UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
- -----------------------------------------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) FOR THE
SECURITIES EXCHANGE ACT OF 1934
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 Number)
101 North Broadway, Spring Valley, Minnesota 55975-0231
- -------------------------------------------- -----------
(Address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code: (507) 346-1100
------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes /X/ No / /
Indicate the number of shares outstanding of each of the issuer's common stock
as of the latest practicable date.
Class Outstanding at May 5, 1999
- ---------------------------------------- ----------------------------
Common stock, $0.01 par value 5,168,604
<PAGE>
<PAGE>
HMN FINANCIAL, INC.
CONTENTS
PART I - FINANCIAL INFORMATION
Page
----
Item 1:Financial Statements (unaudited)
Consolidated Balance Sheets at
March 31, 1999 and December 31, 1998 3
Consolidated Statements of Income for the
Three Months Ended March 31, 1999 and 1998 4
Consolidated Statement of Comprehensive Income
for the Three Months Ended March 31, 1999 and 1998 5
Consolidated Statement of Stockholders' Equity
for the Three Month Period Ended March 31, 1999 5
Consolidated Statements of Cash Flows for
the Three Months Ended March 31, 1999 and 1998 6-7
Notes to Consolidated Financial Statements 8-13
Item 2:Management's Discussion and Analysis of Financial
Condition and Results of Operations 14-23
Item 3:Quantitative and Qualitative Disclosures about
Market Risk Discussion included in Item 2 under
Market Risk 17
PART II - OTHER INFORMATION
Item 1:Legal Proceedings 24
Item 2:Changes in Securities 24
Item 3:Defaults Upon Senior Securities 24
Item 4:Submission of Matters to a Vote of Security Holders 24
Item 5:Other Information 24
Item 6:Exhibits and Reports on Form 8-K 24
Signatures 25
2<PAGE>
<PAGE>
PART I - FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(unaudited)
March 31, December 31,
ASSETS 1999 1998
------------ ------------
<S> <C> <C>
Cash and cash equivalents $ 6,688,168 20,960,957
Securities available for sale:
Mortgage-backed and related securities
(amortized cost $125,326,017
and $144,320,926) 124,786,630 143,146,165
Other marketable securities
(amortized cost $60,546,066 and
$38,657,193) 59,759,748 38,478,623
------------ ------------
184,546,378 181,624,788
------------ ------------
Loans held for sale 9,102,220 13,094,528
Loans receivable, net 449,872,046 447,455,052
Accrued interest receivable 3,804,760 3,952,763
Federal Home Loan Bank stock, at cost 9,837,900 9,837,900
Mortgage servicing rights, net 1,033,750 1,005,693
Real estate, net 10,625 10,602
Premises and equipment, net 8,452,277 8,382,136
Investment in limited partnerships 2,450,160 2,437,246
Goodwill 4,296,024 4,341,033
Core deposit intangible 1,201,133 1,259,245
Prepaid expenses and other assets 640,085 295,829
----------- ------------
Total assets $ 681,935,526 694,657,772
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 421,210,122 433,868,907
Federal Home Loan Bank advances 185,400,000 185,400,000
Other borrowed money 0 2,500,000
Accrued interest payable 1,430,756 1,086,013
Advance payments by borrowers for taxes and
insurance 884,880 657,089
Accrued expenses and other liabilities 3,969,295 2,663,373
Due to stockholders of Marshalltown Financial
Corporation 26,806 37,051
----------- -----------
Total liabilities 612,921,859 626,212,433
----------- -----------
Commitments and contingencies
Stockholders' equity:
Serial preferred stock: authorized 500,000
shares; issued and outstanding none 0 0
Common stock ($.01 par value): authorized
11,000,000; issued shares 9,128,662 91,287 91,287
Additional paid-in capital 59,755,485 59,739,020
Retained earnings, subject to certain
restrictions 64,663,580 63,424,378
Accumulated other comprehensive income (loss) (814,943) (837,838)
Unearned employee stock ownership
plan shares (5,656,835) (5,705,152)
Unearned compensation restricted stock
awards (233,106) (276,867)
Treasury stock, at cost 3,896,558 and
3,835,058 shares (48,791,801) (47,989,489)
------------ -----------
Total stockholders' equity 69,013,667 68,445,339
------------ -----------
Total liabilities and stockholders'
equity $681,935,526 694,657,772
============ ===========
</TABLE>
See accompanying notes to consolidated financial statements.
3<PAGE>
<PAGE>
<TABLE>
<CAPTION>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(unaudited)
Three Months Ended
March 31,
1999 1998
-------------------------------
<S> <C> <C>
Interest Income:
Loans receivable $ 8,643,574 8,642,372
Securities available for sale:
Mortgage-backed and related 1,949,496 2,218,698
Other marketable 762,138 956,472
Cash equivalents 96,552 161,324
Other 151,611 122,334
----------- -----------
Total interest income 11,603,371 12,101,200
----------- -----------
Interest expense:
Deposits 4,622,019 5,703,524
Federal Home Loan Bank advances 2,541,321 2,084,466
Other borrowed money 7,207 0
----------- -----------
Total interest expense 7,170,547 7,787,990
----------- -----------
Net interest income 4,432,824 4,313,210
Provision for loan losses 75,000 75,000
----------- -----------
Net interest income after
provision for loan losses 4,357,824 4,238,210
----------- -----------
Non-interest income:
Fees and service charges 215,427 201,756
Securities gains, net 139,438 896,447
Gain on sales of loans 694,992 366,244
Earnings in limited partnerships 17,067 53,608
Other 119,542 112,114
----------- -----------
Total non-interest income 1,186,466 1,630,169
----------- -----------
Non-interest expense:
Compensation and benefits 1,428,498 1,852,480
Occupancy 420,099 364,721
Federal deposit insurance premiums 72,608 73,831
Advertising 69,796 92,981
Data processing 184,712 174,055
Amortization of mortgage servicing rights
and net valuation adjustments 165,598 38,772
Other 592,579 625,184
----------- -----------
Total non-interest expense 2,933,890 3,222,024
----------- -----------
Income before income tax expense 2,610,400 2,646,355
Income tax expense 1,008,400 983,000
----------- -----------
Net income $ 1,602,000 1,663,355
=========== ===========
Basic earnings per share $ 0.36 0.31
=========== ===========
Diluted earnings per share $ 0.34 0.28
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
4<PAGE>
<PAGE>
<TABLE>
<CAPTION>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(unaudited)
Three Months Ended March 31,
1999 1998
--------------------- ------------------------
<S> <C> <C> <C> <C>
Net income $ 1,602,000 1,663,355
Other comprehensive income,
net of tax:
Unrealized gains
on securities:
Unrealized holding gains
arising during period 108,709 452,347
Less: reclassification
adjustment for gains
included in net
income 85,814 550,239
---------- ----------
Other comprehensive income
(loss) 22,895 (97,892)
---------- ----------
Comprehensive income $ 1,624,895 1,565,463
========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
<TABLE>
<CAPTION>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For the Three Months Ended March 31, 1999
(unaudited)
Accumulated
Additional Other
Common Paid-In Retained Comprehensive
Stock Capital Earnings Income (Loss)
----------------------------------------------------
<S> <C> <C> <C> <C>
Balance,
December 31, 1998 $ 91,287 59,739,020 63,424,378 (837,838)
Net income 1,602,000
Treasury stock purchases
Other comprehensive income 22,895
Amortization of restricted
stock awards
Dividends paid (362,798)
Earned employee stock
ownership plan shares 16,465
----------- ---------- ---------- ---------
Balance,
March 31, 1999 $ 91,287 59,755,485 64,663,580 (814,943)
=========== ========== ========== =========
<CAPTION>
Unearned
Employee
Stock Unearned
Ownership Compensation Total
Plan Restricted Treasury Stockholders'
Shares Stock Awards Stock Equity
-----------------------------------------------------
<S> <C> <C> <C> <C>
Balance,
December 31, 1998 $(5,705,152) (276,867) (47,989,489) 68,445,339
Net income 1,602,000
Treasury stock
purchases (802,312) (802,312)
Other comprehensive
income 22,895
Amortization of
restricted
stock awards 43,761 43,761
Dividends paid (362,798)
Earned employee stock
ownership plan
shares 48,317 64,782
----------- --------- ----------- -----------
Balance,
March 31, 1999 $(5,656,835) (233,106) (48,791,801) 69,013,667
=========== ========= =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
<PAGE>
<TABLE>
<CAPTION>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(unaudited)
Three Months Ended
March 31,
1999 1998
-----------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,602,000 1,663,355
Adjustments to reconcile net income
to cash provided by operating activities:
Provision for loan losses 75,000 75,000
Depreciation 173,068 144,845
Amortization of (discounts) premiums, net 41,093 (20,916)
Amortization of deferred loan fees (165,405) (148,028)
Amortization of goodwill 45,009 45,159
Amortization of core deposit intangible 58,112 71,757
Amortization of other purchase accounting
adjustments 11,384 184,119
Amortization of mortgage servicing rights
and net valuation adjustments 165,598 38,772
Capitalized mortgage servicing rights (172,145) (64,085)
Increase in deferred income taxes 81,000 90,000
Securities gains, net (139,438) (896,447)
Gain on sales of real estate 0 (2,768)
Gain on sales of loans (694,992) (366,244)
Proceeds from sales of loans held
for sale 52,911,809 34,212,150
Disbursements on loans held for sale (29,600,697) (28,386,755)
Principal collected on loans held
for sale 1,099 0
Amortization of restricted stock awards 43,761 61,724
Amortization of unearned ESOP shares 48,317 116,243
Earned employee stock ownership shares
priced above original cost 16,465 101,763
Decrease in accrued interest receivable 148,003 167,387
Increase in accrued interest payable 344,743 739,505
Equity earnings of limited partnerships (17,067) (51,943)
Decrease (increase) in other assets (344,256) 481,381
Increase (decrease) in other liabilities 1,214,279 (61,153)
Other, net 24,499 (34,420)
----------- -----------
Net cash provided by operating
activities 25,871,239 8,160,401
----------- -----------
Cash flows from investing activities:
Proceeds from sales of securities
available for sale 2,858,250 61,083,048
Principal collected on securities
available for sale 19,954,254 6,290,945
Proceeds collected on maturity of
securities available for sale 11,400,000 6,100,000
Purchases of securities available
for sale (34,591,894) (82,365,386)
Proceeds from sales of loans receivable 119,835 1,965,018
Purchases of mortgage servicing rights (12,729) (265,827)
Purchase of interest in limited partnerships 0 (181,125)
Purchase of Federal Home Loan Bank stock 0 (1,055,800)
Net increase in loans receivable (23,549,915) (21,711,768)
Proceeds from sale of real estate 0 50,574
Purchases of premises and equipment (243,209) (779,848)
Decrease in due to shareholders of
Marshalltown Financial Corporation (10,245) (3,362,462)
----------- -----------
Net cash used by investing activities (24,075,653) (34,232,631)
----------- -----------
Cash flows from financing activities:
Decrease in deposits (12,631,056) (268,567)
Purchase of treasury stock (802,312) 0
Increase in unearned ESOP shares 0 (1,361,595)
Payments to ESOP trustee to purchase
additional HMN shares 0 (114,405)
Dividends to stockholders (362,798) 0
Proceeds from Federal Home Loan Bank
advances 11,500,000 62,500,000
Repayment of Federal Home Loan Bank
advances (11,500,000) (22,857,142)
Decrease in other borrowed money (2,500,000) 0
Increase in advance payments by borrowers
for taxes and insurance 227,791 76,365
----------- -----------
Net cash provided (used) by financing
activities (16,068,375) 37,974,656
----------- -----------
Increase (decrease) in cash and cash
equivalents (14,272,789) 11,902,426
Cash and cash equivalents, beginning
of period 20,960,957 9,364,635
----------- -----------
Cash and cash equivalents, end of period $ 6,688,168 21,267,061
=========== ===========
6
<PAGE>
<S> <C> <C>
Supplemental cash flow disclosures:
Cash paid for interest $ 6,825,804 7,048,485
Cash paid for income taxes 640,000 175,000
Supplemental noncash flow disclosures:
SBA certificates transferred from loans
to securities available for sale $ 2,528,442 0
Loans transferred to loans held
for sale 18,648,998 11,495,290
Securities purchased with liability
due to broker 0 3,745,250
Due to stockholders of Marshalltown
Financial, Inc. 26,806 192,890
</TABLE>
See accompanying notes to consolidated financial statements.
7<PAGE>
<PAGE>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
March 31, 1999 and 1998
(1) HMN FINANCIAL, INC.
HMN Financial, Inc.(HMN) is a stock savings bank holding company which owns 100
percent of Home Federal Savings Bank (the Bank or Home Federal). Home Federal
has a community banking philosophy and operates retail banking facilities in
Minnesota and Iowa. The Bank has two wholly owned subsidiaries, Osterud
Insurance Agency, Inc. (OAI) and MSL Financial Corporation (MSL), which offer
financial planning products and services. HMN has two other wholly owned
subsidiaries, Security Finance Corporation (SFC) and HMN Mortgage Services,
Inc. (MSI). SFC invests in commercial loans and commercial real-estate loans
located throughout the United States which were originated by third parties.
MSI operates a mortgage banking and mortgage brokerage facility located in
Brooklyn Park, Minnesota.
The consolidated financial statements included herein are for HMN, SFC, MSI,
the Bank and the Bank's wholly owned subsidiaries, OAI and MSL. All significant
intercompany accounts and transactions have been eliminated in consolidation.
(2) BASIS OF PREPARATION
The accompanying unaudited consolidated financial statements were prepared in
accordance with instructions for Form 10-Q and therefore, do not include all
disclosures necessary for a complete presentation of the consolidated balance
sheets, consolidated statements of income, consolidated statements of
comprehensive income, consolidated statements of stockholders' equity and
consolidated statements of cash flows in conformity with generally accepted
accounting principles. However, all adjustments consisting of only normal
recurring adjustments which are, in the opinion of management, necessary for
the fair presentation of the interim financial statements have been included.
The statement of income for the three month period ended March 31, 1999 is not
necessarily indicative of the results which may be expected for the entire
year.
Certain amounts in the consolidated financial statements for prior periods have
been reclassified to conform with the current period presentation.
(3) NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES, which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives), and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and measure
those instruments at fair value. If certain conditions are met, a derivative
may be specifically designated as (a) a hedge of the exposure to changes in the
fair value of a recognized asset or liability or an unrecognized firm
commitment, (b) a hedge of the exposure to variable cash flows of a forecasted
transaction, or (c) a hedge of the foreign currency exposure of a net
investment in a foreign operation, an unrecognized firm commitment, an
available-for-sale security, or a foreign-currency-denominated forecasted
transaction.
The accounting for changes in the fair value of a derivative (that is, gains
and losses) depends on the intended use of the derivative and the resulting
designation.
- - For a derivative designated as hedging the exposure to changes in the
fair value of a recognized asset or liability or a firm commitment
(referred to as a fair value hedge), the gain or loss is recognized
in earnings
8
<PAGE>
in the period of change together with the offsetting loss or gain on
the hedged item attributable to the risk being hedged. The effect of
that accounting is to reflect in earnings the extent to which the
hedge is not effective in achieving offsetting changes in fair value.
- - For a derivative designated as hedging the exposure to variable cash
flows of a forecasted transaction (referred to as a cash flow hedge),
the effective portion of the derivative's gain or loss is initially
reported as a component of other comprehensive income (outside
earnings) and subsequently reclassified into earnings when the
forecasted transaction affects earnings. The ineffective portion of
the gain or loss is reported in earnings immediately.
- - For a derivative designated as hedging the foreign currency exposure
of a net investment in a foreign operation, the gain or loss is
reported in other comprehensive income (outside earnings) as part of
the cumulative translation adjustment. The accounting for a fair
value hedge described above applies to a derivative designated or an
available-for-sale security. Similarly, the accounting for a cash
flow hedge described above applies to a derivative designated as a
hedge of the foreign currency exposure of a foreign-currency-
denominated forecasted transaction.
- - For a derivative not designated as a hedging instrument, the gain or
loss is recognized in earnings in the period of change.
Under SFAS No. 133, an entity that elects to apply hedge accounting is required
to establish at the inception of the hedge the method it will use for assessing
the effectiveness of the hedging derivative and the measurement approach for
determining the ineffective aspect of the hedge. Those methods must be
consistent with the entity's approach to managing risk.
SFAS No. 133 precludes designating a nonderivative financial instrument as a
hedge of an asset, liability, unrecognized firm commitment, or forecasted
transaction except that a nonderivative instrument denominated in a foreign
currency may be designated as a hedge of the foreign currency exposure of an
unrecognized firm commitment denominated in a foreign currency or a net
investment in a foreign operation.
SFAS No. 133 is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. Initial application should be as of the beginning of an
entity's fiscal quarter; on that date, hedging relationships must be designated
anew and documented pursuant to the provisions of SFAS No. 133. HMN is
anticipating that it will adopt SFAS No. 133 in the first quarter of 2000. HMN
is currently researching the impact on its financial condition and results of
operations of adopting SFAS No. 133.
Effective January 1, 1999 HMN adopted FASB issued SFAS No. 134, ACCOUNTING FOR
MORTGAGE-BACKED SECURITIES RETAINED AFTER THE SECURITIZATION OF MORTGAGE LOANS
HELD FOR SALE BY A MORTGAGE BANKING ENTERPRISE, which amended SFAS No. 65 to
require that after the securitization of mortgage loans held for sale, an
entity engaged in mortgage banking activities classify the resulting mortgage-
backed securities or other retained interests based on its ability and intent
to sell or hold those investments. The adoption of SFAS No. 134 in the first
quarter of 1999 did not have a material impact on HMN's financial condition or
the results of its operations.
(4) COMPREHENSIVE INCOME
Comprehensive income is defined as the change in equity during a period from
transactions and other events from nonowner sources. Comprehensive income is
the total of net income and other comprehensive income, which for HMN is
comprised entirely of unrealized gains and losses on securities available for
sale.
The gross unrealized holding gains for the first quarter of 1999 were $167,200,
the income tax expense would have been $58,500 and therefore, the net gain was
$108,700. The gross reclassification adjustment for the first quarter of 1999
was $139,400, the income tax expense would have been $53,600 and therefore, the
net reclassification adjustment was $85,800. The gross unrealized holding
gains for the first quarter of 1998 were $681,000, the income tax expense would
have been $228,000 and therefore, the net gain was $452,000. The gross
reclassification adjustment for the first quarter of 1998 was $896,000, the
income tax expense would have been $346,000 and therefore, the net
reclassification adjustment was $550,000.
9
<PAGE>
(5) CASH DIVIDEND
On April 27, 1999 HMN's Board of Directors announced a cash dividend of $0.08
per share, payable on June 10, 1999 to stockholders of record on May 26, 1999.
(6) INVESTMENT IN MORTGAGE SERVICING RIGHTS
A summary of mortgage servicing activity is as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Mortgage servicing rights
Balance, beginning of period $ 1,117,193 845,517
Originations 172,145 64,085
Purchases 12,729 265,827
Amortization (200,217) (46,193)
------------ ----------
Balance, March 31 1,101,850 1,129,236
------------ ----------
Valuation reserve
Balance, beginning of period (111,500) (64,512)
Additions 0 0
Reductions 43,400 32,000
------------ ----------
Balance, March 31 (68,100) (32,512)
------------ ----------
Mortgage servicing rights, net $ 1,033,750 1,096,724
============ ==========
Fair value of mortgage servicing rights $ 1,033,750 1,096,724
============ ==========
- ----------------------------------------------------------------------
</TABLE>
(7) INVESTMENT IN LIMITED PARTNERSHIPS
Investments in limited partnerships at March 31 were as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
Primary partnership activity 1999 1998
- --------------------------------- ----------- -----------
<S> <C> <C>
Mortgage servicing rights $ 1,683,691 5,298,717
Common stock of financial
institutions 401,493 480,904
Low to moderate income housing 364,976 442,846
----------- -----------
$ 2,450,160 6,222,467
=========== ===========
- ---------------------------------------------------------------------
</TABLE>
During the first quarter of 1999 HMN's proportionate revenue from a mortgage
servicing partnership was $61,172, its proportionate share of losses from the
common stock investments in financial institutions was $13,696 and it did not
recognize any revenue or loss on the low income housing partnerships. During
1999 HMN anticipates receiving low income housing credits totaling $80,000 of
which $20,000 were credited to current income tax benefits. During 1998 HMN's
proportionate revenue from the mortgage servicing
10
<PAGE>
partnership was $51,911, its proportionate share of losses from common stock
investments in financial institutions was $32 and it did not recognize any
revenue or loss from low income housing partnerships.
(8) EARNINGS PER SHARE
The following table reconciles the weighted average shares outstanding and the
income available to common shareholders used for basic and diluted EPS:
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------
1999 1998
----------------------------
<S> <C> <C>
Weighted average number of common
shares outstanding used in basic
earnings per common share
calculation 4,509,368 5,447,501
Net dilutive effect of:
Options 186,223 403,037
Restricted stock awards 26,551 61,395
--------- ---------
Weighted average number of shares
outstanding adjusted for effect
of dilutive securities 4,722,142 5,911,933
========= =========
Income available to common
shareholders $ 1,602,000 1,663,355
Basic earnings per common share $ 0.36 0.31
Diluted earnings per common share $ 0.34 0.28
</TABLE>
(9) REGULATORY CAPITAL
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on HMN's
financial condition. 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, Tier I (Core), and Risk-based capital (as defined
in the regulations) to adjusted total assets and risk-weighted assets (as
defined). Management believes, as of March 31, 1999, that the Bank meets all
capital adequacy requirements to which it is subject.
Management believes that based upon the Bank's capital calculations at March
31, 1999 and other conditions consistent with the Prompt Corrective Actions
Provisions of the OTS regulations, the Bank would be categorized as well
capitalized.
On March 31, 1999 the Bank's tangible assets and adjusted total assets were
$656,680,000 and its risk-weighted assets were $342,038,000. The following
table presents the Bank's capital amounts and ratios at March 31, 1999 for
actual capital, required capital and excess capital including ratios in order
to qualify as being well capitalized under the Prompt Corrective Actions
regulations.
11
<PAGE>
<TABLE>
<CAPTION>
Required to be
Adequately
Actual Capitalized
---------------------- ----------------------
Percent of Percent Of
(IN THOUSANDS) Amount Assets <F1> Amount Assets <F1>
------- ------------- -------- --------------
<S> <C> <C> <C> <C>
Bank stockholder's equity $ 48,738
Plus:
Net unrealized loss on
certain securities
available for sale 416
Less:
Goodwill and other
intangibles 5,497
Excess mortgage
servicing rights 242
------
Tier I or core capital 43,415
------
Tier I capital to
adjusted total assets 6.61% $ 26,267 4.00%
Tier I capital to risk-
weighted assets 12.69% $ 13,682 4.00%
Less:
Equity investments & other
assets required to be
deducted 22
Plus:
Allowable allowance for
loan losses 3,117
------
Risk-based capital $ 46,510 $ 27,363
======
Risk-based capital to risk-
weighted assets 13.60% 8.00%
<CAPTION>
To Be Well Capitalized
Under Prompt
Corrective Actions
Excess Capital Provisions
---------------------- ----------------------
Percent of Percent Of
(IN THOUSANDS) Amount Assets <F1> Amount Assets <F1>
------- ------------- -------- --------------
<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
Tier I or core capital
Tier I capital to adjusted
total assets $ 17,148 2.61% $ 32,834 5.00%
Tier I capital to risk-
weighted assets $ 29,733 8.69% $ 20,522 6.00%
Less:
Equity investments &
other assets required
to be deducted
Plus:
Allowable allowance for
loan losses
Risk-based capital $ 19,147 $ 34,204
Risk-based capital to risk-
weighted assets 5.60% 10.00%
<FN>
<F1> 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.
</FN>
</TABLE>
The tangible capital of the Bank was in excess of the minimum 2% required at
March 31, 1999 but is not reflected in the table above.
(10) BUSINESS SEGMENTS
HMN's wholly owned subsidiaries, Home Federal Savings Bank, and Mortgage
Services, Inc. have been identified as reportable operating segments in
accordance with the provisions of SFAS 131. MSI was deemed to be a segment
because it is a separate corporation which operates independently from the Bank
and it is not regulated by the Office of Thrift Supervision. MSI has been
segmented further into Mortgage Servicing Rights and Mortgage Banking
activities. The mortgage servicing segment owns servicing rights on loans
which have either been sold to FNMA or securitized into mortgage backed
instruments which were issued by FNMA. MSI receives a servicing fee which is
based upon the outstanding balance of the loan being serviced and pays a
subservicer a monthly fee to service the loan. MSI's mortgage banking activity
includes an origination function and it also purchases loans from other loan
originators. All loans acquired either by origination or by purchase are
intended to be resold in the secondary loan market.
Security Finance Corporation and HMN, the holding company, did not meet the
quantitative thresholds for determining reportable segments and therefore are
included in the 'Other' category.
HMN evaluates performance and allocates resources based on the segments net
income or loss, return on average assets and return on average equity. The
segments follow generally accepted accounting principles as described in the
summary of significant accounting policies.
12
<PAGE>
Each corporation is managed separately with its own president, who reports
directly to HMN's chief operating decision maker, and board of directors.
The following table sets forth certain information about the reconciliations of
reported profit or loss and assets for each of HMN's reportable segments.
<TABLE>
<CAPTION>
HMN Mortgage
Services, Inc.
----------------------
Mortgage Total
Home Federal Servicing Mortgage Reportable
(DOLLARS IN THOUSANDS) Savings Bank Rights Banking Segments
- --------------------------------------------------------------------------
<S> <C> <C> <C> <C>
At or for the quarter ended
March 31, 1999:
Interest income -
external customers $ 11,326 0 77 11,403
Non-interest income -
external customers 816 32 278 1,126
Earnings (loss) on
limited partnerships 31 0 0 31
Intersegment interest
income 2 0 0 2
Intersegment non-
interest income 80 0 0 80
Interest expense 7,164 0 78 7,242
Amortization of
mortgage servicing
rights and net
valuation adjustments 57 109 0 166
Other non-interest
expense 2,434 3 282 2,719
Income tax expense
(benefit) 987 (31) (3) 953
Net income (loss) 1,539 (49) (2) 1,488
Total assets 661,985 302 7,339 669,626
Net interest margin 2.64 % NM NM NM
Return on average assets 0.94 % (57.81)% (0.14)% NM
Return on average
realized common equity 12.79 % (121.22)% (0.30)% NM
At or for the quarter
ended March 31, 1998:
Interest income -
external customers $ 11,711 0 48 11,759
Non-interest income -
external customers 618 79 207 904
Earnings (loss) on
limited partnerships 54 0 0 54
Intersegment interest
income 8 0 0 8
Intersegment non-
interest income 77 0 0 77
Interest expense 7,788 0 52 7,840
Amortization of mortgage
servicing rights
and net valuation
adjustments 5 34 0 39
Other non-interest
expense 2,846 0 272 3,118
Income tax expense
(benefit) 726 14 (23) 717
Net income (loss) 1,028 31 (46) 1,013
Total assets 698,187 1,000 6,829 706,016
Net interest margin 2.09 % NM NM NM
Return on average assets 0.62 % 14.94% (5.43)% NM
Return on average
realized common equity 7.77 % 50.86% (18.46)% NM
<CAPTION>
Consolidated
(DOLLARS IN THOUSANDS) Other Eliminations Total
- --------------------------------------------------------------------------
<S> <C> <C> <C>
At or for the quarter ended
March 31, 1999:
Interest income -
external customers $ 200 0 11,603
Non-interest income -
external customers 43 0 1,169
Earnings (loss) on limited
partnerships (14) 0 17
Intersegment interest
income 108 (110) 0
Intersegment non-interest
income 1,506 (1,586) 0
Interest expense 39 (110) 7,171
Amortization of mortgage
servicing rights and
net valuation adjustments 0 0 166
Other non-interest expense 129 (80) 2,768
Income tax expense (benefit) 55 0 1,008
Net income (loss) 1,620 (1,506) 1,602
Total assets 72,705 (60,395) 681,936
Net interest margin NM NM 2.73%
Return on average assets NM NM 0.95%
Return on average realized
common equity NM NM 9.31%
At or for the quarter
ended March 31, 1998:
Interest income -
external customers $ 342 0 12,101
Non-interest income -
external customers 672 0 1,576
Earnings (loss) on limited
partnerships 0 0 54
Intersegment interest income 115 (123) 0
Intersegment non-interest
income 1,061 (1,138) 0
Interest expense 71 (123) 7,788
Amortization of mortgage
servicing rights
and net valuation adjustments 0 0 39
Other non-interest expense 142 (77) 3,183
Income tax expense (benefit) 266 0 983
Net income (loss) 1,711 (1,061) 1,663
Total assets 91,990 (65,888) 732,118
Net interest margin NM NM 2.59%
Return on average assets NM NM 0.96%
Return on average realized
common equity NM NM 7.98%
</TABLE>
NM - Not meaningful
13
<PAGE>
<PAGE>
HMN FINANCIAL, INC.
Item 2: MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
HMN's net income is dependent primarily on its net interest income, which is
the difference between interest earned on its loans and investments and the
interest paid on interest-bearing liabilities. Net interest income is
determined by (i) the difference between the yield earned on interest-earning
assets and rates paid on interest-bearing liabilities (interest rate spread)
and (ii) the relative amounts of interest-earning assets and interest-bearing
liabilities. HMN's interest rate spread is affected by regulatory, economic
and competitive factors that influence interest rates, loan demand and deposit
flows. Net interest margin is calculated by dividing net interest income by
the average interest-earning assets and is normally expressed as a percentage.
Net interest income and net interest margin are affected by changes in interest
rates, the volume and the mix of interest-earning assets and interest-bearing
liabilities, and the level of non-performing assets. HMN's net income is also
affected by the generation of non-interest income, which primarily consists of
gains from the sale of securities, gains from sale of loans, service charges,
fees and other income. In addition, net income is affected by the level of
operating expenses, provisions made for loan losses and impairment reserve
adjustments required on mortgage servicing assets.
The operations of financial institutions, including the Bank, are significantly
affected by prevailing economic conditions, competition and the monetary and
fiscal policies of governmental agencies. Lending activities are influenced by
the demand for and supply of housing, competition among lenders, the level of
interest rates and the availability of funds. Deposit flows and costs of funds
are influenced by prevailing market rates of interest primarily on competing
investments, account maturities and the levels of personal income and savings
in the market area of the Bank.
NET INCOME
HMN's net income for the first quarter of 1999 was $1.6 million, a decrease of
$61,000, or 3.7%, compared to $1.66 million for the first quarter of 1998.
Basic earnings per share was $0.36 for the quarter ended March 31, 1999, an
increase of $0.05 per share, or 16.1%, from $0.31 basic earnings per share for
the same quarter of 1998. Diluted earnings per share was $0.34 per share for
the first quarter of 1999, an increase of $0.06, or 21.4% from $0.28 diluted
earnings per share for the first quarter of 1998.
NET INTEREST INCOME
Net interest income for the first quarter of 1999 was $4.4 million an increase
of $120,000, or 2.8%, compared to $4.3 million for the first quarter of 1998.
Interest income for the first quarter of 1999 was $11.6 million, a decrease of
$498,000, or 4.1%, compared to $12.1 million for the first quarter of 1998.
The decline in interest income was primarily due to a $15.9 million decrease in
net average interest-earning assets from the first quarter of 1998 to the first
quarter of 1999 principally due to interest-earning assets being used to
purchase HMN's common stock under its stock repurchase program. Interest
income also decreased because the yield earned on interest-earning assets
decreased from 7.27% at March 31, 1998 to 7.14% at March 31, 1999 due to a
general decline in interest rates.
Interest expense was $7.2 million for the first quarter of 1999 a decrease of
$617,000, or 7.9%, compared to $7.8 million for the same quarter of 1998. The
decrease in interest expense is primarily related to a decrease in the interest
rates paid on deposits and an increase in the average balances of deposits held
in transaction accounts versus certificates of deposit. The average interest
rate paid on the average interest-bearing liabilities was 4.79% during the
first quarter of 1999 compared to 5.20% for the first quarter of 1998.
14
<PAGE>
PROVISION FOR LOAN LOSSES
*The provision for loan losses for the first quarter of 1999 and 1998 was
$75,000. The provision is the result of management's evaluation of the loan
portfolio, a historically low level of non-performing loans, minimal loan
charge-off experience, and its assessment of the general economic conditions in
the geographic area where properties securing the loan portfolio are located
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.
Management's evaluation did not reveal conditions that would cause it to
increase the provision for loan losses during 1999 compared to 1998. HMN will
continue to monitor its allowance for losses as these conditions dictate.
Future economic conditions and other unknown factors will impact the need for
future provisions for loan losses. As a result, no assurances can be given
that increases in the allowance for loan losses will not be required during
future periods.
A reconciliation of HMN's allowance for loan losses is summarized as follows:
1999 1998
----------- ----------
Balance at January 1, $ 3,041,485 2,748,219
Provision 75,000 75,000
Recoveries 841 1,576
----------- ----------
Balance at March 31, $ 3,117,326 2,824,795
=========== ==========
NON-INTEREST INCOME
Non-interest income was $1.2 million for the first quarter of 1999, a decrease
of $444,000, or 27.2% compared to $1.6 million for the first quarter of 1998.
The decrease in non-interest income is primarily due to $757,000 decrease in
security gains, net and a $37,000 decrease in earnings in limited partnerships
which were partially offset by a $329,000 increase in gains recognized on the
sales of loans. During the first quarter of 1999 interest rates in general
started to rise from rates that were in effect at December 31, 1998. The
rising rate scenario caused the market value of many securities to decline and
therefore few securities were sold at a profit. The loan sale activity did
increase from the first quarter of 1998 to the first quarter of 1999 because
both the Bank and MSI were selling more loans.
NON-INTEREST EXPENSE
Non-interest expense was $2.9 million for the first quarter of 1999, a decrease
of $288,000, or 8.9%, compared to $3.2 million for the same quarter of 1998.
The decrease in non-interest expense was primarily due to a decline in
compensation and benefit expense of $424,000 due to a decrease in work force
and was partially offset by a $127,000 increase in amortization of mortgage
servicing assets.
INCOME TAX EXPENSE
Income tax expense was $1.0 million for the first quarter of 1999, an increase
of $25,000 compared to $983,000 for the first quarter of 1998. The increase is
primarily due to an increase in the effective tax rates between the two
periods.
* This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 22 of this discussion.
15
<PAGE>
NON-PERFORMING ASSETS
The following table sets forth the amounts and categories of non-performing
assets in the Bank's portfolio at
March 31, 1999 and December 31, 1998.
<TABLE>
<CAPTOIN>
March 31, December 31,
(DOLLARS IN THOUSANDS) 1999 1998
----------- -----------
<S> <C> <C>
Non-Accruing Loans
One-to-four family real estate $ 241 317
Nonresidential real estate 72 73
Consumer 87 86
---- ----
Total 400 476
---- ----
Accruing loans delinquent 90
days or more 324 312
---- ----
Foreclosed Assets
Real estate:
One-to-four family 19 18
---- ----
Total non-performing assets $ 743 $ 806
==== ====
Total as a percentage of total assets 0.11% 0.12%
==== ====
Total non-performing loans $ 724 $ 788
==== ====
Total as a percentage of total
loans receivable, net 0.16% 0.18%
==== ====
</TABLE>
Total non-performing assets at March 31, 1999 were $743,000, a decrease of
$63,000, from $806,000 at December 31, 1998. The net decrease of $63,000 was
the result of a decrease of non-accruing loans.
DIVIDENDS
On April 27, 1999 HMN declared a cash dividend of $.08 per share, payable on
June 10, 1999 to shareholders of record on May 26, 1999.
During the first quarter of 1999, HMN declared and paid dividends as follows:
Record Payable Dividend Dividend
date date per share Payout Ratio
----------------- -------------- ------------ ---------------
February 24, 1999 March 10, 1999 $0.08 21.6 %
The annualized dividend payout ratio for the past four quarters, ending with
the June 10, 1999 payment will be 36.4%.
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.
LIQUIDITY
For the quarter ended March 31, 1999, the net cash provided by operating
activities was $25.9 million. HMN collected $2.9 million from the sale of
securities, and $31.4 million in principal repayments or on the maturity of
securities during the quarter. HMN also collected $120,000 on the sale of
loans receivable during the quarter. It purchased $34.6 million of securities
and funded a net increase in loans receivable of $23.5 million. HMN funded
$12.6 million of deposit withdrawals during the quarter and also purchased
$802,000 of HMN treasury stock.
16
<PAGE>
*HMN has certificates of deposits with outstanding balances of $194.1 million
that come due over the next 12 months. Based upon past experience management
anticipates that the majority of the deposits will renew for another term. HMN
believes that deposits which do not renew will be replaced with deposits from
other customers, or funded with advances from the FHLB, or will be funded
through the sale of securities. Management does not anticipate that it will
have a liquidity problem due to maturing deposits.
*HMN has $14.0 million of FHLB advances which mature in 2001 but have call
features which can be exercised by the FHLB on a semiannual basis starting in
1999. If the call features are exercised HMN has the option of requesting any
advance otherwise available to it pursuant to the Credit Policy of the FHLB.
Since HMN has the ability to request another advance to replace the advance
that is being called, management does not anticipate that it will have a
liquidity problem due to advances being called by the FHLB during 1999.
MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
rates. HMN's market risk arises primarily from interest rate risk inherent in
its investing, lending and deposit taking activities. Management actively
monitors and manages its interest rate risk exposure.
HMN's profitability is affected by fluctuations in interest rates. A sudden
and substantial increase in interest rates may adversely impact HMN's earnings
to the extent that the interest rates borne by assets and liabilities do not
change at the same speed, to the same extent, or on the same basis. HMN
monitors how its assets will mature or reprice in comparison to how its
liabilities will mature or reprice. The MATURITY OR REPRICING TABLE located in
the Asset/Liability Management section of this report is used as part of the
monitoring process. HMN also monitors the projected changes in net interest
income that would occur if interest rates were to suddenly change up or down.
The RATE SHOCK TABLE located in the Asset/Liability Management section of this
report discloses HMN's projected changes in net interest income based upon
immediate interest rate changes called rate shocks.
*HMN utilizes a model which uses the discounted cash flows from its interest-
earning assets and its interest-bearing liabilities to calculate the current
market value of those assets and liabilities. The model also calculates the
changes in market value of the interest-earning assets and interest-bearing
liabilities due to different interest rate changes. HMN believes that over the
next twelve months interest rates could conceivably fluctuate in a range of 200
basis points up or down from where the rates were at March 31, 1999. 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 March 31, 1999.
* This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 22 of this discussion.
17<PAGE>
<PAGE>
<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 $ 5,695 5,690 5,686 5,681 5,676
Securities available for sale:
Fixed-rate CMOs 28,890 28,898 28,829 28,298 27,646
Variable-rate CMOs 89,899 90,703 92,465 91,152 87,923
Fixed-rate available for
sale mortgage-backed
and related securities 2,981 2,937 2,891 2,824 2,722
Variable-rate available for
sale mortgage-backed and
related securities 104 102 100 98 98
Fixed-rate available for sale other
marketable securities 79,199 75,498 72,012 68,804 65,831
Variable-rate available for
sale other marketable securities 723 721 719 718 716
Fixed-rate loans held for sale 9,116 9,108 9,101 9,093 9,086
Loans receivable, net:
Fixed-rate real estate loans 302,061 298,970 293,636 285,268 275,678
Variable-rate real estate loans 120,834 119,574 117,363 114,528 110,713
Fixed-rate other loans 24,198 23,961 23,599 23,092 22,664
Variable-rate other loans 26,910 26,363 26,274 26,165 26,038
Mortgage servicing rights, net 336 672 1,034 1,191 1,310
Investment in limited partnerships 706 1,084 2,450 5,663 6,776
------- -------- ------- ------- --------
Total market risk sensitive assets 691,652 684,281 676,159 662,575 642,877
------- -------- ------- ------- --------
NOW deposits 32,513 32,486 32,459 32,432 32,405
Passbook deposits 36,143 34,585 33,156 31,840 30,625
Money market deposits 28,938 27,698 26,561 25,514 24,545
Certificate deposits 333,918 330,003 326,179 322,443 318,792
Fixed-rate Federal Home Loan Bank
advances 173,853 168,627 163,553 160,229 158,370
Variable-rate Federal Home Loan Bank
advances 24,046 24,026 24,006 23,986 23,966
------- -------- ------- ------- --------
Total market risk sensitive
liabilities 629,411 617,425 605,914 596,444 588,703
------- -------- ------- ------- --------
Off-balance sheet financial instruments:
Commitments to extend credit 43 43 42 41 39
------- -------- ------- ------- --------
Net market risk $62,284 66,899 70,287 66,172 54,213
======= ======== ======= ======= ========
Percentage change from current
market value (11.39)% (4.82)% 0.00% (5.85)%(22.87)%
======= ======== ======= ========= ======
- ------------------------------------------------------------------------------
</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 8% to 45%, depending on the coupon and period
to maturity. Adjustable rate mortgages ('ARMs') were assumed to prepay at
annual rates of between 10% and 32%, depending on coupon and the period to
maturity. Growing Equity Mortgage (GEM) loans were assumed to prepay at annual
rates of between 18% and 55% 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 and the related cash flow priority of the CMO tranche
owned. 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%. FHLB advances were projected to be called at the first call date where
the projected interest rate on similar remaining term advances exceeded the
interest rate on HMN's callable advance.
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
18
<PAGE>
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 March 31,
1999 to determine if its current level of interest rate risk is acceptable.
The following table projects the estimated annual impact on net interest income
of immediate interest rate changes called rate shocks.
Rate Shock Net Interest Percentage
in Basis Points Income Change
--------------- ------------- -------------
+200 20,346 1.98%
+100 20,438 2.44%
0 19,951 0.00%
-100 18,732 -6.11%
-200 17,248 -13.55%
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.
*This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 22 of this discussion.
19
<PAGE>
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.
The following table sets forth the interest rate sensitivity of HMN's assets
and liabilities at March 31, 1999, using certain assumptions that are described
in more detail below:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------
Maturing or Repricing
-----------------------------------------------
Over 6
6 Months Months to Over 1-3 Over 3-5
(DOLLARS IN THOUSANDS) or Less One Year Years Years
- --------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Cash equivalents $ 5,688 0 0 0
Securities available
for sale:
Mortgage-backed and
related securities<F1> 100,014 6,466 9,690 4,160
Other marketable
securities 8,801 1,350 14,054 10,428
Loans held for sale, net 9,102 0 0 0
Loans receivable, net<F1><F2>
Fixed rate one-to-four
family 33,249 29,091 85,261 50,434
Adjustable rate
one-to-four family 21,013 15,956 26,032 31,815
Multi family 1,267 896 1,722 562
Fixed rate commercial
real estate 5,038 3,332 7,388 2,764
Adjustable rate commercial
real estate 6,387 4,115 5,279 2,228
Commercial business 4,158 2,527 5,656 1,101
Consumer loans 23,068 1,954 5,434 2,793
Federal Home Loan Bank stock 0 0 0 0
------- ------- ------- --------
Total interest-earning
assets 217,785 65,687 160,516 106,285
------- ------- ------- --------
Non-interest checking 9,026 0 0 0
NOW accounts 23,515 0 0 0
Passbooks 3,617 3,617 10,417 6,667
Money market accounts 2,918 2,918 8,405 5,379
Certificates 109,384 84,709 103,717 23,689
Federal Home Loan Bank
advances 24,000 5,000 40,000 116,400
------- ------- ------- --------
Total interest-bearing
liabilities 172,460 96,244 162,539 152,135
------- ------- ------- --------
Interest-earning assets less
interest-bearing
liabilities $ 45,325 (30,557) (2,023) (45,850)
======= ======= ======= ========
Cumulative interest-rate
sensitivity gap $ 45,325 14,768 12,745 (33,105)
======= ======= ======= =======
Cumulative interest-rate
gap as a percentage of
total assets at
March 31, 1999 6.65% 2.17% 1.87% (4.86)%
======= ======= ======= =======
<CAPTION>
- -------------------------------------------------------------------------
Maturing or Repricing
-----------------------------------------------
(DOLLARS IN THOUSANDS)
Over 5 No Stated
Year Maturity Total
- --------------------------------------------------------------------------
<S> <C> <C> <C>
Cash equivalents $ 0 0 5,688
Securities available for sale:
Mortgage-backed and
related securities<F1> 4,996 0 125,326
Other marketable securities 17,326 8,587 60,546
Loans held for sale, net 0 0 9,102
Loans receivable, net<F1><F2>
Fixed rate one-to-four
family 67,530 0 265,565
Adjustable rate
one-to-four family 196 0 95,012
Multi family 433 0 4,880
Fixed rate commercial real
estate 1,525 0 20,047
Adjustable rate commercial
real estate 0 0 18,009
Commercial business 138 0 13,580
Consumer loans 2,647 0 35,896
Federal Home Loan Bank stock 0 9,838 9,838
-------- ------- --------
Total interest-earning
assets 94,791 18,425 663,489
-------- ------- --------
Non-interest checking 0 0 9,026
NOW accounts 0 0 23,515
Passbooks 11,851 0 36,169
Money market accounts 9,563 0 29,183
Certificates 1,818 0 323,317
Federal Home Loan Bank advances 0 0 185,400
-------- ------- --------
Total interest-bearing
liabilities 23,232 0 606,610
-------- ------- --------
Interest-earning assets less
interest-bearing liabilities$ 71,559 18,425 56,879
======== ======= ========
Cumulative interest-rate
sensitivity gap $ 38,454 56,879 56,879
======== ======= ========
Cumulative interest-rate gap
as a percentage of total
assets at March 31, 1999 5.64 % 8.34 % 8.34 %
======== ======= ========
<FN>
<F1> 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.
<F2>Loans receivable are presented net of loans in process and deferred loan
fees.
</FN>
</TABLE>
20<PAGE>
<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 8% to 45%,
depending on the coupon and period to maturity. ARMs were assumed to prepay at
annual rates of between 10% and 32%, depending on coupon and the period to
maturity. GEM loans were assumed to prepay at annual rates of between 18% and
55% 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
and the related cash flow priority of the CMO tranche owned. 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%. FHLB advances
were projected to be called at the first call date where the projected interest
rate on similar remaining term advances exceeded the interest rate on HMN's
callable advance.
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
*HMN has inventoried its computer hardware, computer software, third party
vendors and its other non-computer equipment and has assessed or is in the
process of assessing whether the items are year 2000 compliant. The hardware
testing has been completed. The majority of the non-compliant hardware was
replaced during 1998 at a cost of $67,500. The remaining non-compliant
hardware will be replaced at an approximate cost of $7,500 in the second
quarter of 1999. The computer software inventory indicated that certain
programs were not compliant. Some of those software programs were replaced
during 1998 at a cost of $53,000. Other software programs are scheduled to be
replaced with year 2000 compliant software during the second quarter of 1999 at
an anticipated cost of $27,000. HMN is also in the process of testing all
computer software to determine that the software is year 2000 compliant. The
testing is scheduled to be completed during the second quarter of 1999. The
assessment of non-computer equipment for year 2000 compliance indicated that
HMN did not have any significant issues in this area.
*The majority of the Bank's loan and deposit data is supported by a third party
data processing center. Other third party providers support the automated
teller machines owned by the Bank and process the check clearings for the
Bank's negotiable order of withdrawal accounts ('checking accounts'). The Bank
is also reliant upon the Federal Home Loan Bank of Des Moines and the Federal
Reserve System to properly and efficiently conduct its business.
Notwithstanding the Bank's efforts, the failure of any of these third party
vendors to address their year 2000 issues in a timely fashion may have an
adverse effect on the Bank's ability to conduct its business and/or process its
customers' transactions. The Bank's Year 2000 Committee (the 'Committee') is
working very closely with its data processing center to ascertain that all
software applications and hardware will be year 2000 compliant by the second
quarter of 1999. The Committee is also monitoring the progress that other key
third party providers are making toward becoming year 2000 compliant.
*The Committee is in the process of developing a contingency plan which
incorporates the actions the Bank will take in situations where the data
processing center or other key third party providers are not able to become
year 2000 compliant and it will have a major impact on the Bank's business.
The contingency plan is anticipated to be completed in the second quarter of
1999.
*This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 22 of this discussion.
21
<PAGE>
FORWARD-LOOKING INFORMATION
The following paragraphs within Management's Discussion and Analysis of
Financial Condition and Results of Operations contain forward-looking
statements and actual results may differ materially from the expectations
disclosed within this Discussion and Analysis. These forward-looking
statements are subject to risks and uncertainties, including those discussed
below. HMN assumes no obligations to publicly release results of any revision
or updates to these forward-looking statements to reflect future events or
unanticipated occurrences.
PROVISION FOR LOAN LOSSES
The provision for loan losses for the first quarter of 1999 and 1998 was
$75,000. The provision is the result of management's evaluation of the
loan portfolio, a historically low level of non-performing loans, minimal
loan charge-off experience, and its assessment of the general economic
conditions in the geographic area where properties securing the loan
portfolio are located 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. Management's evaluation did not reveal
conditions that would cause it to increase the provision for loan losses
during 1999 compared to 1998. HMN will continue to monitor its allowance
for losses as these conditions dictate. Future economic conditions and
other unknown factors will impact the need for future provisions for loan
losses. As a result, no assurances can be given that increases in the
allowance for loan losses will not be required during future periods.
LIQUIDITY
HMN has certificates of deposits with outstanding balances of $194.1
million that come due over the next 12 months. Based upon past experience
management anticipates that the majority of the deposits will renew for
another term. HMN believes that deposits which do not renew will be
replaced with deposits from other customers, or funded with advances from
the FHLB, or will be funded through the sale of securities. Management
does not anticipate that it will have a liquidity problem due to maturing
deposits.
HMN has $14.0 million of FHLB advances which mature in 2001 but have call
features which can be exercised by the FHLB on a semiannual basis starting
in 1999. If the call features are exercised HMN has the option of
requesting any advance otherwise available to it pursuant to the Credit
Policy of the FHLB. Since HMN has the ability to request another advance
to replace the advance that is being called, management does not
anticipate that it will have a liquidity problem due to advances being
called by the FHLB during 1999.
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 the desire by customers to put more of their funds into
nontraditional bank products such as stocks and bonds could be
circumstances that would cause the maturing certificates to become a
liquidity problem
MARKET RISK
HMN utilizes a model which uses the discounted cash flows from its
interest-earning assets and its interest-bearing liabilities to calculate
the current market value of those assets and liabilities. The model also
calculates the changes in market value of the interest-earning assets and
interest-bearing liabilities due to different interest rate changes. HMN
believes that over the next twelve months interest rates could conceivably
fluctuate in a range of 200 basis points up or down from where the rates
were at March 31, 1999. HMN does not have a trading portfolio. The
table in the Market Risk section 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 March 31, 1999.
Certain shortcomings are inherent in the method of analysis in the table
presented in the Market Risk section. 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
22
<PAGE>
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 March
31, 1999 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 in the Asset/
Liability section 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 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.
YEAR 2000
HMN has inventoried its computer hardware, computer software, third party
vendors and its other non-computer equipment and has assessed or is in the
process of assessing whether the items are year 2000 compliant. The
hardware testing has been completed. The majority of the non-compliant
hardware was replaced during 1998 at a cost of $67,500. The remaining
non-compliant hardware will be replaced at an approximate cost of $7,500
in the second quarter of 1999. The computer software inventory indicated
that certain programs were not compliant. Some of those software programs
were replaced during 1998 at a cost of $53,000. Other software programs
are scheduled to be replaced with year 2000 compliant software during the
second quarter of 1999 at an anticipated cost of $27,000. HMN is also in
the process of testing all computer software to determine that the
software is year 2000 compliant. The testing is scheduled to be completed
during the second quarter of 1999. The assessment of non-computer
equipment for year 2000 compliance indicated that HMN did not have any
significant issues in this area.
The majority of the Bank's loan and deposit data is supported by a third
party data processing center. Other third party providers support the
automated teller machines owned by the Bank and process the check
clearings for the Bank's negotiable order of withdrawal accounts
('checking accounts'). The Bank is also reliant upon the Federal Home
Loan Bank of Des Moines and the Federal Reserve System to properly
and efficiently conduct its business. Notwithstanding the Bank's
efforts, the failure of any of these third party vendors to address
their year 2000 issues in a timely fashion may have an adverse
effect on the Bank's ability to conduct its business and/or process
its customers' transactions. The Bank's Year 2000 Committee
(the 'Committee') is working very closely with its data processing center
to ascertain that all software applications and hardware will be year 2000
compliant by the second quarter of 1999. The Committee is also monitoring
the progress that other key third party providers are making toward
becoming year 2000 compliant.
The Committee is in the process of developing a contingency plan which
incorporates the actions the Bank will take in situations where the data
processing center or other key third party providers are not able to
become year 2000 compliant and it will have a major impact on the Bank's
business. The contingency plan is anticipated to be completed in the
second quarter of 1999.
23<PAGE>
<PAGE>
HMN FINANCIAL, INC.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings.
None.
ITEM 2. Changes in Securities.
Not applicable
ITEM 3. Defaults Upon Senior Securities.
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders.
None.
ITEM 5. Other Information.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. See Index to Exhibits on page 27 of this report.
(b) Reports on Form 8-K - None.
24
<PAGE>
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HMN FINANCIAL, INC.
Registrant
Date: May 17, 1999 /s/ Roger P. Weise
--------------------- -------------------------
Roger P. Weise,
Chairman, President and
Chief Executive Officer
(Principal Executive Officer)
Date: May 17, 1999 /s/ James B. Gardner
-------------------- -------------------------
James B. Gardner,
Executive Vice President
(Principal Financial Officer)
25<PAGE>
<PAGE>
HMN FINANCIAL, INC.
INDEX TO EXHIBITS
FOR FORM 10-Q
Reference Sequential
to Prior Page Numbering
Regulation Filing or Where Attached
S-K Exhibit Exhibits Are
Exhibit Number Located in This
Number Document Attached Hereto Form 10-Q Report
- ------- -------------------------------- --------------- ----------------
2 Plan of acquisition, reorganization,
arrangement, liquidation or succession. N/A N/A
3(a) Articles of Incorporation
Certificate of Incorporation as amended. *4 N/A
3(b) By-laws *3 N/A
Resolution to Amend By-laws of
HMN Financial, Inc., By-laws of HMN
Financial, Inc. as amended
4 Instruments defining the rights of
security holders, Including indentures *1 N/A
5(a) Amendment to the Home Federal Savings *2 N/A
Bank Employees' Savings & Profit Sharing
Plan dated January 28, 1997.
5(b) Amendment to the Adoption Agreement *2 N/A
for Home Federal Savings Bank Employees'
Savings & Profit Sharing Plan and Trust
effective June 17, 1997.
11 Computation of Earnings Per Common Share 11 Filed electronically
27 Financial Data Schedule 27 Filed electronically
*1 Filed April 1, 1994, as exhibits to the Registrant's Form S-1
registration statement (Registration No. 33-77212) pursuant to the
Securities Act of 1933. All of such previously filed documents are
hereby incorporated herein by reference in accordance with Item 601 of
Regulation S-K.
*2 Filed as an exhibit to Registrant's Form 10-Q for June 30, 1997 (file no.
0-24100). All previously filed documents are hereby incorporated by
reference in accordance with Item 601 of Regulation S-K.
*3 Filed as an exhibit to Registrant's Form 10-Q for September 30, 1997
(file no. 0-24100). All previously filed documents are hereby
incorporated by reference in accordance with Item 601 of Regulation S-K.
*4 Filed as an exhibit to Registrant's Form 10-Q for September 30, 1998
(file no. 0-24100). All previously filed documents are hereby
incorporated by reference in accordance with Item 601 of Regulation S-K.
26
Exhibit 11
HMN Financial, Inc.
Computation of Earnings Per Common Share
Three Months Ended March 31,
-----------------------------
Computation of Earnings
Per Common Share: 1999 1998
------------- ------------
Weighted average number of common
shares outstanding used in basic
earnings per common share
calculation 4,509,368 5,447,501
Net dilutive effect of:
Options 186,223 403,037
Restricted stock awards 26,551 61,395
----------- -----------
Weighted average number of shares
outstanding adjusted for effect
of dilutive securities 4,722,142 5,911,933
=========== ===========
Income available to common
shareholders $ 1,602,000 1,663,355
Basic earnings per common share $ 0.36 0.31
Diluted earnings per common share $ 0.34 0.28
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AT MARCH 31, 1999 AND DECEMBER 31, 1998 AND THE
CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS ENDED MARCH 31, 1999
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 2,029
<INT-BEARING-DEPOSITS> 4,659
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 184,546
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 449,872
<ALLOWANCE> 3,117
<TOTAL-ASSETS> 681,936
<DEPOSITS> 421,210
<SHORT-TERM> 15,000
<LIABILITIES-OTHER> 6,312
<LONG-TERM> 170,400
0
0
<COMMON> 91
<OTHER-SE> 68,923
<TOTAL-LIABILITIES-AND-EQUITY> 681,936
<INTEREST-LOAN> 8,644
<INTEREST-INVEST> 2,711
<INTEREST-OTHER> 248
<INTEREST-TOTAL> 11,603
<INTEREST-DEPOSIT> 4,622
<INTEREST-EXPENSE> 7,170
<INTEREST-INCOME-NET> 4,433
<LOAN-LOSSES> 75
<SECURITIES-GAINS> 139
<EXPENSE-OTHER> 2,934
<INCOME-PRETAX> 2,610
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,602
<EPS-PRIMARY> .36
<EPS-DILUTED> .34
<YIELD-ACTUAL> 2.73
<LOANS-NON> 400
<LOANS-PAST> 324
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 37
<ALLOWANCE-OPEN> 3,041
<CHARGE-OFFS> 0
<RECOVERIES> 1
<ALLOWANCE-CLOSE> 3,117
<ALLOWANCE-DOMESTIC> 1,434
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 1,671
</TABLE>
