.
The Unaudited Pro Forma Condensed Combined Financial Information 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 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 periods indicated.
HMN FINANCIAL, INC. AND SUBSIDIARIES
MARSHALLTOWN FINANCIAL CORPORATION AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
HMN MFC Pro Forma
Year Ended Year Ended ------------------------------
12-31-97 9-30-97 Adjustments Combined
- - ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total interest income................... $ 41,090,231 8,849,795 (2,004,299)(1)(2) 47,935,727
Total interest expense.................. 25,643,019 5,484,065 387,570 (3)(4) 31,514,654
------------ ---------- ---------- ----------
Net interest income................... 15,447,212 3,365,730 (2,391,869) 16,421,073
Provision for loan losses............... 300,000 10,000 310,000
Non-interest income..................... 2,722,359 202,010 2,924,369
Non-interest expense.................... 9,022,705 2,378,914 494,242 (5)(6) 11,895,861
------------ ---------- ---------- ----------
Income before income tax expense...... 8,846,866 1,178,826 (2,886,111) 7,139,581
Income tax expense...................... 3,268,000 331,771 (1,024,971) 2,574,800
------------ ---------- ---------- ----------
Net income............................ $ 5,578,866 847,055 (1,861,140) 4,564,781
------------ ---------- ---------- ----------
------------ ---------- ---------- ----------
Basic earnings per share................ $ 1.51 0.58 1.24
Diluted earnings per share.............. $ 1.41 0.57 1.16
Weighted average shares outstanding:
Basic................................. 3,683,458 1,470,885 3,683,458
Diluted............................... 3,943,613 1,477,287 3,943,613
<CAPTION>
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1996
HMN MFC Pro Forma
Year Ended Year Ended -----------------------------
12-31-96 9-30-96 Adjustments Combined
- - --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Total interest income................... $39,864,325 8,756,211 (2,004,299)(1)(2) 46,616,237
Total interest expense.................. 24,193,790 5,579,496 387,570 (3)(4) 30,160,856
------------ ---------- ---------- ----------
Net interest income................... 15,670,535 3,176,715 (2,391,869) 16,455,381
Provision for loan losses............... 300,000 10,000 310,000
Non-interest income..................... 1,922,700 152,643 2,075,343
Non-interest expense.................... 10,508,886 3,187,416 494,242 (5)(6) 14,190,544
------------ ---------- ---------- ----------
Income before income tax expense...... 6,784,349 131,942 (2,886,111) 4,030,180
Income tax expense...................... 2,510,000 57,212 (1,009,212) 1,558,000
------------ ---------- ---------- ----------
Net income............................ $ 4,274,349 74,730 (1,876,899) 2,472,180
------------ ---------- ---------- ----------
------------ ---------- ---------- ----------
Basic earnings per share................ $ 0.99 0.05 0.57
Diluted earnings per share.............. $ 0.96 0.05 0.56
Weighted average shares outstanding:
Basic................................. 4,315,410 1,472,185 4,315,410
Diluted............................... 4,437,251 1,473,784 4,437,251
</TABLE>
34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENTS
OF INCOME
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 preliminary
estimates and 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 year ended December 31,
1997 or 1996 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.
Provided the accounting estimates related to the acquisition of MFC are not
revised, the estimated impact of amortizing goodwill and other purchase
accounting adjustments will reduce pretax income by the following amounts in
each of the following years: $1,256,000 for 1998, $593,000 for 1999, $564,000
for 2000, $426,694 for 2001 and $346,674 for 2002.
NOTE 3 SECURITIES AVAILABLE FOR SALE
A summary of securities available for sale at December 31, 1997 and 1996 is as
follows:
<TABLE>
<CAPTION>
- - ----------------------------------------------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
cost gains losses value
- - ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1997:
Mortgage-backed securities:
FHLMC..................................... $ 29,934,261 159,036 13,126 30,080,171
FNMA...................................... 14,352,421 46,710 59,159 14,339,972
GNMA...................................... 6,213,917 12,741 7,885 6,218,773
Other..................................... 186,523 0 881 185,642
Collateralized mortgage obligations:
FHLMC..................................... 21,583,016 227,165 207,710 21,602,471
FNMA...................................... 38,603,926 271,415 217,204 38,658,137
Other..................................... 24,724,340 127,068 1,092 24,850,316
----------- ---------- ---------- -----------
135,598,404 844,135 507,057 135,935,482
----------- ---------- ---------- -----------
Other marketable securities:
U.S. Government and agency obligations.... 43,403,323 40,398 100,965 43,342,756
Corporate debt............................ 2,903,330 0 182 2,903,148
Corporate equity.......................... 22,050,273 1,632,826 5,526 23,677,573
----------- ---------- ---------- -----------
68,356,926 1,673,224 106,673 69,923,477
----------- ---------- ---------- -----------
$203,955,330 2,517,359 613,730 205,858,959
----------- ---------- ---------- -----------
----------- ---------- ---------- -----------
DECEMBER 31, 1996:
Mortgage-backed securities:
FHLMC..................................... $ 1,776,252 32,567 0 1,808,819
FNMA...................................... 968,924 14,833 0 983,757
Collateralized mortgage obligations:
FHLMC..................................... 56,867,103 98,316 1,162,269 55,803,150
FNMA...................................... 45,236,461 113,800 596,858 44,753,403
Other..................................... 29,625,427 449,747 69,025 30,006,149
----------- ---------- ---------- -----------
134,474,167 709,263 1,828,152 133,355,278
----------- ---------- ---------- -----------
Other marketable securities:
U.S. Government and agency obligations.... 29,599,717 33,566 355,602 29,277,681
Corporate debt............................ 1,090,420 1,218 0 1,091,638
Corporate equity.......................... 11,670,362 555,608 120,479 12,105,491
----------- ---------- ---------- -----------
42,360,499 590,392 476,081 42,474,810
----------- ---------- ---------- -----------
$176,834,666 1,299,655 2,304,233 175,830,088
----------- ---------- ---------- -----------
----------- ---------- ---------- -----------
- - ----------------------------------------------------------------------------------------------------------
</TABLE>
Proceeds from securities available for sale which were sold during 1997
were $94,462,303, resulting in gross gains of $1,533,046 and gross losses of
$283,477. Proceeds from securities available for sale which were sold during
1996 were $101,157,643, resulting in gross gains of $1,235,754 and gross losses
of $206,116. Proceeds from securities available for sale which were sold during
1995 were $85,454,779, resulting in gross gains of $565,441 and gross losses of
$149,486.
HMN FINANCIAL, INC. 35
<PAGE>
The following table indicates amortized cost and estimated fair value of
securities available for sale at December 31, 1997, based upon contractual
maturity adjusted for scheduled repayments of principal and projected
prepayments of principal based upon current economic conditions and interest
rates. Actual maturities may differ from the maturities in the following table
because obligors may have the right to call or prepay obligations with or
without call or prepayment penalties:
<TABLE>
<CAPTION>
- - ------------------------------------------------------------------------
Amortized Fair
cost value
- - ------------------------------------------------------------------------
<S> <C> <C>
Due less than one year.................. $101,595,473 101,749,806
Due after one year through five years... 71,013,632 71,121,508
Due after five years through ten years . 6,732,965 6,743,193
After ten years......................... 2,562,987 2,566,880
No stated maturity...................... 22,050,273 23,677,572
------------ ------------
Total................................. $203,955,330 205,858,959
------------ ------------
------------ ------------
- - ------------------------------------------------------------------------
</TABLE>
The allocation of mortgage-backed securities and collateralized mortgage
obligations in the table above is based upon the anticipated future cash flow of
the securities using estimated mortgage prepayment speeds.
NOTE 4 SECURITIES HELD TO MATURITY
During the first quarter of 1997, HMN determined that it no longer had the
intent to hold its securities classified as held to maturity to the actual
maturity date of the securities. Therefore, it sold one security and on March
31, 1997 it transferred all the remaining securities in the held to maturity
portfolio to the available for sale portfolio.
The following information summarizes the sale and transfer of the
securities held to maturity during 1997.
<TABLE>
<CAPTION>
- - -------------------------------------------------------------------------------------------------------------------------------
Unrealized
Unrealized Holding Gain,
Amortized Fair Realized Holding Net of Tax,
Cost Value Gain Gain in Equity
- - -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Security sold..................................... $ 344,139 348,871 4,732
Securities transferred to available for sale...... $1,223,753 1,295,147 71,394 42,641
- - -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
A summary of securities held to maturity at December 31, 1996 is as follows:
- - ----------------------------------------------------------------------------
<TABLE>
<CAPTION>
Gross Gross
Amortized unrealized unrealized Fair
cost gains losses value
- - -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
DECEMBER 31, 1996:
Mortgage-backed securities:
FHLMC........................... $1,403,866 90,477 0 1,494,343
FNMA............................ 158,425 9,941 0 168,366
Other........................... 243,453 0 1,169 242,284
--------- -------- --------- ----------
1,805,744 100,418 1,169 1,904,993
--------- -------- --------- ----------
Other marketable securities:
Corporate debt.................. 999,812 738 0 1,000,550
--------- -------- --------- ----------
$2,805,556 101,156 1,169 2,905,543
--------- -------- --------- ----------
--------- -------- --------- ----------
- - -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
There were no sales of securities held to maturity in 1996.
<TABLE>
<CAPTION>
NOTE 5 LOANS RECEIVABLE, NET
A summary of loans receivable at December 31 is as follows:
- - ---------------------------------------------------------------------------------
1997 1996
---------------------------------
<S> <C> <C>
Residential real estate loans:
Conventional.............................. $399,029,974 320,317,356
FHA....................................... 1,797,006 2,203,983
VA........................................ 1,857,827 2,572,878
------------ -----------
402,684,807 325,094,217
------------ -----------
Other loans:
Commercial real estate 11,997,014 7,917,882
Autos..................................... 2,437,516 565,464
Home equity line.......................... 19,490,392 11,881,305
Home equity............................... 7,176,253 5,926,753
Other consumer............................ 411,100 370,417
Commercial business ...................... 5,226,095 2,344,421
Savings .................................. 1,362,186 938,308
Education................................. 123,313 466,576
Other..................................... 864,238 782,885
------------ -----------
49,088,107 31,194,011
------------ -----------
Total loans............................. 451,772,914 356,288,228
Less:
Unamortized discounts..................... 547,007 417,031
Net deferred loan fees.................... 1,846,692 1,694,730
Allowance for losses...................... 2,748,219 2,340,585
Loans in process.......................... 4,562,396 2,813,646
------------ -----------
$442,068,600 349,022,236
------------ -----------
------------ -----------
Weighted average contractual
interest rate............................. 7.39% 7.67%
Commitments to originate,
fund or purchase loans.................... $ 7,367,650 24,504,320
- - ---------------------------------------------------------------------------------
</TABLE>
Included in total commitments to originate or purchase loans
are fixed rate loans aggregating approximately $6,010,250 and $2,861,025 as of
December 31, 1997 and 1996, respectively. The interest rates on these
commitments ranged from 6.678% to 7.5% at December 31, 1997 and from 7.11% to
8.375% at December 31, 1996.
At December 31, 1997 and 1996, loans on nonaccrual status totaled $263,329
and $338,310, respectively. Had the loans performed in accordance with their
original terms throughout 1997, HMN would have recorded gross interest income of
$27,690 for these loans. Interest income of $14,444 has been recorded on these
loans for the year ended December 31, 1997.
At December 31, 1997 and 1996 there were no loans included in loans
receivable, net with terms that had been modified in a troubled debt
restructuring.
There were no material commitments to lend additional funds to customers
whose loans were classified as restructured or nonaccrual at December 31, 1997.
At December 31, 1997, 1996 and 1995, the recorded investment in loans that
are considered to be impaired were $665,151, $338,310 and $535,450,
respectively, for which the related allowance for credit losses were $34,762,
$17,571 and $70,097, respectively. The average investment in impaired loans
during 1997, 1996 and 1995 were $443,754, $423,042 and $466,288, respectively.
For the years ended December 31, 1997, 1996 and 1995, HMN recognized interest
income on impaired loans of $36,564, $24,662 and $40,553, respectively. All of
the interest
36
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
income that was recognized during 1997, 1996 and 1995 for impaired loans was
recognized using the cash basis method of income recognition.
The aggregate amount of loans to executive officers and directors of HMN
were $884,244, $385,023, and $169,489 at December 31, 1997, 1996 and 1995,
respectively. During 1997 repayments on loans to executive officers and
directors aggregated $30,679 and loans originated aggregated $529,900.
At December 31, 1997, 1996 and 1995, HMN was servicing real estate loans
for others with aggregate unpaid principal balances of approximately
$8,218,564, $1,417,954 and $1,130,649, respectively.
HMN originates residential, commercial real estate and other loans
primarily in southern Minnesota and after December 5, 1997 in Iowa. HMN also
purchases loans from a third party broker located in the Southeastern United
States. At December 31, 1997, HMN owned single family residential loans
located in the following states:
<TABLE>
<CAPTION>
- - -------------------------------------------------------------------------------
Percent
Amount of Total
- - -------------------------------------------------------------------------------
<S> <C> <C>
Alabama............. $ 4,462,834 1.1%
California.......... 9,054,681 2.2
Georgia............. 46,309,887 11.5
Iowa................ 49,705,322 12.3
Minnesota........... 233,002,052 57.9
North Carolina...... 11,819,254 2.9
Ohio................ 8,477,956 2.1
South Carolina...... 8,314,943 2.1
Tennessee........... 4,288,917 1.1
Wisconsin........... 20,130,423 5.0
Other states........ 7,118,538 1.8
------------ -------
Total............. $402,684,807 100.0%
------------ -------
------------ -------
- - -------------------------------------------------------------------------------
</TABLE>
- - --------------------------------------------------
NOTE 6 ALLOWANCE FOR LOAN AND REAL ESTATE LOSSES
The allowance for losses is summarized as follows:
<TABLE>
<CAPTION>
Loans Real estate Total
- - -------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, December 31, 1994............ $1,893,143 36,997 1,930,140
Provision for losses............... 300,000 9,327 309,327
Charge-offs........................ (2,612) (11,324) (13,936)
Recoveries......................... 133 0 133
----------- -------- ---------
Balance, December 31, 1995............ 2,190,664 35,000 2,225,664
Provision for losses............... 300,000 2,000 302,000
Charge-offs........................ (150,136) 0 (150,136)
Recoveries......................... 57 0 57
Other.............................. 0 (35,000) (35,000)
----------- -------- ---------
Balance, December 31, 1996............ 2,340,585 2,000 2,342,585
Provision for losses............... 300,000 18,000 318,000
MFC allowance for losses acquired . 122,500 0 122,500
Charge-offs........................ (22,691) (12,000) (34,691)
Recoveries......................... 7,825 0 7,825
----------- -------- ---------
Balance, December 31, 1997............ $2,748,219 8,000 2,756,219
----------- -------- ---------
----------- -------- ---------
- - -------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
NOTE 7 REAL ESTATE
A summary of real estate at December 31 is as follows:
- - ---------------------------------------------------------------------------
1997 1996
-----------------------
<S> <C> <C>
Real estate in judgement subject
to redemption............................ $ 0 22,610
Real estate acquired through foreclosure.... 141,939 0
-------- ------
141,939 22,610
Allowance for losses........................ 8,000 2,000
-------- ------
$133,939 20,610
-------- ------
-------- ------
- - ---------------------------------------------------------------------------
</TABLE>
NOTE 8 PREMISES AND EQUIPMENT
A summary of premises and equipment at December 31 is
as follows:
<TABLE>
<CAPTION>
- - ---------------------------------------------------------------------------
1997 1996
-------------------------
<S> <C> <C>
Land ......................................... $1,175,169 726,923
Office buildings and improvements............. 5,196,656 3,704,146
Furniture and equipment....................... 2,735,835 1,966,130
---------- ---------
9,107,660 6,397,199
---------- ---------
Less accumulated depreciation................. 3,226,950 2,815,702
---------- ---------
$5,880,710 3,581,497
---------- ---------
---------- ---------
- - ---------------------------------------------------------------------------
</TABLE>
During 1997 HMN purchased land totaling $392,700 in order to build new
retail banking facilities in Spring Valley and Winona. During 1997 HMN spent
$700,000 for construction in process on the two banking facilities. During 1998
HMN will spend approximately $2,200,000 to complete its building projects and
provide the buildings with furniture and equipment.
NOTE 9 ACCRUED INTEREST RECEIVABLE
Accrued interest receivable at December 31 is summarized
as follows:
<TABLE>
<CAPTION>
- - ----------------------------------------------------------------------
1997 1996
------------------------
<S> <C> <C>
Securities available for sale............. $1,549,173 1,256,214
Securities held to maturity............... 0 41,730
Loans receivable ......................... 2,488,958 2,117,208
---------- ---------
$4,038,131 3,415,152
---------- ---------
---------- ---------
- - ----------------------------------------------------------------------
</TABLE>
HMN FINANCIAL, INC. 37
<PAGE>
NOTE 10 DEPOSITS
Deposits and their weighted average interest rates at December 31 are summarized
as follows:
<TABLE>
<CAPTION>
- - --------------------------------------------------------------------------------------------------------------------------
1997 1996
--------------------------------------- --------------------------------------
Weighted Percent of Weighted Percent of
average rate Amount total average rate Amount total
- - --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Noninterest checking.................... 0.00% $ 3,832,736 0.8% 0.00% $ 2,389,034 0.7%
NOW accounts............................ 1.50 23,143,564 5.0 2.01 17,588,877 4.8
Passbooks............................... 2.62 36,198,890 7.6 2.50 30,070,326 8.3
Money market accounts................... 3.34 24,807,554 5.3 2.83 16,532,806 4.6
------------ ----- ------------ -----
87,982,744 18.7 66,581,043 18.4
------------ ----- ------------ -----
Certificates:
3-3.99%................................. 726,629 0.2 425,284 0.1
4-4.99%................................. 24,155,281 5.2 22,552,550 6.2
5-5.99%................................. 162,916,038 34.9 168,040,084 46.4
6-6.99%................................. 178,847,401 38.3 76,703,716 21.2
7-7.99%................................. 11,627,046 2.5 28,077,048 7.7
Over 8.00%.............................. 1,092,549 0.2 97,219 0.0
------------ ----- ------------ -----
Total certificates...................... 5.81 379,364,944 81.3 5.76 295,895,901 81.6
------------ ----- ------------ -----
Total deposits.......................... 5.17 $467,347,688 100.0% 5.14 $362,476,944 100.0%
------------ ----- ------------ -----
------------ ----- ------------ -----
- - --------------------------------------------------------------------------------------------------------------------------
</TABLE>
At December 31, 1997 and 1996, HMN had $47,546,431 and $38,226,676,
respectively, of deposit accounts with balances at $100,000 or more.
Certificates had the following maturities at December 31:
<TABLE>
<CAPTION>
- - ------------------------------------------------------------------------------------------------------
1997 1996
------------------------------------------------------------
Weighted Weighted
Amount average Amount average
REMAINING TERM TO MATURITY (in thousands) rate (in thousands) rate
- - ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1-6 months.............................. $121,295 5.69% $ 92,495 5.38%
7-12 months............................. 138,235 5.86 71,077 5.95
13-36 months............................ 98,515 5.87 111,369 5.91
37-60 months............................ 21,320 5.92 20,955 6.02
------- -------
$379,365 5.81 $295,896 5.76
------- -------
------- -------
- - ------------------------------------------------------------------------------------------------------
</TABLE>
At December 31, 1997 mortgage loans and mortgage-backed and related
securities with an amortized cost of approximately $42,579,000 and $2,328,000 of
letters of credit from the Federal Home Loan Bank (FHLB) were pledged as
collateral on deposits.
Interest expense on deposits is summarized as follows for the years ended
December 31:
<TABLE>
<CAPTION>
- - --------------------------------------------------------------------------------------
1997 1996 1995
----------- ---------- -----------
<S> <C> <C> <C>
NOW..................................... $ 257,261 323,311 311,359
Passbook................................ 762,923 760,083 759,167
Money Market............................ 490,223 500,811 547,412
Certificates............................ 17,545,757 17,365,732 16,960,806
----------- ---------- -----------
$19,056,164 18,949,937 18,578,744
----------- ---------- -----------
----------- ---------- -----------
- - --------------------------------------------------------------------------------------
</TABLE>
NOTE 11 FEDERAL HOME LOAN BANK ADVANCES
Federal Home Loan Bank advances consisted of the following at December 31, 1997
and 1996:
<TABLE>
<CAPTION>
- - -----------------------------------------------------------------------------------------------------
1997 1996
------------------------ ----------------------------
YEAR OF MATURITY Amount Rate Amount Rate
- - -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997.................................... $ 46,428,568 5.52
1998.................................... $ 43,250,021 5.85% 1,250,021 6.55
1999.................................... 15,000,000 5.42 5,000,000 5.16
2000.................................... 24,000,000 5.97 19,000,000 6.00
2001.................................... 19,000,000 5.86 24,000,000 5.51
2002.................................... 16,000,000 5.61 0 0.00
2003.................................... 10,400,000 5.89 10,400,000 5.89
------------ ------------
$127,650,021 5.80 $106,078,589 5.64
------------ ------------
------------ ------------
- - -----------------------------------------------------------------------------------------------------
</TABLE>
Certain advances have call provisions which allow the FHLB to request that
the advance be paid back prior to its maturity date. At December 31, 1997 all
advances maturing in 2001 have semiannual call features which start in 1998 and
$10,000,000 of the advances maturing in 2002 have quarterly call features which
start in 1998.
At December 31, 1997 and 1996 the Bank had an undrawn open line of credit
for $5,000,000 from the FHLB.
At December 31, 1997 the advances, the open line of credit, and
$2,328,000 of letters of credit from the FHLB were collateralized by the
Bank's FHLB stock and mortgage loans with unamortized principal balances of
approximately $375,000,000. The Bank has the ability to draw additional
borrowings of $150,000,000 based upon the mortgage loans that are currently
pledged subject to a requirement to purchase FHLB stock.
38
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 INCOME TAXES
Income tax expense for the years ended December 31 is as follows:
<TABLE>
<CAPTION>
- - ----------------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
------------------------------------------
<S> <C> <C> <C>
Current:
Federal ............................................................................ $2,425,591 1,838,158 2,152,628
State .............................................................................. 758,814 561,442 660,222
--------- --------- ---------
Total current..................................................................... 3,184,405 2,399,600 2,812,850
--------- --------- ---------
Deferred:
Federal ............................................................................ 65,395 83,833 439,945
State .............................................................................. 18,200 26,567 128,105
--------- --------- ---------
Total deferred ................................................................... 83,595 110,400 568,050
--------- --------- ---------
$3,268,000 2,510,000 3,380,900
--------- --------- ---------
--------- --------- ---------
- - ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The reasons for the difference between "expected" income tax expense
utilizing the federal corporate tax rate of 34% and the actual income tax
expense are as follows:
<TABLE>
<CAPTION>
- - ---------------------------------------------------------------------------------------------------------------------------------
1997 1996 1995
----------------------------------------
<S> <C> <C> <C>
Federal expected income tax expense................................................. $3,007,934 $2,306,677 3,060,434
Items affecting federal income tax:
State income taxes, net of federal income tax benefit............................ 512,829 388,086 520,296
---------- ---------- ---------
Other, net........................................................................ (252,763) (184,763) (199,830)
---------- ---------- ---------
3,268,000 $2,510,000 3,380,900
---------- ---------- ---------
---------- ---------- ---------
- - ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The tax effects of temporary differences that give rise to the deferred tax
assets and deferred tax liabilities are as follows at December 31:
<TABLE>
<CAPTION>
- - -----------------------------------------------------------------------------------------------------------------------------
1997 1996
---------------------------
<S> <C> <C>
Deferred tax assets:
Allowances for loan and real estate losses................................................. $ 1,096,900 947,200
Discounts on assets and liabilities acquired from MFC...................................... 343,400 0
Deferred loan fees......................................................................... 185,900 377,100
Deferred compensation and pension costs.................................................... 143,250 172,500
Restricted stock awards.................................................................... 46,400 0
Loan servicing assets...................................................................... 20,800 0
Net unrealized loss on market value adjustment to securities available for sale............ 0 406,600
--------- ---------
Total gross deferred tax assets........................................................... 1,836,650 1,903,400
Valuation allowance........................................................................ 0 0
--------- ---------
Net deferred tax assets................................................................... 1,836,650 1,903,400
--------- ---------
Deferred tax liabilities:
Tax bad debt reserve over base year........................................................ 1,540,600 1,462,000
Mark up on assets acquired from MFC........................................................ 1,341,600 0
Net unrealized gain on market value adjustment to securities available for sale............ 793,000 0
FHLB stock................................................................................. 463,100 359,700
Deferred loan fees and costs............................................................... 334,500 250,600
Premises and equipment basis difference.................................................... 333,817 106,600
Other...................................................................................... 144,733 26,200
Unamortized discount on loan sale.......................................................... 92,900 136,200
--------- ---------
Total gross deferred tax liabilities...................................................... 5,044,250 2,341,300
--------- ---------
Net deferred tax liabilities.............................................................. $(3,207,600) (437,900)
--------- ---------
--------- ---------
</TABLE>
Retained earnings at December 31, 1997 included approximately $8,800,000
for which no provision for income taxes was made. This amount represents
allocations of income to bad debt deductions for tax purposes. Reduction of
amounts so allocated for purposes other than absorbing losses will create income
for tax purposes, which will be subject to the then-current corporate income tax
rate.
NOTE 13 EMPLOYEE BENEFITS
Substantially all full-time employees of the Bank are included
in a trusteed noncontributory retirement plan sponsored by the Financial
Institutions Retirement Fund. The actuarial present value of accumulated plan
benefits and net assets available for benefits relating to the Bank's employees
is not available because such information is not accumulated for each
participating institution. No contributions were required in 1997, 1996 or 1995
because the retirement plan is fully funded. The Bank's policy is to fund
retirement plan costs accrued and there are no unfunded past service costs. For
the years ended December 31, 1997, 1996 and 1995 the amounts charged to
operating expenses were $5,700, $5,100 and $4,222, respectively.
The Bank has a qualified, tax-exempt savings plan with a cash or deferred
feature qualifying under Section 401(k) of the Internal Revenue Code (the 401(k)
Plan). All employees who have attained age 21 and completed one month of
employment are eligible to par-
HMN FINANCIAL, INC. 39
<PAGE>
ticipate provided they work at least 1,000 hours in each plan year. Participants
are permitted to make salary reduction contributions to the 401(k) Plan of up to
12% of the participant's annual salary. Each participant's salary reduction is
matched by the Bank in an amount equal to 25% of the participant's salary
reduction up to a maximum contribution of 8%. Contributions above 8% are not
matched by the Bank. Generally all participant and Bank contributions and
earnings are fully and immediately vested. Effective January 1, 1997, for new
employees the Bank's contributions are vested on a five year cliff basis. The
Bank's matching contributions are expensed when made. The Bank's contributions
to the 401(k) Plan were $47,800, $41,804 and $41,324 in 1997, 1996 and 1995,
respectively.
During 1994 HMN adopted an Employee Stock Ownership Plan (the ESOP) which
met the requirements of Section 4975(e)(7) of the Internal Revenue Code and
Section 407(d)(6) of the Employee Retirement Income Security Act of 1974, as
amended (ERISA), and, as such the ESOP was empowered to borrow in order to
finance purchases of the common stock of HMN. The ESOP borrowed $6,085,770 from
HMN to purchase 608,577 shares of common stock of HMN on the date of the
conversion. The ESOP debt requires quarterly payments of principal plus interest
at 7.52%. HMN has committed to make quarterly contributions to the ESOP
necessary to repay the loan including interest. HMN contributed $689,636,
$713,656, and $735,383 to the ESOP, respectively, during 1997, 1996 and 1995.
As the debt is repaid, ESOP shares which were initially pledged as
collateral for its debt, are committed to be released from collateral and
allocated to active employees, based on the proportion of debt service paid
in the year. HMN accounts for its ESOP in accordance with Statement of
Position 93-6, EMPLOYERS' ACCOUNTING FOR EMPLOYEE STOCK OWNERSHIP PLANS.
Accordingly, the shares pledged as collateral are reported as unearned ESOP
shares in stockholders' equity. As shares are determined to be ratably
released from collateral, HMN reports compensation expense equal to the
current market price of the shares, and the shares become outstanding for
earnings per share computations. ESOP compensation benefit expense was
$885,208, $634,702 and $566,395, respectively, for 1997, 1996 and 1995.
All employees of the Bank are eligible to participate in the ESOP after
they attain age 21 and complete one year of service during which they worked at
least 1,000 hours. A summary of the ESOP share allocation is as follows for the
years ended:
<TABLE>
<CAPTION>
- - -------------------------------------------------------------------------------------
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
Shares allocated
beginning of year..................... 108,421 74,962 33,989
Shares allocated during year............ 38,426 39,763 40,973
Shares distributed
to participants...................... (1,985) (5,361) 0
Unreleased shares....................... 455,428 493,852 533,615
-------- -------- -------
Total ESOP shares....................... 600,290 603,216 608,577
-------- -------- -------
-------- -------- -------
Fair value of unreleased
shares at December 31................ $14,801,410 8,951,067 8,537,840
- - -------------------------------------------------------------------------------------
</TABLE>
In June of 1995, HMN as part of a Recognition and Retention Plan (RRP)
awarded 84,486 shares of restricted common stock to its officers and directors.
The shares vest over a five year period and were issued from treasury stock.
Compensation and benefit expense related to the RRP was $231,600, $231,048 and
$116,700 for 1997, 1996 and 1995. In April 1997, 2,000 shares of restricted
common stock were awarded to a director. Those shares vest over a five year
period beginning in 1998.
In June 1995, HMN adopted its only stock option plan, the 1995 Stock Option
and Incentive Plan (the SOP). During 1995, options exercisable for 547,713
shares of HMN common stock were granted to certain officers and directors at an
exercise price of $13.81 per share. The options vest over a five year period and
may be exercised within 10 years of the grant date. In December 1996, options
exercisable for 1,000 shares of common stock were granted to officers at an
exercise price of $18.125. In April 1997, options for 12,000 shares of common
stock were granted to a director at an exercise price of $19.50.
The fair value of the options granted were $9.12, $8.32 and $6.73 for 1997,
1996 and 1995, respectively. A summary of stock option activity under the SOP is
detailed as follows:
<TABLE>
<CAPTION>
- - --------------------------------------------------------------------------------------------------------------------------------
Weighted
Options average
available for Options exercise
grant outstanding price
----------------------------------------------
<S> <C> <C> <C>
December 31, 1994............................................................... 0 0
Plan adopted.................................................................... 608,577
Granted June 21, 1995........................................................... (547,713) 547,713 $13.810
-------- ------- ------
December 31, 1995............................................................... 60,864 547,713 13.810
Exercised....................................................................... (4,699) 13.810
Forfeited....................................................................... 12,172 (12,172) 13.810
Granted December 11, 1996....................................................... (1,000) 1,000 18.125
-------- ------- ------
December 31, 1996............................................................... 72,036 531,842 13.818
Granted April 22, 1997.......................................................... (12,000) 12,000 19.500
Exercised....................................................................... (9,042) 13.810
-------- ------- ------
December 31, 1997............................................................... 60,036 534,800 $13.946
-------- ------- ------
-------- ------- ------
- - --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The following table summarizes information about stock options outstanding
at December 31, 1997:
Options Outstanding Options Exercisable
<TABLE>
<CAPTION>
Weighted average
Exercise Number remaining contractual
price outstanding life in years Number Price
- - --------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
$13.810 521,800 7.4 202,305 $13.81
18.125 1,000 8.9 200 18.125
19.500 12,000 9.3
-------
534,800
-------
-------
- - --------------------------------------------------------------------------------------------
</TABLE>
HMN uses the intrinsic value method as described in APB Opinion No. 25 and
related interpretations to account for its stock incentive plans. Accordingly,
no compensation cost has been recognized for the option plan. Proceeds from
stock options exercised are credited to common stock and additional paid-in
capital. There are no charges or credits to expense with respect to the granting
or exercise of options since the options were issued at fair value on the
respective grant dates. Had compensation cost for HMN's stock-based plan been
determined in accordance with the fair value method recommended by SFAS No. 123,
HMN's net income and earnings per share would have been reduced to the pro forma
amounts indicated below:
40
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
- - -----------------------------------------------------------------------------
1997 1996 1995
------------------------------------------
<S> <C> <C> <C>
Net income:
As reported................ $5,578,866 4,274,349 5,620,377
Pro forma.................. 4,839,907 3,085,217 4,728,898
Earnings per common share:
As reported:
Basic................... $ 1.51 0.99 1.10
Diluted................. 1.41 0.96 1.09
Pro forma:
Basic................... 1.31 0.71 0.93
Diluted................. 1.23 0.70 0.91
- - ----------------------------------------------------------------------------
</TABLE>
The above disclosed pro forma effects of applying SFAS No. 123 to
compensation costs, may not be representative of the effects on reported pro
forma net income for future years.
The fair value for each option grant for the SOP is estimated on the date
of the grant using the Option Designer Model. The model incorporates the
following assumptions:
<TABLE>
<CAPTION>
- - ----------------------------------------------------------------------------
1997 1996 1995
----------------------------------------
<S> <C> <C> <C>
Risk-free interest rate....... 6.80% 6.21% 6.28%
Expected life................. 10 YEARS 10 years 10 years
Expected volatility........... 18.00% 18.00% 20.00%
Expected dividends............ NONE None None
- - ----------------------------------------------------------------------------
</TABLE>
NOTE 14 SAIF ASSESSMENT
The Deposit Insurance Fund Act of 1996 (DIFA) was enacted on September 30, 1996.
DIFA addressed the inadequate funding of the Savings Association Insurance Fund
(SAIF). In order to recapitalize the SAIF, DIFA imposed a one-time assessment on
all thrift institutions. The Bank's assessment was a pretax charge of $2,351,563
and was recognized in the third quarter of 1996.
DIFA also addressed the funding for the Financing Corp. (FICO) bonds.
Thrifts will pay 6.4 basis points per $100 of deposits from January 1, 1997
to December 31, 1999. From January 1, 2000 until the FICO bonds are retired
in 2019, the estimated assessment to retire the FICO bonds is expected to be
2.5 basis points per $100 of deposits.
NOTE 15 STOCKHOLDERS' EQUITY
HMN was incorporated for the purpose of becoming the savings and loan holding
company of the Bank in connection with the Bank's conversion from a federally
chartered mutual savings bank to a federally chartered stock savings bank,
pursuant to a Plan of Conversion adopted on February 10, 1994. HMN commenced on
May 23, 1994, a Subscription and Community Offering of its shares in connection
with the conversion of the Bank (the Offering). The Offering was closed on June
22, 1994, and the conversion was consummated on June 29, 1994, with the issuance
of 6,085,775 shares of HMN's common stock at a price of $10 per share. Total
proceeds from the conversion of $59,178,342 net of costs relating to the
conversion of $1,679,408, have been recorded as common stock and additional
paid-in capital. HMN received all of the capital stock of the Bank in exchange
for 50% of the net proceeds of the conversion.
Starting in 1995 and continuing throughout 1997, with Board authorization
and approval from the Office of Thrift Supervision (OTS), HMN purchased 298,334
shares during 1997, 869,785 shares during 1996, and 868,336 shares during 1995
of its own common stock from the open market for $5,988,450, $14,364,754
and $12,509,667, respectively. The shares were placed in treasury stock. In June
of 1995, 84,486 shares were issued out of treasury stock for restricted stock
Retention and Recognition Plan awards.
Refer to Note 1 for disclosure of a potential stock split which is subject
to approval of the stockholders of HMN at their April 28, 1998 annual meeting.
HMN's certificate of incorporation authorized the issuance of
up to 500,000 shares of preferred stock, but to date no shares have been issued.
In order to grant a priority to eligible accountholders in the event of
future liquidation, the Bank, at the time of conversion established a
liquidation account equal to its regulatory capital as of September 30, 1993. In
the event of future liquidation of the Bank, an eligible account holder who
continues to maintain their deposit account shall be entitled to receive a
distribution from the liquidation account. The total amount of the liquidation
account will be decreased as the balance of eligible account holders are reduced
subsequent to the conversion, based on an annual determination of such balance.
The liquidation account of MFC was absorbed by the Bank as a result of the
acquisition.
The Bank may not declare or pay a cash dividend to HMN in excess of 100%
of its net income to date during the current calendar year plus the amount
that would reduce by one-half the Bank's surplus capital ratio at the
beginning of the calendar year without prior notice to the OTS. Additional
limitations on dividends declared or paid on, or repurchases of, the Bank's
capital stock are tied to the Bank's level of compliance with its regulatory
capital requirements.
NOTE 16 FEDERAL HOME LOAN BANK INVESTMENT, REGULATORY LIQUIDITY AND REGULATORY
CAPITAL REQUIREMENTS
The Bank, as a member of the Federal Home Loan Bank System, is required to
hold a specified number of shares of capital stock, which is carried at cost,
in the Federal Home Loan Bank of Des Moines. In addition, the Bank is
required to maintain cash and other liquid assets in an amount equal to 4% of
its deposit accounts and other obligations due within one year. The Bank has
met these requirements as of December 31, 1997.
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital requirements
can initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on HMN's
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Bank must meet specific capital
guidelines that involve quantitative measures of the Bank's assets, liabilities,
and certain off-balance sheet items as calculated under regulatory accounting
practices. The Bank's capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.
Quantitative measures established by regulations to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
following table) of Tangible, Core, and Risk-based capital (as defined in the
regulations) to total assets (as defined). Management believes, as of December
31, 1997, that the Bank meets all capital adequacy requirements to which it is
subject.
HMN FINANCIAL, INC. 41
<PAGE>
Management believes that based upon the Bank's capital calculations at
December 31, 1997 and other conditions consistent with the Prompt Corrective
Actions Provisions of the OTS regulations, the Bank would be categorized as well
capitalized.
At December 31, 1997 the Bank's capital amounts and ratios are also
presented for actual capital, required capital, and excess capital including
amounts and ratios in order to qualify as being well capitalized under the
Prompt Corrective Actions regulations:
<TABLE>
<CAPTION>
- - ---------------------------------------------------------------------------------------------------------
Actual Required
-------------------------- -----------------------------
Percent of Percent of
(IN THOUSANDS) Amount Assets (1) Amount Assets (1)
- - ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Bank stockholder's equity............... $61,081
Plus:
Net unrealized loss on
certain securities
available for sale.................. (375)
Less:
Goodwill and other intangibles....... 6,047
Excess mortgage servicing rights..... 510
-------
Tangible capital........................ 54,149 8.20% $ 9,909 1.50%
-------
Tangible capital to
adjusted total assets .............. 8.20%
Core capital (Tier I)................... 54,149 8.20% 19,818 3.00%
Tier I capital to risk-weighted
assets.............................. 17.85%
Less:
Equity investments and other
assets required to be deducted....... 266
Plus:
Allowable allowance for loan losses .... 2,747
--------
Risk-based capital...................... $56,630 18.66% $24,274 8.00%
--------
--------
<CAPTION>
- - -----------------------------------------------------------------------------------------------------------------
To Be Well Capitalized
Under Prompt
Corrective Actions
Excess Capital Provisions
------------------------- ----------------------------
Percent of Percent of
(IN THOUSANDS) Amount Assets (1) Amount Assets (1)
- - -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Bank stockholder's equity...............
Plus:
Net unrealized loss on
certain securities
available for sale..................
Less:
Goodwill and other intangibles.......
Excess mortgage servicing rights.....
Tangible capital........................ $44,240 6.70%
Tangible capital to
adjusted total assets .............. $33,029 5.00%
Core capital (Tier I)................... 34,331 5.20%
Tier I capital to risk-weighted assets 18,205 6.00%
Less:
Equity investments and other
assets required to be deducted.....
Plus:
Allowable allowance for loan losses ....
Risk-based capital...................... $32,356 10.66% $30,342 10.00%
</TABLE>
(1) Based upon the Bank's adjusted total assets for the purpose of the
tangible and core capital ratios and risk-weighted assets for the purpose of
the risk-based capital ratio.
- - -------------------------------------------------------------------------------
NOTE 17 FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit. These instruments
involve, to varying degrees, elements of credit and interest rate risk in excess
of the amounts recognized in the balance sheet. The contract amounts of these
instruments reflect the extent of involvement by the Bank.
The Bank's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit is
represented by the contract amount of these commitments. The Bank uses the same
credit policies in making commitments as it does for on-balance sheet
instruments.
<TABLE>
<CAPTION>
- - -----------------------------------------------------------------------------------------------------------
Contract amount
-------------------------------
(IN THOUSANDS) 1997 1996
- - -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Financial instruments whose contract amount
represents credit risk:
Commitments to extend credit .............................. $53,681 24,524
Commitment of counter party
to purchase loans........................................ 2,201 0
Financial instruments whose contract amount
represents interest rate risk:
Commitment to purchase limited partnership
interest in mortgage loan servicing rights................. 181 2,120
- - ------------------------------------------------------------------------------------------------------------
</TABLE>
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since a portion of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Bank evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Bank upon extension of credit, is based on
the loan type and on management's credit evaluation of the borrower. Collateral
consists primarily of residential real estate and personal property.
Commitments of counter party to purchase loans represents commitments to
sell loans to FNMA and are entered into in the normal course of business by the
Bank.
NOTE 18 FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS, requires
disclosure of estimated fair values of HMN's financial instruments, including
assets, liabilities and off-balance sheet items for which it is practicable to
estimate fair value. The fair value estimates are made as of December 31, 1997,
and 1996 based upon relevant market information, if available, and upon the
characteristics of the financial instruments themselves. Because no market
exists for a significant portion of HMN's financial instruments, fair value
estimates are based upon judgments regarding future expected loss experience,
current economic conditions, risk characteristics of various financial
instruments, and other factors. The estimates are subjective in nature and
involve uncertainties and matters of significant judgment and therefore cannot
be determined with precision. Changes in assumptions could significantly affect
the estimates.
Fair value estimates are based only on existing financial instruments
without attempting to estimate the value of anticipated future business or the
value of assets and liabilities that are not considered financial instruments.
In addition, the tax ramifications related to the realization of the unrealized
gains and losses can have a significant effect on the fair value estimates and
have not been considered in any of the estimates.
42
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The estimated fair value of HMN's financial instruments are shown below.
Following the table, there is an explanation of the methods and assumptions
used to estimate the fair value of each class of financial instruments.
<TABLE>
<CAPTION>
- - --------------------------------------------------------------------------------------------------------------------------
December 31,
---------------------------------------------------------------------------
1997 1996
---------------------------------- --------------------------------------
Carrying Estimated Contract Carrying Estimated Contract
(IN THOUSANDS) amount fair value amount amount fair value amount
- - --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Financial assets:
Cash and cash equivalents................ $ 9,365 9,365 10,584 10,584
Securities available for sale............ 205,859 205,859 175,830 175,830
Securities held to maturity.............. 0 0 2,806 2,906
Loans held for sale...................... 2,287 2,287 739 739
Loans receivable, net.................... 442,069 456,012 349,022 358,039
Federal Home Loan Bank stock............. 7,432 7,432 5,434 5,434
Accrued interest receivable.............. 4,038 4,038 3,415 3,415
Financial liabilities:
Deposits................................. 467,348 464,670 362,477 358,215
Federal Home Loan Bank advances.......... 127,650 127,147 106,079 105,484
Accrued interest payable................. 1,365 1,365 1,543 1,543
Off-balance sheet financial instruments:
Commitments to extend credit............. 0 50 53,681 0 16 24,524
- - ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
CASH AND CASH EQUIVALENTS The carrying amount of cash and cash equivalents
approximates their fair value.
SECURITIES AVAILABLE FOR SALE AND SECURITIES HELD TO MATURITY The fair values
of securities are based upon quoted market prices.
LOANS HELD FOR SALE The fair value of loans held for sale were based upon
quoted market prices for loans with similar interest rates and terms to
maturity.
LOANS RECEIVABLE The fair values of loans receivable were estimated for groups
of loans with similar characteristics. The fair value of the loan portfolio,
with the exception of the adjustable rate portfolio, was calculated by
discounting the scheduled cash flows through the estimated maturity using
anticipated prepayment speeds and using discount rates that reflect the credit
and interest rate risk inherent in each loan portfolio. The fair value of the
adjustable loan portfolio was estimated by grouping the loans with similar
characteristics and comparing the characteristics of each group to the prices
quoted for similar types of loans in the secondary market.
FEDERAL HOME LOAN BANK STOCK The carrying amount of FHLB stock approximates
its fair value.
ACCRUED INTEREST RECEIVABLE The carrying amount of accrued interest receivable
approximates its fair value since it is short-term in nature and does not
present unanticipated credit concerns.
DEPOSITS Under SFAS No. 107, the fair value of deposits with no stated maturity
such as checking, savings and money market accounts, is equal to the amount
payable on demand. The fair value of certificates of deposit is based on the
discounted value of contractual cash flows using as discount rates the rates
that were offered by HMN as of December 31, 1997 and 1996 for deposits with
maturities similar to the remaining maturities of the existing certificates of
deposit.
The fair value estimate for deposits does not include the benefit that
results from the low cost funding provided by HMN's existing deposits and
long-term customer relationships compared to the cost of obtaining different
sources of funding. This benefit is commonly referred to as the core deposit
intangible. ACCRUED INTEREST PAYABLE The carrying amount of accrued interest
payable approximates its fair value since it is short-term in nature.
FEDERAL HOME LOAN BANK ADVANCES The fair values of advances payable with fixed
maturities are estimated based on discounted cash flow analysis using as
discount rates the interest rates charged by the FHLB at December 31, 1997 and
1996 for borrowings of similar remaining maturities.
COMMITMENTS TO EXTEND CREDIT The fair value of commitments to extend credit
is estimated using the fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
present creditworthiness of the counter parties.
HMN FINANCIAL, INC. 43
<PAGE>
NOTE 19 HMN FINANCIAL, INC. FINANCIAL INFORMATION (PARENT COMPANY ONLY)
The parent company's principal assets are its investment in the Bank and
securities. The following are the condensed financial statements for the parent
company only as of December 31, 1997 and 1996 and for the years ended December
31, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
1997 1996 1995
- - -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CONDENSED BALANCE SHEET
ASSETS:
Cash and cash equivalents......................................................... $ 944,925 3,655,598
Securities available for sale..................................................... 14,287,978 10,187,092
Loans receivable from subsidiaries................................................ 7,050,570 7,334,000
Investment in subsidiaries........................................................ 62,278,302 61,458,395
Investment in limited partnership................................................. 480,871 0
Accrued interest receivable....................................................... 67,883 215,959
Prepaid expenses and other assets................................................. 11,615 17,950
----------- -----------
Total assets................................................................... $85,122,144 82,868,994
----------- -----------
----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY:
Accrued expenses and other liabilities............................................ $ 651,734 769,550
----------- -----------
Total liabilities.............................................................. 651,734 769,550
----------- -----------
Serial preferred stock............................................................ 0 0
Common stock...................................................................... 60,858 60,858
Additional paid-in capital........................................................ 59,729,090 59,428,768
Retained earnings................................................................. 60,224,253 54,645,387
Net unrealized loss on securities available for sale.............................. 1,129,818 (598,045)
Unearned employee stock option plan shares........................................ (4,554,280) (4,938,520)
Unearned compensation restricted stock awards..................................... (600,668) (793,289)
Treasury stock, at cost, 1,941,407 and 1,651,615 shares........................... (31,518,661) (25,705,715)
----------- -----------
Total stockholders' equity..................................................... 84,470,410 82,099,444
----------- -----------
Total liabilities and stockholders' equity........................................ $85,122,144 82,868,994
----------- -----------
----------- -----------
CONDENSED STATEMENT OF INCOME
Interest income................................................................... $ 1,071,818 1,105,218 1,474,107
Interest expense.................................................................. (13,515) (4,943) (1,083)
Securities gains, net............................................................. 644,278 229,002 53,058
Equity in earnings of subsidiaries................................................ 4,512,080 3,565,441 4,755,138
Equity in earnings of limited partnership......................................... (19,129) 0 0
Compensation and benefits......................................................... (17,494) (17,233) (21,775)
Occupancy......................................................................... (6,604) (6,868) (6,353)
Advertising....................................................................... (159) (670) (276)
Data processing................................................................... (1,355) (1,271) (1,200)
Other............................................................................. (477,030) (475,127) (380,039)
----------- ----------- ----------
Income before income tax expense............................................... 5,692,890 4,393,549 5,871,577
Income tax expense................................................................ 114,024 119,200 251,200
----------- ----------- ----------
Net income....................................................................... $ 5,578,866 4,274,349 5,620,377
----------- ----------- ----------
CONDENSED STATEMENT OF CASH FLOWS
Cash flows from operating activities:
Net income....................................................................... $ 5,578,866 4,274,349 5,620,377
Adjustments to reconcile net income to cash provided by operating activities:
Equity in earnings of subsidiaries............................................ (4,512,080) (3,565,441) (4,755,138)
Equity in earnings of limited partnership..................................... 19,129 0 0
Amortization of premiums (discounts), net..................................... (349) 9,727 (21,328)
Securities gains, net......................................................... (644,278) (229,002) (53,058)
Provision for deferred income taxes........................................... (800) (1,400) (2,500)
Earned employee stock ownership shares priced above original cost............. 298,237 141,135 93,267
Decrease in restricted stock awards........................................... 231,621 231,048 116,700
Decrease in unearned ESOP shares.............................................. 384,240 397,630 409,730
(Increase) decrease in accrued interest receivable............................ 148,076 (63,071) 76,510
Increase (decrease) in accrued expenses and other liabilities................. (165,370) 172,831 (81,860)
Decrease (increase) in other assets........................................... 6,335 143,321 (75,550)
Other, net.................................................................... 65,035 9,737 0
----------- ----------- ----------
Net cash provided by operating activities.................................. 1,408,662 1,520,864 1,327,150
----------- ----------- ----------
Cash flows from investing activities:
Proceeds from sales of securities available for sale............................. 9,384,529 5,412,430 8,523,675
Principal collected on securities available for sale............................. 0 5,027,241 1,624,106
Proceeds collected on maturity of securities available for sale.................. 4,018,412 1,500,000 4,000,000
Purchases of securities available for sale....................................... (15,900,938) (5,449,176) (7,754,954)
Purchase of Security Finance Corporation stock................................... 0 0 (388,762)
Investment in Home Federal Savings Bank.......................................... (1,016,063) 0 0
Investment in HMN Mortgage Services, Inc......................................... (844,500) (250,000) 0
Investment in limited partnership................................................ (500,000) 0 0
Net increase (decrease) in loans receivable from subsidiaries.................... 283,430 (7,334,000) 0
----------- ----------- ----------
Net cash provided (used) by investing activities.............................. (4,575,130) (1,093,505) 6,004,065
----------- ----------- ----------
Cash flows from financing activities:
Purchase of treasury stock....................................................... (6,350,950) (14,002,254) 12,509,667)
Stock options exercised.......................................................... 56,745 52,363 0
Proceeds from dividends on Bank stock............................................ 6,750,000 15,600,000 4,000,000
----------- ----------- ----------
Net cash provided (used) by financing activities.............................. 455,795 1,650,109 (8,509,667)
----------- ----------- ----------
Increase (decrease) in cash and cash equivalents.............................. (2,710,673) 2,077,468 (1,178,452)
Cash and cash equivalents, beginning of year........................................ 3,655,598 1,578,130 2,756,582
----------- ----------- ----------
Cash and cash equivalents, end of year.............................................. $ 944,925 3,655,598 1,578,130
----------- ----------- ----------
----------- ----------- ----------
</TABLE>
44
<PAGE>
INDEPENDENT AUDITOR'S REPORT
[LOGO]
THE BOARD OF DIRECTORS
HMN FINANCIAL, INC.
SPRING VALLEY, MINNESOTA
We have audited the accompanying consolidated balance sheets of HMN
Financial, Inc. and Subsidiaries (the Company) as of December 31, 1997 and
1996, and the related consolidated statements of income, stockholders' equity
and cash flows for each of the years in the three-year period ended December
31, 1997. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of HMN
Financial, Inc. and Subsidiaries at December 31, 1997 and 1996, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1997, in conformity with generally accepted accounting
principles.
/S/ KPMG PEAT MARWICK LLP
MINNEAPOLIS, MINNESOTA
FEBRUARY 4, 1998, EXCEPT FOR NOTE 1,
WHICH IS AS OF FEBRUARY 19, 1998
HMN FINANCIAL, INC. 45
<PAGE>
SELECTED QUARTERLY FINANCIAL DATA
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30, JUNE 30,
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1997 1997
- - ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Selected Operations Data (3 MONTHS ENDED):
Interest income................................................................. $ 10,706 10,314 10,166
Interest expense................................................................ 6,857 6,464 6,297
-------- ------ ------
Net interest income............................................................ 3,849 3,850 3,869
Provision for loan losses....................................................... 75 75 75
-------- ------ ------
Net interest income after provision for loan losses............................ 3,774 3,775 3,794
-------- ------ ------
Noninterest income:
Fees and service charges....................................................... 169 122 100
Securities gains, net.......................................................... 377 488 114
Gain on sales of loans......................................................... 135 117 64
Other noninterest income....................................................... 59 152 128
-------- ------ ------
Total noninterest income...................................................... 740 879 406
-------- ------ ------
Noninterest expense:
Compensation and benefits...................................................... 1,484 1,432 1,359
Occupancy...................................................................... 264 245 232
Federal deposit insurance premiums............................................. 63 58 59
SAIF assessment................................................................ 0 0 0
Advertising.................................................................... 101 63 74
Data processing................................................................ 137 129 119
Provision for real estate losses............................................... 15 0 1
Other noninterest expense...................................................... 488 302 283
-------- ------ ------
Total noninterest expense..................................................... 2,552 2,229 2,127
-------- ------ ------
Income before income tax expense............................................... 1,962 2,425 2,073
Income tax expense.............................................................. 714 901 740
-------- ------ ------
-------- ------ ------
Net income..................................................................... $ 1,248 1,524 1,333
-------- ------ ------
-------- ------ ------
Basic earnings per share........................................................ $ 0.34 0.41 0.36
-------- ------ ------
-------- ------ ------
Diluted earnings per share...................................................... $ 0.31 0.38 0.34
-------- ------ ------
-------- ------ ------
Financial Ratios:
Return on average assets(1)..................................................... 0.84% 1.06 0.95
Return on average equity(1)..................................................... 6.09 7.29 6.58
Average equity to average assets................................................ 14.36 14.55 14.55
Net interest margin(1)(2)....................................................... 2.60 2.76 2.83
(DOLLARS IN THOUSANDS)
- - ---------------------------------------------------------------------------------------------------------------------------------
Selected Financial Condition Data:
Total assets.................................................................... $691,232 568,847 566,865
Securities available for sale:
Mortgage-backed and related securities......................................... 135,936 111,117 115,016
Other marketable securities.................................................... 69,923 72,815 73,860
Securities held to maturity:
Mortgage-backed and related securities......................................... 0 0 0
Other marketable securities.................................................... 0 0 0
Loans held for sale............................................................. 2,287 2,090 1,205
Loans receivable, net........................................................... 442,069 352,925 345,516
Deposits........................................................................ 467,348 366,682 365,385
Federal Home Loan Bank advances................................................. 127,650 112,007 114,364
Stockholders' equity............................................................ 84,470 84,619 81,798
- - ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Annualized
(2) Net interest income divided by average interest-earning assets.
46
<PAGE>
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, SEPTEMBER 30,
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1996
- - ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Selected Operations Data (3 MONTHS ENDED):
Interest income................................................................. 9,903 10,111 10,014
Interest expense................................................................ 6,024 6,174 6,191
----- ------ ------
Net interest income............................................................ 3,879 3,937 3,823
Provision for loan losses....................................................... 75 75 75
----- ------ ------
Net interest income after provision for loan losses............................ 3,804 3,862 3,748
----- ------ ------
Noninterest income:
Fees and service charges....................................................... 96 105 95
Securities gains, net.......................................................... 271 68 192
Gain on sales of loans......................................................... 153 22 10
Other noninterest income....................................................... 178 129 115
----- ------ ------
Total noninterest income...................................................... 698 324 412
----- ------ ------
Noninterest expense:
Compensation and benefits...................................................... 1,316 1,211 1,176
Occupancy...................................................................... 241 230 203
Federal deposit insurance premiums............................................. 59 163 212
SAIF assessment................................................................ 0 0 2,352
Advertising.................................................................... 78 79 77
Data processing................................................................ 125 121 119
Provision for real estate losses............................................... 2 2 0
Other noninterest expense...................................................... 294 341 256
----- ------ ------
Total noninterest expense..................................................... 2,115 2,147 4,395
----- ------ ------
Income before income tax expense............................................... 2,387 2,039 (235)
Income tax expense.............................................................. 913 740 (90)
----- ------ ------
----- ------ ------
Net income..................................................................... 1,474 1,299 (145)
----- ------ ------
----- ------ ------
Basic earnings per share........................................................ 0.40 0.32 (0.04)
----- ------ ------
----- ------ ------
Diluted earnings per share...................................................... 0.38 0.31 (0.04)
----- ------ ------
----- ------ ------
Financial Ratios:
Return on average assets(1)..................................................... 1.09 0.93 (0.10)
Return on average equity(1)..................................................... 7.43 6.06 (0.67)
Average equity to average assets................................................ 14.65 15.32 15.48
Net interest margin(1)(2)....................................................... 2.92 2.86 2.77
(DOLLARS IN THOUSANDS)
- - ------------------------------------------------------------------------------------------------------------------------------
Selected Financial Condition Data:
Total assets.................................................................... 553,021 554,732 565,385
Securities available for sale:
Mortgage-backed and related securities......................................... 123,925 133,355 135,191
Other marketable securities.................................................... 56,224 42,475 52,516
Securities held to maturity:
Mortgage-backed and related securities......................................... 0 1,806 2,338
Other marketable securities.................................................... 0 1,000 1,000
Loans held for sale............................................................. 1,061 739 0
Loans receivable, net........................................................... 341,104 349,022 343,736
Deposits........................................................................ 364,123 362,477 363,963
Federal Home Loan Bank advances................................................. 105,721 106,079 101,833
Stockholders' equity............................................................ 78,772 82,099 83,669
- - ------------------------------------------------------------------------------------------------------------------------------
<CAPTION>
JUNE 30, MARCH 31,
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 1996
- - ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Selected Operations Data (3 MONTHS ENDED):
Interest income................................................................. 9,944 9,795
Interest expense................................................................ 5,949 5,880
----- -----
Net interest income............................................................ 3,995 3,915
Provision for loan losses....................................................... 75 75
----- -----
Net interest income after provision for loan losses............................ 3,920 3,840
----- -----
Noninterest income:
Fees and service charges....................................................... 82 77
Securities gains, net.......................................................... 268 501
Gain on sales of loans......................................................... 1 6
Other noninterest income....................................................... 134 117
----- -----
Total noninterest income...................................................... 485 701
----- -----
Noninterest expense:
Compensation and benefits...................................................... 1,099 1,106
Occupancy...................................................................... 195 197
Federal deposit insurance premiums............................................. 215 210
SAIF assessment................................................................ 0 0
Advertising.................................................................... 79 73
Data processing................................................................ 121 128
Provision for real estate losses............................................... 0 0
Other noninterest expense...................................................... 275 269
----- -----
Total noninterest expense..................................................... 1,984 1,983
----- -----
Income before income tax expense............................................... 2,421 2,558
Income tax expense.............................................................. 888 972
----- -----
----- -----
Net income..................................................................... 1,533 1,586
----- -----
----- -----
Basic earnings per share........................................................ 0.34 0.34
----- -----
----- -----
Diluted earnings per share...................................................... 0.33 0.33
----- -----
----- -----
Financial Ratios:
Return on average assets(1)..................................................... 1.13 1.18
Return on average equity(1)..................................................... 6.77 6.91
Average equity to average assets................................................ 16.64 17.09
Net interest margin(1)(2)....................................................... 2.98 2.97
(DOLLARS IN THOUSANDS)
- - -----------------------------------------------------------------------------------------------------------
Selected Financial Condition Data:
Total assets.................................................................... 554,979 542,012
Securities available for sale:
Mortgage-backed and related securities......................................... 148,706 163,273
Other marketable securities.................................................... 40,442 32,245
Securities held to maturity:
Mortgage-backed and related securities......................................... 13,835 14,115
Other marketable securities.................................................... 999 3,227
Loans held for sale............................................................. 0 0
Loans receivable, net........................................................... 331,650 307,658
Deposits........................................................................ 363,195 368,393
Federal Home Loan Bank advances................................................. 101,053 72,493
Stockholders' equity............................................................ 87,263 90,879
- - -----------------------------------------------------------------------------------------------------------
</TABLE>
HMN FINANCIAL, INC. 47
<PAGE>
OTHER FINANCIAL DATA
The following table sets forth the maximum month-end balance and average balance
of FHLB advances.
<TABLE>
<CAPTION>
- - ---------------------------------------------------------------------------------------------------------------
Year Ended December 31,
----------------------------------------
(DOLLARS IN THOUSANDS) 1997 1996 1995
- - ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Maximum Balance:
Federal Home Loan Bank advances............................ $128,007 106,436 74,534
Federal Home Loan Bank short-term borrowings............... 60,429 64,429 42,429
Average Balance:
Federal Home Loan Bank advances............................ 112,500 89,656 65,069
Federal Home Loan Bank short-term borrowings............... 45,598 47,949 20,812
- - ---------------------------------------------------------------------------------------------------------------
</TABLE>
The following table sets forth certain information as to the Bank's FHLB
advances.
<TABLE>
<CAPTION>
- - ----------------------------------------------------------------------------------------------------------------------------------
December 31,
------------------------------------------------------------------------------
1997 1996 1995
------------------------- ------------------- --------------------
Weighted Weighted Weighted
Average Average Average
(DOLLARS IN THOUSANDS) Amount Rate Amount Rate Amount Rate
- - ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Federal Home Loan Bank short-term borrowings...... $ 43,250 5.85% 46,429 5.52% 33,429 6.05%
Other Federal Home Loan Bank long-term advances... 84,400 5.77 59,650 5.74 35,448 5.91
-------- ------- -------
Total............................................. $127,650 5.80 106,079 5.64 68,877 5.98
-------- ------- -------
-------- ------- -------
- - -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Refer to Note 11 of the Notes to Consolidated Financial Statements for more
information on the Bank's FHLB advances.
COMMON STOCK INFORMATION
The common stock of HMN Financial, Inc. is listed on the Nasdaq Stock Market
under the symbol: HMNF. The common stock outstanding is 6,085,775 shares, of
which 1,941,407 shares are in treasury stock at December 31, 1997. As of
December 31, 1997, there are 800 stockholders of record and 1,500 estimated
beneficial stockholders. The following table represents the stock price
information for HMN Financial, Inc. as furnished by Nasdaq for each quarter
starting in 1995 through December 31, 1997.
<TABLE>
<CAPTION>
- - ------------------------------------------------------------------------------------------------------------
March 31, June 30, Sept. 29, Dec. 29, March 29, June 28, Sept. 30, Dec. 31, March 31,
1995 1995 1995 1995 1996 1996 1996 1996 1997
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
High.......... $13.50 14.00 15.62 16.00 14.62 16.50 16.00 18.12 24.75
Low .......... 12.37 13.25 14.62 15.12 14.62 16.00 16.00 18.00 18.00
Close ........ 12.75 13.62 15.25 16.00 14.62 16.50 16.00 18.12 20.05
- - ------------------------------------------------------------------------------------------------------------
<CAPTION>
- - ---------------------------------------------
June 30, Sept. 30, Dec. 31,
1997 1997 1997
----------------------------
<S> <C> <C> <C>
High.......... 24.38 26.00 32.50
Low .......... 18.63 21.88 24.25
Close ........ 23.00 24.75 32.50
- - ---------------------------------------------
</TABLE>
48
<PAGE>
CORPORATE AND SHAREHOLDER INFORMATION
HMN FINANCIAL, INC.
101 North Broadway
Spring Valley, MN 55975-0231
(507) 346-1100
ANNUAL MEETING
The annual meeting of shareholders will be held on Tuesday, April 28, 1998 at
10:00 a.m. (Central Time) at the Best Western Apache Hotel, 1517 16th St. S.W.,
Rochester, Minnesota.
LEGAL COUNSEL
Faegre & Benson LLP
2200 Norwest Center
90 South Seventh St.
Minneapolis, MN 55402-3901
INDEPENDENT AUDITORS
KPMG Peat Marwick LLP
4200 Norwest Center
90 South Seventh St.
Minneapolis, MN 55402-3900
INVESTOR INFORMATION AND FORM 10-K
Additional information and HMN's Form 10-K, filed with the Securities and
Exchange Commission, is available without charge upon request from:
HMN Financial, Inc.
Attn: Investor Relations
101 North Broadway
Spring Valley, MN. 55975-0231
TRANSFER AGENT & REGISTRAR
Inquiries regarding change of address,
transfer requirements, and lost certificates should be directed to the transfer
agent.
First National Bank of Boston
c/o Boston Equiserve
P.O. Box 8040
Boston, MA 02266-8040
(617) 575-3170
DIRECTORS
ROGER P. WEISE
CHAIRMAN OF THE BOARD
PRESIDENT AND CHIEF EXECUTIVE OFFICER
JAMES B. GARDNER
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
IRMA R. RATHBUN
RETIRED VICE PRESIDENT OF
HOME FEDERAL SAVINGS BANK
M.F. SCHUMANN
LICENSED PUBLIC ACCOUNTANT
SCHUMANN, GRANAHAN, HESSE & WILSON LTD.
TIMOTHY R. GEISLER
MANAGER, CORPORATE TAX UNIT
MAYO CLINIC, ROCHESTER, MN
DUANE D. BENSON
EXECUTIVE DIRECTOR
MINNESOTA BUSINESS PARTNERSHIP
EXECUTIVE OFFICERS
ROGER P. WEISE
PRESIDENT AND CHIEF EXECUTIVE OFFICER
JAMES B. GARDNER
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
DWAIN C. JORGENSEN
VICE PRESIDENT AND CONTROLLER
SUSAN K. KOLLING
SENIOR VICE PRESIDENT
ROXANNE M. HELLICKSON
VICE PRESIDENT AND CORPORATE SECRETARY
TIMOTHY P. JOHNSON
VICE PRESIDENT AND TREASURER
BRANCH OFFICES
ALBERT LEA
143 West Clark Street
Albert Lea, MN 56007
(507) 377-3330
AUSTIN
201 Oakland Avenue West
Austin, MN 55912
(507) 433-2355
LACRESCENT
208 South Walnut
LaCrescent, MN 55947
(507) 895-4090
MARSHALLTOWN
303 West Main Street
Marshalltown, IA 50158
(515) 754-6000
29 South Center St.
Marshalltown, IA 50158
(515) 754-6040
ROCHESTER
Crossroads Shopping Center
Rochester, MN 55901
(507) 289-4025
1110 6th Street NW
Rochester, MN 55901
(507) 285-1707
SPRING VALLEY
715 North Broadway
Spring Valley, MN 55975
(507) 346-7345
TOLEDO
119 West High St.
Toledo, IA 52342
(515) 484-5141
WINONA
4th and Center
Winona, MN 55987
(507) 454-4912
EDEN PRAIRIE
Mortgage Banking Office
9973 Valley View Road
Eden Prairie, MN 55344
(612) 914-7440
BROOKLYN PARK
Mortgage Banking Office
7101 Northland Circle, Suite 105
Brooklyn Park, MN 55427
(612) 533-2500
<PAGE>
HMN FINANCIAL, INC. AND HOME FEDERAL SAVINGS BANK ARE HEADQUARTERED IN SPRING
VALLEY, MINNESOTA.
HOME FEDERAL SAVINGS BANK OPERATES SEVEN FULL-SERVICE BANKING FACILITIES IN
SOUTHERN MINNESOTA AND THREE IN IOWA. IN ADDITION, THE COMPANY HAS MORTGAGE
BANKING OFFICES IN EDEN PRAIRIE AND BROOKLYNPARK,
SUBURBS OF MINNEAPOLIS, MINNESOTA.
TABLE OF CONTENTS
FINANCIAL HIGHLIGHTS........................................................ 1
PRESIDENT'S LETTER TO SHAREHOLDERS AND CUSTOMERS............................ 2
GROWING WITH OUR COMMUNITIES................................................ 4
GROWING OUR FACILITIES TO MEET CUSTOMER NEEDS .............................. 8
CORPORATE VALUES............................................................ 9
FIVE-YEAR CONSOLIDATED FINANCIAL HIGHLIGHTS ................................11
MANAGEMENT'S DISCUSSION AND ANALYSIS........................................12
CONSOLIDATED FINANCIAL STATEMENTS ..........................................27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS..................................31
AUDITORS' REPORT............................................................45
SELECTED QUARTERLY FINANCIAL DATA ..........................................46
OTHER FINANCIAL DATA........................................................48
COMMON STOCK INFORMATION....................................................48
CORPORATE AND SHAREHOLDER INFORMATION....................... INSIDE BACK COVER
DIRECTORS AND OFFICERS...................................... INSIDE BACK COVER
<PAGE>
Subsidiaries of Registrant
Exhibit 21
<TABLE>
<CAPTION>
Date and % of
Voting Shares,
Partnership
Interests, Voting
Year & Trust Certificates,
State Capital Description of
Name & Address Inc. Contributions Activity
-------------- ------ ------------------ -------------------
<S> <C> <C> <C>
Home Federal Savings Bank 1934 6/29/94 Federally Chartered
101 North Broadway MN HMN owns 100% of Stock Savings Bank
Spring Valley, MN 55975 voting shares
Osterud Insurance Agency, Inc. 1983 Bank owns 100% Offers credit life
101 North Broadway MN and annuity products
Spring Valley, MN 55975 to the Bank's
customers and others
MSL Financial Corporation 1983 Bank owns 100% Offered annuity
101 North Broadway IA products to
Spring Valley, MN 55975 Marshalltown
Financial
Security Finance Corporation 1929 12/29/95 Corporation invests
101 North Broadway MN HMN owns 100% of in securities and
Spring Valley, MN 55975 voting shares loans
HMN Mortgage Services, Inc. 1996 7/08/96 Mortgage Banking/
9973 Valley View Road MN HMN owns 100% of Brokerage Office
Eden Prairie, MN 55344 voting shares
</TABLE>
<PAGE>
KPMG Peat Marwick LLP
4200 Norwest Center
90 South Seventh Street
Minneapolis, MN 55402
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors
HMN Financial, Inc.:
We consent to incorporation by reference of our report dated February 4, 1998,
except for Note 1, which is as of February 19, 1998, relating to the
consolidated balance sheets of HMN Financial, Inc. as of December 31, 1997 and
1996, and the related consolidated statements of income, stockholders' equity,
and cash flows for each of the years in the three-year period ended December 31,
1997, which report appears in the December 31, 1997 Annual Report on Form 10-K
of HMN Financial, Inc. in the following Registration Statements of HMN
Financial, Inc.: Nos. 33-88228, 33-94388, and 33-94386 on Form S-8.
/s/ KPMG Peat Marwick LLP
KPMG PEAT MARWICK LLP
Minneapolis, Minnesota
March 26, 1998
56
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 1997 AND THE CONSOLIDATED STATEMENT
OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STAEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 9,365
<SECURITIES> 205,859
<RECEIVABLES> 447,104
<ALLOWANCES> 2,748
<INVENTORY> 0
<CURRENT-ASSETS> 262,803
<PP&E> 9,453
<DEPRECIATION> 3,572
<TOTAL-ASSETS> 691,232
<CURRENT-LIABILITIES> 366,426
<BONDS> 0
0
0
<COMMON> 61
<OTHER-SE> 84,409
<TOTAL-LIABILITY-AND-EQUITY> 691,232
<SALES> 0
<TOTAL-REVENUES> 43,813
<CGS> 0
<TOTAL-COSTS> 34,666
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 300
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 8,847
<INCOME-TAX> 3,268
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,579
<EPS-PRIMARY> 1.51
<EPS-DILUTED> 1.41
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AT SEPTEMBER 30, JUNE 30, AND MARCH 31, 1997 AND THE
CONSOLIDATED STATEMENTS OF INCOME FOR THE NINE, SIX, AND THREE MONTHS ENDED
SEPTEMBER 30, JUNE 30, AND MARCH 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C> <C>
<PERIOD-TYPE> 9-MOS 6-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997
<PERIOD-START> JAN-01-1997 JAN-01-1997 JAN-01-1997
<PERIOD-END> SEP-30-1997 JUN-30-1997 MAR-31-1997
<CASH> 9,636 11,570 12,754
<SECURITIES> 183,932 188,876 180,148
<RECEIVABLES> 357,569 347,996 344,588
<ALLOWANCES> 2,554 2,479 2,423
<INVENTORY> 0 0 0
<CURRENT-ASSETS> 187,891 178,569 178,137
<PP&E> 7,334 7,088 6,867
<DEPRECIATION> 3,104 2,997 2,906
<TOTAL-ASSETS> 568,847 566,865 553,021
<CURRENT-LIABILITIES> 285,847 272,474 263,353
<BONDS> 0 0 0
0 0 0
0 0 0
<COMMON> 61 61 61
<OTHER-SE> 84,558 81,737 78,711
<TOTAL-LIABILITY-AND-EQUITY> 568,847 566,865 553,021
<SALES> 0 0 0
<TOTAL-REVENUES> 32,366 21,173 10,602
<CGS> 0 0 0
<TOTAL-COSTS> 25,256 16,563 8,139
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 225 150 75
<INTEREST-EXPENSE> 0 0 0
<INCOME-PRETAX> 6,885 4,460 8,388
<INCOME-TAX> 2,554 1,654 913
<INCOME-CONTINUING> 0 0 0
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 4,331 2,807 1,474
<EPS-PRIMARY> 1.17 .76 .40
<EPS-DILUTED> 1.10 .72 .38
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AT DECEMBER 31, SEPTEMBER 30, JUNE 30, AND MARCH 31,
1996 AND THE CONSOLIDATED STATEMENTS OF INCOME FOR THE TWELVE, NINE, SIX, AND
THREE MONTHS ENDED DECEMBER 31, SEPTEMBER 30, JUNE 30, AND MARCH 31, 1996 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C>
<PERIOD-TYPE> YEAR 9-MOS 6-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996 DEC-31-1996 DEC-31-1996
<PERIOD-START> JAN-01-1996 JAN-01-1996 JAN-01-1996 JAN-01-1996
<PERIOD-END> DEC-31-1996 SEP-30-1996 JUN-30-1996 MAR-31-1996
<CASH> 10,584 17,397 5,942 9,376
<SECURITIES> 178,636 191,044 203,981 212,859
<RECEIVABLES> 352,103 346,002 333,989 309,922
<ALLOWANCES> 2,341 2,266 2,339 2,264
<INVENTORY> 0 0 0 0
<CURRENT-ASSETS> 202,634 215,988 227,103 171,669
<PP&E> 6,397 6,258 6,174 6,112
<DEPRECIATION> 2,816 2,714 2,636 2,550
<TOTAL-ASSETS> 554,732 565,385 554,979 542,012
<CURRENT-LIABILITIES> 259,882 252,827 250,594 242,148
<BONDS> 0 0 0 0
0 0 0 0
0 0 0 0
<COMMON> 61 61 61 61
<OTHER-SE> 82,039 83,608 87,202 90,818
<TOTAL-LIABILITY-AND-EQUITY> 554,732 565,385 554,979 542,012
<SALES> 0 0 0 0
<TOTAL-REVENUES> 41,787 31,353 20,926 10,497
<CGS> 0 0 0 0
<TOTAL-COSTS> 34,703 26,382 15,796 7,863
<OTHER-EXPENSES> 0 0 0 0
<LOSS-PROVISION> 300 225 150 75
<INTEREST-EXPENSE> 0 0 0 0
<INCOME-PRETAX> 6,784 4,745 4,980 2,559
<INCOME-TAX> 2,510 1,770 1,860 972
<INCOME-CONTINUING> 0 0 0 0
<DISCONTINUED> 0 0 0 0
<EXTRAORDINARY> 0 0 0 0
<CHANGES> 0 0 0 0
<NET-INCOME> 4,274 2,975 3,120 1,587
<EPS-PRIMARY> .99 .68 .69 .34
<EPS-DILUTED> .96 .66 .67 .33
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 1995 AND THE CONSOLIDATED STATEMENTS
OF INCOME FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1995 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1995
<CASH> 4,335
<SECURITIES> 207,292
<RECEIVABLES> 317,292
<ALLOWANCES> 2,191
<INVENTORY> 0
<CURRENT-ASSETS> 215,499
<PP&E> 6,105
<DEPRECIATION> 2,460
<TOTAL-ASSETS> 537,949
<CURRENT-LIABILITIES> 253,583
<BONDS> 0
0
0
<COMMON> 61
<OTHER-SE> 91,626
<TOTAL-LIABILITY-AND-EQUITY> 537,949
<SALES> 0
<TOTAL-REVENUES> 39,326
<CGS> 0
<TOTAL-COSTS> 30,025
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 300
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 9,001
<INCOME-TAX> 3,381
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,620
<EPS-PRIMARY> 1.10
<EPS-DILUTED> 1.09
</TABLE>
