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 June 30, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF 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 classes of
common stock as of the latest practicable date.
Class Outstanding at August 5, 1999
------------------------------------ ------------------------------
Common stock, $0.01 par value 5,011,703
1
<PAGE>
<PAGE>
HMN FINANCIAL, INC.
CONTENTS
PART I - FINANCIAL INFORMATION
Page
------
Item 1: Financial Statements (unaudited)
Consolidated Balance Sheets at
June 30, 1999 and December 31, 1998 3
Consolidated Statements of Income for the
Three Months Ended and Six Months Ended
June 30, 1999 and 1998 4
Consolidated Statements of Comprehensive
Income for the Three Months and Six
Months Ended June 30, 1999 and 1998 5
Consolidated Statement of Stockholders' Equity
for the Six Month Period Ended June 30, 1999 5
Consolidated Statements of Cash Flows for
the Six Months Ended June 30, 1999 and 1998 6-7
Notes to Consolidated Financial Statements 8
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 3: Quantitative and Qualitative Disclosures
about Market Risk Discussion included in
Item 2 under Market Risk 20
PART II - OTHER INFORMATION
Item 1: Legal Proceedings 27
Item 2: Changes in Securities 27
Item 3: Defaults Upon Senior Securities 27
Item 4: Submission of Matters to a Vote of Security Holders 27
Item 5: Other Information 28
Item 6: Exhibits and Reports on Form 8-K and Form 11-K 28
Signatures 29
2
<PAGE>
<PAGE>
PART I - FINANCIAL STATEMENTS
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(unaudited)
<TABLE>
<CAPTION>
ASSETS June 30, December 31,
1999 1998
------------- -------------
<S> <C> <C>
Cash and cash equivalents $ 10,543,341 20,960,957
Securities available for sale:
Mortgage-backed and related
securities (amortized cost
$111,702,277 and $144,320,926) 110,453,963 143,146,165
Other marketable securities
(amortized cost $75,034,116
and $38,657,193) 72,886,769 38,478,623
------------ -------------
183,340,732 181,624,788
------------ -------------
Loans held for sale 6,721,778 13,094,528
Loans receivable, net 446,669,533 447,455,052
Accrued interest receivable 3,819,962 3,952,763
Federal Home Loan Bank stock,
at cost 9,837,900 9,837,900
Mortgage servicing rights, net 1,056,509 1,005,693
Real estate, net 10,625 10,602
Premises and equipment, net 8,602,163 8,382,136
Investment in limited partnerships 2,792,773 2,437,246
Goodwill 4,251,015 4,341,033
Core deposit intangible 1,143,023 1,259,245
Prepaid expenses and other assets 914,333 295,829
Deferred income taxes 270,274 0
------------ ------------
Total assets $ 679,973,961 694,657,772
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 416,192,060 433,868,907
Federal Home Loan Bank advances 192,400,000 185,400,000
Other borrowed money 0 2,500,000
Accrued interest payable 1,287,959 1,086,013
Advance payments by borrowers for
taxes and insurance 682,003 657,089
Accrued expenses and other
liabilities 2,216,942 2,700,424
------------ ------------
Total liabilities 612,778,964 626,212,433
------------ ------------
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 59,758,134 59,739,020
Retained earnings, subject to
certain restrictions 66,025,364 63,424,378
Accumulated other comprehensive
loss (2,087,394) (837,838)
Unearned employee stock ownership
plan shares (5,608,499) (5,705,152)
Unearned compensation restricted
stock awards (189,344) (276,867)
Treasury stock, at cost 4,058,058
and 3,835,058 shares (50,794,551) (47,989,489)
------------ -----------
Total stockholders' equity 67,194,997 68,445,339
------------ -----------
Total liabilities and
stockholders' equity $679,973,961 694,657,772
============ ===========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
<PAGE>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1999 1998 1999 1998
----------------------- -----------------------
<S> <C> <C> <C> <C>
Interest Income:
Loans receivable $8,763,487 8,797,708 17,407,061 17,440,080
Securities available
for sale:
Mortgage-backed
and related 1,674,934 2,158,639 3,624,430 4,377,337
Other marketable 1,033,641 1,229,503 1,795,779 2,185,975
Cash equivalents 34,679 110,623 131,231 271,947
Other 153,296 149,224 304,907 271,558
---------- ---------- ----------- ----------
Total interest income 11,660,037 12,445,697 23,263,408 24,546,897
---------- ---------- ----------- ----------
Interest expense:
Deposits 4,521,261 5,721,279 9,143,280 11,424,803
Federal Home Loan Bank
advances 2,597,437 2,454,631 5,138,758 4,539,097
Other borrowed money 0 0 7,207 0
---------- ---------- ----------- ----------
Total interest expense 7,118,698 8,175,910 14,289,245 15,963,900
---------- ---------- ----------- ----------
Net interest
income 4,541,339 4,269,787 8,974,163 8,582,997
Provision for loan losses 75,000 75,000 150,000 150,000
---------- ---------- ----------- ----------
Net interest income
after provision
for loan losses 4,466,339 4,194,787 8,824,163 8,432,997
---------- ---------- ----------- ----------
Non-interest income:
Fees and service charges 280,278 257,589 495,705 459,345
Securities gains, net 23,332 737,632 162,770 1,634,079
Gain on sales of loans 584,682 351,892 1,279,674 718,136
Earnings (loss) in limited
partnerships 345,527 (989,556) 362,594 (937,613)
Other 98,782 161,145 218,324 274,924
---------- ---------- ----------- ----------
Total non-interest
income 1,332,601 518,702 2,519,067 2,148,871
---------- ---------- ----------- ----------
Non-interest expense:
Compensation and benefits 1,535,318 1,879,834 2,963,816 3,732,314
Occupancy 395,968 358,039 816,067 722,760
Federal deposit
insurance premiums 72,608 72,608 145,216 146,439
Advertising 84,045 135,972 153,841 228,953
Data processing 176,836 164,503 361,548 338,558
Amortization of mortgage
servicing rights and net
valuation adjustments 151,381 237,820 316,979 276,592
Other 575,437 593,683 1,168,016 1,218,867
---------- --------- ---------- ----------
Total non-interest
expense 2,991,593 3,442,459 5,925,483 6,664,483
---------- --------- ---------- ----------
Income before income
tax expense 2,807,347 1,271,030 5,417,747 3,917,385
Income tax expense 1,091,000 487,000 2,099,400 1,470,000
---------- --------- ---------- ----------
Net income $ 1,716,347 784,030 3,318,347 2,447,385
========== ========= ========== ==========
Basic earnings per share $ 0.39 0.16 0.74 0.47
========== ========= ========== ==========
Diluted earnings per share $ 0.37 0.14 0.71 0.43
========== ========= ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
<PAGE>
HMN FINANCIAL, INC.
Consolidated Statements of Comprehensive Income
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended June 30,
1999 1998
------------------------ -----------------------
<S> <C> <C> <C> <C>
Net income $ 1,716,347 784,030
Other comprehensive
income, net of tax:
Unrealized gains (losses)
on securities:
Unrealized holding
gains (losses)
arising during
period (1,254,430) 295,168
Less: reclassification
adjustment for gains
included in net income 18,021 452,758
----------- ----------
Other comprehensive loss (1,272,451) (157,590)
---------- --------
Comprehensive income $ 443,896 626,440
========== =========
Six Months Ended June 30,
1999 1998
------------------------ -----------------------
<S> <C> <C> <C> <C>
Net income $ 3,318,347 2,447,385
Other comprehensive
income, net of tax:
Unrealized gains (losses)
on securities:
Unrealized holding
gains (losses)
arising during
period (1,149,648) 747,516
Less: reclassification
adjustment for gains
included in net income 99,908 1,002,998
----------- ----------
Other comprehensive loss (1,249,556) (255,482)
---------- ---------
Comprehensive income $ 2,068,791 2,191,903
========== =========
</TABLE>
See accompanying notes to consolidated financial statements.
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statement of Stockholders' Equity
For the Six Month Period Ended June 30, 1999
(unaudited)
<TABLE>
<CAPTION>
Accumulated
Additional Other
Common Paid-In Retained Comprehensive
Stock Capital Earnings Loss
----------------------------------------------------------
<S> <C> <C> <C> <C>
Balance,
December 31, 1998 $ 91,287 59,739,020 63,424,378 (837,838)
Net income 3,318,347
Treasury stock purchases
Other comprehensive loss (1,249,556)
Tax benefit of restricted
stock awards 26,743
Employee stock options
exercised (42,460)
Tax benefit of exercised
stock options 3,605
Amortization of
restricted stock awards
Dividends paid (717,361)
Earned employee stock
ownership plan shares 31,226
--------- ---------- ---------- ---------
Balance, June 30, 1999 $ 91,287 59,758,134 66,025,364 (2,087,394)
========= ========== ========== =========
<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 3,318,347
Treasury stock purchases (2,953,437) (2,953,437)
Other comprehensive loss (1,249,556)
Tax benefit of restricted
stock awards 26,743
Employee stock options
exercised 148,375 105,915
Tax benefit of exercised
stock options 3,605
Amortization of
restricted stock awards 87,523 87,523
Dividends paid (717,361)
Earned employee stock
ownership plan shares 96,653 127,879
--------- -------- ---------- ----------
Balance, June 30, 1999 $ (5,608,499) (189,344) (50,794,551) 67,194,997
========= ======== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
<PAGE>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
1999 1998
----------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 3,318,347 2,447,385
Adjustments to reconcile net income to
cash provided by operating activities:
Provision for loan losses 150,000 150,000
Depreciation 342,174 283,577
Amortization of (discounts) premiums, net 56,106 (128,956)
Amortization of deferred loan fees (425,539) (317,266)
Amortization of goodwill 90,018 90,318
Amortization of core deposit intangible 116,222 143,514
Amortization of other purchase accounting
adjustments 50,342 382,014
Amortization of mortgage servicing rights
and net valuation adjustments 316,979 276,592
Capitalized mortgage servicing rights (327,631) (130,259)
Increase (decrease) in deferred income taxes (145,499) 167,000
Securities gains, net (162,770) (1,634,079)
Gain on sales of real estate 0 (21,777)
Gain on sales of loans (1,279,674) (718,136)
Proceeds from sale of loans
held for sale 111,643,954 68,990,372
Disbursements on loans held for sale (73,129,568) (53,532,026)
Principal collected on loans
held for sale 1,099 0
Amortization of restricted stock awards 87,523 120,848
Amortization of unearned ESOP shares 96,653 227,716
Earned employee stock ownership shares
priced above original cost 31,226 194,458
Decrease (increase) in accrued
interest receivable 132,801 (516,568)
Increase in accrued interest payable 201,946 20,256
Equity (earnings) loss of limited
partnerships (362,594) 937,613
Decrease (increase) in other assets (618,504) 581,531
Increase (decrease) in other liabilities 219,668 (795,342)
Other, net 14,976 44,179
---------- ----------
Net cash provided by
operating activities 40,418,255 17,262,964
---------- ----------
Cash flows from investing activities:
Proceeds from sales of securities
available for sale 10,943,970 91,763,992
Principal collected on securities
available for sale 33,335,121 16,165,151
Proceeds collected on maturity of
securities available for sale 18,331,000 23,100,000
Purchases of securities available for sale (57,031,349) (136,566,747)
Proceeds from sales of loans receivable 216,156 3,047,939
Purchases of mortgage servicing rights (22,443) (557,536)
Purchase of interest in limited partnerships 0 (181,125)
Purchase of Federal Home Loan Bank stock 0 (1,737,900)
Net increase in loans receivable (39,346,322) (41,486,818)
Proceeds from sale of real estate 0 152,415
Purchases of premises and equipment (562,201) (1,256,046)
Decrease in due to stockholders of
Marshalltown Financial Corporation (10,716) (3,495,888)
----------- ----------
Net cash used by investing activities (34,146,784) (51,052,563)
----------- ----------
Cash flows from financing activities:
Decrease in deposits (17,649,118) (82,370)
Purchase of treasury stock (2,953,437) (14,772,787)
Increase in unearned ESOP shares 0 (1,476,000)
Stock options exercised 105,915 55,237
Dividends to stockholders (717,361) (305,982)
Fractional shares purchased from stock split 0 (1,716)
Proceeds from Federal Home
Loan Bank advances 33,100,000 92,500,000
Repayment of Federal Home Loan Bank advances(26,100,000) (42,214,284)
Decrease in other borrowed money (2,500,000) 0
Decrease (increase) in advance payments
by borrowers for taxes and insurance 24,914 (33,906)
----------- -----------
Net cash provided (used) by
financing activities (16,689,087) 33,668,192
----------- -----------
Decrease in cash and cash equivalents (10,417,616) (121,407)
Cash and cash equivalents, beginning of period 20,960,957 9,364,635
----------- -----------
Cash and cash equivalents, end of period $ 10,543,341 9,243,228
=========== ==========
6
<PAGE>
Supplemental cash flow disclosures:
Cash paid for interest $ 14,087,299 15,943,644
Cash paid for income taxes 2,554,000 967,000
Supplemental noncash flow disclosures:
SBA certificates transferred from loans
to securities available for sale 2,528,442 0
Loans securitized and transferred to
securities available for sale 6,913,219 0
Loans transferred to loans held for sale 30,890,367 20,553,439
Transfer of loans to real estate 0 17,105
Securities purchased with liability
due to broker 0 1,997,812
Securities sold with payment due from broker 0 3,051,977
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE>
<PAGE>
HMN FINANCIAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Unaudited)
June 30, 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. As of April 30, 1999 MSL was
dissolved and its assets were transferred to the Bank in exchange for the stock
of MSL. 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. Results of
operations for MSL are included through April 30, 1999, the date of its
dissolution. 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 and six month periods ended June
30, 1999 are not necessarily indicative of the results which may be expected
for the entire year.
Certain amounts in the consolidated financial statements for prior periods have
been reclassified to conform with the current period presentation.
(3) NEW ACCOUNTING STANDARDS
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.
8
<PAGE>
The accounting for changes in the fair value of a derivative (that is, gains
and losses) depends on the intended use of the derivative and the resulting
designation.
- - For a derivative designated as hedging the exposure to changes in the
fair value of a recognized asset or liability or a firm commitment
(referred to as a fair value hedge), the gain or loss is recognized
in earnings in the period of change together with the offsetting loss
or gain on the hedged item attributable to the risk being hedged. The
effect of that accounting is to reflect in earnings the extent to
which the hedge is not effective in achieving offsetting changes in
fair value.
- - For a derivative designated as hedging the exposure to variable cash
flows of a forecasted transaction (referred to as a cash flow hedge),
the effective portion of the derivative's gain or loss is initially
reported as a component of other comprehensive income (outside
earnings) and subsequently reclassified into earnings when the
forecasted transaction affects earnings. The ineffective portion of
the gain or loss is reported in earnings immediately.
- - For a derivative designated as hedging the foreign currency exposure
of a net investment in a foreign operation, the gain or loss is
reported in other comprehensive income (outside earnings) as part of
the cumulative translation adjustment. The accounting for a fair
value hedge described above applies to a derivative designated or an
available-for-sale security. Similarly, the accounting for a cash
flow hedge described above applies to a derivative designated as a
hedge of the foreign currency exposure of a foreign-currency-
denominated forecasted transaction.
- - 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.
Originally SFAS No. 133 was 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. In June of 1999 the Financial Accounting Standards Board issued SFAS No.
137 which deferred the required adoption of SFAS No. 133 to fiscal years
starting after June 15, 2000. HMN is anticipating that it will adopt SFAS No.
133 in the first quarter of 2001. 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.
9
<PAGE>
The gross unrealized holding losses for the second quarter of 1999 were
$2,040,000 the income tax benefit would have been $786,000 and therefore, the
net loss was $1,254,000. The gross reclassification adjustment for the second
quarter of 1999 was $29,000, the income tax expense would have been $11,000 and
therefore, the net reclassification adjustment was $18,000. The gross
unrealized holding gains for the second quarter of 1998 were $482,000, the
income tax expense would have been $187,000 and therefore, the net gain was
$295,000. The gross reclassification adjustment for the second quarter of 1998
was $738,000, the income tax expense would have been $285,000 and therefore,
the net reclassification adjustment was $453,000.
The gross unrealized holding losses for the six month period ended June 30,
1999 were $1,880,000, the income tax benefit would have been $730,000 and
therefore, the net loss was $1,150,000. The gross reclassification adjustment
for the first six months of 1999 was $163,000, the income tax expense would
have been $63,000 and therefore, the net gain was $100,000. The gross
unrealized holding gains for the first six months of 1998 were $1,162,000, the
income tax expense would have been $415,000 and therefore, the net gain was
$748,000. The gross reclassification adjustment for the first six months of
1998 was $1,634,000, the income tax expense would have been $631,000 and
therefore, the net reclassification adjustment was $1,003,000.
(5) CASH DIVIDEND
On July 20, 1999 HMN's Board of Directors announced a cash dividend of $0.08
per share, payable on September 10, 1999 to stockholders of record on August
25, 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 year $ 1,117,193 845,517
Originations 327,631 127,879
Purchases 22,443 468,998
Amortization (347,558) (105,767)
--------- ---------
Balance, June 30, 1,119,709 1,336,627
--------- ---------
Valuation reserve
Balance, beginning of year (111,500) (64,512)
Additions 0 (165,583)
Reductions 48,300 32,000
--------- ---------
Balance, June 30, (63,200) (198,095)
--------- ---------
Mortgage servicing rights, net $ 1,056,509 1,138,532
========= =========
Fair value of mortgage
servicing rights $ 1,192,509 1,162,532
========= =========
- ------------------------------------------------------------
</TABLE>
10
<PAGE>
(7) INVESTMENT IN LIMITED PARTNERSHIPS
Investments in limited partnerships were as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------
Primary partnership activity June 30, December 31,
1999 1998
------------ ------------
<S> <C> <C>
Mortgage servicing rights $ 2,006,928 1,622,519
Common stock of financial
institutions 430,283 415,189
Low to moderate income housing 355,562 399,538
------------ ------------
$ 2,792,773 2,437,246
============ ============
- -------------------------------------------------------------
</TABLE>
During the second quarter of 1999 HMN's proportionate revenue from a mortgage
servicing partnership (which included the reduction of previously established
impairment reserves of $381,671) was $323,237, its proportionate share of gains
from the common stock investments in financial institutions was $28,790 and it
recognized $6,500 of losses 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 in the second quarter of
1999. During the second quarter of 1998, HMN's proportionate losses from the
mortgage servicing partnership was $1,112,747, its proportionate share of gains
from common stock investments in financial institutions was $123,191 and it did
not recognize any revenue or loss from the low income housing partnerships.
During the six month period ended June 30, 1999 HMN's proportionate revenue
from a mortgage servicing partnership (which included the reduction of
previously established impairment reserves of $497,043) was $384,409, its
proportionate share of gains from the common stock investments in financial
institutions was $15,094 and it recognized $36,909 of losses on the low income
housing partnerships. During 1999 HMN anticipates receiving low income housing
credits totaling $80,000 of which $40,000 were credited to current income tax
benefits in the six month period ended June 30, 1999. During the six month
period ended June 30, 1998, HMN's proportionate revenue from the mortgage
servicing partnership was $1,060,836, its proportionate share of gains from
common stock investments in financial institutions was $123,223 and it did not
recognize any revenue or loss from the 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 Six Months ended
June 30, June 30,
1999 1998 1999 1998
--------------------- ----------------------
<S> <C> <C> <C> <C>
Weighted average number of
common shares outstanding
used in basic earnings per
common share calculation 4,442,471 5,051,205 4,465,679 5,248,262
Net dilutive effect of:
Options 167,858 379,759 177,041 391,398
Restricted stock awards 20,019 54,197 23,267 57,773
--------- --------- --------- ---------
Weighted average number of
shares outstanding adjusted
for effect of dilutive
securities 4,630,348 5,485,161 4,665,987 5,697,433
========= ========= ========= =========
Income available to common
shareholders $ 1,716,347 784,030 3,318,347 2,447,385
Basic earnings per
common share $ 0.39 0.16 0.74 0.47
Diluted earnings per
common share $ 0.37 0.14 0.71 0.43
</TABLE>
11
<PAGE>
(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 June 30, 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 June 30,
1999 and other conditions consistent with the Prompt Corrective Actions
Provisions of the OTS regulations, the Bank would be categorized as well
capitalized.
On June 30, 1999 the Bank's tangible assets and adjusted total assets were
$657,048,000 and its risk-weighted assets were $346,906,000. The following
table presents the Bank's capital amounts and ratios at June 30, 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.
<TABLE>
<CAPTION>
Required to be
Adequately
Actual Capitalized
------------------ --------------------
Percent of<F1> Percent of <F1>
(IN THOUSANDS) Amount Assets Amount Assets
-------- ----------- --------- -----------
<S> <C> <C> <C> <C>
Bank stockholder's equity $48,088
Plus:
Net unrealized loss on
certain securities
available for sale 1,685
Less:
Goodwill and other
intangibles 5,394
Excess mortgage
servicing rights 283
-------
Tier I or core capital 44,096
-------
Tier I capital to adjusted
total assets 6.71% $ 26,282 4.00%
Tier I capital to risk-
weighted assets
12.71% $ 13,876 4.00%
Less:
Equity investments & other
assets required to be deducted 22
Plus:
Allowable allowance for
loan losses 3,185
-------
Risk-based capital $47,259 $ 27,752
=======
Risk-based capital to risk-
weighted assets 13.62% 8.00%
<CAPTION>
To Be Well Capitalized
Under Prompt
Corrective Actions
Excess Capital Provisions
--------------------- ------------------------
Percent of<F1> Percent of <F1>
(IN THOUSANDS) Amount Assets Amount Assets
---------- ---------- ----------- -----------
<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 $ 17,814 2.71% $ 32,852 5.00%
Tier I capital to risk-
weighted assets $ 30,220 8.71% $ 20,814 6.00%
Less:
Equity investments & other
assets required to be deducted
Plus:
Allowable allowance for
loan losses
Risk-based capital $ 19,507 $ 34,691
Risk-based capital to risk-
weighted assets 5.62% 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
June 30, 1999, but is not reflected in the table above.
12
<PAGE>
(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 segment's 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.
Each corporation is managed separately with its own president, who reports
directly to HMN's chief operating decision maker and board of directors.
13
<PAGE>
<PAGE>
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.
-------------------------------
Home Federal Mortgage Mortgage
(Dollars in thousands) Savings Bank Servicing Rights Banking
- -------------------------------------------------------------------------
<S> <C> <C> <C>
At or for the three months
ended June 30, 1999:
Interest income -
external customers $ 11,363 0 95
Non-interest income -
external customers 645 233 17
Earnings (loss) on
limited partnerships 317 0 0
Intersegment interest
income 18 0 0
Intersegment non-
interest income 85 0 0
Interest expense 7,118 0 84
Amortization of mortgage
servicing rights and
net valuation adjustments 61 87 0
Other non-interest
expense 2,483 0 300
Income tax expense (benefit)1,057 (25) 11
Net income (loss) 1,633 (39) 17
Total assets 661,088 231 6,938
Net interest margin 2.67 % NM NM
Return on average assets 0.99 % (57.97)% 1.15%
Return on average
realized common equity 13.03 % (268.16)% 5.32%
At or for the three months
ended June 30, 1998:
Interest income -
external customers $ 11,963 0 60
Non-interest income -
external customers 171 114 190
Earnings (loss) on
limited partnerships (712) 0 0
Intersegment interest income 22 0 0
Intersegment non-interest
income 76 0 0
Interest expense 8,176 0 57
Amortization of mortgage
servicing rights and net
valuation adjustments 7 231 0
Other non-interest expense 2,761 0 295
Income tax expense (benefit) 275 (42) (43)
Net income (loss) 226 (75) (59)
Total assets 701,501 985 5,829
Net interest margin 2.27 % NM NM
Return on average assets 0.13 % (28.19)% (5.58)%
Return on average realized
common equity 1.85 % (79.53)% (16.02)%
<CAPTION>
Total
Reportable Consolidated
(DOLLARS IN THOUSANDS) Segments Other Eliminations Total
------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
At or for the three
months ended June 30, 1999:
Interest income -
external customers $ 11,458 202 0 11,660
Non-interest income -
external customers 985 1 0 986
Earnings (loss) on
limited partnerships 317 29 0 346
Intersegment interest
income 18 115 (133) 0
Intersegment non-
interest income 85 1,629 (1,714) 0
Interest expense 7,202 49 (133) 7,118
Amortization of mortgage
servicing rights and net
valuation adjustments 148 0 0 148
Other non-interest
expense 2,783 145 (85) 2,843
Income tax expense (benefit) 1,043 48 0 1,091
Net income (loss) 1,611 1,734 (1,629) 1,716
Total assets 668,177 69,999 (58,202) 679,974
Net interest margin NM NM NM 2.76%
Return on average assets NM NM NM 1.01%
Return on average
realized common equity NM NM NM 9.83%
At or for the three months
ended June 30, 1998:
Interest income -
external customers $ 12,023 423 0 12,446
Non-interest income -
external customers 475 756 0 1,231
Earnings (loss) on
limited partnerships (712) 0 0 (712)
Intersegment interest
income 22 140 (162) 0
Intersegment non-
interest income 76 133 (209) 0
Interest expense 8,233 105 (162) 8,176
Amortization of mortgage
servicing rights and net
valuation adjustments 238 0 0 238
Other non-interest
expense 3,056 225 (76) 3,205
Income tax expense
(benefit) 190 297 0 487
Net income (loss) 92 825 (133) 784
Total assets 708,315 80,420 (63,555) 725,180
Net interest margin NM NM NM 2.47%
Return on average assets NM NM NM 0.44%
Return on average realized
common equity NM NM NM 4.03%
</TABLE>
NM - Not meaningful
14
<PAGE>
<PAGE>
<TABLE>
<CAPTION>
HMN Mortgage Services, Inc.
-------------------------------
Home Federal Mortgage Mortgage
(DOLLARS IN THOUSANDS) Savings Bank Servicing Rights Banking
- -------------------------------------------------------------------------
<S> <C> <C> <C>
At or for the six months
ended June 30, 1999:
Interest income -
external customers $ 22,689 0 172
Non-interest income -
external customers 1,461 55 595
Earnings (loss) on
limited partnerships 348 0 0
Intersegment interest
income 20 0 0
Intersegment non-
interest income 165 0 0
Interest expense 14,282 0 162
Amortization of mortgage
servicing rights
and net valuation adjustments 118 199 0
Other non-interest
expense 4,917 0 582
Income tax expense
(benefit) 2,044 (56) 8
Net income (loss) 3,172 (88) 15
Total assets 661,008 231 6,938
Net interest margin 2.65 % NM NM
Return on average assets 0.96 % (57.88)% 0.51%
Return on average realized
common equity 12.91 % (160.37)% 1.47%
At or for the six months
ended June 30, 1998:
Interest income -
external customers $ 23,674 0 108
Non-interest income -
external customers 789 193 397
Earnings (loss) on limited
partnerships (658) 0 0
Intersegment interest
income 30 0 0
Intersegment non-
interest income 153 0 0
Interest expense 15,964 0 109
Amortization of mortgage
servicing rights
and net valuation adjustments 12 265 0
Other non-interest
expense 5,607 0 567
Income tax expense
(benefit) 1,001 (28) (66)
Net income (loss) 1,254 (44) (105)
Total assets 701,501 985 5,829
Net interest margin 2.35 % NM NM
Return on average assets 0.37 % (9.24)% (5.57)%
Return on average
realized common equity 4.93 % (28.25)% (17.02)%
NM - Not meaningful
Total
Reportable Consolidated
(DOLLARS IN THOUSANDS) Segments Other Eliminations Total
------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
At or for the six months
ended June 30, 1999:
Interest income -
external customers $ 22,861 402 0 23,263
Non-interest income -
external customers 2,111 44 0 2,155
Earnings (loss) on
limited partnerships 348 15 0 363
Intersegment interest
income 20 223 (243) 0
Intersegment non-interest
income 165 3,135 (3,300) 0
Interest expense 14,444 88 (243) 14,289
Amortization of mortgage
servicing rights and net
valuation adjustments 317 0 0 317
Other non-interest
expense 5,499 274 (165) 5,608
Income tax expense
(benefit) 1,996 103 0 2,099
Net income (loss) 3,099 3,354 (3,135) 3,318
Total assets 668,177 69,999 (58,202) 679,974
Net interest margin NM NM NM 2.74%
Return on average assets NM NM NM 0.98%
Return on average
realized common equity NM NM NM 9.57%
At or for the six months
ended June 30, 1998:
Interest income -
external customers $ 23,782 765 0 24,547
Non-interest income -
external customers 1,379 1,428 0 2,807
Earnings (loss) on
limited partnerships (658) 0 0 (658)
Intersegment interest
income 30 255 (285) 0
Intersegment non-
interest income 153 1,194 (1,347) 0
Interest expense 16,073 176 (285) 15,964
Amortization of mortgage
servicing rights and net
valuation adjustments 277 0 0 277
Other non-interest
expense 6,174 367 (153) 6,388
Income tax expense
(benefit) 907 563 0 1,470
Net income (loss) 1,105 2,536 (1,194) 2,447
Total assets 708,315 80,420 (63,555) 725,180
Net interest margin NM NM NM 2.53%
Return on average assets NM NM NM 0.69%
Return on average realized
common equity NM NM NM 6.07%
NM - Not meaningful
</TABLE>
15
<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 second quarter of 1999 was $1.7 million, an increase
of $932,000, or 118.9%, compared to $784,000 for the second quarter of 1998.
Basic earnings per share were $0.39 for the quarter ended June 30, 1999, an
increase of $0.23, or 143.8% per share, from $0.16 basic earnings per share for
the same quarter of 1998. Diluted earnings per share were $0.37 for the second
quarter of 1999, an increase of $0.23, or 164.3% from $0.14 diluted earnings
per share for the second quarter of 1998.
HMN's net income for the six month period ended June 30, 1999 was $3.3 million,
an increase of $871,000, or 35.6%, compared to $2.4 million for the same period
in 1998. Basic earnings per share were $0.74 for the six month period ended
June 30, 1999, an increase of $0.27, or 57.5% per share, from $0.47 basic
earnings per share for the same six month period of 1998. Diluted earnings per
share were $0.71 for the six month period ended June 30, 1999, an increase of
$0.28, or 65.1%, from $0.43 diluted earnings per share for the same six month
period of 1998.
NET INTEREST INCOME
Net interest income for the second quarter of 1999 was $4.5 million, an
increase of $272,000, or 6.4%, compared to $4.3 million for the second quarter
of 1998. Interest income for the second quarter of 1999 was $11.7 million, a
decrease of $786,000, or 6.3%, compared to $12.4 million for the second quarter
of 1998. Interest income declined $572,000 due to a $32.2 million decrease in
net average interest-earning assets from the second quarter of 1998 to the
second quarter of 1999, principally due to interest-earning assets being used
to fund deposit outflows and to purchase HMN's common stock under its stock
repurchase program. Interest income decreased by $214,000 because the yield
earned on interest-earning assets decreased from 7.21% for the quarter ended
June 30, 1998 to 7.09% for the quarter ended June 30, 1999 primarily due to a
decline in interest rates earned on securities and cash equivalents. Interest
16
<PAGE>
expense was $7.1 million for the second quarter of 1999, a decrease of $1.1
million, or 12.9%, compared to $8.2 million for the same quarter of 1998.
Interest expense decreased by $660,000 due to a net outflow of $46.9 million in
average outstanding deposits from the second quarter of 1998, compared to the
second quarter of 1999. Interest expense increased by $224,000 due to an
increase of $16.6 million in the average outstanding FHLB advances from the
second quarter of 1998 to the second quarter of 1999. FHLB advances were used
to replace a portion of the funds lost to deposit outflows. Interest expense
decreased by $621,000 primarily due to lower interest rates being paid on
customer deposits and advances from the FHLB. The average interest rate paid
on average interest-bearing liabilities was 4.72% during the second quarter of
1999, compared to 5.17% for the second quarter of 1998. HMN's margin was 2.76%
for the second quarter of 1999, an increase of 29 basis points, or 11.7%, from
2.47% for the second quarter of 1998.
Net interest income for the six month period ended June 30, 1999 was $9.0
million, an increase of $391,000, or 4.6%, compared to $8.6 million for the
same six month period of 1998. Interest income for the six month period ended
in 1999 was $23.3 million, a decrease of $1.3 million, or 5.2%, compared to
$24.5 million for the same six month period of 1998. Interest income declined
by $856,000 due to a $24.1 million decrease in net average interest-earning
assets from the six month period ended in 1998 to the same period in 1999,
principally due to interest-earning assets being used to fund deposit outflows
and to purchase HMN's common stock under its stock repurchase program.
Interest income decreased by $428,000 because the yield earned on interest-
earning assets for the six month period decreased from 7.24% at June 30, 1998
to 7.11% at June 30, 1999 primarily due to a decline in interest rates earned
on securities and cash equivalents. Interest expense was $14.3 million for the
six month period ended June 30, 1999, a decrease of $1.7 million, or 10.5%,
compared to $16.0 million for the same six month period of 1998. Interest
expense decreased by $1.3 million due to a net outflow of $45.7 million in the
average outstanding balance of deposits from the six months ended June 30,
1998, compared to the same six month period of 1999. Interest expense
increased by $763,000 due to an increase of $28.1 million in the average
outstanding FHLB advances for the six months ended June 30, 1998, compared to
the same six month period of 1999. FHLB advances were used to replace a
portion of the funds lost to deposit outflows. Interest expense decreased by
$1.1 million primarily due to lower interest rates being paid on customer
deposits and advances from the FHLB. The average interest rate paid on average
interest-bearing liabilities was 4.76% during the six month period ended June
30, 1999, compared to 5.19% for the same six month period of 1998. HMN's
margin was 2.74% for the six month period ended June 30, 1999, an increase of
21 basis points, or 8.3%, from 2.53% for the same six month period of 1998.
PROVISION FOR LOAN LOSSES
*The provision for loan losses for the second quarters ended June 30, 1999 and
1998 were both $75,000. The provision for loan losses for the six months ended
June 30, 1999 and 1998 were both $150,000. The provision is the result of
management's evaluation of the loan portfolio, a historically low level of non-
performing loans, minimal loan charge-off experience, and its assessment of the
general economic conditions in the geographic area where properties securing
the loan portfolio are located 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 of probable losses inherent in the loan
portfolio 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, $ 3,041,486 2,748,219
Provision 150,000 150,000
Charge-offs (4,676) (8,099)
Recoveries 840 1,576
----------- -------------
Balance at June 30, $ 3,187,650 2,891,696
=========== =============
* This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 25 of this discussion.
17
<PAGE>
NON-INTEREST INCOME
Non-interest income for the second quarter of 1999 was $1.3 million, an
increase of $814,000, or 156.9%, from $519,000 for the same quarter of 1998.
The increase in non-interest income was principally due to a $1.3 million
increase in earnings from limited partnership interests and an increase in the
gain on the sale of loans of $233,000 which were partially offset by a $714,000
decline in net gain on the sale of securities. In the second quarter of 1998,
HMN recognized a charge of $1.14 million as its proportionate share of an
impairment reserve established on mortgage servicing assets from its investment
in a limited partnership. During the second quarter of 1999, the number of
single family mortgage loan refinancings declined primarily due to an increase
in the interest rates charged on mortgage loans. The decline in single family
loan refinancings caused the loan prepayment assumptions used to calculate the
market value of mortgage servicing assets to decline which in turn caused the
market value of mortgage servicing assets to increase. The increase in the
market value allowed HMN to reverse, during the second quarter of 1999,
$382,000 of previously established impairment reserves. Gain on the sale of
loans increased due to improved profitability on the sale of loans. During the
second quarter of 1999 interest rates in general were increasing which reduced
the opportunity to sell fixed rate securities at a gain.
Non-interest income for the six month period ended June 30, 1999 was $2.5
million, an increase of $370,000, or 17.2%, from $2.1 million for the same six
month period of 1998. The increase in non-interest income was principally due
to a $1.3 million increase in earnings from limited partnerships and an
increase in gain on the sale of loans of $562,000, which were partially offset
by a $1.5 million decline in the net gain from the sale of securities. During
the first six months of 1998, HMN recognized a charge of $1.14 million as its
proportionate share of an impairment reserve established on mortgage servicing
assets from its investment in a limited partnership. During the first six
months of 1999, the number of single family mortgage loan refinancings declined
primarily due to an increase in the interest rates charged on mortgage loans.
The decline in single family loan refinancings caused the loan prepayment
assumptions used to calculate the market value of mortgage servicing assets to
decline which in turn caused the market value of mortgage servicing assets to
increase. The increase in the market value allowed HMN to reverse, during the
six month period ended June 30, 1999, $497,000 of previously established
impairment reserves. Gain on the sale of loans increased by $562,000 due to
improved profitability on the sale of loans. The net gain on the sale of
securities for the six months ended June 30, 1999 was $163,000, a decline of
$1.5 million from $1.63 million for the same six month period of 1998. During
the first six months of 1999 interest rates in general were increasing which
reduced the opportunity to sell fixed rate securities at a gain.
NON-INTEREST EXPENSE
Non-interest expense was $3.0 million for the second quarter of 1999, a
decrease of $451,000, or 13.1%, from $3.4 million for the second quarter of
1998. Compensation and benefit expense decreased by $345,000, primarily due to
reduced compensation and benefits paid as a result of work force reductions,
commissions paid on declining loan production and a reduction in the stock
allocation formula for employee stock ownership participants. Non-interest
expense declined by $86,000 due to decreased amortization recorded on mortgage
servicing assets and it decreased by $52,000 due to a change in HMN's
advertising emphasis. Occupancy expense increased by $38,000, primarily due to
the occupancy costs related to the new retail banking facility in Winona
opening in December 1998.
Non-interest expense was $5.9 million for the six months ended June 30, 1999, a
decrease of $739,000, or 11.1%, from $6.7 million for the same period of 1998.
Compensation and benefit expense decreased by $768,000, primarily due to
reduced compensation and benefits paid as a result of work force reductions,
commissions paid on declining loan production and a reduction in the stock
allocation formula for employee stock ownership participants. HMN changed its
advertising emphasis on media and was able to reduce its advertising expense by
$75,000. Occupancy expense increased by $93,000 primarily due to the occupancy
costs related to new retail banking facilities located in Spring Valley and
Winona. The Spring Valley location opened in late February of 1998 and the
Winona location opened in December of 1998 so only a portion of the occupancy
costs for Spring Valley and none of the occupancy costs for Winona were
included in the occupancy costs for 1998, whereas a full six months of costs
were included in the six month period ended June 30, 1999.
18
<PAGE>
INCOME TAX EXPENSE
Income tax expense was $1.1 million for the second quarter of 1999, an increase
of $932,000, from $784,000 for the second quarter of 1998. The increase is
primarily due to an increase in taxable income between the two quarters.
Income tax expense was $3.3 million for the six month period ended June 30,
1999, an increase of $871,000, from $2.4 million for the same period in 1998.
The increase is primarily due to an increase in taxable income between the two
six month periods.
NON-PERFORMING ASSETS
The following table sets forth the amounts and categories of non-performing
assets in the Bank's portfolio at June 30, 1999 and December 31, 1998.
June 30, December 31,
(DOLLARS IN THOUSANDS) 1999 1998
----------- --------------
Non-Accruing Loans
One-to-four family real estate $ 154 317
Nonresidential real estate 0 73
Consumer 143 86
---- ----
Total 297 476
---- ----
Accruing loans delinquent 9 0
days or more 421 312
---- ----
Foreclosed Assets
Real estate:
One-to-four family 16 18
---- ----
Total non-performing assets $ 734 $ 806
==== ====
Total as a percentage of total
assets 0.11% 0.12%
==== ====
Total non-performing loans $ 718 $ 788
==== ====
Total as a percentage of total
loans receivable, net 0.16% 0.18%
==== ====
Total non-performing assets at June 30, 1999 were $734,000, a decrease of
$72,000, from $806,000 at December 31, 1998. Non-accruing loans decreased by
$179,000, primarily related to one-to-four family real estate loans being
transferred to accruing loan status, nonresidential real estate being brought
current on late payments, and a net increase of $57,000 in non-accruing
consumer debt.
DIVIDENDS
During 1998 and 1999 HMN declared and paid dividends as follows:
Payable Dividend
Record date date per share Dividend Payout Ratio
---------------- --------------- ----------- ---------------------
May 27, 1998 June 12, 1998 $0.06 21.4 %
August 27, 1998 September 10, 1998 $0.06 42.9
December 1, 1998 December 15, 1998 $0.06 (66.7)
February 24, 1999 March 10, 1999 $0.08 21.6
May 26, 1999 June 10, 1999 $0.08 23.5
On July 20, 1999 HMN's Board of Directors announced a cash dividend of $0.08
per share, payable on September 9, 1999 to stockholders of record on August 25,
1999. The annualized dividend payout ratio for the past four quarters was
30.3%. The dividend payout ratio is calculated by dividing dividends per share
by diluted earnings per share.
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.
19
<PAGE>
LIQUIDITY
For the six month period ended June 30, 1999, the net cash provided by
operating activities was $40.4 million. HMN collected $10.9 million from the
sale of securities; it collected $51.6 million in principal repayments or on
the maturity of securities during the period. HMN also collected $216,000 on
the sale of loans receivable during the period. It purchased $57.0 million of
securities, funded a net increase in loans receivable of $39.3 million, and
purchased premises and equipment of $562,000. HMN had a net deposit outflow of
$17.6 million, additional net borrowing from the FHLB of $7.0 million and
borrowed $2.5 million from other sources. HMN paid $3.0 million to purchase
234,500 shares of its own common stock during the first six months of 1999 and
it paid $717,000 in dividends to its stockholders.
*HMN has certificates of deposits with outstanding balances of $183.2 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 $24.0 million of FHLB advances which mature over the next 12 months
and $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 August or
September of 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 maturing or being called by the FHLB
during the next 12 month period.
MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
rates. HMN's market risk arises primarily from interest rate risk inherent in
its investing, lending and deposit taking activities. Management actively
monitors and manages its interest rate risk exposure.
HMN's profitability is affected by fluctuations in interest rates. A sudden
and substantial increase in interest rates may adversely impact HMN's earnings
to the extent that the interest rates borne by assets and liabilities do not
change at the same speed, to the same extent, or on the same basis. HMN
monitors how its assets will mature or reprice in comparison to how its
liabilities will mature or reprice. The MATURITY OR REPRICING TABLE located in
the Asset/Liability Management section of this report is used as part of the
monitoring process. HMN also monitors the projected changes in net interest
income that would occur if interest rates were to suddenly change up or down.
The RATE SHOCK TABLE located in the Asset/Liability Management section of this
report discloses HMN's projected changes in net interest income based upon
immediate interest rate changes called rate shocks.
*HMN utilizes a model which uses the discounted cash flows from its interest-
earning assets and its interest-bearing liabilities to calculate the current
market value of those assets and liabilities. The model also calculates the
changes in market value of the interest-earning assets and interest-bearing
liabilities due to different interest rate changes. HMN believes that over the
next twelve months interest rates could conceivably fluctuate in a range of 200
basis points up or down from where the rates were at June 30, 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 June 30, 1999.
* This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 25 of this discussion.
20
<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 $ 9,549 9,542 9,534 9,526 9,518
Securities available for sale:
Fixed-rate CMOs 20,389 20,470 20,248 19,820 19,344
Variable-rate CMOs 86,926 89,079 88,202 85,534 82,212
Fixed-rate available for
sale mortgage-backed
and related securities 2,004 1,971 1,932 1,884 1,828
Variable-rate available for
sale mortgage-backed and
related securities 72 70 68 67 66
Fixed-rate available for sale
other marketable securities87,429 85,310 82,937 79,399 76,152
Variable-rate available for
sale other marketable
securities 1,662 1,660 1,658 1,655 1,653
Fixed-rate loans held for sale 6,730 6,725 6,719 6,714 6,708
Loans receivable, net:
Fixed-rate real
estate loans 294,525 289,787 282,121 272,977 263,662
Variable-rate real estate
loans 122,861 120,971 118,251 114,694 110,486
Fixed-rate other loans 32,592 32,042 31,373 30,627 29,947
Variable-rate other loans 24,510 23,978 23,943 23,921 23,898
Mortgage servicing rights, net 343 686 1,056 1,211 1,332
Investment in limited
partnerships 721 1,169 2,792 6,618 7,942
-------- ------- ------- ------ -------
Total market risk sensitive
assets 690,313 683,460 670,834 654,647 634,748
-------- ------- ------- ------- -------
NOW deposits 32,054 32,028 32,001 31,975 31,948
Passbook deposits 34,892 33,434 32,093 30,855 29,710
Money market deposits 30,337 29,074 27,912 26,840 25,847
Certificate deposits 323,920 320,192 316,552 312,997 309,525
Fixed-rate Federal Home
Loan Bank advances 173,721 165,257 159,858 155,310 150,921
Variable-rate Federal Home
Loan Bank advances 31,070 31,045 31,019 30,994 30,968
------- ------- ------- ------- -------
Total market risk sensitive
liabilities 625,994 611,030 599,435 588,971 578,919
------- ------- ------- ------- -------
Off-balance sheet
financial instruments:
Commitments to extend credit 57 56 55 53 51
------- ------- ------- ------- -------
Net market risk $ 64,376 72,486 71,454 65,729 55,880
======= ======= ======= ======= =======
Percentage change from
current market value (9.91)% (1.44)% 0.00% (8.01)% (21.80)%
======= ======= ======= ======= =======
</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.
21
<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 June 30, 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 $ 21,595 6.68%
+100 20,999 3.74%
0 20,242 0.00%
-100 19,406 -4.13%
-200 18,275 -9.72%
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 25 of this discussion.
22
<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 June 30, 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 $ 9,543 0 0 0
Securities available
for sale:
Mortgage-backed and
related securities<F1> 100,869 4,012 2,654 700
Other marketable
securities 8,995 3,416 27,739 20,764
Loans held for sale, net 6,722 0 0 0
Loans receivable, net<F1><F2>
Fixed rate one-to-
four family 27,233 24,472 75,164 48,583
Adjustable rate
one-to-four family 20,851 13,508 26,334 34,992
Multi family 6,511 342 1,525 440
Fixed rate commercial
real estate 3,589 2,037 6,306 3,919
Adjustable rate commercial
real estate 5,884 2,102 2,759 3,368
Commercial business 4,527 1,610 4,679 2,223
Consumer loans 24,123 2,097 6,144 3,214
Federal Home Loan Bank stock 0 0 0 0
------- ------ ------- -------
Total interest-earning
assets 218,847 53,596 153,304 118,203
------- ------ ------- -------
Non-interest checking 8,008 0 0 0
NOW accounts 24,084 0 0 0
Passbooks 3,605 3,605 10,383 6,645
Money market accounts 3,149 3,149 9,071 5,805
Certificates 118,068 65,118 103,160 28,815
Federal Home Loan Bank
advances 31,000 14,000 31,000 116,400
------- ------ ------- -------
Total interest-
bearing liabilities 187,914 85,872 153,614 157,665
------- ------ ------- -------
Interest-earning assets less
interest-bearing
liabilities $ 30,933 (32,276) (310) (39,462)
======= ====== ======= =======
Cumulative interest-rate
sensitivity gap $ 30,933 (1,343) (1,653) (41,115)
======= ====== ======= =======
Cumulative interest-rate
gap as a percentage of
total assets at
June 30, 1999 4.55% (0.20)% (0.24)% (6.05)%
======= ====== ======= =======
<CAPTION>
Over 5 No Stated
(DOLLARS IN THOUSANDS) Years Maturity Total
- --------------------------------------------------------------------------
<S> <C> <C> <C>
Cash equivalents $ 0 0 9,543
Securities available for sale:
Mortgage-backed and
related securities<F1> 3,467 0 111,702
Other marketable
securities 5,533 8,587 75,034
Loans held for sale, net 0 0 6,722
Loans receivable, net<F1><F2>
Fixed rate one-to-four
family 78,181 0 253,633
Adjustable rate
one-to-four family 228 0 95,913
Multi family 500 0 9,318
Fixed rate commercial real
estate 6,034 0 21,885
Adjustable rate commercial
real estate 0 0 14,113
Commercial business 2,957 0 15,996
Consumer loans 3,421 0 38,999
Federal Home Loan Bank stock 0 9,838 9,838
------- ------- -------
Total interest-earning
assets 100,321 18,425 662,696
------- ------- -------
Non-interest checking 0 0 8,008
NOW accounts 0 0 24,084
Passbooks 11,816 0 36,054
Money market accounts 10,320 0 31,494
Certificates 1,392 0 316,553
Federal Home Loan Bank
advances 0 0 192,400
------- ------ -------
Total interest-bearing
liabilities 23,528 0 608,593
------- ------ -------
Interest-earning assets less
interest-bearing
liabilities $ 76,793 18,425 54,103
======= ====== =======
Cumulative interest-rate
sensitivity gap $ 35,678 58,103 54,103
======= ====== =======
Cumulative interest-rate
gap as a percentage of
total assets at
June 30, 1999 5.25 % 7.96 % 7.96 %
======= ======= ======
<FN>
<F1>Schedule prepared based upon the earlier of contactural 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>
*This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 25 of this discussion.
23
<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.
YEAR 2000
HMN has been actively engaged in managing the Year 2000 (Y2K) project since
September of 1997. HMN's management has consistently met the completion
deadlines for various phases of the project that were established by the
Federal Financial Institutions Examination Council (FFIEC) guidelines.
HMN has an extensive business recovery plan that addresses the procedures that
would be implemented in the event of certain types of disasters. A Y2K
Contingency Plan (the Plan) was developed by the Y2K Committee to document how
HMN would respond to the unique aspects of possible Y2K disruptions. The Plan
focuses on the core business processes of HMN and the systems that support
those processes in accordance with the FFIEC guidelines.
*In developing the Plan HMN inventoried its computer hardware, computer
software, third party vendors and its other non-computer equipment and assessed
whether the items were Y2K compliant. All non-compliant hardware was replaced
in either 1998 or 1999 at an aggregate cost of $102,000. The computer software
inventory indicated that certain programs were not compliant. Those software
programs were replaced during 1998 and 1999 at an aggregate cost of $80,000.
HMN has also tested computer software to determine that the software was Y2K
compliant. The assessment of non-computer equipment for Y2K 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 Y2K 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 Y2K Committee has worked very closely with
its data processing center to ascertain that their software applications and
hardware will be Y2K compliant. The Y2K Committee is also monitoring the
progress that other key third party providers are making toward becoming Y2K
compliant. The Y2K Committee is not aware that either the data processing
center or any other key third party providers to the Bank will have issues
related to Y2K that will have an adverse effect on the Bank's ability to
conduct its business.
*This paragraph contains a forward-looking statement(s). Refer to information
regarding Forward-looking Information on page 25 of this discussion.
24
<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 second quarters ended June 30, 1999
and 1998 were both $75,000. The provision for loan losses for the six
months ended June 30, 1999 and 1998 were both $150,000. The provision is
the result of management's evaluation of the loan portfolio, a
historically low level of non-performing loans, minimal loan charge-off
experience, and its assessment of the general economic conditions in the
geographic area where properties securing the loan portfolio are located
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 of probable losses inherent in the
loan portfolio 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 $183.2
million that come due over the next 12 months. Based upon past experience
management anticipates that the majority of the deposits will renew for
another term. HMN believes that deposits which do not renew will be
replaced with deposits from other customers, or funded with advances from
the FHLB, or will be funded through the sale of securities. Management
does not anticipate that it will have a liquidity problem due to maturing
deposits.
Competitive pricing by other institutions, the desire of a competitor to
pay interest rates on deposits that are above the current rates paid by
HMN, or 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.
HMN has $24.0 million of FHLB advances which mature over the next 12
months and $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 August or September of 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 maturing or being called by the FHLB during the
next 12 month period.
If circumstances exist which cause the maturing certificates of deposit to
become a liquidity problem then the advances which mature and or the
advances that would be called by the FHLB would also become a liquidity
problem.
MARKET RISK
HMN utilizes a model which uses the discounted cash flows from its
interest-earning assets and its interest-bearing liabilities to calculate
the current market value of those assets and liabilities. The model also
calculates the changes in market value of the interest-earning assets and
interest-bearing liabilities due to different interest rate changes. HMN
believes that over the next twelve months interest rates could conceivably
fluctuate in a range of 200 basis points up or down from where the rates
were at June 30, 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
25
<PAGE>
changes in interest rates from interest rates in effect on June 30, 1999.
Interest rates could fluctuate in a range of more than 200 basis points up
or down from where the rates were on June 30, 1999 due to the influence of
many unforeseen factors not now known to HMN's management.
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 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 June
30, 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.
The following (Maturing or Repricing) table sets forth the interest rate
risk sensitivity of HMN's assets and liabilities at June 30, 1999 using
certain assumptions that are described in more detail below. 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
In developing the Plan HMN inventoried its computer hardware, computer
software, third party vendors and its other non-computer equipment and
assessed whether the items were Y2K compliant. All non-compliant hardware
was replaced in either 1998 or 1999 at an aggregate cost of $102,000. The
computer software inventory indicated that certain programs were not
compliant. Those software programs were replaced during 1998 and 1999 at
an aggregate cost of $80,000. HMN has also tested computer software to
determine that the software was Y2K compliant. The assessment of non-
computer equipment for Y2K 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 Y2K 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 Y2K Committee has worked very closely with its data processing
center to ascertain that their software applications and hardware will be
Y2K compliant. The Y2K Committee is also monitoring the progress that
other key third party providers are making toward becoming Y2K compliant.
The Y2K Committee is not aware that either the data processing
26
<PAGE>
center or any other key third party providers to the Bank will have issues
related to Y2K that will have an adverse effect on the Bank's ability to
conduct its business.
While HMN has inventoried and assessed its hardware, software and other
non computer equipment other unforeseen issues may come to light in the
future with the above mentioned items that would cause HMN to incur
additional costs in order to become Y2K compliant.
While HMN has identified and assessed the Y2K risks related to each of its
major third party vendors and providers, it is monitoring their activities
related to becoming Y2K compliant. It is still possible that the vendors
and providers may not be Y2K compliant and the Plan that HMN has developed
would not have anticipated the problem. An example of this situation
would be if all the telephone communication lines became inoperative
because of a Y2K issue on September 9, 1999, the Bank would not be able to
process its daily activity and servicing its customers would be difficult
without the communication lines for any extended period of time. It would
be difficult to have a contingency plan that would allow the Bank to
conduct its business without using the communication lines to transmit its
business activity.
27
<PAGE>
<PAGE>
HMN FINANCIAL, INC.
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings.
None.
ITEM 2. Changes in Securities.
Not applicable
ITEM 3. Defaults Upon Senior Securities.
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders.
The Annual Meeting of Stockholders of the Company was held on April
27, 1999 at 10:00 a.m..
The following is a record of the votes cast in the election of
directors of the Company:
FOR VOTE WITHHELD
---------- --------------
Term expiring in 2000:
Michael McNeil 4,677,368 94,331
Term expiring in 2001:
Richard J. Ziebell 4,686,696 85,003
Term expiring in 2001:
James B. Gardner 4,621,964 149,690
Timothy R. Geisler 4,681,701 89,998
Allan R. DeBoer 4,686,509 85,190
Accordingly, the individuals named above were declared to be duly
elected directors of the Company for terms to expire as stated above.
The following is a record of the votes cast in respect of the
proposal to ratify the appointment of KPMG LLP as the Company's
auditors for the fiscal year ending December 31, 1999.
NUMBER PERCENTAGE OF VOTES
OF VOTES ACTUALLY CAST
------------- ----------------
FOR 4,703,896 98.58%
AGAINST 31,137 .65%
ABSTAIN 36,666 .77%
BROKER
NON-VOTES -- 0%
28
<PAGE>
Accordingly, the proposal described above was declared to be duly
adopted by the stockholders of the Company.
ITEM 5. Other Information.
None.
ITEM 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. See Index to Exhibits on page 30 of this report.
29
<PAGE>
<PAGE>
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HMN FINANCIAL, INC.
Registrant
Date: 8/13/99 /s/ Roger P. Weise
----------------------- --------------------------------
Roger P. Weise,
Chairman, President and
Chief Executive Officer
(Duly Authorized Officer)
Date: 8/13/99 /s/ James B. Gardner
----------------------- --------------------------------
James B. Gardner,
Executive Vice President
(Principal Financial Officer)
30
<PAGE>
HMN FINANCIAL, INC.
INDEX TO EXHIBITS
FOR FORM 10-Q
Sequential
Reference Page Numbering
to Prior Where Attached
Filing or Exhibits Are
Exhibit Located
Number In This
Regulation S-K Attached Form 10-Q
Exhibit Number Document Hereto Report
- -------------- ----------------------- ------------- ------------
3.1 Amended and Restated Articles
of Incorporation *1 N/A
3.2 Amended and Restated By-laws *2 N/A
4 Form of Common Stock Certificate *3 N/A
10.1 Extension of Employment Agreement 10.1 Filed electronically
for Roger P. Weise dated
May 25, 1999
10.2 Extension of Employment Agreement 10.2 Filed electronically
for James B. Gardner dated
May 25, 1999
11 Computation of Earnings Per
Common Share 11 Filed electronically
27 Financial Data Schedule 27 Filed electronically
*1 Incorporated by reference to the same numbered exhibit to the Company's
Quarterly Report on Form 10-Q for the period ended March 31, 1998 (File No. 0-
24100).
*2 Incorporated by reference to the same numbered exhibit to the Company's
Quarterly Report on Form 10-Q for the period ended September 30, 1997 (File No.
0-24100).
*3 Incorporated by reference to the same numbered exhibit to the Company's
Registration Statement on Form S-1 dated
April 1, 1994 (File No. 33-77212).
31
MEMORANDUM
TO: Roger P. Weise
FROM: Carol J. Thouin, Corporate Secretary
DATE: May 25, 1999
RE: Notice of Extension of Employment Contract
- ----------------------------------------------------------------
The Board of Directors (the 'Board') of Home Federal Savings Bank
has reviewed your formal performance evaluation performed by
selected members of the Board. In connection therewith and
pursuant to Section 1 of your contract, on May 25, 1999, the
Board determined to extend your employment contract until the May
Board Meeting, 2002.
HOME FEDERAL SAVINGS BANK
By: /s/ M.F. Schumann
---------------------------
M.F. Schumann
Director
EMPLOYEE ACKNOWLEDGMENT
I hereby acknowledge receipt of this notice of extension of
the above-referenced agreement and accept the extension of the
term of such agreement.
EMPLOYEE
Dated: May 25, 1999 By: /s/ Roger P. Weise
--------------------- ------------------------
Roger P. Weise
MEMORANDUM
TO: James B. Gardner
FROM: Carol J. Thouin, Corporate Secretary
DATE: May 25, 1999
RE: Notice of Extension of Employment Contract
- ----------------------------------------------------------------
The Board of Directors (the "Board") of Home Federal Savings Bank
has reviewed your formal performance evaluation performed by
selected members of the Board. In connection therewith and
pursuant to Section 1 of your contract, on May 25, 1999, the
Board determined to extend your employment contract until the May
Board Meeting, 2002.
HOME FEDERAL SAVINGS BANK
By: /s/ M.F. Schumann
---------------------------
M.F. Schumann
Director
EMPLOYEE ACKNOWLEDGMENT
I hereby acknowledge receipt of this notice of extension of
the above-referenced agreement and accept the extension of the
term of such agreement.
EMPLOYEE
Dated: May 25, 1999 By: /s/ James B. Gardner
--------------------- --------------------------
James B. Gardner
EXHIBIT 11 - Computation of Earnings per Common Share
HMN Financial, Inc.
Computation of Earnings Per Common Share
(Unaudited)
Three months ended Six Months ended
June 30, June 30,
1999 1998 1999 1998
--------------------- ----------------------
Weighted average number of
common shares outstanding
used in basic earnings per
common share calculation 4,442,471 5,051,205 4,465,679 5,248,262
Net dilutive effect of:
Options 167,858 379,759 177,041 391,398
Restricted stock awards 20,019 54,197 23,267 57,773
--------- --------- --------- ---------
Weighted average number of
shares outstanding adjusted
for effect of dilutive
securities 4,630,348 5,485,161 4,665,987 5,697,433
========= ========= ========= =========
Income available to common
shareholders $ 1,716,347 784,030 3,318,347 2,447,385
Basic earnings per
common share $ 0.39 0.16 0.74 0.47
Diluted earnings per
common share $ 0.37 0.14 0.71 0.43
The earnings per share calculations reflected above are presented as if the
split had been completed at the beginning of each period presented for the
weighted average number of shares outstanding for each period.
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AT JUNE 30, 1999 AND DECEMBER 31, 1998 AND THE
CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE
30, 1999 AND 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 2,413
<INT-BEARING-DEPOSITS> 8,130
<FED-FUNDS-SOLD> 0
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 183,341
<INVESTMENTS-CARRYING> 0
<INVESTMENTS-MARKET> 0
<LOANS> 446,670
<ALLOWANCE> 3,188
<TOTAL-ASSETS> 679,974
<DEPOSITS> 416,192
<SHORT-TERM> 24,000
<LIABILITIES-OTHER> 4,187
<LONG-TERM> 168,400
0
0
<COMMON> 91
<OTHER-SE> 67,104
<TOTAL-LIABILITIES-AND-EQUITY> 679,974
<INTEREST-LOAN> 17,407
<INTEREST-INVEST> 5,552
<INTEREST-OTHER> 304
<INTEREST-TOTAL> 23,263
<INTEREST-DEPOSIT> 9,143
<INTEREST-EXPENSE> 14,289
<INTEREST-INCOME-NET> 8,974
<LOAN-LOSSES> 150
<SECURITIES-GAINS> 163
<EXPENSE-OTHER> 5,925
<INCOME-PRETAX> 5,418
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,318
<EPS-BASIC> .74
<EPS-DILUTED> .71
<YIELD-ACTUAL> 2.74
<LOANS-NON> 297
<LOANS-PAST> 421
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 133
<ALLOWANCE-OPEN> 3,041
<CHARGE-OFFS> (4)
<RECOVERIES> 1
<ALLOWANCE-CLOSE> 3,188
<ALLOWANCE-DOMESTIC> 1,284
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 1,904
</TABLE>
